Tuesday, January 3, 2012

Of Inflation, Commodity Shortages and US Treasury Shorts they dream...

Failure to understand the implications of the exponential curve on real prices and demand has been a very common problem. While I have and have had great respect for Jim Rogers - he appears now to be totally confused. He has been shorting US Treasuries for a long time, as have Marc Faber and others…fundementally misunderstanding the dynamics of our system. Jim has been talking dovishly regarding China and during the last year…China equities have done nothing but go down. One of Jim’s core themes, a lot of elements of which I like, revolve around the idea that the next generation of millionaires and Ferrari drivers will not be the Wall Streeters but rather people who make something or grow something like farmers or miners. I definitely agree that, value is not created by people pushing around papers and want to see more emphasis on real value creation as opposed to theoretical value creation. However, I have discussed at length the distortions that BURNanke and many other leaders have regarding the potential for continued exponential demand. Nature is fractal and is much more powerful that any human. When demand gets too great nature solves the problem for us - that ususally does not result in higher prices for said items. Trying to preserve buying power with a store of commodities will work somewhat, but not very well…but you will be able to swap oil for gold or wheat…most likely for similar ratios as you can currently well into the future. Will your buying power be preserved? NO…I do not think so.

Now in a perplexing set of assumptions, Jim encourages investing in the EURO, a currency bent on extinction, the renminbi and the Canadian dollar. I could not choose a worse group of currencies if I tried. I do think and agree that an allocation of the Swiss Franc is appropriate…however, the Swiss Franc is still rather expensive. Where this attitude relating to the U.S. comes from, in my opinion, is related to a general theory that the US is in a tremendous sovereign debt bubble itself. Rogers and quite a few others are chomping at the bit to short Treasuries it appears - especially of the 30 year kind. There is such a huge misunderstanding here that it is almost ridiculous. Most of the biggest names on wall street have not seen the treasury rally coming and have been trying to short the far end of the curve. That my friends is just too popular of a trade. With the recent rally in treasuries, the concept is coming back into fashion again.

The reality of is that , US treasuries will continue persistently towards negative yield as the US and a few other countries are the only places in which other large investors and sovereigns can deposit gargantuan amounts of cash and reasonably expect its return. "The Bank called the United States of America" will be the theme for 2012. Any asset that is unable to backed by printable (Non IOU cash) cash will lose in value on a nominal basis - those include corporate bonds, most European bonds, junk bonds, municipal bonds, stocks and all commodities. In fact, this may very likely become a profit center for the U.S. and result in a significant positive reduction of the federal government operating budget deficit as the U.S. Treasury is able to issue bonds at negative yield…it may significantly reduce the risk that somehow the government may at any point be required to devalue the dollar as a means to settle obligations.

It is important to understand that most money that is created in the U.S. is created as credit money issued in small part by the Fed and the Government and largely by leverage junkie financial firms we call “Banks"…a small percentage of our money in the financial system is actually pure fiat - most of the currnecy in our system are credit or IOU based fiat proxies - and, yes, there IS a big difference. It is the pure fiat currency that is in demand and the credit money that has been oversupplied and can only be contracted via insolvencies and unwinds transacted with pure fiat currency.

The imbalances in china combined with their lack of transparency and additionally their economic planning, regulation and management tactics related their financial system will suffer tremendous strain because of the divergence between negative yielding sovereign debts for countries like the U.S. and the collapse in commodities prices and local GDP.

What I see is that it appears that many, including Rogers, are very confused. Rogers, for example is just all over the place…and it appears that many of his ideas are performing badly while a few of them are working. I guess this is the type of market that is designed to get and confuse the best of them. The unwind of the leveraged financial system should not offer an easily implementable investment basket now, should it?
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