Gold and Oil are Acting as Though They Expect Higher Rates of Inflation

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Today, we’ll keep it short and sweet.

The Dow managed only a piddling 32-point rise Tuesday; still no recovery from last week’s big losses.

Oil rose another $1.30 – to close over $141. Gold jumped $16; it will now cost you $944 to buy an ounce.

“Caught between a fragile economy and banking system and rising inflation,” writes James Saft, “Bernanke and other Fed policy makers seem to have arrived on a strategy of jawboning the dollar higher and inflation lower.

“But talk is only effective if your audience judges that you have the means and willingness to follow through.”

Based on the last few days’ trading results, Team Bernanke might as well have kept their mouths shut. Gold and oil are acting as though they expect higher rates of inflation, not lower rates. And the dollar loses value daily – though it still has not collapsed completely.

The last part of that phrase might be worth a thought or two. The dollar has fallen against other major currencies. Against the euro, for example, it is worth barely half what it was at its high, which was reached shortly after the euro was launched 10 years ago. Against gold, it is worth only about a third of what it was worth 10 years ago. And against oil…the loss has been even greater – it’s down about 80%.

Yet, the U.S. dollar still hasn’t “collapsed.”

To give you an idea of what a collapse looks like, we look out the window. The English housing market seemed to defy the California trendsetters. As U.S. houses fell in value, U.K. prices stubbornly held up.

“It’s a small island,” explained the analysts. “We have a lot of immigration from overseas,” they went on. “We like owning our own houses,” was the verdict. Said a woman in the office when we enquired: “Housing always goes up in Britain.”

It goes up until it goes down. Now, it is going down, say the London papers. And the house builders are collapsing. Comes news this morning that the U.K.’s largest house-builder, Taylor Wimpey, was cut in half yesterday after it failed to raise the money it was looking for. This morning, the shares are still falling.

Another English builder has already collapsed. Its shares are selling for less than one times trailing earnings.

You want to see collapse? Just look at what has happened to Wall Street this year. In the last 6 months, Citigroup has lost 43% of its value. Merrill Lynch is down 40%. And Lehman Bros. has fallen 68%. The Wall Street Journal says banking stocks are beginning to look like the dotcoms in 2000. The big question is whether these are just temporary corrections – caused by panic over subprime losses and a credit crunch. Or whether it is a case of another dotcom-style bubble popping; if so, the Wall Street firms have further to fall and will not recover for many, many years.

But, back to the dollar.

In the vaults of various central banks around the world lies $4.8 trillion worth of foreign currency reserves – the fruit of selling oil and widgets, mainly to U.S. consumers. And like oranges or papayas…these dollars have a limited shelf life.

We have not been invited to peek into these vaults, but we have no doubt what we would find: huge stacks of green money, with the faces of dead U.S. presidents on the notes. Americans have been the world’s biggest spenders of the last 20 years. Naturally, it is their money that makes up the bulk of those foreign currency reserves. It is their money, too, that now poses the biggest problem – not only for the people who shipped it overseas, but also for those who have it in their vaults.

By our very rough calculation the total of these reserves will hit $5 trillion before the end of this calendar year. Then, we will be talking about real money. But that is the trouble; we are not really talking about real money at all, are we?

We should have said: $5 trillion is a lot of money; too bad it isn’t real. These are dollars, remember, the faith-based currency. The same dollars that have lost approximately 97% of their value over the last hundred years…and, according to the statisticians on the government payroll…now loses value at about 4% per year.

If we take the government’s number goons at their word, and presume that the entire $5 trillion were invested in 91-day U.S. Treasury bills, currently yielding 1.63%, the holders of all this dough are losing about $120 billion per year. The fruit is starting to smell a little rich, in other words.

But it could be a lot worse. If the euro, gold, oil, or commodities rise sharply, foreign dollar holders will feel like chumps. A few may give up on the dollar and dump it on the world market in large quantities. This could cause a sudden drop in the value of the greenback…leading other holders to rush for the exits. The dollar’s collapse would bring down the whole post-’71 monetary system…and pitch the world into a much more serious problem.

Already, many dollar holders are getting itchy. Many are looking to lighten up their loads. Some are trading dollars for food…

(“Hoarding nations drive food costs ever higher,” says the New York Times.)

A few have helped recapitalize the banks. And Abu Dhabi just traded $900 million for the Empire State Building. Only about $4.7 trillion left to go.

By comparison, the entire world’s stock of gold – above ground – is only worth about $4.2 trillion.

*** Starbucks says it will close 600 stores…and lay off 12,000 employees.

*** Yesterday, we reported that revenues were down at Nevada’s brothels. Today, The Wall Street Journal reports that revenues are down at the casinos too.

Yes, it is looking grimmer and grimmer.

Until tomorrow,

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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3 Comments on "Gold and Oil are Acting as Though They Expect Higher Rates of Inflation"

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Martin
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Thanks in part to reading the DR, I switched my superannuation (pension) funds out of shares in late 07 and managed to avoid much of the carnage in 08. Presently it’s all parked in a cash unit fund, denominated in Australian dollars. Within the broader fund scheme, the worthwhile choices are basically; A$ cash with a little interest, Australian ASX200 share index units, Property units, international share units (mostly US) both with and without currency hedge, and an oddball emerging markets unit. The other ‘choices’ are 25 or so rubbish funds provided to give the appearance of choice. It’s a… Read more »
Coffee Addict
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Martin I’m parked in cash also. What most funds advertise as cash actually means “cash based”. This can include mixtures of actual cash at bank, corporate bonds, securities, subordinated debt, CDS’ and CDOs etc. There may also be some options used as short term hedges. While most “cash” cocktails tend towards the lower end of the risk scale you will need to confirm the actual mix (and the associated risks) with your fund. No its not safe but neither is anything else. And the AUD is linked strongly to commodity prices! A problem is that the rules and procudures pertaining… Read more »
jack
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THE ONE THING YOU ALL HAVE TO REMEMBER IS THE GOV WILL TELL YOU ANYTHING ,THE REALITY IS THAT AUSTRALIA IS IN A MUCH WORSE STATE THAN USA IN THE HOUSING AND CREDIT BUBBLES ,REMEMBER WHEN KRUDD SAID BACK IN FEB WHEN HE GAVE THE BANKS A BAILOUT THAT THEY ALMOST WENT BROKE ,WEL THATS THE REAL STORY I BELIEVE THEY ARE ,REMEMBER BANKS LEVERAGE OVER HERE AT LEAST TEN TIMES THE AMOUNT ,1 TRILION DEBT IN CREDIT DEBT WOULD NOW BE TEN TRILLION ,SAVINGS OF WHICH THEY ONLY HAVE TO KEEP HALF BY LAW MEANS THAT THE 1 TRILLION… Read more »
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