By John Galt
December 7, 2011 – 05:00 ET
As Europe burns, bankers stew, and investors fret one man is asking his shopping crazed wife to start selecting the theme for their home for 2013 and beyond. Unfortunately, that man is President Barrack Obama and the shopper is his wife, Michelle. How is this possible with the horrid job he has done since 2009 and the anger from his own constituents along with the Republican and Conservative furor about the expanded role government now plays in our lives? It is not only possible, nay it is probably, that the collapse of the European Union and economic destruction which shall follow in its wake might create that once in a decade opportunity for the leader of a nation to expand his power and influence regardless of personality, accomplishments, or popularity.
The European Union is behaving in a manner which indicates that the decades old bickering of bureaucrats who have advanced through the chain of desk drudgery to the top of their fields are now in control and as such, have no clue how to manage the monster they created with the Treaty of Maastricht. The formation of the union was initially thought to be a stroke of brilliance, where the Euro-Socialism which enabled large government power structures to share power with the financial sector would insure domestic peace and tranquility with the macro economic aspects of its members controlled by a distant bureaucracy that gave elected officials the right to plausible deniability as economic cycles impacted the member states. The problem was that when the union was initially created, the desire to maintain the appearance of state sovereignty was obscured by the lack of a fiscal union to prevent the events we are witnessing today from impacting other states within the continent.
Unfortunately for America, the economic conditions in Europe, Japan, and the other advanced Western industrialized nations has earned the U.S. the title of the least ugly house in the neighborhood as the policies of the G-7, now G-8, are destined to flame out in a dramatic Keynesian fashion which could actually buy enough time for what many of my fellow citizens which will declare a disaster of historic proportions.
France and Germany are trading barbs and the future of the PIIGS along with Eastern Europe like MF Global used to trade leveraged garbage (allegedly) and clients funds with their own (allegedly) which indicates that third parties are not going to have input or sovereign rights over the future determination of their nations or economies. The resulting backlash and impossible prospect of nations like Greece or Portugal growing their economies sufficiently enough to grow out of their death debt spiral will ultimately lead to several nations departing the Eurozone, creating a massive recession and financial crisis. The tidal wave of banking problems will cause a substantial, yet short-lived economic contraction in the U.S. as the final disposition of the weak banksters in our nations appears to head towards final resolution. The boomerang effect of this however will shock most of the population as the economy will turn on a dime before the election and historically, their just might be some substantial statistical data to back this up.
The Volcker Fed elected to destroy the inflationary threat in the early 1980′s and the resulting rocket ride out of the 1982 period caused the dollar index to rise to historic levels as reflected in the Major Currency Trade Weighted Dollar Index (DTWEXM):
(click to enlarge/reduce graphs)
What is fascinating about this graph is that the 90 level is somewhat of a long term historical average outside of the move above 140 in the 1980′s. Based on the recent moves in the last five years, odds are the index will retest the 90 level once more which I assume will occur early next year as the Eurozone implodes and falls into recession, creating the proverbial flight to safety into the U.S. Dollar.
As the DTWEXM increased prior to and during the recent recession when the panic began, as illustrated in the chart below from January 2006 to December 2010, the equity market collapsed in dramatic fashion then rose dramatically as the Federal Reserve diluted the currency and demonstrated a willingness to monetize U.S. debt for the first time in history:
The arrows in red reflect the movement of the U.S. dollar based on the trade weighted index with the blue arrows the inverse move from the Standard and Poor’s 500 equity index. Assuming the relationship remains intact, a European crisis with the associated flight to safety in U.S. assets would create the rally back to the 90 area and corresponding massive decline in the S&P 500 quite probably to or below the 800-825 price level.
During the insane period after the 1982 recession over an eleven year period the rise in the S&P 500 quadrupled despite the U.S. Dollar achieving a record high:
The end of the great late 1960′s bear market heralded a move which ended with a speculative boom that continued through the 1990′s which ultimately perished with the internet bubble popping. The reaction of the Fed under Greenspan was to attempt a stealth inflationary move with easy money policies to accommodate the post 9-11 period and of course the resulting asset bubble centered on housing and associate derivative investments. As the Obama administration took office, the instability in the markets finished the downward move making an intraday low of 666 in March of 2009 and despite some recovery in the economy, behaving erratically since that period due to uncertain monetary and financial policies from the Fed and U.S. Government:
Despite the uncertainty, the trend is still higher but a retest of the lows, at least in the 800 range, would not be shocking should a recession be recognized or created by a European Union collapse. That is why I think the potential for the U.S. to become a financial refugee center of the world will create explosive economic growth which bails out the Euro and Obama re-election efforts.
The primary area of interest though is the amount of foreign owned assets inside the U.S. (BOPI) and how the flow works with the moves in the US dollar’s strength and weakness. From 1982-1993 that pattern was steady until the 1987 stock market crash and Middle East disruptions culminating with the first Gulf War and subsequent recession:
As the chart clearly displays, the Fed eased for years after the record high in the US currency and despite the invasion of Kuwait by Iraq and subsequent conflict, the dollar remained somewhat subdued while foreign assets or investment cratered then surged in late 1990 to 1991 as the war preparations began. After the war and U.S. recession, the cheap dollar still allowed for substantial investment in the U.S. This trend continued for years but after the Great Recession of 2007-2009, the divergence of a lower dollar and higher investment, or safe haven, evaporated as foreigners sought safety elsewhere around the world:
With the data only available through the second quarter of this year, the decline in foreign assets to almost zero along with the dollar index is a fairly good indicator that a recession, no matter how brief, is probably in the future for the U.S. However, as Europe and China are beginning to indicate massive financial instability in concert with a slow but steady rise in the U.S. dollar, odds are that another surge in foreign investment if not a 1980′s style tidal wave will be splashing on to the shores of Washington and Wall Street. This will probably be the salvation Obama needs in the second half of 2012 to carry the day.
Presuming that the massive flight to safety occurs as the Eurozone and Chinese economies contract, the excessive liquidity and investment in U.S. assets should help with many of the fiscal problems our political elites have created. Based on the idea that at European Union crisis will also create a U.S. recession and weakness in the domestic financial industry to force the Federal Reserve into an unnecessary and probably excessive easing move which will overwhelm the economy with cheap easy money creating the final speculative bubble of the current American era.
When the tidal wave of foreign money hits in conjunction with the Fed easing, the quantities of money will finally overwhelm the system and provide an economic kick start similar to the spike in activity after the 1982 recession. This increase in economic activity will finally impact Main Street by starting to reduce unemployment and improving the earnings of the average worker. The political elites will play ball by enacting fiscal froth as they dole out all sorts of tax breaks to assist the voters in 2012, if not outright rebates to pacify and purchase votes. No matter how unpopular Obama might seem in early 2012, the resulting post-recession liquidity avalanche will purchase the votes needed to ensure his re-election because it truly is “the economy, stupid.”
Sadly for conservative voters, Austrian economic purists, and the nation as a whole, the other price to be paid will be quite expensive as a result of this monetary deluge far beyond four more years of Progressive hegemony from the President, Democrats, and complicit Republicans.
In fact, the ultimate price will be hyperinflation and a change in the United States for the remainder of many of our lifetimes.
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