Monetary Independence Day

by Dan Denning

I came to Asia looking for a path out of a dollar-based U.S. centric world and into a something-else-based non-U.S. centric world. If possible, I wanted to find Asian stocks that provide direct exposure to the growth story taking place here, without taking on too much risk. Easier said than done.

Asia has all the tools to get out of the dollar…high savings rates, domestic demand, raw materials, and cheap labor. Yet it’s still wedded at the head to the greenback. And Asian stock markets are dominated by foreign money – which as we’ve seen in the past few weeks, is skittish.

But I’ll now confess one of the other reasons I came to Asia, and specifically to Australia. I’m looking to become Sovereign. What do I mean by that? Let me put it in the form of a question….

What can you do today to make sure that your financial future is not dependent on things beyond your control?

I’m asking because most people’s eyes glaze over when you tell them the dollar could lose all of its purchasing power in the next ten years.

Most people, and maybe you’re one of them, find it unrealistic that the world’s entire financial system is so over-leveraged that it threatens to topple and radically affect living standards.

These aren’t pleasant things to think about. But neither is Hell. And if you choose to ignore them, you do so are your own peril. Why not make Pascal’s Wager instead…hoping you’re wrong but hedging your bets in case you’re right? And if you haven’t done anything yet, the markets have given you a reprieve.

The dollar hasn’t crashed, yet. The bond market hasn’t imploded, yet. And the stock market hasn’t set a new standard for wealth destruction, yet . There is still time to reduce your risk.

Part of reducing your exposure to the biggest financial risk of your lifetime is to think about more than just your stock portfolio. You have to think about all your assets. If you take seriously the proposition that no currency regimes last longer than seventy five years, than you have to put some real thought into what changes you’re going to make to your personal balance sheet to adjust for a radical decline in the dollar.

It’s not simply a matter of reducing your equity allocation from 75% to 50% and adding cash and bullion. You can start with simple, principled goals. Stay debt free. You’re your assets liquid. Have enough cash to survive in a crunch. Live in a place that’s not going to go up in a ball of flame if there’s a great deal of social “disruption” in an American financial crisis.

That’s why I like Western Australia so much. It’s not densely populated. The climate, from what I hear, is a lot like San Diego. And it’s in close proximity to the major investment story of the next one hundred years.

It would be even sweeter, I thought, if it turned out you could get some real Indian Ocean real estate on top of all the other benefits, and get a cheap, with a currency upside. But there’s a slight problem.

Australia, like the U.S. and the U.K. is in the grip of a housing hysteria. A real estate broker I talked to yesterday says the average new homebuyer borrows around 95% of the cost of the purchase price. She also said the margin of error for a first time homebuyer is incredibly thin. If incomes don’t rise faster than inflation or interest rates…the marginal buyer falls off the margin, and is doing so at the rate of 50%.

That’s why the central bank here has already started hiking rates. And just a modest hike has been enough to put a crunch on new housing demand in the hot markets of Sydney and Melbourne.

But you’re hard pressed to find bargains anywhere, especially here in Perth. The market favors renters. It IS true that in some places of the world, this being one of them, people will always want to live. The Napa Valley, the Rockies, Paris, anything near a beach with a breeze…there are pockets of real estate that survive cyclical downturns quite well. At the worst, you may see real estate values and home prices grow less fast in these regions, but not fall in real terms.

However, in those places where home values have risen strictly as a function of low interest rates making a home affordable to new buyers, watch out. In those places, the housing stock itself is of lower quality. And the appreciation in prices is dedicated on a steady stream of low-rate powered demand coming on line.

The real systemic risk is not in the housing market anyway. It’s in the mortgage lending market, and the fact that personal liabilities (mortgages) have been securitized and turned into assets. The mortgage lending bubble has put trillions of dollars of mortgage-backed securities into the portfolios of pensioners, retirees, and otherwise hapless investors…whose retirements may now depend on the ability of their neighbors to make the monthly mortgage payment.

It’s too bad that the housing angle here hasn’t worked out in Perth. You’ll have to look in more exotic, less well-lighted places, where the sanitation is dodgy and the value is still obscure to your average comfort loving business traveler. That’s where today’s real estate bargains are.

But the hard asset/real asset strategy is still very much alive. And Western Australia is going to play a big part in it. Which brings me to Independence Day.

On Monday my hosts Andre and his mother went with me to the Perth Mint. You may know the mint through my colleague and friend Michael Checkan. Michael works with the folks here in Perth to sell gold-backed certificates to American investors looking for gold bullion exposure and some currency diversification.

I went to the Mint in a pensive mood, pondering the fate of the dollar. You’ve probably heard about the death of the dollar in a dozen articles by now. Maybe you believe it. Maybe you don’t.

For my part, I believe the Federal Reserve and the Federal Government have betrayed the American people. They’ve robbed savers by destroying yields in the money market. They’ve issued debt that will either destroy America’s credit rating when the government defaults, or take Americans generations to pay back.

The government has sold America’s financial future to foreign investors. Some people think the foreigners are patsies for owning American debt and that there’s no risk to America if foreigners buy our bonds. I couldn’t disagree more.

Instead of directing their savings into new, wealth-creating investments, Americans are going to spend years paying higher taxes so the government can make interest payments to foreign borrowers. Not money well spent.

And with over $400 billion annually going to the defense establishment, we’ve managed to garner the enmity and distrust of nearly the entire civilized world (and all of the uncivilized world), while accepting and now passively enduring routine encroachments on our right to move freely in our own country.

The so-called guardians of our money have destroyed it. Interest rates are about incentives and rewarding risk. A market determined rate of interest would fund good entrepreneurial risks and punish bad risk takers by limiting their ability to borrow through high rates.

Failure would be punished. Risks that create new products and services for consumers that improve standards of living would be rewarded.

Instead, we have a Fed that’s changed the incentives to encourage financial speculation. Why borrow to spend on your business when you can borrow at one percent and buy a mortgage-backed bond yielding four percent? It’s risk free return right? Why worry about the future when you can consume today?

The Fed has engaged in what Richard Russell calls immoral behavior. Russell is right. Free markets break down when people start behaving immorally and taking bad risks simply because they can afford to. As my friend Andre says, it’s going to end up being return free risk by the time the whole affair ends. But when, you might ask, will the whole thing end? And why?

The ‘when’ is anyone’s guess; the whole world is bound to the dollar’s fate. No one is eager to abandon the devil they know for the devil they don’t. So foreigners keep on selling their own currency and buying the American one. Asia lacks the self-confidence to get off the dollar standard.

Of course there’s got to be a real limit to how many yen Japan’s government can sell or how many dollars it can buy. And as Andre pointed out, the fact that China is now running a trade deficit may have a serious impact on its dollar consumption. When you have no surplus with which to buy dollars or U.S. bonds, you buy a lot less of them.

Heck, you might even sell a few of those bonds to raise the money you need for your raw material and energy needs, or the money you need to feed and provide medical care for the 600 million peasants who live in the countryside and have not enjoyed the prosperity of coastal capitalism.

But just what is the limit? Well…I suppose it’s possible you could see a current account deficit that’s 10% of GDP before the imbalances become so radical that an involuntary adjustment (crash) occurs.

Ten percent is just a number out of a hat though.

The truth is that the world’s financial system is now so intertwined and complex that it’s getting harder and harder for different financial players, from the biggest to the small, to make simultaneous adjustments for interest rates, currency fluctuations, and geopolitical risk.

That leads me to believe that when the adjustment comes, it will be because something has broken…a bullion bank goes bankrupt, a sovereign, corporate, or GSE bond default…an oil terminal terrorist attack that drives crude to $100.

Of course, these are all events, which are out of your control. You can’t do anything to prevent them. But you can acknowledge that any or all of them could happen today…in five weeks, or five years.

That means you still have time to make the big decisions about where you want your money invested and what mix of assets you want in your personal balance sheet. As I said, I’m leaning ever more to fewer equities, more bullion, and when you are in the equities market, being in with leveraged options bets that hedge your risk on your open long positions.

And then there’s gold. The other day at the mint Andre’s mom suggested I have a coin stamped in honor of American Independence Day. But I did her one better. Andre and I were unable to describe what the world will look like when the dollar-standard levee breaks and the great pool of liquidity pumped by the Fed over the last four years sloshes down the drainpipe of history.

But a little bullion in your pocket never hurts.

Accordingly, I had three coins stamped at the Mint. Mind you, I’ve not violated the U.S. constitution by minting my own currency. It’s not legal tender and it’s not transferable. Still, I have three collectable coins as a start to a new monetary regime.

On one side of the two silver coins and one gold-plated coin is the Black Swan, a symbol for Perth and the mint. It says, “The Perth Mint, est. 1899.”

On the other I had the following inscribed: One Bill Bonner, Reckoning Day Reserve, DDGU, July 4, 2004.

I know Bill is probably not keen to have a currency named after him. He’s pretty modest. But the Reckoning Day Reserve sounded right to me. DDGU is short for the trade of the decade, “dollar down, and gold up.” And I backdated the date by one day to commemorate this new declaration of monetary independence.

But the date doesn’t really matter. The question for you is, when are YOU going to declare your monetary independence from the fate of the currency your government has done so much to endanger? It’s not too late.

And who knows…maybe the Reckoning Day Reserve will catch on. I’m here in Perth for two more days. Maybe if I crank up the printing presses I can give the Fed Chairman a run for his money.

If not, I plan on giving the coins away as door prizes, one at the commodity and resource conference I’m speaking at in San Diego next week and the other at the annual Agora Wealth Symposium in Vancouver in August. I’ve posted pictures of my monetary experiment below (and the image that inspired them), although they’re kind of fuzzy.

It’s ironic that the hotel I’m typing from formerly housed the Australian Tax Office. Some things, like buildings and land, can be reclaimed and put to their proper, life-affirming, profit-making use. Other things, like fiat money, are irredeemable.

Human beings, for their part, are always redeemable.

It is our great virtue, or gift from God, as you choose to believe. And while our government may have betrayed us and behaved in a grossly immoral fashion by running up debts it can’t pay and selling out ownership of our future, there is always personal redemption to be found, and the financial kind can even be secured in this lifetime.

That redemption begins without debt, proceeds with cash in hand, and endures with real assets that you can make liquid if and when you need them. You may never need them. But it’s better to be sovereign than sorry.