Importing Inflation

China’s decision to de-peg the yuan and allow for a maximum movement of 0.3% per day may not seem like a very big deal, but as the Mogambo Guru points out, these little bits of movement could add up to big trouble for the U.S. economy…

The big, big, big, BIG, BIGBIGBIG news is, of course, is that China has lowered the peg of the Chinese yuan to the dollar by 2.1%. As David Tribble commented, "From this point forward, the United States Federal Reserve no longer matters. The balance of power has shifted from the West to the East."

He is right, as the new currency regime is a "managed float" of currencies, and the people managing the float are the Chinese, so they run things from now on. It’s a scary new world, and I am sure that you are, like I am, in the throes of hysterical paroxysms of fear, characterized by infantile screaming, crying, begging, moaning, and random bursts of gunfire at unseen enemies lurking in menacing, murky shadows.

At the same time, Malaysia also announced it would no longer tie their currency, the Ringgit, to our dollar, either. Apparently this Malaysian currency untying does not surprise Chuck Butler, president of EverBank, and who is a guy that they say knows what in the hell he is talking about when it comes to this kind of currency stuff. Putting all this wisdom and education to work, he noted that the Chinese de-pegging would "lead to other currencies in the region to allow their currencies to gain vs. the dollar."

Floating the Yuan: Two Bits Here, Two Bits There

Aside from the problems of one more large group ganging up on us Americans, there is no more permanent peg at all, although the government will allow a maximum movement of 0.3% per day. 0.3? Like you, at first I said, "A third of a lousy percent? That doesn’t sound like much!" But it is! This percentage move is every (pause) freaking (pause) DAY! It is like the little boy who killed his mother and father for twenty-five cents and explained, "You know how it is, judge; two bits here, two bits there, it adds up!" It adds up!

My horror lies in the fact that after a few months of this "two bits here and two bits there," and the dollar could be down by fifty percent! There is a lot of work done through the last few years that suggests that the Chinese yuan is overvalued by around 40%, so overshooting that overvaluation is not inconceivable to me.

If you notice that you are suddenly bathed in a cold chill, then you have passed a milestone in your quest for Total Mogambo Enlightenment (TME), as you understand that a giant disturbance has occurred in the cosmic continuum, and things are not going to be good.

Or perhaps you heard a bell, as Peter Schiff of Euro Pacific Capital suggests when he said, "The old saying ‘no one rings a bell,’ certainly doesn’t apply today, as China rang the ‘mother of all bells.’ So deafening was its sound, that its vibrations will be felt around the world. Nowhere will the amplitude of these waves be more pronounced than in the United States."

Immediately (and this is the part that ought to make your trigger finger twitch involuntarily and your heart slam-dance against your ribcage), oil, precious, precious oil, which is priced in dollars, becomes instantly 2.1% cheaper for the Chinese! The price to us is (big sigh of relief!) unchanged. So far. Note the caveat "so far," which is very meaningful to those of you with sharp eyes.

But the oil exporters have to be looking at this, too, and figuring that getting paid in dollars is really, really, really stupid if they are going to turn around and buy something from the Chinese. If they do intend to buy some Chinese products (and who doesn’t?), then petroleum exporters just lost 2.1% of their buying power! In one day! Remember, these oil production companies are in the business of making profits, currently denominated in dollars, by pumping and selling oil. Then, in the natural course of events (and this is the best part!), they will take some of their new dollars and spend them on a few necessities and some other really neat stuff. But when the wife gets to the store, she finds that the prices of everything are 2.1% higher! And getting higher by 0.3% per freaking day!

Floating the Yuan: The Alternatives Aren’t Promising

But this is not about my life in hell, but rather about that, as Americans, it will just get worse and worse and worse, as Chinese imports will immediately cost 2.1% dollars more, because the dollar is worth 2.1% in buying power, UNLESS (and this is the crucial part) somebody along the way agrees to make less profit, which is bad for the company, or otherwise cuts expenses. Both of these ideas will work, but crap for somebody else, because all of those lost profits or cuts in expenses were somebody else’s income (shareholders or suppliers), and now THEY are suffering a loss of income! There is nothing good about price inflation. Nothing. It is always bad news. Always.

So why have we allowed this? Occam’s Razor mandates that we find the simplest answer. Thus I loudly declare that we, as a nation, are really, really stupid. A lot like me, personally, but without the crippling emotional problems. But perhaps there is something more to this whole thing, something in the line of, ummm, destiny, as Bill Bonner of The Daily Reckoning perhaps suggests when he observes, "An empire has to figure out a way to exhaust or destroy itself in order to make room for the next empire." And that is exactly what we have done. We have destroyed ourselves so that the Chinese empire can assume dominance, continuing the universal cosmic dance of birth, death and renewal.

Out of the corner of my eye I can see Peter Schiff is bored with listening to this metaphysical philosophy, and me and is furtively looking around for a discreet way out. I figure "I’ll teach him!" I spin around, point my finger at him, and say, "So, Mr. Schiff, what are your final conclusions?" Without missing a beat, the guy jumps up, snatches the microphone out of my hand, and, ignoring the audience cheering him on and urging him to use it to beat the hell out of me, says, "In conclusion, July 21, 2005 will be another date likely to live in infamy. This time the aggressor is China not Japan, and the bombs are purely economic. Though there will be no immediate loss of life, and no American retaliation, the financial damages will be devastating. History will remember this date as the beginning of Chinese independence, and the beginning of the end of America’s ability to depend on the Chinese."

So I confidently predict, without fear of contradiction that the yuan will continue to gain strength over the long run. It will be, of course, in fits and starts so that the Chinese can "manage" the currency markets so that the local boys will profit from the ups and downs of the currencies, and Wall Street, the Federal Reserve and government will "manage" the stock and bond markets in the United States so that this whole stock/bond/housing idiocy will not implode, and at the same time allow American local boys to make profits from the manipulation. The whole cost will be shifted onto the average American citizens, paid for by suffering a huge, huge, decline in their standard of living, and the wrenching societal dislocations that will result, as the coming years and decades roll by.

And this will be peachy with China, as their strong currency makes imports cheap! Thus, they can import a lot of raw materials to the emerging Chinese consumer, whose average wage is increasing at ten percent a year, and who is a-hungering for the Promised Land of up-scale goods and downright luxuries.

So, and this is the important part for those of you who are whining, "When the hell is he going to get to the damned point?" with a strengthening currency they will import deflation into China, which will offset a lot of the monetary inflation. The downside is for everybody else to gag on, because when the Chinese import deflation, they simultaneously export inflation. So what will we be mainly importing from China? Inflation! Hahahaha!

Regards,

The Mogambo Guru
for The Daily Reckoning

August 1, 2005

The Mogambo Sez: Addison Wiggin of the Daily Reckoning has some advice gleaned from technical analysis that is better than anything I could come up with. He writes, "Since the beginning of the Dollar Standard era, every time an ounce of gold could buy less than 10 barrels of oil, an investor would do well to buy gold. Today, an ounce of gold buys only seven barrels of oil. The message from the markets it clear: Buy gold."

And this devaluation of the dollar makes that analysis even more clear and compelling.

Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter, an avocational exercise to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning and other fine publications.

Long time Daily Reckoning sufferers can breathe a sigh of relief today.

This edition will be short, partly because your editor is on vacation and partly because he wrenched his back riding a horse and cannot sit up to type. He finds he can only get relief by hanging from the porch rafters. He has been hanging so much he is beginning to feel like an ape. His children offer him bananas.

We note, however, that not much is happening in the financial markets. And in the broad economy, the trends of the last half-century continue – an expansion of credit.

"We’ve never seen a real credit contraction," said our friend John Mauldin.

The last time debt levels went down dramatically was in the Great Depression. No one expects a repeat. Not even John.

"But, John," we argued yesterday, "credit has to contract sometime. There are booms and there are busts. At some point people have so much debt…and so much invested badly…and so many bills to pay…that they cannot go on. Then, there must be a break…a retreat from debt…a recession…"

"Maybe…" said John, "but, usually, we just muddle through."

Yes…we muddle through, until we can muddle no more. When the end of the muddle-through period comes, we don’t know. But that it will come we have no doubt.

In the meantime, dear reader, you may want to make some money. For that, we have been little help. Buy gold, we keep saying. Gold is not really a way to make money. It is a way to not lose money. It is what you buy when you fear a credit contraction…or a period of economic instability. You never know what will happen, exactly; all you know is that when things go wrong, gold is a good thing to own. It goes down in good times; it goes up in bad times. And it never goes away.

But there are times to make money…and times not to lose it. We continue to think this is a time not to lose it. At today’s prices, stocks are unlikely to produce much in the way of profit. If the cycles of the past repeat themselves, it will be another 10 years before another bull market begins. Houses are too expensive…and should not be considered as investments anyway. And bonds? We suspect that bonds may be a decent investment…for the reasons given by our friend, Martin Spring, below. But they are dangerously exposed to a drop in the dollar.

Buy gold.

More news, from our currency counselor…

————–

Chris Gaffney, reporting from the EverBank trading desk in St. Louis:

"When the dollar is rallying it goes up no matter what the data shows, and the opposite is also true. Even the hedge funds were selling dollars. The trading action we saw Friday, confirms to me that this 2005 dollar rally is finally over."

————–

Bill Bonner, with more views:

*** King Fahd Bin Abdul Aziz, ruler of Saudi Arabia, died early this morning – sending crude oil prices higher, up to $62.30 in the front and 64.70 in the back.

Saudi Arabia is the largest producer in OPEC, and Fahd was important in continuing strong Saudi-U.S. diplomatic relations…so it goes without saying that the energy markets will be feeling the impact of this transition as the week progresses.

But, wait – there’s more…

BP’s Texas City refinery can’t seem to catch a break. After their second fire in four months on Thursday, BP had to shut down a gasoline-producing fluidic catalytic unit on Sunday for maintenance repairs. According to the notice that was filed with the Texas Commission on Environmental Quality, it was not clear if the shutdown had to do with Thursday’s explosion.

"In my opinion, the biggest item for gasoline obviously is the ongoing problems at the BP refinery, which is called the ‘barnacle barge’ by those in the industry," commodities authority, Kevin Kerr, tell us.

"The Texas City facility is known to be plagued with decay and corrosion problems. The article in the WSJ that was discussed in the Weekend DR only scrapes the surface in looking at the decay of these facilities.

"Just as I predicted, these bullish items of uncertainty and delay are helping crude over $61 and close to $65 in the back months, and edging toward $3 unleaded. All we need now is for the tropical disturbance in the Caribbean to turn into a hurricane and make a bee-line for Houston."

*** "Inflation is the bogeyman that others use to frighten you into making bad investments," writes our old friend, Martin Spring. "It’s about as likely to return as the gold standard. Year after year, the experts (or nearly all of them) tell you that the central banks are "printing" (creating) so much money that it’s only a matter of time before the prices of goods and services are inflated by it…explosively.

"Inconveniently, that just doesn’t seem to happen. Last year, despite the strongest growth in the world economy for nearly three decades, inflation only reached 2.7 per cent in the US, 1.8 per cent in the Eurozone, 1.3 per cent in the UK and 0.1 per cent in Japan.

"Even allowing for official manipulation so the statistics understate the reality (which they undoubtedly do), these are very low figures. And economists don’t forecast much change over the next year or two.

"The inflationistas are convinced that inflation must return because it always has. True. But investors could lose a lot of money waiting for it. The inflationists choose to forget that there was no inflation in the world economy for most of the 19th century, and for a long period in the 20th. More recently, the world’s second biggest economy – Japan — has not experienced inflation for more than a decade, despite massive monetary and fiscal stimulation.

"Money creation only causes inflation if it boosts demand for goods and services greater than available supply. In the world as a whole, that has not been happening for years, and there is no sign that it’s about to happen."