Dear Reader,
Today I would like to talk about a few big themes – deep tides that are inexorably pushing the world of today toward the world of tomorrow. By understanding the tides, it becomes far simpler to make intelligent decisions on how to position our portfolios.
1. Race to the Bottom.
This is a topic I have recently discussed in these musings. The U.S. government has clearly decided to abandon the dollar in favor of a combination of official policies designed to (a) keep the U.S. economy from falling over the edge; (b) engage in a flurry of new "perfect world" legislation; and (c) reduce the cost of repaying its many debts.
Our major trading partners, and those who compete with the U.S. for global business, see very well what is going on and can be increasingly expected to respond in kind. Which is to say, take actions to reduce further appreciation of their own currencies.
In a call yesterday, our own Terry Coxon, who knows more about the subject of money and inflation than just about anybody I know, put it well when he said that history is replete with examples of people and governments making the same mistake over and over again, only in different ways. He pointed out that the 1930s’ passage of the Smoot-Hawley Act led to a devastating trade war whose results were a prolonged and even deeper depression. In the modern context, the trade war will be fought by competitive devaluation. Same mistake, just in a different way.
I don't have time to go into great detail on this, but the topic is nonetheless worthy of great deliberation. You know, a comfortable chair, a notepad, a pipe if you smoke one, or a glass of brandy if you indulge, followed by a good think.
For instance, while many people – ourselves included – have been concerned about what might happen to the dollar should the foreign owners decide to dump their trillions of holdings, that becomes less likely in a competitive devaluation. In that scenario, we might expect to see – and have already seen – foreign governments surreptitiously trading their greenbacks for harder assets, but still showing up at the Treasury auctions in order to help support the dollar. This is, of course, the equivalent of monetary nirvana for the U.S. government, because it gives it the ability to continue spending without the painful flip side of being forced to offer higher interest rates.
In time, the foreign buying of such massive quantities of unbacked debt from a bankrupt nation will cause great damage to their local economies, but, as is the case with politicians the world over, their views are heavily skewed towards the short term. In other words, they are doing whatever they think they need to do to prevent their economies from hitting a brick wall. (And in some countries, to avoid having their own backs put up against that wall while being offered “Blindfold or no blindfold.”)
Likewise, all this Treasury paper floating around the world will eventually come back in this direction – but if the administration manages things right, it'll land on the doorstep of some future president and her political cronies.
(Click to enlarge)
As you reflect more deeply on the implications of the race to the bottom, you’ll probably come to the conclusion that hard assets ultimately have to be the beneficiary – not just against the U.S. dollar, which has primarily been the case lately, but against all the major currencies.
Looking at the tit-for-tat dance of the U.S. dollar versus gold this year provides a useful glimpse of where things are headed.
Okay, so that's one big theme. Now, let's check our assumption and try to see if this analysis could be wrong. What if, instead of engaging in competitive devaluation, the Chinese, the Europeans, Japan, India, etc., etc. decided to actually raise their interest rates, therefore boosting the value of their currencies?
Considering that the U.S. administration is looking down the barrel at tens of trillions of dollars of unpayable obligations and appears eager to spend trillions more on social engineering, and further considering that a second leg down in the U.S. economy is all but certain -- the odds are good that the U.S. government would not follow suit by raising its own interest rates. Coupled with energetic deficit spending, the only possible outcome would be that the dollar would sink against global currencies even more quickly than it has so far – giving U.S. manufacturers a serious competitive advantage both here and abroad.
While the U.S. consumer is certainly not the spendthrift fool of the recent past, they are still an important market for many countries, and the exports of those countries would be quickly derailed. Likewise, U.S. exporters would be able to aggressively go after new markets and expand existing ones at the expense of world suppliers.
And if the Chinese et al. stayed away from U.S. Treasury auctions? The Fed would have little choice but to ramp up its monetization of the government’s spending. That would accelerate the downward spiral of the U.S. dollar, causing the foreigners big losses in their dollar holdings, with none of the commercial advantages of having their own currency remain more or less at par.
Of course, the best-laid plans often don't work out quite as hoped. Right now the U.S. government's plan – which foresees a steady but not dramatic devaluation – could be turned upside down if, for reasons entirely of their own, the Chinese or the Russians or the Middle Eastern oligarchies, or all of them together decided to wipe the proverbial floor with the greenback. After all, while these countries are willing to suffer a certain degradation in their dollar holdings, people do have their limits. With the dollar down 15% since March, a very big number for a major currency, we may be skating near the edge.
Be that as it may, history's lesson places the odds on a competitive devaluation, and that is what we need to watch out for.
2. It's Not Over.
Casey Research CEO Olivier Garret and I share a number of interests outside of battle golf, one being a twice-a-week torture session with a former Marine down at the local gym. For reasons I have never bothered to explore, Olivier and I are the only two males that show up regularly for these sessions – the balance of the 20 or so other routine participants being of the sturdier sex. Most men, on those rare occasions when they do show up, start out strong but end up having to be helped to a seat and offered water as a restorative before being escorted on wobbly knees from the class, never to return.
One of the women in the class, whom I was partnered with today, is the owner of a small and formerly successful ski inn. In between all the jumping about and lifting of heavy objects, she told me that business is miserable, despite this being peak leaf-peeping season here in the Northeast. Due to the lack of customers and the burden of big taxes – she's on the hook for $250,000 annually just in property taxes – she relayed that it would be a close thing for her, but that she knew for certain there would be an outbreak of bankruptcies in town over the next six months to a year.
"No green shoots?” I panted.
“Are you kidding me?” she gasped, holding her cramping side. "It's a disaster."
While there are many likely triggers for the next phase of the crisis, the collapse of the multi-trillion-dollar commercial real estate market ranks among our top candidates. As you can see in the microscopic glimpse provided by my conversation with the local inn owner, the broader sector is in deep, deep trouble. Office and retail space vacancies are soaring, with close to 90,000 commercial properties in the U.S. now in a distressed state... “distressed” being defined as more than 60% empty.
Add to the commercial problem the continued pressure on struggling homeowners, and the potential of millions of new foreclosures in 2010 becomes a near certainty. Of course, we can expect the U.S. government to step in with all sorts of incentives and programs to get people in their houses or to keep them there – which, in a circular fashion, takes us back to the prior point about competitive devaluation. In one somewhat ironic development, the FHA has been doing a land-office business in enticing first-time homeowners with little credit and almost no down payment into buying homes... reloading the cannon for yet another wave of defaults a few years down the road.
3. Government on the Increase.
A moment ago I talked about how governments make the same mistakes, but in different ways. Yet sometimes they make those mistakes in exactly the same way. Into that category falls the rise of statism at the direct expense of capitalism.
Now, if you think that the success this country has unquestionably had since its founding is due to the overall wonderfulness of its government, then you must be full of hope and optimism about what's to come next.
But if you agree that the solid foundation of this country was laid by hard-working, risk-taking individuals who were free to keep most of the fruits of their labor when they succeeded, and that this foundation was so strong that it has weathered a continued chipping away by an increasingly large bureaucracy over the last century, then you can only be concerned about what's happening now.
The rising tide of government will manifest itself in many ways: increasing taxes, increasing regulations, increasing restrictions on the free flow of goods and capital internationally, increasing meddling in the daily affairs of the citizenry -- all that and more are what's coming. I would like to think that this folly will be turned back at the barricades, but I suspect it will not. We won't have to wait long to see how things are going to shake out -- if cap-and-trade and healthcare reform pass, then a new dark age for the individual will have begun. I don't mean to be overly dramatic, but that's how I see it.
As I was going to press, our own Dody Day sent me a link to a YouTube video of Mike Rogers, a congressman I hadn't heard of before, addressing Congress on the flawed nature of the healthcare bill that is steaming toward passage. While I'm not much for political speeches, I can find nothing to disagree with in his comments. You can watch it here.
So, as investors, how should we arrange our affairs to make money from all of this, or at least to avoid the worst? Some quick thoughts:
Competitive Devaluation:
Continue adding gold, silver, and other hard assets to your portfolio. Invest in stocks connected to those assets, including the energy sector, because they will only go up as fiat currencies weaken. But don't chase them, buy only on pullbacks – and there will be pullbacks. For currency plays, look at the Australian and Canadian dollars as resource currencies, which should do better than others in the monetary crisis that we expect will be the final act on the current crisis.
It Isn’t Over:
Doug Casey has often said that in a depression everybody loses. To a certain extent, this is clearly true. For example, I have to assume that if I were to sell my house today – or more correctly, try to sell my house – I would almost certainly have to take a 35% to 40% haircut from what it would have sold for at the peak.
Clearly, the important move for the near term is to be extra cautious. Spread your assets around a number of different financial institutions, dedicate a higher allocation to short-term cash instruments, set strict value targets for any securities you buy – and then don't buy until they hit those targets, and don't forget to take a profit when you have one.
I think it is important to say that we are not overly bearish on the U.S. stock market – or global stock markets, for that matter. But we do think that many sectors, for example insurance companies, the banking sector, real estate companies, hotel chains, are in for a world of hurt. And the broader markets are sure to take a hit when the institutional investors and the masses come to the collective conclusion that there is another leg down.
In time, there will be real value in real companies selling real products to real consumers. But we can be patient in chasing those opportunities. Right now, our overarching goal is capital preservation.
Government on the Rise:
Get a good accountant/tax planner. Consider diversifying your assets internationally, though that door will probably only stay open for a short time to come. Already, the IRS is aggressively going after anyone who fails to disclose the ownership of a foreign bank or securities account, and there has always been talk out of the White House to force multinational corporations to pay higher taxes. While the idea has been shelved for now, a recent article in the WSJ makes it clear it’s far from dead. And I quote:
Obama aides say the administration has set the idea aside for now, but may return to it as part of a broader tax overhaul sometime next year. The White House had billed the proposed change as an overdue fix to the tax code and potentially a key revenue-raiser.
And, I suppose, writing angry letters to your representatives in government each time one of these initiatives comes up wouldn’t hurt either. Then again, maybe it will get you on a list for further questioning as things worsen. Whatever you do, watch cap-and-trade and healthcare – they’ll tell you where things are going.
With that, I must move on. Be cautious and warn your friends; this crisis is far from over.
And that, dear readers, is that for today’s missive. As always, thanks for reading and for being a subscriber to a Casey Research service.
David Galland
Managing Director
Casey Research
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