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The Sovereign Debt Disaster |
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China vs. America in the coming,
post-depression era new world order,
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Nations around the globe face up to the great
sovereign default crisis,
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Plus, Bill Bonner with a few words on that
"recovery" and Dr. Faber on a contrarian play in Japan...
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[Ed. Note: Your wayfaring editor is on the road again today, so
we'll turn you over to our Australian-based counterpart, Dan Denning, who
offers some thought-provoking musings on the reshaping of the new world.
Please enjoy and send any comments to the address below...]
Dan Denning, reporting from Melbourne, Australia...
Recently we claimed that borrowing your way to national prosperity is a
sure-fire way to servitude and political instability. Today, we aim to
prove it. To do so, we cite
this article from Reuters. It suggests that
China is using or should use its large holdings of US Treasury bonds as a
cudgel with which to bludgeon the United States, its strategic
adversary/indispensable economic partner.
Figures in the People's Liberation Army want the financiers to sell US
bonds as a way of punishing Washington for selling arms to Taiwan. Mind
you this might not seem like such a good idea if the bond selling triggers
a run on the dollar and swift devaluation in China's forex reserves. But
maybe China's arsenal of US bonds is like a pile of bullets - they're no
good unless you fire them.
Of course what we're suggesting is that China accumulated US debt as both
a by-product and a weapon. The huge stock of US government securities was
a by-product of China's trade strategy. That strategy was to keep its
currency low and gain global manufacturing market share through low labour
and production costs. The result was a blizzard of US dollar trade
surpluses that were reinvested into US bonds.
You could say it's China that's paid for the wars in Afghanistan and Iraq.
But why is this bundle of bonds now a weapon? We think China's export-
driven growth strategy is on its last legs. Labor unions in Europe and
America - given today's political climate and high unemployment - will
have the ear of politicians. And they will be saying something like this,
"Make the Chinese pay!"
What they'll mean is that China will be pressured to give up its main
economic weapon - currency manipulation. This has kept Chinese exports
cheap all over the world and led to the gutting of American manufacturing
jobs. It's made it pretty tough on exporters in Europe too. As a result of
China's dollar peg, European exporters suffered doubly from a weaker US
dollar. American goods were cheaper in Europe. But European goods were not
cheaper in China.
So the unions and the politicians will probably not tolerate another leg
of the global recession in which China gains more market share by keeping
the currency peg and exporting its way to more growth (if growth is to be
had). It brings us to the end-game of China's export- driven development.
It also brings us back to one of the great monetary questions of the day:
when will China de-peg? The answer has always been simple: when it is in
China's interests to do. To us, that means China will de-peg when the
benefits of increased purchasing power in the currency are more important
that dwindling export profits.
In other words, we think China is close to a new phase of growth that's
driven by consumer demand, domestic consumption, and more mature Chinese
capital markets open to foreign investment. A de-pegging of the currency
would see a much stronger yuan. This would give Chinese savers a lot of
spending power on global markets. They would also be able to buy more
Chinese goods, which might lead to higher wages in China too (and more
stoking of consumer demand).
This is all a theory, of course. And we could be way wrong. But there will
come a day when Chinese customers are worth more to Chinese producers than
American customers. De-pegging the currency will bring that day forward.
And it could be sooner than you think.
This means that the accumulation of forex reserves was never really meant
to protect China from external trade shocks, although they would be handy
in that event. It means they were a side effect of a trade strategy whose
ultimate objective was to gain as much global manufacturing market share
as possible.
Now, you might wonder why China would damage its own interests by
"punishing" the United States and selling bonds. But it depends on what
China's interests are. If China's interests are in fundamentally weakening
an economic competitor and strategic adversary, then selling US bonds is
in China's interests.
China's ultimate interests are in regaining Taiwan. And we'd suggest it
try and use its bond leverage to weaken US resolve about defending Taiwan.
And selling US bonds or crashing the dollar wouldn't just weaken US
resolve. It would expose the loss of strategic influence that occurs when
you are a chronic debtor nation.
Mind you the US still has a lot of aircraft carriers, strategic bombers,
and nuclear weapons. It's not like it is bereft of tools of persuasion.
But the basis of all those tools has always been a strong economy, a
strong industrial base, and sound finances.
The question now is, if the base of military strength has been eroded, how
long will the US maintain its military advantage? Can America afford it?
And when push comes to shove, will American voters demand that an American
President defend Taiwan? Hmmn...
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The Daily Reckoning
Presents: |
Speaking of world shake-ups, sovereign nations
around the globe are lining up to default on their debt obligations. From
Europe's PIIGS to the Middle East's Dububble, to the economic woes in the
UK, Japan and the US, the world is in for a mighty reshaping. In today's
essay, guest columnist, Egon von Greyerz of Matterhorn Asset Management,
lends us his perspective on the battle to keep national budgets above
water...
The Sovereign Debt Disaster
by Egon von Greyerz - Matterhorn Asset Management
Zurich, Switzerland
Wherever we look at the world economy today, we see a wall of risk...and
potential financial catastrophe. We see a large number of virtually
bankrupt major sovereign states (US, UK, Spain, Italy, Greece, Japan and
many more) teetering atop a financial system that is bankrupt, but is
temporarily kept alive with phony valuations and unlimited money printing.
Increasingly, therefore, investors will want to exchange this funny money
for gold.
Governments like the US and the UK are committed to printing increasing
amounts of worthless paper money in order to finance their growing
deficits. The consequence of this rescue mission will be a
hyperinflationary depression in many countries, due to many currencies
becoming worthless.
The list of countries at risk of bankruptcy is increasing by the day. The
acronym used to be PIGS (Portugal, Ireland, Greece and Spain). It is now
PIIGSJUKUS and growing. The main contenders are currently: USA, UK, Japan,
Spain, Italy, Greece, Ireland, France, Portugal, Baltic States, Eastern
Europe and many more. On a proper accounting basis all of these countries
are already bankrupt, but since many nations can either print money, like
the US and the UK, or increase their already high borrowings, like Greece
and the Baltic States, they have technically avoided bankruptcy.
The problem is not just the current debt levels of these nations, because
the deficits in all the countries are rising. Tax revenues are collapsing
at the same time, while the governments' expenses for social charges are
soaring. In the US for example the federal deficit in 2009 was $1.5
trillion (10.7% of GDP) and is forecast to stay around that level for many
years. The plight of the US states is just as bad. Out of 50 states only
four are expected to have a balanced budget in 2010.
It took almost 200 years for US Federal debt to reach $1 trillion, which
it did in 1981. In 2009 the debt increased by $1.9 trillion in just that
year to $12.4 trillion. In the next ten years the US debt is forecast to
reach $25 trillion. And this doubling of the debt does not include any
funds to continue propping up a bankrupt financial system. The forecast
also assumes optimistic growth in GDP, which is extremely unlikely.
Currently, US Federal debt is six times what it collects in tax revenue
every year. With debt exploding and tax revenues collapsing, there is no
chance that the debt can ever be repaid with normal money. Also, with debt
out of control, interest rates will rise substantially to 10-20% per
annum. Applying a 15% interest rate to a $25 trillion debt would give an
annual interest bill of $3.75 trillion, which is the same size as this
year's ENTIRE budget.
The chart below shows the US Federal Debt per person. In the last ten
years it has gone from $ 20,000 to $ 40,000. If we were to also include
the present value of the government's future unfunded liabilities like
Social Security and Medicare, the debt per person would soar to more than
$250,000.
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Therefore, the indebted governments of the world
have two choices: continue to borrow and print money or reduce government
spending. This is a lose-lose situation. Countries within the EU like
Greece or Spain are introducing austerity programs that forecast their
deficits to come down to 3% of GDP, which is the EU maximum deficit limit.
These are totally unrealistic targets that are mainly based on an
improvement in the economy. Ironically, not one single country within the
EU is below the 3% limit, not even Germany. Furthermore, the austerity
programs would lead to such a major contraction of the economies that tax
revenues would collapse, further exacerbating the plight of these
countries.
The alternative is to print or borrow more money. Printing is not a luxury
that individual EU members have. And borrowing is becoming increasingly
expensive...or impossible. But the European Central Bank can print money
and this is likely to be the path they will initially choose to save
Greece and possibly Spain. Countries like the US and the UK can still
borrow and print money. And this is what they will continue to do. With
rising deficits, rising unemployment and the problems in the financial
system re-emerging they have no choice. We will see trillions of pounds
and dollars printed in the next few years.
We will also see trillions of pounds and dollars worth of new government
securities. But the buyers of these government securities might start to
become scarce. The rest of the world may dump their holdings of US and UK
debt, which would result in both the dollar and the pound dropping
precipitously and interest rates rising substantially. The effect of a
collapsing currency will be a hyperinflationary depression. This is the
inevitable outcome for the UK and US.
All the countries of the major trading currencies - the dollar, euro,
pound and yen - have major economic problems that can only be resolved by
massive money printing. This is why it is a futile game to try to predict
which currency will be the weakest out of the above four. They will all
weaken substantially but not at the same time. Therefore, we will have
incredible volatility in currency markets in the next few years whilst
speculators lose their shirts jumping from one currency to the next. There
will be very few winners in that game.
So the last 100 years will be seen in history as an extraordinary period
when governments thought that they had invented a new economic miracle
based on unlimited credit and money printing. But sadly this miracle will
be seen by future historians as another failed delusional economic theory
dreamed up by politicians.
Therefore, as many paper currencies become virtually worthless in the next
few years, gold will continue to do what it has done for 6,000 years. It
will maintain its purchasing power and therefore appreciate substantially
against all paper currencies. The recent correction in gold is the weak
hands getting out of speculative positions in the paper gold market. There
has been virtually no selling in the physical market. So far gold has gone
up more than four times in the last ten years in a stealth bull market
that very few investors have participated in. There is no other asset
during this period that has given such an excellent return whilst at the
same time providing the highest form of wealth protection (provided it is
physical gold).
The chart shows gold in 2009 dollars adjusted for inflation, as calculated
by Shadowstats.com. (Shadowstats.com is a superb service that analyzes
government statistics on a true basis, taking out all adjustments,
revisions and other manipulations). Applying the true inflation rate on
the gold price shows that the gold high in 1980 of $850 in today's terms
is $6,400.
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Governments have suppressed the gold price in
the last 30 years by both overt operations (official gold sales) and
covert operations (manipulations in the paper gold market and unofficial
sales). Central banks have now stopped official sales and China, India,
Russia and many other countries are major buyers. Production is falling
steadily and investment demand is soaring. With the fundamentals so much
in gold's favor, it should have no problem to reach the 1980
inflation-adjusted high of $6,400. With inflation or hyperinflation, gold
will go a lot higher than that.
During the next phase up in gold, which we expect to start within the next
few weeks, mainstream investors will discover what only a few investors
have understood in the last ten years, namely that physical gold is one of
the very few ways to protect their assets and preserve capital.
Regards,
Egon von Greyerz
for The Daily Reckoning
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And now over to Bill Bonner with today's reckoning from Baltimore,
Maryland...
"How can you keep talking about a depression," asks a Dear Reader, "when
the economy is clearly recovering just as it should be."
Ah ha! We'll explain in a minute.
First, the latest from Wall Street: The Dow fell 18 points yesterday.
We're still not sure whether the final, fading phase of the bear market
has begun or not. This bounce took the Dow back to 10,725 on January 19th.
It hasn't seen that level since. Was that it? Was that as high as it's
going to get? Is it down from here on out...until the Dow finally bottoms
out somewhere south of 5,000?
We don't know. We'll just have to wait to find out...along with everyone
else.
Now...back to that 'recovery'...
It's true that there are some signs of "stabilization." The unemployment
rate is not getting badder as fast as it was a few months ago. And house
prices seem to have stopped falling - for the moment.
It's also true that the economy managed to register positive 'growth' in
the last quarter...mostly thanks to government spending and inventory
restocking.
The trouble is, all of these things are consistent with a depression -
especially a depression that the feds are fighting every inch of the way.
In the 1930s, there were several years of growth...and there were great
years for the stock market too. Then, things fell apart again. The nation
ended the '30s not one penny richer than it had been when it began them.
And Japan has seen some good years and some bad years, too, since its
depression began in 1990. Oddly, Japan's population is falling...so in per
capita terms, Japan's downturn hasn't really been so bad. Per person, the
Japanese got richer over the last 10 years.
It's also true that here at The Daily Reckoning, we use the term
'depression' a bit differently than most economists. Most economists
believe GDP growth represents increasing prosperity. They think a
depression is merely a recession, with negative GDP growth, that lasts
longer and goes more deeply than normal.
Our definitions are better:
A recession is a pause during a period of
growth. A depression marks the end of the period of growth...giving the
economy a chance to make adjustments so that a new period of growth may
begin.
GDP growth alone is a fraud. The gross number
just doesn't tell you anything worth knowing. It doesn't really matter how
fast an economy is growing. What counts is how fast it is growing per
person...and whether that 'growth' is real or phony.
Growth is not the same as prosperity...
Someday, we promise you, modern economists will be ranked below doctors
who bled their patients to death and jungle tribes who threw maidens into
volcanoes. They are quacks.
These imposter economists think they can fix a recession and prevent a
depression. When the private sector stops spending they urge the public
sector to step in and replace the missing private spending. That, in a
nutshell, is Keynes' theory.
A nutshell is the appropriate container. Because there's a world of
difference between private spending and government spending. Private
spending is voluntary; people choose to spend their money on things they
really want. When the government spends, on the other hand, it is merely
squandering stolen property. It may look like private spending. But it's
not at all the same thing. You can hand out checks to people; it's not the
same as when people earn money. You can build bridges and airports
too...but they are only valuable to the extent that they are used
efficiently. And you can hire all the government employees you want; they
don't necessarily add to the sum of human happiness or wealth (most likely
they subtract from it!).
Just look at societies that put everyone to work. There was no
unemployment in Cambodia under the Khmer Rouge! Or in the Soviet Union.
North Korea is another good example today. They all show that putting
people to work for the government doesn't make them rich...it makes them
poor.
Yet, these modern economists - Martin Wolf at The Financial Times,
Paul Krugman at The New York Times, Bernanke, Summers and
Geithner in Washington - believe that they can control and cure a
depression. All they have to do is to keep the GDP expanding...and keep
unemployment from rising. How? Just spend money!
The GDP calculators can't tell a phony expense from a real one. Whether
the government spends money to do something that is not worth doing...or
hire someone who is not worth hiring...or just gives away money to someone
who is not worth giving money to...the GDP quants don't know the
difference. They think one dollar spent is as good as any other...
..even if it is a dollar that didn't exist! (Don't get us started on that
one...)
And who knows if a job is worth doing? Only the person who pays for it.
That's the trouble with government employment; the people who pay the
bills don't make the hiring decisions.
Modern economists don't even bother to think about it. All they care about
is the unemployment rate...not about whether the job is actually useful or
efficient. Want to boost the job rate? Easy. Just hire people. Does this
make people better off? Of course not.
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And more thoughts...
The Financial Times had a full page in its Wednesday edition
devoted to China's empty towns. Bloomberg has been on the story
too.
It is the story of what actually happens when government meddles in an
economy.
Last year, China ordered its banks to lend money to infrastructure
programs in order to offset the worldwide financial meltdown. The banks
responded, doubling their lending.
Observers in the West were stunned...and envious. If only we could 'get
things done' like that, they lamented. If only our governments had more
authority and control over the economy!
But let us go back a year and put ourselves in the shoes of the bankers.
They must have had loan requests. Some of them they must have judged
worthy of funding, others not. But how was it possible that the number of
project deemed creditworthy doubled in the space of a few months?
Well, it didn't happen. Instead, the Chinese government merely changed the
rules of the game. The banks, under pressure to loan out money, reacted by
lending it out...to marginal projects. Now, we're beginning to read about
them in the paper - mostly towns without any people. Just wait until China
blows up. Then, we'll read about banks without money. Stores without
customers. And businesses without a prayer.
China is either going to blow up...or slow down.
And here's our old friend Marc Faber. He's also become bullish on Japanese
companies:
TOKYO (MarketWatch) - Japan Inc. got an endorsement from a seemingly
unlikely character Monday, when one of the investment world's so-called
'Dr. Dooms' had positive words for the Japanese stock market.
"Here, there is an investment opportunity," said Marc Faber, the publisher
of the Gloom, Boom & Doom Report, who called Japan a "neglected
market."
"Valuations are not terribly expensive," Faber said in a speech to the
CLSA Japan Forum in Tokyo... The slide presentation that accompanied his
speech described Japan as "the perfect contrarian play," and simply added,
"Banks!"
Regards,
Bill Bonner,
for The Daily Reckoning
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