Saturday, December 19, 2009

What Chinese Pig Farmers Have to Do with Fannie Mae, AIG and Goldman Sachs

The New York Times is running a concise review of financial companies that are to one degree or another wards of the Feds. It is horrifying. Here are excerpts from 4 Big Mortgage Backers Swim in Ocean of Debt:

Even as the biggest banks repay their government debt in what is being heralded as a successful rescue program, four troubled giants of the financial world remain on government life support.

These companies, the American International Group, Fannie Mae, Freddie Mac and GMAC, are not only unable to repay the government, they are in need of continuing infusions that make them look increasingly like long-term wards of the state.

And the total risk they pose to the taxpayer far exceeds that of the big banks. Fannie and Freddie, in the final days of the year, are even said to be negotiating with the Treasury about greatly expanding the money available to them. . .

Fannie Mae recently warned, for example, that it could not pay the dividends it owes the Treasury, so “future dividend payments will be effectively funded with equity drawn from the Treasury.”

It would appear that Fannie Mae is involved in a Ponzi scheme with the Treasury.

All the above and almost all of the point of the entire article relates to the old Irving Fisher/Austrian economics point of too much aggregate debt. As debt levels in the West relative to the size of the economy have risen over the past 3 decades, secular economic growth has slowed and Treasury borrowing rates have fallen concomitant with decreased private demand for funds (e.g., decreased perceived real investment opportunities for the private sector).

From an investment standpoint, the opposite of debt is ownership, and an opposite of paper money is hard money AKA gold (and silver?), and by extension other physical goods known as commodities. But what happens when ownership of hard money occurs due to borrowing paper money (in electronic form)? One has a confusing situation. The mistrusted fiat money sector is used, on the margin with leverage, to purchase a form of insurance against itself. Logical? I think not. Yet ultimately gold is gold, nothing more or less. It just sits there, not tarnishing even after centuries at the bottom of the sea. It can't pull an AIG and have one obscure division ruin the entire entity or morph from an auto manufacturer to a finance company with a manufacturing subsidiary, as GM effectively did. It also can't become Apple Inc. Gold should be the ultimate non-get rich quick asset, a topic addressed next.

Mish has a compelling, must-read article that addresses this in China Faces Crash Scenario, which in turn references what strikes me as a credible article by a man named Brent Cook titled Pig Farmers are Making Brent Nervous. Here are excerpts from the latter:

Before getting into to the relationship between copper and pork products, I want to draw your attention to what makes me nervous, have a look at these photos from China. They are excerpted from a China Central Television Channel (CCTV) program documenting private speculation and hoarding of metals throughout the country. According to an associate of mine at an Asia-focused hedge fund who was just in China, “It’s pervasive; people are piling this stuff up in their backyards."

He Jinbi from Maike (metal trading company). He told CCTV they saw many farmers in Guangdong province stocking more than 100 tonnes of aluminium at home. These people used to raise geese for living.

Because the interest rate is too low in China. Many farmers could make hundreds of RMB profits per tonne, with dozens of Rmb per tonne cost of interests. They use their existing inventories to borrow more from banks. Banks are very 'happy' to lend to them. . .

A September 17 Bloomberg story by Singapore-based Glenys Sim reports that “Private investors in China, the world’s largest metals user, have stockpiled ‘substantial’ quantities of copper as the government ramps up stimulus spending to spur the economy.” The article points out that pig farmers and other speculators have amassed in the order of 50,000 tonnes of copper. That is about half the level of inventories tallied by the Shanghai Futures Exchange."

Mr. Cook goes on to state flatly:

What is obvious is that gold and now base metals have become speculative investments that in addition to being bought as hedges against inflation and a falling US dollar are the latest get rich quick scheme. . .

I remain cautious and somewhat concerned by what appears to be hot and fickle money jumping into a sector that is apparently taking its cue from pig farmers.

Only for reasons of space have I ignored the rest of Mish's article, which has several linked articles.

The Brent Cook article states that banks are happy to lend to pig farmers for commodity speculation. Here is an online dictionary's definition of a bank:

"an institution for receiving, lending, exchanging, and safeguarding money and, in some cases, issuing notes and transacting other financial business."

Note the word "safeguarding". Your "money" in the "bank" is not safe except at the most conservative institutions. It would appear that much of the global economy has been, through overt governmental and business policy and by governmental neglect as well, subjugated to the traders, middlemen and salespeople who benefit from volatility with government bailouts as a given.

When what should be an uncorrelated asset--gold--trades up hard and down hard due to the same leverage that it should be insurance against, what you have is a mess. My guess--just a guess-- is that central banks need "money" and those in countries that have lots of gold, such as the U. S., France and Germany are more than happy to see gold's price trend higher, because this provides a larger capital base on which to continue to support the economic basket cases of their economies, so that unlike past years, official policy may work in favor of gold owners, not against them.

On the other hand, every other commodity, including silver and platinum, are for official purposes all the same: industrial commodities. They are imports for the powers in the G7 and G20 and all things being equal, lower prices are better for their economies than are higher ones.

To summarize, the post-Cold War economic stability of the West of the 1990s is definitely gone.
Whatever price gold and stocks had then is mostly of historical relevance. The U. S. is going the route of Japan with weak, giant financial institutions, politically-motivated infrastructure spending paid for with borrowed funds and a carry trade currency. The economy built on outsourcing, China, may well be in the late stages of a complex financial bubble, and the world's largest economy is being propped up by taxpayers borrowing in part at zero percent interest rates (but with massive re-financing risk as this borrowing is short-term), and Goldman, Sachs and other trading companies are as happy as Chinese pig farmers.

The only theme an investor can follow is that the powers that be don't care about you. In fact, they want your money. Thus American homeowners have systematically been turned into renters for the most part. How to preserve capital adjusted for "flation" has been deliberately been made so complex that the average person has better odds, perhaps, in Vegas than playing our markets. "They" have made it overly complex. Your job is to keep it simple and keep your eyes open and your hand on your wallet. Emulate not Chinese pig farmers. Whether precious metals and other ETFs are the Western equivalent of copper and aluminum in their yards is unclear. More than ever in modern financial times, you never know.

Copyright (C) Long Lake LLC 2009

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