Careful where you're putting your money?

 

The thrust of this essay is the effects of  Federal Reserves fiat money creation on commodity based nations. The currency used as the example is the Australian Dollar

 

This first chart has a defined channel, very basic TA, but the trend is clearly defined. I can see why people who play currencies are heading for commodity based nations. But it comes with a warning as the next chart will show.

 

 

The assumption is that these countries are wealthy, and for sure if the producers of those countries had borrowed their working capital in $US they would be laughing all the way to the bank. That is how the carry trade works. But rest assured, there are very few primary producers who made use of that trade. The effect on them shows clearly on the second chart, they are receiving less in their native currency. Commodity prices are not keeping up with currency adjustments. A lot less than the chart suggests. This comes back to costs of production.

 

Now if you go back to the first chart, you will see that the costs were fixed in late 2001. This is how it works in the real world. Wages relate to the most that producers can afford financially, once they are fixed they seldom come down. This is the double whammy. Producers are forced to cut costs. Don't worry about the consumers at this stage they are as happy as can be. High wages relative to the currency, their costs have gone down. (Price wages in 2001 $US, then calculate relative spending power adjustments for currency appreciation. The result is an increase in spending power relative to the domestic economy. The effect is a consumer generated bubble which the productive sector has to absorb.) Consumers are spending up large on consumer goods and property. The goods are now mostly imported from China and other low cost nations, and commodity countries are starting to have blowouts in current accounts via consumer spending. With many thanks to the Federal Reserve, and it's credit creation, these countries are flooded with liquidity via the carry trade and direct investment. The consumers can afford to borrow more as their spending power has improved. Hence property price blowouts.

 

But over time, as is being proven in the United States now, income from production must equal expenditure from consumption. Mr McKiber in David Copperfield had it right.

 

Back to the productive sector. Cost cutting is now imperative in order to survive, and one of the costly inputs is labour. Suddenly it doesn't seem so good to be a consumer, especially if your job is on the line. Right at this moment we are at a tipping point economically.

 

Keynesian economic theory dictates that loose fiscal policy is imperative to draw a nation out of a recession. Austrian theory states that the recession should be allowed to run it's course and purge Malinvestments. This is the conundrum of commodity nations now, the Keynesians have won through Greenspans money spigot which is attempting to draw the US out of recession. All the cash that is arriving, via the carry trade and speculative investment, in countries that don't need it is fueling speculative investments at a time when the central banks of those countries are trying desperately to hold their productive sectors together. It is a loosing situation, local production is being steamrolled into the gutter. The natural time that leads to a recession is as a currency is strengthening, that is not the time to be throwing cash at the system the Keynesian way. It is a time for prudence.

 

According to John Tyler  of www.infognome.com the increasing velocity of money is signaling inflation even as M3 creation in the United States is shrinking. He is correct as to commodity based nations and the inflation risks as is born out by Australia increasing the open market rate by ¼%. The Feds money spigot is depreciating commodity nations currency via inflation, these nations do not need to create fiat and partake in a currency war. Greenspan's Keynesian plan is beginning to work against him.

 

With falling income, increased costs, inflation, and rising interest rates to contend with the productive sectors in countries like Australia and New Zealand are loosing the battle for profitability.

 

I would think very carefully about investing in a commodity nation now. The odds have turned against us on two fronts, loose liquidity and strengthening currency. Malinvestments are being encouraged in non productive areas such as housing, and not allowing for the natural business cycle to complete. Look out below.

 

Buy gold!!!

 

Allie Oop

 

For further reference regarding business cycles look to Sean Corrigans essay on Gold Eagle. http://www.gold-eagle.com/gold_digest_03/corrigan110503.html

 

Alan Lunt is a student of the market.