Tag Archives: inflation

Deja Vu – Part 3, Lessons from the US economy,1979-1985

26 Dec

In my last blog entry I mentioned three US currency policy decisions over the years 1979 to 1995 (https://ravendragon.wordpress.com/2010/12/16/deja-vu-%E2%80%93-part-2-lessons-from-the-us-economy1973-1993/). Each decision was a response to the decreasing returns in US industry. In this blog entry I will outline each of these decisions in greater detail.

As mentioned the 70’s saw Nixon embark on a policy of federal deficits and extreme monetary ease. One aim of the policy was to lower the value of the dollar in order to sustain the competitive position of US manufacturing. This policy helped the US ride the 1974-5 oil crisis. On the one hand the policy was a great success vis-à-vis US manufacturing. Nonetheless, such extreme Keynesian measures lead to over production and over capacity. In addition, it prevented the much needed exit (what Brenner calls “the medicine of shakeout”) of many lower return companies from the market place. The upshot was an overall continued decrease in returns, which eventually dis-incentivised manufacturers from increasing output. With massive deficits (i.e. increased money supply), and little to no increase in output, the US began to suffer inflation. Simultaneously and related, massive deficits led to run on the USD, threatening its status as a global reserve currency.

Before we see how the US tackled this issue, let’s pause and understand that this dynamic sounds rather similar to the US today. Today the US is running a policy of extreme monetary ease, MASSIVE federal deficits, and has relatively uncompetitive manufacturing compared with countries like China. It led to inflation in the late 70’s. The risks of inflation in the coming years ia fairly apparent wouldn’t you say? In addition I believe today’s policy is aimed at helping US exporters/manufacturers, whether it’s explicitly stated or not.

In 1979/1980 the US enacted the Reagan-Thatcher Monetarist revolution, which reduced corporate taxes, increased unemployment, and removed controls on capital. The aim of the policy was to provide the US economy with a serious dose of “the medicine of shakeout” and purge the US economy of the low profit manufacturing firms that had become an ill of previous Keynesian expansionism, thereby controlling inflation and the currency. However, this time the pendulum had swung too far the other way. Record interest rates and the associated rising USD almost caused a US crash with the threat of contagion.

How did the US (and the global economy) get out of this situation? The government started the Reagan military buildup – purely Keynesian in nature, though most right-wingers would feel queasy to admit it! In addition Reagan enacted a program of huge tax cuts for the wealthy. These 2 policies combined did offset the government’s tight monetarist policies, yet they equally reopened US trade and current account deficits. The deficits required to pay for the military buildup were in fact larger than the deficits in the late 70’s. However, the combination of high US interest rates ensured there was no run on the dollar this time. In fact the currency (aided by a push of capital flows from the Japanese) appreciated considerably.

The Reaganites liked the combination of high interest rates and low inflation. Why? It played to the theme on increased the strength of US financing capital. However, it caused severe pain to US manufacturing. Under extreme pressure from congress, the Whitehouse was forced into a U-turn.

On 22 September 1985 the G5 met to sign the Plaza accords, under which the G5 powers agreed (under US pressure) to relieve the stress on US manufacturing by reducing the USD exchange rate. Over the coming few years the US administration passed a number of pieces of protectionist legislation (including the Omnibus Trade and Competition Act of 1985, and the Structural Impediments Act of 1989). Whilst simultaneously closing home markets to foreign imports the US was forcing its exports and FDI onto overseas markets.

So we see a continued US policy of not dealing with the real structural issue of lowering returns and non-competitiveness. Ford, Nixon, Carter, and even Reagan continued a policy of using the US currency as a band aid to be placed over a brewing problem. We know that since the late 80’s the US has continued in the same vein as we are facing similar structural issues today, and similar short-term currency play and Keynesian remedies are being used by the Feb and President Obama’s administration. As I’ve said before, this pattern of behavior is not a good sign that the US will deal with its structural issues. I will stress again that I am not against a band aid, as long as a real medicine is given in combination.

In the next blog entry I will hope to conclude my economic history lesson. But this is a blog about China, so I will be putting this history in the context of Chinese production and trade. In a nutshell I can already see that the US’s failure to deal with the issue of its lowering returns is a boon for the Chinese, in both the short and long-term future. More next time!

See you all in 2011.

Happy New Year

再见
新年快乐
乔恩 (https://ravendragon.wordpress.com/about/)

 

 

Cotton prices are a bubble – all bubbles burst

12 Nov

I couldn’t help but notice some economists point out that clothing was one of the reasons for the upside surprise in China’s October CPI figure (4.4% vs. 4% consensus, and 3.6% in September). I would expect continued policy responses in this inflationary environment, including the chance of price curbs in addition to the market’s expectations of increased bank RRR rate.

I want to take a step back in this article and talk about cotton. The price of cotton is above $1/lb for only the second time since the US civil war! In fact look at the Bloomberg chart below – the price of cotton futures have almost doubled since July! Why?

Well there are some long term secular trends at work here.

  • I can’t deny that cotton demand in both China and India has doubled since 1995 – the result of increased urbanization and GDP/capita.
  • Over the past few years the prices of other soft commodities, such as corn and soy have also increased. This is the result of (1) improved diets in emerging markets (corn feeds animals, and animal consumption rises as nations grow wealthier); (2) a growing world population; (3) reduced arable acreage; and (4) bio-diesel production. As the prices of corn and soy have increased, farmers are naturally compelled to replace cotton production with the likes of corn production, which reduces cotton supply.

However I can’t ignore that the price of cotton smells like a bubble. Just look above at the chart again. Then look below at the chart of the historical price of potash.

When the prices of corn and soy increase, it makes economic sense for farmers to apply more potash to increase their yields. As a consequence the price of potash similarly increases. Over the period highlighted, the price of crops and potash increased dramatically. Now I know hindsight is a wonderful thing, but the price of potash eventually came crashing down – history shows us that was a bubble. During the years before the recent economic crisis market participants were well aware of the long-term soft commodity cycle (which I explained above).   Yet some kind of over exuberance grasped the imagination of market participants. The cotton chart looks like the left hand side of this potash chart before the price tumbled.

In my opinion short-term drivers of the cotton market have been overplayed. It has led to an over exuberance in cotton futures, and created a bubble. I’m not the first person to posit that when things are good the market thinks they are better than they are, and when things are bad the market thinks they are worse than they are.

What are these short-term drivers?

  • Weakened USD, which I believe is more likely to strengthen in the medium-term. Why?
    • I am against the consensus and believe that QE2 was over done. I think there’s a chance that all USD600bn might not be used. Why? Corporate tax receipts are healthy and indicative of strong profits in the next quarter. Unemployment is a lagging indicator, and always stagnates at this stage of a recovery – what’s more recent data has been encouraging and revised up. Employment agencies are seeing growth in profits, especially in temporary work (which as a quasi-lead indicator). IMS data highlights the inventory cycle is close to an inflection point (which will be great for employment). When the market sees this the USD is sure to strengthen. Also consumer confidence indexes are forecasting a solid consumer Christmas.
  • Potential for prolonged Indian cotton export bans
  • Bad weather in China and Pakistan
    • This is clearly cannot be factored in as a long-term issue!
  • The weather and Indian story have lead to short-term purchases by mills not wanting to be left short.

So you see there’s a decreased supply in the short-term, a short-term increase in demand, and a short term FX issue.  This must have led to massive speculation pushing up the price of those cotton futures. It simply can’t be the case that these short term elements could double the price of an asset on a fundamental basis, especially considering the fact that the long-term drivers have been known for years.

Now, I can’t tell you how long the price will remain elevated, or whether it will go up another 10%, 25% or 50%. But what I will say is that this is a bubble, and bubbles always burst.

So on the one hand beware. And on the other hand, look for stocks that have been hit and see if they present a good entry point – for example clothes retailers or manufacturers.

Zai Jian

PS – I hope soon to return to writing about building a core China portfolio. All articles on the subject can be found here –https://ravendragon.wordpress.com/category/building-a-core-china-portfolio/)

 

Back to double digit growth

21 Jan

There’s been a lot of buzz in the media this morning about China’s announcement that GDP grew 10.7% year-on-year in the 4th quarter of 2009.  2009 GDP expanded 8.7% as a whole, which was higher than market forecasts of 8.4%-8.5% (though I note than the figures published for the first half of the year were slightly upgraded).

I would imagine 2010 is going to be strong, and might actually reach 10%, helped by a surge in exports, which could increase by as much as 35% in the second quarter of this year.

Infaltion in December jupmed 1.9% (against market expectations of 1.4%).  This was primarily due to food prices.  I can see the CPI increasing above the 2.25% deposite benchmark rate some time in the first quarter of 2010, which I would expect to result in an interest rate hike sooner rather than later.

Governmment sponsered spending on rail and highway projects slowed towards the end of 2009.  In conjunction with the macro tightening policies enacted last week (raising banks reserve ratio requirements) this is negative news for the raw material and construction segments.

People are asking what this means for the world economy.  Essentially growth can only be good.  On the back of this good news I would expect wall street to rally today, and perhaps for the dollar to continue strengthening (after its little fall last week) – though that could be affected by payroll data due out today.

Getting sector specific

18 Jan

In China, like most other markets, investors will have to focus more on individual companies and sectors rather than riding the general upward trend enjoyed in 2009.  The market has lost 1.7% this year on concerns that lending might be tightened to avoid asset bubbles.  This makes China the worst performing Asian market in 2010.  Nonetheless there are still opportunities, as today’s trading highlighted: for every stock that lost ground in China during today’s trading, about 2 were up.

Air and rail fared well today.  Air China, China’s largest international carrier, gained 5% reaching 11.13 Yuan, its highest level since June of 2008 on news that it may have swung to a profit in 2009.  Railways inched up on the prospect of improving orders , including Daqin Railway, the operator of China’s largest coal transport network.

However, without a macro catalyst it looks like the market is set to consolidate at current levels.  The upshot is that it will be more important to pick those sectors and companies most likely to benefit in the coming environment which is likely to witness the continuing tightrope of inflation (BNP forecast it could reach 8% this year) and the gentle tightening of credit (as per the increase in banks reserve ratios mandated last week).