A Nightmare Before Christmas

By Peter Schiff
Euro Pacific Capital

Like many pragmatic economists I have always warned that rapid expansions of government debt would result in inflation and higher interest rates. The explanation was always simple: rising supply of government debt inflates the money supply and weakens the government’s ability to service its debt through legitimate means.

But In recent months, government has flooded the market with hundreds of new Treasury obligations and telegraphed its intention to increase the deluge even more. In response, both bond prices and the dollar have risen. This benign reaction has led many to the happy conclusion that the doom and gloomers are wrong and that bailouts and economic “stimuli” can be financed with deficit spending without any adverse consequences on interest rates or consumer prices. Recent action in the foreign exchange markets suggests these hopes will prove illusory. The renewed strength in gold, together with the long over do rupture of the correlation between the movements of foreign currencies and U.S. equities, is further evidence that recent market dynamics are changing.

When the financial crisis of 2008 kicked into high gear in September, the U.S. dollar began to rally furiously. While America’s economic ship was sinking from stem to stern, its currency was becoming the must have asset for public and private investors around the world. The dollar benefitted from the positive flows that result from massive global deleveraging. Treasuries got an added boost from a reflexive flight to “safety.” As a result, politicians were able to fill out their Christmas wish lists with complete confidence that Santa would deliver. However, as these dollar-positive forces appear to be giving way, the Grinch is about make an unwanted appearance.

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