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An Address
CARA Bahamas Conference
Freeport, Grand Bahama
Januray 17, 2010
Ladies and Gentlemen:
The cliché that the present
credit collapse is "the greatest financial crisis since 1929" is
the understatement of the century. One measure of the crises is the ratio of
gross private debt to nominal GDP. This ratio captures the idea how many
years of current output it would take to retire outstanding debt. In these
terms, the crisis is truly unprecedented. The world plunged into the present
crisis with far greater debt than the debt outstanding at the time when it
plunged into the Great Depression in 1929. Add to this the qualitative change
in the structure of debt. The most exotic of the Roaring Twenties era debt
was brokers' margin lending on the stock purchases of clients. Today, in
addition, we have: (1) derivative instruments valued up to one quadrillion
dollars, (2) adjustable-rate mortgages, (3) the unquantifiable
off-balance-sheet activities of financial institutions, and (4) the junk-bond
activities of private equity firms. The unwinding, or should I say unravelling, of this financial esoterica
will greatly increase the underlying debt. The momentum of change in the
debt-tower will insure that debt -- and bankruptcies -- will continue to rise
even as the economy contracts.
The greatest amplifier of the debt
burden: falling interest rates
I won't beat around the bush and say it
without hesitation that the greatest underlying cause of the present crisis
is the ongoing destruction of capital induced by the falling interest-rate
structure. Economists and accountants are still blind to the fact that
falling interest rates amplify the burden of debt. According to Fischer's
Paradox: "The more debtors pay, the more they owe". In this
single sentence we have the essence of deflation. Payments of the debtors are
discounted at the lower current rate of interest -- not at the higher rate at
which the debt was originally contracted!
This may be the nightmare that keeps Ben
Bernanke awake and his printing presses in high gear. All in vain: falling
prices defy the printing presses. Last year the fall in CPI was the steepest
since 1932 at 2 percent. Forget monetarism, forget
the Quantity Theory of Money. Forget Friedman. Call it Fekete's
Paradox if you will: "The more the Fed tries to pump up commodity
prices with its printing presses, the more they will fall". The
explanation of this paradox is found in the contrarian behavior of the
speculators. Yes, they will snap up the newly printed dollars and run with
them. But run they will in the wrong direction. They run not to the commodity
market as hoped by Bernanke, but to the bill market where the fun is. They
front-run Bernanke and his team. They effectively corner the market for
T-bills before Bernanke can buy his quota, without which he cannot print more
dollars. Then speculators turn around and feed the T-bills to the Fed on
their own terms. Thus the Fed's effort to induce inflation will fail --
just as the effort of the Bank of Japan to pump up prices was a dismal
failure in 2002.
Greenspan surfing the tsunamis
In a testimony to Congress Alan
Greenspan has described the financial crisis as a "once-in-a-century
credit tsunami". His simile is as misleading as it is inappropriate, on
at least two counts. First, geologists do understand the cause of a tsunami;
Greenspan and other policy-makers do not understand why the global financial
crisis has occurred. Second, while geologists understand tsunamis, they do
not cause them. In contrast, policies implemented at the Fed and at the
Treasury are directly responsible for the financial tsunami. Worse still,
policy-makers fight the destructive effects of the tsunami with means that
can only be described as counter-productive. They make the crisis worse, not
better.
They had encouraged a debt-financed
speculative bubble in asset prices that created a 25-year illusory prosperity
but was doomed to burst, ushering in a self-aggravating economic downturn.
They are utterly ignorant about the role of capital and debt in the
productive process. They believe that credit can replace capital, so that
capital destruction can be repaired with more credit expansion. The vast
majority of their colleagues at the universities are not any better informed,
either.
Gold as the ultimate extinguisher of
debt
If we accept the thesis that exorbitant
debt and the destruction of capital is at the root of the present crisis,
then we'll be directed to the solution of the problem. The solution is gold.
The reason why there can be no resolution of the crisis without gold is
two-fold.
(1) Gold is the only form of capital
that is immune to destruction under any circumstances.
(2) Gold is the only ultimate extinguisher of debt.
I shall deal with the first reason in a
moment. Here I just point out that when a debtor repays his debt by handing
over Federal Reserve notes to his creditor, the debt is not extinguished. It
is merely transferred to the Federal Reserve bank that issued the note.
Transferring debt is not the same as extinguishing it. One reason for the
present plight of the world is that for the past forty years gold, the only
ultimate extinguisher of debt, has been forcibly
prevented by the U.S. government to discharge its debt-extinguishing
function. As a consequence the debt-tower has kept growing, rain or shine.
Conversely, until policy-makers at the Fed and the Treasury will understand
that there is no substitute for gold in taming the debt-monster, their
tinkering at the edges will keep making the global debt crisis worse.
Unfortunately, the news is not good in
this regard. Bernanke is a dyed-in-the-wool chrysophobe.
He would hardly be competent to make the necessary changes that would restore
gold as the ultimate extinguisher of debt in the international monetary
system.
Here I come to the point of my talk.
What can the individual investor do to make sure that his investments will
not be completely wiped out in the coming financial Armageddon?
Gold as the only form of capital that
cannot be destroyed
In wartime capital destruction normally
presents itself as physical destruction of plant, equipment, and products at
various stages of production. By contrast, in peacetime, capital destruction
takes place on paper, through the consolidation of balance sheets. Take the
simplest case when a bankrupt economic entity is overtaken by another in
order to save whatever can be saved. Clearly, that part of the assets of the
latter that have a counterpart in the liabilities of the former cannot be
saved. It will be wiped out.
It follows that no asset that also
occurs as liability in the balance sheet of a counter-party
is safe against destruction through consolidation -- even if that
counter-party is the government. We must remember that every government
experiment with irredeemable currency in history has been an abysmal failure.
In the extreme case, when the balance
sheets of all economic entities are consolidated in a holocaust, and all
paper assets are wiped out, gold is always a survivor: the only asset that
cannot be destroyed through inflation, through deflation, or through any
other malady of the monetary system.
This means that gold, and only gold,
qualifies as an instrument of hedging paper assets. Every investor owes it to
himself to provide an adequate level of insurance against risks that prey
upon the value of paper investments. But unless this insurance consists of
physical gold held by the investor himself on his own premises, it will be
ineffective.
Trading insurance makes no sense
This also shows that the attitude of
most investors with regard to gold is faulty, not to say foolish. They keep
talking about the "performance" of gold. They trade gold: buy it
when they expect the gold price to rise; they sell it when they expect the
gold price to fall. Many of them are finished with gold saying that "the
bloom is off the roses". This attitude is akin to that of the
property-owner who thinks that he is saving money by cancelling his insurance
coverage hoping to reinstate it later. It never occurs to him that it may not
be possible to reinstate, if the external conditions change drastically.
The best policy concerning insurance is
to buy it and "forget about it". No regrets if the occasion to
collect insurance compensation never arises. It is not a loss: it should be
looked at as a gain.
A simple gold-accumulation plan, aiming
at a gold hedge equivalent to 10-15 percent of net worth, with monthly
additions will suffice, with the proviso that it is preferable to increase
the hedge when the gold price is down.
Gold investors typically get nervous as
they listen to rumors that the volatility in the price of gold indicates that
the value of gold has become unstable. They forget that it is not gold that
is unstable, but the dollar in which the gold price is quoted. Gold has been,
is, and will be the paragon of stability. Ultimately, the price at which you
have purchased your hedges is unimportant.
Tips for hedging
Buy anonymously and don't talk about it.
Don't worry that you can't sell anonymously: you are not going to sell, just
like you are not going to cancel your fire insurance policy as long as you
own the house. Don't worry about capital gains taxes on your gold that you
hold as hedges against paper assets. Since you never sell, you never incur a
tax liability. There is no way the government can impose or collect taxes on
paper profits. At any rate, those so called profits on your gold hedges
should never be considered as profits. They should be looked at as advances
on payments of insurance compensation for anticipated losses. It would be
foolish to take these "profits" and spend them. Those losses may
disappear, together with the gold profits, creating the impression that your
hedges don't work. They do, but the results have to be interpreted correctly.
Spending gold profits is tantamount to cancelling the insurance policy
prematurely. The big test is still ahead. The crisis is not over, not by a
long shot.
The shape of things to come
The world lives in a delusion. It sets
great stores on Keynesian nostrums, hoping that public debt-financed
government spending, or inflating the money supply will resolve the crisis.
They won't. The first-mentioned Keynesian remedy will fail because replacing
private debt with public debt means jumping from the frying pan into the
fire. A true solution must reduce total debt. The second-mentioned Keynesian
remedy will fail to induce the intended inflation because the newly created
money just won't go where the Fed would like it to go: to the commodity, real
estate, and stock markets. Instead it will go to the bond market to
facilitate bond speculation: borrowing short and lending long, putting a
downward pressure on the yield curve. Alternatively, it will be used to
retire private debt. In either case, the result will be deflationary, not
inflationary.
As the decrease in debt reaches a
threshold, it will have two immediate consequences. One: unemployment will
skyrocket. Two: the financial system will self-destruct in a spectacular
fire-work that will make the fact obvious to one and all. Concerning the
first consequence, the U.S. must face the situation squarely that during the
boom years it has dismantled much of its industrial park producing consumer
goods for the mass market. It no longer has the factories needed to employ
the armies of unemployed people that will be laid off in the financial
sector: at brokerages, real estate agencies, insurance companies, not to
mention banks.
Concerning the second consequence, it
must be stated that the U.S. financial system is bankrupt already: it
self-destructed during the long-drawn-out decline of interest rates to zero.
This bankruptcy is camouflaged by the wholly misconceived measure of allowing
the banks, pension funds and insurance companies to cook their books. They
can only balance their books through the trick of overstating the value of
their assets and understating the value of their liabilities. The government
and the accounting profession are accomplices. Not only do they fail to
prosecute violators of the accounting code, they even cheer them on and
encourage others to do the same. Worst of all, they set the example. The Fed
carries dead assets such as mortgage-backed bonds with no bid and no market
at a positive value.
Revaluation of gold
The nation is lulled into a false sense
of security. When the truth dawns on the nation that the American financial
system is working without capital (following in the footsteps of the Japanese
banks that have been brain-dead for over a decade), the shock will greatly
aggravate the crisis. It would be better to let the truth come out now, so
that the process of re-industrializing the country and recapitalizing the
financial system by an appropriate revaluation of gold could start without
delay.
The alternative to the revaluation of
gold, seriously suggested by some respectable economists, is a complete debt-jubilee, that is, forgiving any and all dollar-denominated
debt, starting with the government debt through mortgages and corporate debt,
all the way down to the short-term liabilities of banks, including bank
deposits. This is, of course, the ultimate shock-therapy with all the unknown
consequences that it may bring with it in its train. Nobody knows how the
unfairly dispossessed creditors, including all the pensioners and holders of
life insurance policies will react. Nobody knows what the unjustly enriched
debtors will do with their godsend, the transfer of unencumbered assets to
their possession. Maybe bloodshed in the streets can be avoided. Maybe not.
The still unsolved problem of unemployment strongly suggests the latter.
At any rate, why take the risk, when
this dormant asset, gold, has been lying around fallow for some forty years
and is waiting for rehabilitation. It has the two prerequisite properties
that fit the need just like the glove fits the hand: the ultimate
extinguisher of debt, and capital indestructible par excellence. With
a proper revaluation of monetary gold, much of the existing debt-burden could
be alleviated and new productive capital could be accumulated.
I am not suggesting that sufficient
wisdom presently resides in the leadership of the world to see this. But as
their false remedies will be tried, and one after the other will backfire,
the ultimate solution to the crisis, gold-revaluation, would dawn on the
world.
Let's face it: the only reason why this
plausible solution to the long-festering problem of runaway debt has not been
applied already is sheer envy. Those who saw in gold only a "barbarous
relic" would always look with envy at those who saw in gold the ultimate
extinguisher of debt and the only indestructible form of capital. They would
do everything in their power to deny the latter any benefit of their superior
foresight.
Calendar of Events
Seminar at the Martineum Academy, Szombathely,
Hungary, March 25-29, 2010
Is the Global Financial Crisis Over?
Sponsored by the Gold Standard Institute, with the participation of Darryl Schoon, Rudy Fritsch, Sandeep Jaitly, Peter van Coppenolle,
Nathan Narusis, Professor Fekete.
Among other topics, there will be a presentation of the latest research on
the gold basis, the world's pension and insurance woes due to the destruction
of capital in the financial sector, still unrecocnized
by the mainstream, and an exclusive business ideahow
to turn the ridiculously undervalued "legal tender" gold coins to
your advantage.
For further details, see: www.professorfekete.com/gsul.asp
Antal E. Fekete
DISCLAIMER
AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright
© 2002-2008 by Antal E. Fekete
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