A Little Understanding Goes a Long Way

As the world confronts one of the most critical periods of economic upheaval that it has ever seen, it is clear that our most influential economic stewards have absolutely no idea what they are doing. But, like kids with a new chemistry set, they are nevertheless unwilling to let that stand in the way of their experimental fun. As they pour an ever-growing number of volatile ingredients into their test tubes, we can either hope that they magically stumble on the secret formula to cure the world’s ills, or more pragmatically, we can try to prepare for the explosion that is likely to result.

Recent comments from current and former Federal Reserve Chairmen, and from the leaders of the European Central Bank, have starkly illustrated this stunning lack of understanding. In an extended interview on CNBC today, former Fed Chairman Alan Greenspan, once considered the sagest of all economic gurus, admitted that he had no idea whether the Fed’s current quantitative easing program will help or hurt the economy. The Maestro simply said that we must wait and see, and if positive economic indicators come, then we may begin considering the policy to be a success. That’s some serious insight.

In other words, after dedicating his life to the study of macroeconomics, Greenspan is left with no deep understanding of how the injection of trillions of dollars of printed money affects an economy. The chicken who plays tic-tac-toe in Chinatown could likely offer the same level of critical analysis. To paraphrase Nancy Pelosi: according to Greenspan, we have to conclude the policy to know if it works. Although I have never been thought of as an economic expert by anyone with actual access to power, permit me to offer a thought on the subject: printing money creates inflation, which weakens an economy. Unfortunately, this kind of common-sense thinking never seems to penetrate academic circles.  

Without fundamental understanding, all economists are left with is surface analysis of current data and an inclination to play probability and statistics. This is like a meteorologist opening the window, checking current conditions, and making predictions based on analysis of recent days. While this may be useful, it is no substitute for an understanding of atmospheric dynamics and climatology. In his interview, Greenspan essentially confirmed this bias for “open window” economics, saying that Ben Bernanke and Jean-Claude Trichet both follow the same models, but with different statistical sensitivities: Bernanke toward growth data and Trichet toward inflation data. In that sense, both are no better than Las Vegas odds-makers, with one putting his chips on inflation risk and the other betting on recession risk.

This gambler’s approach helps explain why economists fail to understand the obvious benefits of a strong currency. According to people like Bernanke, a weak currency is like an ace up the sleeve, a clever way to undercut the competition. The problem is either everyone does it and the game ends up swimming in aces, or Bernanke gets caught and other countries decided they don’t want to play anymore (sell Treasuries).

Conventional warfare in this arena used to involve central bank buying and selling currency reserves in the open. But in the aftermath of the financial crisis, these timid measures were abandoned. In the last few years, the United States has upped the ante and brought out unconventional weaponry. The trillions of dollars printed by the Fed are the economic equivalent of carpet bombing. Initially our enemies responded in kind, and sought to devalue their currencies in lock step. They fought fire with fire and showered liquidity on their own economies. However, as the collateral damage mounted in the form of surging food and energy prices, they have begun sounding the general retreat.
A Little Understanding Goes a Long Way

In an interview on CNBC this week, James Bullard, the President of the Federal Reserve Bank of St. Louis, claimed that the Fed’s easy money policies were not responsible for inflation overseas, arguing that foreign central banks had a choice. They could have allowed their currencies to rise, which would have kept prices from rising in their internal markets. Instead, they chose to prevent their currencies from rising – thereby importing our inflation. In other words, they had to choose between exchange rate stability and price stability. Apparently, they couldn’t stand the heat, so they are getting out of the kitchen.

Bernanke’s recent testimony before Congress, in which he argued that the Fed can’t be blamed for rising commodity prices, will surely increase international unease. Yet still, as the issuer of the world’s reserve currency, the Fed is blazing a trail that other central banks feel compelled to follow. It is no coincidence that inflation is highest in those nations that maintain a peg against the dollar. But making this fundamental connection is beyond the ability of our statistician-in-chief.

Bernanke makes another fundamental error by blaming higher commodity prices on faster global growth. Growing economies produce more stuff, which keeps prices in check. However, if money supply grows faster than production, prices rise. So, the increased demand to which Bernanke refers is merely a function of more money, not faster growth.

In the end, we will overwhelm our competitors with a show of extreme force. By the time the Fed rolls out QE IV or QE V, the US will emerge as the undisputed winner of the currency war. To the victor goes the spoils, which, in this case, will be higher consumer prices and interest rates and lower standards of living. On the other hand, the losers will enjoy rising living standards, as their stronger currencies serve to lower prices and increase consumption. If that doesn’t make perfect sense, maybe we should run it by the chicken.

Subscribe to Euro Pacific’s Weekly Digest: Receive all commentaries by Peter Schiff, Michael Pento, and John Browne delivered to your inbox every Monday.

Click here for free access to Euro Pacific’s new special report: What’s Ahead for Canadian Energy Trusts?

Be sure to pick up a copy of Peter Schiff’s just-released economic fable, How an Economy Grows and Why It Crashes. Click here to learn m

http://www.321gold.com/editorials/hoye/hoye030811.html

http://www.globaldividends.com/?utm_source=NL-DO&utm_medium=EMAIL&U=1161970&utm_campaign=DO_Carla_Pasternaks_Dividend_Opportunities_

In this issue

• While you were sleeping: better tone to the global equity markets after a rough day yesterday

• The long and the short of it: a look at speculative positions in various commodities and currencies

• Random market and macro comments

• Consumer confidence turns back down

• Update on our in-house valuation models

Rope a dope.

Want a winning investment strategy? Find out what the dopes are doing with their money. Do the opposite.

Some investment advisors are smart. Some aren’t. Some are mavericks with original, interesting ideas. Some just read the paper and do what everyone else is doing.

Last week, we got an advisory letter from one of the latter…one of the dopes. We read it carefully; if he were pointing investors in the same direction we are going, we’d have to change course.

But no! He urges investors to buy major US stocks and to sell gold. Gold is “overpriced” he says.

What a relief. He still has no idea what is going on; he thinks things are getting back to “normal.”

And wait. Here’s James K. Glassman, writing in The Washington Post. His piece is entitled, “The Modern Investor.”

What’s the modern investor supposed to do? Put half your money in stocks. The other half in bonds.

Wait a minute… Is this the same man who came out with “Dow 36,000” in 2000 – the year the stock market peaked out? It is? Well, great! That does it for us.

We don’t want to be a modern investor. We don’t want stocks or bonds. We’ll stick with being an old fashioned investor and stick with our program: Sell stocks on rallies; buy gold on dips.

Headline in The Financial Times on Friday:

“ECB hint on rate rise jolts markets.”

The European Fed said it might raise its key lending rate in April. The euro rose sharply…the Dow fell 88 points. Gold rose $12.

The case we’ve been making is that the ECB can’t “normalize” interest rates. Neither can the Fed. In Ireland, most people have floating rate mortgages. If rates floated up to market levels, the Irish would sink. They can’t afford higher interest payments.

The situation is the same for the Irish government. At market rates – 9% or more – it will go broke immediately. So, it looks to the ECB, the IMF, and the World Bank…and every other possible source of below-market financing…to meet its budget needs.

And the US? Ditto!

Historically, which is to say for the last two decades, the average rate of interest on US 10-year Treasury notes is about 5.7%. You’ll notice that that’s a bit more than the 3.5% the Treasury is paying now.

And then you can do the math. Nah, we’ll do it for you. Imagine that the whole of the federal debt was financed at 5.7%. The total bill would be about $800 billion per year – or more than a third of total tax receipts. Of course, much of the debt is fairly long-term…so it won’t have to be rolled over tomorrow. And much of it is held by the government itself…

But you can imagine what would happen to the bond market.

And imagine what would happen to the stock market if interest rates went back to 5.7%?

If interest rates returned to “normal” stockholders and bondholders would lose trillions of dollars.

What’s more, there’s no law that says interest rates can’t go higher than the recent average. Suppose they went to 18% – as they did at the end of the ’70s? Suppose the whole of the federal government’s debt were financed at 18%? Then, guess what, the total interest charge would be approximately equal to 100% of tax revenues.

Well, you can imagine how long that would last. Not a single minute. The whole system would fall apart long before it came to that.

But you see what we mean? Normal is out of the question. Grotesque. Weird. Strange. Extraordinary. Perverted. That’s the financial system we have. And that’s the financial situation we’ll have for a while longer…until it finally blows up.

At least, that’s our theory.

No recovery. No “back to normal.” No exit.

If the feds try to exit from their twilight zone policies they’re going to hit a bridge abutment. Markets will crash. The economy will go to pieces. Unemployment will go up. People will point fingers and accuse them of exiting “too soon.”

We saw, too, editorial opinions already stating that the ECB was “trigger happy”…and urging the Fed to avoid following its lead.

No worries on that score. Here at The Daily Reckoning we put the odds of an exit at zero.

The economy now depends on cheap money. It can’t survive without it.

And more thoughts…

“That’s one of the big differences between the French and British aristocracy,” Elizabeth enlightened us. “The French aristocrats were encouraged to move to Versailles and take part in the life of the central government. They may have owned vast estates in Normandy or Aquitaine. But the real action – social as well as political – took place in and near Paris. So, they lost contact with their sources of power…their “terres”…their family strongholds. When the revolution came, they had no local support. Their peasants turned against them. Many lost their estates and their heads.

“The English aristocracy, on the other hand, tended to be jealous of its local rights and privileges and stuck close to its land. They were never so cut off from the local people and never so dependent on the court of St. James in London. That was part of the reason they evolved a different, more decentralized system of government with more emphasis on individual rights and limited central power. And it’s probably why there was never any popular uprising against them.”

Lesson? If you want to keep your head, stay close to your roots…your base…and your family stronghold.

We never concluded our rambling comments on the importance of a Family Stronghold. So, we’ll continue…

It’s one of the things we recommend for our members at the Bonner Family Office. You need roots…a sense of being connected…a refuge from the outside world…a place where your family is safe and sure of itself. As our old friend Gary North says, you need a place where you can “dig in.”

In earlier reflections on the subject, we noticed how, as society becomes wealthier, each part of it becomes more dependent on the others. Today, very few people can survive on their own. In developed countries there are few subsistence farmers left. Very few could people live for more than just a few days if the sophisticated system of production and distribution were interrupted. And yet, it seems very unlikely that the system won’t be disrupted. War, revolution, Internet bugs, real bugs, bankruptcy, hyperinflation…there are so many things that could go wrong, it is hard to believe that at least one of them won’t.

In light of this, we urge members of our Family Office to have a place where the family can run…hide…and survive.

Where? The best place is a farm…a place not too far from where you usually are…easy to get to…and stocked with enough food and water to keep you going for a few months. Best bet is an old-fashioned pantry full of canned goods, chickens in the hen house and a pig or two in the sty.

Here in Maryland, your editor has not completely followed his own advice. He has a country house in Maryland, for example. But has no animals…and has never gotten around to stocking anything more than firewood and wine. How long can you survive on Bordeaux? We don’t know, but in case of a total breakdown, we intend to find out.

Does this sound alarmist? Paranoid? Nutty?

Maybe. We are so accustomed to thinking that everything will work out fine. It always has…at least in our lifetimes. But everything doesn’t always work out fine. There are, remember, a few black swans as well as many white ones. Those black swans can be nasty. And it only takes one to wipe you out.

Here’s one way to look at it… A bolt-hole of your own is like an insurance policy. Maybe you won’t need it. But if you do need it, you’ll need it very, very badly.

Of course, if an asteroid strikes the earth…or the Yellowstone volcano blows up…or if government goons go through the countryside, as the Soviets did in the Ukraine, torturing peasants to find out where they had hidden grain…even a family farm of your own may not save you. But in the case of many other calamities, it might make the difference between life and death.

“You’re just looking at the negative side of it,” adds Elizabeth. “On the positive side, a family stronghold can give you a richer family life. You need a place that gives your family a sense of identity, unity, and stability. Generations come and go. But places last. A place gives a family a sense of permanence too.

“Family strongholds help families develop their own culture…their own resources…their own histories. They are good places to get the family together for holidays…for reunions…and to help family members learn to work together. They’re places that you remember…no matter where you go…or where you live. They’re places where grandparents live. Where family portraits and family papers are stored. Places you think about. And, I know what you would say; they’re the places where you bury your gold.

“A family stronghold…or a refuge…is a also a good place to retreat…to recover…and to think. It should be fully paid for, of course. You don’t want to have to worry about it. It should be a real stronghold…where you’re safe. And where you’re happy. So, if you lose your job, for example, it’s a place where you go back to…to take time to think about your next move. Or, if you wan to write a book…or invent a new computer app…or just try to figure out what’s going on in your life, a family stronghold is a good place to do it. It should be quiet, tranquil, and protective.”

Your editor’s family recovered its family farm in Maryland last year, after spending 15 years in Europe. The place was a mess – overgrown with trees and bushes, with fallen-down fences and grown-up fields…cracked and rotting shutters on the house…and barn roofs that you could see daylight through.

Almost every weekend since, we’ve spent fixing the place up. Sometimes just Edward (the last child still living with us) would be available to help. Sometimes one of the other boys would come home for the weekend. Occasionally, the girls would be able to help out too. And sometimes – such as Thanksgiving weekend – we had the whole family outside – pruning, clipping, digging, raking, nailing…

It is a great thing when you can get the children to help. There’s nothing quiet or tranquil about it. The noise of chainsaws and old, diesel tractors.

“Hey, don’t hitch it up that way…” “Wait, we’re not finished…” “You bent the nail…”

The kids often disagree, tease each other…and fool around. They have their own ideas. Their own programs. They laugh. They joke. Progress often slows. Still, it is always heartwarming to watch them work.

Bill Bonner
for The Daily Reckoning

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning .