The Biggest Transfer of Wealth in History

With the advent of such enormous amounts of debt and credit, all of the heads on Wall Street seem to be rocking towards the East. Why? Because they’ve got all of our money. Bill Bonner explains…

This week began with alarm bells. First Bridgewater Associates broke the glass and pulled the handle; it said the conflagration in the credit markets might lead to losses four times higher than previous estimates – at $1.6 trillion. A lot of money – even for someone who lives in London.

Bridgewater helpfully pointed out that this was just the beginning; the world would lose an additional $12 trillion in foregone credit. When the going is good, each ounce of a bank’s share capital grows into as much as a pound of credit available to borrowers. But when the cycle turns, the shrinkage takes your breath away. Remove a dollar from a bank’s balance sheet and you wipe out a ten-spot of credit. Bad news for people in Britain and America who are accustomed to living off of credit. Bad news for their economies, too. Without access to the fire hose of easy credit, the consumer economy goes up in smoke.

To give you an idea of the scale of a $12 trillion problem, the entire U.K. economy generates only $2.8 trillion of output annually. The U.S. economy – at $13.8 trillion – is only slightly bigger than the anticipated damage.

When the alarums quieted and the flames died down, hopeful analysts sifted the ruins and wondered where the City and Wall Street might find the resources to restock their shelves. Suddenly, all heads rocked towards the East. Visions of myrrh and incense danced before their greedy eyes. Sultans as rich as Croesus…oil sheiks with sand dunes for brains…maharajas of motor industries and mandarins of manufacturing. Enriched by the black gold flowing from deep holes in Arabia…or from commerce on the trade routes between Hong Kong and Long Beach, these princes of modern finance have trillions. Surely they will come to the aid of those who had made them rich?

The gist of the following reflection is this: no, they won’t. Just because people are rich doesn’t mean they are stupid.

Outside the Bank of England and the U.S. Fed lies some $5.3 trillion in central bank reserves. In foreign government pension reserves and other accounts is another $6.1 trillion. Add $3 trillion more now in the hands of Sovereign Wealth Funds. The IMF says these SWFs will grow to $12 trillion within four years. Morgan Stanley estimates a $17.5 trillion pot by 2017. Altogether, this is enough moolah to buy control of every public company in Britain and America combined.

Few people bother to ask where they got all that money. Never mind, we will answer the question anyway: it is the fruit of a monumental hornswoggle.

“It is the biggest transfer of wealth in history,” says T. Boone Pickens, speaking of the oil trade. Americans alone import 3.6 billion barrels of oil a year. In 2003, the tab for all that goo was only about $70 billion. At today’s oil price, it is pushing half a trillion.

A quarter of oil’s price increase since 2003 was because the dollar skidded against foreign currencies. What about the other 75%? That too, is probably largely a feature of a slippery dollar. For the last 100 years, the oil price has greased along – more or less – with U.S. money supply growth. As M3 increased, so did the price of oil. Currently, the money supply – as measured by M3 – is increasing at an annual rate of about 18%. Oil is going up – on a 10-year moving average basis – about 23% per year. Looked at another way, from 1974 to the present, the price of oil has gone up a bit more than 14 times. The U.S. money supply, meanwhile, has gone up a bit more than 11 times.

What does this mean? Oil is probably overpriced. But don’t worry, Mr. Market will sort that out. Just don’t get distracted. This is one of the funniest and most perverse scenes in modern finance; it would be a shame to miss it. In effect, the world’s most sophisticated capitalists are also the dumbest when it comes to money. America and Britain spent too much money. Now, they owe more money to more people than any nations ever did before. Once, they owned the world; now the world owns them. And now, the U.S. central bank inflates in order to try to rescue its errant banks, reckless spenders and condo speculators. But in the global economy, the easy money won’t stay put. Instead, it seeps over to oil sheiks in the Near East to pay for petrol…or over to the sweatshop operators in Far East to pay for electronic gadgets and designer T-shirts. It doesn’t stimulate the U.S. economy, in other words; it stimulates the foreigners’ economies and raises prices for everyone, including themselves. Unfortunately, while the foreigners earn more money and can keep up with rising prices – incomes in India are up 148% since 2001 – the Anglo-saxons’ wages are stagnant. Americans haven’t had a real wage increase in 40 years.

And now the lynchpins of leveraged finance are praying that the cash they spent on imports will come back to them. And it will. But it comes back like a young man who got rich in the colonies…with better clothes and a sniffy air. It left a servant; it comes back a master, buying up valuable assets and expecting the indigenes of Wall Street to shine its shoes. Foreign purchases of U.S. assets rose 90% last year. Foreigners are bidding for America’s leading brewery, Britain’s stock exchange, hedge funds, infrastructure projects and technology companies. A Chinese company bought MG. An SWF from the Gulf bought the emblematic Chrysler in New York. A Russian who got rich in fertilizer bought Donald Trump’s Palm Beach mansion for $100 million. And the balance sheet of the U.S. Fed shows $2.3 trillion of US treasury debt held in custody for foreign central banks.

The harder the Fed fights the correction…the more money and credit it puts out. This monetary inflation causes prices for oil and imports to rise…and more money goes into foreign reserves and Sovereign Wealth Funds in the East, to be used to buy more assets in the West. Thanks to America’s mad monetary policy, these private assets are being taken into public ownership. Some of America’s most important properties are being nationalized…but by other nations.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

July 11, 2008 — Ouzilly, France

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.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now.

“Hedge Fund Manager Describes Rock Bottom,” says a New York Times headline.

Poor Mr. John Devaney. He had to sell his Renoir. His Gulfstream. One of his mansions. And his yacht. Ouch. He says he’s personally lost $150 million trying to keep his funds alive. Alas, in vain!

“Devaney funds wiped out,” Bloomberg reports.

Now, the sad victim of the credit crunch is reduced to living in his remaining mansion in Aspen…and flying first class in commercial aircraft.

But is Mr. Devaney beaten? Not at all. “Do I retire?” (Even in his straightened circumstances, he allows himself a rhetorical flourish…) “No,” he replies, as if there were any doubt about it.

And why should he? He may have wiped out a handful of unlucky investors, but there are still plenty more.

Yes, dear reader…the battle between inflation and deflation…between truth and malarkey…between comeuppance and postponement continues.

Elizabeth’s stockbroker kindly wrote her a letter, explaining why her account had lost money:

“On the one hand, fixed income markets were signaling a weak economy and even deflationary conditions as interest rates were below the rate of inflation. On the other hand, commodity markets were signaling a strengthening economy and even highly inflationary conditions as the prices of almost all raw materials rose sharply…housing problems were getting worse, not stabilizing…[leading to] fears that the banks might be in worse shape than had been thought…this prompted analysts to predict continuing losses at financial institutions in what seemed like a competition to see who could generate the most frightening numbers…”

(We would say Bridgewater Associates won the competition with last week’s prediction that $1.6 trillion would be lost directly…and $12 trillion of credit would be withdrawn from the economy…)

“To top off the anxiety,” the broker continued, “oil prices spiked dramatically to more than double the level they had reached only months earlier, stoking inflation worries.”

Sound familiar? Inflation and deflation…both hitting hard.

What’s he doing about this situation? He’s “taking profits” and holding cash.

What happened yesterday on Wall Street? The Dow rose 81 points. The euro rose slightly.

Most of the headlines this week told of deflation’s hearty counter-offensive, which began only about a week ago. Foreclosures rose 53% in June, from a year ago. Bank seizures have almost tripled, according to Bloomberg.

And poor Freddie and Fannie.

He that did ride so high doth lie so low, as Marc Antony said of Caesar, after the latter was stabbed to death. Freddie and Fannie were the darlings of Wall Street…the leaders of the house price bubble…with nearly half the nation’s $12 trillion worth of mortgages. A couple of years ago, they could do no wrong.

Now, they can do no right.

The government-chartered mortgage lenders are “in turmoil,” says the Financial Times.

They should be in Chapter 11, says former St. Louis Fed chief, William Poole. Fannie has $5.2 billion more in liabilities than in assets, he says. Both lenders are insolvent, he maintains. Like a racehorse in the Kentucky Derby, they should be given the coup de grace as quickly as possible, he believes.

That is not likely to happen. The feds are counting on Fannie and Freddie to end the nation’s housing misery, not make it worse. They’re not going to let the twins go under. Instead, they’re going to give them more rope…and show them the steps to the scaffold.

Yes, dear reader…this is what it has come to. It’s not just a war between inflation and deflation. It’s also a fight between the forces of delusion…and the forces of reality. The delusion is that you can make the problems caused by too much credit go away – by giving more credit! A related delusion: that you can make people richer by printing up more money for them. Yet another: that you can spend your way out of a slump caused by too much spending. And here’s another: the federal bureaucrats can manage the economy better than it can manage itself. And how’s this: that hedge fund hustlers such as Mr. Devaney can make you rich by making huge gambles with your money. Or this: that if you just allow capitalism to work, we’ll all get rich.

The reality is that you can’t get something for nothing. Asians are gaining wealth because they work for peanuts and save their money. Americans are losing wealth because they spend too much and don’t save at all. And when a bubble is ready to pop, it will pop…no matter what you do. Sometimes you can delay it…or push the damage onto to someone who doesn’t deserve it – such as the taxpayer. But all interventions just make the situation worse…causing more, and bigger problems elsewhere.

Fannie’s shares fell 13% yesterday. The whole financial sector went down too…and now is at a loss of about 46% for the year.

*** How do they do it? The Los Angeles Times wanted to know how commuters coped with such high gasoline price.

We wondered the same thing. Yesterday, we had to take a long drive for an important meeting. We drove for three and a half hours through a beautiful part of France, between Limoges and Le Mans, roughly. The fields were lush and green. Sunflowers were in bloom. Combines were harvesting what we took to be wheat, but we weren’t sure.

Making the drive more interesting, there was a huge antique car rally going on in Le Mans. We passed old Jaguars, Triumphs, MGs…all the brands the British sold to foreigners. There were also many cars we couldn’t identify.

When we stopped for gas, a mint condition Austin Healey 3000 drove up next to us. We saw the driver had English license plates.

“Hey, we haven’t seen one of those in years,” we began a conversation.

“Well, they’re still around…but they’re not as cheap as they used to be.”

Nothing is as cheap as it used to be. Coming and going on our journey, we had to fill the gas tank twice, which cost a total of 186 euros – or about $260. We can afford it – barely. But what about people who only earn minimum wage? Or even an average income?

Well, the LA Times tells us that they are spending less on food, movies and clothes.

The Wall Street Journal addresses the subject more broadly. They are “trading down…” it says. What else can they do? They’re getting rid of the gas-guzzlers…and the big houses. They’re cutting back.

“Gas use at 5-year low,” further reports the WSJ.

Oil added $5 yesterday – to $141. And gold jumped $13.

Has oil topped out? It didn’t seem so yesterday. Inflation hasn’t gone away. Japan reports price increases at the wholesale level at a 27-year high.

*** “I think future historians will put the beginning of America’s decline as a great empire in the year 2003, when the U.S. invaded Iraq,” said a French historian at dinner last night.

The summer is an idyllic time in the French countryside. Parisian intellectuals return to their ancestral estates and invite you to dinner. We dined al fresco, under the stars, next to a large lake.

“Hear the frogs croaking?” asked our hostess. “The noise is much louder in June. These are love songs…quite a racket. But now what we’re hearing is just the old frogs remembering what a good time they had a few weeks ago. These are the nostalgic frogs…”

“I would put the beginning of the decline a bit earlier,” we had protested, “to the crash of the speculative bubble on Wall Street. That was really when the markdown of U.S. assets began. Of course, you could put it almost at any time. It’s not a precise moment…but a whole series of things…and we don’t really know what it means, not yet. This might not be the top of U.S. power at all. There could be hyperinflation to wipe out the debts…a revolution or coup d’etat to get rid of the bureaucracy…who knows?”

Nobody knows. But our guess is that the great empire is on a downward slide. So much the better, in our opinion. We liked it better as a humble republic. Empires can be great. But they are rarely good.

“No…when you talk about empire,” she continued, “you are talking politics, not economics. Political power, not purchasing power. And it was with the invasion of Iraq that the United States lost its political position in the world. When the Twin Towers came down, America was still at its peak of power and prestige. The rest of the world was sympathetic and eager to get behind America’s campaign to rid the world of terrorists. But then, with this military adventure in Iraq, America’s political capital began to drain away. People lost their faith in American power and American judgment.”

The Daily Reckoning