The Inflation / Deflation Debate and China's Commodity Carry Trade

The inflation vs. deflation debate has heated up again. The debate looks far from being settled, even among professional investors. This may be the single most important debate in the investment world.

Jim Rogers, Peter Schiff, James Sinclair, Gerald Celente, Marc Faber and Congressman Ron Paul are on the inflation camp. The argument is simple: As the US government racks up trillion dollars of deficit spending, the money can come from neither raising tax, nor borrowing. So the only way out is print money out of thin air. In history, any time a government chooses to solve its fiscal problem through massive money printing, it always leads to hyper-inflation at the end. So that is going to happen. It might be postponed a bit but can not be avoided.

But I will not immediately dismiss the arguments from the deflation camp, either. Well known people on the deflation camp includes Mike Shedlock, Nouriel Roubini, and market ticker Karl Denninger. They present three strong arguments for deflation:

1. Credits are destroyed in the ongoing de-leveraging process. Credits are circulated as money so the destruction of credit means less liquidity in the system.


2. Although the government is massively printing money, most of the newly printed money is just hoarded away in the vaults of banks and do not enter circulation.


3. Where is the inflation today? It's nowhere to be found!

Debunking the second argument is simple. Banks keep a high reserve because they are highly leveraged and they fear a bank run. If banks hoard cash instead of extend consumer credits, people will have to withdraw cash so they have the money to spend. Such a bank de-leveraging process could escalate into a bank run, resulting in the destruction of the banks and massive release of cash into the general circulation.

De-leveraging of the financial derivatives bubble does not cause deflation. Look at the history of Dutch Tulip Mania and the subsequent collapse. Did it lead to price inflation and deflation of things unrelated to tulips? Of course it didn't. The Dutch grocery stores never took a flower as a payment for milk and bread. Can I use a credit default swap to pay for milk and bread today? I can't. Inflation is a currency phenomenon. It has nothing to do with leverage.

De-leveraging is the process that people abandon paper assets due to counter party risks, and turn towards physical assets with no such risk. Physical assets have intrinsic values: the marginal costs to replace them and maintain an adequate supply. So in the de-leveraging process, paper assets will lose value, and physical assets will gain value. The US dollar is a paper asset. The dollar is leveraged on the full faith and credit of the US government on its ability to pay off its huge amount of debts, which frankly does not look good at all.

The world knows the US dollar is going down. Chinese students laughed loudly when Tim Geithner told them China's US dollar assets are "very safe". Many very rich and successful Americans know the dollar is going down. People like Jim Rogers are moving their assets out of the US dollars and into China and other places. No wonder the US government is cracking down on Swiss accounts owned by Americans.

So here is your answer to where is the inflation. Blame it on guys like Jim Rogers
who are selling their US assets! Jim Rogers is a billionaire. He sold his house in New York, therefore New York real estate collapsed. He sold his furniture, sofas and tables and chairs, so that brings the furniture prices down. He sold his US stocks so the US equity market is down. He sold his stuff for US dollars, and bring his dollars away from the US soil, and into China. Jim Rogers drains liquidity from the US market, thus prices of everything drop. Speaking seriously: This is an ongoing bankruptcy liquidation sale, not deflation. The low prices will not last.

I told you that is exactly what happened, in my last article. Liquidity is drained from the US market because smart capital is escaping from US soil to look for opportunities in places like China. This is a huge liquidity drain from the US. But it also causes headache for the Chinese. They need to deal with all the "hot money", the US dollars flooded into China to be exchanged into Chinese Yuan, as speculators are betting on Yuan appreciation over the dollar.

In other words, currency speculators are exporting our inflation to China by draining the liquidity from the US and bringing hot money to China.

How does China handle the massive inflow of hot money? China simply prints their own money to soak up all the inflowing US dollars. It costs them nothing to print the Yuan to buy the dollars, and they can spend all the dollars to purchase physical assets and raw materials around the world. This is the Commodity Carry Trade they are playing, very successfully.

Few people in the west recognize China's real strategy. They thought it was impossible for China to sell the dollar and exchange it into euro or yen. Why would China sell one paper just to exchange for another paper? They thought China's recent commodities buying spree is to merely boost price to help domestic producers, or to stockpile for strategic safety. But China's buying of aluminum, a material that China has plenty, signals that it goes far beyond strategic hoarding. Commodities are China's new foreign exchange reserves. China is not selling the dollars, China is spending the dollars.

With continued inflow of US dollars, and with China's own money printers running at high speed, China has plenty of money to spend and continue the buying spree. With Yuan tightly pegged to the dollar, this game can continue indefinitely until currency speculators stop sending the dollars to China. Then the US will go from being the largest exporter to the largest importer of inflation, over night! All the dollars will fight their way back home at once. Goods and raw materials will flow out of the USA, until this land is ripped barren! I predict many people will be voting with their feet, before the nightmare scenery occurs.

The currency speculators did the wrong thing selling dollars buy the Yuan. The dollar is going down, but so will the Chinese Yuan. Investors should go to physical commodities, not Yuan or any foreign fiat paper money.

Some Chinese already realize that the Yuan is losing purchase power. In recent months, there was a sudden turn up in real estate markets in major cities in China. The housing slump turned into red hot housing boom, literally over-night, caught many people in a big surprise.

Unless you read news in Chinese, you might think I was telling a fairy tale. But it is absolutely true. There is a sudden housing boom; an auto sales boom; a boom in bank loans. Mean while China could NOT sell its own treasury bonds. What does that tell you? China could not borrow a mere Y28 billion Yuan (US$7B) from its own people. Why would China be able or willing to extend another trillion dollars of credit to the US government?

Jim Rogers is absolutely right that commodity is the only asset class whose fundamentals have not been impaired, but improved. One of the best sectors to play the Chinese commodity buying spree is dry bulk shipping, as China's global buying spree is far from over.

Stocks in dry bulk shipping include the follow names: EXM, [[EGLE]], TBSI, DRYS, GNK, DSX, NM, OCNF and SBLK.

There is also a shipping ETF called [[SEA]]. Do your own due diligence on specific positions.

Raw materials that China does not produce, but are critically important to China's economy, are the best commodities to buy. This includes platinum group metals, platinum and palladium; aviation metal titanium; battery technology metal cobalt. My best favorite is the palladium metal, and palladium mining plays: Stillwater Mining (SWC) and North American Palladium (PAL). Recently Andrew Snyder published an article pitching palladium as a critical metal for China, and SWC
with a potential of 1,389% gain, without naming the names! I am not sure any one knows what China's next big purchase is. But it is a fact that palladium is one of the critical strategic metals that any modern country must stockpile. Look at TIE as a titanium play, and [[OMG]] as for cobalt play. I also recommend buying physical cobalt.

If you are interested in rare and strategically important metals, then follow Jack Lifton, a regular writer for Resource Investor. Jack's article on tellurium got me first interested in the metal. I actually bought some tellurium. Read a recent article on First Solar (FSLR) and tellurium: Hard to Find, Easy to Smell. It's amazing that FSLR still holds up well today and there is still no rush to buy tellurium. But as I predicted, Samsung bets big on tellurium based Phase Change Memory. The chip is already in commercial production. I recommend shorting FSLR if it raises near $200 a share. If you hold long or short position in FSLR, you have a fidelity to your money to demand the truth from FSLR on their tellurium supply.

I have high respect for Jim Rogers. But I have a huge disagreement with him on his love of agriculture commodities. I know his agriculture love is very influential and a lot of people agree with him. But I must point out that he is completely wrong on agriculture. In terms of dollar or any fiat currency, all commodities are bullish. But in terms of growth potential in real purchase power term, agriculture products will perform near the bottom, only better than gold. I don't like gold (GLD) at the current price at all. As the world is facing so many resource crisis, I can not understand why the world as a whole still dedicate a lot of efforts digging a metal that is least useful, and least in shortage. Sell gold to buy silver, physical silver, not [[SLV]]. After I carefully scrutinized the silver bars list I do NOT believe SLV has the actual silver bars.

On agriculture: granted that the world sees a food crisis looming; granted that every fact Jim Rogers cited is correct: Farmers can't get loans to buy fertilizer; Asian countries eat more meat; And that food is the single most important human need. Despite all these facts, Jim Rogers is still wrong on being overly too optimistic on growth potential of agriculture products.

Jim Rogers doesn't know how the poorest people in the world are struggling to feed their families. There is demand destruction. The poorest people in the world are already spending 80%, 90% or more of their income on food. Farmers could barely make any profit raising their cattle. If food price doubles, do you think the poor people will have more than 100% of their income to spend? Or a farmer can spend more to feed their cattle? No! Poor people will have to buy less and eat less, and farmers will have to slaughter their cattle.

Such demand destruction can quickly reduce food demand, and hence it tightly caps the price growth potential of agriculture products. This is why agriculture products will never be the most bullish of all commodity plays. Agriculture is still bullish, not bearish, but the growth potential is simply unattractive. A number of rare metal plays can easily beat any agriculture hands down.

My last article called to buy United States Natural Gas (UNG) fund. I was a bit premature. But at current price level, UNG has no more down side and plenty of explosive upside potential. A recent EIA report noted an important trend: At current low natural gas price, it could become economically incentive for power plants to switch to burning natural gas instead of coal to generate electricity! Please read that document carefully. If power stations switch from coal to natural gas, the huge demand boost will put a rock solid bottom at current natural gas price. In comparison, I will caution about adding position on US Oil Fund (USO).

Full Disclosure: The Author is heavily invested in palladium mining stocks SWC and PAL. I also hold significant positions on shipping stocks EXM, EGLE, TBSI, DRYS, GNK, as well as positions in UNG. I hoard physical tellurium metal but have no position in FSLR.

Comments

[Yo-yo:]

You are a clown - why do you bother talking up the same illiquid stocks on Seeking Alpha?

Jul 13 05:56 AM

[PNG:]

Every company on the planet cannot think they can put all their "eggs" in the China "basket". These companies need to hire true salesmen not "order takers" which is what they were in a robust economy and now forgot the art of selling. Having the majority of your profit potential tied up with one or two customers spells doom when there is a major pull back as last year and then this cycle starts all over again. China plans for success in periods of "centuries" , we look at it from quarter to quarter. Given time with that game plan, China will have it all eventually.

Jul 13 08:22 AM

[Mark Anthony:]

The original, with a little bit formatting, can be read here:
stockology.blogspot.co...
Latest article on Market Skeptics seem to support my conclusion:
www.marketskeptics.com...
I have direct information from China that shows high inflation is coming. We will see in the next few weeks.

Jul 13 09:55 AM

[DaveW:]

"Debunking the second argument is simple. Banks keep a high reserve because they are highly leveraged and they fear a bank run. If banks hoard cash instead of extend consumer credits, people will have to withdraw cash so they have the money to spend. Such a bank de-leveraging process could escalate into a bank run, resulting in the destruction of the banks and massive release of cash into the general circulation."

IMHO, everyone keeps underestimating the seeming slow but quietly enormous on-going destruction of wealth. The fact that there was no run on BAC in February of this year is *very* telling. Back then, it was almost a foregone conclusion they were going under, yet no run on the bank. There is apathy and tolerance of large institutional volatility due to the mass perception of FDIC backing as well as the backing of a government hell-bent on bailing out anything that is too-big-to-fail. June's fall in housing prices of *only* 0.6% represented $100 billion in wealth destruction...and it was hailed as good news!!
No, deflation has been, and will continue to be, quietly mis-understood.

Jul 13 06:03 PM

[User 422955:]

Mark Anthony wrote:

"The Dutch grocery stores never took a flower as a payment . . . ".

Of course not. The tulip craze was about bulbs, not flowers. I'll bet that stores took bulbs instead of cash, but I don't know where to look it up.

I don't understand how Mark Anthony can recommend cobalt. This mineral is only found in association with others, primarily copper and nickel. Which copper and nickel miners do you recommend, Mark?

Jul 13 07:41 PM

[BigOlDave:]

There are some staggeringly bad shippers in the list, but the best (NMM) is missing. NMM is NM's limited partnership.

Jul 13 09:45 PM

[Chickenpookie:]

So hasn't China been hording US Dollars as bounty for their exports? You wouldn't think that toys made by kids for kids would be unsafe either, but they are.

Okay then, so what happens when all those dollars start coming back to the US? I think this must be why only a small portion of the US QE has actually hit the streets?

Summer's over, it's time for back to school! (for the kids)

Jul 14 01:58 AM

[Mark Anthony:]

If you have invested in precious metal ETFs like GLD and SLV then please read this:
seekingalpha.com/insta...

Jul 14 02:16 AM

[Chickenpookie:]

You have good insight Mark Anthony. Please keep writing and let us know what's really happening in China. The Chinese people have worked very hard, including the last decade I seem to detect their lifestyle improving (assuming progress actually equates to improvement, a debatable subject).

Now I hope we can move on to the next stage.


On Jul 14 02:16 AM Mark Anthony wrote:

> If you have invested in precious metal ETFs like GLD and SLV then
> please read this:
> seekingalpha.com/insta...

Jul 14 09:10 AM

[Mark Anthony:]

Interesting read. This backs up my arguments:

China finds the backdoor…how to unload $2 Trillion in Treasuries without tanking value

www.rapidtrends.com/20.../

Enjoy!

Jul 14 02:21 PM

[Mark Anthony:]

Read also this recent Instblog on SeekingAlpha:

China's Investing in a New Currency and It Ain't the Dollar
seekingalpha.com/insta...

Jul 14 02:49 PM

[dancing diva:]

Chinese inflation coming? Gimme a break! The demand increases you cited from autos, housing, etc. has been manufactured by the government granting massive incentives. What the gov giveth can be just as easily taken away.

When the Chinese economy moves again on free market forces wake me up.

Jul 19 09:50 AM

[svosavvy:]

Can anyone explain demandless inflation. Makes about as much sense as jobless recovery. WTF. I agree palladium looks interesting (cheap) here, especially with our forward "greentech" leanings. This article gives food for thought, thanks for your time.

Jul 20 12:10 PM

[Mark Anthony:]

Yes indeed you need to wake up from your slump!

You are not alone. Most westerners have a very poor understanding of China and the Chinese people today. Their perception of China was from the era of the Culture Revolution when the Red Guards were waving the small red books of Mao. There has been a gigantic paradigm shift in China. Jim Rogers are calling the Chinese "the best capitalists in the world".

The average Chinese today are way much more acutely aware of what's going on in the world and what's going on in their own country, their own community. In a huge contrast, it's the American people are are brain washed and who are clueless what's going on. The young Chinese students bursted into loud laughters when Tin Geithner told them China's US dollar assets "are very safe". Such behavior would have been unthinable a few years ago.

Let's face it: The massive liquidity of Chinese Yuan that the govermnet created must leads to high inflation. The weathest Chinese are completely aware of that and are doing what they can to protect themselves. They KNOW. The average Americans do not know. That's the difference. But very soon even Americans will feel the inflation in their daily life.

On Jul 19 09:50 AM dancing diva wrote:

> Chinese inflation coming? Gimme a break! The demand increases you
> cited from autos, housing, etc. has been manufactured by the government
> granting massive incentives. What the gov giveth can be just as easily
> taken away.
>
> When the Chinese economy moves again on free market forces wake me
> up.

Jul 27 02:49 PM

[Poborsky:]

Its about currency collapse caused by loss of confidence when a country borrows more than it can afford to pay back and starts trying to print its way out of trouble. Argentina and Zimbabwe are recent examples. Cant happen to the US though its too big to fail LOL.


On Jul 20 12:10 PM svosavvy wrote:

> Can anyone explain demandless inflation. Makes about as much sense
> as jobless recovery. WTF. I agree palladium looks interesting (cheap)
> here, especially with our forward "greentech" leanings. This article
> gives food for thought, thanks for your time.

Aug 07 04:02 AM

[tellurium:]

"Mark anthony" just had several thousand posts removed by yahoo finance forums for his TOS violations and spamming.

Once again, this article repesents a rambling and incoherent, inconsistent mish mash of ideas cribbed from various web authors.

Example of how absurd it is. Mark states that you shouldn't hold the indpendantly audited, inventoried, custodial oversigthed, silver backed, silver ETF SLV..due to his 'concerns' about the physical bullion actually existing...misusing and misunderstanding the term he often invokes, 'counter party risk'..

...yet then he recommends and has as his 'second largest position' the ETF UNG!!! Which is getting killed due to 'counter party risk' issues including investigation by the CFTC and Congress for market manipulation, and is currently being restructured to hold WHO KNOWS what derivitiaves in lieu of the futures contracts it will no longer be able to use as its exclusive NAV vehicle.

Then of course there's Mark's 3rd largest position, EXM. He was crowing on Yahoo all early last week, (Tuesday) about just tripling his position in it...just before it collapsed big time due to poor earnings release (which mark claimed was 1200% more earnings / share than it actually was)... and due to a huge dilution of shares in a secondary offering.

I find it grossly incongruent that a guy crowing about 'counter party risk' all the time, uses an investment strategy of putting all his eggs in very few baskets which are LOADED with counter party risk, and does this on margin to boot!

But then, his purpose here is not to inform, but to try and steer people into his picks. Which is why he just had thousands of posts removed from yahoo forums due to his frequent spam and other violations.

Aug 08 09:20 PM

[Mike L:]

Wow, let's just look at anthony's final paragraph about UNG for an example of how to treat the rest of his cobbled up screed. He states UNG is at rock bottom and has no more downside risk...and since he wrote this, it has collapsed horrifically and has much further to fall! Indeed, just about everything he predicted has gone in the opposite direction, or was flat wrong...(consistent with his previos track record of course).. and he has no idea what is meant by 'counter party risk'..which he ascribes to SLV, which holds silver bullion to fully back its ETF...yet he recommends UNG which has terrible counter party risks! as has been evidenced by its price action. Just see this excerpt for example re UNG, and you will see all you need to know about 'mark anthony's' credibility.

*************
UNG

Words like 'desperate' and 'counter party risk' are not what you want to see in what you invest in..

stocks.investopedia.co......

....The fund has also, for all intents and purposes, reached its position limits set forth by the CFTC, all but deeming UNG a closed-end fund due to its inability to issue new shares. The lack of new shares has led UNG to trade at an almost unheard of premium of 11% over its NAV.

Swaps
In a desperate maneuver to create more units, UNG's managers entered into a $250 million over-the-counter swap contract in July, and recently announced that they had also entered into a $500 million natural gas total return swap. By entering into these swap contracts, UNG has added significant risk to shareholders by introducing a large amount of counterparty risk into the equation. It's a desperate move by a desperate group.

Aug 28 11:21 AM

[tripleblack:]

I have elected to follow MA just to make sure I keep up to date on whatever odd message he wants to issue in these areas. If you don't ocassionally read what the logical opposite pole says, you lose perspective on just how bizarre the market has become.

Aug 31 05:41 PM

[Bronzeback5:]

From the Yahoo boards where Tellie pumps this turd nonstop. I could not have said it better.


"I find it TRULY hysterically funny that this clown of a laughable buffoon, tellstupidum/markanthony still believes that geophysicists were hired to explore for minerals based on the e mail of an uncredentialed school dropout's review of google earth views, LOL!

Dellerium truly is the most infantile, hilariously funny, mentally ill, delusonal nutball I have ever come across, bar none.

I wonder if he still believes that auto sales rose all through 2008 and early 2009 like he stated frequently on SWC board? Or that silver was worth 40% more than spot because he found a quote in CHinese Yuan and doesn't understand the 'fixed' Chinese currency exchange issue? "

Sep 23 03:06 AM

[Bronzeback5:]

www.youtube.com/watch?...


This is a classic. Stock picks from an alternative universe.

Sep 23 03:09 AM