The Joke's on Us

We have found The Mighty Mogambo’s kryptonite: inflation. It’s not just inflation, but also the massaging of the inflation statistics by the Federal Reserve that scares the beejeesus out of him.

Asia Times presented Henry C K Liu, who is chairman of the New York-based Liu Investment Group, who has written a very good article that explains the problem, the dilemma, and the looming disaster with China, entitled  "Part 1: Follies of Fiddling with the Yuan".  After tracing the history of Chinese exchange rate policy, he notes, "In China, eight reductions over a period of eight years since 1994 halved the benchmark yuan one-year lending rate to 5.31%. The yuan one-year deposit rate is now 1.98%. China’s consumer price index rose 5.3% in the year through July, meaning that borrowers now enjoy near interest-free loans after adjusting for inflation."

Interest-free loans!  Just like here!  And you think China’s growth is going to slow? Hahahaha!  Liu goes on to say, "Industrial prices climbed 14% in the first seven months of 2004, making real interest rates negative by a wide margin in industrial sectors." Negative interest rates!  Yow!  "Yuan bank deposits at 1.98% now suffer erosion of principle to inflation at the rate of 3.32% a year, which then as bank loans goes to support a built-in 8.69% annual profit for those who borrow at 5.31% to speculate in the industrial sectors with 14% inflation."

Just like here, where the banks are screwing over us little dirt bag depositors! If you listen carefully you can hear them laughing and spitting on us lowlife depositor trash, and with my Super Mogambo Hearing (SMH) I can actually hear them saying, "Depositors?  Hahaha!  I spit on the lowly depositors!" which confirms your earlier reports of laughing and spitting.

Inflation Statistics: Hot Money into China

"International money flow is closely linked to interest rate differentials between economies, in the direction of the higher rate. Speculative hot money poured into China for the past two years as the Fed cut (the Fed Funds Rate) to 1%."  So, here in America, the Fed cut rates, and the money poured into China!   Hahaha!  The joke’s on us, huh?   Old folks with their Certificates of Deposit paying squat, and bank depositors getting squat for their savings, all got screwed, so that money could flow into China!

Liu continues: "Ample liquidity triggered an investment boom in China that exacerbated inflation. The resulting negative real interest rate amplified investment demand and caused a speculative bubble."

If you want to argue that China’s economy can’t grow, you can quote Mr. Liu when he says that China, "Despite spectacularly rapid growth, still accounts for only an insignificant 3.5% of the global GDP, a pathetic figure for a nation with one fifth of the world’s population. Yet China now accounts for 60% of the growth in world trade."

Then he touches on "recent calls from U.S. officials for China to simultaneously raise both the yuan exchange rate to the dollar, and yuan interest rates further above dollar interest rates are ill advised. Such moves will cause an upward spiral of interest rates and inflation in the United States, China, Asia and the rest of the world."  The Mogambo Inflation Detector (MID) is clicking like crazy!

Apparently this Liu guy is unaware that the reason that I am on the floor, twitching and gagging in fear, is this inflation thing. Then, without warning, as if to kick me in the guts, he gets into this issue of the Fed hedonic massaging of inflation statistics so as to disguise it.   "As this measuring technique is being extended to a growing number of goods, it has become a most important factor in reducing the United States inflation rate, and intrinsically raises nominal GDP growth while the real GDP may actually decline.

"All this suggests two important things: first, that the reported new paradigm increases in real GDP and productivity growth have been exaggerated by a statistical illusion; and second, that real interest rates have been far too low in relation to real inflation, which also explains the most rampant money and credit creation that the United States has ever seen in recent history."

Inflation Statistics: Inaccurate Cost of Living

He then quotes the heroic Bill Gross of PIMCO, who wrote: "The CPI inaccurately calculates Americans’ cost of living. Since social security and pension benefits as well as the level of wage hikes are predicated upon the specific number and/or the perception of annual increases, Americans are being in effect conned by their government and falling behind the inflationary eight-ball year after year."

Mr. Liu continues: "With every passing day, more market watchers are joining the ranks of those predicting looming financial crisis in U.S. markets from excessive debt, particularly external debt."  Unfortunately, he says, "This danger cannot possibly be defused by China, regardless of what monetary policy it adopts.

"But the longer the Fed takes to bring (the Fed Funds rate) back to neutral or restraining levels," he says "the bloodier will be the crash of the bond market when it happens. And it will happen. Reality does not stop merely because some short-sellers lost money. Borrowing short-term to finance long-term bets is a deadly game that cannot be made safe by hedging, no matter how sophisticated the strategy.  Hedging does not eliminate risk; it only transmits unit risk onto systemic risk."

And no truer words were ever spoken, even though neither the Federal Reserve, nor the banks sucking money, vampire-like, out of the system, nor the SEC, or Wall Street, nor the government, nor the armies of clueless university economics professor morons, nor any of the stock touts on TV believe a word of it. To the contrary, they all believe, for reasons that they cannot enunciate, that financial derivatives in quantities that swamp global GDP will prove to be some bizarre economic savior or another.   But one day, when the whole derivative mess collapses in a huge stinking heap, they will rise as one and say, "The Mogambo was right!  We are all a bunch of idiots!   All hail The Mogambo!"


The Mogambo Guru
for The Daily Reckoning
November 8, 2004

You now have a clear choice, dear reader.

October’s employment figures leapt by 331,000.  "At last, the jobless recovery is no longer jobless," said the Bush-Greenspan crowd.  The Dow moved up on the news; chartists thought they saw a key break to the upside.  Now that Bush has another four years, could deliverance from our economic woes be at hand?

The Bush-Greenspan formula is simple enough – lower taxes, more spending, more debt, more credit, more war.  They believe this agenda will produce growth in the economy, employment, and the Dow.  They also think this supply-side approach will resolve the world’s financial imbalances by allowing the dollar to sink slowly as the U.S. economy booms.  "We will grow out of our problems," they say.

We had a hunch Bush would win the election; he’s the man the times require.  (Yes, the "thinking conservatives" voted against him, but he didn’t need those 2 votes.)

The European press looks upon the president as a free spirit, a straight-shooting cowboy who cannot be restrained by more moderate advisors.  They think he turns his back on the wise counsel in order to follow his own instincts.

Nothing could be further from the truth.  Bush is the man for the job precisely because he seems to lack any critical judgment of his own; instead he is a stooge for every self-serving opportunist and brazen theorist who comes through his door.  No spending proposition is too absurd.  No military adventure is too costly.  No boondoggle to big industry is too corrupt.

More credit?  No problem.  More spending?  You got it.  Pass a law?  Where do I sign?

The going has been very good in America for a very long time.  Lately, it has been just too wonderful to last.  But how does something like this come to an end?  Do people get together and decide to lower their expectations?  Do the voters elect a humble accountant who tells them they will have make do with less?  Do the Republicans come to their senses, cut spending, raise taxes, and ask Alan Greenspan to raise rates?  Americans desperately needs to spend less and save more.  But who’s going to tell them?

A man on his own may wake up and decide to check himself into a detox center, go on a diet, or straighten out his own finances.  But groups of people never do.  It is as if they all had the same credit card.  Everyone in the group may know they must cut back on spending; but who’s going to do it?  The larger the group, the less an individual gains, personally, from doing the right thing.  The best he can do for himself is to run up as many charges as possible – and make sure he’s got another credit card!

When a group of people put themselves on the road to ruin… there’s no stopping them; thoughts make no difference.

Consider WWI, for example.  By 1916, it was obvious to nearly everyone that the war was a losing proposition.  Ten million people had already died.  Nothing had been gained.  Nothing stood to be gained.  Many people realized the situation was hopeless, but what could they do?  Imagine them trying to "get the word out," or write letters to the newspapers.  It was hopeless.  The war had logic of its own; it didn’t matter what anyone thought about it.  And so it continued for another two years…at a cost of another 10 million lives.

After the war, Russia turned to communism.  It was clear to most Russians, and even to Lenin himself, that the system did not produce the paradise on earth that had been promised.  But imagine the poor Russian, writing to the newspaper in 1925:

"Well, we gave it a good try. But this thing really doesn’t seem to be working.  Let’s go back to where we were in 1917 and start over."

Again, the system had logic of its own.  Stalin came along just when he was needed, to keep the nation on its path to ruin.  It stayed on it for another 64 years.

And now it’s America’s turn.  Our consumer capitalism will not be destroyed by communism, or by terrorism…but by it’s own excesses.  Thus, we need leaders who not only permit excess, but also encourage it.  Bush and Greenspan are the men we need now.  We can count on them to produce as much ruin as possible.

But there’s another choice, dear reader.

The world economy is "an accident waiting to happen," says the FT.

While the Dow rose last week, so did the price of gold – to a new high for this go-round: $434.30.   Meanwhile, the dollar fell to a new low: nearly $1.30/euro.

Bush-Greenspan?  No thank you; we’ll take the other side of the trade: gold.  The yellow metal has risen almost 60% since 1998.  Stocks have gone nowhere.

We’ll stick with gold.

Meanwhile, more news, from our currency counselor:


Chuck Butler, reporting from the Everbank trading desk in St. Louis…

"I left you Friday with the question of whether or not the United States had created jobs in October…and the answer came through right away, with +337,000 jobs created!"


Bill Bonner, back in France…

*** Addison Wiggin reporting from Shanghai, China:

"I’ve been on many tours with Agora," a fellow traveler told us over a traditional dim sum lunch. "But while you were speaking, I thought, this is the first time they’ve sent along a ‘wet blanket’."

We took the comment in stride. During a brief, informal speech with the group, we merely pointed out that "China" is the most interesting story in the investment world today. But that’s it. As travelers from the West, China is mysterious… fascinating. As writers, you couldn’t ask for better fodder. But as investors? We’re not at all convinced.

The city of Shanghai has some 3,800 hundred high rises. From the window of our 54th-story corner hotel room, you cannot see the end of them in any direction, smog and fog notwithstanding. We’ve been getting a kick out of watching helicopters drop off passengers on two different heliports atop office buildings… below us. The "national tree" – the construction crane – dots the skyline in every direction.

And, according to an acre-wide model of the city, set up by city planners at the Shanghai Urban Planning Exhibition Center – the largest of its kind in the world –  "we ain’t seen nothing yet."  A color-coded map shows what buildings have been built, those that are being built, and those that are on the way. Nearly a quarter of the buildings planned for the city have yet to break ground.

On the first day of meetings we heard from several companies: A value-added data provider for Shanghai’s young, burgeoning mobile phone crowd; a travel agency hoping to break free from its state-owned development corp. parent; and a third developing a wireless network in the Shanghai province.

Will they be good investments? We don’t know. But they share an underlying theme: A strong relationship to the Communist party or dependency on state-owned businesses. One of the selling points of the travel agency, for example, is that the local party had "parachuted" one of its secretaries down into the private sector to serve as the company’s CEO.

This is capitalism, no doubt. "Getting rich is glorious" is one of the Party’s latest buzz lines. And the rapid growth of the economic zone around Shanghai would make any 20th century-style robber baron drool with envy. But it’s not the kind of capitalism individual investors in the West are used to dealing in. And we suspect we’ve got a lot to learn before the "story" we’re writing has tycoon-style riches as one of its themes. Then, again we could just be playing the part of the "wet blanket."

*** "There used to be a lot more small birds in this part of France; we ate them all the time.  Nothing is better than wild birds."

Our gardener joined us for lunch on Saturday, bringing two bottles of "vin d’epine" – an aperitif flavored with the buds of thorn bushes, just in case we were running low.  The conversation was fairly typical:

"Yes, when I was a child we would hunt the birds…like the thrush.  Mmmmm…they were good.  It was hard to capture them.  You had to find a tree limb where they were likely to land and put a kind of glue on it.  But you had to do it just right.  And then, you’d go back and find a bird stuck on the limb.

"You can’t do that anymore.  It’s illegal.  And there aren’t a lot of birds anymore.  That’s why they just told us in the county to stop trimming hedges.  We’re supposed to let them grow up all over France so the birds can find shelter in them.

"In the springtime, when we climbed trees to catch birds, we would also look for nests of young birds.  We’d take the little birds and use them to fish for eels.  Eels are carnivores.  There’s nothing they like better than a young bird that has fallen out of its nest.  So we’d tie a string to the bird and throw it out on the river.  The eel would gobble it down and we’d bring in the eel.

"Eels are delicious too.  You can still catch them.  You just roll them in flour and grill them over an open fire with parsley and garlic.  Mmmm…"

The Daily Reckoning