Boom-retardant Portfolios

We kicked off our annual Agora Financial Symposium in Vancouver yesterday. As always, debates were heated, drinks were had, and one speaker warned:

“We’re all freaking doomed!”

You guessed it, dear reader. The great and mighty Mogambo made an appearance as the first day of the conference wrapped up.

“And why are we all freaking doomed? INFLATION!” he bellowed, to many a startled conference goer. “The world’s greatest evil.”

So, perhaps the Mogambo is a bit melodramatic, but the points he made were valid. “Monetary inflation leads to price inflation…causing EVERYTHING you buy to cost more: stocks, bonds, houses – even food.

“All excesses of new money and credit always drives up prices – but not wages.”

And a lot of what the Mogambo had to say fits in directly with a topic we’ve been writing about in these pages: the Crack Up Boom.

Mises originally coined the term, describing the Crack Up Boom as an occurrence that happens when the generally ignorant masses catch on to the “deliberate policy of inflation.” Meaning that while prices of everything in our world go up, up, up…the average consumer looks on blissfully, believing that eventually, price will drop.

“But then [the masses] become suddenly aware that inflation will go on endlessly. A breakdown occurs. The crack up boom appears. Everybody is anxious to swap his money against real goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.”

So what do you want at the end of a crack up boom? Gold. Something tangible…that doesn’t lose value and can’t be created out of thin air – or by flipping a switch on a printing press.

While the yellow metal basically sits on the sidelines doing nothing, when the dollar starts hitting record lows, but your grocery bill…electricity bill…and kids tuition is getting higher and higher, these lazy lumps of metal starts looking pretty darn good.

“When the crack up boom cracks up,” Bill finished up his speech, “you’ll find no happier person than the one holding lumps of gold that are doing nothing.”

(You can get a sneak peek into Bill’s second speech, below. In the meantime, why not see if those lazy lumps of yellow metal can be of any use to you as the dollar continues its long, slow slump.

Bill Bonner
The Daily Reckoning
Vancouver, British Columbia
Wednesday, July 25, 2007

More news…

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Chris Gaffney, reporting from the EverBank world currency trading desk in St. Louis…

“I find it strange that currency traders picked this morning to rally the dollar, but it happened, and the euro and pound sterling are both off about a cent in early European trading.”

For the rest of this story, and for more market insights, read today’s issue of The Daily Pfennig

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And More Views…

*** “Gloom and doom ain’t what it used to be,” Bill began his speech this morning, eliciting a chuckle from the over 700 attendees.

“Back when we had a lot of trouble…the Great Depression…the Cuban missile crisis…people had sense of appreciation for that trouble.

“To put it another way – there is nothing like a long run of good luck to destroy a person.”

Some would argue that this is the major problem in America today – being ill equipped to deal with rainy days. Like we wrote in Empire of Debt, Americans believe these delusions: that you can get something for nothing…that this generation can consume and stick the next with the bill…and that house prices will forever go up, just to name a few.

“And the big problem with that is: when you don’t appreciate trouble,” continued Bill, “you go looking for it.”

Even if you weren’t able to join us this year, you can hear Bill’s full speech – and speeches from the 5 other best-selling authors, financial analysts and experts we’ve gathered in Vancouver – by purchasing the audio recordings of the conference.

For a limited time, you can get the cds at a discounted price – but once the conference is over, the price of the recordings (and the special report that we are throwing in) will go up to $149 – so be sure and order your set of cds now.

*** All you have to do is look at the housing market – or, more specifically, the subprime market – to see that America has been looking for trouble.

A recent report from Moody’s says that the credit market shakeup caused by the faltering subprime market gives “serious reasons to worry” and is a “reality check” – but that everything will be just fine.

Seems like they’ve been taking lessons in doublespeak from the Fed heads.

Bloomberg reports:

“Financial institutions’ ‘ability to withstand shocks is very high, perhaps higher than ever,’ Moody’s said. ‘The main risk in our view at this juncture is not that the system may suddenly collapse but rather that it derives a feeling of invulnerability from this episode, when losses have been eventually digested.’

“The current crisis may worsen if one or more ‘systemically important financial institutions may be threatened.’ Another scenario might be a ‘severe retrenchment from risk taking’ causing a credit crunch, Moody’s said. A third might be the destruction of enough financial assets to threaten the prospects of the economy, Moody’s said.”

So…we’re not sure how you want to take that, dear reader. Our advice? Check out Dan Amoss’ latest report – he tell you exactly what level of worry is appropriate in this situation, and how you can protect your assets from the ripples the subprime bust is causing the global economy.

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The Daily Reckoning PRESENTS: It’s true; central banks do have a huge impact on the debasement of fiat currencies, but consumers, too, have their part to play, as the more people spend, the more they risk pushing up prices. Adrian Ash explains…

STOP! OR THE ECONOMY GETS IT

We only have ourselves to blame. Consumers in the West, rich in credit ratings if not cash, shouldn’t have borrowed and spent so much money when interest rates hit a half-a-century low in 2003.

Nor should we have continued to borrow and spend when the rate of interest slipped below the inflation rate – making debt pay as cash savings lost value – over the next two years.

And we really should have then spurned all those super-low teaser mortgages…0% charge cards…and money-back deals on shiny new SUVs…when the global money supply began to balloon between 2005 and 2007.

If the cost of living suddenly shoots higher, then our monetary masters at the West’s central banks will stand ready to say: “Told you so!” Because they themselves, of course, have got nothing to do with the problem.

“The sooner households begin to acknowledge the consequences of higher interest rates,” warned Bank of England member Tim Besley in a speech this week, “the greater is the chance of a smooth adjustment towards a level of consumption consistent with maintaining the inflation target in the medium term.”

In other words, “Stop – or the economy gets it!” And Besley’s logic, like his task as a central banker, is simple enough.

The more people spend, the more they risk pushing up prices. He might have been wagging his finger at consumers across the Atlantic as well as in the United Kingdom – along with households in Australia, New Zealand, South Africa, Spain, Ireland…

Wherever household debt has exploded, funding an explosion in house prices and consumptive debt, the solution looks clear: Make money dearer, and inflation will recede. Indeed, “it is a widely accepted proposition in the economic profession,” as the European Central Bank notes in its most recent policy statement, “that a change in the quantity of money in the economy will be reflected in a change in the general level of prices.”

The task of central banking, in short, is to maintain the quality of money – preserving its purchasing power – by controlling the quantity that’s sloshing around.

Right?

Trouble is, the Western world’s central bankers don’t seem to have much control over the very mechanism that they claim turns higher interest rates into lower inflation. The supply of money – the actual quantity of cash and near-cash financial instruments sloshing around the globe – has shot higher even as the Fed, Bank of England and ECB in Europe have begun making debt more expensive.

Classically defined, inflation means exactly this kind of growth in the quantity of money. Capping it with higher borrowing costs makes sense in theory. That was how central bankers led by Paul Volcker at the Federal Reserve finally got round to killing the Great Inflation of the late 1970s. It took them more than one attempt, too.

“By the end of the 1970s and the early 1980s a number of the leading central banks acted more forcibly against inflation,” Volcker said in a speech 10 years later. “They acted in the only way they effectively could, by restricting the overall growth of money and credit.”

Problem was, “as the restraint took hold, one country after another was caught up in recession or an extended period of stagnation” – and even central bankers need to make their mortgage repayments each month. Raising interest rates to slow inflation will never be popular. Raising them so far that your neighbors lose their lose jobs is a tough call to ‘fess up to at your local barbecue.

“Many government officials throughout the free world became monetarists in the 1970s,” writes David Hackett Fischer in his grand history of price inflations, The Great Wave. “Major efforts were made by the Federal Reserve Board in the United States and the Bank of England in the United Kingdom to stabilize their disordered economies by regulating the money supply. These efforts were not successful and actually increased instabilities.”

“Economist Milton Friedman raged against the errors of his own disciples,” notes Hackett Fischer, “repeatedly accusing the governors of the Federal Reserve System and the Bank of England of grievous incompetence.”

But as John Kenneth Galbraith commented, “An economic policy needs to be within the competence, however limited, of those available to administer it.” In other words, a solution proposed is no solution at all if it proves impossible in practice – and perhaps a return to some kind of Gold Standard would prove to be just such a non-solution today.

Limiting the growth of world money supplies to the 1.3% growth in above-ground gold stocks each year, a Gold Standard might seem the only solution to our brave new century’s insane bubble in credit and debt. Tinkering with interest rates has done nothing to slow the current boom in world credit and debt.

“The global derivatives market grew nearly 40% in 2006,” as Robert Rodriguez of First Pacific Advisors, an $11-billion investment fund, noted in a speech to the CFA Society of Chicago late last month. “The amount of contracts based on bonds more than doubled to $29 trillion. The actual money at risk through credit derivatives increased 93% to $470 billion, while that amount for the entire derivatives market was $9.7 trillion.

“The International Monetary Fund, in its April 2006 Global Financial Stability Report, estimated that credit-oriented hedge fund assets grew to more than $300 billion in 2005,” Rodriguez went on, “a six-fold increase in five years. When levered at five to six times, this represents $1.5 to $1.8 trillion deployed into the credit markets.”

Squashing the global supply of what now passes for money into the even broadest measure of world gold holdings – the outstanding stock of 153,000 tonnes now reckoned to sit above ground – might just mean destroying the economy first. That’s why, like the fake monetarism practiced by central bankers in the late ’70s, it’s unlikely to work. Just try getting a Gold Standard past Congress…no matter how bad inflation becomes!

But that’s not to say gold doesn’t hold a monetary value today. The only question for investors and savers: Why wait for the rest of the world to catch on?

If the bubble in credit and money hadn’t grown so large in the first place, we wouldn’t need to defend ourselves with a lump of shiny yellow metal. But perhaps that’s where we’ve got to, awaiting the whirlwind now due after sowing so much bad debt.

Regards,

Adrian Ash
for The Daily Reckoning
July 25, 2007

Editor’s Note: Adrian Ash is the City correspondent for The Daily Reckoning in London and is formerly the head of editorials at Fleet Street Publications Ltd. He has been studying and writing about the investment markets for the last 9 years, and is now head of research at BullionVault.com – giving you direct access to investment gold, vaulted in Zurich, on $3 spreads and 0.8% dealing fees. Read the latest from the vault at www.BullionVault.com.