Against the Gods

You are probably rolling your eyes, aren’t you, dear reader?  You imagine that we are going to harp

again on our Trade of the Decade.

Well, you’re right.  Long gold, short stocks – that’s the basic position.  Stocks are going down because we’re on the downside of the credit expansion.  Gold is going up because people in charge of paper currencies are determined to print more of them.  We wish we could give you more specifics, but we don’t have them; no one does.

Yesterday, the Dow rose again…the dead cat is still bouncing.  Gold shot up too – by $22, to $905.   Just what we would expect.  The Fed is pumping as hard as it can in order to save the stock market and the economy.  The dollar should be going down and gold should be going up.  Our guess is that it won’t save stocks…but it should do wonders for gold.

The euro rose to $1.47.

But there is more under heaven than is contained in our Trade of the Decade.  More opportunities for investors, that is.

There is not much subprime debt in Argentina’s financial industry, for example.  In fact, there’s not much prime debt either.  Or credit card debt.  Or home equity debt.  Or corporate debt.  Or any kind of debt.

Argentina was protected from debt by its own recklessness.  Want to buy property on the pampas?  You will have to pony up in cash.   Neither consumers nor businesses have much debt in Argentina because no one would lend them money.  Adjustable rate mortgages?  You’ll be lucky to get a mortgage of any sort.

Nor do the emerging countries have huge trade deficits – they couldn’t afford them.  Instead, they tend to be on a pay-as-you-go system of international finance.  And now, many are building up large stockpiles of hundreds of billions of dollars.  By contrast, the United States of America has a paltry sum socked away in foreign currency reserves…and practically none of it in the currencies of emerging markets.   Not surprisingly, most emerging markets, including former and present backet cases, such as Argentina and Iraq, have watched their currencies rise against the greenback over the last two years.

Many emerging markets are major exporters of raw materials…and food products.  Often, they are the world’s low cost producers.  In a worldwide downturn, demand for oil may go down…but would demand for cheap chicken?  Nor are emerging countries generally burdened by high social and environmental costs.  They’ve been too poor to afford expensive public pension and health care systems.

As a consequence of all these things, if there is a broad slump, these emerging markets – especially those in Latin America – are likely to come through with the least damage, says our Buenos Aires colleague, Horacio Pozzo.

Another buy is Japan.  The land of the rising sun seems to rest in perpetual darkness.  The sun never climbs above the horizon.

While domestic companies focus on new products that disguise pedestrians as common mechanical devices, Japanese investors look elsewhere to place their money.  The slump has been going on for so long they’ve pulled out.  Foreign investors, too, given up.

But not your editor!  Colleague Merryn Somerset Webb of Money Week magazine tells us that many Japanese companies are selling below book value…and some below the value of their cash.  Of course, in the interest of full disclosure, we both rated Japan a buy a year ago too – when Japanese stocks were 20% higher.  Now, we like it even more…

We wish we had been there, when George W. Bush visited with the headman of Saudi Arabia.

We wonder how he put it.

“C’mon buddy, pump some more of that oil so we can get this recession thing over with.”

For his part, we wonder if the Arab curved up the edges of his mouth, slightly, when he replied:

“Don’t try to blame us for your problems.  If you’d protect the dollar, the oil price wouldn’t be at $90…or $80…or even $50.  It’d still be at $30.

“And oil isn’t the only thing.  Just look at wheat, corn, and soybeans.  Instead of coming here to ask us to pump more oil, maybe you ought to go to Kansas and tell your own people to plant more wheat.  And while you’re at it, maybe you should ask the miners to produce more gold – that’s up too.”

Both men had a point.  If more oil were pumped out, its price would go down.  But the same thing could be achieved by pumping out fewer dollars.

As to either possibility, we can safely say nothing.  All we know is that if the rate of dollar creation goes down, it will be in spite of the best efforts of Bush, Bernanke and the whole company of market manipulators who are desperately trying to stop Mr. Market’s correction.

Now, everyone accepts the idea of a slowdown…even with falling rates from the Fed.  What they are all asking is:  how bad will it be?

The force of a correction is equal and opposite to the deception that precedes it.  The last five years have seen the most lavish dissembling the planet has ever seen.  The Greatest Boom Ever was a complete fraud…and it was accompanied by more extravagant delusions than a presidential election.  Millions of people apparently took out mortgages never intending to pay them off.  Sophisticated investors believed these bad loans could be made good by splicing and dicing them.  Economists believed you could get rich by spending more money…or by printing more!  Whole populations thought they could live on the savings of others.  And the world’s imperial power thought it could finance its military campaigns by borrowing from its rivals.

We blink…and wonder what kind of correction could possibly equal such breathtaking claptrap.

A couple of years ago, we saw the world evolving in five key ways.  We called them the 5 Big E’s.  This morning, we wonder how they held up.

At the top of the list was Energy.  We saw it getting more expensive.  Partly because the world was using more of it.  And partly because the currency in which it was calibrated, the dollar, was increasing faster than oil production. In the last two years, oil has shot up to $100.  All right so far.

Next up was the Exodus of money and power from West to East.  Has anything happened in the last two years to slow it down?  Nope.  Asians have more market share than ever….and more of Westerners’ money.  A global recession might slow down the process, but we see nothing that will stop it.

The Economic cycle also seemed to be bearing down on the West when we wrote two years ago.  We were a little ahead of ourselves, or so it appeared at the time.  Stocks kept rising, at least in dollar terms.  But now even the economic cycle seems to have turned down.  George Soros says we have reached the end of a 60-year credit expansion.  Well…maybe a 25-year credit expansion.  Either way, the tide has turned.  Liquidity is ebbing out.  And the assets that ride on that tide are going down.

What else?  Ah…the Experimental money.  Since 1971, the world has toyed with a money system that never, ever worked before.  Never before had paper money, not backed by gold, lasted for very long.  But for the last 25 years, it looked as though maybe, just maybe, this time was different.  Then again, maybe not.  More on that below.

And finally, the declining Anglo-Saxon Empire.  Yes, dear reader…if you have to borrow from your competitors to pay for it, your empire won’t last very long.  The United States Empire began in the late 19th century, when America began throwing its weight around in the Philippines and Latin America.  It probably hit its peak in the Clinton years…after its last major rival, the Soviet Union, threw in the towel…and the U.S. stock market rose 11 fold in 17 years.

Then, along came George W. Bush, just at the right time with just the right program.  Empires don’t last forever.  So every great empire needs to find a way to ruin itself.  Bush was the man for the job — with huge new spending projects…including a war in Iraq that pinned down the U.S. military, while Congress and the public squandered its assets.

Yes, stocks will eventually bounce back.  They always do.  But unless there is some remarkable renaissance – probably marked by bankruptcy, revolution and civil war, like the period in Rome preceding the rise of Augustus — the glory days of the empire are over.  It has peaked out.

This from old friend, Lord Rees-Mogg:

“All paper money has historically proved defective in terms of one of the classic functions of money.  Nineteenth century economists such as William Stanley Jerons – a great economist by any test – taught that money ought to act as a “store of value”.  There is no fiduciary issue which has survived the period since the end of the Second World War in 1945 without very substantial depreciation.  Even comparatively respectable currencies, like the pound or the dollar, have lost a significant proportion of their purchasing power since 1945, and are expected to continue to lose purchasing power for the foreseeable future.

“…A non-convertible paper money [not convertible into gold] can be expected to depreciate over time, more or less rapidly.  In the twentieth century, the great majority of non-convertible paper currencies depreciated by more than 90 per cent in purchasing power, and money depreciated to zero.

“Gold, on the other hand, has a high degree of stability in the purchasing price over very long periods, as demonstrated in statistical studies by Professor Jastrom and others.  …  The gold standard, and indeed the principle of stable money, had two great enemies.  They were, and are, war and democracy.  The gold standard had to be suspended by the European powers in 1914, when the First World War broke out.  It has never been fully restored.  The Bretton Woods system, which was based on international convertibility into the dollar, and dollar convertibility into gold, lasted for about twenty five years before President Nixon suspended gold convertibility in 1971.  After the Bretton Woods system collapsed, the final link of currencies to gold was broken.

“The great democracies of the West will find it difficult to make the sacrifices necessary to deal with the growing shortage of fundamental sources of energy, including oil, gas and uranium.  The excessive levels of debt are likely at some point to lead to inflation – which wipes out the real value of debt.  In these conditions, the underlying economic pressures are for a still higher gold price.  In the last decade, the gold price has been doubling every five or six years.  My own guess would be that gold will hit $2,000 an ounce in the early 2020s, but some analysts think that will happen much earlier.”

More below,

Bill Bonner
The Daily Reckoning
London, England
Friday, January 25, 2008

The Daily Reckoning PRESENTS:

The world held its breath on Tuesday morning.  On the day after “Black Monday” everybody wanted to know what would happen when the U.S. stock market opened. How can this be happening to the richest country in the world? Bill Bonner explores how the American economy got to where it is today, below…

Against the Gods

by Bill Bonner

What makes the blow up so astonishing is that it is astonishing at all…

An emergency meeting of the U.S. President’s “Plunge Protection Team” must have been called Monday night.  Any other group of chief executives, colluding to rig prices, would have drawn, say, 5 to 10 with time off for good behavior.  But the fix was in.  And the Fed announced the new price of credit and waited to see how the rubes would react.  In the event…reactions were mixed.  Asian stocks rebounded.  The Dow ended the day down.  Then, the following day…it looked like the fixers might have rearranged the whole deck; rumors of a deal to save Wall Street further losses sent the Dow up more than 300 points.

Thus the long-running spectacle continues.  Today, for the benefit of those who haven’t been paying attention, we clarify the plot.

The dramatis personae are many.  But they fit into two camps.  In one is a whole line of Promethean protagonists — prominent economists and politicians, beginning with Fed chairman Arthur Burns …followed by the epic hero Alan Greenspan.   Currently, the lead is being played by Ben Bernanke, supported by George W. Bush in the White house and colleagues Mervyn King in England and Jean-Claude Trichet at the European Central Bank. In the other camp are, well, the gods.

It’s an antique story but the current action began in 1971, when Richard Milhous Nixon snuck in and stole the gods’ golden fire.  Not surprisingly, the gods were cheesed off.  They had put the metal in the ground themselves.  And gold’s record for maintaining steady prices was second to none.  An ounce of gold would buy about as much in 1950 as it would have in 1800…or 1700, when Isaac Newton was Master of the Mint.  But modern political economists turned their backs on number 79 on the periodic table.  They wanted a different kind of price stability…a stability they could mess with.  Henceforth, the Nixon team announced, the world financial system would dispense with gold entirely.  They would control the value of money themselves.  They no longer needed gold backing them up.

As to this proposition, David Ricardo spoke for the gods:

“Experience shows that neither a State nor a Bank ever had the unrestricted power of issuing paper money, without abusing that power:  in all States, therefore, the issue of paper money ought to be under some check and control, none seems so proper for that purpose, as that of subjecting the issues of paper money to the obligation of paying their notes, either in gold coin or bullion.”

And thus were the lines drawn.  Who would prevail?  The gods or The Man?  It would be a first for mankind.  But in the 190 years since Ricardo wrote, had man evolved into a more perfect being?  Given a once-in-a-lifetime opportunity to stiff foreign creditors by printing up dollars at will, would a nation of angels be able to resist?

You may guess the answer, dear reader.  But what is extraordinary about this tale is that the telling has taken so long.  And then, when it inevitably goes the way it always goes, people are astonished by it!

It looked as though the question would be settled quickly when prices ran wild in the ’70s.  Inflation in July of ’71 was almost the same as it is today – about 4.4%.  But then, Richard Nixon judged it such a threat to the nation that he imposed price controls.  Still, without gold anchoring the dollar, prices rose.  Ten years later, CPI was running over 10%…and gold had soared over $800.  The gods were having their fun.

But then, into the Fed stepped a colossus of a man; “Tall Paul” Volcker moved quickly to rescue man’s paper money.  He tightened lending and pushed up 30-year Treasury yields over 15%.  The dollar advanced and the gods retreated.  Man was proud again.  The drama seemed to be over.  The fellows with their feet on the ground had triumphed.

For the next 20 years, crises came and crises went.  Each one was dealt with by softening up man’s money with more cash and credit.  And each one seemed like such a success; man’s confidence grew.  Consumer price inflation remained low and gold fell.  By ’99, gold coins were practically the only thing you leave on the seats of your car in Baltimore…confident that no one would bother stealing them.  And as recently as this past November, William Poole, president of the Federal Reserve Bank of St. Louis, speaking for the whole race and sounding like Scipio after the destruction of Carthage, announced:

“Macroeconomists today do not believe that policies to stabilize the price level and aggregate economic activity create a hazard…  Investors and entrepreneurs have as much incentive as they ever had to manage risk appropriately.  What they do not have to deal with it macroeconomic risk of the magnitude experienced all too often in the past.”

But this week, the macro-economic risk seemed as great as ever before.  What had gone wrong?  The gods had set a trap.  Between the Nixon and the Bush II administrations, low rates of consumer price inflation caused our heroes to err.   With the quality of their money in no apparent danger, they allowed themselves to print more and more of it.   Money was available to anyone who asked for it.  For 25 years, the cost of credit fell…leading Americans to borrow and spend …until they had borrowed and spent too much.   And after the limp recession of 2001-2002, the quantity of paper money increased even faster – three or four times faster than GDP.  Fancy new instruments – ARMs, SIVs, CDOs, Swaps and MBSs – gave him even more rope.  And then, the gods roared with laughter.

Gold shot up to three times its price in 1999.  Oil reached $100 a barrel.  Housing markets wobbled…credit markets crunched…and then stocks fell.

And now Mr. Bernanke has panicked.  He offers even more money and credit to a world that already has too much.  Of course, we don’t know how the contest will turn out, but we bet on the gods.


Bill Bonner
The Daily Reckoning

P.S. In an interview for I.O.U.S.A, political columnist for the Des Monies Register, David Yepsen summed up the entire economic debacle when he said, “It’s going to take a crisis to get Americans to act. This is America – we don’t act unless there is a crisis.

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

The Daily Reckoning