The media is abuzz with China’s central banks decision to allow the RMB to float a bit more freely, but no one is asking the more important question, which way will they let the currency float? Everyone and by everyone I mean certain U.S. Senators and some White House officials, claims that the artificial weak currency has cost Americans their jobs. The claim is it has cost millions of Americans jobs, but the it utter nonsense and political posturing.
A weak currency definitely gives China an advantage, it gives any country an advantage, but at the end of the day China had their currency pegged to the U.S. dollar, so perhaps our political officials should have been looking in the mirror while throwing criticism towards China. In other words, if our currency was stronger it stands to reason that China’s currency would be stronger as well. However, we all know that the intention of the U.S. government is not to have a strong dollar, but to have a weak dollar. That would mean a weaker RMB which would give China an advantage, in the eyes of those living in the land of the blind, in world trade.
How do we know the U.S. wants a weak dollar? Simple, Obama told us. He wants to double exports within 5 years, but we have the most expensive workforce in the world and are largely viewed as inefficient because of our pesky workers rights laws. That makes producing goods in the U.S. for export very difficult with the exception of complicated financial instruments, bombs, military hardware and some technology items. Let’s look at producing hammers, a hammer made in the U.S. would cost about $10, but a hammer made in China would cost about $5, why? Labor costs. The steel is going to be about the same and they are shipping the steel to China and the final product from China to the U.S. at half the cost. They pay the same amount of money for transportation, energy and raw materials, but they pay less for labor. My point is that we cannot export more without severely devaluing our currency or our standard of living.
Which brings me to my next point, China’s willingness to let their currency float more freely, great, but which way? One of China’s major manufacturers, the one were all the people are killing themselves, you know, Apples plant, is raising their workers’ salaries by 14%. Now, forget that 14% on $2 an hour only means another $.28 an hour, but that is a significant increase in labor costs, but are your iPad and iPhone costs going up? No, as an aside, this is just one more reason that I feel good about not owning an Apple product. I have also said that the Euro’s collapse is a significant issue for China, it still is, and a further decline in the Euro means China’s #1 importer of goods will import less, much less from the big red giant. What I am saying is it is entirely likely that China will float their currency lower and now they can claim it is the free market doing it, smooth move if you ask me.
It is not possible for China to have a rising currency, a weakening Euro, a weakening USD and higher wages for its workers with most manufacturers maintaining profit margins of 3%. It just doesn’t work for China and we all know the ruling party wants to maintain its power and in order to do that it must make the people happy. Without plus 8% GDP growth unemployment will increase and discontent will grow threatening the powers that be. In other words, the RMB will go lower unless other currencies increase in value. I realize this is an outside the norm view, but if one steps back and looks at the bigger picture it makes sense.
I could be wrong and perhaps every firm is out there hedging their currency, but that is highly doubtful. Even if they did it would not stop the slowdown in exports and all the bubbles in China will pop at roughly the same time, in the next few months. It is funny that the same people who said the U.S. was not in a real estate bubble in 2006 are saying China is not in bubble territory now, they are. Any slowdown, even a minor hiccup is extremely dangerous and has worldwide ramifications. We are talking about the engine of the “worldwide recovery story” here, not some small corner of the world that does not matter. If their currency appreciates and the slowdown is bigger than anticipated, they always are I might add, there are no more surpluses, no more U.S. debt auctions to show up at and prices will head higher on products.
It also means that they may become net sellers of treasuries instead of buyers, that is not good news, if their currency does appreciate. However, it won’t happen, it will go lower and everyone will be surprised when it happens, except for me. It is clear as day that the Chinese economy is showing extreme signs of stress, look at their markets, they are way off their highs and have been for some time now.
From my lens the entire system is in major trouble and it is evident when we try to find scapegoats for our problems, bankers, the Chinese with their cheap currency, etc. The system needs to reset itself and it cannot happen with all of this intervention and additional debt. Everything needs to be restructured and debts need to be purged from the system, but this will never happen as it means everything goes to zero. Instead we will carry on blaming others, inflating our way out and causing much more pain than by having an absolute reset.
I am watching the happenings in Venezuela carefully as this might be an indication of things to come in the US. While most people naively think that “it can never happen here” I would like to warn you that every country where these things have happened uttered that exact same phrase. Whether it happens because the Federal Reserve loses control over the devaluation of the USD or because foreign debt buyers just stop buying US debt the one thing I am sure of is that it can and will happen here at some point in the future.
What I am talking about is massive devaluation of the currency which leads to inflation or, in this case, hyperinflation. I have stated that for the moment we do not have to worry about inflation, and I stand by that prediction, for now, at some point we will have to cleanse our demons and massive balance sheet. The one and only thing that is saving us right now from inflation is our pitiful employment situation, which is not getting any better I might add. Without employment there will not be wage inflation and we will continue to have subdued demand for products with the exception of food and energy.
Even though I fully believe deflation is here for the near-term, reinforced by the Fed itself, there is one caveat to my prediction, the devaluation of the USD. I have made no secret that I believe that the Fed and the current administration, along with the former administration, have had an unofficial policy of maintaining a weak dollar. The reason for the weak dollar policy is simple, it boosts GDP and earnings in a globalized world along with a host of other seemingly positive economic stimulus. However, a weak dollar is not good long-term for a country and hurts the population as dollar sensitive products become very expensive, i.e. $140 a barrel oil marks the low point of the USD in 2008, and is inflationary without the benefit of actual inflation.
Let me explain, inflation created by excess money printing usually enters the banking system and is loaned out to the population. This is called money velocity and creates too many dollars chasing too few of goods. However, without money velocity traditional inflation cannot happen, but even if the excess money printing does not enter the economy it can still devalue the currency based on the future expectation of it entering the system. This is what was happening up until the last dollar rally and I would like to point out that the last dollar rally was because, depending on who you listen to, short covering, fear about sovereign default (i.e. people were afraid of another systemic meltdown which, in turn, initiated short covering. This is the scenario I favor), or people felt the Fed was actually going to raise interest rates which is absurd, in my opinion.
The dollar devaluation that we have seen explains why oil prices are on the rise as demand simply is not there. It also explains why metals have also climbed for most of 2009 as well. What is scary about both oil and metals going up, especially in 4Q09, are the fact that these prices increased in the face of a stronger dollar which is counterintuitive. Well, it is for gold at least as oil could increase with a strong dollar if there is sufficient demand, but, frankly, there is not as much demand as the price indicates. Regardless, rising energy prices when the economy is weak, to me, is a warning sign of a problem and should forewarn you of things to come, inflation.
If we continue with our insanity that Washington and the Fed is telling us we need it is inevitable that we will end up in a situation like Venezuela where we will either willingly or unwillingly have to devalue our currency. There are pluses to devaluation as your debt, assuming a fixed interest rate, will remain static and your earnings will eventually increase allowing you to pay off your debt faster. However, the negatives outweigh the positives by a long shot as your savings are worthless. This is why we saw the people of Venezuela go out and buy everything they could because goods will be worth more than the paper money.
What is disturbing though is the fact that even though devaluation creates higher prices the Venezuelan government shutdown some stores for “price gouging” which is humorous, in a sick way. The government intentionally creates inflation to make their balance sheet look better, but because new goods will cost more stores cannot compensate by charging more for products they currently have. How in the world are these stores supposed to stay in business or id the governments point to put them out of business? The next logical question to ask is how would this type of scenario play out in the US?
While we do not really have any past history to use as a bench market I think what we see happening in Venezuela is probably a very good example. Right down to the black markets that are more than likely popping up all over the place to provide goods and services the population cannot receive from the usual sources. What I would be interested in knowing is if these black markets are using another medium of exchange, i.e. US dollars, gold, silver, Euros, whatever it might be, to pay for these goods and services. I would be inclined to believe that is what is happening, but there is simply no proof and I am willing to bet no one wants to openly talk about such things for obvious reasons.
What is usually accompanied with this type of devaluation is the government imposing its will that its citizens continue to use its currency no matter what. We saw this happen in Zimbabwe, but just like in Zimbabwe the black market switched over to an alternative payment system, gold. It is important to note that gold is being used because dollars or other currencies simply are not plentiful in the country and gold can be mined, of course gold has also been used as currency for thousands of years as well and at current prices a little bit goes a long way. Basically, forced price controls and forced use of devalued, or worthless, currencies simply do not work, that type of system never has in 4,000 years.
I am not suggesting the US or Venezuela will turn into Zimbabwe, but I am saying that we are facing certain financial Armageddon at some point in the future. All the US has managed to do is kick the can further down the road for others to manage and we are running out of road, unfortunately. We will have only a few choices in the very near future and the most obvious, because it is politically easier, is to inflate our way out of our problems. While this seems like a good idea I am thinking that the 77 million soon to be retired Baby Boomers who are about to be living on a fixed income will like this strategy. However, it is unlikely that they will like the alternative either, much higher taxes, less Social Security and steep cuts in Medicare.
We live in unique times and the one certainty we have is that there is no certainty of anything. I do not believe that there is any question of whether or not we will follow Venezuela, in my mind it is only a matter of when it will happen, not if. However, before we go down that road you will be comforted in knowing that Japan or the UK will more than likely go down that path before us as they are in worse shape than the US. Regardless, watching what happens now will give you an idea of what could happen here and is also why I am a big proponent of investing in precious metals.
So far holding gold, silver, platinum or palladium has been a very sound move on my part, but I actually hope that these investments turn out to be horrible for me because that will mean I was wrong about the future of the US monetary system. While I might be wrong what concerns me is that there are many people who are a lot smarter than I who are sounding the same alarm I am. I would also like to not be naïve enough to believe that “it could never happen here” either because I am sure there are millions of people throughout history who would tell us that you should never, ever, utter those words because no person or country is special.
As stated several times in the past there is a breaking point between how low the dollar can go before it will negatively start impacting the market. As my kids ask all the time, are we there yet? I think we are close, very close. As the dollar closes in on that 75 handle and the EUR/USD crosses the 1.50 mark it is becoming a major problem.
Why? A cheap dollar is great, in the short run, for international earnings, i.e. see Intel and Google’s positive FX results. However, long-term it is horrible for the US because it boosts productivity on false pretenses. Sure, our trade deficit decreases, but did it really? No, it did not. It also increases energy costs which is a huge problem when we have wage deflation and 10% unemployment. I believe that the administration’s goal was to devalue the dollar to boost manufacturing, but like all plans there are unintended consequences and those consequences are real and devastating to the people.
In effect, the devaluation process will wipe out the middle class and the Fed will certainly lose control over the process. Also, what does it matter if companies have record profits if the value of the currency is worthless? That is the potential problem we are facing right now. If the USD breaks below the 71 handle there is no bottom, none. Computers will then take over and without severe intervention then we are in big trouble. Unfortunately intervention means the printing of more money which means a weaker currency, see the problem?
The Chinese would help because they hold dollars? Oh yeah, why? Their currency is pegged to the USD so if the USD is devalued then their currency is cheaper to making their products cheaper to their largest client, Europe. So, why would they intervene? They would not. Perhaps Japan might, but I would not hold my breath they got their own problems. Your only hope is Korea and other smaller Asian countries and they do not have the buying power to stop it, they already tried to intervene a week or so ago and it did nothing. Getting back to China, they also hold large quantities of gold and other commodities, so they are hedged they really don’t care, I don’t think anyhow.
With that said, the Dow was up and then the dollar got pounded and we are seeing a down trend as that happened. We are at the point where the value of the dollar matters and that is a very good thing, finally. While I have done very well with gold and other metals, I care about the dollar’s value and so should you because a 60% rally means nothing if the value of those dollars is reduced by roughly the same real return. Right now I believe a move in either direction is bearish for stocks, but especially a lower dollar as it moves energy higher.
Be the First to Comment 
Subscribe to Annuity IQ's Feed
