While the U.S. Exports Inflation, China Is Attacking It!

Let's not sugarcoat the state of our economy: Unemployment is stubbornly high, real estate prices are in the dumps, our nation is up to its eyeballs in debt, and we're teetering on the cusp of recession.

That's why two weeks ago Ben Bernanke and his Federal Reserve buddies promised to keep interest rates near zero ... at least until mid-2013.

Some Fed members "felt that the recent economic developments justified a more substantial move" beyond the two-year easy money promise. That could mean additional purchases of government bonds with a QE3, purchases of other assets like stocks, extending the maturity of the Fed's balance sheet, or some other insane monetary Frankenstein.

Obsessing about what the Fed might do is not what we investors should be watching. Instead, what really matters is what the Fed is not doing. And that is keeping to one of its primary, historical missions: Controlling inflation.

The Federal Reserve Act of 1913 created the central banking system of the U.S. and gave the Federal Reserve Bank the legal authority to issue paper money. The Fed would make emergency loans to member banks, print money, and act as the fiscal agent for the U.S. government.

The Act was amended in 1930 to create the Federal Open Market Committee (FOMC), consisting of the seven members of the Board of Governors of the Federal Reserve System and five representatives from the Federal Reserve banks. The FOMC is chartered "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."

Like Mr. Magoo, Bernanke stubbornly refuses to admit there is a problem.

The Fed, under Alan Greenspan and now Ben Bernanke, has completely ignored the part about moderate long-term interest rates and stable prices. Today, the Federal Reserve Bank only cares about propping up the asset prices (stocks and real estate) and has done more to blow more air into our ready-to-pop debt bubble than even our spendthrift politicians!

My perspective is different than most observers because I devote most of my time to following Asian economies and markets. So I see the contrast between our central bankers and Asian central bankers.

The comparison that surprises and worries me the most: The one between our Federal Reserve Bank and the People's Bank of China.

China's Central Bank Beating the Fed ...
Hands Down!

When it comes to economic growth, you would think that the United States, the bastion of freedom and capitalism, would make a bunch of communist bureaucrats from China look like fools. Instead, it is the Chinese central planners that make Ben Bernanke and his Fed buddies look like a bunch of bumbling Keystone Cops!

I'm ashamed to tell you that the Chinese central bankers are doing much better as stewards of their economy than our Federal Reserve Bank is with ours. Here's what I mean:

  • China recently raised the bank reserve requirement to 21.5% of their deposits. This is the ninth time China's central bank has increased the reserve requirement since the second half of 2010.
  • China's key lending rate has been increased five times since the start of 2010.
  • Down payments requirements and mortgage rates have also been raised.

Despite those tightening measures, M2 (a broad measure of money supply) was 20% in 2010 and on track to rise by another 15% to 16% this year.

China's leaders are more worried about inflation than propping up assets prices like Bernanke is. The National Development and Reform Commission, China's lead planning body, understands that the rise in commodities prices is fueling consumer inflation in China.

Interestingly, the National Development and Reform Commission says,

"The loose global liquidity condition is unlikely to change in the short term and the global commodity prices are still high, so the impact from imported inflation has not eased."

In other words, commodity prices around the world are high because desperate western countries are using loose monetary policies to stimulate their economies.

China has set an annual inflation ceiling at 4%. But its consumer price index hit a three-year high of 6.5% in July.

The incomes for taxi drivers in China are getting squeezed by higher gas prices and government-controlled taxi fares.

Some commodities, especially food, are rising at even a faster pace. In just the last 30 days, the price of spinach has shot up by 31% and lettuce by 27%. Over the last year, eggs are up 16% and edible cooking oil is now 21.8% higher.

Inflation isn't the only byproduct of Bernanke's printing press ...

One of China's top officials warned: "Not only is the European debt problem worsening and spreading, the U.S. and Japan's debt problems are also worsening" and that the debt crisis in the euro zone is "deteriorating and spreading."

What Does All this
Mean to Investors?

Despite China's best efforts, it is fighting a losing battle because Bernanke is as blind as Mr. Magoo when it comes to inflation. And unless you think that American policymakers will suddenly act responsibly, you need to invest accordingly.

Here are four steps you should consider taking now:

#1 Raise Cash

In February, I instructed my Asia Stock Alert subscribers to reduce equity allocation and build up a 38% safety net of sleep-at-night cash. How much cash is a very individual decision but 'significant' is the right answer for everyone.

#2 Find a Safe Place to Park

My favorite parking place is the Merck Hard Currency fund (MERKX) which invests in the short-term AAA debt of the world's economies with the strongest economies and monetary policies. This fund is essentially a non-dollar money market fund with very low volatility.

#3 Bet Against the Dollar

If you are more aggressive and want to profit from the ineptness of the Federal Reserve, take a look at PowerShares Deutsche Bank U.S. Dollar Bear ETF (NYSE:UDN). This is an ETF that is designed to track the Deutsche Bank Short U.S. Dollar Index (UDSX) Futures Index, a benchmark composed solely of short U.S. dollar futures contracts. These futures contracts are designed to replicate the performance of being short the U.S. dollar against a basket of six major currencies.

#4 Bet on Gold

Inflation + incompetent U.S. policymakers = higher gold prices. I currently am not recommending gold to my Asia Stock Alert subscribers. But the long-term trend for gold is certainly higher. So you should add some haywire insurance to your portfolio when gold goes on sale.

[Editor's note: Tony travels throughout Asia, looking for profit-packed opportunities for his Asia Stock Alert members. Click here to see how you can join them, risk free!]

Lastly, I'm not suggesting you sell EVERY stock you own. Stocks in the natural resource/commodity industries have very bright futures. And overweighting your portfolio with stocks that are denominated in currencies such as the yuan, yen, won, ringgit, rupiah, and baht could be your best equity bets going forward.

Best wishes,

Tony


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Posted 09-09-2011 10:30 AM by Tony Sagami

Comments

Andrew Reynolds wrote re: While the U.S. Exports Inflation, China Is Attacking It!
on 09-12-2011 10:54 PM

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