Guest Post: Preparing For What's Next

Tyler Durden's picture

Submitted by David Galland of The Casey Report

Oh, what a tangled web we live in.

On one side of the Atlantic, there is a fundamentally broke European Union. On the other, the world’s largest debtor nation, these United States.

Rotate the globe and you discover China, the world’s most populous nation: a nation whose economy is desperately dependent on export revenues, without which its government may find it hard to meet the population’s soaring aspirations. And who is China’s largest trading partner? The European Union, that’s who.

The web also encompasses the role that the U.S. dollar plays in the relationship between the European Union and the Chinese. Or, more specifically, the role the peg plays that China maintains with the U.S. dollar. As long as the U.S. dollar is weak, the Chinese yuan is weak and therefore competitive in European markets.

The problem now is that, with the euro falling, in order to remain competitive, Chinese companies must reduce their margins. Therein lies the rub, because the razor-thin margins of the Chinese companies – estimated to be on the order of just 2% -- face the very real danger of thinning to the vanishing point. After which the best a Chinese company will be able to hope for is to make up its losses on volume.

That was a joke.

It gets more tangled. Because as the euro falls, the competitiveness of eurozone companies on world markets rises, adding further pressures on the trade that China so desperately needs (and that the U.S. would like more of as well). In this race to the bottom that the editors of The Casey Report have been warning of, the latest leg goes to the Europeans, though no conceivable improvement in their exports will offset the crushing debt burden that is now laying the continent low.

While this chapter in the unfolding saga may not end with the phrase, “And so it was that the eurozone collapsed and its common currency passed into the annals of history,” as this chapter is still being worked on, it could end that way.

Likewise, with China’s #1 market on the thin edge of becoming uneconomic, so, too, the current chapter might end with the myth of the Chinese miracle being shattered. And the U.S.?

To get to a rational assumption about the U.S., we need to ponder the fate of the dollar, as this plays a mighty role in the global economy.

We begin our pondering by recognizing that, given the massive sovereign – and private – debt load, there’s no way that the central banks of Europe or the U.S. are going to voluntarily raise interest rates anytime soon. To do so would be akin to Count Dracula voluntarily stepping into the sunlight.

Regardless of the wishes of the sovereign debtors, whether rates rise – especially when it comes to medium and long-term paper – is almost entirely driven by market forces. And what market forces might cause rates to rise?

  • One is that the supply of new credit greatly outstrips demand. We already know that the U.S. is blowing out Treasuries in a manner not dissimilar to the way that the Deepwater Horizon well is blowing out crude.
  • However, dominating the news just now is the massive bailout organized by the European Union in an attempt to beat back the troubles besetting eurozone banks with balance sheets buried in the unpayable sovereign debt of the PIIGS – an amount that could exceed a trillion dollars. This bailout will require, á la the U.S., a serious ramping up of the supply of eurozone sovereign debt.

With one important difference – while the situation in the U.S. is untenable, as it is not front page news, it is not urgent.

Therefore, at this point in the crisis, while LIBOR is on the rise, the U.S. Treasury is again enjoying a wonderful uptick in demand for its trash and that, in turn, is driving U.S. rates down and helping to prop the dollar up.

Still with me?

Getting circular here, we return to the fact that China’s link to the dollar means that its currency is likely to keep rising in relation to the common currency of its largest trading partner – the eurozone. And per above, that risks shoving a stick into the spokes of the Chinese economy.

On that point, an excellent recent commentary by Eclectica fund manager Hugh Hendry included a quote by China’s Vice Commerce Minister Zhong Shan in the Wall Street Journal: “Water doesn’t boil if it is heated to 99 degrees Celsius. But it will boil if it is heated by one more degree.” And, “A further rise in the yuan by a very small magnitude might cause fundamental changes.”

A serious downturn in China will have big consequences. For instance, as Hendry also points out, while China represents just 7% of the world’s GDP, it currently consumes upwards of 30% of the world’s aluminum, 47% of the steel, and 40% of the copper.

So what are we to make of all of this? How are we to invest?

Until there is some semblance of clarity in just how badly banged up the balance sheets of the European banks are, and whether the governments of that region will be able to pull the oars in sync, the euro is in for a lot of trouble. Counter-trend reversals aside, parity with the U.S. dollar is not out of the question.

That increases the potential for China to hit a wall, at which point the world will find itself facing a whole new set of problems. Per many past comments on the topic, for us the myth of China has long sounded eerily like that of Japan in its now past glory days. All of which is to say that, in the current chapter of the crisis, the U.S. dollar is likely to regain its aura of being the fair-haired lad of the global financial community, albeit a deeply dysfunctional fair-haired lad.

For commodity investors, that gives rise to the clear potential that the base metals and energy sectors are going to come under considerable pressure.

As will gold, if for no other reason than that when the trading herd sees the dollar rising against the euro, it reflexively hears “sell gold.”

Of course, with the “safe harbor” trade back in vogue, the U.S. government will redouble its efforts to paper over the nation’s systematic problems – a papering over that will only accelerate as it becomes apparent that the economy is headed for the next leg in the crisis.

While the timing is impossible to predict, I suspect that in a relatively short period of time (three months? Six months?) it will become clear to absolutely everyone that the U.S. has no intention of changing its spendthrift ways, making it no safe harbor, at which point the show for tangible assets – gold, above all – will really get moving.

The way to play the situation is to follow our constant advice to have a heavier-than-normal concentration of cash in your portfolio and look to use corrections to steadily build positions in gold and the high-quality gold stocks. And, as energy is also under pressure – pressure that would intensify if China stumbles – you need to be researching the sector now, with an eye toward building a solid portfolio in that sector as well. Not quite yet, but soon.

Now, having shared those prognostications, a caveat is in order.

Namely that no one can tell the future. The best we can do is to examine the data and try to make rational assumptions. Those are my assumptions, but I may have overlooked many a critical factor in this immensely complex and interconnected world.

And, of course, more than just about any time in living memory, there is a heightened probability that a black swan might land and turn everything on its head.

Even so, a portfolio whose core is heavy with cash against near-term deflation and that gives you the flexibility to buy tangible assets when they get cheap… bolstered by a solid position in gold to ward off the effects of an all-but-certain future inflation, and a winner in crisis as well… and which focuses on a slow build of shares in high-quality precious metals and energy companies… should pretty much get you through any conceivable scenario that may come to pass.

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MsCreant's picture

No offense to these folks here, but I see nothing new. That is because I read ZH.

pan-the-ist's picture

Cash short term, gold long term... Bitches!

(Now only if I had enough of either to make a difference.  I'm filling my basement with TP so I have something to trade with when the chips are down....)

M. Barr's picture

Barney Frank on NECN just now: he's "consistently maintained" that there are too many homeowners and he's "consistently pushed" for more rental housing.

Monkey Craig's picture

yes he lies and yes he worried about the coming elections

DosZap's picture

I always find it amusing when the most complicit bastards, scream the loudest.

What a dipshit.

Monkey Craig's picture

I could not agree more that energy shares are a great way to play the global war for resources (we need an acronym for this, much like the DoD's GWOT - war on terror). The war for resources makes things like water, hydrocarbons, and fertilizer very interesting.


The black swan now looks like it is the Gulf of Mexico....and I'm calling it the Black Pelican. With so many crises happening concurrently and globally, the American public will eventually focus on issues within the continental US. What this does for our wars in Iraq, Colombia, Afghanistan, I'm not sure. I do believe this changes the complexion of the 2010 elections and results in more Obama coupons for fishermen, FL hotel owners, and Katrina victims.


I believe that the middle class gets devastated by either (a) currency devaluation (b) rise in energy prices or (c) the rising regulations coming out of the EPA, FDIC, IRS, state of California, HUD, etc. If oil gets priced in gold, then you have (a) and (b) at the same time. Please consider these issue in your macro hedge funds and swap arrangements.


What is a wealthy saver (owner of CDs, S&P 500 index, no precious metals exposure) to do? Make sure you have enough ammunition for your Glock 17, buy enough insulin for a winter, and buy some calls on POT.


Full disclosure: long MCD, XOM, TLT, SLV and ammo. 

Church will not save you. Hopium might.

Janice's picture

I agree with the black pelican thing.  As the government becomes increasingly unresponsive and unable to stop the flow of oil in the Gulf, people will begin to wonder if the government can "fix" the economy or anything else.  Then people lose faith in the government and the currency.  All they have left is church & hopium

Mr. Anonymous's picture

Unlike the ongoing financial crisis, the People get this.  They can see the ongoing incompetence and lack of effectiveness.  The anger grows.   Just wait til November.  Mad as hell and they won't take it anymore.  Couple this with the sweeping real-world effects of ongoing, unstoppable leaking oil and its massive impact to the food chain's foundation via dying plankton and blue green algae, and you have the mother of all black pelicans.

Soylent Green is people. 


Nikki's picture

Savers or investors should be looking at the steady behaviour of dividend yielding stocks as a conservative alternative to speculation in stawks or the disfunctional bubbly bond markets. Shorting MO for instance is not without a severe quarterly penalty and is not an easy target for chicanery. It's generous 7% yield at reduced tax rate beats the crap outta any fed tp. My .02$

MO is just 1 example btw, chosen for it's genral familiarity to all esp. the thug in chief Obummer...

Segestan's picture

The term  Volume.... is the plan that has been the achilles heel for decades, so to speak from,  banking, to housing to mass immigration. We where always told we were needing higher and higher numbers just to make up for low labor and profit prices, while jobs were sent to third world sweat factories.... volume. Higher and higher numbers in a system of compounding dept, but we were told, we must not have higher inflation... ya right! .Make it up with cheap labor and volume, ....Productivity!!. Now we see we will have a new game in town, and it will be the same as the old game before our utopian world was shoved down our collective minds ...that would be .. securing our nations borders, by locally building domestic demand, economies,  and our governments helping our citizens,  to meet our volume needs . Globalization was needed so long a dept could find another holder, a sucker,  but the world can no longer find another holder of dept that is rich enough , stupid enough, big enough to carry on the gig. Oh well. got Gold?

Temporalist's picture

Every company eventually learns its lesson about "volume" for volume's sake.  Why can't countries learn the same lesson?

Caviar Emptor's picture

Agree. And that very issue, volume gone wild, is what's leading to overcapacity on a grand scale. Even in services.

AssFire's picture


Guest Post: Preparing For What's Next

Funny title since the article neither describes what is next or how to prepare for it..

Seems like collapse and ammo would suffice.

MsCreant's picture

Too much truth there william, too much truth. I wouldn't make those glow marks look so much like stars. A small dead black fish silhouette in the spill would be good.

But a great concept. It's where we are at.

pros's picture

"make up its losses on volume"

actually, the analysis is a misleading oversimplification:

divide total costs into fixed and variable

So long as variable costs are covered the producer commonly elects to sell at a "loss" so long as there is a contribution to "overhead" (fixed costs)

obviously in the long run this leads to liquidation,

but in the short run it is cash-flow positive on the margin.

The Chinese will sell at a loss to cover some overhead,

and to maintain employment

eventually this will result in disaster.

bugs_'s picture

Whats next?  Can it get worse?  War.

Temporalist's picture

Gerald Celente and Marc Faber agree with you completely.

thesapein's picture

I would like to see China's ultra modern warfare go ahead and destroy our obsolete military. Our death machines deserve the death that only China can dish out.

Ah, then we wouldn't be able to rebuild our military without importing materials from China, just like the Pentagon predicted.

Psquared's picture

He was wrong about "The Greatest Depression" when he predicted it on Glenn Beck in Feb. 2009. Now he is predicting The Crash of 2010.

I have a hard time taking him seriously.

Kina's picture

In any of the above situations whilst there is uncertainty in the world, and with major changes and events there always will be, then gold remains a prominent safe haven.


For me if commodities tank, even Gold, the AUD tanks and the value of my gold quoted in USD rises, that would offset decrease in the gold price. AUD is now 85c in the crash it got to 60s and a future crash that includes China could see it approach the 50s?

And if gold increases in value from now that is further cream.

I have a hedge against the tanking of the Australian economy. Thus if the housing market crashes I can convert gold to buy up a cheap property or agri stocks etc.

It becomes perverse as I end up wanting the world to crash to get rich, shorting the world.

I lose if the world looks like it will return to normal...but that doesn't seem liklely for a while at least.



Temporalist's picture

"if the world looks like it will return to normal"


See BP oil disaster, N/S Korea, Eurozone, Greece, Thailand, Middle's the "new normal" that will prove you right.

Caviar Emptor's picture

Valuations in term of currencies will become much more fluid. Many are shifting into defensive mode and some will remain there long term. 

DosZap's picture

When the USD goes up,DUMP IT.................tangibles, hard assets.

On the statement, When the world get's back to normal.......

There will not ever be ANOTHER Normal as we knew it...........

We are IN, and going thru and into a Major Paradigm Shift.

Global Governance, is going to take our PREVIOUS freedoms, and RIGHT's, and stick them where the Sun doesn't shine.

The only people who come out on top of this, are the Uber Elite...

We're F*$*#*...............unless Americans grow some huge NADS, and decide to not go quietly into that goodnight.

thesapein's picture

Don't you ZHers get tired of hearing this dribble about China being dependent on consumers in Europe and US?

I agree with Faber on this one. That was then, this is now. China's biggest exports are now to emerging markets. Get up to speed, everyone.

Temporalist's picture

Agreed.  China can be its own consumer but there will probably be a revolution there for wage increases and who know how that will play out, same can maybe be said for India and surrounding SE Asian region.

thesapein's picture

I think you just touched on a very important dynamic.

China's wages will go up. Regardless of our obsession with the dollar deflating/inflating, in real terms, say gold, China is going to see their living standards go up, whilst ours will drop. Our economy is deflating, no matter the inflation vs deflation of the dollar. Keep an eye on wages in terms of real assets.

theprofromdover's picture

I suspect China could double their manufacturing costs and their export volume wouldn't get hit much in the meantime.

And since they are now converting all their dollars into stockpiling mineral imports and foreign infrastructure, they are not going to get stiffed as badly when the US eventually goes down the plug-hole.

It is you who are being sold into slavery. In 20 years time China will be opening assembly plants in Detroit and tomato processing in Salinas, using cheap American labour to support the Chinese middle classes........


theprofromdover's picture

I suspect China could double their manufacturing costs and their export volume wouldn't get hit much in the meantime.

And since they are now converting all their dollars into stockpiling mineral imports and foreign infrastructure, they are not going to get stiffed as badly when the US eventually goes down the plug-hole.

It is you who are being sold into slavery. In 20 years time China will be opening assembly plants in Detroit and tomato processing in Salinas, using cheap American labour to support the Chinese middle classes........

thesapein's picture

Emerging markets are becoming their own consumers.

Going metamacro, what is happening is that emerging markets are realizing that exporting real goods for fake money is like exporting your real economy for a phony one.

This may be hard for many people to fully understand, but THEY REALLY DON'T NEED ANY MORE DOLLARS.

Yes, they did import much of our manufacturing base; another reason they no longer need us.


Julien's picture

I don't agree with you, they inherited our manufacturing base because we are now spending our time working on things more productive than manufacturing basic stuff. Thats called comparative advantage and we all benefit from it. We need them and they need us

merehuman's picture

julian,  "we are now spending our time working on things more productive"

Like what? And who is "we"? Our people are idle, no jobs, no product creation.

Maybe you are referring to the printing of money

or the creation of debt?   It seems you may be clueless and i hope you learn soon.

ThreeTrees's picture

Until they don't.  Outside investment stimulates growth, ie: capital creation/accumulation.  Sooner or later, when left to market forces, that increasing capital base makes it feasible to produce for domestic consumption by driving down costs.

If demand for emerging market exports drops their economies will obviously shrink, but tangible capital (real savings) will stick around, get liquidated and be reintegrated productively into the economy.

Western capital gave the emerging economies the tools it needed to grow.  In the end the rest takes care of itself.

pan-the-ist's picture

Julien is simply sharing the view from the Wall Street ivory tower reality.  He even used the word 'Comparative Advantage.'  He is right because our Military will protect Wall Street and the elite, the bansters are safe with their world ending wagers because our guns will make those nations pay their debt.  In dollars.  If you are an unemployed shlep you can always join the military and protect Julien's investments.  (Let me know if I missed anything.)

thesapein's picture

I caught that, too. "Comparative advantage" brings back fond memories of college. Man, econ was so easy if you just played along.

akak's picture

"I don't agree with you, they inherited our manufacturing base because we are now spending our time working on things more productive than manufacturing basic stuff. Thats called comparative advantage and we all benefit from it. We need them and they need us."

I've got a bit of hard news for you: almost the only comparative advantage the USA possesses over other economies today is the size of, and the degree of control exercised by, our sociopathic power elite.  And despite their shrill and self-serving threats, NOBODY needs them, domestically or internationally!

Hephasteus's picture

It frees them up to endlessly squabble over intellectual rights and such.  Now respect my patent!!  You can make anything you want as long as you pay me my license fee because england and america invented everything. If you have to fight and make stuff how can you possibly defeat someone who just fights and takes part or all of what you make? It's like pitting farmers against professional soldiers.

bob resurrected's picture

In my opinion, the Black Swan is if the Debt Commission is unsuccessful, or even late. Dec 1 is the deadline.

bob resurrected's picture

I guess that is simply stating the obvious though.

Fred Hayek's picture

There's no way they'll be successful.  None.  Zero chance.  Nil.  Zed.  Nought.

The problem is that the solution is almost completely a spending adjustment and they'll want to make mostly a taxation adjustment, as if the IRS just hasn't been getting enough money from all of us.  That's why B.O. had the head thug from the government employees' union, SEIU, added to the commission, to make sure it didn't accidentally look at reality and tell all the featherbedded layabouts that they're the ones taking the ax. 

Look at the states with the worst debt problems.  All of them, CA, NY, PA and IL prominent among them, have had explosive growth in revenues but they simply spend it even faster.  If the problem were insufficient growth of revenues, then one might expect that the states with lesser revenue growth would be the ones with the debt problems.  But, it's CA, NY, PA and IL because they spend too much.  Period.  And that's the problem with the federal government.  Any actual solution would take a chainsaw to the federal budget.  They'll use a Gillete Mach 3 with skin softeners and cover any nicks over with massive income tax increases and a new VAT.  It will fail.




Trichy's picture

In my opinion, the Black Swan is if/when BenCo for some incredible reason runs out of imagination on how to cook the books and has to announce re-recession.

ConfederateH's picture

On Friday I a sold off a 2013 Nestle CHF bond.  It was aaa and had a yield to maturity of .8%/year.  I figured "why would I want to tie that money up in a bond that is paying virtually nothing".

At some point, treasury buyers are going to realize the same thing.  At the latest, that time will be when the first european country can no longer sell it's sovereign debt into the bond markets.  Then things will start getting really interesting as the Fed leans on the SEC to put withdrawel limits on all the Vanguard and Pimco government bond funds.

exportbank's picture

The Chinese will devalue the RMB and have a joke on everyone. That also solves their EURO problem.

thisandthat's picture

Originally, the EU wanted to closely tie the Euro with the Dollar, but the US refused and the Euro ended up soaring, so the Euro isn't really so devalued:

China could peg the Yuan to the Dollar and the Euro - what's the probability that happening and what if?

thesapein's picture

Wait, what?

How do you peg one rate to two rates?