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Simon Black – from South Africa….admin

In Business, Money and Finances, Political on October 8, 2010 at 9:08 am

Sovereign Man

Notes from the Field

Date: October 7, 2010
Reporting From: Cape Town, Republic of South Africa

On the flight down to South Africa last night, I read a rather pointed article in the FT entitled, “IMF chief warns on exchange rate wars.” Here’s the basic premise:

In their fight against the Great Recession, politicians and central bankers around the world have slashed interest rates, inflated their money supplies, and spent incalculable billions in fiscal stimulus.

The measures aren’t working. Growth in most of the developed world has sputtered, and policymakers are scratching their heads wondering what to do next. Conventional wisdom, if there is any, suggests more of the same– more printing and more spending.

Clearly, this course of action fits the classic definition of insanity: trying the same thing over and over again but expecting a different result.

In their efforts to jump-start their respective economies, though, policymakers worldwide are stepping up their criticism and intervention in the foreign exchange market.

The US, for example, is consciously choosing to depreciate the dollar by printing so much more of it. Over the last several months, investors have shied away from the greenback in favor of other currencies, including the euro, yen, franc, Aussie dollar, Canadian dollar, etc.

The Canadian and Australian dollars, in fact, are essentially at parity with the USD, and the Swiss franc actually surpassed the US dollar. Meanwhile, the Japanese yen is at a 15-year high, and the euro has enjoyed a 17% surge since its low in May.

To many foreign leaders, however, this outcome simply will not do. Olli Rehn, European Commissioner for Economic and Monetary Affairs, recently spoke out against the euro’s rise and argued that continued euro strength will threaten Europe’s economic recovery.

Even in Switzerland, which is usually hailed for its independence and restraint, the national bank has attempted (and largely failed) to hold down the Swiss franc in its rapid ascent against the euro.

Oceans away, the Japanese government has also intervened in the foreign exchange markets for the first time in years, selling vast amounts of yen in order to weaken their currency.

So why is everyone doing this?

With consumer spending on the decline in many parts of the world, manufacturers have little domestic demand for their products. Consequently, everyone is looking to export products overseas, and a weaker currency makes products seem cheaper and more attractive to foreign buyers.

A strong currency is like a hot potato– no one wants to be the nation with the strong currency because then the rest of the world won’t import those products. Even some of the countries with healthy economies like South Korea and Brazil are trying to hold their currencies down… otherwise exports would suffer.

In the past, the United States played global consumer. America had the strong currency, and the rest of the world happily exported products and services to the US. When the US trade and budget deficits got out of control, foreign countries obligingly purchased US debt in order to keep the party going.

China was the biggest participant over the last few decades; the Chinese spent years working hard for 10 cents an hour to supply American consumers with cheap goods. In exchange for their efforts, they bought trillions of dollars of US debt… and amazingly enough, now Congress wants ‘vengeance.’

US politicians may escalate the currency wars by slapping hefty tariffs on Chinese imports, though this will likely be disastrous. Even if Chinese goods cost 50% more, American manufacturers still wouldn’t be able to compete given US labor costs. In the end, the consumer will simply get stuck paying more.

In the long run, the US has the ingredients to pull itself out of this production hole… but the trend for now is worse, not better. As such, it’s a sure bet that policymakers will continue this ongoing battle to see who can debase their currency faster, and this has implications for us all.

Though certain deflationary pressures still exist (such as the lack of a thriving consumer market in the developed world), the currency wars should have an impact on many commodities.

Investors don’t like currency debasement, so they’ll be looking for reasonable stores of value. Gold and silver will continue to benefit until the mania phase takes hold, another short-term financial cataclysm occurs, or until particular governments make it illegal to own precious metals again.

Agricultural commodities also have a lot to gain. In addition to monetary inflation creating upward pressure on nominal food prices, agriculture is also supported by strong supply/demand fundamentals.

There are roughly 1 billion emerging middle class consumers in Asia, and it’s a fact that dietary habits change significantly in proportion to discretionary income and spending.

In a recent study, the Hong Kong Monetary Authority found that a 10% increase in household spending led to an 11.5% increase in spending for meat among Chinese consumers on the mainland.

In addition to surging demand, there are also supply constraints such as higher input costs, reduction in arable land, soil erosion, idiotic government policies, and water availability. It’s no wonder that BHP mounted a hostile takeover for Canadian fertilizer maker Potash Corporation.

As I’ve argued before, I think agriculture is a smart place to be, both personally and financially. I strongly support the idea of holding a bit of land outside one’s home country– it can make for a great investment, an escape hatch, a means to move money offshore, and possibly a way to feed your family.

This is one of the key reasons why I decided to make the trip down to Africa. It’s been a while since I’ve assessed the property market, and I wanted to put some boots on the ground to see what the opportunities are.

More to follow.

Simon Black
Senior Editor, SovereignMan.com

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