December 22, 2006

With the failure of the China mission, we have crossed a modern economic Rubicon. The die is cast.

by Michael J. Kosares (12/22/06; usagold.com msg#: 150425)
Centennial Precious Metals, Denver
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"If history teaches anything, it is that government cannot be trusted to manage money."
--The Nightmare German Inflation, Scientific Market Analysis

I read with interest the essay by James K. Galbraith from the Manchester Guardian, "Clueless in China". As most of you already know, I consider the China/US relationship -- flawed as it is -- the Achilles heel of the world economy. Now, I believe, with the failure of the Paulson-Bernanke mission, the arrow has found its target. Gold ownership globally, as a result, is not just an important aspect of the private investment portfolio. For reasons outlined below, it has become essential.

The China visit by a large and influential American entourage marks a watershed. Now, certain long proscribed outcomes are not simply assured in some obscure future; they are immediate -- launched and in progress. There will be no turning back. In fact, there has been no turning back for a very long time. The failure in China confirms what many of us have suspected for some time now. China and the United States have trapped themselves in their own policies. There is no way out.

The visit will be a subject of discussion for historians probably for generations. Ultimately, in my view, that discussion will revolve around what role the mission played in the early 21st century international economic maelstrom which followed. It will question why no one in power on either side did anything substantive to alter the outcome. Those of you who are students of history will remember Barbara Tuchman's book on how the first World War was actually launched (The Guns of August). You will recall that she concluded that the war began not so much because anyone or anything actually "started" it. The war began because no one tried to "stop" it. Now, almost 100 years since August, 1914, we have come to a similar place but this time in the less violent arena of modern economic history.

Let me come to the point:

If China is going to more or less allow its currency to decline in purchasing power in concert with the U.S. dollar (which seems to be the final outcome of the meeting), the other major trading nations will take their cue from this policy and force their currency to depreciate as well. Essentially, they have no choice. Only Europe, at this time, is attempting to increase demand for its currency (by raising interest rates) while all others head in the other direction, that is, the direction of deliberate currency depreciation and inflation. All currencies, whether or not they make half-hearted attempts at letting the dollar go down, will depreciate markedly against goods and services nearly in concert. (I expect the European position to change next year as pressure builds from the left of the political spectrum and finance ministers step up their attacks on the European Central Banks, and by proxy, the union itself.)

The net effect of these policies will be international inflation and in some places, most notably the United States, double digit inflation -- at least in the beginning. It could get much worse from there if the dollar becomes anathema in the portfolios of the world, and, as the saying goes, a crowd gathers at the exit. We got a dose of the future last week when out of the clear blue wholesale prices jumped 2% in the United States for no apparent reason. That was quickly swept under the carpet by Washington and Wall Street and the markets hardly reacted. I believe the reaction, though meager and, I am certain, heartening in some sectors of the financial markets, has only been delayed.

Last week's inflation numbers, however, are only a luke warm warning of what's to come. If allowed to go unchecked, the natural progression, pushed by the U.S. and China's deadly tango, would be to ignite an international hyperinflation as each nation attempts to cheapen its currency against all others in a mad game of one upsmanship -- a deadly game of economic Russian roulette which builds to critical mass and a final core meltdown. The United States, in this scenario, might lead the way on inflation but it will be far from alone. All the world's citizens should be gold owners, and I do not exaggerate by saying that.

For those with a penchant for historical example, the Weimar experience will serve as a educational template and good study of how quickly and inexorably things can get out of control. What we are about to experience will be unprecedented historically. For the first time in the planet's history, the scale and implications are global. For those who wish to understand how these things tend to work out, a link to the interesting German hyperinflation history is provide here. (To give you an idea what people are thinking, this page is among the most widely linked USAGOLD pages on the web.) It could happen -- a international hyperinflationary blow-off, that is. Furthermore, the politicians and economic bureaucrats responsible for currency policy are likely to continue denying the logical outcome of their policies both to themselves and the electorates they serve and/or represent. This is playing with fire.
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When is the last time half the United States government, including its chief central banker, showed-up at anyones doorstep to discuss anything. Just the appearance of so many high-ranking American politicians and bureaucrats alone should have been enough to send the opposition into a compliant mood. China, under the circumstances, should have been impressed. It should have been convinced to do the RIGHT thing by the speeches, the toasts, the pleas of the Secretary of the Treasury and the long academic presentation from Bernanke including footnotes.

One problem. It wasn't. As Ms. Wu pointed out, the visitors did not truly understand China's history. They didn't know what its like to starve. They didn't know what it's like to impose one-child families on a population -- as a prerequisite to survival. They didn't understand what it is like to struggle out of utter poverty. Not by a long shot. Now that China had enjoyed basic economic security, why would it do anything to jeopardize it?

And we cannot forget that after Paulson's last visit to China, the Financial Times published a lengthy article on its prestigious opinion page wherein Chinese academics and high government officials made a series of public warnings. (Visit the USAGOLD NewsGroup linked from the Daily Market Repot page) One of them was that China would not fold to American pressure like Japan did in the 1980s creating a depression from which that country still suffers. Officials also said that they stood ready to trade U.S. Treasuries for oil and gold as a way to balance its inordinately high stake in the dollar -- some $700 trillion in U.S. government paper.

But, alas, the delegation failed. Momentum was lost -- probably forever. China will stand in contemporary history alongside that other notable failure -- Iraq. The big chill descends. It will be business as usual on the economic front and the Paulson-Bernanke China mission will serve as just another marker -- albeit an important one -- on a long road that started in 1971 with the first official devaluation of the dollar and its severance from gold. Perhaps the die was cast back then, but be assured we have now crossed an important economic Rubicon from which there can be no turning back. Under the circumstances, there will be no slowing down the international scramble for anything tangible -- most notably. . . gold.
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This concludes my series on China. I look forward to the comments of my fellow posters and gold owners on these important matters.


[SEE ALSO... previous commentary on the changing face of China's reserves and whate it means for gold.]


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For more information on the role gold can play in your portfolio, please visit The ABCs of Gold Investing: How to Protect and Build Your Wealth with Gold by Michael J. Kosares.