Lessons of History, Part I

Marc Faber, on his way to the ultimate question: ‘…How much longer will foreign investors, which are financing the U.S. trade and current account deficit, be willing buyers and holders of American stocks, bonds, and the dollar?’ The ‘answer’? Tommorrow…

I recently read and reviewed ‘The Great Swindle – The Story of the South Sea Bubble’ by Virginia Cowles (Collins, 1960). The book deals with the rise and fall of the South Sea Company and John Law’s Mississippi Company in the early part of the 18th century.

As I read this entertaining book I became more and more fascinated by the many parallels between this early period of speculation in our capitalistic age and today’s financial environment. In particular, I was astounded by the similar role that paper money, excessive credit creation, and highly questionable practices – by governments as well as businesses – played in fuelling the financial excesses in both periods.

From time to time, a wave of optimism spreads around the world like a bushfire. People believe they are seeing the dawn of a new era, which will bring unimaginable riches and prosperity to all. Waves of new era thinking are usually associated with discoveries (the Americas, gold deposits in California), the opening up of new territories (the Western territories of the U.S., the opening of China in recent years), the application of new inventions (canals, railroads, the automobile, radio, PCs, the Internet, wireless communication, etc), the rise in the price of an important commodity (rubber at the beginning of the 20th century, oil in the 1970s), peace treaties (the breakdown of communism), or strong economic performances.

South Sea Bubble: New Era Thinking

A typical feature of ‘new era’ thinking is that it usually engulfs a country or the world not at the beginning of an era of prosperity, but towards the end of such a period, and is associated with some sort of a ‘rush’ or investment mania. Two of the most well known examples of this phenomenon are John Law’s Mississippi Scheme and the South Sea Bubble, which occurred almost simultaneously in the early 18th century.

‘The Great Swindle’ is an excellent account of the events that surrounded the South Sea Bubble and the Mississippi Scheme. Although over the following 300 or so years the stage of investment manias repeatedly changed, the script, the accessories, and the nature of the actors participating in the bubble have largely remained the same.

The ‘bubble’ model always involves a ‘displacement,’ which leads to extraordinary profit opportunities, overtrading, over-borrowings, speculative excesses, swindles and catchpenny schemes, followed by a crisis during which fraud on a massive scale comes to light, then by the closing act during which the outraged public calls for the culprits to be taken to account. In each case, excessive monetary stimulus and the use of credit fuels the flames of irrational speculation and public participation, which involves a larger and larger group of people seeking to become rich without any understanding of the object of speculation.

The saga of the Mississippi Scheme and the South Sea Company is historically relevant, for example, because it contains all the major features of subsequent manias: shady characters, corruption, fraud, dubious practices, the creation of money and the extension of risky loans in order to keep the speculative orgy going, the catalyst, which leads to the initial collapse – usually the revelation of fraud, the inability of a large speculator to come up with the money to meet a margin call, the revelation that insiders cashed out, or some adverse economic or political news – and then the panic during which greed and euphoria are replaced by fear and the speculators’ desire to get out at any price.

What is also important to understand is that both the promoters of the South Sea Company and John Law attempted to support the market at any cost. At some point, however, market forces proved to be far more powerful than any price-supporting measures they could ever have taken.

South Sea Bubble: the Mississippi Scheme

The Mississippi scheme in particular provides a relevant example of the ineffectiveness of printing money to stimulate the economy and lighten its debt load. John Law’s policies of the day are reminiscent of those of the current U.S. central bank, the aim of which is to solve any problem the same way Law tried to solve the Mississippi Company’s problem – simply by increasing the money supply.

That such monetary policies will lead to the same price increases, which, at the time of Law’s Mississippi Scheme, destroyed people’s faith in paper money, ought to be clear. Whether, at that point, current central bankers and government officials will conspire to expropriate investors’ gold possessions, as Law did, remains to be seen. But we shouldn’t forget that in 1933, in the midst of the Depression, the U.S. government declared the possession of gold by individuals to be illegal.

But despite its eventual failure, John Law’s Mississippi Scheme is an important event in economic history since it represented an attempt to introduce paper money on a large scale. The Banque Générale was primarily a deposit bank and not a lending bank, and it proved to be a great success for a while. With a limited note issue (backed by gold) and branches in the provinces, it spread means of payment away from the financial centers of Paris and Lyons and therefore had a beneficial effect on trade and industry.

The problem occurred when the regent took over the bank (it became the Banque Royal) and began to issue notes with no limit to their quantity. That having been said, we must realize that there is, of course, always a limit to the quantity of money that is being issued, and this limit comes from the market mechanism. At some point, the French public began to distrust the notes that had been issued by the Banque Royal, and then – despite all the efforts of John Law, who was by then finance minister, and the regent of France – no one wanted to hold paper money anymore. The result was that the banknotes issued by the Banque Royal began rapidly to depreciate against gold, commodities, and real assets.

We see, therefore, that a financial system based on paper money depends almost entirely on the confidence of the public in the currency that is issued by the monetary authorities, and that once confidence in a currency is badly shaken, painful consequences are inevitable.

Therefore, the reader should ask himself the question: for how much longer will foreign investors, which are financing the U.S. trade and current account deficit, be willing buyers and holders of American stocks, bonds, and the dollar?


Marc Faber
For The Daily Reckoning

October 14, 2003

P.S. Surely, there will be a time when, as was the case at the time of the Mississippi Scheme and the South Sea Bubble, the present ‘chain letter’ type of fiat money operation practiced by the U.S. Federal Reserve Board will no longer work and lead to a sharp depreciation of the U.S. dollar.

The other possibility, of course, is that the dollar begins to depreciate, not compared to foreign currencies, but – as was also the case at the time of John Law – against commodities and real assets.

Dr. Marc Faber is the editor of The Gloom, Boom and Doom Report. Headquartered in Hong Kong for the past 20 years, Dr. Faber has specialized in Asian markets and advised major clients seeking down-and-out bargains with deep hidden value, unknown to the average investing public.

Looking ahead to where the real growth opportunities of the next 30 years lie, Dr. Faber has distilled his analyses into the ground-breaking book, ‘Tomorrow’s Gold’ – a wake-up call to Western investors.

We caught up with our old friend, investment biker Jim Rogers, last night. Jim was making a presentation at the Royal Automobile Club to a group of fund managers and private investors.

‘You can read the papers all you want. You can even go to a country and talk to the finance minister. I can tell you exactly what he’ll say: that things are improving.

‘But if you really want to know what is going on, you have to go out and talk to real people…cross the border at some remote location…talk to people. What we found after going around the world for 3 years was that if you really want to know what a place is like, you should talk to the woman who runs the whorehouse. The madams seem to know everything.’

What Jim wants to find out when he travels is what we try to figure out at home: Are stocks going up or down? Is the currency solid? What is going on?

‘I’ll tell you what is going on right now,’ Jim continued, echoing themes from his foreword to our book. ‘Americans have over-reached. That is what you find out when you get out and talk to people. No matter where you go, people generally are friendly to Americans, but they distrust and dislike the way the American government throws its weight around. We have troops in 120 different countries. It costs a fortune to keep them overseas. They’re supposed to be making the world safer for us, but from what I can tell, all they’re doing is making enemies. When we were traveling around, Paige [his wife] and I tried to defend our government, but I don’t know how many times people asked ‘Well, how would you like it if there were troops from Iran or Iraq or India stationed in your country?’

‘Or, ‘What would you think if there were Moslem soldiers in the Vatican…or in Jerusalem?’

‘I didn’t have a good answer. The truth is, I probably wouldn’t like it.

‘But it’s not just in foreign policy that Americans have over-reached…it’s economically, too. Americans are too far in debt. They owe more money to more people than the entire rest of the world put together.

‘Now, almost all central banks – except maybe China – have gotten very good at debasing their currencies. But none of them have gotten as good at it as our own Fed. At the Fed, debasing the currency is the stated policy. Fed governors have promised to dump dollars from helicopters if that is what it takes. And already, there are dollars all over the world. Everybody takes dollars…and everybody has dollars. And, if they ever decide they don’t need so many dollars, the greenback is in big trouble…

‘If I have one piece of advice for you, it is to get out of the dollar…’

What have we been telling you, dear reader? What have we been telling you.

And now, the latest news from our man on Wall Street, Eric Fry:


Eric Fry in Lower Manhattan…

– In the spirit of Columbus Day, the Dow Jones Industrial Average re-discovered territory it last explored in June 2002. The Dow rose 90 points to 9,764. The Nasdaq Composite also ventured into regions so unfamiliar that they seemed almost foreign. The Nasdaq added 1% to 1,933, a level not seen in almost 21 months.

– But investors fully expect the stock market to secure the territory around Dow 9,700 and Nasdaq 1,900 before advancing to subdue distant, savage locales like Dow 10,000 and Nasdaq 2,000.

– Gold, looking every bit the frightened native, retreated $4 during the morning yesterday, but then regained its courage to advance $1.60 for the session to $375.70 an ounce. Gold stocks fared even better than the metal itself, as the Philadelphia Gold and Silver Index rose 2.4%. Gold’s resilience yesterday was quite surprising, given the fact that the dollar strengthened nearly 1% against the euro to $1.167.

– Typically, gold falls when the dollar rallies. But these days, the gold market seems to be charting a steady, bullish course toward $400 an ounce, no matter what direction the dollar winds are blowing. Clearly, the gold market has gained a few admirers during the past couple of years, both here in the States and overseas. Asian demand, for example, is strong and growing.

– ‘More domestic investors are interested in tapping into the gold market,’ the Shanghai Daily reports, ‘with more than 20 percent of stock investors willing to transfer part of their funds to the gold market, according to a questionnaire of investors in ten Chinese cities…7.5 million stock investors will invest in gold in the near future, said the questionnaire.’

– Hmmm…7.5 million Chinese investors couldn’t be wrong, could they?

– Continuing the explorers-of-the-world theme, your New York editor attended a party on the banks of the Hudson River yesterday. (The majestic river is, of course, named after Henry Hudson, who discovered the river in 1609 while searching for a northwest passage to the Orient.) On a spectacular autumn day, your editor dined al fresco at the Harvest restaurant in Hastings, New York. He spent about half the time gorging himself on antipasti and roasted lamb, and the other half of the time trying to shoo his 5-year old son away from the water’s edge.

– Every October, the restaurant’s owners invite family and friends to the Harvest for a grape-pressing and Italian-style feast. And what a feast it is! The Harvest is your New York editor’s favorite restaurant outside of Manhattan, both for its outstanding menu and its spectacular location. The restaurant sits a half-hour train ride north of the city along the Hudson River.

– The cuisine at the Harvest derives from the very same meals that its gastronomic Italian owners prepare for themselves. In other words, the owners eat their own cooking…unlike their counterparts on Wall Street.

– Down on Wall Street, no one eats their own cooking, especially not corporate insiders. Stock purchases by company insiders last quarter hit their lowest level in a decade, according to Thomson Financial. But insiders are not hesitating to dump their stock. Company executives unloaded a hefty $36 worth of their own stock for each $1 in purchases.

– ‘Since March,’ Newsday observes, ‘investors have bid up share prices almost consistently, apparently convinced that the economy is improving, corporate earnings are growing again and the market rally is real. Corporate insiders apparently don’t agree. Corporate executives combined to sell $8.7-billion worth of stock during the third quarter, the highest quarterly volume since the second quarter of 2001…Do executives know something the rest of us don’t?’

– Why is it that they don’t like home cooking?


Bill Bonner, back in London…

*** Today’s headline from the Guardian: ‘The high cost of E-Z credit: debt in arrears up 70%.’

In Britain, as in America, consumers have gone into debt at an alarming pace. The costs are beginning to mount up.

*** And another: ‘House prices start to fall in many parts of Britain,’ says the Daily Telegraph. Last year, house prices in Britain rose at a 30% rate. This year, they are still becoming more expensive but at only half the rate.

‘The average price of a first-time home is 123,000 pounds,’ reports the paper. ‘For someone on the average salary of 25,000 pounds, this is still impossibly expensive.’

*** William Bennett, Jim Bakker, Jimmy Swaggert, Newt Gingrich…one by one, the great scolds of conservative Republicanism and religious damnation have fallen, victims to their own sordid weaknesses. And now, we have the spectacle of Rush Limbaugh’s admission that he is hooked on drugs.

First, a disclosure: a family member, Elizabeth, was once a fervent dittohead…a Rush Limbaugh fan.

Followed by a condemnation: Limbaugh should be ashamed of himself. If he wants to take drugs, it is nobody’s business but his own. But for him to confess in such a limp, pathetic fashion that he is ‘addicted to prescription pain medication,’ is appalling. If he is not proud of taking drugs, he may keep it to himself or blurt it out on the airways. But at least he might be a man about it. The spectacle of confession, apology, clinical treatment and rehabilitation has become as tiresome and fraudulent as a congressional hearing.

How refreshing it would be to find an honest sinner in the public spotlight. Like the great Southern politician who, accused of sleeping with a prostitute, gave this public retort:

‘It is reported right here in the paper,’ he began, ‘that I was seen coming out of the Sleepy-Time Motel at 5am after sleeping with a well-known prostitute. Well….I want to tell you that every word of this is a bald-faced lie. I never laid eyes on the woman before in my life. And it wasn’t the Sleepy-Time Motel, it was the Triangle Motel. And I didn’t come out at 5am…I came out at 7am…And we didn’t sleep a wink.’

*** And our own confession: Yes, we admit it; there is no weakness of the flesh we have not envied and no bad habit we have not tried to take up. Every man should have at least one well-developed fault, something to which he can be loyal.

A man with a serious drinking problem, for example, is practically immune from womanizing; he cannot remember where he left the girl’s phone number. So is a man with a good mistress immunized from strong drink or gambling; the woman will not readily share him with another vice. She’ll keep him to herself until she’s squeezed the life out of him. Then, when they put the pulp of the man in the grave, the happy fellow can go meet his God with only a single blemish on his record.

A man without a sustaining bad habit, on the other hand, is open to suggestion and prey to any sort of trouble that comes along. That is our problem; we are always out of step, even at sin we cannot seem to go along with the parade, nor ever entirely give up our suspicion that the whole thing is a waste of time. We almost never see a skirt we wouldn’t like to chase…but the one we find most alluring is worn by our own wife. We drink too much whenever we get the chance…but we’re too busy to make a serious past-time of it; we rarely drink so much we fall down. Gambling requires too much attention…we could never master it. And drugs? We are saving them for later in life, when we really need them.

So you see, dear reader, if ever we are called to make an apology on national television, it will be a sad and disappointing farce. The ratings would go down.

*** ‘Dear Mr. Bonner, read your book: Loved it! Congratulations for putting such a wise and funny book together.’

Readers continue to write in about Financial Reckoning Day, currently making its way to bookstores around the country.

‘What a fantastic book!’ writes another. ‘Thank you very much for sharing such deep insights. Normally, it takes me a considerable length of time to read a book, by dribs and drabs, ‘when I find time’ or when it is convenient. Some books I never complete – I get so far, and don’t find any good information, so I never find the time to complete them. Unfortunately, there are too many of those piling up.

‘However, your book I could not put down. Every chapter was better than the last.’

‘Financial Reckoning Day was a thoroughly enjoyable read,’ writes a third. ‘Its perspective surely needs to be considered by any astute investor. I have positioned my financial portfolio for the currency crises of the U.S. dollar, which I agree is inevitable thanks to Greenspan et al. Many thanks for your enlightenment!’

On the other hand, one reader warns: ‘Beware, your book may end up being a contrary indicator…signaling a monstrous new bull market…somewhat like that book written in the early 1990s called ‘The Coming Great Depression of the 1990s’…being published and released right before the great move up that started in 1995…LOL’

Unfortunately, we may not get to all the e-mails. So, we would like to say ‘thank you’ to everyone who has purchased a copy thus far. And ask, if you liked it, maybe you could recommend the book to a friend.