In an April speech in Berlin, Dr. Andreas Dombret, a member of the Executive Board of the Deutsche Bundesbank (the German central bank), offered a startlingly frank assessment of the current problems in Europe.  Although his comments were meant to apply to the tensions and imbalances that exist between the northern and southern tier of the 17-member eurozone, they shed inadvertent light on the broader global economy.

Rebuffing calls that Germany do more to support the faltering southern economies, Dr. Dombret said:

…Exchange rate movements are usually an important channel through which unsustainable current account positions are corrected….In a monetary union, however, this is obviously no longer an option. Spain no longer has a peseta to devalue; Germany no longer has a deutsche mark to revalue. Other things must therefore give instead: prices, wages, employment and output.

The question now is which countries have to shoulder the adjustment burden. Naturally, this is where opinions start to differ. The German position could be described as follows: the deficit countries must adjust. They must address their structural problems, reduce domestic demand, become more competitive and increase their exports.

In economics it is axiomatic that positive and negative current account balances will ultimately be offset by changes in relative currency valuations. The currencies of surplus countries are supposed to rise and the currencies of the deficit countries are supposed to fall. But the current global political alignment has altered this process. Like many of his German and continental peers in government and finance, Dombret is likely in favor of maintaining a common currency at all costs. But as he outlines, when currencies fail to adjust something else has to give. He insists that the giving come from those who have been getting.

Given their weak economies and strained fiscal positions, it should be evident that citizens of Greece, Portugal, Spain and Italy have been living beyond their means. Their relative prosperity over the last decade has largely been maintained by the purchasing power of the euro which itself has been buoyed by the strong German economy. Rather than forcing Germans, whose savings rates and current account surplus results from years of fiscal prudence, to lend even more money and suffer higher inflation so that the southern tier can receive more monetary stimulus, Dombret argues the citizens of deficit economies must spend less while working, producing and saving more.  In other words, their living standards must match their productivity.

Economic dynamics do not change with scale. And as it happens, there is a much bigger and equally flawed currency bloc in the world than the one Dr. Dombret is seeking to cure. In that larger bloc, the exact same dynamic of surplus and deficit nations is playing out within an inflexible monetary straightjacket.

In order to maintain exports and to manage economic expectations, many nations (most notably China) have instituted fixed exchange rates between their own currencies and the U.S. dollar. Although this system is not governed by a formal treaty like the one that binds the 17-nation eurozone, it has given rise to a virtual bloc of currencies that are unnaturally tethered, even while the underlying economics are drifting apart. And although there has been some recent flexibility from China on exchange rates, there is nearly universal consensus that these movements would be far more pronounced absent significant central bank manipulation.

Like the nations of southern Europe, the United States consumes far more than it produces. But rather than closing the gap by producing more and consuming less, both have followed a far less painful path. They have borrowed instead. Who can blame them? After all, it’s far more enjoyable to consume than produce. And as we have seen in many financial arenas, a borrower will tend to borrow for as long as a lender is willing to lend, especially if there are no immediate adverse consequences.

Both Germany and China produce more than they consume. It is from these resulting surpluses that the deficit nations are borrowing. But these two creditor nations are currently showing different policy drifts with respect to their hard-earned savings. In Europe, German leaders are showing increasing reluctance to sacrifice the living standards of their own citizens to perpetuate an imbalanced economic system. The Chinese on the other hand appear to heartily encourage such a policy. This difference can be attributed to their respective political systems. In Germany, public opinion matters. In China, not so much.

The currency peg of the Yuan against the dollar, which China has enforced with varying degrees of exactitude over the past few decades, has helped the Chinese government exert greater influence over the growth and contours of its economy. But the policy has created hardships for Chinese citizens (such as disproportionately low rates of consumption and high rates of inflation). But lacking any means to overtly influence public policy, Chinese citizens have had little choice but to take it on the chin. German citizens on the other hand are much freer to voice their discontent. And in fact, fears of a voter backlash have been determinative in setting Berlin’s agenda.  

The question for the global economy is whether China will become more like Germany, or Germany more like China. From my perspective the answer is clear. German leaders are unlikely to risk the scorn of voters by repudiating their cultural aversion to overly accommodative monetary policy. In China, the decisions will be more pragmatic.  Currently Beijing perceives advantages in the status quo. But ultimately the costs, in terms of increasing foreign exchange reserves and rising inflation, may force its hand. When that happens, the United States and Southern Europe will be in the same boat.  

To many, the “Golden Rule” is an idea that underscores the value of civility and fair dealing. But there is another, less magnanimous definition: “He who has the gold makes the rules.” In the current global economy, the surplus countries have the gold and sooner or later we will be living by their rules. 

“I think lots of things that have changed since 1984. Despite metal prices being substantially higher than they were 10 or 20 years ago, we’ve really haven’t seen those prices reflected in mining equities”. Peter Grandich

Peter Grandich, author and publisher of The Grandich Letter, which can be read by visitingwww.grandich.com, says the bottom is close and that the 180-dregree turning point could be at hand. In this Smallcappower.com exclusive Mr. Grandich says the market odds are stacked against the retail investor but still names a few companies that he owns and believes are completely undervalued in this incredibly bearish market for junior resource equities.

Peter, in late April during an interview with the Korelin Economics Report, hosted by Al Korelin, you said that certain entities are manipulating or “influencing” the gold and silver markets. Obviously, the gold market, given its sheer size, is more difficult to influence, but the silver market is relatively small and has been manipulated in the past. Should retail investors be alarmed?

Peter Grandich: They shouldn’t be alarmed, but I can’t think of any financial market that hasn’t had at least had one person convicted of some form of market manipulation. So why do people think that doesn’t happen in the gold and silver markets?

I don’t believe it happens hour-to-hour or even day-to-day but I think that there are people who try to take advantage of the market and move it in a certain way. And while they likely don’t all get together and discuss it on the phone before they actually do it, there are certain groups that know when other groups are attempting something. And within the silver market it tends to happen more because the market is much smaller in size and thus more easily manipulated.

SmallCapPower: What are some of the ways these larger players move precious metals markets?

Peter Grandich: They tend to move it at certain times. For instance, there are certain dates when options are about to expire. And the vast majority of time on option days, in the metals market in particular, markets tend to go down below those option prices because so many of the option writers are the professionals who dominate the market, therefore wrote with the hope of not having to deliver. If they can pressure the market below a certain strike price, then they don’t have to deliver or cover their sales. And because that happens, most buyers refrain from buying around those known timeframes; and those who are trading the market kind of push it lower because they know it can almost become a self-fulfilling prophecy.

It also seemingly tends to happen around big announcements like the monthly employment numbers. If someone were to look back at a chart monitoring the gold and silver prices 24 hours before those announcements, I would say three out of four times those markets go down. When in reality it should be more like a 50-50.

I think there are other periods of time, too, but I don’t think it’s every day or every hour.

SmallCapPower: Would you avoid trading when those U.S. economic numbers come out?

Peter Grandich: If I was strictly a trader and certainly from the long side, I would refrain from that. I would actually look to buy any sell-offs because the market almost inevitably rebounds shortly after that.

….read more HERE

A Leaderless World

I recently had a chance to speak at a conference where Dr. Ian Bremmer spoke after me. I was very impressed with his thought process and asked him to give me an outline of his speech to share with you for this week’s Outside the Box. It’s a shorter version of his powerhouse book, Every Nation for Itself: Winners and Losers in a G-Zero World. I highly recommend it.

And what, you’re asking, is a “G-Zero world”? In a word, it’s a leaderless world. A world in which, as Bremmer says, “Not so long ago, America, Western Europe and Japan were the world’s powerhouses. Today, they’re struggling to recover their dynamism…. But nor are rising powers like China, India, Brazil, Turkey, the Gulf Arabs and others ready to take up the slack…. If not the West, the rest, or the institutions where they come together, who will lead? The answer is, no one.”

And that means the world’s big problems won’t get addressed as effectively as they should, as long as the leadership vacuum persists. Talk about Muddling Through!

This book by Bremmer is going to make a difference, and I’m not the only one who thinks so–

“Ian Bremmer combines shrewd analysis with colorful storytelling to reveal the risks and opportunities in a world without leadership. This is a fascinating and important book.” –FAREED ZAKARIA

“Every Nation for Itself is a provocative and important book about what comes next. Ian Bremmer has again turned conventional wisdom on its head.” –NOURIEL ROUBINI

Tonight I am in Chicago, where I spoke at the CFA conference this morning. It went well. I will try to get a link for you later. It hasn’t been all work, either. David Rosenberg, Barry Ritholtz, and I all had dinner gigs, but we met up at the bar and just hung out for about three hours. Got to love O’Doul’s NA beer. Not quite the same as a good chardonnay but healthier for me.

I will hit the send button as I have to get up for a breakfast meeting with Sam Zell. We have never met and I am looking forward to it. He is quite the legend. I will give you an update on the conference next weekend. The reviews are coming in quite strong. It was interesting to see the European elections after the analysis we were given. There is so much that seems up in the air. You can almost feel the changes coming. I feel like the kid in the back of the car on a long road trip: “Are we there yet?”

Your holding out for a world that works analyst,

John Mauldin, Editor
Outside the Box
JohnMauldin@2000wave.com“>JohnMauldin@2000wave.com