The Buck must Duck!

[wabmester]

I really enjoyed this exhange between Bill Gross and Stephen Roach:

http://www.investorsinsight.com/article.asp?id=jmotb100404

My favorite quote is from Gross:

I think we should remind each other that forecasting Armageddon is a tricky business. Mankind's indomitably optimistic spirit has a habit of postponing foggy days until the gloomsters' warnings and ultimate sanity are called into question.

This has always been the source of my investment angst. The numbers look bad, but do I really want to bet against that crazy human drive to fix things on the fly?

 

[Whakamole]

Once I was hearing a discussion about something similar. It was pointed out that, yes, what we are doing is unsustainable but it has always been unsustainable, and people are very good at making the best of it. Sometimes it's painful.

I think the dollar devaluation talk isn't precise enough... here is my theory: among modern, industrialized countries, the cost of living is roughly the same. That is, $50K a year would buy you a roughly equivalent, middle-class lifestyle in the US, Europe, and Canada. (Not sure what it would buy you in Japan; obviously not a house, but few people own houses there anyway.)

As the developing nations turn into developed nations, this principal will have to hold true, so their currencies will rise against the dollar (and the Euro, and...)

Now, say you think the Chinese currency will have to be worth more compared to the US dollar at some point. We're forcing the Chinese to buy our bonds - they have to, because if they stopped I'm sure we'd find a way to prevent their goods from reaching the marketplace. When the US dollar devalues, it means that they will be left holding the bag because their bonds will be worth less.

This happened to Japan in the 80s. Actually, the Japanese went and bought real estate - remember all the golf courses they bought, and Rockefeller Center, and the like? It didn't help.

So what happens if the shock happens?
- China will be in dire straits. Not only will their products be less competitive, but they'll have all their US dollar-held assets depreciate in value significantly. Yes, they'll have plenty of nice factories but unless they have a consumer for the products they make, they'll just be nice, unused factories.
- How about the US? Maybe the factories start coming back here, with the cost advantage removed or negated. You'll have a problem financing the deficit, but you won't need it as much. Interest rates will probably rise. Real estate prices will drop (especially if the Chinese go on a buying spree like the Japanese did.)

If the Chinese manage to develop a solid consumer market, that's different, but it's a long-term proposition. Even the Japanese, with a big consumer market, still need exports to drive their economy.

Guess we'll find out.

Great article.