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Princeton Economics Archive Crisis-In-Democracy1987

Princeton Economics Archive Crisis-In-Democracy1987

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04/03/2011

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A Crisis in Democracy
 
by Martin A. Armstrong 
 
©Copyright April 15, 1987
 
Arthur William Edgar O'Shaughnessy once wrote in his classic Ode back in the 19thcentury...
 
"We are the music-makers, And we are the dreamers of dreams, Wandering by lone sea breakers, And sitting by desolate streams; World-losers and world-forsakers, On whom the pale moon gleams: Yet we are the movers and shakers of the world forever, it seems." 
 
Perhaps we have been merely dreamers of dreams and indeed in the end we may findour children's children one day writing of a society of "world-losers" and "world-forsakers." Perhaps the dreams of lower interest rates have suddenly been shattered asthe Ides of March brought in its shadow the first prime rate hike in many long months.Of course the words that poured forth from the mouths of our politicians all clearlyforetell of this event as a mere glitch in the long journey to where full employment, noinflation and cheap money lies patiently just around the next bend. Either our fearlessleaders are lying through their dentures or they are so confused themselves that theybelieve in what they actually speak. They have taken the role of a father who sits on hischild's bed and reads stories of endless wonder; the stuff that dreams are made ofwhich disappear in the mist of the night when the new born sun begins to rise.
 
Are we dealing with a glitch in a long-term journey to the land of fables where the bestof all extremes lies waiting to be plucked from a tree like the legendary golden fleece? Isit really possible that lower interest rates lie ahead, unemployment will be banishedalong with the trade deficit at the hand of a lower dollar and our politicians will suddenlysee the light and balance our fiscal budgets with the sweep of the pen? Or are we at thebeginning of the end of a dream which has overstayed its welcome? It is always nice tobe the dreamer of dreams like a child who falls fast asleep leaving behind in the world ofreality only a tiny smile for all to see. But when we gave up our youth, we gave up thatspecial right to dream of things which no mortal should dare. For when we wake, theharsh consciousness of reality becomes the master of our own fate. But strange as itmay seem, the real power of the future lies within the grasp of us all, for indeed in theend, we are the movers and the shakers of the world forever.
 
The golden dreams of cheap money, full employment, no inflation and prosperity for all,has never graced the world simultaneously. Oh sure, one nation has experienced thisphenomenon for a brief period in time at the expense of its neighbors; but it has neverlasted. Such goals on a long-term basis are mere fables for children told to comfortthem and their fears of the oncoming night. The long-term models, which we havedesigned, have foretold of events in a far different light than most. March, we warned,was the ideal turning point for interest rates, particularly on the short-term. This recenthike in the prime rate is not a freak, but a forewarning of what is yet to come. It came onthe heels of our model so quickly, that this in itself is not a omen of stability, but achange in the winds of destiny.At the 1985 Economic Conference held here in Princeton, I went over our long-termmodels on over 300 various economic indicators from 35 different nations. In each case,it was pointed out that the VOLATILITY was increasing with each turning pointthroughout this century. The fact that the model called for the turning point to be inMarch of 1987 for the short-term rates is important. But of even greater importance isthe fact that under normal conditions, a rate hike would take place within 3 months ofreaching a major turning point. In this case, the first rate hike in years came precisely onthe turning point. This is itself forewarning of even greater VOLATILITY than what wasdiscussed at the 1985 Economic Conference.This subtle glitch, as everyone is calling it, is more serious than we had expected. Themere fact that it has come so soon in conjunction with the major cyclical target,suggests that the upside potential in interest rates will be far greater than we have beentalking about. We could easily see levels matching those of 1981 by January 1990 andthis may be too conservative at that. The confirmation as to whether or not we are infact in a new uptrend in interest rates overall, will arrive when the Federal ReserveDiscount Rate exceeds 6%. When that happens, then the possibility of this being amere glitch, will forever be erased from our financial history.O'Shaughnessy's words themselves express the overall role of us all in this battlebetween the free markets and the aspirations of our Napoleonic forms of financialgovernments who seek to manipulate and control our economic social interaction. Forindeed we are perhaps a bunch of world losers who really do not know what lies ahead,but the mystical aspect behind our power lies in our sheer numbers. Governmentintervention can never work for a variety of reasons. If the central banks wish to supportthe dollar, and the free market forces continue to add selling pressure, the only way thecentral banks can hold their ground in terms of supporting the dollar will be tocontinually buy all that is offered. The outstanding supply of paper money in circulationvastly outnumbers the buying power of the central banks. Even collectively, their totalinfluence upon the money supply can at best reach 6-7% or roughly the amount ofreserves it requires from its member banks. Thus, these scares which inflict thecurrencies sporadically, have been merely temporary. The forces of volatility are alwaysinfluenced by psychological implications of the central banks rather than the realamount of currencies they buy or sell through their intervention practices.
 
The central bank's influence upon the credit structure is perhaps greater than itsinfluence over cash itself and to exercise that influence will require discount rate hikes!As long as capital continues to run away from the bond market and into equities andgold, the selling of the dollar will continue at least on a short-term basis. The prospectsof a trade war with Japan will only further weaken the dollar's posture in the short-termand interest rates will rise in an effort to attract capital away from the equity markets.The dreams of dreamers who foretold of the promised land of lower interest rates willhave turned into a dark and frightening nightmare.There is no doubt that we have listened to a lot of things politically these past two years.We have been told that our trade deficit could be reversed if we only force the dollarlower. Well nearly two years later and with a 40% lower dollar since 1985, the tradedeficit has continued to worsen. These trade figures are now being used to embark on atit-for-tat trade war with Japan, who has by and large justly deserved it to some degree.But those who now spout forth warnings that we will slip into another world depressiondue to protectionism (as they cite the Smoot-Hawley Tariff Act for creating the worlddepression in 1931), not only do they have their historical facts a bit out of order, buttheir reliance upon these current trade figures is not on solid ground either.Have our government officials been disrupting the foreign exchange markets and arethey liable to disrupt the interest rate markets based upon solid trade data for a justcause? The answer is NO! The first thing you should know is that the trade deficitfigures are NOT actual sales or capital flows which are being counted as is the casewith the money supply figures, new housing starts, retail sales or the consumer priceindex. Most of these indexes we hear of are actual hard numbers which are seasonallyadjusted. But the figures used in the balance of trade status are NOT! These figures arepurely a census, which means they are put together by doing a survey. The datacollected is not only unreliable, it is grossly distorted.Unless the trade balance census is broadened to redefine this change which has takenplace in our economy, the trade deficit figures which are being reported will not get aheck of a lot better. This fooling around with the foreign exchange markets to help themanufacturing sector in some areas hurts the bulk of the American population byinflicting upon them an abnormal increased level of volatility in not merely foreignexchange, but in the equity markets, bond markets as well as gold and interest rates. Tothrow more salt on the wound, it doesn't matter how low you force the dollar, theconsumer has no other choice but to buy foreign manufactured goods in many cases.
Stereos, VCR’s, televisions, appliances, and m
any other areas of manufactured goodshave little or no American domestic produced counterpart who will benefit from a tradewar or a lower dollar. It will only increase the price of those goods to the Americanconsumer which will spark inflation and then the Fed will raise interest rates to combatthe inflation. The consumer loses no matter what happens!Another aspect of forcing the dollar lower comes to light when one looks at the influenceit has had upon the markets here in the United States. The decline in the dollar hassparked a flood of foreign buying in all areas of U.S. assets. If we look at the following

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