By proclaiming last week that that inflation was too low, Allen Greenspan
raised the specter of “deflation,” a straw man that he can pretend
to battle as he peruses the most inflationary monetary policy in U.S. history.

As the world’s largest debtor nation, the U.S. clearly needs inflation to
diminish the real vale of its obligations. However, since the Fed must continuously
borrow enormous additional sums of money, Greenspan must try to con America’s
creditors into believing that there is no inflation. However, to anyone with
at least a basic understanding of economics, Greenspan’s statements concerning
the lack of inflation are similar to those made by the Iraqi Information Minister
concerning the lack of U.S tanks in Baghdad. Obviously, if the enormous inflation
risk were correctly perceived by America’s creditors, interest rates would
sky rocket, and the debt-ridden U.S. economy would collapse.

The fact that the bond market is making new highs as the dollar is making
new lows is helping to create a false sense of security that weakness in the
U.S. dollar will not necessarily mean higher U.S. interest rates. There are
two potential explanations for this phenomena. One is complacency. Since U.S.
interest rates represent a risk premium for holding dollars, America’s creditors
must believe that the dollar’s current weakness is only temporary, and are
anticipating an eventual rebound in the dollar. Such positive sentiment in
the face of overwhelming dollar weakness is a negative indicator for the dollar.

Another explanation is that foreign buyers of U.S. debt are aware of the currency
risks, and are hedging those risks with derivatives. However, if this is the
case, with U.S. interest rates so low, and considering the cost of hedging,
why would foreigners be buying any U.S. debt at all? The answer is that they
are speculating on price appreciation. Greenspan’s propaganda campaign is working.
Believing that Greenspan will keep lowering rates, foreigners are speculating
in the “mother of all bubbles” the U.S. bond market. However, this
hot money will only be around as long as the momentum is positive. The minute
the trend breaks, bonds prices will collapse, crushing the U.S. economy, and
sending the dollar into free fall. Greenspan knows that this will happen, so
he is doing all that he can to keep inflating the bubble even though the more
successful he is the worse the ultimate collapse will be.

I have to hand it to him though, he has kept the balls in the air a lot longer
than anyone with a proper understanding of economics could have imagined.

In another circus act, Treasury Secretary Snow is trying to defend the non-existent “strong
dollar policy” while simultaneously proclaiming the “virtues” of
the falling dollar for the U.S. economy. How can we have a “strong dollar
policy” if the dollar is collapsing in value? If such a policy does in
fact exist, its obviously a complete failure. To their credit, many investors
now understand that this policy has been rhetorical at best, and blatantly
deceptive at worst. With all the talk about the “benefits” of a falling
dollar, has the administration now adopted a weak dollar policy? There is an
old saying that “when you are being run out of town, run to the head of
the crowd and make like your leading a parade.” The reality is with negative
real interest rates, the printing presses running full steam, and enormous
budget and current account deficits, the U.S. has had a weak dollar policy
all along. However, the only way to sell trillions in IOU’s with a weak dollar
policy is to convince the buyers of those obligations of the opposite.