Overheating or Under Control?

The Daily Reckoning – Weekend Edition
April 21-22, 2007
Los Angeles, California
by Kate “Short Fuse” Incontrera

VIEWS FROM THE FUSE: OVERHEATING OR UNDER CONTROL?

We mentioned earlier this week that even with all the analysts, experts and number crunchers out there, sometimes the markets take everyone by surprise.

China did just that this week, as a report released on Thursday showed that China’s economy had grown at 11.1% during the first quarter of 2007. This was much faster than most expected, and spurred fears that China’s economy is threatening to overheat.

While many benefit from this boom, this rapid growth worries investors who bank on a sustained and steady rise in the Chinese economy. As we always say, generally the force of the correction is equal and opposite to the trend that precedes it. And the pain it causes is directly proportional to the pleasant deception before it.

In other words, if the Chinese economy continues to go up, up, up at this pace, who’s to say it won’t tumble down with a fast and furious ‘thud’?

The fear of out of control inflation also has investors spooked. TIME writes, “…is China’s growth so strong that it is going to fuel inflation, followed by sharply higher interest rates, and conceivably, problems in a deeply dysfunctional domestic banking system? And will there be a hard-landing, meaning a sharp reduction in growth from around 11% to anywhere between 6% and 8%?”

That is what is at the root of these concerns: the hard landing, or the aforementioned ‘thud’. With China vying for the spot as the world’s third-largest economy, after the United States and Japan, a hard landing would be hard on the entire global economy.

The consensus with Chinese economists and foreign market experts, though, is that there is time to steady this surging economy – if they take the correct measures. A couple more interest rate hikes this year, along with further tightening measures seem to be the solution.

Our resident global market guru, EverBank’s Chuck Butler, had this to say:

“Investment in China continues to be off the charts. And now something that I’ve warned about for some time now is beginning to take shape. Inflation in China has accelerated to 3.3%. The Chinese Central Bank does have a ceiling target on inflation of 3%. So, obviously this exceeds that ceiling. I wonder what the Chinese will do about this?

“Well, you know my solution. It’s the same one that I’ve had for as long as I’ve been warning about the surging inflation in China – to allow the currency to strengthen. A strong currency goes a long way toward keeping inflation in line. Look what it did for the United States in the late ’90s and into the new millennium. The U.S. economy was rocking and rolling, and the dollar was strong. Inflation wasn’t the problem it is today, with the dollar much weaker, eh?

“When it all adds up, the amazing 11.1% growth in China is going to throw gasoline on the fire that’s already lit under commodities.”

Short Fuse
The Daily Reckoning

P.S. We still think there is plenty of opportunity for safe and profitable investment in the Far East…if you know where to look. But don’t take it from us – all of your favorite DR experts with be speaking about the best ways to play the Asian profit opportunity of a lifetime at this year’s Agora Financial Investment Symposium, where the topic is “Rim of Fire: Crisis & Opportunity in the New Asian Era.”

The Symposium is taking place at the Fairmont Hotel in Vancouver, British Columbia, July 24 – 27. Secure your spot now, and receive $200 off the regular price of admission. Call Agora Travel at 800-926-6575 to be added to the list right away.

— The Daily Reckoning Book of the Week —

American Theocracy: The Peril and Politics of Radical Religion, Oil, and Borrowed Money in the 21stCentury

by Kevin Phillips

The title of political analyst Phillips’s latest book may overstate his case (in the text, he prefers the term “theocratic direction”), but his analysis likely will strike chords among those troubled by our current political moment.

Phillips (American Dynasty) expounds upon historical parallels for each of his three subjects. In his section on “Oil and American Supremacy,” for example, he points to Britain’s post-WWI involvement in the Middle East as an analogy to Iraq, and in his section on radicalized religion, he warns of “the pitfalls of imperial Christian overreach from Rome to Britain.”

The five major measures of U.S. debt-from national to household-keep setting records, he observes in his section on “Borrowed Prosperity,” and the real estate boom spurred by the Federal Reserve, he argues, cannot continue. Phillips identifies the escalating clout of the financial services industry and suggests that Americans should emulate policies in Asia that encourage savings and in Europe that encourage manufacturing. The lesson of the past, he warns, is that intractable national issues “generate weak and compromising politicians or zealous bumblers.”

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THIS WEEK in THE DAILY RECKONING: Caught a bit of spring fever and missed an issue of The Daily Reckoning? No worries…we have all five issues from this week for you, below…

Globalization and Its Discontents                    04/20/07
by Bill Bonner

“Globalization is nothing more than the extension of the division of labor across international boundaries. However, in this DR classique from April of 2005, Bill Bonner asserts that in modern America, globalization means the rest of the world sends you things you don’t have to pay for. Read on…”

Standby Commodities                                        04/19/07
by Kevin Kerr

“There are certain commodities that are staples of trading…beef…sugar…soybeans, etc. Kevin Kerr asserts that all investors should know these sectors and be very comfortable with them. Read on…”

The Energy Predicament                                   04/18/07
by James Howard Kunstler

“Oil prices ended pretty much where they began last year, reassuring the American public that the Peak Oil debate is easily dismissible. However, James Howard Kunstler points out that there are ominous trends that contributed to the stall in oil prices. Read on…”

Oil Booms and Busts                                           04/17/07
by Byron King

“Over the past 25 years, the ‘growth’ in oil reserves estimated to be in existing oil fields has actually exceeded the additions to reserves from new discoveries. The implication is that the existing oil fields of the world are as important, and maybe even more important, than the prospective new discoveries out in wildcat country. Byron King explores…”

Expensive Ethanol Eggs                                       04/16/07
by The Mogambo Guru

“It’s true; eggs are both incredible, and edible. But lately, they’re also very pricey. This week, the Mogambo discovers why ethanol is the reason you might soon be spending $19.95 on a Denver Omelet.”

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FLOTSAM AND JETSAM: On Thursday, the dollar sunk to a 26-year low against the British pound. At the same time, the Dow Jones industrial average made a new high. Chris Mayer explores…

Dollar Woes Continue
by Chris Mayer

On Thursday, the dollar sunk to a 26-year low against the British pound. At the same time, the Dow Jones industrial average made a new high.

Most investors never think about the way in which these two facts tie together. The bottom line is that a weaker dollar makes the stock market’s returns look a lot better than they are.

If you factor in currency changes, dramatic things happen to stock market returns. Since 2000, the dollar has lost 39% of its value, according to today’s Financial Times. One result of this is that investors who have parked money overseas have done very well.

As the Financial Times pointed out, “The MSCI World ex-USA index has gained32% in dollar terms. It has lost 19.2% in euro terms.” In other words, for a dollar investor, overseas investments have done so well because of foreign currencies appreciating against the weakening dollar.

Meanwhile, U.S. markets lag badly. “MSCI’s U.S. index is up 7% in dollars and down 35% in euros.” Foreign investors have lost a third of their investment because the depreciating dollar buys less and less when they convert back to euros or pounds.

So it is ironic that most investors celebrated a new high in markets. But adjusted for weakness in the dollar, things look much worse. According to Marc Faber, “Since 2000, the Dow Jones has lost more than 50% of its value against gold, and much more against industrial commodity prices.”

Such trends show no signs of slowing. The dollar is on a slow train to oblivion. Another good reason to buy tangible assets and sell paper.