An Ill Wind Indeed

I don't know what I did before YouTube. With just a few mouse clicks, I can pull up literally hundreds of interviews, editorials, and broadcasts about anything that suits my fancy. And lately, my fancy consists of interviews with some of the most vocal and compelling minds daring to speak out against the atrocious fiscal policies the U.S. is employing to battle this economic crisis.

I have seen Jim Rogers dress down countless reporters and anchors bent on defending the status quo. I've seen Marc Faber confidently proclaim that 2009 is the year to "massively short Treasuries." I've seen Peter Schiff stand firm while being publicly jeered at by the likes of Art Laffer, as well as Ben Stein (who proudly proclaimed that investment banks were undervalued in late 2007), only to be vindicated within months.

And now, Ben Stein has even reversed course, jumping on the "Schiff Bandwagon," as it were, predicting nothing less radical than the possible breakup of the U.S. as we know it. Where were you, Ben Stein, when I proposed such a dissolution in 2001? Would you have jeered at me too?

Our critics call us pessimists, defeatists, and killjoys. They attack our characters and our intentions. They say we're trying to destroy the world. And yet nothing could be further from the truth. Yes, I do believe the dollar will soon be reduced to only a fraction of its former value -- and it certainly will lose its status as the world's reserve currency. It's also true that I believe other major currencies – like the euro and the yen – will suffer similar fates.

The United States used to be one of the largest manufacturing and creditor nations on earth. It exported vast amounts of goods. Over the last several decades, however, the U.S. has transitioned to being the largest debtor nation on earth, manufacturing relatively little, and consuming far more than any other nation in history. It has become soft.

Unfortunately, contrary to the popular belief -- that this is a mere secular economic correction -- what we are witnessing is only the beginning of an economic collapse deriving from decades of mismanagement and mal-investment; for over a century, the U.S. government has employed gimmickry and sleight of hand to prop up a bogus consumer class that couldn't, in any other context, afford the goods and services put before them in such quantities. The result has been a gluttonous spending-spree that has bankrupted the nation.

The Obama administration, along with Fed Chairman Bernanke, have committed an unprecedented amount of money – more than $12.8 trillion – to battling this economic crisis. You may be one of the multitudes still clinging to the Keynesian status quo, remembering relatively minor recessions of the recent and distant past, desperately clamoring that we got through it before, and we will get through it again.

Did you read what I just wrote? $12.8 trillion. I'll give it to you another way: $12,800,000,000,000.00. If you are a citizen of the United States, and you have a pulse, your share of the commitment is just a little over $42,000. And that sum has nothing to do with previous obligations, nor will it be included in future budgets. Your $42,000 share only applies to this economic crisis.

I'll say it again: the U.S. is now the largest debtor nation on earth. Credit card and housing loans have all but disappeared. The country has no savings. There are no more sources of capital left to feed the fires of consumption. We have only seen the beginning -- the U.S. economy has no option but to unwind – for a very long time. Add to this the fact that the government is "fighting" this crisis by using the same rotten policies that got us here in the first place, and the economic outlook only becomes gloomier.

You can see I'm not terribly enthusiastic about the prospects of the United States. But before you dismiss me as the quintessential pessimist, you should know that I actually do see a prodigious number of opportunities out there. I certainly don't believe the entire global economy is simply going to disappear; I simply cannot think in such absolute terms.

The first law of thermodynamics requires the conservation of energy – that is to say, that energy can neither be created nor destroyed. And this is perhaps the closest metaphor I can procure: capital is like energy; I don't see wealth simply drying up and blowing away so much as I see it transitioning to a new paradigm.

Who Wants a Job?

Where the United States is full of overweight union workers who believe it is their God-given right to work a mere thirty hours a week, collecting exorbitant wages, Asia is full of very thin, motivated people, who are not only willing, but actually want to work six or seven days a week -- for a mere fraction of the wages enjoyed by their western counterparts.

Almost every country in Asia boasts net savings. And while these countries may not be able to export to the U.S. and Europe in the mass quantities they have enjoyed in recent decades, they will make up for much -- if not all -- of the shortfall by fulfilling the needs of their own burgeoning middle classes. Compare it, if you will, to the U.S. from say, 1875 to 1925. As the financial center of power shifted from London to New York, The U.S. prospered in spite of England's downward slide.

How Will the Money Go?

As technology has improved in recent decades, capital flows that might have -- only forty years ago -- taken days to move from one point to another can now occur in a fraction of a second. The ability for people to transfer wealth from medium to medium has grown exponentially faster, and as the world's major currencies disintegrate, people and institutions will quickly find alternatives – some public, and some private – with which to make transactions.

So what will be the world's new reserve currency? Well, as I said, it won't be the euro or the yen – or any major fiat currency, for that matter. One of my astute readers reminded me this week that no fiat currency has ever survived for very long in this world, and yet every major currency on the planet today holds that status. The people who use these currencies are about to get burned – and burned badly; we're going to see a massive return to currencies backed by assets, and that probably means gold, primarily.

People laugh and say silly things like, "Have you ever tried to by soap with a gold coin?" And I throw my head back and laugh with them. For a moment or two. And then I remind them that it doesn't take much effort to put gold in a vault and issue a piece of paper representing a fixed amount of that stockpile. In fact, it's not difficult at all.

As I said, capital is more efficient today than ever in history, and I see no reason why private institutions wouldn't issue currencies backed by their own assets. Why shouldn't they – especially in the wake of demonstrable failures by governments charged with protecting their citizenry's wealth? It's going to be profitable as hell, and how much credence do you think people are really going to give legal tender laws after this party is over? My guess is not much.

Where Will the Money Go?

Asia, of course – for all the reasons I've already listed, and more. And everyone on earth knows it.

Once the most powerful sources of capital in the world recognize that efficiency, innovation, and productivity are going to create colossal rates of return in Asia, the mass exodus will be unstoppable. We will finally see the return of real investment and true wealth creation – nothing like this fraudulent house of cards that's been perpetuated in the United States for so long. Further, I believe the shift is coming soon, and that it will be explosive and unrestrained.

Asia will be the world's next financial center, and I am a strong believer that any investment in these economies will provide superior returns over the next 50 to 100 years. But equity investment in the east is by no means the only place where I see huge returns.

There are two reasons why I'm extremely bullish on energy and agriculture. First, people are never going to stop needing these commodities. Demand may continue to wane a bit as we transition into the new economic paradigm, but as major currencies fall, energy and agriculture will not only keep pace with inflationary price increases, but they will outperform – if for no other reason, simply because investors tend to overshoot intrinsic value when they become exuberant. And when the bottom falls out of world currencies, investors are all but certain to become exuberant about energy and agriculture.

As I'm sure you are well aware, loans are extremely difficult to come by these days, and the second reason I'm so optimistic about these sectors is that farmers and energy producers are no exceptions to this difficult truism. It doesn't take a Nobel Laureate to recognize that, if producers can't produce, then supply will suffer, and prices will go higher. Coupled with my reasoning in the previous paragraph, I see nothing but upside in these commodities.

The Ill Wind…

Over the last few nights, I've been watching a documentary about Benjamin Franklin. I was surprised to find out that he remained a loyalist for so long -- despite the fact that many of his fellow Americans were already starting to rebel. Finally, however, he recognized that change was inevitable, and that his perception had been flawed. He thus became a champion of the American cause – even at the expense of his relationship with his son -- the person to whom he was arguably closest in the world.

Gloom-and-doom may be unpalatable, but sometimes, no matter how much it hurts, it represents the state of the universe. And when these conditions arise, we would do better to acknowledge them and face them with courage, rather than to simply ignore them – or worse still, waste valuable resources trying to "fix" them. Sometimes the only way to deal with a fire is to simply let it burn itself out.

The other side of this equation is the immutable fact that with every tragedy, there is opportunity. It might be easy to blame the people whose perspectives offer the most accuracy, but it is likely more prudent to simply listen to the message, and then to react appropriately by finding those opportunities.

No matter how you choose to see it, there's no question that for the last year members of the Austrian School of Economics – of which I am a proud and vocal member – have been correct at almost every turn. Every day that passes only offers more evidentiary confirmation of our theories. And yet, despite the pain that comes with the actualization of our predictions, there are still bright spots in this story.

Unfortunately, finding those bright spots is going to take the courage and conviction to admit that the U.S. government not only caused this crisis, but that it is only perpetuating it by employing the same rotten policies that got us here in the first place. There are ways to ride this out, and even prosper, but clinging desperately to the broken ideas -- based only on the tattered shreds of empiricism -- is a sure means to financial devastation.

Pledging allegiance to the flag and eating apple pie aren't going to get us out of this one. The only way to prosper is to embrace change. And change is surely coming.

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.

Comments

[Larry House]

Thanks, Paco. I think you are spot on. I have seen too that "fear-mongers" is now a term used for people who try to see the current situation in a realistic way. I guess they really think our economic problems can be cured by positive thinking. If investors are going to make reasonable decisions, all possibilities need to be considered.

2009 Jun 10 10:27 AM

[thiazole]

The reason people don't like what you have to say is that you make outrageous claims and you use outrageous numbers to back them up (without any explanation where those numbers came from).

It would be like if I started posting that the dollar would maintain its strength, yet the Dow will go to 100,000 in 10 years. People would be angry with that and it has nothing to do with optimism or pessimism, but with a complete separation from reality.

If you are going to make claims like "$12.8 trillion" and repeat it over and over like it is your greatest revalation, then you should at least back it up with some proof. Perhaps you realize that once people see how you arrived at $12.8 trillion, they won't buy your argument any more? If you argument holds water and you aren't just trying to blow smoke up our rears, you'll disclose how you arrive at your claims.

2009 Jun 10 10:31 AM

[doubleguns]

Paco, when you argue about the gold buying bread you might also mention that silver and copper might fall into that mix.

Why are the Chinese buying so much copper. Maybe they are planning on a return to gold, silver and copper coin as a new currency.

It might not all be for construction.

2009 Jun 10 10:49 AM

[rafastil]

briliant paco.

2009 Jun 10 10:56 AM

[Paco Ahlgren]

www.bloomberg.com/apps...

I've posted this source several times. Your assertion is pretty empty.


On Jun 10 10:31 AM thiazole wrote:

> The reason people don't like what you have to say is that you make
> outrageous claims and you use outrageous numbers to back them up
> (without any explanation where those numbers came from).
>
> It would be like if I started posting that the dollar would maintain
> its strength, yet the Dow will go to 100,000 in 10 years. People
> would be angry with that and it has nothing to do with optimism or
> pessimism, but with a complete separation from reality.
>
> If you are going to make claims like "$12.8 trillion" and repeat
> it over and over like it is your greatest revalation, then you should
> at least back it up with some proof. Perhaps you realize that once
> people see how you arrived at $12.8 trillion, they won't buy your
> argument any more? If you argument holds water and you aren't just
> trying to blow smoke up our rears, you'll disclose how you arrive
> at your claims.

2009 Jun 10 10:56 AM

[Bob 123]

"Where the United States is full of overweight union workers who believe it is their God-given right to work a mere thirty hours a week, collecting exorbitant wages......"

Not sure what union(s) you are talking about, that's a pretty crass, over-generalizing and ignorant statement. Most union workers I know are far from secure, having endured many pay cuts and benefit reductions. But as you imply, shame on them for not accepting that they must become like Chinese peasant slave labor without protections, rights or benefits.
But not to worry, the unions have been in decline for a long time now, a shadow of their former selves.
Too bad you know so little about what the unions did to create the American middle class and the prosperity that was enjoyed by most.
I don't know where you have worked in your career, but the comforts of your workplace, the safety of the water and the air, the right to time-off if you are sick or have to care for a loved one, the right to fair compensation for hours worked, overtime or not -- all of these things were paid for in blood by union people. It didn't used to be that way and it wasn't so long ago.
Thanks to them, snot-nosed punks like you who probably never worked a hard day in your life can now sit back in your air conditioned office and insult what they fought for and did for you, while you sit back and make money on the money, not producing or creating anything, all the while running them down and telling them they should live no better than slave labor, as the market and it's profits demand it.
If anyone is overcompensated, it's not them. perhaps they should have all become CEOs, making millions for destroying their companies and the lives/futures of their employees. And not having to listen to insults from the likes of you.

2009 Jun 10 11:02 AM

[Donald Ingram]

Paco - Most excellent article.
Simply the Truth.
Some people don't like to hear the truth. Unpalatable.
First reaction is one of disbelief and ridicule.
Second reaction is a maybe consideration.
Third reaction is acceptance and submission to what can only be true.
Ludwig von Mises said it best years ago, "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crises should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

2009 Jun 10 11:04 AM

[Jason722]

I don't think the $12.8T number needs to be backed up. It is a widely reported number. Even BHO, congress, helicopter Ben, et al don't dispute this.

If you would prefer, we could use a more 'controversial' number. The $110+T that the Dallas Fed uses that includes social welfare liabilities.

As compared to reality, the 12.8T number looks comforting!


On Jun 10 10:31 AM thiazole wrote:

> The reason people don't like what you have to say is that you make
> outrageous claims and you use outrageous numbers to back them up
> (without any explanation where those numbers came from).
>
> It would be like if I started posting that the dollar would maintain
> its strength, yet the Dow will go to 100,000 in 10 years. People
> would be angry with that and it has nothing to do with optimism or
> pessimism, but with a complete separation from reality.
>
> If you are going to make claims like "$12.8 trillion" and repeat
> it over and over like it is your greatest revalation, then you should
> at least back it up with some proof. Perhaps you realize that once
> people see how you arrived at $12.8 trillion, they won't buy your
> argument any more? If you argument holds water and you aren't just
> trying to blow smoke up our rears, you'll disclose how you arrive
> at your claims.

2009 Jun 10 11:11 AM

[thiazole]

Do banks have to show a loss when they lend money? If a bank loans $1 billion do they have to call that an expense? You are confusing loans and investments for spending. Sure, some of that money will be lost but some will make the government money. But to write all $12.8 trillion off as a loss right now is absurd. It is part of your self-reinforcing gloom logic. The government is losing $12.8 trillion so the world is coming to an end - the world is coming to an end so the government will surely lose all $12.8 trillion.


On Jun 10 10:56 AM Paco Ahlgren wrote:

> www.bloomberg.com/apps...;sid=armOzfkwtCA4
>
>
> I've posted this source several times. Your assertion is pretty empty.
>

2009 Jun 10 11:17 AM

[thiazole]

Yes, at least that number is based on real expenses and not interest earning loans and investments.


On Jun 10 11:11 AM Jason722 wrote:

> I don't think the $12.8T number needs to be backed up. It is a widely
> reported number. Even BHO, congress, helicopter Ben, et al don't
> dispute this.
>
> If you would prefer, we could use a more 'controversial' number.
> The $110+T that the Dallas Fed uses that includes social welfare
> liabilities.
>
> As compared to reality, the 12.8T number looks comforting!

2009 Jun 10 11:18 AM

[The Geoffster]

Meanwhile, BHO wants to use this crisis to nationalize health care, strengthen unions and raise taxes on the rich. This was tried in California which is now asking for a federal bailout. The last time the percentage of debt to GDP was this high was during WW2 and we had the largest industrial base in the world to show for it. It looks like we're going the way of Great Britain.

2009 Jun 10 11:35 AM

[Thomas J. Gordon]

Paco, I like you but you are excessively negative. Think about an ipod. China ships ipods to us but we don't ship anything to them. but the u.s. is still adding a ton of value. aapl figured out something people wanted that they didn't know they wanted, they figured out how to make it fit in a small package, they figured out how to market it. maybe the u.s. is morphing into the new product idea country. just because gm and chrysler are having problems doesn't mean it's over for the u.s.. we still have orcl, msft, intc, goog, csco. Those companies have near monopolies because of thier innovations in incredibly important global economic markets.

2009 Jun 10 12:18 PM

[thiazole]

This is exactly my point. People who are subscribing to this irrational bear position are doing so for religious reasons on not economic reasons. You are trying to bend reality to fit your religious views. I'm a Christian as well, but I'm smart enough to realize that if you think the end of the world is coming every time we have a recession, you will be doing yourself a major disservice.

In the end, even if you are right, buying gold or whatever the bears are recommending won't help you. If the end of the world IS here, no matter where you put your money (cash, gold, stocks, bonds), you will lose it, so you might as well assume the end of the world isn't here.


On Jun 10 11:59 AM lex wrote:

> If you believe what is written in the
> Bible then mankind faces a bleak future. Why else would there be
> the 2nd coming?

2009 Jun 10 12:39 PM

[Grumley]

Mary Kubler Ross is known for her stages of "Death and Dying". Her original stages were Denial, then Anger, then Bargaining, then Depression, and finally Acceptance. The American lifestyle is dying. Where stage do you think you are on?

Incidently I've had the benefit of working for a union many years ago. And even at the early and naive age of 18 I was amazed at what the union had become. I saw people who should have been fired, rehired repeatedly based on the tiniest of technicalities. I also watched my union steward routinely fall asleep at this board while the rest of us worked. Are all unions bad? Of course not. Were they critical to fair treatment of workers during the 50's and 60's? Absolutely. But today, they are simply a smaller form of government.

We cannot continue to make high salaries compared to our international counter parts who have the fire in their belly like our grandparents did. There is no free lunch, anywhere in life. Good, bad, or indifferent, we are now being handed the check for three decades over unsupported prosperity.

2009 Jun 10 12:50 PM

[Jason722]

WTF does religion have to do with this? For that matter, partisan politics have nothing to with it either (because both of our wonderful choices are basically the same; working the same tired vote-buying schemes to 'solve' our problems).

I don't believe the end of the world is coming. I pretty much agree with Paco. We are approaching the potential end of the US as a world leader (maybe the end of freedom as we think we know it; but I will accept that this might be extreme).


On Jun 10 12:39 PM thiazole wrote:

> This is exactly my point. People who are subscribing to this irrational
> bear position are doing so for religious reasons on not economic
> reasons. You are trying to bend reality to fit your religious views.
> I'm a Christian as well, but I'm smart enough to realize that if
> you think the end of the world is coming every time we have a recession,
> you will be doing yourself a major disservice.
>
> In the end, even if you are right, buying gold or whatever the bears
> are recommending won't help you. If the end of the world IS here,
> no matter where you put your money (cash, gold, stocks, bonds), you
> will lose it, so you might as well assume the end of the world isn't
> here.

2009 Jun 10 12:50 PM

[Grumley]

Sorry all, please excuse the previous typos. I am currently in transit.

2009 Jun 10 12:55 PM

[Whippet]

Great article; great comment.
Your assessment of American labor unions vs. Chinese labor is painful but true. When the average UAW employee costs GM $75 an hour, a lemur could discern this company was headed for the toilet. America rose to manufacturing greatness when we had the best mix in the world of labor costs, technology, and education. Now, our labor is about the most expensive, our technology is barely above par, and our education is disintegrating. The only sustainable way to make America a "hard" manufacturer again is to shut down free trade; this could be accomplished any matter of ways. The best one would be to follow truly Free Trade practices- right now, we allow the developing world and its pitiful human rights, wages, worker safety, healthcare, etc. to undercut every Western manufacturer. Tariff them at a rate that brings their cost of goods to parity, plain and simple. This was the previous system- funding Federal coffers with excise and use taxes. But we're too terrified of the Chinese... And the American laborers have to "get real" with their salaries in light of what their efforts are worth to an employer. Everyone needs a haircut, especially the Chinese sweatshop operators.


On Jun 10 11:04 AM Donald Ingram wrote:

> Paco - Most excellent article.
> Simply the Truth.
> Some people don't like to hear the truth. Unpalatable.
> First reaction is one of disbelief and ridicule.
> Second reaction is a maybe consideration.
> Third reaction is acceptance and submission to what can only be true.
>
> Ludwig von Mises said it best years ago, "There is no means of avoiding
> the final collapse of a boom brought about by credit expansion. The
> alternative is only whether the crises should come sooner as the
> result of a voluntary abandonment of further credit expansion, or
> later as a final and total catastrophe of the currency system involved."

2009 Jun 10 01:36 PM

[mrmillergd]

Paco, you've put words to my underlying intuitions. I think you may be a bit to hard on the average U.S. citizen and his output - we are still far more efficient than Asia and hence can produce more value per hour worked - but I agree that wealth transfer is on the way.

2009 Jun 10 01:48 PM

[thiazole]

I think you guys are over thinking this. Chinese labor is so cheap because they manipulate their currency and because they are a developing economy. In the end, everything will equilibrate. People should get as much as they produce. Economics is that simple. The more we produce, the more we can consume. This idea that the global standard of living will somehow decrease because of wage/labor competition really doesn't make any sense. The very laborers who earn the wages, big or small, are the consumers that drive the economy. An efficient economy will give those laborers enough money to continue to purchase goods and services, but less than the innovators who create the jobs. If people earn too little to buy more goods, the economy won't be able to sustain itself.

2009 Jun 10 02:00 PM

[Dave Dorgan]

A valid point on AAPL, but considering which minds are getting the education these days, when do the ideas get offshored also?


On Jun 10 12:18 PM Thomas J. Gordon wrote:

> Paco, I like you but you are excessively negative. Think about an
> ipod. China ships ipods to us but we don't ship anything to them.
> but the u.s. is still adding a ton of value. aapl figured out something
> people wanted that they didn't know they wanted, they figured out
> how to make it fit in a small package, they figured out how to market
> it. maybe the u.s. is morphing into the new product idea country.
> just because gm and chrysler are having problems doesn't mean it's
> over for the u.s.. we still have orcl, msft, intc, goog, csco. Those
> companies have near monopolies because of thier innovations in incredibly
> important global economic markets.

2009 Jun 10 02:39 PM