rice paddies of China drained of cheap, docile labor

Foxconn workers are striking again—this time in Chongqing. But you have to look at the map to see why this is an event of extraordinary significance. In a word, these strikes mean that the rice paddies of China have been nearly drained of cheap, docile labor.

So the strikes in Chongqing are of global and potentially epochal significance. It was the two-decades-long flow of quasi-slave labor into the export factories of east China that enabled the major global central banks to go on a money printing rampage like the world has never before seen. The latter was conducted with apparent impunity because during that same period the induction of several hundred million peasants into the world’s factory system caused worldwide prices of consumer goods to fall, even as the money printers were enabling an orgy of credit-fueled spending by American and European households.

Yes, there is an extensive geography west of Chongqing, but here’s what it mostly consists of: mountains, as in the massive Plateau of Tibet; arid lands, culminating in the forbidding expanse of the Gobi Desert; and the factory-less rain forests of southwest China.

In short, there are few rice paddies west of Chongqing to drain because no one lives there. And this means the closing of the world’s cheap labor frontier is at hand.

Indeed, it had been approaching for several years now as Chinese manufacturers desperately migrated westward, attempting to perpetuate a regime of ultra-cheap factory labor. This perverse arrangement is virtually symbolized by Foxconn’s million plus workers in sweatshops throughout China—-factories which keep the likes of Apple, HPQ, Sony, Samsung and all the rest, as well as their American and European customers, in cheap gadgets, cheap electronics and cheap computers. But economically speaking, China’s cheap labor frontier has now it reached its Pacific Ocean equivalent.

So unless Mars is inhabited after all, the last two decades constituted a unique and non-replicable confluence. Accordingly, having used up its reservoir of cheap pre-industrial labor, the world economy is about ready to enter a wholly different era—-one when the massive central bank balance sheet expansion of recent years functions to crush global corporate profits, not just DM factory labor.

Folks, this is how Greenspan, Bernanke, Shirakawa, Trichet, King, Draghi and all the other central bank magicians did it. While they spent years breast-beating about their success in quelling inflation and generating enormous financial wealth effects, while intermittently fretting about “deflation”, their red hot printing presses were generating an altogether more insidious impact deeper down the economic strata.

In the developed world, they fueled household credit binges that were unprecedented. But owing to the vast mobilization of ultra-cheap labor in China and elsewhere in the EM, this credit fueled demand for sneakers, sweaters, furniture, fabrics, flat-screen TVs, computers, tablets, smartphones and the rest of the i-Gadgets did not drive up domestic prices; it was diverted to the booming export factories of east China, Bangladesh etc.

In the developing world markets (DM), on the other hand, the central bank money printers fueled a tsunami of cheap capital, thereby enabling an explosion of factory and infrastructure building and machinery and equipment acquisition. This drastically uneconomic investment boom was financed by yield hungry capital flows from New York, London and Tokyo—abetted by mercantilist currency pegging policies of the People’s Printing Press in China and other EM central banks. After all, the $4 trillion of reserves sitting in the vaults of China’s central bank were not gathered by old fashioned 19th century bankers stocking monetary acorns for a rainy day.

No, it was the handiwork of China’s red capitalist overlords in Beijing.  While clinging to power for dear life, they accidently discovered the magical powers of the state’s printing presses, and that unremitting credit expansion could fuel an orgy of building and construction not seen since the pharaohs built the pyramids.

Stated differently, the inexorable consequence of currency pegging in China and the rest of the EM was an eruption of domestic money supplies and banking systems. When the EM central banks bought dollars to keep their exchanges rates low and their exports high they created vast emissions of yen, yuan, won, ringgit, rupiah and the rest.

That’s how China’s credit market debt outstanding soared from $1 trillion in the year 2000 to $25 trillion at present. And it meant that anything in the realm of manufacturing, mining, international shipping and domestic transportation and infrastructure which could be built was built. That was the consequence of endless cheap capital flowing in from global bond markets and domestic banking systems.

Needless to say, the households of Europe and America have at length reached “peak debt”. Spain had a mortgage borrowing binge, for example, that even put Los Vegas and Phoenix to shame. But now the day of reckoning has arrived. Even as the Fed and ECB keep pumping liquidity into the financial markets, they fail to notice that they are not inflating consumer borrowing, just financial asset prices.

Household Leverage Ratio - Click to enlarge

Household Leverage Ratio – Click to enlarge

This means that the world’s ballooning capacity to produce and transport “things and stuff” can no longer be supported by exuberant, credit-fueled household spending from the developed world markets (DM). As China’s building boom comes to an end, for example, it finds itself choking on vast excess capacity to produce rebar for high rises, plate steel for ships and concrete for building highways, bridges, office buildings, factories, warehouses and practically everything else.

Indeed, with more than 2 billion tons of annual production capacity, China’s cement industry is 25X the size of its US counterpart. During 2012 and 2013, in fact, it produced more cement than did the US during the entire 20th century.

But the vast excess industrial capacity of China is only part of the central banks’ handiwork. In generating artificially cheap capital financed by fiat credit, not honest private savings from earned incomes, they also enabled the mining and shipping industries to become equally bloated. Yet the imbalances only worsen as the momentum of prior CapEx completions adds to supply—- even as demand falters.

This year will see nearly record expansion of global iron ore production capacity, for example, just as China’s stock piles soar and new orders plummet. Not surprisingly, iron ore prices have been in free fall since early 2014, and at about $80 per ton today they are already down by 60% from the $200/ton peak of 2012.

And this is not just a problem for iron ore commodity speculators or punters in the mining stocks. Instead, mining CapEx is in the process of taking an staggering plunge. The big three miners—-BHP, Rio Tinto and Vale—collectively spent $60 billion in CapEx during the peak year of 2012. That figure is already down to a run rate of $30 billion and will doubtless plunge to $20 billion or even lower as the cycle plays out.

This means, in turn, that CapEx suppliers like Caterpillar and Joy Global will also hit the skids. So will the German machinery and engineering suppliers like Siemens, as China’s orders for factory equipment, high rise elevators, locomotives, and power generating equipment also subside. And then the shrinkage will travel further up the food chain—–hitting high paid labor in the capital goods industries and the out-sourced vendors who supply, maintain and often mange these plants.

In short, the recent age of madcap central bank money printing brought a twin deformation. Its mobilization of the world’s cheap labor reservoir allowed out-of-control central bankers to pull a monetary Alfred E. Neuman. Why worry? There’s no inflation!

Meanwhile, the middle and lower income households throughout the DMs were being wrangled into debt servitude.

And now monumental excess industrial capacity will cause savage price-cutting as competitors scramble to generate enough volume and cash flow to cover the huge fixed costs and bloated balance sheets that attended the global investment boom.  The obvious victim will be profit margins throughout the world’s resource extraction and industrial production food chain.

So Chongqing may be far away and hard to pronounce. But the workers striking there are actually marking a crucial inflection point. It is one that denotes the world’s central banks have painted themselves into a corner and that the global economic and financial game of the last two decades is about to change. Big time.

Submitted by David Stockman via Contra Corner blog

Fooled Again!

This has been an unbelievable week in the markets. Just when it began to look like the European Union was on the verge of breakup (or at least a significant restructuring), six major central banks pledged – in unison – to provide whatever liquidity banks need to remain solvent. Central banks essentially told the markets that they would do whatever was necessary to keep the global financial system inflated. Of course, stock markets around the world jubilantly rocketed higher. The bears among us got bloodied once again. Now that the markets have calmed down a little it’s time to put the central bank actions in context. Can their plant work? An recent article from the Dollar Collapse blog provides a good summary and analysis.

Fooled Again!


The pattern is by now so familiar that it deserves a place beside other technical indicators like moving averages and Fibonacci retracements.

The patternbegins with part or all of the global economy appearing to implode under its five-decade accumulation of debt. The public sector/central bank nexus responds with a liquidity injection, leading the markets to rally explosively and the pundits to declare the problem fixed. Then the markets gradually remember that liquidity and solvency are two different things, and that the mortgage lenders/money center banks/PIIGS countries/hedge funds/State and local governments, etc., are insolvent, not illiquid. And the cycle begins again.

But what to call it? “Sucker rally” seems a little too benign and prosaic for a process that looks more like fraud perpetrated on a learning-disabled, desperately-credulous victim.

“Death throes of a decadent system” is accurate but too pretentious and doesn’t convey the cyclical (and cynical) nature of the process.

“Financial terrorism” is better, since the regularity of the cycle — and the fact that central banks have absolute control over the timing — seems to imply that there’s massive insider trading going on, possibly as part of a scheme by the (name your favorite elite conspiracy group) to suck as much wealth out of the system as possible before finally letting it collapse. Still, the term doesn’t convey the comic aspect of rich, supposedly-astute players getting suckered over and over. Incompetent money managers are funny.

In the end, what it’s called is less important that the fact that it’s a great trading indicator. Starting in 2007, if you’d gone long risk when the markets were falling apart — on the assumption that panicked governments would quickly intervene — and then taken profits and gone short a few weeks after the intervention, you’d have made a fortune from all the volatility.

This looks like another perfect set-up: A week ago, Europe was collapsing, China was slowing down and the US budgeting process was paralyzed. Stocks around the world had fallen hard, and a Euro-zone breakup was being actively planned for by governments and trading exchanges. Armageddon, in other words. So the central banks inject another hit of liquidity and Germany and the ECB appear to embrace the commingling of the continent’s balance sheets. And voila, the bulls are back in charge.

Now, trading strategies work until they don’t, and there’s always the risk that this latest bailout will actually fix the world’s problems and usher in a new era of consumer-led growth with soaring corporate profits, low inflation, and rising share prices. But…nah, why even give this possibility serious consideration? Nothing that was promised this week will make much of a near-term difference. Lower reserve requirements in China and cheaper dollar-denominated loans in Europe are just tweaks to already existing programs. More fiscal integration in Europe is inevitable if the common currency is to function as promised. But think for a moment about what this implies — Germany and France getting to micromanage Italy’s pension and tax system — and it clearly isn’t happening this month. Getting from here to a German-run Europe will take maybe five more near-death experiences, and in any event won’t address the fact that even Germany’s balance sheet (when you include its unfunded liabilities) really isn’t AAA.

So, the pattern should hold: “Risk-on” trades work this week, then things get choppy for a while. Then the markets grow cautious and finally terrified. The most likely catalyst for the panic stage is the massive, front-loaded refinancing schedule that Italy and Spain have unwisely set up for early 2012. But it could be anything. The point is to be short risk when it hits but not to marry the position, because more liquidity is on the way. The con will keep working as long as the world continues to see fiat currencies as valuable.

Death of the Dollar

“When you or I write a check there must be sufficient funds in our account to cover the check, but when the Federal Reserve writes a check there is no bank deposit on which the check is drawn. When the Federal Reserve writes a check it is creating money.”

-The Federal Reserve, Putting It Simply, 1977

I disagree and believe it’s important to draw a distinction. The Federal Reserve does not create money, it creates currency.

And it is disconcerting the way the Federal Reserve creates that currency:

  • It makes loans to the government or banking system by writing a bad check.
  • It buys something with the bad check.
    And once those newly created dollars are deposited in the banks, the banks get to employ the miracle practice of fractional reserve banking, further debasing our currency – the dollar.
    Here is the definition of fractional reserve banking in a nutshell. All banks have a reserve requirement, meaning the must keep a certain amount of dollars available for withdrawals and other day-to-day requirements. If the reserve requirement set by the Fed is 10 percent (and it currently is) the bank must keep 10 percent of the currency deposited on hand in case someone wants to make a withdrawal. They are allowed to loan out the remaining 90 percent of those deposits.But the bank doesn’t actually loan out the currency that is in their depositor accounts. It creates brand new fiat dollars out of nothing and loans them out, which means that they too were “borrowed” into existence. In other words. when you deposit $1,000 dollars, the bank can create 900 brand new dollars with nothing but a book entry, and then loan them out with interest. This process repeats over and over again. If those 900 brand new dollars are deposited in a checking account, that bank is allowed to create another 90 percent of the value of that deposit, and then another 90 percent until that original $1,000 deposit becomes $10,000 freshly minted (actually electronically created) dollars. Is it any wonder why our nation’s money supply has exploded over the past few decades.
    Coincidentally, the same year the Federal Reserve Act was passed, 1913, the 16th amendment to the Constitution was approved, which created the dreaded income tax. And guess who championed the 16th amendment? None other than Senator Nelson Aldrich, one of the driving forces behind the formation of the Federal Reserve.

The Beginning of the End

By far the most secret and least accountable operation of the federal government is not, as one might expect, the CIA, DIA, or some other super-secret intelligence agency. The CIA and other intelligence operations are under the control of Congress. They are accountable: a Congressional committee supervises these operations, controls their budgets, and is informed of their covert activities.

The Federal Reserve however, is accountable to no one; it has no budget; it is subject to no audit; and no Congressional committee knows of, or can truly supervise, its operations. The Federal Reserve, virtually in total control of the nation’s monetary system, is accountable to nobody.

-Murray N. Rothbard in The Case Against the Fed, 1994

Here’s how it began.

In 1907 there was a banking and stock market panic in the United States, aptly called the Panic of 1907. In was believed that the big New York banks, know as the Money Trust, had been causing stock market crashes and then profiting from them by buying up stocks from panicked investors and selling them for big profits days or weeks later. The Panic of 1907 was especially devastating for the U.S. economy. There was an outcry by the public for the government to do something. The federal government did something, however as we have learned in last decade – be careful what you ask for.

In 1908 Congress created the National Monetary Commission to recommend banking reforms that would prevent such panics, as well as to investigate the Money Trust. Senator Nelson Aldrich, a powerful and influential Republican, was appointed chairman. He immediately went to Europe where he spent the next two years and $300,000 – $6 million adjusted for inflation – consulting with the central bankers of England, France and Germany.

Upon his return to the states, Aldrich called a secret meeting of the top U.S. economic power brokers, many of whom, coincidentally, were bankers. It is estimated that the men invited to the conference on Jekyll Island, Georgia represented one-quarter of the world’s wealth. Aldrich and his guests spent nine days writing legislation – the Aldrich Plan – that eventually became the Federal Reserve.

Here is what two of the attendees had to say about the meeting:

“Picture a party of the nation’s greatest bankers stealing out of New York on a private railroad car under cover of darkness, stealthily hieing hundreds of miles South, embarking on a mysterious launch, sneaking to an island deserted by all but a few servants, living there a full week under such rigid secrecy that the names of not one of them was once mentioned lest the servants learn the identity and disclose to the world this strangest, most secret expedition in the history of American finance.

I am not romancing. I am giving to the world, for the first time, the real story of how the famous Aldrich currency report, the foundation of our new currency system, was written.”

-B.C. Forbes, Forbes magazine, 1916

“The results of the conference were entirely confidential. Even the fact there had had been a meeting was not permitted to become public. Though eighteen years have since gone by, I do not feel free to give a description of the most interesting conference concerning which Senator Aldrich pledged all participants to secrecy.”

-Paul Warburg, The Federal Reserve System: Its Origin and Growth,bodytext>

Secrecy was so important to the attendees of this summit because Aldrich, as a U.S. Senator and chairman of the National Monetary Commission, was charged with investigating the banking practices of the very people he conspired with on Jekyll Island. Aldrich and the bankers plotted at a secret meeting on an isolated island to draft a bill – the Aldrich Plan – for a private central bank (the Federal Reserve) that the bankers under investigation would own.

Congressional debate raged when the bill was introduced. Congressman Charles Lindberg was quoted as saying, “Our financial system is a false one and a huge burden on the people. I have alleged that there is a Money Trust. Why does the Money Trust press so hard for the Aldrich Plan now, before the people know what the Money Trust has been doing?”

Ultimately the Aldrich Plan never became law for partisan reasons. However, the bankers did not give up. In 1913 a nearly identical bill, called the Federal Reserve Act, was presented to Congress. And on December 22, 1913, three days before Christmas when the populace wasn’t looking, Congress relinquished its Constitutional right to coin money and regulate the value of that money, and passed it to a private corporation – the Federal Reserve.

Dread The Fed

The beginning of the end for the United States economy started with the inception of the Federal Reserve, the United States Central Bank, some 98 years ago. The Fed as it’s called, is a private bank, separate from (and presumably not under the control of) the federal government. The Federal Reserve has the power to dictate the country’s fiscal policy. The Federal Reserve chairman, not the President, is arguably the most powerful bureaucrat in the nation.

From about 1871 to 1914, when World War I began, most of the developed world operated under the classical gold standard. Most of the world’s currencies were pegged to gold. This meant they were also pegged to each other. This made business planning and investment far more reliable than today. Business people could make plans and  projections far into the future and trade with foreign countries knowing exactly what the currency exchange rate would be.

During this period, on average, there was no inflation – none. Yes, there were the inevitable booms and busts – inflations and deflations, but from the beginning of this period until World War I inflation averaged out to zero. Gold, and the gold standard, was the equalizer.

Here’s how it worked: When a country experienced an economic boom it imported more goods. These goods were paid for with (currency backed by) gold, so gold flowed out of the country. As gold flowed out of the country the currency supply contracted (i.e. deflated). This caused the economy to slow and demand for imports to fall. As the economy slowed, prices fell, making the country’s goods more attractive to foreign buyers. As exports rose to meet foreign demand, gold flowed back into the country. Then the process started all over again. The value of a countries currency (again based on gold) continuously moved up and down in a narrow range.

During this period currency, paper money, was just a receipt for actual money – gold. The gold standard stabilized currencies worldwide and acted as a constraint on the growth (inflation) of the currency supply.

Central banking is a controversial subject. Governments have embraced the concept, while sound money advocates increasingly decry the economic destruction caused by central banks the world over.

Central banking offers no benefits to society and contributes, mostly through the process of inflation, to serious problems. The following are just a few of the issues engendered by central banking and inflation:

  • It causes capital consumption and misallocation of capital
  • It taxes fixed income earners (savers and fixed wage laborers)
  • It discourages saving or forces savers to take more risk
  • It encourages consumption and debt
  • It benefits debtors (especially government), speculators, politicians, lobbyists, and fractional reserve banks
  • It produces the business boom/bust cycle
  • It rewards corruption and leads to morals hazards
  • It accelerates the growth of government
  • And if not abandoned it can result in a currency crisis, impoverishment, and economic and social chaos

By manipulating interest rates away from their natural free-market level central banks distort the pricing mechanisms by which entrepreneurs, businesses and consumers make decisions. This distortion results in massive amounts of wasted resources as capital gets invested in unsustainable areas. Row after row of empty houses in Florida, Nevada and Arizona are excellent such examples of capital that was put to work in the wrong area because people were fooled by artificially low interest rates into believing there was a need for new housing in these areas.

This boom and bust process has been recurring over and over for decades and the boom/bust cycle is now accelerating as the system nears collapse. This continual boom/bust cycle and massive amount of misallocation of capital has destroyed trillions of dollars in wealth and is the real reason why the US is in such terrible shape today.
Yet, despite decades of wealth destruction caused by the Federal Reserve, who does the American public look to in order to fix the problems? Unbelievably, they look to Ben Bernanke and the Fed.