-->The Short Happy Life Of Fiat Currency

The Daily Reckoning

Paris, France

Thursday, 18 March 2004

---------------------

*** We think, and we cross our fingers... the rally is
dead... what if our countrymen were to get wiped out?

*** The luck of the lumps... terrorism and the price of
gold... oil hits a 13-year high...

*** Merryn in the land of raw fish... high cost of living in
London... the French in fear... debt magicians... and, of
course, more!

---------------------

You will remember that we took two important guesses in the
last few weeks. We guessed that the world might have seen
$400 gold for the last time in our lives. And we guessed -
just this week - that the bear market rally of 2002-2004
has finally rolled over. In both cases, we hedged our bets
with the saving grace: 'we think.'

We were happy with our guesses. But even happier with our
hedges. For hardly had our fingers left the keyboard than
gold dropped below $400... down as low as $395. Now, it is
back well above $400, as it should be. But we retain our
'we think' preface to 'it should stay above $400,' just in
case.

Yesterday, the Dow bounced back... and most of the news was
upbeat... if not delusional.

"Refinancing demand soars 40%," says CNN. Mortgage
applications increased 25% last week. And from around the
country come signs that the housing boom is not entirely
over. Arizona reports homes sales hitting records. From
Orange County, CA, comes news of a 23% increase in house
prices last year.

Still, we note that the major stock market averages all
seem to have topped out between January and March... just as
they did 4 years ago in the U.S. and 14 years ago in Japan.
We think, we add with our fingers crossed, the rally is
over.

Oil rose to its highest level in 13 years yesterday. The
dollar fell again. Credit is still plentiful, but jobs are
scarce.

Should we actually hope for a continuation of the bear
market, readers might ask themselves? Would we enjoy
watching our countrymen get wiped out in the stock market?
Would we chuckle with schadenfreude as millions of lumps
went upside down... owing more on their houses and cars than
they were worth?

Well... yes... it is only money... and it is such a grand
comedy!

Besides, what kind of heartless brute would want to see
Americans continue to ruin themselves? On the advice of
Alan"Bubbles" Greenspan, the poor lumps go further and
further into debt, digging a deeper and deeper grave for
their money. They refinance their houses to buy what they
cannot afford and do not need - and count on Alan"Bubbles"
Greenspan to pull the right levers and turn the right knobs
so they will never have to pay for their mistakes.

Day by day, the entire Lumpen Nation loses its jobs, its
skills, its capital... and risks losing its soul... to E-Z
credit. The Feds add $2 billion to the national debt every
day. Five hundred billion per year is the net cost of
America's trade deficit. Ben Bernanke at the central bank
pledges to keep short-term lending rates as low as
necessary, as long as necessary... to make sure the
borrowing binge continues.

The sooner it is over, the better. So cheer up, dear
reader. The end is coming... we think.

In the meantime, and in-between time, here's our
correspondent in New York, Eric Fry, with more of what is,
like, happening...

-------------

Eric Fry from the heart of Wall Street...

- While Manhattan's St. Patrick's Day Parade trudged up 5th
Avenue yesterday through the snow and sleet, a little"luck
of the Irish" rubbed off on Wall Street. The Dow Jones
Industrial Average jumped 116 points to 10,300 and the
Nasdaq Composite surged 33 points to 1,977.

-"The triple-digit move in the Dow has become old hat of
late," notes CBS Marketwatch,"as the blue-chip barometer
has closed with either a gain or loss of 100 points or more
in four of the last five trading sessions."

- Stock-buyers did not seem especially perturbed by news
that inflation is ticking up slightly; nor were they overly
troubled by the news that terrorism is ticking up
significantly... Less than one week after the deadly Madrid
bombings, another terrorist bomb exploded in Baghdad's
Jabal Lebanon Hotel, killing at least 27 people.

- When news of the bombing crossed the wires shortly after
noontime in New York, the Dow dipped briefly. But the
lumpeninvestoriat stepped in quickly and aggressively,
bidding the market higher throughout the rest of the day.
The gold market responded more visibly to the grim news -
surging $5.00 to $407.25 an ounce. That's the safe-haven
metal's highest closing price in a month. Perhaps the
firming gold price is also a reaction to an inflationary
trend that the Consumer Price Index fails to recognize.
According to the Labor Department, the CPI rose 0.3% in
February, which means that consumer prices have increased
only 1.2% year-over-year.

- But for those of us who eat food, heat our homes and
drive cars, the real-world inflation rate seems somewhat
higher... Even within the government's own misleading CPI
report, some signs of inflation are evident.

- Energy prices jumped 1.7% in February, for example, while
"core" goods prices increased 0.2 percent, the first rise
in 18 months. And of course, medical costs continued rising
in February at twice the overall inflation rate. Meanwhile,
unofficial signs of a budding inflation are as plentiful as
acne on a teenager. Oil gushed yesterday to a new one-year
high above $38 a barrel, while gasoline prices neared a new
all-time high.

- Refineries are running full-out to keep pace with demand,
but gasoline prices are climbing anyway. The nation's oil
refineries operated at 90.5% of capacity in February -
"only a fraction of a percent below the all-time high for
February utilization set in 1998," the API says. Maybe
expensive gasoline is not the same thing as inflation
itself, but that fact does not make filling up your car any
less painful.

- Meanwhile, mortgage applications are also"inflating."
Last week, mortgage applications jumped to their highest
level since July 2003, according to a survey by the
Mortgage Bankers Association of America. The group's
mortgage loan applications index soared 25.6% in the week
ended March 12, as the number of mortgage applications for
refinancing rocketed 39.7%. Some of this easy money, we
assume, will make its way into shopping malls and auto
dealerships - boosting consumer spending yet again. Expect
the consumer to continue spending other people's money
throughout the second quarter... at least.

- What should we make of gold's recent resurgence? The
yellow metal has gained $12 over the last three trading
sessions."Gold prices are poised to push above $425 very
soon," says Kevin Kerr, editor of Kwest Market Edge."Gold
is a safe haven... and [with] the ever-present and growing
fear of terrorism at home and abroad, many investors are
sleeping better with a few gold bricks under their
proverbial pillow."

- According to Kerr, Spain's decision to withdraw its
troops from Iraq sends a message to the terrorists of the
world that"it's effective to blow things up." The
implications of that message are not lost on gold stock
investors.

-------------

Bill Bonner, back in Paris...

*** The latest inflation numbers show the cost of living
rising at 1.7% over the last 12 months. Hourly wage income
rose at the same amount. Spending continues to increase two
to three times faster.

*** Over in Japan, Mr. Mizoguchi and his sidekicks must be
starting to sweat. They have invested $320 billion in U.S.
government and agency securities over the past 14 months,
in an effort to keep the dollar up. Almost every day, in
yen terms, the value of those assets goes down. If they
stop buying U.S. paper, their companies can't make money
selling products to Americans. But what's the point of
making money... if you have to lend it back to your deadbeat
customers?

*** And here's a first-hand report from MoneyWeek editor
and colleague Merryn Somerset-Webb, reporting from the land
of raw fish:"Tokyo has changed since I was last here - the
extent of the construction is astounding. The new
development of Roppongi hills has changed the center of
town so much it is totally disorientating to anyone who
knew the old Tokyo. A lot of my old haunts are long, long
gone and the city which is by nature rather scruffy seems
shinier and shinier. It's also cheap - much much cheaper
than London - everything from taxis to wine. Foreigners are
all very excited about the leveling out [bottoming] of the
property market (quite something when you consider that
prices have fallen 1-2% a year for god knows how many
years) but the locals are so jaded after years of false
alarms they are calling this flattening of prices a mini
bubble.

"[There is] still some feel here of a city in recession,
though the new Prada building is quite wonderful and
everyone keeps telling me about the 2km line outside the
new Luis Vuitton shop when it opened. But getting a taxi is
easier than it ever was... and the rather nice, new
restaurant I had dinner in last night was empty except for
our party."

*** London is amazingly expensive. A simple lunch for two -
which would have cost about $30 in Paris - set us back $70
in the British capital. We don't know how the English do
it. Salary levels are comparable to those in France and
America. But living costs seem much higher. An observation:
the English do not seem to live as well.

"I feel like I'm getting a glimpse into the future... I'm
downsizing," said colleague Dan Denning, who recently moved
to London."At the margin, I have to cut back here.
Everything is so expensive... I have to watch how I spend my
money. This is what I expect will happen throughout America
when the dollar goes down and interest rates go up. People
will have to tighten their belts and sharpen their wits."

*** France, or at least Paris, is in a state of alert.
Threats have been received from Islamic terrorists groups.
If they are serious threats, it marks a nasty turn in the
history of Muslim terrorism. Until now, it appeared that
terrorists were motivated by a desire to protect their own
holy lands from foreign occupiers. Thus attacks against the
U.S. and Spain, arguably, were the result of the presence
of their troops in Muslim countries.

To the French, with a large Islamic minority, the solution
seemed simple enough: don't meddle around in the Middle
East. But suddenly, a kind of darkness settled over the
City of Light... when a group acting in the name of Allah
said it will attack the French because of France's ban on
headscarves in the public schools. Oh là là. France imposed
the ban to try to avoid religious conflicts in its public
schools. If the threats turn into acts... it will mark a
large and sinister milestone: terrorists will be attempting
to change the internal policies of a non-Islamic country.

*** Byron King:"The other day, I was talking with a couple
of people with whom I work. We were discussing bankruptcy
law and procedure. I said that recently, since moving to
electronic filing, it seems to me that the clerks at the
Bankruptcy Court now have increased power. These civil
servants sit behind bullet-proof glass, staring at their
screens, clicking away at the bankruptcy petitions people
file by the armload, with the power of debt discharge in
their little mouses. Whatever the clerks enter into the
system is what the Trustees and Judges see, and this input
controls the entire process.

"One of my colleagues chimed in something along the lines
of, 'Just think, we have all these hard-working people at
the Fed, down in Washington, creating credit. And we have
all these hard-working clerks in the Bankruptcy Courts, all
over the country, discharging debt. It is as if there is a
circle of credit creation and destruction, and it is all
one big government program.'

"Yep. Exactly. Credit, debt and discharge. Courtesy of the
debt magicians, dealing with the 'money illusion' of the
world of the dollar standard. Ex nihil, nihil."

---------------------

The Daily Reckoning PRESENTS: Inflation has all but
destroyed paper currency over the last century - the dollar
lost 95% of its value. But slow and steady has not been the
rule, argues Christopher Mayer; hyperinflation is"not so
rare." Could it happen to the dollar?


THE SHORT HAPPY LIFE OF FIAT CURRENCY
By Christopher Mayer

"We inflate our paper currency, we repair commerce with
unlimited credit, and are presently visited with unlimited
bankruptcy."

- R.W. Emerson, The Young American, 1844

According to the Chambers Dictionary of Etymology, the
quotation above was the first appearance in English of the
verb inflate - meaning an increase in currency. If only
Emerson could see now what inflating has wrought.

In the pages of a book titled"Triumph of the Optimists:
101 Years of Global Investment Returns" there is a spread
of telling graphs conveying the inflationary damage done to
the world's currencies. Here we can see that not only the
dollar, but also all paper currencies, are engaged in a
race to the bottom.

Monetary inflation is uniquely a 20th century problem that
continues to the present day. Prior to that, monetary
systems, such as they were, consisted of commodity-backed
money. Inflation, then, was most often a product of
temporary suspensions of the commodity standard, usually
occurring during wars or panics.

At times, inflation also occurred as the supply of gold and
silver grew. There were spikes in some countries and
regions during certain periods of time when the supply of
gold jumped due to discoveries and such (in California
during the gold rush, for example). But, by and large, a
dollar in 1900 had held its purchasing power with the
dollar of 1800.

The 20th century American had a vastly different
experience. As the"Triumph" authors note,"A dollar bill
put under the mattress 101 years ago would today have only
4.2 percent of its 1900 purchasing power, that is, four
cents in 1900 had the same purchasing power as $1 in 2000."
Said another way - that's a loss of 95%.

Furthermore, the pace of price increases was much greater
in the period subsequent to 1970, where, as"Triumph"
notes, annual prices rose at a 5.1% clip compared to 2.4%
for the first seventy years of the century.

What is particularly scary about the dollar is that it has
been the third-best-performing currency in the world. Only
the Swiss franc and the Dutch guilder (by a very small
margin) have held up better. In the UK, for example, the
rate of price increases over the same full 101-year period
was 4.2%, compared to the 3.2% in the U.S. - a seemingly
small difference. And yet, compounded over time, U.K.
prices increased 55-fold, a factor more than 2 times that
of the U.S.!

In a line graph found on page 92, the authors show us a
spread of sixteen currencies, plotted in terms of nominal
exchange rates against the U.S. dollar. Because of the
German hyperinflation in the early 1920s, the German mark
just falls off the graph, literally becoming worthless. The
other currencies turn in visibly worse performances than
the dollar, with the aforementioned exceptions of the Swiss
franc and Dutch guilder.

Keep in mind, as I pointed out earlier, the dollar has lost
95% of its purchasing power... and yet, it still beats
almost all of its rivals, sometimes by very large margins.
The performance of fiat currencies in the past century has
been dreadful.

But what has changed? If anything, the monetary setting of
today is worse than that of the 20th century, for at least
in the earlier part of that century there was still a gold
standard. Really, up until 1971, there was some semblance,
however weak, of an international gold standard.

The monetary shackles on today's central bankers are, I
would argue, much more lenient. Hence, the threat of
inflation is far more lethal. As horrid a performance as
the dollar turned in for the 20th century, the 21st might
make it look pretty good.

Paper monetary systems have a tendency to blow up, in what
is commonly called a hyperinflation. They are really not so
rare, looking again at the 20th-century experience, as one
might suppose. Yes, there is the famous German
hyperinflation of 1922-23, where price inflation was 3,422%
in 1922 alone (and where, in January 1923, one could buy a
dollar for 20,000 marks - but by early November it took 630
billion marks to buy that same dollar). The numbers are
simply staggering and hard to comprehend. Yet, Hungary's
hyperinflation of 1945-46 was even more spectacular, with
price inflation of 19,800% per month.

Phillip Cagan wrote, in the 1950s, what many consider to be
a classic study of hyperinflation, in which he set the
definition of the term at an arbitrary price inflation rate
exceeding 50% per month. Even so, Cagan finds seven
hyperinflations meeting his definition, the limiting factor
being that these seven were the only ones where monthly
price data was available. They include the great German
hyperinflation, two in Hungary and also hyperinflations in
Austria, Greece, Poland and Russia. These all occurred
between 1921 and 1946. Witness, then, that the phenomenon
was not a rare thing.

To update Cagan, I hunted around for some more recent
hyperinflations. There were many, mostly in emerging
markets. A recent essay by a pair of IMF researchers
(Carmen Reinhart and Miguel Savastano,"The Realities of
Modern Hyperinflation") revealed a bunch more, occurring in
places like Argentina, Bolivia, Brazil, Peru and the
Ukraine. And they don't cover them all. Further searching
provided examples of devastating hyperinflations in
Zimbabwe, Zaire, Georgia and Nicaragua. I suspect there are
many more.

The most interesting part of the IMF researchers' essay was
their conclusion. They wrote:"The benign inflation
environment of recent years may lead some to believe that
chronic high inflation and hyperinflation have been
eradicated for good. History suggests that such a
conclusion is not warranted."

Indeed, that is precisely the point. Do not be deceived by
recent experience. Structurally, all the pieces are in
place to experience very high levels of price inflation.

Crystal ball gazing on monetary systems is extraordinarily
difficult, of course. There are lots of things that can
happen along the way. It was not that long ago - 1996, to
be exact - that economist Steven Hanke wrote a piece titled
"Argentina, the 'Germany' of South America." He meant the
Germany of the post-WWII era, where the sturdy mark proved
to be one of the world's most stable currencies. His case
rested mainly on the passage of tougher laws and a currency
board-like system.

This prediction, of course, proved very far off the mark,
since the Argentina of today is recovering after its most
recent financial meltdown. Far from being the Germany Hanke
envisioned, it became more like the Germany of the 1920s.

This is not to say hyperinflation is imminent or even
likely in the U.S., but it points to the dangers of men
with printing presses. And it points to the weakness of the
dollar - or any paper currency - as a long-term investment.


Regards,

Christopher Mayer,
for The Daily Reckoning