“All men can see these tactics whereby I conquer, but what none can see is the strategy out of which victory is evolved.”
Commentary & Analysis
Ben “Machiavelli Sun-Tzu” Bernanke holds the power!
Commodities investment seems to be taking on a Malthus-like mindset. But there are some reasons why current expectations could be upset quickly and most of them start with Ben Machiavelli Sun-Tzu Bernanke.
Malthus has been credited as the economist/author who defined how populations increase stress on existing resources; thus leading to a struggle for said resources leading to famine, wars, etc. Malthus was a lot more interesting and multi-dimensional than that of course, and much of what he said has merit. Maybe we are seeing some of that now as the world seems to have a hankering to move back to its old tribal roots and abandon the artificial barriers drawn by Western mapmakers and multicultural dreamers, which by the way is a trend that doesn’t bode well for the EU experiment. But that is a story for another day.
I read with interest the powerful case put forward by HSBC Chief Economist Stephen King explaining why the West is now paying the tab for the outsized growth in emerging markets; it has a Malthusian ring to it. The clamoring for resources as EM populations boom, and their eating and consumption habits change in direct relation with the upward path of per capita income, means commodity prices are poised to ride this upslope in growth as far as the eye can see.
Mr. King does an excellent job of describing the rationales to justify the big run we have seen in commodity prices. It makes much sense.
But, despite Mr. King’s arguments, and that of many others who made excellent calls and jumped on this boom early (Jim Rogers was a leader here no doubt), the outlook seems a bit too pat–too perfect–too easy. I remembered I read an interesting scenario a couple of years ago that seems to correspond with the EM/Develop world position today. Problem was, during that time commodities proved to be one of the worst investments over that period for decades…not just years…
This comes from Gavekal Research; “The End is Not Nigh,” published 2007:
Imagine that we are in 1946 and we describe to you a world of air-conditioners, neon lights, electrical appliances, computers, jet airplanes, pleasure yachts, three car garages and the SUVs that go in them…Imagine we also show you how the world will grow from a total population of 1.5bn people to 6.5bn people…Imagine then that, in our great foresight, we saw how central banks would lose the plots, allow monetary aggregates to explode, move everyone to fiat-money, etc…Then we would have probably agreed that the best thing to own would have been commodities. In fact, we probably would want to own nothing but commodities!
CRB index (down sloping line from upper left to lower right) & Consumer Price Index (up sloping line from lower left to upper right):
This is not to suggest the boom in commodities prices now is not driven by real factors–it most certainly is. But the normal boom/bust cycle is alive and well. When you hear 20 ads a day for gold and silver on the radio and people who never pay attention to this stuff, I mean the Word Wide Wrestling Federation watcher crowd (not that there is anything wrong with that, as many are my peeps, but not usually the same crowd that keeps an eye on the CRB index or global capital flow scenarios), starts to ask questions about how to buy gold and gold stocks…you just can’t help but wonder if we aren’t near slogan stage or beyond–a cycle outlined by Woody Dorsey and recently shared in JR’s Commodities Essential letter:
Two key points:
- I suspect much of the recent move in commodities has been liquidity driven. A good example may be the price of gold. I shared this chart and brief commentary yesterday with Members of our Currency Currents Professional service:
Gold vs. 10-Treasury Note Futures: Interesting how well bonds have held up in price despite all the talk about inflation in the US. It still leaves us thinking that much of the move in gold is very much a “liquidity-driven” affair. When long rates do go up, i.e. bond prices as on this chart fall, might gold follow in lock step? It likely depends on the reason why long rates go up…if growth-driven (not inflation driven), we would expect gold to take a big hit accordingly.
Now if we look at the red line above–the price of the US 10-year Treasury Future–the benchmark bond representing the credit worthiness of the US government and we consider the fact that said creditworthiness is increasingly shaky as the US government attempts to spend its way to prosperity and meddles with its military into every corner of the globe, one wonders why this benchmark has held up so nicely!
This is no mystery, according to the consensus. They post the blame squarely on the shoulders of Ben “Machiavelli” Bernanke (we added that nickname in a past Currency Currents and it plays into our next key point…just a second…let me attempt to develop it).
Big Ben has flooded the world with Federal Reserve notes. Notes that represent nothing more than the full faith and credit of the US government; yes, that same government that issues the world’s benchmark 10-year bond and is one of the most irresponsible and out of control governments in the world today among the industrialized world (thank goodness for Greece).
In Currency Currents past (several months ago I think; our filing system here is downright lousy) I wrote a piece (before others did, I might add) referring to Ben as a sheep in Machiavelli clothes. A look behind his implicit strategy of using the US dollar as toilet paper for global growth would lead to increased price pressures in China as their credit and monetary aggregates would soar if they attempted to maintain their peg with the US dollar. Of course they attempted just that–and their food and energy prices are now soaring, leading to social unrest.
Thus, the goal of Ben Machiavelli was to push China to revalue its currency by “other means.” So maybe we add to Ben’s nicknames: Ben Machiavelli Sun-Tzu Bernanke (that will really piss off the Chi-coms! ), as Sun-Tzu I think said something to the effect:
“Plays dumb to create a false sense of superiority on the part of the opponent.”
Ben has played dumb quite well. I can think of few who have been criticized more than he in the financial world.
Chinese yuan – US Dollar Daily: The Chinese currency is starting to move higher against the US dollar…
…but still depreciating nicely, albeit more slowly, against the euro and maintaining that trade advantage…
Okay…now on to point number two:
- There was absolutely no reason for China to increase the value of its currency in a world without rising prices (the currency plays a major role in blunting import costs); and in that world where growth lurched to more growth as investment capital continued to pour into domestic investment and export subsidy, all were happy. Thus, those surpluses were neatly funneled back into those US benchmark notes as we talked about above. This was the same scenario for all of Asia, and for other EM’s to a lesser degree.
- Now that Ben’s elixir of global liquidity extraordinaire is doing the dirty deed of raising prices, China and EMs will be forced to act, i.e. raise interest rates or curtail credit in some way lest they have full-blown social unrest on their hands. Can you say Tiananmen Square? Well, only if you live outside of China can you say it; if you live inside you must whisper it internally lest you wish to do a disappearing act and be beaten around the head a few times.
So, ladies and gentlemen, we have the makings of a major surprise on the horizon. It is not one I can handicap…but only outline:
If Ben surprises and says “Uncle” on QE2, murmuring something about achieving objectives, we could have the specter of most of the world’s major central banks in pseudo tightening mode (or less loosening mode which may have the same impact at this stage in the bubble). And we have EM/Developing world central banks trying to put the inflation genie back in the bottle and we have a recipe for:
- Slower global growth
- Enforcing rising rates on the longer end of the curve in the US as less is recycled from Asia
- Leading to lower growth opportunities in EM world
- Leading to money flow out of EMs at the margin
- Leading to concern US corporate earnings may disappoint
- Leading to an “adjustment” in S&P 500 P/E ratios now running at 23 times earnings normalized over the last 10 years, compared with a historical average of 16, according to Prof. Robert Schiller.
This is a scenario the consensus is not expecting. But one that would mean:
- Stocks get whacked
- Commodities get whacked
- The US dollar gets a risk bid
So, there is a lot riding on Ben Machiavelli Sun-Tzu Bernanke today. Stay tuned.