Posts Tagged ‘bubble’

Turkeys fattened for slaughter in the Chi-tralia bubble

Sunday, January 17th, 2010

In our previous article (Is the coming ?crash? in China not a real crash?), one of our readers sent us a link to a very good article (Trapped Inside a Property Bubble) written by a former Morgan Stanley economist named Andy Xie. He is a very contrarian and provocative analyst who called China’s economy as a “Panda Economy” (named after the cartoon movie,? “Kung Fu Panda”). His bearish call on the Chinese economy attracted a fair amount of criticism from Chinese government officials.

One of our readers, Pete, had highlighted sections of Andy’s article, with some good questions and comments…

Once a country loses export market share on rising costs, it stagnates because property bubbles during high growth periods deter consumption while overwhelming the middle class with housing expenses.

As property bubble grows further, debt servicing burden will grow as well. That in turn will deter consumption further as more and more of income will be spent on repaying debts. The only way to increase consumption whilst debt servicing burden is increasing is to increase debt further. Obviously, if a consumption-based economy is dependent on increasing debt to sustain consumption, then it is an economy that is addicted to debt. Once credit growth stalls, the die is cast for the economy. Back in January 2007, we wrote in Myth of asset-driven growth,

… asset-driven growth magnifies the consumption debts of the economy, which will have to be serviced in the future. By deferring the burden of debt servicing to the indefinite future, it can only mean that the nation?s wealth will shrink in the future. Hence, asset prices cannot rise in perpetuity. Eventually, the weight of future debt servicing burdens dooms the bubble to collapse under its own weight.

Since the Chinese economy is still dependent on cheap labour to achieve low cost production, labour costs increase will kill its competitiveness. As a result, exports will decline. If at that point in time, citizens are burdened heavily with debt, there is no way they can increase their consumption to replace the lost exports.

Similarly, Australia is already a highly indebted nation. The only thing preventing the Australian economy from falling into deflation is Chinese demand for Australian resources. As we wrote before in Hazard ahead for Australia- interim crash in China,

Therefore, investors should understand this basic principle: because of the leverage that Australia is exposed to China, any slowdown in China will have a leveraged effect on Australia.

There are some signs that Australian consumers are binging on debt once again. Should this translate into a resumption of increasing credit growth, it will mean that Australia is increasing its vulnerability to any slowdown in the Chinese economy. Worse still, Australia is selling more and more of its businesses, capital and resource companies to China, which means that more and more future economic growth will no longer benefit the next generation.

Enough about Australia. Let’s look at Andy Xie’s article further,

The dollar has bottomed. The Fed will begin raising interest rates in 2010.

Andy Xie reckons that the US dollar has bottomed and that the interest rate cycle has bottomed as well. What are our views?

As we wrote in Permanently low interest rates for Uncle Sam?, the more indebted the US government is, the harder it is for them to raise interest rates. According to Marc Faber, currently, 12 percent of US government’s tax receipts goes to interest payment on their debt. In 5 years time, it could be at 35 percent. Should the US raise interest rates to combat any potential price inflation, that will increase the debt burden of the US government unless the US economy can put on a miraculous feat of super-turbo-charged growth. This means that the higher interest rates goes, the higher the risk of the US government becomes insolvent sooner.

Next, Andy Xie wrote,

One possible way to prolong the bubble is to appreciate the currency, as Japan did after the Plaza Accord, to contain inflation and attract hot money. Such a strategy will not work in China. Japan’s businesses were already at the cutting edge in production technologies and had pricing power during currency appreciation. They could raise export prices to partly offset currency appreciation. Chinese companies don’t have such advantages but rely on low costs to compete.

That’s a reason why China cannot let the yuan appreciate too much too soon. Next, Andy wrote,

China has been trying to promote consumption for a decade. However, consumption’s share of GDP has declined annually. The reason is the policy environment has been squeezing China’s nascent middle class through high property and auto prices along with high income tax rates.

Recently, there’s a Chinese soap opera titled “Dwelling Narrowness.” That was a very highly popular show because it strikes a cord with the Chinese middle-class, who are burdened with taxes, corruption, high property prices, inflation and so on. Unfortunately, that soap opera was terminated early by the Chinese government.

As we wrote in Chinese government cornered by inflation, bubbles & rich-poor gap,

In other words, the paradox is that the further the Chinese government delay in tackling inflation, the more reliant they will have to rely on American consumers, which means it is harder for them to let the yuan appreciate.

The inflationary policies of the Chinese government are hurting Chinese consumption more and more.

Andy wrote further,

China’s property market is creating winners and losers based on timing. All other factors ? including education and experience — have been marginalized as the economy rewards speculators. And as more play the game, the speculator ranks rise and fewer people work, perhaps contributing to a labor shortage.

Our reader, Pete was wondering how could it be that China can have labour shortage. Our take is that it is skilled labour shortage that China is increasingly short of. Anyway, as we wrote in Harmful effects of inflation, an economy based on inflation and asset price bubble to sustain growth is an economy that rewards speculation instead of hard work.

Finally, Andy wrote,

The killer is inflation driven by a surge in money printing. The average lag between currency creation and inflation is 18 months in the United States. China’s lag could be two years since the government uses subsidies to suppress inflation. By 2012, China could experience 1990s-like inflation. And that’s when the property bubble will probably burst.

We will add this: in a highly indebted society, price inflation without adequate wage inflation will contribute to the bursting of the asset price bubble.

Many of what Andy Xie wrote also applies to Australia. When the Chinese bubble burst, Australia’s bubble will burst too. Marc Faber, while he agrees with Jim Chanos that China is in a bubble, believes that the implosion of the Chinese economy will not happen soon (see China bubble will not burst right away: Marc Faber). If this is true, it means that many Australians will be suckered into more debt (property prices may even be inflated further), which is akin to a turkey being fattened for the day of slaughter. The difference between 2008 and that day of reckoning is that more Australian businesses, mines and capital will be under Chinese control by then.

Tags: , , ,
Posted in Economics/Finance | 3 Comments »

Is gold going parabolic?

Tuesday, December 8th, 2009

No doubt, as gold prices run up in the latter half of 2009, a lot of commentators are saying that gold is in a bubble territory. Their justification for such a claim is that when an industrially useless metal to go up in price so quickly, irrationality is the only explanation. Hence, according to them, it can only be described as a “bubble.” Even the Sydney Morning Herald, came up with an article titled, Gold a ‘useless asset to own’.

But as contrarian investors, we welcome such ignorance. That is how wealth is transferred from the weak hands to the strong hands. If you have not already, we recommend that you read If gold has no intrinsic value, is it a bubble?. Those who believe that gold is in a bubble do not understand the fundamental of what money is- they fail to see the mirror image irrationality. With that, we shall take a quote from Marco Polo in our book, How to buy and invest in physical gold and silver bullion,

With regard to the money of Kambalu the great be called a perfect alchymist for he makes it himself. He orders people to collect the bark of a whose leaves are eaten by the worms that spin silk thin rind between the bark and the interior wood is taken and from it cards are formed like those of paper all black He then causes them to be cut into pieces and each is declared worth respectively half a livre a whole one a silver grosso of Venice and so on to the value of ten bezants All these cards are stamped with his seal and so many are fabricated that they would buy all the treasuries in the world He makes all his payments in them and circulates them through the kingdoms and provinces over which he holds dominion and none dares to refuse them under pain of death All the nations under his sway receive and pay this money for their merchandise gold silver precious stones and whatever they transport buy or sell The merchants often bring to him goods worth 400,000 bezants and he pays them all in these cards which they willingly accept because they can make purchases with them throughout the whole empire He frequently commands those who have gold silver cloths of silk and gold or other precious commodities to bring them to him Then he calls twelve men skilful in these matters and commands them to look at the articles and fix their price Whatever they name is paid in these cards which the merchant cordially receives In this manner the great sire possesses all the gold silver pearls and precious stones in his dominions When any of the cards are torn or spoiled the owner carries them to the place whence they were issued and receives fresh ones with a deduction of 3 per cent If a man wishes gold or silver to make plate girdles or other ornaments he goes to the office carrying a sufficient number of cards and gives them in payment for the quantity which he requires. This is the reason why the khan has more treasure than other lord in the world nay all the princes in the together have not an equal amount.

Chapter XXVI, Paper Money Immense Wealth of the Great Khan, The Travels of Marco Polo

To understand gold, one needs to understand the history of money (which our book, How to buy and invest in physical gold and silver bullion has more information on). If we can laugh at the irrationality of the ancients as described in Marco Polo’s memoirs, then we certainly have to laugh at humanity’s irrationality today with regards to money.

But at the same time, we are not saying that gold is the cure-all for the the ills of today’s monetary system. In other words, we are not worshipping gold (see When to sell your gold?).

But if you are still worried that gold prices are running up too fast, you ain’t seen nothing yet. This speed in price increase is nothing compared to what happened in 1980. Let’s take a look at the gold price chart back then:

Gold price from 1975

Gold price from 1975

By 1979, inflation in most countries was running in double digits in most countries. Oil prices was spiking and the Iranian revolution toppled the Shahs. The Soviets was entering Afghanistan. Back then, there was a real fear that the world will end and that seemed like the end of fiat currencies (8 years after President Nixon cut the final link between gold and the US dollar). The price of gold doubled in a few weeks between December 1979 and January 1980. That’s really a parabolic movement. Today’s run up in gold prices is nothing compared what happened in 1979/1980. We have friends who bought gold in 1980 at around US$800. Back then, there was talk that gold price would be hitting US$1000. Unfortunately, gold price fell and our friends lost half their capital in a flash.

But fortunately, fiat currencies survived and the world did not end. But those who ridiculed gold used that as a basis to believe fiat currencies will still survive i.e. fiat currencies will survive because they did survive after 1979. This is an example of a mental pitfall that we call “lazy induction” (see Mental pitfall: Lazy Induction). That’s because if you take an even bigger picture view, there were many countless examples whereby all the other fiat currencies in the entire history of human civilisation failed to survive. The Mongol currency during Marco Polo’s time was such an example.

As Nassimb Nicholas Taleb wrote in The Black Swan: The Impact of the Highly Improbable, the wrong way to learn from history and looked at happened and then extrapolate it into today. It is equally important to look at what could have happened and evaluate whether it is still applicable today. In his words, we have to study the “alternative paths” of history. For all we know, fiat currencies could have died after 1979. Maybe, someone powerful back then could have made a slightly different decision and that could have set a chain reaction that would culminate in the death of fiat currencies.

We never know whether the “alternative path” of history will happen today. But it pays to be prepared.

Tags: , , ,
Posted in Gold, History | 11 Comments »

Is the Chinese economy a house of cards?

Thursday, November 26th, 2009

When you trawl through the mainstream media, blogs and pundits’ opinions, you will notice that there’s increasing reservation on China’s ‘impressive’ economic growth. One of the world’s most notorious short-seller, Jim Chanos recently announced his intention to short China. He’s the one who famously shorted Enron and Macquarie Bank.

Jimmy Rogers, on the other hand, is bullish on China. But that’s not mean that he believes that it’ll be forever blue skies ahead for China. In fact, he acknowledges that China will experience problems from time to time. Unfortunately, his bullishness gets the more attention from people. We do not know whether it’s because he seldom talks about his reservations on China, if any, or it’s selective hearing from the ears of people.

Anyway, this new-found bearishness on China is based on the idea that China’s economic growth is:

  1. An artificially induced bubbly boom through the force feeding of credit into the economy and government stimulated infrastructure investments (white elephant infrastructure projects??)
  2. Based on doctored figures

Back in July, we wrote of the massive force-feeding of credit in China:

  1. Is China setting itself up for a credit bust?
  2. How big is the credit bubble in China?

Indeed, there is a burgeoning asset price bubble in China. Hong Kong luxury apartments have sky-rocketed in price. There are even stories of speculators stockpiling physical base metals. There are also many anecdotal evidences that China infrastructure oriented stimulus is resulting in huge white elephant infrastructure. For example, this YouTube video showed a huge Chinese ghost city built from scratch in Inner Mongolia. We heard of reports of massive 5-lane motorways with no traffic.

Yu Yongding, economics professor at the Chinese Academy of Social Sciences (and formerly a member of the People’s Bank of China monetary policy committee), has recently sounded the alarm (see China bubble puts our recovery in doubt). We first mentioned this economist back in October 2007 at China considers leaking money to overseas stock when he warned the Chinese government on certain policies.

More ominously, we are seeing signs that the Chinese government is repenting on their extremely lax credit policies. As China’s banking regulator warned (see Capital crunch for Chinese banks),

China’s banking regulator has warned it would refuse approvals for expansion and limit banking operations if lenders did not meet new capital adequacy requirements, a move that has prompted the country’s largest state-owned banks to prepare capital-raising plans for next year and beyond.

Even the adviser to the People’s Bank of China is sounding the alarm on asset price bubbles. As China Faces Asset-Bubble Risk, PBOC Adviser Fan Says (Update2),

?The real risk is really asset bubbles,? Fan, who heads the National Institute of Economic Research, said at a business conference in Hong Kong today. A ?Chinese asset bubble would be something very dangerous, that would cause the overheating? elsewhere as well, he said.

Also, Bloomberg reported that China is taking the first steps in capital control in a bid to stem its asset price bubbles (see China Tightens Rules on Transfers to Stop ?Hot Money? (Update1)) from overseas speculative capital.

If Australia has to thank China’s economic strength for protecting its economy from a hard landing, what will a bust in China do to Australia?

Tags: ,
Posted in Economics/Finance, Looking Forward | 16 Comments »

Which asset class for the next financial markets panic?

Thursday, November 19th, 2009

If you still have lots of spare bullets in your investing arsenal (i.e. lots of spare cash free for investment), it is very tempting to use them up in fear of missing out on further rally. But if your over-riding concern is to preserve your capital in real terms, this is a very difficult market to invest.

For value investors, the proportion of undervalued stocks is decreasing as the stock market continues to trend upwards. Recently, a highly prominent banking analyst, Meredith Whitney has turned the most bearish for over a year:

If you are a technical analyst, you will see that stocks are at an extremely overbought territory. According to the Market Club Trade Triangle, the trend for the S&P500 is still at a very strong up-trend. Statistically, this is the point whereby the risk of a major correction is very high. The previous one is too mild to be counted as a correction (see Aborted correction?).

In terms of property prices, Hong Kong luxury apartments are bubbling away. Base metal prices (especially copper) have recovered strongly from the Panic of 2008. Chinese fly-by-night bidders are reportedly appearing in Australian residential property auctions. The Aussie dollar is approaching parity with the US dollar.

It looks very much like bubbly 2007 all over again.

We are not prepared to use our spare bullets in such a bubbly environment. But if you are based in Australia, we do see a silver lining. The price for gold is rising rapidly in terms of US dollars. But in terms of Aussie dollar, it has hardly risen. In fact, even though it is at a record high in USD, it is down 20% from the March 2009 record high in AUD.

Let’s say there’s going to be a short covering in the USD (see Currency crisis ahead? Part 1- Potential short squeeze on the US dollar) due to some deflationary threat. Chances are, gold price (along with commodity and stock prices) in USD will come down. At the same time, stocks worldwide will be down as well, along with the depreciation of the AUD. A falling gold price in USD will be mitigated by the depreciation of the AUD. As a result, Australian holders of gold may not suffer as badly as gold prices in AUD may not fall as much, perhaps even rising should the AUD depreciates very rapidly.

But even in this scenario, there will be a limit to a fall in gold price in USD. As we wrote before in Has gold moved on to a secular shift?, central bankers have crossed the line from being a collective seller of gold to a collective buyer of gold (e.g. Mauritius central bank is now buying gold). The Chinese will see any temporary strengthening of the USD as an opportunity to get rid of them to buy gold.

On the other hand, if there’s going to be a currency crisis, our guess is that gold prices will soar in USD. If the AUD depreciates against the USD as well, we will get soaring gold prices in AUD.

Our speculative view is that (and this is NOT financial advice) if you want to be on the other side of the trade in the next panic (i.e. on the winning side, not on the panicking herd’s side), the currently high AUD may prove to be a stroke of good luck for Australian investors because it gives them a wonderful opportunity to buy gold on the cheap. Not only that, if you are planning to buy physical gold, it helps that Australia is a gold producing nation (you may want to read our book, How to buy and invest in physical gold and silver bullion).

Only time will tell whether this idea will be a winning Black Swan trade.

Tags: , , ,
Posted in Gold, Looking Forward, Market Observations | 6 Comments »

Booming real economy, falling stock market?

Tuesday, November 10th, 2009

One of the most common ideas floating around is that the real economy must be on its way to recovery because the stock market, which is often a leading indicator, is recovering. The mainstream economist will tell you that the contradictory newspaper headlines that we showed in our previous article are not really contradictory at all. They will say that since the stock market is a leading indicator, then it will bottom out first before the real economy bottoms out. According to their logic, that’s why you can see rising unemployment and rising stock prices simultaneously.

The idea that the stock market predicts the business cycle is a very dangerous one for the investor. The truth is that, as we said before in Is this a bear market rally or a turning point?,

To be more precise, the stock market anticipates but not predicts turning points. What this means is that economic recoveries are followed from recoveries in the stock market, but a stock market rally does not necessarily indicate an economic recovery.

So, assuming that this stock market rally does not signify an economic recovery, what will be the outcome? The deflationist believes that this rally will eventually run out of steam and collapse into a rout. The inflationist believes that the worse the real economy is, the bigger the bubble in the stock market will be (see Should you be bullish on stocks?) because of unprecedented money printing.

If you subscribe to the inflationists’ view then it follows that should the real economy recovers, then it will be very bad for the stock market. To understand why, consider what will happen if the real economy really recovers:

  1. Stimulus will be withdrawn.
  2. The Federal Reserve will mop up the ‘printed’ money from the financial system.
  3. Government tax revenue will increase sustainably, which means the the size of the budget deficit can decrease, which in turn means that the government will be less sensitive to rising interest rates by the Fed.
  4. The Fed will then raise interest rates.

A truly recovering real economy will result in liquidity draining out of the system. Since the current rally is fuelled by massive loosening of liquidity, draining liquidity will imply that the stock prices will fall and the US dollar strengthens. As the US dollar strengthens, then the short squeeze in the US dollar will happen (see Currency crisis ahead? Part 1- Potential short squeeze on the US dollar), which implies that the Aussie dollar and stock prices will tank.

So, beware of the stock market rally!

Tags: , , ,
Posted in Looking Forward, Market Observations | 2 Comments »

Why is the modern economy so dependent on ever-lasting growth?

Tuesday, August 11th, 2009

Have you ever wonder why economists and policy makers are so obsessed with economic growth? Why is it such an acute problem if the economy is not in a treadmill of growth (i.e. ever-lasting increase in the quantity of goods and services produced)? What is so bad with zero economic growth (i.e. an economy that takes it free and easy)?

As one of our readers wrote in our previous article,

This is all to say that the [modern capitalist] system is much more fragile than anyone would have guessed and that the cult of markets and efficiency have left the world with a system that is less and less resilient. The crisis that has begun over the last couple years begins to bear that out. In fact we’ve become dependent on efficiency and without it the system may just fail under it own weight. Time will tell but the process has begun.

Why?

We believe the root of the problem lies in the monetary system. Today, we have a monetary system that is at its heart a system of credit. That is, the ‘money’ that flows around the system is loaned out of existence. To understand what this means, read on…

Originally, mankind started with commodity money. Money was a physically tangible thing. In the 15th century, Spain found gold in the New World. As gold was money back then, Spain found a lot of money and became ‘rich’ as a result. Today, most of our money has become virtual, intangible and in the form of electronic information. The overwhelming values of transactions are made in the form of electronic fund transfers instead of exchange in physical paper cash.

Now, think of your cash at bank- it is an asset to you and a liability of the bank. Say, when you make a non-cash purchase (either with cheque, credit card, bank transfer, etc), that transaction ultimately becomes a transfer of liability from one entity to another. This text-book idea implies that assets have to exist first before it can be loaned out as someone’s else’s liability.

The real world does not conform to this text-book idea: liabilities are created by banks first (in the form of loans) before the assets exist (we recommend you read Marc Faber vs Steve Keen in inflation/deflation debate- Part 1: Steve Keen’s model if you need a deeper understanding). After the liabilities are created out of thin air, the bank then go hunting for the assets by borrowing from another entity (e.g. central bank, depositors, another bank, investors, etc). Ultimately, either directly or indirectly, that asset (currency) originates from the central bank.

The central bank is the only institution that can create assets (currency) out of thin air to be loaned out as liabilities. Imagine you are a central bank- all you need to do is to declare $100 into existence, lend it to the banking system and then have the power to demand that the money (which you created out of thin air) to be paid back to you at an interest rate that you decide.

The observant reader will then be asking this question: “If the entire economy pays back all the currency that was borrowed into existence, but still owes the interest, where does it get the currency to pay the interest?” The answer is startling simple: more currency has to be borrowed into existence to pay back the original interest!

Now, you can see that total debt in the economy will grow exponentially (compounded interest) continuously and can never be repaid fully. That means the economy has to grow continuously in order to generate the income to pay back the continuously growing debt. Since the physical world has a finite quantity of resources, the quantity of goods and services produced in the economy cannot always grow fast enough to match the continuously growing debt. Therefore, the only way to keep the system running is to add in price inflation (growth in the nominal value of the goods and services produced) so that the nominal value of the continuously growing debt can be repaid. That’s why, as our reader observed, the “cult of markets and efficiency” in the modern capitalistic economy is there by necessity to keep the economy growing continuously.

For the past decade, total private debt is growing at a speed far in excess of GDP growth (i.e. growth in income). For a while, it seemed sustainable because asset prices (most notably, house prices) were rising fast enough to keep the financial system solvent (i.e. able to pay back the continuously growing compounding debt in nominal terms). As you can see by now, if asset prices stops rising in the context of adequate economic growth, the game is over. That game-over situation is what we all know as the Global Financial Crisis (GFC).

The GFC trigger the economic phenomenon called deflation. Once the debtors (e.g. banks, households, businesses) become insolvent, they can cause their creditors to become insolvent, who in turn threaten the creditors’ creditors with insolvency. This systemic debt defaults will now reverse the debt growth, which means the currencies that are loaned into existence will be written off into non-existence, which means money supply will shrink, which in turn will cause vast tracts of the economy to shave off its productive capacity (e.g. unemployment, idle factories, excess capacity).

If the economy is not expected to grow sufficiently and the government wants to keep the wheel running, what would they do? The only course of action is run the money printing press (i.e. create currencies out of thin air, pump them into the system for free). The risk is that without a properly growing economy, they risk igniting another asset price bubble. An asset price bubble may seem to ‘work’ because they can keep the system solvent for a while, until the bubble burst and restart the deflation nightmare again. The government will then have to start the monetary printing press again while the economy shaves its productive capacity the second time. If this process is repeated umpteen times, it will come to a point whereby the only thing to keep the system running is rising asset prices and not economic growth. When that happens, it is hyperinflation.

The current asset price rebound around the world is the stage where rising asset prices are keeping the debt wheel running. We don’t know how long that gig will keep running.

Tags: , , , , ,
Posted in Economics/Finance | 30 Comments »

If gold has no intrinsic value, is it a bubble?

Tuesday, March 17th, 2009

Today, we just received a comment from one of our readers,

I got two emails in my inbox today from sources I subscribe to that made me think of you and your hoard of gold. Firstly, the view of a smart guy who knows a lot about investing:

Gold is very expensive

Secondly, the views of another smart guy who knows a lot about technical analysis:

Gold Divergence Poses A Question

I think the gold/oil ratio is particularly telling, in that a gold bubble began forming in late 2008. Like I said previously, I don?t want to try to timing getting out of gold and into real assets, but good luck to you.

We took a read at the first link and saw this:

I know the gold bugs will hate this idea – because it harks back to the argument against gold – which is that it has no intrinsic value.

This is one of the most common argument against gold. While this argument is true in itself, the person who wrote that sentence has clearly forgotten the mirror image of that argument. As we wrote in October 2006 at Is gold an investment?,

This is because with its extremely limited industrial use, gold will not be worth that much at all.

So, we will repeat this point again: Gold has no intrinsic value. So, if gold has no intrinsic value and if you see its price going up, it is easy to conclude that it is a bubble. Now, having established the fact that gold has no intrinsic value, we will ask a mirror image question. What intrinsic value does a crisp piece of paper called the US dollar has?

You see, like gold, a crisp piece of US dollar has no intrinsic value too! There are completely no industrial uses for that piece of paper called the US dollar. Now, ask yourself this question: if that piece of paper called the US dollar has practical industrial use or is consumable the way tissue paper and tooth-pastes are, do you think people will still want to treat it as money? Now, imagine if one day the US government decree that all tooth-pastes become legal tender for payment and settlement of debt (i.e. function as money), how would you feel if you have to physically consume your money daily for the sake of oral hygiene?

Therefore, as we said before in Properties of good money, one important property of money is that it must not be something that is consumable. The only way for this property to be fulfilled is for money not to have any intrinsic value.

Now, back to gold. As we wrote before in What should be your fundamental reason for accumulating gold?,

We accumulate gold not just simply because we believe its ?price? is going up (though we think it is most likely to be so as a side effect?in case you are confused by what we mean, read on). This is because if we do so, the implication is that we are calibrating the value of gold in terms of units of fiat paper money (see Entrenched perception on the value of paper money).

Therefore, the fundamental reason for accumulating gold is not to ‘make’ money. The reason why you do so, is because you lack confidence in legal tender money. The bull market for gold since 2001 is an indication of a declining confidence in legal tender money, which like gold, has no intrinsic value. So, if you are very suspicious of central bankers playing hanky panky with the crisp piece of paper money called the dollar/ poound/ yen/ franc/ yuan/ etc, then your only alternative is to exchange those funny paper for physical gold.

Now that you understand this very fundamental point, what if you are still concerned about timing the market? If you are getting more and more suspicious of legal tender money (or getting more and more worried of a doomsday scenario), then market timing will be the least of your concern. Sure, you may want to time the market to get the maximum bang (gold) for your buck (paper money). But if market timing is still your over-ridding concern, then you are really missing the big picture. If you see gold price going up and up, it means you will have much greater worries than just market timing.

But if after all these explanations, you are still concerned about marketing timing, Marc Faber has this to say in his latest commentary:

I really dislike being called a gold bug. I wish I could be positive about the global economy and social and geopolitical condition, but the more I think about current condition, the more depressed I become. Amidst a global slump I believe that we are moving toward high inflation (a further depreciation in paper money?s purchasing power), evil fascism, and vicious military confrontations. In theory, gold would be the best asset to own in this condition. Also, in theory, gold should be the perfect insurance against economic, social, and political Armageddon. However, I have some reservations.

For one, gold has already experienced a powerful bull market between 2001 and the present. As a result, gold has become relatively expensive compared to equities and the CRB Index. I am not suggesting that this outperformance of gold compared to other commodities and equities cannot continue. In fact, I believe that in time one Dow Jones will buy less than one ounce of gold. However, near term, gold would seem to be both over-bought against the Dow Jones and the CRB Index. I concede that the overbought condition of gold compared to the Dow Jones and compared to the CRB Index could be corrected by a strong rebound in the Dow and the CRB Index rather than a further downward correction in gold. My bet would be that the CRB Index has significant rebound potential and…

The other concern I have about owning physical gold (and as I just said, I am holding on to my physical gold) is that things will get one day so bad in the world that governments will expropriate gold, as the US did in 1933. This is unlikely to happen this year but it is a concern I have for the long term, especially if gold rallies to several thousand dollars per ounce as a result of money printing by all central banks or because of wars! As Voltaire remarked, ?it is dangerous to be right when the government is wrong.?

Whether you should be buying, holding or selling gold today will depend on your personal circumstances, which includes what percentage of your wealth are currently in gold, your level of suspicion against fiat money and your level fear for a doomsday scenario. But remember, having some gold is better than having zero gold.

Tags: , , , , , ,
Posted in Gold | 40 Comments »

What should be your real reason for buying gold?

Monday, November 20th, 2006

Speculators are always in the market. Where speculators congregate, there will be herd behaviour, mob rule and rumours. Late last year, gold pierced the psychological US$500 market, which heralded in a ‘gold rush,’ culminating in a short-term price bubble of around US$730 in May this year (see our article, The story of gold). After the bubble burst, the gold price, till today, remained trapped in volatile range.

The aim of these gold speculators was to make as much money as possible in the shortest possible time. When they saw the price of gold moving up with great momentum, they joined in the party, resulting in a dangerous price bubble. Since they did not care about understanding the underlying value of gold that they were punting their money on (for hedge funds, it is usually other people’s money), the only reason for them buying is because the price was going up. As investors, we prefer to invest, not bet. When we look at gold, we perceive it differently from the gold speculators.

At this point in time, the gold price is still in a long-term uptrend. There is a good reason for it?its underlying trend is a big hint to us that something amiss is going on in the global currency system. Thus, as we said before, the root reason for investing in gold lies in your confidence (or rather, the lack of) in the fiat currency system which the world is using right now. And we would like to repeat this point again: the ?money? that we commonly use everyday is the fiat paper currency, which has no intrinsic value because it is not backed by anything physical (e.g. gold). Such ?money? can be conjured up at will by the central bank?s printing press. Thus, its value merely lies in everyone?s confidence in it (see our previous article, Gold & Oil, hand-in-hand).

Thus, your real reason for investing in gold is not to ?make money??you do so as a hedge to preserve your wealth.

Tags: , , , ,
Posted in Gold | No Comments »

The Bubble Economy

Monday, October 30th, 2006

 

Introduction

Over the course of the past several years, the ?wealth? of many people in the Western English-speaking countries (mainly the US, Australia and Britain) had increased, thanks to the real estate price boom. Consequently, the economies of those countries had been growing and expanding over that period. This type of economic growth is what the IMF called the ?asset-driven growth.? One manifestation of this kind of growth is the rise of ?wealth-creation? fades, which advocate the attainment of riches through property ?investments.?

As contrarians, we see that such growth should be more appropriately called ?bubble-driven growth.? For the economists trained in the Austrian School of economic thought, such kind of growth is unsustainable. Furthermore, they believe that the severity of the following eventual bursting of the bubble is related to the preceding inflation of the bubble.

It is good if we could learn from our own mistake. We would be wiser if we learn from the mistake of others. But if we repeat the same mistake of others, we are indeed fools. It is amazing to see that the US, Australia and Britain (for convenience?s sake, let?s call those countries the ?UBA countries? from now on) are not only not learning from the mistake of Japan, but even worse, following the same path. The collapse of the Japanese property bubble in the 1990s led to a downward recessional spiral of the Japanese economy for more than a decade. Property prices have been falling (at least not rising) for 16 years since. At least the Japanese have their savings to count on. But what about those UBA countries, whose savings rates are below zero (that is, they are already deep in debt)? What will happen when the property bubble burst in these countries?

Illusions of ?wealth?

Sydney?s housing property market was the epitome of the great amount of ?wealth? generated by the housing boom in the UBA countries. It started in the mid-1990s, accelerated after the 2000 Olympics and reached its apex in 2003 when house prices were rising at staggering rate of more than 20 per cent a year!

Yes, you heard it right. More than 20 per cent a year!

Where can you find other financial investments that can pay more than 20 per cent return except for the ones that are highly risky in nature? The belief that housing property investment was the way to great wealth was highly delusional. Surprisingly, the mob believed that. At that time (in 2003) there were proliferations of seminars that taught attendees how to be rich through property investments. A cursory glance at the investment sections of bookshops yields titles upon titles of wealth attainment through real estates.

In reality, such ?wealth? was and always is an illusion.

First, let?s see the ludicrousness of the idea that a nation?s general rise in asset value equals a rise in wealth. In a nation?s stock of real estate, only a tiny fraction of it got sold and changed hands in any given year. Those sale prices were imputed into the values of the vast majority of the other properties that never got traded in the market. Therefore, in a rising market, the vast majority of un-traded properties have rising imputed values, which is commonly described as ?rising asset values.?

Theoretically, an economy with only (a very important qualifier) rising asset prices does not produce a single extra widget. That is, there is no real growth. Rising asset prices are illusionary in nature because they are basically imputed values, which are rising fast during the bubble period of exceptionally low interest rates. Meanwhile, the real economy is theoretically no better than before, regardless of the movements of asset prices.

In the case of what is happening in those UBA countries, rising property values merely created higher valued collaterals for which money can be borrowed. With the introduction of equity redraw facilities, borrowers could even extract the ?values? in their properties as cash. As long as property prices kept rising, borrowers needed not worry about repaying back the loans – the increase in the ?value? of their property would take care of that. Meanwhile, some ?investors? (more accurately, speculators) used a sophisticated sounding financial strategy called ?negative gearing? to bet on continuing rise in house prices. Thus, with the economy awash with plenty of borrowed money, there was little wonder why people felt rich! With such feelings of wealth, people tended to spend more. This effect is what the economists call the ?wealth effect.?

Today, with the benefit of hindsight, we could see what a great spectacle it was!

Source of the ?wealth?

Now, the question is: where is the source of all these ?wealth??

For the answer to this question, we will take the case of Australia for example. Over the past 5 years, Australia?s money supply (M3) grew (that is, printing of money) by 10.1% per annum, which is much faster than the rate of economic growth. In other words, the growth of the amount of money circulating in the economy exceeded the growth in the production of goods and services. The natural consequence of this is inflation as there are now more money chasing fewer goods and services.

But in Australia?s case, the inflation remained within the Reserve Bank?s target of 2-3%. Where did all those excess money go? Part of the answer to this question, as you would have guessed by now, lies in the inflation of asset (house) prices. The well-known ?inflation? that everyone talks about in the media is the consumer price inflation, which can be seen statistically by the rise in the Consumer Price Index (CPI) and experienced by everyone from the general increase of price levels in everyday life. Unfortunately, the CPI figures do not capture the price behaviour of assets (property, stocks, bonds, etc.). In Australia?s case, the housing boom was contributed by such excess money printing.

Furthermore, another force was at work in curbing Australia?s consumer price inflation – the rise of Chinese manufacturing. In recent years, Chinese productivity had soared, which means overall, the Chinese economy was producing more and more goods at lower and lower costs. In China itself, that had a good deflationary effect – the fall in the consumer price levels. As China exported more and more of its cheaper goods to Australia, the effect on Australia was disinflation (decelerating growth in consumer price inflation). That helped keep a lid on the Australian consumer price inflation.

This phenomenon is an example of what were happening in the UBA countries. It began in the US in 2001 when it suffered the mildest ever recession after the crash in technology stocks. In order to prop up the economy, the US central bank – the Federal Reserve (commonly called the ?Fed?) – embarked on a massive expansionary monetary policy. That is, the Fed printed huge amount of money, which also increased the amount of credit granted (the flip side of granted credit is owed debt) in the economy. When central banks print money, they cannot control how the excess money is being used. In the case of the UBA countries, the excess money and credit fed the housing bubble.

In the US, interest rates consequently had to fall significantly to accommodate the monetary inflation (printing of money). With that, other countries had to follow suit by lowering their interest rates (to prevent their currencies from appreciating too much against the US dollar), resulting in a worldwide trend towards lower interest rates and monetary inflation.

Effects of the rising ‘wealth’

What was the effect of rising house asset prices, which were caused by the increase in money supply and credit in the economy?

When house asset prices rose, house owners felt wealthier. When they felt wealthier, they increased their spending. This is what the economist called the ?wealth effect.? Increased consumer spending in the economy resulted in businesses expanding their production due to their perception of increased demand by the consumers. Ideally, expanding production should in turn lead to increase in hiring and business investments, which in turn increase employment and productive capacity of the economy respectively. That should result in economic growth.

But unfortunately, the reality in the US was not as good as the ideal. The increase in consumer demand resulted in the increase in import of foreign goods. That showed up in the widening current account deficit, which simply meant that the US was spending more than it produced. The implication for this was that the increase in production in the US economy was not keeping up with the increase in consumer demand, which was fuelled by the boom in house asset prices, which in turn was fuelled by the inflation of money supply and credit in the economy.

Meanwhile, the amount of debt owed (its flip side is credit granted) in the US economy ballooned as the rising house asset prices increased the collateral for which money could be borrowed for consumer spending.

Indeed, this was how the UBA countries? economy grew. The IMF called this ?asset-driven growth.? The question is, how sustainable is this kind of growth?

Sustainability of such growth

Is such kind of economic growth sustainable in the long run?

Before we decide on the answer for this question, let us ponder upon this quote:

The deficit country is absorbing more, taking consumption and investment together, than its own production; in this sense, its economy is drawing on savings made for it abroad. In return, it has a permanent obligation to pay interest or profits to the lender. Whether this is a good bargain or not depends on the nature of the use to which the funds are put. If they merely permit an excess of consumption over production, the economy is on the road to ruin. – Joan Robinson, Collected Economic Papers, Vol. IV, 1973

In the case of the US, the side effects of the economic growth manifested itself in the form of ballooning household debt and widening current account deficit. Put it simply, the US, as a nation, was borrowing money not to invest in the betterment of its future, but to consume to the detriment of its future. Since 2001, the economic growth was accompanied ?with unprecedented large and lasting shortfalls in employment, income growth and business fixed investment? (Restructuring the U.S. Economy – Downward). Indeed, such kind of profligacy is the beginning of the transference of wealth from the spend-thrift nations to the prudent nations (see Transference of wealth from West to East).

These are some of the serious questions we would like to ask:

  1. As the US spends its way into economic ruin, its economy is being damaged structurally. How much longer can the US sustain its colossal debt?
  2. Right now, the US housing bubble is deflating. Will it eventually burst and wreck havoc on the rest of the economy?


Tags: , , , , , , , , , , , , , , ,
Posted in Economics/Finance | 12 Comments »

Transference of wealth from West to East

Monday, October 23rd, 2006

According to media reports, Qantas recently announced that they are outsourcing their ?IT applications support and maintenance operations to global services companies Satyam Computer Services Ltd and Tata Consulting Services.? Furthermore, ?Chief executive Geoff Dixon said the transition to Satyam and Tata, which would take place over 15 months from November, would mean the loss of up to 340 Qantas IT positions.?

We were dismayed to hear that. Our immediate dismay laid in the poor souls who have lost their jobs. But our greater dismay laid in the long-term big picture trend that is going to affect our country for our future generations. The news from Qantas was just one of the incremental steps in the current macroeconomic trend towards the massive transfer of wealth from the West (mainly the spendthrift countries: US, Britain and Australia) to the East (mainly India and China). The West?s bubble economy set the stage for the beginning of its decline. Virtues like thrift and hard-work were forgotten, giving way to greed and profligacy. What started of as a trickle soon developed into a flow, which then formed a gush. Eventually, the dike will be overwhelmed and a final collapse ensued.

All right, we may be exaggerating about what may happen in the future, but our hyperbole served to illustrate a truth?the West is getting economically poorer and poorer while the East is getting economically richer and richer. How is this happening?

It all began with the outsourcing of manufacturing to the East. This common myth was often believed in the West: They sweat, we think. The assumption was that we will push the base, labour-intensive and low-level jobs to the East, while we concentrate on the more capital-intensive, high-level, technologically advanced and value-added jobs. Pundits will point to the fact that the Eastern economies consisted mainly of producing goods while the Western economies consisted mainly of providing services.

It is this kind of complacency that we wish to shake off. As the West manufacture less and less, its manufacturing industries got more and more hollow. As the manufacturing industries migrated to the East, technology hitched a ride along as well. As the East manufacture more and more, they learn from us more and more. As they learn more, they moved up the technological ladder, create better products and move up the value-added chain. With the wasteful and spendthrift ways of the West, more jobs get outsourced to the East to protect corporate profits while the real wage of West stagnate and even decline. As the trend continues, Western skills, know-how, capital and industries get increasingly eroded. This erosion is a portent for the eventual loss of wealth by the West.

Now, let?s examine this issue at the grassroots level, where the frontline battles are fought daily. Qantas?s decision to outsource its IT jobs to India is just a small example of a wider trend. In Australia, university enrolments for IT courses are pathetically low. Who would want to learn a skill for a job that you believe has got no future and is going to be outsourced eventually? With less and less people wanting to learn IT, no wonder there?s an outcry of an acute IT skills ?shortage? by businesses in Australia. We believe the IT skills ?shortage? is a humbug?business whinged on the lack of IT skills and yet, on the other hand, not willing to pay the price to acquire them in the first place. We believe that if nothing is done about it, one day, we will not even have an IT industry to whinge about!

Lately, we heard that Satyam (the company which Qantas outsourced its job to) is the same Indian IT company that is drawing people from the West to learn from its training campuses in India. Hey, aren?t the East supposed to sweat while we think?

Meanwhile, as investors, we are more willing to trust our wealth to grow faster in the East than in the West.

Tags: , , , , ,
Posted in Economics/Finance | 22 Comments »