An economic forecaster once told a class I attended that he loved to make thirty year forecasts because no one would remember his forecast when the events actually occurred. So he could collect his fee without fear of request for a refund. I will make a thirty year forecast, nonetheless. We are in for soft and declining markets for the rest of my life.
The unfolding of the banking problems in the past two years and the ongoing subsidization of the housing and stock markets via low-to-negative real interest rates will have predictable effects. The current situation is complicated by the de facto pegging of the dollar by international central banks. The real effects of the subsidization are wealth transfers from productive to unproductive factors of production. The chief beneficiaries of the transfers are beneficiaries of government (both employees and welfare recipients), investors and speculators in assets, including stocks, currency, bonds, commodities and real estate. The chief losers are savers in cash and productive workers.
The debt of the US government is growing in absolute numbers to an extent unparalleled in history. Generally, large government debt increases have been associated with monetary expansion and inflation. This time, central bank dollar pegging has limited inflation in the US. The pegging is a form of international inflation. That is, the nations that are supporting the dollar are making their citizens poorer in order to keep them working.
Ultimately, the complex deception becomes untenable. The public starts to question why harder work is met with ever lower rewards. Larger and larger transfers to asset holders are required to keep markets steady, and workers will become poorer and poorer, driving increasing numbers out of the labor market. Democrats and collectivist altruists will say that the deprivation of the productive is in the public interest.
It has become apparent that the US government will not allow the stock and real estate markets to fall. As well, it cannot afford to pay off its massive, ever-increasing debts. So it will depreciate the dollar.
The alternative to stock markets that are soft and retain value only because of government subsidy and dollar holdings that are vulnerable to hyper inflation is commodities. But there is no reason to trust the stability of commodity markets. The pegging system coupled with carry trade and hedge fund activity ensures support for the dollar when it weakens.
The forces for inflation and dollar (and international currency) depreciation are far more powerful than the forces for stability, for the debt is growing too quickly to ever be repaid; the Fed is creating a bubble in US Treasury debt; and the Fed has shown that it will not permit real estate or stock markets to fall. So in the long run, over thirty years, commodities will be better than dollars. But it will be a bumpy road.
Given the uncertainty, firms cannot think long term in the new world socialist order and so sustainable economic growth is out of the question for the foreseeable future. Likewise, the growth absorbing power of government will ensure a declining economy. Innovation in the US once powered the world's advancement, but unless the Asian nations more aggressively permit entrepreneurship, there is no longer a growth engine. It certainly is not the United Socialist States of America. As George Soros pushes for an American society ever more closed and totalitarian, opportunities for shorting and going long on commodities and currency become greater.
Do not expect the highs of the early 2000s to be significantly surpassed in real dollars. But there will be plenty of inflation to confuse everyone.
Showing posts with label bear market. Show all posts
Showing posts with label bear market. Show all posts
Monday, February 1, 2010
Wednesday, May 23, 2007
An Imminent Protectionist Depression?
When credit expands investment becomes easy because there are loans to invest. As with any resource, care declines as the resource becomes abundant. As credit expands, banks and entrepreneurs make less careful investments. These can be into businesses that don't succeed, such as websites seven years ago, or they can be into real estate. Once the borrower spends the credit as money, the money circulates through the economy. As the amount of money increases because of the easy credit, prices begin to rise, and there is inflation. The inflation occurs in part because the investments for which the credit was used may not have been good ones. Back in the 1960s investment was made in bowling alleys, which failed, for example. The use of the credit for failed bowling alleys amounted to giving entrepreneurs and business people "food stamps" for which they did not produce anything. They used up resources to build failed bowling alleys. Demand for resources around the economy expanded. Prices rose unevenly because the money was distributed unevenly, being spent first on the bowling alleys for which the bank gave credit. For example, since, more recently, there has been stimulation of demand for house construction, construction-related commodities may have been the first to increase in price.
In the last cycle, China has modified the inflationary pattern. China has purchased a surplus of treasury bonds denominated in dollars. By purchasing dollars, China has reduced the number of dollars in circulation. This has reduced the price inflation that otherwise would have occurred. Why has China purchased the bonds? The reason is that it sees an advantage in reducing the value of its own currency, i.e., causing inflation in China. The advantage is that it wishes to redirect the way Chinese farmers work. Previously they had worked in small-scale agriculture. The Chinese government would like to see them working in manufacturing. By causing inflation, i.e., reducing the value of the Chinese yuan, demand for manufacturing output is increased. Because of the inexpensive yuan, it is inexpensive to purchase land relative to the demand, so extra factories can open.
The problems with stimulating the extra demand for land are two. First, the Chinese government must hold depreciating dollars. If (more accurately "when") the US stimulates its economy further, the number of treasury bonds that the Chinese must hold will increase as well. This is a risky strategy. Would you invest your entire investment portfolio in a currency investment where the economic forces suggest future depreciation? That is China's strategy. So it is borrowing from Peter (the Chinese taxpayer) to pay Paul (the Chinese farmer turned factory worker). Second, the stimulation of the Chinese economy will cause prices to rise. The January 4th Economist carries an article "Go West, Young Man" describing rapid wage increases in the Pearl River/Hong Kong and Shanghai regions where most of the development has occurred. Firms are increasingly locating factories in countries other than China because of costs or to inland China, further west. The problem with inland China is transportation costs and likely inadequate roads, which will require significant investment. With major infrastructure investments needed, will China be able to keep buying US treasury bonds?
There is no reason to assume that China will continue this policy indefinitely. Nor is there any reason to assume that China does this because it is charitable. China does this as long as the US and the west buys Chinese goods. If the US initiates a round of protectionism, what would stop China from selling the bonds? What motive would it have to continue holding the bonds?
Dinocrat.com reminds us that the Great Depression was in large part a banking and monetary phenomenon and that Milton Friedman in his Monetary History of the United States speculated that religious bias against the president of the Bank of the United States, who was Jewish, led to the Fed's refusal to assist that bank run leading to its failure. In other words, biases can have economic consequences.
Dinocrat mentions that the current anti-protectionist movement is reminiscent of this very kind of trivial bias that can mushroom into larger-scale economic catastrophe. Let us hope the current protectionist saber-rattling by the knucklehead left is not to be taken seriously. There is a strategic inflationary risk that would exacerbate the always harmful consequences of trade barriers.
In the last cycle, China has modified the inflationary pattern. China has purchased a surplus of treasury bonds denominated in dollars. By purchasing dollars, China has reduced the number of dollars in circulation. This has reduced the price inflation that otherwise would have occurred. Why has China purchased the bonds? The reason is that it sees an advantage in reducing the value of its own currency, i.e., causing inflation in China. The advantage is that it wishes to redirect the way Chinese farmers work. Previously they had worked in small-scale agriculture. The Chinese government would like to see them working in manufacturing. By causing inflation, i.e., reducing the value of the Chinese yuan, demand for manufacturing output is increased. Because of the inexpensive yuan, it is inexpensive to purchase land relative to the demand, so extra factories can open.
The problems with stimulating the extra demand for land are two. First, the Chinese government must hold depreciating dollars. If (more accurately "when") the US stimulates its economy further, the number of treasury bonds that the Chinese must hold will increase as well. This is a risky strategy. Would you invest your entire investment portfolio in a currency investment where the economic forces suggest future depreciation? That is China's strategy. So it is borrowing from Peter (the Chinese taxpayer) to pay Paul (the Chinese farmer turned factory worker). Second, the stimulation of the Chinese economy will cause prices to rise. The January 4th Economist carries an article "Go West, Young Man" describing rapid wage increases in the Pearl River/Hong Kong and Shanghai regions where most of the development has occurred. Firms are increasingly locating factories in countries other than China because of costs or to inland China, further west. The problem with inland China is transportation costs and likely inadequate roads, which will require significant investment. With major infrastructure investments needed, will China be able to keep buying US treasury bonds?
There is no reason to assume that China will continue this policy indefinitely. Nor is there any reason to assume that China does this because it is charitable. China does this as long as the US and the west buys Chinese goods. If the US initiates a round of protectionism, what would stop China from selling the bonds? What motive would it have to continue holding the bonds?
Dinocrat.com reminds us that the Great Depression was in large part a banking and monetary phenomenon and that Milton Friedman in his Monetary History of the United States speculated that religious bias against the president of the Bank of the United States, who was Jewish, led to the Fed's refusal to assist that bank run leading to its failure. In other words, biases can have economic consequences.
Dinocrat mentions that the current anti-protectionist movement is reminiscent of this very kind of trivial bias that can mushroom into larger-scale economic catastrophe. Let us hope the current protectionist saber-rattling by the knucklehead left is not to be taken seriously. There is a strategic inflationary risk that would exacerbate the always harmful consequences of trade barriers.
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