The U.S. economy is currently in the fifth Schlumpeter wave. This opinion is due to my own analysis and not of those associated with the wave theory. The previous four waves have had many things in common. First, technological advances lit them up. Second, all four previous waves abandoned their gold standard to allow price inflation to pay for trade wars.
The fifth wave, one in which I have fashioned from my own analysis, also portends a great price inflation following what could be regarded as a war on terrorism. However, many contend that this war on terrorism has more to do with the price of crude than anything else. If this were true, then the war on terrorism would become a trade war as well. As stated, the eventual price inflation of the previous four waves were caused by a number of governments moving their monetary systems from the gold standard or gold exchange system to a fiat money system in order to finance their wars. This war, like those before it, will be financed by price inflation and dollar devaluation.
Direct taxation could never fund a major long-term war. Therefore, an indirect tax or inflation is the only method by which governments can fund such a war. Thus, dollar devaluation caused by excessive government debt and low interest rates will be the means by which the U.S. government will fund its war on terrorism. A nation's moral and resolve would be destroyed if its government ventured to tax its citizens for the cost of a long-term war. Consequently, governments in such situations are compelled to create money in order to fund their military endeavors.
The fifth Schlumpeter wave, however, may be different in some ways. There can be no dissolution of a gold standard because the U.S. ended its gold exchange system in 1971. Our nation will have already financed the war on terrorism for the past five years based on the assumption that the war began when the U.S. sent troops into Bosnia during the Clinton administration. Furthermore, President Bush estimated that the war on terrorism would last ten years. It is highly probable that the time frame proposed by the Bush administration, like government spending, was understated. The war on terrorism looks like it has just begun.
The U.S. economy will soon find itself in another financial predicament in addition to the massive debt it is building from the war. The U.S. government is able to print fiat money, however, it cannot resort to instant price inflation without causing long-term calamitous consequences. An excessively devalued dollar pushes the price of foreign goods sold in the U.S. to much higher levels. This would slow the flow of foreign goods into the U.S. Goods made in the U.S. would then be able to be sold abroad at a much cheaper price. However, by doing so, the U.S. may provoke a trade war with China and the Eurolands.
On the other hand, these countries have huge hoards of dollars in their reserves. If they exert a little pressure on the U.S. to ease up dollar devaluation by selling them, they will only further its devaluation. For this reason, nations abroad holding large numbers of dollars are sure to take a cautious approach when selling them into a down market.
Will the war on terror be funded through a direct taxation (increased taxes) or through indirect taxation (dollar devaluation and price inflation)? The government recently lowered taxes in order to facilitate corporate spending and encourage employment. It will take another year for our economy to reach a full recovery. In the meantime, it will be fragile. Moreover, any sudden impact on the economy, such as, an increase in the price of crude, an increase in taxes, and higher interest rates, could push its recovery back into a recession.
Our government cannot afford to allow this to happen. Therefore, it will continue to manipulate many of our markets by selling gold into a rising market, buying up its own debt, and exerting pressure on OPEC's oil cartel in order to moderate the price of crude oil. In addition, the U.S. government will do what it can to keep the U.S. stock market from collapsing. The Federal Reserve has been able to keep long-term interest rates down by talking the economy down for the past year. As a result, the price of long-term interest rates has moved up.
Time is up for talk as a means of affecting the price of stocks and bonds. The chance that foreign governments will continue buying our debt is slim to none. It appears as though the U.S. government has reached that point in the business cycle where it must chose to either allow the pressure of a free market to push interest rates higher or the U.S. government must opt to buy back large numbers of its bonds. This process is known as monitising debt. This accelerates the lag-time between monetary creation and price inflation (dollar devaluation).
It will be less than a year before excess liquidity begins to pressure prices and markets after the U.S. Treasury Dept. begins monitising its debt. The good news is the excess liquidity will also enable corporations to invest in physical and human capitol.
There are reasons why foreign governments will be reluctant to buy U.S. debt. One is that no foreign nation wants to explain to its citizens why they bought large amounts of U.S. debt while the dollar devalued as much as 60%. There is an 85% chance the U.S. economy will have higher long-term interest rates within one year. The odds are similar for bond rates. They will move higher while real estate will correct in the short-term. I will discuss what the future holds in store for the U.S. economy over the next 12 months in the upcoming issue. I expect to have it posted by July 21.
In the meantime, monitor the pro-picks portfolio. Eventually, those of you who loathe putting money into select stocks may be forced to do so. Bonds have topped, the price of precious metals are being controlled, the price of real estate is becoming unreal, and banks continue to provide savers a return well under the real rate of inflation. Thus, there are several directions to go. You can continue to consume while prices remain low, or invest in select U.S. stocks, Swiss Franc investments, and Euroland investments.
