Gold above $800, crude looking to attack $100, and the Dollar dropping like a stone against Euro, Pound, and other Western currencies, while the stock market surges. What's going on here? My guess: the first hints of the long threatened unravelling.
The US is, and has been, living well beyond its means, borrowing to finance consumption. This year, for example, we will run a current account deficit of about a trillion dollars, or $3000 per American. Two factors have conspired to make this happen: the suicidally reckless economic policies of the Bush administration and China's determination not to let its own trade be balanced.
The US is the classic profligate, borrowing and spending like crazy, while China, Japan, and expecially the Gulf states play the role of the irresponsible banker willing to keep lending no matter what.
Bartender: That damn drunk keeps running up his tab and never paying.
Customer: Why don't you cut him off?
Bartender: I can't afford to. He's the best customer I've got!
By now, the Dollar is almost certainly undervalued against the Pound, the Euro, and the other Dollars. This is a big problem for the countries using those currencies, since their trade goods have lost a lot of competitiveness against the Dollar. The problem is that China, Japan, and the emerging economies are afraid to let their currencies appreciate against the dollar. As a result, they have saddled their own citizens with a vast quantity of a rapidly depreciating asset, the US Dollar. This leaves a lot of Dollars out there that everybody wants to unload - so they buy stocks, gold, oil, Euros, etc.
The big question in my mind is what price does China pay for its role in creating this mess? One price is obvious - they are buying a lot of Dollars dear and seeing their value evaporate, but this doesn't seem to bother them enough to change their ways. A second, less obvious (to me) price is inflation. They buy those Dollars with RMB, which puts a lot of them out there, which they try to control by "steriliztion" - don't ask me to explain it, I can't really.
Inflation is appearing in China. The price of oil is affecting the price controlled supply of diesel and gasoline, apparently causing considerable tension and dislocation. Will it become severe enough to threaten China's economic juggernaut? It's the only threat that I find likely to get them to mend their ways.
For the US, the pain is likely to be more severe.