January 7, 2009

China to Reduce $US Transactions

By admin

Please note:  the opinions expressed in this blog do not constitute financial advice.  Any investment action that you take in response to this article or other articles on this blog (or other blogs, for that matter) should be done with the support or review of a registered financial advisor.

The government of China has announced that it will reduce the volume of $US transactions, mainly out of a requirement to protect local economies from the volatility of the American currency.

A full story can be found here .

In the past, I’ve argued that the US dollar has a lot of depreciation ahead of it.

As people wake up and realize that the Americans are out of control with their debt financings and printing of money, they will seek out ways to limit their exposure to this economic madness, just like the Chinese are.  In turn, the US dollar will plummet in value.  The result?  The laws of economics hold:  lack of demand = collapse in price.

However, most commodities are still priced in US funds.  This means that as the value of the US dollar collapses, the inverse happens with the price of oil, corn, lumber, oats, wheat and other commodities.  We saw this when W Bush took office, with a long, slow depreciation of the US dollar and a gradual rise in the price of everything else.  The ‘benefits’ of tax cuts and deregulation had to be financed by the creation of dollars in order to sustain wars in Iraq, bailouts and other financial disasters created by the Bush administration.

The trend was reversed briefly in 2008 as financial traders had to expunge themselves of toxic debt and other financial instruments.  For a short time, the US dollar was in demand because … you guessed it … all of the products were traded in US currency.  To sell them meant you had to buy the greenback.

That trend has stopped for a time and we’re seeing the return of the mighty dropping buck.

The result of all of this?  We get what I call ‘interflation’, which is the internationalization of American inflation.  The rest of the world will have to pay for the mess that the Americans are creating.

For example, the value of the US dollar vs the Yen reached a 10-year high in December 2008 of 110 (ie. one $US would buy 110 Japanese Yen). MSN chart here .  The same trend could be seen with the buck vs the Euro, where a 10-year was again reached in December at 1.56 (ie. one $US would buy 1.56 Euros).  MSN chart here .

My guess is that by mid-2009, the US dollar will be worth 90 Yen and about 1.2-1.3 Euros.  It may not seem like much, but decreases in the US dollar vis-a-vis other international currencies seem to result in near-exponential increases in commodity prices.  We saw this through late 2007 and early 2008 and will most likely see it again in 2009.

Headlines that were forgotten during 2008 such as ‘world starvation’ and ‘pain at the pump’ will quickly return.

One of the biggest issues I have with this kind of review is that there’s not enough honest analysis.  Most people usually say ‘oil prices are up again’, not fully realizing that the reason they’re up is because the commodity they’re priced in – the US dollar – is down.

That’s right:  I just called the US dollar a commodity.  Why shouldn’t I?  It’s got a supply and demand just like everything else, right?

And the supply is rapidly increasing.

And when you start thinking of it as a commodity, you can start thinking of it as a product that can be substituted for something else.  The world needs to realize that the economic cycle does not need to revolve around inflated demand for the almighty buck.

China’s made a start.  Maybe other countries will follow suit.  But when they do, the inflationary impact will be a most painful cost of this adjustment.