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Money Flows, Where Will It Go?

Commodities / Inflation Feb 17, 2011 - 03:19 AM GMT

By: Dr_Jeff_Lewis

Commodities The price of money is rising, especially as it relates to time.  With inflation fears growing and governments local and federal looking toward record deficit and financing requirements, strain is beginning to take its toll on the bond markets.  Treasuries are rising, and muni bonds, which are generally very slow in their price action, have reached peak volatility.


We are soon to see a global rebalancing of risk and inflation when the emerging markets, tired of being the brunt of every other central banks’ policy, begin to raise their own domestic rates.  While it is suspected that China and India each offer negative real rates, any additional hikes will further compromise that easy carry trade, and the result will be financial flows out of the emerging markets and back to their home countries.

The media has misconstrued the problem, noting that inflation is highest in the emerging markets and is affecting investors in developed economies.  That point, though, is moot.  The emerging markets are more transparent in their inflation, bringing it to the top of the inverted money pyramid, while the developed world continues to hide money at the bank reserve level.  Where you can spend the inflated cash in China and India, it rests in bank coffers in the US, making banks plenty of risk-free money with net-zero exposure to inflation. 

A Tsunami of Cash

Because the purchasing power carry trade from the United States to China and India is highly-levered and largely dependent on a very small spread between inflation and interest rates, each uptick in rates makes the trade significantly less profitable.

If, for example, the cost to borrow was 4%, and inflation was 5%, then the net gain is 1% per year.  However, if rates rise to 4.25%, profits drop 25%, creating an overnight change in the risk to reward ratio, and pushing many investors out of the foreign markets. 

Such is the problem with systemic, centralized monetary policy.  It is unlikely that in a free market where interest rates are set not by central banks, but by the supply of capital, rates would ever fluctuate that much in one day.  Nor would there be as many guessing games as to the future direction of interest rates.  Where one institution decides the value of money, 7 billion people would take their place. 

Any further rate increases in China and India mean less foreign investment.  Much of this foreign investment comes from the United States which has one of the lowest rates of the developed world. 

Time Arbitrage

It is believed that negative real interest rates in India and China are soon to disappear, perhaps by the end of 2011.  Analysts suspect that with the present unemployment outlook as bleak as it is today, a slow-growth economy might allow for Fed rate hikes by 2012, but not sooner. The Bank of England and the European Central Bank are expected to hike rates later in the year.  Canada, Australia, and New Zealand, each developed world countries with strong commodity economies are already raising rates.

By the end of 2011, negative real rates in foreign economies will have closed, and dollars will have to come back to the United States (in order to protect unnecessary currency exposure).  Where will they go then?  An easy question!  That money will go to the favorite place for inflation protection: commodities and monetary metals.

Beat the next rush, but hurry because time is of the essence.

By Dr. Jeff Lewis

    Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of Silver-Coin-Investor.com and Hard-Money-Newsletter-Review.com

    Copyright © 2011 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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