The Madness of George II

The dark underbelly of human calculation…and an inevitable side effect.

Squeeze a human heart, and the slime oozes out.

We weren’t aware that the U.S. Constitution was still in force, but we read that retired General Tommy Franks told Cigar Aficionado magazine that another terrorist attack like Sept. 11th would bring it to an end. We wondered how Americans would bear up under the strain of a financial disaster.

Under pressure, a man reveals the juice – good and bad. A soldier, for example, may tell a reporter he is building a democracy. But threatened by a mob, he reaches for the trigger.

The list of stable paper currencies built by central bankers is as short as the list of stable democracies built by armed invaders. Some basic grease in the human heart seems to work against them. When bankers discover that they can increase the supply of money simply by printing up some worthless paper, they don’t seem able to stop themselves. Soon, there is too much paper and it becomes worthless. And when foreigners invade a country – even foreigners who think they have a better idea how to run the place – the locals seem to resent it. That may not stop us from hoping. But readers might want to check the odds – just in case.

Central Bankers: Wishing and Hoping and Praying

The madness of George II, reigning president of the American government, is that he believes he can do what has never been done. Never mind the grease, says he; with some Ajax and a little scrubbing, the economy and the war effort will sparkle.

Most Americans believe he will succeed. More spending and borrowing will bring a recovery, they think. Somehow, the war in Iraq will work itself out, they pray. Few notice the long odds; fewer still bet against them. What will they do if things go against them? Suppose the dollar falls more and the Chinese stop buying U.S. debt…or actually sell it? What would happen to U.S. spending if interest rates were forced up? How many people would refinance their homes? How many could continue to live in the style to which they’ve become accustomed? How many would lose their homes? How many would lose their jobs – or be humbled into accepting a lower income, and a lower standard of living? How many would blame themselves?

Our worry is not that George II will be proved wrong; we have little doubt that neither of his grand projects will yield a decent return. Instead, we worry what will happen when the hearts are squeezed harder…when the miry clay of disappointment, bankruptcy, depression, inflation, and national humiliation have Americans entrapped, struggling to stand up straight.

"Incompetent central bankers are more lethal even than incompetent generals," writes our old friend Lord Rees-Mogg in the Times of London this week. "They, too, have their Gallipolis.

Central Bankers: Bad Paper Money

"’We have suffered more from this cause [bad paper money] than from every other cause of calamity,’" Lord Rees-Mogg quotes a dead man, Daniel Webster. "’It has killed more men, pervaded and corrupted the choicest interests of our country more, and done more injustice than even the arms and artifices of our enemy.’

"I have lived through most of the period of the decline of the pound and the disintegration of the sterling area," his Lordship continues. "It was a long, historic process. Its early stages, which occurred before I was born, have some resemblance to the current state of the dollar. After 1918, Britain was heavily indebted and had lost competitiveness to new economies.

"The U.S. is now heavily indebted, and the debts are growing rapidly. The U.S. in its turn has lost competitive advantage to the countries of East Asia….High savings and competitive exports were the characteristic of the U.S. 100 years ago. Now they are the characteristics of East Asia."

The U.S. dollar cannot be called stable. A dollar today will buy only about 5% of what it would have bought a century ago. Compared to gold, too, it has lost more than 90% of its value since Franklin Roosevelt devalued it in the ’30s.

‘Steady’ might be a better word to describe it. But even that is not true. The dollar does not drop at a steady rate, but at a jerky one. Like a melting polar ice cap, it tends to lose a little every year…and then, suddenly, a large iceberg falls off. Over the last 20 years or so, a strange weather pattern has persisted over the northern hemisphere. While the dollar has continued to melt away…it has melted at a slower and slower pace. Against gold, it did not melt at all – until recently, it froze even more solidly.

Central Bankers: Reminiscing about Paper Currencies

With no telling entrails in front of us, we cannot know what will happen. But we take a guess: a chunk the size of New Jersey is about to fall off.

Your editor had tea with Lord Rees-Mogg on Wednesday. We reminisced about paper currencies. None had ever survived for very long – and even gold-backed currencies tended to give way under the stress of a shooting war. Squeezed for cash, the Continental Congress of the American colonies issued ‘continentals’ – I.O.U.s not backed by gold. They were just promises to pay later, after the war was over. But after the war was over, they became the thing that worthless things were worth more than.

In America’s war against the Southern States, again, the Lincoln administration resorted to paper. It established a central bank – a forerunner to the Federal Reserve system – and issued I.O.U.s….which subsequently lost their value. The Confederate States did likewise. Years after the war, desk drawers in Atlanta were still full of I.O.U.s – completely worthless, of course.

Largely under pressure from Johnson’s War on Poverty and war in Vietnam, the Nixon Administration resorted to I.O.U.s again – paper dollars backed by the world’s biggest debtor. Since 1971, the world has seen nothing else. Central bank coffers are full of them. For every ounce of gold in the world, there are approximately $20,000 worth of dollar-based assets and maybe $10,000 worth of dollar- denominated debts, with the paper-based assets and credits growing many times as fast.

The dollar will almost surely fall more – perhaps much more…and perhaps very suddenly. That is when hearts get pinched…and the juice oozes out.

Bill Bonner

Decemeber 05, 2003 — Paris, France

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the NY Times and international best-seller: "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons).

"Our economy was strong and is getting stronger. Productivity is high; business investment is strong; housing construction is strong. The tax relief we passed is working."

The president was speaking at a fund-raising event in Dearborn, Michigan. The crowd of amateur economists – as Nixon remarked years ago, we’re all Keynesians now – looked on as if they had a clue. The next line of the New York Times report stuck the fly in the honey jar:

"The positive news is tempered somewhat by the federal budget deficit, which is expected to reach $500 billion next year as growth is financed in large part with borrowed money, and by a lofty trade deficit."

The tax cut did not exactly increase America’s wealth. Neither taxpayers nor tax collectors were putting any money aside. Every penny was already being spent. But by the ledgerdemain of fiscal policy, money that would have been spent by government was shifted back to the people who earned it, who then promptly spent it.

The government, meanwhile, did not decrease spending in line with its reduced resources. No, it increased spending, too – borrowing on more than 100 years of good credit, and 20 years of declining consumer price inflation, to get a good rate. Spending went up, but so did the mountain of debt that will one day cause a problem for someone. (More on this, below…)

But this is still 2003…not 2004…nor 2005…nor any higher number.

We’re looking out for number 1 right here and now. Next month, next year, the next generation – they can all take care of themselves!

We note a couple of sly little articles in the Wall Street Journal. One tells us that corporate leaders are selling stock in their own companies at twice the average rate of the last 5 years. Forget going down with the ship; these captains are taking to the life rafts. They’ll be safely in St. Barts before the passengers even hear the alarm.

"Companies Race to Issue Debt," begins the other. We don’t need to read it. We can imagine. When fools want to part with their money, someone has to take it. The cleverest thing to do in the late ’90s was to get together some kids who wore their baseball caps backward, create a business, hire a publicist, cut a deal with Jack Grubman or Henry Blodget to pump the stock…and sell as much stock as possible. Then, instead of spending the money, junk the business plan immediately. Put it in T-bonds. Then, after the stock collapsed in the bust of 2001…either close the company and distribute the shares…or use it to buy a real business.

Now, tax and rate cuts have produced another bubble. And this time there are plenty of fools – foreign and domestic – who are willing to lend money at rates that barely cover the current inflation rate. It is as if they hadn’t noticed that the dollar is falling…that the federal deficit has reached half a trillion…that the trade deficit is another half trillion…that consumer debt is higher than ever…that the federal government is $44 trillion in the hole…that debt has reached three times GDP…and that it is growing 6 times as fast…and that consumers are already going bankrupt at record rates.

Borrowed money may not seem cheap today. But it will likely seem almost free before it is paid off. Advice to borrowers: just don’t forget to hold onto it.

Over to Addison…for more news:


Addison Wiggin in, er, London…

– "Foreign central bank holdings of U.S. securities rose to a massive $1.045 trillion on Wednesday," our London correspondent, Sean Corrigan, reports (from the wilds of the West Texas oil fields, curiously). "A cool $40 billion has been gifted to the Federal Reserve by these non-dollar banks in just FOUR weeks…at a rate of $2 billion every trading day."

– You’d think that would have single-handedly boosted the dollar’s value, wouldn’t you? Instead, these central bank billions have merely managed to limit the greenback’s decline to just 2.3% over the same period. "Imagine what would have happened had they not pumped $2 billion a day into the Fed’s reserves," Sean wonders aloud. "If $40 billion cannot bring about even a minor rally, just how weak and despised IS the once-Almighty dollar?"

– On November 20th, we noted the Bank of Japan has been selling their own currency short at a rate of $1 billion per day. At the time, we’d heard they only had 8500 yen left in their Forex accounts…giving them 79.9 more days of spending at that rate.

– We’ve also noticed that the bank will deny the Japanese government of over 1% in annual tax receipts because they’ve lost so much money this year. Given the bias of the six other G7 nations, since they met in Dubai in October, you’ve got to wonder how long they can hold out. (Back of the envelope calculation: 64.9 days. Then, look out below!) The dollar fought off a fifth straight low against the euro yesterday and closed at $1.20 versus the euro.

– Fear of the doomed dollar dropping didn’t deny dealers in Dow stocks the pleasure of watching their index rise another 57 points to 9,930 yesterday. The S&P and Nasdaq put on 5 and 8.5 points respectively.

– "While the U.S. has less than 2 per cent of world crude- oil reserves," observes a tangy e-mail put out by a British outfit called, "it gobbles up a quarter of the world’s supplies. Without imports, it would run out of its own reserves in just three years. Britain’s total oil reserves are enough to satisfy our cravings for a mere seven and a half years.

– "Attracting the greatest interest [among political strategists in London and Washington] will be places that harbor particularly abundant supplies of vital materials," schNEWS quotes U.S. Professor of Peace and Security studies, Michael Klare. As you may recall from Tuesday’s essay, we have been pondering the conclusions of the Chinese economist Wang Jian, who pointed out to his superiors in the Zhongnanhai – the Chinese answer the White House and the Kremlin (heck, we might as well get used to the term!) – that "America’s wars abroad have always had a clear goal; however, such goals were never made obvious to the public." And that in order to "see through the surface," the Chinese need "to figure out what the fundamental economic interests of America are."

– Well, the editors at schNEWs think they’ve got the Americo-British strategy all figured out. They suspect that the Persian Gulf region – including Iraq, Iran, Saudi Arabia, and Kuwait, which possess two-thirds of known future oil reserves – as well as the Caspian Sea Basin – including the Central Asian states of Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan, which harbor a fifth of the world’s total reserves – are the next targets for the "oil junkie West."

– "Last year, Georgia," the e-mail offers up as proof, "a country of five million, was given $64 million of U.S. aid, making it the second-biggest recipient of U.S. aid per capita after Israel. The reason? Georgia is in the frontline of the ‘war on terror.’ Russia says that its mountainous Pankisi gorge is a hideout for Chechen rebels, while the U.S. reckons that amongst these fighters there might be as many as a dozen Al-Qaeda members, which works out around over five million dollars a head!"

– Reading between the lines, schNEWS suspects an alternative explanation might help those who are unusually attracted to the truth: "…for the last 10 years, the U.S. and Britain have been investing in central Asian oilfields, but have been struggling to find a way of getting the oil to the West without taking it through Iran or Russia. Bingo! Just weeks ago, the World Bank and European Development Bank each approved a £300 million contribution for BP’s massive Baku-Ceyhan pipeline project, which will stretch from the Caspian through Azerbaijan, Georgia and Turkey to the Mediterranean.

– "According to the director of the ‘Liberty Institute’ in Georgia," schNEWS goes on, "Western oil money provided some of the finance behind the toppling of the Shevardnadze regime. With 60 percent of its population living well below the poverty level, the Georgian people had clearly had enough of Shevardnadze. But he had also upset his western ‘friends’ by arguing that the Baku-Ceyhan pipelines could damage the country’s ecology and, more importantly, by pursuing major energy deals with Russia.

"Within weeks, President ‘elect’ Bush sent senior adviser Stephen Mann to Tbilisi with a warning: ‘Georgia should not do anything that undercuts the powerful promise of an East- West energy corridor.’ When the energy deals with Russia went ahead anyway, former U.S. secretary of state James Baker flew in and warned the Georgian leader of the need for a free, fair parliamentary election. The vote was rigged, the people rose, and in a bloodless coup Shevardnadze became history. The new president Mikhail Saakashvili is a U.S.-trained lawyer who, according to Business Week, has been courting Washington for some time with promises to block Shevardnadze’s plan to give Russian oil interests a foothold in the country."

– What interesting times we live in, eh?


Bill Bonner, back in Paris…

*** Gold slipped a little yesterday, but still trades over $400. Stocks have gone up, too, which leaves the gold/Dow ratio unchanged at about 25 to 1. Our Trade of the Decade, we remind new readers, is to sell the Dow and buy gold. We expect gold and the Dow to come to about the same level – sometime in the years ahead. At that point, an ounce of gold will buy the entire 30 Dow stocks. Few people will want to make the trade. But it will probably be a good idea.

*** Gold is in a major bull market. All our friends say so. But in terms of euros, gold has barely moved at all. Gold is not in a bull market, after all. It is the dollar that is moving – down. The dollar is in a major bear market, we conclude.

"I’m shorting the dollar," said Kurt Richebächer yesterday, dropping by the Daily Reckoning headquarters in Paris. "I don’t trade," he explained after talking to his broker on the phone. "I make big money every once in a while by investing in these big movements."

"You know," the octagenarian continued, "Americans have such strange ideas. They don’t mind spending all their money – leaving their children nothing. They even make a virtue of it…as if it were a good thing to start with nothing…or even less than nothing. I detest this mentality. I see the collapse of the dollar as the way to make a lot of money to leave to my children and grandchildren."

The Austrian economist expects the greenback to go to $1.50 to the euro. It now trades at $1.20.

*** Last night, your editor was stood up by two women in one evening. At least, he thought so. Sitting at a table at Les Editeurs, by himself, in front of a mirrored wall, he had an opportunity to reflect. Everyone he knows is short the dollar. Buffett and Soros are said to be short. Buffett never bought a foreign currency in his life. Now, he says he can’t avoid it; he has his shareholders to considers. Economists are quoted in almost every paper; all say a continued fall in the dollar should be anticipated. Hearing Kurt Richebächer talk about it, the fall of the dollar is the surest thing since the bubble blew up. Even TIME magazine warns readers to ‘hedge’ against a falling dollars, without telling them how.

Is it too late, we wondered? Is the fall of the dollar over – now that everybody is onto the trend?

Probably not. Most dollar holders still cannot imagine a genuine collapse of the currency. Most Americans have all their assets in dollars and would have no idea how to hedge. The value of those dollar-based assets is over $50 trillion, and may be as much as $100 trillion. By contrast, the value of all the gold and all the world’s gold mining companies is barely $2 trillion. Gold is the world’s money of last resort…it is its anti-dollar…its anti- economics…its antidote to paper assets, debts, derivatives…its reality check. Most Americans own no gold. Most don’t even know how or where to buy it. Organized crime and central banks still rely almost exclusively on the dollar to hold their reserves. And corner drug dealers still quote prices in dollars.

No, dear reader, the collapse of the dollar has a long, long way to go. Most likely it will surprise us all – by falling more, faster than anyone expects.

*** From our friend Byron King:

"I just read your attribution in today’s TDR (12-04-03) to Tom Friedman and David Brooks:

"Instead, (American soldiers are) ‘idealists’ and ‘committed democracy builders’ sent…by a ‘non-healing administration’ on the ‘most important liberal, revolutionary U.S. democracy-building project since the Marshall Plan… ‘

"’Nurturing,’ says…(Mr.) Friedman, ‘that is our real goal in Iraq.’"

Bill, you know that I am a Navy guy. And one of the things I do in my Navy Reserve job is look after a bunch of other Navy guys, all of whom are somebody’s son, husband, father, brother, uncle, friend. In October, we drilled for a good many days and got everybody re-qualified to shoot M-16 rifles, M-9 pistols, 12-gauge shotguns and some other heavier weapons. This is in anticipation of some of those fine souls being sent off to distant parts, there to use such martial skills. I assure you, and you can pass this along to Messrs. Friedman and Brooks, that "democracy- building," and revisiting the goals of the "Marshall Plan," and especially "nurturing" anything, particularly in Iraq, are not even close to the radar screen of any member of the gun-toting combat arms with whom I am acquainted.