Stefan Zweig Meets Mr. Market

Fred Sheehan

Legislators are as powerless to abrogate moral and economic laws as they are to abrogate physical laws. They cannot convert wrong into right nor divorce effect from cause, either by parliamentary majorities, or by unity of supporting opinions. The penalties of such legislative folly will always be exacted in inexorable time. While these propositions may be regarded as commonplaces, and while they are acknowledged in a general way, they are in effect denied by the many of the legislative experiments and the tendencies of public opinion of the current day.

– John MacKay (1912)

The February 25, 2004, Gloom, Boom & Doom Report, titled “Are Investment Markets Beginning to Stall?” opened with a book review of the Two Income Trap (by keeping up appearances, the American middle class is drowning in debt) which described the decline in living standards, and culminated with the dismal admission: “I am deeply concerned about the economic future of the West.”

I share this fear. If we are on the cusp of a deep decline, what happens next? There is no syllabus for such a study. The approach taken was to look at precedents, identify the common social and financial characteristics, and observe how they unfold. My point of embarkation, like the average investors’ response to the Federal Reserve chairman’s latest pronouncement, is to take the statement as fact. That will avoid the endless ratiocinations of whether we are headed into an inflationary or deflationary period and when – or if – whatever happens is going to happen.

If all the inflationists and deflationists sat down to dinner, they would probably come to at least one majority opinion: prices will fluctuate to a degree most have never known. The financial cause and effect is there for anyone with eyes to see: the world’s integration is rising on a vast expansion of unsecured credit, tightly bound in carry trades, hedge funds, derivative swaps and multi-billion dollar institutional portfolios solely positioned for this quarter’s relative performance. Part-and-parcel to the world’s trading position is the worldwide bubble in every market: US and UK houses, copper and soybeans, Euro bonds.

Where will it burst first? What’s next? Can some of the minor bubbles deflate rather than burst? It would be silly to predict the markets in which to hide and chase and avoid when the trillions of dollars start to unwind, or how quickly or slowly it will unravel. In times past, prices moved very quickly, once they got going. Leo Tolstoy described such a situation when Napoleon reached the outskirts of Moscow: “Prices that day indicated the state of affairs. The price of weapons, of gold, of carts and horses kept rising, but the value of paper money kept falling…peasant horses were fetching five hundred rubbles each [a life’s savings – ed. note] and furniture, mirrors, and bronzes were being given away for nothing.”

Note that both inflationists and deflationists receive a gold star. Note also that both teams of combatants were right at the same time! Life is bliss. Please note, too, that gold was a hedge against deflation, which (along with silver) has historically been true.

We live in the midst of the largest financial bubble the world has ever known. The past patterns are what I hope will steer the reader to recognise any similarities to conditions today, where we are likely headed, and what to do about it. World bubble-isation is courtesy of a monetary phenomenon that lacks antecedents.

Never before has any country printed as much money or extended as much credit without melting down the printing presses. The US dollar remains the world’s reserve currency, and our dollars are absorbed by any and all. Thus the 25% inflation rate shows up in speculative finance, the traditional cubbyhole for excessive credit.

One financial effect is the barely detectable movement from paper to real assets. If it grows, financial assets such as stocks, bonds, houses (which are 0% down payment financial products), mortgage-backed securities, and assorted derivatives will sink. The demise of the US dollar and bond market seems a good bet, but not a sure one. There is no knowing where the bubble will burst first. There could be an instinctive rally into the dollar and bonds – dealing with the devil you know.

The credit madness is difficult to comprehend. It is hard to understand in relation to past economic imbalances, because none exist. The relationship, though, between money printing and credit expansion is as old as the hills. (In the end, it is the overextension of credit to vagabond borrowers and speculators that crashes.)

The most virulent bacillus is the Federal Reserve Bank. It feeds the credit-creating agencies, banks and enterprises with the means to sell credit: money.

A broad measure of the US money supply, M-3, rose by US$500 billion in the front half of the 1990s, then accelerated by US$2.5 trillion in the back half. To keep the bubble aloft after the stock market debacle, the amount of money issued from 2000 through 2003 exceeded the entire amount of currency printed in the history of the United States, from George Washington’s inauguration to 1980. The baton then passed to the central banks of Japan and China, which have consumed our currency at an astounding rate. More money is the platform for more borrowing.

Total credit market debt in the US (government, corporate, individual) rose from US$4.7 trillion in 1980 to US$28.9 trillion by the third quarter of 2001, and hit US$33.6 trillion two years later, a period during which Americans acquired more than the total amount of debt borrowed and accumulated from the Constitutional Convention to Ronald Reagan’s inauguration. Credit must move at an ever-expanding pace. The 1.0% fed funds rate and Fannie Mae’s insatiable appetite for any and all mortgages help, but a sinking debt structure needs to move faster and faster – a centrifugal supernova.

We witnessed the recent spectacle of the Federal Reserve chairman imploring homeowners to replace their fixed-rate mortgages with variable-rate loans because homeowners “pay a lot more money for…the insurance against increasing mortgage payments than option-pricing models deem statistically necessary”. (In testimony a few days later, he acknowledged that 1% interest rates are “inconsistent with long-term stability”, a truism surely not incorporated in his option-pricing model.)

It is best to open with a scenario and we will look at the future as seen through the eyes of Sir John Templeton. His fortune was earned with the guiding policy of “buy at the time of maximum pessimism and sell at the time of maximum optimism”.

He left little ambiguity as to his state of mind in an interview last year with Equities magazine, in which he informed investors to expect a 1929-style stock market crash. Total current debt in the US is three times the GDP.

“That is unprecedented in a major nation…and it’s bigger than it was at the peak of the stock market boom.” Then Templeton really let loose: “A home price decline of as little as 20% would put a lot of people in bankruptcy…[I]n bankruptcy, houses are sold at lower prices, pushing home prices down further. After home prices go down to one-tenth of the highest prices homeowners paid, then buy.” An alternative, though not inconsistent, possibility was submitted by Marc Faber in the June 23, 2003, Gloom, Boom & Doom Report.

Should we even remotely approach the conditions under which Templeton’s scenario kicks into action, this would “prompt Mr Greenspan, whose habits have changed little since he was a consulting economist…in the early 1970s [when Faber met regularly with him], to erroneously believe the Fed hadn’t eased sufficiently.

Another tidal wave of liquidity would be injected into the system…the bond and foreign exchange markets would no longer be fooled…[and] a violent downward adjustment in the dollar exchange rate…would immediately follow….” Faber goes on to say that foreign central banks would be compelled to follow. This would depreciate all currencies against hard assets and would lead to a stabilisation crisis that would be worse than the German stabilisation crisis of 1923.

Precedents of suicidal money experiments abound – it has happened in the US before. We will first discuss the French assignat, which has all the characteristics that reoccur in other brouhahas. The inflation and deflation; the lack of political will to stop it in time; the subsequent destruction of political institutions that have lost all credibility; moral degeneracy; ubiquitous vulgarity; speculation; the annihilation of time; abandonment of the future; the impoverishment of the poor and the middle class; feverish economic and financial activity before the collapse; and the consequent strong man as Leader.

Again, I am not predicting, but instead, expounding on the initial premise. One other common feature is the bedazzlement of smart and knowledgeable people, whistling past the graveyard, while the hangman adjusts the scaffold. This is usually the case and worth remembering since it is difficult to hold convictions, and only human to harbour doubt, when all around live on Fantasy Island. A central problem within the investment industries is of narrow concentrations. Someone may be expertly versed in the monetary aggregates, flow of funds, historical market ratios and the hidden debt shifted off-balance sheet, but a person who anticipates the calamity discussed must be equally attuned to how people behave.

An eloquent witness to his own myopia was Stefan Zweig. It is for this reason I include a rather prolonged quotation from his autobiography, The World of yesterday, about late 19thcentury Vienna during the Habsburg monarchy.

When I attempt to find a simple formula for the period in which I grew up, prior to the First World War, I hope that I convey its fullness by calling it the Golden Age of Security. Everything in our almost thousand-year-old Austrian monarchy seemed based on permanency, and the State itself was the chief guarantor of this stability.

The rights which it granted to its citizens were duly confirmed by parliament, the freely elected representative of the people, and every duty was exactly prescribed. Our currency, the Austrian crown,circulated in bright gold pieces, an assurance of its immutability. Everyone knew how much he possessed or what he was entitled to, what was permitted and what was forbidden.

Everything had its norm, its definite measure and weight. He who was fortunate could accurately compute his annual interest. An official or an officer, for example, could confidently look up in the calendar the year when he would be advanced in grade, or when he would be pensioned. Every family had its fixed budget, and knew how much could be spent for rent and food, for vacations and entertainment; and what is more, invariably a small sum was carefully laid aside for sickness and the doctor’s bills, for the unexpected. Whoever owned a house looked upon it as a secure domicile for his children and grandchildren; estates and businesses were handed down from generation to generation…. No one thought of wars or revolutions, or revolts. All that was radical, all violence, seemed impossible in an age of reason.

When all is well, the tendency is to believe that all is well. This is true where debts pile up higher than ever before in human history, yet, this is believed to be “wealth”. Where a nation spends more than it earns, reduces capital spending to the vanishing point, and yet (completely missing the point) moans about outsourcing of jobs to countries where capital is funding new plants and factories. Where an economic recovery is predicated, not on a rejuvenation of industry and production, which may be sustainable, but on

an artificial, upwardly sloping yield curve manipulated by a government agency. Where the population is told, by a Federal Reserve governor, that if all else fails, the government will drop money from helicopters; therefore, do not busy your minds with the complicated subject of economics; all will be well.

Zweig, writing in 1942, sees his own folly in retrospect: There was a grave and dangerous arrogance in this touching confidence that we had barricaded ourselves to the last loophole against any possible invasion of fate. In its liberal idealism, the nineteenth century was honestly convinced that it was on the straight and narrow path toward being the best of all worlds.

Zweig lived to see everything he believed of the world turned upside down. We, of the new generation who have learned not to be surprised by any outbreak of bestiality, we who each day expect things worse than the day before, are markedly more skeptical about a possible moral improvement of mankind. We have had to accustom ourselves gradually to living without the ground beneath our feet, without justice, without freedom, without security…. We finally know that world of security was naught but a castle of dreams.

Another world existed in Vienna at the same time as the Golden Age of Security. Zweig ignored it. His autobiography contrasts these two tales of one city, and we will come back to it later. In our own investment world, the indolence of not looking at things as a whole occurs over and over. Yet, so few learn. The incendiary consequences of printing more money and extending more credit than is used to finance fruitful production are well known: surplus money speculates.

A new phrase (to my mind) was introduced in the early 1990s: the carry trade. Short-term US Treasury bills yielded 3%, seemingly forever. Long-term US treasuries yielded above 6%, seemingly forever. Using 90% (or greater) leverage, investors borrowed short-term and lent long. This was very profitable, as long as forever lasted. Forever came to an end and so did several investment firms. Most everyone knew that forever would end, yet continued to play this multi-billion dollar game of chicken. Bluford Putnam, president of Bayesian Edge Technology & Solutions, gave a speech in which he described the calamity.

The market goes through a storm, and then encounters the calm after the storm. If that period of calm is long, managers should be scared. Bad things are probably about to happen. February, March and April of 1994, for example, were the worst months in the bond market since World War II. What preceded them was 18 months of the fed funds rate at 3%. The standard deviation (based on monthly data) of something that does not move for eighteen months will mislead managers into thinking they have no risk. Based on historical data, bond managers had the least amount of risk just before the riskiest period the modern bond market ever had.

Putnam’s consciousness-raising lecture emphasizes our gifts for observation and intuition, two faculties buried deep in the cargo hold of our flank-speed tramp-steamer aimed at a munitions pier on a mislabelled course called “Benchmark”. Before the market broke in 1994, investment banks had sold billions of newly developed and highly sophisticated derivatives to corporations that had no clue as to how these critters would behave. Neither did the bankers. The Orange County treasurer Robert Citron, when asked how he knew interest rates would not rise (an essential condition for his highly leveraged position), replied: “I am one of the largest investors in America. I know these things.” Piper, Jaffrey thrived under the leadership of a derivative expert who projected both authority and buffoonery. He led sales meetings dressed as General Patton. It turned out this rocket scientist never graduated from college. Citron (who also lacked a college diploma) lost the county US$2 billion and Piper, Jaffrey lost bundles, not to mention the clients who got what they deserved. Yet, at the time, the arguments to take a leveraged bet on a 3% fed funds rate made a lot of sense – if our talents, informed by experience, history and common sense were frozen in the embryo stage.

In an attempt to advance the causes of experience, history and common sense, we retreat to the reign of Louis XVI. MacKay’s introductory quotation (to a 1912 edition) is itself an introduction to Fiat Money in France: How It Came, What It Brought, and How It Ended, written by Andrew Dickson White in 1876. The book, developed from a speech, was intended to forestall some easy money experimentation floating through the Congressional agenda. A French historian by training (and the founder of Cornell University), White takes the reader on a chronological tour of a money experiment in the 1790s.

The French drama will be central to what follows. It contains all of the characteristics that reoccur in future money meltdowns: Zweig’s Austria, Germany, Argentina, and, perhaps, the world credit bubble today. The Estates General (soon after: the National Assembly) had been summoned to address the spiralling debt of the Crown. Its first act was to “place the creditors of the state under the protection and honor and loyalty of the French Nation”. The Bastille was stormed in 1789, but the Assembly was not a forum for death warrants. White, the French historian, stood sure of his opinion that: Whatever may have been the character of the men who legislated France afterward, it would be a mistake to suppose the National Assembly…was composed of wild revolutionaries; no inference could be more wide of the fact…. [Despite] all the arguments and sneers of reactionary statesmen and historians, few more keen-sighted legislative bodies have ever met than this first French Constitutional Assembly.

The Assembly’s Mission Statement, in the paragraph above, is the decree of a political body that took its responsibilities seriously. The level of knowledge in the Assembly on the nature of money was on a far higher plateau than we could expect of Congress today. One reason is the bitter aftertaste of John Law’s Mississippi scheme in 1720. Law’s experiment in paper money scarred France to a degree that, sitting in the National Assembly (of 1790) were several men “who owed the poverty of their families to those issues of paper”.

From that earlier “ruinous experience”, they knew how easy it was to issue irredeemable paper money, and (quoting White), “how seductively it leads to the absorption of the means of the workingman and men of small fortunes; how heavily it falls on all those living on fixed incomes, salaries and wages; how it stimulated overproduction at first and leaves every industry flaccid afterward; how it breaks down thrift and develops political and social immorality”.

An irredeemable currency exists where a “specie” currency does not. A specie currency is one in which the trading medium (such as a paper $20 bill) is redeemable into a set amount of (generally) gold or silver. (It was once true that if one distrusted the value of the US dollar, payment could be contractually demanded in a previously calculated fixed-rate of gold.) Where a redeemable currency does not exist, it has been jettisoned by choice or necessity. In France, it was choice hastened by a necessity.

The state finances were a shambles, the king was imprisoned. The General Assembly met in the throes of a lethargic economy in which the trading of goods had ground to a halt. “Real” money – gold and silver – had disappeared under the mattress. This is generally true in times of upheaval. (This tradition of holding dear the currency of value and offloading that which the government has compromised has a long tradition. We may soon contribute our own chapter. From Macaulay’s History of England, when the government (under William III) attempted to introduce an exchange rate at an equal value for new round coins to replace the older coins with the corners clipped off: “[New crowns] vanished as fast as they appeared. Great masses were melted down; great masses were exported; great masses were hoarded: but scarcely one new piece was to be found in the till of a shop….”)

The protagonist in our drama is Compte Honore- Gabriel Riqueti Mirabeau, described by White as “the great orator of the Assembly” who “had carried the nation through some of its worst dangers by a boldness almost godlike”. This sounds like something written by one of Greenspan’s biographers, which adds appropriate texture to Le Compte’s centre-stage appearance. Mirabeau recognized the opportunity thrust upon the Assembly, but also acknowledged the requisite responsibility: “[T]oday the June 2004 constitution is up for auction; it is the deficit that is the treasure of the State, it is the public debt that is the germ of our liberty. Do you wish to receive the benefit, while refusing to pay the price?”

Its heart may have been in the right place, but the Assembly dodged the hard choices. To honour pledges, it was necessary to raise taxes. This, the Assembly would not do.

For those who think the world’s financial system today is battered but salvageable, the Assembly’s dissembling is not inevitable. It may be that the French Revolution could have taken a gentler turn.

Macaulay describes the recognition which prompted the government of William III to act in time: “[I]t is no more in the power of Parliament to make the kingdom richer by calling a crown a pound than to make the kingdom larger by calling a furlong a mile.” He identifies a common characteristic of money meltdowns:

“The evil proceeded with constantly accelerating velocity.”

Macaulay’s narrative is of a government that looked the beast in the eye and didn’t blink. Add exactly 300 years to the following description and we may project the definitive action Greenspan could have taken at his “irrational exuberance” moment: “[Parliament understood] …something must be hazarded, or…everything was lost….There might have been recoinage in 1694 with half the risk which must be run in 1696, that risk would be doubled if the recoinage were postponed till 1698.” The government did not tarry. The recoinage was painful, but life moved on, encumbered by much higher tax rates.

Using Macaulay’s biannual, doubling-of-risk, rule-of-thumb, the post- Irrational Exuberance failure to act is now a monster 16 times the size of 1996. (Likewise, Costantino Bresciani-Turroni believed “it would have been possible to save the mark if the German government had taken energetic measures to re-establish a balanced budget [in 1920] instead of allowing Treasury bills to be discounted continually by the Reichsbank”. He also wrote (in The Economics of Inflation) that war reparations in 1920-1921 were “not relevant in the explanation of the deficit of the Reich”.)

Actions speak louder than Mirabeau’s words and here we see the first false step. James MacDonald writes in A Free Nation Deep in Debt: “If the debt was not to be touched, but taxes were not to be raised, and neither loans nor gifts were forthcoming in sufficient amounts, a financial impasse loomed that could be resolved only if some hitherto undreamed of expedient was found.” They found it. The church properties were nationalized and the independent appraisers, much like ours today, recorded it at the convenient value of 2 billion livres, almost exactly the 2.1 billion of debt owed by the state.

This expediency was followed by the equally rapacious solution of resorting to a paper currency, but not without heated debate. The same Mirabeau who had earlier told the Assembly of its responsibilities regarding the national debt, now wrote that a paper currency “is a nursery of tyranny, corruption and delusion; a veritable debauch of authority in delirium…. That infamous word, paper money, should be banished from our language.” It is “a loan to an armed robber”. The reproachful Mirabeau cohort forced the Assembly to back the assignat with property and engraved the bill with the face of King Louis XVI. (The king kept his head on his shoulders until 1792. Mirabeau’s goal was to create a constitutional monarchy, modelled after England.

The king’s picture was intended as iconic collateral. The people would be assured he was still there. This is much the same reason that every time Greenspan speaks on any topic, it is front-page news and always accompanied by his picture.) The naysayers were converted by a pledge – this 400 million issue would be the extent of the money printing. In April 1790, 400 million assignats (the new French currency) were issued with this pledge of real estate.

The currency also paid 3% interest to the holder. This is impressive collateral except for the practical consideration that one could not hand over a fist full of assignats for a few yards of dirt.

The assignat was also compromised by a pledge of property that was not for the Assembly to award. Neither king nor republican held a claim. In White’s assessment: “The pious accumulation of fifteen hundred years. [T]hese formed between one-quarter and one-third of the entire real property of France…. By a few sweeping strokes [church lands] became the property of the nation.”

The National Assembly issued a proclamation, and, sounding like a gaggle of politicians, pronounced the nation was: “delivered from uncertainty by this grand means from all the ruinous results of the credit system”. It vouchsafed this issue of 400 million assignats would “bring back into the private treasury, into commerce, all branches of industrial strength, abundance and prosperity”. In 2002, President Bush pronounced that “even though times are kind of tough right now, we’re America….We’ve got the highest productivity in the world, we’ve got the best farmers and ranchers in the world. We’ve got the best manufacturers in the world. We’ve got the hardest working people in the world. We’ve got the best tax policy in the world….” How does he know all that? As with the Assembly’s claim, it is meaningless but comforting.

The initial results seemed to bear out the government claims. A portion of the national debt was paid down, creditors were paid, thus credit revived; trade increased to the level one would expect of a redeemable, specie currency.

By the fall of 1790, “times grew less easy” and the government had spent itself into a hole. The cry reverberated between Notre Dame and Versailles: “If we only had more money!” The Assembly and the legislature authorised the issue of 800 million more assignats. (The nation’s leading financial daily and Larry Kudlow were among the wise men who claimed the 6.0% fed funds rate choked the economy in 1999. This was the pedestal upon which they exhumed their old New Era arguments from the dustbin of history.)

Alas: “Legislators are as powerless to abrogate moral and economic laws as they are to abrogate physical laws. They cannot convert wrong into right….” A government that confiscated one-quarter of French property to kick start the currency paid homage to vice over virtue. It requires men of impenetrable virtue to hold a paper currency at par. All paper currencies have turned to dust. Not one has survived the temptations of human nature.

Edmund Burke is remembered as a parliamentarian and political philosopher; he is not so well remembered as a currency trader. He possessed a “universality” of mind and understood the closely-knit relationship between an economy and the disposition of a people. Burke’s analytical punch is worth more than all the empty suits on Wall Street. He wrote Reflections of the Revolution in France in 1790. Note how closely he weaves the integrity of credit with that of the body politic – the perversion of moral standards and of credit corrosion are of one piece: [The French] have found their punishment in their success.

Laws overturned; tribunals subverted; industry without vigor; commerce expiring; the revenue unpaid, yet the people impoverished; a church pillaged, and a state not relieved; civil and military anarchy made the constitution of the kingdom; everything human and divine sacrificed to the idol of public credit; and national bankruptcy the consequence; and, to crown it all, paper securities of new, precarious, tottering power, the discredited paper securities of impoverished fraud and beggared rapine, held out as a currency for support of an empire, in lieu of the two great, recognized species [gold and silver] that represent the lasting, conventional credit of mankind, which disappeared and hid themselves in the earth from whence they came, when the principle of property, whose creatures and representatives they are was systematically subverted.


Burke surveyed the entire perimeter; Zweig’s vision was constrained, not least because he did not have a French Revolution to write about. All we know is the past, and Zweig’s circumference was blind to revolutionary tendencies. His Vienna was of a “live and let live” quality.

There are strengths and weaknesses to such an attitude. In Hitler’s Vienna, A Dictatorship’s Appearance (where Hitler lived between 1906 and 1913), Brigette Hamann writes: “Before World War I, Vienna was a swinging and – in contrast to, say, Linz [closer to Hitler’s home port] – downright depraved city with great sexual permissiveness.”

She then writes of “Hitler’s contemporary Stefan Zweig” who wrote of sidewalks cluttered with working girls who were easy to buy for the cost of a newspaper. Zweig dismissed the election of the anti-Semite Karl Lueger as mayor; he may or may not have known of the parliamentary debate to tattoo a number on gypsies’ wrists for identification, but most definitely saw (since Hamann is quoting Zweig here) the “scar-faced, drunken and brutal ‘thugs’ [Burschenschaften] …. armed with hard, heavy sticks. Unceasingly aggressive, they attacked the Jewish, the Slavic, the Catholic, and the Italian students.” The police were not allowed on university grounds and “could do no more than carry off the wounded who were thrown bleeding down the steps into the streets by these nationalist rowdies”.

This was of small moment. Zweig and his university friends were “completely wrapped up in our literary ambitions, noticed little of these dangerous changes in our homeland”. Zweig and Hitler may have been contemporaries, but they were learning very different lessons. The former’s estimation of bygone Vienna was idyllic: “Whoever lived and worked there felt free of narrow-mindedness and prejudice…. I owe it largely to the city…to love the concept of community as the loftiest idea I know.” Again, Hitler was learning very different lessons.

His ideas of “community” one cannot help but classify as narrow-minded and prejudicial, but these were lost on the highly intelligent, superbly educated and (probably) alltoo-worldly Stefan Zweig. The Austro-Hungarian Empire’s economy was in tatters; again lost on Zweig, who wrote of his father, in the context of the Vienna he understood: “His greatest pride during his lifetime was that no one had ever seen his name on a promissory note or on a draft, and that his accounts were always on credit side in the Rothschild bank, the Kreditanstalt – needless to say, the safest of banks.” These principles died with his father’s eneration and Kreditanstalt failed in 1931.

Eugene von Böhm-Bawerk was a great economist as well as the Minister of Finance of the Austro-Hungarian Empire during the early years of the 20th century. He also saw a different Vienna than Zweig, and consequently drew different conclusions of the Austrian people: “[T]hose theories brought forth to explain the persistently negative trade balance [of the Austro-Hungarian Empire] – such as a surge in industrial strength and its attractiveness for foreign investment – do not stand a more profound analysis…. We slithered from surpluses into a haze of easyhearted and willing expenditures, and we continued to slither even after the surpluses were long gone.”

(Karl Lueger may have slithered most of all. In the people’s interest, the mayor of Vienna municipalised the gasworks, power stations, transport services, waterworks, slaughterhouses and the brewery, and established municipal banks and mortuaries. Lueger claimed that the loans Vienna received to finance this extravaganza were paid by the profits of the enterprises. Hamann writes that this could not have been further from the truth. The people loved Lueger and could not have cared less about the ruinous debt. This included Herr Hitler, who would say in 1941: “Everything we have today in terms of municipal autonomy goes back to [Lueger].” National Socialism, indeed.)

Bill Bonner summarised the Böhm-Bawerk slant on things in the January 2004 Strategic Investment: “Böhm-Bawerk pointed out that persistent trade deficits, negative trade balances, lack of domestic savings, and ‘wasteful consumption’ had their source in a ‘change of mind’ of the people which reflected a ‘lack of morality’.”

We have suffered a similar decay today, captured by the Daily Reckoning: Americans were on top of the world after World War II. Gradually, they lost the habits that made them rich…they became less thrifty and more immodest. Over 5 decades, my countrymen switched from making things to buying things, from saving money to spending it, and from lending money to the rest of the world to borrowing from it. The economy gradually changed from production to consumption, from manufacturing to retailing, from GM to Wal-Mart. And Wall Street mutated too…. from investing in industries to investing in speculative finance.

Most people either do not see this, or do not want to hear it or see it but do not make the consequent connections to their own lives. A century back, Theodore Roosevelt understood his countrymen’s weaknesses: “The things that will destroy America are prosperity-at-any-price, peace-at-any-price, safety-first instead of duty-first, the love of soft living and the get-rich-quick theory of life.”

Daniel Boorstin bemoaned the American inclination to create the news that suits our own tastes rather than take the news as it comes, if there is any news at all. Generally, there isn’t. TV ad rates demand pseudo-news brought to us by some TV news anchor possessed by Caligula and Jim Cramer shrieking about firemen chasing cops up burning buildings who are arresting crack addicts and Elvis imitators. Boorstin wrote in The Image (1962) that the American …lives in a world where fantasy is more real than reality, where the image has more dignity than its original. We hardly dare face our bewilderment, because our ambiguous experience is so pleasantly irredescent, and the solace of belief in the contrived reality is so thoroughly real.

Iridescence invades the president’s cabinet. Former Secretary of the Treasury O’Neill asserted that the current account deficit is “a meaningless number”. He would certainly prefer to think that borrowing US$500 billion from overseas lenders is meaningless. Current Secretary of the Treasury John Snow improved on O’Neill’s twist by turning the (now, closer to US$600 billion) trade gap into an example of American Exceptionalism. He told those foreigners: “[Y]ou don’t buy enough from us. And because we provide the highest risk-adjusted returns on capital in the world, so your capital flows over here. So why don’t you take some steps to improve your domestic economy so you’ll be stronger and can buy more from us. And you might think as well about steps to improve returns on invested capital, and then capital would flow your way as well as to the United States.”

Now, here is where observation and intuition create scepticism: When was the last time you saw a factory under construction in America? There are plenty of houses and office buildings, but all the factories are being built in Asia and points elsewhere. All things equal, factory-made products produce better returns

than the activities behind closed curtains inside a starter mansion. Then there is the presidential candidate John Kerry who blasted those “Benedict Arnold CEOs” who later claimed this statement was the work of “overzealous speechwriters”.

This raises the possibility that a President Kerry might not be the man we see but a seat-of-the-pants,

scripted role he creates from the image of himself that he would like to be. (Yes, John Kennedy.)

It is easy to dismiss Zweig’s naiveté, but that would be naïve on our part. In fin-de-siecle Vienna, he was a young student. In the 1930s, the reification of campus beatings was apparent on a national, systematic level in Germany and Austria. Zweig was Jewish. The question of why the Jews hung on in Germany includes the explanation, and one reads this time and again, they could not believe this was happening in Germany. It must have been difficult to take Hitler seriously.

Who was this twerp? In Clive James’s view: “To the detached observer he looked like a six-year-old boy throwing a temper tantrum in tight underpants. But at the time it was hard to remain a detached observer.”

Zweig never met Mr. Market, who was Benjamin Graham’s fictional creation. Mr. Market commutes to the stock exchange on a skateboard with nothing on his mind. When the price of oil soars yet energy stocks collapse, the incoherence of Wall Street’s finest has had its say. He is as out to lunch as the average Wall Street talking head.

Graham’s advice was to ignore Mr. Market. Understand what you own, know what it is worth, and the market will discover its value in good time. The short-term stuff is chatter. Zweig was (literally) caught up in chatter. He applied no discount to the Golden Future. Had he paid attention to the thugs, they gave him reason to reassess his long-term forecast. The chatter today, specifically from the April 4 Financial Times, is that “confidence among business leaders is stronger than it has been for twenty years”.

Investors love that type of headline, but they may be better off not reading the day’s poll, and instead read a very old book in which T.K. Whipple wrote that whenever numerous people speak of a renaissance, of the birth of a new culture, “you may be sure the era is dying. It is a law in literary history that these spectacular outbursts which look as though they were ushering in a new epoch are in truth ushering out an old one.”

We have seen our own spectacular outbursts in recent years of IPOs, venture capital, derivative products, stock option grants and mergers. The Richebächer Letter reports that the US$4 trillion of mergers from 1998 through 2000 exceeded the previous 30 years in total. David Hale notes that 70% of all technology venture capital funding in the US between 1980 and 2000 occurred in 1999 and 2000. In a similar comparison, 56% of all technology IPO financing occurred in these same two years. The flurry in 2004 is insider selling (28 shares sold for every one share bought – a “normal” ratio is 2.5:1) and the paper mania (mergers, wildly popular Caa bonds, negative-amortising mortgages).


Whether the second issue of assignats was heroic or criminal was a distinction every Frenchman debated. Mirabeau’s brilliant oration of September 27, 1790, is worth reading because his arguments are either specious or the opposite to the truth, yet quite convincing. Parallels to modern chameleons are arresting, and shall constitute the concluding section of this essay. In White’s summary: Through the whole course of his arguments there is one leading point enforced with all his eloquence and ingenuity – the excellence of the proposed currency.

He declares that, being based on the pledge of public lands and convertible into them, the notes are better secured than if redeemable in specie; that the precious metals are only used in the secondary arts; while the French paper money represents the first and most real of all property, the source of all production, the land; that while other nations have been obliged to emit paper money, none has ever been so fortunate as the French nation, for the reason that none before have been able to give this landed security; that whoever takes French paper money has practically a mortgage to secure it, and on landed property which can easily be sold to satisfy his claims, while other nations have been able to give a vague claim on the whole nation, ‘And,’ [Mirabeau stressed] ‘I would rather have a mortgage on a garden than a kingdom.’

We have a Federal Reserve chairman who wrote of “the ‘welfare statists’ tirades against gold. Deficit spending is simply a scheme for the ‘hidden’ confiscation of wealth. Gold stands in the way of this insidious process.” True to form, Greenspan committed a Mirabeau. Today, Greenspan is surprised and quite pleased that the paper-printing central bankers have been able to simulate the characteristics of the gold standard.

It was the rare patriot – in the real sense – who stood foursquare in the Assembly and “called attention to the depreciation of assignats already felt…” and, anticipating John MacKay, held “that the natural laws work as inexorably in France as anywhere else”. Here we have a speaker of courage, insight and a true multi-tasker: Jean Brillat-Savarin, the first superstar chef.

Of course, the second issue was soon deemed inadequate and the “scarcity of money” argument carried the vote for a third, then a fourth and (why not?) a fifth issue. Patriotism grew more demanding and patriotic arguments grew more ingenious. As the security of the land seemed to falter, a very modern and abstract collateral was tossed at the citizens: the loot France was sure to harvest in future wars. (If some derivatives salesman reads this, we’re sure to see Iraqi Conquest Inverse-Floater contracts.)

In time, more and more land was confiscated on evermore capricious pretexts; investments by Frenchmen in foreign countries were punishable by death; heavy duties were put upon foreign goods; purchasing power was falling so fast that “capitalists feared to embark on their means in business”; demand for labour collapsed; and labour was the one price that kept going down; in time, to say that the currency was depreciating carried a four-year sentence in irons; and a vast debtor class emerged, “directly interested in the depreciation of the currency in which they had to pay their debts”.

This last point is of fundamental importance to our financial climate ahead. (In England as in France, the threat of death did not deter speculators. Macaulay: “The gains were such as to lawless spirits seemed more than proportioned to the risks…. [T]he severity of the punishment gave encouragement to the crime.”)

By 1795, new issues were old before they reached the public: “Complaints were made that the array of engravers and printers at the mint could not meet demand for assignats – that they could produce only sixty to seventy millions per day and that the government was spending daily from eighty to ninety millions.” The distinction between now and then may in time be understood as the true source of our New Era. Federal Reserve governor Ben Bernanke slipped our modern advancement into the parenthetical phrase of his most famous oration: “The government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many dollars as it wishes at no cost…[By doing so] the US government can reduce the value of the dollar in terms of goods and services…. We conclude that, under a papermoney system, a determined government can always generate higher spending and hence positive inflation…”

In our post-physical world, money is no more than an electronic, digital pulse. All were not lost. Here, too, we have two tales in one city. There was a last gasp of economic activity which, like today, was misinterpreted by the market strategists, technicians and analysts.

But, just as today, the strategists, technicians and analysts possessed sparse evidence of the qualities their names suggest; they were literalists and missed the point that: “It was simply a feverish activity caused by the intense desire of a large number of the shrewder class to convert their paper money into anything and everything which they could get hold of and hoard until the collapse they foresaw took place…. Financiers and men of large means were shrewd enough to put as much of their property as possible into objects of permanent value.”

Again, the urge to own real assets. As White summed up the decrepitude: “[I]n the complete uncertainty as to the future, all business became a game of chance, and all businessmen, gamblers…. Instead of a satisfaction with legitimate profits, came a passion for inordinate gains…. In this mania for yielding to present enjoyment rather than for providing for future comfort were the seeds of new growths of wretchedness: luxury, senseless and extravagance.”

“Repudiation and dishonor” of the money kept: …all values in fluctuation; discouraging enterprise; paralyzing energy; undermining sobriety; obliterating thrift; promoting extravagance and exciting riot by the issue of an irredeemable currency…. The paper money of the nation seemed to transmute prosperity into adversity and plenty into famine…. Before the end of the year 1795 the paper money was almost exclusively

in the hands of the working classes…. On them finally came the great crushing weight of the loss. After the first collapse came the cries of the starving….

It ended in the complete financial, moral and political prostration of France – a prostration from which only a Napoleon could raise it. The inevitability of a Napoleon may look contrived. White knew what happened. But Edmund Burke did not. He wrote Reflections on the Revolution in France in 1790 with almost a sixth sense of where the corruption would lead.

More than that, he could see where it would end. Burke observed that armies would view sceptically a tottering Assembly. This transience, this weakness of authority would alert the military; it would look for a popular general “who possesses the true spirit of command…. Armies will obey him on his personal account. There is no other way of securing military obedience in this state of things.” Burke forewarned that when the army owes its obedience to a general on his personal account, the person “who…commands the army is your master…the master of your Assembly, the master of your whole republic”.

He nearly achieved mastery of all Europe, much like his German successor, a century and a half later.


The post-World War I German hyperinflation is well known to readers of the Gloom, Doom and Doom Report. (In November 1918, it cost 100 reichmarks to buy one US dollar; by November 1921, 276 marks per dollar; a year later, 4,456 marks; in August 1923, five million marks; then the mark shot straight up (or is it down?), and soon passed a billion, then a trillion per dollar by November 1923.) The concentration here is on the social consequences, starting with Austria. Ludwig von Mises recalled hearing “the heavy drone of the Austrian Bank’s printing presses which were running incessantly day and night to produce new bank notes in Vienna”. Manufacturing machinery sat idle other than “the printing presses stamping out notes [that] were operating at full speed”.

“The government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many dollars as it wishes at no cost….” The Austrian inflation ran greater than 50% a month. Von Mises’ wife, Magrit, carried a suitcase containing money for the day, and the 41-year-old president of the Biedermann Bank “became insolvent in 1924, leaving him out of work with a pile of debts”. Out of work, he followed a familiar 20th-century pattern and decided to teach. In this case, he taught economics: his name is Joseph Schumpeter.

To look at the degradation of Austro-Hungary’s ally, I quote from Before the Deluge: Berlin in the Twenties. Otto Freidrich wrote this journalistic history of the decade, in which the author captures the dismal nature of the times: A journalist believed “the inflation was by far the most important event of the period. It wiped out the savings of the whole middle class, but those are just words. You have to understand what that meant. There was not a single girl in the entire middle class who could get married without her father paying a dowry…. They saved and saved so that they could get married, and so it destroyed the whole idea of remaining chaste until marriage…. But what happened from the inflation was that the girls learned that virginity didn’t matter anymore….”

By the way, in 1923, the Reichsbank, in concert with a long line of propagandists, from Mirabeau to Greenspan, was miffed at public opinion and denied that the central bank was “responsible for the enormous new burdens of increasing inflation and acute payments difficulties. We expect the Reich government will take care to inform the people and reject these incriminations as unjustified.”

Whatever the government response, it mattered little to the people who were so malignantly served by both institutions.

For those looking for a money-making opportunity in all this gloom and doom, I transcribe the advice of Alexandra Ritchie, from Faust’s Metropolis: “One could buy a row of elegant houses, or hire the Berlin Philharmonic for the night for a mere $100.” If Fannie Mae had been a German invention, instead of our own Faustian horror, what would that collapse in real estate prices do to its hedge position?

Someone should pose the question to Franklin Raines (CEO of Fannie Mae – ed. note). Ritchie also identifies all of the common maladies we have seen in the French hyperinflation: Hard work now seemed to mean nothing; one could only get ahead through crime, black marketing or prostitution…. Girls of twelve or fourteen prostituted themselves after school with their parents’ approval. [To point out the obvious, we have come a long way from the obligatory dowry, in a very short period of time.

When Berlin blew up, there wasn’t much time to get one’s affairs in order.] As things grew increasingly dire Berlin threw itself into an orgy…. The higher prices rose the greater the abandon, the madder the nightclubs, the faster the dance steps, the louder the jazz bands, the more plentiful the cocaine…. For outsiders the city was a thrilling whirlwind of sensual pleasure but for most Berliners it was a living hell. This sounds like halftime at the Super Bowl.

Freidrich quotes from Alan Bullock’s book, Hitler: A Study in Tyranny: “[The inflation] had the effect, which is the unique quality of economic catastrophe, of reaching down and touching every single member of the community in a way in which no political event can. The savings of the middle classes and working classes were wiped out at a single blow with a ruthlessness which no revolution could ever equal….” Bullock goes on to say that the foundations of German society were not destroyed so much by the war, but by the inflation. Ritchie revs up the Bernanke Model of 1923: “People carried wages home in huge crates; by the time they could spend even their trillion-mark notes they were practically worthless. Over 300 paper mills and 2,000 printing presses worked on 24-hour shifts to supply the Reichbank with notes.”

“The government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many dollars as it wishes at no cost….” Okay, that’s more than enough of Bernanke. The printing press is not always an enemy of sound money.

True, John Law also ran eight printing presses around the clock, but this technology has proved a most satisfactory incubator for conservative finance – when those overzealous machines are destroyed. Most recently, the Kurds in Northern Iraq have used the “Swiss dinar” (called such, after the country where they were printed) of which the last was issued in 1988. The money supply could only grow dirtier and unreadable. In Hussein’s Iraq, the dinar supply grew by 25 times over a decade’s period. The “Swiss dinar” was worth 300 Iraqi government dinars. And this, in the Kurdish territory with “no government, no central bank, no legal tender and no cash”.

In anticipation of accusations that the case studies employed are Eurocentric, we head south, to Argentina. At the turn of the last century, the Argentinean stock exchange was of comparable size to the US. The railways rolled inland; the cattle and wheat export industries boomed. The real wage of the Argentinean workman was 76% of the British worker in 1864 and 94% in 1913. The place to shop in Buenos Aires was Harrod’s. Stephen Schwartz described this world of yesterday in the Atlantic Monthly: In 1929, Argentina was one of the ten richest countries in the world…. [I]t was populated by a highly educated middle class…. [It] was democratically governed. Its capital, Buenos Aires, boasted the largest opera house and probably the finest publishing firms, newspapers, and universities in the Hispanic world. In fact, the only city in the western hemisphere that rivaled it for sophistication was New York – and Buenos Aires, with its broad boulevards and Beaux arts architecture, was grander by far.

To make a long story short, democracy tottered, the coup of 1943 included Juan Peron. Handouts flowed to the people, funded by property confiscated from the malefactors of wealth. (FDR’s phrase. Peron may have liked it.) The average annual inflation rate between 1960 and 1964 was 127%. That’s a lot of inflation. Like all

nations shopping for today with no tomorrow, Argentina has suffered from a dearth of long-term investment.

This was ham-handedly expressed by ex-US Secretary of the Treasury Paul O’Neill: “[Argentina has] been off and on in trouble for 70 years or more. They don’t have any export industry to speak of at all. And they like it that way. Nobody forced them to be what they are.” In December 2001, Argentina weaned itself from its dollar peg (to create stability, the Argentinean peso had been set at exactly one US dollar, no matter what local hardship this might cause) by introducing a third currency: “the argentino”. With great fanfare, Rodolfo Frigeri, the finance secretary, “said the government would be ‘prudent’ in the way it issued the currency and would stick to austere fiscal policies. Interim president Adolfo Rodriguez Saa said the new currency would be backed by property owned by the Argentine State. ‘All the land, real estate, palace houses – the national congress, the presidential palace, all the embassies that Argentina has all over the world – will be the common guarantee of this currency.'” Oh no, here we go again.

But hark! Hot off the wire – an e-mail from Dr. Steve Sjuggerud, Investment U E-Letter #324, posted from Buenos Aires, March 30, 2004. He finds that, from Patagonia to the Intercontinental Hotel, no one will take his dollars. Many Argentineans grew up thinking in US dollars while dumping the peso. This is a country in which currency trading is learned along with basic arithmetic. Argentineans are aware that two years ago, a peso was worth a quarter. And today, it’s closer to 35 cents. In early April 2004, the Argentinean central bank announced it is now buying up US dollars in the open market, because the peso appreciates at an unwelcome rate.


Why is it that these cataclysmic events are anticipated by one in a thousand, other than that if they were widely anticipated they generally would not have been cataclysmic? I must beg forgiveness for re-quoting some favourites from a previous article I wrote for the Gloom, Boom & Doom Report (“Ironic Art”, October 2002). This reintroduction is an attempt to comprehend the pervasive nonsense most everyone believes about the current state of the US economic and financial position. There are a lot of bright people around. These are lawyers who discover penumbras in the codicils and cut four generations out of their inheritance. These are philosophers who can trace the magnitude of the mind with 72 quadratic equations divided by pi. These are investment bankers who tear apart one $40 billion conglomerate in the morning and launch eight Chinese IPOs in the afternoon.

Yet, the imbalances and contradictions of the economy are beyond their grasp. Ours is a culture consumed with making and spending money but which does not interest itself in the medium of its chosen indulgence.

Edward C. Johnson II, the father of the current Fidelity Investments chairman, gave a speech in 1963 at the Contrary Opinion Forum. He cut to the heart of investment management when he claimed that “…operation in securities is not mainly a matter of reasoning at all…. [T]he best investors don’t really reason things out, though they often pretend to.” He concluded that “the stock market is just a bunch of minds – there is no science”. Investing is an art and “when we turn to art we find that it is not scientific, it is basically a matter of individual emotion and a feeling for universality, channeled into a particular mode of expression such as painting, music or philosophy.

It is an instinctive sense of things that are too complicated to reason out.” He proposed that “[u]nusual results in securities, as I say, have to be looked for in basically artistic groups, which is relatively small in number as are all artistic groups”. Flannery O’Connor, the American novelist, described the characteristics of the artist: “…[H]abits have to be rooted deep in the whole personality. They have to be cultivated like any other habit, over a long period of time, by experience…. I think it is more than a discipline, although it is that; I think it is a way of looking at the created world and of using the senses so as to make them find as much meaning as possible.”

She draws on Joseph Conrad: “When he said that his aim as an artist was to render the highest possible justice to the visible audience, he was speaking with the novelist’s surest instinct. The artist penetrates the concrete world in order to find at its depths the image of its source, the image of ultimate reality.”

What in practice does a mind that penetrates to the depths produce? Paul Morand, a Frenchman who admired Manhattan, concluded his book New York (1930) on a sombre note: “Will New York, like the town filled by the scientist with oxygen, one day blow up? This vertical city will perhaps crash down in a heap…. Nothing can destroy Paris, an unsinkable hull. Paris exists in itself…. Will the Atlantic waves return to break on those gray rocks that were once New York, and are so no longer…?” Scott Fitzgerald (writing of how his awareness of the city had changed by 1932): “I had discovered the crowning error of the city, its Pandora’s box…. [T]he city was not the endless succession of canyons…. [I]t had limits…. [W]ith the awful realization that New York was a city after all and not a universe, the whole shining edifice that [I] had reared in [my] imagination came crashing to the ground.”

E.B. White (1948): “The subtlest change in New York is something people don’t speak about but that is on everybody’s mind. The city, for the first time in its history, is destructible. A flight of planes no bigger than a wedge of geese can quickly end this island fantasy, burn the towers, crumble the bridges, turn the underground tunnels into lethal chambers, cremate the millions. The intimation of mortality is part of New York now: in the sound of jets above, in the latest edition.” Conrad’s approach applies to a much wider audience, wider than the categories we traditionally consider as “art”.

The bricklayer, dry cleaner, lawyer, pharmacist, barber, teacher and market strategist all face daily decisions to which we may rise, but generally do not even recognise as demanding the concentrated attention that Conrad describes. It requires our attention to a hundred different actions and thoughts a day. His injunction is a ruthless taskmaster: “These habits have to be rooted deep in the whole personality.” And so, few in number penetrate to the ultimate reality and those who do are generally not recognised in their lifetime. It took half a century before Morand, et al., who penetrated the concrete, could be appreciated by the populace at large, before the fragility looked real.

Artistry exists in the oil painter and the house painter; from masonry to theatrics, whether on the stage or from the pulpit or in the political quadrant known as propaganda. At the 1934 Nuremberg rally, Joseph Goebbels spoke on the art of propaganda. He was well ahead of

This essay was taken from Marc Faber’s Gloom, Doom and Boom Report

Fred Sheehan is an analyst with John Hancock Financial Services.

Both Fred and Marc are contributors to Strategic Investment.