This piece was originally written in March 2013 but is even more relevant now as we enter into uncertain times in 2020.
“If I have seen further it, it is by standing on the shoulders of Giants.” Isaac Newton
“Truth, like gold, is to be obtained not by its growth, but by washing away from it all that is not gold.” Leo Tolstoy
“It’s important to realize that whenever you give power to politicians or bureaucrats, it will be used for what they want, not for what you want.” Harry Browne
“The further back you look, the further forward you can see.” Winston Churchill
“The conscious and intelligent manipulation of the organized habits and opinions of the masses is an important element in a democratic society. Those who manipulate this unseen mechanism of society constitute an invisible government which is the true ruling power of our country. …We are governed, our minds are molded, our tastes formed, our ideas suggested, largely by men we have never heard of. In almost every act of our daily lives, whether in the sphere of politics or business, in our social conduct or our ethical thinking, we are dominated by the relatively small number of persons…who understand the mental processes and social patterns of the masses.
It is they who pull the wires which control the public mind.” Edward L. Bernays
“If a problem has no solution, it may not be a problem, but a fact — not to be solved, but to be coped with over time.” Shimon Peres
The US Dollar has lost 96% of its purchasing power since the Foundation of the Federal Reserve in 1913. Fact.
Our role at The Impartial Lens is to be the bad influence, the contrarians encouraging you to take a look outside of the accepted belief system and viewing economics and investing through a less emotional and impartial lens. We believe that an understanding of the “Big Picture” is of primary importance to each of us as investors. One of our primary concerns is the malicious and insidious nature of momentary inflation and the intended and unintended consequences of global monetary and fiscal policies. As social observers, we find it despicable what governments, economists and central bankers are doing to societies and economies globally. As participants in the financial industry, we benefit by taking advantage of these distortions and misallocations created by the above and by being positioned on the correct side of the trade. Our view is perhaps seen by some as heresy against the orthodoxy of mainstream Keynesian economic thought. However, we find it surprising that so many investors and financial advisors do not fully comprehend the process and the effects of monetization.
In the last ten years alone debt around the world, that is the total credit market debt (on the balance sheet, sovereign obligations, corporate and household debt) has grown from $80 trillion to just over $200 trillion. That is an 11% annual compounded growth rate, with corresponding global GDP growth of 3.8% and a Global population growth rate of 1.2%. This is the largest peacetime accumulation of debt in world history and our contention is that this ends through war, economic wars, currency wars, trade wars and finally physical war. War is simply economic entropy played out to its final and logical conclusion.
Indeed we have already begun to see the beginning of the economic and physical wars. We have global competitive currency devaluations as nations try to “beggar thy” neighbors and we have geopolitical tensions rising between neighbors across the globe. As far are we are concerned the quantitative analysis is already done, it is just math, the facts, and figures. The big question is how and when this will all unravel, how do we protect ourselves as investors and perhaps benefit. We believe that in order to move forward as successful investors and participants in the markets, it is of prime importance to understand how we got here.
To try and glean an insight into what is unfolding in the markets, how this will unravel and how we should successfully proceed, we will take a look into the past. The following is the chronology of events that unfolded and resulted in the “Global Financial Crisis”. Indeed the crisis is still unfolding as governments and central bankers react to the unwinding and misallocation of capital. Those who saw the crisis coming did not just avoid losses, they benefited from the knowledge. As Mark Twain said; “History doesn’t repeat itself, but it does rhyme” and as Edmund Burke warned, “Those who don’t know history are doomed to repeat it”.
The deleveraging of the financial and household sectors has created a terrific global macroeconomic undertow since 2008, eroding growth and has been given the title of the “Global Financial Crisis”. Our contention is that the “Global Financial Crisis” of 2008 is but a symptom, an effect of a greater cause. The diagnosis and the treatment prescribed thus far by the witch doctors of central banks and governments are treating the symptom and not the cause of the “Global Financial Crisis”. They have prescribed copious amounts of steroids/stimulus to treat the symptom of the cause and to try keeping the patient/economic growth alive a little longer. The steroid/stimulus/QE is only having a temporary and limited impact, as each round of easing by the Fed, and central bankers have propped up stocks only until a crisis in Europe, U.S., etc. undermines incipient recovery again. Now, this period of prolonged economic pain is giving way to economic war, currency war, competitive devaluations, as the major powers scramble to blame and subsequently maintain a currency edge on their competitors in order to keep exports and growth alive.
When we analyze the deleveraging of the financial and household sectors since the housing bust in 2007-2008, we must look back in time to determine the cause and subsequently properly dialogize the effect.
Empire is defined as:
1. A political unit having an extensive territory or comprising a number of territories or nations and ruled by a single supreme authority.
2. An extensive enterprise under a unified authority.
3. Imperial or imperialistic sovereignty, domination, or control.
Historically a nation-state taxes its own citizenry while an empire taxes other nation-states. The imperial ability to tax has always rested on a better and stronger economy and subsequently a better and stronger military. The tax imposed on the other nations has always been direct and sometimes violent, the empire taking whatever economic goods it demanded and whatever the subject state could deliver.
This all changed on 27 Dec. 1945 with the implementation of the Bretton Woods Agreement. The agreement was clamored together by the 44 allied nations at the end of World War II in order to rebuild the international economic system (The United States and to a lesser extent Great Britain dominating the process.) They set up a system of rules, procedures, and institutions to regulate the international system and the International Monetary Fund and the World Bank Group came into being. (Both bureaucratic systems should be abolished as they serve no useful function, only misallocate capital).
The principal features of the Bretton Woods agreement were an obligation for each country to adopt a monetary policy that maintained its exchange rate by tying its currency to the U.S. dollar. Meanwhile, the United States agreed to link the U.S. dollar to gold at a rate of $35 per ounce of gold. (The U.S. had amassed massive amounts of gold during the war in exchange for goods, munitions, etc). In theory, foreign governments and central banks could exchange dollars for gold whenever they desired. In essence, the new international monetary system was, in fact, a return to a system similar to the pre-war de jure gold standard, only using the U.S. dollar as the world’s new De Facto reserve currency until the world’s gold supply could be reallocated via international trade. The American Empire was conceived.
The design of the Bretton Woods System was that nations could only enforce gold convertibility on the anchor currency—the United States’ dollar. Nations could forgo converting dollars to gold, and instead, hold dollars necessary for trade. Rather than full convertibility, it provided a fixed price for sales between central banks. As long as other countries were willing to hold dollars, the U.S. could carry out massive foreign expenditures for political purposes (The Truman Doctrine and the Marshall Plan)—military activities and foreign/humanitarian aid (The Cold War of Eisenhower and Kennedy, Lyndon B. Johnson’s Imperial policies, Great Society and Guns and Butter policies)—without the threat of balance-of-payments constraints. The agreement and the reserve currency status of the US dollar entitled and encouraged the United States to inflate its currency and run a balance of payments deficits in order to keep the new international financial system liquid and fuel economic growth. (Bretton Woods was flawed from the beginning and would lead to its own demise as pointed out by the Belgian economist Robert Triffin in 1960 …Triffin’s Dilemma)
By 1968, the policies of the Eisenhower, Kennedy and Johnson administrations had become increasingly untenable. Foreign nations concluded the US had abused the privilege of the agreement and exported inflation via U.S. Dollar inflation. Most of those dollars were handed over to foreigners in exchange for economic goods, without the prospect of buying them back at the same value. The increase in dollar holdings of foreigners via persistent U.S. trade deficits was tantamount to a tax—the classical inflation tax that a country imposes on its own citizens, this time around an inflation tax that the U.S. imposed on the rest of the world. Gold outflows from the U.S. accelerated, and despite gaining assurances from Germany, France, and other nations to hold dollars, the unbalanced fiscal spending of the Johnson administration had transformed the dollar shortage of the 1940s and 1950s into a dollar glut by the 1960s. By the early 1970s, as the Vietnam War accelerated inflation, the United States as a whole began running a trade deficit. The crucial turning point was 1970, which saw the U.S. Gold/Dollar coverage deteriorate from 55% to 22%. This represented the point where holders of the dollar had lost faith in the ability of the U.S. to cut the budget and trade deficits.
In 1971 more and more dollars were being printed in Washington, then being pumped overseas to pay for government expenditure on military and social programs. In the first six months of 1971, assets of $22 billion fled the U.S. In response, on 15 August 1971, Nixon issued Executive Order 11615 pursuant to the Economic Stabilization Act of 1970, unilaterally imposing 90-day wage and price controls, a 10% import surcharge, and most importantly “closed the gold window”, making the dollar inconvertible to gold directly, except on the open market. Unusually, this decision was made without consulting members of the international monetary system or even his own State Department and was soon dubbed the Nixon Shock. Essentially the U.S. declared an act of bankruptcy and declared itself an Empire.
It had extracted an enormous amount of goods from the rest of the world, with no intention or ability to pay for or return those goods. The U.S. had imposed a tax on the world and the world could do nothing about it. This action of the United States to unilaterally terminate convertibility of the US$ to gold brought about the end of the Bretton Woods system and saw the U.S. dollar become a fiat currency. As most currencies were tied to the U.S. dollar, they became fiat currencies also.
From that point on, to sustain the American Empire and to continue to tax the rest of the world, the United States had to force the world to continue to accept ever-depreciating dollars in exchange for economic goods and to have the world hold more and more of those depreciating dollars. In order to ensure their economic hegemony, and thereby preserve an increasing demand for the dollar, the Washington elites needed a plan. In order for this plan to succeed, it would require that the artificial dollar demand that had been lost in the wake of the Bretton Woods collapse be replaced through some other mechanism. It had to give the world an economic reason to hold them, and that reason was oil.
In 1971, as it became clearer and clearer that the U.S Government would not be able to buy back its dollars in gold, in 1972-73 the U.S. dispatched Secretary of State Henry Kissinger to make an iron-clad arrangement with Saudi Arabia to support the power of the House of Saud in exchange for accepting only U.S. dollars for its oil. By 1975, all of the oil-producing nations of OPEC had agreed to price their oil in dollars and to hold their surplus oil proceeds in U.S. government debt securities in exchange for the generous offers by the U.S. Because the world had to buy oil from the OPEC oil countries, it had reason to hold dollars as payment for oil. Because the world needed ever-increasing quantities of oil at ever-increasing oil prices, the world’s demand for dollars could only increase. Even though dollars could no longer be exchanged for gold, they were now exchangeable for oil. The beginning of the Petro-Dollar recycling throughout the world.
1970’s, 1980’s
The 1970s were perhaps the worst decade of economic growth for industrial nations since the Great Depression. Economic stagflation ensued, inflation in the US topped out in 1979 at 13.3%, and interest rates spiked reaching an all-time high of 21.98% in 1980. We had an oil crisis in 1973 and an energy crisis in 1979, gasoline being rationed in many countries. We had the Watergate scandal and the subsequent resignation of Nixon. Tensions in the Cold War escalated. Major conflicts between capitalist and communist forces in multiple countries raged. The Vietnam War intensified, forcing the eventual U.S. withdrawal in 1975. Arab-Israel conflicts increased and we had the Yom Kippur War in 1973, leading to the Camp David Peace Treaty and subsequent assassination of Sadat in Egypt. We had the beginning of the Lebanese Civil war. The beginning of the Soviet War in Afghanistan. Multiple civil wars and wars between nations in Africa. Ethnic tensions rose in the Balkans. The beginning of the Iranian Revolution and the subsequent Iran-Iraq war. Multiple conflicts and crises occurred in India and Pakistan during the 1970s including the Indo-Pakistani War of 1971, Bangladesh Liberation War, and the Indian Emergency 1975–1977.
The Munich Massacre in 1972 and the rise of militant organizations across the globe. The beginning of The Dirty war in Argentina. Tensions escalated in the Central American nations, civil wars and violence ensued in El Salvador, Guatemala, Honduras, Nicaragua, and Panama.
Paul Volcker was appointed the chairman of the Federal Reserve by Carter in August 1979 and reappointed by Reagan in 1983. The Federal Reserve board led by Volcker raised the federal funds rate, which had averaged 11.2% in 1979, to a peak of 20% in June 1981. The prime rate rose to 21.5% in 1981 as well. However, Volcker’s most important contribution to crushing inflation came after the economy began to recover from the recession of 1982. His policy of preemptive restraint during the economic upturn after 1983 increased real interest rates and pushed congress and the president to adopt a plan to balance the budget. The combination of sound monetary and fiscal integrity sustained the goal of price stability. Volcker was ousted by the Reagan administration because he was not seen as an adequate de-regulator of the financial system. Alan “The Maestro” Greenspan replaced Volcker as head of the Federal Reserve in 1987. Two months after his confirmation, Greenspan said immediately following the Black Monday 1987 stock market crash that the Fed “affirmed today its readiness to serve as a source of liquidity to support the economic and financial system”. An ominous warning for things to come and the foundation of the “Global Financial Crisis” of 2008.
Greenspan Fed 1987-2000
The monetary base in the US alone has increased 10 fold since 1990 as credit began to grow at a faster pace than the economy and debt to GDP expanded rapidly. Please re-read Alan Greenspan’s statement above, the Fed “affirmed today its readiness to serve as a source of liquidity to support the economic and financial system”. Alan Greenspan’s monetary policy approach became infamously known as ‘The Greenspan Put’, later termed ‘moral hazard’. During Greenspan’s chairmanship, when a crisis arose, and the stock market fell more than 20%, the Fed would lower the Fed Funds rate, often resulting in negative real yield. In essence, the Fed added monetary liquidity and encouraged risk-taking in the financial markets to avert further deterioration. The Fed bailed out the financial system (and the banking interests of Wall Street) after Black Friday in 1987, the S&L crisis of 1990, the Tequila Crisis of 1994, the Asian crisis of 1997, the LTCM crisis of 1998, the Dot-com bubble of 1999 and they flooded the system with liquidity after Gulf War 1 1991, before Y2K in 2000 and the September 11th attacks in 2001.
Bernanke Fed 2000-2007
We had the collapse of the NASDAQ and the Fed was concerned about a deflationary recession, so once again they flooded the system with liquidity by dropping interest rates. The Fed fund rate dropped from 6.5% to 1.0% between 2000 and 2003. In the years 2000-2007 the economy expanded by $4.2 trillion and total credit expanded by $21.3 trillion, which is five times the rate of nominal GDP. As early as 2002 it was apparent to those paying any attention that credit was fueling a speculative housing bubble and replacing the NASDAQ bubble.
We had the repeal of sections 20 and 32 of the 1930 Glass-Steagall Act in 1999 (a seminal moment in itself) removing the social responsibility and fiduciary duty of the banking sector in the U.S. We have had the complete financialization of capitalism since 1971 onwards that emphasized deregulation to encourage the taking of risks, combined with the inter-connection of a global financial system that globalized the risk. Plus we have had the securitization of assets, which were subsequently leveraged up, with the risk off-loaded to insurance companies (AIG) or other counterparties through credit default swaps.
We had the publically traded “government-sponsored enterprises” (GSE) Fannie Mae and Freddie Mac, whose mandate was to expand the secondary mortgage market by securitizing mortgages in the form of “mortgage-backed securities” (MBS), with an implied government guarantee which allowed borrowing at very low rates.
We have had Edward Bernay’s consumerization, and corporatization of the U.S. in full flow and we have the brainwashing of the masses based on his Uncle Sigmund Freud’s theories. Consumer expectations were that housing would only appreciate, and they subsequently refinanced to support their spending.
We had the Fed and the treasury asleep at the wheel and did not see it coming, complicit credit rating agencies, and systemic breaches in accountability, ethics, and morals on all levels.
Eventually, the credit bubble that was focused on the housing industry unraveled and the ramifications not only shocked the US but the global financial system and the rest, as they say, is history.
Conclusion – Present.
You may say thanks for the history lesson…Yawn! But, what does it mean for me?
Since the “Global Financial Crisis” of 2008, we have been bombarded by our central bankers/planners with an alphabet soup of bailout and stimulus acronyms, TAF, TARP, TALF, CPFF, PPIP, EFSF, EFSM, ESM, LTRO, QE1,2,3,4.. ZIRP, TWIST, BS, etc. For all the good intentions and hundreds of billions, indeed trillions in bailouts, subsidies, interventions, promised interventions, contingent interventions, and handouts, we at The Impartial Lens conclude that we have done nothing more than prevaricate, procrastinate and postpone the ominous, clearing and clarifying the mechanism of the free market.
The promises and interventions have distorted the markets function as an efficient and effective clearing mechanism; the central bankers of the western industrialized countries seem to us, perilously close to the institution of central planning. As history teaches us central planning of an economy is doomed to failure and despite or in spite of the tremendous amounts of economic stimulus we have not reached “escape velocity” as can be seen by the contraction of 4Q 2012 GDP and anemic growth since 2009. What the Fed is fighting in the US is a deflationary depression, as they have had extremely low actual growth (1-2 %) and no trend growth (4-5%) since the beginning of the global financial crisis.
The accommodative/bailout policies of Greenspan and his protégé Bernanke as figureheads of federal intervention and involvement into financial and monetary affairs and their ability to arbitrarily yield federal power have done nothing more than turn market participants into Pavlov’s dogs. The money they have materialized and forced fed into the global financial system without any commensurate increase in production in their economies is money in search of mischief and is very likely to find it…in the form of very serious inflation.
Some insightful economic commentators will have you believe inflation is a big issue in the U.S. at the moment. What they fail to understand are the dynamics of the “Quantity Theory of Money” which the Fed employs to guide Monetary Policy (basically MV=PT). It is an equation in which the monetary base times the velocity of money equals price inflation times real GDP. They confuse the amount of money in circulation (M) with inflation; they don’t understand velocity (V) and mistakenly believe demand-pull inflation is cost-push inflation. The US has experienced some elements of demand-pull inflation, certain agriculture commodities, agricultural land, gasoline, stocks, bonds, etc. However, we do not have cost-push inflation… yet. To understand what the Fed is doing and the consequences for global investors you need to have this basic understanding of the “quantity theory of money”. The only direct influence the Fed has on the equation is the Monetary base (M) and the indirect influence on inflationary expectations. You can increase the monetary base (M) all you want, but if you have no velocity (V), which is behavioral and physiological, you have no growth in GDP.
The U.S. economy is predominantly driven by consumer spending, which accounts for approximately 70 percent of all economic activity. That engine stalled after the Global Financial Crisis, and the Fed has been trying to resuscitate or jump-start the engine again, via interventions, stimulus, policy changes, etc. The Fed is racing to create inflation in the U.S. to counteract the deflationary/depressionary forces on growth and is ambivalent to the problems this is creating with its global trading partners India, China, Russia Brazil, Vietnam, etc….it is an Empire after all. The policies employed by the Fed domestically to create inflation have failed. They have tried to induce the consumer to borrow by keeping negative real rates (also enabling congressional profligacy), and they have tried to shock the consumer to spend by increasing inflationary expectations, via an increase in the money supply. It has failed.
What the U.S. has done since late 2010 is to try to import inflation via cheapening the U.S. Dollar against other currencies (the rhyme of history). In the State of the Union Address on January 2010, the White House made it explicit that it will have to cheapen the U.S. Dollar via the ‘National Export Initiative’. The Chairman of the Fed Bernanke also made it explicit in a speech in Tokyo on Oct. 2012 (sponsored by the Bank of Japan and the IMF) and attended by finance ministers from around the globe, that the U.S. will devalue the U.S. dollar. Indeed Brazil’s finance minister Guido Mantega was the most vocal in his objections. Mantega told the IMF’s 188 member countries in Tokyo that the policy was “selfish” and harming emerging markets both by stealing their share of exports and by spurring destabilizing capital flows and currency movements. “Advanced countries cannot count on exporting their way out of the crisis at the expense of emerging market economies,” he told the IMF’s governing panel. “Brazil, for one, will take whatever measures it deems necessary to avoid the detrimental effects of these spillovers.” Rich nations had engaged in a currency war to boost their exports at the expense of developing countries. Russia, China, etc. have echoed the feelings of Mantega about the ensuing currency wars. The U.S. is determined to get its inflation ‘by hook or by crook”, by any means necessary, at the expense of everybody if necessary.
The symptoms of inflation are erratic, in that the liquidity does not flow to all asset classes and sectors evenly, at the same time or with the same intensity. Furthermore, the increase in liquidity is not confined to the host country’s monetary expansion. We have witnessed inflation in stocks, bonds, commodities and real estate in the host countries throughout recent history. We have seen inflation exported to foreign markets via economic leakages, where the liquidity leaks out of the system and boosts foreign GDP and economic activity. The emerging economies such as India, Brazil, Russia, China, Vietnam, etc. have seen industrial production almost triple since 1995, as opposed to the advanced host countries of the U.S., Europe, Japan, the UK, Switzerland, etc. We at The Impartial Lens believe we are at the beginning of a great turning point in economic history as inflation, currency wars, capital controls, recessions, and depressions grip the economies of the world.
So the question we ask is; how do we protect ourselves from “cost-push” inflation and the erosion of our purchasing power?
We as newsletter writers, economists, investors, and asset managers try to remain impartial to the latest news/rhetoric coming from our central bankers and across the airwaves. We are ambivalent about what we are being told by news pundits, government officials, mainstream economists, political apologists, presidents, kings, and emperors. Quite often the latest news, analysis or press release is derived or contrived, wittingly or unwittingly, innocently or maliciously, from a particular ideology. We have all witnessed the misallocations of capital, manipulation, financial repression, and distortions, intended and unintended consequences over the last decade or two. Some have benefitted, some have lost, and some have been destroyed. It is our mission to root out fact from fiction when it comes to deploying capital and present it to you as raw as possible.
When it comes to investing what tends to give you a better statistical chance are rational and reasonable goals, due diligence, discipline, a common-sense approach to risk management, balanced portfolio, (sectors/asset class, and geographical diversification), proper position sizes, trailing stops, let the winners run and cut your losses with no exceptions (based on your risk profile).
It is our opinion that we are entering a period of great volatility, and there are great buying opportunities coming. As we proceed, we shall have opinions to rebalance and diversify to take advantage of the big trends happening globally. Namely:
• Inflation: This trend is set to intensify over the coming years as governments worldwide try to fight deflation and finance debt. As has been seen recently agriculture and energy prices are surging, and this trend is set to continue. We will have our battles with deflation, but ultimately inflationary forces will prevail.
• Gold and Silver are set to continue to rise as governments try to inflate. We would suggest you hold bullion outside of the banking system.
• The currencies of central banks are set to continue on their volatile paths as they grapple with their monetary and fiscal policies, inflation, the balance of trade and sovereign debt. We suggest you hold multiple currencies as a hedge against central banking debasement.
• Interest rates are extremely manipulated, and this financial repression is distorting the markets, the basic price mechanism is distorted, i.e. the clearing mechanism between supply and demand is no longer a reliable indicator.
• Bond prices will fall, and interest rates will rise as the Bond Vigilantes and the market punish the Keynesians.
• Volatility: We do recognize that we will have volatile times ahead and are prepared to take advantage of this volatility. Within each and every crisis there is an opportunity. We seek to own productive assets, businesses that are capital efficient and well managed, businesses that are geopolitically diversified and have exposure to currency diversification. Global businesses that have “economic goodwill”. Global real estate that is income-producing. We view both the technology and the pharmaceutical industries as catalysts for change and are prepared to participate in future growth.
The sectors and asset classes that we tend to follow are based on our philosophy above: Value, Distortions, Need, Speculation and the Horizon…
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