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September 04, 2006

Storm Clouds to the East?
by Gary Tanashian

I was browsing around the Resources page of the Biiwii.com website recently, checking links I hadn't visited for a while to make sure they are alive and well. In the section entitled The Inflation/Deflation Debate I found myself reading from The Great Depression, which is actually part of a website on poetry from the University of Illinois at Urbana-Champaign that presents a vivid picture (literally) of the depression. I took particular note of the following passage from a section called About the Great Depression:

"The Great Depression began in the United States but quickly turned into a worldwide economic slump owing to the special and intimate relationships that had been forged between the United States and European economies after World War I. The United States had emerged from the war as the major creditor and financier of postwar Europe, whose national economies had been greatly weakened by the war itself, by war debts, and, in the case of Germany and other defeated nations, by the need to pay war reparations. So once the American economy slumped and the flow of American investment credits to Europe dried up, prosperity tended to collapse there as well. The Depression hit hardest those nations that were most deeply indebted to the United States, i.e., Germany and Great Britain. In Germany, unemployment rose sharply beginning in late 1929, and by early 1932 it had reached 6 million workers, or 25 percent of the work force. Britain was less severely affected, but its industrial and export sectors remained seriously depressed until World War II."

"Uhhgg!" said I. That first response, if articulated more clearly would have come out as "Wait a minute, I hear a lot of chatter out there, including some of my own, about the debt-ridden USA being in danger of an economic implosion that could set off a global depression, at least in so far as creditor nations need the vast debt-for-consumption engine the US has become to fuel their economies". But let's think about this for a moment. The US can, does and most likely will continue to inflate its money supply as needed to keep its debt situation from lighting the fuse to a bomb of epic proportions. But what happens if the fuse is lit elsewhere? What about China, a country with a murky (at best) banking system and a debt-for-growth (the yin to our debt-for-consumption yang) economic system? A growth story running well-publicized surpluses with the US, year after year. Lazy, greedy bulls think this can go on forever. Conventional doomsters bearish on the US buy commodities and hop aboard a global train that is passing the United States by. I am not currently long the "China Story" nor, by extension, the general commodity story. Yes, China is in the process of industrializing (like the US of the early 20th century) and they are recycling USD reserves into "resources" (read: necessary commodities for infrastructure and gold for an alternative to the US debt note), but none of this makes them immune to a deflationary hiccup along the way to a big picture of ascendancy, especially given that saving is ingrained in the culture.

I will leave it to global economists to sort out the extent to which China is propped on an unsound financial and economic foundation, but it seems to me that a real economic Armageddon, if it is to happen in the US, could start with our creditors who, led by the likes of China and Japan are major players in the US Dollar via the US Treasury markets. Until crisis strikes at home, and our creditors begin to sell off assets for liquidity, we may not enter a terminal stage of this great economic experiment. When will that be? What will the trigger be?

Meanwhile, I personally move forward with a smile, running a sound business, nailing the turns in the pig (blog-speak for stock market), eliminating debt and investing in things of value, some of which are not the often-touted hard assets we all read about constantly. Life goes on in America. A young rookie lefty on the Red Sox has been diagnosed with cancer. Andre Agassi has ended a classy career in classy fashion. The Patriots traded for a wide receiver to hopefully fill one of Deion Branch's shoes. Some people argue George Bush blew up the World Trade Center and others call them crazed Bush haters. Angelina and Brad, Brittany Spears and the guy with the hat are doing whatever it is that they do. Inflationists and deflationists continue to fight it out while the pig simply levitates higher carrying the hopes, dreams and delusions of millions. Business pretty much as usual in America.

But most of us know something is not right. Yes, the leveraged real estate bubble is deflating for all to see. The public has been bearish the stock market (we await their capitulation to the bullish upside with declining crude oil - gotta love those commodities - and a dovish Fed providing the crack for their pipes or pipe dreams) and with war, terrorism and deep divisions politically on the home front, the United States is certainly not aloof and sleeping through its troubles. Even the irrepressible American consumer is beginning to question his gluttonous ways. Beginning to. The US is conscious of its debt problem, its war problem, its housing ATM closed for repairs problem and many other problems. But as long as we have inflation (and for the zillionth time since 2004 I will link Ben Bernanke's own words Making Sure "It" Doesn't Happen Here) as an economic input, the whole mess can be carried forward, economically at least, indefinitely.

I have long felt that deflation is a natural and healthy component of human progress. See 2004's Deflation: A Manufacturer's View. Clif Droke's recent Production: The True Money Standard hit close to home. Torn between micro-optimistic and macro-pessimistic views, I believe in human progress, innovation and technology. But this happy story is disrupted by an elephant in the room and that elephant is taking the form of mind boggling credits issued by investors, like China, that are unsound themselves. This is an era of greed where hedge funds "play" all the leveraged angles and Wall Street spins whatever it needs to spin, commodity/China story included, to make a buck. Sooner or later a global depression may try to happen and it is advisable to check and re-check assumptions as to what the catalysts will be. I can envision a scenario where China begins a deflation similar to that of Japan after its miracle boom of the 1980's. How did the US respond then? Inflation of course. Inflation disguised a secular bull market in paper assets. How would the US respond to a deflationary impulse once again coming from the east? The Fed has got the bond herd positioned as though they are unafraid of inflation. Take a guess what would happen if the Yuan were to rise, the dollar were to decline and the US consumer were to lose the last vestiges of his ability to prop the consumer economy.

Gary Tanashian
http://www.biiwii.com/

Disclaimer: biiwii.com does not recommend that any trading or investment positions be taken based on views expressed on this site. If you speculate or invest it is suggested that you consult a financial advisor qualified in your area of interest.

Copyright © 2005-2008 Gary Tanashian

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