China Hedge Part II

Earlier last year I wrote a post about the China Hedge and there's further activity as the video shows.

Click here to view Video.

Is Gold in a mania? Is this the end of the bubble? Or are the Chinese ahead of the game yet again? The clip mentioned that China has now become the largest Gold producer in the world, surpassing South Africa (which incidentally has been in decline for a while now). The Chinese are digging like crazy for the stuff, they have been for years as the Government knows the yellow stuff is the key to their economic well being during the next 10-20 years. We don't have a bubble, but the Central Banks and Governments will create one here. George Soros aptly called it the 'ultimate bubble' and I agree. When he said this many looked at his comments and concluded that this meant gold was already in a bubble, but I never drew that conclusion, he's a smart guy. As it transpired later Soros actually added gold to his fund. Funds all around the world are increasing their holdings. But we are way off the bubble top, years away. 

The fundamentals for the bull market just keep getting better and the authorities apostles, such as Paul Krugman, keep telling us Gold bugs what we want to hear. Apparently we aren't doing enough. Right? We've been here before Mr Krugman. You've been telling that gruff to Japan for 20 years now and what have they got? Huge debts and a basket case economy. Get those interest rates lower, increase spending and get more money into the pockets of people. I forgot that prosperity was that easy.

China has also become the largest Gold consumer, which is another huge shift in the world. Ten years ago their citizens couldn't buy it, now the Government actively encourages purchases. You can't eat gold? You can't use gold? But you can't use or eat worthless paper tickets, promises of payment, that we call money. Bonds are a disaster. Housing is going to be a terrible way to hedge going forward and stocks, dear me, companies have that much state intervention Karl Marx would be proud. Only Cash is going to do worse than the list above. However Gold is outside the system. It's no ones liability. However stupid, despotic or mad our leaders become, it won't affect gold. 

We all await the China crash. Marc Faber seems to suggest sometime in the next 9-12 months. More market commentators have noticed. Hugh Hendry, Jim Chanos, Mish Shedlock with many of the underground economics forums also beginning to discuss the events that are happening. Evey Credit boom ends, and there is never the 'soft landing' that is always told, it always gets messy. However when China does run into difficulties don't think this is it. It will just be a setback, many of the above also agree with that concept. Unlike the West, China is starting from a very low industrial base, meaning there is still huge potential to grow. She will just grow her way out of problems eventually. Remember the US had huge issues as it rose to become the superpower. The Great Depression, the panic of 1907 and many financial storms throughout the nineteenth century. She overcame them all as it was from a lower industrial base and she borrowed money to produce not consume, similar to China. Of course when China stumbles what will happen to Australia in the short term? Many Asian nations - Japan, Malaysia, Vietnam? African nations such as oil rich Angola or Nigeria? South America, with Chile and Venezuela? Not only are the Chinese buying gold but they are forming huge trade links around the world and also practice a form of check book diplomacy. They use their monetary reserves and labour to build infrastructure for such countries to access the natural resources they need and buy some friends while they are at it. 

The Eurozone, Chinas biggest importer won't be doing the country any good with what's happening there. Previously I contemplated that Euro members could leave as they can't adapt to the Germans mentality. However I now think its the Germans, the strong rather than the weak, who will leave! I mean the recent bailout is a complete disaster - no one has the funds to pay for it. This will just further undermine the Euro in the long run. I think it may now be more likely that Germany will leave as there are more mutterings from their public that they've already had enough and want a return to the sound Mark. If that happens you can kiss the Euro goodbye. The Germans are the only ones disciplined enough to run a relatively sound currency (perhaps Finland, Holland and France also). The Euro needs the Germans. Again all this just puts further gloss to the gold bull run. You can't even turn to the Germans for sound money any more.

We are witnessing the breakdown of the welfare experiment since Nazi and Japanese expansion created the Western promises 'a society fit for their war hero's'. The social ratchet kept tightening, with no politician loosening the grip. Just like the collapse of communism it will be the free market that defeats statist policies. It always does. While we transition there's going to be some pain along the way. Chinas Hedge continues....

Interest Rates are Prices

A while back I posted on Interest Rates and Capital using explanations of supply and demand. It was to my astonishment that I noticed an article published by a popular newspaper. Rather then heap praise on the recent lowering of interest rates and accepting at face value what the central bankers were saying, it actually challenged these concepts and the so called 'wise men'. There is no logic to having a centralised committee setting prices such as interest rates. Rather than determined by the market these prices are adjusted by these central institutions. Despite all the propaganda that central banks are now 'Independent' its still the same as when politicians have control over interest rates. They always try to keep them as low as possible for as long as possible. Creating inflationary booms is the best weapon politicians have at creating artificial prosperity. Until the public balks at the inflation or the scale of malinvestment becomes too large, then these prices are risen by the powers that be.

A good question would be, how should interest rates be set? Who would set them if Central Banks were not in control? That simple micro-economic concept called supply and demand would set it. The great Austrian economist Eugen von Bohm-Bawerk noted that the setting of interest rates is a time preference, peoples preference to get money upfront in the current time frame. Many sections of society view making money off money as immoral, historic notions of Usury, the reason why Jewish people have been casted outside society due to their role in money lending. Karl Marx in his critique of Capitalism stated that charging interest was 'exploitation' of the workers (everything he wrote was one big exploitation, his Communist Manifesto is heavy on that concept) with no inherent purpose. Of course Bohm-Bawerk's time preference explained this concept. If I saved then I have produced more than I have consumed during that time period. I may give this to a bank who I charge interest, as they may wish to make use of these savings. The bank in turn may lend it out to a business at a slightly higher rate as they may have immediate plans to hire more people to expand their business in the current time frame however they do not have sufficient capital to do so. They are therefore paying for this privilege. Time preference also applies to entrepreneurs and labor. Labor was not exploited, again as Marx falsely assumed. Labor gets paid upfront for what it does. I go to work and I don't risk my capital, my time - I get paid for what I produce, regardless of what happens in the market. Entrepreneurs don't. They risk their capital, their time and in the end they may not earn a penny. Again time preference explains this, do you want to get paid upfront for less, or potentially earn more later down the line if you succeed.

So how would interest rates fit in with the above example. Interest rates are set based on peoples time preference. If no one saved and lots of people wished to borrow for the current time frame, then interest rates would go up as a shortage of genuine capital would be evident. Similarly if there were lots of savers and few borrowers, interest rates would fall, deterring saving and spurring consumption or investment. The above is just a supply and demand concept, one that Governments always like to abuse.

Once the above is understood the whole economic crisis becomes quite simple to explain. It was the setting of these prices, outside of the markets control, that caused all sorts of industries to exist that were never sustainable in the long term. It's the reason why unemployment is on the rise, why businesses are failing in mass. Many economists are still blinded by such simplicities. BBC's Robert Preston drones on about regulatory structures, but its akin to a doctor putting a plaster on a cancer patient, its the wrong diagnosis. The free market interest rate article sums up this process:

"This illusion creates waste, because it makes people overestimate the available resources. Ventures that would have been unprofitable if interest rates were not artificially low are now embarked upon, drawing scarce resources away from better uses. According to Friedrich von Hayek and other advocates of the Austrian theory of the business cycle, it is this interference with interest rates and the money supply that causes an unsustainable combination of consumption and investment — a boom that inevitably leads to a bust."

We got into this mess because of low interest rates and expansive monetary policy. So how do we try and navigate out of the current situation? By using exactly the same policies as before. Putting another plaster over the other plaster of the cancer patient. A similar re-run of the seventies, more inflation to try and solve the previous inflation. Recession after recession.

This is of course a great magic act that Governments have. Through the inflationary boom, all the 'robust' growth is down to the Governments policies. During the bust it's suddenly the free markets fault, it peoples 'psychology', speculators and so on, but never the government. Blame the banks if you will, but the majority just play this game knowing the rules, profits in the boom, bailouts in the bust (we could also go into the practice of fractional reserve banking - again governments rules, banks just playing the game).

Bubble China

The most recent example of a Government creating an artificial inflationary boom is China as I write. Rather than causing the economy to readjust painfully due to the lack of Western or Japanese demand for their export products, the government have begun on a program of recklessly expanding the money supply, around 30% per annum. This is causing all sorts of incorrect investments may it be the stock market, real estate or certain sectors. The end game? They can't put off their depression merely buy time and make it much worse when it arrives. China's Banks are now copying the Wests - reckless lending fueled by cheap money and their economy will suffer eventually. The Communist party is scared that the depression would be so bad that its people would begin asking for democratic change like I mentioned in my Building Bridges post. We will have to see when.

As bad as the dollar is, where's the alternative? Governments are all bad, its just some are worse than others. There is nothing good I can see around the world right now. We are in a classic bear stock market rally all over the world at the moment. It doesn't matter what the news is, it just goes up. Japans Nikkei after 1990 rallied on numerous occasions, sometimes rallying as high as 70%, but where did it go? Right back down hitting new lows (its real lows we may have to watch, not the nominal price). The sign of a long term great bear market is the size of the rallies, so in my opinion this is truly a great bear market we are in. Lost decade? Only this time global?