MIKE

Posts Tagged ‘World Reserve Currency’

theeconomiccollapseblog.com

If you want to figure out what is going to happen next in the financial markets, carefully watch what the insiders are doing.  Those that are “connected” have access to far better sources of information than the rest of us have, and if they hear that something big is coming up they will often make very significant moves with their money in anticipation of what is about to happen.  Right now, Wall Street insiders and central banks all around the globe are making some very unusual moves.  In fact, they appear to be rapidly preparing for something really big.  So exactly what are they up to?  In a previous article entitled “Are The Government And The Big Banks Quietly Preparing For An Imminent Financial Collapse?“, I speculated that they may be preparing for a financial meltdown of some sort.  As I noted in that article, more than 600 banking executiveshave resigned from their positions over the past 12 months, and I have been personally told that a substantial number of Wall Street bankers have been shopping for “prepper properties” this summer.  But now even more evidence has emerged that quiet preparations are being made for an imminent financial collapse.  That doesn’t guarantee that something will happen or won’t happen.  Like any good detective, we are gathering clues and trying to figure out what the evidence is telling us.

Why Is George Soros Selling So Much Stock And Buying So Much Gold?

I am certainly not a fan of George Soros.  He has funneled millions upon millions of dollars into organizations that are trying to take America in the exact wrong direction.

However, I do recognize that he is extremely well connected in the financial world.  Soros is almost always ahead of the curve on financial matters, and if something big is going to go down George Soros is probably going to know about it ahead of time.

That is why it is very alarming that he has dumped all of his banking stocks and that he is massively hoarding gold.  The following is from shtfplan.com….

In a harbinger of what may be coming our way in the Fall of 2012, billionaire financier George Soros has sold all of his equity positions in major financial stocks according to a 13-F report filed with the SEC for the quarter ending June 30, 2012.

Soros, who manages funds through various accounts in the US and the Cayman Islands, has reportedly unloaded over one million shares of stock in financial companies and banks that include Citigroup (420,000 shares), JP Morgan (701,400 shares) and Goldman Sachs (120,000 shares). The total value of the stock sales amounts to nearly $50 million.

What’s equally as interesting as his sale of major financials is where Soros has shifted his money. At the same time he was selling bank stocks, he was acquiring some 884,000 shares (approx. $130 million) of Gold via the SPDR Gold Trust.

Why would you dump over a million shares of stock in major banks and purchase more than 100 million dollars worth of gold?

Well, it would make perfect sense if you believed that a collapse of the financial system was about to happen.

Earlier this year, George Soros told the following to Newsweek….

“I am not here to cheer you up. The situation is about as serious and difficult as I’ve experienced in my career,” Soros tells Newsweek. “We are facing an extremely difficult time, comparable in many ways to the 1930s, the Great Depression. We are facing now a general retrenchment in the developed world, which threatens to put us in a decade of more stagnation, or worse. The best-case scenario is a deflationary environment. The worst-case scenario is a collapse of the financial system.”

It looks like he is putting his money where his mouth is.

Perhaps even more disturbing is what he believes is coming after the financial collapse….

As anger rises, riots on the streets of American cities are inevitable. “Yes, yes, yes,” he says, almost gleefully. The response to the unrest could be more damaging than the violence itself. “It will be an excuse for cracking down and using strong-arm tactics to maintain law and order, which, carried to an extreme, could bring about a repressive political system, a society where individual liberty is much more constrained, which would be a break with the tradition of the United States.”

That doesn’t sound good.

George Soros has told us what he believes is going to happen, and now he is making moves with his money that indicate that he is convinced that it is actually about to start happening.

But he is not the only one that has been busy accumulating gold.

Billionaire John Paulson (the one that made 20 billion dollars on the subprime mortgage meltdown) has been buying gold like crazy and his company now “has 44 percent of its $24 billion fund exposed to bullion.”

So why are Soros and Paulson buying up so much gold?

Central Banks Are Also Hoarding Gold

According to the World Gold Council, the amount of gold bought by the central banks of the world absolutely soared during the second quarter of 2012.  The 157.5 metric tons of gold bought by the central banks of the world last quarter was an increase of 62.9 percent from the first quarter of 2012 and a 137.9 percent increase from the second quarter of 2011.

Prior to 2009, the central banks of the world had been net sellers of gold for about two decades.  But now that has totally changed, and last quarter central banks stocked up on gold in quantities that we have not seen before….

At 157.5 metric tons, gold buying among central banks came in at its highest quarterly level since the sector became a net buyer of the precious metal in the second quarter of 2009, data in the organization’s quarterly Gold Demand Trends report show.

So why have the central banks of the world become such gold bugs?

Is there something they aren’t telling us?

Rampant Insider Selling

Wall Street insiders have been dumping a whole lot of stock this year.

In my previous article, I linked to a CNN article from back in April….

First quarter earnings have been decent, if not spectacular. And many corporate executives are issuing cautiously optimistic guidance for the rest of the year.

But while insiders’ lips are saying one thing, their wallets are saying another. The level of insider selling among S&P 500 (SPX) companies is the highest in nearly 10 years. That is not good.

A lot of insiders appear to be getting out at the top of the market while the getting is still good.

Other insiders appear to be bailing out before the bottom falls out from beneath them.

Just check out what has been happening to Facebook stock.  It hit another new record low on Thursday as insiders dumped stock.  The following is from a CNN article….

Facebook’s life as a public company has been a nightmare from day one, and the pain continued on Thursday as some company insiders got their first chance to dump shares.

Facebook stock hit a new intra-day low of $19.69 Thursday morning, and ended the day 6.3% lower at $19.87.

Sadly, Facebook has now lost close to half of its value since the IPO.

Will Facebook end up being the poster child for the irrational stock market bubble that we have seen over the past couple of years?

Overall, retail investors have been very busy pulling money out of stocks in recent weeks.

The following are the net inflows to equity funds over the past five weeks (in millions of dollars) according to ICI….

7/11/2012: -537

7/18/2012: 637

7/25/2012: -2,999

8/1/2012: -6,866

8/8/2012: -3,684

According to the figures above, more than 10 billion dollars has been pulled out of equity funds over the past two weeks alone.

So does this mean anything?

Maybe.

Maybe not.

But it is very interesting and it bears watching.

Why Does The U.S. Government Need So Much Ammunition?

In my previous article, I also noted that the U.S. government appears to be very rapidly making preparations for something really big.

This week, it was revealed that the Social Security Administration plans to buy 174,000 hollow point bullets which will be delivered to 41 different locations all over America.

Now why in the world does the Social Security Administration need 174,000 bullets?

And why do they need hollow point bullets?  Those bullets are designed to cause as much damage to internal organs as possible.

But of course this is only the latest in a series of very large purchases of ammunition by U.S. government agencies.  The following is from a recent article by Paul Joseph Watson….

Back in March, Homeland Security purchased 450 million rounds of .40-caliber hollow point bullets that are designed to expand upon entry and cause maximum organ damage, prompting questions as to why the DHS needed such a large amount of powerful bullets merely for training purposes.

This was followed by another DHS solicitation asking for a further 750 million rounds of assorted bullets, including 357 mag rounds that are able to penetrate walls.

Now why in the world would the government need over a billion rounds of ammunition?

If it was the U.S. military I could understand this.  You can burn through a whole lot of ammunition fighting wars.

But this makes no sense – unless they believe that big trouble is coming.

Personally, I wouldn’t blame them for getting prepared.  Our economy continues to fall apart and there are signs of social decay everywhere around us.

The American people are more frustrated and more angry than at any other time in modern history.  This upcoming election is only going to cause Americans to become even more angry and even more divided.

All it would take is just the right “spark” to cause this country to erupt.

It could be the upcoming election.

It could be the collapse of the financial system.

Or it might be something else.

But the conditions are definitely there for it to happen.

Unfortunately, the American public is never told to prepare because authorities never want “to panic” the general population.

We are always the last to know, and that stinks.

So don’t wait for someone to come on the television and announce that a crisis is happening.

If you wait that long, it will be too late.

Instead, open up your eyes and think for yourself.

We all need to work hard to get prepared for the coming crisis while we still can.

As you can see, Wall Street insiders, the U.S. government and the central banks of the world are busy getting prepared.

Don’t put your head in the sand.

The warning signs are there and time is running out.

Read the entire article HERE.

Mac Slavo
August 16th, 2012
SHTFplan.com

In a harbinger of what may be coming our way in the Fall of 2012, billionaire financier George Soros has sold all of his equity positions in major financial stocks according to a 13-F report filed with the SEC for the quarter ending June 30, 2012.

Soros, who manages funds through various accounts in the US and the Cayman Islands, has reportedly unloaded over one million shares of stock in financial companies and banks that include Citigroup (420,000 shares), JP Morgan (701,400 shares) and Goldman Sachs (120,000 shares). The total value of the stock sales amounts to nearly $50 million.

What’s equally as interesting as his sale of major financials is where Soros has shifted his money. At the same time he was selling bank stocks, he was acquiring some 884,000 shares (approx. $130 million) of Gold via the SPDR Gold Trust.

When a major global player with direct ties to the White House, Wall Street, and the banking system starts off-loading stocks and starts stacking gold, it suggests a very serious market move is set to happen.

While often lambasted for his calls to centralize global banking, increase government intervention in the economy and his support of what he has called an “emergence of the new world order,” if there’s anyone with an inside track of where things are headed next it’s Soros.

Soros, who has written extensively of a coming global paradigm shift  in his book The Crash of 2008 and What It Means, calling the current economic and political model ”an end of an era,” has recently suggested that the financial and economic situation across the world is so serious that Europe could soon descend into chaos and conflict. He also notes that the world is entering “one of the most dangerous periods in modern history”, and foresees violent riots in America and a brutal clamp-down by the government that will dramatically curtail civil liberties.

This is an individual who not only predicted the collapse of 2008 and took action to insulate himself, he also proposed the various fixes that governments in Europe and the US would eventually implement in order to stave off a deflationary depression. In his aforementioned book he suggested that central banks infuse the system with massive amounts of monetary expansion, but also warned that not injecting enough money would simply extend the onset of deflation and printing too much could lead to hyperinflationary currency collapse.

Based on recent activity in Soros’ US held accounts, it seems that governments and central banks have failed at those efforts to stabilize the system. As such, Soros is getting out of those companies which are most at risk should the financial system buckle like it did in 2008 and he’s shifting his assets into what may be the only asset class left standing when it’s all said and done.
Read the entire article HERE.

Another example of why you should choose physical gold and silver rather than the paper counterpart. These derivatives are simply way too over leveraged and when the music stops someone is going to be left without a chair and the one sitting will most likely be JPMorgan or Goldman Sachs. And don’t expect the government to do anything about it. Lawrence Lepard describes the heist below:

By Lawrence Lepard
November 18, 2011
ZeroHedge

Imagine you are Ben Bernanke, or on the Board of Governors of the Federal Reserve. The time frame is July and August of 2011 and the price of gold is on a tear. Commodities inflation has been persistent and is breaking out everywhere. Your prediction that inflation “is contained” and is a “temporary phenomena” are beginning to look absurd. What do you do?

Simple. Hint that QE3, the primary drive of inflation, is coming and then fail to deliver at the September FOMC meeting. That takes care of the price of gold and the gold stocks. Ah, but those pesky commodities speculators keep making money and trading against what you want the markets to do. So what is to be done there? Hey Jon Corzine, how about you tank the largest broker for the small commodities punters in the world, and we let them twist in the wind? That will serve them right. Teach them to bet against the government approved scenario.

Think it did not happen? Well think again. All of the pieces fit. It sure is convenient that all those commodities speculators are now out of the box. Also, who will want to speculate on commodities in the future given customer funds are no longer protected. Furthermore, commodities speculators are not a very “All American” group. From the authorities point of view they can say: screw them, who will feel sympathy? Hell, James Bullard, Fed Governor, in an interview on CNBC yesterday said the MF Global collapse proves that the system works. Yes it does Jim, for you. Personally, I have $90,000 at MF Global and I would like to have my honestly earned money returned. Unfortunately, the odds of that happening any time soon seem slim. In part because when MF Global entered bankruptcy the judge appointed a Trustee whose law firm has done substantial work for JP Morgan, a deeply interested party. We will probably never find out what happened here. But for those of us whose eyes are open the results speak for themselves.

This whole mess stinks to high heaven. I am with Gerald Celente, if the largest commodity broker in America can go bankrupt and nothing is done, then where can you put your money and expect it to be safe? I, for one, do not accept that Jon Corzine is stupid enough to lever up MF Global 40:1 and use the proceeds and customer money to bet on European sovereign debt. This was a hit, pure and simple. That is why there is no resolution to the problem, and it is just another example of the deeply corrupt US political/financial axis. It may take money away from a bunch of commodities speculators, and it may cool down the perceived inflation, but it is just another hole in the dike which is The US Financial System. A dike whose life can probably now be measured in months, not years.

Read the entire article HERE.

Interview by James Turk
The Gold Report
November 7, 2011

A war-mongering U.S. government could be less than 18 months away from decimating the last 5% of value left in the dollar, says Richard Maybury, the author of the U.S. & World Early Warning Report. Until some new exchange-traded-fund-like basket of natural resources provides a store of value, this “juris naturalist” has some advice about how to protect your wealth during the coming collapse.

The Gold Report: Richard, last month, you made a presentation at the Casey Research/Sprott Inc. “When Money Dies” Summit entitled “The War that Will Kill the Dollar.” You explained that the corrupting influence of power had sent our country’s leaders shopping for war, disregarding Westphalian respect for sovereignty and hastening the collapse of society. What are the signs that we are reaching a critical point? And, is there any way we can change course?

Richard Maybury: You can see the signs very clearly in the Middle East and North Africa. The Federal government is involved in several wars there that have nothing to do with America. One of the best examples is Libya. U.S. officials are taking credit for Moammar Gadhafi’s death just a year after they were bragging about having tamed the threat. Now Libya is a mess. It will very likely be taken over by some sort of Islamic government that isn’t going to be very friendly to America.

TGR: Why do we, as a country, do this? If it’s not going to end well for us, what’s the economic or political reason to get involved?

RM: The U.S. government gets into wars in far corners of the world that have nothing to do with America because the leaders like getting into wars. That is how presidents achieve greatness in the history books. A president has no prayer of going down in history as great unless he has won a war. Look at Mount Rushmore. All four presidents featured there won wars. That seems to be the number one criteria historians use for deciding whether someone is a great president. It constitutes an automatic incentive to go out looking for wars.

TGR: What is the incentive for the American people to go war shopping?

RM: Nothing. It’s absurd. During the First Gulf War, people had a tremendous good feeling about going to war with Iraq. They would come home from work, order a pizza, sit in front of their TV sets and watch the war like it was a football game. War became a form of entertainment.

TGR: Is there anything we could do to incentivize our presidents to act peacefully?

RM: I doubt it very much. People go into politics because they seek political power. Once they get the power, they naturally want to use it on somebody. What is the point of having power if you can’t use it? So, no matter what kinds of controls you put on, future presidents will find a way around it.

The ideal situation would be one where war is used as a last resort. Westphalian sovereignty, a set of agreements dating back in the 1600s, established the precedent that the European powers would only go to war in self-defense. You had to have a clear and present danger before you could go to war. And, even then, it was supposed to be the last resort. That was the basis of international law up until this year. That isn’t to say that the Westphalia treaties weren’t violated a lot of times, but they helped. After Iraq, Serbia and now Libya, it is pretty clear that the policy is we can just go out and hit anybody we want for any reason we want as long as we believe the other guy is up to no good.

TGR: If this is the new reality, then let’s talk about some of the economics around it. War is expensive. You have pointed out that since the Federal Reserve was created in 1913, the dollar has lost 95% of its buying power. You said, “War destroys currencies.” It usually leads to governments printing more dollars to pay for guns and tanks. How much debt and overprinting can the country take before the velocity of economics, which is something that you also talked about in association with how quickly dollars are exchanged, catches up with reality and the dollar loses that last 5% of its value?

RM: Velocity refers to the speed at which money changes hands, and it is a measure of money demand. When people don’t really want the money, they start trading it away faster, trying to get their hands on things they do want, things that have value that they trust. The cost of this war in the Islamic world will continue going up. At some point, it’s going to be a major contributor to people losing what confidence is left in the dollar and people all over the world will start dumping it. This is a psychological thing. It’s about emotions, so it is hard to pinpoint when they will lose all confidence in the dollar.

TGR: What would it look like if that last 5% were gone? Are we talking about hyperinflation? Are we talking about banks collapsing? Are we talking about bartering? What would it look like?

RM: We are talking about all of that. It would be chaos. We saw it in Zimbabwe when the Zimbabwean dollar became worthless because the government printed so many that people wouldn’t accept them anymore. The country experienced enormous runaway inflation where prices were rising 50% a day before the Zimbabwe dollar collapsed.

It would probably start with someone somewhere in the world selling off his dollars and begin trading them for whatever it was he had confidence in. The foreign exchange value of the dollar would fall. Other people would notice; they would get scared and start selling their dollars. The foreign exchange value of the dollar would drop more. This process would continue until you have panic around the world to get out of dollars. Americans would be the last ones to get involved. We are always the last to know what is happening to America. Suddenly Americans would wake up one morning and find that a gallon of milk that cost $4 the day before costs $6 today. The next day they would find that it costs $12. And the next day they would find that it costs $36. That is when Americans would realize that they are in deep trouble; their dollars are about to become worthless.

TGR: Of course the Fed wants to avoid that scenario. You describe yourself as a follower of Austrian economics made famous by the Nobel laureates Friedrich Hayek and Ludwig von Mises. They describe financial systems as complex processes run by billions of constantly changing individuals rather than something that can be manipulated from a central point, which seems to be what is being attempted right now. If that is the case, what will be the outcome if the central government tries to force a more Keynesian control of the flow of money?

RM: They will mess it up even worse than they already have. The world has been living under Keynesian economics since 1971 when Nixon took the dollar off the gold standard. John Maynard Keynes was a semi-socialist. He believed that the way to fix the economy was to print a whole bunch of dollars and dump them out there. This has been standard procedure for the past 40 years. All currencies have been dropping in value during that time. Another round of quantitative easing (QE) could further speed the rate at which the money circulates, something that has the same effect as increasing the supply of dollars, creating a larger demand for goods and services and having an inflationary effect. I think Fed officials are dropping hints about the next QE because they are trying to cause velocity to rise, a secret QE if you will.

TGR: What if the stealth QE campaign doesn’t work? What form might a real QE3 take?

RM: It is hard to tell what they will do. One of the myths that everyone is taught is that the government has some sort of tremendous understanding of economics and the ability to make adjustments to economic activity. The term fine-tuning is used sometimes. Actually, we are talking about a group of human beings who don’t know much more about real economics than anybody else. They think they do, but they don’t. They just bounce around from one attempt to control things to the next, making a mess of the country. The economy is not a machine. It is people, human beings. It is a biological system, not a mechanical system. But, the government treats it like a mechanical system, so they are always making mistakes.

TGR: If war and hyperinflation are the inevitable future, how can investors survive or maybe even thrive during a time like this? What are the opportunities? Natural resources? Commodity equities? Where can we be safe other than putting that $100 bill under the bed?

RM: Well, I wouldn’t put $100 under the mattress, at least not for very long, because it will soon become worthless. But commodities, stocks of raw materials firms, gold and silver and platinum coins have value. Generally, I try to see the world in terms of two kinds of investments: dollars and non-dollars. You definitely want non-dollars, things that do not have their value tied to the value of the dollar. An example of a dollar asset is something like a bond or bank CD. Their values are tied directly to the value of the dollar. If the dollar falls, then their values fall.

Gold is a non-dollar asset. When the dollar falls, usually gold rises. The same is true with silver and oil. All of these things have values that are not tied to the dollar. My advice is to invest in non-dollar assets. Gold would be at the top of the list, silver and platinum and then oil.

TGR: In your Early Warning Report Newsletter, you predicted that gold will top $3,000/ounce (oz), silver will hit $50/oz and oil will exceed $300/barrel. Gasoline will go to $9/gallon. When will we see these rises? And what will be the catalysts that take them there?

RM: The next QE, which I expect to come along no later than March, could set off a flight from dollars. Then we could see those predictions realized within 18 months.

TGR: You said that once we have had this loss of the entire value of the dollar and people are looking for another way to trade, money could be based on some collection of metals with currency acting as a receipt for the tangible gold, silver, platinum and whatever else happens to be in that basket. What would that transition look like? How painful would that be? How would it be orchestrated?

RM: It doesn’t have to be painful. The markets are moving in that direction. People trade exchange-traded funds (ETFs) for practically everything now. I can envision a mutual fund or an ETF that is a collection of various things. It could be gold, silver and platinum. It could have oil in there. It might include Swiss francs. It could even have various patches of real estate. The ETF itself would then become a currency, not because anybody has it planned that way, but because the markets will see that there will be a demand for something that is a non-dollar asset that is easily tradable and seen as a store of value. There would probably be hundreds of these baskets of assets at the start. Some would work better than others would; the less workable ones would shake out. You might wind up with maybe a half dozen ETFs or mutual funds that are baskets of various assets circulating in the world. They would essentially become the currencies.

TGR: Would investing in ETFs now be a good way to prepare?

RM: No. I don’t know of any that are arranged that way. It may be a while until somebody catches the idea and decides to give it a try.

TGR: What about the precious metal equities? Would that be a good way to prepare?

RM: Yes. There are lots of good precious metal stocks. I own quite a few. That is another way to protect yourself. However, be sure to deal with a broker who really knows natural resources. You have to have some skill in picking those stocks. It’s not like going down and buying a gold coin where you just walk into the coin dealer and tell him I want a handful of American Eagles or Canadian Maple Leaves. You really have to know what you are doing when you are buying gold stocks.

TGR: Any final thoughts you want to leave with The Gold Report readers?

RM: The world has changed. When you look at the news and you say to yourself, “My God, America isn’t what it was; the world isn’t what it was,” have the confidence to know you are right. We are probably not going back to what America or the world was anytime in my lifetime. Therefore, you want to start learning everything you possibly can about this new condition and adapt to it.

TGR: Thank you for sharing your thoughts.

RM: Thank you, JT. I appreciate being here.

BY MICHAEL PETTIS
October 17, 2011
Financial Sense

My friend Mark Williams sent me last week a reference to a very interesting paper written by Malhar Nabar, an economist at the IMF.  The paper is called “Targets, Interest Rates, and Household Saving in Urban China” and in it Nabar tries to measure the impact of changes in the real deposit rate on changes in Chinese consumptions levels.

How do interest rates normally affect the savings and consumption rate?  The consensus view, of course, is that there should be a negative correlation between interest rates and consumption.  In other words when interest rates rise, households should save more and so consume less out of current income.

Why?  One reason may be that savings are simply postponed consumption, and we are willing to postpone consumption if we are paid enough to do so.  The more you pay me to save in the form of a high interest rate, in other words, the more I save out of current income, and so the less I consume.  The same thing happens, by the way, when rising interest rates cause the cost of consumer financing to rise, and so discourage the use of credit cards.

There is another reason why this may be the case.  Typically we associate rising interest rates with falling stock, real estate and bond prices.  If most of our wealth consists of those three kinds of assets, then higher interest rates should be associated with a decline in our wealth, and because we feel poorer, we reduce our consumption rate.

In both cases rising interest rates are assumed to bring declining consumption and higher savings.  This relationship seems to be supported by the data in many countries.

I am nonetheless a little uncomfortable with the first explanation – that as you increase the reward for postponing consumption, households save more.  I find it hard to believe that people really think this way about savings, and if they did, it seems to me that unless there were an enormous preference for liquidity, in any country in which deposit rates were negative in real terms (i.e. households are paying, not getting paid, to postpone consumption) consumption rates should rise to 100% or more.

This certainly isn’t the case.  In China, for example, deposit rates are seriously negative and have been negative for many years, and yet the household savings rate is nonetheless very high.  In fact it seems that, as a rule, countries with repressed interest rates have higher, not lower savings rates.

What’s more, I have seen US historical data that suggests that when interest-rate declines have coincided with falling, not rising, stock and real estate markets (as they have recently), the savings rate usually rises rather than declines.  In other words households care mainly about their wealth, not about the reward for postponing consumption.

Which explanation is more correct matters a lot for Chinese monetary policy.  We tend to be so US-centric when we think about economics – including, unfortunately, most Chinese economists – that we automatically assume that because raising interest rates in the US will reduce consumption and so limit inflation, it must also be the case in China.

Even very prestigious newspapers, citing prominent economists and research analysts, assure us that in order to fight inflation the PBoC raises interest rates.  Here for example, is what the Financial Times said three months ago:

China has raised interest rates for the fifth time in eight months, indicating the country’s leaders are still focused on taming politically sensitive inflation, despite evidence that the world’s second-biggest economy is slowing. Benchmark one-year lending rates will be raised 25 basis points to 6.56 per cent from Thursday, while one-year deposit rates will go up 25 basis points to 3.5 per cent, the central bank said on Wednesday.

The rise suggests that inflation is likely to have accelerated to a three-year high of more than 6 per cent in June, well beyond Beijing’s comfort zone.  The government is scheduled to announce the inflation figure next week.

Here is Xinhua, on the same day:

The interest-rate hike will help check high inflation and the June CPI data will be 6.2 percent, Lu Zhengwei, chief economist for the Industrial Bank, predicted.

…Guo Tianyong, a professor with the Central China Finance University, said the move is necessary as it can help correct the negative interest rates and manage inflation, but it can also slow economic growth and precipitate inflows of speculative hot money.

A quick Google search uncovers thousands of articles and OpEd pieces that make the same point.

The Empirical Evidence

But for many years I have strongly disagreed with this claim that raising rates is a way of combating inflation.  If it is the wealth effect, and not the consumption-postponement effect, that really drives changes in savings and consumption rates, then raising rates would only reduce consumption if there were a negative correlation between interest rates and wealth, as there clearly is in the US.

Is there a negative correlation between the two in China?  Probably not.  Most Chinese savings, at least until recently, have been in the form of bank deposits.  In a financial system in which deposit rates are set by the central bank, the value of bank deposits is positively, not negatively, correlated with the deposit rate.

Chinese households, in other words, should feel richer when the deposit rate rises and poorer when it declines.  In that case, rising rates should be associated with rising, not declining, consumption and with higher, not lower, inflationary pressure.

I want to repeat this because I think it is a very important source of confusion.  In the past few years the consensus on China has dramatically changed, and as a result many of the things I used to discuss which once sounded so strange and “contrarian” (I hate that word) – discussions for example about the unsustainable increase in Chinese debt, the role of financial repression in undermining household income growth, the nature of the Chinese growth model – are now pretty widely held.

But it is still very rare to hear anyone acknowledge that while raising interest rates in China may be a very good thing – because it reduces the capital misallocation on which Chinese growth is highly dependent – it does not reduce inflationary pressure.  It increases it.

Needless to say that is why I found the Nabar paper so interesting.  My argument had always been a conceptual argument based on balance sheet principles, but Nabar has tested the correlation.  He went out and measured changes in consumption as a function of changes in the real deposit rate.

And he finds in fact, in line with my conceptual argument, that higher real rates really are associated with lower savings and higher consumption.  Here is what he says:

Although a large body of research has examined the determinants of household saving in China, little attention has been directed to interest rates and their impact on saving decisions.  Bank deposits are currently the primary saving vehicle available to Chinese households.
The return households earn on these bank deposits could therefore potentially influence household saving behavior in a tangible way. This research assesses how interest rates affect household saving decisions using a panel dataset that covers China’s 31 provincial-level administrative units over the period 1996–2009.
The main findings are as follows. 

•  Panel estimates suggest that household savings respond strongly to a change in the real interest rate. A one percentage point increase in the real rate of return on bank deposits lowers the urban household saving rate by 0.6 percentage points.

•  A comparison of the relationship across sub-periods shows that the association is stronger in the later period, 2003–09, relative to the earlier period, 1996–2002. The relationship is robust to the inclusion of variables that proxy for other influences on saving such as life cycle considerations and self-insurance against income volatility.  

•  The evidence also indicates that when the return on alternative investment is high (for example when real property price growth is relatively strong), a decline in the real return on bank deposits does not have as negative an impact on household portfolios.  

The results suggest that China’s households save to meet a multiplicity of needs – retirement consumption, purchase of durables, self-insurance against income volatility and health shocks – and act as though they have a target level of saving in mind. An increase in financial rates of return, which raises the return on saving, makes it easier for them to meet their target saving. Financial reform that boosts interest rates could therefore have a strong effect on current tendencies to save. 

The Consumption Share of GDP

I think this is a very important point.  For one thing it confirms the claim that financial repression also represses consumption growth, and so is one of the factors at the heart of China’s economic imbalances – in fact I would say it is the main factor.

It also says that monetary policy may have very different consequences from our hidden assumption that it works the same way in China as it works in the US.  In the US if the Fed wants to lower inflationary pressures, it raises interest rates to reduce household wealth, to raise the cost of consumer financing, and otherwise to put downward pressure on demand by reducing consumption.

In China however when the PBoC raises the interest rate it has limited effect through the cost of consumer financing (consumer finance is negligible in China) and it actually increases household wealth.  This means that raising rates is more likely to encourage inflation than to reduce it.

And since real interest rates have actually declined in the past year, lower real rates help explain why inflation may have already peaked, and why it is coming down.  In fact this may be why financially repressed countries can have both rapid monetary expansion and limited inflation, as they typically do.  Inflation itself, by lowering real rates, can reduce inflationary pressure.  It is self-correcting – at least until households begin withdrawing deposits and spending the money simply because the cost of holding money is too great.

Not surprisingly, as inflation has risen and deposits rates lagged during the past year, much of the evidence suggested that contrary to Beijing’s announced plans, consumption was likely to be declining as a share of GDP.  I have said many times that when they finally published the 2010 data in the China Yearbook 2011, I would expect to see consumption drop from 35.0% in 2009 to 34% in 2010 and perhaps another point lower in 2011.

On Friday my associate Chen Long told me the yearbook had in fact just been published, and he sent me the data.  Our expectation turns out to have been right.  Household consumption for 2010 is reported to be 33.8% of GDP.

Here is the full data:

Aside from the extraordinary decline in the consumption rate, it is interesting to see what happened to the trade surplus.  At 6.4% of GDP in 2010, it is extremely high, but well off its record levels in 2007 and 2008, when as a share of global GDP China’s trade surplus may well have been the highest in modern history.  Notice that as it declined from its peak, investment surged.

This is just what we would have expected.  The negative growth impact of the sharp drop in China’s trade surplus may have forced GDP growth rates to nearly zero, and the sudden and violent expansion in investment was necessary as the counterbalance to keep growth rates high.  Changes in the declining consumption share of GDP have had very little impact on changes in GDP growth.  And it continues to decline.

PS: I often mention my central bank seminar as a fascinating class in which some of the brightest students at Peking University debate and analyze monetary and credit conditions in China in a way that impresses even real central bankers.  The Soros-funded Institute for New Economics Thinking has asked them to provide a blog outlining their deliberations, and you can find here their first few reports examining debt levels in China.  Its in early stages, but keep an eye on it.  These guys are very smart.

Read the entire article HERE.

by Tyler Durden
09/03/2011 17:22 -0400
ZeroHedge

Wondering why gold at $1850 is cheap, or why gold at double that price will also be cheap, or frankly at any price? Because, as the following leaked cable explains, gold is, to China at least, nothing but the opportunity cost of destroying the dollar’s reserve status. Putting that into dollar terms is, therefore, impractical at best, and illogical at worst. We have a suspicion that the following cable from the US embassy in China is about to go not viral but very much global, and prompt all those mutual fund managers who are on the golden sidelines to dip a toe in the 24 karat pool. The only thing that matters from China’s perspective is that “suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar’s role as the international reserve currency. China’s increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.” Now, what would happen if mutual and pension funds finally comprehend they are massively underinvested in the one asset which China is without a trace of doubt massively accumulating behind the scenes is nothing short of a worldwide scramble, not so much for paper, but every last ounce of physical gold…

From Wikileaks:

3. CHINA’S GOLD RESERVES

“China increases its gold reserves in order to kill two birds with one stone”

The China Radio International sponsored newspaper World News Journal
(Shijie Xinwenbao)(04/28): “According to China’s National Foreign
Exchanges Administration China ‘s gold reserves have recently
increased. Currently, the majority of its gold reserves have been
located in the U.S. and European countries. The U.S. and Europe have
always suppressed the rising price of gold. They intend to weaken
gold’s function as an international reserve currency. They don’t
want to see other countries turning to gold reserves instead of the
U.S. dollar or Euro. Therefore, suppressing the price of gold is
very beneficial for the U.S. in maintaining the U.S. dollar’s role
as the international reserve currency. China’s increased gold
reserves will thus act as a model and lead other countries towards
reserving more gold. Large gold reserves are also beneficial in
promoting the internationalization of the RMB.”

Perhaps now is a good time to remind readers what will happen if and when America’s always behind the curve mutual and pension fund managers finally comprehend that they are massively underinvested in the one best performing asset class.

From The Driver for Gold You’re Not Watching (via Casey Research)

You already know the basic reasons for owning gold – currency protection, inflation hedge, store of value, calamity insurance – many of which are becoming clichés even in mainstream articles. Throw in the supply and demand imbalance, and you’ve got the basic arguments for why one should hold gold for the foreseeable future.

All of these factors remain very bullish, in spite of gold’s 450% rise over the past 10 years. No, it’s not too late to buy, especially if you don’t own a meaningful amount; and yes, I’m convinced the price is headed much higher, regardless of the corrections we’ll inevitably see. Each of the aforementioned catalysts will force gold’s price higher and higher in the years ahead, especially the currency issues.

But there’s another driver of the price that escapes many gold watchers and certainly the mainstream media. And I’m convinced that once this sleeping giant wakes, it could ignite the gold market like nothing we’ve ever seen.

The fund management industry handles the bulk of the world’s wealth. These institutions include insurance companies, hedge funds, mutual funds, sovereign wealth funds, etc. But the elephant in the room is pension funds. These are institutions that provide retirement income, both public and private.

Global pension assets are estimated to be – drum roll, please – $31.1 trillion. No, that is not a misprint. It is more than twice the size of last year’s GDP in the U.S. ($14.7 trillion).

We know a few hedge fund managers have invested in gold, like John Paulson, David Einhorn, Jean-Marie Eveillard. There are close to twenty mutual funds devoted to gold and precious metals. Lots of gold and silver bugs have been buying.

So, what about pension funds?

According to estimates by Shayne McGuire in his new book, Hard Money; Taking Gold to a Higher Investment Level, the typical pension fund holds about 0.15% of its assets in gold. He estimates another 0.15% is devoted to gold mining stocks, giving us a total of 0.30% – that is, less than one third of one percent of assets committed to the gold sector.

Shayne is head of global research at the Teacher Retirement System of Texas. He bases his estimate on the fact that commodities represent about 3% of the total assets in the average pension fund. And of that 3%, about 5% is devoted to gold. It is, by any account, a negligible portion of a fund’s asset allocation.

Now here’s the fun part. Let’s say fund managers as a group realize that bonds, equities, and real estate have become poor or risky investments and so decide to increase their allocation to the gold market. If they doubled their exposure to gold and gold stocks – which would still represent only 0.6% of their total assets – it would amount to $93.3 billion in new purchases.

How much is that? The assets of GLD total $55.2 billion, so this amount of money is 1.7 times bigger than the largest gold ETF. SLV, the largest silver ETF, has net assets of $9.3 billion, a mere one-tenth of that extra allocation.

The market cap of the entire sector of gold stocks (producers only) is about $234 billion. The gold industry would see a 40% increase in new money to the sector. Its market cap would double if pension institutions allocated just 1.2% of their assets to it.

But what if currency issues spiral out of control? What if bonds wither and die? What if real estate takes ten years to recover? What if inflation becomes a rabid dog like it has every other time in history when governments have diluted their currency to this degree? If these funds allocate just 5% of their assets to gold – which would amount to $1.5 trillion – it would overwhelm the system and rocket prices skyward.

And let’s not forget that this is only one class of institution. Insurance companies have about $18.7 trillion in assets. Hedge funds manage approximately $1.7 trillion. Sovereign wealth funds control $3.8 trillion. Then there are mutual funds, ETFs, private equity funds, and private wealth funds. Throw in millions of retail investors like you and me and Joe Sixpack and Jiao Sixpack, and we’re looking in the rear view mirror at $100 trillion.

I don’t know if pension funds will devote that much money to this sector or not. What I do know is that sovereign debt risks are far from over, the U.S. dollar and other currencies will lose considerably more value against gold, interest rates will most certainly rise in the years ahead, and inflation is just getting started. These forces are in place and building, and if there’s a paradigm shift in how these managers view gold, look out!

I thought of titling this piece, “Why $5,000 Gold May Be Too Low.” Because once fund managers enter the gold market in mass, this tiny sector will light on fire with blazing speed.

My advice is to not just hope you can jump in once these drivers hit the gas, but to claim your seat during the relative calm of this month’s level prices.

Read the entire article HERE.

by JS Kim
Chief Investment Strategist
SmartKnowledgeU
June 6th, 2011

Please find below my interview with Max Keiser and our discussion regarding the Greek crisis and continued banker price suppression and manipulation schemes executed against gold and silver to prop up the US dollar and prevent a US dollar collapse. Max raises the issue of the European Parliament’s move to accept gold from EU nations as collateral as reported on Zero Hedge here, which I believe is a step towards making gold acceptable as money for the purposes of debt repayment. However, this step is nothing new as Bankers have long been known to make loans in weak currencies and demand repayment in much stronger currencies before, even when dealing with fiat currencies. For example, the World Bank, which has long dispensed loans in US dollars to struggling nations, started a program in the early1990s whereby it asked nations to repay their USD loans in local currencies, fully aware of the fact that the US dollar was falling against many global currencies very rapidly. The World Bank aggressively instituted this “we lend you money in junk US dollar fiat currency and repay us in better currency” program in 15 different currencies in the early 1990s and aggressively pushed it further in the 2000s. So it is no surprise at all that the European Parliament has extended and refined this World Bank program for their own use into a “collateralize your debt with real money (physical gold) but continue to take out loans in our junk fiat currencies”.

UPDATED:

I also discuss the shenanigans of the gold/futures silver market with Max. Here is the link to the evidence and the letter I sent to CFTC Commissioner Bart Chilton in late summer of 2008 of Banker fraud in the gold futures markets and his reply to me. Mr. Chilton replied that the enormous arbitrage opportunities daily for several months in the summer of 2008 of $20, $30, $40 and $50 an ounce higher prices of gold futures in Asia versus the New York COMEX was due to Chinese banker manipulation of gold prices higher and not due to Western banker manipulation of gold prices lower. You can read, in that same article, my further line of questioning of Mr. Chilton’s response that went unanswered by the CFTC. Furthermore, I discuss with Max the recent shenanigans in gold and silver futures markets where nearly 99% of all daily transactions for the month of May, 2011 consisted of paper for paper swaps in the form of EFP (Exchange of Futures for Physical) and EFS (Exchange of Futures for Swaps). While at first the Exchange of Futures for Physical transaction may sound legitimate in name, all legitimacy disappears when one realizes that paper may be substituted for the “physical” component of this transaction.

Exchange Rule 104.36 enacted on February 18, 2005, which allows for the substitution of gold ETFs for physical gold, states that the “physical” part of the transaction “need only be substantially the economic equivalent of the futures contract being exchanged” and that “the purpose of this Notice is to confirm that the Exchange would accept gold-backed exchange-traded funds (‘ETF’) shares as the physical commodity component for an EFP transaction involving COMEX gold futures contracts, provided that all elements of a bona fide EFP pursuant to Exchange Rule 104.36 are satisfied. Thus, acceptable gold-backed and exchange-traded ETF funds include, but are not limited to, the iSharesCOMEX Gold Trust (ticker: IAU), which began trading on the American Stock Exchange on January 28, 2005.”

GATA’s Adrian Douglas first brought to my attention Exchange Rule 104.36 in his article, “Commodity Exchanges Can Dump Gold Debts on ETFs”, prompting me to search the CFTC database even further. My search revealed a further amendment to the “exchange of future for physical” transactions enacted onMarch 11, 2005. This amendment stated that “for purposes of this Rule 414, the term ‘Related Position’ [Physical] shall include, but not be limited to, a security [a group or basket of securities], an option, [or] any commodity as that term is defined by the CEA or a group or basket of any of the foregoing. The Related Position [Physical] being exchanged need not be the same as the underlying of the Futures transaction being exchanged, but the Related Position [Physical] must have a high degree of price correlation to the underlying of the Futures transaction so that the Futures transaction would serve as an appropriate hedge for the Related Position [Physical].” This amendment not only opens up PM ETFs as substitutes for the “physical” component of a gold/silver futures transaction but even other metal ETFs or physical metals that have a “high degree of price correlation” to gold and silver.

Furthermore, remember that an EFP transaction can be used to either initiate or liquidate a futures position. Thus, from this amendment, though not specifically mentioned, it is obvious that SLV shares could be used in an EFP transaction to represent the “physical silver” part of a futures transaction. If you look at my below diagram, this may also explain why a huge number of spread positions in the gold/silver futures markets are initiated from time to time in the COMEX. I have illustrated how an EFP in silver futures may work below:

(Click Image for a Larger View)

In recent months, the number of EFP transactions in silver AND gold, as opposed to the number of contracts settled in cash or settled in physical delivery, has exploded. When the majority of gold/silver futures transactions daily consist of EFP and EFS transactions versus cash settlement or physical settlement, this points to a pronounced manipulation of this market and an absence of any true price discovery in gold/silver futures markets.

ZeroHedge recently reported that JP Morgan was one of the largest owners of the likely bogus SLV ETF, holding 3,600,000 shares as of the end of the 2010 fiscal year calendar. ZeroHedge also reported that bullion banks, in early May, moved 20% of COMEX physical silver out of the registered category that is available to satisfy requests for physical delivery and into the eligible category that is not “eligible” for physical delivery. Scottia Mocatta followed this significant move by transferring 186,000 of their physical silver ounces from registered to eligible as well. JP Morgan, as of the May 27th CME report, held ZERO ounces of registered silver in the COMEX vaults.

In the meantime, selling of SLV shares reached an all time high in May. What does this all mean? I’m not quite sure I have the full answer yet as I keep digging, but I’m quite certain that whatever is going on in these paper for paper swaps in the gold/silver futures markets on the COMEX is not kosher and an attempt to hide physical shortages of precious metals that exist versus the open interest numbers in gold/silver futures. The CME makes it very difficult to compile stats regarding EFS and EFP transactions because while they provide a running total of month-to-date transactions for gold/silver futures contracts settled in cash and settled through physical delivery, they do NOT provide a running total of EFS and EFP transactions month-to-date in their daily metal reports nor do they respond to any requests for such information. When one of my staff members wrote the CME and inquired if running totals were available each month for EFS and EFP transactions in gold/silver futures, the CME staff answered no. Thus, one of my staff compiled the daily totals for EFS and EFP transactions for the month of May by pulling every daily report for gold/silver futures. This is what the totals looked like from May 2 to May 26, 2011.

For gold futures, from May 2, 2011 until May 26,2011, 0.01% of transactions settled in cash, 0.27% settled in physical, 78.22% consisted of EFP and 21.50% consisted of EFS (for a combined 99.72% of all gold futures transactions in EFP and EFS). For silver futures, from May 2, 2011 until May 26, 2011, 0.19% settled in cash, 0.93% settled in physical, 85.39% consisted of EFP, and 13.49% consisted of EFS (for a combined 98.88% of all silver futures transactions in EFP and EFS). Thus these paper for (possibly) paper swaps, if that is indeed what is happening in the EFP transactions, are casting huge distortions in the price of gold and silver to the downside.

Read the entire article HERE.

By Patrick Worsnip
Reuters
May 25, 2011 – 2:17 PM ET
Updated: May 26, 2011 8:15 AM ET

UNITED NATIONS – The United Nations warned on Wednesday of a possible crisis of confidence in, and even a “collapse” of, the U.S. dollar if its value against other currencies continued to decline.

In a mid-year review of the world economy, the UN economic division said such a development, stemming from the falling value of foreign dollar holdings, would imperil the global financial system.

The report, an update of the UN “World Economic Situation and Prospects 2011” report first issued in December, noted that the dollar exchange rate against a basket of other key currencies had reached its lowest level since the 1970s.

This trend, it said, had recently been driven in part by interest rate differentials between the United States and other major economies and growing concern about the sustainability of the U.S. public debt, half of which is held by foreigners.

“As a result, further (expected) losses of the book value of the vast foreign reserve holdings could trigger a crisis of confidence in the reserve currency, which would put the entire global financial system at risk,” it said.

The 17-page report referred at another point to the “still looming risk of a collapse of the United States dollar.”

Rob Vos, a senior UN economist involved with the report, said if emerging markets “massively start selling off dollars, then you can have this risk of a slide in the dollar.

“We’re not saying the collapse is imminent, but the factors are further building up that we could quickly come to that stage if other things are not improving quickly on other fronts — like the risk of the U.S. not being able to service its obligations,” he told Reuters.

UN economists have for some time queried whether the dollar should continue to be the world’s sole reserve currency. Others have also expressed concerns about U.S. finances.

Standard & Poor’s threatened on April 18 to downgrade the United States’ prized AAA credit rating unless the Obama administration and Congress found a way to slash the yawning federal budget deficit within two years.

A downgrade would erode the status of the United States as the world’s most powerful economy and the dollar’s role as the dominant global currency.

Treasury Secretary Timothy Geithner said on Wednesday the U.S. government would “never default on its obligations.”

ASSET BUBBLES

Assessing the broader global economy, the UN report said recovery from the 2008 financial crisis continued to be led by China, India and Brazil, but that their growth outlook was moderating due to fears of inflation and domestic asset price bubbles.

It took a slightly more optimistic view of world growth prospects than it did six months ago, forecasting 3.3% expansion this year and 3.6% in 2012, compared with 3.1% and 3.5% respectively.

The United Nations uses a different exchange rate calculation than the International Monetary Fund and the Organization for Economic Cooperation and Development, making its global growth figures slightly lower.

It boosted its forecast for U.S. gross domestic product growth this year from 2.2% to 2.6% but kept next year’s estimate steady at 2.8%.

The report cut Japan’s growth outlook this year by more than a third to 0.7% following March’s catastrophic earthquake, tsunami and nuclear plant crisis. It put damage to buildings and infrastructure at about 25 trillion yen (US$305-billion) or 5% of GDP.

Despite a recent surge in oil prices, it predicted that barring major disruptions from political unrest in the Middle East, they would level off at an average $99 a barrel this year — close to the price of U.S. crude on Wednesday — and fall to an average of US$90 next year.

“Supply and demand conditions do not warrant a continued upward trend,” it said.

Food prices have also been soaring but the report said better harvests were expected to moderate them in the second half of this year.

Read the entire article HERE.

by Michael Piromgraipakd
May 23, 2011
MikePiro.com

Welcome back, I hope everyone made it back from Rapture in one piece. Leaving where we left off last week before hiding in my underground shelter, I never had the chance to discuss or address the topic of Silver and it’s recent plunge on May 6, 2011 to $34.00 from it’s near historic high of $49 and some change. There are Gold Bugs and then there are the people who believe Silver will blow the socks off of Gold. Don’t tell but I am one. The week following May 6, people were calling the 30%, $15 drop a correction and I will admit I thought it was too. However, 30% in that short amount of time is not a correction and in the back of my mind I thought manipulation. Seeing as how $50 is considered the psychological threshold for silver and as other precious metals were skyrocketing, Silver breaking this barrier would have destroyed the confidence in the US Dollar. Of course no one wants the dollar or the economy to die, yet the Federal Reserve continues to print more dollars which in itself erodes and devalues the dollar. A hedge for inflation of course is Gold and it’s little sister Silver. If people load up on Gold and Silver and ditch the greenback, well guess what happens. So you see the irony in this. To keep metals at bay, someone must make more imaginary units of Gold and in this particular case, Silver in the form of ETF’s. It’s a vicious circle. Gov’t prints more money… people scared money will become worthless… people buy precious metals… Gov’t scared so they print more ETF’s which make metals drop in value. But the big “clue you in” moment here is, there are not as many real pieces of silver as there are contracts (ETF’s) for them. That means there is and there will continue to be a serious short squeeze in the physical silver market. For example, the physical stocks of silver on the COMEX continue to dwindle from 87,000,000 ounces in 2009 to a little over 32,000,000 ounces a mere 2 years later. That’s 27,500,000 ounces per year. This year there are 32,000,000 and if the “dwindle” rate is 27,500,000 in 2012 COMEX will have 4,500,000 ounces of Silver. You can imagine what will happen in 2013.

In searching for answers I came across this interview by David Morgan and other precious metals gurus discussing the recent events. Speakers include David Morgan (Host), Eric Sprott, Bill Murphy, Rob Kirby, Bob Quartermain, Sean SGTReport and James Anderson in for Mike Maloney.

Enjoy and Happy Rapture Day:

Part 1

Part 2

Part 3

Part 4

By SHAI OSTER
MAY 9, 2011
Wall Street Journal

HONG KONG—Wages are rising in China, heralding the possible end of an era of cheap goods.

For the past 30 years, customers would ask William Fung, the managing director of one of the world’s biggest manufacturing-outsourcing companies, to make his products—whether T-shirts, jeans or dishes—cheaper. Thanks to China’s seemingly limitless labor force, he usually could.

Now, the head of Li & Fung Ltd. says the times are changing. Wages for the tens of thousands of workers his Hong Kong-based firm indirectly employs are surging: He predicts overall, China’s wages will increase 80% over the next five years. That means prices for Li & Fung’s goods will have to rise, too.

(Click for a Larger Image)

“What we will have for the next 30 years is inflation,” Mr. Fung said. “A lot of Western managers have never coped with inflation.”

The issue is likely to hover behind talks Monday, between Chinese and U.S. leaders in Washington at their annual Strategic Economic Dialogue. Currency and debt issues are expected to dominate the agenda. But there are signs that the low labor costs—and cheap currency—that led to China’s huge trade surplus with the U.S. could be reaching a tipping point. This comes amid pressure from rising wages as China’s working-age population begins to decline.

For decades, plentiful Chinese labor kept down costs of a range of goods bought by Americans. Even as politicians in Washington accused China of hollowing out the American manufacturing sector, cheap DVD players, sweaters and barbecue sets were a silver lining for consumers who grew accustomed to ever-lower prices. China also kept down the value of its currency, giving domestic exporters a competitive edge.

“Inflation has been damped pretty dramatically in the U.S. because it exported work to China and other places at 20% or 30% of the cost,” said Hal Sirkin, a consultant at Boston Consulting Group. The years of dramatic reductions in costs are over, the firm says.

Li & Fung traces the start of rising wages to the “Foxconn Effect.” Foxconn is the trade name of Hon Hai Precision Industry Co., maker of iPads for Apple Inc., and computers for Hewlett-Packard Co., among others. After a string of worker suicides last year at one of its China plants spurred Foxconn to defend its treatment of employees, the company raised wages 30% or more in a bid to improve worker conditions. That raise came as workers at other factories, including staff at a Honda Motor Co. parts plant, went on strike for higher pay.

Since then, the Chinese government has supported higher wages in part to address labor unrest, but also as way to boost domestic consumption and reduce reliance on exports to expand the economy. The rising wages affect both foreign and domestic companies.

Other factors besides rising wages are pushing up the price of goods. Chinese workers, for one, are starting to buy more with their higher salaries. That’s contributing to higher prices for commodities such as cotton and oil, which are already climbing in part because of a weaker dollar. Rising living standards in developing economies like China will keep prices of natural resources high as demand outpaces supply.

China’s move to let the yuan slowly appreciate in value—something eagerly sought by its Western trading partners—adds fuel to the fire. A stronger yuan makes it cheaper for China to import the raw materials it needs, such as iron and soybeans, helping tame domestic inflation. But it makes its exported goods more expensive for other countries to buy.

“This idea that we have moved from an era of easy deflationary environment to one of inflation is correct,” said Jeffrey Sachs, economist and director of the Earth Institute at Columbia University.

During China’s 30 years of economic growth, hundreds of millions of factory and urban jobs soaked up surplus rural farm labor. In the past three or four years, he says, that extra labor has been exhausted.

Many analysts predict that China’s vast labor force will begin declining in the next year or two, the result of family-planning policies. Others say there’s already a shortage of the most active members of the factory floor, workers aged 15 to 34. That group has been steadily declining since 2007, according to Jun Ma, Deutsche Bank’s chief economist for Greater China. A shrinking work force will need higher salaries to support an expanding population of elderly.

There’s some debate about the impact and extent of these wage increases on foreign markets. The pace of inflation for U.S. imports is running around 7% this year, but it doesn’t account for a big enough portion of spending to significantly affect overall low inflation rates of about 1.6%, Morgan Stanley’s China strategist Jonathan Garner said. Still, with real wages stagnant for decades, many Americans who have grown dependent on cheap imported goods such as polo shirts or power tools could see their purchasing power decrease.

China still has cheap labor in its interior, away from its developed coastal cities, and productivity gains could mitigate higher wage costs. For example, Foxconn announced it was expanding operations to inland areas near Chengdu, Wuhan, and Zhengzhou, away from its coastal base.Li & Fung is encouraging its suppliers to invest more in their factories to increase worker productivity and raise the quality of goods.

There are limits to what those measures will achieve. Some analysts say that the wage increases will sharply outpace any productivity gains. Moving inland means lower wages, but higher transportation costs on China’s crowded highways and railroads. Furthermore, locating the factories in China’s hinterland puts them in a better position to service China’s growing domestic consumer market instead of exporting to consumers in the U.S. and elsewhere.

Faced with rising wages within China, some companies are shifting resources elsewhere to keep costs down. Yue Yuen Industrial (Holdings) Ltd., the world’s biggest shoe maker, has started moving manufacturing of low-cost shoes from China to countries such as Bangladesh and Cambodia. Li & Fung has been hired a prominent Chinese sneaker brand, Li Ning Co., to help it search for cheap production outside China.

But the wage gap between China and other developing countries will shrink, said Mr. Fung, echoing views shared by Boston Consulting Group, because “China was the thing that kept the price low,” he says. “China was the benchmark. With the China price rising, everyone else wants to raise prices.”

As factories relocate to other countries, local wages will rise faster than they did in China because the potential pools of surplus labor are smaller. In addition, because no other country can replicate the massive scale of China, logistics will become a larger part of costs as companies are forced to slice up their manufacturing over several countries, analysts say.

“Things will be more expensive and people will buy less,” Mr. Fung warns. That means that the West will have to adopt new consumption trends.

Read the entire article HERE.