Hot Money, Gold, Foreign Exchange And The Fallout From QE

This article originally appeared in The Daily Capitalist.

What do "hot money," gold, sovereign debt, foreign trade, and Germany and China all have in common? Everything. They are all lined up against the U.S. and our new quantitative easing (QE2). There is fallout related to quantitative easing, and the markets are reacting, from the Fed's perspective, badly.

QE is just a way to flood the economy, and the world, with more dollars. And that act is the very definition of inflation. I've written about this many times. Rising prices are just one of the manifestations of "inflation." Unfortunately, the most important phenomenon is that it distorts the pricing mechanisms of goods and money (interest rates) and sends false signals to bankers, businesses, entrepreneurs, and consumers. This is what leads to "overproduction" or, in Austrian theory terms, malinvestment.

It isn't that difficult to figure out that more dollars in the system will lead to increased demand for goods as people spend all this new money. It isn't that difficult to figure out that more dollars will cheapen the current market value of dollars. It is just supply and demand like any other good on the market: if you have too many dollars than you want to hold, and you suspect they will eventually buy less, then you have an incentive to get rid of dollars and buy goods. Prices rise, but not as a result of improving economic activity, but just from a flood of paper.

It isn't that difficult to figure out that since the first recipients of the money from QE2 will be merchant and investment banks (the primary dealers) that a lot of green pieces of paper will chase financial assets including stocks. Viola! The stock market goes up even though fundamentals are relatively unchanged.

These are all things the Fed wishes to achieve. Rising prices that will trick businesses into thinking that the economy is improving and thus they will borrow, expand, and hire. With a rising stock market, even though companies' underlying values haven't really improved, folks will think they are better off and that the wealth effect will trick them into spending and borrowing again. A declining dollar will spur U.S. export because our goods will be "cheaper" on the international markets, and we all know that exports are good and imports are bad, right?

None of this will work, except to cause inflation and stagnation.

Apparently everyone in the world except Ben Bernanke thinks QE is bad. They would like to see our government spend less, tax more, and clean up our sovereign debt. At least that's what Ben is going to hear at today's G-20 meeting in Seoul.

China:

They have made a pact with the devil (the U.S.), so to speak. With their currency pegged to the dollar, when we devalue the dollar their exports to the U.S. don't get more expensive for us and business goes on as usual. As dollars pile up in their central bank, they have to do something with them. They have been the No. 2 buyer of U.S. Treasurys. When Chinese exporters turn in their dollars to the central bank for yuan, they have to print more yuan to make the exchange. It is the way we export our inflation. But, even with more Chinese inflation, their huge accumulation of dollars still makes the yuan more valuable than the fixed peg. Speculators try to accumulate yuan and force them to buy dollars in exchange for yuan. This means they have to print more yuan to try to maintain the peg.

The Chinese have complained rather bitterly about QE2. The problem is, the more we print, those dollars are worth less and less.  They are starting to engage in a game of "chicken" with the U.S. A Chinese bond rating agency, Dagong, has just downgraded U.S. Treasurys by one notch. If you read their report, you would agree with almost everything they say about our profligate government spending and economic policy:

The serious defects in the United States economic development and management model will lead to the long-term recession of its national economy, fundamentally lowering the national solvency. The new round of quantitative easing monetary policy adopted by the Federal Reserve has brought about an obvious trend of depreciation of the U.S. dollar, and the continuation and deepening of credit crisis in the U.S. Such a move entirely encroaches on the interests of the creditors, indicating the decline of the U.S. government’s intention of debt repayment. Analysis shows that the crisis confronting the U.S. cannot be ultimately resolved through currency depreciation. On the contrary, it is likely that an overall crisis might be triggered by the U.S. government’s policy to continuously depreciate the U.S. dollar against the will of creditors.

It is pretty obvious that the Dagong report is something that was created by their central bank as sharp-elbow tactic in the currency wars between the U.S. and the rest of the world. All's fair ... as they say. But they are stuck with dollars. What can they do with them? No one else wants dollars, so all they can do is buy Treasurys and buy U.S. goods and assets. When you think about it, dollars are just a claim on U.S. assets. And, thanks, guys for subsidizing our purchase of your goods.

What if they don't buy our Treasurys? Do they have a real choice? As the dollar really declines in value, and they try to buy, say Bunds, they will be very expensive so whatever they do they will probably be stuck will a devaluing asset. If they do dump Treasurys, my guess is they will end up with even less as international markets panic.

Germany:

They have four aces at this point. They are the only sane ones in the world right now. Angela Merkel and her finance minister, Wolfgang Schäuble have been very blunt about what they think of QE. Schäuble said:

The Fed's decisions are "undermining the credibility of U.S. financial policy," Mr. Schäuble said in an interview with Der Spiegel magazine published over the weekend, referring to the Fed's move, known as "quantitative easing" and designed to spur demand and keep interest rates low. " It doesn't add up when the Americans accuse the Chinese of currency manipulation and then, with the help of their central bank's printing presses [QE], artificially lower the value of the dollar."

At an economics conference in Berlin Friday, Mr. Schäuble said the Fed's action shows U.S. policy makers are "at a loss about what to do. Germany's exporting success is based on the increased competitiveness of our companies, not on some sort of currency sleight-of-hand. The American growth model, by comparison, is stuck in a deep crisis," he said. "The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base. There are many reasons for America's problems—German export surpluses aren't one of them."

Mr. Schäuble said last week that he doubted the U.S. would live up to a commitment world leaders made this summer at a G-20 summit in Toronto to halve government deficits by 2013.

Pretty harsh talk. But he's right. Merkel wasn't kind either:

We reject quantitative targets for imbalances for good reason,” Merkel told reporters in Berlin today. In Seoul, “the issue of competitiveness has to be on the agenda, explicitly the issue of exports.” ...

“We will discuss this issue with United States in a spirit of partnership,” Merkel said today. “We don’t want to have new asset bubbles and rather want to ensure that growth remains sustainable.”

You have to sympathize with a country that mostly ignored what the U.S., China, UK, and others urged them to do (fiscal and monetary stimulus) and now their economy is recovering. What is their incentive to cut back exports and stimulate imports and consumption? None. Except the big U.S. stick.

Hot Money:

Let's say you are a burgeoning developing country, like, say Brazil (pick your country), and you have a healthy export market which is raising your standard of living which in turn increases consumption at home. Let's say you have been successful because of wiser monetary and fiscal policy and you have a relatively stable currency and the country is growing.

As an investor wouldn't you want to invest in a growing Brazil instead of a stagnating U.S. or EU (other than Germany)? The answer is yes, especially if you can borrow U.S. dollars at next to nothing and reinvest them in Brazil with better yields. This is the "carry trade." It works well for investors because they get rid of devaluing dollars for hard asset or high yielding Brazilian bonds. The problem is with floating exchange rates, the value of the real rises because the positive yields for investors signals that the real is undervalued. This is what is pejoratively called "hot money." "Hot" because it is fickle money and can be rather quickly sucked out for better yields elsewhere.

The Brazilians don't like hot money because it revalues the real and makes exports more expensive in foreign markets. They and others (Taiwan, South Korea, and many others) have been trying to limit hot money by taxing it or limiting it in various ways. This is a two-edged sword, because the Brazilians report that since they need foreign capital, such protective moves make capital expensive for them as well.

They have been very critical of our QE because it only makes their problem worse.

For an excellent piece on this see this article in The Wall Street Journal.

Gold:

The IMF estimates that the 15 major sovereigns (including the U.S.) will need to borrow $10.2 trillion in 2011 to refinance existing debt and finance new deficits. They say that it is highly likely that lenders' will balk at refinancing this debt. Which suggests that interest rates for sovereign debt may rise. They note that, "The total amount of foreign portfolio investment sloshing in across advanced countries’ borders averaged about 3.8% of global GDP in the twelve months ended June, compared to an average 9.5% in the eight years leading up to the recession."

Could it be that they are getting tapped out? Next year, the U.S. government will have to find $4.2 trillion. That’s 27.8% of its annual economic output, up from 26.5% this year." The accompanying article notes that domestic demand for U.S. Treasurys have been strong. Plus, as we all know, the Fed will buy $600 billion of it.

If we see interest rate pressure on sovereign debt, then that would be a negative sign because it would only exacerbate sovereign deficits and impact GDP. Which brings me to yesterday's (Wednesday) 30-year Treasury auction:

A Treasury auction of $16 billion in new 30-year bonds on Wednesday was poorly received, with the government having to pay a slightly higher yield than expected to attract buyers.

The 30-year Treasury bond's price has fallen nearly 12% since Aug. 26, just before Fed Chairman Ben Bernanke hinted at QE2 in a speech at Jackson Hole, Wyo. The yield has jumped to 4.239% from 3.53% in that time, and at one point on Wednesday surged to the highest since May.

I'm not suggesting this is necessarily a trend; there are a lot of factors behind this. On the other hand, the gold market is telling us something.

This is the backdrop to today's G-20 meeting in Seoul. Good luck President Obama, Secretary Geithner, and Chairman Bernanke.

Comments

[greenewave]

Watch the YouTube video Global Riots, Currency War, Fed Bubbles at (http://youtu.be/PieHhMepVb0) for more information on the global economic collapse.

Anonymous-

"The only thing we have to fear is fear itself, and? being completely fucking destitute due to great deppression II."

[ATG]

Watched it thanks

Best part RT riot footage at the end

[Waterfallsparkles]

Manufacturing Jobs will come back to the US when the Minimum wage is $2. an hour or less.  That is what the FED is trying to do.  Devalue the American Dollar and the value of the workers hourly pay.  They have to make America EQUAL to balance trade.  So, Americans have to become as Poor as the people in China are now and the China workers become more wealthy.  Then the Balance will be equal.

[ATG]

Bingo

The Brzezinski Kissinger Bilderberg CFR Trilateralist New World Order

http://en.wikipedia.org/wiki/Zbigniew_Brzezinski

http://en.wikipedia.org/wiki/Henry_Kissinger

[RockyRacoon]

The following is an excerpt from the November edition of Dr. Faber’s indispensable monthly newsletter, The Gloom, Doom & Boom Report.]

I think there may be a window of opportunity left in frontier markets. Let me explain. In last month’s report, I noted that we should think of the US as a “huge money-printing machine that produces an unlimited quantity of dollars”.

Most of these dollars flow to the corporate sector, wealthy individuals, and financial institutions. A large proportion of these dollars is then transferred to emerging economies through the US trade deficit and investment flows, where it boosts those economies’ economic activity and increases wealth relative to the US. I also warned that potentially spectacular bubbles could develop in emerging stock markets, as well as in selected hard assets (i.e. in precious metals, art prices, and prestigious properties). I am now beginning to think that even more spectacular bubbles could develop in frontier markets. How so?

I mentioned that the US transfers dollars to emerging economies through its trade deficit and investment flows. Emerging economies are then faced with the decision of what to do about the dollar inflows. If they let the currency appreciate, a temporary loss of competitiveness may result. (This is not my view, however.) If they do nothing, spectacular asset bubbles can occur that are accompanied by high consumer price increases. In either case, the price level (especially of assets) in traditional emerging economies initially increases compared to the level in frontier markets. What happens next?

International investors, sovereign funds, and wealthy individuals who live in more advanced neighboring emerging economies become aware of the huge differences in price (for everything, including all kinds of assets and services) between their own economy and that of the frontier region. As an example, wealthy Hong Kong, Singaporean, Korean, Taiwanese, and Japanese businessmen and investors (and their sovereign funds) won’t fail to recognize the enormous difference between real estate prices in their own relatively advanced economies and those in countries such as Cambodia, Vietnam, Myanmar, Mongolia, and Laos.

Now let us go back to the huge money-printing machine in the US, which transfers economic activity (including employment) and wealth to foreign countries.

First, US dollars flow to the countries with the highest current account surpluses and, as explained earlier, push these countries’ asset prices up either through appreciation of the currency or through high domestic price increases – or a combination of the two. In a second instance, this “additional liquidity”, which created enormous wealth in Asia, will flow to the least developed countries. I believe that in this context, Vietnam is currently an attractive investment destination.

I was recently in Vietnam and, as on previous visits since 1989, I was immensely impressed by the dynamism of its population and the ongoing economic growth. This is not to say that Vietnam is problem free (witness the struggle between the reformists and the hard liners in the government, the large trade deficit, high inflation of between 12% and 15%, a weakening currency, etc.), but for the first time in years the valuation of the equity market has become compelling.

For a modest exposure to Vietnam, investors may consider the purchase of the Market Vectors Vietnam ETF (VNM), which is listed on the NYSE.

Other stock markets that have failed to participate meaningfully in the global “asset reflation” since early 2009 include those in the Middle East, about which I have written before.

Obviously, as in the case of investments in Russia and Central Asia, the performance of the Middle Eastern markets will depend largely on stable or rising oil prices. However, oil and oil-related equities have begun to show favorable relative strength based on several technical indicators, which gives me some comfort when making these recommendations. Stable or rising oil prices should also have a positive impact on US oil stocks, and on Canadian oil stocks that have exposure to oil sands.

The Market Vectors Gulf States ETF (MES) offers an exposure to the Middle East.

Regards,

Dr. Marc Faber

[ATG]

VNM @ 25, target 15.

http://stockcharts.com/charts/gallery.html?s=vnm

MES@23, target 31.5

When America or China sneeze, frontier markets may catch cold

[doolittlegeorge]

the "problem with QE" is not at ALL mere "excessive dollar printing."  It is "the problem of driving up in price what is most valuable."  In short "it is the inverse of the 90's" where "priceless stuff could be had for an inchoate dollar."  Now "we have the exact opposite"--only worthless stuff to be had with what was a worthless dollar but now appears to be a suddenly dear dollar.  Frankly I don't understand the Fed policy to begin with but "if the underlying problem to be fixed is securitization" quite simply "THEY'VE DONE EVERYTHING ALMOST PERFECTLY WRONG."  And with "another leg down" in the mortgage market "they're now saddled with a couple of trillion in bad debt" with the Federal Government's answer being "more debt on the way, folks!"  Amazingly "now we have encomic recovery" which says to me "you're phucked Bernanke" because "the growth money is simply ignoring the securitization market (as differentiated from REITS which are Wall Street creations) which the Fed and indeed the entire Federal Government has spent trillions trying to save."  And so the response?  "Raise margin requirements in the silver market"?  That's gonna cause that price to positively SOAR not fall thus "expanding lending from private sources into that space and of FURTHER diverting it from the public policy goal of restarting the securitization space."  In short "now your capital Ben Bernanke (through QE) is moving EN MASSE into the space you were suppose to be diverting it from and evern FURTHER away from the public policy goal." Needless to say the "public debt to commodity price ratio" can be rearranged more favorably in relation to the latter...but for that to happen prices in that space would have to rise 1000 fold "just to keep pace with the debt issuance."  In short "if nobody's paying the bills somebody's gotta pay," right?

[apberusdisvet]

My long-time (30 year) PM dealer informed me today that he is back ordered on all bullion, especially silver; this has never happed before.  I used to pay $0.79 to 0.89 over spot; now it's $2.00.  WTF!

[Azannoth]

Here in Germany silver coins went from 20 to 23 in a week, gold from 1000 to 1060 too, I'd be buying a lot more silver except for the 7% tax and silver is bulky

[DCon]

Tax is 17.5% in the UK. Be glad you are in Germany

NNo tx in teh Netherlands for silver purchases, it seems

[Kina]

There is always Perth Mint Certificates

http://www.perthmint.com.au/investment_certificate.aspx

[tom a taxpayer]

"Hot money". Today Mandy looks delicious and is a "Hot Honey".

[Vampyroteuthis ...]

None of this will work, except to cause inflation and stagnation.

That sums it up right there. Helicopter Ben is fighting the black hole of deflation with his printing presses. By driving up commodity prices, it is further destroying an already devastated economy.

As for China, they bought UST with the idea that they would remain relatively stable and to manipulate their currency. The tables have been turned as the UST are declining in value. Tough sh*t!