Steady Diet of Chinese Currency

With the devaluation of U.S. currency expected to continue – if not speed up – in the coming year, we’ll probably see a new “big man on campus” begin to take over. His name is Chinese Yuan, and he’s here to take your girlfriend, Reserve Status. Read on…

I keep watching the steady march of China towards world domination, and their currency (the yuan) getting bigger and stronger until it achieves reserve status and replaces the worthless dollar; and people around the world will say, “Fooey on the dollar!” and I will get really nervous like I do every time some dirtbag country starts getting uppity like they are going to begin paying us back for the misery we have inflicted on them, and their friends, for the last century or so.

And yet I eat a lot of Chinese food, which seems somehow unpatriotic, but like most self-absorbed gluttons, I cannot stop because I don’t want to, just like I still eat tacos even though Mexico is taking over the USA, and I am uneasy about that, too, and I walk around outdoors without an aluminum foil hat to shield my brains from interstellar rays and invisible CIA cameras reading my thoughts.

News.bbc.co.uk had nothing to say about how one’s dietary excesses are reflective of one’s patriotism, or about any of my other weird paranoid delusions, either, but it did say that (just as bad) up to now, “Most of China’s foreign trade is settled in U.S. dollars or the euro, leaving exporters vulnerable to exchange rate fluctuations” and, of course, vulnerable to all the little bites taken by middlemen.

Now, “China has said it is to allow some trade with its neighbours to be settled with its currency, the yuan. It means if the two parties to a trade have yuan available, they need not enter world exchange markets to pay”, which will save them both a lot of time and money, as they can bypass all those expensive intermediaries that each take a little bite of your action.

Now, without these parasites, the inflationary implications caused by such cost-push factors are eliminated! Inflation goes down!

Anyway, the announcement is almost a fait accompli, as “Analysts told Chinese media that the yuan was already being used in some South East Asian countries and that China was happy to see such use extended”, which suddenly explains many of my unnamed fears and a lot of frightening nightmares about being eaten by gigantic egg rolls, instead of the delicious other way around.

Well, egg rolls or not, pretty soon everybody is going to have more egg rolls, as the Chinese are engaging in massive stimulus spending, too, just like we and everyone else are, and “announced more measures to stimulate domestic consumption”, which included such things as “subsidies to rural households for the purchase of household appliances and other goods, and the setting up of new stores and distribution centres in rural areas.”

Subsidizing raw consumption! Wow! Now THAT’S stimulus spending! But maybe such heroic measures are just to take up the slack, as the Chinese are taking a whack, which is almost poetic, which is why I wrote it that way, but also for dark, mysterious reasons about which one can only speculate and shudder, but mostly because the Commerce Department announced that consumer spending in America fell 0.6% in November, and U.S. exports fell for a third straight month, which is a lot, which also explains why the Chinese are taking a whack from slack!

What slack? From Marketwatch.com we learn that the Federal Reserve reported, “Stung by the loss of $2.81 trillion in their net wealth, U.S. households paid down their debts in the third quarter for the first time since at least 1952.”

The actual numbers are that “As of Sept. 30, households’ total outstanding debt shrank at an annual rate of 0.8% from $13.94 trillion to $13.91 trillion”, the difference being a hefty $300 billion in foregone consumption right there, unless it was all offset by higher incomes, which it wasn’t! Gaaahhh! We’re freaking doomed!

As staggering and as bewildering as to what any of this could possibly mean, it was not until later that they reveal that when you adjust this fall in nominal consumer spending for the effects of inflation (perhaps using the recently revised Gross Domestic Product Deflator that shows that inflation in prices is 3.9%?), then “Real consumer spending rose 0.6%”, which seems weird and contradictory until you remember that “Everybody’s lying to me and that is why I understand nothing”, and then everything makes sense again.

And that sudden clarity, that transcendental moment of total consciousness, is when you realize that you can trust only gold, silver and oil.

You wish you could trust The Mogambo, too, but you’ve seen how he looks at your wife behind your back, and you realize, “This guy’s a real scumbag! But maybe his advice about gold, silver and oil is good, which will make up for it!”

Until next time,

The Mogambo Guru
for The Daily Reckoning
January 5, 2009

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.

What a beautiful day it is in Paris. It’s snowing. The streets are white. And the streetlights, shoplights, and automobile lights make everything glow. It would be a nice morning to sit in a café and drink a cup of coffee.

But we don’t have time for that. We’re back at our desk…there is another year to be reckoned with…and it promises to be a doozy. The trouble with this year so far is that it is missing the question marks. What lies ahead seems obvious…too obvious…

“World stocks rise on US rally, stimulus hopes,” comes the headline from CNN/Money.

The Dow flew up 258 points on Friday – stocks have been up in the last three trading sessions. Oil rose to $46. Gold fell to $879.

The expected rebound seems to be underway. Even dead cats bounce. And considering the height from which this one fell, it would not at all be surprising to see it bounce up 30% or even more…over the next three months.

Investors took a terrible beating in ’08. It was the worst year in stock market history. They’ll figure that this year is bound to be better. And along will come many reasons to believe that things are looking up.

President-elect Obama is talking about relief on a Rooseveltian scale. He wants to spread unemployment and Medicare benefits around more freely, for example. But he knows he can’t just toss out a few dimes to bums on the street corners; he needs a stimulus plan that knocks peoples’ socks off.

“Economists from all across the political spectrum agree that if you don’t act swiftly and boldly we could see a deepening economic downturn,” he said recently.

We must be somewhere on the political spectrum. But he didn’t ask us. If he had, we would have explained that every penny spent on a bailout has to be taken out of the spending of the person who earned it. We’d add that there is no economic problem at all. The markets are doing what they’re supposed to do…clearing away the mistakes of the Bubble Epoch.

It’s a political problem, not an economic one. People don’t like to have to pay for their mistakes. So, they whine to politicians. And then the politicians make things worse…by trying to prevent the correction from taking place.

But, our “Head of State Hotline” has been silent, here at The Daily Reckoning headquarters. So we have to assume it was Barack Obama who was not calling – along with every other government leader on planet earth.

Mr. Obama figures he needs to do something spectacular…something that will give the impression of really turning things around. He calls his project the ‘American Recovery and Reinvestment Plan.’

Ahh…here are some question marks: What is it meant to recover? We don’t know…maybe the glory days of the Bubble Epoch. What is being reinvested? We can’t figure that out either. Typically, you reinvest a profit. But you have to have a profit to reinvest it. As near as we can tell, 2008 was a year of losses. You can’t reinvest losses.

Nevertheless, we know what American Recovery and Reinvestment Plan is…political claptrap. And now it’s expected to cost as much as $1 trillion. At least, that is what state governors are calling for. Congressional leaders say they want to stay below the “politically charged” one trillion dollar level. But they also say the bill won’t be ready for Obama’s signature until February. Congress needs time to pry open the pork barrel and spread it around – no question about that, either. By the time they’re finished, there’s almost sure to be $1 trillion work of grease in the package.

“US Debt Expected to Soar,” says the Washington Post, stating the obvious.

All this extra debt will do no good for the economy, but investors will probably feel like the good old days are back. And for a while, they will be…

*** This time of year you’ll find a lot of looking back at the year that just passed…and with good reason. Strategic Short Report’s Dan Amoss offers his views on 2008…and what lies ahead for us in 2009:

“When asked by family and friends over the holidays what I think about the 2008 stock market and economy, my response has been, ‘I expected a nasty bear market in 2008, but the carnage since September took me by surprise. The economy will remain weak, but I think the worst of the widespread market carnage is behind us. Future damage should be concentrated in sectors with horrible fundamentals. Thankfully, 2009 should be a year when fundamental analysis should start to matter once more.’

“This will be a welcome development, because 2008 was a year when the following strategy worked best:

1) Sell short any stock or ETF, without bothering to do any fundamental research
2) Invest the proceeds in Treasury bonds, preferably with as much margin as possible
3) Repeat Steps 1 and 2, over and over.

“Clearly, this ‘deflation trade’ strategy is not sustainable over longer time frames — not in an era of worldwide paper money standards. In fact, I’d expect that such a shotgun-based investment strategy of short S&P 500/long Treasuries could lead to big losses in 2009.

“Overall, I’m happy with Strategic Short Report’s performance. Obviously, I could have done even better, had I been more bearish since September. But it certainly felt unwise to sell short into an already panicked market. Let’s learn as much as we can from our experiences and move on; it never helps your trading discipline to dwell on past mistakes and missed opportunities.”

*** It all seems so simple. After the crash comes the bounce. And the bailouts. The bailouts cost money we don’t have. So, we get more debt…and more printing press money. What’s to wonder about?

In the last two months of last year, MZM – a measure of the money supply – grew at 11% per year. Gold rose. With the Obama bailout…and the Fed’s bailouts…it seems a cinch that the price of gold will go up.

At $879 an ounce, gold is today no higher than it was 29 years ago. In January 1980, it briefly hit $875. If it were just to reach the same level now, adjusted for inflation, it would have to go to $2,400.

What bothers us about this is that it is so obvious. Looking at the facts, a sensible person would conclude: the price of gold is going up. Most likely, it will go to three times its current price.

And so, sensible people seem to be doing the sensible thing; the World Gold Council says demand for gold is increasing fast. The price of gold rose more than $100 – while every other asset, save U.S. Treasury paper – fell. Gold coins have become difficult to buy; the premium on a bullion coin has risen to about 10% over the gold price.

Still, the price of an ounce of gold is under $900…not over $2,000. Does the big money…the inside money…see something we don’t? Or do we see something it doesn’t? We don’t know…but it worries us.

Will there be no run-up in gold? Or will it come on sooner and more violently than even we ever imagined?

There’s bound to be a surprise waiting for us somewhere…but, just to be on the safe side, we’ll hang onto the gold we have. And we urge our dear readers to do the same. No gold? There’s still time to pad your portfolio with our favorite yellow metal.

*** It also troubles us that so many people expect a bounce…followed by a further collapse. How can Mr. Market work his mischief if so many people see what he is up to? Where’s the surprise? Will the bounce not come at all? Or, will it come much more emphatically than people expect?

Perhaps markets will rally strongly all over the world. Chinese manufacturing will show signs of recovery. Housing in the United States will appear to have stabilized. Commodities will edge up. Investors may begin to believe they have another bull market on their hands – or at least a tradable rally. They won’t want to miss the opportunity to ‘get even.’ And then, as stock prices rise, investors will slip back into their old habits. They will turn to risky investments in order to boost their profits. Among other things, they are likely to invest in emerging markets, which will probably rise more than the U.S. market itself. Currencies such as the Brazilian real and the ruble will go up against the dollar.

As the rally recovers 40%…50%…maybe even 60% of last year’s losses, investors will be suckered into seeing it not as a bear market rally, but as a genuine new boom. They will think it is real…and durable. And they will forget to sell.

Mr. Market will have pulled another fast one.

*** “In a severe crisis, orthodoxy can prove a very bad strategy,” said Ben Bernanke last week.

We are as puzzled by this as by Obama’s American Recovery and Reinvestment Plan. Economics is not improv theatre. You can’t just make it up as you go along. You make a change in banking regulations or fiscal policies, for example, and it will take months or years before you know if it has worked. That’s why you need theories to guide you…you can’t wait to see how an economy reacts. In the absence of a theory about the way things work, you are just committing random acts of kinkiness.

Today’s news from Bloomberg also tells us that the “Fed has abandoned monetary policy.” We’re puzzled by that too. With rates at zero, what monetary policy did the Fed have left? Not much.

*** Poor Ireland. The Celtic Tiger has been de-clawed and spayed. House prices have fallen as much as 50%. Bank shares are down 90%. Unemployment – which had all but disappeared in the boom years – is headed back to 10%.

Until tomorrow,

Bill Bonner
The Daily Reckoning