Interesting times continue to drive the market every which way but loose. Rallies go to resistance, declines to support -- more feverishly so in recent weeks, seemingly, than many of us can recall. One of these days a trend is going to exceed our tired expectations, then reverse with a unanimous consensus leaning the wrong way. Friday’s little frisson was attributed to exuberance over summer GDP figures that were revised upward to suggest the economy was stronger than it seemed. From where I’m sitting, that wouldn’t have taken much. Here in the Denver area, the economy hasn’t exactly been booming. Consider the names of some of the region’s biggest employers: Sun Microsystems, Qwest, United Airlines, Janus Fund. Stagnant real estate prices have accompanied the vacuum that these companies, and others equally moribund, have created in employment.
Well, no point in moping. Let’s pick up the pace by continuing our lively discussion of deflation. First up is James Carpenter, who is old enough to teach us all a thing or two:
“I am 86 years of age and figured I would write this letter in the name of my twin brother who died in Europe in 1944, Cpl. William G. Davenport 35456698US. We were drafted and all he had is a stone cross and all I have is GOLD. It takes hand truck after hand truck to get it up the stairs.
The Great Depression
“I am answering your article, “Who will bid up Gold?” My father moved from Tennessee during the Depression and we fought in WWI. In 1939 he was in the automotive supply business and did very well as everybody was fixing their own cars. He stocked up on 1940-1941 auto-supplies and sold them on the black market at very high prices and we had oodles of cash. He decided to buy Gold and it was against the law for a jeweler or pawnbroker to buy gold that was touched by fire, so we went to Nassau Street and bought double eagles -- $20 coins -- in Very Good condition. There were no Bright uncirculated coins for sale. The dealers were stuck with them by the thousands of dollars and nobody was collecting. We paid, depending on condition $28-$30 a piece. We have almost 9+ tons.
“After the War, with the death of my brother, I sold free “thins” condoms at 75 cents each which I obtained free. I sold them for Gold Die Stamped with Gold Seal Dollars and brought then back via MATS to the USA as die-cast bars from Switzerland. It took four years to get them home. In 1958 the finding companies were formed that would buy Gold at $40 and ounce and make charms. Religious Medals and heavy Gold Chain. They moved from Canal Street in NYC to 47th Street.
MSFT a “Swindle”
“My father in 1968 thought we would have a depression and put all his money into Homestake Mining at $22 a share. That is what we were left with. Well, the depression never happened but Homestake went in 1974 to 128? And I sold at $122. I bought what I called “Need” stocks and bonds.
“In 1986 I bought Microsoft because it was a swindle as they had had more money in stock options and just as much in cash. All other stocks I sold in 1986, January. I sat on the cash until I saw that Greenspan was going to bail out the Banks with low interest rates with LTCM. I bought another swindle, Cisco, a Bank Stock at $12, and other what proved be good stocks. I bought Enron Gas Pipe Line. In 1995 I bought a lot of Gold Corp. I liquidated all stock when England sold its Gold hoard and USA $55 Eagles paid my taxes and filled out all my tax papers. I have my Social Security, Dutch Bonds which are now Euro Bonds.
I hold more Gold than I can lift or even move by hand truck. I took 40 USA Eagles to coin dealers and then could not buy them. We sell the coins, “we do not sell them twice.”
My Bonafides
Just what do I do and where do I sell it for “Legal Tender? There is no right of mintage. You are smart and I just use common sense. I will be happy to pay for honest advice which is not found on 123gold or Daily Reckoning or other swindles. I do not need seminars. I am not a Gold bug. I do not buy Gold unless the price is very right. I do not invest in Gold as I do not find it any investment. It moves quietly. We bought all the surplus .30-ammo cans we could where the World Trade Center once stood. This may be small potatoes to you. I have Gold in Europe and pay $27,000 a year just for storage and insurance. You can get my bona fides from the Army and with grave registration. Signed, James Carpenter, 3419xxx9US.”
Most enlightening to hear from you, sir, and thank you sincerely for sharing tales from what has obviously been a remarkable life. RA
***
Next is a letter from John Pope, who makes some of the most persuasive points I’ve seen in favor of hyperinflation. My dissenting note follows.
Hyperdeflation Scenario
“I just discovered your site. Thought-provoking views you have, and I will probably subscribe in the near future. I would be interested to get more details about the hyper-deflation scenario you described. Your wrote the following:
Although nearly everyone seems to think the Fed will effect some sort of bailout before a meltdown occurs, the fact is, there is no practical way to do so. An administered hyperinflation is most certainly not the answer, since it would destroy savers and lenders as a class, rendering the bond markets largely inoperable for a generation.
“I don’t see how you can so easily conclude that the Fed will not administer hyperinflation on the basis that it is not practical and would destroy savers and lenders. I would submit that hyperdeflation cannot be administered practically either and that hyperinflation is the only viable option for the Fed, given that (i) 80% of the population (including the federal government itself) are borrowers and the political pressure to save them would far outweigh saving the 20% wealthy savers; (ii) while the lenders would be severely damaged by hyperinflation (via a loss of buying power), hyperdeflation would annihilate them (bankruptcy) and therefore is a more viable outcome as the debtors would be saved in the process; (iii) the Fed learned its lesson in the 1930s when it tried to save the lenders by keeping interest rates unnecessarily high, which precipitated making the Fed independent of the banks and Fed governors since (including Bernanke) have stated time and again that the necessary response to such a crisis in the future would be to ‘flood the streets with money’ (or the helicopter visual in BBs case); and (iv) the government is obligated by structure and/or by historical precedent to bail out the system (i.e. PBGC, FDIC, SIPC, Continental Illinois, Latin American debt, LTCM and on and on...)
A Gradual Disaster…
“I agree that a major shock could cause the house of cards to come tumbling down in the near future, which could necessitate a bailout in the trillions. But I don’t think that the next shock will unfold overnight (unless it be nuclear) but rather, gradually and probably unbeknownst to the general public for a great while. A major stock-market correction is not a shock that can cause damage of significant proportions. It would have to be a dislocation of a financial pillar -- for instance, the unraveling of the housing bubble, and these can be managed covertly over time and out of the public eye (until a workout plan it developed). Fact is, the central banks of the world have managed extremely significant crises in the past with behind-the-scenes agreements (Continental Illinois, Latin debt, LTCM). No reason they won’t (and maybe are) do the same in the future.
“What I believe will be the scenarios in which the credit bubble will be unwound are: (i) a financial upheaval is avoided and the credit unwound smoothly, financed through the dismantling of entitlement programs; or (ii) a financial upheaval occurs which will necessitate and give the government the excuse to dismantle entitlement programs through which the bailout can be financed. Of the two, I believe the latter scenario to be much more likely.
“At any rate, I would be very interested in your response and to further understand why hyperdeflation is the more likely route beyond the ‘practicality’ argument. Thank you.”
…or a World Ablaze?
And thank you. Your letter is the most compelling I have received to date concerning the hyperinflation/deflation conundrum. You make the administered hyperinflation that I had asserted was impossible sound at least mildly plausible. However, I would argue that there are several crucial flaws in your logic. The first is that the crisis will unfold so slowly as to be manageable. In fact, debt risks have continued to mount since the tech-stock collapse of 2000-02. While we might have expected this ruinous episode to throw the economy into deep recession, a massive expansion of credit allowed us instead to segue into a spectacular housing boom.
But has this averted a day of reckoning, or merely postponed it? I strongly contend the latter and would argue furthermore that we have done so at an increasing cost. The economy has remained marginally afloat, yielding the feeblest recovery on record. But in the process, we have taken on trillions of dollars of additional debt, increasing the risk of a precipitous collapse. Much of the debt has been collateralized by inflated home prices. But if real estate values were to fall even slightly it would subject millions of mortgagors to real interest rates of 7 to 8 percent or more. This would be catastrophic, for reasons that each of us can well understand.
Only in Our Prayers…
While it might be possible to keep home prices buoyant for a while longer, they cannot possibly continue upward forever. If and when they start to level off – or, heaven forbid, fall – it seems unlikely that the Fed would be able to stimulate yet another re-fi boom. In any event, it is only in our prayers that a credit-induced resurgence in real estate prices could cure the economy’s structural ills.
Putting these specific concerns aside, there is the much larger problem of a $40 trillion global economy supporting a $250 trillion (per BIS data) derivatives business. The ratio implies not only that there’s not much substance behind all the financial wheeling and dealing, but that the markets which support it could easily be thrown into chaos. So why should anyone expect the implosion of a $250 trillion house of cards to proceed at a measured pace? The matching of durations in these markets is almost genetically complex -- so abstruse, probably, as to lie beyond the full understanding of the financial wizards who engineered them. As I wrote here earlier, keeping this Byzantine edifice from toppling when the ground starts to give way will be like trying to fortify the World Trade Towers when they were still ablaze.
With respect to the dollar sums involved, the coming debt collapse will dwarf LTCM, Brazil, Argentina, Continental Illinois, Russia, Mexico, Refco and all the others combined. These were sub-trillion-dollar affairs, each a discrete crisis rather than part of a systemic collapse. A little spin control here, a dollop of liquidity there, and only the reckless and the greedy perished. This was crisis management in the way of dousing a fire that has erupted on one’s kitchen stove. But if the world’s banks and bourses were to explode into flames simultaneously, who truly believes that it would be possible to contain the blaze?
Are Savers Expendable?
You have also casually written off the wealthy 20% of savers as though they were expendable. This might be true at the ballot box, where the rabble have the votes, in theory, to confiscate Patek Phillipe wristwatches, Mercedes Benzes and Beluga if they so desire. But if the downtrodden and their elected representatives decide to punish the rich by hyperinflating savings into oblivion, they will be destroying the only source of wealth we have to rebuild the financial system. Printing-press money might keep us employed, as it did WPA workers during the Great Depression, but it would hardly offer a path back to prosperity. Furthermore, it is not just the assets of the rentiers that hyperinflation will have destroyed, but the institutional conduits of saving as well. The bond markets would cease to function because investors would no longer trust the government to hold their nest eggs. Without private capital, how would we rebuild?
You also note that the Fed is committed to “flooding the streets” with cash if need be. But by what means? The Monetary Control Act of 1980 provides a statutory mechanism to do so, enabling the Fed to buy the bonds of any sovereign, corporate or private entity. But does anyone actually believe it would be possible for the Fed to assume everyone’s debts in so orderly and efficient a manner as to preserve the public’s confidence? Remember, it is deflationary mindset – i.e., a reluctance to borrow and spend – that in the past has perpetuated deflationary cycles, not a lack of credit. We already know from the experience of the 1930s, and from Japan’s intractable wallow, that confidence is crucial and that, once gloomy expectations reach a certain threshold, they can persist not just for weeks, months, or even years, but for decades.
Helicopter Money
The uncanny timing of our new bankruptcy laws suggests lenders are aware of the stakes. But it is entirely predictable that their greed will undo them, since they will not be able to squeeze blood from a stone. If unemployment should reach the levels of the 1930s and millions of homes are thrown into foreclosure as a result, the bill collectors will be dodging sniper fire when they venture into the neighborhoods. And the more aggressively they persist, the greater will be the clamor to rein them in. While it is true that the mortgage holders will still be the legal owners of our homes, as they always have been, monthly payments will have to be reduced to reflect the realities of massive unemployment and economic depression. As for the corporate giants, what good will it do to bail them out with printing-press money? At that point, even Kirk Kerkorian will be trying to unload his GM shares on taxpayers.
Make no mistake, that is exactly what “helicopter money” implies. That so many continue to overlook this elemental fact is testimony to the Fed’s ability, for the time being, to manage the expectations of fools.
***
Information and commentary contained herein comes from sources believed to be reliable, but this cannot be guaranteed. Past performance should not be construed as an indicator of future results, so let the buyer beware. Rick's Picks does not provide investment advice to individuals, nor act as an investment advisor, nor individually advocate the purchase or sale of any security or investment. From time to time, its editor may hold positions in issues referred to in this service, and he may alter or augment them at any time. Investments recommended herein should be made only after consulting with your investment advisor, and only after reviewing the prospectus or financial statements of the company. Rick's Picks reserves the right to use e-mail endorsements and/or profit claims from its subscribers for marketing purposes. All names will be kept anonymous and only subscribers’ initials will be used unless express written permission has been granted to the contrary. All Contents © 2005, Rick Ackerman. All Rights Reserved. www.rickackerman.com
-- Posted Sunday, 30 October 2005
