Gregor Macdonald

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: The Triggers That Will Spark ‘Hot’ Inflation

Arthur Lewis was an economist from the small, Caribbean island of St. Lucia who went on to win a Nobel Prize in 1979. His work identified the process by which very cheap labor is brought from the countryside to urban areas during phases of industrialization in developing countries. At a certain point, this supply of cheap labor went into decline and wage pressures began to mount.

Now referred to as the Lewis Turning Point, such a phase marks the end of a kind of deflationary boom, in which input costs fall during a phase of hyper-strong growth, and the beginning of inflationary restraints, in which profit margins stop growing. This is exactly what’s happening in China today.

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: The Case for $2,500 Gold in 2012

In a recent New York Times editorial, Christina Romer, former chair of the Obama’s Council of Economic Advisors, essentially dismissed the view that manufacturing was a crucial component to any economy. Readers will recall my most recent essay on the boom in US exports, The Price of Growth, in which I also highlighted the skepticism of the economics establishment toward exports.

Subsequent to that essay, Annie Lowrey, the new reporter covering economic policy at the New York Times, wrote a fine overview piece that essentially echoed my own view: The US has a new industrial policy to bring back manufacturing and boost exports. The two are obviously inter-related. And it’s revealing how many mid-career professionals in America are completely oblivious to the newest thinking on the subject. Indeed, we are learning more about the crucial dynamic mentioned briefly in Part I, which is that a relationship between design and manufacturing requires a close physical proximity to flourish.

Here is Alexis Madrigal on the subject as early as 2010, in an Atlantic piece, Key Question: Can the US Innovate Without Manufacturing?

An audience member asked a simple question with deep implications: if manufacturing continues to move offshore, can the United States continue to innovate? The premise behind the question, as Splinter explained, is that manufacturing isn’t just where ideas are put into practice, but a key part of the innovation ecosystem. (He should know: he once ran Intel’s top chip fab.) It’s possible, the question suggested, that the factory itself is a site of innovation because the people closest to the work of building things know how to make them better. That view is a challenge to the simplified idea that research, product development, and manufacturing are discrete steps.

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Between you and me, I think I’ve shown that the US is only at the very start of a long road back to recovery, which will not only establish a New Normal, but will have to include exports, manufacturing, and an economy with less surplus capital. The same holds true for the other two major players in the OECD puzzle, Japan and Europe.

So what does this mean for the financial markets, and in particular, gold?

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: Prepare for the Collapse of the Dollar

The just-released GDP report, which wraps up the 2011 performance of the US economy, made for unhappy reading.

While the headline number was stronger in the fourth quarter, after adjusting for inflation, the reading for the entire year came in at 1.7%. As Business Insider’s Joe Weisenthal put it, that is the “final, pathetic growth number for 2011.”

Many writers over the past year, including me, have hammered away at the idea that the performance of the US economy in real terms was statistically indistinguishable from a flatline in the aggregate.

No one disputes that some sectors of the economy, like exports and shipping, are growing. At issue is whether the economy as a whole is operating for the majority and not just segments of the populace. (Again, in real terms.) At a growth rate of 1.7%, we can at least conclude that no meaningful headway can be made in employment. Since the 2008 crisis, the US has been building a multi-million sub-population of people who are unemployed long-term. Only monthly job growth that first utilizes all new workers coming into the labor force will be able to eventually cut into this labor pool. Hence the revelations from the Federal Reserve this week related to targeting inflation, maintaining a zero-interest rate policy through late 2014, and conducting further quantitative easing (QE).

Before we dissect this week’s Fed meeting, let’s take a look at the recent trend in exports.