The industrial countries are on their way to Japanese style deflation including rock bottom low interest rates and inflation over the next years. Commodity prices are on contrary still on a strong upward trend. This is exactly the scenario I have predicted in my article from last year. This never happened so far in economic history, yet evolved as a fantastic investment opportunity for small investors (we know today where big scale and conventional investors put and lost their money).

The reason for this truly strange scenario evolving lies within the globalisation of the worldwide economy. Twenty years ago it all started in Japan as Japan went into an incredible asset bubble financed through debt. The collapse of this bubble in 1996 then ignited the high tech bubble in the US, which collapse in turn triggered the US housing bubble.

As the US housing bubble implodes, this triggers now the next bubble. This will be in my view without any doubt an incredible boom in emerging markets. Needless to say, that this will be accompanied by unbelievable high commodity prices.

As previously already explained in my articles, the world economy works on capital flows. Capital goes where it feels save and - naturally can earn some return. Since the US economy went through a long period of debt excess in the last thirty years (this trend has been started by Paul Volcker and President Reagan), it is so much in debt, that the US economy cannot pay anymore a real return to international investors. Below chart shows exactly how real returns on US Treasuries went from a strong 4 % in the eighties and nineties to virtually nil in the latest months.

This is the reason behind the recent dollar weakness. In order to compensate for the huge US current account deficit, international investors have to invest vast sums into the US economy. Nevertheless, this becomes more and more unappealing due to low real US interest rates. The US FED has tried to keep real interests high over the course of the last years in order to prevent an outflow from the dollar, yet the collapse of the US financial system (=strong parallel to Japan) does simply not allow high interest rates in the US. If the FED keeps interests high, it risks an even more devastating implosion of its financial system. It is forced then to lower interest rates much more and faster. In my view US policy makers have recognised this and take already the right steps. There is no way out of it: the US has painted itself into a corner over the last decades. The current policy makers cannot do very much about this anymore.

Contrary to many other commentators this is in my view no tragedy for the world economy. The implosion of the US economy will actually trigger a worldwide economic boom. The US dollar will transform from an investing currency towards a financing currency (taking over the role of the yen). Massive amounts of US dollars will be used to finance projects worldwide.

Imagine US interest rates will go to zero. This is virtually free money to earn high real returns in Brazil, Russia, India,….As real US rates are currently below zero, this indicates already high worldwide liquidity.

It is no coincidence that the recent fall in real interest rates has triggered a sharp increase in the gold price. As this trend will carry on for a while, we can look for a bright future for the gold price, emerging markets and commodity prices.

This is in no way a decoupling of worldwide economic growth. It is exactly the weakness in industrial economies, which triggers high worldwide economic growth through low interest rates in developed countries.

It is a fantastic example how nature works. No bill goes unpaid. The greed of the last decades in industrial nations is forcing its toll. Industrial nations have to pay now a high economic aid for emerging countries in form of high commodity prices.

Unfortunately the bill will not be paid by the generation (baby-boomers) who has actually caused this disaster. Nevertheless, this opens another bill for the baby boomers who will very likely live a life in poverty - not much help from younger generations - during retirement.

Heinrich Leopold
hgleopold@yahoo.com

25 January 2008

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