Archive for September, 2007

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Tuesday, September 18th, 2007

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Inflating out of trouble- unprecedented move by the Bank of England

Tuesday, September 18th, 2007

As we have already heard by now, the Bank of England had pleged to ?guarantee all deposits? in the failed Northern Rock bank (see Northern Rock deposits guaranteed). That is the glorified way of saying that they will print as much money as possible to ensure that the bank will remain solvent.

That’s the wonder of fiat money isn’t it?

Change of web hosting complete

Monday, September 17th, 2007

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US dollar in imminent danger?

Wednesday, September 12th, 2007

Recently, in Is China quietly dumping US Treasuries? in the news media, it was reported that,

A sharp drop in foreign holdings of US Treasury bonds over the last five weeks has raised concerns that China is quietly withdrawing its funds from the United States, leaving the dollar increasingly vulnerable.

This piece of news is hardly surprising. As we said before in Will the US dollar collapse?, central bankers around the world has been murmuring about holding US dollars in the form of the US Treasury bonds. China, had already made it clear that they no longer want to accumulate US dollars indefinitely (see China unwilling to hoard US dollars?what?s the implication?). Thus, we would hardly be surprised if it turns out that China is the main culprit for the sharp drop of foreign holdings in US Treasuries.

What does this mean? By not buying US Treasury bonds, foreign central bankers are no longer financing the US current account deficit (see Understanding the Balance of Payments for understanding about the current account deficit). That is, foreigners are no longer willing to extend any more credit to the profligate ways of the US. As we said before in Awash with cash?what to do with it?, with the US printing so much of its own dollars to pay foreigners, it is fast becoming more and more worthless with each passing day. If foreign central bankers had not been so diligent in buying up US Treasury bonds with their excess US dollars, the US dollar would have become worthless long ago. If this trend of foreign dumping of US Treasuries continue, what will happen to the US dollars?

Recently, with the dysfunction of the credit market, money had been fleeing to the ?safest? debt instrument i.e. US Treasury bond. This drives up the price of US Treasuries (and drives down the yield). It is no surprise that foreign central bankers are taking advantage of this spike in price to dump their US Treasuries holdings to the market.

Are global asset prices going to deflate?

Friday, September 7th, 2007
Back in June, in Epic, unprecedented inflation, we mentioned that:

Today, the world is experiencing an unparalleled inflation of asset prices. This is the first time ever that the world is experiencing asset price inflation in all asset classes (e.g. property, bonds, commodities, stocks and even art!) and in all major nations (e.g. US, China, Japan, Australia, UK, Russia, etc). We will repeat this point again: never before had such a universal scale of asset price inflation ever happened in the entire history of humanity! Today, even artwork is also in a ?bull? market (if you consider artwork as an asset class)!

As we mentioned in Liquidity?Global Markets Face `Severe Correction,? Faber Says, we asserted that what is driving asset prices higher is the sheer volume of liquidity. That article further explains how liquidity can be crunched, resulting in collapsing asset prices.

The question we have to ask ourselves today is: are we at a turning point in terms of change in the volume of global liquidity? If we are in an ongoing process of liquidity contraction, then global falling asset prices will ensue in the months and years to come. Since today’s economic prosperity is driven by asset-driven growth, any failure in asset price inflation can have real economic consequences (see Myth of asset-driven growth).

Today, we will look at some of the indications that liquidity is in the process of contraction. Please note that these are merely symptoms of the process, not evidence for it:

  1. Currently, the debt market has not yet returned to normality. This means it is still very hard to borrow money (i.e. higher borrowing cost). As we said before in How does liquidity dry up?, such lending phobia will spread to other sectors of the financial industry, cutting off money to legitimate and sound borrowers. Since asset prices are fueled by debt, any choking on the supply of credit will have detrimental effect on them:

    (i) Take a read at Turmoil could drive rates higher in the Sydney Morning Herald (SMH)?eventually, consumers are going to feel the brunt of more expensive money in the form of higher mortgage rates, which in turn will have an effect on house prices. As we implied in Myth of asset-driven growth, a sustained and significant deflation in house prices (or asset prices in general) will eventually result in negative wealth effects (especially true in the US), which will manifest itself in the form of deteriorating consumer confidence. Since three-quarters of the US economy is mainly made up of consumer spending, you can be sure that falling asset prices can drag the US economy into recession (see The Bubble Economy). In Australia, it is the mining boom that is propping up the economy. If the mining cycle turns, the Australian economy will go as well.

    (ii) With money become much more expensive, we can expect a slowdown in business spending and investments. Business activities that once relied on cheap money will grind to a halt as they become uneconomical. When that happens, we will witness layoffs, cost cuttings, business failures and so on. As Credit crunch de facto monetary policy from The Australian quote, ?The longer that credit conditions remain tight, there are downside risks to growth in that environment.? The market is hoping that somehow, by magic, the credit conditions will improve significantly and the orgy of debt and derivatives will be restored, resulting in forever rising asset prices. We believe this is a fat hope by the market?without solving the core of the rot, there can be no sustainable recovery in the long run.

  2. Central bankers had reacted to this credit dysfunction by injecting liquidity into the financial system (see Money printing operations begin). The US Federal Reserve had cut the discount rate (see Federal Reserve cutting interest rates). But what had happened since then? As this Bloomberg article said, the ?shortage of funds in global money markets has worsened since the Federal Reserve and the European Central Bank tried to ease a squeeze on interbank lending, according to Barclays Capital.? Our call is that as the situation deteriorates further, central bankers will further react in desperation by printing even more money in concert (in an attempt to preempt mass insolvency’s in the economy). Thus, we believe fiat currencies will be debased further, which is the reason why we recommend accumulating gold (see What should be your fundamental reason for accumulating gold?). We are not bullish on gold?rather, we are bearish on fiat currencies.

Our views are aligned with the Bank for International Settlements (BIS), which believes that global economy is at risk of running into a Greater Depression. This is a view shared by economists from the Austrian School of economic thought (see Bank for International Settlements warns of another Great Depression).

Conspiracy theory: ‘Bin Laden’ trade in action?

Tuesday, September 4th, 2007

Recently, the market was rife with speculations and rumours of highly unusual trades in the options market (see Dispelling the ‘Bin Laden’ Options Trades). This was reminiscent of the time just prior to September 11 when a mysterious buyer bought a lot of put options on airlines stock.

What can we do about this? Well, let’s put it this way: if the stock market crash this month, we will not be surprised at all.

Understanding the Balance of Payments

Monday, September 3rd, 2007

Recently, in the Sydney Morning Herald (SMH), there is an article titled More exposed as deficit widens. If this article contains too many jargons for you to understand, then today’s article will be very useful to you?it will explain the concepts and definitions with regards to the Balance of Payment, which is a pre-requisite for understanding that article in the SMH. After the Balance of Payments have been explained, we will then comment about that article.

First, what is the Balance of Payments? Basically, it is a summary of Australia’s trade with the rest of the world, along with its associated flow of money. There are two components in the Balance of Payments:

  1. Current Account
  2. Capital Account

In theory, both of these components should balance because they are akin to the double entry in an accounting system. In practice, due to impossibility of perfect data collection in the real world, they never balance. Thus, there will be a third component named along the lines of ?net errors and omissions? to account for the differences.

Now, let’s tackle each of the components:

Current Account

The Current Account consists of two sub-components:

  1. Trade in goods and services Australia and the rest of the world.
  2. Payment and incomes of Australia
  3. Transfer of money to and from Australia

The first one is obvious. If Australia exports more than imports, then there will be a trade surplus. Otherwise, there will be a trade deficit. The second is the payments that Australia pays to foreigners or income that foreigners pay to Australia. Interest and dividend payments (and income) is made up of this sub-component. The third components can include foreign aid, gifts and pensions.

Capital Account

The Capital and Financial Account covers the purchases and sales of assets (e.g. stocks, bonds, property, etc). If the Capital Account is in surplus, this means that foreigners are accumulating Australian assets more than Australian accumulating foreign assets.

Why must they balance in theory?

Let’s say there is a deficit in the Current Account i.e. Australian dollars is flowing out of Australia. What will happen to the Australia dollars overseas? Since they are useless in foreign countries, they will have to eventually make their way back to Australia to be ?parked.? That means buying up assets in Australia. The converse is true if there is a Current Account surplus. Thus, in theory, the Current Account should balance with the Capital Account.

Now that you are armed with theĀ  understanding of the Balance of Payment, we will then comment about Australia’s situation in the next article.

Here the comes the cavalry

Saturday, September 1st, 2007

As you will surely hear by now, Bush and Bernanke had assured the market with the ?good? news that they will do anything and everything ?save? the economy from going under. As this news article, Stocks close higher as rate-cut hopes hold firm say,

“Bernanke and Bush were the highlights of the day with the former reminding the markets that the Fed is not out of touch and the latter offering some proposals on how to mitigate some of the problems facing homeowners,” said Drew Matus, U.S. senior economic at Lehman Brothers Inc.

Bernanke will act by standing ready to cut interest rates at a moment’s notice (i.e. ?print? money), while Bush will use the power of the government to help prop up sub-prime mortgage borrowers who are behind in their adjustable rate mortgage payments (see Is the worst over yet?).

Can this really save the economy? What is the root of this crisis? Politicians would like to point the finger at those so-called greedy lenders, but they would rarely look at themselves. As we said before in Have we escaped from the dangers of inflation?,

Today, the global spigot of liquidity (see Liquidity?Global Markets Face `Severe Correction,? Faber Says on the concept of ?liquidity?) is wide open, spewing out huge amounts of money and money substitutes into the financial system. The growth of money supply of major economies is estimated around or above 10% per annum, with China having the dubious ?honour? of being near the top at 18% (see Why is China printing so much money?). The top ?honour? goes to Russia, with their M2 money supply rising a whopping 48.8% from the beginning of 2006 to beginning of 2007 (see the figures at the Russia Central Bank web site here).

With all these flood of fiat money inundating the global financial system, we look at all these skyrocketing financial asset prices with a yawn. Price bubbles of all sorts are found everywhere in the world?from Chinese stocks, junk bonds to private equity booms.

If central bankers had not been so free and easy with their monetary printing press, can those lenders be so greedy in the first place? If too much fiat paper money has been forced fed into the economy (i.e. money too cheap and too easily available), is there little wonder that a lot of them will end up languishing in unproductive mal-investments (see The first step in an economic slowdown?mal-investment in capital)? Is it a surprise that a lot of bad debts accrue at the end of the day? Can we expect humans not to be greedy when a lot of money is raining down from heaven (central banks)?

Now that the nation is reaping what was sown, how are the central bank and government reacting to ?solve? this problem? By handing out more money!

Now, wait a minute! Isn’t too much money the root of the problem? Exactly! If so, what will be consequences?

Long time readers of this blog will know the answer by now. The consequence is price inflation (see Cause of inflation: Shanghai bubble case study). The US will have no choice but to debase the quality US dollar by increasing its quantity in order to print its way out of debt. That is why we still advocate buying gold (see What should be your fundamental reason for accumulating gold?).