Another Fed Meeting, Another Bernanke Airdrop?
If you have been long gold and short USD for as long as I have, and if you weren't unduly burned by my bad advice of shorting the GBP last week when I was convinced it was poised for a fall, it's high time you recognized your newfound wealth with a little present. My suggestion is on the below: Splurging is chicken soup for the soul.
Actually, I have been too hard on Bernanke and too easy on myself. No, I'm serious. I am going to take this opportunity to eat some crow.
It has been very easy for us goldbugs, especially the ones like me who ignored warnings to “take profits” and bet that Bernanke would continue cutting rates, to write off Bernanke's rate cuts as a pathetically obvious attempt to bail out the Wall Street flagship banks for the hundreds of billions of dollars' worth of subprime loans they made over the years.
With the Fed's most recent interest-rate cut (despite the fact that the economy grew at a 3.9 percent clip in the third quarter), vindication seems to be at hand. The explanations have been made in this newsletter many times. Is Bernanke really this craven? Does the Princeton academic need validation from the old boys' club on Wall Street? Or is something else going on?
I no longer believe Bernanke is cutting rates merely to stave off a credit contraction. Yes, there is a big multiplier effect from a credit recession, but whether or not Bernanke has an irrational fear of the 'externalities' of one, it has to happen sooner or later. Countries whose central banks have tried to engineer their way out of one (Japan) have regretted it to this very day. Furthermore, the standard critiques of stoking asset price bubbles, the value of the dollar, and understated inflation are very old. There's no way Bernanke hasn't heard them all a million times before.
Jim Rogers, the feverishly self-promoting commodity speculator who has become the goldbugs' favored prophet of dollar Armageddon, always likes to say about Bernanke, “This is a guy who has studied the creation of money his entire life, and now we've given him control of the printing presses. I don't want to own that kind of currency.” Rogers is not being specific enough. Bernanke studied the creation of money – and the failure to create money – in the context of the Great Depression his entire life.
One parallel between now and the late 1920's that never gets mentioned is the parallel between the United States, which was growing at an absolutely feverish rate at the time, and the “Sterling Area,” the British Empire. The British Empire was still fairly stable at the time, but it was saddled with an enormous amount of debt. In 1925, seven years after the end of WW1, the British re-pegged the sterling to the dollar, which was then pegged to the gold standard. Unfortunately, the peg was unsustainable. Britain had a large and growing trade deficit with the United States, which at the time was the manufacturer of the world, running gigantic surpluses left and right. In 1927, the United States moved to prop up the sterling to prevent an imminent devaluation and preserve the status quo. Four years later, the system blew to pieces. The debtor country, Britain, underwent a sharp recession; the United States was on the cusp of a decade-long nightmare.
Eighty years later, China holds the position the United States did then. Its attempts to prop up the dollar have been more aggressive and more desperate. Its banks are weaker. Its valuations are more absurd. (The Shanghai Stock Exchange has reached P/E's of approximately 80, and I have heard that anywhere between 10 and 30 percent of the average Chinese company's earnings in the past year have come from stock-market gains.) So the effective P/E of Chinese equity is now in triple digits. The analogy must weigh heavily on Bernanke's mind. Had Britain refused to support their sterling peg in 1927, and the devaluation not postponed four years, the Depression would have probably been much milder. It's anybody's guess what is on Bernanke's mind, but the simple “Bernanke is a pansy” or “Bernanke is conducting a USD leveraged sellout” explanations are not cutting it anymore.
Devaluation of the dollar constitutes a “triple whammy” for China. Under China's currency sterilization regime, internal inflation increases exponentially in relation to how overvalued the yuan is relative to the dollar. The value of its reserves, overwhelmingly in dollars, declines as the dollar loses value. And its export-addicted economy becomes dramatically less competitive as the dollar loses value relative to the yuan.
China has been cooking its latest statistics egregiously. It was no coincidence that within hours of the Fed's decision, the Chinese government lifted price caps on jet fuel, diesel, gasoline, food and assorted “upwards-volatile” commodities. I also heard that the PBoC has arm-twisted its banks to hold dollars instead of yuan, quietly hedged with off-market yuan buys, to minimize open-market downwards pressure on the USD – and thus rate-cutting pressure on the Fed – in the run-up to the Fed meeting.
The Bottom Line
Bernanke, I now believe, is trying to blow up the yuan-dollar peg by devaluing the dollar. The Chinese have shown themselves politically paralyzed and completely unable to forge an internal consensus to act, in the face of rising domestic inflation, unsustainable trade disequilibria, and a glut of easy money. Higher inflation, a falling dollar, and a raging bull market in commodities will be symptoms of Bernanke's competitive devaluation of the dollar, which will itself continue until the Chinese surrender the yuan. But the yuan's revaluation day of reckoning is a lot closer than people think.
There has been so much information in the past two weeks, and it would take a book to comment on all of it, when I am much more strapped for time than usual. But in the meantime, don't buy any Chinese assets that aren't hard currency, and maintain all prior positions (long EUR, short GBP, short USD, long gold, ... and long Chinese yuan)
--Alex Forshaw,
Editor in Chief
http://www.bestwaytoinvest.com
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