Interest rates close to zero and all the related issues are relatively new in the U.S. and Europe, but they’ve been around in Japan for two decades. So, many wonder if the U.S. is headed for Japan’s 20-years-and-running deflationary depression. And regardless, what does the Japanese experience tell us about living in this atmosphere?
The Japanese bubble economy was cruisin’ for a bruisin’, and its demise was aided by the Bank of Japan’s hike in interest rates, starting on May 31, 1989. Soon, exuberant real estate prices collapsed as did stock prices and economic growth nearly ceased. Lately, the earthquake and tsunami have added to Japan’s woes, at least on a short-term basis. Real GDP fell 1.3% in the second quarter from a quarter earlier at annual rates, following the 3.6% drop in the first quarter and the third quarter in succession to decline.
Similarities
There are a number of similarities that suggest that America is entering a comparable long period of economic malaise. The Age of Deleveraging forecasts a similar decade, at least quite a few years, of slow growth and deflation as financial leverage and other excesses of past decades are worked off. The recent downgrade of Treasurys by S&P parallels the first cut in Japanese government bond ratings in 1998, followed by S&P’s cut to AA-minus early this year and Moody’s reduction from Aa2 to Aa3 last month.
The recent slow growth in the U.S. economy—real GDP gains of 0.4% in the first quarter and 1.0% in the second—looks absolutely Japanese. Furthermore, the prospects of substantial fiscal restraint in the U.S. to curb the federal deficit is reminiscent of tightening actions in Japan in the mid- 1990s. The economy was growing modestly, but deficit- and debt-wary policymakers in 1997 cut government spending and raised the national sales tax to 5%. Instant recession was the result.
Big government deficits in recent years are another similarly between these two countries.
The U.S. net federal debt-to-GDP ratio is also headed for the Japanese level.
Japan’s gross government debt last year was 226% of GDP, far and away the largest ration of any G-7 country. All governments lend back and forth among official entities so their gross debt is bigger than the net debt held by non-government investors, and Japan does more of this than other developed lands. Still, on a net basis, its government debt-to-GDP is only rivaled by Italy’s and leaped from a mere 11.7% in 1991 to 120.7% in 2010. Is the U.S. far behind?
Japan, in reaction to chronic economic weakness, has spent gobs of money in recent years, much of it politically motivated but economically questionable, like paving river beds in rural areas and building bridges to nowhere. Is that distinctly different than the U.S. 2009 $814 billion stimulus package that was supposed to finance shovel-ready infrastructure projects when, in reality, the shovels had not even been made yet?
A key reason for the 2009 and 2010 U.S. fiscal stimuli and continuing deficit spending in Japan is because aggressive conventional monetary ease did not revive either economy. Zero interest doesn’t help when banks don’t want to lend and creditworthy borrowers don’t want to borrow. Both central banks found themselves in classic liquidity traps, so both resorted to quantitative ease, without notable success.
But Differences, Too
There are, then, many similarities between financial and economic conditions in the U.S. and Japan. Nevertheless, there are considerable differences that make Japan’s experience in the last two decades questionable as a model for America in future years. Note, however, that every time I visit Japan, I return convinced that I understand less about how they function than I did on the previous trip. I’m sure they behave rationally, but it’s a different rationale than in the West, or at least the one I understand.
The Japanese are stoic by nature, always looking for the worst outcome while Americans are optimistic—not as optimistic as Brazilians, but still prone to look on the bright side. Otherwise, why would the Japanese voters stand for two decades of almost no economic growth? Japanese are comfortable with group decision-making while Americans revere individual initiative, something the Japanese disdain. The nail that sticks up will be pounded down, is a favorite expression there. Perhaps because of this, the government bureaucracy in Japan is much stronger than in the U.S. while elected officials have less control and room for initiative.
Despite little economic growth, the Japanese enjoy high living standards.
And the Japanese are an extremely homogenous and racially-pure population. In a related vein, immigration visas don’t exist in Japan, so there’s nothing in Japan like the chronic shift of U.S. income to the top quintile. Nothing like the two-tier economic recovery that benefited top-tier stockholders in 2009-2010, but left the rest struggling with collapsing prices for their homes and high unemployment.
Fertility rates in Japan are about the lowest in the world and life expectancy is high. So the rapidly aging and declining population lack the innovation and dynamism of more youthful populations in the U.S. where immigration, legal and illegal, is high as are fertility rates.
Wednesday, September 28, 2011
Wednesday, August 3, 2011
Marc Faber’s May Outlook: Beware the False Breakout in Stocks
Swiss investor Marc Faber has just released his latest issue of the Gloom, Boom, and Doom Report where he discussed his outlook for the stock market, gold, emerging markets, and other financial topics. Here are a few highlights from the report:
1. Equity Markets–The markets may be giddy about stocks hitting new highs, but contrarian investor Marc Faber is having nothing of this. He is concerned that stocks will fall sharply in May and that the recent breakout in stocks will prove to be trap for the bulls. The markets are due for a correction and the technicals point to a weak market. In particular, Faber points to the decline in new 52 week highs as evidence of an unhealthy internal market. Right now, Faber would stay away from cyclicals, tech stocks, and banks. If you have to own stocks make sure it is something safe like consumer staples (MO, JNJ, PEP, KO, etc).
2. Gold & Silver—Still likes gold as a long-term investment and recommends dollar cost averaging every month regardless of the price. However, when it comes to silver, Faber is more cautious, noting the recent run-up in the price. He expects a 20%+ correction in the metals complex because the inflation trade has become too crowded.
3. Commodities–Dr Copper is issuing a warning to investors. While the S&P 500 has made a new high, copper failed to do so (non-confirmation). This is a significant development because Dr Copper and the SP 500 have a very high correlation. This signal, along with the large declines in other commodities such as sugar and cotton, leads Faber to believe that stocks could follow commodities lower (in the short-term)
4. Buy Housing–While Faber thinks the US housing market has another 10% to fall, he would be a buyer because of attractive valuations. Faber compares the price of US housing to gold and concludes that housing has not been this cheap since the early 1980′s. But do not think there will be a quick recovery–there won’t be. The main point about housing is that it is a good inflation hedge and will likely keep its purchasing power of the next 10 years. In a serious inflation environment, Faber would rather own housing than paper dollars.
5. More QE Guaranteed–In Faber’s opinion, QE 3 is a near certainty. The US will be running trillion dollar budget deficits for the next 10 years. There is no way they can finance all of this through bond issuance. The Fed will have to at least partially monetize this to keep interest rates low.
1. Equity Markets–The markets may be giddy about stocks hitting new highs, but contrarian investor Marc Faber is having nothing of this. He is concerned that stocks will fall sharply in May and that the recent breakout in stocks will prove to be trap for the bulls. The markets are due for a correction and the technicals point to a weak market. In particular, Faber points to the decline in new 52 week highs as evidence of an unhealthy internal market. Right now, Faber would stay away from cyclicals, tech stocks, and banks. If you have to own stocks make sure it is something safe like consumer staples (MO, JNJ, PEP, KO, etc).
2. Gold & Silver—Still likes gold as a long-term investment and recommends dollar cost averaging every month regardless of the price. However, when it comes to silver, Faber is more cautious, noting the recent run-up in the price. He expects a 20%+ correction in the metals complex because the inflation trade has become too crowded.
3. Commodities–Dr Copper is issuing a warning to investors. While the S&P 500 has made a new high, copper failed to do so (non-confirmation). This is a significant development because Dr Copper and the SP 500 have a very high correlation. This signal, along with the large declines in other commodities such as sugar and cotton, leads Faber to believe that stocks could follow commodities lower (in the short-term)
4. Buy Housing–While Faber thinks the US housing market has another 10% to fall, he would be a buyer because of attractive valuations. Faber compares the price of US housing to gold and concludes that housing has not been this cheap since the early 1980′s. But do not think there will be a quick recovery–there won’t be. The main point about housing is that it is a good inflation hedge and will likely keep its purchasing power of the next 10 years. In a serious inflation environment, Faber would rather own housing than paper dollars.
5. More QE Guaranteed–In Faber’s opinion, QE 3 is a near certainty. The US will be running trillion dollar budget deficits for the next 10 years. There is no way they can finance all of this through bond issuance. The Fed will have to at least partially monetize this to keep interest rates low.
Monday, July 18, 2011
Financial Sense Newshour
In the deflationist scenario, you don’t want to be in US govt. bonds & cash. In that scenario, the fiscal deficit would deteriorate greatly. If the Dow went below 1000, we would be in a total economic collapse where tax revenues would fall off a cliff. So even in the deflationist scenario you don’t want to be in the long end of the government bond market.
In the 50s and 60s, people were more free. Now, we have police states in the West, where restrictions are rather onerous. Also, back in the 50s & 60s, the Bretton Woods System restricted the potential for severe inflation.
‘What is money?’ is a big question. Generally speaking, it’s a medium of exchange, a store of value and a unit of account. Gold is a much better store of value than the dollar. As a unit of account, the dollar is poor. Has the US really been growing at 3% per annum?
The standard of living for the average US household has gone down over the past 20 years. Relative to the rest of the World, the peak of US prosperity occurred in the 1950s. It’s very difficult to measure economic growth and prosperity.
The Emerging Markets used to be way behind the US. Now, the infrastructure in the Emerging Markets is way better than in the US. The US have grossly underinvested in infrastructure.
The US has survived on the continued expansion of borrowing to offset declining income in real terms. Now the power to borrow is gone.
Europeans & Americans are generally complaining about onerous regulations.
On the one hand you have money printing & expansionary fiscal policies. On the other, you have more and more regulation. The small businessman, who can’t employ an army of lawyers and accountants have no appetite to hire. They say that the more tax they pay, the more the government will harass them!
In Asia, there exists the opposite scenario: There is relative economic freedom insofar as you don’t criticise the government. A great quality of the US is that you can pretty much say what you want.
The likelihood of a hyperinflation has increased. If you go back to Jan 2011, would you have thought that the Middle East would blow up as it has? Would you have thought that the NATO countries would go to war against an idiot in Libya? He’s just one of many idiots, if you go after a country like Libya, you may as well go against 180 countries in the world!
The Western press is focussed on how to ‘contain’ China. One way is to control oil in the middle east; for then they can switch on the tap, or close it. The Allies have gone to the Middle East to attempt to gain control of the Oil. But this costs a lot! They’re not in a position to finance the war unless they print money. So we’re likely to see higher inflation.
Bernanke has some knowledge about economic contraction & expansion in a closed system. But he has no clue about the international system!
The more the US will print money, the more the dollar will depreciate against gold, silver, platinum & palladium.
Bernanke is a typical academic. He knows about everything in theory, but no clue about the real world.
A bubble occurs after several years of price increases. At the tail end of the trend, you get an annual appreciation that almost goes vertically. This hasn’t happened in the gold market.
Most people have sold their gold according to Marc Faber’s feedback from his subscribers at gloomboomdoom.com
Marc Faber was at a popular resource conference recently. He asked how many people had more than 5% invested in gold and only about 5 in 400 raised their hands!
If Marc Faber had to have one asset over the next 10 years, he would own gold (for maintenance of purchasing power) or equities (for profits).
It’s important to diversify your assets geographically. Political changes can completely wipe you out if you keep it all in one country.
It’s extremely difficult to get a bank account overseas if you’re an American. Officially there is a free foreign exchange market, but unofficially there are foreign exchange controls.
Easy monetary policies create greed & bubbles. One of the symptoms is fraud & embezzlement. Fannie Mae & Freddie Mac were frauds.
Money Printing in the US has produced bubbles elsewhere in the world.
Do what the Jews do! Marc Faber’s jewish friends have lots of gold and silver. Marc Faber has around 20% in gold & silver & mining stocks.
All this being said, we should note that a correction can occur!!!
In the previous gold bubble, everyone watched gold all day and all night! We don’t have a heavy euphoria yet.
America is a great place with great people. It’s only the Government that’s awful!
In the 50s and 60s, people were more free. Now, we have police states in the West, where restrictions are rather onerous. Also, back in the 50s & 60s, the Bretton Woods System restricted the potential for severe inflation.
‘What is money?’ is a big question. Generally speaking, it’s a medium of exchange, a store of value and a unit of account. Gold is a much better store of value than the dollar. As a unit of account, the dollar is poor. Has the US really been growing at 3% per annum?
The standard of living for the average US household has gone down over the past 20 years. Relative to the rest of the World, the peak of US prosperity occurred in the 1950s. It’s very difficult to measure economic growth and prosperity.
The Emerging Markets used to be way behind the US. Now, the infrastructure in the Emerging Markets is way better than in the US. The US have grossly underinvested in infrastructure.
The US has survived on the continued expansion of borrowing to offset declining income in real terms. Now the power to borrow is gone.
Europeans & Americans are generally complaining about onerous regulations.
On the one hand you have money printing & expansionary fiscal policies. On the other, you have more and more regulation. The small businessman, who can’t employ an army of lawyers and accountants have no appetite to hire. They say that the more tax they pay, the more the government will harass them!
In Asia, there exists the opposite scenario: There is relative economic freedom insofar as you don’t criticise the government. A great quality of the US is that you can pretty much say what you want.
The likelihood of a hyperinflation has increased. If you go back to Jan 2011, would you have thought that the Middle East would blow up as it has? Would you have thought that the NATO countries would go to war against an idiot in Libya? He’s just one of many idiots, if you go after a country like Libya, you may as well go against 180 countries in the world!
The Western press is focussed on how to ‘contain’ China. One way is to control oil in the middle east; for then they can switch on the tap, or close it. The Allies have gone to the Middle East to attempt to gain control of the Oil. But this costs a lot! They’re not in a position to finance the war unless they print money. So we’re likely to see higher inflation.
Bernanke has some knowledge about economic contraction & expansion in a closed system. But he has no clue about the international system!
The more the US will print money, the more the dollar will depreciate against gold, silver, platinum & palladium.
Bernanke is a typical academic. He knows about everything in theory, but no clue about the real world.
A bubble occurs after several years of price increases. At the tail end of the trend, you get an annual appreciation that almost goes vertically. This hasn’t happened in the gold market.
Most people have sold their gold according to Marc Faber’s feedback from his subscribers at gloomboomdoom.com
Marc Faber was at a popular resource conference recently. He asked how many people had more than 5% invested in gold and only about 5 in 400 raised their hands!
If Marc Faber had to have one asset over the next 10 years, he would own gold (for maintenance of purchasing power) or equities (for profits).
It’s important to diversify your assets geographically. Political changes can completely wipe you out if you keep it all in one country.
It’s extremely difficult to get a bank account overseas if you’re an American. Officially there is a free foreign exchange market, but unofficially there are foreign exchange controls.
Easy monetary policies create greed & bubbles. One of the symptoms is fraud & embezzlement. Fannie Mae & Freddie Mac were frauds.
Money Printing in the US has produced bubbles elsewhere in the world.
Do what the Jews do! Marc Faber’s jewish friends have lots of gold and silver. Marc Faber has around 20% in gold & silver & mining stocks.
All this being said, we should note that a correction can occur!!!
In the previous gold bubble, everyone watched gold all day and all night! We don’t have a heavy euphoria yet.
America is a great place with great people. It’s only the Government that’s awful!
Friday, July 15, 2011
Marc Faber again, I started to get crazy about Marc again.
The Daily Bell is pleased to present an exclusive interview with Dr. Marc Faber.
Introduction: Dr. Marc Faber was born in Zurich, Switzerland. He went to school in Geneva and Zurich and finished high school with the Matura. He studied Economics at the University of Zurich and, at the age of 24, obtained a Ph.D in Economics magna cum laude. Between 1970 and 1978, Dr. Faber worked for White Weld & Company Limited in New York, Zurich and Hong Kong. Since 1973, he has lived in Hong Kong. From 1978 to February 1990, he was the Managing Director of Drexel Burnham Lambert (HK) Ltd. In June 1990, he set up his own business, MARC FABER LIMITED, which acts as an investment advisor, fund manager and broker/dealer. Dr. Faber publishes a widely read monthly investment newsletter THE GLOOM, BOOM & DOOM report which highlights unusual investment opportunities. A regular speaker at various investment seminars, Dr. Faber is well known for his "contrarian" investment approach. He is also associated with a variety of funds.
Daily Bell: Thank you for sitting down with us today. Please give us some background. Where were you born? Where did you grow up?
Marc Faber: I grew up in Geneva and Zurich.
Daily Bell: You obtained, at the age of 24, a Ph.D. degree in Economics, magna cum laude. What drove you to accomplish such a feat?
Marc Faber: Well, I passed all my classes not because I was particularly bright but because you have to study what is most important to the work you are interested in doing. I also studied economics, and in those days you didn't have to study more than four years, so I was able to finish relatively early.
Daily Bell: For a while, you worked for the famous White Weld & Company Limited that caused the paper crunch.
Marc Faber: I started with White Weld in 1970 and then in 1978 they were taken over by Merrill Lynch and then I worked for Drexel Burnham.
Daily Bell: You worked in New York City, Zürich and Hong Kong. What was that like?
Marc Faber: In the early 70s, New York was the leading financial center. When I moved to Asia in 1973, Asia was still very poor. Countries like Taiwan, South Korea and Singapore had very poor infrastructure and were still essentially run by "Dictators.". I felt, based on the experience and the rise of Japan in the 50s and 60s, that other countries in Asia were going to grow very rapidly, so I stayed on, mostly in Hong Kong and throughout Asia.
Daily Bell: You moved to Hong Kong in 1973, and became a managing director at Drexel Burnham Lambert Ltd. Hong Kong. You were there throughout. Did Drexel get a bad rap? What about Mike Milken? What do you think of Drexel these days?
Marc Faber: Well I think Mike Milken was a financial genius. I have great admiration for him and his ability to work under enormous pressure. At the end, he had lawsuits, he was defending himself; Drexel Burnham had lawsuits and he was still trading bonds every day. He had unusual abilities to function under very heavy pressure but, obviously, the firm and his department did a few things that were not entirely above the board. I wouldn't think, when looking at what has happened in the last few years, he deserved to go to jail. There are many people that committed far larger financial fraud, or at least contributed to irregularities, that have never gone to jail in the last few years or up to this day. The penalty was disproportionate.
Daily Bell: In 1990 you set up your own business, Marc Faber Limited, now in Thailand. Why there?
Marc Faber: I moved to Thailand in 2000. I still keep an office in Hong Kong.
Daily Bell: Who gave you the title "Doctor Doom?"
Marc Faber: Well, I had predicted the 1987 crash and then it happened and then I was predicting in '88 and '89, the crash of Japan. The first person who gave me the name was Nury Vittachi. He was a journalist at the South China Post and an author of several books; he also had a very popular column in the Post, called "Lai See."
Daily Bell: A book written by Nury Vittachi was entitled Doctor Doom - Riding the Millennial Storm - Marc Faber's Path to Profit in the Financial Crisis. Do you still work with Vittachi? What was the book about?
Marc Faber: The book is a personal account of my life in Hong Kong in the 1980's, but I believe it was published in the early '90's.
Daily Bell: Your company, Marc Faber Limited, acts as an investment advisor, concentrating on value investments. Are there lots of value investments today? Would you elaborate on your investing philosophy?
Marc Faber: Well I think when we talk about value, there is value in the purchase of certain assets if they are depressed and neglected. I also suppose there is value in selling short if assets are way above what I would call an equilibrium price or way above the trend line price. So, value can be interpreted in many different ways. You cannot be too rigid. I don't think there is a clear-cut definition of what value is and each analyst has to decide for himself where he finds value.
In general, value will emerge when things look bad for a corporation or a country or an industry, because market prices will fluctuate more than the fundamentals. In other words, if you look at the price of gold and you look at gold shares, the gold shares will be more volatile than the gold price. Or look at the price of real estate; the price of real-estate related companies will overshoot and undershoot. Some unusual opportunities eventually arise, either on the short or on the long side.
Daily Bell: You also act as a fund manager to private wealthy clients. What do you recommend to them? Why do they come to you?
Marc Faber: The clients I have now, I have had for 20 years. I haven't taken new clients for 12 years. They come to me because they recognize that I have a slightly different investment strategy than most portfolio managers or funds managers. They are remunerated according to whether they beat the index or not. So, if the index is up 20% and the fund manager is up 22%, he's done a good job. Or if the index is down 30% and he's down only 29%, he's done a good job. My clients are different. They want to see a return every year, even if the return is modest.
Daily Bell: Your current – if eccentric – tag-line is: "buy a $100 US bond and frame it to teach your children about inflation by watching the US bond value diminish to almost nothing over the next 20 years." Why are you negative about US Treasuries?
Marc Faber: We have to distinguish the short term and the long term. I think about two months ago, I turned quite positive for US Treasuries. But obviously long term, at less than 3% yield on a ten year US Treasury, I don't see any value. I think that interest rates in time will be much higher because the fiscal deficit will stay very elevated or even increase and that will impair the ability of the government to pay the interest. If the ability to pay the interest is impaired, there's only one way out and that is for them to print money, and so eventually you will get higher interest rates.
Daily Bell: What caused the crash of 1987? Was it caused by a currency agreement between the Reagan White House and Japan? Please tell us about that.
Marc Faber: Well I am not sure what caused the crash but the market started to go down in August '87. The market had become immensely over bought and there was a lot of speculation and investor sentiment played on one side – the bullish side. So I think a correction was easy to predict and that the crash would happen. As I said, it was an accidental thing, but I had predicted it and then it happened one week later. In other cases, like the NASDAQ or the Japanese market crash, it took longer.
Daily Bell: You predicted the rise of oil, precious metals, other commodities, emerging markets and especially China in your book Tomorrow's Gold: Asia's Age of Discovery. How did you know?
Marc Faber: Basically, commodities move in long-term cycles and they had peaked out in 1980. After 1980, they had been in a downtrend, including oil and industrial commodities. When the incremental demand from China kicked in, it was an easy call to say, "eventually commodities will go up," given a 20-year bear market and they were extremely inexpensive compared to NASDAQ stocks.
Daily Bell: You also correctly predicted the slide of the U.S. dollar since 2002.
Marc Faber: The US has essentially one advantage and that is they issue their governments debt in US dollars. In other words, they have no mismatch of assets and liabilities. So, that's imperative to printing money. When you read the notes and the speeches from Mr. Bernanke, it's very clear that he would rather take the weaker dollar, than to have domestic style deflation. So, I think that there are several factors that point to a declining dollar, but I have to say the other currencies are not much better. I would also say the purchasing power of the Euro has gone down, along with the purchasing power of the Swiss franc, which has also dropped when we measure what kind of basket of goods we can buy in Switzerland today compared to 10 years ago.
Daily Bell: You said at one point there were no value investments left except for farmland and real estate in some emerging markets. Do you still believe this?
Marc Faber: I think that I was lucky because I kind of predicted the 2008 financial crisis; it took a while until it happened and I was worried about it for a number of years. If someone today would receive a billion dollars, it will be quite difficult to make a lot of money in the next 10 years. I am not saying if he puts the whole billion in gold, maybe gold will go up or if he puts the whole billion in silver, silver will go up. It would be quite risky for an investor to put the billion in one asset. Even if he diversifies, I don't think he will make a lot of money.
I think we had the collapse of the financial system in 2008; the failed institutions and failed system were bailed out by government. Ultimately governments will fail. The US and Europe will print money, and when everything fails, they'll go to war and then we have the complete collapse.
Daily Bell: You said in 2007 there was going to be a crash, but you also said US equities were only moderately overvalued. Would you tell us more about that?
Marc Faber: The market based on price earnings was not incredibly over valued. What concerned me was the over-valuation in real estate and in financial stocks. The overall market wasn't selling at 80 times earnings, like Japan in '89 or the NASDAQ in March 2000. From that point of view, there wasn't a tremendous over-valuation. What was happening in 2008 was that there was an earnings collapse in the financial sector.
The financial sector accounted at the peak in 2007 for over 40% of S&P earnings and obviously the S&P earnings collapsed. 2008 was not really a financial crisis and we have come out of it. In 2007, there wasn't a huge over-valuation, but there was a concentration of money in the financial sector.
Daily Bell: Do you still expect hyperinflation?
Marc Faber: In my view, the debt level, especially in the US, if we include the unfunded liabilities of Medicare, Medicaid, Social Security and these entitlement programs, is beyond repair. And this will necessitate printing more money. Also, in my view, there is no real political will to address the issues, because who ever would cut entitlements, will not be re-elected. So we have a tyranny of the masses.
Daily Bell: Did you miss the stock market rally of the last two years?
Marc Faber: No, as I said, I felt positive in March 2009. Starting about a year ago, I became more cautious. Since February of this year, I am kind of concerned that the market is building something more significant than just a short downturn correction. This is a distribution phase and for the market to make a new high, above the recent high, will be difficult.
Daily Bell: What has been your position on gold and silver? Do you expect the purchasing power of either or both to go higher?
Marc Faber: Well I basically focus more on gold than silver, although I am on the board of a company, Sprott Inc., that is identified with a very bullish view of silver. I prefer gold. My view is, yes, I have been positive for gold for the past 10 or 12 years and I could make a case that gold today is cheaper than it was in 1999 when it was at $252. Cheaper in the sense that if I compare gold to international reserves or to the increase in the credit markets in the world, I don't think it's expensive. And yes, I think it will go higher or, expressed differently, that paper currencies will go lower against the value of gold. But this will be an irregular process, and along with this move into US Treasuries and away from risky assets, I wouldn't be surprised if the price of gold went down $200. It's not necessarily a prediction, it just wouldn't surprise me.
Daily Bell: Tell us about your report. Why you named it what you did and how people can get it.
Marc Faber: I have two reports, the written, printed report called the Gloom, Boom and Doom report, which is relatively detailed and focuses on monetary issues. Then I have a website report which is sent out by email and people can inquire about it on the website, www.gloomboomdoom.com.
Daily Bell: Here is a famous quote: "The federal government is sending each of us a $600 rebate. If we spend that money at Wal-Mart, the money goes to China. If we spend it on gasoline it goes to the Arabs. If we buy a computer it will go to India. If we purchase fruit and vegetables it will go to Mexico, Honduras and Guatemala. If we purchase a good car it will go to Germany. If we purchase useless crap it will go to Taiwan and none of it will help the American economy. The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in US. I've been doing my part." Is this really true?
Marc Faber: Well, actually beer is now mostly owned by foreign companies. In reality, America still has a very large manufacturing base and we shouldn't underestimate that; there are some very good companies in America. At the moment, it's meant as a joke. But it is true that the problem of America is consumerism. By encouraging this leverage on the consumer level, particularly in the housing market and on credit cards, which is the worst, America has lent to a consumer economy and an economy that doesn't spend enough on investment.
Investments are infrastructure expenditures. They are expenditures for education, research and development, and plants and equipment. A lot of money has been channeled into wasteful government administrations. The smaller a government is, the more dynamic the economy will be and the larger the government is, the more stagnant the economy will become.
There are exceptions to this rule. The Nordic countries of Norway, Sweden, Finland and Denmark, have very large governments but I suppose in small countries, you can run the country like a country club where people essentially develop solidarity and say OK, we pay high taxes – but we have very good health care; OK, we pay high taxes but we have very good schools for our children. So let's say in Norway and Finland you don't need to send your children to private schools, but in America it would be difficult to send your children to government schools because essentially they are inefficient.
Daily Bell: You serve as director or advisor of a number of investment funds that focus on emerging and frontier markets, including Leopard Capital's Leopard Cambodia Fund and Leopard Sri Lanka Fund. You seem to believe a lot in emerging markets. True?
Marc Faber: Yes. I think the world is in a gigantic transition. The growth will be in new economies, countries like India and China. This trend I think, will be with us for a very long time. It will be a contributing factor to geopolitical tensions because obviously the West will not be very happy to see its super power status diminish relative to the rest of the world.
Daily Bell: Would you say you are an Austrian when it comes to economics?
Marc Faber: Yes, but I think we can't be overly dogmatic in economics because certain things may work for one system and other things may not work in another system and so forth. Economics is a very complex system and is essentially human life and the behavior of humans. So to build one theory around it is probably wrong. Sure I am leaning more to the Austrian school, particularly when it comes to debt cycles. But I have sympathy for the Keynesian approach if, and this is a big question, IF it is implemented properly.
In other words, the business cycles will lead to excursions of prosperity and during these excursions into prosperity the system should build up reserves. Then when the excursion in depressions occurs below the trend line, use these reserves. But the problem with Keynesian economics has been that in the excursions into depression the reserves were always used but were never accumulated in the periods of prosperity, and so you build up larger and larger government debt and print more money; that is the problem. It's the problem of democracy.
Daily Bell: What do you think of Ludwig von Mises?
Marc Faber: I have a high regard for all the Austrian economists, but I also have a high regard for other economists. They made many contributions to the understanding of economics. I have little understanding when it comes to Ben Bernanke because he disregards the entire importance of credit and is obsessive about credit growth. Also Alan Greenspan, I mean, credit expanded much more rapidly in the past 30 years. This is not sustainable. Maybe for 10 years, but not in the long run. That they completely disregard the danger of leverage will always remain a mystery to me.
Daily Bell: Is there a cartel of wealthy banking families that runs the world? Are they located in the City of London? Do they by any chance seek one world government?
Marc Faber: I don't know. I think there are some very important banking dynasties for sure. People sometimes refer to them as the Rothschilds and that they have benefitted from wars – so I am not sure I would want a one-world government. When I compare my life today to the life I had in the 50s and 60s, we have much less freedom. Everything is regulated as the governments have become like a cancer; they keep expanding and regulating and dictating everything. In my opinion, this creates not a very favorable environment in the Western world.
Daily Bell: Is the EU going to collapse? Just the euro?
Marc Faber: This is a political question and it will depend on the political will. The euro in my opinion will weaken against the US dollar in the next couple of months and along with the dollar it will weaken against the price of gold in the long run.
Daily Bell: Is the dollar finished as the world's reserve currency?
Marc Faber: It's not finished as the world's reserve currency; it will continue to exist for a while. But obviously there will be competition and there will be currencies people trust more than the US dollar. I think the US dollar has lost prestige. When I think of the 50s or 60s, the US dollar was worth a lot of money and people trusted the US dollar and also the United States. At that time, it was by far the leading economy in the world; that prestige will continue to be eroded.
Daily Bell: What will take its place?
Marc Faber: That I don't know, but I think in Asia we will have currencies that will be important. I don't think we can have united currencies the way we have the Euro because there are numerous political disagreements from the expansion of the influence of China. Obviously, the Chinese currency will be an important currency in Asia.
Daily Bell: Do you have any thoughts on Real Bills? How about free banking?
Marc Faber: I think the idea that you have different banks issuing their own currencies is not a bad idea. The bank that has a very conservative balance sheet will have a strong paper currency and the ones with a weak balance sheet will have a weak currency. There is some merit between having competition this way, and we have that with currency issued by different governments. Some are more desirable than others, like Canadian dollars, Australian dollars, the Swiss Franc ... but that hasn't always been the case. In the US, because of the political process, I have my reservations, I think it's already too late.
Daily Bell: Are you hopeful about the world's economic future in the long term?
Marc Faber: I suppose the world will always develop but that we will always have periods where we have wars and tremendous wealth destruction, or where we have plague and where the population shrinks. I am optimistic about certain issues and pessimistic about others.
Daily Bell: What are you working on now?
Marc Faber: Every month I am writing my report, so I am always working on something. But I am not working on anything new or writing any books because I don't have the time. I will again in the future.
Daily Bell: Thank you for your time and a very interesting interview.
Daily Bell After Thoughts
This was a lot of fun. You have to read the interview closely, but if you do, you may start to sense a kind of musical quality in the way Dr. Marc Faber responds. Ask him a question and you get back free-form jazz riff, complete with prices, dates and macro- and micro-elaborations.
To be Dr. Marc. Faber is to have a head that is constantly processing data, comparing it to other data and putting it into a larger context. You can hear it if you listen. He's like Charlie Parker – "The Bird" – the great alto-saxophone composer. Ask Marc Faber a question and the answer just pours out of him. He may have an eidetic memory – remembering virtually everything about every day, at least as it relates to finance. He sure remembers a lot, specific prices, etc.
Interviewing him, one is reminded again that there are few accidents when it comes to achievement over time. People who have success, especially when it comes to investing, are usually pretty smart. That's not say there aren't plenty of fund managers who ride the market up and then all the way back down, but Faber has been doing what he does for decades and is still in business. He hasn't had the crutch of a big financial firm to support him. For the most part, he's done it on his own.
We found several quotes of his to be most thought provoking. The first one was this: "We had the collapse of the financial system in 2008; the failed institutions and failed system were bailed out by government. Ultimately governments will fail. The US and Europe will print money, and when everything fails, they'll go to war and then we have the complete collapse."
We surely agree!. We've written over and over that the dollar-reserve financial system basically died in 2008. The Federal Reserve and other central banks have by now apparently handed out tens of trillions in low-interest loans and outright "investments."
In fact, we've estimated that this financial "crisis" will eventually result in an aggregate of US$100 trillion being injected into the West's "free-market" economies by central banks and fiscally, too, before this current episode of fiat money insanity trickles to a close. Invest US$100 trillion into ANYTHING and you are basically re-setting the system, whatever it may be. You are showing, by your actions, that it doesn't exist anymore.
The ramifications are endless. Europe is collapsing. UK and America may be next. Unlike Dr. Faber, we expect China to collapse as well. Doesn't matter about the region or the cycle. China's financial system is Western – actually worse than Western. We don't believe you can trust a single Chinese number at this point. They're building empty cities and ghost highways throughout that vast country.
China is an inflationary accident ready to happen. We'll be surprised if the landing is soft. If it IS hard, like a bowling ball, it will knock down a lot of other economies as well. Europe is already teetering. America is on the brink. Japan is savaged. Imagine what a crash in China will do to Western economies.
If China does crash, or even if it doesn't, the US dollar reserve system is pretty much finished. Something else is in the air. Something else is destined to take its place. The "crisis" shows no sign of receding in our view; in fact, doubtless there will be more financial stimuli as time goes on. None of it will be any more effective than what has gone before.
The only solution, as Dr. Faber says (and as we regularly write), is war. And war is what we are starting to get. There will be more of it. Nothing else will suffice. The elites are desperate to retain their seat at the head of the table. Let chaos reign.
This brings us to the other quote we found interesting. Dr. Faber seems positive about John Maynard Keynes, a Fabian Socialist and Bloomsbury member who believed that the implementation of economic leveling was to take place via trickery in order to maintain the current system with its elite beneficences.
We differ. As believers in free-market thinking, we can't conceive that government interventions into the marketplace EVER result in anything good. In fact, this latest crisis shows once again that Keynes' approaches are basically bunkum. It is impossible for bureaucrats to save up currency in the "good" times to anticipate the bad ones. It's like asking a heroin addict to build up a stash in anticipation of scarcity. Won't happen.
But let us not quibble. We return to our fundamental observation that, like a great musician, Dr. Faber does what he does because he CAN – perhaps unconsciously. He makes market calls within a week of their occurrence. He turns a profit when others do not. He talks at one point about sensing where the market is headed. This is certain kind of talent. Investing as an art form.
It's interesting to listen to. Read between the lines and you may come to the conclusion as we did, that he's holding back in a few places. A smart guy. Success, no accident.
Reprinted with permission from The Daily Bell.
Introduction: Dr. Marc Faber was born in Zurich, Switzerland. He went to school in Geneva and Zurich and finished high school with the Matura. He studied Economics at the University of Zurich and, at the age of 24, obtained a Ph.D in Economics magna cum laude. Between 1970 and 1978, Dr. Faber worked for White Weld & Company Limited in New York, Zurich and Hong Kong. Since 1973, he has lived in Hong Kong. From 1978 to February 1990, he was the Managing Director of Drexel Burnham Lambert (HK) Ltd. In June 1990, he set up his own business, MARC FABER LIMITED, which acts as an investment advisor, fund manager and broker/dealer. Dr. Faber publishes a widely read monthly investment newsletter THE GLOOM, BOOM & DOOM report which highlights unusual investment opportunities. A regular speaker at various investment seminars, Dr. Faber is well known for his "contrarian" investment approach. He is also associated with a variety of funds.
Daily Bell: Thank you for sitting down with us today. Please give us some background. Where were you born? Where did you grow up?
Marc Faber: I grew up in Geneva and Zurich.
Daily Bell: You obtained, at the age of 24, a Ph.D. degree in Economics, magna cum laude. What drove you to accomplish such a feat?
Marc Faber: Well, I passed all my classes not because I was particularly bright but because you have to study what is most important to the work you are interested in doing. I also studied economics, and in those days you didn't have to study more than four years, so I was able to finish relatively early.
Daily Bell: For a while, you worked for the famous White Weld & Company Limited that caused the paper crunch.
Marc Faber: I started with White Weld in 1970 and then in 1978 they were taken over by Merrill Lynch and then I worked for Drexel Burnham.
Daily Bell: You worked in New York City, Zürich and Hong Kong. What was that like?
Marc Faber: In the early 70s, New York was the leading financial center. When I moved to Asia in 1973, Asia was still very poor. Countries like Taiwan, South Korea and Singapore had very poor infrastructure and were still essentially run by "Dictators.". I felt, based on the experience and the rise of Japan in the 50s and 60s, that other countries in Asia were going to grow very rapidly, so I stayed on, mostly in Hong Kong and throughout Asia.
Daily Bell: You moved to Hong Kong in 1973, and became a managing director at Drexel Burnham Lambert Ltd. Hong Kong. You were there throughout. Did Drexel get a bad rap? What about Mike Milken? What do you think of Drexel these days?
Marc Faber: Well I think Mike Milken was a financial genius. I have great admiration for him and his ability to work under enormous pressure. At the end, he had lawsuits, he was defending himself; Drexel Burnham had lawsuits and he was still trading bonds every day. He had unusual abilities to function under very heavy pressure but, obviously, the firm and his department did a few things that were not entirely above the board. I wouldn't think, when looking at what has happened in the last few years, he deserved to go to jail. There are many people that committed far larger financial fraud, or at least contributed to irregularities, that have never gone to jail in the last few years or up to this day. The penalty was disproportionate.
Daily Bell: In 1990 you set up your own business, Marc Faber Limited, now in Thailand. Why there?
Marc Faber: I moved to Thailand in 2000. I still keep an office in Hong Kong.
Daily Bell: Who gave you the title "Doctor Doom?"
Marc Faber: Well, I had predicted the 1987 crash and then it happened and then I was predicting in '88 and '89, the crash of Japan. The first person who gave me the name was Nury Vittachi. He was a journalist at the South China Post and an author of several books; he also had a very popular column in the Post, called "Lai See."
Daily Bell: A book written by Nury Vittachi was entitled Doctor Doom - Riding the Millennial Storm - Marc Faber's Path to Profit in the Financial Crisis. Do you still work with Vittachi? What was the book about?
Marc Faber: The book is a personal account of my life in Hong Kong in the 1980's, but I believe it was published in the early '90's.
Daily Bell: Your company, Marc Faber Limited, acts as an investment advisor, concentrating on value investments. Are there lots of value investments today? Would you elaborate on your investing philosophy?
Marc Faber: Well I think when we talk about value, there is value in the purchase of certain assets if they are depressed and neglected. I also suppose there is value in selling short if assets are way above what I would call an equilibrium price or way above the trend line price. So, value can be interpreted in many different ways. You cannot be too rigid. I don't think there is a clear-cut definition of what value is and each analyst has to decide for himself where he finds value.
In general, value will emerge when things look bad for a corporation or a country or an industry, because market prices will fluctuate more than the fundamentals. In other words, if you look at the price of gold and you look at gold shares, the gold shares will be more volatile than the gold price. Or look at the price of real estate; the price of real-estate related companies will overshoot and undershoot. Some unusual opportunities eventually arise, either on the short or on the long side.
Daily Bell: You also act as a fund manager to private wealthy clients. What do you recommend to them? Why do they come to you?
Marc Faber: The clients I have now, I have had for 20 years. I haven't taken new clients for 12 years. They come to me because they recognize that I have a slightly different investment strategy than most portfolio managers or funds managers. They are remunerated according to whether they beat the index or not. So, if the index is up 20% and the fund manager is up 22%, he's done a good job. Or if the index is down 30% and he's down only 29%, he's done a good job. My clients are different. They want to see a return every year, even if the return is modest.
Daily Bell: Your current – if eccentric – tag-line is: "buy a $100 US bond and frame it to teach your children about inflation by watching the US bond value diminish to almost nothing over the next 20 years." Why are you negative about US Treasuries?
Marc Faber: We have to distinguish the short term and the long term. I think about two months ago, I turned quite positive for US Treasuries. But obviously long term, at less than 3% yield on a ten year US Treasury, I don't see any value. I think that interest rates in time will be much higher because the fiscal deficit will stay very elevated or even increase and that will impair the ability of the government to pay the interest. If the ability to pay the interest is impaired, there's only one way out and that is for them to print money, and so eventually you will get higher interest rates.
Daily Bell: What caused the crash of 1987? Was it caused by a currency agreement between the Reagan White House and Japan? Please tell us about that.
Marc Faber: Well I am not sure what caused the crash but the market started to go down in August '87. The market had become immensely over bought and there was a lot of speculation and investor sentiment played on one side – the bullish side. So I think a correction was easy to predict and that the crash would happen. As I said, it was an accidental thing, but I had predicted it and then it happened one week later. In other cases, like the NASDAQ or the Japanese market crash, it took longer.
Daily Bell: You predicted the rise of oil, precious metals, other commodities, emerging markets and especially China in your book Tomorrow's Gold: Asia's Age of Discovery. How did you know?
Marc Faber: Basically, commodities move in long-term cycles and they had peaked out in 1980. After 1980, they had been in a downtrend, including oil and industrial commodities. When the incremental demand from China kicked in, it was an easy call to say, "eventually commodities will go up," given a 20-year bear market and they were extremely inexpensive compared to NASDAQ stocks.
Daily Bell: You also correctly predicted the slide of the U.S. dollar since 2002.
Marc Faber: The US has essentially one advantage and that is they issue their governments debt in US dollars. In other words, they have no mismatch of assets and liabilities. So, that's imperative to printing money. When you read the notes and the speeches from Mr. Bernanke, it's very clear that he would rather take the weaker dollar, than to have domestic style deflation. So, I think that there are several factors that point to a declining dollar, but I have to say the other currencies are not much better. I would also say the purchasing power of the Euro has gone down, along with the purchasing power of the Swiss franc, which has also dropped when we measure what kind of basket of goods we can buy in Switzerland today compared to 10 years ago.
Daily Bell: You said at one point there were no value investments left except for farmland and real estate in some emerging markets. Do you still believe this?
Marc Faber: I think that I was lucky because I kind of predicted the 2008 financial crisis; it took a while until it happened and I was worried about it for a number of years. If someone today would receive a billion dollars, it will be quite difficult to make a lot of money in the next 10 years. I am not saying if he puts the whole billion in gold, maybe gold will go up or if he puts the whole billion in silver, silver will go up. It would be quite risky for an investor to put the billion in one asset. Even if he diversifies, I don't think he will make a lot of money.
I think we had the collapse of the financial system in 2008; the failed institutions and failed system were bailed out by government. Ultimately governments will fail. The US and Europe will print money, and when everything fails, they'll go to war and then we have the complete collapse.
Daily Bell: You said in 2007 there was going to be a crash, but you also said US equities were only moderately overvalued. Would you tell us more about that?
Marc Faber: The market based on price earnings was not incredibly over valued. What concerned me was the over-valuation in real estate and in financial stocks. The overall market wasn't selling at 80 times earnings, like Japan in '89 or the NASDAQ in March 2000. From that point of view, there wasn't a tremendous over-valuation. What was happening in 2008 was that there was an earnings collapse in the financial sector.
The financial sector accounted at the peak in 2007 for over 40% of S&P earnings and obviously the S&P earnings collapsed. 2008 was not really a financial crisis and we have come out of it. In 2007, there wasn't a huge over-valuation, but there was a concentration of money in the financial sector.
Daily Bell: Do you still expect hyperinflation?
Marc Faber: In my view, the debt level, especially in the US, if we include the unfunded liabilities of Medicare, Medicaid, Social Security and these entitlement programs, is beyond repair. And this will necessitate printing more money. Also, in my view, there is no real political will to address the issues, because who ever would cut entitlements, will not be re-elected. So we have a tyranny of the masses.
Daily Bell: Did you miss the stock market rally of the last two years?
Marc Faber: No, as I said, I felt positive in March 2009. Starting about a year ago, I became more cautious. Since February of this year, I am kind of concerned that the market is building something more significant than just a short downturn correction. This is a distribution phase and for the market to make a new high, above the recent high, will be difficult.
Daily Bell: What has been your position on gold and silver? Do you expect the purchasing power of either or both to go higher?
Marc Faber: Well I basically focus more on gold than silver, although I am on the board of a company, Sprott Inc., that is identified with a very bullish view of silver. I prefer gold. My view is, yes, I have been positive for gold for the past 10 or 12 years and I could make a case that gold today is cheaper than it was in 1999 when it was at $252. Cheaper in the sense that if I compare gold to international reserves or to the increase in the credit markets in the world, I don't think it's expensive. And yes, I think it will go higher or, expressed differently, that paper currencies will go lower against the value of gold. But this will be an irregular process, and along with this move into US Treasuries and away from risky assets, I wouldn't be surprised if the price of gold went down $200. It's not necessarily a prediction, it just wouldn't surprise me.
Daily Bell: Tell us about your report. Why you named it what you did and how people can get it.
Marc Faber: I have two reports, the written, printed report called the Gloom, Boom and Doom report, which is relatively detailed and focuses on monetary issues. Then I have a website report which is sent out by email and people can inquire about it on the website, www.gloomboomdoom.com.
Daily Bell: Here is a famous quote: "The federal government is sending each of us a $600 rebate. If we spend that money at Wal-Mart, the money goes to China. If we spend it on gasoline it goes to the Arabs. If we buy a computer it will go to India. If we purchase fruit and vegetables it will go to Mexico, Honduras and Guatemala. If we purchase a good car it will go to Germany. If we purchase useless crap it will go to Taiwan and none of it will help the American economy. The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in US. I've been doing my part." Is this really true?
Marc Faber: Well, actually beer is now mostly owned by foreign companies. In reality, America still has a very large manufacturing base and we shouldn't underestimate that; there are some very good companies in America. At the moment, it's meant as a joke. But it is true that the problem of America is consumerism. By encouraging this leverage on the consumer level, particularly in the housing market and on credit cards, which is the worst, America has lent to a consumer economy and an economy that doesn't spend enough on investment.
Investments are infrastructure expenditures. They are expenditures for education, research and development, and plants and equipment. A lot of money has been channeled into wasteful government administrations. The smaller a government is, the more dynamic the economy will be and the larger the government is, the more stagnant the economy will become.
There are exceptions to this rule. The Nordic countries of Norway, Sweden, Finland and Denmark, have very large governments but I suppose in small countries, you can run the country like a country club where people essentially develop solidarity and say OK, we pay high taxes – but we have very good health care; OK, we pay high taxes but we have very good schools for our children. So let's say in Norway and Finland you don't need to send your children to private schools, but in America it would be difficult to send your children to government schools because essentially they are inefficient.
Daily Bell: You serve as director or advisor of a number of investment funds that focus on emerging and frontier markets, including Leopard Capital's Leopard Cambodia Fund and Leopard Sri Lanka Fund. You seem to believe a lot in emerging markets. True?
Marc Faber: Yes. I think the world is in a gigantic transition. The growth will be in new economies, countries like India and China. This trend I think, will be with us for a very long time. It will be a contributing factor to geopolitical tensions because obviously the West will not be very happy to see its super power status diminish relative to the rest of the world.
Daily Bell: Would you say you are an Austrian when it comes to economics?
Marc Faber: Yes, but I think we can't be overly dogmatic in economics because certain things may work for one system and other things may not work in another system and so forth. Economics is a very complex system and is essentially human life and the behavior of humans. So to build one theory around it is probably wrong. Sure I am leaning more to the Austrian school, particularly when it comes to debt cycles. But I have sympathy for the Keynesian approach if, and this is a big question, IF it is implemented properly.
In other words, the business cycles will lead to excursions of prosperity and during these excursions into prosperity the system should build up reserves. Then when the excursion in depressions occurs below the trend line, use these reserves. But the problem with Keynesian economics has been that in the excursions into depression the reserves were always used but were never accumulated in the periods of prosperity, and so you build up larger and larger government debt and print more money; that is the problem. It's the problem of democracy.
Daily Bell: What do you think of Ludwig von Mises?
Marc Faber: I have a high regard for all the Austrian economists, but I also have a high regard for other economists. They made many contributions to the understanding of economics. I have little understanding when it comes to Ben Bernanke because he disregards the entire importance of credit and is obsessive about credit growth. Also Alan Greenspan, I mean, credit expanded much more rapidly in the past 30 years. This is not sustainable. Maybe for 10 years, but not in the long run. That they completely disregard the danger of leverage will always remain a mystery to me.
Daily Bell: Is there a cartel of wealthy banking families that runs the world? Are they located in the City of London? Do they by any chance seek one world government?
Marc Faber: I don't know. I think there are some very important banking dynasties for sure. People sometimes refer to them as the Rothschilds and that they have benefitted from wars – so I am not sure I would want a one-world government. When I compare my life today to the life I had in the 50s and 60s, we have much less freedom. Everything is regulated as the governments have become like a cancer; they keep expanding and regulating and dictating everything. In my opinion, this creates not a very favorable environment in the Western world.
Daily Bell: Is the EU going to collapse? Just the euro?
Marc Faber: This is a political question and it will depend on the political will. The euro in my opinion will weaken against the US dollar in the next couple of months and along with the dollar it will weaken against the price of gold in the long run.
Daily Bell: Is the dollar finished as the world's reserve currency?
Marc Faber: It's not finished as the world's reserve currency; it will continue to exist for a while. But obviously there will be competition and there will be currencies people trust more than the US dollar. I think the US dollar has lost prestige. When I think of the 50s or 60s, the US dollar was worth a lot of money and people trusted the US dollar and also the United States. At that time, it was by far the leading economy in the world; that prestige will continue to be eroded.
Daily Bell: What will take its place?
Marc Faber: That I don't know, but I think in Asia we will have currencies that will be important. I don't think we can have united currencies the way we have the Euro because there are numerous political disagreements from the expansion of the influence of China. Obviously, the Chinese currency will be an important currency in Asia.
Daily Bell: Do you have any thoughts on Real Bills? How about free banking?
Marc Faber: I think the idea that you have different banks issuing their own currencies is not a bad idea. The bank that has a very conservative balance sheet will have a strong paper currency and the ones with a weak balance sheet will have a weak currency. There is some merit between having competition this way, and we have that with currency issued by different governments. Some are more desirable than others, like Canadian dollars, Australian dollars, the Swiss Franc ... but that hasn't always been the case. In the US, because of the political process, I have my reservations, I think it's already too late.
Daily Bell: Are you hopeful about the world's economic future in the long term?
Marc Faber: I suppose the world will always develop but that we will always have periods where we have wars and tremendous wealth destruction, or where we have plague and where the population shrinks. I am optimistic about certain issues and pessimistic about others.
Daily Bell: What are you working on now?
Marc Faber: Every month I am writing my report, so I am always working on something. But I am not working on anything new or writing any books because I don't have the time. I will again in the future.
Daily Bell: Thank you for your time and a very interesting interview.
Daily Bell After Thoughts
This was a lot of fun. You have to read the interview closely, but if you do, you may start to sense a kind of musical quality in the way Dr. Marc Faber responds. Ask him a question and you get back free-form jazz riff, complete with prices, dates and macro- and micro-elaborations.
To be Dr. Marc. Faber is to have a head that is constantly processing data, comparing it to other data and putting it into a larger context. You can hear it if you listen. He's like Charlie Parker – "The Bird" – the great alto-saxophone composer. Ask Marc Faber a question and the answer just pours out of him. He may have an eidetic memory – remembering virtually everything about every day, at least as it relates to finance. He sure remembers a lot, specific prices, etc.
Interviewing him, one is reminded again that there are few accidents when it comes to achievement over time. People who have success, especially when it comes to investing, are usually pretty smart. That's not say there aren't plenty of fund managers who ride the market up and then all the way back down, but Faber has been doing what he does for decades and is still in business. He hasn't had the crutch of a big financial firm to support him. For the most part, he's done it on his own.
We found several quotes of his to be most thought provoking. The first one was this: "We had the collapse of the financial system in 2008; the failed institutions and failed system were bailed out by government. Ultimately governments will fail. The US and Europe will print money, and when everything fails, they'll go to war and then we have the complete collapse."
We surely agree!. We've written over and over that the dollar-reserve financial system basically died in 2008. The Federal Reserve and other central banks have by now apparently handed out tens of trillions in low-interest loans and outright "investments."
In fact, we've estimated that this financial "crisis" will eventually result in an aggregate of US$100 trillion being injected into the West's "free-market" economies by central banks and fiscally, too, before this current episode of fiat money insanity trickles to a close. Invest US$100 trillion into ANYTHING and you are basically re-setting the system, whatever it may be. You are showing, by your actions, that it doesn't exist anymore.
The ramifications are endless. Europe is collapsing. UK and America may be next. Unlike Dr. Faber, we expect China to collapse as well. Doesn't matter about the region or the cycle. China's financial system is Western – actually worse than Western. We don't believe you can trust a single Chinese number at this point. They're building empty cities and ghost highways throughout that vast country.
China is an inflationary accident ready to happen. We'll be surprised if the landing is soft. If it IS hard, like a bowling ball, it will knock down a lot of other economies as well. Europe is already teetering. America is on the brink. Japan is savaged. Imagine what a crash in China will do to Western economies.
If China does crash, or even if it doesn't, the US dollar reserve system is pretty much finished. Something else is in the air. Something else is destined to take its place. The "crisis" shows no sign of receding in our view; in fact, doubtless there will be more financial stimuli as time goes on. None of it will be any more effective than what has gone before.
The only solution, as Dr. Faber says (and as we regularly write), is war. And war is what we are starting to get. There will be more of it. Nothing else will suffice. The elites are desperate to retain their seat at the head of the table. Let chaos reign.
This brings us to the other quote we found interesting. Dr. Faber seems positive about John Maynard Keynes, a Fabian Socialist and Bloomsbury member who believed that the implementation of economic leveling was to take place via trickery in order to maintain the current system with its elite beneficences.
We differ. As believers in free-market thinking, we can't conceive that government interventions into the marketplace EVER result in anything good. In fact, this latest crisis shows once again that Keynes' approaches are basically bunkum. It is impossible for bureaucrats to save up currency in the "good" times to anticipate the bad ones. It's like asking a heroin addict to build up a stash in anticipation of scarcity. Won't happen.
But let us not quibble. We return to our fundamental observation that, like a great musician, Dr. Faber does what he does because he CAN – perhaps unconsciously. He makes market calls within a week of their occurrence. He turns a profit when others do not. He talks at one point about sensing where the market is headed. This is certain kind of talent. Investing as an art form.
It's interesting to listen to. Read between the lines and you may come to the conclusion as we did, that he's holding back in a few places. A smart guy. Success, no accident.
Reprinted with permission from The Daily Bell.
Thursday, July 14, 2011
Buying US Debt 'Mind Boggling"
It is mind boggling that people would consider buying 10-year U.S. Treasurys with yields trading at around 3 percent, said Marc Faber, the author of the closely-watched Gloom, Boom and Doom report in an interview with CNBC on Thursday.
“I don’t think the U.S. will default in terms of not paying the interest on its debt. They will though default via a falling dollar [.DXY 75.26 0.05 (+0.07%) ] as Bernanke begins printing more money,” Faber said.
His comments follow statements by Ben Bernanke on Wednesday in which the Federal Reserve chairman indicated he would consider more extraordinary measures if U.S. economic conditions get worse.
On Wednesday, Moody’s [MCO 36.28 -0.37 (-1.01%) ] warned it could downgrade America’s credit rating as talks over the debt ceiling became increasingly acrimonious on Capitol Hill.
“They will get an agreement or fiddle around with the debt ceiling,” Faber said.
“I disagree with the bond bulls that are basing their case on a deflationary environment. In such an outcome tax revenues would collapse and stocks would fall heavily.”
Faber predicted that 1,370 was the high for the S&P 500 index in 2011 and told CNBC that if stocks fall another 10 percent or 20 percent from here, another round of quantitative easing is inevitable.
“The risk is not to hold gold. Whilst there is the potential for 10 percent downside in the short term over the next five to ten years the gains will be big. Or put another way, the purchasing power of paper money will fall," Faber said.
“Cash is very risky asset except in times of major market corrections,” he added
“I don’t think the U.S. will default in terms of not paying the interest on its debt. They will though default via a falling dollar [.DXY 75.26 0.05 (+0.07%) ] as Bernanke begins printing more money,” Faber said.
His comments follow statements by Ben Bernanke on Wednesday in which the Federal Reserve chairman indicated he would consider more extraordinary measures if U.S. economic conditions get worse.
On Wednesday, Moody’s [MCO 36.28 -0.37 (-1.01%) ] warned it could downgrade America’s credit rating as talks over the debt ceiling became increasingly acrimonious on Capitol Hill.
“They will get an agreement or fiddle around with the debt ceiling,” Faber said.
“I disagree with the bond bulls that are basing their case on a deflationary environment. In such an outcome tax revenues would collapse and stocks would fall heavily.”
Faber predicted that 1,370 was the high for the S&P 500 index in 2011 and told CNBC that if stocks fall another 10 percent or 20 percent from here, another round of quantitative easing is inevitable.
“The risk is not to hold gold. Whilst there is the potential for 10 percent downside in the short term over the next five to ten years the gains will be big. Or put another way, the purchasing power of paper money will fall," Faber said.
“Cash is very risky asset except in times of major market corrections,” he added
Monday, July 11, 2011
Horror Story
The economy burns while Washington fiddles—and what our chosen representatives and the administration are fiddling with is not the great American job machine, which, as June's downright putrid employment report demonstrated beyond cavil, badly needs cranking up. Instead, they are laboring unstintingly on how to plug the deficit gap by such smarmy tactics as changing the way inflation is reckoned to make it easier to stick it to the geezers.
Social Security and vets' disability payments are tied to the cost of living, and, in their infinite wisdom, the politicos have concluded that the current gauge overstates inflation. No less an authority—and we can't think of any less an authority—than Oklahoma Republican Sen. Tom Coburn is quoted by Bloomberg as saying: "There hasn't been any economist anywhere that says we shouldn't do that." The senator obviously needs to get out more.
For the life of us, we cannot remember any sober being in full possession of his faculties believing that the Bureau of Labor Statistics has ever overstated—and we must stress overstated—inflation. We have our reservations about the number crunchers, but none of them to our knowledge has exhibited an irrepressible urge to commit occupational suicide.
It's not the first time, of course, that Washington has sought to tackle the thorny issue of inflation by manipulating how the cost of living is calculated (elimination of food and energy when they were rising vigorously, remember, gave us "core inflation," which just happens to invariably lag behind plain old inflation).
Understand, we hold no brief for the particular yardstick Uncle Sam uses to measure the cost of living. Quite the opposite: With something approaching glee, we've passed along, from time to time, John Williams' blistering critiques of it from his perch at Shadow Government Statistics. However, John's take is that for decades, the rise in the cost of living has been greater than the official measurements indicate. It's just that we think such silly tinkering is symptomatic of how much at a remove Washington is from what's happening to the economy (and just about everything else, for that matter).
The atrocious June job numbers bring that disconnect into sharp relief. Although the incurable bulls strained to put a smiley face on the report, prattling on about a soft patch and trying to change the subject to the second half of this year, which they naturally envisioned as a period of quickening recovery, unimpeded by the absence of stimulus, the continuing drag of a bum housing market and a dismal job picture.
Give us a break. Which, come to think of it, is just what the bulls may get, but not, needless to say, the kind they're looking for.
THE STREET SOOTHSAYERS WERE A TAD OFF in their prognostications, anticipating a rise in payrolls to around 125,000. In fact, a grand total of 18,000 jobs were added. That was the feeblest increase since September of last year, in case you're keeping score. Moreover, the two previous months were revised downward, by 29,000 in May and 15,000 in April.
And if you add the 131,000 slots plucked pretty much out of the thin air by the BLS's birth/death computer models, what our friends Philippa Dunne and Doug Henwood at the Liscio Report dub "an unspinnably disappointing report" becomes even more disappointing. The private sector generated 57,000 jobs, while government at all levels subtracted an aggregate 39,000.
The unemployment rate edged up to 9.2% from May's 9.1%, and would have been a bit higher but for the shrinkage in the labor pool, which occurred likely as not because more folks without a job got discouraged and stopped looking for one. Even working stiffs had something tangible to beef about: Earnings in June fell a penny an hour, and the workweek contracted as well.
As Philippa and Doug comment, there were "no consolations in the household survey," which showed a loss of 445,000 jobs, and, even adjusting to match the payroll concept, was down a not-inconsiderable 401,000. They note with some dismay that the rise in unemployment was most emphatic "at the extremes of the duration spectrum, which includes those jobless five weeks or less at one end and people out of work for 99 weeks or more." They call the increase in the ranks of the newly unemployed especially "alarming."
What we find alarming as well is the rise in U-6, which includes both the unemployed and underemployed, to 16.2%, from 15.8%. This all-inclusive category hasn't been so high since back in December.
And while there are roughly 14 million people out of work by the usual count of unemployment, there are, uncomfortably, some 25 million by the U-6 measure.
That translates into an awful lot of unhappy people. And, if nothing else, we have a hunch that many of them may decide to vote come next year's election. Consider this a heads-up to any stray pol who can read the report without making his lips tired.
THE ESTIMABLE DAVE ROSENBERG, Gluskin Sheff's man about markets and economies, calls the employment report a "mega reality check." Like Philippa and Doug, he views the jobs tally as "horrible…not just the headline but also the details." And it casts severe doubt, he feels, on the popular notion among many economists and strategists that the lag in growth in the first half of the year can be blamed on myriad transitory factors.
Obviously, Dave says, last month's consumer-confidence surveys were so weak because of the crummy job market, which, we might add, somehow seemed to elude the ken of any number of economists and strategists. And the dismal employment situation reflects in no small way why the private sector is hiring so gingerly.
Pure and simple, business is jittery about the macroeconomic outlook, "especially with the Fed fading into the background and fiscal policies swinging from stimulus to restraint."
While, he allows, employment picked up some earlier this year, the uptick was largely in response "to the psychological effects of illusionary prosperity" inspired by the monetary and fiscal largess unleashed last fall. As it emerges, these stimuli gave the economy a "brief sugar high, with no lasting multiplier impact."
Now the policy cupboard is bare, and "we can see what the emperor looks like disrobed. It's not a pretty picture."
The economy, Dave goes on, is in a very fragile state. Which isn't all that surprising since it still bears the scars of the credit and market collapse and the Great Recession that accompanied it.
However, historically, such ugly episodes—and there are quite a few slumps and crashes in the postwar period—are not typically followed by recoveries as flaccid and as pathetic one has been.
Particularly rare is to see an economy that's supposedly well into recovery produce the likes of a puny 18,000 monthly job gain. For a recovery worthy of its name, Dave contends, celebrating its second anniversary you would expect employment to rise more on the order of 180,000. It's hard to overlook that missing zero in Friday's headlines.
Scanning the gory details of the data, Dave notes that the total of unemployed in June swelled by 173,000 and exceeded 14 million for the first time this year. Including discouraged workers, the pool of available labor soared by 483,000 to 20.6 million, which works out to seven people vying for every job opening. The normal ratio is close to three.
The logical question, he writes, is what are the prospects for a rebound in July? Not great, he says. In the June report, virtually all the tell-tale indicators of what's ahead—temp hiring, the decline in the workweek, since "hours tend to lead bodies," and the revisions, which have a habit of feeding on themselves—were negative.
In his summing up, Dave points out that: "Here we are, two years into an economic recovery, and the level of employment at 131 million is actually lower than it was in March 2000. At this stage of the cycle, what is normal is that payrolls are making new cyclical highs. This time around, barely 20% of the recession losses have been recouped."
He scoffs at the "myopic attention paid to a second-half revival," which he considers "a classic failure to look at the forest past the trees." The U.S. economy, "sadly enough, is saddled with numerous structural headwinds from excessive noncorporate debt, excessive housing inventories, excessive reliance on imported oil and excessive labor-market supply."
And he adds, facetiously, "Did we mention excessive denial?"
Dave, as our readers doubtless know, is given to morose musings about the economy and the markets.
But you disregard his cautions at your peril. He was indisputably on the money in plugging for bonds when just about everyone on this aching planet was bearish. And Dave has also been right as rain about gold.
One small absence in his list of excesses currently bedeviling the economy: He didn't comment on excess of blockheads in Washington—perhaps, we suspect, he believes that's a given.
Social Security and vets' disability payments are tied to the cost of living, and, in their infinite wisdom, the politicos have concluded that the current gauge overstates inflation. No less an authority—and we can't think of any less an authority—than Oklahoma Republican Sen. Tom Coburn is quoted by Bloomberg as saying: "There hasn't been any economist anywhere that says we shouldn't do that." The senator obviously needs to get out more.
For the life of us, we cannot remember any sober being in full possession of his faculties believing that the Bureau of Labor Statistics has ever overstated—and we must stress overstated—inflation. We have our reservations about the number crunchers, but none of them to our knowledge has exhibited an irrepressible urge to commit occupational suicide.
It's not the first time, of course, that Washington has sought to tackle the thorny issue of inflation by manipulating how the cost of living is calculated (elimination of food and energy when they were rising vigorously, remember, gave us "core inflation," which just happens to invariably lag behind plain old inflation).
Understand, we hold no brief for the particular yardstick Uncle Sam uses to measure the cost of living. Quite the opposite: With something approaching glee, we've passed along, from time to time, John Williams' blistering critiques of it from his perch at Shadow Government Statistics. However, John's take is that for decades, the rise in the cost of living has been greater than the official measurements indicate. It's just that we think such silly tinkering is symptomatic of how much at a remove Washington is from what's happening to the economy (and just about everything else, for that matter).
The atrocious June job numbers bring that disconnect into sharp relief. Although the incurable bulls strained to put a smiley face on the report, prattling on about a soft patch and trying to change the subject to the second half of this year, which they naturally envisioned as a period of quickening recovery, unimpeded by the absence of stimulus, the continuing drag of a bum housing market and a dismal job picture.
Give us a break. Which, come to think of it, is just what the bulls may get, but not, needless to say, the kind they're looking for.
THE STREET SOOTHSAYERS WERE A TAD OFF in their prognostications, anticipating a rise in payrolls to around 125,000. In fact, a grand total of 18,000 jobs were added. That was the feeblest increase since September of last year, in case you're keeping score. Moreover, the two previous months were revised downward, by 29,000 in May and 15,000 in April.
And if you add the 131,000 slots plucked pretty much out of the thin air by the BLS's birth/death computer models, what our friends Philippa Dunne and Doug Henwood at the Liscio Report dub "an unspinnably disappointing report" becomes even more disappointing. The private sector generated 57,000 jobs, while government at all levels subtracted an aggregate 39,000.
The unemployment rate edged up to 9.2% from May's 9.1%, and would have been a bit higher but for the shrinkage in the labor pool, which occurred likely as not because more folks without a job got discouraged and stopped looking for one. Even working stiffs had something tangible to beef about: Earnings in June fell a penny an hour, and the workweek contracted as well.
As Philippa and Doug comment, there were "no consolations in the household survey," which showed a loss of 445,000 jobs, and, even adjusting to match the payroll concept, was down a not-inconsiderable 401,000. They note with some dismay that the rise in unemployment was most emphatic "at the extremes of the duration spectrum, which includes those jobless five weeks or less at one end and people out of work for 99 weeks or more." They call the increase in the ranks of the newly unemployed especially "alarming."
What we find alarming as well is the rise in U-6, which includes both the unemployed and underemployed, to 16.2%, from 15.8%. This all-inclusive category hasn't been so high since back in December.
And while there are roughly 14 million people out of work by the usual count of unemployment, there are, uncomfortably, some 25 million by the U-6 measure.
That translates into an awful lot of unhappy people. And, if nothing else, we have a hunch that many of them may decide to vote come next year's election. Consider this a heads-up to any stray pol who can read the report without making his lips tired.
THE ESTIMABLE DAVE ROSENBERG, Gluskin Sheff's man about markets and economies, calls the employment report a "mega reality check." Like Philippa and Doug, he views the jobs tally as "horrible…not just the headline but also the details." And it casts severe doubt, he feels, on the popular notion among many economists and strategists that the lag in growth in the first half of the year can be blamed on myriad transitory factors.
Obviously, Dave says, last month's consumer-confidence surveys were so weak because of the crummy job market, which, we might add, somehow seemed to elude the ken of any number of economists and strategists. And the dismal employment situation reflects in no small way why the private sector is hiring so gingerly.
Pure and simple, business is jittery about the macroeconomic outlook, "especially with the Fed fading into the background and fiscal policies swinging from stimulus to restraint."
While, he allows, employment picked up some earlier this year, the uptick was largely in response "to the psychological effects of illusionary prosperity" inspired by the monetary and fiscal largess unleashed last fall. As it emerges, these stimuli gave the economy a "brief sugar high, with no lasting multiplier impact."
Now the policy cupboard is bare, and "we can see what the emperor looks like disrobed. It's not a pretty picture."
The economy, Dave goes on, is in a very fragile state. Which isn't all that surprising since it still bears the scars of the credit and market collapse and the Great Recession that accompanied it.
However, historically, such ugly episodes—and there are quite a few slumps and crashes in the postwar period—are not typically followed by recoveries as flaccid and as pathetic one has been.
Particularly rare is to see an economy that's supposedly well into recovery produce the likes of a puny 18,000 monthly job gain. For a recovery worthy of its name, Dave contends, celebrating its second anniversary you would expect employment to rise more on the order of 180,000. It's hard to overlook that missing zero in Friday's headlines.
Scanning the gory details of the data, Dave notes that the total of unemployed in June swelled by 173,000 and exceeded 14 million for the first time this year. Including discouraged workers, the pool of available labor soared by 483,000 to 20.6 million, which works out to seven people vying for every job opening. The normal ratio is close to three.
The logical question, he writes, is what are the prospects for a rebound in July? Not great, he says. In the June report, virtually all the tell-tale indicators of what's ahead—temp hiring, the decline in the workweek, since "hours tend to lead bodies," and the revisions, which have a habit of feeding on themselves—were negative.
In his summing up, Dave points out that: "Here we are, two years into an economic recovery, and the level of employment at 131 million is actually lower than it was in March 2000. At this stage of the cycle, what is normal is that payrolls are making new cyclical highs. This time around, barely 20% of the recession losses have been recouped."
He scoffs at the "myopic attention paid to a second-half revival," which he considers "a classic failure to look at the forest past the trees." The U.S. economy, "sadly enough, is saddled with numerous structural headwinds from excessive noncorporate debt, excessive housing inventories, excessive reliance on imported oil and excessive labor-market supply."
And he adds, facetiously, "Did we mention excessive denial?"
Dave, as our readers doubtless know, is given to morose musings about the economy and the markets.
But you disregard his cautions at your peril. He was indisputably on the money in plugging for bonds when just about everyone on this aching planet was bearish. And Dave has also been right as rain about gold.
One small absence in his list of excesses currently bedeviling the economy: He didn't comment on excess of blockheads in Washington—perhaps, we suspect, he believes that's a given.
Thursday, July 7, 2011
The Nightmare German Inflation
Introduction
If history teaches anything, it is that government cannot be trusted to manage money. When currency is not redeemable in gold, its value depends entirely on the judgment and the conscience of the politicians. (That is the situation in this country today.)
Especially in an economic crisis or a war, the pressure to inflate becomes overwhelming. Any alternative may seem politically disastrous. Whether it be the Roman emperors repeatedly debasing their coinage, the French revolutionary government printing a flood of assignats, John Law flooding France with debased money, or the Continental Congress issuing money until it was literally "not worth a Continental," the story is similar. A government in financial straits finds its easiest recourse is to issue more and more money until the money loses its value. The entire process is accompanied by a barrage of explanations, propaganda and new regulations which hide the true situation from the eyes of most
people until they have lost all their savings. In World War I, Germany -- like other governments -- borrowed heavily to pay its war costs. This led to inflation, but not much more than in the U.S. during the same period. After the war there was a period of stability, but then the inflation resumed. By 1923, the wildest inflation in history was raging. Often prices doubled in a few hours. A wild stampede developed to buy goods and get rid of money. By late 1923 it took 200 billion marks buy a loaf of bread.
Millions of the hard-working, thrifty German people found that their life's savings would not buy a postage stamp. They were penniless. How could this happen in a highly civilized nation run at the time by intelligent, democratically chosen leaders? What happened to business, to wages and employment? How did some people manage to save their capital while a few speculators made fortunes?
The Years 1914-1921
When the war broke out on July 31, 1914, the Reichsbank (German Central Bank) suspended redeemability of its notes in gold. After that there was no legal limit as to how many notes it could print. The government did not want to upset people with heavy taxes. Instead it borrowed huge amounts of money which were to be paid by the enemy after Germany had won the war, Much of the borrowing was discounted and monetized by the Reichsbank. As explained later, this amounted to issuing straight printing press money.
By the end of the war, the amount of money in circulation had increased four-fold. In view of this, the extent of inflation was less than one might have expected. The consumer price index had risen 140% by December 1918. This was equal to the inflation during the same time in England, a little more than in the United States, but less than in France. Yet the floating debt of the Reichsbank had increased from 3 billion to 55 billion marks!
Why was inflation kept within bounds? For the same reason that it got off to a slow start in the Unites States during World War II. Necessities were rationed and luxury goods were not easily available. Millions of men were at the front and not in the market for goods. Civilians worked hard and had little leisure for spending. People saved money against peace time, and in some cases to evade taxes. But the fuel for inflation was accumulating in the form of vast hoards of money.
The harsh reparation payments imposed on Germany led the mark to depreciate against foreign currencies. Also, the new democratic socialist leaders had promised the people all types of bounties--increased wages, reduced hours, an expanded educational system, and new social benefits. But all this meant a vastly increased demand on a limited production capacity.
For these reasons inflation resumed after the peace until by February 1920 the price level was five times as high as it had been at the armistice. Yet during this same time the amount of currency in circulation had only doubled. Prices were in fact rising much faster than the rate at which money was being printed. Therefore, reasoned the officials, the price inflation could hardly be blamed on the government. Actually, as we shall see, the ebb and flow of confidence can play a big role in the short-term trend of prices. Confidence in the mark had weakened. At the same time, and as a consequence, billions of hoarded marks came out of hiding and entered the marketplace. The accumulated fuel was burning.
By February 1920 this inflationary episode had run its course. For the next fifteen months the price index held stable. The mark actually gained in value against foreign currencies, so that prices of imported goods fell by some 50%. Here was a golden opportunity to establish a stable currency. However, during these fifteen months the government kept issuing new money. The currency in circulation increased by 50% and the floating debt of the Reichsbank by 100%, providing fuel for a new outbreak.
In May 1921, price inflation started again and by July 1922 prices had risen 700%. The Reichsbank continued printing new currency, although more slowly than the rate at which prices were rising. In fact, all through this period the issue of currency proceeded at a fairly smooth steady rate, while the price index moved up in great surges, interspersed by periods of stability.
After July 1922 the phase of hyperinflation began. All confidence in money vanished and the price index rose faster and faster for fifteen months, outpacing the printing presses which could not run out money as fast as it was depreciating.
The Years 1922-1923 -- Hyperinflation!
From Mid-1922 to November 1923 hyperinflation raged. The table above tells the story. Seemingly Reichsbank officials believed that the basic trouble was the depreciation of the mark in terms of foreign currencies. In late 1922 they tried to support the mark by purchasing it in the foreign exchange markets. However, since they continued printing new currency at a feverish rate, the attempt failed. They merely succeeded in buying worthless marks in return for valuable gold and foreign exchange.
All hope of checking the collapse of the mark vanished in January 1923 when the French--alleging treaty violations--occupied Germany's key industrial district, the Ruhr. Germany subsidized the occupied companies and financed an expensive program of "passive resistance." New billions of marks were printing to finance these heavy new costs. By late 1923, 300 paper mills were working top speed and 150 printing companies had 2000 presses going day and night turning out currency.
Under the forced draft of inflation, business was now operating at feverish speed and unemployment had disappeared. However, the real wages of workers dropped badly. Unions obtained frequent increases, but these could not keep pace. Workers --domestics, farm workers and various white collar groups-- fared especially badly. They had no unions to fight for pay boosts for them, and often they were reduced to hunger. Many people showed visible signs of malnutrition. Skilled workers, writers, artisans and professionals found their wages lagging until they reached the unskilled worker level, which often meant the bare minimum needed to support life.
Businessmen began to abandon their legitimate occupations to speculate in stocks and in goods. Thousands of small businessmen tried to eke out a living by speculating in fabrics, shoes, meat, soap, clothing--in any produce they could obtain. Each fall in the mark brought a rush to the shops. People bought dozens of hats or sweaters.
By mid-1923 workers were being paid as often as three times a day. Their wives would meet them, take the money and rush to the shops to exchange it for goods. However, by this time, more and more often, shops were empty. Storekeepers could not obtain goods or could not do business fast enough to protect their cash receipts. Farmers refused to bring produce into the city in return for worthless paper. Food riots broke out. Parties of workers marched into the countryside to dig up vegetables and to loot the farms. Businesses started to close down and unemployment suddenly soared. The economy was collapsing.
Meanwhile, middle-class people who depended on any sort of fixed income found themselves destitute. They sold furniture, clothing, jewelry and works of art to buy food. Little shops became crowded with such merchandise. Hospitals, literary and art societies, charitable and religious institutions closed down as their funds disappeared.
Then by a mere effort of will, the government stepped in and stabilized the currency overnight.
Throughout the "miracle of the Rentenmark" the depreciation halted in its tracks, business revived, the inflationary spree was ended although, as we shall see, there was a nasty hangover yet to come.
Millions of middle-class Germans--normally the mainstay of a republic--were ruined by the inflation. They became receptive to rabid right wing propaganda and formed a fertile soil for Hitler. Workers who had suffered through the inflation turned, in many cases, to the Communists. The biggest beneficiaries of this enormous redistribution of wealth were feudalistic industrial leaders who distrusted the democracy and who proved willing to deal with Hitler, thinking that they could control him. The democratic parties and the labor unions lost their capital and were weakened. The liberal democratic regime was discredited.
What caused the inflation?
Our thesis is simple: The inflation was caused by the government issuing a flood of new money, causing prices to rise. Then, as the inflation gained momentum, events seemed to demand the printing of larger and larger issues of currency. To half the process would have taken political courage, and this was lacking. As usual, the true facts were hidden behind a barrage of excuses, explanations and propaganda laying blame on everyone except the true culprit.
First, it would be wrong to think that everyone was opposed to inflation. Many big business leaders accepted it cheerfully. It wiped out their debts. They knew how to protect themselves and even profit--by speculating in foreign exchange, by converting money into goods and fixed plant, by borrowing money from the bank and using it to buy up cheap stocks and competing companies. Their wage costs, in true value, decreased, swelling their profits. Yet many workers also thought that they were benefiting, at least in the earlier stages of the inflation. Their wages were increased, and it took time before they recognized that, with prices soaring even faster, they were actually suffering a cut in true income.
A crew of speculators arose who traded in goods and foreign exchange, they had a vested interest in continued inflations. And the government could not help realizing that the inflation was wiping out its burden of debt and would ease its financial problems.
Above all, it became an article of faith among the political leaders and most ordinary citizens that the inflation was really due to the burden of reparation payments imposed by the peace treaty. This meant, so the argument ran, that Germany would be stripped of its gold, foreign exchange and wealth; it would be bankrupt. Hence, the mark fell in value in terms of gold or dollars. This drop in the foreign exchange value of the mark was said to be the true reason for the inflation.
The German leaders felt that the collapse of the mark was proving how impossible it was for Germany to pay the reparations which were demanded. Stabilization of the mark would have spoiled this "proof." Especially after France occupied the Ruhr in January 1923, it was felt that the destruction of the mark was somehow a blow against the hated occupier--the only patriotic response available to disarmed Germany.
Finally, inflation seemed to bring prosperity. In 1921, when the rest of the world was in a severe post-war recession, production indices in Germany rose sharply. Late in 1921 the mark stabilized temporarily, and business promptly weakened. By early 1922 the mark was sliding again, and business immediately revived. People were buying goods as fast as they obtained money; companies rushed to expand plants and turn money into fixed investment. Germany was actually envied for its "prosperity" by many foreigners.
[Ed. Note: Does this sound like modern-day America, albeit with people spending on stocks in addition to goods?]
The mechanism of inflation was simple. The government issued paper promises to pay, and the Reichsbank issued money on the security of these promises. When a government spends more than its income, it must borrow. If it merely borrows money from its citizens by selling them bonds, there need be no inflation. Instead of that money being spent or invested by the citizen, it is borrowed and spent by the government, but the total amount of money is not increased.
When the government needs more money than its people are able or willing to lend it, it monetizes the debt. That is what happens in this country when the government runs a big deficit. The Federal Reserve (our central bank) "buys" as many bonds as necessary to stabilize the market. It prints money on the security of these bonds. Despite the facade of the government supposedly "borrowing," the net result is the creation of printing press money. (Actually these days the money is created in the form of new bank deposits--checkbook money--but the net result is exactly the same as if bills were printed.)
This is what happened in Germany. The government issued notes which were promptly discounted by the Reichsbank, i.e., the bank issued money on the "security" of these worthless notes. To compound the evil, the bank failed to raise its interest rate sufficiently. Businessmen found it very profitable to borrow money from the bank and buy up goods, shares and companies. Their debt was wiped out within weeks by the rapid inflation, and the businessman remained holding the valuable assets he had bought. The net result was a huge "private inflation" caused by the rapid expansion of credit. Even foreign exchange was bought with borrowed money, so that the Reichsbank actually financed speculation against its own currency. Yet the bank refused to raise interest rates, arguing that this would only add to the cost of business and thus would increase inflation!
The tax system virtually broke down. Businessmen found that by merely delaying tax payments, the depreciation in the mark would virtually eliminate their true value. But the government, lacking adequate income, felt forced to resort more and more to creating money. By October 1923, 1% of government income came from taxes and 99% from the creation of new money.
But the main force which gave inflation its momentum was the steady decrease in the true value of money in circulation. This has been observed in all past rapid inflations and it is vital to understand it if inflation is to be coped with. During the war, as we saw, the price inflation lagged behind the rate at which money was issued. But now, as people lost confidence, prices began jumping much faster than the government could generate new money. Thus the total circulating currency fell drastically when measured in terms of its true value. One economist stated that, "In proportion to the need, less money circulates in Germany now than before the war. This statement may cause surprise but it is correct. The circulation is now 15-20 times that of pre-war days, whilst prices have risen 40-50 times." In fact, the total currency when calculated in gold value fell from 7428 million marks in January 1920 to a mere 168 million by July 1923.
Despite the proliferating billions of trillions of marks, the average citizen found it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks. Businessmen were strapped for money to buy materials and meet payrolls. The government faced the same problem. It appeared that there was not too much money around, but rather much too little. The clamor for more money grew on all sides. It seemed that any halt to the printing presses would bring business to a standstill and throw millions of workers out on the street. The government itself would be unable to carry on. Riding a tiger, it dared not dismount. On October 25, 1923, the Reichsbank noted that it had that day printed 120,000 trillion marks. Unfortunately, the day's demand had been for one million trillion. However, it announced that it was expanding production and the daily issue would soon be 500,000 trillion!
Once people lose confidence in a currency, they try to get rid of it. As Lord Keynes pointed out, this makes circulation speed up enormously, and hence prices rise faster than the government can print new money. Marshall, studying this process, concluded that, "The total value of an ' inconvertible paper currency cannot be increased by increasing its quantity; any increase in quantity which seems likely to be repeated will lower the value of each unit more than in proportion to the increase."
Customarily, however, governments blame everyone and everything except themselves for inflation. When inflation lags behind issue of money, as it did in the war, they say that this shows that the issue of money is not dangerously high. Later, when confidence vanishes, and prices soar ahead of currency issues, that again is taken to prove that the government is not to blame--it is only reluctantly issuing money that is desperately needed in view of rising prices.
We will conclude this discussion with a quotation from Dr. Milton Friedman's book, Dollars and Deficits. Friedman notes that after the Russian revolution, the Bolsheviks introduced a new currency. They printed huge amounts of it and soon it became almost worthless. At the same time some of the older Czarist currency still circulated and maintained its value in terms of goods. It appreciated enormously in terms of the new money. Why? This money was not redeemable. Nobody expected the Czarist government to return. Why did this currency hold up? "Because," says Friedman, "there was nobody to print any more of it."
Effects of Inflation on Business
As inflation proceeded, people rushed to buy goods and get rid of their depreciated money. For similar reasons, businessmen hastened to buy machinery, to build new factories, to buy huge stocks of coal, steel and other raw materials. Those who had access to credit borrowed heavily for these purposes, and inflation wiped out their debt. There was a tremendous conversion of working capital into fixed investments. Business was booming and unemployment virtually vanished until the last stages of the inflation.
Farmers got rid of currency by heavy purchases of equipment, and later many were left holding large supplies of useless machinery. Shipbuilding was expanded beyond all market needs. Marginal mines were opened leading to serious overproduction later on. But while basic industries prospered, there was a severe depression in consumer goods industries such as textiles, meat, beer, sugar and tobacco. Too many workers and persons on fixed incomes had lost their purchasing power.
There was a tremendous move toward concentration of industry. Large firms or combinations found it much easier to raise prices, to obtain raw materials and above all to obtain bank credit. Also, they could issue "notgeld" or emergency money which more and more came to replace the paper mark as a medium of exchange. Some of these new industrial combinations were rational and efficient, but many were purely speculative operations. A new breed of financier arose.
Earlier the great German industrial leaders--men like Krupp, Thyssen and Siemens--had developed basic new ideas in technology or in organization. But now the rising stars were those of shrewd speculators and manipulators geared to quick trading and to jumping from deal to deal and from company to company. The most successful were those who saw the trend of events early, who borrowed to the hilt and bought up goods, shares and companies at bargain prices. Conglomerates sprung up forty years before the heyday of the conglomerate movement in the U.S. Perhaps the biggest operator of the day, Hugo Stinnes, formed a giant conglomerate including companies in oil, coal, steel, shipyards, electrical works, insurance, newspapers and hotels. He died in 1924, just before his empire fell apart in the cold winds of the stabilization period. Most of these new mushroom combinations and conglomerates were speculative bubbles which were only able to survive as long as they benefited from ongoing inflation.
Beneath the surface of prosperity there was enormous waste and inefficiency. Much of the new capital plant proved inefficient or unneeded. Middlemen multiplied like locusts, and more and more time and energy went to speculation and to endless paperwork generated by currency fluctuations, new tax law regulations and labor disputes. Speculation caused banks to multiply; there were 100,000 bank workers in 1913 and 375,000 in 1923. Labor became much less productive. Workmen were pre-occupied with their own problems of trading, getting wage boosts, and staying ahead of inflation. With paper wages rising rapidly and full employment, they were less inclined to work hard. Despite the surface boom, net production was really much less than before the war.
Bewildering fluctuations in costs prices and wages made it impossible to allocate resources and production rationally. More and more, the businessman became a speculator in goods and currencies. However, very few businesses failed, since their debts were constantly wiped out by inflation. Bankruptcies had run to 815 per month in 1913; by late 1923 they were 10 per month.
Finally, however, in the last stages of the inflation, the economy began to collapse. Retailers could not get goods or else could not sell at a profit. The money they received was depreciating too fast. Farmers stopped selling their produce. More and more stores became empty. Now unemployment began to soar.
Some economists argued that inflation may have helped Germany by stimulating the building of capital plant and the rationalization of industry. But much of this investment proved to have no value except in the dream world of inflation. Most of the inflation combinations fell apart after stabilization. On the whole, much energy and wealth was wasted in unproductive channels--speculation, paperwork and unprofitable equipment. The working capital of industry was largely dissipated, making that much harder the eventual process of economic rebuilding and rationalization.
Stabilization--The Rentenmark Miracle
In November 1923, a currency reform was undertaken. A new bank, the Rentenbank, was created to issue a new currency--the Rentenmark. This money was exchangeable for bonds supposedly backed up by land and industrial plant A total of 2.4 billion Rentenmarks was created, and each Rentenmark was valued at one trillion old paper marks. From that moment on the depreciation stopped--the Rentenmarks held their value; even the old paper marks held stable. Inflation ceased.
What was the secret of the "miracle of the Rentenmark"? After all, the new currency was not redeemable in anything. Its backing by real property was a fiction, since there was no way by which property could be foreclosed or distributed. Further, there we have the government distributing a vast new supply of money--2.4 billion trillion in terms of the old mark. Ought that not have led to a new wild inflation?
To understand this, we must recall that the real value of the money circulating in late 1923 was small--equal to a mere 168 million pre-war gold marks. The continued depreciation at this point was due to utter lack of confidence--to the belief that the printing presses would run indefinitely. But actually there was a great shortage of and need for money. New money could be introduced without price inflation if only people had confidence in it. How was confidence developed?
First, the government announced that the new currency would be "wertbestaendig"--stable in value. In their hunger for usable money people accepted this, at least until it should be proven false. Then the property backing seemed to give the currency value. True, the Assignats of the French Revolution, backed by fixed property, had depreciated, but still the backing helped.
Second, and certainly most important, the government limited strictly the amount of Rentenmarks which could be issued and it halted the issue and discounting of notes and the creation of paper marks. Finally, after April 1924, the Reichsbank stopped the expansion of credit to businesses which had been stimulating inflation. Businessmen were required to repay loans in gold marks, equal to the original value of the loan. Thereafter, incentive was gone to borrow except for legitimate needs.
In August 1924 the reform was completed by introduction of a new Reichsmark, equal in value to the Rentenmark. The Reichsmark has a 30% gold backing. It was not redeemable in gold, but the government undertook to support it by buying in the foreign exchange markets as necessary. Drastic new taxes were imposed, and with the inflation ended, tax receipts incr
eased impressively. In 1924-1925 the government had a surplus.
After the stabilization, most companies found that they were critically short of working capital. Their funds had been dissipated or converted into goods and plant, and cash was very short. They could no longer rely on a stream of incoming capital at the cost of bond holders and workers. Taxes were again a serious burden, as were wage agreements that had been made under the inflation.
In other ways the business climate changed. Now there was a huge demand for consumer goods, but the capital goods industries which had so overexpanded in the inflation were depressed. Huge stocks of coal, steel and other materials which had been accumulated were a drug on the market. Agriculture and building, however, flourished.
Many of the speculative and conglomerate companies which had been formed in the inflation were unable to survive. They failed, or split up into their original components. In 1923 there had been only 263 bankruptcies; in 1924 there were 6,033. Most of the great inflation speculators were ruined or faded from the business scene. However, strong, well-organized companies like Krupp and Thyssen which had resisted overexpansion and speculation were able to weather the stabilization period and to thrive.
How Investments Fared
At the start it is important to understand how hard it was to obtain real income during the inflation. Professionals, skilled workers and others used to enjoying good income found their real salaries disastrously cut. Those who depended on savings, pensions or investment income for a living faced a terrible situation.
Interest from bonds or savings deposits soon depreciated to where they had no real value. Stocks paid meager dividends or none at all; corporate managements needed the money for working capital, or used it for capital building and speculation. Owners of rental property fared no better; the government froze rents, which soon meant that tenants were occupying premises virtually rent-free. Dipping into capital led to big losses, since cash, bonds and even stocks quickly shrunk drastically in value. The urgent need for income had important effects on the true prices of various types of property and investments.
Cash: Money held in cash lost value rapidly and soon became completely worthless. Of all investment forms, this was the most disastrous.
Bank Deposits: In theory, bank deposits became as worthless as cash. However, after the stabilization the government decreed partial reimbursement, and sums in the range of 15-30% of the original deposit value were repaid. Naturally, however, the great majority of depositors withdrew their funds at some time during the inflation, after much of the value had been lost, and exchanged them for goods. Few Germans held money in deposits through the entire period.
Bonds, Mortgages: As usual in an inflation, bonds and mortgages fell in value even faster than cash. After the stabilization, some restitution was provided by law. Holders of government bonds were reimbursed to the extent of 2.5% of the original bond values. Mortgage holders also received some repayment, while a 1925 law provided for 15-25% reimbursement of corporate bondholders, though the payment was delayed for some years. Here again, few investors held bonds or mortgages throughout the entire period; most holders got rid of them for whatever pittance they would bring during the inflation.
Real Estate: Farmers and holders of urban property seemed to benefit if their property was mortgaged; the inflation soon wiped out the mortgage debt. However, they received no income, as noted above, since rents were frozen. After the stabilization, heavy new taxes and the urgent need for cash forced most holders to remortgage their property, often more heavily than originally, so that their gains were illusory. Still, those who held real estate throughout managed to save the capital thus invested. However, those who sold during the inflation (often through desperate need for cash) fared poorly. Because it brought no income, real estate sold at extremely low real price levels during inflation.
Foreign Exchange: Those who held funds in dollars, pounds or other stable currencies, or in gold,saved their capital. The government set up rigid exchange controls as the inflation proceeded. As usual under such conditions, a black market flourished. The ones who fared best were the small minority who had the foresight to exchange marks into foreign money or gold very early, before new laws made this difficult and before the mark lost too much value.
Personal Property: Capital was preserved by those who early changed it into objects of lasting value--rare coins, stamps, jewelry, works of art, antiques--or into merchandise such as clothing, fabrics, etc. Of course, most people did not understand the advantage of accumulating such property until the inflation was well along. By that time the prices of all goods had risen so much that they seemed outrageously bad bargains. In the event, however, cash proved an even worse bargain.
Common Stocks: In an inflation, common stocks are generally considered a desirable hedge to protect against or even to profit from the rise in prices. In practice, it is not so simple. In this country stock prices have been known to fall violently just when inflation was most evident (1946, 1957, 1966, 1969). Market fluctuations--the rise of exciting new speculative stocks, waves of fear or greed--all make it much too easy to buy or to sell at the wrong time or to go into the wrong stocks.
Getting down to specifics, we can say that those who bought a well-diversified list of stocks in solid, well-established companies quite early in the inflation and who held on throughout the period and also through the stabilization crisis saved much or all of their capital. However, there were many pitfalls along the wayside for the greedy, the fearful and the over-clever. Those who did best were investors with a certain unemotional, stolid character, a basic confidence that strong, well-managed companies would come through, and an immunity to excitement, anxiety and speculative temptations.
Many very sharp but brief advances and declines in the market led to widespread speculation, and well-intentioned investors often wound up as traders. Naturally most of them did as badly as amateur speculators generally do. Many decided that speculation was the only sensible approach; when the entire economy and financial structure was visibly crumbling, who could wait patiently with confidence in the long-range value of anything?
Could it Happen Here?
Since 1939 the general price levels have gone up some 200% in this country. Much of this inflation was due to the government generating large amounts of money to pay for three wars. You can be absolutely certain that if we are involved in any further wars for big increases in military spending, there will be new inflationary surges. Modem governments do not dare to impose the taxes needed to pay for war. They find it much easier politically to inflate instead.
The most recent wave of inflation, which got underway in 1965, was triggered by enormous expansion in spending for the Vietnam war. The government ran deficits as big as $25 billion, and much of this debt was monetized by a process similar to that by which the Reichsbank monetized the German government's debt. The main difference is that the newly generated money shows up mainly as bank deposits instead of printed currency. Since bank demand deposits are in fact money, convertible into currency and usable for any type of purchase, the net result is the same.
At the same time that Vietnam war spending mushroomed, our government undertook a vast program of expensive social welfare spending. It was argued that this country could afford guns and butter. The result was an inflation which already has imposed a 20% capital tax on all savings held as cash, bonds, insurance and on pension payments and other fixed income.
Now, in March 1970, the government and the Federal Reserve have been fighting for a year to check the inflation. Thus far, they have succeeded in slowing down the economy, but prices have continued rising as fast as ever. The reason is simple. Inflation has developed momentum. Many people, especially businessmen, have no faith that the government will stick to its policy. They look for more boom and inflation ahead. Hence, they have continued to get rid of money as fast as possible and convert it into goods, machinery and factory buildings. Even though our manufacturing plant is already in excess in needs and is being utilized at only 82% of capacity, the building boom continues. The reasons are precisely those which led to this behavior in the German inflation.
The late 1960s also saw the rise of a new breed of financial speculator. Huge conglomerates were organized, often with heavy borrowing, taking advantage of inflationary trends. Although their stocks soared in 1967-1968, even a hint of possible deflation and a cooler economy led to drastic declines of 60-80% in 1969. Many reported serious losses or sharply lower earnings. We believe that many of these companies could not survive a period of recession and deflation. Further, some bankruptcies in a few huge, prominent speculative companies could set off a chain reaction and a financial crash. And that is where the great danger of a wild inflation lies.
Today the public expects and demands that the government must maintain prosperity and full employment. If a very severe business slump developed, Washington would have no choice at all--it would have to spend huge sums for relief, public works, to pay off mortgages, etc. Yet at the same time tax payments would drop sharply as business profits disappeared. Taxes could hardly be raised under such circumstances. What would the President do? Turn on the printing presses? What else could he do? [Editor's note: As a reminder, after this report was written, the redeemability of the dollar for gold was terminated in 1971, two Oil Crises struck in 1973 and 1979, and massive Cold War expenditures characterized the 1980's.]
Ironically enough, we think that all this could be triggered by the anti-inflation campaign. It may prove all too successful. The money managers in Washington are aiming at a mild cooling down in business. This would reduce spending and investment, and hopefully would slow down the rate of price escalation. We think that it may work for a while and to a degree. Unhappily it poses tremendous danger.
During the last several years of inflationary boom, debt has gone far too high. Government, individuals and especially businesses have borrowed and spent without limit. In an inflationary period, this makes sense. At the same time liquidity is at an all-time low. Cash and government bills are less than 20% of the current liabilities of business against a normal 40-50% (and 90% right after the war).
The danger is that some of the especially vulnerable businesses will get into deep trouble and that the trouble will spread. In 1954, 1958 and 1960 the economy could stand a moderate recession without its escalating into something worse. In 1970 this may no longer be the case. The trend toward illiquidity and dangerously high debt has proceeded for twenty years, and other figures indicate that the breaking point is near. It might come very soon, or not for many months or even a year or two. Who can tell just when some stray breeze will cause a rickety house of cards to collapse?
Once a snowballing financial and economic deflation gets underway, it could develop with breathtaking speed. Soon the government, instead of worrying about inflation, would be using desperation measures to halt the collapse, even if it had to run budgetary deficits of 100 billion or more. In the short run, in a pragmatic sense, Washington would simply feel that it was tackling an overriding emergency, relieving hardship, etc. In the long term, what it would be doing was to inflate up to the point where most of the huge debt burden was wiped out, and a fresh start could be made. Of course, this would be at the expense of millions of savers who would lose most of their capital. Hopefully the expropriation would be less drastic than it was in Germany.
______________________
Reprinted from The Nightmare German Inflation by Scientific Market Analysis, 1970.
Editor's note: By the end of the 1970's, double digit inflation had ravaged the American financial landscape. This forecast by Scientific Market Analysis was not only accurate, it was prescient, and the conclusions drawn enduring. Only the very strict monetary policies of the Federal Reserve Bank during the 1980's kept the nation from sliding into the hyperinflationary abyss, and those years became a period of relative calm. The profligate fiscal policies of the United States government, however, continue unabated. The overall national debt has grown to enormous proportions. The defense build-ups of the Reagan and Bush administrations, coupled with the unbridled growth of entitlements --- financed to a large degree with government debt---have set the stage for a new round of inflation. Few believe that the Congress or the President possesses the political will to stop the spending. As argued by Scientific Market Analysis in this report, sooner or later, the deficits will translate to inflation, and sooner or later, the Federal Reserve Bank will find it nigh impossible to continue pulling rabbits out of the hat. Whether or not the inflationary tendency of the American economy will cross the line to hyperinflation is primarily a matter of politics---a reality few of us welcome. For the United States to escape the fate of 1924 Germany, we must alter our ways and soon. MK
If history teaches anything, it is that government cannot be trusted to manage money. When currency is not redeemable in gold, its value depends entirely on the judgment and the conscience of the politicians. (That is the situation in this country today.)
Especially in an economic crisis or a war, the pressure to inflate becomes overwhelming. Any alternative may seem politically disastrous. Whether it be the Roman emperors repeatedly debasing their coinage, the French revolutionary government printing a flood of assignats, John Law flooding France with debased money, or the Continental Congress issuing money until it was literally "not worth a Continental," the story is similar. A government in financial straits finds its easiest recourse is to issue more and more money until the money loses its value. The entire process is accompanied by a barrage of explanations, propaganda and new regulations which hide the true situation from the eyes of most
people until they have lost all their savings. In World War I, Germany -- like other governments -- borrowed heavily to pay its war costs. This led to inflation, but not much more than in the U.S. during the same period. After the war there was a period of stability, but then the inflation resumed. By 1923, the wildest inflation in history was raging. Often prices doubled in a few hours. A wild stampede developed to buy goods and get rid of money. By late 1923 it took 200 billion marks buy a loaf of bread.
Millions of the hard-working, thrifty German people found that their life's savings would not buy a postage stamp. They were penniless. How could this happen in a highly civilized nation run at the time by intelligent, democratically chosen leaders? What happened to business, to wages and employment? How did some people manage to save their capital while a few speculators made fortunes?
The Years 1914-1921
When the war broke out on July 31, 1914, the Reichsbank (German Central Bank) suspended redeemability of its notes in gold. After that there was no legal limit as to how many notes it could print. The government did not want to upset people with heavy taxes. Instead it borrowed huge amounts of money which were to be paid by the enemy after Germany had won the war, Much of the borrowing was discounted and monetized by the Reichsbank. As explained later, this amounted to issuing straight printing press money.
By the end of the war, the amount of money in circulation had increased four-fold. In view of this, the extent of inflation was less than one might have expected. The consumer price index had risen 140% by December 1918. This was equal to the inflation during the same time in England, a little more than in the United States, but less than in France. Yet the floating debt of the Reichsbank had increased from 3 billion to 55 billion marks!
Why was inflation kept within bounds? For the same reason that it got off to a slow start in the Unites States during World War II. Necessities were rationed and luxury goods were not easily available. Millions of men were at the front and not in the market for goods. Civilians worked hard and had little leisure for spending. People saved money against peace time, and in some cases to evade taxes. But the fuel for inflation was accumulating in the form of vast hoards of money.
The harsh reparation payments imposed on Germany led the mark to depreciate against foreign currencies. Also, the new democratic socialist leaders had promised the people all types of bounties--increased wages, reduced hours, an expanded educational system, and new social benefits. But all this meant a vastly increased demand on a limited production capacity.
For these reasons inflation resumed after the peace until by February 1920 the price level was five times as high as it had been at the armistice. Yet during this same time the amount of currency in circulation had only doubled. Prices were in fact rising much faster than the rate at which money was being printed. Therefore, reasoned the officials, the price inflation could hardly be blamed on the government. Actually, as we shall see, the ebb and flow of confidence can play a big role in the short-term trend of prices. Confidence in the mark had weakened. At the same time, and as a consequence, billions of hoarded marks came out of hiding and entered the marketplace. The accumulated fuel was burning.
By February 1920 this inflationary episode had run its course. For the next fifteen months the price index held stable. The mark actually gained in value against foreign currencies, so that prices of imported goods fell by some 50%. Here was a golden opportunity to establish a stable currency. However, during these fifteen months the government kept issuing new money. The currency in circulation increased by 50% and the floating debt of the Reichsbank by 100%, providing fuel for a new outbreak.
In May 1921, price inflation started again and by July 1922 prices had risen 700%. The Reichsbank continued printing new currency, although more slowly than the rate at which prices were rising. In fact, all through this period the issue of currency proceeded at a fairly smooth steady rate, while the price index moved up in great surges, interspersed by periods of stability.
After July 1922 the phase of hyperinflation began. All confidence in money vanished and the price index rose faster and faster for fifteen months, outpacing the printing presses which could not run out money as fast as it was depreciating.
The Years 1922-1923 -- Hyperinflation!
From Mid-1922 to November 1923 hyperinflation raged. The table above tells the story. Seemingly Reichsbank officials believed that the basic trouble was the depreciation of the mark in terms of foreign currencies. In late 1922 they tried to support the mark by purchasing it in the foreign exchange markets. However, since they continued printing new currency at a feverish rate, the attempt failed. They merely succeeded in buying worthless marks in return for valuable gold and foreign exchange.
All hope of checking the collapse of the mark vanished in January 1923 when the French--alleging treaty violations--occupied Germany's key industrial district, the Ruhr. Germany subsidized the occupied companies and financed an expensive program of "passive resistance." New billions of marks were printing to finance these heavy new costs. By late 1923, 300 paper mills were working top speed and 150 printing companies had 2000 presses going day and night turning out currency.
Under the forced draft of inflation, business was now operating at feverish speed and unemployment had disappeared. However, the real wages of workers dropped badly. Unions obtained frequent increases, but these could not keep pace. Workers --domestics, farm workers and various white collar groups-- fared especially badly. They had no unions to fight for pay boosts for them, and often they were reduced to hunger. Many people showed visible signs of malnutrition. Skilled workers, writers, artisans and professionals found their wages lagging until they reached the unskilled worker level, which often meant the bare minimum needed to support life.
Businessmen began to abandon their legitimate occupations to speculate in stocks and in goods. Thousands of small businessmen tried to eke out a living by speculating in fabrics, shoes, meat, soap, clothing--in any produce they could obtain. Each fall in the mark brought a rush to the shops. People bought dozens of hats or sweaters.
By mid-1923 workers were being paid as often as three times a day. Their wives would meet them, take the money and rush to the shops to exchange it for goods. However, by this time, more and more often, shops were empty. Storekeepers could not obtain goods or could not do business fast enough to protect their cash receipts. Farmers refused to bring produce into the city in return for worthless paper. Food riots broke out. Parties of workers marched into the countryside to dig up vegetables and to loot the farms. Businesses started to close down and unemployment suddenly soared. The economy was collapsing.
Meanwhile, middle-class people who depended on any sort of fixed income found themselves destitute. They sold furniture, clothing, jewelry and works of art to buy food. Little shops became crowded with such merchandise. Hospitals, literary and art societies, charitable and religious institutions closed down as their funds disappeared.
Then by a mere effort of will, the government stepped in and stabilized the currency overnight.
Throughout the "miracle of the Rentenmark" the depreciation halted in its tracks, business revived, the inflationary spree was ended although, as we shall see, there was a nasty hangover yet to come.
Millions of middle-class Germans--normally the mainstay of a republic--were ruined by the inflation. They became receptive to rabid right wing propaganda and formed a fertile soil for Hitler. Workers who had suffered through the inflation turned, in many cases, to the Communists. The biggest beneficiaries of this enormous redistribution of wealth were feudalistic industrial leaders who distrusted the democracy and who proved willing to deal with Hitler, thinking that they could control him. The democratic parties and the labor unions lost their capital and were weakened. The liberal democratic regime was discredited.
What caused the inflation?
Our thesis is simple: The inflation was caused by the government issuing a flood of new money, causing prices to rise. Then, as the inflation gained momentum, events seemed to demand the printing of larger and larger issues of currency. To half the process would have taken political courage, and this was lacking. As usual, the true facts were hidden behind a barrage of excuses, explanations and propaganda laying blame on everyone except the true culprit.
First, it would be wrong to think that everyone was opposed to inflation. Many big business leaders accepted it cheerfully. It wiped out their debts. They knew how to protect themselves and even profit--by speculating in foreign exchange, by converting money into goods and fixed plant, by borrowing money from the bank and using it to buy up cheap stocks and competing companies. Their wage costs, in true value, decreased, swelling their profits. Yet many workers also thought that they were benefiting, at least in the earlier stages of the inflation. Their wages were increased, and it took time before they recognized that, with prices soaring even faster, they were actually suffering a cut in true income.
A crew of speculators arose who traded in goods and foreign exchange, they had a vested interest in continued inflations. And the government could not help realizing that the inflation was wiping out its burden of debt and would ease its financial problems.
Above all, it became an article of faith among the political leaders and most ordinary citizens that the inflation was really due to the burden of reparation payments imposed by the peace treaty. This meant, so the argument ran, that Germany would be stripped of its gold, foreign exchange and wealth; it would be bankrupt. Hence, the mark fell in value in terms of gold or dollars. This drop in the foreign exchange value of the mark was said to be the true reason for the inflation.
The German leaders felt that the collapse of the mark was proving how impossible it was for Germany to pay the reparations which were demanded. Stabilization of the mark would have spoiled this "proof." Especially after France occupied the Ruhr in January 1923, it was felt that the destruction of the mark was somehow a blow against the hated occupier--the only patriotic response available to disarmed Germany.
Finally, inflation seemed to bring prosperity. In 1921, when the rest of the world was in a severe post-war recession, production indices in Germany rose sharply. Late in 1921 the mark stabilized temporarily, and business promptly weakened. By early 1922 the mark was sliding again, and business immediately revived. People were buying goods as fast as they obtained money; companies rushed to expand plants and turn money into fixed investment. Germany was actually envied for its "prosperity" by many foreigners.
[Ed. Note: Does this sound like modern-day America, albeit with people spending on stocks in addition to goods?]
The mechanism of inflation was simple. The government issued paper promises to pay, and the Reichsbank issued money on the security of these promises. When a government spends more than its income, it must borrow. If it merely borrows money from its citizens by selling them bonds, there need be no inflation. Instead of that money being spent or invested by the citizen, it is borrowed and spent by the government, but the total amount of money is not increased.
When the government needs more money than its people are able or willing to lend it, it monetizes the debt. That is what happens in this country when the government runs a big deficit. The Federal Reserve (our central bank) "buys" as many bonds as necessary to stabilize the market. It prints money on the security of these bonds. Despite the facade of the government supposedly "borrowing," the net result is the creation of printing press money. (Actually these days the money is created in the form of new bank deposits--checkbook money--but the net result is exactly the same as if bills were printed.)
This is what happened in Germany. The government issued notes which were promptly discounted by the Reichsbank, i.e., the bank issued money on the "security" of these worthless notes. To compound the evil, the bank failed to raise its interest rate sufficiently. Businessmen found it very profitable to borrow money from the bank and buy up goods, shares and companies. Their debt was wiped out within weeks by the rapid inflation, and the businessman remained holding the valuable assets he had bought. The net result was a huge "private inflation" caused by the rapid expansion of credit. Even foreign exchange was bought with borrowed money, so that the Reichsbank actually financed speculation against its own currency. Yet the bank refused to raise interest rates, arguing that this would only add to the cost of business and thus would increase inflation!
The tax system virtually broke down. Businessmen found that by merely delaying tax payments, the depreciation in the mark would virtually eliminate their true value. But the government, lacking adequate income, felt forced to resort more and more to creating money. By October 1923, 1% of government income came from taxes and 99% from the creation of new money.
But the main force which gave inflation its momentum was the steady decrease in the true value of money in circulation. This has been observed in all past rapid inflations and it is vital to understand it if inflation is to be coped with. During the war, as we saw, the price inflation lagged behind the rate at which money was issued. But now, as people lost confidence, prices began jumping much faster than the government could generate new money. Thus the total circulating currency fell drastically when measured in terms of its true value. One economist stated that, "In proportion to the need, less money circulates in Germany now than before the war. This statement may cause surprise but it is correct. The circulation is now 15-20 times that of pre-war days, whilst prices have risen 40-50 times." In fact, the total currency when calculated in gold value fell from 7428 million marks in January 1920 to a mere 168 million by July 1923.
Despite the proliferating billions of trillions of marks, the average citizen found it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks. Businessmen were strapped for money to buy materials and meet payrolls. The government faced the same problem. It appeared that there was not too much money around, but rather much too little. The clamor for more money grew on all sides. It seemed that any halt to the printing presses would bring business to a standstill and throw millions of workers out on the street. The government itself would be unable to carry on. Riding a tiger, it dared not dismount. On October 25, 1923, the Reichsbank noted that it had that day printed 120,000 trillion marks. Unfortunately, the day's demand had been for one million trillion. However, it announced that it was expanding production and the daily issue would soon be 500,000 trillion!
Once people lose confidence in a currency, they try to get rid of it. As Lord Keynes pointed out, this makes circulation speed up enormously, and hence prices rise faster than the government can print new money. Marshall, studying this process, concluded that, "The total value of an ' inconvertible paper currency cannot be increased by increasing its quantity; any increase in quantity which seems likely to be repeated will lower the value of each unit more than in proportion to the increase."
Customarily, however, governments blame everyone and everything except themselves for inflation. When inflation lags behind issue of money, as it did in the war, they say that this shows that the issue of money is not dangerously high. Later, when confidence vanishes, and prices soar ahead of currency issues, that again is taken to prove that the government is not to blame--it is only reluctantly issuing money that is desperately needed in view of rising prices.
We will conclude this discussion with a quotation from Dr. Milton Friedman's book, Dollars and Deficits. Friedman notes that after the Russian revolution, the Bolsheviks introduced a new currency. They printed huge amounts of it and soon it became almost worthless. At the same time some of the older Czarist currency still circulated and maintained its value in terms of goods. It appreciated enormously in terms of the new money. Why? This money was not redeemable. Nobody expected the Czarist government to return. Why did this currency hold up? "Because," says Friedman, "there was nobody to print any more of it."
Effects of Inflation on Business
As inflation proceeded, people rushed to buy goods and get rid of their depreciated money. For similar reasons, businessmen hastened to buy machinery, to build new factories, to buy huge stocks of coal, steel and other raw materials. Those who had access to credit borrowed heavily for these purposes, and inflation wiped out their debt. There was a tremendous conversion of working capital into fixed investments. Business was booming and unemployment virtually vanished until the last stages of the inflation.
Farmers got rid of currency by heavy purchases of equipment, and later many were left holding large supplies of useless machinery. Shipbuilding was expanded beyond all market needs. Marginal mines were opened leading to serious overproduction later on. But while basic industries prospered, there was a severe depression in consumer goods industries such as textiles, meat, beer, sugar and tobacco. Too many workers and persons on fixed incomes had lost their purchasing power.
There was a tremendous move toward concentration of industry. Large firms or combinations found it much easier to raise prices, to obtain raw materials and above all to obtain bank credit. Also, they could issue "notgeld" or emergency money which more and more came to replace the paper mark as a medium of exchange. Some of these new industrial combinations were rational and efficient, but many were purely speculative operations. A new breed of financier arose.
Earlier the great German industrial leaders--men like Krupp, Thyssen and Siemens--had developed basic new ideas in technology or in organization. But now the rising stars were those of shrewd speculators and manipulators geared to quick trading and to jumping from deal to deal and from company to company. The most successful were those who saw the trend of events early, who borrowed to the hilt and bought up goods, shares and companies at bargain prices. Conglomerates sprung up forty years before the heyday of the conglomerate movement in the U.S. Perhaps the biggest operator of the day, Hugo Stinnes, formed a giant conglomerate including companies in oil, coal, steel, shipyards, electrical works, insurance, newspapers and hotels. He died in 1924, just before his empire fell apart in the cold winds of the stabilization period. Most of these new mushroom combinations and conglomerates were speculative bubbles which were only able to survive as long as they benefited from ongoing inflation.
Beneath the surface of prosperity there was enormous waste and inefficiency. Much of the new capital plant proved inefficient or unneeded. Middlemen multiplied like locusts, and more and more time and energy went to speculation and to endless paperwork generated by currency fluctuations, new tax law regulations and labor disputes. Speculation caused banks to multiply; there were 100,000 bank workers in 1913 and 375,000 in 1923. Labor became much less productive. Workmen were pre-occupied with their own problems of trading, getting wage boosts, and staying ahead of inflation. With paper wages rising rapidly and full employment, they were less inclined to work hard. Despite the surface boom, net production was really much less than before the war.
Bewildering fluctuations in costs prices and wages made it impossible to allocate resources and production rationally. More and more, the businessman became a speculator in goods and currencies. However, very few businesses failed, since their debts were constantly wiped out by inflation. Bankruptcies had run to 815 per month in 1913; by late 1923 they were 10 per month.
Finally, however, in the last stages of the inflation, the economy began to collapse. Retailers could not get goods or else could not sell at a profit. The money they received was depreciating too fast. Farmers stopped selling their produce. More and more stores became empty. Now unemployment began to soar.
Some economists argued that inflation may have helped Germany by stimulating the building of capital plant and the rationalization of industry. But much of this investment proved to have no value except in the dream world of inflation. Most of the inflation combinations fell apart after stabilization. On the whole, much energy and wealth was wasted in unproductive channels--speculation, paperwork and unprofitable equipment. The working capital of industry was largely dissipated, making that much harder the eventual process of economic rebuilding and rationalization.
Stabilization--The Rentenmark Miracle
In November 1923, a currency reform was undertaken. A new bank, the Rentenbank, was created to issue a new currency--the Rentenmark. This money was exchangeable for bonds supposedly backed up by land and industrial plant A total of 2.4 billion Rentenmarks was created, and each Rentenmark was valued at one trillion old paper marks. From that moment on the depreciation stopped--the Rentenmarks held their value; even the old paper marks held stable. Inflation ceased.
What was the secret of the "miracle of the Rentenmark"? After all, the new currency was not redeemable in anything. Its backing by real property was a fiction, since there was no way by which property could be foreclosed or distributed. Further, there we have the government distributing a vast new supply of money--2.4 billion trillion in terms of the old mark. Ought that not have led to a new wild inflation?
To understand this, we must recall that the real value of the money circulating in late 1923 was small--equal to a mere 168 million pre-war gold marks. The continued depreciation at this point was due to utter lack of confidence--to the belief that the printing presses would run indefinitely. But actually there was a great shortage of and need for money. New money could be introduced without price inflation if only people had confidence in it. How was confidence developed?
First, the government announced that the new currency would be "wertbestaendig"--stable in value. In their hunger for usable money people accepted this, at least until it should be proven false. Then the property backing seemed to give the currency value. True, the Assignats of the French Revolution, backed by fixed property, had depreciated, but still the backing helped.
Second, and certainly most important, the government limited strictly the amount of Rentenmarks which could be issued and it halted the issue and discounting of notes and the creation of paper marks. Finally, after April 1924, the Reichsbank stopped the expansion of credit to businesses which had been stimulating inflation. Businessmen were required to repay loans in gold marks, equal to the original value of the loan. Thereafter, incentive was gone to borrow except for legitimate needs.
In August 1924 the reform was completed by introduction of a new Reichsmark, equal in value to the Rentenmark. The Reichsmark has a 30% gold backing. It was not redeemable in gold, but the government undertook to support it by buying in the foreign exchange markets as necessary. Drastic new taxes were imposed, and with the inflation ended, tax receipts incr
eased impressively. In 1924-1925 the government had a surplus.
After the stabilization, most companies found that they were critically short of working capital. Their funds had been dissipated or converted into goods and plant, and cash was very short. They could no longer rely on a stream of incoming capital at the cost of bond holders and workers. Taxes were again a serious burden, as were wage agreements that had been made under the inflation.
In other ways the business climate changed. Now there was a huge demand for consumer goods, but the capital goods industries which had so overexpanded in the inflation were depressed. Huge stocks of coal, steel and other materials which had been accumulated were a drug on the market. Agriculture and building, however, flourished.
Many of the speculative and conglomerate companies which had been formed in the inflation were unable to survive. They failed, or split up into their original components. In 1923 there had been only 263 bankruptcies; in 1924 there were 6,033. Most of the great inflation speculators were ruined or faded from the business scene. However, strong, well-organized companies like Krupp and Thyssen which had resisted overexpansion and speculation were able to weather the stabilization period and to thrive.
How Investments Fared
At the start it is important to understand how hard it was to obtain real income during the inflation. Professionals, skilled workers and others used to enjoying good income found their real salaries disastrously cut. Those who depended on savings, pensions or investment income for a living faced a terrible situation.
Interest from bonds or savings deposits soon depreciated to where they had no real value. Stocks paid meager dividends or none at all; corporate managements needed the money for working capital, or used it for capital building and speculation. Owners of rental property fared no better; the government froze rents, which soon meant that tenants were occupying premises virtually rent-free. Dipping into capital led to big losses, since cash, bonds and even stocks quickly shrunk drastically in value. The urgent need for income had important effects on the true prices of various types of property and investments.
Cash: Money held in cash lost value rapidly and soon became completely worthless. Of all investment forms, this was the most disastrous.
Bank Deposits: In theory, bank deposits became as worthless as cash. However, after the stabilization the government decreed partial reimbursement, and sums in the range of 15-30% of the original deposit value were repaid. Naturally, however, the great majority of depositors withdrew their funds at some time during the inflation, after much of the value had been lost, and exchanged them for goods. Few Germans held money in deposits through the entire period.
Bonds, Mortgages: As usual in an inflation, bonds and mortgages fell in value even faster than cash. After the stabilization, some restitution was provided by law. Holders of government bonds were reimbursed to the extent of 2.5% of the original bond values. Mortgage holders also received some repayment, while a 1925 law provided for 15-25% reimbursement of corporate bondholders, though the payment was delayed for some years. Here again, few investors held bonds or mortgages throughout the entire period; most holders got rid of them for whatever pittance they would bring during the inflation.
Real Estate: Farmers and holders of urban property seemed to benefit if their property was mortgaged; the inflation soon wiped out the mortgage debt. However, they received no income, as noted above, since rents were frozen. After the stabilization, heavy new taxes and the urgent need for cash forced most holders to remortgage their property, often more heavily than originally, so that their gains were illusory. Still, those who held real estate throughout managed to save the capital thus invested. However, those who sold during the inflation (often through desperate need for cash) fared poorly. Because it brought no income, real estate sold at extremely low real price levels during inflation.
Foreign Exchange: Those who held funds in dollars, pounds or other stable currencies, or in gold,saved their capital. The government set up rigid exchange controls as the inflation proceeded. As usual under such conditions, a black market flourished. The ones who fared best were the small minority who had the foresight to exchange marks into foreign money or gold very early, before new laws made this difficult and before the mark lost too much value.
Personal Property: Capital was preserved by those who early changed it into objects of lasting value--rare coins, stamps, jewelry, works of art, antiques--or into merchandise such as clothing, fabrics, etc. Of course, most people did not understand the advantage of accumulating such property until the inflation was well along. By that time the prices of all goods had risen so much that they seemed outrageously bad bargains. In the event, however, cash proved an even worse bargain.
Common Stocks: In an inflation, common stocks are generally considered a desirable hedge to protect against or even to profit from the rise in prices. In practice, it is not so simple. In this country stock prices have been known to fall violently just when inflation was most evident (1946, 1957, 1966, 1969). Market fluctuations--the rise of exciting new speculative stocks, waves of fear or greed--all make it much too easy to buy or to sell at the wrong time or to go into the wrong stocks.
Getting down to specifics, we can say that those who bought a well-diversified list of stocks in solid, well-established companies quite early in the inflation and who held on throughout the period and also through the stabilization crisis saved much or all of their capital. However, there were many pitfalls along the wayside for the greedy, the fearful and the over-clever. Those who did best were investors with a certain unemotional, stolid character, a basic confidence that strong, well-managed companies would come through, and an immunity to excitement, anxiety and speculative temptations.
Many very sharp but brief advances and declines in the market led to widespread speculation, and well-intentioned investors often wound up as traders. Naturally most of them did as badly as amateur speculators generally do. Many decided that speculation was the only sensible approach; when the entire economy and financial structure was visibly crumbling, who could wait patiently with confidence in the long-range value of anything?
Could it Happen Here?
Since 1939 the general price levels have gone up some 200% in this country. Much of this inflation was due to the government generating large amounts of money to pay for three wars. You can be absolutely certain that if we are involved in any further wars for big increases in military spending, there will be new inflationary surges. Modem governments do not dare to impose the taxes needed to pay for war. They find it much easier politically to inflate instead.
The most recent wave of inflation, which got underway in 1965, was triggered by enormous expansion in spending for the Vietnam war. The government ran deficits as big as $25 billion, and much of this debt was monetized by a process similar to that by which the Reichsbank monetized the German government's debt. The main difference is that the newly generated money shows up mainly as bank deposits instead of printed currency. Since bank demand deposits are in fact money, convertible into currency and usable for any type of purchase, the net result is the same.
At the same time that Vietnam war spending mushroomed, our government undertook a vast program of expensive social welfare spending. It was argued that this country could afford guns and butter. The result was an inflation which already has imposed a 20% capital tax on all savings held as cash, bonds, insurance and on pension payments and other fixed income.
Now, in March 1970, the government and the Federal Reserve have been fighting for a year to check the inflation. Thus far, they have succeeded in slowing down the economy, but prices have continued rising as fast as ever. The reason is simple. Inflation has developed momentum. Many people, especially businessmen, have no faith that the government will stick to its policy. They look for more boom and inflation ahead. Hence, they have continued to get rid of money as fast as possible and convert it into goods, machinery and factory buildings. Even though our manufacturing plant is already in excess in needs and is being utilized at only 82% of capacity, the building boom continues. The reasons are precisely those which led to this behavior in the German inflation.
The late 1960s also saw the rise of a new breed of financial speculator. Huge conglomerates were organized, often with heavy borrowing, taking advantage of inflationary trends. Although their stocks soared in 1967-1968, even a hint of possible deflation and a cooler economy led to drastic declines of 60-80% in 1969. Many reported serious losses or sharply lower earnings. We believe that many of these companies could not survive a period of recession and deflation. Further, some bankruptcies in a few huge, prominent speculative companies could set off a chain reaction and a financial crash. And that is where the great danger of a wild inflation lies.
Today the public expects and demands that the government must maintain prosperity and full employment. If a very severe business slump developed, Washington would have no choice at all--it would have to spend huge sums for relief, public works, to pay off mortgages, etc. Yet at the same time tax payments would drop sharply as business profits disappeared. Taxes could hardly be raised under such circumstances. What would the President do? Turn on the printing presses? What else could he do? [Editor's note: As a reminder, after this report was written, the redeemability of the dollar for gold was terminated in 1971, two Oil Crises struck in 1973 and 1979, and massive Cold War expenditures characterized the 1980's.]
Ironically enough, we think that all this could be triggered by the anti-inflation campaign. It may prove all too successful. The money managers in Washington are aiming at a mild cooling down in business. This would reduce spending and investment, and hopefully would slow down the rate of price escalation. We think that it may work for a while and to a degree. Unhappily it poses tremendous danger.
During the last several years of inflationary boom, debt has gone far too high. Government, individuals and especially businesses have borrowed and spent without limit. In an inflationary period, this makes sense. At the same time liquidity is at an all-time low. Cash and government bills are less than 20% of the current liabilities of business against a normal 40-50% (and 90% right after the war).
The danger is that some of the especially vulnerable businesses will get into deep trouble and that the trouble will spread. In 1954, 1958 and 1960 the economy could stand a moderate recession without its escalating into something worse. In 1970 this may no longer be the case. The trend toward illiquidity and dangerously high debt has proceeded for twenty years, and other figures indicate that the breaking point is near. It might come very soon, or not for many months or even a year or two. Who can tell just when some stray breeze will cause a rickety house of cards to collapse?
Once a snowballing financial and economic deflation gets underway, it could develop with breathtaking speed. Soon the government, instead of worrying about inflation, would be using desperation measures to halt the collapse, even if it had to run budgetary deficits of 100 billion or more. In the short run, in a pragmatic sense, Washington would simply feel that it was tackling an overriding emergency, relieving hardship, etc. In the long term, what it would be doing was to inflate up to the point where most of the huge debt burden was wiped out, and a fresh start could be made. Of course, this would be at the expense of millions of savers who would lose most of their capital. Hopefully the expropriation would be less drastic than it was in Germany.
______________________
Reprinted from The Nightmare German Inflation by Scientific Market Analysis, 1970.
Editor's note: By the end of the 1970's, double digit inflation had ravaged the American financial landscape. This forecast by Scientific Market Analysis was not only accurate, it was prescient, and the conclusions drawn enduring. Only the very strict monetary policies of the Federal Reserve Bank during the 1980's kept the nation from sliding into the hyperinflationary abyss, and those years became a period of relative calm. The profligate fiscal policies of the United States government, however, continue unabated. The overall national debt has grown to enormous proportions. The defense build-ups of the Reagan and Bush administrations, coupled with the unbridled growth of entitlements --- financed to a large degree with government debt---have set the stage for a new round of inflation. Few believe that the Congress or the President possesses the political will to stop the spending. As argued by Scientific Market Analysis in this report, sooner or later, the deficits will translate to inflation, and sooner or later, the Federal Reserve Bank will find it nigh impossible to continue pulling rabbits out of the hat. Whether or not the inflationary tendency of the American economy will cross the line to hyperinflation is primarily a matter of politics---a reality few of us welcome. For the United States to escape the fate of 1924 Germany, we must alter our ways and soon. MK
Wednesday, July 6, 2011
Greece's Slippery Slope
For what seems like ages now but really dates back only a few highly regrettable years, Wall Street has been the butt of a relentless barrage of badmouthing, in the main, we must admit, richly deserved. But one thing that it can't justly be accused of is a lack of patriotism, especially when that noble impulse inadvertently happens to coincide with an opportunity to make a few extra bucks.
So it was with great verve and enthusiasm that it staged a rousing rally last week in anticipatory celebration of Independence Day. Even absent their actual presence, you could hear the music, see the flag.
Not that brokers and bankers and all the worthies who labor in the canyons of capitalism hadn't reason to celebrate, if only because bonuses were back, generous as ever, and gas prices had come down, which meant they make the trip to the Hamptons every Friday without borrowing from their kids' piggy banks.
Even more inspiriting, though, despite the bellowing importuning of the envious press, except for a few thorough rotters, they hadn't spent so much as two minutes in the slammer. And it hasn't been for lack of trying by the SEC, which does, however, seem to have trouble distinguishing a Ponzi scheme from an extra-large pizza.
The rally that the Street put on last week was a real nifty one. It came pretty much out of the blue, was well paced and widespread, ending the second quarter and starting the third on an upbeat. In its lack of any evident catalyst, apart from Greece's not going under—yet—(more of that below) it looks at this point more like a short-term bounce than a sustainable upswing.
But, so what? All investing is short-term these days, so if you're going to play the market, you might as well get used to it. The trick is to keep tuned to sentiment and be ready to buy when bearishness becomes epidemic, as it threatened to become a few weeks ago, and be willing to dump when bullishness is rampant, as it will be should this rally go on for a few weeks more.
And, of course, happy holiday!
GOLD, WE COULDN'T HELP NOTICING, has lost a bit of its glisten. It's had a wonderfully long run and is entitled to take a breather. But we couldn't resist passing along a note from Matthew Menken, a savvy reader, who reports from London that the first gold vending machine opened in London on Friday in a shopping mall. Supposedly no security guards are necessary because the operators claim "the most sophisticated" security is being used.
Prices are updated every 10 minutes. For buys greater than 2,500 British pounds you have to scan your passport.
We fervently hope for the sake of all those fluttering gold bugs that the introduction of a gold vending machine isn't a glittering negative indicator for the yellow metal.
HOW DO YOU SAY "WHEW!' IN GREEK? In whatever language the globe over, political movers and shakers, finance ministers, banksters, dabblers in precious metals, traders in virtually everything tradable and investors whatever their proclivities breathed a sigh of relief last week when Greece's Parliament voted to accept a no-nonsense regimen to put its acutely troubled fiscal affairs in order.
This splendid act of responsible governance was inspired by deep-rooted patriotism. Although we won't deny that the country was teetering on the edge of economic ruin, and unless it agreed to tread the straight and narrow it wouldn't get the 12 billion euros the European Union and the IMF were supposed to toss its way as an installment on the 110 billion-euro loan extended to it last year, which just might have played some modest role in persuading the lawmakers to give the proposal a thumbs-up.
Not all the citizens, it may shock you to learn, were overjoyed at the prospect of tightening their belts or losing their jobs, but then—sigh!—you can't please everyone. In sizable numbers, these disgruntled folks took their complaints to the streets turning the air blue with imprecation (you didn't need a translator; a glance at their horribly and venomously contorted faces was more than sufficiently eloquent).
And not a few of these unhappy souls sought to express their discontent more tangibly by heaving rocks at the Parliament building. Athens, of course, is the birthplace of democracy and it struck us we Americans might do worse than follow the lead of its inhabitants and, as the occasion warranted and if you happen to be in the D.C. vicinity, rain stones on the Capitol to encourage our slumbering representatives to bestir themselves or at least dream up some semblance of positive action.
We can't say, for that matter, that the European Union covered itself with glory as it bickered publicly and loudly over how to deal with Greece. But, then, every nation for itself—and there are 27 of them in the EU and 17 in the so-called euro zone—is the group's vaguely Darwinian modus operandi. As a result, its deliberations often resemble nothing so much as the haggling in a crowded fishmonger's shop over the catch of the day.
The irony in this instance is that Greece will have spent its 12 billion euros and have its tin cup out again before the snow falls (and that's an optimistic assumption). So if you happened not to be paying all that much attention to this recent chapter in the long-running Greek tragedy, don't fret—you're sure to get a chance to witness the sequel.
Better yet, a new "improved" financial package coughing up more euros and effectively stretching out the required payback schedule is in the works. Which means you needn't worry too much about missing this sequel, either, since you can rest assured you'll always be able catch the next one.
WHILE WORLD EQUITY MARKETS, most definitely including ours, took heart from the happy if temporary ending to this cliff-hanging episode, permitting Greece to escape the ignominy of defaulting on its sovereign debt, the response among professional economic and market kibitzers was not universally sanguine. Among the grumpiest was the irrepressible and inevitably iconoclastic Barry Ritholtz. From his perch at Fusion IQ, he notes the immediate tendency to "blame the profligate Greeks."
Barry has no illusions about the state of the Greek economy, citing, among other absurdities, the government's obscene spending, overly generous pension plans and similar sins. Too much of its populace, he thunders, are "tax scofflaws." In short, he agrees, Greece is a mess.
But, hey, he claims, as even a casual visitor can attest, none of Greece's financial shortcomings are a secret. So why the big surprise and feigned outrage that profligacy is among its weaknesses? For here as elsewhere, Barry firmly contends, the blame for lending to insolvent borrowers, be they individuals, institutions or countries, first and always belong to the lenders. If they can't independently determine who is creditworthy and who is not, for heaven's sake, what, he asks, is their role? They might as well "leave piles of money around," he snorts, "and ask borrowers to self-regulate their appropriate credit limits."
The invariably perceptive Michael Darda, of MKM Partners, whose take on markets and economies we've quoted from time to time, continues to view with undisguised and profound skepticism (which we share) what he calls the bailout/austerity/tight-money policy mix that the European Central Bank (ECB, for short) has chosen to deal with the Old World's fiscal woes. Nor does he hold with the notion that Greece's latest avoidance of default is "an inflection point in the euro-zone sovereign-debt crisis."
On that score, he points out that debt spreads in Ireland and Portugal are within spitting distance of all-time peaks, indicating both are leading candidates for another rescue. And although each of their economies is not very high on the euro-zone pecking order, together they're saddled with enough of a debt loan to create a real headache for the European banking system.
More worrying still by Michael's lights are Spain and Italy, which have much larger economies that are heavily laden with debt. Prices and wages in both countries, he feels, are too high compared with the rest of the euro zone, and a dose of deflation might be necessary if both are to remain part of the European Monetary Union. The ECB might, if it chose, lend a helping hand with a more accommodative monetary approach. Instead, alas, there are expectations that, perhaps as early as this week, the bank will tighten further.
Michael reiterates his conviction that the economically weaker sisters of the euro zone—Italy, Ireland, Portugal, Spain and, of course, Greece—cannot withstand higher funding rates and tighter liquidity, "yet the ECB continues to believe that bailouts/austerity can coexist with tighter money." As he comments wryly, the "events of the last year suggest otherwise."
Dipping into financial history, he notes the shivery similarity between our beloved Fed's misguided decision in 1936-37 to tighten monetary policy during a "savage fiscal austerity" and what the European Central Bank seems hell-bent on doing today. The Fed's action precipitated the 1937-38 "recession within the Depression," Michael recounts, and the ECB's version of that policy "is not likely to end well in the euro zone, either."
Or, as the quote by Albert Einstein atop Michael's commentary nicely summed up his point: "Insanity is doing the same thing over and over again and expecting different results." Poor old Albert obviously would never have made it as a central banker
So it was with great verve and enthusiasm that it staged a rousing rally last week in anticipatory celebration of Independence Day. Even absent their actual presence, you could hear the music, see the flag.
Not that brokers and bankers and all the worthies who labor in the canyons of capitalism hadn't reason to celebrate, if only because bonuses were back, generous as ever, and gas prices had come down, which meant they make the trip to the Hamptons every Friday without borrowing from their kids' piggy banks.
Even more inspiriting, though, despite the bellowing importuning of the envious press, except for a few thorough rotters, they hadn't spent so much as two minutes in the slammer. And it hasn't been for lack of trying by the SEC, which does, however, seem to have trouble distinguishing a Ponzi scheme from an extra-large pizza.
The rally that the Street put on last week was a real nifty one. It came pretty much out of the blue, was well paced and widespread, ending the second quarter and starting the third on an upbeat. In its lack of any evident catalyst, apart from Greece's not going under—yet—(more of that below) it looks at this point more like a short-term bounce than a sustainable upswing.
But, so what? All investing is short-term these days, so if you're going to play the market, you might as well get used to it. The trick is to keep tuned to sentiment and be ready to buy when bearishness becomes epidemic, as it threatened to become a few weeks ago, and be willing to dump when bullishness is rampant, as it will be should this rally go on for a few weeks more.
And, of course, happy holiday!
GOLD, WE COULDN'T HELP NOTICING, has lost a bit of its glisten. It's had a wonderfully long run and is entitled to take a breather. But we couldn't resist passing along a note from Matthew Menken, a savvy reader, who reports from London that the first gold vending machine opened in London on Friday in a shopping mall. Supposedly no security guards are necessary because the operators claim "the most sophisticated" security is being used.
Prices are updated every 10 minutes. For buys greater than 2,500 British pounds you have to scan your passport.
We fervently hope for the sake of all those fluttering gold bugs that the introduction of a gold vending machine isn't a glittering negative indicator for the yellow metal.
HOW DO YOU SAY "WHEW!' IN GREEK? In whatever language the globe over, political movers and shakers, finance ministers, banksters, dabblers in precious metals, traders in virtually everything tradable and investors whatever their proclivities breathed a sigh of relief last week when Greece's Parliament voted to accept a no-nonsense regimen to put its acutely troubled fiscal affairs in order.
This splendid act of responsible governance was inspired by deep-rooted patriotism. Although we won't deny that the country was teetering on the edge of economic ruin, and unless it agreed to tread the straight and narrow it wouldn't get the 12 billion euros the European Union and the IMF were supposed to toss its way as an installment on the 110 billion-euro loan extended to it last year, which just might have played some modest role in persuading the lawmakers to give the proposal a thumbs-up.
Not all the citizens, it may shock you to learn, were overjoyed at the prospect of tightening their belts or losing their jobs, but then—sigh!—you can't please everyone. In sizable numbers, these disgruntled folks took their complaints to the streets turning the air blue with imprecation (you didn't need a translator; a glance at their horribly and venomously contorted faces was more than sufficiently eloquent).
And not a few of these unhappy souls sought to express their discontent more tangibly by heaving rocks at the Parliament building. Athens, of course, is the birthplace of democracy and it struck us we Americans might do worse than follow the lead of its inhabitants and, as the occasion warranted and if you happen to be in the D.C. vicinity, rain stones on the Capitol to encourage our slumbering representatives to bestir themselves or at least dream up some semblance of positive action.
We can't say, for that matter, that the European Union covered itself with glory as it bickered publicly and loudly over how to deal with Greece. But, then, every nation for itself—and there are 27 of them in the EU and 17 in the so-called euro zone—is the group's vaguely Darwinian modus operandi. As a result, its deliberations often resemble nothing so much as the haggling in a crowded fishmonger's shop over the catch of the day.
The irony in this instance is that Greece will have spent its 12 billion euros and have its tin cup out again before the snow falls (and that's an optimistic assumption). So if you happened not to be paying all that much attention to this recent chapter in the long-running Greek tragedy, don't fret—you're sure to get a chance to witness the sequel.
Better yet, a new "improved" financial package coughing up more euros and effectively stretching out the required payback schedule is in the works. Which means you needn't worry too much about missing this sequel, either, since you can rest assured you'll always be able catch the next one.
WHILE WORLD EQUITY MARKETS, most definitely including ours, took heart from the happy if temporary ending to this cliff-hanging episode, permitting Greece to escape the ignominy of defaulting on its sovereign debt, the response among professional economic and market kibitzers was not universally sanguine. Among the grumpiest was the irrepressible and inevitably iconoclastic Barry Ritholtz. From his perch at Fusion IQ, he notes the immediate tendency to "blame the profligate Greeks."
Barry has no illusions about the state of the Greek economy, citing, among other absurdities, the government's obscene spending, overly generous pension plans and similar sins. Too much of its populace, he thunders, are "tax scofflaws." In short, he agrees, Greece is a mess.
But, hey, he claims, as even a casual visitor can attest, none of Greece's financial shortcomings are a secret. So why the big surprise and feigned outrage that profligacy is among its weaknesses? For here as elsewhere, Barry firmly contends, the blame for lending to insolvent borrowers, be they individuals, institutions or countries, first and always belong to the lenders. If they can't independently determine who is creditworthy and who is not, for heaven's sake, what, he asks, is their role? They might as well "leave piles of money around," he snorts, "and ask borrowers to self-regulate their appropriate credit limits."
The invariably perceptive Michael Darda, of MKM Partners, whose take on markets and economies we've quoted from time to time, continues to view with undisguised and profound skepticism (which we share) what he calls the bailout/austerity/tight-money policy mix that the European Central Bank (ECB, for short) has chosen to deal with the Old World's fiscal woes. Nor does he hold with the notion that Greece's latest avoidance of default is "an inflection point in the euro-zone sovereign-debt crisis."
On that score, he points out that debt spreads in Ireland and Portugal are within spitting distance of all-time peaks, indicating both are leading candidates for another rescue. And although each of their economies is not very high on the euro-zone pecking order, together they're saddled with enough of a debt loan to create a real headache for the European banking system.
More worrying still by Michael's lights are Spain and Italy, which have much larger economies that are heavily laden with debt. Prices and wages in both countries, he feels, are too high compared with the rest of the euro zone, and a dose of deflation might be necessary if both are to remain part of the European Monetary Union. The ECB might, if it chose, lend a helping hand with a more accommodative monetary approach. Instead, alas, there are expectations that, perhaps as early as this week, the bank will tighten further.
Michael reiterates his conviction that the economically weaker sisters of the euro zone—Italy, Ireland, Portugal, Spain and, of course, Greece—cannot withstand higher funding rates and tighter liquidity, "yet the ECB continues to believe that bailouts/austerity can coexist with tighter money." As he comments wryly, the "events of the last year suggest otherwise."
Dipping into financial history, he notes the shivery similarity between our beloved Fed's misguided decision in 1936-37 to tighten monetary policy during a "savage fiscal austerity" and what the European Central Bank seems hell-bent on doing today. The Fed's action precipitated the 1937-38 "recession within the Depression," Michael recounts, and the ECB's version of that policy "is not likely to end well in the euro zone, either."
Or, as the quote by Albert Einstein atop Michael's commentary nicely summed up his point: "Insanity is doing the same thing over and over again and expecting different results." Poor old Albert obviously would never have made it as a central banker
Subscribe to:
Posts (Atom)