Presenting the latest terrific analysis by Michael Krieger, formerly a macro analyst at Bernstein, and currently running his own fund, KAM LP, who joins Willem Buiter and everyone else left with a gram of prudence, in realizing that this is nothing more than the “last dance.”
“History is a set of lies agreed upon.”
– Napoleon Bonaparte
Most people prefer to believe their leaders are just and fair even in the face of evidence to the contrary, because most people do not want to admit they do not have the courage to do anything about it. Most propaganda is not designed to fool the critical thinker, but only to give moral cowards an excuse not to think at all”
– Michael Rivero
Every man gotta right to decide his own destiny, And in this judgment there is no partiality. So arm in arms, with arms, we’ll fight this little struggle, ‘Cause that’s the only way we can overcome our little trouble. – Bob Marley, Zimbabwe
A Thousand Words On Conventional Wisdom
Conventional wisdom. Many market analysts define conventional wisdom in relation to what direction the market is going to head in the future, but I think this is an utter mischaracterization of the concept. For example, someone that is bullish on the market right now is likely to see conventional wisdom on stocks and the economy as overly bearish after ten years of no returns for U.S. equities. In contrast, someone that expects a market collapse will say that everyone is a cheerleader and that the “conventional wisdom” after such a huge rally is for stocks to continue to go up. This is not how I would describe conventional wisdom and all is does is drag the debate into the intellectual gutter. Rather, to me conventional wisdom is more the “zeitgeist” of the financial and economic community at any given time. Zeitgeist is defined by the Merriam-Webster dictionary as: the general intellectual, moral, and cultural climate of an era. In this sense an “era” will generally mean a lengthy period of time, several decades or perhaps even more extended periods. That said, what is interesting is that every cycle in the global economy seems to bring forward distinct “mini-zeitgeists” that the experts create to justify market movements or give credence to economic dogma.
When I define conventional wisdom in this manner what I have found is that I almost always disagree with conventional wisdom. Two very interesting recent periods were fall 2007-July 2008 and then mid-2008-early 2009 period. In the first period, it was clear to me that decoupling was impossible because the U.S. was too large and it was clearly on the verge of collapse and, more importantly, that China and the U.S. were joined at the hip in a Keynesian economic Frankenstein that would not be easily severed. Despite what I thought was pretty obvious at the time, conventional wisdom was that the BRICS had decoupled and all would be well. Rather than seeing the commodity surge as the flight out of the dollar due to the distinct money policies of the U.S. Fed and everyone else, the rally was seen as evidence of decoupling. This is mainly because conventional wisdom tends to view rising assets as a signal of prosperity. I believe this was and is generally due to a misunderstanding of economics (we are all taught mostly rubbish in schools) and a shocking ignorance of the global financial system, how it really works and who/what is pulling the levers.
Once the collapse occurred the mini-zeitgeist cycle changed and everyone was forced to admit the errors of the decoupling thesis. That said, a new “conventional wisdom” emerged that was just as ridiculous as the one that came before. For example, the dollar rally was perceived as a flight to safety when this is not exactly true. The real reason for the dollar rally was that the world expected deflation and with the world’s reserve currency still the U.S. dollar this meant it would be time to settle positions much of which meant dollar settlement. So while many investors did indeed end up rushing out of “risk assets” and into the dollar, the desire to be in the dollar due to the relative strength of the U.S. economy was not the cause of the rally. This misunderstanding is also why so many investors remained in the deflationary mindset for far too long. The only way a deflation defined as dollar strength and commodity weakness could occur on a sustainable basis would have been if things were allowed to fail and the financial system was allowed to collapse. As soon as quantitative easing became a reality if should have been clear to all that we had just entered a new era. Even if one wanted to make the deflation case today (and I think the case can be made), the idea that deflation would lead to commodities falling in value versus the dollar is preposterous given the stance of the Federal Reserve. In my opinion, the deflation would be in relation to gold since it is now rightfully starting to be appreciated as the natural reserve currency of the world. The whole idea of the inflation/deflation debate is asinine since both sides are right in their own ways. The missing component is that the deflationists by and large haven’t figured out that the new reserve currency is gold. This becomes very clear when one watches the recent debate between Jim Grant and David Rosenberg. Grant argues that long-term treasuries are a horrific investment right now (I agree 100%) while Rosenberg thinks they are attractive. I respect Mr. Rosenberg and I think he does fantastic work but it wasn’t lost on me that he had no good response when Mr. Grant posed to him the question about what if the entire monetary system itself changes. This is the key point. The Central Bankers and their inept political allies will be the last to figure out that the entire paper ponzi they created and nurtured is falling apart all around them. The Central Bankers because they are loyalists to economic dogma as absurd as the notion that the sun revolves around the earth. The politicians because for the most part they don’t understand anything and have few skills other than getting elected to office by making promised they can’t keep. Look back at history and you will notice that it is entrenched academic ideas that die the hardest. In the Middle Ages they would send people to prison or worse for speaking against the dogma of the day. The establishment has and will fight back hard to maintain the status quo but the truth and economic law will win out in the end. Ben Bernanke is a parlor magician with a printing press. Please just go away!
For more on this topic please read the following piece by Martin Armstrong titled “The Clash of Two Worlds: The Battle Between Knowledge and Ignorance.” http://www.martinarmstrong.org/files/The-Clash-of-Two-Worlds-2-7-10.pdf
Does China Need the U.S. to Collapse?
Another piece of conventional wisdom espoused these days is this idea that the Chinese “need the U.S. as much as we need them.” I think this is utter nonsense and in fact the opposite may in fact be true. At the least, it is worth considering. In July 2009 I wrote a piece titled “The Emerging China Risk” just before the Shanghai market topped out in early August. I noted that M2 and loan growth in China was dangerously high and that they risked creating major bubbles. Very few people were talking about this at that time. Now it is accepted that China has a property issue and the Shanghai index is still around 18% off from the August high. When I talk to people I respect in the business about the tremendous mal-investments occurring in China as a result of the government’s throwing money at the problem in an attempt to retain power, the main pushback I get are ” well x number of people still need to move to the cities” and “cars person in China is x versus the developed world.” This is all well and good but has anyone noticed oil is $85/b. As I have said time and time again, resource constraints are a very serious fact of life in the short-term. What 2007-2008 should prove to everyone is that the developed world and the emerging world cannot both grow strongly at the same time in the near-term. Resources will not allow China to grow at 10% and the U.S. to grow at 3%. Sorry folks, we will see oil at $200/b before you know it.
What is happening right now is everyone is printing enormous amounts of money in this Keynesian nightmare and thus supporting inefficient aggregate demand as I mentioned in last week’s email. This means the market’s rebellion will continue to be expressed in surging commodity prices and then surging sovereign yields. The really scary thing for me as an American is that the longer this goes on and the more empty cities and malls the Chinese create the greater their incentive and need to collapse the United States becomes. This is because as commodity prices continue to soar and the terms of China shifts against China (this has already started) the more they will need the improve their consumers purchasing power so that they can fill all of the vacant infrastructure. This is when the need to allow the yuan to strengthen will be most apparent and there will be no choice. Purchasing power for the Chinese will surge and the U.S. and Europe will be priced out.
The Last Dance
Either China’s leadership is very smart or is very stupid (I know what ours is). I do not have a great feel for this since I have no connections there but I am pretty sure it is one or the other. Conventional wisdom at the moment tells us two things with regard to China. 1) They need us as much as we need them. 2) They are creating monster bubbles that are dangerous and have no idea what they are doing. With point #1 I completely disagree. On point #2 I had tended to agree with that and in fact may have even played a small role in making that notion part of conventional wisdom with my prior writings. More and more I am doubting #2. The alternate scenario goes like this. They refuse to allow the yuan to strengthen because they know that once they do that it will mark the real end of the dollar era. So instead they are spending like crazy on infrastructure ahead of them allowing the dollar to plunge. Then the strong yuan will be employed to purchase all the commodities they need to utilize their infrastructure and the OECD gets priced out. To those that talk about yuan devaluation, you need to be specific. Devaluation versus what? Versus commodities generally along with other currencies? I can buy that argument very easily. Versus the dollar, highly doubtful. Why? The latest data says China owns $877.5 billion in U.S. treasuries. All they have to do is start dumping and the dollar is finished as the Fed will be forced to print so many dollars it will make Mugabe blush. People need to wake up.
Last year I wrote about how the leaders in America were essentially fiddling as Rome burned. This fiddling has become an all out dance party and many investors have been dragged onto the floor one more time due to money printing, an inherent desire to be optimistic, a plethora of propaganda and rising asset prices. However, this is the last dance folks. Our corporate and political leaders have destroyed us. Chuck Prince would be proud.
Mike Submitted by Tyler Durden on 04/29/2010