Oil and Dollar decoupling - Good news for gold - Ron Paul was right

Note: I am not an investment advisor and nothing I state should be taken as investment advice. Please consult your own private professional financial advisor for help in making investment decisions.

The Independent newspaper out of Britain has an amazing article called 'The demise of the dollar'.

The gist is that the Gulf states, China, Russia, Japan and France plan to stop using the U.S. Dollar for oil transactions beginning in 2018. The dollar will be replaced by a basket of currencies that will include the Japanese yen, the Chinese yuan, the euro, gold and a new unified currency that will be introduced for all the Gulf Arab states. Brazil and India have shown interest in participating in such a transition.

This transformation will be a pretty big blow against the value and supremacy of the U.S. Dollar.

I subtitled this post "Good news for gold" because the article also states:

The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves.

That means significantly greater demand for gold may be on the horizon. If these "Chinese banking sources" are right. How far on the horizon is an entirely different question. Keep in mind that this transformation isn't likely to take full effect before 2018. If this article is trying to imply that these participating states will buy their gold with dollars, that will only serve to weaken the dollar further and push up the value of gold even more.

I also subtitled this post 'Ron Paul was right.' First of all, Ron Paul is a huge gold bull so there's that. More importantly, Ron Paul has publicly spoken about the oil-dollar relationship for a long time and he warned us that something like this was unavoidable quite a while ago.

I direct your attention to Paul's article: 'The End of Dollar Hegemony.'

Realizing the world was embarking on something new and mind-boggling, elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC to price oil in U.S. dollars exclusively for all worldwide transactions. This gave the dollar a special place among world currencies and in essence “backed” the dollar with oil. In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup. This arrangement helped ignite the radical Islamic movement among those who resented our influence in the region. The arrangement gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as dollar influence flourished.

This post-Bretton Woods system was much more fragile than the system that existed between 1945 and 1971. Though the dollar/oil arrangement was helpful, it was not nearly as stable as the pseudo–gold standard under Bretton Woods. It certainly was less stable than the gold standard of the late 19th century.

During the 1970s the dollar nearly collapsed, as oil prices surged and gold skyrocketed to $800 an ounce. By 1979 interest rates of 21% were required to rescue the system. The pressure on the dollar in the 1970s, in spite of the benefits accrued to it, reflected reckless budget deficits and monetary inflation during the 1960s. The markets were not fooled by LBJ’s claim that we could afford both “guns and butter.”

Brazil's economy on the rise

Note: I am not an investment advisor and nothing I state should be taken as investment advice. Please consult your own private professional financial advisor for help in making investment decisions.

The big news yesterday was that the 2016 Summer Olympics were awarded to the city of Rio de Janeiro. I say good for Rio, congratulations!

A lot of the media coverage around this story in the U.S. focused on President Obama's trip to Copenhagen to lobby the International Olympic Committee on behalf of the city of Chicago's Olympic bid. Clearly those efforts failed.

However, I was more interested in another angle: how this announcement relates to the Brazilian economy.

The 2014 FIFA World Cup is also being held in Brazil. The FIFA World Cup actually garners more television viewers around the globe than the Summer Olympics does. Unlike the Summer Olympics, which will take place almost entirely within Rio de Janeiro, the World Cup will be staged in twelve host cities across the country.

So two of the biggest atheletic competitions in the world (possible, the two biggest atheletic competitions in the world) will both be held in Brazil within 2 years of each other. This is great news for the Brazilian economy. Construction will create jobs. Brazil will likely see a multitude of tourists and foreign media visit its country and spend. Brazil will be forced to expand and build up its infrastructure. The economic "multiplier effect" of this infracture spending will likely be considerably greater than it would have been in Chicago, Tokyo or Madrid where infrastructure is already considerably built out and already of a relatively high quality.

The government of Brazil is planning on investing $11 billion into the economy as host. Some analysts have commented that Brazilian commodity producers stand to gain from the massive infrastructure construction. [1]

Reuters India is reporting that a Brazilian government-commissioned study is estimating that the Olympics alone will give the Brazilian-economy a $24.5 billion boost. Furthermore, a U.C. Berkeley study has found that countries that host the Olympics generally have a subsequent growth in exports. [2]

The news goes beyond athletics and international spectacles however.

Just yesterday, the Los Angeles Times reported that Brazil "is leading Latin American nations out of recession." It will have flat to slight growth this year and is projected to grow at a rate of 3.5% in 2010. Compared to another large, industrial Latin American country, Mexico, the differences are stark. The IMF is projecting that Mexico will contract an alarming 7% this year before growing 3% next year. [3]

Of course, these projections are based on the premise that Latin America is indeed going to enter a recovery phase next year. Thats not a given, although it seems more likely than the possibility that the United States will enter recovery next year, in my opinion. Regardless, its clear that Brazil seems to be out-competing many other Latin American countries and is emerging as a strong and dynamic economy in the region.

The Wall Street Journal is painting an even rosier picture. Its reporting economic growth of 1% in 2009, with projected growth of 4.5% to 5% for 2010. However, economists also warn about the dangers of inflation and higher interest rates (despite interest rates being at a historic low at the moment). [4]

I don't mean to sound like a rah-rah cheerleader for Brazil (really!). Brazil still faces major obstacles. The image most Americans have of Brazil is of violent slums, as depicted in the movie 'City of God.' Violent crime is a major issue facing the country. Much of the country lives in poverty and, of those, many are down-right destitute. As is the case in most Third World countries, political and civic corruption is endemic. It has a history of political instability. The list of problems that Brazil faces could go on and on.

However, I think theres some substance to all of the positive reports coming out about Brazil. Normally, when Americans think of large, industrial, developing economies we think of China. However, the Chinese economy is deeply intertwined with the troubled American economy and faces significant structural problems of its own. If you look at my post from yesterday on a possible stock market crash, you'll see that some analysts believe that there is a Chinese commodities bubble. Brazil has many of the positive aspects of an economy like the Chinese one but seems to be a bit less exposed to the type of risks that China faces. Thats my (uneducated) opinion at least, so take it as you will. At the very least, its an economy to keep your eye on.

Of course, who can forget Brazil's two most important assets (nay, national treasures): beautiful Brazilian women and beautiful Brazilian beaches. :)

Sources:
1: http://www.miamiherald.com/business/story/1264538.html
2: http://in.reuters.com/article/worldNews/idINIndia-42874720091002
3: http://www.latimes.com/business/la-fi-brazil-econ2-2009oct02,0,4409341.story
4: http://online.wsj.com/article/BT-CO-20091002-708835.html

Ten reasons for a stock market crash?

Note: I am not an investment advisor and nothing I state should be taken as investment advice. Please consult your own private professional financial advisor for help in making investment decisions.

The stock market has taken a dive the past two days. Will that trend continue? I don't know.

What I do know is that on September 24th, SeekingAlpha published an article written by Robert Baggio entitled "Ten Reasons for an Imminent Stock Market Crash." Was Mr. Baggio prescient with his article? Only time will tell but its definitely worth a read.

What are his ten reasons? Well, I encourage you to go over to SeekingAlpha and read the article for yourself but I'll give you a taste here. In my own words, his ten reasons are:

1. Rampant insider selling.

2. Much of the current rally has been (a.) based on trading in bankrupt companies (Fannie Mae, Freddie Mac, Lehman Brothers, etc) (b.) made up of investors trying to cover their shorts and (c.) of a low volume.

3. Most investors are short-term bullish and long-term bearish. Furthermore, market psychology does not currently correlate with the economic fundamentals.

4. A lot of the market is short on the U.S. Dollar and long on ... "everything else."

5. Household incomes are going down while the number of people living in poverty is growing. "Income dispersion" is growing.

6. There is a Chinese commodities bubble. The rise in commodities prices isn't because the Chinese economy is really growing as fast as it appears to be, its the result of the Chinese investing in commodities so as to avoid the U.S. Dollar. The Chinese business model is just as flawed as the American one.

7. Under President Obama we have more government intervention into the economy, there is increased protectionist sentiment and there are "socialist tones" to our political rhetoric.

8. The money supply and credit continue to contract at alarming rates.

9. The market is very complacent and everyone is (falsely) assuming that everything is okay.

10. The European economy is still in shambles despite proclamations from European political leaders that "the recession is over" there. To quote Baggio:
"What happened to Latvia’s currency crisis or the Swedish Banks? Are Hungary and Poland ok? Has the Austrian Banks’ exposure to Eastern Europe disappeared? Is Spain back on its feet? Is the UK solvent again? Are Irish banks lending like there is no tomorrow? How about Germany’s manufacturing base—is it solid with a EUR at 1.48 and the US consumer missing-in-action? Is Deutsche Bank’s $3 trillion balance sheet made up of only physical Gold? Are German banks profitable and healthy again? I guess somebody waved a magic wand and fixed all Europe’s problems overnight!"

This is just a very basic summary of Mr. Baggio's article. This summary doesn't do it justice so I encourage you to go over to the actual article and read it in-depthly.

So there you have it. Are you convinced? What are your thoughts on the future of the stock market?

Source: http://seekingalpha.com/article/163213-ten-reasons-for-an-imminent-stock-market-crash

What I'm Reading (9/25/09 edition)

*The founder and Chairman of Tiger Management, Julian Robertson, warned that the U.S. faces a financial "armageddon" if China and Japan stop buying U.S. debt or start selling off the bonds they already own. He advised that the U.S. should "quit spending, start saving, and scale backward."

I think hes probably right but how politically feasible is that? What politician would be willing to publicly promote austerity measures in the U.S. and could still manage to win elected office? Ron Paul maybe? Unfortunately that still seems like a long shot if we're talking about the Presidency.
Read more: US May Face 'Armageddon' If China, Japan Don't Buy Debt

*Citigroup is thinking about closing some of its branches across the country. Apparently Citibank has previously announced plans to close its consumer finance division (news to me). Citigroup's plans for revitalizing itself include figuring out how to collect more deposits and improving customer service. Ingenious, I'm sure it only took an army of consultants a lot of time and money to come to that radical conclusion.
Read more: Citigroup Said to Consider Shrinking Branch Network (Update 1)

*A research firm in Spain is predicting that the Spanish economy will continue to conract for the next three years. They state that the economy is likely to eventually lose 11% of GDP compared to its peak in this decade. Unemployment will peak at 25%. In other words, it is entering a full-fledged Depression. One analyst claims it will take a 10% reduction in salaries to make the Spanish economy better able to compete globally, but the trade unions and current government will fight to prevent any declines. Despite all this, the government continues to claim that the recession will be milder in Spain than in the rest of Europe.

Ambrose Evans-Pritchard blames Spain's membership in the European Monetary Union for having a big role in creating the crisis. Membership in the EMU automatically cut interest rates in half. If this recession/crisis continues, or gets more severe, I expect more cracks to appear in the European Union.
Read more: Spain tips into depression

China and the future of Gold

Note: I am not an investment advisor and nothing I state should be taken as investment advice. Please consult your own private professional financial advisor for help in making investment decisions.

The whole world is talking about gold breaking $1,000 in price.

Many people are asking: is this price sustainable? Where will gold go from here?

I can't really answer these questions myself as I'm not an expert on gold or on precious metals in general. I will note that gold is not really an asset in the normal sense, it is quite simply a form of money. So the question of whether or not gold will go higher can also be framed as "Will the U.S. Dollar (or whatever the currency may be where you live) go lower/weaken?" If so, then the answer is likely yes, the price of gold will go higher vis-a-vis that currency.

We all know the U.S. Dollar (USD) is in the dumps. The Federal Reserve's "quantitative easing" policy and climbing federal deficits are working a one-two combo on the USD. This makes me think that the gold rally isn't unwarranted and that a "gold bubble" probably isn't in effect right now, contrary to what some pundits have postulated.

A lot of news about gold has been coming out of Asia as of late.

To begin with, an Internet publication related to the mining industry and precious metals (Mineweb) is reporting that China's state-run Central Television network has aired a news program extolling the benefits of investing in precious metals and seemingly advocating that the Chinese public engage in precious metals investing by promoting the Chinese mint's bullion products. [1] A recent Wall Street Journal article seems to confirm this news report. [2] Several websites are repeating rumors first published by an employee of SinoLatin Capital, a merchant bank which specializes in transactions between Chinese and Latin American firms, that China may attempt to ban the export of gold. [3] These are just rumors and the author mentions that his firm has several Chinese mining companies as clients, so make of that what you will. All of this comes on top of the admission earlier this year that the Chinese Central Bank has been purchasing gold in order to build up its reserves.

If you want to get an idea of what the "gold mania" in China is like at the layman's level, I suggest you read this article. [4] Apparently you can buy gold at most retail bank branches in China and the Chinese mint is opening shops from which to sell bullion in many cities.

Elsewhere in Asia, it was announced today that Pakistan is abolishing import duties on gold in order to encourage legal imports of gold and discourage black market imports. [5]

Now for the "but." In the past I've mentioned the possibility of a debt-fueled deflationary depression in the U.S. (see Debt Deflation and False Dawns) I thus have to bring to your attention this article which states that in a deflationary decline gold would not be a good hedge. [6] The article's authors make a convincing argument, especially if you're a fan of the gold standard and a critic of fiat currencies.

Regardless of what happens in the future, my judgment right now is as follows. We have to remember that the price of gold is notoriously volatile. The fact that gold is so strong right now and so many people are talking about investing in it reveals how little confidence there is in the current financial order and how much unease and uncertainty continues to exist out there. That's the only conclusion I can positively take away from this situation at the moment.

Sources:
1: http://www.mineweb.co.za/mineweb/view/mineweb/en/page33?oid=88452
2: http://online.wsj.com/article/SB125249222381695221.html
3: http://www.commodityonline.com/news/China-may-ban-export-of-gold-silver-21219-3-1.html
4: http://www.sovereignman.com/finance/gold-mania-in-china/#more-650
5: http://www.dailytimes.com.pk/default.asp?page=2009\09\18\story_18-9-2009_pg5_11
6: http://www.speculative-investor.com/new/article060902.html

Indian Exports Seek New Markets

Bloomberg reports:

“About 60 percent of our traditional export markets are in recession,” Sharma told reporters in New Delhi today. India will be looking to expand its markets to “make sure that our exports remain competitive,” he said.

The worst global recession since the Great Depression has cut demand for made-in-Asia goods. Flagging exports are forcing Indian companies in sectors such as jewelry, textiles and leather to cut production, weakening an economy expected by the central bank to expand at the slowest pace since 2003.

The Trade Ministry will announce more assistance for exporters in a policy statement on Aug. 27, Sharma said. India’s exports dropped 27.7 percent in June from a year earlier to $12.8 billion, the ninth consecutive monthly decline. Exports plunged 33.3 percent in March, the biggest fall on record, according to Bloomberg data going back to April 1995.

That's a pretty disastrous drop in exports for India.

August 27th will be an important day. I would advise paying close attention to the markets; it will be interesting to see how they react. India looks ready to diversify to new export markets. Does this represent a decline in confidence in the U.S. consumer (and dollar)?

India is also relying on trade agreements with other countries in a bid to bolster exports as the global recession drags on demand.

India last week signed a trade pact with the 10-member Association of Southeast Asian Nations, a move that may result in trade between the two increasing to as much as $60 billion from $47 billion last year.

The trade deal is “positive from two strategic perspectives: to counter the influence of China in Asean markets and to improve India’s negotiating capabilities at an international level,” said Rohini Malkani, an economist at Citigroup Inc.

Are these the new markets India will pursue? Will we see increased competition between China and India? Just how much money will the Indian Trade Ministry devote to developing these new trade markets?

All questions that will be answered in due time ... This is certainly a bold move by India, or at least it seems that way from this preliminary announcement. If this pays off for India, we could see other countries follow suit and decide to diversify in terms of who they export to. Namely, it will be interesting to see whether or not China responds to this with its own initiative in Southeast Asia.

Reuters on the Fate of the Dollar

A few days ago I responded to a Reuters Blogs posting by writer Agnes Crane regarding the ongoing bull market for U.S. stocks. Crane's perspective was ultimately optimistic - she argued that, while American stocks would face volatility, the rally would continue.

I definitely took notice today when I cruised over to Reuters Blogs and saw a post by the same author entitled 'Getting ready for the dollar's fall.'

I'd like to respond to that article here.

It just won’t go away, this needling worry about the U.S. dollar losing its coveted top-dog status.

No matter that there are plenty of reasonable arguments to support the dollar as the world reserve currency — namely there’s just no alternative — for perhaps decades to come.

Yet, in a world where once-rock-solid assumptions quickly turn to dust, investors should keep an eye on the dollar since changing perceptions are chipping away at its cherished status as currency to world.

Much of the debate so far this year has centered on creating an alternative to the U.S. dollar, championed by China and Russia as a way to wean the world off its dependence on the U.S. as well as buffer individual nations against the missteps of those in developed world. Most recognize creating a new currency will take years and the chances of an existing currency, like the yuan, usurping the dollar anytime soon are remote.

I would argue that Crane needs to reflect a little bit more on her own writings as she answers some of her own questions.

Why won't worries about the dollar go away? Maybe its precisely because we live in a world "where once-rock-solid assumptions quickly turn to dust." We're living in historic times, as some would say. We have already seen a variety of banks, corporations and institutions that were all dubbed "too big to fail", well, fail. Now we have the financial media essentially telling us that the dollar is "too big to fail." And the public is supposed to believe that without question?

Crane also states that there is no alternative to the dollar. A few paragraphs down though, she points out that China and Russia are already contemplating alternatives. Her new argument is that such a large-scale implementation of a new currency would take a long time, years in fact. No doubt that is true. But if Russia and China were to announce their intent to create a new supra-national currency (more on that below) and begin reducing their dollar investments, that alone would destroy much of the value of the dollar before any actual implementation began.

In fact, I would argue with the very premise of this article. The dollar doesn't have to lose its reserve-status. Foreign countries, especially China, could simply begin investing in baskets of other currencies and move away from dollar holdings. That alone would provide a pretty big blow to the American economy in this economic climate.

But that doesn’t mean big money isn’t starting to prepare for world in which the buck isn’t the currency of choice.

Curtis Mewbourne, a portfolio manager at PIMCO, has suggested that investors diversify away from the dollar and to move into other currencies, especially those in emerging markets.

“And while we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative,” he wrote in an article published on PIMCO’s website.

Indeed, Bloomberg news has an article on PIMCO's report. Ms. Crane argues that implementation of a new supra-national currency would take a long time. Well, how about this: Bloomberg mentions that Russian President Dmitry Medvedev presented a sample coin for a new supra-national currency at a recent international summit. No doubt its a bit of political side-show but you're definitely not hearing news like that on the economic report of your eleven o'clock newscast.

The financial crisis, however, woke the world up to just how vulnerable those squirreling away dollars — like China and Russia — were to the fortunes of the United States. The bulk of the world’s currency reserves are in dollars, with the euro still a distant second. Foreign central banks, however, could hardly start selling dollar-denominated assets to limit their exposure because such sales would cause prices on their remaining holdings to fall further.

Here, Crane finally makes a good point in favor of her argument, one she should have made at the beginning. This is the critical dillema facing countries like China right now. Its something of a Catch-22. However, if the dollar's value keeps declining China loses either way, so eventually the cost-benefit analysis might tip and make reform the best option for China anyway.

That’s because the loss of reserve status means, among other things, that the United States would lose a crucial crutch that has allowed it to borrow its way into prosperity as well as out of depression with relative impunity. Foreign investment in dollar assets have helped keep a cap on interest rates even though the government’s borrowing binge in recent years has brought new meaning to the word stimulus.

Yes, a dollar dive would be pretty disastrous for the U.S. We would likely see the standard of living of the average American decline (further). The really scary question is ... if the dollar does take a dive where does the American economy go from there? 70% of our economy is consumption and that consumption would be severely impacted by a large decline in value for the dollar. This is why you have so many ultra-bears predicting Doomsday - the effects of hyperinflation would pretty much be ruinous. Of course, some are actually predicing massive deflation as I point out in a previous post.

In an op-ed published in the New York Times today, Warren Buffett railed against the flowing red ink that will push the nation’s debt to roughly 56 percent of GDP from 41 percent in this fiscal year.

Presumably this is something that has also caught the eye of foreign investors.

While the greenback is likely to stay on top for some years, persistent concerns about its reserve status and moves to diversify away from it could usher in a new era for U.S. borrowers, public and private alike — a more painful one where debt costs can no longer be offset by the kindness of foreign investment.

Indeed.

Although I've criticized this article and Agnes Crane, I actually find it quite refreshing that Reuters is tackling this topic. Its quite timely and quite serious but it seems like a lot of mainstream media outlets don't want to touch the topic, either because its too complex for the average American or because the implications are too scary. Overall I would say that this was a decent blog post.

Addendum: Spoke Too Soon on China/Australia

In my previous post, I pointed out the dependence of the Australian economy on exports to China. There, I said that as long as the Chinese government's stimulus program didn't change Australia would likely fare fairly well during the rest of this recession.

It seems as if I spoke far too soon.

I was just surfing through Reuters when I stumbled upon this news article:

BEIJING (Reuters) - The Chinese government is attempting to pass the baton of growth from state-funded infrastructure investment to the private housing sector, a risky but necessary move to sustain the economic recovery.

Construction cranes sprouting in big cities, busy furniture shops and soaring property sales all show that the transition is going smoothly so far, though officials are wary that house prices may rise too high, too quickly.

The rest of the article is about the Chinese government's fears about the housing market heating up too fast. No further comment is offered on how state-funded infrastructure investment is being reduced, if in fact it is. I don't know the intricacies of the Chinese economy enough to be able to comment on how this will effect Chinese raw materials imports from Australia. Nonetheless, this seems to complicate the situation and what I stated in my previous post.

Australian Economic Forecast

The Australian economy doesn't get much attention in the American press. Today, however, I found an interesting article from Forbes on the future of the Australian economy.

The good news is that the Australian economy is nowhere near as over-leveraged as the American and British economies are.

Australian activity has remained surprisingly strong during the global crisis. Monetary and fiscal policy were aggressively switched to stimulus at an early stage. Australian banks were never exposed to the same degree of risky lending as their counterparts in the United States and the United Kingdom. The strong fiscal position enjoyed by the government enabled it to extend guarantees to various parts of the financial system at relatively low cost.

The bad news?

Over the past two years China's share of Australia's merchandise exports has risen from 15-20%.

and

The sharp fall in Chinese exports has not resulted in lower demand for Australian resources, as China's fiscal stimulus has focused on infrastructure, for which Australia is a supplier of raw materials. Although export prices are down from 2008 peaks, total Australian merchandise export volumes have risen in the nine months to June.

So Australia is heavily dependent on the Chinese market for raw goods. Lately, the media has been printing all kinds of troubling news concerning the Chinese economy ... everything from the macro effects of slumping American consumption to the decline in the real estate markets of Shanghai and Beijing. However, China is importing raw goods that are to be used in infrastructure construction. As long as the Chinese government keeps up its fiscal stimulus program and keeps it oriented towards infrastructure construction, the Australian economy should be, more or less, fine.

So, for now, I think the Australian economy will face some pain, but, not quite on the level that the U.S. and U.K. are facing. Of course, if the entire global financial system melts down, this all goes out the window. That's a big "if" of course.