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09-28-06, 02:00 PM

The Hard Way or the Harder Way

Two Options for Correcting Global Economic Imbalances

By Eric Janszen

September 28, 2006

In one of my previous commentaries on this subject, "The Coming End of the US Foreign Investment Bubble (http://www.itulip.com/forums/showthread.php?t=252)" I make the case that foreign investment in the US is mostly driven by belief versus fundamentals. In "China vs USA: Economic M.A.D. (http://www.itulip.com/economicMAD.htm)" I describe the unstable and unsustainable economic interdependency between the US and its major goods trading partners, especially China. I occasionally run across thoughtful arguments to the contrary, such as the Deloitte Research Study, Global Economic Outlook 2007: "Is a crisis imminent, or are things better than we thought? (pdf) (http://www.deloitte.com/dtt/cda/doc/content/dtt_GlobEcon07_091506.pdf)."

The Deloitte study makes the argument for a benign correction of global imbalances, what I will call the Easy Way. They frame their case like this.

The US invests far more than it saves (its current account deficit) and the rest of the world saves far more than it invests (a current account surplus). This is the big imbalance in the global economy. It involves a massive flow of capital to the US from the rest of the world. The magnitude of this transfer is unprecedented in recent history and probably cannot be sustained indefinitely. Therefore, when it ends, it could have a destabilizing effect on the global economy, if only because of the shifting of gears.

Some pundits argue that financial market participants recognize this fact and will ultimately move exchange rates and interest rates in a direction that will lead to a decline in the imbalance. The pessimists argue for a sudden decline, the optimists for a gradual decline. In either case, the imbalance has persisted far longer than anyone expected, and a correction, with or without onerous consequences, has not yet happened. Perhaps we have entered a "New Era"–a rhetorical red flag if ever there was one–which massive one-way capital flows can take place for long periods without any serious consequences.

The Deloitte report does not argue that the imbalance is sustainable, but asks: "Is the terrifying hard landing imminent or not?" In other words, is there an Easy Way?

They describe two schools of thought, the "Pessimists" and the "Optimists":

Pessimists

The imbalance is due to the sins of Americans. That is to say, American consumers save too little and borrow too much, while their elected government does much the same. The result is a need to import capital from overseas in order to maintain the American standard of living. The argument is that the imbalance will become unsustainable once the rest of the world becomes reluctant to finance America’s largesse. At that point, the dollar will drop and interest rates will soar, pushing the US into a recession and wreaking havoc on the global economy. Indeed Deloitte Research has warned of this outcome in past publications.
There is historical precedent for this scenario. In the late 1970s and again in the late 1980s, a large US current account deficit was ultimately unwound through large dollar depreciations, rising interest rates, and recessions. This was followed by financial crises in emerging markets.
The pessimists believe that this could happen again, but possibly on a larger scale.

Optimists

Believe that the imbalance is principally due to excessive saving in Asia. For a variety of reasons, Asian consumers and businesses save far more than the demand for investment in their countries. They must therefore find outlets for this excess savings. The US is only too happy to import the excess savings given its propensity for budget deficits and consumer debt. Importing this capital enables the US to run large budget deficits combined with low personal savings without having to endure higher interest rates. The imbalance is Asia’s fault and that it will persist as long as Asia continues its excessive saving.
There is historical precedent for large, sustained, one-way capital flows. In the late 19th century, massive amounts of capital flowed from Great Britain to the New World (US, Canada, Australia, and the rest of the British Empire). These flows, as a share of GDP, were much larger than what we see today and persisted for decades.
There is nothing so bad about the current situation and that it can persist for much longer.

There is one glaring problem with this framework, and most long time iTulip readers no doubt caught it. The "historical precedent for large, sustained, one-way capital flows" between Great Britain and the US, Canada, Australia, and the rest of the British Empire" were capital flows going in the opposite direction. The standard of living of Great Britain's citizens did not depend on its colonies' need to fund the consumption of the goods they produced with the savings they earned through trade. The relationship between the US and its trading partners is not between an empire and its colonies. The relationship is a reverse variant, best described as global vendor-finance, with the US in the role of a national "company town (http://en.wikipedia.org/wiki/Company_town)" owned by its goods exporting, financial assets purchasing trading partners.

The Deloitte study asserts that there are elements of truth in both the Optimist and Pessimist arguments. "Asia is certainly prone to excess savings, while the US seems prone to excess borrowing. Perhaps the best explanation of the current situation is that the US and Asia have a comfortable symbiosis." The report concludes: "The US can engage in wanton profligacy largely because Asians have so much savings to dispose of."

They are wrong. There is no Easy Way. This proposal of the Easy Way reminds me of the "soft landing" arguments (http://www.bankrate.com/aolcan/news/investing/20000321l.asp) I'd get back in the late 1990s when I was writing about the stock market bubble and the "soft landing" arguments (http://www.alwayson-network.com/comments.php?id=P10732_0_4_0_C) I got in 2004 and 2005 when I was writing about the housing bubble (see some of the nasty-gram comments).

I understand why. Bubbles are belief systems. You cannot reason a person out of a belief that he or she did not arrive at by reason, particularly if they have money, reputation, or employment–or all three–that depend on the asset in question: dot com or telecoms stocks, or housing, or dollar denominated assets–or all three. A man or woman with everything on Number Seven has got to believe that Seven is their lucky number. Or that they are not betting at all but are "investing" in the latest New Era (http://www.itulip.com/nonewera.htm).

But there is no Easy Way. There is only the Hard Way and The Harder Way. Here's why.

Asian countries and their citizens have a lot savings. That begs the question: Why? Top three reasons:

With respect to national savings, Asian economies are organized around production and export; goods flow out and money flows in.
National income earned from trade is used by Asian central banks to purchase US debt to the extent necessary to keep US interest rates low and the dollar strong so that US consumers can borrow money to buy their exports, and keep those exports cheap by exchanging their own currencies for dollars when they buy US financial assets.
With respect to household savings, history and culture are the main cause. According to this December 2004 McKinsey report (http://www.mckinseyquarterly.com/article_page.aspx?ar=1555&L2=7&L3=10): "In China... the savings rate climbed to 44 percent of GDP last year, as opposed to 26 percent in Taiwan and 32 percent in South Korea. In big cities, such as Beijing and Shanghai, savings rates are as high as 50 percent, reflecting the consumers' propensity to save a higher proportion of their growing household income." The reason? "Few Chinese consumers, unlike their Western counterparts, are afraid of losing their jobs. Thanks to a booming economy, members of China's middle class are confident they can secure new employment almost at will and often at higher salary levels. But they do worry about a potential increase in health care, pension, and private-education expenses. Many estimate these potential costs to be much higher than they are likely to be. The instincts of these people have told them to save against the extreme case rather than the more likely outcome. As a result, they are over-saving for future events given what they would really have to pay if they could share risk through quality pension programs or health insurance products."

The US is running the largest trade and fiscal deficits in history, and its citizens have a negative savings rate. But, why? Top three reasons:

With respect to national savings, the US economy is organized around domestic consumption, the inflating and trading of inflated assets among its citizens and the sale of financial assets to foreigners–the asset-based economy.
Much of the resulting international obligations are denominated in our own home currency. This means that when international debts are paid to foreigners they are paid in US currency rather than foreign currency. This relieves the US from the need to sell products abroad to acquire sufficient foreign currency to repay its debts. The status if the US dollar as the world's reserve currency is the other reason why the US economy has gotten away with running the levels of trade deficits it has to date, besides the desire by exporting countries to continue to grow their economies via exports.
With respect to household savings–again–history and culture are the main cause. As readers know, during the housing bubble, household savings in the US turned negative for the first time since The Great Depression. The official reason is that home owners came to believe that they didn't need to save income–all they had to do to build savings was sit on the couch and let the house do the saving for them. But the real historical and cultural reasons are the same that cause so many US citizens to go into debt, home or not. Unlike their counterparts in Asia who "worry about a potential increase in health care, pension, and private-education expenses" and whose "instincts ... have told them to save against the extreme case rather than the more likely outcome," US citizens simply cannot imagine a time when having debt and no savings can mean real hardship. The US has had only a couple of minor recessions since the early 1980s. That means that if you were born in the US since 1970 or so, you likely have no personal experience with economic hardship. Even if you were born earlier, you've likely forgotten what it was like because the last truly painful recession happened twenty five years ago. In the mean time, fresh credit seems to always be available, and while the job market can get tough, it has not left thousands of people camping on the White House lawn.

A nation of financially fearless citizens is both good and bad. Good, because it encourages the risk-taking that has made the US the engine of innovation. Bad, because–when the imbalances correct–either the Hard Way or the Harder Way, many citizens are woefully unprepared.

The US government doesn't provide incentives for its citizens to save. Instead, it demands that its trading partners–China especially–motivate its citizens to save less and "allow" their currency to appreciate.

US politicians claim that Chinese currency appreciation will solve everything: Chinese households will save less and consume more. They will buy more, cheaper US exports. US households will consume fewer, more expensive exports, and thus save more.

But as explained in this paper by Stanford professor Ronald MacKinnon "Exchange, Wage Rates and International Adjustment (http://www.chinaonline.com/pdf/exchange_wage_adjust.swf)" in December 2004, currency appreciation by key US trading partners China and Japan will not solve the US trade imbalance.

Currency appreciation by China will expose it to the kind of deflation that Japan suffered in the 1990s. Japan fell for the same bad advice from the US in the late 1980s, and for the same reasons: the US was running a huge trade deficit with Japan because Japan exported and saved, and the Japanese people worked, produced, and saved, while the US government spent and borrowed, and its citizens borrowed and borrowed some more.

http://www.itulip.com/images/chinaonline1.png

MacKinnon's paper predicted that the US policy of dollar depreciation undertaken around 2002 to help re-start the US economy after the post stock market crash recession was not going to help improve the US trade imbalance, as the US government believed. MacKinnon warned that the policy might make it worse. It did. While a euro went from buying $0.78 worth of US exports in 2001 to $1.12 in 2005, the US trade deficit grew from $436 billion in 2001 to $651 billion in 2005.

That's not how it's supposed to work.

The answer to the global savings imbalance is as complicated as it is painless–it is neither. The imbalance will correct, sooner or later, the Hard Way or the Harder Way.

Professor of economics Laurence J. Kotlikoff in his paper "Is the United States Bankrupt? (pdf) (http://research.stlouisfed.org/publications/review/06/07/Kotlikoff.pdf)" explains the Hard Way. Many would scoff at this notion. They’d point out that the country has never defaulted on its debt; that its debt-to-GDP (gross domestic product) ratio is substantially lower than that of Japan and other developed countries; that its long-term nominal interest rates are historically low; that the dollar is the world’s reserve currency; and that China, Japan, and other countries have an insatiable demand for U.S. Treasuries. Others would argue that the official debt reflects nomenclature, not fiscal fundamentals; that the sum total of official and unofficial liabilities is massive; that federal discretionary spending and medical expenditures are exploding; that the United States has a history of defaulting on its official debt via inflation; that the government has cut taxes well below the bone; that countries holding U.S. bonds can sell them in a nanosecond; that the financial markets have a long and impressive record of mis-pricing securities; and that financial implosion is just around the corner.

This paper explores these views from both partial and general equilibrium perspectives. It concludes that countries can go broke, that the United States is going broke, that remaining open to foreign investment can help stave off bankruptcy, but that radical reform of U.S. fiscal institutions is essential to secure the nation’s economic future. The paper offers three policies to eliminate the nation’s enormous fiscal gap and avert bankruptcy: a retail sales tax, personalized Social Security, and a globally budgeted universal healthcare system.
The Hard Way is comprised of policies that encourage saving.

What's the Harder Way? As the IMF stated in its Global Financial Stability Report last week: "A low-probability but potentially high-cost risk to the global financial system is that a dollar decline could become self-reinforcing and hence disorderly.'' Rapidly rising inflation, interest rates and unemployment, attended by series of recessions at least as severe as those that happened between 1980 - 1983.

The idea that there is an Easy Way, as the Deloitte Research Study suggests, is politically convenient but requires a new New Era in global economics and trade. Even to buy the Hard Way argument you have to believe that intellectual honesty will return to the political establishment and that the political will to legislate Hard Way policies will emerge before Mr. Market fixes the imbalances the Harder Way.

I contributed to America\'s Bubble Economy: Profit When It Pops (http://www.amazon.com/exec/obidos/redirect?link_code=as2&path=ASIN/047175367X&tag=wwwitulipcom-20&camp=1789&creative=9325)http://www.assoc-amazon.com/e/ir?t=wwwitulipcom-20&l=as2&o=1&a=047175367X because I do not expect to see intellectual honesty and strong political will–from either Republicans or Democrats–return without a crisis to motivate it, and I want iTulip readers to have a specific, actionable plan to address the risks posed to them and their families.

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09-28-06, 03:18 PM

I expect the harder way - to be the only way

Many of my fellow citizens of this country are completely clueless about finances and will never get behind a Political Party or candidate who proposes fixing fiscal problems without a full blown crisis.
I look at the local community spending issues to demonstrate who dumb voters are. Schools or new ball fields the voters merely focus on the cost of acquiring the new asset (there is never a discussing about the cost of maintaining debt or maintaining the new building or cost to maintain the new ball fields).
It scares the heck out of me.....but, my fellow citizens have absolutely no self descipline.
Many had parents (like mine) who lived pay check to pay check - and when you are a Union worker with a pay check that often works out. But, when you are managing your own 401K Pension and need to save for Healthcare Insurance payments - that don't work out so good!

Uncle Jack

09-28-06, 03:39 PM

<blockquote>You cannot reason a person out of a belief that they did not arrive at by reason, particularly if that person has money, reputation, or employment–or all three–that depend on dot com or telecoms stocks, or housing, or dollar denominated assets, or all three.</blockquote>

I think this is biblical, but not sure:

"A man convinced against his will is unconvinced still."

<imf src="http://www.itulip.com/forums/images/icons/icon10.gif"/>

fountainhead

09-28-06, 06:46 PM

[quote] While a euro went from buying $0.78 worth of US exports in 2001 to $1.12 in 2005, the US trade deficit grew from $436 billion in 2001 to $651 billion in 2005. .........
[quote] The US is running the largest trade and fiscal deficits in history, and its citizens have a negative savings rate.

It's getting worse - top with the Cost of Iraq War.

07/13/06 -- Information Clearing House (http://informationclearinghouse.info), Washington D.C.- We are spending $8 billion a month in Iraq. That equates to $2 billion a week, or $267 million a day, or $11 million an hour.

Iraq War calculator is set to reach $318.5 billion September 30, 2006, the end of fiscal year 2006.
(http://nationalpriorities.org/index.php?option=com_wrapper&Itemid=182)

[quote] But there is no Easy Way. There is only the Hard Way and The Harder Way.

09-28-06, 06:54 PM

deloitte creates a straw man by saying the trigger for a correction in the pessimistic scenario is a sudden change of heart by our vendor financiers -- they suddenly stop buying u.s. debt instruments. that drops the dollar, raises rates and precipitates a recession. surely, they would not be so self-destructive as do any such thing in a precipitous manner.

the more likely arrow of causation is runs the other way: a housing led recession causes a drop in the trade deficit by reducing american consumption; our vendors can no longer sell as much to us. global commodity prices will drop along with american consumption.

what will china, for example, do when it can no longer export nearly as much to the u.s.? china is sitting on enormous productive [over]capacity as well as an army of redundant workers in the state operated enterprises, and suddenly its main customer won't be buying so much.

china will be forced to stimulate consumption. one possiblity is government consumption such as a military build-up - this is easy to legislate and helps keep centrifugal social forces under control via its stimulation of nationalism. this seems like an inevitable component of the chinese response. the other possiblity is somehow stimulating chinese consumer demand. this could be done by providing more in the way of social safety nets - unemployement benefits, pensions, health care - which would serve the purpose of both consuming inputs and at the same time reduce the chinese need and propensity to save for a proverbial rainy day. such a gearing up of chinese consumption is at the heart of schiff's scenario.

a different form of chinese consumption involves spending from the chinese hoard of u.s. dollars - a global buying spree spending down the pboc's involuntary "savings" heretofore locked up in treasuries. the dollar is the old maid - whoever has it will want to get rid of it. this is the harder way, i suppose.

09-28-06, 07:36 PM

what will china, for example, do when it can no longer export nearly as much to the u.s.? china is sitting on enormous productive [over]capacity as well as an army of redundant workers in the state operated enterprises, and suddenly its main customer won't be buying so much.

china will be forced to stimulate consumption. one possiblity is government consumption such as a military build-up - this is easy to legislate and helps keep centrifugal social forces under control via its stimulation of nationalism. this seems like an inevitable component of the chinese response.

You have explained, in one post–never mind the WWIII nonesense we heard during the Israel/Lebanon war a few weeks ago from others, now ancient history–how real world wars start. Congratulations.

09-29-06, 10:16 AM

You have explained, in one post–never mind the WWIII nonesense we heard during the Israel/Lebanon war a few weeks ago from others, now ancient history–how real world wars start. Congratulations.

thanks ...... i think. i was hoping i was just talking about a buildup, and not a war.

sparki

09-29-06, 10:59 AM

hello from germany,

thank you for the beautiful post.

it should be clear to almost everyone that all the political talk to revalue the yuan and other currencies against the $ and the problems for the us are gone is just to calm down the people before the elections.

your comment is spot on and unmasked yet another spinn that is repeatet without thinking day in and day out even here in germany.

this site is really WUNDERBAR!

jan-martin
http://immobilienblasen.blogspot.com/

metalman

09-29-06, 01:52 PM

Slow Bear

09-29-06, 06:25 PM

09-29-06, 07:18 PM

i believe housing is counted as a capital good. [you might think it was a consumer durable, but that's not true since we're all renting from ourselves via owner's equivalent rent.] for a long time the u.s. has overinvested in housing to the detriment of other investment. it's just gotten a lot more extreme the last few years.

Jim Nickerson

09-29-06, 07:21 PM

09-29-06, 07:25 PM

Hello Eric,

I used to post on the Bear Forum under the name "SLO Bear", when I lived in San Luis Obispo. Now I'm a slower bear, thanks to suffering a "cerebral accident", a couple of years back. I think I'm a little dumber now, but the world seems to have gotten a lot dumber more quickly, so on a relative basis, I seem to be OK!!

I read Von Mises' "Human Action" over thirty years ago, and I am still guided by "Austrian" theory in making sense of current events. Thus I am a little perplexed when I read that the U.S. current account deficit is equated in the Deloitte Research Study to the statement: “The US invests far more than it saves". Back before Newspeak, it was impossible to invest more than one saves. The US is drawing down its savings and buying more than it sells abroad, but it is NOT adding to its domestic productive capability, which is what "invest" used to mean.

Another sentence from that study that kind of irked me was: "It [the current account deficit] involves a massive flow of capital to the US from the rest of the world." “Capital” is one of those multivalent words that can be used to mean (1) “capital goods”, i.e. goods used in the production of consumer goods or of other capital goods (recursively), (2) “money”, or, more particularly, (3) “money intended for the production and/or purchase of capital goods”. In the quoted sentence, it certainly means (2) in the non-(3) sense. Exported dollars are being repatriated to purchase US Treasury bonds. (Treasury bonds, by the way, are not capital goods. Purchasing them does not add to productive capacity, but rather, in the late A. J. Galambos’ words, only “contribute to the delinquency of a bureaucrat”.)

Later, Deloitte says “In the late 19th century, massive amounts of capital flowed from Great Britain to the New World . . .”, where the word “capital” is certainly being used in sense (3) above. I mean, really, were Americans borrowing British Sterling in the 19th century to buy big houses? I didn’t think so. Definitely sense (3).

Another thing that makes the two cases of long-term “capital” flows not comparable: Who owned the “capital” sent to America? Private investors (in Great Britain in the 19th century) or governmental entities (PRC banks in the current situation)? The former rationally estimate the expected return on their investment, whereas the latter do what they do for whatever political reasons.

I could have some more fun with the phrase “excess savings”, but this reply is long enough already. I have no bones to pick with you about the Hard vs. the Harder Way. Excellent analysis as usual. The reigning complacency is making me get my umbrella out.

Welcome, Slow Bear. Yes, I do recall you and your thoughtful, articulate posts. I'm delighted to have you pull up a chair at the iTulip Bar & Grill and join us. Sorry to hear about your accident, but it doesn't appear to have impared your reasoning abilities–sharp as ever.

Remember the endless arguments on that forum in the late 1990s about inflation/deflation? The end of the stock market bubble was a fait accompli among forum members and we were all trying to figure out if we'd have a big deflation. At long last I decided on Ka-Poom Theory as the transition to which we are inexorably headed, and was trying to figure out how close we might get to actual deflation before the inflation, and then how big the inflation might get.

Thinking back, I don't recall that it ever occurred to any of us–even crossed our minds–that the Fed would permit a housing bubble to happen. But we should have known. If the Federal Government were RJ Reynolds, the Surgeon General would be shipping cartons of cigarettes to ten year olds if that's what it took to keep "the company" from going out of business.

I especially appreciate your attention to the meaning of words. The loss of this discipline is causing a lot of the problems we're seeing. Low interest rates, creative mortgages, and lax lending standards made a $500K home in 2000 affordable on the same monthly payment at $1M in 2005. Not surprisingly, in fact, the price of that house grew to $1M. The $500K profit that the guy made selling it after five years was not taxed, not even a dollar. (By the way, we call the US dollar the US bonar here, again trying to maintain discipline in our use of language; the unit of US currency formerly known as the dollar is no more, so we had to come up with another name for it.) Further, this $500K was then put on the nation's books as economic output, counted as part of GDP. Over the past several years, I made almost as much money sleeping in my home every night as I made at work all day.

It's all very modern, just like the stock market bubble that was happening when you and I met...
Some in clandestine companies combine;
Erect new stocks to trade beyond the line;
With air and empty names beguile the town,
And raise new credits first, then cry 'em down;
Divide the empty nothing into shares,
And set the crowd together by the ears. - Daniel Defoe (1660 - 1731)
Welcome back.

Jim Nickerson

09-29-06, 10:25 PM

Thinking back, I don't recall that it ever occurred to any of us–even crossed our minds–that the Fed would permit a housing bubble to happen. But we should have known.

EJ,

Five or 10 years from now some will be thinking back to now. Might they then be saying, "But we should have known."?

If greater inflation is the most likely prediction for our futures, where will the money and credit go?

09-30-06, 05:21 AM

EJ,

Five or 10 years from now some will be thinking back to now. Might they then be saying, "But we should have known."?

If greater inflation is the most likely prediction for our futures, where will the money and credit go?
i'd be very interested in ej's, and others', thoughts on this question, too.

my own are that it will go to commodities. if you assume the answer to the inflation/deflation debate is inflation, then you have to assume a weaker dollar. [the alternative is global inflation of all currencies, in which case people all over the world will be looking for stores of value - commodities and especially pms.] so, given a weaker dollar you have americans looking for stores of value domestically, and also competing for global resources with their weaker dollars. sounds like commodities including, but not necessarily "especially," pms.

alternatives 1 - if we assume low, low rates, then housing can be pumped up to a degree, softening the housing decline, but can it become a repeat bubble? it is hard to see speculators jumping right back in after their recent scare. but perhaps i am crediting people with too much rationality. i'm thinking of the people in the anecdote related at safehaven, in a link supplied by jim nickerson: these were ordinary folks, with not a lot of income, who had leveraged themselves into 5 properties around the san diego area, with a total mortgage debt of $3.6million. i think the psychology isn't right, though. a bubble has to build to a widespread belief in the inevitability of ever rising prices. there have been too many newspaper articles about the housing bubble popping: it would take years for that to reverse.

alternatives 2 - stocks? this seems somewhat more plausible for a repeat performance. a lot depends on what happens in the stock market between now and then. there is apparently some noise being made even now about the dow approaching its old high. if the stock market isn't hit too badly between now and when the pumps get turned on, then i could see equities moving up a lot. it's been several years since people were swearing "never again" about the stock market. it seems more likely, however, that stocks will be hit hard BEFORE the pumps are turned on. their decline will be one of the triggers that elicit the inflationary response. in that scenario, in which the stock market will be hit hard AGAIN before the inflation, it's hard to see the public wave of enthusiasm settling on stocks.

alternative 2b- foreign stocks. this seems more plausible. if the dollar is weak but we don't have global runaway inflation, then other economies may be growing in a relatively healthy way. [could they really? with a sick economy in the u.s.? let's assume so.] also, the declining dollar will translate into rising foreign equity prices from the american viewpoint. it's hard to see a broad interest in foreign stocks, americans are in general too insular, but foreign stocks will have a following. american demand for e.g. asian stocks will add to the currency effect and push up those stocks even in terms of their base currencies. so there will be substantial bull market in foreign stocks. the strength of this move will depend on how fast the dollar declines- if the dollar drops too quickly it won't work.

the recent commodity moves are most likely a precursor to the big commodity wave to come. looking at multidecade charts the recent peaks are not all that high. for all that some commentators have labelled gold's move, for example, as "a bubble," it never got close to widespread public ownership and enthusiasm.

i think commodities have completed stage 1 of a 3 stage move. their ownership to date has been restricted to enthusiasts and speculators. the great majority of day-to-day market participants never touched them.

the slowdown or recession which we are now entering, along with the pullback in commodity prices, marks the shift to stage 2. stage 2 will be the institutionalization of the commodities markets. commodities will be legitimized as mainstream investments. ownership will broaden significantly, but will not reach the man in the street. thus the rise should be relatively orderly.

another slowdown or recession, accompanied by another pullback in prices, will mark the shift to stage 3. in stage 3 there will be a wave of new mutual fund offerings, helping the public get on board. fraudulant junior mining companies will be floated on smaller exchanges around the world. the price of gold will again be announced every half hour on the radio business reports. the newsweeklies will run articles on the commodities markets [but not a cover, yet].

the last part of stage 3 will be a wild acceleration for precious metals in particular. that's because, to quote richard russell, gold is unique because it is moved first by greed, but then by fear.

these processes will take many many years to play out. i just took a look at ej's ka-poom chart, which puts a peak in 2014. whenever it happens, we get the magazine covers, the last peak and drop for commodities, the re-incarnation of paul volcker [if we're lucky], and the worst recession since the 1930's. time to buy bonds.

that recession, with its pullback in prices, may well mark the clear end of u.s. global hegemony, and a shift to a different global system.

that's my science fiction story. i feel a little dumb, or limited, for not being able to think of other alternatives: stocks, real estate, bonds, commodities. and? and this is just the replay-of-the-'70s model. not too creative. other ideas?

Jim Nickerson

09-30-06, 11:20 AM

jk,

I always appreciate your perspectives and your time to make more than brief comments.

Part of what we are all thinking about is what will happen and how to play it.

Today in Barron's which requires subscription, in Abelson's column, he comments on Stephanie Pompoy's (MacroMaven's chief maven) prophesies.

To paraphrase: Deflation in housing market will be worse than the dot-com bust, hitting the US consumer and the financial system with its record exposure to real estate. Current fear of inflation will succumb to fear of deflation with FOMC action to lower rates possibly by Christmas. She thinks these efforts--using Japan and dot-com bubbles as recent examples--will fail because consumers will resist taking on new debt even cheaper debt. A worsening US credit environment will "send liquidity in sharp retreat, taking all assets with it."

She thinks it is high-end consumers who drive discretionary spending, so she'd short Starbucks, go long Spam (Hormel), and long pawn brokers.

Financials involved with home building in any way will be hit. Banks still own 3 trillion Bonars (43% of total assets) and 1 trillion in mortgage backed securities, thus a 55% exposure to real estate. She supposed banks will have to rebuild their loan-loss reserves, now at 20 year lows. [I, JN, do not personally understand the implications of the last sentence.]

Suggestions (hers): short or underweight regional banks, credit card companies and subprime lenders.

She thinks the Feds will be forced to monetize Treasuries (print more money to buy them which is inflationary) while the rest of the world does not devalue their currencies competitively. If that happens the Bonar will start steadily to decline. Assuming that, US investors should seek hard-assets, and certain things--Treasuries, multinationals, and consumer staples may rally, but those rallies will disguise their devaluation in dollar terms.

Simplest answer to play the coming Bonar decline--according to Ms. Pompy: long commodities and short stocks; specifically long gold-index and short bank-stock index. Abelson said she said a lot more, but this is all he shared.

09-30-06, 12:43 PM

Today in Barron's which requires subscription, in Abelson's column, he comments on Stephanie Pompoy's (MacroMaven's chief maven) prophesies.

To paraphrase: Deflation in housing market will be worse than the dot-com bust, hitting the US consumer and the financial system with its record exposure to real estate. Current fear of inflation will succumb to fear of deflation with FOMC action to lower rates possibly by Christmas. She thinks these efforts--using Japan and dot-com bubbles as recent examples--will fail because consumers will resist taking on new debt even cheaper debt. A worsening US credit environment will "send liquidity in sharp retreat, taking all assets with it."

She thinks it is high-end consumers who drive discretionary spending, so she'd short Starbucks, go long Spam (Hormel), and long pawn brokers.

Financials involved with home building in any way will be hit. Banks still own 3 trillion Bonars (43% of total assets) and 1 trillion in mortgage backed securities, thus a 55% exposure to real estate. She supposed banks will have to rebuild their loan-loss reserves, now at 20 year lows. [I, JN, do not personally understand the implications of the last sentence.]

Suggestions (hers): short or underweight regional banks, credit card companies and subprime lenders.

She thinks the Feds will be forced to monetize Treasuries (print more money to buy them which is inflationary) while the rest of the world does not devalue their currencies competitively. If that happens the Bonar will start steadily to decline. Assuming that, US investors should seek hard-assets, and certain things--Treasuries, multinationals, and consumer staples may rally, but those rallies will disguise their devaluation in dollar terms.

Simplest answer to play the coming Bonar decline--according to Ms. Pompy: long commodities and short stocks; specifically long gold-index and short bank-stock index. Abelson said she said a lot more, but this is all he shared.

i also read abelson on pomboy this morning. it sounds like ms. pomboy would fit right in around here. her scenario sounds a lot like ka-poom.

09-30-06, 01:59 PM

speaking of stephanie pomboy- i did a search and came upon this short piece she published at minyanville.com 8/29/06

http://www.minyanville.com/assets/Image/spom8291.png

For those of us whose investment time horizon extends beyond one day, the present environment is -- in a word -- exasperating. Somehow, we just can’t seem to advance the debate. While there is some discussion about whether the housing bubble’s deflation will be orderly or not, the larger issues remain unexplored. Eventually, we console ourselves, the markets will be forced to acknowledge (as they did in 2001) that the bubble’s bust has derivative consequences (e.g., it’s not just homebuilders that are exposed). But will we still be sane and/or solvent when that happens? Only time will tell.

From a less self-interested standpoint: When it does become apparent to all that we are in deep you-know–what, how will the rest of the world respond? Will they, as they did last time ‘round, rush to our rescue, plugging our asset dike with their capital? Or are they about to pull the ripcord on US consumers and this whole vendor-financing gig once and for all?? This is, arguably, the most important question of all. If the rest of the world is willing to ‘go again,’ extending more credit to massively over-extended US consumers, then we just delay the inevitable reckoning another day. If not, the dollar will at last decline unanswered.

While this week’s headline TIC stats suggest no cause for alarm, these aren’t exactly stable flows. We long since lost the stickiest of all capital flows—direct investment. Today, the bulk of our capital inflows come courtesy of foreign speculators stretching for yield (with private sector purchases of non-government paper accounting for 70% of the inflows over the past year) rather than policymakers trying to keep the US flush. One need look no further than China, our chief vendor financier, for proof. The chart above suggests they’re not exactly tripping over themselves to send bucks back to Hank Paulsen & the gang.

The conspicuous gap between the dollars China is taking in and those it is sending back to us, as we all know by now, reflects its purchase of stuff. From investments in infrastructure to spending on welfare programs to filling their SPR, China is using its bucks to buy economic independence rather than US paper. Can you imagine?!

The key, though, is that China is not unique. Developing economies have always had a propensity to spend rather than ‘recycle’ their dollars, holding only 32% of their allocated reserves in dollars versus 74% in the industrial world. And, importantly, dollars are now flowing from industrial to developing nations in record fashion. This would be bad for the dollar (and good for commodities) in normal times, but is bound to be particularly so today. After all, we are in the middle of a Cold War for Resources.

Which brings us to the other potentially-pivotal difference between today and post-bubble 2001. In the formation of the legendary global imbalances over the last 5 years, the world has been flooded with dollars. The result is that, unlike 2001, the world is now desperately SHORT on resources and massively LONG the dollars required to purchase them. Essentially, we have stocked the rest of the world the dollar ammunition it needs to fight the war for resources. Might the U.S., like Stonewall Jackson, inadvertently be done in by its own dollar troops? The idea that a commodity boom could be sustained, much less accelerate, at a time when the US economy is slowing is not one that’s bound to be widely embraced. But given the surplus of dollars … and lack of compelling paper opportunities… it may be a mistake to rule it out.

Of course, dollar bulls will argue that the point is moot. Ya know, the great Petro-dollar recycling story. According to them, the fact that roughly $300 bln a year is being transferred from the hands of our friends (like Japan, Europe, UK, etc) to our enemies (Venezuela, Russia, etc) is actually good news!? Call me crazy. But for folks like Putin and Chavez, buying U.S. financial assets would seem to rank pretty low on the list of things ‘To Do’ with forex reserves. The chart below confirms our suspicions. In fact, one gets the distinct impression that Russia has a cutoff of, say, $10 bln it will ‘recycle’ each year, regardless of how much forex reserves might swell.

http://www.minyanville.com/assets/Image/spom8292.png

To be sure, these dollars will eventually find their way back to the U.S. But, by the time they do they’ll have been man-handled so much they’ll scarcely be recognizable, much less desirable.

In this regard, the current market discourse misses the point. While talking heads engage in a lively debate as to whether the housing bubble deflation will be orderly or dis (orderly), they all share a smug confidence that the answer simply determines how frantically the rest of the world rushes to our rescue. With the cold war for resources underway and the world well-munitioned with the dollars required to fight it, this may prove a rather dangerous assumption.

and this from 9/14
"Looking through the retail sales report the thing that really stands out is the increase in 'grocery stores.' Of the $560 mln increase in Non Auto retail, the food component has accounted for $296 mln (with grocery stores =$200 mln of that). Over the last three months, food has accounted for 33% of the increase in total retail sales and 53% of the increase in NonAuto retail sales."

and in a barron's interview way back in 2/05

the dollar which has heretofore acted as a uniter -- bringing global economies together in the common purpose of debasing their currencies so as to maintain their export audience with the U.S. consumer -- will now become a divider.
As one country after another concludes the destructive consequences aren't worth the reward, it's no longer guaranteed that when we have a weaker dollar, the rest of the world is going to rush to try and weaken their currencies in response; therefore the global-liquidity floodgates will be thrown open, and money will flow like mad. We've now pushed the rest of the world to the point where they've had enough.
So my sense is that, contrary to the conventional wisdom that this sort of global liquidity will continue to flow and a weaker dollar will ensure that this high-beta game keeps going, we will experience the opposite. I think the reflation trade is over, and it's going to be much harder to make money in the year ahead.
Q: But you have been a huge fan of gold. Why own it now if you think the reflation trade is over?
A: Most people view the two as inextricably linked. However, I'm not most people.
I think the reflation trade is over insofar as the rest of the world is no longer going to follow us down the path of the currency debasement. So the global-liquidity spigots will begin to close. However, here in the U.S., we clearly have an agenda to weaken the dollar. Therefore, as someone who resides in the U.S. and earns a living in dollars, I think having gold is a vital hedge against what we are clearly trying to do politically...namely, inflate away our debt.
Q: And are there any fundamental reasons to expect the dollar to continue to go lower?
A: Circling back to my earlier comments on the economy, I believe that we will reach a point where the Fed actually ends up having to reverse course [jk- remember the fed was still tightening when this was written] -- as evidence mounts to suggest that this levered economy simply "can't handle the truth" when it comes to higher rates.
As foreign central banks make fewer appearances at our Treasury auctions, and rates begin to rise, the Fed might soon find itself forced to assume the role of buyer of last resort. Then there's the very real possibility that the retreat of global liquidity precipitates a financial crisis. This, as ever, would surely find the Fed rushing in to mitigate the pain. Any or all of these would further undermine the dollar's already-limited virtues and enhance the appeal of gold. If you believe, as I do, that the dollar is headed lower, $500 gold is really a no-brainer. [jk- "$500" target shows what a difference 18 mos. makes]

PeterM

10-02-06, 07:39 AM

Thanks for referring to Pomboy. Found the MacroMaven site and there are some nice charts there. The 'free' stories appear very well researched and eloquently argumented. I think they see the Ka a little worse than only disflation due to a reduction in the willingness to lend. What I don’t yet understand yet is why they think the other currencies will not devalue and why the Chinese economy will hum along.

I started yesterday to formulate my thoughts based on what JK wrote. It got a little long.

i'd be very interested in ej's, and others', thoughts on this question, too.
Thanks jk, and the others to take the time to write a clear and comprehensible way. Ok, then here are my 2 cts. looking (mainly) from a EU perspective.

my own are that it will go to commodities. if you assume the answer to the inflation/deflation debate is inflation, then you have to assume a weaker dollar. [the alternative is global inflation of all currencies, in which case people all over the world will be looking for stores of value - commodities and especially pms.] so, given a weaker dollar you have americans looking for stores of value domestically, and also competing for global resources with their weaker dollars. sounds like commodities including, but not necessarily "especially," pms.
Assuming it will be Ka-disflation and then Boom-inflation (before deflation takes hold), I am not sure if the US will get away with unilateral currency devaluation. Also I don’t see the decoupling of world economies as Schiff sees it.

First the EU
I see many concurrencies between the US and EU. The regional differences in the EU are probably larger than within the US, but broadly I see hidden inflation, hidden unemployment, real estate bubbles, decreased manufacturing, money expansion, looming baby boomer cost problems, ineffective political processes, etc..
Take e.g. the inflation. The official inflation is now 2% in Holland, but probably this is as bogus as the US numbers. I see an utter disconnect between necessities and gadgets. Going to the shops everything feels distorted. Fresh produce doubled in price during the last years. Processed/imported food items increased less as margins decreased in the chain. What got cheaper is cheap imported Chinese clothing and especially gadgets like DVD players and laptops. A DVD player is now cheaper than a bag of potatoes, milk and some fruit, but how often do you buy a DVD player?
The general public ‘feels’ that everything is more expensive and blames it on the introduction of the Euro, and more recently on the cost of energy. The politicians however wave with inflation statistics that ‘prove’ low inflation.
I reckon that the price of everything that is limited in supply, is rising in a sea of 8% money expansion in the Euro zone. Incidentally this is double the money expansion as agreed in the Euro treaties (but nobody talks about it). The RE bubble in Holland and some other countries is flat the last 4 years and did not yet deflate due to decreasing interest rates, remortgage and heavily advertised lending. The liquidity just moved to the cheap markets (Southern EU, Ireland, Eastern EU) pushing RE out of reach for the local people there. Also gold got more expensive in Euro terms …. what more prove do you need for inflation.

The general public is however oblivious about financials and politicians are cheering the booming economy of 2% growth. During the last months consumer confidence is increasing, but the producer index appears to be stalling/dropping. Unemployment is still high in Germany and decreasing in Holland (but the statistics don't count the disabled workers).
The EU has expanded in size considerably last years which decreased the labor cost base of the Eu zone. Manufacturing is shifting East and laborers are allowed to move into the West resulting in pressure on wages. EU transit truck driving was mostly Dutch but is now mostly done by Eastern European drivers, tradesmen are setting up business in Holland, etc. I see a distribution of the wealth from the West to East, but I yet fail to see a net increase in total wealth over the EU zone. Politicians promoted all this by claiming ‘we in the West’ would do the smart innovative work and ‘they in the East’ (Far East) the production. But, unfortunately only a small fraction of the population has the capacities and/or the education to do this ‘smart’ work. Personally I see a lot of financial and political problems coming from the speedy integration of too many countries.

Part of the EU output is going to the US; if US demand drops I don’t see other customers who will pick up the slack. Also some business fundamentals appear shaky to me, as they are based on tariffs and politics. E.g. a growing business in Holland is assembly. Who would have thought? If you bring complete electronic devices to the EU you pay steep import duties, so …. import the chunks, screw it together and presto you have a EU product (with much lower total import duties). Also these products are exported as EU products. I don’t know the volumes, but I am pretty sure that the EU economy would take a hit if the US slows. Except probably for the production of real luxury goods.
With respect to EU bank actions, I think they will talk tough but in the end they will inflate and devalue too, to limit the difference between the bonar and the Euro.

Russia
I think Russia is a wild card, but based on what I have read and my visits there, I don’t see them picking up any demand destruction in the US. There is a very wealthy minority in some cities that will keep buying extravagant expensive stuff, but the majority of people outside Moscow is still poor. I think their currency will remain strong as long as the world thinks they have oil (which might be less than generally assumed), and as long as the power plays of Putin and others don’t disturb the perception of a working Russian market/economy too much. I assume that they will spend more on military capabilities or invest in defense industry over the coming years, but I consider it unlikely that they will buy the Chinese stuff that the US now imports.

Latin America
I read somewhere (can’t find the link) that some LATAM economies are heavily dependent on money being sent home from (undocumented) workers in the US. If the US reduces consumption, building activity, restaurant visits, etc., I would expect less work and income for these people, and hence less spending power of their relatives abroad.
The Mexican economy might have an extra problem now their wealth proving Cantarell oil-field is starting its decline. That should reduce the possibilities for further governmental economic ‘stimulation’ by pet projects and social expenditures. State lending will of course be the preferred option, but that would devalue the peso against the bonar. Competative devaluation race between bonars and pesars?
Brazil, Argentine, Venezuela etc. have money, economy doing good now, but I don’t see a customer base for buying the Chinese products that are now produced for the US. The have cheap labor available locally.

The strong point in these economies is that, as region, they are less dependent on oil imports, have minerals, and may-be most important water and agricultural crops (food).
This might be a region where I would expect that liquidity would flow too. The only problem I see (from the point of money masters) is the communist tendencies of some governments. But that probably something that money can be ‘solve’.

Another aspect that I think is often not addressed when people talk about other countries picking up the US demand, is the logistical part of China export and US import. When I think about the US infrastructure and distribution system (including all the way up to WallMarts everywhere), I don't think that LATAM or Russia has the infrastructure to get cheap Chinese products to the people. That kind of retail infrastructure is not in place outside the capital cities.

Canada
Good place to be, but not very relevant with respect to customer demand.

Australia
Good place, but some debt bubble problems. No oil, but plenty coal, agriculture. But again not relevant with respect to customer demand.

Middle East
Lot of money, but in a few hands.

Africa
Too poor to act as customers. No logistical / retail system.

Japan
Some demand may come from Japan as economy finally appears to be on the rise (pent up demand?) and there are 128 milllion consumers. Japan already trades a lot with China and the retail infrastructure is in place. My concern with Japan is the demographics and public debt at 150% of GDP. In 2004 the population started to decrease, so I would expect less need for more or bigger housing (no asset inflating housing booms anymore). Also people are very aware of the need to save for their retirements, as there will be less people to take care of them. It is estimated that the population will drop 50% over the next 70 years.
Also don’t forget that Japan still holds 750 Billion US treasuries and 80 Billion Agencies (this is more than double of what China has). What will happen with this 'paper wealth' if the bonar drops? How resilient will the spending power be?
BTW I always wonder why we single out China as our vendor-lender partner??

So what is left?
In my perception, the only customer base that could replace the US is the exporting Far East itself (China, India, Indonesia, etc.). By sheer numbers 1% demand increase of 2.5 billion people is as much as 10% demand decrease in 250 million people.
I see however several caveats:
- the preceding numbers only work when salaries, salary structure, taxation, etc. are somewhere equivalent… which is not. Vast numbers are still very poor.
- Is the Chinese production or rather overproduction capacity geared to stuff that the Chinese want/need. If not how fast can they retool their production capacity. E.g. IMO the Chinese market/infrastructure/demand is not yet ready for widespread use of 2 meter home cinema sets. Their desires might just be a little more limited.
I think you should look more to the Chinese as other countries that went through an industrial transition. What are the first needs and wants? I would first expect a desire for better food (more meat, especially poultry) and transportation (mopeds). Both involve the use of limited commodities. I will address this point later.
- As the inflow of bonars decreases and the bonar reserve decreases due to devaluation, how long will the reserves last to keep buying the required input? Of will they start to print money too?
- Can their banking system absorb the shock? As I understand there is a lot of bad debt in the system.
- As the rate of economic expansion decreases, how will China cope with their disappointed citizens that not yet benefited from the boom? Increased internal tension, followed by a need for a publicly acceptable external enemy?
- If they can’t export, will they build more public infrastructure or will rhetoric and defense spending increase?
Too many questions, and I don’t know much about China. Would love to hear your input.

alternatives 1 - if we assume low, low rates, then housing can be pumped up to a degree, softening the housing decline, but can it become a repeat bubble? it is hard to see speculators jumping right back in after their recent scare. but perhaps i am crediting people with too much rationality. i'm thinking of the people in the anecdote related at safehaven, in a link supplied by jim nickerson: these were ordinary folks, with not a lot of income, who had leveraged themselves into 5 properties around the san diego area, with a total mortgage debt of $3.6million. i think the psychology isn't right, though. a bubble has to build to a widespread belief in the inevitability of ever rising prices. there have been too many newspaper articles about the housing bubble popping: it would take years for that to reverse. .

I would agree completely from my EU (somewhat more frugal perspective), but the US consumer did surprise me so far in the desire to take on debt.

alternatives 2 - stocks? this seems somewhat more plausible for a repeat performance. a lot depends on what happens in the stock market between now and then. there is apparently some noise being made even now about the dow approaching its old high. if the stock market isn't hit too badly between now and when the pumps get turned on, then i could see equities moving up a lot. it's been several years since people were swearing "never again" about the stock market. it seems more likely, however, that stocks will be hit hard BEFORE the pumps are turned on. their decline will be one of the triggers that elicit the inflationary response. in that scenario, in which the stock market will be hit hard AGAIN before the inflation, it's hard to see the public wave of enthusiasm settling on stocks.
Agree again, however some questions:
-How relevant is J6P for the stock market (was it 80% program trading now)?
-Where does J6P get the money from to put in the stock market. Will he get margin again to leverage himself?
-What will happen to the willingness to lend (provide margin) and the willingness to take debt/risk?
I can image the stock market going up (in numbers, but falling in gold terms). But is the stock market the real economy, or is it a financial mirage of proprietary bank trading, taking hedge funds and pension funds taking to the cleaner. Legalized rigged robbing.

Alternative 2b- foreign stocks. this seems more plausible. if the dollar is weak but we don't have global runaway inflation, then other economies may be growing in a relatively healthy way. [could they really? with a sick economy in the u.s.? let's assume so.] also, the declining dollar will translate into rising foreign equity prices from the american viewpoint. it's hard to see a broad interest in foreign stocks, americans are in general too insular, but foreign stocks will have a following. american demand for e.g. asian stocks will add to the currency effect and push up those stocks even in terms of their base currencies. so there will be substantial bull market in foreign stocks. the strength of this move will depend on how fast the dollar declines- if the dollar drops too quickly it won't work.
Looks better than US stocks to me. But for me not EU, Russia, not ME, … what then?
May-be Canadian, Australian, Brasil in with emphasis on PM, energy (longer term), and food.

the recent commodity moves are most likely a precursor to the big commodity wave to come. looking at multidecade charts the recent peaks are not all that high. for all that some commentators have labelled gold's move, for example, as "a bubble," it never got close to widespread public ownership and enthusiasm.
i think commodities have completed stage 1 of a 3 stage move. their ownership to date has been restricted to enthusiasts and speculators. the great majority of day-to-day market participants never touched them.

the slowdown or recession which we are now entering, along with the pullback in commodity prices, marks the shift to stage 2. stage 2 will be the institutionalization of the commodities markets. commodities will be legitimized as mainstream investments. ownership will broaden significantly, but will not reach the man in the street. thus the rise should be relatively orderly.

another slowdown or recession, accompanied by another pullback in prices, will mark the shift to stage 3. in stage 3 there will be a wave of new mutual fund offerings, helping the public get on board. fraudulant junior mining companies will be floated on smaller exchanges around the world. the price of gold will again be announced every half hour on the radio business reports. the newsweeklies will run articles on the commodities markets [but not a cover, yet].

the last part of stage 3 will be a wild acceleration for precious metals in particular. that's because, to quote richard russell, gold is unique because it is moved first by greed, but then by fear.

these processes will take many many years to play out. i just took a look at ej's ka-poom chart, which puts a peak in 2014. whenever it happens, we get the magazine covers, the last peak and drop for commodities, the re-incarnation of paul volcker [if we're lucky], and the worst recession since the 1930's. time to buy bonds.

that recession, with its pullback in prices, may well mark the clear end of lace w:st="on">u.s.lace> global hegemony, and a shift to a different global system.

Yep, I pretty much agree with that. But I don’t know about the timing … Who does??
BTW the bottom chart on page 14 on MacroMaven http://www.macromavens.com/reports/FinancialConditionsChartwrap.8.4.06.pdf
gives some perspective on how low the CRB still is compared to stocks.
Sorry, extracted the chart with SnagIt but could not figure out how to copy the chart into this mail. :o.
http://www.itulip.com/forums/z:/crb.jpg

But I see some major potential wrenches that may influence the process and the outcome.
1. War. I try to be positive and non-conspiracy but I get the chills of the things that happened last years, the rhetoric of some governments and the lack of reaction of the masses. I really wonder if we will not have war before 2014. May be I read too much history but if the last 5 years rhyme with historic events such as the Reichsbrand, Gladio, Tonkin, etc. we are on the wrong track.

2. Peak-oil and the realization that even IF peak-oil is not yet here, the demand increase from China just does not match with any potential supply. May be recession will give us some reprieve due to temporary demand destruction. Unfortunately that may just be enough to kill recently started alternative energy projects instead of increasing efforts to find alternatives. I was involved in a large multi-year study for bio-fuel opportunities etc. and looked at all alternatives. I far as I know there just are NO short/medium term feasible alternatives out there to mitigate the demand/supply gap.

3. Internal unrest, when people in the West realize they have to abandon their their energy intensive way of life. And upheaval in China etc. when the people there realize they will never get an opportunity to live a life they dreamed of, and as portrayed in all those shows on the television.
A drop in cheap fly-tourism, which will leave touristic areas like Egypt Red Sea and Turkey with high unemployment. There just is nothing there besides sand, sea and concrete. More desperate Islamic people?
I don’t know what the parallel in the US would be.

Of course for some (especially the well prepared) life will go on. And the hardship might even bring back some virtues neglected in our individualistic, commercial society.

that's my science fiction story. i feel a little dumb, or limited, for not being able to think of other alternatives: stocks, real estate, bonds, commodities. and? and this is just the replay-of-the-'70s model. not too creative. other ideas?
In the 70s I was still at school, happily ignorant of any economics. My science fiction book would agree on commodities, but more than only PM. I would agree on gold for hedging against the devaluation of most currencies, and as transportable wealth in crises. But unfortunately you cannot eat or drink gold.

In my (slightly pessimistic) fictional book I see much higher energy prices, impacting the way we live (how to commute to and A/C a 3000ft McMansion in exurbia?) but also a huge impact on the price and sorts of food we eat.
I expect a sharp rise in the cost of food production (fertilizer production cost is 70% energy, running the tractors, transporting it to processing plants, getting the water, etc. all requires energy). The increased fertilizer cost will IMO lead to lower application rates and decreased average acreage production. Furthermore the biofuel demand might decrease acreage now allocated for food. The import of food (and feed raw materials) will get more expensive.
And don't forget the energy cost in food processing (e.g. evaporation in corn syrup production, spray drying of soy isolate, ring drying of starch, etc.). Note that this also cuts into the whole structure of food industry that is now optimized on few plants, lot of drying, no inventory and long transport. Where possible membrane technology will replace heat based concentration.
IMO this will also result in other products on the shelves. No 2000 mile Cesar Salad anymore. No fresh crab legs in Vegas casino's.

Furthermore this will be happen against a backdrop of increased international demand for better food (more animal protein) and energy from the Chinese.

Such things are long term scenarios but thinking about it may help to register developments. In the mean time don't forget to enjoy.
It will be interesting years ahead.

Jim Nickerson

10-02-06, 09:05 AM

Peter,

No need to ask what you did this weekend. Nice of you to put down your broad, thoughtful perceptions.

When I think about all these problems and possbile answers, I conclude the final answers will be forced upon people.

At some point part of the answer to the world's problem has to be a reduction in the number of people on earth--whether by wars, plague, flu--something has to reduce the number of people utilizing the supply of stuff--needed stuff:food, water, air.

Food needs to be grown near where people are and those who grow their own stuff may be the long-term survivors.

I inquired as to subscription rates at Macromavens.com. 25K bonars a year, or just 10K for a 6-month trial. So much for that.

FRED

10-02-06, 09:50 AM

Posted for John Serrapere by Fred...

Rome, Spain, and Holland Empires experienced economic woes after their coins became global currencies and they quit producing/exporting goods. All of their economies were dominated by financial sector speculation (GDPs). Britain to a lesser degree experienced same from 1880-1921. Production was left to their subject nations/colonies because they could do it cheaply, which lowered inflation and fostered financial speculation (funding military conquests and expanding trade rooted in foreign centers of production) much like the USA and Britain today.

Their empires ran great trade deficits and ran up huge debts and these imbalances were sustained in some cases for 50 or more years. Their low savings rates guaranteed debtors with huge burdens while the high savers (producers) had low debts and high production, which enabled them to exchange “hedgehog coins” for their own appreciating currencies. The producers later went own to rein over their masters after they developed their own economies that were balanced in export-import exchange.

Jim Nickerson

10-02-06, 12:09 PM

The more the merrier, and the bleaker the future.

U.S. population to top 300 million this month

http://news.yahoo.com/s/nm/20061002/ts_nm/environment_population_dc

Whether the 300 millionth U.S. person is added by immigration or by being born in the United States, the expected absolute number of Americans prompted a report by the non-profit Center for Environment and Population.
The report's author, Victoria Markham, noted that the United States is the only industrialized nation with significant population growth. The vast majority of the world's population rise -- about 98 percent -- is in poor countries, she said.
"In combination with our very high rates of natural resource consumption and the associated pollution, that results in America having the highest per capita environmental impact in the world," Markham said in a telephone interview.

NUMBERS DON'T TELL THE WHOLE STORY
Sheer numbers of human beings don't necessarily have the heaviest impact on the environment; instead, environmental impact is a calculation that involves population, affluence and technology, the report said.
In the areas of land-use, water, biodiversity, forests, fisheries and aquatic resources, Americans are consuming more than they did in the past. The report found:
-- Each American occupies 20 percent more developed land -- housing, schools, shopping and roads -- than 20 years ago.
-- Each American uses three times as much water as the world average; over half the original wetlands in the United States have been lost, mainly due to urban and suburban development and agriculture.
-- Half the continental United States can no longer support its original vegetation; nearly 1,000 plant and animal species are listed by the U.S. government as endangered or threatened, with 85 percent of those due to habitat loss or alteration.
-- The United States consumes nearly 25 percent of the world's energy, though it has only 5 percent of the world's population, and has the highest per capita oil consumption worldwide.
-- Each American produces about 5 pounds (2.3 kilogram) of trash a day, up from about 3 pounds (1.4 kilogram) in 1960; the current rate is about five times that in developing countries

and this is the kicker

After U.S. population hit 200 million in 1967, Paul Erlich gained notoriety with a book called "The Population Bomb," which predicted mass starvation due to population growth.
No such dire warnings accompany the center's report, Markham said. "We aren't saying there's too many of us," Markham said. "We were trying to step back and take a look at the broad picture and at the population trends and the scientific data."

To me the emphasized sentences [my emphasis] demonstrate behavior of an idiot.

Jim Nickerson

10-02-06, 12:40 PM

http://www.financialsense.com/fsu/editorials/west/2006/images/1002.h8.gif

So infers James West today @

http://www.financialsense.com/fsu/editorials/west/2006/1002.html

I find West's reports focusing on COT data offer a bit different perspective than most other things I read.

Jim Nickerson

10-02-06, 01:29 PM

10-02-06, 07:01 PM

PeterM

10-03-06, 05:37 AM

peterm, thanks for your long post. it's terrific. a few comments:

you ask how the u.s. could get away with a unilateral devaluation. as i understand pomboy's analysis, from the stuff i posted and some other stuff of hers i've since come across, the issue has to do with the fact that oil is priced in dollars. if china pushes up the dollar, it is also pushing up the cost of the oil it imports. that might be worthwhile for a huge u.s. market for its exports. as the u.s. economy slows and consumption is reduced, what is the incentive for china to keep supporting the dollar? they will lose more on the cost of oil imports than they gain in exports. the issue isn't unilateral devaluation initiated by the u.s., it's the withdrawal of support for the dollar by our vendor financiers.
I have trouble to understand why the cost of oil import is pushed up if the dollar rises. I would expect the value of oil to be dependent on supply/demand, indirectly priced based on the mix of international currencies used by the buyers, and contracted in dollar terms.
Suppose China stops supporting the dollar and the value of the dollar is halved unilateraly. I then would expect the oil price in dollars to double as the suppliers still want the same value. But the price denominated in gold or other currencies would remain the same.
This would of course also halve the value of all paper 'assets' denominated of dollars. Which will hurt Japan first and then China.

I remember some similar debates about dollar-pricing of oil, but then related to a potential euro-priced oil bourse in Iran. Some said this would be dangerous for the dollar as there would be less demand for dollars.
Others claimed that it would not matter as anybody could make the contract in dollars, and the moment of the deal convert the payment into Euros and hedge the currency effects in the financial market. I tend to agree with the latter.

if the chinese indeed allow their currency to appreciate as the u.s. consumer market implodes, however, they will have increased buying power vis a vis global commodities. and they have a hoard of a trillion dollars or so to go shopping with. a military build-up can absorb some of their workforce and productive capacity. plus this supplies part of the answer to your question about how the chinese will be able to purchase oil: they will sell weapons and [e.g. nuclear?] technology. note that hugo chavez just went on a weapons shopping trip to russia and china. [/qoute]

If the Chinese appreciate their currency compared to the US the cost of their products for US consumers will increase, probably resulting in lower sales. The same if they appreciates compared to other currencies. In my book this might decrease rather than increase buying power viv a vis global commodidies.

For sure they have a lot of dollars, but the spending power of these dollars might be reduced in future.

Regarding military build-up. Yep, in history that is a well proven way to absorb workforce. And indeed, good point about exporting militar hardware and nuclear technology. I think China is leading now in the development of pebble-bed reactors. Which is yet another pointer to the independent knowledge development in a previously 'me too & copy' economy.

[qoute]As for foreign stocks, you mention canada, australia and brazil, but neglect to mention the asian markets- singapore, thailand, viet nam, china, japan, taiwan, korea. all those markets should do well.. eventually. the difficulty is predicting whether a global recession will hit them before they take true leadership away from the american markets.
I mentioned Japan and China, not the others. It was long enough already :) and I don't know too much about the others.
Singapore with only 4 million people is not very relevant in the demand picture. They don't have any resources expect human labour. Don't know much about the companies on the stock exchange there.

Thailand, Vietnam ,Taiwan and Korea appear interesting to me, and I certainly expect them to be part of the next world economy. Appears a good place to invest to me, but not yet. I too wonder if they will be hit by a potential rippling globl recession IF US demand would slow.
From what I read, I expect less impact than on China as their economies are probably more diversified, with more developed internal markets.

10-03-06, 06:39 AM

I have trouble to understand why the cost of oil import is pushed up if the dollar rises. I would expect the value of oil to be dependent on supply/demand, indirectly priced based on the mix of international currencies used by the buyers, and contracted in dollar terms.
Suppose China stops supporting the dollar and the value of the dollar is halved unilateraly. I then would expect the oil price in dollars to double as the suppliers still want the same value. But the price denominated in gold or other currencies would remain the same.
This would of course also halve the value of all paper 'assets' denominated of dollars. Which will hurt Japan first and then China.

if the dollar depreciates then, yes, the price of oil will rise in dollars. but the depreciating dollar will be a symptom of a weakened u.s. economy, with lower demand for oil. thus global demand should drop and the global price of oil with it. for americans the price will rise, for everyone else it will fall.

for the chinese, to support the dollar is to support u.s. demand, and thus support the cost of oil. this is worth it for a huge u.s. export market. otherwise, it's not worth it. also the pool of dollars brought into china by chinese exports will shrink. for the chinese to support the dollar in the face of lower u.s. demand, they would have to buy dollars from others on the open market, and add to their dollar hoard without having the offsetting benefit of exports. why not, instead, spend the dollars on global commodities, as long as anyone is willing to accept them? watching the dollar slide lower, china and japan are going to develop a might itch to spend the dollars they have, putting further pressure on the dollar's value.

PeterM

10-03-06, 08:09 AM

if the dollar depreciates then, yes, the price of oil will rise in dollars. but the depreciating dollar will be a symptom of a weakened u.s. economy, with lower demand for oil. thus global demand should drop and the global price of oil with it. for americans the price will rise, for everyone else it will fall.

for the chinese, to support the dollar is to support u.s. demand, and thus support the cost of oil. this is worth it for a huge u.s. export market. otherwise, it's not worth it. also the pool of dollars brought into china by chinese exports will shrink. for the chinese to support the dollar in the face of lower u.s. demand, they would have to buy dollars from others on the open market, and add to their dollar hoard without having the offsetting benefit of exports. why not, instead, spend the dollars on global commodities, as long as anyone is willing to accept them? watching the dollar slide lower, china and japan are going to develop a might itch to spend the dollars they have, putting further pressure on the dollar's value.
With this I agree completely. I might have misread your reference to Pomboy. I read it as a statement from Pomboy that it was a 'pricing in dollars' issue.

Jim Nickerson

10-03-06, 03:19 PM

It seems a lot of individuals are expecting the dollar to weaken.

If one looks at the Japanese Yen in Q1 1990 it was about 160 to the US Bonar. It definitely strengthened as the Nikkei collapsed, in fact it doubled in value against the Bonar by first half of 1995.

http://bigcharts.marketwatch.com/intchart/frames/frames.asp?symb=C_JPY

(I just noted, url above doesn't give you the chart I want, you have to select "time frame" > "All Data" > Draw Chart)

How does one explain that? And were the US markets to relatively collapse from around where they are now--DJI and SPX at multiyear highs--why would the Bonar not increase in value, as the Yen did?

I posted this a day or so ago, and it hasn't evoked any response, and I would appreciate someone's thoughts, if anyone has a thought. Below is a link to the US Bonar since 2000. Since 01/2004 the Bonar seems to have put in a reverse head and shoulders, and the RSI and MACD both appear positive to me. With all the debt we have it seems improbable that the Bonar is strengthening, but it seems to be.

Current Bonar chart.
http://stockcharts.com/h-sc/ui?s=$USD&p=D&st=2000-01-01&id=p40400013016&a=80445168

bart

10-03-06, 04:20 PM

I posted this a day or so ago, and it hasn't evoked any response, and I would appreciate someone's thoughts, if anyone has a thought. Below is a link to the US Bonar since 2000. Since 01/2004 the Bonar seems to have put in a reverse head and shoulders, and the RSI and MACD both appear positive to me. With all the debt we have it seems improbable that the Bonar is strengthening, but it seems to be.

Current Bonar chart.
http://stockcharts.com/h-sc/ui?s=$USD&p=D&st=2000-01-01&id=p40400013016&a=80445168

I'll see that chart and raise you this one to chew on: ;)

http://www.nowandfutures.com/images/nikkei_10_year_bond.png

Here's a key chart in my book on the dollar - its how many dollars all major central banks are holding as a percent of their overall reserves:

http://www.nowandfutures.com/images/cofer_dollars.png

10-03-06, 07:14 PM

Jim Nickerson

10-03-06, 10:59 PM

http://i89.photobucket.com/albums/k216/jklugmn/interestrates.gif

u.s. interest rates have been supporting the dollar. when the housing bust forces rates lower, that prop will be kicked out from underneath.

The cyberspace in which I look is filled with stories to no end of the "housing bust." The "bust" strikes me as a fait accompli as well as is the "fact" that the FOMC is going to lower rates, likely sooner rather than later. What if the housing bubble doesn't burst because the Fed doesn't let it? Asked another way, is it impossible for the Fed to stop the housing bubble from bursting? What if the indomitable US consumer finds a way to keep on going to the mall and buying stuff?

It appears a lots of folks think and have thought the Bonar is doomed, but despite predictions (see jk's post above #18 for details of Stepahie Pompoy's sentiment 02/05--now 20 months ago), the Bonar is as high or a bit higher now as it was in 02/05, and for the most part over this time has been higher, and at the moment seems set to go up still.
http://stockcharts.com/h-sc/ui?s=$USD&p=D&yr=2&mn=0&dy=0&id=p

10-04-06, 05:51 PM

The cyberspace in which I look is filled with stories to no end of the "housing bust." The "bust" strikes me as a fait accompli as well as is the "fact" that the FOMC is going to lower rates, likely sooner rather than later. What if the housing bubble doesn't burst because the Fed doesn't let it? Asked another way, is it impossible for the Fed to stop the housing bubble from bursting? What if the indomitable US consumer finds a way to keep on going to the mall and buying stuff?

It appears a lots of folks think and have thought the Bonar is doomed, but despite predictions (see jk's post above #18 for details of Stepahie Pompoy's sentiment 02/05--now 20 months ago), the Bonar is as high or a bit higher now as it was in 02/05, and for the most part over this time has been higher, and at the moment seems set to go up still.
http://stockcharts.com/h-sc/ui?s=$USD&p=D&yr=2&mn=0&dy=0&id=p
housing is finally rolling over but it has to happen slowly at first. unlike a stock market in which there is liquidity and continuous pricing, the illiquid and lumpy nature of real estate makes the sellers disbelievers when told prices have to go lower. so there is instead a sharp reduction in transaction volume. in the meantime, inventory continues to rise sharply. so i think it's still early days in the housing bust. imo, the inventory overhang and the fear put into speculators prevent the re-inflation of the housing bubble any time soon.

lower rates have increased mortgage applications [reported today in a daily news with antispin post, i believe]. the ability to refinance now, before prices drop that much and in time to head off resets on a.r.m.s will soften the blow to the economy. [perhaps this moderating feedback is part of why ej says disinflation but no deflation.]

i've learned that everything, at least every big thing, in the markets takes much longer than i expect. i remember reading the barron's roundtable some time in the late 1980's. paul tudor jones was on the panel and said he wasn't going to recommend shorting the nikkei that year, because he'd recommended it the prior 3 years and it just kept going up. eventually, of course, it went down. a lot. but as keynes is famous for saying, the market can stay irrational longer than you can stay solvent.

i still think the dollar is doomed. eventually. the trick is to stay solvent long enough to cash in. in a crisis old habits may drive investors to the "safety" of the u.s. dollar, so the dollar could go up. a lot. so i can't bet the farm on the dollar's fall.

what's the difference between being patient as an investor and being stubborn as an investor? 1. whether you're right. that is, whether what you expect indeed comes to pass. 2. whether you're still financially healthy enough when the time comes to take advantage of your prediction.

medved

10-05-06, 03:44 AM

housing is finally rolling over but it has to happen slowly at first. unlike a stock market in which there is liquidity and continuous pricing, the illiquid and lumpy nature of real estate makes the sellers disbelievers when told prices have to go lower. so there is instead a sharp reduction in transaction volume. in the meantime, inventory continues to rise sharply. so i think it's still early days in the housing bust. imo, the inventory overhang and the fear put into speculators prevent the re-inflation of the housing bubble any time soon.

This is what's going to happen, IMHO:

1. The bubble continues to deflate slowly.

2. As it approaches a critical level, the Fed, the gov't and the media get into action: excesses are blamed on the mortgage fraud, greedy speculators, uneducated massses etc. (similar to NASDAQ bubble).

3. Speculators/flippers get to feel some (or a lot of) pain, some little fish in banking/RE industry gets caught and fried. Some losses in the financial system are acknowledged and marked to market (not a big deal, because the risk was spread through the derivatives and passed to the big weak hands like pension funds).

4. Everybody is sure, RE market will collapse tomorrow, all realtors are criminals and renting is cool.

5. Fed begins (or continues) reducing interest rates. Gov't (most likely, Democrats) introduces new wonderful programs to help the affected communities. REO houses are bought by HUD, distressed homeowners get to refinance their loans at new subsidized rates etc., etc. Something like housing PPT.

6. In spite of low rates and subsidies nobody except professional RE speculators invests in housing. Precisely what the gov't and Fed needs: now, with the housing bubble out of the way, the *real* rates go down real hard.

7. If real low rates do not help, non-traditional measures (black helicopters) are used to reflate the economy. Another Ka is over, another poO begins.

8. At this point we enter unknown territory. Not many people predicted the housing bubble after stock market crash. Not many people can predict now, what's going to happen after housing Ka ('the next bubble' conundrum). What we do know, is the housing bubble will not be back, but neither will the housing crash. I am ready to believe, this process will repeat more, than once, in different markets, with different Ka's and poO's. This is what I call 'the KapoOKapoO correction of the KaPoom theory'.

i still think the dollar is doomed. eventually. the trick is to stay solvent long enough to cash in. in a crisis old habits may drive investors to the "safety" of the u.s. dollar, so the dollar could go up. a lot. so i can't bet the farm on the dollar's fall.

The dollar *is* doomed, but not the dollar-denominated US assets. Investors *will* be driven to the safety of US assets, but the US gov't will take care of the dollar and put it out of its misery. This combination of highly valued US assets and low-life US currency is what I call 'the M paradox of the KaPoom theory'.

Right now I just stick to PM, commodities and cash, and trying to find some decent dividend-paying companies in Canada and US. When we get to the point 6 described above, I may think of buyng a rental property.

m.

Jim Nickerson

10-05-06, 08:21 AM

The dollar *is* doomed, but not the dollar-denominated US assets. Investors *will* be driven to the safety of US assets, but the US gov't will take care of the dollar and put it out of its misery. This combination of highly valued US assets and low-life US currency is what I call 'the M paradox of the KaPoom theory'.

Right now I just stick to PM, commodities and cash, and trying to find some decent dividend-paying companies in Canada and US. When we get to the point 6 described above, I may think of buyng a rental property.

m.

What do you mean: "the government will take the care of the Bonar and put it out of its misery"?

medved

10-05-06, 08:03 PM

What do you mean: "the government will take the care of the Bonar and put it out of its misery"?

I mean, no matter demand for the safe haven currency, the US gov't will always issue enough of it to destroy the value of this currency.

m.