No,
there will be no double dip. It will be a lot worse. The world economy will
soon go into an accelerated and precipitous decline which will make the 2007
to early 2009 downturn seem like a walk in the park. The world financial
system has temporarily been on life support by trillions of printed dollars
that governments call money. But the effect of this massive money printing is
ephemeral since it is not possible to save a world economy built on worthless
paper by creating more of the same. Nevertheless, governments will continue
to print since this is the only remedy they know. Therefore, we are soon
likely to enter a phase of money printing of a magnitude that the world has
never experienced. But this will not save the Western World which is
likely to go in to a decline lasting at least 20 years but most probably a
lot longer.
The
End of an Era
The
hyperinflationary depression that many western countries, including the US
and the UK, will experience is likely to mark the end of an era that has
lasted over 200 years since the industrial revolution. A major part of
the growth in the last 100 years and especially in the last 40 years has been
built on an unsustainable build-up of debt levels. These debt levels will
continue to swell for another few years until the coming hyperinflation in
the West leads to a destruction of real asset values and a debt implosion.
In the
last 100 years the Western world has experienced a historically unprecedented
growth in production, in inventions and technical developments leading to a
major increase in the standard of living. During the same period government
debt, as well as private debt have grown exponentially leading to a major
increase in inflation compared to previous centuries.
Until
the early 1970s the growth in credit to GDP had been going up gradually since
the creation of the Fed in 1913.. But from 1971 when Nixon abolished gold
backing of the dollar, virtually all of the growth in the Western world has
come from the massive increase in credit rather than from real growth of the
economy. The US consumer price index was stable for 200 years until the early
1900s. From 1971 to 2010 CPI went up by almost 500%. The reason for this is
uncontrolled credit creation and money printing. Total US debt went from $9
trillion in 1971 to $59 trillion today and this excludes unfunded liabilities
of anywhere from $70 to $110 trillion. US nominal GDP went from $1.1 trillion
to $14.5 trillion between 1971 and 2010. So it has taken an increase in
borrowings of $50 trillion to produce an increase in annual GDP of $13
trillion over a 40 year period. Without
this massive increase in debt, the US would probably have had negative growth
for most of the last 39 years.
Total
US debt to GDP is now 380% and is likely to escalate substantially.
The
coming hyperinflationary depression and the credit and asset implosion that
is likely to follow will most probably lead to the end of a 200 year era of
growth for the Western world. If only the excesses from the 1970s were
corrected we might have a circa 20 year decline. But more likely we will
correct the era all the way back from the industrial revolution in the 18th
century and this could take 100 years or more.
So
after the tumultuous and very painful times that we are likely to experience
in the next few years, the West will have a sustained period of decline. All the excesses in the economy
and in society must be unwound. These abnormal and unreal
excesses are not just corporate executives, bankers, hedge fund managers or
sportsmen earning $10s to $100s of millions but also a total collapse of
ethical and moral values as well as a breakdown of the family as the kernel
of society.
Most
people believe and hope that this major trend change could not happen today
with all the measures that governments have at their disposal. But very few
people comprehend that it is precisely the government interference, controls
and regulations as well as money printing that have created the problems in
the first place. Power corrupts, and the more pressure a government is under
the more they intervene. Because they believe that their interference in the
economy will save the country – read Obama, or the world – read
Gordon Brown. Little
do they understand that each interference, each regulation or each dollar or
pound or Euro printed will exacerbate the problems of the economy manifold.
Governments
now have two options; continue to spend and print money like the US or
introduce austerity programmes like Europe. Whichever way they chose will not
matter since they have reached the point of no return. The economy of the West cannot be
saved by any means. But governments both in the US and in
Europe will still apply the only method they know which is to print money.
Government
is Stealing from the People
Very
few people understand that money printing is a form of robbing the citizens
of their money and their work. Money is supposed to be a medium of exchange
for goods and services equalling the value of the good or the service
produced. For example, an individual works extremely hard to earn an
annual wage of say $40,000 which he receives in the form of paper money. The
government, due to its mismanagement and incompetence simultaneously prints
$40,000 in order to cover its deficits. So the government has by pressing a
button produced the same amount of money that a man had to work a year for.
This is what is currently taking place all over the world and which will
accelerate in coming months and years leading to a total destruction of paper
money. Paper money
has completely lost its function as a medium of exchange or a store of value.
This is why gold is gaining and will continue to gain value against
perishable paper that is called money.
Deflation
Inflation or Hyperinflation
The
only reason that the US could build up such a major debt is that the US
dollar has been the reserve currency of the world and therefore the US has
been able to finance its debts and deficits internationally. The US has now
reached a point when debts have to increase dramatically for the country just
to standstill. Like all Ponzi schemes this one will also come to an end
– and this very soon. The US dollar will decline dramatically and lose
its reserve status and the US government will be unable to finance its
deficit in any market. This process will lead to endless money printing,
collapsing treasury bonds (substantially higher interest rates) and the
dollar becoming worthless in a hyperinflationary black hole.
Let us
just reiterate that hyperinflation arises as a result of money printing
leading to a currency collapse and not from demand pull. The slight deflation
that we are experiencing currently is a prerequisite for hyperinflation. The
fear of a deflationary implosion forces governments to print money, leading
to a collapsing currency which historically has always been the cause of
hyperinflation.
Real
M3 (source: Shadow Government Statistics) is falling at an unprecedented
rate. This is the precursor to economic decline, quantitative easing and
inflation (see early 1970s in the chart).
Many
“experts” make the analogy between the deflationary period in
Japan since the 1990s and the US today. In our view the US is in a totally
different situation for the following reasons:
- In the early
1990s Japan could still export their production to the rest of the
world.
- In the
current downturn all countries (even China and India) will suffer and
there will be no one to export the problems to.
- The ability
to export made Japan a creditor nation with major payment surpluses.
US are a major debtor and have been for 25 years.
- Japan had a
very high personal savings ratio at the time (which has now
disappeared). US has had a declining savings rate for years (the US
savings rate is now going up which it always does in a downturn).
- The balance
of payments and the personal savings surpluses made it possible for
Japan to finance their budget deficit without resorting to QE. Very soon
he US will only be able to finance their deficits with QE and so will
most of the rest of the Western world.
- Japanese
unemployment in 1992 was 2% and went slowly up to 5% by 2000 where it is
now. Real US unemployment is 22% and increasing.
- Many major
sovereign states are now virtually bankrupt and the financial system is
on life support. This was not the case in the 1990s.
The
above are some of the reasons why the current US situation is totally
different to Japan. QE will accelerate in the US and worldwide.
What
will make this process so much more complex than the world has ever
experienced is that the same development is likely to take place in many
countries around the world simultaneously. It will most probably happen in
the UK, the rest of the EU and most other European nations. Due to the total
interdependence of the world financial system, it will be difficult to
forecast which countries can withstand the coming worldwide tsunami of money
printing but many Asian countries probably stand a good chance.
Can we
be wrong in our forecast of a hyperinflationary depression? Yes, of course we
can. But the alternative can only be a deflationary collapse which would be
unacceptable to (dropping money from) helicopter Bernanke and deficit
demagogue Obama as well as most other governments.
Conventional
wisdom and most experts say that we will not have inflation but deflation.
The problem with most conventional wisdom is that it is only conventional
without an ounce of wisdom. When have the world’s so called experts,
politicians etc ever been right on the current crisis? They will be wrong
this time again.
The
“conventional wisdom experts” also say that it will be years
before we can see inflation or hyperinflation. In our view it can happen a
lot faster. The world economy is resting on a foundation of matchsticks. All
that is needed is a change in confidence or psychology for this fragile
foundation to crumble. Falling
currencies, rising bond yields and falling stock markets could very quickly
result in a vicious and fast spinning hyperinflationary circle. The frailties
of the financial system could make this happen like a flash fire.
Wealth
Creation
Banks
and the financial industry have throughout history existed in order to
finance production and trading of goods. But in the last 100 years and
especially in the last 20-30 years it has become a major industry in its own
right and an important but unproductive part of the economy in many
countries. Today, the financial industry is too a great extent involved in
trading for its own and clients’ accounts, creating a raft of obscure
instruments that only benefit the banks and as well as financing consumption
rather than investment. All of these areas are totally non-productive and the
only beneficiaries are the participants in the financial industry. And the
rewards have been absolutely astronomical. In investment banking, hedge funds
and private equity in particular, the most massive wealth has been created.
Many players have become billionaires or created fortunes of tens to hundreds
of millions of dollars in the last 10-15 years just by shuffling money
around. In the past fortunes were created by building factories and
industries. But today any normal employee working in Wall Street or the City
in London will, by just showing up to work, make hundreds of thousands to
millions of dollars. This
is the proof of a world totally out of balance when people dealing in money
become the richest segment of society. Since this activity contributes very
little to the prosperity of a nation (but very much to its participants) it
is not sustainable. The biggest reason why it exists is the
massive amount of money that governments have created or printed and the fact
that the financial industry has developed into a fractal wealth creation
machine for the benefit of its participants.
For
the last 40 years in particular the rich are getting richer and the average
person has seen very little increase in real income. In the US, the real
annual income of the bottom 90% of US families has increased by only 10%
since 1970. And in the expansion between 2002 and 2007, median US household
income dropped $2,000. The
perceived increase in wealth for the majority of Americans derives from an
increase in their debt level not from an increase in real earnings. So the
improvement in living standards that the average American and many other
Western countries have enjoyed in the last 40 odd years is primarily based on
debt – debt that can never be and will never be repaid with normal
money.
On the
other hand, management has achieved a major increase in income and wealth. In
1973, chief executives in the US earned 26 times the median income. Today
they earn 300 times. This enormous widening of the gap between the top few
percent in society and the masses is morally and socially unacceptable. When
the bad times start in earnest, this is likely to lead to major social unrest
and violence directed against the privileged.
The
Focus will Shift
For a
major part of 2010 the focus has been on the problems within the EU starting
with Greece, then Spain, Portugal, Italy etc. The problems in Europe are
major and many European countries as well as the European financial system
will lead to massive money printing. Although the problems in Europe are very
serious, the US economy is in a much worse state. The diversion of the focus
away from the problems in the US economy onto Europe has suited the US
Administration perfectly. It can hardly be a coincidence, for example, that
US rating agencies downgrade the Sovereign debt of Greece and Spain on the same
days as Treasury auctions are held. But the problems in the US economy are
deteriorating at a rapid rate; factory orders, consumer confidence, existing
home sales, retail sales, the ECRI index (Economic Cycle Research Institute)
are all falling more than expected and real unemployment, personal
bankruptcies (will exceed 1.6 million in 2010), trade deficit, state and
federal deficits are all increasing.
The
ECRI index is an important leading indicator. It has now fallen for 10
straight weeks.
There
are three
insurmountable problems in the US economy that are of a
magnitude and gravity which can only be remedied by money printing:
- Federal and
state deficits will soon escalate at an
exponential rate. The US Federal debt has increased from $ 8 trillion in
2006 when Bernanke took office to soon $ 14 trillion. Many forecasts
expect this debt to go up to nearer $ 20 trillion in the next 5 years.
In our view it will be substantially higher. Add to that interest rates
of 15% or higher and the American people will work just to pay taxes
that don’t even cover the interest payments on the federal debt.
This is why the US will either default or more likely print unlimited
amounts of money.
- The real
unemployment rate is now 22%. Since 2007
over 8 million Americans have lost their jobs and it will get a lot
worse. Non-farm unemployment in the 1930s reached 35% and we would
expect this level to be reached in the next few years.
- The
financial system is bankrupt. Banks are
failing at a much faster rate than last year. In the first 7 months of
2010 circa 110 banks have failed. More seriously the assets of the
failed banks are only worth an estimated 30-50% of their balance sheet
value. Banks are valuing their toxic debt at phoney values with the
blessing of the government. But even debt that today is considered safe
will soon turn toxic with the consumer coming under enormous financial
pressure. Add to that the OTC derivatives held by US banks of at least $
400 trillion. A big percentage of these are worthless and there are
virtually no reserves to cover potential losses.
Within
the next few years, the three areas above are likely to result in the biggest
money printing programme in world history and simultaneously lead the US (and
many other countries) into the abyss.
Markets
There
has probably never been a period in world history which has caused the amount
of wealth destruction that we are likely to see in the next few years. If we
are correct in our assumption that the West will see a correction of the
excesses of the last circa 40 years but more probably of the last 200 years, since
the start of the industrial revolution, we could see a total annihilation of
the assets that have been fuelled by the credit bubbles. The spike in asset
values in the last 100 years, which is unprecedented in history, is likely to
be corrected by a waterfall which could start at any time. We will issue a
separate report in the next 10 days covering our market predictions and the
importance of physical gold for wealth preservation purposes.
Egon von Greyerz
Mattherhorn
Asset Management AG
Matterhorn Asset Management has set up a
separate Gold Division called GoldSwitzerland (www.goldswitzerland.com)
in order for investors to purchase physical gold at very competitive prices
and store it in their own name in Zurich, Switzerland outside the banking
system and with personal access to their own gold bars.
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