The
non-federal, private federal reserve corporation has a no-bid contract to
print money out of thin air and charge U.S. citizens money (interest) for
this enormous privilege. Their so-called powers are legion and they are the
cause of much distortion and inequality in our economy, to be sure.
But the
belief that the fed can inflate forever in a fiat system ignores a few
important concepts. First, a debt-based system requires someone to get into
debt. There has to be a willing and capable borrower for a banker to acquire
a new debt slave. The American public is now finally at the point of
saturation and is, in aggregate, underwater and a poor credit risk. Additionally,
people in the United States in aggregate are (finally) starting to become
scared to take on more debt. These are new secular trends not to be taken
lightly.
Now, you
must understand that, in aggregate, the banking system of the United States is insolvent. This is largely due to the amount of risk taken by the largest
institutions that were just bailed out by the U.S. taxpayer to no one's
advantage but those large banks, but it was aided and abetted by a bull
market in real estate and confidence that spread to most medium and
smaller-sized banks. You also have to understand that our "modern"
banking system, after the credit boom we just had and given the skimpy
reserve requirements of banks these days, is unable to tolerate the real
estate market crash that has already occurred and is now in full swing.
The real
estate bear market is not over after 2-3 years! Anyone who says or thinks so
doesn't understand the facts, market cycles or previous historical precedents
(or they are just lying to you to get you to buy a house). We have a recent
example from Japan in the decade after 1990. I know, I know, we're different.
You know why? Because we have much more usable land and we overbuilt much
more than Japan did during their boom. Otherwise, its the same, particularly
the government response to help banks hide the fact that they're insolvent
(which prolongs the bear market by years). Here's a chart of Japanese land
price that I stole from somewhere in cyberspace (can't remember where - sorry
to the creator):
Maybe we
get through this mess in 6-10 years instead of 15. I don't think that's an
unreasonable optimistic scenario (though it will take 20 years if the
government insists on continuing to stop the free markets from functioning). So,
maybe by the 2011-2012 time frame we will find a bottom in housing. If that's
true, we will drag along the bottom for another 5 years as the psychology of
housing as an investment or speculation turns 180 degrees in the opposite
direction from a culture that actually had a popular television show about
"flipping" houses. Once a bubble like this pops, it ain't coming
back for a generation or two. Period.
This
means that banks and debtors who hold mortgage notes are in trouble for a
long, long time (in aggregate). When a bank is in trouble, it gets cautious.
It doesn't want to loan money to risky borrowers. Once bitten, twice shy.
Please don't forget that banks are actually in the business of trying to make
money! If they don't think they can get paid back, they won't make a loan. The
exception is if there is a secondary market to sell their loans to so that
the banks don't have to be the ones worrying about getting paid back. This is
why Freddie Mac and Fannie Mae are such nefarious organizations. They
promoted (and continue to promote) unsound lending and put the risk on the
taxpayers' backs with no sharing of profits when times were good!
The flip
side of this is the consumer. Even if the bankers want to continue to make
unsound loans and the U.S. government gave them free money to loan, the U.S. consumer, in aggregate, is exhausted. We have finally reached that point after two
decades of unbelievable profligacy by the typical American. After refinancing
their home, maxing out every credit card they could find and getting
themselves into long term loans for vehicles, second homes, appliances and
education, the final wall has been hit.
If you
make $40,000/year and take out a loan for $1 billion, it doesn't matter what
the interest rate is, even if it's zero. There is a mathematical limit of how
much debt can be serviced by a certain income. The final stages of the credit
boom required subprime debtors to take on loans with negative amortization,
meaning they were paying less than interest only on housing-backed debt (i.e.
Option ARM or "pick-pay" loans that are HEAVILY concentrated in
bubble states like California and are now exploding on schedule) and every
month their amount of debt was increasing despite making payments!
The
bottom line is that Americans, in aggregate, can no longer service any more
debt. They have reached their mathematical limit of debt payment and much of
their debt is going bad at a staggering pace as unemployment continues to
rise. That feeling of being underwater on a mortgage and coming to realize
that your "asset" has become a trap is not one to be
underestimated. Many folks don't have the financial ability to pay their
debts down any faster, by the way.
Our
government and our non-federal private federal reserve corporation are trying
everything to get the party going again. Since the consumer can or will no
longer borrow on their own, the government takes on more debt in their name. The
federal reserve pushes credit out the door at a pace that alarms anyone who
is paying attention.
It seems
that many think the federal reserve can create inflation and cause markets to
rise at will by throwing our currency and future savings under the bus. Cash
for clunkers and cash for refrigerators both show the depths the apparatchiks
are willing to go to cause inflation and take on more worthless debt. Visions
of helicopter Ben Bernanke throwing money from helicopters are not
heart-warming to say the least.
But is
there a limit? Is there a point where the party stops and nothing works
anymore? The answer is yes but the question is how this party comes to an
end. Some say hyperinflation and some say deflation. Hyperinflation seems to
be the obvious choice. If you keep pushing and pushing cheap money, the
currency just spirals down to its intrinsic value, which is zero.
Deflation
requires a different view, which is that the central bank and our government
are not the only ones who have an effect on the economy. The fed is not
omnipotent or omniscient. They have only one play in their playbook (though
it has many twists) - create money and throw it around by getting people to
borrow it and multiply it. But you see, someone has to actually borrow it and
do something with it to make prices rise in the real world when the system is
credit-based. The deflation argument states that at times there are not
enough people left who want to borrow and not enough banks who want to lend
and the net decline in credit and the credit multiplier effect in the economy
more than overwhelms notions of "base" money.
This is
the "pushing on a string" theory that I favor is happening right in
front of our eyes. You see, government debt doesn't grow the economy.
Government is a parasite on the economy. Government and its private fed bank
distort the primary trend, they do not create it. I think the lack of
fed power is about to be exposed and I think what's left of the free markets
will teach apparatchiks a powerful lesson (again) about what they can and
cannot do.
Lost in
many discussions is what happens to the engine of the economy at this point
in the cycle. The private sector is the economy, not the government and not
its non-federal central bank. If you are a citizen in debt up to your
eyeballs with no realistic ability to pay that debt back and no one left to
lend you money, cash becomes very valuable. And believe me, at this point in
our economic cycle and country's history, there are many, many people in this
boat already. Many, many more are only one paycheck away from disaster - a
family illness, job loss or some other slip on a banana peel and it's game
over. When thinking in "big picture" terms, this is important.
For
people who are in this situation, it doesn't matter what widdle Timmy
Geithner is doing to steal all he can from the taxpayer kitty. It might make
these people mad and possibly (hopefully) mad enough to do something about
it, but it doesn't change their economic reality. They have to cut back,
start saving, and start paying down debt. Alternatively, they can or may be
forced to walk away from their debts without paying. Both of these trends are
highly deflationary.
When we
defaulted on the Gold standard in 1971, we basically walked away from our
debt to other countries. Our currency went on a pretty serious slide over the
next decade, culminating in a commodity spike that Gold and silver bugs still
talk about today and hope will repeat. And please remember that I am bullish
on Gold. But I want to show you another historical perspective on what could
happen besides stagflation or hyperinflation.
It comes
from the 1930s. The major economies were on a Gold standard to start the
1930s. As things got bad to kick off the economic depression, however,
governments did what they do so well - they broke their promises. Britain, the senior economy of the time in the eyes of the world, left the Gold standard
completely and abandoned it in 1931, just like we did in 1971. Want to guess
what happened to their currency?
Well,
here's what actually happened (chart copied from Martin Armstrong's book
"The Greatest Bull Market in History" but credited to the Wall
Street Journal by him):
Not what
you'd expect, eh? And, no Britain did not return to the Gold standard to
cause the spike in their currency back higher after the plunge in the early
1930s. So, why did their currency spike higher even after they left the Gold
standard? Simple: a deflationary depression caused a bull market in cash and,
additionally, every other government in the world played the same game and
devalued their currency! Major European countries left the Gold standard in
the early 1930s and only the U.S. stayed on the Gold standard. Even the U.S. finally changed the rules and did a one-time devaluation of its currency and switched
to a weaker, watered-down quasi-Gold standard in 1934 after stealing its
citizens Gold and criminalizing private Gold possession.
So, I
hold Gold instead of U.S. Dollars to protect from what now seems an inevitable
U.S. (and global?!) currency devaluation. But there's a good chance the U.S.
Dollar won't spiral into hyperinflation, but rather a one-time rapid
devaluation will help spark a weak cyclical bull market in anti-dollar plays
(i.e. stocks and commodities) and then the value of cash may well rise once
again (just like in Britain in the 1930s).
We won't
be making new highs in stocks or commodities for several years in my opinion,
as the underlying economy is too weak to support such a rise. I think the
international currency Gold will outperform the U.S. Dollar and thus it is my
preferred form of cash. Forget interest payments, I want my purchasing power
retained and enhanced and I want protection against a one-time intentional
currency devaluation or temporary capital flight from the U.S caused by
economic weakness and an unrealistic fiscal policy (we are not the only
country at risk, by the way!).
If you
are a Gold stock bull, like I am, deflation is a wildly bullish scenario. Most
Gold bugs don't understand that Gold miners can more consistently grow profits during deflation than
during inflation. This is paradoxical only when you look at Gold as a commodity
instead of as a form of cash. Gold is money. If Gold (i.e. cash) is becoming
more valuable and the costs of mining are going down (i.e., the
Gold:Commodity ratio as a proxy), miner profitability for unhedged miners
goes up exponentially. This is why Gold miners did so well during the last
economic depression of the 1930s.
So, not
only can you make money buying Gold stocks, but your profits will be more
valuable in U.S. Dollar terms relative to real estate, general equities and
commodities. Though I am not interested in buying senior Gold stocks at
current prices, especially since the equity bear market is about to resume,
another great buying opportunity is coming and it should be welcomed and
seized by interested investors.
I realize
that many people think Gold will get killed during deflation but none of the
deflationists who predicted this thought Gold would be within spitting
distance of its all-time highs a few months after the most intense
deflationary liquidation this country has seen in 30 years (i.e. the fall
Panic of '08). All Gold stock investors should personally welcome a
deflationary decade after seeing the table below, stolen from Ian Gordon. This
table is shown because these were two of the main senior Gold stocks and this
is their price action during the worst stock bear market America has seen in
100 years (i.e. the 1929-1932 bear, during which the Dow Jones lost 89% of
its value).:
And
believe me, Gold stocks absolutely exploded over the three years following
this table's data!
Why am I
harping about all this? Because I like Gold as a cash equivalent and
insurance and Gold stocks as an investment, but I don't like commodities at
this point in the business cycle. Most Gold bugs are just inflationists or
hyperinflationists and don't understand the role of Gold as money and a hedge
and they don't understand that deflation is consistently bullish for Gold
miners' profits. Another good Gold and Gold stock buying opportunity is
coming soon I believe, and I for one am happy to wait patiently for it.
I don't
believe the fed or any other single private corporation can control everyone
in the economy. The primary trends in the real economy are all deflationary
and the fed cannot stop them. If you believe the fed is all-powerful and can
control the value of the currency at will, then let me play along for a
minute. A willful creation of hyperinflation, and it would have to be
willful, would put the federal reserve franchise at risk. If you owned the
for-profit federal reserve, which is not part of the U.S. government and has no allegiance to it, why would you want to end the most lucrative
no-bid government contract in history?
Adam Brochert
GoldVersusPaper
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