Thursday, October 15, 2009

Boomers Have Their Backs Against the Wall; Chuck Butler With a Look at the BRIC Nations' Fundamentals

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Thursday, October 14, 2009

An extraordinary bubble means an extraordinary correction... Is there any business the Chinese can't compete in? Another high in gold - what are investors trying to protect against? Chuck Butler with a look at the BRIC nations' fundamentals...

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Boomers Have Their Backs Against the Wall
by Bill Bonner
London, England

Two important items in the news today:

First, Bloomberg reports that retails sales fell 2.1% in September - the biggest decrease this year.

Know what that means? It means the "Age of Thrift" is here...and that consumers really are cutting back - just like we said they would.

And it means that the consumer economy is not going to return to robust growth anytime soon. And it means, too, that people will find it hard to find jobs for a very long time.

Another thing it means is that housing prices are not likely to recover - not in our lifetimes. That was a once-a-century bubble and it has blown up.

Mortgage lenders say they expect the peak in foreclosures to come about a year from now. As for the bottom of price declines, you can expect that in 2013 or beyond. A housing bubble typically takes prices down for six years, says a study by professors Reinhart and Rogoff. But this was not a typical bubble; it was an extraordinary bubble. Seems logical that the correction will be extraordinarily deep and long too.

And it also means that this stock market rally is very vulnerable. The stock market and the economy seem to be reading different newspapers!

The Dow fell 14 points yesterday. It could begin a major drop any day. That's why our 'Crash Alert' flag is flying from our London headquarters.

Yesterday, we reported the curious fact that consumer spending as a percentage of the GDP had increased. But it only increased because the other parts of the GDP - notably business spending and investment - fell off even faster..

With output falling...sales falling...and investment (in new plant and equipment) falling even faster...who's going to hire new workers? Not many companies. And which companies are going to invest in young workers...who will have to be trained - sometimes over a period of many years - before they are really productive? Not many.

It's the "Lost Generation," says BusinessWeek. Unemployment nationwide is officially 9.8%. But for young people the rate is nearly twice that level - at 18%.

Their elders aren't doing so well either.

"Baby boomers working longer hours, for less," says a Financial Times headline. What do you expect? Their currency is going down in value. Their customers are disappearing. Their retirement savings disappeared with housing prices. They can't even borrow money anymore.

David Rosenberg:

"Now that lenders have started to respond to their record-high delinquency rates by rationing credit, a mad scramble for cash is occurring to replace the loans - food stamp usage is up 22% year-over- year, pawn shop business is up nearly 40%, and there is a tidal wave of applications for Social Security disability benefits that are not explained alone by workplace mishaps."

Boomers have no choice. They need money. So they work harder, and longer. And they get paid less. Why? Because prices are falling. Even the price of labor. It's a deflationary world.

Meanwhile, The New York Times reports, "China consolidates its lead in global trade."

This headline is a little like the announcement that consumer spending is a bigger part of the economy. It might lead you to think that global trade is growing - or, at least that the Chinese part of global trade is growing. Not at all! Global trade is still shrinking. Chinese exports too. It's just that China's part of the global marketplace is increasing...because America and Europe are losing market share. China is gaining market share because it competes on price. And price competition is what is driving this market.

No discount? No sale!

Power and wealth are shifting east. No doubt about it. The Chinese took over the Hummer this week. And they are even building a 'big plane' - the C919 - to compete against Boeing and Airbus.

Is there any business they can't compete in? We don't know...but we're counting on them to stay out of financial publishing at least until we retire!

[However, the idea that China can save the global economy is flawed. So flawed in fact, that if you're placing any faith in a whole new Asian miracle, I urge you right now to reconsider. Especially if your wealth depends on it, as it might - in more ways than you imagine. Learn how to shield your assets - and set up a simple hedge - against the Asian downturn by clicking here.]

The other big news today, below. But first, let's turn to The 5 Min. Forecast:

"You know we love 'signs of the times,'" writes Ian Mathias in today's issue of The 5. "This might be the granddaddy of them all:

"China National Offshore Oil Corp and Exxon Mobil are about to enter a bidding war over oil-rich water near Ghana. At stake is 'Jubilee,' a recently discovered offshore site that probably holds a couple billion barrels of oil. This isn't China's state-owned offshore oil company's first foray into the global energy grab, but its one of its biggest. Exxon currently has the winning bid - $4 billion.

"Technically it's going to be a 'bidding war,' but really its just a matter of how much China is willing to pay. The Red Nation announced this morning that its foreign exchange reserves rose $178 billion in the third quarter to $2.27 trillion - the biggest national war chest in the history of fiat money...a feat they've accomplished in a remarkably short time:

US Consumption vs. Chines Savings

"No company, not even the mighty XOM, can hang with that.

"Heh, and can you even imagine the US - the world's largest oil consumer - trying to elbow our way into this Jubilee deal? With what... T-bills? Citigroup preferred shares? Chevy Malibus?

"By the way, the African oil producer that controls the Jubilee field is a core holding in Byron King's Energy & Scarcity portfolio. We'll be looking a lot closer into that portfolio later this week...stay tuned."
And now, back to our rambling:

The other big news is that gold has reached a new high. It rose yesterday to $1065 yesterday - an increase of $7.

"Why so fast?" That was the question in our Daily Reckoning analyst meeting this morning.

"In the last big boom in gold - in the late '70s - gold followed inflation...and the central bank. Investors saw inflation increasing. And they saw the central bank failing to react fast enough. They bought gold to protect themselves.

"But now...there is no inflation. And central banks are alert to the problem. They haven't raised rates...but they don't need to. There's no need to protect against a problem that doesn't exist. So what are investors trying to protect against?"

No one at the table had a good answer.

"They're just looking ahead to when all that money the feds put in the system finally shows up in inflation. If you believe there's a real recovery you might think it is coming soon..." said one analyst.

"They're worried about a crash of the dollar...they're just buying gold because it's the anti-dollar..." said another.

"Maybe the Chinese are switching their reserves to gold...just like they said they would. And maybe instead of buying at below $1,000 they're buying quietly below $1,100..." offered another.

"Gold is being re-monetized," says MoneyWeek editor Simone Wapler. "All the world's paper monies are losing value - and credibility. There's a race to the bottom as they try to devalue their currencies."

All countries are fighting for market share. In a price-sensitive world, they increase exports by cutting prices. And the fastest - sometimes, the only - way to do that is by devaluing the currency. But when one nation devalues - say, by printing extra money - other nations must devalue too in order to stay competitive.

What can they all devalue against?

"Gold is rediscovering its old role," says Simone. "Once again, it is the way we preserve wealth and keep track of what things are worth."

Your editor had his say too.

"Most people are buying gold only because gold is going up. Maybe they realize that the world's financial system is in a period of crisis. They see the central banks are being derelict in their duty. Instead of protecting the value of their paper money the bankers are intentionally undermining it. They figure that if the central banks aren't doing their jobs - that is, if they aren't maintaining a reserve of real money - they'll have to do it themselves. Each person now needs to be his own central bank, with his own reserve of real wealth - gold.

[You can be your own central bank too...but hurry - gold is reaching to the moon. Get in while the price is relatively low. See how here.]

"Or maybe investors don't see that all. Maybe they just see the price going up and they want to hitch a ride. What else can they buy that has been going up for the last 10 years? Gold is up $150 - about 17% - in the last 6 months. It's up 27% in the last year. It's up 300% since 1999."

Gold is in a bull market. How far it will go and how long it takes it to get where it is going, no one knows. No one knows, either, how many scrapes and setbacks it will suffer before it finally reaches its destination.

But it is a bull market. And you don't ask questions in a bull market. You get on board and ride it to the end.

Then, you wished you had asked some questions.

Until tomorrow,

Bill Bonner
The Daily Reckoning

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The Daily Reckoning PRESENTS: We've been talking a lot about the BRIC countries lately: Brazil, Russia, India and China.. In the essay below, our currency counselor, Chuck Butler, takes a look at the fundamentals of each of the BRIC countries. Read on...

BRIC Nations: The Fundamentals
by Chuck Butler
St. Louis, Missouri

A few years ago, someone coined the term: BRICs. This was an acronym for the countries of Brazil, Russia, India, and China. Before the huge deleveraging of risk assets leading up the collapse of Lehman Brothers in the fall of 2008, the currencies of these 4 countries were very strong versus the dollar, and growing in global prominence.

But then came the huge deleveraging of risk assets beginning in July of 2008. There's an old saying that when established currencies that are widely traded and very liquid, get grounded, the emerging market currencies (like the BRICs) get sent to the woodshed. And so, we had the BRIC currencies lose major ground to the dollar during this period of time.

However, in March of this year, the non-dollar currencies began to rebound versus the dollar once more. This rebound in the established currencies like, euro, francs, yen, and Aussie dollars, has led to an even stronger rebound in the emerging market currencies, including the BRICs.

So... I thought it best to take a step back, and look at the fundamentals of each of the BRIC countries, and see if the stage if set for yet another strong run on the dollar.

Before we start though, I wanted to tell you the two reasons I originally put these countries together to form EverBank's BRIC MarketSafe CD.

In the spring of 2009, China was making noise about the need for a new reserve currency to replace the dollar. The other BRIC nations joined in and at the next G-7 meeting, all four nations stood up and wanted to be counted as countries that want a new reserve currency, for they had see enough deficit spending in the US to convince them the dollar had no other avenue to follow but down.

The "markets" sort of shrugged off the BRIC nations call for a new reserve currency to replace the dollar. But I looked at it differently. I saw nations that had HUGE Treasure chests of dollar reserves, and nations that currently have a very large portion of the globe's population. I believed then as I do now, that these countries would need to be reckoned with, and eventually their cries for a new reserve currency to replace the dollar would be heard, loud and clear.

Since we announced the creation of the BRIC MarketSafe CD, where an owner of the CD receives the positive gains in the currencies over 3 years, but does not experience any currency risk, as the CD has 100% principal protection, the BRIC nations are receiving more notice!

At the last G-20 meeting, of which the BRIC nations are a part of, it was announced that the watchdog duties for the global economies were being taken over by G-20 (from G-8). And a week later, the G-7 Finance Ministers suggested that G-20 take over the currency watchdog duties!

Now G-20 has both global economies and currencies under their watch and care, and the BRIC nations are right there to offer their suggestions...

So... Now that we've gone through the background, let's take a look at the current fundamentals of these four nations, to see if the prospect of further potential currency appreciation is warranted..

First up... Brazil!

Brazil was the first Latin American country and first in the Americas to see its economy grind out of its recession. Brazilian GDP for 2009 overall will probably be just a nick over flat, while the forecasts for 2010 GDP show that economic growth will expand by 3.8%, as firmer domestic demand leads the economy.

For instance, Brazil's recent Industrial Production output grew 1.2% in August, which was the eighth consecutive month of growth.

Brazil currently enjoys a Trade Surplus of 1.5% of GDP, with forecasts for the Surplus to also grow to 3.1% of GDP by 2011.

Overall, Brazil's Current Account Balance is a narrowing 1.1% of GDP Deficit... as the economy gets back on track; the Current Account Deficit is expected to grow to 1.5% of GDP.

These are "manageable" deficit figures, and ones that would be welcomed in many countries of the world.

Inflation as always been a problem in Brazil, but assuming no economic shocks, and a strong currency (the real), it is expected that inflation could fall to 4.1% by year-end 2009, and remain stable throughout 2010- 2011.

Brazil is one of the world's largest democracies and emerging markets, which leads one to believe that their influence on the international stage will only continue to grow. Recently, China has moved past the US as Brazil's top trading partner. It is believed that Brazil and China will sign a currency swap agreement that would remove the dollar in trade settlements. I'll talk more about this in the "China segment".

The prospects for the real are good. However, one must always remember, that even with strong economic fundamentals, any mass sell off of risk assets, would be magnified for an emerging currency like the real.

Next, we have Russia...

When we announced the BRIC MarketSafe CD, I received a lot of responses to the announcement with wishes that we had not included Russia in the CD. Well, it wouldn't be a BRIC without Russia!

I told people that in essence, the only way I would buy Russian rubles is in a MarketSafe CD, and that the only way to look at Russia was as an "oil play"...

Who among us believes that oil prices will continue to remain in the $70 a barrel range?

OK... now that we've played that game... Let's get to the data!

Russia went against the flow in September, by cutting their base interest rate, when it was believed that a good number of countries around the world were preparing to begin rate hike cycles.

Russia's economy is still mired in a deep recession, as witnessed by the 10.5% fall in GDP from a year earlier, and industrial activity contracted by 12.6% in August!

Russia's economy had seen two consecutive months of growth before this step backwards in August, and thus the rate cut in September. There are only mixed signs that the recession in Russia has bottomed out. But that means the Russian ruble is much cheaper than a year ago, and will probably remain weak as long as 1. The price of oil remains in the $70 range, and 2. The Russian economy remains mired in a deep recession.

Growth for 2010 is forecast to be 3.5%, which would mean that Russia's recession will have ended late in 2009. An end of the recession and economic growth are very dependent on the persisting problems of the bad assets on the books of Russian Banks.

So... the rebound in the ruble may take some time to come to fruition. The good thing about that is that the ruble will remain cheap for new buyers.
"I saw nations that had HUGE Treasure chests of dollar reserves, and nations that currently have a very large portion of the globe's population. I believe that these countries would need to be reckoned with, and eventually their cries for a new reserve currency to replace the dollar would be heard, loud and clear."

Next... India...

India has maintained strong economic growth through the global financial meltdown, and will post a very impressive growth of 5.5% this year. This does represent a sharp deceleration from the 10% growth rates during the go-go years before the global financial meltdown. So, while 5.5% growth is lower than previous growth rates, it remains one of the best rates of economic growth in Asia!

Economic growth in India is forecast to grow 6.3% in 2010 as private consumption, investment and trade growth all show renewed strength.

Inflation in India, at present is not a problem coming in at 1.3% in 2009. However, as domestic growth takes hold, inflation is expected to rise to 5.1% in 2010.

The Indian Central Bank will continue to fight inflation, probably raising rates as we go along in 2010. The higher interest rates will go a long way toward additional currency strength.

India does not have a problematic current account deficit, like many emerging market countries. With rising exports at a 9.6% rate, the current account deficit will be the equivalent of 0.5% of GDP... Future growth in India will present itself as a problem as far as the Current Account Deficit is concerned. But it will remain manageable, and again, not the stuff that some countries experience.

The prospects for the rupee remain strong going forward.

And, last on the roster, but number one in the hearts of the fans....


This is the proverbial 200 lb gorilla in the room! China has long been on my mind as the most undervalued currency on the planet, and as long as the Chinese government has their hands on the purse strings of the renminbi, it will remain that way.

However, there are signs that the Chinese government is looking to widen the use of the renminbi, which would eventually lead to more of a free float or at least a wider band of currency movement allowed.

The IMF recently wrote that the renminbi remains the most undervalued currency at probably a level of 40% undervalued versus the dollar. As long as the renminbi's daily movement is controlled so strictly by the Chinese government the renminbi will not be allowed to cut into that 40% figure by very much. However, with the signs of a wider use of the currency, it is thought that the renminbi could be allowed to float more in the future.

What is this "wider use" I'm talking about? Well... you see, the renminbi is not a transactional currency, it is not liquid, and is traded on what's called a "non-deliverable forward". Which simply means it cannot be converted to physical form, or deliverable form.

It is my belief that China is taking baby steps to one day, have their currency take over the title of reserve currency of the world replacing the dollar. And to do this, the Chinese must begin to obtain a wider use of their currency.

They began this process by signing currency swap agreements with most of the Asian countries, and then moved on to Argentina. As I said earlier, it is believed that China will soon sign another of these currency swap agreements with Brazil.

The currency swap agreement between two countries eliminates the dollar from any transaction between the two countries, and only uses the currencies of the two respective countries. This is the "first step" toward gaining a wider use.

The "second step" came in September when China issued renminbi denominated bonds in Hong Kong. These were the first renminbi denominated bonds issued by China.

A wider use, in my mind, is equal to a stronger renminbi versus the dollar going forward.

Now for some data!

China's GDP is expected to grow 8% in 2009, and 8.6% in 2010. China's economic recovery this year has been fueled by government stimulus. But Hey! China has a treasure chest of reserves and surpluses... So, if any country was going to spend some money to boost their economy, China would be the one, for they have the money to do so!

And... with China being a Communist country, they were able to dictate where and to whom the money was being directed to, and how it was to be spent. This has gone a long way toward seeing the results of China's stimulus.

Inflation remains a problem in China, and the sooner the Chinese realize that a strong currency can go a long way toward fighting inflation, the better!

So... For now, the renminbi remains pegged to a basket of currencies, and controlled by the Chinese Government, through the Chinese central bank. However, there are signs that this arrangement for the currency is changing, and a wider use of the renminbi is the objective... If that's the case, then the prospects for a potentially stronger renminbi versus the dollar are very good.

And that's how I see the BRIC currencies/ countries...


Chuck Butler
for The Daily Reckoning

P.S. If what I said about the EverBank BRIC MarketSafe CD interests you, you're in luck. I've been working with my friends at Agora Financial to have this CD be a part of their newest service, BRIC by BRIC. If you sign up for this service today, you'll get 50% off a charter membership, plus the no-risk BRIC currency play described in The Zero-Downside Play of the Year: How to Buy the BRIC Currencies Right Now Without Risking a Dime.

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Editor's Note: Chuck Butler is President of EverBank(r) World Markets and the author of the popular Daily Pfennig newsletter, which is reposted here at The Daily Reckoning. With a career in investment services and currencies extending over 35 years, Mr. Butler oversees all aspects of customer service and the trading desk for EverBank World Markets. A respected analyst of the currency market, Mr. Butler has frequently made appearances or been quoted by the national media. These include The Wall Street Journal, US News and World Report, MarketWatch, USAToday, CNNfn, Bloomberg TV, CNBC, and The Chicago Tribune. Mr. Butler was previously the Chief International Bond Trader and Director of Risk Management for Mark Twain Bank, and has held significant positions in the investment industry since 1973.

For additional information visit the EverBank website.

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