Has World Trade Been Picking Up?

Yes, according to Businessweek.

Chart from Panjiva

This from Businessweek's Joe Weber,

``In yet another sign that some key players are acting as if recession is on the run, more offshore manufacturers are shipping goods into the consumer-driven U.S. market, global-trade tracker Panjiva reports. The May trade data mark the third consecutive monthly rise in the number of shippers moving such goods, the first such Trifecta since the firm began following this metric in July 2007.

``“Increasingly, it feels that the worst is behind us,” says Josh Green, chief executive officer of the trade-tracking firm. Waxing cautious, however, he adds “Still, we have a long way to get back to the pre-crisis level of global trade.”

``Nonetheless, the data, released June 16, suggest that global trade has hit bottom and is taking the first steps toward recovery. Some 131,688 suppliers were active in May, up 2% from the number in April. The rises in shipper tallies give the Panjiva analysts heart, since such totals have been sliding since at least July 2007, when they counted 161,905 shippers moving goods into the U.S.

``The analysts point to other barometers of improvement, too. The percentage of significant manufacturers on a watch list – those in danger of going out of business – dropped a percentage point to 30% in May, for instance. This marked the first such decline since Panjiva started tracking this metric last September."

Read the rest here. (Hat tip: Mark Perry)

The recent rise in the Baltic Dry Index, commodities (CRB) and oil could be partly be due to this.

Nevertheless, our take has been that the collapse in global trade was mainly a consequence of the seizure "shock" in the US banking system which virtually shackled global trade flows by constricting access to financing.

Although the paradigm which underpinned the past boom won't be revived, present signs of recovery could have been due to the replenishment of inventory destocking.

As for how sustainable this would be remains to be seen.

Our Mises Moment Answers Mainstream’s Conundrum of Market-Fundamental Disconnect

``But on the other hand inflation cannot continue indefinitely. As soon as the public realizes that the government does not intend to stop inflation, that the quantity of money will continue to increase with no end in sight, and that consequently the money prices of all goods and services will continue to soar with no possibility of stopping them, everybody will tend to buy as much as possible and to keep his ready cash at a minimum. The keeping of cash under such conditions involves not only the costs usually called interest, but also considerable losses due to the decrease in the money’s purchasing power. The advantages of holding cash must be bought at sacrifices which appear so high that everybody restricts more and more his ready cash. During the great inflations of World War I, this development was termed “a flight to commodities” and the “crack-up boom.” The monetary system is then bound to collapse; a panic ensues; it ends in a complete devaluation of money Barter is substituted or a new kind of money is resorted to. Examples are the Continental Currency in 1781, the French Assignats in 1796, and the German Mark in 1923.”-Ludwig von Mises, Interventionism: An Economic Analysis, Inflation and Credit Expansion

The mainstream is obviously very perplexed.

They can’t seem to figure what’s going on with market prices that can’t seem to match “fundamentals”.

Take this as an example. ``With oil inventories high and demand down year on year, yet prices surging, "fundamentalists" are puzzled” observes Liam Denning of the Wall street Journal.

Skeptical of the fundamental –market disconnect, the unconvinced Mr. Denning concludes his article with, `` Ultimately, however, the danger for China, and commodities bulls, is that Beijing's efforts fail to fully offset the harsh realities afflicting the world economy as a whole.” (bold highlight mine)

Figure 6: Wall Street Journal: China Watch The Body Language

Many have attributed the rise in oil or iron ore prices primarily to China see figure 6. But the unpleasant fact is that this isn’t just about oil or iron ore or China.

It’s about policy induced inflation whose growing influences are being ventilated on markets and which has been percolating and distorting the real economy.

And the primary mechanism for such release valve has been the US dollar.

As we wrote in last week’s Mainstream Denials And The Greenshoots of Inflation, a broadening category of the commodities have been experiencing price gains. So it’s not only oil or iron ore or gold but a whole range of commodities which includes food prices.

In addition, it isn’t just China or Sovereign Wealth Funds, but a broader spectrum of participants have joined the bandwagon as buyers of commodities. As we noted in Hedge Funds Pile Into Commodities, hedge funds have been growing exposure to commodities.

Even life insurance outfit as Northwestern Mutual Life Insurance Co. ``has bought gold for the first time the company’s 152-year history to hedge against further asset declines” (Bloomberg) could be signs of possible major reconfigurations of investments flows towards commodities.

My recent post which surprisingly turned out with a high number of hits, deals with Hedge Fund Ace John Paulson who made an amazing allotment of 46% of his portfolio into gold and gold related investments [see Hedge Fund Wizard John Paulson Loads Up On Gold]! He didn’t say why, but the message was loud and clear! What a statement.

Aside, Bond King and regulatory arbitrageur Bill Gross recently wrote to warn the public to diversify away from US dollar before ``central banks and sovereign wealth funds ultimately do the same amid concern about surging deficits” (Bloomberg)

He thinks that the US has reached a “point of no return”, again from the same Bloomberg article, ``“I think he’ll fail at pulling a balanced rabbit out of a hat,” Gross said from Pimco’s headquarters in Newport Beach, California. “They are talking about -- once the economy in the U.S. renormalizes -- the move back toward balance or much less of a deficit. I suspect that will be hard to do.”

Moreover, a public gold fever (not swine flu) appears to have infected ordinary Chinese sparked by the revelation of massive gold accumulations by the China’s government. According to the China Daily, ``Inspired by the increase in the government gold reserves, the more savvy investors are also buying shares of Chinese gold producers on the Shanghai Stock Exchange and the smaller Shenzhen Stock Exchange.”

Furthermore, drug trades have reportedly been reducing transactions based in the US dollar and could have possibly been replaced by trades in gold bullion (telegraph).

This Dollar based concerns won’t be complete without Russia’s continued outspoken campaign to replace the US dollar as the world’s international reserve currency, which apparently not only got support from major Emerging Markets as China and Brazil, but even the IMF has reportedly jumped on the bandwagon saying that replacing the US dollar is possible.

This from Bloomberg, ``The IMF’s so-called special drawing rights could be used as the basis for a new currency, First Deputy Managing Director John Lipsky told a panel discussing reserve currencies at the St. Petersburg International Economic Forum today.

``“There are many, many attractions in the long run to such an outcome,” Lipsky told a panel discussing reserve currencies at the St. Petersburg International Economic Forum today. “But this is not a quick, short or easy decision,” he said, adding that it would be “quite revolutionary.” (bold highlight mine)

And worst of all, US dollar as a safehaven status has been scoffed at by Chinese students! Incredible.

This from Reuters, ``"Chinese assets are very safe," Geithner said in response to a question after a speech at Peking University, where he studied Chinese as a student in the 1980s.

``His answer drew loud laughter from his student audience, reflecting skepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home.” (bold highlight mine)

It’s obviously a question of what degree of the Chinese population has been represented by the adverse reactions of Chinese students on Mr. Geithner’s statement. If these students account for a majority of China’s sentiment, then it is quite obvious that the public will likely be shunning the US dollar as mode of payment or as transactional currency or as medium of exchange (sooner than later) despite the Chinese policymakers’ avowed insistence to buy US dollar assets (but on a short term basis) which is no less than politically premised, as previously discussed here and here.

All these account for votes of displeasure over policies governing the US as reflected on its currency the US dollar, which mainstream can’t seem to comprehend.

As I wrote in my March outlook Expect A Different Inflationary Environment (emphasis added), ``This leads us to surmise that most of global stock markets (especially EM economies which we expect to rise faster in relative terms) could rise to absorb the collective inflationary actions led by the US Federal Reserve but on a much divergent scale. Currency destruction measures will also possibly support OECD prices but could underperform, as the onus from the tug-of-war will probably remain as a hefty drag in their financial markets.

``And this also suggests that commodity prices will also likely rise faster (although not equally in relative terms) than the previous experience which would eventually filter into consumer prices.

``In other words, the evolution of the opening up of about 3 billion people into the global markets, a more integrated global economy and the increased sophistication of the financial markets have successfully imbued the inflationary actions by central banks over the past few years. But this isn’t going to be the case this time around-unless economies which have low leverage level (mostly in the EM economies) will manage to sop up much of the slack.”

So far everything that we have said has turned out to be quite accurate.

But we seem to be transitioning to the next level.

This brings us to the question why the public seems to be gravitating towards commodities?

Ludwig von Mises has an explicit answer which I unearthed in Stabilization of the Monetary Unit? From the Viewpoint of Theory,

``If people are buying unnecessary commodities, or at least commodities not needed at the moment, because they do not want to hold on to their paper notes, then the process which forces the notes out of use as a generally acceptable medium of exchange has already begun. This is the beginning of the “demonetization” of the notes. The panicky quality inherent in the operation must speed up the process. It may be possible to calm the excited masses once, twice, perhaps even three or four times. However, matters must finally come to an end. Then there is no going back. Once the depreciation makes such rapid strides that sellers are fearful of suffering heavy losses, even if they buy again with the greatest possible speed, there is no longer any chance of rescuing the currency. In every country in which inflation has proceeded at a rapid pace, it has been discovered that the depreciation of the money has eventually proceeded faster than the increase in its quantity.”

So let us break these down into stages:

First, the loss of the currency’s purchasing power.

Second, is the loss of a currency’s function as medium of exchange or the “demonetization process”.

Third, is the accelerating feedback loop between the first two stages which brings upon the irreversibility of the process and

Finally, the total collapse of the currency.

So there you have it. The public’s increasing exposure to commodities is fundamentally a question of the viability of the present monetary standards.

So far the political path and market responses have been behaving exactly as described by Prof. von Mises.

Hence, I call this the Mises Moment.

$200 Per Barrel Oil, Here We Come!

``This gets back to the disagreement I’ve had with the “inflationists” for years now: In the name of Keynesian economics, inflation proponents have repeatedly called for massive stimulus in response to the bursting of THE Bubble, while in reality this activist policymaking was instrumental in only extending and worsening a systemic Credit Bubble. This was especially the case after the bursting of the technology Bubble and is again true today following the bursting of the Wall Street finance/mortgage finance Bubble. Now, more than ever before, “Keynesian” inflationism is THE Bubble. When it eventually bursts Washington policymakers will have little left to offer.” Doug Noland Inflationism’s Seductive Battle Cry

For us, $200 oil is not an issue of IF, but rather an issue of WHEN. This will be highly dependent on the course of actions undertaken by global policymakers.

Here, we won’t deal with demand and supply imbalances of oil, as we had made our case late last year in Reflexivity Theory And $60 Oil: Fairy Tales or Great Depression?, instead we will deal with the rapidly evolving market signals and prospective political actions by policymakers

Growing Disconnect Between Markets And Real Economy

“World oil demand to hit 28-year low” screams the headline from the National.

So one must be wondering: Why has oil impetuously shot beyond $60? Has the oil market been pricing an abrupt global recovery?

The Economist instead finds justification on widening supply constraints, ``The explanation is simple. Oilmen are worried because they believe that many of the factors behind the record-breaking ascent last year remain in place. Much of the world’s “easy” oil has already been extracted, or is in the hands of nationalist governments that will not allow foreigners to exploit it…So when demand begins to revive, a sharp rise in prices is inevitable. That does not mean that a price spike is just around the corner, however. The speed with which it arrives will depend on the strength of the global recovery.”

While the article mainly underscores the geographical access limitations posed by governmental restrictions, falling demand and high inventories, as discussed in Seeds of Hyperinflation Have Been Sown have reflected on an egregious disconnect between fundamentals and the marketplace. The Economist article appears more like an attempt to explain away or to rationalize on the market activity than vet from the causality angle.

The highly reputed independent research outfit the BCA Research has a fabulous chart manifesting this phenomenon, see figure 1.

Figure 1: BCA Research: Oil Breaks Out: Is It Sustainable?

According to the BCA, ``The higher price of oil reflects in part the upturn in Chinese oil imports and car sales at a time when oil production is lagging. Russia continues to have difficulty boosting output and oil production has been flat for most OPEC countries. Saudi Arabia has cut production sharply. As with other commodities, oil should benefit from both a weaker U.S. dollar and a shift in investor portfolio preference toward real assets as a hedge against inflation. The upturn in our global leading economic indicators is another positive sign for the commodity complex.” (bold highlight mine)

True, China has been massively acquiring oil and other commodities.

And we won’t dismiss some veritable evidences of economic and financial “recovery” following the “banking meltdown” late last year, of which has functioned as a psychological “shock” (Posttraumatic Stress Disorder-PTSD) that has buffeted world financial markets and global economy.

But China has been buying way beyond its needs. It has been buying to shore up its strategic reserves.

Analysts at Sanford Bernstein reported that Google Images reveal on how China has been intensively constructing depots to hold oil. ``Bernstein says satellite images show a marked increase in oil-storage construction over the past few years and estimates that China’s number of days of forward demand–a gauge of oil storage–amount to just 28 days of imports and 14 days of total demand. China is targeting storage capacity that will hold demand cover of around 90 days,” wrote the Wall Street Journal,

Yet according to another researcher as excerpted by the Guardian, China plans to amass 3 million tonnes (about 22.5 million barrels) of oil, ``China wants to set up a 3 million tonne reserve of oil products this year, which is practically impossible, a researcher at a think-tank run by the country's top oil refiner, Sinopec Group, was quoted as saying on Saturday.”

Moreover, China’s huge appetite for commodities registered record imports for Copper and Aluminum this April. However many experts say that China’s buying activities for these commodities may have probably peaked since targets may have been met. According to Bloomberg, ``Refined copper imports by China will slow over the rest of this year as scrap supplies improve, said Ma Xiaoqin, deputy- general manager of the copper department at Minmetals Nonferrous Metals Co., the country’s largest trader, on May 8. The State Reserve Bureau has mostly completed its buying and stockpiling by manufacturers has ended, said Edward Fang, an analyst at China International Futures (Shanghai) Co.”

If such buying activities have indeed culminated then copper and aluminum prices should be expected to meaningfully correct, see figure 2. But we have our doubts.

Figure 2: stockcharts.com: Copper and Aluminum

So far only Aluminum has been showing signs of relative weakness. Although copper seems to be in a consolidation phase where a “pennant” pattern (blue converging lines) may suggest a continuation of the present uptrend.

China Attempts To Balance Political Rhetoric With Market Actions And Political Goals

This isn’t about China believing its own “bullish” tale of vigorous economic recovery, where the supposed “conventional” view equates China’s economic growth to commodity bullishness. Instead the above dynamics reflects the ongoing inflation phenomenon.

The fact that China’s officials have raised the furor over possible losses of its US asset portfolio holdings from the current US policies appears to dovetail with the activities in the commodities market.

China’s Premier Wen Jiabao, as quoted by the Financial Times recently said, ``We have lent a huge amount of money to the United States,” Mr Wen said. “Of course we are concerned about the safety of our assets. To be honest, I am a little bit worried. I request the US to maintain its good credit, to honour its promises and to guarantee the safety of China’s assets.” (bold emphasis mine)

Of course one may argue that China’s acquisition of US assets hasn’t slowed.

In contrast to Premier Wen’s statement, China has even increased its acquisition of US treasuries see Figure 3. And this would seem like a conflict between China’s intentions and actions. But this view myopically glosses over the geopolitical implication. There’s more than meets the eye.

Figure 3: New York Times: China’s Changing Role

It would be tantamount to political suicide if China decides to naively “sell” US treasuries to support its concerns, especially under the present environment which has been a fertile ground for engendering protectionist policies. For instance, recently some US lawmakers have revived efforts to brand China as a currency manipulator. Hence mass liquidations of treasuries would only fuel bilateral antagonism. And a trade war isn’t in the interest of China.

Another, it isn’t also a certainty that the underlying motivation behind China’s purchases of US assets reflects on the same paradigm of “promoting exports” as it had been in the past. Past performance doesn’t guarantee future results-that’s because the incentives behind today’s conditions have radically changed. The US consumer model as the world’s growth engine has apparently been broken. And China appears to be well cognizant of this.

Moreover, since China holds massive amount of US dollar assets- estimated at an astounding 82% of foreign currency reserves (Standard Chartered/New York Times)-any mass liquidation will most likely impact the markets extensively and stoke disorder. Where such actions will likely be mutually destructive, such policy directions will likely be avoided.

Hence, China’s political actions should also be seen from a different prism- China may want to be seen in good light with the US, where she would continually support the US even at the risks of incurring substantial losses in its portfolio of US dollar assets.

As Luo Ping, a director-general at the China Banking Regulatory Commission recently justified, ``Except for U.S. Treasuries, what can you hold?”

Moreover, China may want to project that in case a possible mayhem emerges in the financial markets this isn’t going be due to her doing. In other words, China seems to be placing the onus of the consequences from policy choices squarely on US shoulders.

Nevertheless, actions demonstrate preferences. While China remains supportive of the US in terms of buying assets, the composition of its acquisitions has materially changed.

According to the Keith Bradsher of the New York Times, ``China has also changed which Treasuries it buys. It has done so in ways calculated to reduce its exposure to inflation or other problems in the United States. As recently as a year ago, China actively bought long-dated bonds, seeking the extra yield they could bring compared to Treasury securities with short maturities, of which China bought virtually none.

``But in each month since November, China has been buying more Treasury bills, with a maturity of a year or less, than Treasuries with longer maturities. This gives China the option of cashing out its positions in a hurry, by not rolling over its investments into new Treasury bills as they come due should inflation in the United States start rising and make Treasury securities less attractive.” (bold emphasis mine)

So yes, China has been increasing its purchases of US treasuries to appease the US government, but has been concentrating these activities towards short term maturities. And by doing so she has been acting to reduce her risk exposure as well as balancing political rhetoric (bleating about US policies, announcement of past ‘covert’ gold purchases) with market actions (diversifying portfolio holdings into commodities) and political goals.

And aside from heavily buying into commodities, as previously discussed in The Nonsense About Current Account Imbalances And Super-Sovereign Reserve Currency, China has been utilizing its currency as an instrument to expand its political and economic influence across the globe by increasing swap agreements, by providing project financing and conducting trade in the remimbi or ex-US dollar currencies. Recently Brazil and China concluded an accord to conduct transactions using their national currencies instead of the US dollar.

In all, China could be working to insure herself from the risks of substantial US inflation, to expand its influence globally with its currency and possibly to challenge the US hegemony in terms of having the remimbi as a global currency reserve sometime in the future.

The Global Inflation Train Speeds Faster

And as we keep repeating, in the world of unprecedented scale of government intervention in the marketplace combined with unparalleled degree of applied inflationary measures, the repercussions intended or unintended will be vented on the currency markets.

And we agree with Professor Steve Hanke where he wrote in a Forbes article ``There are tectonic moves afoot in the currency markets these days.”

Tectonic moves afoot in the currency markets will also be parlayed in the Oil Market see Figure 4.

Figure 4: stockcharts.com: Inverse Correlation of Oil and the US Dollar

Visibly, oil in the past has moved in consonance with the US dollar, albeit in an inverse scale (see blue trend lines).

This dynamic seems to be a classic rerun as the recent weakness of the US dollar index (USD) has equally coincided with rising oil prices (WTIC-main window).

Alongside this development has been the rise of 10-year US Treasury yields (TNX) in spite of the recent activities from the US Federal Reserve where the ``Fed bought $18.277 billion of U.S. debt in three purchase operations this week and minutes of the central bank’s April 28-29.” (Bloomberg).

The US Federal Reserve in its March 18^th press release has earmarked $300 billion to purchase long term Treasury securities.

But there seems to be one missing ingredient. In the past, the falling US dollar had been accompanied by falling treasury yields-perhaps reflecting what Former Fed Chair Alan Greenspan’s calls as a conundrum of low bond yields. And this phenomenon was suspected to have been influenced by foreign purchases of US treasuries that have kept yields low.

But since recent treasury issuance to fund US government deficits has surged far more than what foreigners or China has recently bought as shown in the chart earlier, where according to the same Bloomberg report, ``President Barack Obama has pushed the nation’s marketable debt to an unprecedented $6.36 trillion. [bold highlight--mine] His administration raised on May 11 its estimate for the deficit this year to a record $1.84 trillion, up 5 percent from the February estimate, and equal to about 13 percent of the nation’s GDP”, yields have materially risen!

And as we have previously discussed in Ignoble Deficits And The $33 Trillion Global Government Debt Bubble?, the colossal government spending by the US and elsewhere and the prospective surges of government treasury issuance are posing as risks towards hefty inflation or national bankruptcies.

Hence, today’s rapidly deteriorating US Dollar, rising treasury yields and rising oil prices seem to be solidifying the manifestations of inflation gaining traction globally.

Credit Rating Downgrades Amidst Exploding Deficits

Figure 5: Washington Post: Projected Deficits

The recent spate of massive waves of deficit spending in many crisis havocked economies has put pressure on their respective credit rating standings.

The S&P recently issued a downgrade from “stable” to “negative” on UK’s outlook which means the country is at risk of losing its coveted AAA status.

Concerns over the same predicament has apparently spilled over to the US considering the huge planned dosages of government spending aimed at jumpstarting the economy as shown in Figure 5.

Well the impact of concerns over these deficits, aside from rising treasury yields, has been deterioration in credit default swaps, which function as insurance against the risks of credit default.

According to Bloomberg, ``The cost to hedge against losses on U.S. government bonds for five years climbed to a three-week high, indicating perceptions the nation’s credit quality is deteriorating. Credit-default swaps on U.S. debt rose 3.5 basis points to 41, the highest since April 29, according to prices from CMA Datavision in New York. An investor would have to pay $41,000 a year to protect $10 million of debt from default.” (bold highlight mine)

Mainstream Calls For More Inflation Ensures Oil at $200!

These credit rating warnings should serve as call to action on governments to limit overspending. Remember there is no free lunch. Ultimately taxpayers will pay for government profligacy.

But will these warnings be heeded? Apparently not.

On the contrary the mainstream has vociferously been desiring for more inflation.

The Bond King, PIMCO’s William Gross, recently predicted that the US will eventually lose its AAA rating according to Bloomberg.

Yet his prescriptions to support the economy account for the same factors that would ensure the US will likely lose its prime credit rating.

It’s because Mr. Gross subscribes to the Keynesian methodology of printing money as a cure, where the same report quotes Mr. Gross, ``We need more than that,” Gross said at the time. The Fed’s balance sheet “will probably have to grow to about $5 trillion or $6 trillion,” he said.”

And the policy prescriptions of Mr. Gross have been joined by the similar calls from well known Harvard experts-Kenneth Rogoff and Greg Mankiw.

``I’m advocating 6 percent inflation for at least a couple of years,” says Rogoff, 56, who’s now a professor at Harvard University. “It would ameliorate the debt bomb and help us work through the deleveraging process.” (Bloomberg)

Meanwhile, Mr. Mankiw former chairman of the Council of Economic Advisors under President George W. Bush said ``Faster inflation might be preferable to increased unemployment, or to further budget stimulus packages that push up the national debt” (Bloomberg)

So in the face of rising risks of default, these mainstream experts sporting a good clout over at the officialdom may be reflective of the policy directions of the present administration.

Of course inflation can be achieved through massive credit expansion (through public or private channels) or via the government spending route or both.

And if Mr. Bond King’s suggestion will be adhered to and if it’ll likewise be copied elsewhere the risk of a runaway inflation will be tremendous.Figure 6: BIS: Balance Sheets of the Central Banks of the US, UK and ECB

Since the advent of the crisis the balance sheets of the US Federal Reserve, the ECB and the Bank of England have surged see figure 6.

So policymakers have made sure that inflation will likely take hold; inflation is what they ask for hence inflation is what we will get.

As Dr. John Hussman admonished in his latest weekly outlook (bold highlight mine),

``The bottom line is that the attempt to save bank bondholders from losses – to provide monetary compensation without economic production – is not sound economic policy but is instead a grand monetary experiment that has never been tried in the developed world except in Germany circa 1921. This policy can only have one of two effects: either it will crowd out over $1 trillion of gross domestic investment that would otherwise have occurred if the appropriate losses had been wiped off the ledger (instead of making bank bondholders whole), or it will result in a stunning and durable increase in the quantity of base money, which will ultimately be accompanied not by a year or two of 5-6% inflation, but most probably by a near-doubling of the U.S. price level over the next decade. As I've noted previously, the growth rate of government spending is better correlated with subsequent inflation than even growth in money supply itself, particularly at 4-year intervals. Regardless of near-term deflation pressures from a continued mortgage crisis, our present course is consistent with double digit inflation once any incipient recovery emerges.”

Even Yale’s David Swenson told Bloomberg that everyone must own inflation protected securities in the face of substantial inflation, ``We’ve had this massive fiscal stimulus, massive monetary stimulus, and it’s hard to see how that doesn’t translate into pretty substantial inflation, or at least pretty substantial risk of inflation,” Swensen, Yale University’s investment chief, said in an interview on the “Consuelo Mack WealthTrack” television show that aired yesterday. Treasury Inflation- Protected Securities “should be in every investor’s portfolio," he said.”

Finally fund manager David Dreman has another unorthodox suggestion for the US government.

He posits that the US stimulus package be directed at the commodity markets.

According to Mr. Dreman, ``My idea is that we accumulate useful resources, such as crude for our strategic oil reserve. This would create new jobs, halt a deflationary spiral and give us some protection against the next international oil crisis. If the government allocated $500 billion at current prices, it would add 10 billion barrels of oil, which amounts to 17 months' consumption. The government could undertake similar purchase programs for copper, aluminum, lead and other essential industrial commodities now trading at very depressed prices.

``An oil-buying binge would be a win for taxpayers as well. Oil bought today below $60 a barrel can be released back into the market at $120 after economic activity has picked up and inflation has resumed.”

Mr. Dreman’s suggestion implies that the US government should engage with China and the rest of the world in a bidding war over oil and other commodities. The idea is to directly stoke inflation by means of direct intervention in the commodity markets.

However, high commodity prices reduce the purchasing power of consumers or the taxpayers, so it is a contradiction how taxpayers/consumers would benefit from high commodity prices. Put differently, the US government may earn from a spread alright, but the world in general will be poorer because of the lesser amount of goods the Americans and people around the world can acquire.

Moreover he seems to suggest that the US government should be transformed into a proprietary trading desk. Governments don’t work for profit but for social concerns.

Besides a policy directed at a race to own commodities could serve as a casus belli for a world war at war or a world resource war.

What have these “inflationists” have been smoking, anyway?

Overall, the inflationary policies of global governments are key drivers to oil prices at over $200 per barrel!

Effects Of Inflationary Policies Surface In Currency Markets

``America’s policy is pushing China towards developing an alternative financial system. For the past two decades China’s entry into the global economy rested on making cheap labour available to multi-nationals and pegging the renminbi to the dollar. The dollar peg allowed China to leverage the US financial system for its international needs, while domestic finance remained state-controlled to redistribute prosperity from the coast to interior provinces. This dual approach has worked remarkably well. China could have its cake and eat it too. Of course, the global credit bubble was what allowed China’s dual approach to be effective; its inefficiency was masked by bubble-generated global demand. China is aware that it must become independent from the dollar at some point. Its recent decision to turn Shanghai into a financial centre by 2020 reflects China’s anxiety over relying on the dollar system. The year 2020 seems remote, and the US will not pay attention to something so distant. However, if global stagflation takes hold, as I expect it to, it will force China to accelerate its reforms to float its currency and create a single, independent and market-based financial system. When that happens, the dollar will collapse.”- Andy Xie If China loses faith the dollar will collapse

This episode of the stock markets in a fierce rebound has brought about exhortations of “greenshoots” and “prospective” economic recovery, which we have described as the reflexivity theory at work.

And as we have repeatedly been saying, the unparalleled scale of concerted and collaborative global central bank actions will ultimately be transmitted to the currency markets which subsequently will pose as the underlying current to financial market actions.

Figure 3: stockcharts.com: Falling US Dollar And Rising Stocks, Commodities and Treasury Yields

As governments continue to distort the market pricing process by providing subsidies, guarantees, fiscal spending and other interventionist measures, the pressures accrued from the imbalances will ultimately be vented on the world’s currency market which risks a cataclysmic collapse in the present monetary system.

Let me reiterate, this grandest experiment of the unbacked paper-digital money system has been 38 years old. If one would treasure the lessons of history, ALL paper money had been extinguished out of the propensity of the rulers to inflate or destroy the currency-mostly for political survival or wars, see our previous discussion Government Guarantees And the US Dollar Standard.

So those fervently praying for governments to “print money” as a way out of the present predicament or to “avoid a Japan” have been putting undue faith on a system which had temporarily weaved “short term” magic before, but at the cost of building a riskier economic and financial structure based on the exponential growth in systemic leverage and moral hazard, which only leads to worsening cyclical bubbles or worst a collapse in the world’s monetary architecture.

Yet policies that serve to uphold the economically unsustainable borrow, speculate and spend policies will ultimately meet its comeuppance. You can dream of printing away the economic crisis similar to Zimbabwe. But that dream we know only turned into a real life nightmare.

Yet, today’s global policy directions reflect on the very essence of why paper money has failed.

The present “boom” appears to be manifesting inflation as getting some “traction”.

As figure 3 shows, the Euro-weighted US dollar index (USD) has broken below its 200-day moving averages, which signals a regression to its long term bear market.

Some will interpret today’s phenomenon as the revival of risk appetite or the reawakening of the “animal spirits” especially when seen with rising yields of the long term US treasuries (TNX).

Some others will adduce market activities especially by the performances of the global stock markets (DJW) alongside rising commodity prices (oil broke above $55 and is now $58!) to prospective global economic recovery.

We hope both of these arguments are right because this will be the ideal “goldilocks” scenario.

From our end, we understand this “goldilocks” scenario as toothfairy economics simply because of the “the marginal utility of real goods and services divided by the marginal utility (mostly for portfolio and transactions purposes) of government liabilities” or inflation as defined by Professor John Hussman in our previous discussion Expect A Different Inflationary Environment.

In short, when more paper money is produced than real goods we essentially get inflation.

But think of it, if present trends will persist and inflation is indeed gaining traction, then rising commodities will essentially squeeze purchasing power of consumers and raise the cost of production for producers.

Meanwhile, rising interest rates will jeopardize or even defeat programs instituted by governments to ease debtor angst, especially in the crisis affected nations.

Aside, rising interest will translate to higher cost of maintaining or servicing debt for the government and the private sector.

So governments seem trapped in a fix; on one hand by allowing markets to function this will translate to the much dreaded (but needed) deflation, which policymakers won’t accept.

On the other hand, policies to pump money in the system will mean more inflation which essentially will undermine most of the programs that have been put in place to mend the dislocations brought upon by the present crisis.

More proof of inflation driving the currency markets in Asia which seems being transmitted to the stock markets? See figure 4.

Figure 4: Bloomberg: Bloomberg-JP Morgan Asia Dollar Index (yellow), MSCI AC ASIA PACIFIC (green)

When Asian Markets are on a rebound as shown by the Bloomberg’s MSCI ASIA PACIFIC [MXAP:IND-green], the Asian currency benchmark Bloomberg-JP Morgan Asia Dollar Index [ADXY:IND-yellow] goes positive-meaning regional currencies appreciate against the US dollar.

There appears to be a strong correlation between the activities in the stock markets and the region’s currency values possibly influenced by portfolio flows, relative economic growth, relative inflation and or yield differential expectations.

But I would like to remind you that currency markets aren’t free markets (no markets are actually free) and are subjected to repeated government manipulations directly (direct market operations) or indirectly (domestic inflationary policies).

Yes, today’s fiat paper money currency standard is a monopoly supplied by governments.

This makes currencies values vulnerable to political interferences which may induce short term aberrations where arguably market prices do not manifest efficiency.

Nevertheless, while imbalances can be deferred for sometime, in due course they get to be exposed by the natural forces of the market.

And applied to the Philippine Peso, in contrast to mainstream and popular predictions, we argued in 2009: Phisix and Peso Will Advance!, that the Peso like the Phisix will defy bearish projections, which had mostly been anchored on remittances and exports, made by mainstream experts who remain afflicted with rear view looking, ivory tower ensconced-laboratory based economic theories and an obsession with self-importance.

The Philippine Peso has been marginally up on a year to date basis with Friday’s close at Php 47.25 and quite distant yet to the Php 50-52 level predicted by the consensus of “experts”.

And based on the above premises, we expect the Peso to similarly reflect gains in the Phisix. In my view, the Peso will possibly appreciate towards the Php 45-46 level or better by the yearend.

And as a final word today’s boom in contrast to the 2003-2007 cycle which basically lasted more than 4 years maybe swifter, steeper and shorter.

Seeds of Hyperinflation Have Been Sown

``Many false arguments are used to defend inflationism. Least harmful is the claim that a moderate inflation does not do much harm. This has to be admitted. A small dose of poison is less pernicious than a large one. But this is no justification for administering the poison in the first place. It is claimed that in times of a grave emergency the use of means may be justified which in normal times would not be considered. But who is to decide whether the emergency is grave enough to warrant the application of dangerous measures? Every government and every political party in power is inclined to regard the difficulties it has to cope with as quite extraordinary and to conclude that any means for combatting them is justified. The drug addict, who says he will abstain from tomorrow on, will never conquer the drug habit. We have to adopt a sound policy today, not tomorrow.”-Ludwig von Mises, Interventionism: An Economic Analysis, Inflation and Credit Expansion

While “greenshoots” have been more evident in Asia and emerging markets than their OECD counterparts, as evidenced by rising reports of indices based on Purchasing Managers Index and bank lending, some have questioned the sustainability of these improvements.

For instance, acquisitions of oil and petroleum products allegedly haven’t been reflective of the economy’s demand and supply, here we quote CBI China (FT Alphaville)

``Most players expected bearish gasoil market in may amid weaker speculative demand and increased supplies. Speculative demand will probably plunge if the market gains no more support in may, but end-user demand is not likely to grow much amid gloomy economy. Meanwhile, oversupply will probably remain as supplies grow. When supplies from PetroChina and Sinopec are not seen to change, CNOOC Huizhou refinery is estimated to supply 200,000-300,000mt of gasoil to East and South China per month. Without much support from international crude, PetroChina and Sinopec may cut prices to promote sales in some regions, where they failed to fulfill their sales targets in April.

``There is little possibility for China to import any gasoil in May in view of negative import margin and weak demand from the domestic market. Meanwhile, Sinopec’s and PetroChina’s gasoil exports may be little changed from the previous three months, about 200,000-300,000mt altogether.” (emphasis added)

Moreover, China’s electricity consumption which serves as a key barometer of economic activities has equally registered a decline on a year to year basis in April (Xinhua).

Furthermore, energy bears point to the growing disconnect between rising oil prices and high inventory, see figure 5.

Figure 5: FT Alphavile: US Oil Inventories Nearly At The Brim

The Financial Times Alphaville quotes Goldman Sachs; ``Commodity prices cannot diverge for long from physical fundamentals as they are largely “spot” assets….As storage bridges the gap between today and the future, commodities that are easier to store, such as metals and agriculture, are more anticipatory.

``Thus, electricity followed by natural gas are the most spot or least anticipatory commodities given the difficulties in storing these commodities while base metals are generally the least spot or most anticipatory given their ease of storage, followed by agriculture and then oil.”

In other words, given the storage issues energy prices are supposed to reflect actual demand and supply.

But as we have earlier asserted experts tend to look at ONLY demand and supply of real goods frequently disregarding the demand and supply of money relative to real goods.

Left to markets, storage issues will find a remedy. And most likely rising oil prices could a manifestation of the diffusing liquidity in the system.

Proof?

In China, the surge in bank lending has mainly been about government induced lending rather than growth in the private sector activity, according to the Wall Street Journal (bold highlight mine),

``China’s state-controlled banks are clearly leading the lending charge, accounting for 50.5% of the new credit extended during the quarter. Foreign banks are, however, behaving more like they are elsewhere, and are not following their Chinese colleagues into the lending surge. Loans by foreign financial institutions declined by 26.4 billion yuan in the first quarter.

``The central bank’s breakdown of new medium- and long-term borrowing, the kind most likely to be used to pay for investment, shows that 50.1% went to infrastructure in the first quarter. That clearly reflects how banks are being pressed to give priority to government stimulus projects. But such lending has its own risks. “Recent bank lending has been concentrated in government projects which, while helping drive rapid investment, also requires evaluation of local governments’ ability to repay the debts,” the central bank said.

``Outside of stimulus projects, demand for credit is not as strong. Only 7.9% of new medium- and long-term lending went to manufacturing, and 11.2% to real estate development.”

Moreover, China continues to massively import iron ore which jumped 24% in April.

As we discussed in The Nonsense About Current Account Imbalances And Super-Sovereign Reserve Currency and Has China Begun Preparing For The Crack-Up Boom? China appears to be heavily acquiring commodities mostly likely designed to diversify from its US dollar reserves holdings which could function as insurance against the risks of hyperinflation or have been consolidating its potential role as primary contender to the currency reserve hegemony, presently held by the US dollar or both.

But as far as the loose connections leaving experts in the quandary, for us they all seem like puzzles falling into place.

As Ludwig von Mises wrote in Interventionism: An Economic Analysis, Inflation and Credit Expansion, ``But on the other hand inflation cannot continue indefinitely. As soon as the public realizes that the government does not intend to stop inflation, that the quantity of money will continue to increase with no end in sight, and that consequently the money prices of all goods and services will continue to soar with no possibility of stopping them, everybody will tend to buy as much as possible and to keep his ready cash at a minimum. The keeping of cash under such conditions involves not only the costs usually called interest, but also considerable losses due to the decrease in the money’s purchasing power. The advantages of holding cash must be bought at sacrifices which appear so high that everybody restricts more and more his ready cash. During the great inflations of World War I, this development was termed “a flight to commodities” and the “crack-up boom.” The monetary system is then bound to collapse; a panic ensues; it ends in a complete devaluation of money Barter is substituted or a new kind of money is resorted to. Examples are the Continental Currency in 1781, the French Assignats in 1796, and the German Mark in 1923.”

For us, this means that the seeds for hyperinflation have been sown, and that those arguing for “timing” and the “inevitability” have been tunneling their market outlook based on Holy Grail economics as guide to investing.

Mr. Russell Napier, author of the Anatomy of the Bear Market seems to share our outlook, in an interview at the Financial Times quoted by FT Alphaville, we quote Mr. Napier (bold emphasis mine),

``The key three indicators that we’ve passed the risk of deflation are rising price of Treasury inflation protected securities, the rising price of commodities and the rising price of corporate bonds. This is not to say that this bounce is the end of the bear market…

And a decoupling with China?

Adds Mr. Napier, ``So I see inflation problems in a couple of years and I see problems with the Chinese not being as big a buyer of US treasuries simply because they will be having a great domestic consumption boom which means they’ll not run surpluses and buy these surpluses. And the crucial one people sometimes forget is the retirement of the babyboomers, the medicare costs in particular and the social security costs of this is going to be issuing a lot of treasuries into the future…

And the US will probably experience a fierce bear market in US treasuries aside from the excruciating effects to its economy due to rising interest rates…see figure 6.

Figure 6: Economagic: The End of the US Treasury Bull Market?

Again Mr. Napier, ``For the next couple of years people will see it as normalisation, if yields on Treasuries go to 4 or 4.5 per cent. People will say this is a normalisation of the treasury yield as we pass the deflation risk . There’ll be a great breath and sigh of relief that we’re going back into another business cycle, and when it looks like we may never get there equity prices will go up. But the final sting I believe is in the tail. The last treasury bear market lasted from 1946 -1981 and there’s no reason to suggest that this one will be any shorter.”

US Treasuries have been in a bullmarket since 1980s, the long cycle does indicate that an inflection point is imminent.

The last word from Mr. Warren Buffett during his latest Berkshire Hathaway’s Woodstock for Capitalists, ``Anybody who holds (US) dollar obligations from outside this country is going to get back less in purchasing power in the future”.