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EXPORTED INFLATION & CRISES
One by one, imperial advantages are being chipped away. Over a decade ago, the US Economy became a net importer of critical resource supplies, most notably crude oil. Other important and strategic metals such as copper and titanium and cobalt now enter our country as raw materials. We still dig up the earth’s bounty, but not enough to be net neutral. Beginning in the 1970 decade, and rapidly completing the process in the 1980 decade, our industrial base has been abandoned as manufacturing processes were dispatched offshore, primarily to Asia, but also to Mexico. Lower labor costs were the attraction, and facilitated the offshore movement. We still produce end products, but not enough to be net neutral. The advent of our technological developments, worldwide computer network connectivity, improved foreigner science education and English speaking, all render our service manpower as vulnerable. US labor costs are a quantum level higher. Our sacrosanct service sector, on an accelerated basis, is now being sidestepped under the directive of cost cuts. Service functions, from low-level call centers to high-level skilled operations such as software design and accounting, are being outsourced to Asia, mainly China and India. Lower labor costs are again the attraction, and provide impetus for the outsource movement. We still provide wide-ranging services, enough to be net positive by about $5 billion steadily per month. The manufactured goods side of the equation reveals gaps almost ten times this size, to produce a net $41 to 43 billion monthly deficit. We have made big strides to become foreign dependent in recent years. Critical industries such as steel and automobiles are losing ground, and capital itself is imported on a grand scale. Decline of critical industries plainly jeopardizes our national security. America has had to resort to inflation, leverage, and financial engineering in order to create wealth and remain as the predominant world power and largest world economy. Its real engines of wealth (machines and people) have been either abandoned or circumvented. Let us not overlook how the USDollar currency, health care costs, higher corporate taxation, and more obstructive environmental regulations add to the cost of doing business within our borders. Now we resort to phony financial engines to produce what we falsely claim as wealth. While dependence has impinged our national security, we boast of working as the world economic engine. We depend upon foreign credit supply. Since the fall of the Soviet Union, no nation or region can challenge our military power. Military might plays a role with the annexation of Iraq, and the squatter claim on its oil supply. We seem to export crises with impunity, or else under the cover of ignorance. Few among the economic expert brain trust even detect a problem, at home or abroad. In fact, they recognize inflation, debt, and negative real interest rates as potentially a problem, but make no connection to the crises. POLITICS OF COLLUSION & DENIAL We must deny responsibility for having a hand in most of the world financial crises, if our prestige is to be maintained. We prefer to deny a centerpiece role of exported monetary inflation in the destabilization of the world economy. Its export is behind many, if not most, of world crises in the modern era. By resorting to a managed world currency system, major economies must “get it right” or suffer horrible crises. The source of the problem is the monetary system and its undisciplined issuance of credit, aggravated by central bank steroid-driven printing of money. Production overcapacity abroad is a direct result. Humans are running the asylum though, imperfect, driven at times by greed, by pursuit of power, and the lure of public adulation. Aristotle had this to say about managed money back in 340BC: "In
effect, there is nothing inherently wrong with fiat money, Just as the Roaring Twenties ushered in a decline of morality, so did the Roaring Nineties. Party hearty, dude! Pass a beer, or pass the bong. Rather than cite a litany of societal symptoms or political misdeeds, let us focus on denial of financial responsibility. Since the USDollar went to the Bretton Woods divorce court to enjoy (suffer) separation from gold in 1972, the cycles of boom and bust have grown in volatility. A primary vehicle of the boom-bust cycle originates from within the United States, despite claims otherwise. Our phony financial engines distribute monetary inflation in the form of private sector debt, federal debt, leveraged carry trade, real estate appreciation, and more. A key component to world economic growth is accumulated US Treasurys, either purchased directly (auction, open market, or intervention), or soaked up in sterilization efforts after trade surpluses are gathered by central banks. Foreigners can buy TBonds when they are first issued by our Federal Reserve to finance USGovt operations. They can buy TBonds during brisk trade in open daily markets. Their central central banks can intervene, create new money in the domestic currency (e.g. yen or euro), and immediately accept all the extra USDollars entering as export booty from trade surplus. Into foreign economies is sent “super money” from the United States. It acts like real money, and due to fractional banking practices, is multiplied often ten-fold when lent to businesses, consumers, and investors. If their financial leaders exercise unwise fiscally unsound policy, their monetary base can actually expand several times faster than our inflated capital export. The US Economy sends monetary inflation to foreign lands. We embrace a false sense of security, if not conceit, that we can stand insulated from the damage. Past experiences point to the contrary. The globalization phenomenon extends from commerce to financial markets, all connected more closely than ever. The Y2K event brought harmony to world economies, and Chairman Greenspan coordinated the distant financial music from the Fed podium. Since 2000, the world economy acts in unison, marching to the Fed drumbeat. We utilize no divine mental powers, to be sure. So like children in the back yard, we make a mess. Like genius gone awry, we make monster machines which break. Like bullies, we step on neighbor toes. Like misguided experimenters, we tinker with a system and risk having it break or turn against us. However, we keep the game going year after year, crisis after crisis, by denying our role in making the mess. We opened Pandora’s Inflationary Box at the Bretton Woods divorce. We unleashed funny money and encouraged imbalances as capital sloshes around the globe with little stability. We dread “hot money” while our printing press continues to pour it out. We over speculate at home, while they overbuilt abroad. Before the China boom, foreigners had overbuilt their industrial base. As foreign investors own a larger share of our Treasury debt, we risk hot money fleeing our homeland. We celebrate the printing press, but deny its role in creating crises. What follows is a partial list of crises, with a sketch of how we encouraged or caused them. We do so with inflation, control of world bank institutions, and political power implicitly enforced by ownership of the largest economy and by control of an unchallenged military. When it comes to keeping inflation under wraps, the US financial system is like a bedridden hospital patient, hopelessly incontinent. He messes the sheets constantly. What has been inflated in the body economic are the US bladder & bowels, and foreign muscle mass. The current danger is for exported inflation to return to our shores. That process has begun. Its signature is finished product prices held down, and rising raw material prices (BOTH DEFLATION AND INFLATION). DENIED US ROLE IN FOREIGN CRISES Japanese Economic Bust (1989) Following a decade of US manufacturing being sent to Asia, Japan grew as a powerhouse to become the second largest economy. Much of the original offshore mfg movement had its destination in Japan. Their automation processes, lower labor costs, ample finance, and clever conglomerate organization enabled them to develop quickly. But was their growth too fast? Japan built their economy according to the US model. They employed fractional banking, whereby ten times as much new money can flow into the economy as is supported by reserves. The reserves came largely from export surplus and personal savings. The Japanese are the world’s premier savers. However, industry overbuilt. As profits flowed, their stock market and Nikkei index soared to crazy heights, amplified by margin debt. As the national wealth rose sharply, real estate prices, both residential and commercial, went out of sight. After Black Monday 1987 in the USA, Japan’s miracle quickly dissolved. The Nikkei fell 80%, and property fell 50%. Their bank system went underwater, technically insolvent, worthless, destroyed. Our crises were linked, and had much the same causes. The source of capital which fed the Japan Miracle was exported US trade surplus and national savings. Control of credit extension was lost entirely. One method driving the process was speed in product development, which at times began with US Patent submission. It might be no coincidence that the Japanese banking system has staged a revival only after the display of Chinese flexed muscles. Japanese banks hold giant blocks of Nikkei stocks, rather than giant tranches of bonds. They endured suspended animation, or a coma, for over a decade until a new outsized trade surplus was realized with China. Japan is in recovery mode, but perhaps only as long as China expands. For a couple of years, that sounds like a one-way bet. The USA acknowledges almost no responsibility. We claim the Japanese mismanaged their growth; they pushed a stock market until it blew up in their faces; they speculated to excess with real estate; their banks were undercapitalized; they built roads to nowhere; they subsidized $5 peaches. However, the United States was at the time a mature economy who had adopted and nurtured the Japanese. They mimicked our irresponsible investment tendencies in assets. They duplicated our fractional banking methods. They repeated our Great Depression sixty years earlier. We fed them the seed capital from our inflation machinery. Thailand, Korea & Asian Meltdown (1997) An argument can be made that the Asian Meltdown was but an echo of the Japanese Bust. The weak link was Thailand, whose export surplus also accumulated a mass of funny hotmoney from American origin. Stir with fractional bank lending, mix in real estate excess to build entire empty cities, and poof, a meltdown. It quickly spread to South Korea, whose currency and stock market could not withstand the assault of speculators. The taste of blood was in the FOREX waters. They melted down. The USA acknowledges almost no responsibility. We claim that the PacRim economy was not mature enough to withstand the jolt. The pathogenesis was similar to the Japanese bust. We fed them the seed capital from our inflation machinery. Long Term Capital Management (1998) Take a strong-minded Wall Street bond investor, bring in a Nobel Prize winning financial mathematicians Black & Scholes, hatch a hedge fund firm, mix in mammoth amounts of investment money, multiply by mind-numbing leverage, toss in sophisticated gaming rules, assume three-sigma events never occur, and stand clear. The founder, John Meriwether, was a legendary trader who, after a spectacular career, left Salomon Brothers following a scandal involving US Treasury bonds. This had not tarnished his reputation or dented his confidence. Asked whether he believed in efficient markets, he replied: "I MAKE them efficient." The new firm had $5 billion in capital, and balanced $200 billion atop that sum. The dark underside of inflation is leverage. LTCM used leverage with cantilevered giant spades. The Asian Meltdown circled the globe. Dominoes delivered a lethal blow one year later in the form of a Russian debt default to the big New York money center banks. LTCM folded and folded fast in the quickest private decimation of capital in Wall Street history at the time. Responsibility is handed to the LTCM founder and his rigid rules, which could not foresee rogue events. The speculative machinery is not even scrutinized. The leverage upon leverage was incredible. Commercial loans worked at 10-20 times leverage. Futures contracts multiplied the leverage by a factor of 25-35, depending upon the contract. That is 200x force acting on a relatively small capital base. Amazingly, Meriwether was not banned for life, in the wake of a state-sponsored bailout of a private firm. A bad precedent was made. The same sort of hedge fund speculation continues. Therein lies the absence of responsibility. Wall Street refused to clean house. A reckless leverage engineer continues to ply his trade. China Buildup (1999 to present) The story of China is a magnificent walk from communism and its tight control, to a one-party system and an embrace of capitalism. Kurt Richebächer made a remarkable observation last August over an outdoor dinner in coastal Cannes. In response to my comments about the machine tools business, state-of-the-art design systems, advanced robotic control, talented but plentiful labor, foreign direct investment, and zero debt burdens, he made his reply. “The Chinese are the real capitalists now, not the Americans.” The 1999 grant by US Congress of Most Favored Nation status was not thought through very deeply. The grant unleashed a renewed wave of offshore mfg which even submerged the Mexican border enterprises. The AFL/CIO can find little satisfaction from the NAFTA backfire to domestic labor, since China has taken the game to a more grand level to exploit its labor costs at one quarter the Mexican costs. China employs enormous foreign direct investment capital, half of which originates from US firms. They use fractional bank lending to an unknown degree, since banks are not open for scrutiny. As the Federal Reserve provides massive monetary stimulus, as the Wall Street leveraged machinery turns its gears, as bond bubbles power the carry trade and inflate the housing market, little attention is paid to the finances behind China’s expansion. Three major factors are at work, and comprise a cascade of inflation in unison. 1) China generates its own profits, from which business investment is seeded. Foreign firms (a list as long as your arm) invest directly in mfg plants and more. 2) The lion’s share of tangible physical investment in China comes from the $130 billion in annual US trade surplus. They have a surplus with the European Union also, one sure to grow if they peg their yuan currency to a basket led by the euro. 3) At least $150B in total, possibly more, feeds the Chinese giant banks, and provides it a source of “super money” from which to multiply via fractional banking if it so chooses. China has copied the inflation-powered growth apparatus of both the USA and Japan, more so their Asian neighbor. A good argument can be made that Chinese equipment demand and consumer product demand might be the chief reason behind the Japan revival and renewed solvency of its banks. The majority of export demand in South Korea and Taiwan can be traced to invoices from China. Chinese economic expansion, driven in large part by exported US inflation, now puts huge pressure on a wide range of commodities. Demand for crude oil, copper, steel, lumber, grains, and soybeans now puts prices under stress, to the point that US firms must react to and absorb higher production costs. Quietly, China has opened the Shanghai Gold Exchange for public ownership of gold. Their bank leaders might be accumulating gold for a yuan birth on the FOREX in future years, backed by gold. This will happen only when China bears a much reduced reliance on export markets. My guess is the timing coincides with further growth and maturity of its middle class. In the meantime, our exported inflation quickly results in higher production costs, as our firms compete with Chinese firms for materials. Soon, many expect higher import prices for Chinese finished products. We will see inside the USA greater pricing power when China enforces it. That step is precisely in progress now. As the Japanese yen continues its appreciation in time, the US Economy must contend with higher import product prices across all Asian sources. China, with its rapid growth and dominant role in Asia, has ensured an accelerated pace for the roundtrip of our exported inflation and its full circle return to our shores in the form of commodity demand. A year ago, and two years ago, I predicted that China would be a daily news hot topic, a major force, and a scapegoat in 2004 and 2005. We are here. Their growth and influence was easy to see for anyone who took the time to examine trends. Instead of recognizing and admitting our role to utilize a giant inflationary engine, and to make large capital investments in China, we observe domestic job stress due to offshoring mfg and outsourcing services and make calls for trade sanctions and other protectionist measures. We also blame China for driving up the price of crude oil, copper, steel, lumber, grains, and soybeans. Tariffs, friction, and retaliation are the likely outcome, not curtailment of our inflationary engines. Argentina Collapse (2001) The story behind Argentina brings two major forces to bear, each a principal factor in its economic and banking death spiral. The story is similar for Mexico and Brazil, where the other shoes have yet to fall. First, they paid for their federal govt deficits in the 1960 and 1970 decades by simply printing money. We now give that practice the legitimate label of “monetizing” debt. The quick relentless reaction was not just inflation, but hyper-inflation. Argentina endured over 100% inflation rates annually. In the late 1970’s the USA came to the rescue and lifted their financial system with fixed loans. Giant money center banks like Citibank, JPMorgan, and Fleet participated. In Europe, Barclays and Deutsche Bank joined. In the ensuing years, those loans failed in default. Former Treasury Secretary Nicholas Brady, who served from 1988 to 1992, devised new bond securities to address Latin American credit distress. The key was their securitized nature, which enabled them to be investment vehicles, trade freely, and fluctuate in value. They were called Brady Bonds, collateralized by U.S. Treasury zero-coupon bonds. The USA enjoys the luxury of securitizing Treasury bonds, but exporting them with their attendant risk and problems. Argentina could not contain the risk by inflating, then inflating again, as does the US financial system. Brady, in association with the International Monetary Fund and World Bank, sponsored the effort to permanently restructure outstanding sovereign loans and overdue interest (in arrears) into liquid debt instruments. The move was highly successful, but not repeated. Because the Brady Bonds were backed by zero-coupon bonds, repayment of principal was insured. Similar bonds were used to bail out and restructure debt for other nations, such as Brazil, Mexico, Costa Rica, Uruguay, and Ecuador. The practice even extended to the Dominican Republic, Eastern Europe, and Africa, but on a smaller scale. Although these bonds were sound, Argentina made a deal with the devil as new debt was racked up. Harsh strict rules imposed by the IMF ensured that economic stimulus (namely, inflation via printing press and debt extension) was removed or held in check. At the first sign of trouble in 2000, foreign money left the bank system rapidly. In fact, so did domestic aristocrat money depart, while rules were imposed to limit plebeian withdrawals. Their bank system collapsed, exposing the raw features of fractional banking. Depositors (such as my sister-in-law) could claim only 10% of their money held in savings accounts. That is, after given the runaround, forced to wait in lines for hours, and being shuffled from one bank to another, in a cruel game that invited depositors to give up, go home, and abandon savings. To this day, Argentina’s federal debt is managed by installment loans, much like a car loan amortized over a few years. Balances have been written down, in exchange for concessions on budgetary discipline. Brazil threatens default so as to receive loan balance writedown concessions. Uruguay received a $1.5 billion bailout in August 2002. The USA denies responsibility. Brady Bonds worked well for a time, but as a patch on the failed system. IMF imposes draconian measures which ensure economic distress from the spark lost from inflation. The International Monetary Fund has been accused of being a Manhattan bank lackey. It actually forbids creation of new money backed by hard assets like gold, a revolutionary move back to the 19th century. Amazing. DENIED BANKING ROLE IN DOMESTIC CRISES We Americans are hardly immune from our inflationary wreckage. Sure, we export it, as above rants claim. We have our share of crises domestically. The Great Depression occurred less than 15 years after the birth of the Federal Reserve. Following a stock rally in the face of a falling USDollar and rising interest rates in 1987, Black Monday reversed another inflationary bubble. The Savings & Loan Collapse in 1989 occurred after unchecked mortgage expansion. Leveraged bond speculation during Fed accommodative periods is nothing new. We saw it go willy nilly from 1991 to 1993, in reaction to the Gulf War recession. As it does now, the carry trade generated huge profits for the speculative crowd, the Manhattan Made Men. When the Fed began its rate hikes a decade ago, experts attempted to sooth nerves with promise of gradual rise in yields and assurance of orderly bond market response. What we witnessed in 1994 was the biggest bond revolt in modern history. They offer the same reassurances now, when the destruction is likely to be much worse. The M.O. is the same: the insiders in tailored suits get out first, while urging the public to hang in there. One should note that if markets are selling off BEFORE the Fed hikes, imagine what happens when we later wonder whether the Fed has FINISHED its series of hikes. The upcoming crisis will not be seen as the aftershock from the stock bust. Nor will it be seen as the inevitable outcome of three years of more inflation and easy money. We treat inflation’s ills with evermore inflation. Every single analysis, every single crisis response, is met with the kneejerk conclusion: treat it with more inflation. Few attribute the great stock bust of 2000 to inflation and its inevitable response of bust. We hear of over-eager technology speculation, rabid telecom expansion, excessive USDollar appreciation, foreign participation, public 401k pension contributions, and a new millennium accident. Greenspan turned his back on addressing irrational exuberance, and we saw the outcome. He cheered the New Economy myth, only to see it fade, something he still cannot properly perceive as he justifies the New Macro myth. The Fed kept the punch bowl on the party table too long, and we got drunk. The hangover is a chapter of historical annals, along with Greenspan’s legacy. Post-mortem claims of an unrecognizable bubble when inside it come across as pure nonsense, if not grand banker rationalization. The present punch bowl has been replaced by a punch trough, a vast pool from which all can drink across the globe. We have brought new meaning to global trade, i.e. carry trade. SCAPEGOATS AT THE READY Plenty of them to go around. My favorites remain Chinese exporters, FOREX currency traders, OPEC oil producers, and Al Qaeda Islamic terrorists. We cannot fix blame where it belongs, on our inflation machinery, dangerously subject to backfire to both the operators and to bill collectors. Nothing but a climax crisis can stop our inflation machinery, from discredit. The crises will continue, one after the other, the grand real estate decline being the upcoming headline story. A colossal destruction of wealth awaits. NEWS TIDBITS Saudi Arabia announced intentions to increase production by 1.5 million barrels per day across OPEC. Their oil minister said a price reduction was essential so as not to choke off the economic recoveries. Markets might suspect that, like the Fed, OPEC’s main weapon is TALK, not action. Gasoline prices are up 10 cents in the last two weeks, now at an average of $1.93, on rising demand, but also seasonal environmental regulations. USAir ponders bankruptcy in response to higher fuel costs. Libya has opened itself up to contractors. Estimates are for $12 billion in oil facilities, with Exxon-Mobil, Occidental, and Conoco-Phillips in top positions. In support, at least $8 billion in construction is estimated, with Bechtel and Fluor in leading positions. Communications, banking, and tourism are also expected to bring large contracts. The “Great Man-made River Project” is planned to build 30 thousand wells across Libya, at a cost of over $5 billion. The Japanese stock index Nikkei fell by 5% overnight as the yen currency rose by over 1%. Chinese officials announced some details on their tightening measures. They will seek price controls on a limited basis, and will review the prices for projects and contracts. SunTrust announced a buyout of National Commerce Bank for $7 billion in a cash & stock deal, to extend their coverage of the southeast region. Cincinnati’s Fifth Third Bank was left as a bridesmaid to watch. Citigroup settles the WorldCom charge for $2.65 billion, but denies violations of the law. They increased their litigation reserves afterwards to $6.7 billion, up $4.5 billion. The name Jack Grubman, the WCOM analyst under investigation, did not come up in final agreements. Former NYSE chairman and CEO Grasso offered to return $48 million of his $188 million retirement package if the NYSE apologized for “destroying my reputation.” The offer was put forth amidst imminent Spitzer prosecution. The Federal Reserve fined UBS $100 million for engaging in business deals with Cuba, Libya, Iran and Yugoslavia, in violation of trade restrictions. UBS did not admit or deny guilt, but consented to the order. Seymour Hersh of The New Yorker magazine reports that Abu Ghraid prisoner supervision and interrogation went under Military Intelligence, displacing Military Police, under order by General Sanchez in November 2003. The photographs were taken by an MP who refused to participate. To the casual observer, use of dogs against naked prisoners smacks of Gestapo tactics, which our nation sought to end under the Saddam regime. Court martial trials are being scheduled. How high up in the chain of command were orders given? A bomb blast in Grozny killed 7 people, including the pro-Russian Chechnya president Kadyrov, during a celebration of the Soviet victory over Nazi Germany. A Chechen separatist group is blamed. US employment has fallen from 45% to 37% in the past three years, among 16-19 yr olds. A German 18-yr old man using the name “Sven J” was arrested for unleashing the Sasser virus. “Van Helsing” took in $54 million (#1 spot) in box office receipts, with “Mean Girls” and “Man on Fire” far behind. Comedian Alan King died at age 76, from lung cancer. Today's
Market Jim Willie CB
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Inflation
not only causes erosion to stored wealth, it creates false wealth like a
cancer. Worse still, when it is exported, international crises
inevitably occur. In recent years, extraordinary measures have been used
to hang onto to the alpha dog position. Ever reliable inflation and debt
have been the hallmark devices utilized, but unfortunately they exist as
weapons of mass destruction. Many authentic factors enabled the United
States to attain a world leadership position. The
“arsenal of democracy” was quite the reality during World War II as
our massive resources, industrial capacity, and manpower were marshaled
in the defense of freedom, against totalitarianism. The USA
prevailed, which set the stage for our nation to rise to geopolitical
leader, economic leader, and financial leader, not to mention cold war
military leader. Times have changed; the empire is fading. What the
heck, let’s mix metaphors. The inflation chickens are finally coming
home to roost, winging on both inflationary and deflationary winds. At
the same time, the timed sequence of recent crises is rising in tempo.
We lost all control all through the 1980 decade, and after 1995, when
crises occurred.
