Monday, November 26th, 2007...10:18 am
Are Prices Rising or Falling? You Bet!
Ouzilly, France
- World derivatives market races towards a quadrillion,
- Inflation vs. deflation – an standoff of epic proportions,
- A poetic offering from Chavez and plenty more…
Bill Bonner, reporting from Ouzilly, France…
What comes after a trillion?
We ask because today brings word that the world’s derivatives have surpassed
$500 trillion. In other words, they’re halfway to somewhere. We suspect they
are halfway to Hell…but we don’t know how many zeros there are in the
netherworld.
When we left you yesterday…things were getting interesting.
The unstoppable force of inflation was about to smash into the immovable
object of deflation.
Today’s news tells us that the two are getting closer and closer. Pretty
soon, there’s going to be a collision.
Most newsworthy, Wednesday, the Dow sold off. Dow stocks were down another
211 points, triggering a Dow Theory sell signal. According to Richard
Russell, who keeps track of these things, stocks are now in a primary bear
market. As near as we can figure, that means that stocks will go down – until
they go up. We’ve never gotten the hang of Dow Theory, but some of the
smartest guys in the business swear by it.
Of course, it appeared to us a couple of weeks ago that stocks were in a bear
market. “The tide has turned,” we wrote. With earnings now falling…and
liquidity disappearing from the financial markets, generally…we guessed
that stocks would have to go down.
What this means, in a broader sense, is that wealth is ebbing away. When the
tide goes out, says Buffett, you see who’s been swimming naked – meaning, you
find out who’s forgotten to put on his shorts. Prices go down…and he finds
he has nothing to protect his most vulnerable parts. But even the investors
who were more careful lose money. Everybody loses money. And as Russell puts
it, the winner is just the guy who loses least.
When the tide goes out…all the assets that had been buoyed up by flowing
liquidity begin to fall down. Of course, we’ve already seen this in the
housing market – where, according to the latest reports, sales are off in 46
states…and prices are falling all across the USA, for the first time since
the Great Depression. “We still have not hit the worst point in resets,
delinquencies and ultimate losses on mortgages,” says a report from the OECD.
The United States is “on the brink of recession,” says the UK Times.
The fall of stock prices so far has wiped out a couple trillion in implied
wealth. The fall of the dollar has wiped out a couple trillion more.
Goldman Sachs estimates that the credit crunch will take out $2 trillion in
credit. And, of course, there are the direct losses from the credit crunch
itself…which could add another $300 billion or so. A trillion here…a
trillion there…pretty soon, you’re talking real money.
That’s the immovable object we’ve been talking about… prices fall…money
disappears. It’s deflation, with a capital ‘D’.
Meanwhile…the unstoppable force of inflation is heading our way. Prices
all over the world are heading up…
“Would you believe it…on the rue de Passy they have cakes in the shop
windows selling for 30 euros (about $45)?” said a Frenchwoman we met
yesterday. “They say inflation is low in France…but I don’t believe it.
Many things are as expensive in Paris as they are here in London…”
Below we take a look at the quandary of betting on prices…either rising OR
falling.
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Are Prices Rising or Falling? You Bet!
By Bill Bonner
First, the basics: China is a big country in Asia with a big pile of cash -
$1.4 trillion of it. Most of this currency features pictures of dead U.S.
presidents. The USA is a big country in North America that emits these
dollars, and uses them to buy things it cannot afford and doesn’t really
need.
Meanwhile, Americans owe more dollars than ever before. Until 1980, debt as
compared to GDP never surpassed 150%. Now it is 330%. Many people are finding
it hard to pay their debts. And many leveraged bets made on this debt are now
going bad, reducing the availability of cash and credit generally.
So, back to our views:
On the one hand…the world is awash in paper money. So much of it is gushing
into the world economy that prices – notably of oil and gold – can only float
up higher. And, the dollar, of course, is doomed by inflation. It will be
dragged down by the weight of its own numbers.
On the other hand, the world is caught in a credit crunch. The days of
reckless lending are over. Assets – real and imagined – are falling in value,
prefiguring a major drop in prices across the board. The housing industry got
nailed first. Then, property prices headed down. Finance was next. And then
technology. And now stocks, generally, are in retreat…with much further to
go.
Pick your hand.
The right hand is clearly working the pumps. For clarity, we turn to no less
an authority than Mr. Mahnoud Ahmadi-Nejad. You may recognize the name, dear
reader. Mr. Ahmadi-Nejad is the desperado in charge of Iran. He was in the
news this week, appearing in Monday’s Financial Times. A photo showed him
looking rather glum. Of course, you’d probably look gloomy too if Hugo
Chavez had his arm around you. Still, Ahmadi-Nejad managed to summarize the
entire post-1971 world monetary system so clearly and so precisely; it was
almost poetry. A haiku:
“They get our oil
and give us
a worthless piece of paper.”
Nobel Prize committee, take note.
Mr. Ahmadi –Nejad is not known as a poet nor as an economist. Still, he went
on to give graduate level instruction in central banking: “We all know that
the U.S. dollar has no economic value.”
How dollars came to have no economic value is a long story. How there came to
be so many of them is shorter; the dollar is the USA’s most successful
export. Americans are world champion spenders. They may make up only 5% of
the world’s people, but they do 20% of its consuming – in dollars. Central
banks, fearing that an over-supply of dollars will drive their own currencies
up, print local currencies, use the money to buy dollars, and add the dollars
to their reserves. This year alone, China has accumulated nearly $400 billion
of foreign reserves, mostly dollars. Indeed, it has so many dollars that the
Chinese are getting nervous. Wen Jiabao, China’s premier, told an audience in
Singapore:
“We have never been experiencing such big pressure. We are worried about how
to preserve the value of our reserves.”
Meanwhile, another headline from the FT told us that the greenback is under
attack in other parts of the world: “Dollar loses grip on Asian debt sector.”
“The US dollar has lost is status as the pre-eminent currency for fixed-
income products such as corporate bonds in Asia, a sector it used to
dominate…” said the story. The dollar itself fell to record lows against
practically everything – notably, the pound, the euro, and oil. And if the
Fed cuts rates again in December – which is given a 90% probability by the
futures market – the dollar will fall further…and prices will continue to
go up.
But, while the right hand pumps, the left knocks a hole in the bucket. Week
after week, more losses are announced. The latest tally by Goldman Sachs
estimates total losses at $400 billion from the subprime debacle, with a
total of $2 trillion of cash and credit sucked out of the financial system.
Leverage works in both ways, it turns out. When credit is expanding, a
deposit of $10 million can be levered into a $100 million gamble. When it is
contracting, a $10 million loss reduces the supply of credit by as much as
$100 million.
The drop in the dollar and the drop in housing prices have already cost
Americans trillions in implied wealth. It’s money that is going, not coming.
Says the Economist Intelligence Unit: “The main risk to the world economy is
a deflationary spiral in asset prices.”
Which hand will do the most damage? We don’t know. Probably both of them will
smack us sooner or later.
[Joel's Note: Bill Bonner is the founder and editor of The Daily Reckoning .
He is also the author, with Addison Wiggin, of the national best sellers
Financial Reckoning Day: Surviving the Soft Depression of the 21st Century
and Empire of Debt: The Rise of an Epic Financial Crisis .
Bill’s latest book, Mobs, Messiahs and Markets : Surviving the Public
Spectacle in Finance and Politics is available now by clicking here:
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Rude Endnote: A few weeks back we wrote a comment piece on the whole DP World debacle in the US. We followed it right through to the launch of the company’s IPO and listing on the Dubai International Financial Exchange. At almost $5 Billion, it is the largest ever in the Middle East.
Well, trading began today. Investors will be happy to see that shares are up almost 10% early in the day. That’s good news for forward thinking investors…bad news for paranoid protectionists. We’ll be glad to keep an eye on America’s most hated company in the future.
Cheers,
Joel Bowman
Rude Awakening
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