odin

Gold Fever Spreads to India

What do central banks care about? Do they care whether they get an extra few points return on their FX reserves or whether there is employment, stability and sustainable growth?

Regardless of the recent strength in their currencies, the Asians have not forgotten the currency crisis. The stockpiling of $ they are pursuing and the undervaluation of the currency is not stupidity, they are plainly merchantilist policies designed to collect US$. This policy keeps the masses employed, stability in the financial systems and politicians in power.

While the market has looked at this news as unadulteratedly bullish for gold, it was always clear that IMF was not dumping 400 tonnes on gold on the open market. I'm not sure if anything at all has changed with this purchase.

The fact is that trade surpluses will trending down as US savings rate (post the clunker dip) start rising again. The priority of these banks will be to ensure that their respective currencies DONT rise too fast (and that the $ doesnt fall too fast).

China's Economy: All GDP Is Not Created Equal

China faces difficult challenges - while rebalancing is desired, it MUST grow. The short term incentives are heavily skewed towards providing continued employment -- even if it is on digging or filling holes. Just as the US is kicking the can down the road regarding inevitable slowdown in consumption, China is delaying the bitter medicine of shifts in employment patterns.

Continued structural imbalances and nascent signs of conflict within the governing structure (Xi Jinping failure to make it to the Central Military Commission) do not bode well for the well-being of the world.

The Next Major Crisis Brewing

The C/A surplus nations dont buy treasuries because they are good investments. When they run a surplus, they can either let their currencies rise or recycle the surplus into something else (like Treasuries). If they want to run merchantilist policies and keep unemployment low, they choose the latter.

While they are changing the mix of what they are buying (agencies etc.), the theory that CBs are buying LESS (in absolute terms) US securities is not borne out by the TIC data. Could Mr. Graham perhaps show us where he got the data showing that the foreign banks are reducing in absolute terms their T-bill purchases? I also dont understand how higher yields induce any CB to buy a T-bill. Did we get deficit nations in Africa scrambling to buy T-bills in the 80s? You only buy a foreign bond if you have a surplus. If you dont, your currency will rise and ceteris paribus, over time, you will run less of a surplus. That is how international economics works.

I wont decipher the chicken-and-egg connections here, but the foreign buyers undoubtedly will buy less treasuries in the future as US saves more, China consumes more, international trade contracts and the US runs a smaller trade deficit, while these surplus nations run a smaller surplus.

There is a choice however of WHAT foreign asset to buy. China has been buying more commodities, some gold....even foreign companies. But I have yet to see convincing evidence (and random comments from various pols in China in news publications is not that evidence) that China believes it should make MORE of these purchases in lieu of US Treasuries. What I have seen is that China is buying more of everything, incl. Treasuries.

You Can Spend Your Way Out of a Recession

I think the question is less whether you can spend your way out of a recession (as you pointed out, whether it is government spending or consumers borrowing, its not difficult to turbocharge current consumption by sacrificing future earnings). The real question is whether you should: and there is the point of contention with those who trust free markets and those who call themselves Keynesians and everyone in between that spectrum.

Our world operates on confidence and trust. And not just because we have fiat currencies. The level of trade and mutual give-and-take will be greatly reduced if we turned away from such systems. And if we doubt the solvency of the system, no one benefits. Bernanke's monetary lubrication to restore confidence in the solvency of the entire system was well warranted.

Even fiscal stimulus that keeps people productive and out of bankruptcy is welcome. However, we should realize that fiscal stimulus takes a much longer time to work and we should rely less on stimulus checks, _unworkable_ mortgage modifications, continued transfers (why should only certain states benefit from extended unemployment?) that spend massive amounts of future earnings and try to provide an immediate boost.

Ultimately, people over the medium term, do realize that that money spent today that they do not have (either by government or via their own borrowing) must be paid back in one form or another. For governments, it means either via inflation or higher taxation (or via growth). Perhaps some people think that it will only be the rich that will be taxed but thats a fallacy (there simply arent enough of them and they have great incentive and resources to hide taxable wealth). And Inflation is actually a regressive tax. We will get both -- actually also accompanied by spending cuts and higher deadweight losses as politicians try to wiggle their way out of this mess.

So my view is that while we can use a defibrillator to shock the patients heart into beating, there is only so long we can continue to administer that same treatment. There is no way to avoid diet and exercise. We need to spend in areas that generate jobs and also recognize that there will be unemployment pain in the near term. That will generate growth and lessen the pain of both higher taxes, social spending cuts and higher inflation that is to come.

China’s August Data Confirms Both Optimists and Pessimists

I am curious as to the breakdown of retail sales. Where is this growth concentrated? It is clear that asset prices in China have skyrocketed in the past few months. Is it possible that this has made a small segment of the population feel wealthy and splurge (just as rising house prices in the US led to better times for the luxury market)?

When I think of and hope for rising domestic consumption in China, that is not quite the rise I trust. Consumption by a small segment of the population based on paper wealth is likely to come down just as fast. The consumption that global companies get excited about is broad-based -- driven not just by buying cars and luxury goods but by spending on mass-marketed goods (appliances, apparel etc) -- and based on rising wages and consumer confidence. To some degree, that is the hallmark of Chinese growth story (and while export subsidies did transfer away wealth from the workers to the exporters, its also undoubtedly true that a significant portion trickled down).

As to the risks facing the Chinese (and global) economy due to its export orientation and a point that Prof. Pettis has been making for a while (nations running a surplus are a lot more vulnerable than those running a deficit when there is overcapacity in the system), read these shades of Smoot-Hawley: www.ft.com/cms/s/0/f67...

5 Reasons to Avoid the Gold Rush

I think commentators really missed a major point -- the risk of owning gold. Its not that gold is not a good diversifier nor that it shouldnt be a part of your portfolio. But those who advocate a massive overweight in gold are completely discounting the risks of gold investing. Does no one ask why Paulson chose to pay higher fees and invest in the ETF? He's not paid to pick the beauty queen. He's paid to pick what others believe is the beauty queen. There is an exit strategy for the hot money crowd and its when retail goes gung-ho on gold. What really is the outcome -- however remote -- of one of these big holders trying to dump the ETF?

While its nice to think (just because the CCP says so) that China will put a floor under gold to escape the dollar, the exit trade _is_ a risk. The simple truth is China cant exist in a vacuum. The reserve currency is still the prerogative of military and economic strength and China is decades away from overtaking the US in both arenas. They will have to contend with an inverted demographic pyramid thats probably stronger than the one in Japan. They will have to deal with the health impact of two decades of heavy pollution. They will have to deal with a generation of wealth transfers from workers to exporters. China is a big nation -- one with many natural resources and bright people and it has a bright future, but these are real problems that are on the same scale as the ones that plague the US. Its relationship with the US is symbiotic. The moment China stops funding the C/A deficit is the moment it stops accumulating a surplus and its when US stops needing that funding (In a simple two economy model: US imports less, period. Its not a choice, its a tautology). Does it really make sense for China to do anything but make symbolic gestures against the USD unless it wants a domestic crisis on its hands?

Now, if collapse of society is where your bet is, then, by all means, push all chips into gold. (though probably not the ETF)

But inflation? Look at the performance of gold vs. consumable commodities (oil particularly) in the 70s. Gold isnt my first choice when I think of high inflation.

Trading the 'Theme du Jour'

While fashions du jour change rapidly, it seems to me the short dollar crowd is touching the elephant trunk and calling it a snake. My big question to the $-fall over the medium term is: against what? MM has answered it in the short-run: against everything else but it makes little sense over the long run.

We talk of Fed $-printing. Arent the Chinese doing the same thing at a much more accelerated and an even more unsustainable pace?

Against gold because of inflation? But are wages going up? Unemployment going down? (i actually believe employing will be a a leading rather than a lagging indicator in this cycle) Re-leveraging into asset speculation is no inflation. That is the only recovery I see and likely to end up the same way as the earlier experience -- in tears.

The Chinese have NO choice but to buy dollars if they wish to keep employment levels remotely close to where they are. Even small economies dont turn on a dime, let alone the worlds 2nd largest suddenly turning its export-focus and promoting domestic consumption in a short time-frame. Repatriating physical gold, jawboning about dollar worries are just that -- noise.

I would not be surprised if DXY ended the year in the mid-80s. If ever the world gets back to full productive capacity and near-full employment levels AND the central banks all over the world keep easy money policies that result is more than just asset bubbles (especially widespread shortages in food and energy), then and only then will I worry about high inflation (and invest not in gold but in those commodities and the equities of companies that produce/service them).

However, I cant put weight scales in the voting booth and am content to stay on the sidelines through these rallies.

The Shanghai Market Calls the Tune

The story about the attacks is significant not so much for its contents (after all, I'm sure more people get hurt by more violent levels of crime in areas bigger than Urumqi) but as a reflection on the state of the people. The fact that fear (especially rumors) gets wings like this among a large section of population (enough to get international attention) and rapidly gets transformed into anger against the GOVT (www.timesonline.co.uk/...) is significant and worrisome.

From a psychological perspective, it reinforces the idea that despite other signs that may be impacted by governmental interference, the ordinary people are concerned about their future, nervous about the changes that may come and distrustful of the government to solve their problems. It is in such environments that random rumors grow bigger than life and cause headaches for governments and force them to make sub-optimal choices.

Of course, this is just one incident and I wouldnt want to let the imagination run wild solely on this story but I keep my ears open for similar signs of discontent and fear (which to me portend tougher economic times)

Volatile Trading Conditions Continue

Just to throw some natural gas on the fire: in the absence of near-term inflation, the ruling out of armageddon deflationary scenarios, the loss of jewelry buying, the explosion in ETF buying (esp. by the fast money crowd - does anyone have an answer for why Paulson wants to own the ETF rather than the futures?), I'm a little lost as far as gold as an investment thesis is concerned. Have we forgotten 1980 that quickly?

Dont get me wrong, gold bugs. Gold plays a very healthy role in any diversified portfolio. Its the overweight bias in this environment that I question.

What Happens in China Doesn't Stay in China

Its perhaps the years I have spent practising this trade that makes me sound silly but reserve requirements are one tool -- a blunt tool -- to manage the money supply. China CRR is 15.5%, the US is 10%. Furthermore, you will find that the US pays interest on excess reserves and the actual reserve ratio is much higher (lending is depressed). Given these levels of reserve requirements, perhaps you will be kind enough to explain how bank stability is much superiorly managed in China. Comparing to what happened during the credit crisis, as loans go sour, I doubt you are claiming that extra 5 1/2% reserve cushion is what makes the difference for financial stability.

We wont repeat the level of loan growth in China (the numbers have been hashed to death all over this site) but just as a comparison: the M2 YoY is growing at 28.2% in China. The equivalent number is 8.5% (4% seasonally adj) in the US. In light of these numbers, tell me how China has more of an ability to CUT rates.

The problem with China is not lending -- it is to whom they are lending. Continuing to support and subsidize export-oriented industries is simply building overcapacity and will lead to souring loans. Small and medium enterprises catering to internal demand are actually getting starved for credit. This is not making things competitively. This is a wholesale transfer of wealth from the workers in China (by reducing their buying power) to the exporters in China.

You can continue to keep your currency artifically low, keep interest rates low, and continue to allow asset inflation but we have seen how that script ends.

This is not intended to bash China (and China does have a bright future) but to point out a growing problem that threatens the stability of everyone (again) less than a year after the credit crisis. Now if you have been a "domain speculator", perhaps you do revel in the highs and lows of speculation and undoubtedly many make their fortunes during these times but then lets call it speculation and not couch it in pseudo-economic terms.


On Aug 26 02:06 PM Dave Wrixon wrote:

> Yes, and you are another one that has no clue what he is talking
> about.
>
> The whole point of reserve ratios initially was to ensure the stability
> of banks. In other words it ensure that they were not creating too
> much money out of thin air.
>
> In China's case they actually use them to control the money supply,
> in a similar way to which both we and they use interest rates to
> control the money supply. If Western nations had as interest rates
> and reserve ratios as high as the Chinese their economies would sink
> without trace. This simply underline the real financial strength
> in China and shows that, however, much of a bubble you think the
> Chinese might have on their hands their ability to unleash money
> into the system without getting a penny into debt is almost unlimited.
> Of course the reason they have this power is that they make things
> and they make things very competitively. This is why we are lead
> to believe that their economy is on the point of collapse!
>
> Do you guys have any idea how silly you sound?

What Happens in China Doesn't Stay in China

I'm not sure what reserve ratios have to do with viability of banks. However, while believable data is hard to obtain, something is amiss when during times of export slowdown, and exponential loan growth, non-performing loans go down. Subprime crisis anyone? It makes sense if people use credit productively. Otherwise, speculation in financial assets in China is no different than speculation in real-estate or internet stocks in the US.

China can also import all the commodities it wants (and doesnt want), but someone will have to buy the products it creates with those commodities. There are some who believe that the vast middle class in China will replace the US consumer. I, on the other hand, do not believe that that middle class is as able or willing to consume like an US consumer (we are not talking about people making $40-60K/yr). Granted that there is more car-buying and appliance-buying at the upper end of the middle-class, but that is not where the bulk of the population is and that segment will be massively hurt in any real-estate or equity pullback to demand much of anything.

I am also not sure how anyone can "afford" bubbles or policy mistakes. One could actually say that the US with a bigger, more diversified economy can better withstand systemic shocks than smaller, export-centered, centrally planned economies with a lot less wiggle room when it comes to providing growth (employment) to its population.

While a 6% growth rate is stellar for the US (on a $14T economy), if China grow at a rate much lower than 7-8%, it has a stability problem on its hands. The massive number of people entering the workplace and finding no employment will create an explosive situation. Even with 8% growth, China will add about 12M job-seekers to its unemployment figure.

However, I am not sure that a fall in Chinese buying equates to a $-fall. If China buys less USD, it is because the US current account deficit has gone down (US net imports to China have gone down). Now, China can unilaterally appreciate the RMB against other currencies (which will devalue the USD of course) but the value of USD (against most global currencies) will be fine. In fact, that revaluation will point to a further collapse in US imports and as pointed out, if this is coincident with a crisis, the global demand for USD will go up and not down.

Struggling with Divergences

Not sure about Fannie and Freddie but I have heard a variant of that explanation in China. Several retail punters claimed that lower priced equities were "cheaper" and thus a better value than higher-priced equities.

Unemployment: Historical Chart Sends Scary Message

To chap08's point about long-term structural employment -- there is also a expectations' adjustment over the years (willingness to be employed, not just ability). Unemployment insurance is indeed a good thing if it gives people the cushion they need and prevents people from being underemployed (taking the first job they are offered). However, I fear, there is a sense of entitlement thats creeping in that translates these safety-net benefits into a belief that its a right (without corresponding responbilities.)

Furthermore, with youth unemployment figures much higher, I bet that a lot of young people are headed back to graduate education and are not counted in this figure.

(Anecdotally, to support both statements above:I had a conversation with a young lady recently who was lamenting the fact that she could not get unemployment benefits when she quit her job to go to post-graduate school. Far be it from me to tell her that she is technically not "unemployed" or the irrationality of expecting to be "bailed out" for something she was doing to further her own career).

Why Gold Could Hit $1,300 This Year

Always consider the possibility (however remote you think it might be) that your thesis is incorrect. The proportion held by long-term holders: central banks (save for China/Russia), jewelry buyers, industrial users is steadily going down. The proportion held by "hot-money" investors -- ETFs, hedge funds -- has skyrocketed. Draw your own conclusions at what will happen IF that hyper-inflation/crisis deflation thesis is wrong.

Having said that, gold has a valid place in a well-diversified portfolio.

Debate Continues About the Validity of China's Economic Data

There is a lot more unity in views that the market is bubbling but are quite a few unanswered questions re: who is speculating in these markets. The more interesting questions are what happens after there is a large correction in China. I dont claim to have the answers but the right questions are just as important.

If the Shanghai market unravels, will there be contagion effects in commodities and real estate in Asia (undoubtedly)? Will this contagion spread to neighboring or other emerging markets (shades of the Asian crisis)?

And what impact will this have on local population (esp. if the average Wang or Lee has been speculating in these markets and borrowing to fund his position)? Unrest in China? Military adventurism in the Pacific?

What about the impact on US retailers whose profits are largely derived from labor arbitrage (Walmart)? What impact on consumers who have gotten used to cheap goods?