Credit Crisis Solution

I’ve been following the interest yield on CD’s, specifically the Bank of America Risk Free CD. I opened one in March yielding 2.5%. I’ve been noticing a steady drop in APY’s from 2.5% down to 1.4% today. At the same time I’m watching my investments surge in the market. There’s been a two month rally with the DJA increasing from $6,500 to $8,500 over the same period or nearly 23.5%, which annualized, would means comparative yields greater than 100%, which is absolutely unsustainable, and has been mainly driven by speculation of inflation in the commodity markets.

At the same time the market is rallying, consumer confidence is soaring. Strong consumer confidence is largely a reflection of a strong market and low energy prices, which are both true. Additionally, the low yields on low risk securities such as the one aforementioned make people more willing to risk their cash hoards to recoup their past losses. This bear rally is happening as other high impact macro situations playing out and waiting in the shadows;

1) This drive in the commodities means that people already realize that inflation is ahead, and if people continue to show the demand, it will show a cultural acceptance of the increased prices, including imported goods like oil, further impacting the deficit.

2) China is expressing worry about their treasury investments, and have began decreasing their reserves including diversifying into stockpiles of commodities and equities while promoting situation 1. This essentially is shutting off the American credit card.

3) As the Chinese are expressing their worries about the dollar, savings rates are increasing at home, and at the same time lending and investment is stagnant as banks are risk adverse because of the uncertainty. This is leading to a potential collapse of the American consumer mentality which will have far reaching consequences, albeit with a silver lining.

4) The housing market is still waiting for its bottom, but nobody is really talking about the adjustable rate mortgages (ARMS), with interest rates about to reset. As interest is a reflection of risk, the interest rates will increase to match the risk. Already 1/5 of Americans are backwards on their mortgages and with the unemployment rising, it is almost certain that we will see very significant rises in foreclosures as well as bank write downs.

Most these events are inclusive and will have direct and indirect impacts on the market as a whole. The moral of the story is people are going to create a bubble in the bear market, primarily with commodities. This bubble will eventually erupt as it calms continual scary economic snap shots and becomes unsustainable.

It’s hard to believe that the US may be dethroned within the next few decades, but the Chinese are doing many things to set a foundation for a run. A few weeks ago, I wrote some articles on China and Russia pushing for a new world reserve currency which would be backed by commodities. I’ve also been seeing a lot of articles about the Chinese intelligence and attempts to hack into the US energy grid and defense system, though these articles credibility may be suspect, I’ve been seeing them quite often and two major themes are Trojans and viruses in the Energy Grid (possibly our financial system), and special programs in military aircraft chips imported from China. These are extremely intelligent, as they are non-lethal offensive strategies, but would have severe consequences to the US.

Additionally, with the pushing for a new world currency, and most of the leading countries agreeing to the look into the idea ($1 trillion grant to the IMF), it is highly probable that a commodity backed reserve currency would replace the USD. China, the biggest promoted of the currency and largest holder of US bonds has expressed concern about the value of the $, especially with the increased printing. This concern has led them to begin diversifying their holdings into stock piles of Copper, which for good reason, may be a big part of the the worlds next currency. All this is not drawing much attention and will set them up for the future in 2 ways: 1) massive quantities of essential manufacturing metals, 2) if the new currency is put into place, China’s investments will pay off. This week is a big earnings release week, with all the uncertainty, stay on the sidelines and let the week playout, but much like there were drivers behind the banks beating estimates, Copper stocks may be a nice pick up.

As mentioned in the article Unintended Consequences I mentioned China expressed concern in the future value of the dollar with the recent spending increases. In the summer of 2008, at the first signs of the weakening economy, Iran proposed the Euro be used for energy trading. This week, China made a similar proposal, a single, an international reserve currency (to replace the dollar) managed by the International Monetary Fund (IMF).

The advantages for the US of the dollar as the reserve currency:
1) We can easily borrow against our own currency which gives us low interest rates.
2) When the US borrows against its own currency it is independent of fluctuations in other currencies, and can be paid back in less real value at maturity.
3) For now it’s the best option.

The positives for the world:
1) It will deter US racking up large deficits with an increase in interest rates.
2) It will give poorer countries access to the currency.
3) It will continue to support the union of the world into one currency.
4) With the questions about the US economy it would be better to act now then after substantial depreciation of the dollar.
5) A shared interest will lead to better stability, fairness, and transparency.

The dollar is the reserve currency now because the US is the world’s largest economy, and the $ is the most liquid form of money. The idea of creating a world currency isn’t anything new, and prior to 1972 the US dollar was pegged against gold (Bretton Woods fixed exchange). After the Bretton Woods system was dropped, inflation began to climb, and it would likely create a similar scenario with a world reserve currency. However, this will not happen anytime in the near future.