Worst Trade of the Decade

The Daily Reckoning PRESENTS: London is one of the most expensive cities in the world – so expensive that the average Brit can’t afford to live there. Bill Bonner wonders why London has kept its head above water as the rest of the British Empire sank…


“How do they do it?” asked an American visitor earlier this week. How do they pay their bills? How can they afford to live in London?

Americans can stop worrying. The empire may be in decline, but there’s still plenty of declining left to do. Rome declined for at least 300years before the Barbarians took over. England has been in decline – in terms of its place in the world – for at least a century. Even now, the world’s last imperial capital is still a decent place to live, provided you have the money, of course.

London is one of the most expensive cities in the world. It is so expensive that the ordinary Londoner has to move out to the far suburbs and travel by train into the heart of the city every day. A one-hour commute is regarded as standard. Many people spend two hours traveling to work; people have been known not simply to read novels traveling to and from work, but to write them.

On Wednesday night, we went to dinner at an antique gentleman’s club. The members are all distinguished older men, many with titles, ranks, honors – and all with gray hair. Your editor gets in not because of his many fine qualities, but because he is a member of an American club with reciprocity privileges. Always feeling as though he could be chucked out at any moment, he keeps a low profile.

Dinner for four with a single bottle of wine was $320. And that seemed quite reasonable compared to other prices in the city. London is a fine city with much history, good taxis, many delightful restaurants, interesting architecture, a rich, dynamic financial-service industry, and a bubbly property market. It is a great place to live. It’s too bad most Englishmen can’t afford it.

How did the city get to be so expensive, we wondered? How come it didn’t sink along with the British Empire? And, what can we learn from the British experience? The burthen of the following reflection is…not much. But, a look at the details serves to reinforce opinions we already hold.

In the 19th century, the British Empire was an empire fueled by coal, and financed by trade. Successful manufacturers in Manchester and Bristol imported raw materials and exported finished products to the rest of the world. Profits were used to build new plants and equipment. Profits also helped pay for British colonial administrators all over the globe.

Britain’s industry was solid; so was its money. For a good hundred years, the crown’s money was the world’s reserve currency, as the dollar is today. From the defeat of Bonaparte at Waterloo in 1815 to the trenches on the banks of the Marne in 1914, the pound ruled the world. But what ruled the pound? God was in His heaven; the Queen was on her throne. The Bank of England would exchange an ounce of gold for about 3.85 pounds – with no hard feelings.

At the beginning of the 20th century came the Great War. It so strained Britain’s finances that she was forced to turn to her erstwhile New World colony, America, for financial support. Thereafter, followed a long string of reverses, defeats, setbacks, world improvements, devaluations, inflations, and hustles – both for the British Empire and for its money. As the British Empire softened, so did the pound. American and German manufacturers had already surpassed British output by 1910. By 1917, during World War I, America was paying the piper and calling the tune. By the 1950s, America was indisputably the Free World’s hegemon.

The great Anglo-Saxon commercial empire did not die. It had always been a collection of English-speaking people. Its soldiers were gathered up from all over the empire. In the mud of Flanders, German troops were surprised to find the corpses of young men in plaid skirts, for the English had always made good use of conquered vassals and distant colonials: the Scots, Irish, Welsh, Canadians, Australians, New Zealanders, Indians.

And so, between 1917 and 1952, the empire simply evolved. Its capital was transferred from London to Washington and today, it is led not by William Pitt the Elder, but by George Bush the Younger. Otherwise, however, it is much the same. Is it not a commercial empire still? Is it not still regulated by English common law principles – as amended and contradicted by the many moronic edicts and nonsensical rules that have been issued from parliaments over the years? Is it not misgoverned by the same squawking knaves and hectored by the same world-improvers-on-the-make?

But there is a big difference, too. The U.S. Empire is built on the dollar, not the pound. It reached its apogee at a time when the dollar had become only an abstraction. This is another first. Not only is the U.S. Empire the first to squander its most precious resource in a war against nobody, it is also the first to do so with money of no value. Since 1971, the dollar has had no sure connection to anything of real value. It is only a piece of paper. You can buy things with it, but how much of anything you can buy with it depends.

But, let us back to the tale of the pound. Enter World War I, and the Bank of England was forced off the gold standard. As soon as the shooting stopped, however, it tried to force its way back onto it at the same level. Aiming to help our English cousins, U.S. Fed chief Ben Strong administered a little “coup de whiskey” to the American market and put the U.S. economy on the road to the hell of the ’29 crash – and the Great Depression thereafter. Even with American support, Britain couldn’t hold its ground. The pound was devalued in 1931, again in 1949, and then again in 1969. The British money was still widely used in international commerce, but it was steadily slipping. By 1960, British reserves represented less than one-twentieth of the world’s total, and were only half of those of Germany. Ten years later, the country was nearly broke, and in 1976, the poor Brits had to beg the IMF for emergency loans in order to meet current obligations.

Through all this, you can imagine how the pound fared. We recall visiting London in 1985. Back then, a pound was scarcely worth more than a dollar, but that was before Alan Greenspan came to his post at the Fed two years later. Since then, in the race to monetary hell, the dollar has spurted ahead. Today, the dollar is quoted at $1.73 to the pound, but it is in terms of gold that the damage is most clearly visible. At today’s price, you can buy an ounce of gold for 317 pounds. Thus has the pound of Queen Victoria lost 98.79% of its value.

With so much recent monetary history available to them, you’d think Britain’s central bankers would be among the world’s most sage. They have only to look back a quarter of a century to see what can happen to a mismanaged currency. They might even remember that gold, during the late 1970s, was setting new price records. And, they might have reminded themselves that the financial world is a treacherous place, that things go wrong, and that when they do go wrong, it is not such a bad idea to have a little of something solid stashed away…just in case. They might have even reflected on how history has a way of grinding down empires and paper money, until there is almost nothing left of them.

But alas, they who made themselves so familiar with monetary history seemed to have learned nothing but contempt for it. When Britain’s brightest and best got together in the late ’90s to plot monetary policy, every sensible thought seems to have fled straight out of their heads. They came up, instead, with what had to be the worst trade of the decade: after watching their own paper currency go down against gold for nearly a century, they decided to swap the nation’s remaining gold for more paper currency at the lowest prices in 20 years! Nearly 400 tons of the metal was sold between 1999 and 2002, at prices only half of those of today.

“Was there ever a worse time to sell gold?” we asked earlier this week. We still haven’t come up with one.

Bill Bonner
The Daily Reckoning
March 22, 2006

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount – just click on the link below:

“Now Perhaps Someone Will Listen!”

Who would you rather be, dear reader? Alan Greenspan or Ben Bernanke? Would you rather be coming into the top job at the world’s top bank near the beginning of a boom…or near the end of it? Would you rather start when rates are relatively high…or when they are absolutely very low?

The LA Times reports, “30 year Mortgage Rates Fall for a Second Week.” But what’s this? “Money fund rates near five year highs,” says the AP.

Yes, the Financial Times of London informs us, it’s true that ye olde yielde curve is pointing in the wrong way – down, rather than up. But don’t worry about it, dear reader. Our new Fed chief, Ben Bernanke, tells us that the most reliable predictor of recession – an inverted yield curve – is old hat. It just doesn’t matter in this exciting new economy of ours. We don’t need no stinkin’ concave bend in the nation’s lending rates.

But what if lenders on the long end of the curve – those lending for 10 years or more, such as mortgage lenders – suddenly decide that they need a little more yield to make up for, say, the risk of inflation? Or the risk that the dollar will go down? The supply of dollars is exploding worldwide, faster than just about everything – except maybe automobiles in Paris. But so are the claims against those dollars. As we mentioned a couple of days ago, the Feds’ real debts and obligations are over $51 trillion. The interest charges alone are $3 billion a day.

You’d think that long-term lenders would be a little concerned that maybe – just maybe – the U.S. dollar will not be worth as much in 2036 as it is in 2006.

MSN Money’s Jim Jubak notices a couple of reasons why U.S. rates are bound to rise:

“Overseas investors are going to need their own money back to pay for their own old age. Japan is the biggest holder of U.S. Treasuries, and, demographically, it is the oldest country in the developed world. Europe isn’t far behind. The U.S. is aging, too, but at a comparatively slower rate. The real demographic story, however, is taking place in China and India. By 2020, the median age of China’s huge population will be higher than that of the United States. India is further behind, but by 2050, the median age of its population will be 37.9 years, making the country as old as the United States is today. China and India are both going to get old before they get rich. Because of global demographics, we’re looking at a world in transition from a period of surplus capital to a world of tight capital as aging populations go from savers to consumers of savings. Tighter capital means higher interest rates.

“Overseas investors may lose faith in our intention to pay our debts. Sovereign nations saddled with too much debt have an option that’s not available to the overstretched homeowner. Instead of declaring bankruptcy, they can just roll the printing presses and create money in order to inflate their way out of the debts. But overseas investors aren’t likely to sit still as the value of the dollars they hold and the dollars they receive in interest are slashed as the presses roll. As countries such as Argentina have learned, once investors have decided that the government has lost all discipline, they will demand punitive interest rates. Short-term interest rates broke 100% in Argentina in 2002, for example. Once a country has forfeited the faith of the markets, it takes a long time to earn it back. In Brazil, now lauded for its fiscal responsibility, the equivalent of the U.S. federal funds rate was above 16% in December.”

Just why real rates will rise, we don’t know. We only know that every day that passes brings us closer to the day real rates must rise again. How do we know that?

Because history never stops grinding. And she grinds out a long trail of ups and downs, bulls and bears, war and peace, life and death. It is a long tale of victory and woe – of battles and bromides, upheavals and downturns, misery and mystery…mistakes, mischance, misfortune. It is also a record of world improvers and their blunders, but we will leave that theme for another day.

That is the history we are seeing in the Middle East, and in the U.S. economy. The former Fed chief tried to improve the world by making credit too cheap. It worked like gangbusters for a long time, but now his successor comes into a different world – a world where borrowers are already loaded up with so much debt they cannot take on much more. And they cannot tolerate a rising cost of credit because they now depend on cheap loans just to keep going.

And yet, history decrees that the cost of credit must go up as well as down. Sometimes people look ahead and see nothing to worry about – and no reason to ask for more than 4% on their money. Other times, they get nervous; they want 10%, 20% or more. Sometimes they’d just as soon do something else with it.

We know what will happen when real rates rise: people will wish they had depended less on credit “just in time” and more on savings “just in case.” And that is when Ben Bernanke will wish he were Alan Greenspan.

More news from Aussie Joel and The Rude Awakening…


Justice Litle, reporting from Reno, Nevada:

“For the patient investor, the ultimate payoff should come in the form of both accelerated earnings growth and a ‘perception premium’ that kicks in when Wall Street sees the beauty of ‘green is green.'”

For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening.


Back to Bill Bonner with more opinions…

*** Addison was on Bloomberg TV this afternoon, in a segment that featured Outstanding Investments as “the best newsletter in the industry.”

He also discussed the record-breaking trade deficit and the fact that the U.S. government is spending money like a teenager with his dad’s credit card.

“How can investors make money in such a volatile market?” the Bloomberg anchor asked Addison.

“Well, Outstanding Investment subscribers are actually poised to make money off of markets with high volatility. We’ve made some major gains in oil and the precious metals market, but the next big thing for us is going to be water treatment companies and natural gas.”

*** Poor George W. Bush. Nothing seems to go right for the world-improvers. At the edges of the empire, his war against nobody is going nowhere. His “Ownership Society” back at home has a tinny ring to it. Now, the typical American is far more a slave to debt than he or she was when Bush-the-Younger took office. People own less of their own homes than they did in the ’90s; stocks have gone down and the S&P 500 has fallen 2.8% – the worst performance since the Nixon administration.

*** Jim Jubak gives advice to savings-short Americans:

“Since you can’t trust their accounting, do your own and be brutally honest. You’ve probably got some plan for retirement, but do you have a plan to pay for health care after you retire? Fidelity Investments does an annual calculation of how much a couple without employer-sponsored health care should set aside to pay for health-care costs after 65. This year, the recommended health-care nest egg hit $200,000, up 5.3% from last year and up from $160,000 in 2002, when Fidelity started its surveys.

“Save, save and save some more. It won’t do the trick alone, but, without capital, you’re at a huge disadvantage in a capitalist society.

“Right now, you should be saving for retirement, and for health care in retirement, and for the kids’ college education – and for a rainy day, too.

“There’s no way you can do all of that without some pain, so grit your teeth and think of saving like exercise. You may not enjoy it, but your future will be a whole lot brighter if you do it every day.

“Invest what you’ve saved as intelligently as you can. Every dollar you receive from your investments is a dollar that you don’t have to save or earn at your job. I’d divide my portfolio in half. Use half as a core that – either through individual stocks or mutual funds (or ETFs) – puts you on the side of identifiable long-term trends.

“Pay up for education. Whether it’s for yourself or your kids, it’s the single factor likely to make the most difference in the years ahead. Wage growth stagnated last year, with real wages – that’s wages after inflation – actually falling from the fourth quarter of 2004 to the fourth quarter of 2005 by 0.8%. If that’s the beginning – or, some would argue, the continuation – of a trend, then the only way to fight back is by constantly upgrading your skills. And our children are now competing in a global economy where the best jobs are increasingly likely to go to the best educated – no matter where they live – and where the only way to justify higher pay is by higher competence or productivity.

“Throw the bums out. I’m not here to preach to you about how to define a bum, but it’s clear that we aren’t getting the foresight and leadership we need out of our political leaders of either party. So why put up with them? Do more than vote – that’s a minimum. Give money, organize, stand on the table and yell, whatever. Force them to pay attention. Otherwise, we’ll deserve the politicians we get.”

*** On Jubak’s last two points we cheerfully dissent. First, throwing the bums out seems hopelessly naïve, and an unsatisfying kindness. A firing squad would be too humane, but what would happen? Bums are lined up all down the Potomac to take their places. No matter how dimwitted the program, the opposition has a program even more block-headed, and a candidate who could make George W. Bush look like John Adams in comparison.

Second, we return to our “good news” theme of yesterday. Most of the money spent by most people is spent for reasons of vanity not necessity. Education included.

We made the point over dinner last night.

“But wait,” said Henry, “the more you know, the better off you are. That’s why people with more education earn more money.”

“That’s what all the studies show,” added his mother. “Henry, don’t pay any attention to your father. He’s just making one of his contrarian points. You’re going to college.”

“Post hoc ergo propter hoc,” we replied, delighted to have an opportunity to pull out one of the few Latin maxims we know.

“Dad…you don’t even know Latin. I know Latin…I’ve been studying it in school for the last three years.”

“Well, then you can tell us what that means…”

“It means…something like ‘after the fact…therefore causing the fact’…something like that.”

“Yes, it’s a typical logical error that people make. Just because the people who go to college earn more money, it doesn’t mean they would have earned any less if they had not gone to college. What if I drank a glass of water and then got sick. It doesn’t mean the glass of water made me sick.

“People who go to college tend to be from the middle classes and upper middle classes. People from these classes tend to get white-collar jobs, so they tend to earn more than people who get working-class jobs. As far as I know, no one has ever studied what happened to people with the same backgrounds, I.Q., family connections, ambitions, and so forth, who did not go to college. I’m just talking about liberal arts here…not about science or engineering. If you want to be a doctor, of course you have to go to school.

“But a couple of the smartest and most successful guys I ever met didn’t go to college. Actually, one of them did go and dropped out almost immediately. Of course, they’re both dead. Does that mean that if you don’t go to college you’ll die sooner? I bet the statistics show that too – but it’s nonsense.

“One of my friends started his own business and made a fortune. The other one didn’t make a lot of money, but he didn’t seem to want to. Both of them were very well read. In fact, one of them told me why he had dropped out. He said he stopped because it was interfering with his education. Those are the words he used. He wanted to read books that were important to him and instead he had to go to class and listen to lectures and so forth. Maybe he also felt he would feel compelled to participate in university life – keg parties, football games, campus rallies.”

“But all of that is important in helping to develop a young person, helping them make useful contacts, and helping them learn how to get along in the world, don’t you think?” asked Elizabeth.

We did not really have the last word in last night’s conversation; we rarely do. But at least we will have it in today’s Daily Reckoning:

“No…just the opposite. University life is a false life – massively subsidized by parents, dead alumni, and taxpayers. Real life is off campus, and students know it. That’s why they’re terrified of it. That’s why some never want to leave campus. When you’re in school, they tell you when the tests are coming. In real life, you never know when you’ll be tested…or how.”

Take heart, dear reader; we repeat ourselves: there’s good news. You can save a fortune on the big-ticket items. Next week: transportation…health care…and more!