Not done yet

I didn't manage to finish the article I am working on (70% done). I will tomorrow for sure.

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I now view hyperinflation in China as absolutely guaranteed. Zero doubt. China is abandoning all the measures it has put in place 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 deficit means that its base money supply looks set to double in 2009. There is also the fact that China's velocity of money is stagnant due to cash hoarding and can't slow any further. Finally, the commodity bubble has finished bursting, and China's economy looks set to shrink.

Every single factor in China suggest an enormous wave of hyperinflation will begin early this year. It is the event that will finally end the US's borrowing binge and the dollar.

Hyperinflation in China would be a monument event. Here are a two reasons why:

1) Because China makes most of the world cheap consumer goods, it will export its hyperinflation around the world. This will come as a shock to all those people who are expecting deflation. This means that no fiat/paper currencies will survive this . The only money that will retain its purchasing power in the face of Chinese hyperinflation is gold.

2) Since hyperinflation would hurt China worst than losing its exports to the US (millions of its citizens would starve as their savings got wiped out), China will drop its dollar peg and sell off its US holdings. While I have written about all the threats facing the dollar


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0 Responses to Not done yet

  1. Anonymous says:

    Yet gold prices keep falling. I guess most peolple don't beleive this could happen.

  2. Anonymous says:

    do not worry about falling gold price. Thanks to that you can buy even more bullion.

  3. Anonymous says:

    Where is the rest of this post?

  4. Yohay says:

    Interesting analysis. Currently, inflation seems to belong in the past. The West is lowering interest rate very sharply, without fearing inflation.

  5. Anonymous says:

    I'm not sure how selling USD holdings would restore stability to the Yuan. What would they buy with it? Commodities from abroad? Perhaps that could have some mitigating effect.

    I would imagine that selling USD holdings would only add to the instability as the US hyperinflates.

  6. "Where is the rest of this post?"

    It will be there tonight, about 6 or 7 hours from. It takes a lot of work to research major economic developments, draw conclusions from them, and then put those conclusions together in a way that is easy to read and understand. Sorry for the wait, but please be patient.

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

    "I'm not sure how selling USD holdings would restore stability to the Yuan."

    By dumping the dollar peg and selling its USD holdings, China would help contain domestic inflation in several 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 fall. That means cheaper commodity prices across the board.
    5) Dropping the dollar peg will make the yuan a major reserve currency. That means interests rates in China will fall as foreign central banks build up yuan reserves.

    These factors combined pretty much guarantee that China will be able to halt domestic inflation by dropping the dollar peg.

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

    "What would they buy with it? Commodities from abroad?"

    China would use dollars to buy:

    1) Its own currency, shrinking its domestic money supply
    2) Other foreign currencies like the euro (dollar reserves become euro reserves, etc). This will help those other currencies maintain their value against the yuan, and prevent Chinese exports to those countries from falling too much.
    3) It will buy gold. After the dollar's fall, central banks will find gold much more appealing. Gold can be used as a reserve currency without worrying about a foreign government printing more of it and reducing its value (like the US is doing with the dollar).

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

    "Yet gold prices keep falling. I guess most people don't believe this could happen."

    Not yet they don't. However, I will say this: when the gold rush finally begins, it will become very difficult, if not impossible, to buy more physical gold. This happens in all cases of hyperinflation, because, once a currency's value starts tumbling, everyone holds on to their gold and becomes unwilling to sell until the currency's fall stabilizes.

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

    "Do not worry about falling gold price. Thanks to that you can buy even more bullion."

    Agreed. No asset class will do as well in 2009 than gold. None.

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

    "Interesting analysis. Currently, inflation seems to belong in the past. The West is lowering interest rate very sharply, without fearing inflation."

    True, everyone is expecting deflation in 2009, probably because they haven't thought things through. 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 Chinese cheap consumer imports stop being cheap anymore, it will catch them completely by surprise.

    Inflation in China will force Wal-marts and other discounters around the world to raise prices. So Inflation in China means inflation in the US and everywhere else.

  7. Sig says:

    re: "It is the event that will finally end the US's borrowing binge and the dollar".

    If what your saying is, that basically the U.S. will be reduced to a third world nation than this could easily ignite WW3.No world power goes down without a fight. Never

    What say you?

  8. Mark says:

    Eric, thanks so much for your thoughtful answers. You have a blog of tremendous quality, one of the few on these topics where it is worthwhile dropping by every day. This inflation/deflation issue has been so frustrating for me to wrap my head around, and now I feel much less anxiety understanding what the future is likely to look like and how to protect myself. Thanks for all of your hard work.

    - Mark

  9. Anonymous says:

    I second the appreciation Eric, you're doing a great job and your analysis is well thought out and original.

    Many people think T bills are the last bubble to pop, I think not! Gold will be the last bubble to pop because when people exit the dollar in panic they'll go straight to gold.

    I like Jim Rogers take on gold he says if gold goes up he'll buy some, if it goes down he'll buy some more. His point is that there is no "best time" to buy gold. Gold is a STORAGE of wealth, kind of like a container that holds excess productivity you can use later. Gold freezes the purchasing power of your money NOW. Unless there's speculation in gold (which will happen after the T bill burst and the run on the dollar) gold just holds its value relative to other goods, commodities etc. in the long term.

    Inflation that is dollar inspired is what will drive the Chinese from their dollar peg. We saw a preview last spring and summer of inflation becoming a problem before this de-leveraging happened.

    Inflation will return in mass to the Chinese due to their excessive dollar holdings, and that will force them to let their currency float, certainly against us, which will effectively cancel our free trade relationship with China.

    we'll be on a "pay-go" system no more T-bills for toys.

  10. Anonymous says:

    A final thought on gold.

    Gold has held its own against alomost all asset classes EXCEPT the dollar. The dollar would fall flat on its face were it not for the fact that money velocity has slowed and run into "safe investments". So all the money the fed recently created along with all the liqidated money sloshing around is inflationary.

    Thats why inflation should be solely defined as when money is created NOT when prices rise. \

  11. "If what your saying is, that basically the U.S. will be reduced to a third world nation than this could easily ignite WW3.No world power goes down without a fight. Never

    What say you?"

    After WWII, the British gave up being the world's reserve currency without a fight. They were too indebted and dependent on US oil/goods to do anything about it. Same thing with the US today.

    The US is too dependent on foreign imports to threaten anyone military. All the world has to do to win a fight with the US is to stop sending us stuff. Without oil and cheap consumer goods from china, the US wouldn't even last 2 months.

  12. Robert says:

    I think you're right that China will decouple from the dollar and that will drive up the cost of consumer goods. I don't think commodities will stay cheap either though -- there's now almost a $10 difference between Brent Crude ($47.05) and West texas intermediate ($37.75). This is an absolutely huge difference - especially since WTI is a lighter blend and actually worth more. Although all the news articles are mostly still talking about how oil is going down in price this really only applies to WTI which is a tiny portion of the global market.

    I found another article about this on FT:

    http://www.ft.com/cms/s/0/47e6788c-e274-11dd-b1dd-0000779fd2ac.html

    Also, you can watch live prices on the ICE:

    https://www.theice.com/homepage.jhtml

  13. Great article robert. I will write an entry about it after I get some sleep...

  14. Anonymous says:

    re:After WWII, the British gave up being the world's reserve currency without a fight. They were too indebted and dependent on US oil/goods to do anything about it. Same thing with the US today.

    The US is too dependent on foreign imports to threaten anyone military. All the world has to do to win a fight with the US is to stop sending us stuff. Without oil and cheap consumer goods from china, the US wouldn't even last 2 months.

    You may have overlooked the fact that today, its considered a dual Englo-American world power that runs the show, not to mention nuclear armed. This could lead to a showdown.

  15. Anonymous says:

    Here's another thing to consider. If China and the U.S. collapse would no doubt cause a global meltdown. So the question is which country is going to rise up and become the new world leader?

  16. "You may have overlooked the fact that today, its considered a dual Englo-American world power that runs the show, not to mention nuclear armed. This could lead to a showdown."

    1) Do you have any idea how pissed off the entire world is going to be when the dollar collapses? Every nation on Earth is going to have most of their foreign reserves wiped out. They will not be in a mood to tolerate a US temper tantrum.

    2) Also, every nation around the world is going to be needing China's cheap consumer goods, but won't have any reserves to pay for them. That is going to give China a lot of influence.

    3) After the war in Alfganistand and Iraq, the US military is in no shape to fight with China (and Russia, which would side with China).

    4) Yes, the US is nuclear armed, but so is China and Russia. Do you really believe the US, lead by Obama, would lauch an unprovoked nuclear attack? Or even threaten to lauch one?

    "Here's another thing to consider. If China and the U.S. collapse would no doubt cause a global meltdown. So the question is which country is going to rise up and become the new world leader?"

    China mostly, with Europe, Japan, and Russia also playing a bigger role.

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