Splat

A couple of days ago I said that US debt default would splat the US far worse than its trading partners; of course, I missed the point. The real danger is rejection of US debt and the US dollar by its foreign purchasers, and both Karl Denninger and Jesse see that as an outcome of the Japanese election result.

The New World Order

I said earlier this week that rich and powerful foreign investors will call the tune now, and London Banker relays a threat from the Chinese re Fannie and Freddie. Unlike the domestic citizen and taxpayer, these people absolutely will not be stiffed.

Which is why we will get high interest rates, to prevent robbery-by-inflation. Which is why cash may remain on its throne for quite a while yet.

The question remains, which currency? One says the yen, another coughs and says "Euro." Wish I knew.

The returning wave

Hokusai: Mount Fuji off Kanagawa

As Japanese currency is getting out of risky investments and heading home, Brady Willett lists the factors putting the dollar under downward pressure:

In recent weeks the markets have speculated that the Saudis may drop their peg, that other Gulf states and sovereign wealth funds in the area are lightening their exposure to the dollar, and that OPEC continues to eye settling in Euros instead of dollars. Also recently China and Japan dumped a combined $33 billion in U.S. Treasuries (in August), and Chinese officials have continued to discuss reducing exposure to the dollar. Suffice to say, that against an already uncertain backdrop U.S. dollar holders are coming forward threatening to fan the flames and talk of the dollar era being over is running hot is hardly encouraging. Less encouraging still is the fact that those who previously cheered the dollar’s decline are turning scared.

He wonders whether we may see an emergency support plan for the dollar.

Avast behind!

Cut-throat Jake spies danger

Pearce Financial (Financial Sense, yesterday), like Marc Faber, believes that the East is dangerously overheated and deflation could hit commodities as well as shares; also, the dollar could rise again, and the Japanese yen might break free from its moorings.

I'd like some help with understanding this last, as tides of returning dollars and yen would seem to argue inflation in their home countries.

Karl Denninger (Market Ticker, yesterday) explains it as a relativistic effect:

Our problems are bad. The problems that will be faced overseas are FAR WORSE. Overseas economies are dependant on us, not the other way around. When this sinks in the other currencies against which the DX is measured will collapse; this will appear to raise the dollar, but in fact it is the sinking of other currencies.

"Tom the cabin boy smiled, and said nothing."

That sinking feeling

It is now 100 days since July 6, our starting point for measuring the Dow's fall. Against gold, the decline is substantial.

What about currency risk? According to O&A historical figures (using interbank rates), the US dollar has declined against the British pound by only 0.8%; and against the Chinese yuan, only 1.2%. But in the same period, the dollar has lost over 4% against the Euro, and 4.3% against the Japanese yen. Annualised, that's a drop of about 15% per year in yen terms. (Which currency has Warren Buffett bought this year?)

Gold? Acording to the World Gold Council (WGC), in the twelve months to 26 September, the Eurozone has sold 475.75 tonnes. (This zone includes Sweden and Switzerland; the latter has disposed of 113 tonnes out of that total, or nearly 9% of its stock. How strong is the Swiss franc? Is sound money a bad idea?)

The WGC September account reports that the US still holds 8,133.5 tonnes of gold, exactly the same amount as reported for Q1 2005, two and a half years ago. Allegedly: never forget that "credit" is Latin for "he believes it."

But maybe that's so; maybe Uncle Sam has, er, requested that other countries reduce their bullion stock in order to, um, maintain price stability. After all, the dollar has fallen 13.4% against gold already.

The competitive struggle to lose currency value continues.

And so say all of us...

Investment experts Jim Rogers and Marc Faber agree with Jim Puplava that (a) the US will try to reflate out of its troubles, and (b) cutting interest rates to achieve this, will lead to worse trouble.

According to Bloomberg today, "Rogers said he is buying agricultural commodities and recommended investors purchase Asian currencies including the Chinese renminbi and the Japanese yen.

Faber, publisher of the Gloom, Boom & Doom Report, said he is buying gold."

DOW 9,000 update

At the time of writing, the Dow stands at 13,493 and gold at $713.70/oz. Adjusted for the change in the price of gold, the Dow has fallen by just over 10% since July 6.

Marc Faber update

.............................................. Real growth: farmland

A most interesting and informative interview with Marc Faber on Bloomberg TV, last Friday. He thinks we've seen, not a correction, but the start of a bear market. In his opinion, the central banks intervention is inappropriate and will cause inflation. He thinks they "should let the crisis burn through the system, and eliminate some players". The Dow should correct by 20 - 30%; and as hedge funds "de-leverage", i.e. reduce their borrowings, the prices of most assets will drop.

In answer to the defence that p/e ratios are still good (i.e. the share price divided by the dividends, one way to test whether shares are over-valued), he says that at the peak of a market, there is a bubble. In 1999 it was a share price bubble, but now there is a bubble in earnings, and we will see "earnings disappointments" in the near future. So the p/e ratio is misleading and shares are not reasonably valued.

He points out that around the time of Dow peaks in July and August, we were also seeing several hundred shares hitting yearly lows, so underneath the surface a recession has already begun. The Dow has held up because of certain areas, such as oil stocks; but in present conditions, he thinks it will be "very difficult for the market to make new highs". Faber says that realism will return when we see a fall in popular stocks such as Research In Motion, Apple and Google.

The fundamentals of emerging markets are sound, and he foresees their economies de-coupling from the fortunes of the USA; but currently their stockmarkets are also over-valued and may correct when deleveraging causes money to flow back out of them.

As to the dollar, he thinks that if the Fed resists the temptation to cut interest rates, the dollar could strengthen against emerging market currencies. Against the Euro and the yen, he's not so sure. "I think against gold, all currencies will depreciate over time".

In relation to property, he says depressed areas like Detroit probably can't fall much further, unlike Miami and Southern California. Asian property looks promising - he mentions cities like Manila, Jakarta, Kuala Lumpur, Bangkok, Hanoi and Ho Chi Minh City. And relative to financial assets, farmland is depressed.

Accused of bearishness, Faber counters that to be bearish about assets is to be bullish about cash, which he has made plain for several months now. He even thinks that US Treasury notes and good-quality commercial bonds are a good investment.

I'm amazed how much valuable information this generous man gives away for nothing.

..................................................... Modern Manila

UK, US Treasury securities, and blogs (continued)

Well, I've got some sort of response from Iain Dale's commentators, starting with an ad hominem accusation of being emotionally needy (scared, more like!).

Here's my main argument, however inexpertly expressed:

Over the last 12 months, 10 countries have reduced their loans to the US by a combined total of $72 billion; we've increased our commitment by $112 billion, moving us from 10th place to 3rd place in the list of America's creditors. And our own finances aren't that good, either.

America is in hock to foreigners to the tune of 2.18 trillion dollars and rising. Effectively, they're running up a very big credit card bill to maintain domestic living standards. The US Comptroller General has very recently commented that this indebtedness could be used against the US by unfriendly foreign powers.

Our greatly increased support for America's finances is at the cost of some risk to ourselves, because if the borrowing spree continues unabated, we may find we get repaid in dollars that are worth far less than they are today. Can we afford to keep bailing out a spendthrift?

The borrowing is a powerful economic stimulus to China which, despite its relative poverty, is the second biggest creditor to the US. By sending the money back to America in the form of loans (purchase of US Treasury bonds), they avoid having their own currency appreciate. So their wage rates remain fantastically low and they continue to take business and jobs from the West - us included. Think of the transfer of the Swan Hunter shipyard to south India, or the purchase of Rover by China (don't tell me they're desperate to create long-term employment in Birmingham, when the average per capita wage in China is less than £1,000 per year). We're seeing a shift from higher-paid industrial work to lower-paid service jobs - perhaps the economic profile and geographical distribution of the readership of this blog means that it isn't obvious to them. China and others are hoovering up world resources in the dash to industrialise, right down to our iron manhole covers. James Kynge's "China shakes the world" is easy to read and very enlightening about what's going on.

Japan, America's greatest creditor, also buys US bonds to keep excess money out of its own system, so its interest rates are low, so the yen stays low and protects its well-established export markets. Also, a lot of money powering the world's stockmarkets is cheap money borrowed from Japan and invested elsewhere - the so-called "carry trade". All right if it goes on forever - but it can't. You cannot live for the rest of your life on borrowed money.

If currencies were responsibly managed, the trade deficit would cause the US to start to run short of cash, US wages would go down and exports back up, and trade would eventually (if painfully) come back into balance. But the Americans - and others, including ourselves again - respond by increasing the money supply (mostly through bank lending - up another 13% this year on both sides the Atlantic), which leads to price inflation, hence the rise in house prices and the stock markets. But borrowed money has to be repaid someday and then the tide will go out - but this time, we'll be left without much industrial capacity.

There's a fear that to prevent a 3os-style Depression, governments will print money even faster, but this leads to hyperinflation and eventually no one wants the currency at all (cf. Germany in 1923). So we could well have both a slump and high inflation. It may sound dull and technical, but then money is boring - until you haven't got any.

An American Congressional committee recently grilled the chairman of the Federal Reserve (like our Bank of England) and at least one Congressman admitted he realized he didn't understand inflation; the only one who seemed to was Ron Paul, who said that if we can make a living by printing money, we should all quit our jobs and do that. Most of Ron Paul's own investments are in gold and silver; the world's richest investor, Warren Buffett, has been sitting on many billions of dollars of cash for a long time and has recently disclosed that he's hedged by buying into a foreign currency, to protect against financial loss from a falling dollar.

If the value of the dollar (and possibly the pound) starts to collapse through overproduction, we really will notice - it's not just going to be bargain fares to Disneyworld. Americans - rich, expert ones, who manage big funds - are sounding the warnings loudly, clearly and angrily.

The collapse hasn't happened yet, partly because the dollar is the world's standard trading currency. This is changing; already, Iran is demanding payment from Japan in yen, not US dollars. When more countries start to impose similar conditions, the demand for the dollar will drop significantly, and so will its exchange value. China is beginning to de-link from the dollar, in favour of a wider basket of currencies; meanwhile, it's widened the range within which its currency (the renminbi, or Chinese yuan) can move against the dollar. They're not in hurry to appreciate their money, for reasons of international industrial market share; but that's the way the pressure is building.

Although our economy is much smaller than America's, we have (to some extent) similar problems ourselves. Yet here we are, lending money to our bigger cousin. I don't think we can sub him indefinitely, and I don't think we have begun to address the question of our own economic future. Without that, there'll be lots more hoodies to hug.

Puplava on inflation, commodities

Financial Sense, July 14: Jim Puplava discusses inflation figures and the management of our perceptions of inflation.

The effects of expanding the money supply must, he feels, eventually spill over from assets to consumer prices. He sees three scenarios:

1. A credit contraction, leading to recession.
2. An inadequate credit expansion, resulting in consumer price inflation.
3. A change in public perception of inflation. If people expect their money to become progressively worthless, they will eventually try to get rid of it as fast as possible, in exchange for tangible things.

Conclusions:

• Cut unnecessary living expenses, shop smarter.
• Avoid bonds.
• Because there is no sign of (1) or (2) above happening, we are heading for a US hyperinflationary depression, perhaps starting around the same time as the oil crisis, i.e. 2009. So invest in tangibles: gold, silver, oil.

By the way - some thought-provoking replies to listeners:

• Puplava agrees that Israel may be sitting on a valuable oil field!
• He says creditor nations in Asia may have a deflationary depression, while ours will be inflationary.
• He notes that Iran now demands payment from Japan in yen, not US dollars.

Peter Schiff: will Japan pull the plug on America?

Peter Schiff, in The Market Oracle yesterday, reports that Japanese monetary inflation is about to show up in their consumer prices. They may be able to cover it by fudging the inflation index (some of us have seen that done elsewhere), but it can't fool everyone forever.

For a long time, Japan has increased its money supply and exported the excess cash by purchasing US Treasury bonds. This keeps the yen steady against the weak dollar, protecting Japan's exports; and it also keeps US interest rates low, so reducing the pressure to raise rates in Japan.

Schiff felicitously terms this a "vendor financing scheme", but regards America's economic collapse as "inevitable". He thinks hyperinflation is too high a price for Japan to pay, and if she retreats from the brink and alters her monetary policy, then the result will be inflation in the US, forcing higher interest rates, and collapsing stock and real property values.

This is what Schiff has predicted in his book, "Crash Proof" (see my review here) and it's interesting to note that the author has been appearing more frequently in the news lately. Either he thinks the turning point is close, or he's marketing the book more actively.

Schiff also comments on the fear of deflation, saying "falling consumer prices are one of the natural rewards that people enjoy in market economies", a point made in Richard Daughty's masterly performance on You Tube. It's so funny and succinct that I re-watch this myself from time to time - have another look:



UPDATE

For a counter-view (in the sense that he doesn't expect the crisis for some years yet), see Puru Saxena as I reported on July 28 here.

Conspiracy to support the dollar

This exchange of letters in the Market Oracle has very significant implications. It's a discussion of the huge international "carry trade", which means borrowing in one country at low rates of interest, to invest in another country.

In this case, it is loans from Japan to invest in US Treasury bonds. The columnist, Professor Antal E. Fekete, says that Japan will keep its interest rate low, because otherwise the yen would rise, hitting Japanese exports. On the other side, the US Treasury will maintain or even increase interest rates on its bonds, to prevent the dollar from collapsing, despite America's economic weakness. China has no wish to destabilise the dollar, and as the Professor points out, some of China's enormous gains from the US come from its holding of Treasury bonds. So there are powerful vested interests sustaining the status quo.

This is a cool-headed contrary view to that of the most pessimistic bears, who feel in almost a moral sense that the present state of affairs ought to end in tears. It is the very awfulness of the potential consequences of a sudden, radical change of balance in the world economy that motivates the main players to keep the polite fiction of normality going.

So the Professor is a "bond bull": yes, the dollar may gradually decline; no, it will not suddenly dive. That's his position.