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Albert Edwards Explains Why Bernanke And China Are Engaged In A Game Of Global Chicken Whose Downside Is A Hungry Revolution
In his latest letter, in addition to again broaching the subject of the upcoming Eurozone collapse, SocGen's Albert Edwards shares his increasingly high level of conviction that the US will slip into recession and also explains why Ben Bernanke's trashing of the dollar is just a devious ploy to force a real exchange rate revaluation on the Chinese via rampant food price inflation. Keep in mind, in China food prices are actually important, noted and measured, and were the primary reason for the October spike in inflation which oddly caught so many by surprise, probably more for the reason that the government actually agreed to disclose it. In essence, Albert argues that the Chairman has raised the stakes on the global monetary game to such a level, that he risks social discontent either in the US or in China, or both, should China refuse to blink in what has quickly become the most important game of chicken in the history of modern economics.
First, with everyone convinced that the US economy can only continue chugging ever higher, here is the simple counterargument. And it is the old one - inventories.
...Many clients we have spoken to do not believe that the US economy can drop into recession because most of the key cyclical elements of the economy, such as housing and consumer durables, remain depressed. In addition, with profit levels so high and corporates flush with cash, clients remain confident that deep falls in the cyclical elements of the economy cannot now occur. They have forgotten the mathematics of inventories.
Remember, this is an economy that has enjoyed the biggest ever peacetime stimulus, yet has seen the weakest ever rebound in final sales (see left-hand chart below). With final sales so weak, it will not take much in the way of a negative contribution from inventories to send the economy into decline- even without further weakness in the moribund cyclical sectors.
Inventories have surged in recent quarters (see right-hand chart above), and their contribution to GDP growth has been considerable (see left-hand chart below). But wait! As my good friend James Ferguson from Arbuthnot pointed out to me the other day, it is already clear from the ISM data that a slowdown in the inventory build is imminent (see right-hand chart below).
All those who discount the impact of inventories: pay attention.
Now you won't need reminding that it is the change in growth in inventories that counts towards GDP growth. So even if inventories rise another $110bn in Q4, as they did in Q3, the contribution to GDP growth is zero. If inventories rise a still strong $60bn in Q4, for example, inventories will deduct 1.5% from annualised GDP growth. With final sales rising a sickly 0.75% annualised (!!) over the last two quarters, you don't have to be a genius at maths to realise a recession is entirely possible, even without sharp declines in housing or consumer durables.
Over the last quarter, production has exceeded new orders in the ISM survey by the most in 20 years. Hence the mismatch between new orders and inventories is such that the headline ISM falling into the recessionary sub-44 range is likely (see chart below). I feel very confident that the markets have a big growth shock to the downside coming down the tracks. I am confident because I can now hear the toot of the train's whistle above the roar of the engines.
If Edwards is correct, and he is, that the ISM will plunge by almost 10 points shortly, another important observation is that inflation expectations will likely tumble (although that assumes that inflation is still measured in traditional metrics, and not under the post-QE2 regime in which every action by the Fed is solely to weaken the dollar and generate a stock surge). The good thing is that it would validate QE2, and likely lead to QE3 and so forth, further accelerating the endgame to the painful muddle through process.
And in this environment, what do you think will happen to inflation expectations which have been rising recently in the lead-up to QE2? If the ISM is heading back down to recession territory, it will be a strange occurrence indeed if inflation expectations and bond yields do not plunge (see chart below).
And here is the kicker in today's Edwards letter: by risking commodity price inflation, which he realizes all too well is being exported to China first and foremost, Blackhawk Ben is simply forcing China to either unpeg or raise rates sooner rather than later. Of course, in the process he is also hurting 80% of the US population which actually does care about such things as food and energy costs. In essence Bernanke has orchestrated a massive gamble, akin to a game of chicken in which he he poiased popular domestic discontent against that of China. If China blinks first, the Fed wins; if the US does, and food riots break out in D.C. before Beijing, it is game over.
On this view, Ben Bernanke will be vindicated that QE2 was indeed necessary. But perhaps he also has other fish to fry. We showed previously that, without any shadow of doubt, Ben Bernanke believes that printing money to devalue the currency works to avoid deflation (he openly said so in his Nov 2002 speech deflation: Making Sure It doesn't Happen Here).
One consequence of the Fed trashing the dollar is that commodity prices have been surging. And, strange as it may seem, this might be seen as good news in the US as it might help circumvent the problem of China refusing to revalue the yuan against the US dollar. For the surge in China's inflation rate to 4.4% in October was primarily driven by rapid food price inflation and its high weighting in its CPI (see chart below). This rapid inflation, if it feeds through to wages, will force a more rapid rise in the yuan real exchange rate, despite the nominal exchange rate remaining essentially fixed.
China is rightly concerned by this. It remembers the events of 1989 when runaway 28% inflation contributed to the unrest in that year and threatened the regime's grip on power. Hence you are seeing the Chinese authorities respond aggressively to this inflation threat, not only tightening monetary policy more rapidly (which seems pretty pointless to us) but about to introduce food price controls and crack down on those old scapegoats, "the speculators".
But the threat of social unrest goes wider than China. The UN's Food and Agriculture Organization (FAO) estimates that the majority of the world's undernourished people live in developing countries. Two-thirds live in just seven countries (Bangladesh, China, the Democratic Republic of the Congo, Ethiopia, India, Indonesia and Pakistan) and over 40% live in China and India alone - link. Asia stands out as particularly vulnerable to rising food prices because that is where the overwhelming majority of the hungry reside (see right-hand chart above).
In conclusion, Edwards confirms that in his relentless quest to get his way, the Chairman has now, in addition to going all in on the US financial system, has also added a gamble with the prevailing social order.
Finally I leave you with a thought from Dylan from his brilliant work on the unfolding structural rise in grain prices. “Hunger eats civilization” says Marjane Saatrapi, author of the beautiful book Persepolis. Food inflation has a dark history. It has been said that the 70s food crisis contributed to the Iranian revolution. We know the Russian Revolution started with starving workers protesting high bread prices. The Parisian riots of 1789 following the devastated crop of 1788 snowballed into the French Revolution and the revolutionary fervour which swept Europe in 1848 followed a sequence of bad harvests”. No wonder the Chinese authorities have leapt into action. The Fed may have opened a can of very toxic worms. What price for emerging markets in this brave, but very hungry new world?
The bottom line is that even if Ben is successful and China relents first, either by unpegging or hiking rates, the US Fed may have already doomed the developing markets to a slow grind onto the great revolutionary reset. And all of this of course assumes that Americans will continue, as they have been for decades, acting as the docile sheep the Fed expects them to: a fair assumption, but recall that it is precisely the outcomes that are taken for granted and that don't occur that lead to the biggest shocks to the system. Can America finally surprise the Fed?
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The average American can easily survive on half the calories they're ingesting today.
Can you say the same for the average Chinaman?
And for those saying that China can use their 'massive' reserves to buy food. Well... that destroys the peg. That's what Bernanke wants, and China wants to avoid.
I think the CCP can easily see a few million Chinese starve or even resort to cannibalism before they move the peg. They've done it before.
Ben Bernanke starving the poor in China and India. I think he's going to put Pol Pot to shame with his ruthless efficiency. Killing Fields indeed.
Actually, Ben and his ilk have programmed folks in the US to attack the US poor. There's going to be pletty of the Killing Fields chapter in the US too, though it'll be over energy more than food: the Program is to blame all the left-leaning folks and environmentalists for the "problem" (of course, the "problem" has been that the system was pre-programmed for self-destruction to begin with- perpetual growth on a finite planet, but this isn't something that the entitled rich masses want to understand).
They aren't the only ones playing chicken at this moment in time...
"IT MAY seem strange to some that The Irish Times would ask whether this is what the men of 1916 died for: a bailout from the German chancellor with a few shillings of sympathy from the British chancellor on the side. There is the shame of it all. Having obtained our political independence from Britain to be the masters of our own affairs, we have now surrendered our sovereignty to the European Commission, the European Central Bank, and the International Monetary Fund. Their representatives ride into Merrion Street today."
http://www.irishtimes.com/newspaper/opinion/2010/1118/1224283626246.html
I don't get the ISM chart. I'm trying to recreate it at the St Louis Fed website, which is in principle very simple: ISM headline (NAPM) one one line, new orders -inventories (NAPMNOI - NAPMII) on another, but I can't , because in my chart there is a very visible uptick in (new orders - inventories), which is different from the above chart. I know AE has a dual Y axis graph and so it will look somewhat different, but I still think it's weird that they aren't more similar. Almost looks like he omitted the last pop in new orders. The way I interpret this graph is that the trend in new orders-inventories certainly has been down, but lately, the situation looks somewhat better. Somebody else please go to the website and try this:
http://research.stlouisfed.org/fred2/graph/?id=NAPMNOI,NAPMII,NAPM,
Kissinger summed up the game plan more than 25 years ago: "Control the oil and you control the nations; control the food and you control the people."
He might be just as wrong about that as about so much else that is disasterous in US and global modern history.
The people have real power to bring down governments, especially when their children go hungry. To their credit, the Chinese bureaucrats have not forgotten this lesson as the DC elites have done.
Ooops. Quadruple post. Thanks NoScript!
Oops II (not to confused with Basle II).
Oops III (not to be confused with Basle III).
GM: $33.95. ouch!~
Look, people. The fed only cares about 1 thing. Trying to get the insolvent primary dealers out of their mess. That means deflating the dollar in the hope that housing prices will go back up and make their collateral good again... before hyperinflation sets in. It's a hail mary pass.
The fed doesn't give a rat's ass about the chinese people and their feeding, jobs anywhere, commodity prices or currency pairs. These are all secondary minutae for small minds to worry about.
Someone commented that PD's are talking thier book, and have taken massive RMB positions. Well, duh, of course they have. If you know the fed has no choice but to print USD, then you take positions accordingly. But that is just a side show. It's not the main event.
We have gone from a Goldilocks market to the Jim Croce Market. We are in a currency war and Big Ben wants to export inflation to the Chinese so as to starve them until they revalue their BS currency.
We are in a currency war and the mantra is: "You don't tug on Superman's cape, you don't spit into the into the wind, you don't pull the mask off that old Lone Ranger, and you don't mess around with Ben"This is not going to end well, thats for sure.
Are they really playing chicken? or are they bedfellows. The idea that Bernanke is acting alone, through his own analysis is the worst call of the 21st century...
This is an absolutely brilliant piece of analysis. Why is it so rare that I come upon smth. like this?
My bet is that the Chinese WILL blink. It is odd that few realize how huge their problem of urban poor is, and how similar it is to Russia ca. 1914..
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