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Exporting Revolution

From Dan Denning in Melbourne:

–If there’s one lesson to have learned over the weekend it is this: inflation can lead to revolution. That may be putting it simply. But the task of today’s Daily Reckoning is to show that the love of bad money is the root of all politically-destabilising price increases in the developing world.

–That doesn’t exactly roll of the tongue. But it may explain why Tunisian President Zine al-Abidine Ben Ali is watching the events on the streets of Tunis from a hotel in Saudi Arabia. The Tunisian President fled the country after his efforts to placate protestors failed.

–There are certainly other political factors at play. But rising food prices are a factor. Businessweek reports, “On Thursday night he [Ben Ali] went on television to promise not to run for re-election in 2014 and slashed prices on key foods such as sugar, bread and milk. A day later he declared the state of emergency, dissolving the government and promising new legislative elections within six months.”

–None of that worked. And now he’s gone. But rising food prices are not. And for that Tunisians can thank, at least in part, Ben Bernanke’s policy of Quantitative Easing. The Bernanke Fed has in effect exported commodity inflation in its relentless drive to weaken the dollar (and force China to revalue its currency).

–As we mentioned to Australian Wealth Gameplan readers last week, to the extent that there’s a global food crisis, it’s really a global crisis in paper money driving up the price of real things. That doesn’t mean it isn’t a real crisis. It’s just important to understand that the origin of these political and social events is fundamentally unsound money.

–Of course there IS a non-monetary factor too. Flooding, drought, and lower-than-expected crop yields have put the global food supply chain under pressure. In a world of just-in-time-inventory management and $100 oil, the supply chain is proving more fragile than hungry people might like.

–It becomes a political event in those parts of the world where food represents a large portion of discretionary income. World Bank President Robert Zoellick told the Financial Times, “With food accounting for a large and volatile share of tight family budgets in the poorest countries, rising prices are re-emerging as a threat to global growth and social stability.”

–Does a weak dollar really lead to higher food prices? Well, yes. The dollar is falling in value relative to tangible goods. But you have to keep in mind that rising commodity prices are also driven by countries with appreciating currencies using their newfound purchasing power to purchase scarce natural resources. Buy ‘em while you can, before they go up in price again.

–If the weak U.S. dollar keeps undermining political stability in the developing world because of rising food and oil prices, then the developing world will have another reason to hate America. To be fair, maybe the Bernanke Fed is trying to protect American jobs by driving Chinese labour costs higher.

–But that’s probably not how the rest of the world will see U.S. currency policy. They’ll probably see it as a tool for producing involuntary regime change in countries where food and fuel prices are out of control. The Arab world can probably keep oil prices low in OPEC member countries. But do you reckon they’re a bit nervous about what’s happening in Tunisia?

–One country that’s not nervous is China. It’s gaining more confidence, in fact. Yes, China is worried about inflation too. On Friday, the People’s Bank of China announced it would raise reserve ration requirements at banks by 50 basis points, effective January 20th. China is trying to prevent excess liquidity from driving prices out of control (house prices, food prices, stock prices).

–In fact, China’s President Hu Jintao understands perfectly that too many dollars are bad for everyone. China included. In written answers to questions posed by the Wall Street Journal and Washington Post, Hu wrote, “The monetary policy of the United States has a major impact on global liquidity and capital flows and therefore, the liquidity of the US dollar should be kept at a reasonable and stable level.”

–It’s too late for that. But Hu knows that too. He added that, “The current international currency system is the product of the past.” That has a faint resonance with the famous quotation from John Maynard Keynes that the gold standard was, “a barbarous relic.”

–The problem with the gold standard is it imposed fiscal discipline on the 20th century Warfare/Welfare State. It had to go. The problem with the current global fiat dollar standard is it unleashes political and social mayhem. It has to go to.

–But what will replace it? China hopes to internationalise its currency so it will become a new global reserve currency. But it was hoping to do so by about 2015, when the IMF is scheduled to re-weight the currencies that make up its special drawing rights (SDRs).  In with the Yuan, down with the dollar!

–By our reckoning, 2015 is about four years from now. And that’s a long time to tolerate/endure higher oil, energy, and food prices. These well-laid plans may not be good enough. In the meantime, investors can speculate on higher commodity prices. But if high prices lead to increased political instability, even that will be a risky bet.

And now over to Bill Bonner from Cologne, Germany

Nothing much in yesterday’s market news…so we turn to a remarkable article that appeared in MONEY magazine, proving that MONEY doesn’t know anything about money.

(MONEY Magazine) – Can you tell when a boom has turned into a bubble? One clue: When pop culture starts paying attention. The housing bubble, for example, brought both the TV show Flip This House and a rival on another network, Flip That House.

So if you own a lot of gold, you might regard a recent episode of Saturday Night Live as your first warning. In the opening skit, Bill Hader as China’s President Hu Jintao declares that Glenn Beck was right and that “my government should have bought gold. Unfortunately, all our assets were tied up in US Treasury bills.”

Back in the real world, gold is trading at about $1,400 an ounce, up from less than $500 five years ago. That’s a 23% annualized return, far outstripping the gains on stocks (1.1%) or bonds (6.1%). Fear is driving a lot of the rise.

MONEY has a point. But not a good one. When pop culture gets excited about an asset class – tech stocks in ’99 or housing and finance in ’06 – you know it’s late in a roaring party. It’s just a matter of time before the neighbors get mad and call the cops.

But the MONEY writer missed the point. Pop culture has to take the bubble asset seriously. Not as a joke.

The author admits that the magazine tried to persuade readers to dump gold last year at this time. That was a costly mistake. Gold went up nearly 30%. But it just shows how hard it is to get to the top of a bubble market.

Yeah, but gold is not in a bubble market. It’s in a bear market. It will turn into a bubble market later. So far, almost no one is at the party. Ask your friends, dear readers. Ask your relatives. How many of them own gold? Ask the cab drivers, the insurance salesmen, the auto dealers and the psychiatrists. Ask the readers of MONEY magazine. Do they hold gold? Nope. It may have just completed its 11th year of a bull market, but people have still not caught on. They think there’s something weird about gold…something almost unpatriotic. It is as if you didn’t trust Ben Bernanke or something.

MONEY goes on to tell readers why they shouldn’t buy gold now.

Reason #1: “Bad economic news may not make you very much money. Good news could crush you.”

Of course, it depends on what kind of bad news. And how bad. Historically, gold is a refuge against bad news. And we can’t think of anything we’d rather have in bad news…unless the news were so darned bad that we’d rather have a farm far out in the country with a cow, a pig, a flock of chickens and an arsenal of weapons.

But how about the good news? Yes, gold would go down in a good news environment. The author talks about the ’80s and ’90s…as if a re-run of those good news years were possible. Oh boy! This fellow must have read Peter Lynch’s advice about not paying any attention to macroeconomics; he must have taken it seriously! Poor lump! You can ignore the macro weather forecast, but only when the weather is good. When the hurricanes and tornadoes start to blow, you need to know what’s going on so you can nail up the plywood and head for shelter.

What is the likelihood of a repeat of the ’80s and ’90s fair weather? Well, we’d need to begin with the high interest rates of the early Reagan years (they’re extremely low now). Then, we’d need low stock prices (they’re 1,100% higher now). We’d need relatively high inflation (CPI touched 13% in the early ’80s) rather than the 1.1% core CPI we have now. We’d need a monetary base of about $600 billion (rather than the $2.5 trillion Bernanke is building). We need total debt at about 120% of GDP, instead of 400%. And we’d need a Fed that was determined to stop inflation rather than one that was dead set on causing it!

And we’d all have to be 30 years younger, too.

All things considered, we’d gladly go back to the ’80s – if we could do it. But who could possibly believe we could? Only a writer for MONEY magazine.

Yes, if things do go back in time to the ’80s and ’90s, gold will be crushed. That’s a chance we will gladly take.

His reason # 2 is no better. “Sure, the dollar has problems. But just look at the other guys.”

We’re not sure what that is supposed to mean. The whole planet’s monetary system is based on paper currencies, with the dollar at the center of it. Yesterday, the dollar turned down against foreign currencies. But so what? We can’t tell you which of these paper currencies will shrivel up and blow away first…but they’re all going to do so. How do we know that? Well, in all modesty, we admit that we don’t know for sure. We don’t know nothin’ for sure. But every paper currency ever tried – apart from present company – has always disappeared. And none has ever survived a complete credit cycle. They’re okay on the upside. They fall apart on the downside.

We’re on the downside of the credit cycle now. Or not far from it. The dollar won’t survive. And when it begins to limp and cough badly, some investors may go to Chinese yuan or Swiss francs. Most will want to go to real money…the kind you can trust…the kind that never goes away…

..the “last man standing” in a monetary crisis – gold.

MONEY has other reasons for telling readers to stay out of gold. They are no better. And at the end of the article, as if the author were not convinced that he had made his case, he tells readers that if they must get into the yellow metal, they should do so with only 1% of their portfolio. And put the money into an option, not into the real stuff. Then, if the bet pays off, the MONEY reader would get a big payday.

Wait a minute. Picture the MONEY reader. He’s got a $200,000 portfolio. On MONEY’s advice, he keeps it fully invested in a balanced portfolio of equities. Then, he takes $2,000 and buys an option on gold. If gold goes up dramatically, his $2,000 option turns into, say, $20,000. But what has happened to the rest of his portfolio? We don’t know, but there is a good chance that either his option expires worthless – in which case, he loses his $2,000. Or, if it pays off…and gold is soaring…the rest of his portfolio could register far bigger losses than he recovers from his gold play.

Again, MONEY is missing the point. Ordinary people have no business speculating on gold. They should buy the metal as a safety device – to protect themselves from all the dumb policies and speculations of the banks and the Fed itself. The Fed is no longer doing its job. Its reserves are trash – bonds to be paid off by the federal government (which is insolvent) or by underwater homeowners. Since the Fed is derelict, people need to have their own reserves of real money. Gold, in other words.

Meanwhile, California is in the same situation as Portugal, Ireland and Spain. It can’t print its own money. So, it has to take the austerity route. Here’s the latest from Bloomberg:

California’s Brown Unveils $12.5 Billion in Spending Reductions

California Governor Jerry Brown’s budget will cut spending by $12.5 billion, including as much as a 10 percent pay reduction for most state employees, aides said.

The plan, which Brown is to unveil today, will also raise $12 billion by retaining tax increases due to expire and making other modifications. Some of the revenue will go to cities and counties as part of Brown’s plan to transfer spending authority from the state to local governments.


Bill Bonner.
for The Daily Reckoning Australia

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