The Money Illusion That Drives Today's Texas/Canada Economic Hype

by John Tamny,  Toreador Research and Trading (Guest Contributor)

For those who watched television with any frequency in the 1980s, they surely remember the ubiquitous presence of Robin Leach, host of Lifestyles of the Rich and Famous. With a recovering economy having powerfully revived the ability of Americans to grow very rich, Leach's show was a guilty pleasure for those eager to see how they lived.

Of course the '80s economic expansion wasn't uniform across all fifty states. Leach noted this, and would occasionally turn his attention to a lagging Texas.  During the early '80s Leach's cameras revealed pawn shops in the Lone Star State that were lined with rows and rows of repossessed Rolls Royce automobiles up for sale after their original, formerly oil-soaked owners had gone bust. If not familiar with Leach's recessed Texas imagery, many have doubtless read Friday Night Lights, H.G. Bissinger's classic book about high school football in Odessa, TX. If so, they may well remember the author's aside on oil-rich Midland, TX, and how it could claim one of the world's most profitable Rolls Royce dealerships in the 1970s.

Farther north in Iowa and other farm states, the 1980s similarly brought hard times. Having expanded and invested in land and new farm equipment during the '70s, when commodities began their decline in the '80s a lot of formerly economic investments were exposed as less than profitable in a very painful way. Farm-Aid concerts soon followed.

The driver of the horrific capital misallocations that boosted commodity-rich parts of the U.S. in the '70s was the money illusion. With investors having bought into the fanciful view that oil, wheat and meat were scarce, as opposed to beneficiaries of nominal spikes driven by a weak dollar, heavy investment followed only to be negatively exposed with the 1980 election of Ronald Reagan, and a return to a stronger dollar.

Tales of the boom/bust cycle that befell commodity-centric areas a little over 30 years ago have a rhyme to them today. With the dollar in the midst of a 10-year decline, commodities are spiking in nominal terms, and commodity-rich locales are once again the all the economic rage.

Recently this writer has observed headlines such as "California Dreamin' About Texas Jobs", "Houston: Model City", and "Why North Dakota Is Booming" stateside, along with editorials about the Canadian "economic miracle" up north; the broad narrative one of Canada's right-of-center politicians getting economic policy right, and as such, being "rewarded for their economic success." Taking nothing away from the undeniable good that results from Texas's low-tax model, or for that matter, a move toward economic liberalization in Canada, there's a lot of money illusion embedded in today's hype.

Indeed, what's not remarked on enough by commentators when discussing economic renaissance in countries such as Canada, and states like Texas, is how much of the growth is driven by the fact that they're both commodity rich. And as history tells us, during periods of currency weakness a great deal of capital flows to locales where commodities are plentiful.

Iowa? Recently in Des Moines to give a speech, this writer was blown away by all the buoyant optimism within a state put on its back not long ago by a strong-dollar driven flight away from the real. Not far away in North Dakota, a state which is the picture definition for some of prosaic economic activity, its impressive oil reserves have made it a locale full of boisterous economic activity; its population having grown 5% since 2000 according to demographer Joel Kotkin.

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For Canada, Texas, Iowa and North Dakota, the common denominator they all share is that the economy in each is relatively focused on commodities, and with commodities near nominal all-time highs thanks to a weak dollar, job-creating investment has followed. Times are somewhat grand in commodity-rich locales at present, but as has historically been the case, U.S. monetary authorities eventually wake up to their monetary errors, and when they do, the commodities priced in dollars will fall substantially, and with it, a lot of production that was made to appear viable by the illusion of a falling dollar.

Looking at this in the reverse, during periods of intense currency strength, the late '90s most notable in that regard, capital flows away from sagging commodities and into metaphysical economic concepts of the technological variety. In that sense it's no mistake that so many good and so very many bad Silicon Valley ideas were funded in the late '90s only to be eventually exposed as worthless. Basically the strong dollar made a lot of marginal technologists appear attractive in the investment sense, but as the inevitable Internet bust would reveal, people like Amazon's Jeff Bezos don't grow on trees.

Back to the Texas and Canada, though they boom at present with commentators falling all over themselves to praise their sound economic models, this won't end well for two reasons. For one, profits attract imitators, and as this is being read a lot of marginal producers are entering the commodity space, funded by lemming investors desperate to avoid missing out on the boom. The marginal producers and investors are distorting the markets, and their crashes will come first in a very ugly way.

Secondly, and as mentioned before, Washington will eventually wake up to its monetary error owing to the broad pain the weak dollar is bringing to the electorate. When this occurs, commodities will decline substantially in nominal terms as they did in the '80s and '90s, and with that decline, the game will be up.

For those who doubt this, it should be noted that an ounce of gold at $1,500 in 2011 buys 15 barrels of oil, much as a $480 ounce of gold bought 15 barrels of oil at $32 in 1981, much as a $35 ounce of gold bought 15 barrels of oil in 1971. As the constant that is gold reveals in living color, the broad commodity boom is very much the stuff of money illusion, and when the dollar strengthens in concert with gold's decline, commodities will soon follow such that a lot of attractive investments at nosebleed commodity prices will be unmasked in an embarrassing way. History always seems to repeat itself.

The policy answer to this is simple. Monetary authorities should move hastily to fix this most obvious of monetary mistakes through policies meant to strengthen the dollar.

Indeed, every day they delay means that more and more human, physical and financial capital is being misallocated on the way to capital destruction, not to mention the emotional/financial toll it will impose on the late arrivals to a weak-dollar driven phenomenon. The sooner this trend is reversed the better.

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