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Friday, June 3, 2011

Insight & Understanding

To maintain a blog as informative as "Ants & Grasshoppers", one has to scour for information, not just from local and national news outlets, but also from international outlets as well, because one can not truly understand the global economy if readings are limited to American based publications.

I discovered the other day while perusing a publication called 'The Edge Singapore', an interview conducted with a man named Richard Duncan who accurately predicted the last global crisis and is well respected, particularly in Asian economic policy circles.   He conducted an interview with the publication about the global economy and touching upon the various regions of the world.

Because the interview was a bit long, I have condensed a bit to keep the information most relevant and germaine to the reader without altering the context of the answers Mr. Duncan gives.

Though the rest of this posting will be directly from the interview with full credit given to its source, for the purpose of making it easier for you to read and follow, I've highlighted all Mr Duncan's responses in blue font.  Also, any portions underlined or made Bold was done by A&G for emphasis.

I hope you find it as informative...
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Bangkok-based Duncan is currently chief economist at Blackhorse Asset Management. He recently spoke to The Edge Singapore on the sidelines of an investors’ forum. 

The Edge: The US Federal Reserve is about to end the latest round of quantitative easing, or QE2, next month. The markets are fairly nervous about what might happen next. What’s your take?

RD: When QE2 stops, the US economy will weaken again, the global economy will weaken, stock and bond prices will drop. So, interest rates will go up, commodity prices will drop. The US economy will start moving back towards a recession and, around the end of the year, we’ll have QE3 or another round of quantitative easing, and then everything will spike up again — equities, bonds, commodities, all sorts of assets.

The Edge: So, you are predicting another speculative bubble in commodities and other assets? 

RD: It doesn’t cost anything to print money. Yes, I believe inflation will move higher. But, before we get there, when QE2 stops next month, we will probably see a significant correction in commodity prices that will be disinflationary. That will help alleviate inflationary pressures long before QE3 starts.

There are really three different kinds of inflation. The first, what the Fed looks at, is consumer price index, excluding food and energy. That’s been trending downwards for years because of globalization. 

The marginal cost of labor has dropped 90% or 95%.  In the past, if you hired someone to produce car parts in Michigan, you might pay US$200 a day. You can hire someone in Chennai for about 5% of that. In China or Thailand, you’d pay a little bit more, but still far cheaper than Michigan. This represents an unprecedented collapse in the cost of labor.

Nothing like this has ever occurred in history. If it wasn’t for this — all the paper money that is being created by central bank easing — it would have created hyperinflation.

There is also asset price inflation like stocks or real estate. The whole purpose of QE2 was to create asset price inflation. The Fed wanted stock markets to go up, bond prices to be higher, so interest rates were lower and that worked out very well. Since QE2 started, stocks have surged 25% from where they were just before it was announced...

The real problem is the third kind of inflation or commodity price inflation, including food, which is now a serious global issue. You have two billion people who live on less than US$3 a day. As food prices rise, they become hungrier.

That’s what North African revolutions have been all about. Egyptians and Tunisians didn’t wake up one morning and decide they wanted more democracy. They woke up hungry because of food price inflation, which was a consequence of QE2.

The Edge: So, you see a global economy in turmoil?

RD: I believe that the global economy is a very sick patient that is being kept alive by life support primarily in the form of budget deficits. The US deficit has reached 10% of GDP, or US$1.4 trillion ($1.7 trillion). It looks like the US economy might still grow more than 2% this year, but if it weren’t for the 10% budget deficit, the growth rate might actually be minus 8% or far slower.

The budget deficit has kept the economy from collapsing and is being financed in large parts by quantitative easing of US$600 billion over seven months, or roughly US$3 billion a day. That’s new money that the Fed is creating from nothing and using it to buy Treasury bonds.

The Fed has been buying every new bond that the government has sold over the last few months, and that has kept bond prices higher and interest rates lower, which in turn has helped support the economy and forced the people who would normally buy those bonds to buy equities, which is why you have stock prices moving 25% higher and helping create a wealth effect that drives consumption.

The Edge:  So, what should President Obama or the Congress do now? Is there a way out or just a steady deterioration from here on?

RD: The US has two choices. The government can spend less and the US will collapse into a depression, from where it will be all downhill, or just spend more wisely. The US needs to spend in a way that actually restructures the economy and restore its economic viability. It looks like the US government will have a US$10 trillion budget deficit over the next 10 years...

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