Great Depression Online Archive Issue:

Preparing for What's Next

Great Depression Online
Long Beach, CA
June 04, 2010

Inside This Issue You Will Discover…

*** Making Problems Worse
*** Get Use to the Manic Dynamic
*** Preparing for What’s Next
*** And More

Making Problems Worse

The world’s a frantic place…and it’s getting more and more frantic everyday.  Take smartphones, for example… 

Just several years ago, if you had a smartphone, you had an edge over your cohorts.  You could rifle off an email or two each time you used the can, clear out your inbox Sunday morning in church, and come to work after a three day weekend without a flood of emails greeting you like a bucket of ice water to the face.

But now that everyone has a smartphone, and the volume and velocity of emails has gone hyper, what good is it?

What was originally the solution to the glut of emails coming in each day has now exacerbated the problem.  Not only has it not solved the problem…it has made it much worse.

But that’s not all.  Consider paper money…

Get Use to the Manic Dynamic

Paper money is the decadent solution to the limits of nature.  Governments and bankers together can increase its supply faster than replicating cancer cells.  The problem of not having enough money has now been replaced with having too much money.

Of course, the money around these days lacks the scruples it once had.  Rather than cash in hand, it is now cash flow.  Rather than available savings, it is now available credit.  Rather than pay as you go, it is buy now pay later.  And rather than wealth accumulation, it is ability to service debt.  In effect, money has lost its integrity.

Currencies in today’s global monetary system ebb and flow like anchorless buoys floating on a sea of surging currents.  Some currencies rise in value while others fall in value…only to then rise and fall in value again.  Meanwhile, as currencies change in relationship to each other, prices of services and goods, as measured by each individual currency, change too

Economies are constantly changing and adapting to these shifting currency values and price movements.  And, as we’ve just witnessed, in the Greek debt crisis…instabilities are great and their consequences are swift.

We don’t like it…we’d rather have a stable money supply.  But this is the world we all live in, after all.  So get use to the manic dynamic.

For just how to go about it, we leave you in the fine company of David Galland, who will give you all the particulars on what’s next…and how to prepare for it. 

Enjoy,

M.N. Gordon
Great Depression Online

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Preparing for What’s Next

By David Galland, Managing Editor, The Casey Report http://www.caseyresearch.com/crpmkt/crpSolo.php?id=144&ppref=GDO144ED0510A

Oh, what a tangled web we live in.

On one side of the Atlantic, there is a fundamentally broke European Union.  On the other, the world’s largest debtor nation, these United States.

Rotate the globe and you discover China, the world’s most populous nation: a nation whose economy is desperately dependent on export revenues, without which its government may find it hard to meet the population’s soaring aspirations.  And who is China’s largest trading partner?  The European Union, that’s who.

The web also encompasses the role that the U.S. dollar plays in the relationship between the European Union and the Chinese.  Or, more specifically, the role the peg plays that China maintains with the U.S. dollar.  As long as the U.S. dollar is weak, the Chinese yuan is weak and therefore competitive in European markets.

~~~~~~Special Report~~~~~~

Harvard Economist Reveals How to Profit in the Next 12 Months from Rising Inflation.  Inflation is coming, he says.  The economy is going to get worse, lifestyles are going to change – but in the meantime you can still get very rich from rising inflation.

Find Out Here

~~~~~~~~~~~~~~~~~~~~~~~~~

The problem now is that, with the euro falling, in order to remain competitive, Chinese companies must reduce their margins.  Therein lies the rub, because the razor-thin margins of the Chinese companies – estimated to be on the order of just 2% -- face the very real danger of thinning to the vanishing point.  After which the best a Chinese company will be able to hope for is to make up its losses on volume.

That was a joke.

It gets more tangled.  Because as the euro falls, the competitiveness of eurozone companies on world markets rises, adding further pressures on the trade that China so desperately needs (and that the U.S. would like more of as well).  In this race to the bottom that the editors of The Casey Report have been warning of, the latest leg goes to the Europeans, though no conceivable improvement in their exports will offset the crushing debt burden that is now laying the continent low.

While this chapter in the unfolding saga may not end with the phrase, “And so it was that the eurozone collapsed and its common currency passed into the annals of history,” as this chapter is still being worked on, it could end that way.

Likewise, with China’s #1 market on the thin edge of becoming uneconomic, so, too, the current chapter might end with the myth of the Chinese miracle being shattered.  And the U.S.?

To get to a rational assumption about the U.S., we need to ponder the fate of the dollar, as this plays a mighty role in the global economy.

We begin our pondering by recognizing that, given the massive sovereign – and private – debt load, there’s no way that the central banks of Europe or the U.S. are going to voluntarily raise interest rates anytime soon.  To do so would be akin to Count Dracula voluntarily stepping into the sunlight.

Regardless of the wishes of the sovereign debtors, whether rates rise – especially when it comes to medium and long-term paper – is almost entirely driven by market forces.  And what market forces might cause rates to rise?

One is that the supply of new credit greatly outstrips demand. We already know that the U.S. is blowing out Treasuries in a manner not dissimilar to the way that the Deepwater Horizon well is blowing out crude.

However, dominating the news just now is the massive bailout organized by the European Union in an attempt to beat back the troubles besetting eurozone banks with balance sheets buried in the unpayable sovereign debt of the PIIGS – an amount that could exceed a trillion dollars.  This bailout will require, á la the U.S., a serious ramping up of the supply of eurozone sovereign debt.

With one important difference – while the situation in the U.S. is untenable, as it is not front page news, it is not urgent.

Therefore, at this point in the crisis, while LIBOR is on the rise, the U.S. Treasury is again enjoying a wonderful uptick in demand for its trash and that, in turn, is driving U.S. rates down and helping to prop the dollar up.

Still with me?

Getting circular here, we return to the fact that China’s link to the dollar means that its currency is likely to keep rising in relation to the common currency of its largest trading partner – the eurozone.  And per above, that risks shoving a stick into the spokes of the Chinese economy.

On that point, an excellent recent commentary by Eclectica fund manager Hugh Hendry included a quote by China’s Vice Commerce Minister Zhong Shan in the Wall Street Journal: “Water doesn’t boil if it is heated to 99 degrees Celsius.  But it will boil if it is heated by one more degree.”  And, “A further rise in the yuan by a very small magnitude might cause fundamental changes.”

A serious downturn in China will have big consequences.  For instance, as Hendry also points out, while China represents just 7% of the world’s GDP, it currently consumes upwards of 30% of the world’s aluminum, 47% of the steel, and 40% of the copper.

So what are we to make of all of this?  How are we to invest?

Until there is some semblance of clarity in just how badly banged up the balance sheets of the European banks are, and whether the governments of that region will be able to pull the oars in sync, the euro is in for a lot of trouble.  Counter-trend reversals aside, parity with the U.S. dollar is not out of the question.

That increases the potential for China to hit a wall, at which point the world will find itself facing a whole new set of problems.  Per many past comments on the topic, for us the myth of China has long sounded eerily like that of Japan in its now past glory days.  All of which is to say that, in the current chapter of the crisis, the U.S. dollar is likely to regain its aura of being the fair-haired lad of the global financial community, albeit a deeply dysfunctional fair-haired lad.

For commodity investors, that gives rise to the clear potential that the base metals and energy sectors are going to come under considerable pressure.

As will gold, if for no other reason than that when the trading herd sees the dollar rising against the euro, it reflexively hears “sell gold.”

Of course, with the “safe harbor” trade back in vogue, the U.S. government will redouble its efforts to paper over the nation’s systematic problems – a papering over that will only accelerate as it becomes apparent that the economy is headed for the next leg in the crisis.

While the timing is impossible to predict, I suspect that in a relatively short period of time (three months?  Six months?) it will become clear to absolutely everyone that the U.S. has no intention of changing its spendthrift ways, making it no safe harbor, at which point the show for tangible assets – gold, above all – will really get moving.

The way to play the situation is to follow our constant advice to have a heavier-than-normal concentration of cash in your portfolio and look to use corrections to steadily build positions in gold and the high-quality gold stocks.  And, as energy is also under pressure – pressure that would intensify if China stumbles – you need to be researching the sector now, with an eye toward building a solid portfolio in that sector as well. Not quite yet, but soon.

Now, having shared those prognostications, a caveat is in order.

Namely that no one can tell the future.  The best we can do is to examine the data and try to make rational assumptions. Those are my assumptions, but I may have overlooked many a critical factor in this immensely complex and interconnected world.

And, of course, more than just about any time in living memory, there is a heightened probability that a black swan might land and turn everything on its head.

Even so, a portfolio whose core is heavy with cash against near-term deflation and that gives you the flexibility to buy tangible assets when they get cheap… bolstered by a solid position in gold to ward off the effects of an all-but-certain future inflation, and a winner in crisis as well… and which focuses on a slow build of shares in high-quality precious metals and energy companies… should pretty much get you through any conceivable scenario that may come to pass.

Sincerely,

David Galland, Managing Editor
The Casey Report

P.S.  David Galland is managing editor of The Casey Report. He and his colleagues – among them investing legend Doug Casey and Chief Economist Bud Conrad– constantly analyze economic data, recent and historical market moves, as well as the news, to predict big-picture trends and find the best opportunities to profit from them.  Read about their favorite investment for 2010 – a play that’s an absolute no-brainer for all in-the-know.

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