Everyone is looking for convincing evidence that prices have bottomed before concluding the recession is on the way out. I strongly disagree with that approach. Rising prices in the stock market reflect the speculative mood of investors and the lack of alternatives, it’s not a measure of new productive jobs. Rising prices for housing should actually be considered a negative given the millions of homes still waiting to be sold, if anything we should hope for lower prices so the market can clear and construction can resume. Rising prices for consumer goods or commodities can just as easily reflect a reduction in supply as an increase in demand. Prices are not irrelevant, but almost.
Many economists have long known that Chinese consumer demand must rise eventually to balance the excessive trade surpluses of previous years, but the government in Beijing has been actively preventing a shift in trading trends by manipulating the exchange rate through dollar recycling. Their intent is to maintain attractive prices and encourage further American consumption of their products; however, now that American demand is drying up despite cheap prices, there is no longer a reason to maintain an artificially low currency. It hurts China unnecessarily.
Let me try again to explain, more clearly, why government interference may fail. There are people who believe we have entered a new long wave cycle of increased savings and decreased consumption that may last a generation. If people are determined to save, the government can not force them to borrow. If we are entering a new savings paradigm to balance the previous few decades of excessive debt, which the evidence currently supports, government interference, both monetary and fiscal, will not only fail but significantly intensify the crisis.
I haven’t been shy about warning the dollar is doomed. The long run is fast approaching, but that doesn’t mean it will arrive tomorrow. It could, but it probably won’t. We have seen a powerful dollar rally over the last year and many people believe it will continue. I think they’re wrong.
The President-elect has already warned the world to expect massive deficits in the coming years. For the purpose of this post, I won’t discuss whether the spending surge will be productive or inflationary, I will merely ask the question – where will the money come from?
The market for discretionary goods is very large and volatile. There are certainly many things people can do without, but spending will never go to nothing. The performance of the market is irrelevant to our need for food and shelter. People may frequent restaurants less often and moderate their living conditions, but they will eat something, wear something and live somewhere. Homes will be heated, electricity will flow, cell phones will transmit and some form of transportation will still be required. As unemployment grows people will flock to reasonably priced entertainment. Prices may adjust as usage is moderated but these things will never go away.
A liquidity trap occurs when people give up on long term investments due to excessively low returns (interest rates) and maintain hoards of cash in checking accounts or paper instead. I keep a sizeable amount of cash for deflation protection, just in case, and the interest on my savings account is so pathetic I began withdrawing my savings on a regular basis a few months ago. I doubt I’ll take it all out, and it’s spread across several institutions, but I want enough to live for 3-6 months without a bank. The interest return just isn’t enough to compensate me for the risk of failure or bank holiday. I would rather keep the cash in a safety deposit box. Cash that sits outside the system is cash that will not be leant (times 10, look up fractional reserve banking) and cash that will not circulate. This is bad for the economy, but good for people with cash. Holding gold and silver is similar, but it also provides a bonus inflation protection, just in case. I have found that I’m always about 6 to 12 months ahead of everybody else, so I will play Gerald Celente and predict this will be a growing trend in 2009.
I do my own non-scientific research to determine the future potential upside for gold. Here’s how it works — I tell everyone who will listen that I’m buying gold and silver, not just mining shares and exchange traded funds, but actual physical metal, then gauge their reaction. The more ridicule I get, the bigger the potential upside remaining in the gold bull market. I’ve been doing this for about 18 months and I still don’t know a single other person who has begun to accumulate metal, but I can definitely see the tide turning. People aren’t laughing as much anymore, they still aren’t buying, but they are listening. When owning gold to preserve capital is as common a practice to these ordinary people as it is to me, that will be the appropriate time to start exiting the market.