Sunday, September 26, 2010

Race to the Abyss

Just after the September 2008 crash, Ray Dalio, the founder and CEO of the hedge fund Bridgewater Associates {current worth $3.1 billion} gave an interview in The Atlantic magazine in which he predicted a situation whereby existing assets.. real estate primarily.. would go down hard in value and that due to the printing of money worldwide, commodities would soar in value, bringing about a situation he called "DisInflation". We have arrived.

Corn, which was $3.25/bu in June 2010, is now at $5.25. Wheat, which in June was $4.75/bu, is now at $7.20/bu. Gold has finally broke thru the $1,300/oz barrier this week. Copper, which yours truly thought would hit $2.50/lb, went from $2.70 in May to $3.60/lb. Curiously enough, crude has stayed relatively stable in the mid-70s/bbl. Part of the reason for grains was a drought in Russia and the Ukraine, which have banned all exports thru the end of 2011.

The biggest reason is, of course, Ben Bernanke's policy commonly called ZIRP (zero interest rate policy). As we speak, there is no end in sight to this policy; indeed, there are calls for further "monetary stimulus".. ie printing money.. to get the economy going. Lowering the value of the currency makes our own exports cheaper. It's been tried before.

In the midst of the Depression, the US and Britain printed money in heaps with the idea that lowering the value of the currency would lead to a recovery led by exports. The problem was, other nations caught onto this relatively fast and did the same thing; at one point it became a "race to the bottom". In addition, many nations erected trade barriers to protect their own industries. Britain had the "Imperial Preference" policy. Between these currency games and trade barriers, international trade essentially collapsed, making the Depression worse than it already was.

This week, a couple of nations joined the Swiss and Japanese in currency interventions. Brazil's Central Bank began printing money and purchasing US Bonds in an attempt to keep their currency's value down. In addition to this, the US House passed a bill authorizing the President to enact trade sanctions against China, who has for a decade kept the value of it's currency down in order to foster exports. China is also engaging in an economic war against Japan due to Japan's detaining of a Chinese fishing boat captain, who was working the waters claimed by both China and Japan. China retaliated by banning exports of "rare earth metals" to Japan.. some of which are essential in the production of electric and hybrid cars. A protest in China on the anniversary of Japan's invasion in the 1930's did'nt help matters. I also read where the Chinese have been recent buyers of Japanese Gov't Bonds, thus strengthening the Yen against Japan's wishes. I have no doubt that other nations might in some way act to protect (or weaken) their currencies in this most dangerous of games. Throw in things such as national pride and angry electorates and the situation becomes increasingly unstable.

During the Depression, this "race to the bottom" resulted in a debilitating collapse in global trade. But this time, given the vast amounts of debt the industrialized world is in, currency wars can lead to banking collapses, volatile interest rates and other dangerous events. Here in the US, these hikes in grains and metals will lead to higher prices at the grocery store.. and if crude should begin to follow the others, a perhaps drastic hike in gas prices, leading to a host of other problems at the retail level. If interest rates were to spike upwards, the ability of people to purchase homes becomes impaired, leading to less home sales, another leg downwards in home values, and a rise in people who simply give up paying on their underwater home.. thus leading to a huge spike in bank losses and possible failures. In other nations, these games can lead to outright collapse; if Japan cannot halt the rise in the Yen, their exports will become too expensive to be competetive, leading to a contracting economy.. at a time when Government expenses are increasing, the numbers of workers are declining, and savings are near non-existant levels. Despite the appearance to most Americans that all is well, it is far from it. The debt problem is still here, as are derivatives. Our government has to borrow one out of every three dollars it spends. This race to the bottom could have profound consequences.

Update 9/29: "The US House of Representatives has approved legislation designed to combat the manipulation of currency by China that results in unfavorable trade conditions for the United States. As CNN reports, the legislation, which authorizes the Commerce Department to impose duties on imports from countries with undervalued currencies, passed by a vote of 348 to 79"


  1. Thanks for the writeup, Mr.K


  2. I have offered to teach a class at work on how to live within a budget. This is absolutely foreign to most Americans. Geithner and Bubble Ben will ruin what is left of this economy and the average American is too ignorant to do anything about it. When unemployment is exhausted and at 25% then and only then will we get some real change you can believe in. Bankers hanging from light poles lining Wall Street is a good start. We need less Harvard MBA and more financial classes taught in high school on how to manage money not TV telling you how to spend it. Today's economy rewards the consumer and penalizes the saver and it should be the other way around. Great article Mr K. and i don't care how much gold costs as it only shows one how little value is left in the fiat currency. Virtually none.

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