Agora Financial’s Rude Awakening

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London, England

• Markets salute mounting unemployment figures,
• Resources and euros: just two alternatives for the Chinese dragon,
• What happens when rates go up again? And three other ticking time bombs…

Joel Bowman, reporting from Taipei, Taiwan…

Everybody is busy counting…but nothing’s adding up the way they want.

The Chinese are counting on the American’s not to clip their coins; Americans are counting on the Chinese to keep accepting them. The Chinese count on the Americans to buy their widgets; Americans count on the Chinese to loan them the money to pay for them.

The Chinese ask the Americans for some numbers, “some arithmetic.” The Americans squeeze and mold, cram the equations through their models and computers, but still the numbers come out the same: with a negative sign in front of them.

But sometimes bad numbers can be good, or so the market is trying to tell us. What would once have been terrible numbers are now reason for celebration and sighs of relief. Anything under half a million, for example, is apparently a wonderful number of jobs to lose in a month. Maybe we should get some of these newly laid-off people around for a party, to join in the celebration. They must be positively stoked to be part of such a “less-bad” statistic.

“The world’s largest economy has lost 6 million jobs since the recession began in December 2007,” Bloomberg reports, “exacerbating the biggest drop in any post-World War II economic downturn.”

Hmmm…Good number or bad number?

The report continues:

“Including those that have stopped looking for work because they are discouraged by employment prospects and those working only part-time who prefer a full-time job, the jobless rate would have jumped to 16.4 percent in May, the highest level since comparable records began in 1994, from 15.8 percent the prior month.”

Good numbers or bad numbers?

Well, the markets seem to like them, whatever that means. The Dow is back to where it started the year and the S&P is actually up a few percent. Measures from Dubai to Tokyo are racing ahead (though the former collapsed almost 4% today…proving our next point.) Stock markets, by their very nature, suffer from a very severe type of multiple-personality disorder. They are the collection of millions of peoples’ very own hopes, fears and delusions…all wrapped-up neatly in a daily print. And, because of those millions of clashing opinions, markets have a tendency to overshoot themselves.

The higher this rally goes, in other words, the harder we can expect it to fall when the next jolt hits.

In the column below, Bill Bonner does a little common sense arithmetic of his own. For all the details, please read on below…

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Fool on a Fool’s Errand
by Bill Bonner

Last week brought an entertaining episode. Wall Street’s man in Washington, incidentally Secretary of the US Treasury, was sent to Beijing. His mission: to convince the canny Chinese of something that everyone knows is untrue – that US bonds are safe. But if the Americans keep faith with China, it won’t be for lack of trying.

Of US government paper China has plenty. Bond holdings alone tote to $768 billion. Other dollar-denominated assets in Chinese hands add another $700 billion or so. Despite this Newcastle in its vault, the US would like China to buy more coal.

But lately, those dollar holdings have done poorly. Thanks, supposedly, to the economic rebound, the dollar has fallen against just about everything. Against gold, it is down 15% in 2009. Against oil, it is off 50%. As for copper, the dollar has lost 65% of its purchasing power. Thirty-year US Treasuries have fallen too – down about 27% since January. A rough guess is that China has lost more than $200 billion so far this year, thanks to the fall of the dollar and US Treasury bonds.

Martin Wolf, in the Financial Times, says these trends are signs of progress. “Rising government bond rates prove policy is working,” begins his line of thought. Spreads between corporate bonds and Treasuries are narrowing. Real yields on corporate bonds are falling while yields on Treasuries go up. “Normalization,” he calls it; investors now expect inflation instead of extinction.

The rise in inflation expectations is clearly visible in the US bond market, where inflation-indexed bonds are once again selling for substantially higher prices than their non-indexed cousins. Towards the end of ‘08, the bond market anticipated zero inflation. Now, the latest figures imply a 1.6% positive inflation rate over the next 10 years.

If inflation doesn’t show up as forecast it won’t be for lack of effort on the part of Mr. Geithner and his friends. The US deficit for the current year is $1.84 trillion. Every two months, the feds need to borrow nearly the equivalent of the previous entire year’s record- breaking deficit. And if private lenders balk, the Fed stands ready to raise its own hand at the next auction of US government debt.

The Chinese are worried. They’ve put a lot of eggs in the basket now being carried by Geithner, Bernanke et al. What if Team America isn’t as surefooted as it claims?

“It will be helpful if Mr. Geithner can show us some arithmetic,” said Mr. Yu Yongding, described as a former advisor to the central bank of China.

Mr. Geithner showed up with numbers, of course. From a deficit of 12% of GDP, the US plans to take its deficit down to 3%, he said. But when he delivered this solemn fib at the University of Beijing the students laughed at him.

American Secretaries of the Treasury are not used to being laughed at. Almost 40 years ago, a US Treasury Secretary – John Connally – expressed the imperial view: “it may be our currency, but it’s your problem.” Even after the crack up in the fall of ‘08, the US continued in the fantasy that it could lay off as much paper on the foreigners as it wanted.

The aforementioned Mr. Yu Yongding addressed this point directly:

“I wish to tell the U.S. government: ‘Don’t be complacent and think there isn’t any alternative for China to buy your bills and bonds… The euro is an alternative. And there are lots of raw materials we can still buy.’”

China is hedging its bets, buying assets that don’t have dollar signs on them. Along with shrewd speculators, they’re worrying about a government-fueled melt-up in prices. These anxieties – not a return to ‘normalcy’ – are sending the price of gold back towards $1,000 and the dollar towards $1.50 per euro.

Inflation, like cholesterol, comes in two forms – good and bad. The good inflation raises asset prices. The bad inflation raises consumer prices. No one complains when prices of houses and stock are rising. But when toothpaste and bread begin to follow, an alarum goes up. Soon, central banks are taking action to stop it – raising interest rates and credit standards. But this time it is different. Both types of inflation are welcome. Harvard economist Ken Rogoff says he advocates 6 percent inflation “for at least a couple of years.” It would make it easier for debtors to repay loans, he says. Economist John Taylor, of the eponymous ‘Taylor rule’ gives another reason inflation would be well met. He points out that running a balanced US federal budget – even 10 years in the future – would require a permanent 60% tax increase. “A 60% tax hike won’t happen,” he writes. “The government will attempt to inflate the problem away instead.” Even Warren Buffett told CNBC that the likely solution to America’s problem was inflation.

Yu countered: “You should not try to inflate away your debt burden…” But that is exactly what the US is trying to do. So far, it’s not good faith that protects China’s dollar assets. It’s a depression…and incapacity. The Geithner team tries to create inflation, but hasn’t yet got the hang of it. Give them time.

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[Rude Endnote: Markets across the Eurasia region traded mixed overnight.

European markets were mostly down, last we checked. London’s FTSE dropped over 1% shortly after the open as was down about 1.2% a few minutes ago. France’s CAC 40 was also off the pace, as was Germany’s DAX. Both were down 1.5%.

Here in Asia, Hong Kong’s Hang Seng kicked off the week with a 2.3% loss while Japan’s Nikkei 225 managed to gain 1% even. Down Under, the Aussies took the day off to celebrate the queen’s birthday. How embarrassing.

Over in the commodity pits, oil is down slightly at $67.70 per barrel while gold fell to $950 an ounce on dollar strength.

We’ll be back again tomorrow.

Until then…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com