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“Trading is a psychological game. Most people think that they’re playing against the market, but the market doesn’t care. You’re really playing against yourself. You have to stop trying to will things to happen in order to prove that you’re right. Listen only to what the market is telling you now. Forget what you thought it was telling you five minutes ago. The sole objective of trading is not to prove you’re right, but to hear the cash register ring.”
                                          Martin Schwartz

Commentary & Analysis
Perception is Reality?

To the Wikipedia we go for their interpretation of reality:

In Philosophy, Reality is the state of things as they actually exist, rather than as they may appear or may be thought to be.[1] In a wider definition, reality includes everything that is and has been, whether or not it is observable or comprehensible.

Perception is the process of accumulating sensory information from the surroundings.

Here is one person’s perception of the recent US manufacturing and export data released in mid May:

US exports rose to $172.7 billion in March. That is the single best month America has ever had … It doesn’t happen without a strong manufacturing sector. Fact is, US manufacturing is as strong as ever. In 1980 the US produced 22% of the world’s manufactured goods. In 2011 it still does … "Made in USA" did not go away. Yes factories moved overseas. But other factories were built to serve these growing markets. In the meantime US exports have benefited from the decline of the dollar and the rise of productivity. China is going in the opposite direction. Its Yuan is strengthening. And wages are increasing by 15-20% a year. "Made in China" is losing a big chunk of its appeal … US exporters are riding a long-term term of growing global competitiveness. And these companies are still cheap. You should buy now before prices go up.

To be more precise, that was one person’s interpretation based on said person’s perceptual set, which is a psychology term used to explain how a person’s expectations can influence their perception. Again, to Wikipedia:

Philosopher Andy Clark explains that perception, although it occurs quickly, is not simply a bottom-up process (where minute details are put together to form larger wholes). Instead, our brains use what he calls predictive coding. It starts with very broad constraints and expectations for the state of the world, and as expectations are met, it makes more detailed predictions (errors lead to new predictions, or learning processes). Clark says this research has various implications; not only can there be no completely "unbiased, unfiltered" perception, but this means that there is a great deal of feedback between perception and expectation (perceptual experiences often shape our beliefs, but those perceptions were based on existing beliefs).

We continually produce our interpretations and forecasts, based on how we perceive markets and economics, in the pages of Currency Currents and our paid services. One major forecast has been potential US dollar rally based on our expectations of deflation and risk aversion.

Of course, there are many who don’t share our interpretation; and their forecasts are notably much different than ours.

Here are some thoughts that I came across today which could influence, to an extent unknown at this time, how we (or they) perceive future market developments.

First, this is from a Wall Street Journal article from January 2011:

… beyond the rise in primary commodity prices, general price inflation in the U.S. only comes with long and variable lags. After the U.S. monetary shock, hot money flows into countries on the dollar standard’s periphery cause a loss of monetary control and general inflation to show up there more quickly than in the U.S.

In 2010, consumer price indexes shot up more than 5% in major emerging markets such as China, Brazil and Indonesia, while the consumer price index in the U.S. itself rose only 1.2%. Similarly, after the Nixon shock of 1971, there was much more explosive inflation in Japan in 1972-73 than in the U.S. But by December 1979, inflation in America’s producer and consumer price indexes was more than 13%.

Second is this excerpt from a Societe Generale piece, via Pragmatic Capitalism:

As China moves into a cycle of generating autonomous structural inflation, it is widely anticipated that China will export this inflation to the rest of the world. Here is how the dominos will fall.

The first domino is China creating autonomous structural inflation:

China attempts to rebalance economy away from investment/exports towards consumption. In March, inflation hit a 32-month high of 5.4% yoy. Policy makers remain well behind the curve. That domino has already fallen.

The second domino (in the process of falling) is proffered to be that China will then export this inflation to the rest of the world. This dynamic seems as inevitable as gravity itself.
The third domino is teetering.

  • domestic inflation rising in China
  • pace of Yuan appreciation stepping up in Q2-11.

Import price indices from China, for the developed economies, are turning up. Given the “stickiness” of supply, the world will remain a China “price-taker”. The past two decades of outsourcing that turned China into the world’s factory were long term trends. Manufacturing production cannot simply be transplanted quickly to another economy.

Hmmmm. Interesting to see how US inflation lags outside inflation. But that last bit of research (perceived perhaps based on expectations built from past inflationary periods) seems somewhat at odds with the interpretation of US manufacturing I included earlier.

As that author said, “Made in the USA” did not go away and US companies are experiencing growing global competitiveness on behalf of the US dollar. Might that mean China will not be able to export inflation to the extent some anticipate?

If reality is the state of things as they actually exist, and the inflation-exporting “dynamic seems as inevitable as gravity itself,” then inflation is a reality. Then our prediction of a multi-year dollar rally is all washed up … depending on who you ask!

We’ll ask the market.