Submitted by William Bonner, Chairman – Bonner & Partners
Faded, Tired, and Shredded
POITOU – It doesn’t look as though investors will get much Christmas cheer in their stockings this year. Last Wednesday, the Fed raised interest rates – as expected – by a token amount…
At first, there was a little rally in stocks. But in the two trading days thereafter, the Dow lost 621 points. Trading will be thin this week, as the big day approaches and more and more people turn from Mr. Scrooge investors into Mr. Fezziwig revelers.
But on Monday morning, the Japanese stock market sold off – a bad start to what could be a bad day… a bad week… and a bad year.
Investors looking at what happened on Thursday and Friday might think they see a trend. They might decide to spend the holidays “safe and sound” – on the sidelines. Falling prices might create a panic… who knows?
We would run our “Crash Alert” flag up the pole. But the old flag is in tatters. We felt sorry for it and put it into retirement. Each time we thought a panic might occur, we hauled it out and sent it up.
Each time, it hung there… fluttering in the breeze… warning investors. And each time, there was no crash to give meaning to its life.
Faded… tired… shredded on the edges, the poor flag is out of service – and maybe just when we need it most!
Image by fmh
The Nikkei’s EKG is beginning to look like cardiac arrest is imminent – click to enlarge.
Just after World War Two the United States had a massive debt-to-GDP ratio of over 140%. Today’s debt-to-GDP ratio of 104% seems paltry in comparison. But along with a huge debt-to-GDP ratio after the war, the US also had one of the largest trade surpluses in the world. Much like China does now.
The difference, China’s debt-to-GDP ratio today, for government debt, is around 42%, with a balance of payments surplus of over $60 trillion. This puts China in a very strong position within the multilateral monetary transition which is taking place.
At present time, the US has a large trade deficit, with China being the biggest creditor, and a high debt-to-GDP ratio. The ability of the US to push its debt-to-GDP ratio down after the war had a lot to do with its strong balance of payments position at the time.
Also, the status of the dollar as the international reserve currency gave America the ability to print large amounts of money to fund production and increase exports to a world which was rebuilding. The Triffin Paradox defined the problematic and systemic issues which would arise from such an arrangement. The use of the domestic currency of one specific country, here being the USD, would cause deflationary pressure back home and force the central bank to continue printing money to meet the international demands brought about by the reserve currency status.
The chart below defines how the US debt-to-GDP ratio decreased after the war on the back of robust American production and huge exports. But around the early 1970’s, when the original Bretton Woods agreement was ended by Nixon, the American debt-to-GDP ratio began to increase once again.
There are several reasons for this, but it mainly had to do with the US beginning to build a trade deficit as more and more dollars accumulated in the foreign exchange reserve accounts of central banks. The trade agreements which developed from this US debt accumulation forced western companies to move production to the creditor nations. In this particular circumstance, China was becoming the largest American creditor, and as such, many American factories were moved to China to offset the dollar inflation which was being exported. Continue reading
There are a few correlations that I find particularly compelling. The first is Chinese RMB (or CNY) next to WTI crude oil, as both are proxies in their own way of multi-dimensional crosscurrents between global “dollar” finance and real economy function. Since March, that correlation has come into renewed and tight focus. In the past few days, the CNY has traded and fixed narrower, perhaps indicating an end to the latest run that has demonstrated huge “dollar” tightness. WTI, however, is still on the way down “catching up” to CNY and thus signaling instead only a short-term pause in the financial downgrade and downdraft.