Monday, January 3, 2011

Bond Market Implosion!

We will have those Inflation Blues again!

Inside the Fortune Cookie

   Consumer Prices in China have risen to 5.1% annual rate. The Producer Prices are rising better than 6% per year and beneath the surface if you look at food prices, food prices are up almost 12% in a year in China. That is a huge rise in cost of the most basic of all commodities food, and obviously the Chinese government has it’s hands full dealing with all the inflation which is largely a consequence of it’s own foolish policies on pegging it’s currency to the dollar. Because by doing that, China gets our (United States) inflation. The United States biggest export to China is inflation; they send us products and we send them paper. So we get more stuff, that’s what keeps prices low for the U.S. and China gets more paper, that’s what makes prices rise (inflation). Why you ask? Answer: because China is sending their stuff away and paper is coming in; and the way it all works is the U.S. sends those dollars and then the Chinese Banks buy up those dollars and in turn prints RMB. The Chinese Money Supply then rises, that new money goes through the economy biding up prices, meanwhile the dollars that the Chinese buy get loan back to Americans because they buy our Treasury Bonds and our Mortgage Back Securities which keeps this whole phony economy here in the United States moving!

   The consequences for China are rising prices which result in a higher inflation which is at 5% currently in China. To counter this China thought that raising interest rates would curb inflation by encouraging people to put money away in savings at the bank. The only money China is attracting with the raise hike is speculative money; because by raising rates they attract a lot of hot money into RMB’s and people will do a carry trade, in which they short U.S. dollars and buy RMB because they know that the RMB is not going to go down against the dollar; it’s only going to go up and if they can borrow in dollars and buy RMB’s then it becomes a risk less trade from the perspective of a lot of people. So this rate hike may actually backfire on the Chinese because of a lot of the hot money coming into China, results in them having to print more RMB to keep their currency from rising. Normally when you raise interest rates your currency rises but China doesn’t want it’s currency to rise. It’s raising rates because it doesn’t want to let it’s currency to rise, but if it does keep on raising rates then it makes its own currency more attractive. So then to prevent the currency from rising what do they (China) have to do? Answer: they have to buy more dollars; they’ve got to grow their money supply faster. What does that mean? Answer: that means more inflation; but why do we care in America that inflation in China is a big deal? Because this is the key to all of the coming problems we will face in 2011.

   There are two options China really has in this situation. 1.) They can allow inflation to get worse and run out of control and if that happens you’re talking about a billion people, you’re talking about a lot of money that’s going to be chasing commodities and gold and everything if they realize there is massive inflation in their country. 2.) Or the Chinese can get serious about attacking inflation, not just speak about it but actually attack it.

   There’s only one way to do it and it’s not price controls, it’s not through higher rates, it’s through a stronger RMB. They’re not going to stop inflation until they stop inflating and inflating means growing their money supply and they are growing their money supply because they don’t want their currency to go up. Well If you let your currency go up then prices will come down and that will stop the Chinese Inflation but when they stop the Chinese Inflation they ignite the American Inflation. Instead of exporting our (U.S.) inflation to China, our inflation will stay right here in America. We will have our (U.S.) paper money, we won’t have the Chinese products or other products and so we will be biding up prices. Prices will then be going up and Bonds will be falling, interest rates will be rising!

Uncle Bens Animal Farm

   In 2011 the United States will see the 30 Year Bond yield be above 5% in Q1 and by Q2 and Q3 the yield will be above 6% and we will have interest rates at a 10 year high. Now what is that going to do to the economy; what’s it going to do to the Mortgage Market? Remember why this will happen, Ben Bernake “Quantitative Easing” was all about bringing rates down. Instead of rates going down they are doing the opposite; they are going up. They are even going up despite the fact that the FED is buying Bonds in a effort to artificially push them down.

   Look at the charts of some of these commodities; look at the chart of the CRB, extremely bullish! There is no resistance in the CRB, maybe we might get some at the 365 level. That spike in the CRB will happen. We had a similar move in the CRB in 2008 before the collapse in the markets was up at 473 levels. We will be there again in 2011 and may even eclipse the 473 number. This means the FED will be forced to make the decision it has tried to avoid.

   Uncle Ben said on “60 minutes” that “the FED could raise interest rates in 15 minutes if it had to.” well we will see if Ben meant it cause he will have to raise interest rates. That will be the most difficult 15 minutes of his life when he has to raise them, which will end his world and ends his fantasy where we will have a collision course with reality. Because remember the way the government was able too delay the crisis in 2008 which was “print money” expand, stimulate; the FED was able to buy up debt, buy up Mortgages, buy up treasuries. That’s what has kept this whole phony economy going, is the FED’s ability to constantly inject money; to keep buying Bonds and to keep bailing everybody out. When the FED has to deal with Inflation as a problem, when the FED sees prices rising, long term interest rates rising and now is force to raise rates. The FED can’t bail out anybody because it would be adding to the problem; the FED can’t buy Bonds when it’s the one selling Bonds, it can’t buy Mortgages when it’s one of the sellers of Mortgages. So it’s not going to be just the private sector trying to unload and the govt. coming to the rescue. It’s going to be the private sector and the govt. through the FED trying to unload and nobody coming to the rescue. So this is the decision the FED chairman doesn’t want to have to face; raise interest rates or just keep inflating and say “I lied” inflation is here to stay. I think the latter will happen but the FED will try to spin it in some double speak. It will probably go something like this “The increase is welcomed, it shows we have a victory over deflation, a little inflation is good for us.” They will try hard to rationalize why it’s okay so that they don’t have to put on the breaks; “Don’t worry inflation isn’t going to get too bad.” It will not work and it will rage out of control very… very… quickly.

   All of this is going to happen and we will hear it from the puppet master himself on Friday the 7th of January when Uncle Ben gives his speech before the budget committee. This disaster will occur in 2011 and will probably happen in the next couple of months.

  Is it possible that this move up in Bond yields is all a façade? Then the scenario is going to be pushed back and we will get some longer rope to hang ourselves later on. But their may be some real money and real power behind these recent moves in the Bond Market. It’s not just Bonds; look at some of the charts in commodities, Silver, Gold, Crude Oil, Soy Beans, these markets look like they are going a lot higher. I think it’s more than just a coincidence this is all happening and happening at a time when the Chinese are finally having to face the music when it comes to the inflation that resulted from their foolish currency peg.

1 comment:

  1. Good take. Eventually the Chinese will let their currency appreciate so that stop the inflation they are currently importing.