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Message: Achilles Heel of the entire WORLD Financial System
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The World Financial System's Achilles' Heel by Bill Bonner Ouzilly, France The dollar fell to $1.42 per euro yesterday. Many believe it is the Achilles' heel of the entire world financial system - and Warren Buffett is among them. The story goes, Achilles was dipped in the river Styx and made invulnerable. But his mother held him by his heel, leaving that part untouched by the magic waters. Naturally, that is where a poison arrow got him. The moral of this story is that you have to go all the way. If you want your baby to be invulnerable, put him all the way under the water...even the heels. Or, maybe there's another point: that there's always some place where you're vulnerable. For the purpose of today's tale, we'll take the second possibility. Try as you may, you can never escape all risks. All over the world, consumer prices are falling. The world has too much capacity...too many factories...and too many workers. Too many, that is, for current demand. The 'world's mouth' - the USA - has gone on a diet. And if the United States reduces its intake, that means the rest of the world - especially China - must reduce its output. Otherwise, the whole thing will become unbalanced. Yesterday's news tells us that despite press reports of a recovery, the key indicators of real economic growth are still falling. Almost one out of ten mortgages are now delinquent. And the rate of foreclosures is increasing faster than any time in the last 30 years. Housing prices, meanwhile, fell 16% in the 2nd quarter, from a year earlier, according to the National Association of Realtors. Unemployment claims went up last week. The sharp eyes of The Financial Times see the link: "Mounting joblessness fuels US housing crisis," says its headline. In the real economy, people are cutting back...with the inevitable results we discuss every day here in The Daily Reckoning. One major consequence of reduced demand is too much supply. The factories built in China to supply products to America during the bubble years now find they have no market. Currently, overcapacity and oversupply are causing prices to fall. Falling prices mean rising currency values. Each unit of 'money' buys more stuff. But there are many competing currencies, and they don't all rise and fall together. Even in a world of deflation, some currencies will deflate more than others. The dollar is, of course, the world's main money. In a sense, the whole world economy is under its heel. But it is a heel that has never been dipped in the river Styx. It is now a heel that waits for an arrow. PIMCO is the biggest manager of bond funds in the world. It says the greenback is going to lose its status and lose its value. "Investors should consider whether it makes sense to take advantage of any periods of US dollar strength to diversify their currency exposure," says its Emerging Markets Watch report. "The massive amounts of US dollar liquidity produced in response to the crisis" doom the currency. Both China and Russia are calling for a new global currency to replace the dollar. "While we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the US dollar as a store of value even in the absence of a single viable alternative," continues the PIMCO report. Meanwhile, our old friend Jim Rogers says he is moving all his assets out of dollars and buying Chinese yuan. And Warren Buffett warned this week - writing in The New York Times - that "greenback emissions" threaten the whole world econo-system. But what does it mean? What are the threats to you? What are the opportunities? If you pay your bills and keep score in dollars, what does it matter if the dollar loses value against the yuan? If prices are generally falling, the dollar is actually getting stronger, isn't it? So what if some other currencies are getting even stronger still? Colleague Bill Jenkins, at Master FX Options Trader puts in his two cents: "We lived through a financial earthquake in 2008. The effects of it are still being felt. Aftershocks may still be ahead. But predicting when they'll strike is just as hard as predicting natural earthquakes. We had a number of prognosticators for years telling us about what would happen last year; it's just that they didn't know when. And that is the hard part of the life of a prophet. "And while it is equally difficult to tell when the next economic tremors will hit, we can look at the numbers and make some predictions as to their cataclysmic effect." Bill goes on to say that he thinks the US is headed for another shockwave...which will include another round of dollar buying - even while the 'experts' are touting 'green shoots' and a return to normalization. More...after the news: "After a remarkable 51% rise, the S&P 500 has spent most of August wondering what to do next," writes Ian Mathias in today's issue of The 5 Min. Forecast. "There have been some sell-offs and rebounds, but essentially, stocks have taken the month off. See for yourself: |
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| The key to understanding the great credit bubble of 1945-2007 is to capture the codependent relationship between China and the United States of America...especially now that that relationship is at odds with one another. Bill Bonner explores, below... No Recovery, Not Now...Not Ever That we live in an age of miracles has become common knowledge. A man may sit on a beach near Sydney, with nothing but the bucket bottom of the universe over his head, and still carry on a casual conversation with an Eskimo near the North Pole. Using an Internet-based phone service, he may do so at negligible cost. If this were not miracle enough, he may now grow himself a new nose, if he needs one, on his own arm. In this age of miracles, people seem ready to believe that anything is possible. Recklessly crossing the street at the end of the Late Bubble Epoque, the world economy got hit by a cross-town bus. Now, the feds propose to reverse and run over the poor fellow again. It will be as if they had reversed the film; the economy will be as good as new, they say. But we are suspicious. And we begin today's rumination by examining the bus driver's motives. In its naked form, government is not evil; it is merely a self- interested parasite, like a bank lobbyist. Its main value comes from its ability to elbow out other parasites. Of course, the typical citizen is no saint either. Instead, he is merely a parasite in the larval stage. If he is lucky enough or cunning enough, he could grow into a parasite himself. The citizen, generally, doesn't mind being lied to and robbed - just so long it is by someone he elected. Or at least by someone whom tradition or local connivance put in place. He does not usually resent his homegrown government, even though it routinely costs him a substantial part of his output. On the contrary, he grows so fond of it he even dons his helmet from time to time to protect it. Naturally, the feds return the favor. The basic business model of government is to keep order, protect campaign contributors and lure supporters with the promise of other peoples' money. The game plan of the typical citizen is even simpler: to be on the receiving end, not the paying end. Over time, more and more of them get into position. And the whole society becomes more costly, and more corrupt. In the United States, entire industries now operate as wards of the state. They may have too little capital. Or, their operations may be too costly. Or, their products may be simply out-of-date and unattractive. Still, government keeps them going - even at the cost of at the expense of competitors. And the money doesn't only go to business. Cities stay solvent only by the grace of federal government grants. Whole sections of the population depend on government - including 34 million who draw their rations directly from the federal food stamp program. The spectacle is breathtaking and alarming at the same time - like a Pakistani bus on a mountain road, freighted with passengers clinging to the roof. The old rust bucket could tip over at any time, but what politician would tell a voter to get off? That preface on the state out of the way, we turn to the state of the economy. The key to understanding the great credit bubble of 1945-2007 is to capture the codependent relationship between China and the United States of America. It seemed to serve both parties well. Each enabled each other's excess. China added mightily to the world's supply - far more than was actually needed. America, meanwhile, did heroic work on the demand side. While the growth in the United States was led by consumer spending, the growth in China was led by capital investment; factories expanded, towns were built, and output was revved up. But there was a flaw. Americans ran out of money. After the '70s, they could only increase their buying by going into debt. This they did with insouciance bordering on insanity. Total debt rose 370% of GDP and then blew up in 2007, with major lenders forced into bankruptcy and mergers, while GDP sank at its fastest pace since the end of WWII.
Now, the old formula no longer works - neither for Americans nor for the Chinese. Despite the urging of their government, Americans cannot be expected to take on more debt in order to consume more stuff from China. As savings rates grow toward 10%, demand from the United States will collapse by an estimated $1 trillion per year. With the China trade now accounting for 83% of America's non-oil trade deficit, you'd think the Chinese would panic. They already have as much as two times the output capacity needed to meet real demand. They should trim their manufacturing sector, not expand it. We draw out that relationship only to show how hopeless it would be to draw it out further. Borrowing to consume is merely tricking stuff from the future to enjoy in the present. By 2007, some $30 trillion worth of spending that would have occurred 'in the future' had already occurred in the past. Factories that would have produced consumer items for 2009 discovered that they had already produced more than enough of them in 2005 and 2006. It would be better to invite the future in...let her collect her debts...and then get on with things. Yet government officials on both sides of the Pacific continue their numbskull efforts to revive the bubble economy. On the US side, the feds are trying to stimulate demand for more stuff. On the far side, Chinese stimulation is going into producing more stuff. As if the world didn't have too much stuff already. But the role of government is neither prosperity nor plausibility...but protection of the pests and parasites. They will keep paying them off and carrying them along...until the bus runs off the road. But it's not prosperity that government really cares about. The big bus keeps trundling along - picking up pests and parasites along the way. It will keep going until it runs off the road. Enjoy your weekend, Bill Bonner The Daily Reckoning |
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