Your Contrarian

Ron Paul appeared on CNBC last week, advocating sound money and a return to Austrian economics. It's a forgone conclusion that to have sound money, paper (or digital) currency must be tethered to something that can't be corrupted by central bankers' ability to debase the currency via printing. For many years that was gold, so it's a good reference point, but if you listen carefully to Paul, he is suggesting that the currency should be tied to something tangible- gold, a basket of commodities, etc. Losing the dollar as reserve currency would be pointless if the alternative is another fiat currency . In that interview, he referred to this resumed tethering as ‘competition'. What did he mean?

The competition he's referring to is gold. Gold is trading as an alternative currency because people are/have lost faith in fiat currencies due to debasement via the printing press. His argument is if gold were not present in our system, the Fed would have no concern about debasing the dollar to their heart's content. But the more they print, the more likely it is that an alternate standard will emerge with gold being part of the equation- something the Fed does not want.

Paul also suggests that our situation is similar to Japan 's. Japan is a nation of savers while we're a nation of debtors- so it was natural that Japan had outright deflation in addition to their reluctance to debase their currency as aggressively as Bernanke likes to. If the Fed succeeds and continues to print, we will have stagflation accompanied by generational low GDP growth and high inflation in necessities- not exactly what Japan experienced. The similarities may lie in the banking system, where Japan 's central bank decided to prop up their zombie banks similarly to what we have done here.

Many question if deficits really matter any longer. The simple answer is that they matter to every country that doesn't own a printing press for the world's reserve currency- j ust look at Europe as a case in point. So the real question is do they matter for the U.S. ? The other competition the Fed has is the bond market , the deepest, most liquid market in the world. If the Fed continues down this path, bond yields will continue to rise because all of the people holding this debt that will be paid back in devalued fiat +3% are saying 'no thanks' and selling their bonds. This in turn will raise interest rates despite the Fed wanting to keep them low. The Fed has said that because half of their dual mandate is to lower unemployment, it doesn't matter what interest rates do in the short term. In the end, there will come a point where rates have risen so much that it's imperiling any economic recovery and will force the Fed to the sidelines, or congress will strip them of their dual mandate . It also creates problems as far as the government's ability to pay off the interest it owes on its current debt obligations. Any of these events would cause stocks and commodities to crash. This isn't a question of ‘if', but ‘when'. Yes, commodities can continue their upward trajectory just as they did in 2007, but at some point, the piper must be paid.

These aren't exactly the kind of happy New Year wishes one hopes for, but it's the kind of outcome one can expect when policy makers won't permit the market to define price. I think this is what Paul ultimately was alluding to in his interview- an outcome that's painful, but one that can lead to legitimate renewal.

Chris Wilson

EM: chris@cyclespreads.com

Web: www.CycleSpreads.com