Wednesday, April 23, 2008

Getting Ready For The Next One

Spengler at The Asia Times is taking a look at the world food crisis and sees it as a monetary phenomenon. He has charts and graphs. I think he is right.

The global food crisis is a monetary phenomenon, an unintended consequence of America's attempt to inflate its way out of a market failure. There are long-term reasons for food prices to rise, but the unprecedented spike in grain prices during the past year stems from the weakness of the American dollar. Washington's economic misery now threatens to become a geopolitical catastrophe.

Months ago, I offered that China, Russia and other cash-rich nations held the antidote to the incipient credit crisis: "If the US wants to remain the magnet for world capital flows it became during the 1990s, it will have to allow the savers of the world to become partners in the US economy, that is, to buy into its first-rank companies."(Western grasshoppers and Chinese ants, Asia)
Except we are not letting them become partners by buying assets.
No such thing occurred, of course, as Washington has made it clear that it would not allow sovereign funds to own the likes of Citicorp. What are the world's investors doing with the trillion dollars a year they used to invest in American securities, including subprime derivatives and various forms of collateralized obligations that turned out to have more obligation than collateral? They aren't buying American companies because they are not permitted to. They are buying food and other stores of value instead.
Spengler thinks that this will end the run of the dollar as the world's reserve currency.

I think Spengler, who is usually so astute has missed the boat on this one. As he points out the normal way inflation is sopped up is the purchase of productive assets. A call on future production. Since in its wisdom, the US Government (yes it is true - a case of wise government) will not allow the purchase of major assets, the only thing left to sop up all those dollars is production.

Where does that lead? More investment in productive capacity. Leading to even lower cost production than the currency imbalance would indicate. It then becomes a virtuous cycle. As the dollar rises due to all the production being absorbed, the production prices do not go up as fast as straight monetary calculations would indicate.

By dumping dollars these folks (who are taking a short term view and panicking) have outsmarted themselves.

BTW the same thing is happening in oil. Productive capacity is rising but people are buying oil like crazy with dollars as a way to store value. Gasoline inventories in the US are rising. And what happens when the tanks are full? The excess buying stops. What happens to prices then? Look for big declines in the price of oil once the buyers run out of dollars.

H/T LarryD by e-mail.

1 comment:

Neil said...

Congrats, Simon. Spot on.

For all those folks that worried about what would happen when the Chinese eventually decided to dump their dollars, this is it. Just like the Japanese in the early 90's, they're buying stuff at inflated prices, and they're going to lose their shirts. Except that in this case, some of the stuff is actually perishable, so they won't even be able to avoid marking-to-market within the year.

One has to give the other side of the trade its due respect, however. Again, like the Japanese in the early 90's, the Chinese individuals doing the buying really don't have any better options. The best option would be to invest in China, but the Chinese govt. numbers show a net capital outflow. Trust the locals, they know when the local economy is a bad bet. The Euro is too high to make for a good parking-place, the collapse of yields in the U.S. (and restrictions on FDI) blocked that avenue.

They're stuck. After this brief bout of inflation we will have repatriated our dollars in return for perishables--and reinvested the proceeds in production.

Stepwise discontinuous trade is disconcerting, but I think it'll probably work out.