The Studebaker Effect

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Published : January 16th, 2012
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One of my resolutions for 2012 is to spend some time finding new ways to introduce gold-resistant paperbugs to the powerful arguments for buying and holding physical gold right now. But I never want anyone to invest in anything based merely on a recommendation. I want them to understand the reasons for the purchase themselves. Peace of mind can only come from within, and that's what understanding can provide.

This is tricky ground for me because I'm not a gold activist. The purpose of this blog is stated at the top. It is a tribute to Another and FOA. I'm not here to convert the unwilling. I'm not here to project my thoughts and draw in the masses. But at the same time, I do want to share what I've learned with loved ones. And from the email I receive, so do a lot of other people. That said, you can't just approach the unwilling with stories of decade-old anonymous internet personalities.

So this is my first foray into the frustrating world of the gold-resistant paperbug. With your help, I hope to build a primer on the gold thesis explaining "why gold, and why now," to those who know nothing about
The Gold Trail that brought us here. This post is my first baby step.

As most of you already know, you don't get any of the usual hard money, gold standard or gold bug arguments from me. I do not predict a return to the gold standard, I'm not opposed to fiat currency or central banking and I don't think the world is going to end. What you do get is my explanation of the changes that are unfolding right now in the international monetary and financial system, and how they could affect your savings.

That last part is important. How changes in the monetary and financial system could affect your savings. What are your savings? And why do we save the way we do today? Has it always been this way? Are there universal do's and don'ts when it comes to saving for the future or for a rainy day? Do systems ever change or implode, erasing people's savings? Is it ever fair to say "this time it's different"? These are interesting questions to think about.

And now that I'm thinking about it, does anyone even save anymore? If you've got a hundred grand sitting in a bank CD or savings account someone will likely tell you that you should invest it or else you're wasting money. So you invest it in what, mutual funds and bonds? In that case there will be people that will say you should be actively trading, because you're still leaving potentially rich profits on the table.

Have you noticed how many people think they are traders and investors these days? And with all the options to invest in and trade out there, who can blame them? But in reality they are not traders or investors. They are doctors, lawyers, businessmen… and savers. What we call investing today is more like speculating. So why do we "save" the way we do today, by speculating on things we know so little about?

I had an email exchange over the holidays with a reader who was home visiting his parents. He's frustrated because he's been trying to talk to them about gold for at least a year now. Here's what he writes:

"I had to bite my tongue last night because my parents told me of the results of their trip to a financial adviser. My dad has over a million in his retirement account. Thanks to this adviser they went to, 1/2 of that is going into low-yielding Muni-bonds, the other half is going into some mixed fund that my parents really have no idea what it is. I asked about gold and apparently the adviser said it was "too volatile", so zero goes into that. Great!"

I'm guessing this is pretty common, because I received an email from another reader, also during the holidays, that said almost the same thing about his mother's savings: mostly government bonds and no gold thanks to a financial advisor's advice. Is your life's savings so trivial that you will put it somewhere based on a mere recommendation? Do you feel no need to understand, no responsibility to personally protect the fruits of your own life? I'll tell you one thing, it wasn't always done this way.

A saver is different from an investor or a trader/speculator. A saver is one who earns his capital doing whatever it is he does, and then aims to preserve that purchasing power until he needs it later. Investors and traders aim to earn more capital by putting their already-earned capital at risk in one way or another. This takes a certain amount of specialization and focus. But this difference is a big topic for another post. And anyway, it doesn't matter so much in terms of the gold thesis for today.

Today the system is in transition, so you can throw your ideas about these differences out the window. There is no safe medium for simple preservation of purchasing power when the entire system shifts from the old normal to the new normal. When systems implode, the safest place to be pays off big time!

In hindsight, the stock market (represented by the DJIA) would have been a great investment or speculation from the 1970s until 2000. Since 2000 it has gone nowhere:

Likewise, bonds would have been a great trade from about 1981 until now. As I've noted
before, you make capital gains in bonds while interest rates are falling. The real pros know all about this. And from 1981 to present, interest rates fell from 20% to 0%. Flipping the interest rate chart upside down shows how the bond king Bill Gross of PIMCO traded his way into a personal $2.2 billion fortune over the last 30 years:

But markets do change. With the stock market now flat and bond yields at zero, the market is about to change again. Those of you with financial advisors putting your money into bonds should pay attention. If you don't believe me, how about the bond king himself, Bill Gross? Here's what he wrote
just last week (my emphasis):

How many ways can you say it’s different this time?” There’s “abnormal,” “subnormal,” “paranormal” and of course “new normal.”…

Interest rates were lowered and assets securitized to the point where they could go no further and in the aftermath of Lehman 2008 markets substituted sovereign for private credit until it appears that that trend can go no further either. Now we are left with zero-bound yields and creditors that trust no one and very few countries. The financial markets are slowly implodingdelevering – because there’s too much paper and too little trust. Goodbye “Old Normal,” standby to redefine “New Normal,” and welcome to 2012’s “paranormal.”

Bill is a billionaire himself. And he also manages more than a trillion dollars of other people's money, including millions of retirement savers, public and private pension plans, educational institutions, central banks, foundations and endowments, among others. So you can be pretty sure he doesn't use words like "imploding" lightly.

Remember, I'm talking about "how changes in the monetary and financial system could affect your savings." I don't want you to buy anything on my (or anyone else's) recommendation. I want you "to understand the reasons for the investment yourself." And I asked, "do systems ever change or implode," and "is it ever fair to say this time is different?" Well, you just heard a mainstream billionaire bond fund manager answer "yes" and "yes."

In fact, history is chock full of stories about financial and monetary crises and change, and there is a part of these stories that often gets only a one-line mention, buried in between the descriptions of the chaos and the subsequent resolution. That line usually reads something like this: "Many elderly investors lost their life savings." That line is from an actual American story. Here's another one: "[Group 2] got lump sum payments that roughly equated to 15% of the actuarial value of their [savings]. Group 3… got nothing."

So why buy gold? Why buy only discrete coins and unambiguous bars of physical gold? And why right now? A historical perspective is necessary for understanding the answers to these questions. Crisis resolutions always involve the sacrifice of someone. And that someone is usually the savers. But there are always winners and losers. Devaluations play out like a seesaw. There is a force (the crisis devaluation), a fulcrum (what is being devalued against), and a load (the beneficiary or the winner).

I think if we are going to try and talk about gold with gold-resistant savers, we first need to think about why they save in the way that they do today, pretending to be investors and traders, and how it wasn't always this way.

The Studebaker Effect

Most of you reading this in the U.S. probably have some sort of an individual retirement account. Maybe you have a Traditional IRA, or a Roth IRA, a SEP IRA, Simple IRA, a 401(k) plan, or even a Self-Directed IRA. Or maybe you don't have your savings tied up in a tax advantaged account but you still invest in the same way, relying on the advice of an RIA, a registered investment advisor.

If this is you, then you probably also have a diversified mix of stocks, bonds and cash or cash equivalents. Perhaps you even have some non-dollar investments, foreign stocks, commodity positions or fancy REITs. Maybe you've got a little in the tech sector, a little in the banking sector, some in the energy sector and the rest in mutual funds. But have you ever stopped to wonder why this is the way we save today?
Was it always this way? No, it wasn't.

The 1970s were a pivotal decade of change in so many ways. The 70s were not only a decade of high inflation, it was also the first time the U.S. blew the lid off the idea of a "permanent" debt ceiling by introducing the concept of "temporary" increases (later made permanent) and driving U.S. debt into the $Trillions by the end of the decade. In 1979, the House of Representatives passed a rule to automatically raise the debt ceiling when passing a budget, without the need for a separate vote on the debt ceiling itself. This was just one of many big changes that came out of the 70s.

The 70s decade was also the pivot point at which the U.S. switched from a trade surplus to running a perpetual trade deficit. And it was when we changed from being the world's greatest goods producer into a service-driven economy. And in 1974 Congress passed a bill which President Ford signed into law that forever changed the way we save. A law that eventually exploded into the constellation of investment options I just enumerated.

That bill was the Employee Retirement Income Security Act of 1974, or ERISA. But like all of the systemic changes that occurred in the 1970s, the roots of ERISA can be found in the 1960s, 1963 to be exact.

Before 1974, most people's retirement savings were in the form of a "defined benefit" from their employer. If you worked for a company until a specified age, you were "guaranteed" a defined, nominal benefit for the rest of your life. This system was similar to the pension funds used mostly for union workers today, only back then pensions weren't just for unions. The bottom line was that the burden of saving for retirement was on your employer, not on you.

As a pensioner, the comfort of your future retirement was in the hands of a single counterparty, your employer. Post-ERISA, most people put their hopes for retirement in the hands of a more diversified group of counterparties. With a single counterparty, default, mismanagement or fraud was and is a big risk. Secondary risks were the systemic ones, like a currency collapse, because it was your benefit that was nominally defined. Post-ERISA most companies (and individuals) switched to plans based on employee contributions rather than defined benefits.

This was a dramatic shift of burden. By the simple addition of choice, the burden of retirement savings was shifted from your employer to you. You now had not only the choice of how much to contribute, but also where to put your savings. With the old system, the payoff was a fixed, nominal promise. Through ERISA, your retirement is no longer fixed at a certain number of dollars. It now varies based on the amount you save, how you choose to invest it, and how the market values those investments when it comes time for you to retire. This can be a good thing or a bad thing, depending on what happens between now and your retirement.

In many countries other than the U.S., countries that experienced a currency collapse during the last century, it was mostly the pensioners that were wiped out. Owing only a fixed, defined number of currency units to retirees turned out to be a blessing to pension funds in these countries. Pensioners could easily continue receiving their promised $2,500 per month forever, even well after the price of toilet paper had risen above $10,000 per roll.

But getting back to the roots of ERISA in 1963, it was mismanagement and default that destroyed the retirement hopes of many people. The collapse and ultimate liquidation of the Studebaker Automobile Company was pretty orderly on the surface. Production lines were consolidated, then closed, then sold off and renamed. But it was the loss of Studebaker's employee retirement fund that started a movement toward system-wide pension reform.

By the time Studebaker closed its South Bend plant in 1963, its pension fund was so poorly funded that the effect of its default would reverberate for the next five decades. Of 6,900 Studebaker employees that had not yet retired or at least reached retirement age, 4,000 received only 15% of what was the actuarial present value of their savings, and the other 2,900 got nothing. MF Global anyone?

So the Studebaker effect became a systemic transition shifting both the burden of saving and the responsibility of decision-making onto the people themselves. And out of this transition grew the whole financial services industry as well as the full menu of investment choices listed above. Incidentally, and speaking of MF Global, another child of the transitional 70s and the Studebaker effect was the Securities Investor Protection Corporation, or SIPC.

The SIPC promises up to $500,000 insurance for individual investors against broker-dealers that go bankrupt. That is, unless a loophole can be found. Unfortunately for MF Global's customers, the vibrant commodity futures market came later than the SIPC which was only written to cover financial securities, not futures. So while the 400 securities accounts at MF Global were covered by insurance, the other 50,000 or so commodities accounts were left hoping they'll get back more than 72¢ on the dollar. Oops. Oh, and the CME also decided not to back the accounts. It seems nothing is for sure when it comes to counterparties.

The Gold Thesis

The above is a brief description of how the 70s were a decade of many changes. And also how changes in the 70s led to the way we save today. This is important to understand because I think we are in the midst of another historic transition period right now. I think this present period will be viewed by history as far more dynamic than the 70s. And I think the lessons learned from the experience of the 1970s will ultimately prove to be a poor guide for financially navigating this transition.

The evidence is already in — physical gold is "the load," set and levered for revaluation, as in the illustration above. The fulcrum is all other hard assets. And financial securities of all types, the nominal promises of counterparties, bonds, cash and cash equivalents are all vulnerable to the devaluation force. It's a three-part dynamic with hard assets—the middle part—acting as the denominator for both a devaluation of paper promises from counterparties and a revaluation of physical gold (it should be telling that we need to qualify such an elemental word as gold) and physical gold only. And from my
Euro Gold post, here's the lever in early action:

The way people save today is traceable back to the collapse of the Studebaker pension fund and the reform movement that followed. In its 50 years of making automobiles, Studebaker exploded into a large and diversified company that, by 1960, included a missile and space technology division, a home and office appliance division, a tractor division, a generator division, a refrigeration division, a chemical division, and even an airline division. But within a few years it was collapsed, condensed, consolidated, liquidated and closed. And in the process, the employee savings were erased. The savers were sacrificed.

Similarly, the investment landscape that followed has exploded in supernova fashion yielding nominal credits that number like the stars in the heavens. Today's savers have given their savings to every manner of counterparty who went on a spending spree, leaving only the illusion of a debt that is too big to even be serviced in real terms. We have spent the last 35 years exploring the Milky Way galaxy of investment options, pretending to be investors and traders, when all we really are is savers waiting, once again, to be sacrificed.

It seems to me that we are now in the consolidation phase of change, heading back down to Earth. And where you choose to land, to consolidate your savings, has never been more important than it is today. I believe we are in a new transition period that is necessary, natural and inevitable (unstoppable). And that is why I don't take the quixotic stance of an activist, fighting to change the world. The only action I advocate is personal action, like purchasing power preservation and the personal action of expanding your understanding beyond the standard dogma you hear everywhere else.

And for those of you who are also struggling through the frustrating world of the gold-resistant paperbug, I'm looking for feedback so I can continue this project. What anti-gold arguments are you running into these days? And also, what worked for you? Has anyone had success introducing a Western paperbug to gold? I thought Victor's comment
here, on the permanent portfolio, was very good. Those are the kinds of solid arguments I'm looking for. Perhaps, together, we can come up with a few more!



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My son is in 4th year business and seems enamored with the paper market and a future as a stockbroker. When I speak with him about gold or silver its almost like a different language. Tangible vs nontangible assets. He can cite numerous paper longs and shorts with which to " neutralize risk ". But its always more paper upon paper.
To suggest to him that maybe a portfolio should contain 5% physical precious metals seems so far off the main stream.
I had some success in the house insurance analogy. If you have a $400,000 dollar house you buy insurance each year for about $1,000 right. Why if the friggin house will never burn down. Well sometimes they do.
So I ask my son, if you have a $400,000 investment portfolio why would`t you consider buying an insurance policy. Buy $1,000 silver or gold each year.
The most notable difference is that at the end of each year you still have the $1,000 in metal. You don`t get your check back from the Insurance company for your house insurance.
Of course I recommend the original portfolio already include 5% physical metals.
I`ll keep working on my son but have to wonder about the business school.
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My son is in 4th year business and seems enamored with the paper market and a future as a stockbroker. When I speak with him about gold or silver its almost like a different language. Tangible vs nontangible assets. He can cite numerous paper longs and s  Read more
frankkarl - 1/13/2012 at 5:12 PM GMT
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