The China Syndrome


"A building bubble this way bloweth. . ."

The investment world has become obsessed with phenomena that cause catastrophic loss—so much so that a new language has evolved, subjugating old words to new meanings. Meltdowns, for example; collapse. . .bubbles.

Bubble, in fact, is now the word that classifies any asset class believed to be overpriced as a result of investment hysteria. Right now, we have the gold bubble, the silver bubble, more generally, the commodities bubble. The real estate bubble, now burst, precipitated the world financial crisis of 2008, which, according to most financial press, is now over. Strange, that, since unemployment remains rampant, home prices are still at rock bottom, and earnings for any corporation who didn't get stimulus cash to superficially improve their balance sheet optics, are non-existent.

But, as usual, the mainstream financial press misses the point. Gold and silver are not bubbles. Their demand as monetary metals grows in direct proportion to the diminishing confidence in the U.S. dollar, which depreciates intrinsically with every fresh $100 billion printed. The U.S. dollar is the global standard medium of trade in fully 65% of world transactions. Outside of the G7, the rest of the world hates the U.S. dollar, because as more and more of them are printed, those exchanging commodities for dollars are getting increasingly ripped off. But that's the point, as the crooks that run the Fed and the Treasury well know. Devalue the dollar by printing more of them, then accumulate assets for will become pennies on the dollar, default on the dollar, and base the next fraudulent currency on the asset base you have now essentially stolen from everyone else.

To suggest that gold is in a bubble according to the somewhat standardized definition applied to copper, oil, houses and soybeans, is somewhat disingenuous.

The Federal Open Market Committee (FOMC) will conjure another $75 billion in ersatz paper money each month to Q2 next year. Now that's a big bubble. Fake demand for fake money. Headlines in The Wall Street Journal, New York Times and the Economist waxing optimistic about the future. Fake, fake, fake.

The crazy thing about the U.S. dollar bubble, is that it is the very air of which bubbles are these days built. Whole national and international economies trading on fake money. The valuations for products and assets no longer determined by supply and demand born of market forces. More like market forces manipulated to force prices into realms where they have no business being. Oil and copper are the best examples of commodities whose prices are severely inflated thanks to 'investor' interest, but what really amounts to market manipulation.

Gold and silver, as monetary standards regardless of who wants them to be, will continue to appreciate in value as long as this quantitative easing, stimulus and other words invented by the academic and political economist set continue to legitimize such counterfeiting.

On Christmas Day, China raised interest rates in an effort to slow the growth of what it perceives as a bubble within its borders. Low rates attract hot money that pushes up asset prices and floods the infrastructure development pipeline with "me, too" projects beyond reasonable demand. With the lesson of the feckless American crash and burn still resonating through global markets, China appears determined to avoid the blatant mismanagement of its monetary policy that encouraged those conditions in the U.S.

Inflationary pressures that cause price increases in, for example, food in China are more acutely felt by the Chinese who have a much lower average income than do Americans. It is for that reason that the Chinese are forced to also let the yuan appreciate, even though historically it discourages speculation in the yuan. Besides raising rates and letting the yuan appreciate, Beijing restricted banks' lending capacities by raising capital reserve requirements 6 times throughout the year to the current level of 18.5%.

The forces driving the bubble growth in China are the same as the United States in 2006. Higher wages, abundant cheap credit and rampant real estate price increases made the U.S. economy look like it was on a roll that would never end. But it did. . .and so will China's.

China Holds the Aces
China has a higher degree of regulatory ability than the U.S. does, since the U.S. government has essentially become the public perception management division of the financial services sector. Genuine public interest protection had all but disappeared until Obama took control and re-mandated the CFTC and the SEC with such direction. China tends to act more arbitrarily in the interest of preserving public harmony, and therefore its own government. It has ceased to become a communist society and is now more accurately categorized as a totalitarian capitalist system—very similar, in reality, to the United States. Only in the United States, the two-party administration swap every four to eight years means blame can be used to obscure corrupt self-dealing, unlike in China where the uni-party has the very distant future as well as the distant past as constant consciences to inform the present policy.

With such a pro-regulation, hands-on approach to economic management, it is unlikely that there will be a spectacular and sudden collapse such as that which occurred in the U.S. when powerful government supported interest groups decided to pull the plug on Bear Stearns and then Lehman Brothers in a blatant move to eliminate competition from the financial sector. China doesn't tend to wear rose-colored glasses when making economic policy, because they assume that the same government party who cooks up today's policy will be the same one that has to eat it years hence. In this regard, the Chinese have the upper hand in protecting their economy from overheating too much.

But that doesn't mean they can control the root problem to all bubbles, which is excessive capital supply. Arguably, the U.S. is engaged in a form of economic warfare against China by printing and thereby devaluing its dollar as China tightens availability of the yuan and lets its value appreciate.

As 2011 gets underway, and China is forced to confront inflationary pressures with the three tools at its disposal—interest rates, exchange rates, and bank reserve ratios—the U.S. will continue with the only tool at its disposal—counterfeiting U.S. dollars and flooding the market with them. Ironic that China—brutally undemocratic—should emerge as the only global government with the wisdom and forbearance to manage its money supply with a genuine interest in ensuring a disciplined global marketplace for future generations.

What the United States clearly fails to grasp is that their undisciplined quantitative easing malarkey is undermining their ability to remain a dominant force in the increasingly unified global economy. Looking back on 2010, unbiased observers would have no choice but to concede that China easily out-governs the United States in economic terms. In the western world, only Germany approaches the self-discipline apparent in China's policy evolution.

The announcement of the 25 basis point rate hike in China had an immediate effect on industrial commodities prices, and should be a clear warning sign to western economists. Stock prices slumped in reaction as investors priced in the diminished demand that must obviously result from tightening lending policy in China.

The lesson?

That the apparent exuberance driving the U.S. stock market to new highs could be so easily snuffed out by the equivalent of a slight shrug by the Chinese economic regulator means that, yes, China is growing a big, big bubble.

But it is a big bubble that the country can control much better than the United States; and when China decides to let some air out of its bubble, it is the U.S. and Europe that will suffer. In its attempt to subvert growing Chinese economic dominance by printing endless piles of increasingly worthless dollars, the United States has inadvertently handed the one thing to China it thought it would always have—control of the world economy.

Good for Gold and Silver
To commit a crime against another country, or against one's own citizens, is an act of war. The United States financial system, as it exists, is making war on its own citizens, and on the citizens of other countries, by foisting the decrepit system on the rest of the world. As the clearing house for the world's main trade medium, the ostensibly 'private' fed provides the very public service of prime banker to the world, and the ineptitude, or deliberate fraud, with which they execute this office, will be identified by future historians as such, and their names will forever be synonymous with the era of government positioning itself as public enemy number 1.

That this accurate characterization of the U.S. government has not become zeitgeist is due to the huge and well-oiled propaganda machine that is the mainstream press. The complexity of legislative language and its sheer volume prevent most citizens from forming their own opinions about the state of their country. Why read the Health Care bill when you can get Glen Beck's take on it in slickly prepackaged sentences loaded with selected power phrases and words designed to form your impression. Reconfigured semantically and redistributed through Fox Business, Squawk Box, CNBC and CNN, it permeates the public psyche in the metaphysical layer identified as truth. Dissenting and original voices, lacking the officially sanctioned language of the cartel, are labeled crackpots and freaks, and the expert production skills of the networks can make them look like incredible idiots.

But the main target of the machine is China. If China holds one third of all foreign reserves in U.S. dollars and likewise denominated assets, the U.S. figures it can just keeping pounding out the dollars and China will have to continue to own them to preserve their share of global trade. The U.S. is wrong, as it will gradually find out in the upcoming years.

All this means is gold and silver will continue to be the best storage medium for the value now falsely contained in U.S. dollars. There is a day of reckoning out there somewhere, and the holders of gold and silver will understand thoroughly the wisdom of their foresight when that day arrives.

James West is the publisher of the highly influential and widely respected Midas Letter at Midas Letter Premium Edition features 5 stock picks on the first Sunday of each month that are expected to double within 12—18 months in 9 out of 10 cases. The 2009 model portfolio performance was 237%. Until December 31, subscribers to Midas Letter Premium Edition will enjoy it at an annual rate of $39 per month in perpetuity and be entered to win US$100,000 in gold bullion. After January 1, the price is $49 per month.

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James West
Midas Letter

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