The markets have begun their cautious retreat from recent highs. Both stocks and commodity prices fell overnight in New York. They are on their way down here in Australia too. What we don't know yet is whether this a gradual, measured retreat, or whether it is a long march to a new low...lower even than the March lows.
For these few steps back to turn into a tumble, the U.S. economy would have to take a second bigger dip. In other words, the flimsy green shoots of recovery would be ripped up by second recession. And this recession would be the equal, if not greater, of the first one that swept the planet late last year.
Funnily enough, Nouriel Roubini is predicting just this. Roubini told a Reuter's conference in New York that the economic recovery could be choked off in the second half of the year by higher commodity prices and higher interest rates. He said it would look a lot like the stagflation of the 1970s, with high unemployment to go along with zero economic growth.
Uplifting, isn't it?
But even under Roubini's scenario, there may be a few escape avenues. It comes down to figuring out what-if anything-will go up when the U.S. dollar resumes going down. In fact, the question on everyone's minds is what U.S. creditors will do with their money if they aren't lending into Barack Obama to spend.
"Over time," Roubini said, "the willingness of the U.S. creditors to finance U.S. spending and buy dollar reserves is going to be reduced," he said. "People are getting nervous rightly about us devaluing or inflating our way out of the debt problem and causing real losses on the holdings of those assets."
If you're losing money on an asset, naturally you're going to either sell of it, or at the very least, accumulate less of it. But then what? Where does your money go after that? We'd suggest the investment needs of the emerging market nations are the natural replacement for throwing away money in the U.S. Treasury market. Granted, there's risk in emerging markets. But it's now clear there's risk in the sovereign bond market too. Take your pick.
Speaking of those emerging markets, four of them spoke with one voice in Russia last night. The leaders of Brazil, Russia, India, and China gathered to figure out how to solve their dollar dilemma. Criticize it too much, you lose value on your current dollar-denominated holdings. Do nothing, you lose value on your dollar-denominated holdings as Obama and his Congress spend America into poverty and servitude...and then inflate like mad men.
"There is a strong need for a stable, predictable and more diversified international monetary system," the final statement from BRICs read. Russia's Dmitry Medvedev added his own two roubles, saying that existing reserve currencies, "have not managed to perform their functions."
And what is the function of a reserve currency? Well, it's probably the same as the tripartite function of any money: as a store of value, a unit of account, and a medium of exchange. Country's hold baskets of currencies (yen, Euros, Swiss Francs, U.S. dollars) in order to conduct international trade and commerce.
Of course all this is relatively new. That is, when money used to be a commodity (gold and/or silver) then a country's monetary reserves were the same as its precious metal reserves. Debtor nations that consumed more than they produced and borrowed to do so paid the price in a net outflow of commodity money.
It doesn't work that way in a fiat world. But what we're seeing now is that in a world where everyone uses fiat money, the whole system is, well, systemically flawed. As we invited you to consider yesterday, a world economy based on fiat money accelerates the depletion of resources and increases the likelihood that capital is going to be misallocated.
As reader Jack L. puts it:
When you have infinite paper, chasing finite tangibles, the infinite claims, which the paper represents, can only accelerate the depletion of the finite tangibles in the very long run. Especially if the fiat regime is worldwide, as it is currently.Before then though, there is the possibility of inflation, which can cure the extended demand for a little while, via the raising of prices, but only until such time as monetary officials (central banks, treasuries and governments) pump more liquidity in to try to increase more paper claims.
Therefore, the process of resource depletion is non-linear and dynamic, with the very long term trend towards accelerated resource depletion.
However, another question may be: Will the fiat monetary system collapse, before all resources are depleted & further misallocation of capital results?
Ah. Well that is a very good question. So good, in fact that we'll take it up at length tomorrow. In the meantime, is doing nothing the best strategy of all?
Yesterday's Age reports that. "A review of 12 million member accounts by independent research house SuperRatings shows that just 3.4 per cent of pre-retirement super savings have been transferred from medium- or high-risk portfolios to safer cash-style investments in the past year."
Translation: most Australians in the workforce have ridden out the GFC fully invested in medium- to high-risk share portfolios. Hmm.
"This is in contrast to those who have retired," the article continues "where many pension fund members have reduced their exposure to riskier investment options. The level of retirees' savings in cash climbed from 3.7 per cent a year ago to 14.5 per cent at the end of April."
Make of it what you will. What we make of it is that this isn't a bull market. It isn't a bear market. It isn't a market like any of us have seen. That's because the very foundation of the world's commerce and the currency in which it's conducted is shifting. The share market has no idea what to make of it because it is not clear yet who the winners and losers will be. A tip? Sell bonds. Buy energy. More on this tomorrow.
Dan Denning
for The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by G Bear on 17 June 2009:
Hmm, sell bonds you reckon? Like every other punter out there? I fully understand where you think it is coming from, but don't get too greedy. Ben at the Fed might get the inflation he wants for a while at least, but like Roubini points it, it will likey trigger the next wave down on the back of a swathe of home loan defaults. But it will be more about the market destructing well ahead of itself than actual inflation.
US inflation is far from a certainty, take a look at the last US money supply multiplier measured on 3 June, it is stuck below 1 at 0.86 times, which means money supply is not multiplying, its dividing, and that is delfationary, even after trillions in stimulus!
That's why Japan isn't worried about holding bonds, they know deflation when they see it.
Comment by mm on 19 June 2009:
Which one of the BRICs is the odd man out? India, China and Russia all have plenty of enemies and even border disputes with each other. If any country is going ton ride out this general crisis it will be Brazil.