*****Hyperinflation will begin in China and destroy the dollar*****

The conventional wisdom on China is dead wrong. Specifically, there is a widespread belief, as expressed by Goldman Sachs, that "China will keep the yuan trading within a narrow range in 2009 due concerns about exporters." Worse still, others are even predicting that China will devalue its currency! The sheer wishful thinking is astounding! The idea that "China will keep the dollar peg to help its exporters" ranks all the way up there with "Housing prices always go up" and "You can spend your way to prosperity".

THERE ARE NO FREE LUNCHES

If you have learned nothing else in the last year and a half, you should have learned that if something sounds too good to be true, that is because it IS too good to be true. The media overwhelmingly presents China's dollar peg as a win-win situation: Americans get cheap imports and low interest rates while China gets a strong manufacturing sector. While commentators do sometimes debates whether China will keep lending us money forever, they never talk about the REAL problem with the dollar peg.

Below is a chart which shows how China's dollar peg works. See if you can spot the downside that the media never seems to mention.





The US's trade deficit requires China to print money!

The little discussed downside of the dollar peg is all the money China has to print to maintain it. China's Central Bank puts the extra dollars it receives from its trade surplus into its growing foreign reserves and then prints yuan to pay Chinese exporters. This results in an increase in China's base money supply by an amount equal to the increase in its foreign exchange reserves. While China's ability to keep accumulating US reserves is endless, its ability to keep its money supply under control is not.

The true threat to the dollar peg

If there is one development which could force China to drop its dollar peg, it is out of control inflation. Rampant inflation would result in millions of citizens starving and would create widespread social unrest. Keeping food prices low is a matter of political survival for Chinese authorities. So, facing the choice between losing their grip on power and losing the dollar peg, they will not hesitate for a second to sacrifice the dollar to save their own skin.

So far China been able to contain inflation, but…

In recent years, China has been able to contain the inflationary effects of its trade surplus by soaking up or "sterilizing" all the extra liquidity (printed yuan). These sterilization efforts mostly involved:

A) Raising the reserve requirements of commercial banks. In essence, the PBOC (People's Bank of China) prints money to fund its trade surplus and then increases the amount of yuan banks have to keep as reserves at the Central bank, preventing the printed cash from reaching the economy. As of May of last year, commercial banks' reserve requirements were at 16.5 percent

B) Selling RMB-denominated sterilization bills. The state owned and controlled banking system has been forced to absorb the majority of these bills. As of May of last year, the value of sterilization bills reached 10 percent of bank deposits.

Taken together, these two steps have immobilized roughly 26.5 percent of Chinese commercial banks' deposits. This shows the magnitude China has had to intervene so far, as the value of sterilization instruments outstanding has been increasing at roughly the same rate as its foreign reserves.

PBC Foreign Reserves and Sterilization Instruments (US$ Billions)



While China has been able to contain inflation to single digits for the last decade, that is about to change. All economic forces are aligning in China for a surge in inflation.

1) China has abandoned its sterilization operations

Currently, the PBOC has abandoned its sterilization efforts all together:

A) The PBOC has lowered reserve requirements by 2 percentage point for China's big banks and by 4 percentage point for all other banks.

B) The PBOC has scaled back sterilization efforts by reducing liquidity-draining three-month and 52-week bill sales from once a week to once every two weeks. As a result of these decreasing sales, the clearing house for China's interbank bond market expects PBOC's 2009 bill issues to be down over 70%, which will increase the Chinese base money supply by 2 trillion yuan.

These actions signify that the PBOC has ceased sterilizing its currency interventions and is focusing on (imaginary) deflation risks. A flood of cash has been unleashed, and a tsunami of pent-up inflation will soon hit China.

2) China is running record trade surpluses

China's imports are crashing much faster than its exports. In December, Chinese imports fell 21.3% while exports fell only 2.8%. As a result, China has been running record trade surpluses these last three months: $35 billion, $40 billion, and 39 billion.

The reason for China's surplus is obvious when you think about it. Consider the following list of goods a country can exports and ask yourself what would hold up best during a severe global economic downturn.

*** Commodities (Oil, gas, steel, etc)
*** Capital goods (Airplanes, Caterpillars, Machinery for new factories, Machinery for new mining/oil exploration projects, etc)
*** Durable goods (SUVs, CARs, appliances, business equipment, electronic equipment, home furnishings, etc)
*** Luxury goods (brand name products, designer clothing, artwork, etc...)
*** Cheap consumer goods (everything you buy at Wal-Mart)

The answer is that the demand for cheap consumer goods will hold up better than anything else. This can easily be seen in the retail sales this holiday shopping season. Wal-Mart, which imports 70% of its products from China, was the only retailer to post a year-on-year increase in sales. So while the world economy might be imploding spectacularly, demand for Wal-Mart's cheap Chinese goods is holding up quite well. The implications of this is that while China's exports will fall, they will fall less than those of any other country.

The current trade surplus is still completely unsustainable. If China's continues running a 40 billion dollar trade surplus all year, its base money supply will double by the end of 2009. Also, since China has halted the appreciation of the yuan, its trade surplus is unlikely to shrink as demand for cheap consumer goods is set to remain strong.

3) The Chinese economy will shrink in 2009

Consistently amazing economic growth is the biggest factor which has helped China contain inflation. Inflation happens when the money supply is growing faster than the economy, and china's economy has been growing fast. This economic growth has helped absorb the enormous quantities of yuan that have been printed to support the dollar. However, this will change in 2009. Due to falling global demand, China's economy is set for zero, if not negative, growth which will remove a significant mitigating force against inflation and amplify the inflationary impact of China's printing press.

Side note: China's economic strength is underestimated

It is important to note that, while economic growth will go probably go negative, China's economy will not crash. The strength of the Chinese economy is widely underestimated in the media today. In addition to the resilient worldwide demand for its cheap consumer goods, China is also benefiting from import substitution at home. This is why imports to China are falling so fast: Chinese are switching to cheap domestic products instead of expensive foreign imports. So while there has been a sharp drop in Chinese demand for big-ticket brands (Dior, Chanel, Hermes, etc…) and others luxury items, knock-offs and other cheap goods are still flying off the shelves. Chinese consumers are downshifting, but they are still spending strongly, as reflected by the 21% year-over-year growth in 2008.

However, despite China's strong fundamentals, the current worldwide downturn is too strong for it to escape. The worldwide financial carnage is so severe that even the demand for cheap consumer goods will decrease. As a result, while China may outperform every country on Earth, its economy will still suffer in 2009.

4) Deflation in China would be too good to be true

China has been in a constant war with the inflation caused by the dollar peg. Economic growth and sterilization operations alone have not been enough to absorb the growing liquidity, and China has been forced to turn to ever more drastic steps in its efforts to contain inflation. These stifling policy measures together with its sterilization efforts have enormously suppressed domestic demand and have distracting the government from developing key services enjoyed by other developed nations. This suppressed domestic demand has also distorted China's economy, as reflected by the undersized service sector, and has lowered the quality of life for Chinese citizens.

Chinese financial repression and market socialism

Below are just a few of the anti-inflation measures China has adopted to suppress domestic demand and keep prices down:

A) Strict price controls. (ie: Large wholesalers must seek central government approval if they want to raise prices by 6 percent within the space of 10 days or by 10 percent within a month.)
B) Credit ceilings. (limits on how much commercial banks can lend)
C) Floors on lending rates and ceilings on deposit rates
D) Strict rules governing lending decisions
E) Tight land purchase and lending requirements
F) Direct government intervention to limited expansion in certain industries (ie: aluminum, steel, autos and textiles sectors in 2004)
G) Penalty taxes on anyone buying and selling real estate in a short period of time.
H) Forcing local government to cut back spending by delaying approval of their investment projects
I) High sales taxes.
J) Etc...

Suppressed domestic demand has distorted China's economy

The distortions caused by sterilization operations and stifling policy measures are best seen when comparing the Chinese and US economies:

A) US home buyers get tax incentives VS Chinese home buyers get tax penalties
B) US gets artificially low interest rates VS China's artificially high interest rates
C) US's "service economy" VS China's "service-less economy"
D) Etc…

In the US, the overvalued dollar and easy credit environment have caused the service sector to become oversized, artificially raising America's standard of living. In contrast, China's suppressed domestic demand has led its service sector to become undersized, artificially decreasing its standard of living.

Focus on inflation has lead to a lack of key government services

With Chinese authorities sidetracked by their export oriented focus and battle with overheating, the development of key government services enjoyed by other developed nations has been neglected. As a result, Chinese citizens' lack of social security, free education, and available consumer credit, which has forced them to save far more than their Western counterparts, leaving them with less disposable income.

Deflation would be a godsend to China

Chinese authorities must be thrilled about the prospect of fighting deflation instead of inflation. Fighting deflation would allow China to:

A) Scale back its increasingly costly sterilization efforts.
B) Lower interest rates.
C) Get rid of all the controls which are distorting domestic property markets.
D) Promote consumer spending without worrying about the inflationary impact.
E) Develop a comprehensive social security net.
F) Increase funding of public education.
E) Accelerate the development of a system to rate people's credit.
F) Encourage growth in underdeveloped domestic sectors (housing, health care, education, entertainment, etc)
G) Etc…

Most of the steps above are already being taken by Chinese authorities. Unfortunately, there are no free lunches. The probability that China can maintain a highly inflationary currency peg, reverse years of anti-inflation policies, release a flood of sterilized yuan back into circulation, and go on a Western-style stimulus/bailout binge without experiencing double digit inflation is zero.

5) No deleveraging

There is no
chance of real deflation happening in China. None. The Strength of China's Banking System makes it impossible.

A) Apart from Bank of China, Chinese banks have little exposure to overseas debt. So, although toxic US securities were sold to banks around the world, China's capital controls protected its banking system from America's bad debt

B) As a side effect of the country's sterilization operations, 26.5 percent of Chinese commercial banks' deposits were placed with the central bank last year (reserve requirements and forced underwriting of PBOC bills).

C) Unlike Western banks, who have been enjoying a credit bonanza for decades, Chinese banks have only recently gotten into the credit game, after years of being ridiculed for being overly cash-centric. Because of this late entry, Chinese banks completely missed the subprime party.

D) China is also in the enviable position of being one of the few countries which doesn't need to deleverage. While Western banks were going insane with high leverage and off-balance sheet financial vehicles, Chinese banks were doing the opposite, as can be seen on the chart below (from Tao Wang of UBS).



E) China has been waging a war against NPLs (non-performing loans) in the last few years. For example, with heavy penalties having been imposed on bank managers responsible for new NPLs, Chinese banks have become much more concerned about the loan safety than profitability. This battle again NPLs has paid off. As of September 30, 2008, nonperforming loans totaled only 2 percent for Chinese banks, compared to the 2.3 percent for FDIC-insured banks in the US. Loan loss provisions have also improved substantially, with provisions of Chinese banks amounting to an impressive 123 percent of their NPLs.

F) Finally, China's money supply itself is underleveraged when compared to the rest of the world. For example, the US's M2 to M1 ratio is 65% higher than China's. The Chinese M2 to GDP ratio is also more 160 percent, perhaps, the highest in the world.

When considering the strength of Chinese Banks and underlying strength of China's economy, no debt deflation is possible.

If there is no chance of deflation, then why is China's cpi slowing down?

There are three main reasons for the slowdown in China's cpi:

A) The bursting of the commodity bubble. Because of speculator dominated futures markets in the US, commodity prices were boosted to artificial level going into the summer of 2008. As these inflated commodity prices fell back down to Earth, they caused a temporary worldwide slowdown in inflation.

B) In the second half of the year, deleveraging and hedge fund redemption caused the outflow of a large amount of hot money from China. This outflow temporary depressed asset prices.

C) The unwinding of the commodity bubble spread deflation fears worldwide and caused the velocity of money to drop.

6) Deflation fears are paralyzing China's money supply

"deflation fears" have slowed the Chinese money supply to a crawl. While they are still spending, Chinese consumers are delaying big purchases and downshifting to discount stores. Businesses are strapped for cash, and scared Chinese banks are dumping riskier borrowers, like credit-card holders. China is experiencing one of the brief deflationary periods which typically precede hyperinflation.

Deflation fears in China also provide the perfect example of how a slowdown in the "velocity of money" and makes prices fall. Right now, Chinese banks are hoarding cash and delaying payments on personal credit cards. Only a year ago, most banks paid credit-card transactions in 14 days, but now merchants are having to have to wait 20, 40 or even 90 days to get paid. With lenders making credit-card transactions as unattractive as possible, many merchants are refusing to take credit cards from Chinese consumers. Think about that for a second, all that purchasing power from Chinese credit cards wiped out due to nothing but fear itself.

The important point to note about the price deflation caused by the deflation fears is that it will reverse sharply once inflation picks up. Banks will begin paying credit cards normally, and merchants will start accepting them again. The enormous amount of purchasing power which disappeared will reappear just as suddenly, causing a wild jump in inflation.

7) Sterilization operations have become a loss generating ventures

Until last year, China's sterilization operations had been profitable, since the rate of interest that Beijing earned on foreign exchange reserves (mainly US Treasuries) had been higher than the rates it was paying on its yuan-denominated sterilization bills at home. However, now that the fed has lowered US interest rates to zero for the foreseeable future, China's dollar peg has become a loss-making policy. When inflation hits china and interest rates rise again, China's losses from its currency sterilization will become staggering.

8) China likely to attract a flood of hot money in 2009

China has had a problem with hot money inflows in the past, and those problems are likely to get worse this year. Hot money refers to the money that flows regularly between financial markets in search for the highest short term interest rates possible. This hot money has found ways around China's capital controls and flows freely in and out of China to the authorities great frustration.

When hot money flows into china, it forces the PBOC to print money the same way as the trade surplus does. At the beginning of last year, these hot money inflows were one of China's biggest problems, bringing inflation up to 8.6 despite the authorities best efforts. The country's hot money problem ended temporarily with the bursting of the commodity bubble.

In the second half of last year, deflation fears and hedge fund deleveraging cause much of this hot money to leave China and seek the "safety" of US treasuries. This small exodus is what is responsible for the brief fall in China's foreign reserves. However, the outflow of hot money from China has ended, and it now looks set to reverse.

In the next month or so, rising inflation will start pushing up Chinese interest rates at a time when central banks around the world have set their rates at or near zero. Since the entire world knows that the yuan is undervalued, these higher rates will make China the most attractive destination on Earth for those seeking safe high yielding interest rates, and the hot money problem will return with a vengeance.

9) Chinese authorities are pulling out all the stops

Chinese authorities are pulling out all the stops to get the country back on track. In order to prop up economic growth, Chinese authorities have:

A) Raised tax rebates for exporters of everything from high-tech and electronic products (motorcycles, sewing machines and robots, etc) to some rubber and wood products.
B) scraped export taxes for some steel products, aluminum, rice, wheat, flour and fertilizers
C) Cut the lock-up period beyond which people can resell their property without paying a business tax from five years to two years.
D) scraped the urban property tax for foreign firms and individuals
E) Allowed people to buy second homes on the same preferential terms normally reserved for first time buyers.
F) Announced plan to spend 900 billion yuan over three years to build affordable housing
G) Cut the deed tax payable by first-time buyers of homes smaller than 90 sq m is to 1 percent.
H) Announced measures such as cash subsidies and tax cuts to encourage home purchases
I) Announced plans for a 4 trillion yuan (586 billion) stimulus package to boost domestic demand through 2010.
J) Announced plans to invest 5 trillion yuan roads, waterways and ports in the next three to five years (over 2 trillion yuan more than originally planned).
K) Approved 2 trillion yuan for railway investment
M) Announced a tax break for public infrastructure projects.
N) Abolished the 5 percent withholding tax on interest income.
O) Scraped the 0.1 percent tax on purchases of equities.
P) Instructed Central Huijin (a government investment arm) to buy shares of listed Chinese firms.
Q) Encouraged state-owned firms to buy back shares.
R) Raised minimum grain purchase prices by 15 percent
S) Approved landmark reforms that give peasants the right to lease or transfer their land-use rights
T) Issued a stimulus package for its auto sector, including a tax cut
U) Set a price floor for air tickets
V) Handed out cash gifts to brighten the mood before the Chinese New Year
W) Etc...


10) Banks are flooding the economy with new loans

Chinese authorities are pushing banks to extend credit and help fight "deflation". To encourage this money supply growth and new lending, the PBOC (the People's Bank Of China) has halted sterilization operations and has cut the benchmark one-year lending rate by 2.16 percent and the deposit rate by 1.89 percent. Also, as part of these efforts, Chinese officials are reversing decades of financial repression and freeing up their banking system.

As China lifts restrictions on lending, banks are flooding the economy with new loans. Credit ceilings under which commercial banks have been operating have now been removed, and credit controls have been relaxed to give banks more leeway in making lending decisions. Chinese lenders will now be able to restructure loans and adjust the types and maturities of debt. Banks are being pressured to use this new financial freedom to "promote and consolidate the expansion of consumer credit".

In addition to stimulating consumption, credit constraints are being relaxed to give loan access to small and medium privately owned businesses, which have until now been mostly shut out of credit by the state-owned financial system. As part of this effort and in order to help banks overcome their deflation fears,
China has said it will tolerate more bad debt. This step is particularly significant, as the heavy penalties imposed for the creation of new non-performing loans has been a big restraint on credit expansion.

Finally, the commitment of Chinese authorities to fight deflation is so great that regulators have stated they will support the sale and securitization of loans. I repeat, China is moving towards securitization of loans! The adoption of securitization holds the potential to enormously accelerate money supply growth.

China's efforts to boost lending are working. In December,
China's M2 money and loan growth soared. Just look at the graph of Chinese money supply growth below.



Does it look like China is headed towards deflation to you? (this chart will become much scarier once January's numbers are added in)

Conclusion


I view hyperinflation in China as absolutely guaranteed. Zero doubt. China is dismantling all the measures it has put in place over the years to fight inflation. It is dropping restrictions on purchasing property, eliminating price controls, getting rid of loan quotas, lowering interest rates, ceasing its sterilization efforts, etc… It is also pulling out all the stops to boost government spending and new loan creation.

Meanwhile, China's 40 billion dollar trade surplus means that its base money supply looks set to double in 2009. There is also the fact that China's money supply is frozen due to cash hoarding and will cause inflation to increase when it accelerates. Finally, the commodity bubble has finished bursting, and China's economy looks set to shrink.

Every economic factor in China suggests an enormous wave of hyperinflation will begin this year. While I have written about
the threats facing the dollar, this will be the event that finally ends the US's borrowing binge and destroys our currency.

Hyperinflation in China will be a monumental event

Because China makes most of the world cheap consumer goods, it will export its hyperinflation around the world. This means that no fiat/paper currencies will survive this with its purchasing power intact. Some will lose all value (dollar) while others will survive while experiencing a loss of purchasing power (yuan, euro, yen, etc...). The only money that will retain its full value in the face of Chinese hyperinflation is gold.

China will sink the dollar to save the yuan

Once hyperinflation kicks into gear, Chinese authorities will find it impossible to bring it under control without sacrificing the dollar. Since hyperinflation would hurt Chinese exporters as much as losing their US exports, China will face a clear cut decision. By dumping the dollar peg and selling its USD holdings, China will help contain domestic inflation in many ways:

1) China will no longer be printing massive quantities of yuan to support the dollar.
2) By selling dollars in exchange for yuan, China will be able to take those yuan out of circulation, shrinking its monetary base.
3) Since the yuan will strengthen enormously again foreign currencies, Chinese exports will fall and that means there will be a lot more goods available for domestic consumption.
4) Since the yuan will be stronger against foreign currencies like the dollar, Chinese imports will rise. That means cheaper commodity prices across the board.
5) Dropping the dollar peg will make the yuan a major reserve currency. That means lower interests rates in China as foreign central banks build up yuan reserves.

Those expecting deflation are in for a surprise

Western nations who are lowering interest rate very sharply, without fearing inflation, are mainly concentrating on the domestic dynamics of their economies and the value of their currency. My bet is that no one is even considering the possibility that inflation could be imported from China, and, when cheap Chinese imports stop being cheap anymore, it will catch everybody completely by surprise.

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98 Responses to *****Hyperinflation will begin in China and destroy the dollar*****

  1. Hello Sir,
    It is really a good article.
    This will be the definitely the course of dollar and yuan.
    China will definitely dump the peg system to escape out from domestic trouble in future.
    The unprecedented dollar printing to bail out financial system and the economy will create hugely excess dollars than never before.
    This will compound china problem and deflation will be converted in to hyperinflation due to to overcorrection!!!
    Very good and Keep it up..

  2. Some decent ideas but a ludicrous conclusion.

    "Hyperinflation in China will be a monumental event

    Because China makes most of the world cheap consumer goods, it will export its hyperinflation around the world. This means that no fiat/paper currencies will survive this with its purchasing power intact. Some will lose all value (dollar) while others will only survive but experience a loss of purchasing power (yuan, euro, yen, etc...). "

    What an amazingly ridiculous conclsion. If there was hyperinflation in China it would be the Yuan that goes to zero, not the dollar. Just like Zimbabwe.

    There is absolutely no mechanism by which China can cause hyperinflation in the US, no matter how much China prints or does not print.

    The article seems to be written with a pre-ordained conclusion even though no case was made for it in any of the preceding points.

    Mish

  3. Hi Mish,

    "There is absolutely no mechanism by which China can cause hyperinflation in the US, no matter how much China prints or does not print."

    I have to respectfully disagree. China does have a mechanism capable of effecting prices in the US. As the US's biggest supplier of consumer goods, Chinese exporters will have to pass on their rising costs or go out of business, which means either Wal-Mart shelves will either be empty or prices will go up.

    Inflation is China's next export

    In the simplest of terms, the price of goods depends on the balance between supply and demand. For example, when the demand for goods rises (ie: the money supply expands), the price of goods rise.

    Hyperinflation in the US will come from the supply side. When China depegs and the dollar's purchasing power crashes, imports into the US will dry up. This means the supply of goods in the US will suddenly shrink dramatically while the demand for goods remains roughly the same. With the same amount of money chasing far fewer goods, prices in the US will soar.

    PS: Loved your entry on Unsold Car Images From Around The World

  4. Anonymous says:

    Mish's comment is so ironic. Funny that he complains someone else has a pre-ordained conclusion after all the deflation garbage he has been posting for years.

    Understand this Mish.
    1. China has inflation
    2. China drops their dollar peg to end their inflation.
    3. The Yuan strengthens as China allows it to float.
    4. Prices are Walmart rise drastically as Chinese imports become more expensive.

    Thats how the inflation gets transmitted here.

  5. "If there was hyperinflation in China it would be the Yuan that goes to zero, not the dollar. Just like Zimbabwe."

    Except that China has over 2 trillion US reserves, and the reason central banks hold foreign reserves is so they have assets to sell off to defend their currencies. At the very least, if hyperinflation starts in China, we can expect:

    1) China to stop accumulating reserves
    2) China to sell its existing reserves until it either runs out or stabilizes its currency.

    I personnally believe that the idea that China will be selling off its reserves would create a panic out of the dollar.

  6. petkov says:

    Ho hum. Very long article, lost interest half way through.
    Yet another the "sky is falling article"/ "the dollar will collapse in value" article. As I said, ho hum.

    People have been predicting the dollar's fall for a few years now and it hasn't happened. Nobody wants the dollar to fall, the Chinese don't want that either otherewise who will they sell all that junk (they make) to? USA is STILL the biggest market in the world.
    Second and MORE important, you conveniently forget to mention that the dollar is a perto dollar, I.E. is it being supported by the sale or oil and gas in the world. NO other world currency enjoys this added value. Even if the Chinese dump the peg which I actually agree with you that they will do, the dollar will still survive due to the tiny fact that ALL gas/oil is sold in dollars. Sure the dollar WILL lose some value eventually
    as all fiat currencies do; but collapse, no because that will make all other fiat currencies collapse too. and NOBODY want to see that happen.

  7. Anonymous says:

    what's ludicrous is Mish. Nothing but deflation mantra from him and if anyone works backwards it would be him. And stubborn as a mule.

  8. Dave says:

    Excellent analysis! Mish's comment is disappointingly arrogant.

    Dave - Erstwhile Urban Wanderer

  9. sobers says:

    Interesting analysis. Rather ruined by the blatent gold plug at the end tho.........

  10. probin says:

    I disagree by about 70%, i notice the pains that the original writer goes to, to explain how china will not suffer any deflation I'm afraid the numbers do not support this assumption,and furthermore contradict the assumption, the list of reforms are clearly a move against the obvious drop off of export demand to a type of social market with stimulus for domestic demand i.e China will turn to nationalist domestic consumption and be happy at 3 to 4 percent growth they will do this and try to expand the middle class, as you correctly said, but the summation at the end shows your (in my opinion 70% flawed) motive for the original assumption.

  11. Mudar says:

    Dear Sir;

    I highly appreciate your analytical efforts in this article, and I would like to hear more from you in the same context; added to it the Petro-Dollar relation.

    Many thanks

    Mudar M Dudin

  12. Except that China has over 2 trillion US reserves, and the reason central banks hold foreign reserves is so they have assets to sell off to defend their currencies. At the very least, if hyperinflation starts in China, we can expect:

    1) China to stop accumulating reserves
    2) China to sell its existing reserves until it either runs out or stabilizes its currency.

    I personnally believe that the idea that China will be selling off its reserves would create a panic out of the dollar.

    China would dump treasuries to buy what? RMB? From who? It's not as if the RMB is a freely floating currency.

    Buy Euros? Why?

    The fact of the matter is China needs to hold those reserves because it is very fearful of capital flight (hot money) out of China.

    And even if that was not the case, no country would go dumping a position like that. It would hurt China as well. Perhaps they get rid of them over time or more likely just stop buying more.

    Neither of those would cause hyperinflation.

    But lets go one step more and suggest that China dumps them all in mass. And the US takes them all back.

    Is $2 Trillion going to cause hyperinflation? I think not. Hyperinflation is like Zimbawe.

    Zimbabwe has a $100 trillion note. It will buy 15 loaves of bread. That is hyperinflation.

    All this talk of hyperinflation is simply loony.

    Credit is being destroyed in the US, UK, and China at an amazing pace. It would take a couple trillion in printing just to offset that.

    Look at action in the US and Europe. Banks are for the most part refusing to lend. Banks are hoarding cash because the destruction of their balance sheet is immense.

    If the do lend, the credit will go to credit heaven. Hardly inflationary.

    We are in deflation now. It is here and now. There is no debate on deflation except how long it lasts.

    Most never saw it coming, and nothing China does is going to drive the world into hyperinflation. It is silliness.

    Sadly there were some other good point made that were worth considering.

    The leapfrog to hyperinflation at the end makes no sense.

    Mish

  13. dashxdr says:

    I'm not sure if I can accept the term "Hyperinflation" as applied to China's situation.

    I think the general conclusion you're trying to make (Eric) is that China will try to maintain a dollar peg until they really, really start suffering (hyperinflation). Then out of desparation they'll abandon the dollar peg and decouple and their own middle class will be able to pick up the purchasing (ala Peter Schiff's thesis).

    I can buy into all that, except I don't believe China will actually suffer a bout of hyperinflation along the way. They'll get high inflation, but not hyperinflation. Hyperinflation is something else, a complete collapse in confidence in a currency. China will merely get quickly rising prices (in Yuan). That will cause enough anger that they'll have to drop the dollar peg.

    Hyperinflation in the USA is guaranteed, as far as I'm concerned. The US government simply cannot cut spending anywhere. Declining tax base, declining productive base, constant expenditures, endless bailouts -- they'll print dollars to keep the empire going. Confidence in the dollar will collapse worldwide, and dollars will pour back home, and hyperinflation will take off.

    This is a good thing, though. The US empire is evil. Look at what's going on in the Gaza strip. Israel couldn't do this crap if they weren't supported by the US.

    It's time to move past empires.

    Incidentally I stopped reading Mish when it was clear he insanely buys into the deflation camp. Deflation, "Cash is king!" in a fiat currency situation? Insane. All deflation/falling prices is merely short term.

  14. Anonymous says:

    Congratulations Eric, to have the great defaltionist Mish Shedlock comment on your blog is quite impressive (shows hard work pays off) even if he critiqued your idea.

    We forget the events of this summer before this great deleveraging period took hold. China was actually experiencing rapid inflation and was aggresively fighting it buy tightening fiscal measures (restricting real estate sales, increasing bank reserve requirements etc.) China was having inflation due to their dollar holdings and it was brought out into the open by the rapid rise of oil.

    Oil was the canary in the coal mine even before gold (the gold to oil ratio skewed heavily to the oil side ) which triggered significant inflation world wide due to both the widespread use of oil and the widespread use of the dollar to represent oil.

    That was a "shot accross the bow" of this impending inflationary depression that is to say a decrease in paper asset value with an increase in the value of "real stuff" like food, energy etc. Whats so confusing is that commodities are in a correction of a long term secular bull market and equities are in a bear market period. The deleveraging unwind that caused a correction in both markets will stabalize, with a continue on the upside for real stuff and a static to slight increase in value of paper asset. In dollar terms this will be dramatic in time.

    This was both predictable and predicted. Its a phase and the next chapter is inflationary once we hit the depressed level of equities.

    Now as far as Chinese goods go. When the world which uses dollars as an international exchange with petrol as the backstop realizes that we're a bunch of irresponsible children with our currency they will devise a work around, believe you me. If they dont, we will continue to inflate till we're using exponents to express values. We don't have that kind of world wide goodwill to carry that out.

    I think all deflationists (Sorry Mish) suffer from a naive perception that people will act responsibly if given unlimited power ie. foreign currency reserve status.

    China will export inflation only to people who don't have the goods to trade. The Saudis won't see alot of Chinese inflation, in fact they'll probably have lower prices due to not having to go through a middle man ie. dollar to buy Chinese goods.

    So remember folks, the blinders are coming off, the matrix is unwinding. The world once they take the "red pill" will never look at the dollar the same way again.

  15. Anonymous says:

    Did anyone catch that the Middle East is looking to create their own currency and they have sped up the process recently? If that happens, the USD will no longer be the oil currency. With the yaun unpegged, it will no longer be the default trade currency either. How would that affect the yuan, the USD and the new MiddleEastern currency. I am also interested to know if the new gulf currency will be pegged to gold.

  16. dashxdr says:

    Any return to a gold-backed currency must follow a near universal loss in confidence of fiat/paper currencies.

    It can't be accomplished without the pain of hyperinflation. Only pain and fear of pain motivates people. Hunger is pain too.

    Ride it out in precious metals! It's only a matter of time.

  17. Thx for the article. I agree with you on most of your points. But when you say "hyperinflation", you obviously use the term differently than most poeple.
    http://en.wikipedia.org/wiki/Hyperinflation
    The examples of hyperinflation are Zimbabve today, Weimar Republic in 1923, Argentina in 1980. In the case of Argetina, the mildest of 3, 1 1992 peso = 100,000,000,000 pre-1983 pesos.

  18. steve says:

    Impressive article, needs a bit of proof-reading though.

  19. riemann_sphere says:

    Why would exporters have to pass on their domestic inflation to foreign customers.

    In fact they would be best off sitting on their foreign currency receipts as that would be an inflation hedge.

    Even if high inflation were to materialize in China the Chinese government has ample tools to reign it in and no reason not to do so.

    In western societies on the other hand the debt burden is the main problem with the governments being the biggest debtors.

    They have every incentive to engineer inflation (to the detriment of responsible savors),
    all the tools to do it and now even the fear of deflation as an intellectual backup.

  20. Robert says:

    I've been wondering about something..

    In the Japanese deflation scenario Japanese savers were investing all their savings outside of Japan and that was what sustained their deflation after all the banks had been bailed out. The savers kept moving money out of the country undermining the central bank's efforts to inflate the monetary base.

    Is there evidence for anything like this starting to happen in the US? Are large numbers of Americans buying foreign assets or otherwise moving all their savings out of the US dollar? I'd guess at the moment most people have little or no savings to invest..

  21. John Law says:

    Interesting article with a lot of food for thought in it. I have a slight disagreement with the conclusion that the author draws. China may hold the trigger to world wide hyperinflation but they are not going to be the cause of it. The USA and the Fed have most definately destroyed the dollar already. China has been absorbing US Dollars and hiding that fact. There will come a day that they will no longer be able to function as the main dollar sink.

  22. probin said...
    "I disagree by about 70%, i notice the pains that the original writer goes to, to explain how china will not suffer any deflation I'm afraid the numbers do not support this assumption"

    Which numbers are you referring to?

    -------------------------

    sobers said...
    "Interesting analysis. Rather ruined by the blatant gold plug at the end tho........."

    It has been my experience that if I write a piece about hyperinflation without mentioning gold, I get 5 to 10 panicked responses from people asking me what they should do to prepare. Rather than answering those questions every time, it is easier to do so once in the article, even if that means using a "blatant gold plug".

    -------------------------

    Mudar said...
    "I highly appreciate your analytical efforts in this article, and I would like to hear more from you in the same context; added to it the Petro-Dollar relation."

    Gulf nations are moving towards a single currency, possibly backed by gold, which will be called the Khaleeji. I believe we will be buying our oil in Khaleeji and our consumer goods in yuan in the near future.

    -------------------------

    dashxdr said...
    "I'm not sure if I can accept the term "Hyperinflation" as applied to China's situation.

    I think the general conclusion you're trying to make (Eric) is that China will try to maintain a dollar peg until they really, really start suffering (hyperinflation). Then out of desparation they'll abandon the dollar peg and decouple and their own middle class will be able to pick up the purchasing (ala Peter Schiff's thesis)."

    Yes, that is the general conclusion I was trying to make. However, I do expect inflation in China to reach hyperinflation level (+50% annual inflation rate), even if it only last for a single month. It is this spike in inflation which will cause Chinese officials to panic and drop the dollar.

  23. Scott says:

    Great article! Don't let the hecklers get to you. You've done a fantastic job, and I think you're pretty much dead on.

    We're all in a big heap of trouble. It's gonna be mass inflation all around, thanks to a worldwide fiat currency scheme backed by the US dollar, US profligacy, and Asian mercantilism.

    Why didn't China just import goods all these years instead of printing money and financing American profligacy? Why did the US let debt levels get out of hand? Why have we now backed it all with government guarantees?

    It didn't have to be this way. It's all very sad.

  24. Eric thanks for your civil reply. Apologies offered for my earlier tone.

    I was on 3 hours sleep at the time of my reply and I also just happened to be listening to a shrill hyperinflationary rant from Schiff.

    Schiff's clients are reportedly down 40-70% because they believed his dollar is going to zero rant and put everything in foreign equities.

    I was reading your thoughts, thought they were interesting, then got to the end only to see a leapfrog to hyperinflation inflation in the US and flew off the handle.

    Interestingly, I have on many occasions stated the RMB could crash if China floated it. That is not a prediction, just "a could".

    And if China tries to force the issue of jobs, moving people to cities when export demand is falling, and they print enough RMB to try it, yes in theory China could cause hyperinflation to itself.

    The US of course could do the same to itself, again in theory, but I do not think either is likely in practice for many reasons.

    However, I would agree with you that China is more likely than the US.

    Look at the Ruble! Everyone was crowing over that not too long ago. Look at the Baltic states, a complete disaster.

    While not hyperinflation, there is an enormous collapse in Baltic and Russia currencies while I listen to Schiff ranting about how bad the US is.

    I actually congratulate you for looking at the situation from another perspective, although it sure did not come across that way with my comment.

    BTW I am on 5 hours sleep for a second day here but hopefully this comes across much better.

    Mish

  25. Anonymous says:

    "I must admit I didn't spend enough time writing about why hyperinflation in China would result in hyperinflation in the US. However, the fact remains that rising cost in China will have to get passed on to US consumers or Chinese exporters will go out of business (which would reduce the supply of consumer goods in the US, also causing upward pressure on prices). So while there is an enormous amount of credit destruction going on (shrinking money supply), the US's lack of manufacturing, especially in consumer goods, could result in the supply of consumer goods falling even faster.

    Prices are set by supply and demand. I urge you to consider the supply side of this equation when evaluating where prices are going in the US."

    I think this is the most important aspect of proving hyperinflation is coming. US' enourmous dependence on foreign goods. So even if the money supply does not increase Zimbabwe style the large decrease in things to buy with the money we do have will have the same effect. But we very well may experience Zimbabwe style hyperinflation with the 1 quadrillion in derivatives that are deleveraging and being bailed out. I may be wrong about that, I'd like to know more about this 1 quadrillion in derivatives and how it effects the US dollar. But the point is China will stop sending us stuff. Only thing I'm confused of is why they will stop sending us stuff. Is it because we can't afford it because of all the deleveraging debt we have, leaving banks unable to lend causing sales to drop?, or is it because since they are no longer pegged to the US dollar they see no reason to send us stuff otherwise it would be like them sending us stuff for free? Anyway the key point is that if China decides to compensate for the decrease in exports by spurring domestic demand while keeping the peg on the US dollar, with the trillions the US needs to sell in US Treasuries to to stop this deleveraging mess(and isn't that the 1 quadrillion in derivatives that people were talking about?), if China keeps it's peg on the US dollar while financing these bailouts and buying all these US Treasuries(in the hundreds of trillions), it will take an enourmous amount of Yuan to convert and as the govt. is working on spurring domestic demand there is the great chance, I would say it's certain that lending will get out of hand and that enormously large reserves of Yuan will be used for allot of easy credit and that's where hyperinflation in China will be exposed. And like Eric said in order for the exporters to survive they will have to raise the price to compensate or go out of business and either of those results will lead to hyperinflation, either through a direct rise in price from the exporters or a rise in price that happens because of a decrease in supply.

  26. Morganski says:

    Eric, it's truly a pleasure to see you adroitly and respectfully tackle Mish's points here in the comments. You're a young guy but a clearly wise beyond your years.

    I believe that the dialogue here will one day be renowned and considered an important turning point, where the deflationist camp began to realize that the temporary deflation period is coming to an end, because of the actions of other actors like China, and Russia (which is not nearly as much a basketcase as is commonly claimed - Putin has a quite a few tricks up his sleeve and may be ready to use them soon). Deflationist arguments that I've seen generally ignore these effects, which are so crucial when analyzing the economics of debtor nations.

    The rapid inflation in China may already be starting. My nanny's family in northeast China is reporting that they only get half to a third as much food as they used to get last year for their 200RMB regulary grocery bill, with the prices of pork, fish and produce skyrocketing. Food price inflation has been confirmed by another friend with family in Manchuria and on Hainan island. I haven't seen this in official statistics but I put much stock in anecdotal data as I am sure that the Chinese doctor their official stats.

  27. Anonymous says:

    Eric, thank you for the great article. I am truly trying to understand what is going on in re this crisis, because I think such understanding is key to my economic survival. Inflation or deflation...Schiff vs Shedlock? This is an informative debate. Right now I am in the inflation camp, even though we have had price deflation for the last several months. So, I have been buying gold and silver, mainly silver, beginning in October.
    I do note that, during the beginning phase of the Weimar hyperinflation, there was a bout of deflation, of duration about 9 months, before the mark made its final death plunge. Do any of you have analysis of that event? Thank you - Mark V.

  28. "I must admit I didn't spend enough time writing about why hyperinflation in China would result in hyperinflation in the US. However, the fact remains that rising cost in China will have to get passed on to US consumers or Chinese exporters will go out of business (which would reduce the supply of consumer goods in the US, also causing upward pressure on prices).

    I am sorry but that simply makes no sense. The price China pays in RMB for goods (assuming China floats and the RMB crashes) simply cannot cause hyperinflation in the US. If the RMB crashes, the US$ by definition would rise massively in relation to the RMB as would every other currency on the planet.

    That is a simple statement of fact and it should be completely obvious.

    In Chinese hyperinflation, there would be a flight out of RMB into everything else, including US dollars by definition!

    You propose that a flight out of RMB will cause hyperinflation elsewhere. It is patently false by the very definition of hyperinflation itself (a complete collapse in the value of the currency) and a rush to any other currency or tangible goods.

    This should be perfectly obvious. And the reason you failed to tie it all together is because you can't.

    It is that simple.

    Mish

  29. Anonymous says:

    The thing is the worst deflation looks the more sure hyperinflation looks because if China realizes how broke we are and how much debt has to be paid off before lending can resume, they will turn to domestic demand in China to compensate and like i just said in the last anonymous comment, if China works on domestic demand while keeping it's dollar peg with the severity of the bailouts, China will have to print huge amounts of Yuan and with their new risk taking with lending it is certain those large amounts of Yuan will circulate in lending anc cause hyperinflation in China which will be transfered to the US either through exporters high prices or exporters going out of business and leaving the US with is miniscule manufacturing of consumer goods. And this is why there are people that say rising unemployment and hyperinflation are not mutually exclusive because of all the debt in the stock market, we could have a stock market crash, bank runs and still experience hyperinflation mainly because of our poor manufacturing sector and enormous dependence on foreign goods, foreign goods that would stop coming once the exporter realizes we are broke and can't pay for those goods.

  30. China will have to print huge amounts of Yuan and with their new risk taking with lending it is certain those large amounts of Yuan will circulate in lending anc cause hyperinflation in China which will be transfered to the US either through exporters high prices or exporters going out of business and leaving the US with is miniscule manufacturing of consumer goods.

    That is simply not the way it works! Why persists with such silliness. Weimar Germany did not export hyperinflation nor has hyperinflation anywhere in history ever been exported.

    It does not work that way in either theory or practice yet you persist.

    Quite amazing.
    That is it.
    I have had enough.
    Believe what you want.
    Mish

  31. Anonymous says:

    Mish, I didn't write that last post. --Mark V.

  32. Anonymous says:

    Mish you make a good point, I thought about it. And I think I might have been reaching to prove that hyperinflation in the US was unavoidable. But here's something to think about, wouldn't the fact that the US' debt caused China's currency to collapse cause other countries to stay away from US's debt in order to avoid the same fate? In that way the US$ will be less attractive and will loose buyers.

    On top of that by the time China has hyperinflated it would have accumulated allot of US dollars that it could sell off the way Eric explained to stabalize it's currency. Either way it doesn't look good for the US dollar. I don't think you want a nation who is hyperinflating to be holding your currency because that nation has all the reason to sell off your currency to stabalize theirs.

  33. Hi Mish,

    "I actually congratulate you for looking at the situation from another perspective, although it sure did not come across that way with my comment.

    BTW I am on 5 hours sleep for a second day here but hopefully this comes across much better."

    Thanks for the congratulations! Don't worry about your responses, I think we have both developed innate irritation with the other side's viewpoint in the deflation VS hyperinflation debate. Besides, I am familiar with experiencing a lack of sleep.

    Anyway, I fear I may have done a bad job explaining myself, so here is my last attempt:

    1) If China experiences hyperinflation, it will stop printing yuan to fund its trade surplus.
    2) With no one funding the US's trade deficit with China, the US's trade account with China will balance itself. (the value of US imports from China will drop to equal value of exports to China)
    3) The balancing of the US trade deficit with China will cause a big drop in consumer imports to the US.
    4) This shortage of consumer goods will drive up prices.

    Do you agree that, if China stops printing money to finance its trade surplus, the US's trade account with China will balance itself? And, if not, why?

  34. riemann_sphere said...
    Even if high inflation were to materialize in China the Chinese government has ample tools to reign it in and no reason not to do so.

    Except that China is trying to promote domestic spending to get itself out of the current slump. All China's tools to fight inflation (higher interest rates, higher reserve requirements, lending quotas, price controls, etc) involve suppressing domestic demand. So when inflation hits, China is going to have to choose one of the two: keep the dollar peg or promote domestic spending. I believe they will choose to promote domestic spending, as this is a poor environment for an export oriented approach.

    -------------------------

    Anonymous said...
    I do note that, during the beginning phase of the Weimar hyperinflation, there was a bout of deflation, of duration about 9 months, before the mark made its final death plunge. Do any of you have analysis of that event? Thank you - Mark V.

    Here you go:

    How Deflation Creates Hyperinflation

  35. Anonymous says:

    Eric:

    Let me see if you agree with this explanation--

    China is selling stuff to the US in exchange for dollars.
    China is buying US Treasury securities with these dollars. Americans are happy to sell the Chinese these bonds, instead of making stuff to sell tho the Chinese.

    But now, Americans have quit buying so much Chinese stuff. This means the Chinese do not have the dollars to buy more Treasury securities. So, the US government has lost a major buyer of its debt, just when it wants to run even higher government deficits. So the US government cannot fund its growing government deficit....unless the Federal Reserve, the government's lender of last resort, buys the new Treasury bonds.

    But, if the Fed buys the Treasury bonds, it has to create more dollars to do this. In this case, when these new dollars are spent by the government ("stimulus"), it will cause price inflation and a decline in the value of the dollar.

    If the Chinese want to maintain their exports to the US as the dollar declines, they will have to devalue the yuan to match the dollar's decline in value. This will require the Chinese central bank to create more yuan.

    In other words, it is impossible to both maintain the dollar-yuan peg, and also inflate the supply of dollars, without also inflating the supply of yuan. If we quit buying so much Chinese stuff, they have to quit buying so much American government debt in response, or the peg will fail.

    You are saying the Chinese will let the peg fail, rather than inflating the supply of yuan.

    --Mark V.

  36. Anonymous says:

    Thank you, anonymous, for the link to the "Deflation leads to Hyperinflation" article.

    I quote from that article:
    "In 1920, Germany experienced a deflationary collapse, with the average citizen finding it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks, and businesses were strapped for cash to buy materials and meet payroll. Fearing a collapse that would throw millions of workers out on the street, the German government desperately printed money in an attempt to re-inflate the economy. During this period, despite the government's money printing, the mark actually gained in value against foreign currencies, so that prices of imported goods fell by some 50%."

    This is precisely where we are today!

    The Fed is creating trillions of dollars and distributing them to failing banks and other institutions, and these organizations are hoarding the newly created dollars. People are holding on to their cash because 1) they perceive times are hard, and they need a cushion, and 2) prices are falling, so they can get more for less if they defer spending till later.

    But this psychology can, and will, change, if enough debt is retired and people begin to buy again (although not at the spending levels before the bubble burst). Then there will be no gain in deferring purchases, since prices will no longer be falling. In addition, if people fear that the government has created too much money, which could lead to inflation, this will also spur them to spend even more, creating a rush to get rid of dollars. This will be the turning point from price deflation to hyperinflation.

    The government is loading the system now with the money that will come flooding out, when the psychology of the people changes.

    --Mark V.

  37. Anonymous says:

    Oops, anonymous didn't post that link, Eric did. Thanks. -- Mark V.

  38. Anonymous says:

    Haha Mish, still thinking deflation no matter all the stars lining up for hyperinflation. Can't wait to get that towel!

    - HeliBen

  39. Optimistic Curmudgeon says:

    A couple of points possibly worth considering.

    First, China is teetering on the edge of a cliff called social stability. Demographics and just plain overshoot population numbers, added to an aging overall demographic distribution and a basically broken pension system, all make for a very challenging landscape in which to craft fiscal policy. Any major, sudden changes in purchasing power of the yuan will cause domestic impacts far beyond the simple worries of yuan versus dollar valuation. Think of the recent domestic unrest situation in Greece, and scale it up to reflect the relative size of China versus Greece, and you may get some inkling of the potential for chaos which the leaders of China worry about daily. Long before major currency imbalances cause international troubles, domestic inability to afford basics will leave the leaders of China facing a nightmare internally. Talk about demand destruction!

    Secondly, the yuan is not / not / not pegged to the dollar. China has floated the yuan, within floating daily limit stops, since July of 2005. And the change has been significant, although one would never know it by reading the main stream media.

    Thirdly, almost a decade ago, China reopened gold sales for the public, and ordinary chinese have been steadily sinking a portion of their wealth into gold ever since. Of course in Hong Kong, it never stopped.

    Finally, if the price of consumer goods from China were to rise substantially, then with amazing rapidity a unique phenomenon would occur - the revitalization of US manufacturing. The United States and China share a number of similarities, including massive continental space and substantial populations with a decent degree of literacy. Anyone who thinks that the US will never be able to produce widgets again is simply not thinking clearly. We can, and we will, when the cost of widgets gets high enough that they can be profitably produced in the US of A. And we are getting much closer to that point rather rapidly. A wise investor would be looking to locations in the US where readily available power, produced by renewable sources, as well as brownfield physical plant and a decent labor force exists, to position themselves to capture the new electric manufacturing bounce coming in the years ahead. How about Buffalo, NY for a new manufacturing renaissance? Could happen sooner than many think!

  40. Anonymous says:

    To Mish:
    In your earlier comment, referring to the use of US dollar reserve, you said 'Buy what?', but I saw no mention of gold, silver or perhaps to stock up on commodities at historic low prices.

    RobertB

  41. dashxdr says:

    Eric wrote in a comment above:

    Yes, that is the general conclusion I was trying to make. However, I do expect inflation in China to reach hyperinflation level (+50% annual inflation rate), even if it only last for a single month. It is this spike in inflation which will cause Chinese officials to panic and drop the dollar.

    I'm not even sure if I use the term "hyperinflation" accurately. I have an intuitive sense that hyperinflation implies thousands or millions of percentage increases in the money supply per year. But if a meagre 50% is all it takes...I stand corrected, and we seem to be in complete agreement as regards what will occur in China.

    I reserve judgement as regards the effect on the US. I believe hyperinflation in the US will occur because the government has fixed expenses that it cannot avoid, and the only viable way of financing them is through the printing press. QED.

  42. dashxdr says:

    Mish wrote:

    I was on 3 hours sleep at the time of my reply and I also just happened to be listening to a shrill hyperinflationary rant from Schiff.

    Schiff's clients are reportedly down 40-70% because they believed his dollar is going to zero rant and put everything in foreign equities.

    As one of Schiff's clients I'm down about 56%, on paper, from when I moved some money into Euro Pacific about October 2007. That doesn't take into account all the dividends I've received though.

    Peter Schiff is an investor, not a speculator. His investments are designed for the buy-and-hold strategy. Not for day trading. I'm comfortable with his philosophy. Besides which, all markets, everywhere, are down. Peter Schiff has always said gold is a good investment. Gold is up year over year for what, the last 8 years?

    I note Mish recently disagreed with Antal Fekete on the subject of gold backwardization. Fekete spanked Mish -- Mish dropped the debate pretty quickly, if you ask me.

    Also in the past several months Mish claimed gas prices at the pump on the east coast would be $10/gallon, due to a short term shortage in supply (refineries closed due to concerns of hurricane damage). What happened? Prices never rose above $4.00. Some gas stations ran out of gas temporarily, but gas never went to $10.

    And Mish still sings the deflation song, in an environment of absolutely insane increases in the money supply.

    These and other reasons are why I stopped listening to Michael Shedlock.

  43. Anonymous says:

    "Also in the past several months Mish claimed gas prices at the pump on the east coast would be $10/gallon, due to a short term shortage in supply (refineries closed due to concerns of hurricane damage). What happened? Prices never rose above $4.00. Some gas stations ran out of gas temporarily, but gas never went to $10."

    Of course ... if you've got a link to where he said gas would hit $10 a gallon, please post it.
    Are you referring to this post?

    http://globaleconomicanalysis.blogspot.com/2008/09/gasoline-shortages-and-higher-prices.html

    I don't see Shedlock saying gas would hit $10 a gallon. In fact, he pointedly says, "I do not know what price it would take to get efficient usage of fuel in this outage, but I suspect it is far less than $10. Clearly the drum is guessing, but so am I. What I do know is that the market should set the price and any price people are willing to pay is the fair price."

  44. Anonymous says:

    Quite a good article, but I disagree with some of your conclusions. There are some logical mistakes, but I will talk about something else.

    As a "controlled market" economy, chinese govt. has the ability to manipulate nearly everything they want. And that's the only reason why China has this enormous trade surplus.

    The way in wich the chinese govt. spends this surplus is actually what determines wether more yuan are printed or not. So this variable is also controlled by the govt. Just buying some land abroad, or weapons, or whatever it could be solved.

    Furthermore, many of the reforms listed by you as "anti-deflation" were planned out at least four years ago. Chinese govt. wanted the economy to shift from exports to internal demand centered, and a world-wide deflation scenario is the best moment to do this.

    If this shift will go out of control or not, I really don't know. But what I know is that it is much more possible to start an hyperinflation scenario in the United States than in China: just because of the level of governmental control.

  45. Anyway, I fear I may have done a bad job explaining myself, so here is my last attempt:

    1) If China experiences hyperinflation, it will stop printing yuan to fund its trade surplus.
    2) With no one funding the US's trade deficit with China, the US's trade account with China will balance itself. (the value of US imports from China will drop to equal value of exports to China)
    3) The balancing of the US trade deficit with China will cause a big drop in consumer imports to the US.
    4) This shortage of consumer goods will drive up prices.

    Do you agree that, if China stops printing money to finance its trade surplus, the US's trade account with China will balance itself? And, if not, why?

    Hello Eric

    1) Hyperinflation is caused by massive printing so if China does not print, it will not have hyperinflation. It may have inflation depending expansion of credit just as happened in the US. But that credit is now imploding as everyone can easily see. There should be zero doubt of deflation in the US right now. There is deflation in the UK now as well.

    Anyone who does not see there is deflation now is completely blind as a bat, or does not understand the role of credit in deflation. Credit is collapsing far faster than anyone in printing.

    Bank shares around the world prove it. I invite everyone to read "humpty dumpty on inflation"

    http://globaleconomicanalysis.blogspot.com/2008/12/humpty-dumpty-on-inflation.html

    Conditions one would expect to see in deflation are a perfect 15 out of 15 with what is happening

    2) That is not necessarily true, the US could of course print, Japan or Europe could fund it, and a lot depends on what the price of oil does. Finally the savings rate in the US can go up, to fund the deficit. In fact that is happening now. Lots of things could happen. There are lots of variables here that you are ignoring that affect the balance of trade.

    3) Point #3 is stated backwards. What you mean to say is a big enough drop in imports will balance the US trade deficit. You have the cause and effect wrong.

    4) Point 4 is completely false. The most likely reason imports would fall is because there is no demand for them. That is happening now even as prices are falling! Look at all the cars stacking up right now.

    These are stunning images if you have not seen them.
    http://globaleconomicanalysis.blogspot.com/2009/01/unsold-car-images-from-around-world.html

    Look at those images and tell me where you think prices are headed.

    I believe you started with a theory of how hyperinflation would cause hyperinflation in the US and you are struggling to tie them together because it can't really be done.

    What I liked about your thesis was China was going to print and that would weaken the RMB. But that does not cause hyperinflation in the US, and I do not think China would be dumb enough to let things get that out of control there.

    The RMB can collapse just as the British Pound is doing now. Realistically that is about as far as it goes unless China does something drastically stupid. The UK is doing something really stupid and it is mired in deflation anyway.

    Mish

  46. Anonymous says:

    Analyzing the hyperinflation risk, I've done some graphs (thank you, MS Excel! lol)

    Here's one of them.

    Data used:
    FED
    BEA

    Since nominal GDP did not rose that sharply, it's quite clear that we're deflating because of a drop in circulation of money.

    As Eric explained, if the govt. prints more money to fight against deflation, there's a risk of future hyperinflation.

    Somewhere in this article there's a graph showing an increase in money supply in China. But this increase seems far bellow the US increases.

    I'd really like to get the data from china, to compare wich country has a higher risk to get into hyperinflation.

  47. Numonic says:

    Even though Mish is responding to Eric I have to step in because i have questions.

    Mish you said"

    "Hyperinflation is caused by massive printing so if China does not print, it will not have hyperinflation. It may have inflation depending expansion of credit just as happened in the US. But that credit is now imploding as everyone can easily see. There should be zero doubt of deflation in the US right now. There is deflation in the UK now as well."

    As I've read from Eric's writings China's credit is contracting because of it's peg to the US dollar not because of reckless borrowing and lending like the US has been doing. China could end the credit contraction but it would lead to hyperinflation because of it's peg to the US dollar. So that credit contraction is like artificial. China can start lending which Eric's articles have been saying they are preparing to do. If China begins lending while keeping it's US dollar peg and funding all these bailouts, that will create allot more of China's currency and as this more relaxed lending is going on the potential for it to get out of control is high, i would say certain and in anticipation of this China will have to depeg from the US dollar to stop hyperinflating.

    " That is not necessarily true, the US could of course print, Japan or Europe could fund it, and a lot depends on what the price of oil does. Finally the savings rate in the US can go up, to fund the deficit. In fact that is happening now. Lots of things could happen. There are lots of variables here that you are ignoring that affect the balance of trade.
    "
    From what i read Japan and Europe are running trade deficits and will not be able to fund the bailouts and will be sellers of US debt. Oil exporting nations are not in a good spot right now. I don't know about US's savings rate. You say lots of things can happen but i can't see much happening. Who will fund US' huge trade deficit?

    "What I liked about your thesis was China was going to print and that would weaken the RMB. But that does not cause hyperinflation in the US, and I do not think China would be dumb enough to let things get that out of control there.
    "

    I don't know, the conbination of the increased amount of US Treasuries the US is trying to sell coupled with China's already bloated reserves and the relaxation of credit in China, it looks pretty likely to get out of control. And when it does China will depeg from the US dollar and that is how hyperinflation in China would lead to hyperinflation in the US. To stop hyperinflation in China, China will cause hyperinflation in the US by depegging from the US dollar and discontinuing it's funding of US' trade deficit while focusing on domestic consumption. Unlike the US and other places around the world who borrowed and lent recklessly, China does not have all of that mess, they don't have allot of deleveraging and their credit contraction is controllable and is only happening to prevent hyperinflation because of the amount of Yuan they have to print to maintain the peg to the US dollar and fund the US bailouts/trade deficit. Well if credit becomes relaxed in China like I'm reading they are preparing to do, hyperinflation will occur in China and in order to stop it, China will cut it's peg to the US dollar. Then who will the US sell it's debt to?

  48. Martin says:

    Anyone who does not see there is deflation now is completely blind as a bat, or does not understand the role of credit in deflation. Credit is collapsing far faster than anyone in printing

    This is a false assumption. Credit has no role in deflation because the funds loaned have already been spent. You are confusing credit contraction with a decrease in the money supply. The latter is deflation, the former is not. It is the sudden reduction in the availability of new credit that makes people assume there is deflation. This causes hoarding of cash which just exacerbates the impression there is deflation.

    Falling prices are a symptom of deflation, but having falling prices does not mean that deflation exists. Falling temperatures can cause water in your body to freeze, giving you frostbite. Having frostbite does not imply that temperatures will fall. Don't confuse the symptom with the disease. A sudden drop in credit availability can cause changes in supply/demand dynamics that create temporary changes in pricing that mimic deflation. That should not be confused with the real thing.

  49. Anonymous says:

    As an economic illiterate, I never-the-less find this a very interesting discussion. But I'm still totally confused/unsure whether deflation or hyperinflation our way comes.

    So I'm going to stick to my original investment strategy ie 50% bullion, 50% short term bonds (but now moving to cash at call in case the banks decide to have an extended holiday). If it looks like inflation, big time, is on the cards, my intention is to buy real estate.

    Anyone any comments?

  50. Williams says:

    Anonymous,

    Real estate is a good hedge against inflation, but it does not offer protection against changing purchasing power parity between countries. I would advise you to buy real estate in China or Germany, but not in Japan or US. Although you may be protected from inflation locally, it would be value destroying when looked at from the pre US economy collapse days. RE prices strongly depend on the strength of the local economy and people's puchasing power.

    Only precious metals can protect you both against inflation and local economic collapse.

  51. Anonymous says:

    This situation is an ugly mess. The only real remedy is for the USA to live within its means. This means less consumption and more production. Start with some scaling back of regulations which affect our own industries, then focus on local production of basic commodities (mining, drilling,etc.) while at the same time implementing heavy penalties for overconsumption by individuals. This means an all-around change in the tax structure -- less or no tax for simply producing something and/or making a profit, but more tax for consumption and more for imports, and more for using non-renewable energy sources. In terms of industries, it would probably make sense to restore some that have recently been moved overseas due to cheap labor costs. If labor costs in the US and China become equal, importing from them simply no longer makes sense.

  52. Anonymous says:

    You know what i thought about it and I've been battling with the whole hyperinflation VS Deflation for months now and I've come to the conclusion that basically it's stupid to have a bank account. 1. if the stock market crashes and there are bank runs and lets say the govt. decides to stop bailouts even though they are showing no signs of stopping right now but lets say something weird happens and they stop the bailouts and they do not bailout the FDIC and let everything default, if you have your money in anything other than your own holding(like in your closet or how they used to say "under your mattress") well then that money will be lost. The value of the dollar will go up but most will loose money from the bank runs and insuficient FDIC funds. So if you hold physical precious metals in your own private possession, even if the value of the precious metal goes down, at least the value of the dollar would have gone up and whatever you get for the precious metals would make up for the loss in the value of the precious metals because of the rise in the value of the dollar. So basically having a bank account is stupid. In these times you want to either hold your cash yourself or hold physical precious metals. There is always the chance of the printing of money to massively increase (Zimbabwe style) to bail everyone out so that's why the thing I'm holding in my private possession is physical precious metal(silver) especially since there's reports of shortages of it everywhere and the bailouts have been getting larger and larger with no slowing down. But point is you want to be holding your money yourself, whether it be in Federal Reserve Notes or physical silver/gold other wise you'll lose your momney letting someone else hold it for you.

  53. Anonymous says:

    Anon said.."...So basically having a bank account is stupid. In these times you want to either hold your cash yourself or hold physical precious metals..."

    Pretty much my thinking (re my post 2 above). Essentially, 'don't trust govt' - or banks, or public serpents, or...etc. Sad, but a reflection of the result of greed & corruption that rules today.

    Thank Goodness the New Messiah has arrived to sort things out; in a 2001 audio interview as reported on Drudge, TNM said quite plainly that his aim was re-distribution of wealth and that if the Constitution had to be circumnavigated, so be it. If you're an American, maybe it won't really matter if you get inflation/deflation right, you 'aint gonna be allowed keep your winnings. That includes gold with a repeat of confiscation. My, it's gonna be fun!

  54. Anonymous says:

    In order for it to be worth it to confiscate gold and silver to pay off the debt, silver and gold would have to be above the 5 digit price.

    Check out: What if They Returned to the Gold Standard?

    http://silverstockreport.com/2008/standard.html

    The Invisible Grind

    http://silverstockreport.com/2008/grind.html

    So holding physical silver and gold is still a safe bet.

  55. Anonymous says:

    A few things I want to know:

    1. I've been reading that the swap program between the Fed and banks has been a swap for the banks debt for Treasuries from the Fed. Is this swap the reason the dollar is rallying? If the swap is the reason the dollar is rallying, does that mean that the more debt the banks have to swap for Treasuries the longer the dollar rally will last? Isn't the banks swapping for treasuries a form of demand for treasuries? If the banks have allot of debt they want to swap for Treasuries, doesn't that mean the dollar will be rallying allot longer, for as long as the banks have debt to swap for Treasuries? Why am I hearing that hedge fund deleveraging has ended? Why are US Treasuries still rallying? Why would the Fed need to buy Treasuries? Has the swap program for the banks debt and Treasuries ended? Is that what people meant when they said hedge fund deleveraging has ended? I hear there is still allot of overleveraged debt in the stockmarket, won't this create more demand for US Treasuries as these overleveraged debts are swapped for Treasuries? When will what Peter Schiff said would happen, happen. Peter Schiff says there will be no buyers of US Treasuries and there will be a huge sell of of US Treasuries and the Fed will have to buy US treasuries. So either that swap program for the banks debt for US Treasuries has ended or that swap does not have a positive effect on US Treasuries. But I'm hearing the swaps have not ended and I'm hearing the reason Treasuries are rallying is because of the swaps. I'm also hearing that these swap programs will continue for a while as there are tons of debt the banks want to get rid of, and will do so by swapping them for US Treasuries. Someone help me out here? All this spells out that Mish Micheal Shedlock is right and that we are heading for a long period of US Treasury rallying. What am I missing here?

  56. Numonic says:

    I just realized the basis of my process of saying "having a bank account is stupid" and trusting holding precious metals instead of Federal Reserve Notes is the exact process that will cause hyperinflation and is the final step in the Kondratieff Winter. Pretty soon everyone will realize having a bank account is stupid and move to the least riskiest asset which is precious metals and that will be the start of hyperinflation. The longer this deflation takes the more it leads to people being uncertain of if we can get out of it, that drives people to precious metals because on one hand it's risky to be in the Federal Reserve Note with the Quantitative Easing going on and it's risky to be in any dollar denominated assets because with the unprecedented steps being taken to prevent defaults, it looks unlikely that they will succeed in doing so. So on one hand we may be facing imminent defaults of dollar denominated asstes and on the other hand we may be facing too many Federal Reserve Notes being printed. This uncertainty is what will drive people to precious metals because it's a win win situation for precious metals. With precious metals if there are defaults on dollar denominated assets(Treasury Bonds, Bank Deposits, etc.) the Federal Reserve Note would be in short supply and gain in value, which would offset any losses from holding physical precious metals. And on the other hand if too many Federal Reserve Notes are printed the value of the FRN would decrease. So there's a huge chance of loss with FRN and dollar denominated assets especialy with Quantitative Easing going on which exposes the severity of both sides(defaults and massive printing of FRNs) but there is no chance of loss with precious metals. Whatever value is lost in precious metals is gained in the value of the Federal Reserve Note. And in times like these people are moving away from risk and the least riskiest asset is physical precious metals.

    http://www.runtogold.com/2008/02/first-snowfall-of-kondratieff-winter/

  57. Boris says:

    Austrian economist predicted this:

    --------
    China's Great Depression
    http://www.financialsense.com/editorials/petrov/2004/0902.html

    Therefore, it is clear that China travels today the road to Depression... ...it is my belief that the Chinese bust will occur sometime in 2008-2009, since the Chinese government will surely pursue expansionary policies until the 2008 Summer Olympic Games in China. By then, inflation will be most likely out of control, probably already in runaway mode, and the government will have no choice but to slam the brakes and induce contraction. In 1929 the expansion stopped in July, the stock market broke in October, and the economy collapsed in early 1930. Thus, providing for a latency period of approximately half a year between credit contraction and economic collapse, based on my Olympic Games timing, I would pinpoint the bust for 2009.

    To summarize, the likely candidates for a trigger to the Chinese depression are (1) a worldwide currency, banking, or derivatives crisis, (2) a U.S. recession, (3) the containment of runaway inflation, (4) the disappearance of Chinese trade surpluses, and (5) an oil supply crisis.
    --------

    (1) and (2) are happening!

    P.S.
    The most scary part is time when this study was written - September 2nd, 2004!

  58. Karen says:

    The linkage between increasing the money supply and inflation is necessary but not sufficient -- if banks and consumers are confident when the money supply increases, they will overspend and overlend. When consumers and banks are fearful, they save, and the excess money just goes into reserves and savings, not into purchases and loans that cause inflation. This is what is happening in the US right now -- the money supply has balooned and all the money is being gobbled up by savers. The Chinese are savers and it is feared that with lower interest rates they will just save more to compensate for lost interest income.

  59. Mudar says:

    I have previously kindly asked you to elaborate more if possible on the Petro-Dollar theory in connection to your analytical article. And here I need to thank you for your kind of short reply… I thought that you might have not found that much of a relation of what I have asked to your article… maybe…

    Anyhow sir; while researching the Inflation/deflation/recession & depression world in connection to Gold, which is currently driving people crazy on what to do I found a great analytical article (Gold and Deflation: A Dissenting Dissection by Bob Landis) that really can help anyone in that area. Below is the link & I hope you’ll have the time to go through it if you have not already.

    Many thanks again

    http://www.goldensextant.com/Gold&Deflation;.html

  60. OperationNorthwoods says:

    You seem to have great faith in China's leaders and system in general. I don't. China could easily have a crisis before the US. The construction bubble there is like one giant Vegas.

    If you read about past depressions, such as the really great one of 1873, it's easy to imagine that a country on the rise, China, could have a very bad decade.

  61. Anonymous says:

    Nice article. Who knows if you are correct? However, one thing is certain: Mish is starting to really bore me. I've read his blog for months, and he has made some nice calls, but he is unwilling to entertain possibilities. The important point to me about your post is that it is a nice possibility to consider.

    Everyone, keep in mind one very important thing: do NOT let history be your guide in how this drama will play out. History doesn't repeat. It may rhyme, but repeat? No way. What can't happen almost always DOES happen. Hyperinflation? A serious possibility.

  62. Anonymous says:

    http://www.goldensextant.com/Gold&Deflation.html;

    Many thanks for the link to this thought provoking article. I think it goes well to raise the right questions so that we may all challenge are own cherished assumptions during these times.

    Yes - the question of Inflation/Deflation is driving me crazy - yet Gold truly has a place in this world of uncertainty. For myself, who only has limited time for investment/economic research, gold as a means of preserving value, holds a very prominant place.

    What will the future bring? I cannot think of anything else at this moment to put your financial trust in other than physcial gold.

    Mike

  63. Anonymous says:

    Soybeans have rallied 25% off the low in 3 or so months. I guess annualized that would be about 100%.

  64. Anonymous says:

    Oh BTW the rally good weed in town is now $150/qtr. oz. It used to be $100 less than a year ago. I call that inflation!

  65. Anonymous says:

    oops... really good......not rally....you can say the Chinese will do this, the Chinese will do that....take my advice and LEARN Chinese-so you'll get a middle management job when they take over our country! HA! Gung Hay Fat Chow (insert firecracker here)

  66. Anonymous says:

    Great debate. I respect Mish and love to see his responses here.

    One thing about the original thesis. You say prices for Chinese goods will go up in the US, causing inflation here. I think the destruction of credit adn therefore demand here will not allow that to happen. We will simply not buy Chinese goods and they will sell them elsewhere or go out of business. There are few goods we really NEED. As people can no longer use their homes as ATMs, have their credit card limits reduced, get laid off, or are forced to save to replenish their retirement holdings that have been cut in half recently, Americans will not be buying anything but the necessities. And I mean BARE necessities. Walmart sells a lot of crap people don't require to live. People will make do with what they have, or shop even cheaper options like resale. With Craigslist it's easier than ever to buy used things of better quality and cheaper price than a product from China. US demand is down, and it's going to stay down. I think that one of the few silver linings in this crisis is that Americans will finally go back to being frugal.

  67. Anonymous says:

    I think you are right about people only buying what is necessary.

    How Eric's idea of China importing its hyperinflation within that context has me thinking. I know we will continue to import some items from them because there will always be people that can afford to buy - but in this coming economy, few will have any purchasing power beyond the necessities. If China's goods become too expensive people will be unable to buy, and eventually the balance will swing so that our labour becomes cheap enough to make things here again.

    I can see us becoming impoverished while others do better. It is possible that our food producers will export food at world prices. If the U.S. dollar is smashed, food for us will become very expensive indeed. When you are at that level of survival, forget upgrading your iPod, bathroom scales, and buying more clothes when all us have closets full of cltohes.

    Maybe I am simplifying this, but I still am wondering how it is going to play out.

    Mike

  68. Grant R says:

    US wages are not likely to go anywhere near Chinese wages without a devastating collapse in the US.

    A minimum wage of about $6 per hour in the US doesn't compare to $3 per day in China. Manufacturing will probably be cheaper in China as long as ships sail the seas and there is political stability in China.

    On the other hand China is unstable politically in my opinion.

    Shipping requires an physical infrastructure, banking and legal systems to operate efficiently. Some of these could be threatened by collapses in China or the US.

    The credit collapse in the US does affect money supply negatively (yes the money has already been borrowed) because of the reduced valuation of assets allows for less leverage, and requires the lowering of leverage by borrowers. Borrowers who have cash pay it into the bank. The bank holds it because of their own capital requirements (actually a joke now in the US in all practically near 0% versus the 10% that everyone thinks of in fractional reserve banking).

    But yes I do see inflation eventually. When I don't know. Maybe more a collapse of confidence in the US dollar versus huge amounts of cash in the system.

  69. gordy three horses says:

    hoka hay! me thinks this may be the end of the white man's rule over this NEW WORLD. eather way you slice it, i see nothing but gloom and doom for this white man's country. a few have it right stock up on the food and other things you will need to servive. also learn how to hunt and gather as my red brothers have done for thousands of years.

  70. OBSERVER says:

    In your original post, you list items that are exported and state the ones from China will not be as badly effected.

    I disagree. Most of what we buy in Wal-Mart is useless and we can do without. Christmas and other Holiday decorations? Plastic flowers? Light fixtures? On and on.

    IF the Chinese are forced to raise prices, we will just not buy. We don't have to buy ANYTHING From China if you really think about it.

    Essentials? We have them here. We can feed ourselves since we export wheat, corn, soybeans, etc to the world. Fruit and Vegetables? We grow our own.

    Wood products? We export wood to China. Cars? We have a glut. Tools and Hardware? We can fire up those plants in a matter of weeks to make them.

    We actually need nothing from China and in fact, THEY NEED US TO BUY THEIR JUNK since their junk is toys and doo-dads.

    On that alone, your thesis fails.

    (PS: Hi Mish)

  71. Anonymous says:

    About hyperinflation in china and if it did occur, wouldn't the U.S. just try to find another "cheap labor" country to import from???

  72. Anonymous said...
    I think the destruction of credit and therefore demand here will not allow that to happen.

    Demand is irrelevant in the current situation: Goods can't be sold for under their production costs, period. The credit crisis has boosted cost of financing manufacturing operations, and these higher costs must passed on.

    So what if US demand is falling? If Chinese exports can't get enough to cover their costs, they keep going out of business until the supply of goods shrinks enough for the surviving exporters to pass on their higher costs.

    We will simply not buy Chinese goods and they will sell them elsewhere or go out of business.

    Some will go out of business, and the rest will raise their prices to cover their costs.

    There are few goods we really NEED.

    Toasters, microwaves, blenders, laptop computers, cell phones, MP3 players, televisions, etc...

    Sure, Americans don't absolutely need these things, but giving them up is not going to be pleasant.

    US demand is down, and it's going to stay down.

    But the Chinese supply of goods will fall even faster, forcing prices up.

    --------

    Anonymous said...
    If the U.S. dollar is smashed, food for us will become very expensive indeed.

    Exactly, especially with the global droughts that are occurring.

    --------

    Grant R said...
    US wages are not likely to go anywhere near Chinese wages without a devastating collapse in the US.

    A minimum wage of about $6 per hour in the US doesn't compare to $3 per day in China.

    If the dollar loses half its value against the yuan, Chinese minimum wage will be about $6 per hour.
    If the dollar loses three fourths of its value against the yuan, Chinese minimum wage will be about $12 per hour.
    etc...

    --------

    OBSERVER said...
    In your original post, you list items that are exported and state the ones from China will not be as badly effected.

    I disagree. Most of what we buy in Wal-Mart is useless and we can do without. Christmas and other Holiday decorations? Plastic flowers? Light fixtures? On and on.

    Wal-Mart also sells toasters, microwaves, blenders, laptop computers, cellphones, MP3 players, televisions, VCRs, etc...

    Are these things that would be painless to give up?

    We actually need nothing from China and in fact, THEY NEED US TO BUY THEIR JUNK since their junk is toys and doo-dads.

    Really? You could give up your TV, cellphone, microwave, laptop computer, and all your other household appliances?

    Even in poorest countries in Africa, they have cell phones. If we give up this Chinese "JUNK", we would be left with the lowest standard of living in the world. T

    On that alone, your thesis fails.

    And you are writing a comment on my blog with an Asian made computer.

    On that alone, your thesis fails.

    --------

    Anonymous said...
    About hyperinflation in china and if it did occur, wouldn't the U.S. just try to find another "cheap labor" country to import from???

    If hyperinflation occurs, the US will be the "cheap labor" country that the world exports their manufacturing.

  73. gordy three horses says:

    yes we really can DO WITHOUT COMPUTERS AND CELL PHONES, VIDEO GAMES, TV, RAIDOS, I-PODS, MP3 PLAYERS, CARS. YOU WILL NOT CEASE TO EXSIST WITHOUT THESE ITEMS, YOU WILL NOT BE AS LAZY OR SPOILED THOUGH. I GREW UP IN THE ALASKAN WILDERNESS AND I NEVER HAD THESE ITEMS AND I WOULDN'T MISS THEM NOW. I CAN ALWAYS SURVIVE JUST AS MY ANSESTERS DID FOR THOUSANDS OF YEARS BEFORE THE WHITE MAN CAME TO DESTROY OUR CULTURE AND WAY OF LIFE. A FEW OF US STILL HONNOR AND UNDERSTAND THE OLD WAYS. FOR THOSE WHO DON'T, WELL YOU'RE JUST SHIT OUT OF LUCK.

  74. Numonic says:

    Gordy Three horses you're ignoring the fact that demand is irrelevent to the price rising. The price won't be rising because of the demand for those things, it's going to be rising because of rising borrowing costs. This means that anything that requires credit will be passed on to the comsumer. That's anything, surely you need some things to survive. You should be paying more attention to the fact that Walmart has the cheapest stuff. If you say those things in Walmart are things we don't need then think of the prices of the things we need which are not in Walmart. You're also ignoring the fact that, and I like the way Eric put this before, US' manufacturing sector is worse than that of a third world country. So everything we have requires borrowing, meaning prices of everything we have will rise. EVERYTHING! And I know we can't get out of it with more production, not as long as we are still using the US dollar. There is too much debt with the US dollar and it's an insurmountable amount of production we need to do to balance that debt with supply of products. This is why I say we are witnessing the collapse of the US dollar and all paper money and lending for that matter and gold/silver is becoming money again and this will be better for the world economies. The bailouts are stalling the inevitable. And the inevitable will happen before this year is over. The path to the inevitable will include rising prices.

  75. Tony says:

    Your hypothesis is interesting, but in order to understand interaction of your assumptions, try to model and simulate the problem in interest. You may find surprising outcome.

  76. Anonymous says:

    Great debate people!!
    I would like to hear a little more discussion about the gulf countries forming their own currency. From what little I've read, sounds like they are shooting for this Sept. or early 2010 at the latest. The agreement we've had with opec has really allowed us the freedom to run huge deficits and wage almost continual wars for the last 50 years (including cold war). This torpedo to our economy seems to be unavoidable. China's relation is potentially as harmful. So is peak oil. What to you guys think

  77. Hyperinflation - I am really not sure if it is a certainty, for China or elsewhere. The risk of hyperinflation - globally - is definitely rising. But the end game really depends on what governments do. The top priority of decision makers are still "stay in power". They will follow that to keep the regime. If that means hyperinflation, yes they will do it. If that means socialism, sure.

    China would not be able to export hyperinflation, as excess capacity is just everywhere. To deal with domestic inflation (if it ever comes), China would soak domestic liquidity by investing overseas in resources, as aggressive as possible. Even if that drives up commodity prices, China would keep certain price control to curb domestic inflation. In that way the low RMB game can be played for quite a while.

  78. Robert says:

    HELLO FROM SAUDI ARABIA:

    Eric - you mentioned we'll be "buying oil in Khaleeji and consumer goods in Yuan".

    I'm paid in Saudi Riyals and save in Euros and thinking of "skating to where the puck will be" (Wayne Gretzky's claim to why he scored so many goals).

    I'm not fishing for investment advice - I've already reached the same conclusions you have.

    But I'm thinking of splitting my Euro portfolio 3 ways:

    1:Euros (until gold retreats to $750 - ha ha).

    2:Energy backed currencies (Khaleeji)

    (and Arab banks don't seem exposed to eastern europe).

    3: Yuan.

    (and China doesn't seem exposed to eastern Europe either)

    So what am I missing ? What's the chance governments suddenly outlaw gold bullion ownership. Couldn't we just cash out the gold - into some currency - or would governments actually CONFISCATE private bullion ?

    Any opinions welcomed.

    Robert

  79. atomicweeder says:

    Wouldn't the hyperinflation's effect on US be limited to the percentage of our spending on Chinese goods? As opposed to domestically-produced food and cars, and Middle-East oil?

  80. Anonymous says:

    Interesting article. While I'm not 100% certain whether you're analysis is correct, I will say that if China is faced with the choice of dumping the US$ or hyperinflation, it will dump the US Dollar period. Everybody seems to forget their 20th century history. One of the main reasons for the Communists' victory over the KMT in 1949 was hyperinflation caused by KMT monetary mismanagement. I'm sure the current leadership will see the irony of the situation and will do anything to prevent the same fate from befalling themselves.

  81. Amir Timur says:

    Making money of this seems to be difficult.
    If the chinese decide to control inflation, they will sell the dollar against yuan, leaving the yuan as a unilaterally appreciating currency.

    So, after the first phase of massive increases in commodity prices in dollars, we might not have much to play with in terms of currency speculation.
    -Timur

  82. Natasa says:

    Great article Eric... as many I have read those days on your site.

    The guy "Mish" - is one unbelievable arrogant man.
    He was not able to discuss with you on the normal and intelligent level because of his lack of imagination and his arrogance. He did not discuss at all at the beginning, but try to make fun of your so unconventional, but extremely logical view on the GFC.

    You war gentleman complete time of so called "discussion" (it was never a discussion, but lecture to an arrogant man!) - and I find it very good too, when you decided to cut this meaningless talk with this Mish - "the Prophet". Good timing Eric!

    BTW - I check also his (Mish - "The Prophet") side since it looks that this gay pursued himself (with help of his blind "site followers") that he is - a "Prophet" (or something like this)... That is not strange at all that he has "the followers" too - those days.
    I understand that he do not like you - but you of course completely destroyed this arrogate man. I am sure that Mish - "The Prophet" will NEVER ever post anything on your site - after this stigma of himself!
    Additionally, I did not understand - why he was angry on another guy - namely Peter Shiff. It looks that Mish not just "do not like" Peter - but is VERY angry on him!
    When I check little bit Peter Shifs blogg too - it looks like Peter share some of your views on this GFC and that is what irritate "the Prophet" - Mish... haha...
    "The Prophet" Mish - has NO idea what should be solution of the GFC.
    He (as each "Prophet") just "see - Deflation"... That is his - "final count down"...
    AND for one "Prophet" - that is good enough...haha.
    If somebody (you or even Shiff) try to see little bit further - behind the "Prophets Deflation" - he (the "Prophet Mish") - must hate you and defend his "prophecy"... haha...

    Eric, once again - great blogg and really unusual, but so logical explanation of the present events.
    Thank you very much.

  83. Shin says:

    having to read all of the article and comments..
    i have a headache.
    as a college student striving to get of of this sinkhole in economy, your words act as my internet news eric..
    i just wish that i found your site sooner.
    cheers and fight on~

  84. Anonymous says:

    Natasa

    You have no idea what your talking about. I too think Mish is arrogant, but he tend to be correct. To call us his "blind "site followers"" demonstrates your ignorance. If you read his blog and studied his charts you would know this. As a previous inflationist I initially followed Peter Shiff and was invested overseas, lucky for me I found Mish, and Minyanville if not I like Shiff's investors would have been burned. The proof is in the pudding.

  85. Anonymous says:

    Wrong. Hyperinflation will begin in the United States in 129-Days. In November when the U.S. Dollar Index touches 65, foreigners will have had it with the collapsing dollar. The dollar peaked at 121.02: with the dollar losing 50 percent of its' purchasing value, foreign countries will begin a massive exodus. The United States Dollar is finished as a world reserve currency. The only way to prop the dollar is by distraction through terrorist attack or more swine flu.

  86. Natasa says:

    Anon,
    ...
    "...To call us his "blind site followers"" demonstrates your ignorance..."

    You give answer on this question by yourself:

    "...As a previous inflationist I initially followed Peter Shiff..."

    I really do not mind if you or ANYBODY "follow" someone.
    Personally, I do not like to "follow" anybody, but I try to inform myself.
    Of course - you can and should have right to do what you like.
    Actually I am glad that you earn money based on the "prophets prediction"...

    On the other side - I understand now some facts.
    Facts:
    1. Mish is extremely arrogant man.
    It would be a problem, even if he HAS right...
    BUT he is obviously very WRONG...
    2. "The prophets" prediction just STOPPED by "deflation". He has NO idea or logical explanation - what will be the continuation...
    It is simple as 1D analyze.
    You catch just ONE trend but NOT completely phenomena. Even worse! 1D thinking disallowing you to understand complete 3D (REAL!) event... That is the reason that Mish "the Prophet" simply can not see anything other than - "deflation".
    3. As I understand, even Eric started with 1D analyze and WAS a "deflationist" (you can find it on this blogg)...
    With time Eric DEVELOPED his analyze on the 3D situation - and it is obvious that Erics analyzes are far, far, far (!) deeper and more correct (real in longer run!) than those from Mish " the Prophet".

    Even Peter Shiff has more understandings in my point of view than "the Prophet" , but he has (I personally believe) just correct feeling based on his long experience in finance.

    Eric, on the other side has not just feeling, but a ability to put ALL variables in "3D" (REAL!) financial analyze and extract (simulate!) the correct results.

    But Anon,
    as said... Please be not disturbed by my opinion.
    Kind regards
    Natasa

  87. peter says:

    I found what I believe is an error in the following part:
    "Chinese citizens' lack of social security, free education, and available consumer credit, which has forced them to save far more than their Western counterparts, leaving them with less disposable income."
    As government is inherently more inefficient (they require the threat of force to sell their products), westerners have less spending power left after social security.
    In this video it is show that Americans cough up 200k$ per welfare recipient. That means a 5% efficiency.
    http://www.youtube.com/watch?v=gwTDKt_k9kQ
    There is no such thing as 'free healthcare', just healthcare you pay for through voluntary organisations (which have to keep inefficiencies low due to competition) and involuntary ones (who do not care about inefficiencies because they can use coercion). As a result Chinese have to set a side less money for these services and have more left over to spend on other stuff.

  88. Antonovich says:

    http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?Symbol=CNY

    While your analysis may be sound for the longer term, it appears to be totally contradicted by short term data. From not long after you wrote this, there has indeed been deflation in China...

  89. marianne says:

    Why do people call Mish arrogant?
    He is the only one here that talks sense. Any idea how much fiat money has been destroyed since the beginning of 2008? Not even all the CB's in the world can print up to that. Deflation is the word for the years to come, but since governments are not able to spell that word (they are scared as h.ell for it, because it means the end of manipulating the economy), the best they can do is talk about "negative inflation". As long as the consumer doesn't consume, there is no way back.
    And by the way, why would the US citizen, buy too expensive Chinese junk?

  90. peter says:

    I'd say there is no reason to say Mish is arrogant. But I'd like to hear from a deflationist why Mugabe managed to beat deflation, if they are so convinced there is nothing governments can do about deflation.
    All fiat currencies ended worthless after a maximum of 100 years, why is this different?
    He should change his argument from they CAN'T do anything about it to they WON'T do anything about it, because they clearly can.

  91. marianne says:

    Mugabe didn't beat inflation, he just allowed people to pay and be paid in US dollars en euro's, something that was forbidden until half a year ago (they used to be conviscated).
    So in fact, the currency was changed.
    But as long as that lunatic is ruling the country, I don't expect any positive change. He has done his upmost to ruin the country.
    Secondly, I think we concentrate too much on China. The Chinese economy is only 1/4 of that of the USA and less than 10% of that of the US, Euro-countries, UK and Japan together. The Chinese export is minus 30/40% at the moment, so they will not be able to pull us out of recession, but they cannot drag us further down either.

  92. peter says:

    @marianne
    My statement was that Mugaba managed to beat deflation, like the government managed to beat deflation in the Weimar republic and the Hungarian hyperinflation and in the Roman empire hyperinflation.
    The statement that governments can not beat deflation is clearly wrong given the historic evidence.
    Of course, that created a big mess in all instances, but that is not at issue. I do not claim the government can beat deflation and save us from economic collapse, I merely say that they can beat deflation. Period

  93. "Inflation happens when the money supply is growing faster than the economy, and china's economy has been growing fast."

    I find the above statement, from paragraph 3, to be close to meaningless.

    Money Supply x Velocity = GDP. If
    Money Supply is increasing faster than GDP, then velocity is slowing down, which is hardly a phenomena consistent with inflation.

    Considering the velocity equation above, we can see that when we say that an economy is growing, we are pretty much saying that the money supply is growing and nothing more, since velocity pretty much stays flat in the long run. "growth" as an economic concept is therefore close to meaningless as well. Or, more succinctly, there is no unit of measurement for quality of life.

  94. Moamic says:

    The distortions caused by sterilization operations and stifling policy measures are best seen when comparing China's and the US's economy:

    A) US home buyers get tax incentives VS Chinese home buyers get tax penalties
    B) US gets artificially low interest rates VS China's artificially high interest rates
    C) US's "service economy" VS China's "service-less economy"

    The Chinese current trade surplus in dollars doesn’t lead to printing Yuan and the sterilization process is largely overrated if existing at all. China uses this fiat money to buy real assets, mines, commodities, lands and international companies …smart move.
    Their “economic attitude” of saving vs spending, cash vs credit, is the healthy game lesson the western world has forgotten mistaking “spending” with “growth”.

    And I would add it is not “service economy vs service-less economy” but vs productive economy.

    In the US, the overvalued dollar and easy credit environment have caused the service sector to become oversized, artificially raising America's standard of living.

    Credit is pure debt which leads to bankruptcy and there is no better example than today’s situation to prove it. It shouldn’t replace the missing “capital” nor being a mean for the new “engineering accountability” where loans get into the credit side of the balance sheets.

    This oversized services sector giving the feeling of a high standard of living, is very true. Very much so due to the arrogant thinking that a productive activity is degrading so let it be done by the so called “under developed countries”. In return services activities are regarded as “intellectual” luring to an apparent misleading wealth.
    One is producing real wealth, the other a bit of knowledge and a lot of nonsense.

    All this is more a question of mentality than anything else.

    The standard of living in China has risen in the main cities and will spread over but probably at a lower pace for the coming years.
    Inflation in China will follow a normal rate for a developing country, when services will be progressively added to production, norms, quality tests, retirement, social welfare etc…in so raising prices and cost of living.

    Before this inflation move get meaningful to threaten western countries, fiat moneys would have disintegrated already, which is going to happen far sooner than one can think of.

  95. Anonymous says:

    i thank waklntonka that i grew up in yhe old ways. i learned to live without your fiat currency. every thing, and i mean everything i ever needed to survive i got by hunting, gathering and making myself. i pitty you poor people who are soooo dependent on things like paper currency, electricity autos, the telephone, tv, stores to buy your food,clothing, and your health care system. your economey can collapse today and it will not hurt me one bit. i will still enjoy life and continue in pure happyness and joy for each day that the great spirit lets me share in the great mystory with all of my relations.

  96. Veek says:

    I don't think China will resort to dollar sinking - they aren't entirely stupid. What they are doing is squeezing the competition out. By maintaining a pegged yuan, and by being more hardworking and efficient, they squeeze out other manufacturers (in India, Poland, Romania etc).

    It's true that the since a large chunk of their savings are in dollar, their asset (the $) and hence their currency will loose value wrt other national currencies (Euro). Since they do not have some kind of unique product to sell many manufacturers in China will shut shop and layoff workers who will have to be absorbed in the rural hinterland (especially when other nations resort to protectionism).

    What prevents the Chinese govt from, now, spending in the rural areas (hospitals, schools, cleaning up the environment, and agriculture by setting up rural-work-schemes) by buying goods from chinese companies and paying in dollar? The dollar is then used by the Chinese companies to employ ex-pat Americans, import goods from America etc..

    (What can upset this apple-cart is weather)

  97. Smaran says:

    stop fighting & start seeing:
    Value of what you want to buy (@Wal Mart) will go up => Inflation, Eric wins.
    Value of what you own will go down (Home, Dollar etc) => Deflation, Mish wins.
    Simple.

  98. It would be nice to see an update on the topic by Eric!

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