Emerging fronts

The battle to find a bottom for our economic malaise may actually be getting worse. Some critical events happening outside of the US may greatly effect our ability to control the markets inside the US.

From Businessweek via Mish;

"A decade of heavy borrowing has lofted euro zone debt to $11 trillion, and it's starting to come due just when companies are strapped for cash.'

"More toxic debt soon could come crashing through the global financial system. The surprising source: Europe Inc. Once-stodgy Old World companies, from cement makers to phone operators to chemical companies, went on an unprecedented borrowing spree over the past decade that has left them up to their necks in debt. Corporate debt in the euro zone stands at more than $11 trillion, equaling some 95% of the region's economy, vs. only 50% in the U.S." "In better times, companies might have gone to the bank to refinance. No more. Bank lending to euro zone companies plunged 40% last fall as the credit squeeze tightened.' "Rising defaults could send shock waves through global markets. Just as with subprime mortgages in the U.S., corporate bonds and loans were packaged and resold to investors in vehicles called CDOs and CLOs, or collateralized debt obligations and collateralized loan obligations. "There was a flood of cheap debt, lower and lower terms," says Jon Moulton, head of London private equity group Alchemy Partners, "and with less and less due diligence."

It appears our model for financial destruction was carefully followed. Many analysts, of late, have predicted that Europe will suffer more than the US. European Banks have as great, if not greater, exposure to toxic assets, and only look good now because the breakdown of those investments is lagging the US by six months.

Much of the United States' success has come from foreign investment seeking returns here they could not find elsewhere. As the amount of money evaporates with the devaluing of derivatives, that leaves less money to be invested, anywhere.

But that is not the only front to be concerned with.

The graphs in an article from globalresearch.ca are eye catching. They depict the areas of the world under stress from drought, and predict 2009 may have significant shortfalls of food production.

I had wrote earlier that some of my worries in the near future are for a spike in prices of commodities and food. My reasoning is based on market mechanics - as asset deflation sets in, the market makers, whom are accustomed to making huge profits, have less and less opportunity with equities. Lower stock prices leave less room to bet to the downside. Food, fuel and industrial materials are easy targets to manipulate for profit. Since we must have food and fuel, prices can go up, and these things will still be purchased.

Now, Mother Nature is adding her two cents worth.

Seven Chinese provinces are in emergency drought situation. In Australia, the argument of climate change is no longer discussed, with even the most conservative now true believers. In the US, California is in historical drought, Texas is bracing for historic record low rainfall, the western Carolinas and eastern Georgia are in record territory for two straight years and Florida has already realized lost crop production this season as half the state is in some type of drought.

Argentina, Brazil, Paraguay, Uruguay, Bolivia, Chile, Kenya, Tanzania, Burundi, Uganda, South Africa, Malawi, Zambia, Swaziland, Somalia, Zimbabwe, Mozambique, Tunisia, Angola, Ethiopia, Iraq, Syria, Afghanistan, Jordan, Lebanon, Israel, Bangladesh, Myanmar, India, Turkmenistan, Thailand, Nepal, Pakistan Turkey, Kyrgyzstan, Uzbekistan, Cyprus and Iran are all in record or near record drought.

Low food prices also lead to lower food production. Right now, food prices are low, so Kansas farmers have seeded a record low number of acres. Canada will use 1.1 million less acres this year for wheat. Grain output for Australia, Canada, United States and the European Union combined was 47.4 million tons in 2004. In 2008, the combined total was less than 28 million tons.

Because of the global lack of rainfall, sustaining low food prices has little chance of success. This will weigh greatly in the near future as asset deflation sets in, as what goods countries now offer will bring less profit.

"Some observers are anticipating “competitive currency devaluations” in addition to deflation for 2009 (nations devalue their currencies to help their export sector). The coming global food shortage makes this highly unlikely. Depreciating their currency in the current environment will produce the unwanted consequence of boosting exports—of food. Even with export restrictions like those in China, currency depreciation would cause the outflow of significant quantities of grain via the black market.' "Instead of “competitive currency devaluations”, spiking food prices will likely cause competitive currency appreciation in 2009. Foreign exchange reserves exist for just this type of emergency . Central banks around the world will lower domestic food prices by either directly selling off their reserves to appreciate their currencies or by using them to purchase grain on the world market.'

"Appreciating a currency is the fastest way to control food inflation. A more valuable currency allows a nation to monopolize more global resources (ie: the overvalued dollar allows the US to consume 25% of the world's oil despite having only 4% of the world's population). If China were to selloff its US reserves, its enormous population would start sucking up the world's food supply like the US has been doing with oil.'

"On the flip side, when a nation appreciates its currency and starts consuming more of the world's resources, it leaves less for everyone else. So when China appreciates the yuan, food shortages worldwide will increase and prices everywhere else will jump upwards. As there is nothing that breeds social unrest like soaring food prices, nations around the world, from Russia, to the EU, to Saudi Arabia, to India, will sell off their foreign reserves to appreciate their currencies and reduce the cost of food imports. In response to this, China will sell even more of its reserves and so on. That is competitive currency appreciation.'

"When faced with competitive currency appreciation, you do NOT want to be the world's reserve currency. The dollar is likely to do very poorly as central banks liquidate trillions in US holdings to buy food and appreciate their currencies."

Initiatives to wean us from mideast oil will only add to the demand for what crops are being produced to be used as bio-fuels. I would anticipate that the market makers will take full advantage, and food prices will begin a climb sometime soon.