Market Review: Just a Blip on the Radar

Some weeks, it seems that the world is gliding along on autopilot…nothing terribly out-of-the ordinary happens…the sun is shining…birds are chirping…and boredom ensues.

This was not one of those weeks.

The past seven days were chock-full of news – more bombings in London, a nuke threat, a currency revaluation. But all of these out of the ordinary events failed to make more than a blip on the radar – in daily life or on the markets.

Of course, the three explosions in London’s Underground stations on Thursday did succeed in scaring Londoners, but for the most part they followed Tony Blair’s advice to "react calmly and continue as much as possible to normal," and resumed to their regularly-scheduled daily life without too much of a falter in step.

We asked our colleague, and part-time London-dweller, Dan Denning what he thought the impact of the bombings would be on the financial markets.

"I’ve been thinking about it and you know…the truth is, I don’t think they’ll have any impact at all. Financial markets tend to panic when the scale of an external shock is so large that no one knows how much damage it will do the economy or the confidence of consumers. Ironically, the more these types of things happen…the better markets get at absorbing them and operating normally.

"So far, that capability [to release an airborne chemical weapon] appears to be beyond the terrorists in London. So far. And truthfully, if that kind of attack did take place, there is almost no financial asset on the planet that would be safe to own, save gold. In other words, it’s a little bit like worry about what to do when an asteroid hits the earth. There’s not a damn thing you can do. If it happens, it will be bad for markets.

"It seems distasteful to me to use the adage ‘buy when there’s blood in the streets’ when there actually IS blood running in the streets. Perhaps the better motto is Warren Buffets, ‘be fearful when other people are greedy and greedy when other people are fearful.’

"That said, sometimes fear is a useful emotion. It tells you when to take fewer risks and wait for volatility to die down. I’d suggest that now is one of those times."

Even with the flurry of inactivity the second terrorist attack on London in two weeks brought – the major newsmakers this week were our friends in the Far East.

First, on July 14, a Chinese military official sent a warning to Washington: If the U.S. military intervenes in any conflict with Taiwan, they will be forced to retaliate – with nuclear weapons.

"If the Americans draw their missiles and position-guided ammunition on to the target zone on China’s territory, I think we will have to respond with nuclear weapons," Maj. Gen. Zhu Chenghu, said at an official briefing.

"If the Americans are determined to interfere, then we will be determined to respond," he said. "We Chinese will prepare ourselves for the destruction of all the cities east of Xian. Of course the Americans will have to be prepared that hundreds of cities will be destroyed by the Chinese."

Although the general stressed that his comments reflected his personal views and not official Chinese military policy, we got the message loud and clear over at The Daily Reckoning: The U.S. needs to mind its own business. We just hope the world improvers take the threat the same way.

Even bigger news than being threatened with nukes was China’s announcement on Thursday that they will no longer peg their currency, the yuan, to the U.S. dollar.

Zhou Xiaochuan, governor of the People’s Bank of China, said the decision to remove the peg had noting to do with the pressure by the United States and other trading partners who said the yuan was undervalued and gave Chinese exporters an unfair price advantage.

Reuters reports, "Zhou told the conference that China had dropped the dollar peg because the U.S. currency had become too volatile in recent years, partly reflecting economic problems include large trade and budget deficits."

"The renminbi revaluation will help the U.S. trade deficit but the effect will be extremely small because the U.S. economy is so huge," Zhou said. "China’s economy was just on-seventh the size of America’s."

The U.S.’s trade deficit with China hit a record-high $162 billion last year. So, we going to have to side with Zhou – this 2% move will hardly make a noticeable dent in the trade deficit.

The revaluation of the yuan has been the hot topic of week for our editors. Since Thursday, our editors, who are positioned all over the world, have been debating back and forth via email about what this "unpegging" means for the U.S. economy…

"There are definitely varying interpretations of what’s next," writes Justice Litle.

"Some see the 2% move as all but meaningless, as close to ‘no change’ as humanly possible. Others like Goldman Sachs believe that it’s the opening salvo in a gradual adjustment that could put the yuan up almost 10% within a year’s time.

"What’s interesting is that the ‘basket of currencies’ to be valued against is undisclosed. So theoretically they could move the yuan down just as well as up, if they chose.

"Regarding trade, it’s also worthwhile to note that the United States is actually number three with China now… Japan is #1 and EU #2, I think. My guess is that the real problems come when consumer demand on the whole slows down enough to put China in trouble, as no one is in control but the speculators at this point."

From here in Maryland, comes this note from Chris Mayer: "I don’t know if I’d get too excited about China’s new ‘purchasing power’ – the change comes to something like one-quarter of one cent. And, that could easily swing the other way, if China succumbs to the temptation of printing money, for example. Assuming the change helps control domestic inflation implies that you trust the Chinese central bankers more than the central bankers in charge of the basket of foreign currencies…could be, but it is certainly no cinch."

"The best way to control inflation (avoid printing money) is to let the currency strengthen," says Dan Denning.

"What are the risks of doing so? Slower export growth is the obvious one. But they might be more comfortable with that if the goal of state economic policy was no longer to build up huge dollar surpluses, but spend them on real assets before those dollars became worth less. Or, in another sense, it’s more important to the Chinese to acquire energy assets right now than it is to sell crap to Americans. Granted, they use energy to make products, which they sell to Americans. But this is precisely the shift I think is coming…where the Chinese will not depend (or prioritize) exports to America over exports to Asia or their own domestic resource needs ( to keep the population from exploding in anger)."

Focusing on their energy and resource needs should be on the top of the Chinese’s to-do list, without a doubt. With the summer in full-effect, Beijing and other major Chinese cities are experiencing power and water shortages across the nation.

The State Electricity Dispatch Center predicted China would suffer its worst energy shortfall in 20 years this summer. United Press International reports, "962 Beijing-based industrial enterprises had started paid leave this week… Altogether 4,689 businesses will have ‘weeklong summer vacations for their employees’ over the next month."

Our energy expert, Justice Litle tells us what impact these forced blackouts will have on the Chinese economy:

"These shortages highlight the fact that energy is not just an economic necessity for China, it’s a matter of national security. As a country, China has to maintain a rapid rate of growth simply to avoid the political backlash and mass uprisings that come with employment disruptions."

He adds, "China is already focusing heavily on new technology for its future energy needs, like pebble bed nuclear reactor design. They are also rethinking their approach to fossil fuels, partnering with western companies in promising areas like coal liquefaction and liquid natural gas. Energy shortages that threaten the backbone of Chinese commerce will only concentrate minds in Beijing all the more."

All of this happening in the world this week, and yet no real change the markets. Perhaps Dan Denning was right in saying the more chaos there is consistently, the better the markets get at absorbing the shock.

Kate Incontrera
The Daily Reckoning

July 24, 2005

P.S. Last year, over 6,400 factories in China had to shut down because they didn’t have enough electricity to run their machinery. Another 10,000 manufacturers had to ration power. Even big-name companies like Sony and Volkswagen had to cut back production in their Chinese plants. The demand for electricity is obviously there – which means that there is much money to be made in electricity-related investments. Justice Litle has detailed three major moneymakers in his new report. You can get all the details here:

The Great Shanghai Blackout

— Daily Reckoning Book Of The Week —

Asia Rising
by Jim Rohwer

Rohwer traces economic developments in Asia-including the tremendous potential of China and India-describing the regional and international businesses that led the way, the financing behind them, and the potential of emerging consumer and infrastructure markets.

THIS WEEK in THE DAILY RECKONING: This week, the People’s Bank of China decided to take away the yuan’s peg to the dollar. But is buying yuan a sure way to make money? It’s all in Wednesday’s essay, "An American Ultimatum," below…

Love in the Time of Sildenafil Citrate   07/22/05
by Bill Bonner

"Today, Bill turns from the examining the financial world, to much serious matters – life, love and the pursuit of happiness. Read on…"

The "Real" Boom      07/21/05
by Puru Saxena

"When our Paris amie, Amber Garrison, went to China, she met with among other notables Puru Saxena, an investment advisor and money manager based out of Hong Kong. Below you will find the first of Mr. Saxena’s contributions to The Daily Reckoning…"

An American Ultimatum     07/20/05
by Mark Tier

"If the revaluation of the Chinese yuan is a sure thing, as everyone seems to think, buying yuan is a guaranteed way to make money. But is it? Mark Tier explores…"

Debt, Delusion, Deception     07/19/05
by Kurt Richebächer

"The Fed continues to stand by their claim that the U.S. economy is just experiencing a "soft patch" that will be followed by high rates of economic growth. Dr. Richebächer stands firm in his belief, too…"

The World’s Final Consumer     07/18/05
by The Mogambo

"It seems as though America isn’t living up to its reputation as the ‘ultimate consumer,’ which will send a major ripple through the world economy, and spells big trouble America. The Mogambo sheds a little light on the topic…"

FLOTSAM AND JETSAM: Somehow, the Chinese economy needs to get additional purchasing power into the hands of the 900 million people who make up the underclass. Byron Kings wonders how the government could manage that…

by Byron King

When I read the increasing numbers of reports coming out of China about worker violence and related social unrest, I have to wonder if the Chinese leadership is making a conscious decision to redirect some additional amount of the national booty towards placating the masses. That is, they have decided to allocate more resources to the issue, to throw money at the problem, over and above whatever else they would have done according to the latest five-year plan. It is time to toss more bones to the running dogs of social discord, if not hostile and reactionary tendencies.

As Microsoft’s Steve Ballmer predicted in a talk he gave at Harvard in 1997, within about 10 years the Chinese economy would be putting about 200-300 million people into something approaching a lower middle class lifestyle, or better. It has only been eight years since Steve’s talk, but we are there already.

But somehow or another, the Chinese economy needs to get additional purchasing power into the hands of the 900 million dispossessed souls, who live in the relatively undeveloped interior, or who form the substantial underclass of the booming coastal enclaves. During the good old days of air-tight, Red-Guard style central command and control, the Chinese government could pretty much keep the populace literally on their respective reservations. Maybe it was at the point of a pistol, but it worked. Crude, but effective. No more. Word travels fast among the communities of migrating millions, as does the dreaded spectre of social and political disaffection.

With the evident disparities of wealth in that vast nation, the possibility of homegrown social unrest is as severe as in any nation on the planet. (At least in the West, we can more-or-less profile the kind of people who bomb subways, even though for political reasons we have not done it in an open and notorious manner. Not yet.) But in China, how is one to know who is the dreaded social revolutionary? The guy with calloused hands who is wearing dark pants, a white shirt, and has a short haircut? That narrows it down to about, oh, 400 million people or so.

It is probably a better policy for the Chinese government to get its own internal demand spooled up amongst the lowest social-economic classes. That will buy some time, during which the leadership will see what develops, if not just bide time to grow old, die and be replaced by someone else on whose watch the pot will boil over. Now for the Big Question: Can the Chinese government accomplish this? My hunch – I doubt it.

From my own purely parochial perspective, the Chinese are in a position of historical misfortune. They are attempting to build a 20th Century industrial-style society and associated consumer culture, with an excessively large population for the land area of the country, and do it all within a 21st Century world of resource constraints. That is, their hands are tied by Peak Oil, lack of fresh water, collapse of ocean fisheries, loss of arable farmland… and all that. China will run the world out of natural resources and basic commodities (particularly energy resources) long before it can bring to fruition that famous promise of "Let’s all get rich together."

Maybe this is why General Zhu is so sanguine about the possibility of conducting a nuclear war with the United States. Zhu is an old guy, whose youth was formed by the company of his association with the Long March crowd, including Mao Zhedong. As Mao once said, "What is it to China if we lose 200 million or 300 million people in a nuclear war? When it is over, the sun will still rise in the morning. Trees will grow. Women will have babies."

Thus does the old confront the new.

The Daily Reckoning