The Great Correction: 5 Years On...Part II
You will recall. As we ended last week, we were speaking to a crowd at the investment symposium in Vancouver, Canada. We had introduced the provocative idea that maybe the course of history was not something we could understand or control. Maybe destiny, fate, or grand historical forces were at work. We can barely understand them, let alone control them, we argued. As for fighting against them, fugitaboutit. Our speech continues…
Addison chose the “Fight or Flight” theme for this year’s Agora Financial Investment Symposium. Addison is a fighter. He’s devoted a considerable amount of his time…and a considerable amount of my money…to trying to save the nation. His latest documentary, RISK!, which I didn’t get a chance to see, shows how innovation, creativity and entrepreneurship can put some life back in the economy.
It’s a very optimistic way to look at things. And maybe that is the destiny of the United States of America. Or maybe it isn’t. But let me give you an example of the kind of thing that might lead to a much different outcome.
First, we have to understand. The US has an empire…it is an empire. We don’t think of it that way, because we still call the US leader a president. He is elected…as are congressmen and senators. So, it doesn’t seem much like an empire. But in critical aspects, the US has followed Rome on the path of empire. The US is the world’s leading power…with much more of a monopoly on military force than any empire in history, including Rome itself. Rome had the barbarians to the North and the Parthian to the East. Neither could it ever subdue. America has almost no competition.
But what does it matter what happened to Rome? That’s ancient history. Most Americans don’t bother to think about it at all. And they certainly don’t think that it has a destiny that cannot be checked or escaped. Americans don’t believe in Fate. Or destiny. They think they can do whatever they want. They think their future is up to them, completely. They just have to get their leaders together to vote on it!
And yet, every empire ends up broke…and defeated. And the fate of every country that has tried to run a pure paper money system…with currency not backed by gold…has been disaster. The fate of every country has allowed debt to get out of control has been disaster. It didn’t matter what anyone thought or did. Once you head down that road, it seems that you have to go all the way. I guess, there are a lot of byways and side-roads you can take. But you always seem to end up in the same place.
But maybe Obama is smarter than, say, Ceasar Augustus or Marcus Aurelius, or Diocletian. And maybe Bernanke and Geithner are smarter guys than, say, John Law or Karl Helfferich or Domingo Cavalho.
Maybe Obama, Bernanke, Summers, Geithner and all are such geniuses as to be able to do what no leaders or experts have ever been able to do before. But I wouldn’t bet on it.
The US currency used to be fixed to gold. No one had to manage it. We didn’t need geniuses. But since it has been actively managed – by people Bernanke and Geithner, and their predecessors – it has lost 97% of its value. What are the odds that these managers will do better in the future? What are the odds that they will succeed where all the central bankers and central financial planners who came before them failed?
So, if you expect to hold the US dollar for a long time, you’re betting on something that has never happened before. And you’re betting on the genius of the men and women who, so far, appear retarded.
One thing you learn from reading the history of Rome is that the imperial bargain is a tough one. You get glory. But you pay dearly for it. The middle class is destroyed…and the country goes broke. That’s the destiny of empires.
You know, most of you have probably watched the value of your houses go down. They’re down about a third on average. Well imagine how you would have felt as a citizen of Rome after the empire hit its peak under Trajan in about 100 AD. You would have watched the value of your real estate go down…and not come back for 1800 years. There were still goats grazing on 7 hills of Rome – once the world’s most expensive real estate –when English tourists visited in the 19th century.
But those of you are a confident that the US will always be a winner won’t believe me. You believe that that right-thinking, well-intentioned public servants will always find solutions…that they will always do the right thing, at the last minute, perhaps. You think Europeans may get themselves out of an impossible situation. Ha, not us!
But what I notice is that while Europe is broke…the US is even broker. And while Europe can probably recover from its debt problems, the US probably can’t.
“Europe is unraveling as we speak,” said John Mauldin on Tuesday. “The euro will probably not exist within two years.”
I told John I thought he was wrong. So he challenged me. In 2 years if the euro is higher than the dollar, he’ll pay me $100.
I told him I’d rather have euros.
John may be right. He thinks the US has a big advantage. Because it has a political union as well as a currency union. It can force all Americans to pay for debts run up by just a few of them. It can apply one interest rate…and make it work for the entire country. It can put the full faith and credit of every village, borough and backwater at risk…in order to bail out its banks and pay for its central planning experiments. It can increase its debt and debase its own currency almost indefinitely – simply by an act of Congress, raising the debt ceiling.
That’s what people think. No destiny involved.
Europe, meanwhile, is hamstrung and hog-tied. It has no centralized political management, so it cannot force Germans to pay for Greeks’ spending, for example. Interest rates suitable to German savers are demonstrably unsuitable to Italian spenders. And member states of the European Union are given to all manner of silly spending. Italy is sinking under the weight of too many limo drivers. No kidding. Chauffeurs for public officials form a substantial part of the Italian government budget. And don’t forget the bunga-bunga parties, too. The Greeks, meanwhile, can’t collect taxes. France gives away far too many social benefits; it faced massive strikes when it raised the retirement age to 62. And Ireland should never have bailed out its insolvent banks; it didn’t have the money.
To an American crowd these reports from Europe look like evidence of the superiority of the US model. The US may default, they say, but it would be just a voluntary, technical default.
“Compared to Europe,” John continued, “America looks like it is well run.”
To us, the US and its whole capital structure – its stocks and its bonds — looks like a trap. And the tension on that trap is illustrated by current yields on government debt obligations. Greek 2-year debt was still yielding over 30% when last we looked. US 2-year debt yields are so low, there is nothing but a zero on the left side of the decimal.
Greece and the US have about the same amount of government debt to GDP. So does Italy, depending on how you calculate it. Italy actually has a much lower deficit – not even half the US. So why the higher interest yields in Europe? Addison’s movie suggests that America can still harness its traditional strengths…innovation, flexibility and entrepreneurship…to re-invent itself. But the America that led the world in growth and output, did so largely by trailing it in central planning as well as pettifogging, paper-pushing regulations. Now it leads the world in central financial planning, debt and regulation. Will it lead the world in growth and innovation too? I doubt it.
More to come…