Crisis FAQ

Why does the US want China to appreciate the Yuan?

The reason why the US likes China to engage in an appreciation of the (Renminbi) Yuan is based on the fact that there is at this moment little control over capital flows.

During the last decades, The US prospered by outsourcing manufacturing jobs to the east, especially China. The big difference between US and Chiense companies can be found in the fact that Chinese companies could surpress price levels as they seemed to have an infinite supply of workers coming to the big cities, where manufacturing companies are located. A high turnover of workers guaranteed that low wage jobs could be implemented and that more skilled workers attributed only little to increase inflation. This seemingly never ending supply of cheap labor made the game work and opened the opportunity for the Chinese society to grow economically.

Capital flows are in the opposite direction of trade flows. As such we can simplify by saying that the US consumers spent most of their money with Chinese employees. As 70% of the US GDP is based on consumption, this might be actually correct.

The Renminbi, the local Chinese currency, has not been floated internationally. It could only be used for payment within China and therefore it was under the control of the Chinese government to fix the exchange rates by pegging them against the US Dollar (and other currencies). The exchange rates determined import and export prices. Transparency in real and nominal exchange rates was avoided by this artificial valuation mechanism. A series of support mechanism was in place in order to prevent foreigners to outsmart the Chinese currency pegg. For example investments had to meet several conditions. Real-estate could be rented but not actually posessed.

In consequence Chinese inflation caused by growth in monetary amounts and velocity of money did not find its way in the official exchange rates, as the chinese pegged the Yuan against the Dollar.

A devaluation of the Dollar against the Yuan is therefore difficult to achieve for the US. It requires the action of the Chinese government which is in control of the exchange rate peg.

The low yuan valuation has led to a significant issue for the US to deal with the current crisis. While US money supply increases dramatically, the currency does not devalue against the chinese currency. As such the trade deficit remains or even widens. US citizens are incentiviced to purchase underpriced Chinese goods, which they could not afford if they were manufactured in the US. This might continue for as long as the Chinese companies can have access to an ever increasing supply of workforce, which is the key factor in keeping production cost low.

Given the fact that the US government can not increase the production capabilities due to this limitation, it becomes very difficult to change the course of the economic crisis. The way by increasing productivity seems to be blocked.

Import prices also can attribute little in order to change this, as the US which actively devalues its currency as well as China will suffer from the same effect. While the Dollar devalues, little difference is made by an import price inflation.

Expert: Dr. Jörn Berninger (www.berninger.de)
Question asked by: Andreas H.

I hve wondered, when gold fix in London goes up or down, what is driving it?

There are basically thre different types of Gold markets.

The phsicall Bullion Market (which is what many private investors know)
The Gold Spot Markets
The Gold Future Markets

There are various Gold Future Markets around the globe. The Comex is the ones most blogs reference and point out that prices are made in those markets.

A Future contract is basically a very well planned delivery of goods in the future. So the idea is that a banker comes in the game who calculates the cost of storing the Gold and to add storage cost, finance cost and his fees into the cost of the future contract. So physical delivery should be guaranteed by the "banker" because he manages physical stored gold.

The Comex has for example a warehouse and tracks also deliveries and delivery notices.

Much of the critizism comes from the fact that there are naked short positions outstanding. The price therefore is made on those short positions, while physical delivery might not be guaranteed in a worst case szenario.

The prices of Spot andd Future markets should correlate by perfect arbitration. (That is another type of market participants who benefit from the differences between the future and the spot markets) However, the volume of contracts outstanding on the Future markets will "Pull" spot markets into any direction they want. The reason thereofe is easy to understand. Many investors in future contracts actually did historically not seek to purchase physical gold, but to benefit from gains or to hedge positions against losses.

Now finally to answer your question: The cost of financing determine a lot the prices in the future markets. An investor gets access to very low interest rates. Especially if this investor is a bank! Than he has to invest this money and he does so by investing for example in the future markets. That increase in liduidity drives prices up. The increasing liqudity also drives value of the currency down. So finally it makes sense to invest in Gold as your cost of financing the transaction are actually negative (negative interest rates)

That is one of the reasons why for example the London Gold fixing went up. Much of the liquidity in the markets was levereaged by hedge funds who seeked short term profits in the commodity markets. On the other hand it will drive prices down exponentially, when forced liquidation takes place.

The Bullion market however is another thing. You need the mints to coin the gold and you have a premium price for that coinage. There is now limited supply for some coins and prices decouple somehow from the spot prices.

Expert: Dr. Joern Berninger
Question asked by: Victor

Why does the market (US)go up when the dollar goes down? Does that happen with all currencies?

Most investors believe that Stocks are set to benefit or at least hedge from inflation. Businesses will increase their prices and so the idea is that stocks remain somehow valuable, while cash which is sitting along the sidelines will become worthless.

The issue with stocks however is that - if they are already overvalued it becomes risky. And of course you have to do the right picks. Not all businesses will survive the increase in overall price levels.

Expert: Dr. Joern Berninger
Question asked by: Gary

Could you explain what Jim Sinclair means with Inflation is a currency/government issue rather than an economic issue?

First:

Inflation is been viewed (or measured) differently by most people. So there is no common understanding of what it really means, not even amongst economists. That is an advantage and a prerequisite for the governments around the world.

The most common understanding is that Inflation is the expectation on price increases in the future. The monetarist view is that it is caused by increase in money expansion, which outperforms the increase in countries productivity.

Second:

Money is created out of debt. In consequence governmental policies are primarily targeted to increase nations´ debt, while the central bank is supplying and controlling the speed of debt increase.

The lines of Sinclair then make sense: Productivity has to increase at much higher rate in order to compensate for new money created, as otherwise it will not compensate for interest and principal debt. In consequence governments tend to increase debt continuously, as otherwise they would experience inflation. But inflation expectations start to rise with increasing money supply! (vicious cycle)

Summary:

That explains also that employment is primarily independent from inflation. It depends on the governmental ability to utilize the debt (money) in the best way to generate employment with resources available to an economy. Most governments however distribute wealth amongst members of the political parties and lobbyist groups. That inefficiencies cause the economy usually to grow slower than debt.

Depending on what course central banks and governments take that will then either result in higher unemployment (low demand for workforces in a non growth economy) or in higher inflation – or even worse - both.

Question asked by: NAVYGOLDEIGHTFOUR