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In trying to resolve the basic issue of where
prices go from here, we have to balance short‐term market momentum against the increasing drag
of economic reality and we have to weigh the price enhancing effects of
inflationary monetary policy and deliberate currency neglect against the
price depressive ones of a meaningful frustration of current entrepreneurial
assumptions. We then have to grope towards some tentative conclusions on the
vexed issue of whether the cycle in Asia (and, indeed, in Continental Europe)
has achieved sufficient automotive power for it to ride out any more serious
abatement of Atlantic Rim over‐demand.
To take these questions in the order presented,
we would never underestimate the Wile E. Coyote ability of leveraged enthusiasm
to defy the unrelenting force of gravity for a long, Looney Tunes moment. Thus,
the outcome will be signalled best by a combination of technicals and a more
subjective assessment of how much potentially explosive cognitive dissonance
has built up if increased bullishness actually does come to coincide with a
progressively deteriorating data flow.
Regarding the second factor, we can only
underline that we feel the price risks being run here by the central banks
are extraordinary. Not the least of these is the danger that the US will
provoke the fourth great reserve currency crisis in a century — the
previous three being the abandonment of the gold standard during the Great
War, the collapse of the gold exchange standard during the Depression, and
the break‐up of Bretton Woods
at the end of the Sixties.
Since this is a tale of the successive
adulteration of money and of the serial acceptance of a more bastardized
replacement when the burdens of the previous one become too much for
political expediency to bear, we can expect profound, if largely
indeterminate, consequences to follow — social and political, as well
as purely financial — if the ailing dollar does, indeed, end up being
widely forsaken.
A flight to real values might well be unleashed
in such circumstances, boosting prices of selected commodities — gold,
for example — to unheard of heights. Similarly, the full panoply of
protectionism, income support, and the direct administration of prices, which
is a likely policy response, could devastate others, either by promoting
wasteful over‐supply or by inducing
a nasty and protracted recession.
Finally, as for the possibility of Asian
insulation, our intuition is that the Sinophiles might well be right —
but perhaps not for another fifty years, or so. As regular readers will be
aware, our basic premise is that a producer‐led credit boom leads, in course, to a perilous
over‐expansion of certain
lines of business to the point that the relevant firms become utterly
dependent on further, ever more powerful injections of that same credit.
But if this hypertrophy has taken place anywhere
in the past eight years or so, it has done so in Asia. That is, the top of
the global (rather than the local) productive structure — the area
likely to be the most distorted by the credit expansion and hence the most
vulnerable to its later interruption — is no longer predominantly to be
found in the same sovereign jurisdiction as are the end customers for the
goods to which it helps give rise.
Inflation in the West has been much more a matter
of funding unearned consumption. As such it has prevented prices from
falling, but has shortened, rather than over‐lengthened the productive structure. The two main
exceptions to this have been in housing and finance, both of which are
currently paying the price for their credit‐induced gigantism.
Conversely, it is in the Asian manufacturing
centres and in the countries flooded with petrodollars, cuprodollars and
farreodollars in which the inflation has been directed into building and
equipping industrial plant, erecting office blocks, and laying down
infrastructure — all often on a scale which almost defies the
imagination. It cannot be wholly a coincidence that the rapid growth of
Chinese M1, for example, of 17 per cent a year compounded since the start of
2001, has been matched dollar for dollar with $1.2 trillion accumulation of
foreign exchange reserves under the nation’s crawling peg — and
this in a period when industrial output has trebled, exports have more than
quadrupled, and the trade surplus has risen 850 per cent.
If credit expansion and industrial export
capacity have not been engaged in an ever brisker paso doble in the Middle
Kingdom, then the mechanics of the process have obviously escaped us
entirely. It is worth recalling that, in surpassing the prior hegemony of
Britain, the US had achieved its own industrial and commercial pre‐eminence a good 30‐40 years before an economic
meltdown in Europe and Latin America (caused by the mass withdrawal of lavish
American credit facilities in 1928‐9) dealt a severe blow to goods exporters back home in the States.
This helped exacerbate the developing domestic downturn,
but not, paradoxically, before giving a last boost to soaring equity prices
on Wall St. as the funds were first repatriated (shades of China today?). The foreign ‘credit crunch’ was therefore instrumental in both triggering
the ensuing Crash and, ultimately, in worsening its consequences.
The parallel is obviously not exact, but there
are enough echoes of these earlier straitened circumstances to make us wary
of a similar denouement today. If a major devaluation of the dollar is what
we are to endure in coming months, foreign exporters will not necessarily
find that replacement consumers at home will want exactly the same mix of
goods and services as did their US customers, no matter how much the
formers’ purchasing power will have been increased. This means losses
will be widespread and adjustments non‐trivial, whatever the aggregationists might argue
to the contrary.
Conversely, those same US customers will be
largely forced out of the market if they cannot supplement falling real
incomes with the same easy access to vendor finance from abroad that they
have enjoyed to date, which is what an abrogation of present, dollar‐centric reserve arrangements
clearly implies.
Thus, even if the Fed were able to inflate with
sufficient determination to limit the impact on domestic dollar borrowing
rates (though this might be a particularly difficult trick to pull off at the
long end), this would only come at the cost of intensifying the pressure on
the already sickly currency and might, therefore, do little to support
already shrinking import volumes. The impetus towards an Asian slowdown would
be all but inevitable in such a case.
As for the home‐grown ramifications, it is little wonder that
Bill Gross recently told a TV interviewer that though he felt we were due
another year or two of broadly favourable conditions for fixed income, this
would be the last such occasion for a generation and that, even given his
expectation.
Sean Corrigan
Sean Corrigan is Chief
Investment Strategist at Diapason Commodities Management (Lausanne and
London)
Copyright © 2006 -
Copyright © Diapason Commodities Management - Sean Corrigan
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