Get a Life Loser

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It’s a wacky world. For the 13th consecutive month, output from European factories has fallen. Japan remains mired in a deflationary slump, with May consumer prices showing their largest monthly decline since 1971. New Zealand’s economy shrinks by one percent, making it the country’s worst recession in thirty years. And across the world banks like UBS try to replenish their capital with new equity while preparing for more losses in the second half of this year.

Yet stocks rise. Go figure.

We will keep our portion of today’s Daily Reckoning brief. With Michael Jackson’s death, we’re sure most people are tuned into the television to follow the day’s most important story. In the meantime, we’ll publish some additional insights from readers on fraudulent currencies, Chinese collapse, and on being a loser.

First one more quick note. Thanks to those of you who’ve written in saying I.O.U.S.A has already been screened on Foxtel this month. That’s true. We’re organising a one-night symposium on debt in Australia anyway. The one-hour discussion with a panel of experts will be preceded by cocktails and followed by the screening. Stay tuned for details.

And now to the mail bag. By the way, we’re sorry we can’t reply to all your e-mails. There are now close to 60,000 readers who get the DR Australia every day. We do our best to read and respond when we can. But the volume of correspondence is pretty large now. Here are some of this week’s best.

“Dear DR,

If this is an economic recession/depression/implosion…call it what you want…it’s invisible…where are the bread lines?…where[sic] are the blank eyed homeless mobs, constantly on the move?…where is the threat of war?…

I have read your blog for the past 18 months and now reject your monolithic message of imminent economic apocalypse…France has shown that an economy can get along ok/fine with an unemployment rate >10%…even taking into account your ultra pessimistic account that unemployment rates in western economies is nearer 15% that means 85% of workers are employed and doing ok/fine…

Do [sic] you think the 85% who are employed really care about the 15% who aren’t?…life goes on..world isn’t coming to an end, never was coming to an end….equity markets will eventually understand this reality and adjust accordingly…you can buy shares in good companies right now and sleep well

if you want to sleep with your gold, rub it, look at it..whatever! [sic]…go ahead, feel free…you will be the biggest loser in the end…one question?…if things are as bad as you say then why isn’t gold already worth more than a lousy $1000usd?

get a life loser

Hi guys

I am “a dear reader”, and I just want to share some semi-secret knowledge on this great idea [of negative interest rates to create inflation]:

I think I can tell you what happens when a nation realises they are simply being robbed. First, let me set the scene. During the fallout period that took place after the collapse of the Soviet Union, the leaders of the newly independent states were a basket case in many ways, but most prominently in the economic management area.

There were two radical changes that just happened due to their overall weakness: a nearly unbound real freedom of enterprise due to government’s economic illiteracy and loss of control over the economy, and nearly complete collapse of state financial affairs.

The currency inflation that followed ended up at about five extra zeros. I don’t have the statistics; I just keep two nickel coins of equal size, but with somewhat unequal numbers on them: “200’000” (dated 1995) and “2” (dated 2000, when the currency was already stabilised and pegged to USD, and zeros erased). So you get the picture of what happened between 1990 and 1995.

Yet, these five extra zeros had little effect on the monetary side of life. The spontaneous solution unofficially exercised by the entire economy was to stop using local currency altogether. It remained the official currency, but the US dollar became the real currency used by people and businesses, and universally accepted. The local currency was used for small everyday things, and only a small amount was kept for that purpose at any given moment. Whenever a person or a business needed it, they exchanged US dollars for it.

Whenever there was spare local cash, it was exchanged to USD. So the inflating local currency was not used for savings, real salaries, large purchases, or in any business affairs, until it was stabilised years later. Most of the economy switched to black or gray accounting. A typical salary was either pure black (paid in USD cash), or mostly black (paid in USD cash plus some token amount in local currency, just for the books), or grey (local currency equivalent of a fixed USD amount). All salaries in commercial organisations were nominated in US dollars regardless of how they were paid.

Whatever was paid in the local currency was converted into USD the same day. The opposite was used for any shopping: if one wanted to by a computer, the price would be stated in dollars, or later (after a formal ban on the practice) in “notional units” that were incidentally always equal to 1 USD.

At the same time, business taxes went far into surreal: some businesses had to pay over 100% if all done right. No business had a problem with taxes though due to an absence of visible taxable earnings, as all but peanuts was settled in USD (in cash and through offshore banks). Nobody used banks for savings, there was just no trust left, flat zero. There was no such thing as credit, too.

Businesses used credit at exorbitant interest, but for very short loans just to settle their trade transactions. There was no such thing as a mortgage or a credit card, so no one cared about interest rates. If a business wanted to take a local loan for a week at 100% annualised interest, that large number didn’t make any difference.

So my point is hyperinflation is a force so powerful that it doesn’t just burn savings and debts. It weakens or destroys the state that created it. Interestingly, the people and businesses are extremely
resistant to it, as they can adapt quickly and decisively to a new reality. That is, if they do adapt.

Hi Dan

I was interested to read your comments about China. I recently sent you an email that included an article from the FT that suggested that maybe China’s demand for resources won’t be as great as many predict. I also spoke about a few other possible negatives I see in the future for China.

At the moment nearly every economist or financial analyst goes on about the amazing growth potential of China and that that is the country to invest your money etc. Surely when so many economists agree on something one should be afraid.

It is well known that domestic consumption only makes up about one third of the economy and that China, like many other Asian countries, is hugely reliant of exports. Many people seem to think that the government stimulus package in China is going to help make up for the large drop off in exports but this is probably wishful thinking.

Much of this money will be siphoned off by corrupt officials and anyway why should Chinese fiscal stimulus work any better than it works (or doesn’t work) in Western countries? Chinese people hate to lose face so the government will probably be the last one to admit that China needs Western consumers more than any other country to keep its growth going.

But if the economic downturn is going to persist for some time then American and European consumers are not going to start consuming in a big way any time soon. It is a cultural thing for Chinese to save a large portion of their income and up to one third of their savings go towards their children’s education. These saving and spending habits aren’t going to change overnight so domestic spending won’t save the economy from a downturn either.

Who is to say that Chinese consumer spending won’t retrench as is happening in the rest of the world?

After all, unemployment is rising there as well. I have a friend who is married to a woman who was born in China and her parents have recently returned from a trip there and what they noticed was that the gap between rich and poor is increasing rapidly and that many people they spoke to in their village said that in real terms their wages had actually been falling over the past several years. They also noted that many people who had moved from the rural areas to the cities for work were now returning to their villages because they had lost their jobs.

So much of what is being done in China seems to be about not losing face and projecting to the world or to the Chinese people (so as to prevent social unrest) that things are going along fine in the economy. I have recently read an article in one of the Australian papers that quoted an official in China saying that even though steel sales and exports were collapsing and most steel factories wanted to lower production, they were being made to increase production so as to make local production numbers look good.

There was another article recently that told of how civil servants were being ordered to smoke more cigarettes and only Chinese brands to make cigarette production figures look good. Most of the banks are also being forced to lend money. In the first four months of this year banks lent more that their whole year target. Your own Chris Mayer recently mentioned in one of his articles that Chinese banks are potentially hiding massive amounts of bad loans. There have also been suggestions that a lot of the stimulus money and bank lending has found its way into the Chinese share market and into property speculation.

I was talking to a friend who lives in Hong Kong recently and he mentioned that the property speculation has increased massively there in the last couple of months, with the prices of many apartments increasing by 10% in the last six weeks. Analysts are now changing their forecasts for property prices in Hong Kong for this year from a fall of 5% to a rise of 18%. My friend said that house prices were literally going up with the share market. Some analysts are now questioning the quality of the so called economic growth in China. I note that even though the economy is supposedly growing, electricity usage is still falling, indicating less manufacturing activity. I’m sure it will only be a matter of time before the government works out a way to manipulate these figures as well.

One argument put forward for the great growth prospects of China is the idea of urban migration from the rural areas to the cities and the need for massive construction and infrastructure spending that will arise from this. However who is to say that this urban migration won’t be put on hold for several years if the downturn around the world continues for some time yet? After all, rural citizens aren’t going to move to the cities if they are seeing unemployed people returning to their villages having lost their jobs, which is happening now. Global trends have to have an effect on export driven China both in the short and long term.

Two more points worth noting. China is a resource poor country, although this hasn’t hampered Japan, and when in history has a country with a communist style government been greatly successful? Not very often that I can remember, especially if it doesn’t have the advantage of natural resources.

Regards,

Chris

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Second and third letters are very good, thanks.

    As for the first letter, I think that person didn’t read the articles about ‘economic restructuring’. Too bad for them.

    Reply
  2. Just keep on publishing the truth Dan with no hype and you will be doing people a favor. Unfortuneately the truth is not popular but then life wasn’t meant to be easy. You’re helping a lot of people…others just cant be helped. I have benefited a lot from DR’s essays. I have a direction and purpose which takes into account the best and the worst possibilities for the future.
    Thanks mate.

    Reply
  3. Why does everyone get so scared about deflation? One of the big reasons Japan has deflation now is things like oil, wheat and soy prices have fallen from the peaks in 2007/2008. It isn’t such a bad thing for food to be cheaper you know.

    And so why are stocks rising? Because stocks are a leading indicator of the economy. Come on Dan you know that. Stocks will rise when things stop getting worse not when things get better.

    Are things getting better? Who knows, but they ain’t getting worse ;)

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  4. People that bought silver or gold want the collapse to start right away and are getting impatient. There were 7 stock market rallies leading up to the great depression in the 30s… Who knows if this collapse will start next week or in 2 years. Patience.

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  5. Interesting letters. Are all three really Australian? The third clearly is. In terms of China’s global overreach we may sometimes be blindsided to the real possibility that China’s own domestic markets may keep fuelling its ascendancy. The US has managed to make that work for six or seven decades. Completely agree with your views on deflation, Greg. Great for consumers! I will however, keep planting food, just in case deflation is just a transitory phase…!

    Biker Pete
    June 27, 2009
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  6. Deflation Greg? It should terrify anyone with debt I think. And from government responses to the prospect, they are obviously scared witless by it. It would quite literally unwind the entire Western model for growth that is built around debt based purchases supported by a fractional reserve banking system. That actually sounds like a good thing to me? But every politician, recent Nobel prize winning economist, banker and debtor in the world (except Ron Paul?) would seem to disagree with me – So I must be wrong. Smile!

    I’d probably take a bit of issue with the middle letter Biker – By and large it is accurate. But where it states people are extremely resistant to hyperinflation??? People pretty much just survive it I think. The older ones get all their savings wiped out. The younger ones get to stand in food queues with them and wonder why there isn’t money to buy warm clothes anymore when the temperature is cold enough to freeze the moisture on your eyeballs. A mate of mine lives in Russia. His missus went through the bad times. And I’ve spent a little bit of time in Russia. Russians don’t whinge and moan about the 1990s – Not to foreigners anyway? But sometimes from a comment they’ll pass or an attitude they’ll adopt, you do get just a little inkling that the experience left some pretty indelible memories. But yeh, they are tough alright – I think the current GFC is a real cake walk for a Russian – Inflation was only 20% last time I asked. And things are “good”! The other interesting thing about them is that their culture had probably equipped them to cope with such a crisis in ways that ours hasn’t. We hear about Russians drinking a bit much – Sure, there’s truth in it. A sensible Russian knows that it is more fun having a few vodkas inside them than not – And they are pretty sensible people. So being inclined to tipple a bit is not the unforgivable sin it is here – But to be “mean” is about as close to an unforgivable sin as one could get. Where an example might be that if you walked in on a Russian having lunch and they have some sunflower seeds and an apple, you shouldn’t be surprised if they present you with the apple. A dumb foreigner just could say thank you and start to eat it? Or put it in their pocket for later??? But someone who is not “mean” would just automatically pull their knife out of their pocket and slice off a bit for themselves, and after commenting on how good it is, proceed to slice the apple up into enough bits for everyone who is present. I wrote too much. An indulgence. But I was pretty impressed by Russia and Russians – Leastways the older Soviet style ones who managed to get through the 1990s without turning into out and out crims and/or cut throat businessmen.
    Cheers!

    Reply
  7. I have lived though a few periods of deflation here in sunny Japan and there was no mass panic on the streets. The government might not like deflation but nobody complains at the shops :) Not sure it is a problem if you are in debt either if interest rates are almost zero percent :)

    Why is 1% inflation a good thing but 1% deflation a bad thing? Marc Faber was on about this on Bloomberg a while back and I tend to agree with him in that deflation can be a good thing sometimes.

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  8. And Paul Volcker would probably agree with you as well Greg. It would be the ideal for mine – Sometimes a few percent inflation, sometimes a few percent deflation – All balancing out to give things like income and price stability over time. But our lords and masters don’t want it. The fact they intentionally target positive inflation year after year after year tells us that. And the majority of the population probably don’t want it either – As I think you’ve pointed out to me in the past? Nah, people don’t like having to actually pay off their real debts – They’d much rather see them inflated away over time.

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  9. Inflation? Deflation? Pros and cons with both your positions, Ned and Greg. That Russian stoicism and willingness to share is certainly a cultural plus, Ned. Our personal position provides pluses if the Aussie economy inflates or deflates… so despite what Henry comes up with, we’ll tread a fine path in shifting our assets from one class to another. For the last couple of decades, my wife’s counsel has been to create _numerous options_ and several income streams; and to lead us into a more flexible state in which we adjust easily to changing economic conditions. She’s quite the best Financial Adviser we’ve ever had. I’d _never_ call her cheap, tho’! ;)

    Biker Pete
    June 27, 2009
    Reply
  10. I feel inflation and deflation are all part of the economic cycle. The more we seem to try and control things the more we seem to make a mess of the whole situation. Anyway if you are interested I am having a rant about deflation here: Is deflation really such a bad thing?

    Time for me to belt out a few songs down at the local karaoke bar I think :)

    Reply
  11. Get a life, loser?
    Jeez, I’m a loser who has now really got a good life, thanks to being motivated by reading the Daily Reckoning…Lost everything after being nuked in the Family Law Court, but now I live in the Eastern Goldfields, WA, and I have gold nuggets and coins, silver bars and coins, gold leases, prospecting licences, exploration licences, projects and prospects.. Jeeez, I still don’t have much money (yet) but I can see a big GOLDen light at the end of the tunnel of bad times, Love Dan’s writings in the Daily Reckoning, now I can see the big picture of where things are going, and I am Oh so happy to be into gold, I couldn’t afford to buy bullion, so instead I am accumalating gold assets by pegging them. Way ter go, Blokes! We’ll see who the real losers in life’s game are, over the next year or two…as economic reality bites hard

    Reply
  12. couple of points id like to make ,
    yes big ticket items may fall in price food i dont think will but one thing i know for sure charges for utilities are going up and fast .also the cost of council rates and the like , just paid my mooring fees increase from last year 25% plus .local and state govenments are broke and going to come after you for the short fall whether it be through rates or things like speeding fines etc …the reason i cant see food going down is fuel costs and the greed of the multi national companies greed . our $ sits at around 80c to the us $ yet petrol is $1.30 a litre .all the counties we export to are cutting back or going through major downturns that equates to less exports from here and lower prices for what we export so less income for the govenment .so before you cheers for the little aussie battler ( bleeder)think again.
    on the topic of bullion it getting harder to find and more expensive to get out of the ground … bullion doesnt change at all the currencies fluctuate . paper trading of bullion keeping the price suppressed but the day will come when people will realise that we rely on bullion for many everyday things and there aint enough to go around .till that happens i sleep well knowing i have the stack i do. its certainly doing better over the last 10 years compaired cash in the bank .or the stock market for that matter . cheers for taking the time to read this.. Harry

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  13. Inflation, Deflation and the next thing to expect would be hyperinflation due to the trillions of dollars being printed out of thin air and pumped into the economies. Yep, I am also glad I’m into gold and silver because if an economic collapse turns hyperinflationery gold and silver are going to the moon and those holding gold and silver then could become very very wealthy indeed.

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  14. Well Sam they pumped a lot of money into the Japanese economy over many years and hyperinflation was never a problem. By the way if hyperinflation does become a problem who exactly do you think will buy your gold? Do you think people in Zimbabwe have been using their precious wealth to buy gold?

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  15. Sam – Apart from my usual Yeh, I doubt it, Maybe, But thoughts I was going alright with your comment until I hit the last 6 words. Seriously! There is no way that holding bullion during a hyperinflation can make you wealthy – Trading it a lot when other people are panicking about one just could – If you are a skillful trader. But holding it, No, it doesn’t work like that – At best you might be able to hope to swap it for a similar amount of useful stuff to what you could have bought with it before the hyperinflation hit. (Even that is real doubtful – In hyperinflations there typically isn’t much useful stuff around.) But just assuming that you can, that hardly equates to some sort of wealth creation scheme.

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  16. Yep, I’m with Greg and Ned on this. The Zimbabwean analogy is something to think about… ! :0

    Biker Pete
    July 8, 2009
    Reply
  17. While I am a gold bug, I don’t follow the logic that we’ll see a huge run-up in precious metal prices due to inflation. We *might* but it’s no guarantee.

    Firstly, I see no clear evidence that there is any significant inflation risk in the short term. Long term, definitely, but in the short term, the inertia of credit destruction (debt defaults) exceeds the inertia of quantitative easing. It’s hard for me to see serious global inflation before Q2 2012.

    Secondly, I see no guarantee that – in an inflationary environment – money will take flight to precious metals. Some will, but why not some other tangible asset? Tulips, bricks and mortar, stocks, deck chairs, who cares? A lot depends on what the media chooses to spruik. If you put your money in a bubble that is inflating faster than net inflation, great! A gold price bubble would be no different to any other bubble.

    We have had inflation non-stop for decades and gold wasn’t the favoured inflation hedge. So why do people think it will be any different in the future? Why should precious metals become THE next big thing?

    Maybe it will, maybe it won’t. I don’t know because I can’t predict the future, I’m just saying that people screaming “IT WILL GO TO THE MOON” and then crying about conspiracies by the BIS, IMF, Fed, etc, when it doesn’t, should be a bit more realistic.

    I still recommend precious metals as a store of wealth, mainly because the quantity in the world is known and there is a definite floor to the price. They’re safe and relatively cheap. But I have been a gold bug for years, long enough to see it as a lifestyle choice. Maybe I can even convince the Mighty Mogambo to see it this way one day…maybe.

    Julian Tonti-Filippini
    July 8, 2009
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  18. The way I see things a hyperinflation is likely to be set off in a deflationary depression by people who have shown a preference in the past for inflationary policy (as is the case in the US). I’m sure thats the sole reason B.B thinks it likely. At this stage however its anybodies guess as to when this would likely happen. I reckon unlikely in the near term due to mortgage defaults and stocks depreciation.
    The talk of increased QE measures is back again with deflation fears running amock. So there is no sign of a change in the mindset of the powers that be (US).
    I would prefer a deflationary outcome to prevail free of any hyperinflation. From what I can see gold/silver is helpful for either scenario. However a hyperinflation will likely leave us all wretched and anything but rich.

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  19. You summed it all up very nicely Julian T-F. I’m not at all sure myself that precious metals are relatively cheap though – I certainly don’t think gold is. 20% overpriced maybe? Rhodium and Platinum could be different. But these are very uncertain times. And gold CAN be expected to carry a bit of premium.

    If one had been acquiring it for a decade or two I can’t see why they should be too panicked about adding a tad more on any significant dips though. That’s hardly likely to break the bank. I’m even quite happy to sit on the little bit I bought as recently as 2005 – Which is comparatively high risk. But I wouldn’t like to be converting the sum total of my worldly wealth into bullion right now – Smile!

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  20. Hi Ned, yes, ‘relative’ is a heavily hedged word. Relative to what? Relative to real estate in Australia, gold is cheap. Relative to history, gold is a little overvalued. Relative to the future? Then it depends on whether or not you think the worst is behind us (I do not).

    I expect another crisis and another round of global deleveraging before this is over. In that case all assets (including precious metals and stocks of precious metal miners) are overvalued right now, relative to the future bottom.

    Still, precious metals have an intrinsic value that is rarely factored into the price by markets and allows gold bugs to comfortably ignore valuation. Insurance. Precious metals can’t go bankrupt. The same cannot be said for companies, currencies and governments.

    Julian Tonti-Filippini
    July 9, 2009
    Reply
  21. Ah, with Aussie RE you are hitting me where it hurts Julian – Smile! I have a personal bias towards that asset class. Although, yes, I think it is overpriced too. But then, as you say, just about everything does seem overpriced right now – Except credit maybe? And I don’t personally want any of that. I guess I haven’t set my own personal financial goals too high regarding this GFC thing – If I can limp out the other end of it (whenever that might be) with about 80% of my inflation/deflation adjusted income earning potential from assets intact (as opposed to even the $ value of the assets themselves) I’ll regard myself as having done very well. I can certainly understand others hoping to do way better though. A lot of it comes back to one’s appetite for risk. And what their real goals are.

    Reply

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