William Ramseyer

William Ramseyer
Contributor since: 2011
Mr. El-Erian, could you kindly comment on the following:
1. Why Spanish 10-year treasuries now (as of 8/22/14) have a lower interest rate than US 10-year treasuries?
2. What will be the effect of the European Union starting a QE program?
3. How will the new Japanese economic initiatives and the amount of Japanese sovereign bonds affect the US economy and the Fed’s plans?
4. How will the Chinese debt unwind affect the US economy and the Fed’s plans?
My own guess is that these issues might lead to a rising US dollar and a falling US bond rate, and perhaps be deflationary, but I am not an expert on these things. What is your opinion? Thank you. Bill
Arguing about minimum wage levels is about as useful as deciding whether the deck chairs on the Titanic are comfortable enough. Capitalists may be a lot of things, but they are not stupid. When wages rise capital flows to cheaper locations. This began with the industrial revolution in England in the 19th Century when money left the developed industrial areas to seek cheaper wages in the U.S., and then the same thing happened here when capital fled to Japan, and from there to China, and on and on.
When capital leaves it takes real jobs with it, leaving fake jobs (and localized jobs such as fast food cooks and plumbers) and an artificially high (and fake) living standard maintained by every trick politicians and economists can think of: welfare, deficient financing, artificially lowered interest rates, restrictions on the flow of jobs and money, currency regulations, unemployment payments, government jobs, defense spending, governments buying their own debt…and minimum wages.
You cannot create wealth by decree. All of the tricks in the end equate to trying to give out more wealth than has been created.
Consider England. What was the last service or good you bought that was “made in England”? And yet, England appears to have a living standard similar to other developed countries. Magic!
The magic tricksters continue to pull the rabbits out of the hat, and to apparently create wealth from nothing. When the debt marshmallow that is the world economy implodes all the shallow tricks will appear pathetic.
Of course, we will blame someone else for this great disaster, rather than our own fear and greed.
Maybe we will get lucky and instead of war we will have a global welfare state where all the goods are produced (and cooked and served) by robots and given away by governments. We can then all live on robotic welfare.
Thank you. Bill
Hi Ben, I enjoyed your article. If you have not already done so, you might want to read Society of the Spectacle by Guy DeBord, which deals with similar issues.
We all live in a world of illusion and dreams. The examples are endless. For example, do the chunks of steel and plastic that smell like a refinery and are called a “mustang” or a “jaguar” have anything to do with the biological animals of those names? Or do the wood and concrete housing tracts with names like “Running Springs” or “Green Meadows” have anything to do with those natural features? Or does a hair-washing chemical soap that smells like papayas or coconut, have anything to do with a tropical vacation? Who knows? We live in our dream fantasies and they are sold back to us.
The greatest fantasy in the world of investing and economies is that we can collectively avoid arithmetic, and simple brutal bookkeeping facts. The amount of investment must equal the amount of savings. This is simple arithmetic. The amount of wealth that I can obtain by trading in the real world is equal to the amount of wealth that I create. This is also simple arithmetic. Of course, we are all smarter than that, and so are our governments, right?
England has not produced much tradable wealth for a century. Much of Europe and the United States are not far behind. Yet through complex machinations of governments and central banks those countries appear to have great wealth. I will not go through the tedious effort to pull back the curtain on the great Wizard of Money Oz. Here is one of hundreds of techniques—governments lower interest rates below non-manipulated market rates to stimulate the demand for assets. As long as the value of the assets increases, wealth appears to increase. However, at some point the assets do not even produce enough income to pay back the principal, even at zero interest. For example, the rent on a building might not cover the principal payments, but the buyer is relying not on cash flow to pay the debt but is relying instead on the value of the asset going up endlessly. Once the last buyer has bought in, the asset values crash. The only issue at such time is whether the debts liquidate at a fraction of their face value, resulting in collapsing debt money supply, deflation and depression, or whether the government prints so much non-debt money (electronic or paper) that hyper inflation occurs. Either way the debt that cannot be repaid disappears and so does the “wealth” that we thought was there. Civil chaos in weaker countries may trigger the massive interruption of war, allowing economists in other countries to learn nothing from all of this, or even to claim that the problem was a lack of skill in being able to create the illusion of wealth, that with a little more skill they could have fooled everyone one more time; this is a form of delusion or even insanity, which may come from studying economics books with too many advanced math symbols.
In any event, the illusion of wealth disappears and people end up trading their actual time and objects to survive. Neither of which may be worth much. This is the harsh arithmetic of economics. So start saving in a diversified way, so that you can take care of yourself. The clock is ticking. Thanks. Bill
“understand that interest rates are the central price signal off which all assets are priced”
I found this simple statement in the article to be profound. Interest rates are used to increase wealth; low interest rates are designed to increase asset values and hopefully lead to more economic activity. The present problem is that the assets cannot generate a return sufficient to repay even low interest rates. This leads to loan defaults, that is. a decline in the (debt) money supply, and falling asset prices. Thus, we get the many collapsing asset bubble crises that we have seen so often.
The falling asset prices and evaporating debt money make cash more valuable. This is deflation, the collapse of debt money supply. Hyper-inflation involves printing more cash. This would destroy the private banking system, as the banks are net lenders. Thus, hyper-inflation would be opposed by banks, and could only happen if the politicians took direct control of the money supply. This may happen in Japan. Hyper-inflation in Japan would probably take down the world financial system as so many institutions would end up bankrupted.
But who knows?
We could have deflation, hyper-inflation, stagflation—we cannot predict the acts of politicians (or anyone else) in reaction to a world that does not yet exist. In the end, one or more major countries will probably have to default on their bond debt, issue new currency and start over—but more likely war will intervene before we get that far. Thank you.
Thank you. I enjoyed the article, and found it informative.
For me, looking at the problems of Italy, or other countries, is a bit like trying to predict where the volcano will erupt next. The behavior of governments going back at least to the 1980s and probably all the way back to the 1940s is to avert depression and political chaos by making debt cheaper and easier to get. The problem is global since lower interest rates in one country (for example, Japan) lead to investors borrowing in the low rate currency and investing in some other country. When one country or region suffers the inevitable debt overload and asset bubble, the response is—more of the same, more cheap debt. The “wack-a-mole” set of economic crises and “solutions” reflect the giant smoldering volcano underneath the world economy.
As a result of the debt-based economies, Europe and the United States have sovereign debt loads that will not and cannot be repaid.
But, they are the A and B students in the “slow group” central banking class. Japan will never recover from its debt load. I don’t see how they can keep interest rates low, reduce debt and maintain a cheap currency for exports. More likely, they will pile on more sovereign debt until they default.
But Japan is only a C or D student.
The student most likely to fail the class is China.
Remember how Bernanke early on said the sub-prime crisis was contained? China’s debt and real estate disaster is “contained” in the same way. Many banks in China are insolvent. Once again, people mistake liquidity problems for insolvency problems. Governments can easily solve liquidity problems, but the Chinese economy is running off an insolvent banking system. The extent of the problem is X multiplied by F, where X is the publicly disclosed bubble/debt problems, multiplied by F, the accounting fraud that happens in a one-party economy. When the government finally steps in to bail out the local, and maybe larger, banks most economic activity in China will grind to a halt. The army and police will be called in to quell the inevitable unrest and the usual suspects, Japan and the US will get the blame.
My heart goes out to the many people who will suffer. Thank you. Bill
John, that's a very interesting comment regarding who invests in what, and gives me hope for what happens after the Oracle is gone. Thanks.
Zenstone, thank you for your correction.
Ben, great article. I especially appreciated the explanation for foreign demand for US dollars and how that reduces inflation in dollars. Great comments and I especially liked those of Doug regarding the importance of debt (although I felt this was somewhat covered in Ben’s article).
Here’s my take: Money is a thing (including debt “things”) like any other thing and therefore subject to supply and demand. It is a thing that can be used more than once (unless it is debt money and the borrower has defaulted) and so the velocity is also a factor. The US is increasing supply (whether or not the money is yet beginning to move into circulation) and so the value of US money will decline and we will have inflation. However, demand for US dollars increases with economic crisis (because of safe haven status and the need to pay US dollar debts). In addition, the failure to pay debts in full extinguishes those debts and the money supply falls, decreasing supply. Thus, we have both an increase in supply of USD by the Fed, an increase in demand because of crisis, and a decrease in supply because of bankruptcies and defaults. In fact, the Fed is trying to offset the latter two deflationary pressures through its actions.
In a perfect world, inflationary and deflationary pressures could be exactly offset and we would have no depression and no inflation. In my opinion, the chances are very slim and that is because the population will not accept the level of unemployment and business failures that would be required to bring us back to a “real” economy where investment came from savings and increased productivity rather than artificially low interest rates and government deficits.
As a practical matter, I believe that the next debt crisis may come in either China or Japan. This could make the US dollar move up. So, I like precious metal stock (for inflation and crisis) and short term US debt (for deflation and crisis). Of course, we all know Mr. Future is coming to visit, but none of us have ever met him or can say for sure what he looks like. Thanks. Bill
Ben, great article. I especially appreciated the explanation for foreign demand for US dollars and how that reduces inflation in dollars. Great comments and I especially liked those of Doug regarding the importance of debt (although I felt this was somewhat covered in Ben’s article).
Here’s my take: Money is a thing (including debt “things”) like any other thing and therefore subject to supply and demand. It is a thing that can be used more than once (unless it is debt money and the borrower has defaulted) and so the velocity is also a factor. The US is increasing supply (whether or not the money is yet beginning to move into circulation) and so the value of US money will decline and we will have inflation. However, demand for US dollars increases with economic crisis (because of safe haven status and the need to pay US dollar debts). In addition, the failure to pay debts in full extinguishes those debts and the money supply falls, decreasing supply. Thus, we have both an increase in supply of USD by the Fed, an increase in demand because of crisis, and a decrease in supply because of bankruptcies and defaults. In fact, the Fed is trying to offset the latter two deflationary pressures through its actions.
In a perfect world, inflationary and deflationary pressures could be exactly offset and we would have no depression and no inflation. In my opinion, the chances are very slim and that is because the population will not accept the level of unemployment and business failures that would be required to bring us back to a “real” economy where investment came from savings and increased productivity rather than artificially low interest rates and government deficits.
As a practical matter, I believe that the next debt crisis may come in either China or Japan. This could make the US dollar move up. So, I like precious metal stock (for inflation and crisis) and short term US debt (for deflation and crisis). Of course, we all know Mr. Future is coming to visit, but none of us have ever met him. Thanks. Bill
Good article. I have some questions for the author and those making comments. Working with the numbers in the article it appears that almost no QE money (roughly 3% or less) has shown up in the economy as new loans. I therefore would ask these questions, and in particular about the mechanics of the flow of money:
1) Does QE cause an increase in stock or real estate prices, and if so, how? If QE money is parked at the banks then who is loaning money for stock or real estate purchases? And who are the borrowers? Or are all these purchases coming from savings, here or abroad? Do buyers of stock and real estate believe that values will go up in the future because interest rates will stay low, or that the economy will recover leading to increased profits and rents, or that inflation will push asset values up? Do they even think about any of this, or just ride the bull?
2) We often hear about the “carry trade”--borrowing in currencies that have low interest rates, such as the yen or US dollar. But who loans this money and who borrows it? Are there any studies on this? If we knew who was borrowing and lending in the carry trade (if it even exists) and how it actually works mechanically then we might be able to predict the effect of rising US or Japanese on economies around the world.
Thanks. Bill
Economics have often wondered why wages are “sticky” during recessions; that is, wages do not fall very much even when economic activity declines. I find their wonder surprising. The reason wages do not fall significantly during recessions, as partially covered in the article and comments, is that government benefits and laws interfere with the labor market. These benefits and laws include unemployment benefits, as well as cheap student loans, broadened disability benefits, government created “work”, minimum wage laws, and numerous other programs designed to keep incomes higher than the market would otherwise dictate. Increased taxes cannot cover these programs, especially in a weakened economy, so they are paid for by government borrowing. The excess high wages drives capital to other countries, where the process is repeated. Thus, today, we have countries from England to the US and Japan, all sustaining artificially high wages through borrowing. Increased productivity has bought us some time, but the long term prognosis for this process is not good. I sometimes wonder whether the educated financial and political elite are aware of where we are headed and thus are cynical about our chances, or whether they are so ignorant of history and arithmetic as to be insane. Is it really possible that the many Nobel prize winning economists and their followers believe that we can maintain living standards through borrowing without dire consequences? I don’t know. It does appear that both Greenspan (regarding the housing bubble) and McNamara (regarding winning the Vietnam War) acted with some cynicism regarding what they told the public versus what they believed. On the other hand, the process seems to have worked more or less so far so maybe it is more a lack of imagination than anything. Thank you.
DMC and Ronster9, thank you for your comments. Ronster9, in response to your question about DGI--war and social unrest are often the result of economic crisis, and thus companies who are in the defense sector are well-positioned for the future. As to whether DGI is well-managed or not, or what valuation it should have, I have no knowledge or opinion. I have also liked the cyber security space as war and unrest (and the usual hackers and criminals) will provide work there--again, there is always the question of management and valuation. A badly managed firm in a great sector can end up in bankruptcy just like any other badly managed firm. Personally, my main focus is tryng to preserve wealth in both a stagflation and deflation/depression environment. For various reasons I like US money market or short term treasury funds (which should work ok for both inflation and deflation), precious metal stocks, positive cash flow real estate with low or no debt, and some foreign assets (this is basically a hedge investment on the US dollar). I believe that the most likely future crisis will push the USD up--but no one can know the future. As to participating in the musical chairs game of investing in the global bubbles forming from so much easy money--I will prefer to sit it out with what stocks I already have. There is plenty of money to be made there for those lucky enough to get out before the music stops--but I don't trust luck in these things. I hope to buy cheap assets if a crisis comes, and if it never comes, I will have some savings and can enjoy a world much better than I had expected! Thanks. Bill
Thank you James. I always enjoy your articles. I believe that bubbles usually involve debt-asset feedback loops where investors borrow to buy assets pushing up asset values. The increased asset values attract even more purchasers who use debt which is now easier to obtain as lenders and investors feel confident that rising asset prices will protect and benefit them. George Soros described some of these bubble mechanisms in his book, “The Alchemy of Finance”. Some features I look for in bubbles: 1) increasing and easier borrowing; 2) rapidly rising prices; 3) assets no longer producing income (rent or profit) sufficient to pay the interest on the debt (investors relying instead on new buyers to drive up values); and 4) lots of talk about how “it’s different this time”. I especially am wary of the third element. If you borrow at 4% to buy a piece of real property that produces 3% net rental (ignoring tax issues) then you will go bankrupt unless you can use rising asset prices to borrow more money or sell the property to a greater fool. Corporate profits serve the same function in this analysis as rents, although the analysis is more complex. So to me, I would look for signs that investors, especially retail investors, have started to use debt to buy stock.
And now for something completely different. I believe that the world has engaged in an endless carry trade for many decades. In this trade investors borrow at very low interest rates and buy assets around the world. In classic feedback loops this debt drives up values, leading to more borrowing. When a crash occurs, the governments step in to save the economies—by encouraging even more borrowing, and the carry trade starts up again. To cut to the chase, both Japan and China have huge investments inside their countries often involving interactions with the local governments and that do not produce a return to justify the debt (national debt in the Japanese case, and local debt in the Chinese case) used to finance them. Massive portions of both China and Japan are in bubble stage and a blow-out in either of those countries will take down all world stock markets, although it would be very positive for the dollar. That time, if it comes, will offer tremendous opportunities for investors and very great risks for the world. Thank you. Bill
To me inflation in prices is caused by 3 things: lower supply, increased demand or increased money. Let’s ignore changes in supply and demand as they tend to change slowly. However, the amount of money can change very fast. Money exists in at least two forms. Exchange money and debt money. Exchange money includes paper dollars and metal coins. Exchange money lasts as long as people accept it; it does not depend on any further actions of anyone. It can last for a long time. Debt money however requires continuous acts by some person or entity—they must make payments over time or the debt money disappears. Poof. Gone completely. The interest that must be paid eventually requires the borrower to make a profit, sell some asset or find some new debt to replace the old one.
Governments can create inflation with exchange money any time they want to (at least when money is not a rare physical commodity like gold or silver)—they simply make more of it. But how do they get it in the economy? Simple, they give it to people, through lower taxes, government programs, or even just mail it to people to as a “tax refund” even for those who pay no taxes. Such exchange money would be spent and the prices of goods and services would rise as much as the government wants.
So, if it is so simple to create inflation, then why don’t governments do it if that’s what they want? Because they do not want inflation; they want increased economic activity through new borrowing.
To understand this, we need to step back into the history of capitalism. In a nutshell, free market capitalism created winners who became massive monopolies with large political influence. Some estimates of Andrew Carnegie’s wealth in today’s dollars based on his ownership of mainly steel interests are around $300 billion, making him perhaps 5 or 6 times as wealthy as the richest person today. However, the monopolies eventually lost their power to the last great monopoly—the financial sector. This coincides with the rise of debt as the main economic engine. The relationship between the financial sector and modern governments is well-known. Central banks are both the collective will of the financial sector and governments’ main tool to effect financial decisions. We are a democracy, but power mainly exists in the financial sector. If you do not believe that then ask yourself--why was it so easy for the financial sector to obtain massive short term bailouts here and abroad? That is real power, and far beyond what the other capitalist sectors, such as the auto industry, obtained.
Back to my point. The rise of the financial sector is crucial to modern capitalism, as it is the means by which governments seek to prevent recessions and depressions that would lead to: 1) lost elections in democracies; 2) social unrest; and 3) loss of wealth of powerful people. While real economic activity still exists in most capitalist countries it has become a smaller and smaller percentage of economic activity while financial activity has become a larger and larger percentage. Through the use of lower interest rates and many other financial tools, governments, central banks and the financial sector seek to maintain a happy functioning society, and prevent such things as depressions and world wars.
However, the financial sector does not actually produce any wealth. In a nutshell, real wealth which comes from increased productivity and the investment of savings, is dwarfed by the apparent and short term wealth that comes from borrowing. It is this borrowing that goes bad in recessions and depressions, and that is replaced by more and more borrowing traceable to the actions of the governments, which debt in turn goes bad. Debt money differs from exchange money in that debt money has a time fuse—the interest that must be paid back through some return of investment. This borrowing can be by individuals, companies or governments or all three sectors. It produces economic activity, but unless that economic activity continues to produce a return to pay the interest, then it must be replaced by more borrowing, increasingly unsupported by real economic activity (remember debt is being used not to produce more wealth but mainly to prevent bad debt from being liquidated).
This is why we do not have inflation, yet. Increased bad debt to replace old bad debt has not yet resulted in enough economic activity to produce demand; it is mainly preventing bad debt from being liquidated.
The governments want increased economic activity, not inflation. At best, inflation is a tool to drive savings into investments (but are not banks supposed to invest savings into investments?), or a buffer against deflation. It reflects economic activity, but does not cause it in most cases. Since most investments are no longer coming from savings (at least in the US) inflation would not help the economy much. It does help borrowers, mainly governments right now, but it hurts lenders, mainly the important financial sector. This is why high inflation was crushed by the Fed prior to Greenspan’s tenure.
The goal of governments is not really to increase inflation (except perhaps in Japan where there are still large savings that could be driven into investment); the goal of governments it to increase economic activity, and in our modern finance economies that means, increased borrowing. Increased borrowing can only increase inflation until the point where borrowers fail to make the interest payments, then deflation sets in. The governments are desperately trying to prevent deflation by trying to encouraging the substitution of new debt for bad old debt, either through lower interest rate or through increased asset prices that secure the debt.
Hyperinflation and deflation are actually two sides of the same phenomenon---the failure of governments to replace old bad debt with new (accepted) bad debt. In both cases, the lenders ultimately receive back a fraction of what they have lent, and the insolvency of the borrowers spreads to the lenders and then throughout the society (which has been existing on debt activity).
In my opinion, what we have now is sort of like a tree that has lost its roots—on the one side of the tree the winds of deflation and debt default are pushing on the tree, and on the other side governments are desperately pushing to encourage new economic activity based on new debt. We have neither deflation nor hyperinflation. The tree stands, but it has lost its roots in real economic activity. It will fall, now, or later.
Had we been honest with ourselves, we would admitted that our living standard was based on debts that can never be repaid, and we would have allowed the bad debts to be liquidated for pennies on the dollar, even if it meant loss of jobs and bankruptcies (even of large banks), and then allowed the real economic sectors (and they do exist) to rise up from the ashes and create real wealth. Instead, we risk major social disruptions and perhaps war when the hard and inevitable unwind comes.
Thank you. Bill
When real interest rates start rising then heavy borrowers will be in trouble. If we have such a case, then, since the Japanese government must borrow, it will soon be in very serious trouble.
3rd grade economics 101. If I borrow on my credit card I am not wealthier as the amount borrowed equals the increase in debt. Everybody seems to know this about their own life, but many somehow believe that governments can escape 3rd grade arithmetic rules.
I have tried to figure out where we collectively started to accept the insane concept that borrowing that does not come from someone's savings can increase wealth. I believe it comes from the short term apparent increases in wealth. Governments encourage and engage in this strange economic behavior, and even economists with doctorates believe the world (or at least interest rates) is flat. If a Cassandra points out that debt must be repaid and this plan will not work, they are quickly proven wrong, when the government encourages or engages in ever greater borrowing which results in an apparent increase in wealth. It’s hard to argue with increasing values in real estate or stock, and the sore loser Cassandra is ridiculed. But what do you do after the bubbles burst? Even more borrowing?
Japan is close to the end game for the concept of better living through borrowing. Sure, maybe they will get lucky and make it for a few years. But, as Keynes might have said of this debt-ridden world if he had lived this long--in the long run, we are all dead--broke. Sadly, individual freedoms which could have made us truly wealthier may suffer when the stuff hits the fan. Why don't we finally tell people the truth--their living standard is based on debt and they must suffer to clear it away and get things rolling in a real way again. Thanks. Bill
Japan is like the guy down the street that ran up his credit cards too high. When he decided to get back into the job market he discovered that he could not find work unless he reduced his wages, which he did. This ticked off the other workers, as they also had to reduce their wages. In the end, it did not matter as none of them would ever be able to pay their debts anyway. But now they all had someone else to blame.
If JGB rates continue to rise the Japanese government will soon not be able to pay its debts unless:
1) it increases its revenues by higher effective tax rates; 2) it prints money to pay the bonds; 3) it borrows money to pay its debts; or 4) it increases its revenues by increasing taxes from a rapidly growing economy.
No. 1 is not likely as the amount needed is too large. No. 2 is only temporary as borrowers will require greater interest as an inflation risk premium. No. 3 is only temporary as borrowers will also require greater interest because of the default risk premium. No. 4 is the only plan, but to work it requires that Japan grab huge amounts of market share from export competitors. This requires a very cheap Japanese yen.
This in turn requires that the other major exporting countries accept losses to their own exporters, and do so without taking retaliatory action or trying to lower their own currencies. This does not seem likely, but if Japan could trade freely with a cheap yen it could revive its export sector and increase its tax revenue. Cheap yen would be inflationary in Japan and would destroy the living standard of the elderly lenders, but the export section of Japan and the workers in those sectors would do OK. Governments that are in severe debt trouble commonly confiscate the wealth of their own citizens, including the elderly, in the old days by seizure and in modern times by inflation. An “oldie but goodie” technique is to simply devalue the old currency or issue a new one. Another popular technique is to force locals to keep their money at home at artificially low interest rates during high inflation.
The best that the Japanese government could hope for is a cheap yen without international reprisals, lots of dumb borrowers to loan them money at very low interest rates, and old people to see their living standard drop but too old to remember to vote out the government. It’s possible, but does it seem likely?
As to default, Japan will probably not default on its loans, assuming they are in yen. Hey, if you could legally print money to pay your debts, what would you do?
The problems for Japan are many, but in a nutshell, it does not have enough tax income to run its government and pay its government debts, and it will probably soon not be able to borrow the difference because of rising interest rates. Increased taxes, reduced services, destruction of the living standard of old people, higher interest rates, and higher inflation are all possible. It’s not likely that the Japanese banking system will do well when the government can no longer borrow easily, and this would be a hard hit for a weak world financial system.
Every major economy on the planet has tried to maintain a living standard for its people through the use of debt. Those in power fear the loss of control and the civil unrest that would follow if economies plunged into the depression that follows large unsustainable debt build-ups.
When you live on borrowed money, you live on borrowed time.
What will the problems of Japan mean for the rest of us? No one knows. My guess—a stronger USD, more easing around the world, currency devaluations that will trigger new financial crises (although I don’t know where first), and military build-ups in Asia.
The central bankers and treasurers have forgotten what each one of us knows: when you borrow money that you cannot pay back; you do not become richer—you become bankrupt. The ability to print money may hide that, but it does not change it.

Thank you. Bill
April 15, 2013. Lots of big news today: the fall in the price of gold, the fall in stock prices, and the fall in the price of oil. OK, these diverse news items make collective sense as a general fall in the price of risk assets, and we have seen this before, many times. But to me the biggest news of all (and apparently of little interest to investors or the media) was the very large rise in Japanese Government Bond interest rates during the same time. Maybe this is a coincidence, or maybe explainable somehow—but what if?
What if JGBs have become a risk asset? If so then the Japanese government’s attempt to escape deflation will create a bond crisis of epic proportions. A Japanese sovereign bond crisis will crush the world economic system and would make today, looking back, the first day of the Greatest Depression in History.

Let’s hope that I am wrong. Thanks. Bill
The economy sits in the eye of the storm. The winds of debt collapse and deflation blow one way and an equal wind of money expansion blows the opposite way. The boat sits motionless, rocking slowly. Eventually the crew realizes they have not drowned and breathe a sigh of relief. They grow weary of guessing which wind will triumph and begin to dream of the money that they will make from this voyage. Some even forget the struggle of the winds. Some greater power has fixed everything for them, and will take care of them in the future.
When we can print money without inflation, riches appear by magic.
No one knows which wind will prevail. But we know this--in matters of the economy, arithmetic always trumps magic. Eventually, more money supply means more inflation, and when combined with increased government debt, the end result is a scared angry country, forced to raise interest rates to fight inflation but unable to pay the interest on its debt. A country without tools to prevent massive economic hardship and social unrest.
The only “good news” for us is that the tragic end will more likely come first to Japan or Europe.
We, the US, Japan and Europe, cannot pay our present debts. Why do we keep lying to ourselves? We cannot continue to borrow to sustain a false higher living standard, even through the illusion of money printing. We have only created a cruel and false hope.
Instead, we can try honesty, and discuss plans to liquidate our debts. We will face severe economic hardship for a few years, and so we must prepare people and make plans to prevent them from starving or fighting. If we do not do this our fantasy world will collapse with the usual desperation, demagogues and war. What good are our stock investments going to be then? How will we protect our family in such a world? Let’s please not find out.
I hope that all of you who read this do well in your investments, but please don't forget that we all live on the same boat.
Thank you. Bill
I agree with much of this article, but only as it pertains to the near future. I don’t see the collapse of anything—yet. But no one can see the future, as we each have not yet made the individual decisions that will create that future.
As to the “fiscal cliff”, it is a clever, empty term that describes nothing more than a little kid that has to decide whether to steal from the cookie jar (increase taxes) or stiff his older brother on the bet that he lost (cut spending). None of these petty actions will change much, and certainly will not change the fact that the kid must grow up sooner or later.
Here is my confusion as to the fiscal cliff talk—people are worried that if congress does not agree to raise taxes and cut spending that, hmm, they will be forced to raise taxes and cut spending automatically. The truth is—they cannot raise taxes or cut spending much because we live off borrowing. What is the alternative to raising taxes and cutting spending? Borrow more. So, they will announce a compromise that promises to raise revenue some and cut spending, mainly later, and then let the Treasury Fed twins continue to borrow and print. It’s true that we are the Big Kaduna, and we can do this. For a while. In fact, the US Dollar may well go up after we print enough to collapse other economies. After all, we have the world’s reserve currency, and every other major country is also printing and borrowing but from a weaker international position. By my estimate one-half the world’s wealth and one-half the world’s income is based on borrowing, increasingly sovereign borrowing. Most of this debt cannot be repaid, and will not be repaid. Debt that cannot be repaid is not debt as an asset class. It is a worthless promise, a piece of litter. The value of the debt disappears as does the obligation to pay it back. How will the sovereigns escape their promises, since they cannot meet them? Defaults, financial suppression, inflation, civil unrest and demagogues, war—? No one knows, but many do know that serious times are coming when the wealth available through debt dries up.

Sure, we can have an economic recovery for a while--how could we not, considering how much funny money has been pumped into the world economy? But like the guy down the street living off his credit cards and writing increasing suspect I.O.U.s the world economy will not get very far, and not many years down the road, before Japan, China, Europe or some other place blow a fuse and the financial lights go out. Is there not a single politician that can do honest math and tell us the brutal truth so that we can take the hard medicine, lay on our backs until we recover, and then get up and go back to work? I doubt it. Which makes me wonder about us, and whether we even want the truth. Thank you. Bill
The US collected roughly $1T in individual income taxes in 2011 (its biggest source of revenue), and borrowed roughly $1T in new borrowing each of the last several years. Federal debt is approximately $16T, and the interest payment is about $200 B.
If your Uncle Sam, took off his hat and shaved his beard, and dropped lots of zeros and moved into your neighborhood, your neighbor Sam’s situation would look like this:
Sam makes $100,000, owes $1,600,000, and borrows an additional $100,000 each year. Sam “only” pays about $20,000 in interest each year. So, Sam is living it up spending $180,000 each year, even though he only makes $100,000.
Should Neighbor Sam file bankruptcy? Well, maybe when his creditors stop loaning him the $100,000 each year.
Should Uncle Sam file bankruptcy? No, because he has some special powers that Neighbor Sam does not.
First, he can print new debt and hand it to his creditors in payment (printing money) and they have to accept it! Wow. If individuals had that power there would not have been even one foreclosure last year.
Second, everybody uses Sam’s debt around the world. Everyone knows he’s a high risk borrower, but err, are Europe, Japan and China better bets? Would you like to own their currency or debt instead? Further, in order to keep their currencies low and sell to others, foreign countries must keep buying Sam’s new debt.
What a deal Sam has.
So, how will it end? We know for Neighbor Sam, as the Grateful Dead song Truckin goes, “One of these days they know they better get goin
Out of the door and down on the streets all alone…Sometimes your cards aint worth a dime.”
As to Uncle Sam, sorry, but there is not one investor in the world who knows how it will end, although many claim to know. The world financial system of loans, guarantees, swaps, cross ownerships, endless newly created derivatives, etc., most of it denominated in dollars, is like an old coal mine full of tunnels and connections, props and beams, underground streams and slag heaps. When one beam falls it might collapse some mountain far away. Of course, the US Fed knows this, and knows that it can get away with a lot, and that a lot will have to be paid for by other countries before it all becomes impossible to continue here.
We can at least say this, to paraphrase that famous economist, John Maynard G. Krebs, “In the long run, we are all dead, broke, man”.
My personal guess is that ½ or the world’s wealth, and ½ or the world’s income derives from debt. Imagine a world with half the wealth. Since few of us will accept our own responsibility in this, and we will blame someone else--it will not be pretty. It is too late for honesty and collective hard solutions. This is also a world where very few will be able to increase their wealth.
My own guess is stagflation, possibly followed by either a major world war (most likely) or a currency replacement in the US. This is where a government replaces an existing currency with a new one, usually at an exchange rate that wipes out all savings (and government debt). I don’t believe that we have seen this in the US (other than gold-related issues), but the governments in Europe and Asian have done it many times, which is one reason citizens in those countries often store their wealth in gold. But there are many possible outcomes. I don’t know which will happen.
And what should one do? I don’t know that either. If you do, let me know. Thanks. Bill
Great article. Thank you. My questions: are there any mutual funds or ETFs that focus on DGR? If so, what has been their success in increasing annual income (most funds seem to measure increase in value, rather than increase in income)? For example, are they getting the DGR of 17.75% in your example, or less, or more? Also, what is your opinion about using mutual funds or ETFs versus picking, buying and selling your own individual stocks, particularly from a cost perspective? Thank you. Bill
Why do we wait for quantitative easing, Euro bond buying, Chinese stimulus and recycled Japanese Sushi bonds? Governments have shown that they will increase borrowing too slowly and too inefficiently.
It’s time for people around the world to rise up and take action. Our very living standard is at risk.
I have a solution, and here it is.
Loan yourself more money. Not just you, but every person in the developed countries and China.
For example, if you don’t have enough money to buy a new car, then tomorrow morning when you wake up, loan yourself some money.
Decide how much you want and promise to pay yourself back next year, or loan yourself some more next year if you need to. Don’t bother with old-fashioned credit cards and banks—do it yourself! If you need more money at lunch, loan yourself some more.
Tell your friends and neighbors how rich you are, encourage them to loan themselves money. The sky is the limit. You can loan yourself as much as you want.
If you’re the social type, you can get together with your friend and you can each loan each other money. Think big, loan each other millions, or billions. Start a self-loan action group. You can do this in larger and larger groups, even as large as countries. So, if you are really lazy, then sit back and let the governments do the work that you should to yourself—starting tomorrow morning.
Why does this seem so difficult for everyone? The answer to unlimited riches is simple, and so much faster if we leave out the politicians and central banks. Good luck. William Ramseyer
P.S. Do not object that one can’t get something for nothing or create wealth out of thin air. We have heard those tired objections for years. Millions of stock traders can’t be wrong, can they?
Why do we wait for governments to solve the economic crisis by quantitative easing, ECB bond buying, Chinese stimulus, or Japanese recycled sushi bonds? We have given them several years and still they have not fixed things. Our very living standard is at risk. Why do we continue to wait for governments to borrow to save us? Let's save the world. And here is how.
We will all, each person in the developed world and China, loan ourselves more money. Individual loan action, instead of the slow collective.
For example, if you don't have enough to buy a car just wake up tomorrow morning and say, "I hereby loan myself some money, and I will pay myself back next year, or maybe I will loan myself some more then."
Do not count on credit card companies, banks, governments to increase your borrowing power--do it yourself. Tell all your friends and neighbors how rich you are and how better you feel, and encourage them to loan themselves more money too.
Or, if you don't have the energy, then let the governments borrow for you and you will become richer. Right? Why does this seem so difficult to everyone?

Thanks. William Ramseyer
Very good article. My “nutshell” analysis: the sustained use of fiat money supply with interest (i.e. debt) has increased nominal wealth but reduced the percentage of real wealth. As the money supply rises the value of assets goes up, but the percentage of assets that can produce income sufficient to cover expenses (including debt interest payments) goes down. Investors don’t care because they can use cheap debt to acquire assets whose value is rising (mainly because of the cheap debt) and then sell the assets at a profit.
When debt is not available, or if interest rates rise, or if asset values fall, then we see that many assets were actually overvalued compared to the rent or profit they could produce. The loans related to those assets are worth less and sometimes worthless.
The nominal amount of wealth shrinks, and people become poorer. It’s true that the wealth that they had was not going to last long, but they did not know that.
This huge decline in wealth makes it almost impossible to find any safe investments. Anything that might be “safe” is quickly overwhelmed and over-valued.
Here is the hard simple fact. If the world wealth declines 40% (might guess) then the average investor will be 40% poorer! There is no way around that “average” fact.
If you are above-average you might only be 20 or 30% poorer!
The short term havens of this currency or that asset, like tiny sand bars facing a typhoon, are quickly over-whelmed. Meanwhile, a few high risk rollers might look good for a year or two but they go down eventually like almost everyone else. The efforts of central banks to increase money supply with new debt is just more of the same and only changes the date that it all goes bad. What we don’t know is how it will go bad and when.

I would not count on any asset to save you. The assets are just numbers determined by the opinions of other people, people who may be making decisions in a world of currency and sovereign collapses, a world of deflation or perhaps hyper-inflation--so many ways for our wealth to reduce down to its real productive values.
Good luck. Bill
Thank you for the comments. As some commentators mention, it is true that yearly ETF expenses are usually less than 1%, and that the number of stocks is much larger than 10. These numbers were used to make the examples simple (for me!). The basic point is this--there are two main costs in investing: 1) transaction costs; and 2) holding costs. ETFs mainly have holding costs; owning stocks mainly involves transaction costs. In order to compare them we need to know, among other things: 1) brokers fees, 2) number of stocks, 3) holding period, and 4) ETF expenses. Thanks. Bill
I think Leon Blum and the Front Populaire will win and the Germans will not be happy about that. Oops, wrong century. Actually though, the problem is similar to that back in the 1930s. The centrist democracies of Europe split into left and right factions when economic times get tough. Le Pen on the right and the Socialists on the left are hardly the equivalent of the street fighting Communists and Fascists of the 1920s and 1930s, especially those in Spain, Germany and Italy, but the same causes are leading to the same results—a break-up of the centrist governments. If we have a few more years of economic hard times in Europe we will begin to see even the democratic form of government and individual rights come under severe pressure. Every victory by either the left or the right accelerates the polarization of politics during a financial crisis until dictatorship seems an acceptable result to the side that hopes to dictate.
As to the French elections, I believe that it will be closer than the polls indicate. The French, more than any other electorate that I know of, seem to enjoy voting against things. This explains the large turn-out in the mainly useless first round. It’s their great sport to vote for any party that seems to best express “votez non!” Usually, they then move back to the center for the 2nd round. However, winning the center will not suffice for Sarkozy in this election unless he gets the Right to vote for him, and I believe they will stay home unless he can stir up fears about Hollande or make concessions beyond what he appears to be able to do. In other words, the Left will come out and vote and if the Right stays home Sarkozy loses even if he wins the center. Ouch. Ca fait mal.
Thanks. Bill
Very good article. I do agree that interest rates are one of the prime factors that affect the price of gold. In fact, interest rates are one of the prime factors that affect all currencies. If, for example, US 10 year bond rates rose to 4% (absent a crisis) the USD would rise and other currencies (including gold) would fall. Gold backed bonds payable in gold interest are theoretically possible, but a bit cumbersome. In reality, gold is the one currency whose money supply can not be easily increased by printing, or by use of debt-based central bank tools. Therefore, gold is a currency “in reaction”, its value depends on the supply of other currencies. I find it easier to think of the value of gold as a measure of its relative availability compared to other currencies. When interest rates rise, the money supply generally contracts and gold would go down (as it becomes relatively more available). When interest rates fall then money supply contracts and gold becomes relatively less available. It is also possible to think of this in terms of investor demand, as mentioned in the article. I suppose that there is a historical rate of return on loans, let’s say 2.5% for highest quality debt. When interest rates rise, capital is attracted to debt and rates fall, and the reverse.
History shows us that people don’t like taxes, but governments do like to spend. Therefore, the hidden tax of diluting the money value is a long-time government favorite. This was done for thousands of years by adding base metals. Now it is done by paper or electronic printing. Because of the high debt loads of most major governments today they can not afford to let interest rates rise very high. However, they would still like to use inflation if possible to increase revenues. Inflation is also favored as it forces savings into the economy and counters deflationary forces of private debt collapse.
The point of all of this is that governments will use inflation, and will try and keep interest rates lower than inflation (there is no Volcker coming to the Fed soon). This will make real interest rates lower than nominal interest rates and makes gold still a good currency, i.e. investment, to hold. Further, the ability of government to increase inflation long term while holding interest rates low is very questionable. Catastrophic deflationary events or hyper-inflation are unfortunately both possible if the effort continues.
Back to the story--if for example interest rates are 5% but inflation is 4% then real interest rates are 1%, making gold a better currency to hold than dollars. Will we ever get, for example, to 5% interest rates and 2.5% inflation? Sure, but not anytime soon. In fact, the opposite may happen. Already we are seeing inflation rates substantially above interest rates in England.
However, as the article points out there are many other factors that determine gold prices and it’s quite possible that a major correction is coming. I have no idea what the price should be.
But for the long run, I still like gold. In summary, it’s not inflation that counts. It’s interest rates minus inflation, and if the number is less than 2.5% or some similar historical number I’ll pick gold over the paper currencies. If we get interest rates substantially higher than inflation, then at that time I might buy bonds instead. I’m not sure when stocks would be a good investment. I would be interested in hearing a comparison of interest rates, inflation and the relative merits of stocks, bonds and gold. Thank you. Bill

A very well done article. Thank you. My two cents addition, off the top of my head, would be the following: the wealthy of every society (kingdoms, dictatorships, democracies) have always sought to increase their wealth through actions of the country abroad. War, trade, and economic policies that serve the perceived interests of the powerful result. Nothing evil, or surprising here. It’s human nature. One big problem is that actions that might benefit the powerful few, may cost the country dearly. This disconnect between “management” interests and the citizen masses drains the treasury fast. So leaders everywhere seek a way to tax, borrow, inflate, or steal the money they need to pay for their empire efforts. In the end it all fails and a new empire takes over. We took over from the British. Who will take over from us? When the Pax Americana ends the price of stock may be the least of our worries. Thank you. Bill
A major financial crisis leads to severe local hardship. Stock and real estate values fall, unemployment goes up. The government responds by increasing spending, even while collecting less taxes. Sovereign debt levels soar. The currency falls. Eventually, hopefully, exports increase, and money flows in to buy the cheap stock and real estate. Eventually, things get better. (Check out the book, “This Time is Different” by Reinhart and Rogoff, for more on this subject.)
Except when this happens all over the world.
In such a case, as we had in the 1930s, and may well have now, no country can export its way out of trouble or attract in sufficient new beneficial capital. The “solution” to the Great Depression was World War II.
It’s true that the US is now at severe risk because of its level of sovereign debt, but so are most of the countries in Europe and so is Japan. Also, China has many of the same symptoms that the US and Japan had before their crisis’s (Japan in the 1990s and the US in the last few years). China had rapidly increasing real estate values, easy lending, and weakening real productive activity, as loans and real estate took on a greater percentage as national activity. Exports have weakened. Now, real estate values are declining and the lenders are at risk. We will probably find that the amounts of loans and lenders were under-reported, that the asset values were highly over-valued, and plenty of the usual fraud that is disclosed when things go bad. China will not be able to export its way out of such a crisis anytime soon.
A bond crisis in Japan or a financial crisis in China could make the US dollar go up, and make US bonds more valued, driving down interest rates. We saw this many times during the long European financial crisis, which continues. So, like usual, there is no easy investment decision. The US dollar and bond rates could go exactly the opposite direction that one would expect considering its debt level.
No one knows when and if Japan will suffer its bond crisis or China will undergo its own banking and real estate crisis. It’s possible that the US or Europe will have a severe debt crisis first, or that something else we never expected, good or bad, happens.
Can the US run up huge new amounts of debt each year, buy its own bonds, and do so indefinitely? No. Can it do it for a longer than we expect? Maybe, depending on what happens in the rest of the world.
What happens in all of these countries, and the order of what happens, can make a HUGE difference in the values of the different types of assets in one’s portfolio.
The global crisis is very far from over. But no one knows how it will unfold and what we will evolve towards
Thank you. Bill
Thank you. Excellent article and I enjoyed it. Here’s my take:
Sovereigns borrow for 2 main reasons:
1) to pay for war or expand their empires (such as the Kings of Europe several centuries ago); or
2) to satisfy domestic needs: for example, to maintain living standards, win elections, or prevent civil unrest
When it comes time to repay debt, sovereign governments have 3 choices:
1) raise taxes;
2) cut domestic spending; or
3) debase the currency and pay back with debased currency. Traditionally, this was done by adding base metals to gold or silver coins, then it was done by printing more paper currency, and now it is done electronically.
The US spends money for both reasons above. It can not find the political agreement to raise taxes or cut spending. Politicians find it increasingly difficult to obtain political agreement to spend more money to stimulate the economy. This leaves the Fed as the only agency capable of taking action to stimulate the economy (by holding long term interest rates low and thereby keeping mortgage rates and corporate bond interest rates low—that’s the theory anyway) and as the only agency able to “pay back” the sovereign debt, through debasing the currency (this is not something they will admit to, but it is something desperate governments have done many times).
It would be theoretically possible to pay down our debts without debasing our currency. This would require brutal honesty by all. Our living standard would fall dramatically for several years. Yes, you would be poorer, and ouch, I would be poorer. Taxes would be much higher and government spending would be much lower. Interest rates would soar.
We would have a major dose of the medicine that the IMF has doled out to other countries. Can we do it? Frankly, I doubt it. However, we might have a shot if we promised that we would provide food, shelter, medicine and safety to all at government expenses until the unemployment rate reached 6% or so. This would be a lot cheaper than bailing out the banks and a whole lot cheaper than suppressing the riots and violent demonstrations that would come with the (hopefully short) economic downturn that would follow an honest attempt to live within our means and pay down our country’s debts.
Thank you. Bill
Thank you. Excellent article and I enjoyed it. Here’s my take:
Sovereigns borrow for 2 main reasons:
1) to pay for war or expand their empires (such as the Kings of Europe several centuries ago); or
2) to satisfy domestic needs: for example, to maintain living standards, win elections, or prevent civil unrest
When it comes time to repay debt, sovereign governments have 3 choices:
1) raise taxes;
2) cut domestic spending; or
3) debase the currency and pay back with debased currency. Traditionally, this was done by adding base metals to gold or silver coins, then it was done by printing more paper currency, and now it is done electronically.
The US spends money for both reasons above. It can not find the political agreement to raise taxes or cut spending. Politicians find it increasingly difficult to obtain political agreement to spend more money to stimulate the economy. This leaves the Fed as the only agency capable of taking action to stimulate the economy (by holding long term interest rates low and thereby keeping mortgage rates and corporate bond interest rates low—that’s the theory anyway) and as the only agency able to “pay back” the sovereign debt, through debasing the currency (this is not something they will admit to, but it is something desperate governments have done many times).
It would be theoretically possible to pay down our debt. This would require brutal honesty by all. Our living standard would fall dramatically for several years. Yes, you would be poorer, and ouch, I would be poorer. Taxes would be much higher and government spending would be much lower. Interest rates would soar.
We would have a major dose of the medicine that the IMF has doled out to other countries. Can we do it? Frankly, I doubt it. However, we might have a shot if we promised that we would provide food, shelter, medicine and safety to all at government expenses until the unemployment rate reached 6% or so. This would be a lot cheaper than bailing out the banks and a whole lot cheaper than suppressing the riots and violent demonstrations that would come with the (hopefully short) economic downturn that would follow an honest attempt to live within our means and pay down our country’s debts.
Thank you. Bill
I’m not sure that a shortage of consumer spending is the problem (I prefer letting the bad debts liquidate as soon as possible), but if it is, then one possible solution would be to provide people with “spending certificates” based on last years tax payments. These would be like tax rebates but only usable for purchases. For example, let’s say that we provide every taxpayer with a 25% spending certificate based on last years taxes. If someone paid $20,000 in taxes then they would receive $4,000 in spending certificates. They could buy any good or service with the spending certificates. The seller would receive the spending certificate and could then exchange the certificates with the federal government for money. The spending certificates could not be exchanged for any financial instrument or loaned out, so the original purchaser could not deposit the spending certificate in a bank or use it to buy stock. In other words, the rules would seek to encourage consumer spending of the additional “money”, rather than investment or savings. Obviously, some people would save the money they were going to spend, and use the spending certificates instead of that money, and so there would still be some increase in saving or investing. The spending certificates resemble tax rebates, but must be used for purchases (much like food stamps, but for any purchase). Actually, I never understood why Japan did not do something similar. Thanks. Bill