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.
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
4 Scary Charts Warning Of The Next Financial Crisis [View article]
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.
Why Forex Traders Need To Care About Gold's Collapse [View article]
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.
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.
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
Even With A Fiscal Cliff Deal, Stocks And The U.S. Economy Will Unravel In 2013 [View article]
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
5 Years Until Retirement? What's Your Plan? Part II [View article]
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
Market Euphoria Continues As We Get Ready To Jump Off The Fiscal Cliff [View article]
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?
Market Euphoria Continues As We Get Ready To Jump Off The Fiscal Cliff [View article]
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?
Nowhere To Run: The Correlation Bubble [View article]
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.
ETFs Vs. Stocks--Should You Start Your Own ETP? [View article]
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
'Shorting Capitalism; Here Comes Hollande' [View article]
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.
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
Pending Iran Military Action And The Historical Effect Of Wars On The U.S. Dollar [View article]
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
Why Inflation Never Came [View article]
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
Big Things Happening In Japan [View article]
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
4 Scary Charts Warning Of The Next Financial Crisis [View article]
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
Why Forex Traders Need To Care About Gold's Collapse [View article]
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 Fed Vs. The World [View article]
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
The Fiscal 'Cliff' Is A Speed Bump [View article]
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
Even With A Fiscal Cliff Deal, Stocks And The U.S. Economy Will Unravel In 2013 [View article]
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
5 Years Until Retirement? What's Your Plan? Part II [View article]
Market Euphoria Continues As We Get Ready To Jump Off The Fiscal Cliff [View article]
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?
Market Euphoria Continues As We Get Ready To Jump Off The Fiscal Cliff [View article]
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
Nowhere To Run: The Correlation Bubble [View article]
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
ETFs Vs. Stocks--Should You Start Your Own ETP? [View article]
'Shorting Capitalism; Here Comes Hollande' [View article]
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
Rotate Out Of Gold On Rallies [View article]
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
Pending Iran Military Action And The Historical Effect Of Wars On The U.S. Dollar [View article]
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