My Predictions

Although I originally began this blog with the idea of keeping track of inflation and potential results for prices and prosperity in general, I haven’t engaged in prediction. My focus has been on commentary. We are, however, at a point that offers some interesting prospects for the future and I though it might be interesting and possibly helpful to suggest a possible set of outcomes.

Specifically, at this point in late 2012 the governments in the major economies have either implemented or are poised to implement some massive monetary flooding, which they call “easing.” The U.S. Federal Reserve officials have announced an open ended $40B a month scheme that will continue until either employment begins increasing or the end of time, whichever comes first. In Europe, the European Central Bank is ready to create unlimited amounts of money, claiming that it has to reduce the spread in government bond prices (between Spain and Italy, who have had to pay high interest rates, and Germany’s very low rates). China is expected to begin more “easing” in that it is currently seeing a much deeper and more significant drop in economic activity than the government seemed to expect. Apparently they thought that they were a separate, insulated entity. In response, just as any Western mixed economy government would do, the Chinese are moving toward spending newly made-up money. Japan has just begun its own easing program and England began theirs a few months ago. There is a great orgy of money creation in progress.

Those countries with “strong” currencies are also involved. They really don’t want to see their competitive position undercut by having other currencies diving in comparative cost, making their own products much more expensive on the world market. One example is that Switzerland’s central bank been buying euros for several months to keep their currency in line. As has been said by others, there is something akin to the arms race growing where every country inflates their currency in competition with the others. This process could also lead to protectionism, with higher tariffs and import controls.

As long as our economic problems are seen as the consequences of low consumption or low demand (and demand is seen as just money and not production related), we can always expect that the government response will be to create more money. There is some fear of the new money increasing consumer prices beyond a certain level (generally at an annual rate of 2% - some poison is good for you apparently). This concern is an interesting hold over from a point where government economists had a closer contact with reality. But there is little concern about the prospects for unacceptable levels of price inflation. It is the case that the upward pressure on prices from constant increases in the money supply tends to be less when production levels are low.

Consequently, we can expect that we will soon see a lot more money being created and put into the larger, more industrialized economies and interest rate will remain extremely low.

The amount of money that actually comes into the U.S. economy is a question for which I have no good answer. There is certainly some, but not as much as you might think when you hear the Fed brag about its easing. The money created by the Fed for QE1 and QE2 is mostly still sitting at the Fed in the deposit accounts for member banks receiving 0.25% a year.

 

The money supply has continued to grow, but the pace is not as fast as one might expect.

 

You can see in the graph that the average dollar amount of growth every year has been somewhat consistent. That means that the percentage rate of growth is falling. To just keep the constant percentage rate, this graph would need to show a much larger constantly increasing dollar amount, as the total grew each year.

As a result, consumer prices have moved upward modestly in the last few years (by comparison) and asset prices are mixed (housing downward and equities upward, but less than the CPI). Only bond prices have moved upward, as the Fed has moved to force down long-term interest rates as well as short-term. Long-term rates are very low, especially considering the need for capital in our economy. There is no connection today between savings, investment, interest rates, and the capital markets.

In these conditions, I wonder what the Fed believes that more “quantitative easing” or lower interest rates, could achieve. They talk about lowering unemployment as if the problem is that jobs are not being created for of financial reasons. Here we have an excellent example of theoretical, rationalist thinking that doesn’t consider even the possibility of looking at the real world. At present, there is no connection between the interest rate (including the supply of money) and investment/growth decisions. For a business, the difference between 3% and 2.5% on a long-term, profitable investment is insignificant. The real question for businesses is whether the project could be profitable. Some companies have invested when they have cash on hand. Many are considering a merger or acquisition, which doesn’t add to our productive capacity (although it might improve efficiency). But U.S. companies see no justification in future profitability to make the investment needed to put over two million people to work. The Fed and the Government, and Romney and the Republicans just don’t see that.

Another upcoming set of events in the U.S that could have a negative impact on our economy is the end of the Bush tax cuts and the spending cuts required by law. These events, both scheduled for January 1, 2013, won’t improve the capital and investment situation, although the rate of growth of government debt will slow some. At least in the short-term, if the tax cuts do end and the rate of spending slows, the immediate result will be a drag on the U.S. economy.

I am not convinced that the supposed mandatory cuts in spending are particularly important economically. Some people try to make this situation seem cataclysmic by quoting a cut of over a trillion dollars. That is fraud, since that is a ten-year number. As is always the case with government cuts, they are loaded mostly into the latter years. I think that the 2013 number is closer to $69B, which is for the full year. When you are talking about a multi-trillion budget and a deficit of over a trillion dollars, sixty-nine billion is an accounting error.

But saying “cuts” is intended to be misleading. The Congress didn’t pass a cut in spending. They authorized a reduction in the expected growth of spending. It was a cut from what they thought current laws would require the government would spend. There is not going to be a cut in spending. Let me repeat: These are not cuts in spending but small reductions in the growth of spending. Even so, there may be some companies that will feel an impact in their expected revenue from government contracts. But, economically, compared to the total level of spending and the prospect of more “easing”, big deal.

Combined, the tax cut, possible cuts in the growth of spending, and the Fed’s money flood, mean that there will be less money in people’s pocketbooks, but more, potentially, in the banking system. Remember that the way the Fed’s money gets into the economy is via bank loans. If the banks continue to maintain their stricter standards there is not going to be a significant increase in bank loans. In fact, the current trend is for lower corporate profits, meaning that businesses will be less credit worthy than before (and stock prices should decline, instead of booming). In addition, ever since the beginning of the “Great Recession,” bank regulators have been constantly checking on the “quality” of bank loans. Unless regulators are willing to loosen the strings, banks aren’t taking any riskier loans. I don’t see much of the Fed’s new money getting into the economy. That is not to say that there won’t be an effect. As in the past, there is a tendency to some money to find its way into assets.

In addition, the final Dodd-Frank regulations have yet to appear and the costly ObamaCare provisions are coming into effect. All businesses, but especially banks, are legitimately confident that their costs will increase significantly and their range of action considerably curtailed. Startup businesses have declined. dramatically. For the economic/cultural pessimist, there is much support in the U.S.

In Europe, the central bank is being pushed into acting because the market for Spanish and Italian government bonds demands much higher returns to compensate for higher risk. Personally, I think that there is no uncertainty. Neither Spain nor Italy will be able to repay their bonds in the coming years. (I equate being given worthless money with not being paid.). So the higher rates are certainly justified. But enough of the euro country governments don’t like that. The higher rates mean that Spain and Italy would have to face their insolvency soon, which would be a big problem for the other euro government countries. So the euro block is pushing the central bank to create money to avoid reality. In this case the money will go directly into government spending and will have very negative consequences. Not the least consequence will be a lessening of the pressure on Spain and Italy to solve their problems. (Spain is expected to need the euro bank bailout. No one is currently talking about Italy, but its economy is heading the same direction.) By creating money to buy government bonds the European Central Bank is defaulting on the loans by directly creating inflation and thus reducing the purchasing power of the money that bought the bonds. Everyone in Europe is ignoring that fact. In addition, there will be a lot of upward pressure on prices and everyone will feel the cost. But, most of all, the importance of freeing their economies and being fiscally responsible can be evaded. The ultimate result will be greater disasters.

I expect that China’s new money will be similar to earlier efforts, which went primarily into government owned and controlled businesses, shrinking the portion of the economy that is private. It may also be more of a “consumption” orientation, which will mean less of a push in industrialization, and a move toward Western ideas of a consumer driven economy. That government decision would necessarily reduce the growth rate even without the normal consequences of asset booms and busts.

If more “easing” won’t help solve the unemployment problem (who cares about actual production?) and thus won’t help with economic activity, what will it do?

Well, the U.S. economy isn’t going to grow much, if at all. In fact, it could contract. If the new money just sits at the Fed as before, we needn’t worry about hyperinflation. The money supply will grow, but not significantly faster than before, although those numbers should be watched carefully.

I heard someone point out that since the first “easing” the Dow has risen 4000 points and since the second “easing” nearly 3000. I am sure that the Dow and other indexes will raise some more. The Dow has already gone up a few hundred points since the Fed announcement. What would a push by the Fed be without a serious increase in asset prices? Commodity prices could also rise. Some are saying that industrial commodities, such as copper, will not because industrial production is tending to fall. But the money being created will go somewhere. You just need to keep an eye out to see where that is.

So, if you want to put your money somewhere, based upon recent history, there you are! Just be careful about your timing and don’t lose perspective about the causes of the asset price rise and its duration. Be ready to short.

Of course, economic events are really harder to predict than that, especially in a controlled economy. Something will happen that we don’t foresee and things will happen differently than we expect. One thing we do know, whatever happens, it’s unlikely to be good.

Long-term, the consequence of all of this “easing” is to probably bring the day of reckoning closer, possibly by years. With unemployment staying down, Social Security and Medicare spending will continue to widen the gap between tax income and spending. The demands upon the Treasury will increase, meaning more debt. The low levels of production will mean that wealth is not being created and our personal wealth and standard of living will continue to fall.

I think that money can be made from the chaos and misallocation of resources. You just have to pick your method based upon the circumstances and pay attention to the situation.


P.S. I just listened to Yaron Brook on the Mike Slater show (via a notification from Lassiez-Faire). He says so much of what I just mentioned. I really did work it out before. But he says it well.

Process of Leaving the Euro Currency Block

Many people are convinced that some euro zone countries will have to change to their own country specific currency. They all acknowledge that doing so would be expensive and have cause an international economic downturn. One of the commentators who I watch, John Mauldin (who is better than some, but far from excellent), quoted a private newsletter from the Boston Consulting Group, written by Dan Stelter. Mr. Stelter set out the steps that a country would have to take to exit the euro. They aren’t pretty and smack of totalitarianism: complete control of private assets. I have set these steps out below.

Note that there is already significant outflows of capital from all of the poorly performing euro countries, i.e., Greece, Spain, Ireland, and Portugal. If you have funds or assets there, including through mutual funds, consider moving them to somewhere that safer. There really is no safe place for large amounts of assets. Just keep the overall and the country specific issues in mind.


Steps for a country to stop using the euro and introduce a new currency:

Announce and immediately impose capital controls.

Impose immediate trade controls (because companies would otherwise falsify imports in order to get their money out).

Impose immediate border controls (to prevent a flight of cash).

Implement a bank holiday (to stop citizens from withdrawing their money and running before the devaluation) and although this is somewhat hard to imagine stamp every euro note in the country, converting it back to the national currency.

Announce a new exchange rate (presumably not floating at the beginning, given capital and exchange controls) so that trade could continue.

Decide how to deal with existing outstanding euro-denominated debt, which would probably entail a major government and private-sector debt restructuring (that is, default). This might be easier in the case of government debt, which tends to be governed by domestic law, in contrast to the debt of major corporations, which is normally governed by U.K. law (but we would assume enactment of laws declaring a haircut here, as well).

Recapitalize the (insolvent) banks to make up for losses from defaults.

Determine what to do with the non bank financial sector, the stock and bond markets, and every company account and commercial contract in the country.

Any breakup would lead to significant turbulence in financial markets just think about the number of credit default swaps outstanding and a worldwide recession. The OECD has warned that a breakup of the euro zone would lead to "massive wealth destruction, bankruptcies and a collapse in confidence in European integration and cooperation," leading to "a deep depression in both the existing and remaining euro area countries as well as in the world economy."

According to UBS, the economic costs of a breakup would be huge. Depending on whether the country leaving the EU is a "weak" or a "strong" country, the costs would range from Ä3,500 to Ä11,500 per inhabitant per year. Besides these implications for the countries of the euro zone, the world economy would be severely affected, with negative implications for the U.S. amplifying existing recessionary and potentially deflationary pressures and also for the emerging markets that depend on exports to the West.

Self-Fulfilling Fantasies: US Treasury Bonds

Number one on my list of fantasies is the US Treasury Bond. (Just for the record, in this context I mean nightmares. I do have good fantasies!) People feel US Treasury Bonds are safe. Are they?

The usual reason given for the safety of US Treasurys is that they are backed by the ability of the US government to dip into the pocket of the most-wealthy nation on earth to meet interest payments and redeem the bond upon maturity. Well, yes, that is true, still true. But that proposition does have limits, limits that have not been stated or acknowledged before, but need to be seriously considered, soon. (Notice that the wakeup call of the S&P downgrade of US Treasury Bonds has not resulted in honest reconsideration of the path of the Obama administration, but has caused several loud calls for destroying the remaining limited independence of the credit rating companies.)

There is also another issue that isn’t addressed in the basic reasons for the safety of the US Treasury Bond, prices. You see (and I am sure that many of you do see) the price of the bond is related to the interest rate that it pays, which in turn is related to the interest rates paid on other bonds around the world. If interest rates begin to climb, and the secondary market for Treasury Bonds (where bonds purchased from the Treasury are resold), even the Treasury itself, need to compete for funds, the interest rates for the bonds will climb. The consequence will be that the price of the bonds will fall. So Treasury Bond prices do change. If interest rates move, say, a whole percentage point upward what happens to the price? The current benchmark 10 year Treasury Bond has a yield (interest rate) of about 2.4% (the date of my first draft being somewhat different from my publishing date). So I am suggesting that it went from 2.4% over time, however long you want, to 3.4%. The latter interest rate is still very low. Historically, this bond has been much closer to 5%. Even at 3.4%, with taxes at roughly 25% and inflation around 2%, the bond isn’t making you any money (at 2.4% you are taking a loss). (Of course, foreign governments aren’t paying taxes!) But, a bond purchased originally at 2.4% will not yield the new market rate and can’t be sold for the original purchase price (nominally $10,000). Instead it must be sold for the amount that will bring the current market rate of 3.4%. (or $240 – the actual dollars paid in interest – divided by the new interest rate) which is close to $7058 ( there are issues of time to maturity, when you receive back your $10,000 that will adjust the actual sell price). You have lost roughly 29% of your principal. You see, relatively small moves in interest rates will have significant effects on the market value of your bond.

This example demonstrates that bonds are no safer in terms of maintaining your principal than any other asset, unless you hold to maturity. How safe is that? Depends upon the inflation rate doesn’t it. When thinking of long-term monetary values, don’t think in terms of currency, that is, fiat currency. Think in terms of some real, basic thing that you use in daily life, like a loaf of bread, or a pound of ground beef, or a latte in Paris, whatever. You will connect the rate of inflation to your currency denominated assets and be able to better realize what is happening to your capital. The bottom line is that US Treasury Bonds are very risky. (I won’t even go into the fact that you have put your savings into the hands of people like Obama, Bernanke, and Geithner.)

Many, if not most investors know these facts, so why are they still running to US Treasuries? Context. Or, a perhaps better way of putting it, where else are they going to put their money? There are a couple currencies that are considered strong, i.e., the Yen and the Swiss Franc. Both of these have been bid up sky high (much to the dismay and panic of the authorities and business people in those countries). There isn’t any real room there for more money. Other currencies are not considered safe by the populations of those countries. The best current example of that is the eurozone. This group of “developed countries” have people making decisions who are more concerned about voters than solvency. People who wish to protect the value of their liquid assets are scared of what these politicians will do (not to mention the so-called economists who do not think stability or production as important to economic health). The person holding liquid assets wants to put his property somewhere that the whims of the politicians can’t destroy it.

The bond markets for stronger countries, such as German and Austrailia, are small, very small in comparison to that of the US, and can realistically take only a small portion of the available funds. So for anyone wanting to get out of their home market, out of their currency, out away from their authorities, the US is still a better place. It just gives you a good idea of how bad it is elsewhere that the US dollar and the US Treasury Bond are about as good as it gets.

The result is that Obama, Bernanke, and Geithner feel pretty strong and confident, in spite of the downgrade of US government bonds by S&P. Again, isn’t it amazing that the politicians in other countries scare their populations more than the US trio of idiots.

The above discussion also gives you some idea of what could be the future for the cost of gold in fiat currencies. The gold market is smaller than the market for the Yen or even the Swiss Franc.

At this point I should explain how the bid/asked market functions: it is the margin that moves a market, especially a auction market like stocks, bonds, currencies, commodities. It is not the total demand or ownership. It is the most recent orders, their size, their volume, and which side of the transaction they are on, buy or sell, that moves the market. The traders do what they can to meet the reqirements of the open orders, moving the price as required to elicit corresponding orders (a buy order to match the existing sell order) to clear the market. Higher volumes of demand for a item, like gold, will send the price up. The higher the volume, the faster and larger the price movement.

So if people really begin to consider gold as safe and a real alternative to fiat currencies, the current price will be considered very low. Any kind of movement into gold from these other markets will send the gold price to astounding heights and will really scare a lot of people.

What will be interesting to watch (but not to live through) will be the point at which people begin to doubt that US government assets are a good idea, including the dollar. We don’t even have to worry about China or Japan for things to get ugly. If just foreign banks, businesses, and individuals begin to sour on our debt, its yield will move strongly upward and its market price downward. The budget deal and all of the carefully crafted, make-believe scenarios will be revealed as so much fantasy. These scenarios (models) are also among my favorite nightmare fantasies.

THE CHINESE CURRENCY: A BIG SHOE THAT COULD DROP!

For over a year the U.S. economy has been just chugging along without any apparent stresses. I mean, nothing has happened within our economy to cause panic or increase the level of fear people are feeling. Certainly, the economy is far from healthy. It is not growing to speak of. Unemployment is very high and few jobs are being created. Some communities appear to be in depression, while others are only marginally affected.

In the political area, the focus related to the economy is all of the promises made and no results. The current administration isn’t being blamed for making things worse, just not making them better. The government has declared that the “big drop” is over, the recession has ended, but the signs that growth is occurring or may happen in the future are muted at best.

My own mood is that of waiting for the other shoe to drop. Well, there are many shoes that could drop. And any of them could be more disastrous than the big dip of 2007. Which one will it be? Or perhaps the question to ask is which one will be first? Only time will tell. Let’s think about one potential shoe, the push to have the Chinese revalue their currency.

One issue that the politicians are focusing upon is the international value of the Chinese currency. It is contended that if the Chinese currency is valued more in line with real relative national purchasing power, the U.S. dollar would be stronger and the U.S. would benefit from a greater demand for its products. There are several things that are difficult about this. It is true that China’s approach is the old, thoroughly discredited view (among those who are aware of the history of economic ideas) that a nation’s wealth is achieved by hoarding valuables. At the beginning of the exploration of the New World, for example, countries would scour for gold and silver in the Americas, bring it home, and put it in a vault and declare that they were wealthy. So, several Asian countries, including Japan and China, insist on controlling the exchange rates (although Japan is trying counter balance that now) and hoarding the dollar and the Euro (China has a large surplus with the Euro Zone as well).

Of course, hoarding anything is not wealth. A dollar, or any currency is only as valuable as what it will buy. A currency, especially a fiat currency, in international trade is a claim on that country’s production.

On the other hand, a country does need reserves (speaking within today’s structure), i.e., a stash of cash available when and if needed to settle international debt or payments. What cash is available? Well, they aren’t going to begin using gold, if for no other reason than that the process of beginning to use gold would cause the value of the dollar to die. The same problem holds for any other currency that could be chosen other than the dollar. If the process of changing to another currency was done slowly, perhaps the dollar wouldn’t collapse. Unfortunately, such a process should have started a couple decades ago.

As it is, the international system is stuck with dollars into the foreseeable future. Okay, but there is no need for countries like China and Japan to continue accumulating dollars. They have more than they need, and they are worried about the constant flow of dollars and what that means for the future. What they could do is to turn around and begin buying stuff from us with the dollars that they would have hoarded, the current cash flow. Sounds good, right?

We will even ignore the probable, immediate consequence that the dollar would lose significant value just because it wasn’t being hoarded as before. Forget that. Forget that immediately, foreign goods would be significantly more expensive. Let’s just concentrate on our own goods.

The mainstream economists think that to create growth, what is needed is consumption, more spending. That is why they set things up to expand the money supply. More money, more spending, more wealth, they think. Great, huh! So, these same economists would be happy for foreigner to be spending more in the U.S. It means more demand. They felt the same way years ago when the economy seemed to be humming right along, with very high employment, and very low unemployment. We had what some called “full employment”. I always wondered what they thought was going to happen. The unions, progressives, Keynesian economists all thought that more money running after our goods was going to be good, when there was no one to produce them.

Today things are a little different. We have a large number of people unemployed and lots of capacity that is sitting idle. It is not the most efficient capacity, but it is there. What we don’t have is a significant amount of raw material sitting around. Nevertheless, as foreigners began to send those dollars that they don’t hoard back to the U.S., we will now see more dollars running around. At first, the new demand will cause some shortages, and prices will begin to rise, since the actual stock of good will be unaffected, at least for a while. Then, over time, more capacity will be used, more people rehired, more produced. But, then the real bottleneck appears. Or rather two bottlenecks. One will be the need for raw materials for the higher level of production. Costs will have to rise to compensate for the higher costs of materials as users bid for the material available. The other bottleneck is that some new investment will be needed, but the government has soaked up all available savings for its deficit. To get loans or attract investors, businesses wanting to expand will have to bid against the government for savings. That will also tend to raise costs, and the cost of government borrowing will also increase.

What this really means is that the return of all of the money we send out in a year for foreign trade will result in higher prices, both for domestic goods and much more so for foreign goods. It is unlikely that we would see the “gentle” 1-3% inflation we have seen with few exceptions over the last couple of decades. It will be higher.

Now why would we see higher inflation just because foreigners spend the money that we sent for goods? It certainly wasn’t the case throughout our history, right? Wouldn’t it make sense for there to be a balance? Well, yes. But our situation over the last decades is very different. It is hard to understand, apparently. Some supposedly free market bloggers don’t accept my thinking here.

For decades we have had not only a trade deficit, but a cash-flow deficit, called a current account deficit. While the trade category covers trade, obviously, it doesn’t include investment flows between nations and government transfers. Normally, if a country has a trade imbalance, the difference is made up by the return of the deficit in investment, or the purchase of government bonds, for example. Even then, if the current account is not in balance one year, it swings back the other way the next, or at least over time a country’s current account will balance out. This has not been the case for the U.S. for a long time. The current account deficit will be less than the trade deficit.

One way to understand what is happening would be to imagine that you are a country and buying from other people – countries – often. Your purchases are all made by check. You send out many checks and everybody honors them and sends you the merchandise you want. But, you find out, by analyzing your checkbook that some of your trading partners are not cashing your checks. They are just keeping them (for some strange reasons – your crazy cousin has all kinds of weird theories as to why, saying that they want your checks as reserves, that your partners use them as cash with other people, etc.). So, you have both the things you bought and the money you with which you thought you bought them. Sounds like a good deal. It is sort of. But, if your honest, and know that there is a future, you might be somewhat worried about what happens when all of those checks come wondering back, especially if they all come back at once!

Let’s take 2009. The U.S. bought more stuff than it sold by $374 B. The current account difference was $378 B (usually, the current account deficit is smaller than the trade deficit). You can look at the history of the U.S. current account here. So, there have been billions upon billions of dollars that have left the country and not come back, not even as loans to our government. My discussion in this post is limited just about this year’s money not returning. (Think how bad things would be if the money from past years returned as well!)

Under a gold system, if money left every year and didn’t return, the money supply would continue to shrink and there would be a corresponding drop in prices. There would be ramification of a continued outflow of dollars. There are ramifications under the present circumstance, just not the ones that would occur in a rational economy. In the present circumstance, the U.S. price level actually continues to creep up. That is because the money supply continues to creep up. The money supply creeps up in spite of billions of dollars being lost every year to foreigners. Where is the money that is being lost coming from? I am sure that you know the answer. It is the Fed., the official U.S. money maker upper!

One key fact to remember about international trade is that it functions completely on credit. When an importer buys, he sends a letter of credit, which does not pay the exporter until the goods are received and accepted by the importer. The letter of credit is a bank document, and is what it says it is, a credit, a loan. Purchases by U.S. importers are financed by bank credit pushed by the Fed. We see that even though banks in the U.S. are not making loans to businesses for new production, they are making loans for importing, i.e., we still have a big trade deficit. The money we have been exporting for years is all made up, Fed. produced money. So the Fed increased the money supply, we sent it overseas to buy stuff, and those people kept the money, just like the example with your checks. (Why? See my discussion of Schiff’s book, Crashproof. The “Why?” is even more a big question after they have kept so many dollars after so many years.)

The situation is not good for the Chinese and other countries that have built up big surpluses of foreign money (which is mostly in digital form). Recently, there was a push to move away from dollars toward a “basket” of currencies, including Euros. The wisdom of that idea was demonstrated this summer as many of the Euro Zone countries have been shown to be in financial difficulties. Maybe people will begin to realize that fiat currencies of any stripe will not stand up to normal, mixed economy political processes. The dollar became strong, i.e., higher priced against the Euro, for a while because the dollar again looked like the strongest, safest currency. That view will fade. So the Chinese, to use them as the example because they have the biggest hoard, are sitting on vast sums of dollars, some of which are “invested” in U.S. government debt, a little of which is invested in other countries, both real assets and government debt, and some of which is sitting as reserves, as gold would sit. If and when the dollar falls, the value of these massive holdings will fall, which would not be good for the Chinese economy. Thus, the Chinese are walking a tight rope, trying to keep the dollar from a death dive, which also means their currency at a lower price, and make small moves to reduce their dependency on the dollar. Everyone is watching them. They have to be careful.

Which also means that they are confused by the U.S. political leaders constant demands that they increase the value of their currency. The Chinese realize to some extent the consequences of that action. They can only be astounded by the U.S. politicians. Those fine people, the Congressional leaders don’t seem to have much understanding of international economics (not surprisingly, since they don’t have much understanding of domestic economics, either). They do understand that the jobs issue plays very well in this country. They see that demanding that the Chinese buy more U.S. stuff there might be more U.S. jobs, and play it for all they can. Real consequences are far out weighted by political appearance. They can always blame someone else for the unexpected consequence.

But if the Chinese, and the other Asian countries begin spending those dollars on U.S. goods, we begin to see those made up dollars running after the few goods we have purchased and prices begin to rise, interest rates begin to rise, and the quiet calm that we have had, a quiet calm in which we have been able to have good fight for our lives, will end and who knows what could happen then.