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Charlie Atwill
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I manage a Registered Investment Advisory firm (AFCG, LLC) that follows an Austrian School economic and investment approach. We base our portfolio models and financial planning on a macro-based, top-down understanding of Austrian Business Cycle Theory, monetary policy, and a desire for... More
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  • Paradise Borrowed
    Paradise Borrowed

    Our Collective Journey from Thrift to Profligacy

    Charles B. Atwill, CFP®

    In a Reuters article published last October, former U.S. Treasury Secretary Larry Summers provided a rare - and candid - glimpse into what he really thinks about the global debt crisis (emphasis mine):

    "The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence, more borrowing and lending, and more spending."

    This mainstream view of fostering economic growth through perpetual increases in money supply and credit is sometimes likened to the plight of "The Junkie." The first "fix" creates good feelings and euphoria. Over time, more frequent and larger doses are required to create the same effect until, eventually, no amount of the drug (in this case new money and credit) provides an adequate high. Two paths lie ahead for The Junkie:

    · Quit (and suffer terrible withdrawals - but ultimately survive)

    · Continue (and, in time, die from the effects of chronic abuse)

    Our current path, the continuation of an exponential growth of debt, will eventually lead us to a day of financial reckoning. Though it might still be possible to avoid such an event, in order to know where we are going - we must first know where we have been.

    Humble Beginnings

    In the earliest days of our experiment as a constitutional republic, the debate over "a national debt" created a schism within the cabinet of George Washington. On one side, Alexander Hamilton argued that the establishment of a national debt (as well as a federally chartered national bank) would bind the States together under a common financial yoke, and therefore act as a uniting force.

    Thomas Jefferson took the other side of the argument, expressing grave concerns about the dangers of placing too much fiscal authority in one central government. His concerns were perhaps expressed best by Benjamin Franklin, warning that "When the people find that they can vote themselves money, that will herald the end of the republic."

    This debate raged in the U.S. for the better part of the 19th century. For most of that period, federal government debt never exceeded 40% of GDP (compared to 100%+ today). In fact, there was no national debt in 1835, as President Andrew Jackson's administration paid it off in full.

    While debt was not a significant issue for the U.S. in the 19th century, the form of our money was. From the Revolutionary-era "Continental" to the Union's "Greenback" of Civil War vintage, we experimented with a variety of "paper substitutes" for money. Regardless of the particular version in circulation, gold and silver remained the ultimate medium of exchange. Paper could represent wealth; gold and silver were wealth.

    A Hotel in New Hampshire

    In July of 1944, as the Second World War raged on, delegates from the Allied nations met at the Mount Washington Hotel in the quiet town of Bretton Woods, New Hampshire. While the intent of the gathering was to bring economic order and aid to a post-war world, the result was the establishment of a new global monetary regime.

    As it appeared that an Allied victory was almost certain - and that the U.S. was the principal architect of that victory - its position at the bargaining table was quite strong. The popular economic theory at the time, developed in large part by British economist John Maynard Keynes, promoted the benefits of a global currency regime, ostensibly to reduce the potential for international conflict that often began over currency and trade disputes. The theory derided the use of gold as a monetary standard, as it limited the supply of money and expansion of credit.

    The delegates agreed to a compromise solution, whereby the U.S. dollar would be internationally convertible to gold and - in practical terms - become the world's reserve currency. The benefits conferred by that are many. Chief among them is the now unfettered ability to borrow in our own currency and print money. The end of the Bretton Woods Agreement in 1971 marked the beginning of what economist Irving Fisher referred to as a "debt supercycle."

    Post-War Expansion

    Having achieved military and monetary hegemony, the U.S. set out on an expansionary course not unlike that of its progenitor, Great Britain. Just as the British Navy guaranteed safe passage and trade throughout the four corners of the globe, and the Pound Sterling represented a universally accepted medium of exchange - the U.S. now found itself without commercial or military equal.

    With the Great Depression a distant memory, and a strong monetary wind at its back, the U.S. share of global wealth grew at a tremendous clip. Underpinning this growth was a confidence in the strength of the U.S. financial system, the pre-eminence of the dollar, and a rising tide of credit that - in nominal terms at least - has no equal in history. The age of U.S. consumerism was heralded by the ability to purchase cars, homes, appliances - quite literally everything - on credit.

    If the private sector became enamored with credit, the political class raised its use to an art form. The benefits of attracting voters with programs, paid for with borrowed money, were particularly irresistible to career politicians whose "livelihoods" depended on dispensing favors, expanding the social safety net, and defending national interests in every corner of the world. While politicians promised "progress" financed with debt, a credulous electorate simply failed to understand that the "free lunches" being promised were, in fact, anything but free.

    During most of the 20th century, we borrowed from the future to finance a standard of living that was the envy of the world. In 1947, total U.S. debt - public and private - was estimated to be 150% of our Gross Domestic Product. That is to say, for every $1.00 of economic production, there was approximately $1.50 of domestic debt. Today, that number exceeds 350% debt-to-GDP. As the bills came due - public and private - we simply borrowed more and kicked the proverbial can down the road. After all, to borrow a line from the songwriter Robert Earl Keen, "…the road goes on forever, and the party never ends."

    The Party Ends

    The credit bubble finally burst in the Fall of 2008. Trillions of dollars of capital evaporated; credit all but stopped flowing. Since financial markets abhor a vacuum, the U.S Federal Reserve flooded the system with new money in an effort to replace lost capital and re-establish the flow of credit. Concurrently, the U.S. federal government borrowed and spent trillions in an effort to "stimulate" the economy. Real interest rates in the U.S. were taken below 0% (when adjusted for inflation) - and according to the Fed - will now remain there through 2014. No effort has been spared to re-inflate the bubble economy.

    And when previous rounds of monetary stimulus wear off (as with junkies), a new and larger dose will follow - bringing fewer benefits and more side effects (inflation). The law of diminishing returns does not exempt economics.

    Commonwealth Lost?

    If Benjamin Franklin's warning about citizens demanding treasure (i.e., "free lunches") from the government is correct, perhaps we are approaching the nadir of this grand experiment in self-governance. Human nature being what it is, the path of least resistance - once discovered - is immeasurably difficult to leave. The collective delusion that wealth and domestic tranquility can be borrowed into existence is so ingrained in our culture that, to suggest otherwise, is - at best - considered economic heterodoxy. Politicians who favor thrift over profligacy risk an even more ignominious fate: unemployment.

    Whether or not we alter our course, like The Junkie, the path ahead will likely be difficult. The decisions we are now making about our fiscal course have existential consequences for our constitutional republic. The graveyard of failed nation-states is littered with the corpses of once-proud countries that were unwilling to resist the temptation of living richly in the present at the expense of future solvency. If the current fiscal crises going on around the world are merely met with "more confidence, more borrowing and lending, and more spending," then our real challenges have only just begun.

    Feb 15 11:12 AM | Link | Comment!
  • Bedrock
    Seeking Real Value in a Transitory World
    Charles B. Atwill, CFP®
     In a world where an earthquake can move the entire island of Honshu (Japan’s main island) by an estimated 2.4 meters (almost eight feet), the term “bedrock” as a standard of permanence and immovability might ring hollow. The earthquake and tsunami that ravaged coastal Japan in March – quite literally – broke the geological moorings that tethered a country to the planet on which it resides. While the separation of landmass from planet was relatively brief, the destruction of large swathes of the coastline defies words. Tectonic forces like the ones involved in the Fukushima earthquake can shake the very notion that anything of this world is, indeed, permanent.

    As financial markets convulsed through much of the last two months, it was easy to question where exactly one could find safety amid the chaos. Few asset classes – outside of the US dollar and Treasury bonds – afforded much protection from the volatility. However, times like these can inspire one to think about what is valuable in an absolute sense, and what might be cast asunder in the violent forces of a financial tsunami. 

    In a “margin call” event such as the one we experienced last quarter, cash is king. During these events, big market participants (e.g., “hedge funds”), trading with massive amounts of leverage (i.e., “borrowed money”), may be forced to raise cash
    . When a hedge fund borrows money to invest, it is required to maintain a minimum amount of collateral to satisfy the lenders. If this requirement is not met at some point, a margin call ensues. At that point, the hedge fund must sell anything it can – at any price – to raise cash to meet the margin requirements. The result: many good, valuable assets are sold off indiscriminately and prices on them fall until buyers return. When this happens, the market price of an asset disconnects from its intrinsic value.

    Paradoxically, while cash (paper money) is the “safe haven” position
    sine pari during a rout, it is simultaneously dangerous to hold as a long-term position because of the ease with which it is being devalued by governments. Before modern central banking and the advent of multi-trillion dollar deficits, the effects of price inflation were, generally speaking, negligible. With central banks printing electronic money by the trillions and back-stopping entire sectors of the economy (not to mention entire countries at this point) paper currencies have lost much of their appeal as “safe havens” to store purchasing power over time. Once considered bedrock, cash is now more akin to quicksand, slowly devouring the holder until all purchasing power has been consumed.

    AFCG’s foundational investment classes continue to be precious metals, natural resources, and income-producing securities issued by financially strong entities. We are under no illusion that our investments are immune from shorter term periods of sharp volatility. Instead, we look to our investments as the bedrock of portfolios required to withstand the punishing circumstances of the global debt crisis, as well as the arduous test of time.
    The debt crisis has increased near-term volatility in the financial markets while making the case for owning assets of real value (gold/silver, food, energy, etc.) even stronger.
    Oct 21 12:48 PM | Link | Comment!
  • Rediscovering Money
    What is money? If you go out and ask most people that question, you’ll find that you get some puzzled looks and few coherent answers. Try it! If nothing else it’s a great ice-breaker while you’re chatting with the barista at your local coffee shop. Come on, we all know what money is – right? I challenge you to find one person in ten who can provide a reasonably accurate definition of money. I would suggest that this ignorance concerning the nature of money says less about the intelligence of our society in general – and a great deal more about those who control the life-blood of our global economy.
    “Give me control of a nation’s money supply, and I care not who makes its laws.”
    ~Mayer Amschel Rothschild
    It occurred to me recently that I am the product of the first generation of Americans to live under a wholly fiat-based system of currency. (The term fiat is derived from the Latin phrase “Let it be done.”) Money, in its current form, is a creation of the state, with no underlying intrinsic value or quality other than its status as legal tender; that is to say, we are required to accept it as payment “for all debts, public and private.” My generation is the first to have never used “sound money.” Before we delve into a definition of sound money, a little background is in order.
    Historically, paper money had some relationship to an underlying asset, typically gold and/or silver. The paper represented a claim on that underlying asset. This relationship also limited – if not prevented – the ability of the issuer of the paper money from creating too much of it. Some of the earliest paper money was issued by goldsmiths (who also provided safe storage for individuals’ gold) as a certificate of ownership for the gold deposited in their vaults. These pieces of paper eventually began to be traded as payment for goods and services, always redeemable for the real thing. The paper was merely a more convenient way to pay for things.
    When governments got into the business of issuing money, they too backed the paper with precious metals, allowing the holder of the paper to redeem it for the metal. But, governments make promises, some of which they cannot afford. If they were able to pay for these promises with paper money created out of thin air, they could avoid the politically unpopular option of increasing taxes.
    Without going into a very long history of fiat money, suffice it to say that the modern welfare state has promised more than it can ever hope to pay for without taxing itself into oblivion. Cradle-to-grave care by the state comes at the expense of the currency. In 1971, the US ended its ties to a gold standard (convertibility of dollars to gold at a fixed rate of exchange) in order to pay for The Great Society, the Viet Nam War, and numerous other big ticket items. Instead, we merely printed and borrowed what we needed and the dollar began its final, terminal decline.
    “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”
    ~Henry Ford

    In the 4th century B.C., Aristotle gave us one of the earliest definitions of the qualities of good money:
    • It should be durable (which is why, say, wheat isn’t a good money – it rots).
    • It should be divisible (which is why artwork isn’t a good money – you can’t cut up the Mona Lisa for change).
    • It should be convenient (which is why lead isn’t a good money – it just takes too much to be of value).
    • It should be consistent (which is one reason why land can’t be money – each piece is different).  
    • And it should have value in itself (which is why paper money leads to trouble).
    (Credit: Doug Casey)

    This brings us to the function of money in an economy. By most definitions, it serves as a:
    ·         unit of account;
    ·         a medium of exchange; and
    ·         a store of value.
    Any money can adequately serve the first two functions above. In the past, tobacco, seashells, and any number of other items have been used as money. It is the third function that we have almost entirely lost – in less than one generation. As a store of value, one would expect that, over a given period of time, a unit of currency would maintain its purchasing power. That is to say, a dollar that would purchase one widget today ought to be able to purchase that same widget ten years from now. Why then do we consistently find that it requires more dollars in the future to by the same things we buy today? Assuming the widget has no improvements or new qualities to make it more valuable – why does it cost more in the future?

    (Credit: James Turk and Gold Money )
    The chart above illustrates the loss of purchasing power of fiat currencies over time.  The cost of crude oil in US Dollars or British Pounds has risen over time. Priced in gold (the red line on the bottom of the chart), a barrel of oil costs about the same today as it did in 1945. Gold did not go up in value, nor did oil. Instead, the value of the currencies in which we buy the oil, simply lost value over time.
    Is Gold Money?
    In an interesting recent exchange between Rep. Ron Paul of Texas and Fed Chairman Ben Bernanke, the two discussed the nature of money and gold.
    RP: Do you think gold is money?
    BB: No. It’s a precious metal…an asset.
    RP: Why do central banks hold it?
    BB: Well, it’s a form of reserves.
    RP: Why don’t they hold diamonds?
    BB: Well…it’s tradition, a long-term tradition….
    Mr. Bernanke knows full well the historical role of gold as money. The slight-of-hand that has been played on the public and investors for years is that the paper money we use is now “real money” – and that shiny, barbarous relic is not. In the wake of the 2008 financial crisis, and the two concurrent sovereign debt crises on either side of the Atlantic, it may be that we are now in the process of “rediscovering” what money has been all along.

    Disclosure: I am long PHYS, CEF, PSLV.

    Additional disclosure: This commentary should not be construed as investment advice. Author's Investment Advisory firm, AFCG, LLC currently invests in and recommends to clients investments in precious metals as part of a prudent overall investment strategy.
    Jul 26 4:31 PM | Link | Comment!
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