As the US enters deflation, and gold rockets up, it’s time to ask what happens when the USD loses its haven status. The leading candidates to compete with the USD are supposedly the Euro and the Yuan.
Well, one thing that will confuse this situation is that the US enters deflation, while China enters inflation. The US has deflationary pressures due to the exploding US fiscal debt and the continuing housing crash, which has not slowed down.
In the meantime, China is importing US inflation and generating its own with an overheated growth rate of over 8 pct. They are going to have to fix that soon. The inflation is hitting food directly, and even though China is attempting to regulate food prices (stagflation or inflation) it’s not working.
Now, add this one bombshell. What happens if China goes Egypt??? With the way social networking is allowing demonstrations, it seems inevitable that China will see some huge demonstrations too. Time will tell.
But, with China experiencing inflation, which is probably going to get worse, and the US mired in stagflation (stagnating economic growth combined with cost inflation and no wage growth) the USD can endure longer than you might think. Until cost inflation hits the US in a big way. That will probably start to show up more this summer.
But one has to ask themselves whether the Euro can deal with their fiscal problems. Supposedly the EU intends to keep the Euro going no matter what-they say.
China intends to make the Yuan big enough to compete with the USD in the bond markets, where they have a miniscule footprint now. They intend to remedy this by 2020, and it’s the reason the Chinese are doing currency swaps with their trade partners now, foregoing the USD in between.
China spreading the Yuan out will take time though. And right now there is no way the Yuan can take over for the USD or the Euro in trade. 60% of commodities are priced in USD. This is in effect for many markets around the world, and it’s called the USD footprint in the financial world.
Big problem for USD looming this Summer
But, Pimco’s Gross stated that when the US has to end QE2, he wonders who is going to buy US bonds this Summer, after July.
Now, we might just get our first big USD scare and this is how it could happen:
First, suppose the US lets QE2 end. Then, if there is no QE3, the US treasury market might start to struggle. We might just see China and others let the USD rattle around in trouble to see if it is really as strong as it was up to now.
Supposedly the Japanese will jump in as needed, and might even singlehandedly support the USD from falling like they did in late 2004 and 2005.
But that is a problem for Japan this time because they are already being downgraded and have the highest debt in the developed world.
So, we might do well to consider how well our investments will do in a stagflationary environment. For many businesses, staflation is the worst case scenario. They get pinched on costs, and cannot raise prices since there is no corresponding wage inflation in the US. China is the opposite. They will get wage inflation and have already raised the minimum wage from $50 a month (yep u heard right) to $100 roughly.
Stagflation can last years even decades. Japan experiences it, not inflation but a decade of stagnation and slight deflation. Stagflation caused gold and commodities to skyrocket in the late 70’s. Stagflation is gold friendly.
In any case there is another issue I’m concerned with. I don’t like the idea of people trying to survive financially with say only precious metals and commodities as inflation hedges.
That is because these are so volatile (except gold mostly).
Must look further ahead
It seems better to me for US and Western investors to look past the present day story (the USD faltering and China growing stronger by the year) of inflation and stagflation, and start to think of what happens after the USD loses its leading status in the world. Are there US companies who can survive or even thrive?
The thing to do is to combine key US stocks such as Tech, where we still lead, and start to build a tech and US stock portfolio that leverages our advantages, tech in this case. We also have lots of cutting edge energy companies and resources.
The reason I bring up things like Tech stocks is because this is where we have a real chance to escape a stagnant US stock market or Western stock market that is starting to look Japanese.
To do that requires a change in strategy, from only tracking say stagflation in the US to also considering what companies and businesses in the US will benefit from the technical advancements, all the while the Old economy still gets outsourced, deflated, and gradually dies a slow death (with things like labor offshoring).
In my case, I am an expert in the internet, databases, and math. We are starting to look at various tech stocks that might have a long future ahead of us, even if the USD were replaced. There WILL be a USA after a USD crash and a new currency, and many US companies will survive.
But we do feel that some other sectors, such as tech stocks (careful!) will be necessary to get past the coming turmoil of the next few years. We are investigating this area.
In any case, the USD may likely suffer its first real test this summer when QE2 ends. I am fairly sure a QE3 will be implemented. But if not, then we will see some real changes to the markets after Summer.
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Christopher Laird of Prudent Squirrel
Disclaimer: Chris Laird is not an investment advisor/professional. This article, and the PrudentSquirrel newsletter and alerts, are general market commentary only. They are not intended as specific advice. You should talk to your own investment professionals for specific advice. Information here is deemed reliable but should be verified by you if you think it’s important.