Tuesday, 19 April 2022 — Gold Coast

[9 min read]

Dear Reader,

War. Food shortages. Shanghai in lockdown. Commodity prices rising. Interest rates being dialled up.

None of this seems to matter. Since its early 2022 sell-off, Wall Street has stabilised.

The Fed still presents an outward appearance of having matters under control.

Don’t be fooled by these fools. They’re beyond incompetent.

In opting for the easy growth option…suppressing rates for way too long to encourage an already overleveraged system to leverage up even more…these economic buffoons will make us reap what they’ve sowed.

And the harvest is going to be anything but bountiful.

If the Fed tries to play catch-up on runaway inflation by dialling up rates, the debt servicing pain in household, corporate, and semi-government will be excruciating. Defaults are sure to follow…the weak hands fold first, but it won’t stop there.

If the Fed doesn’t act on the higher-than-desired inflationary conditions, we have stagflation…high inflation and slow growth.

While it may not seem like it now, the good times are well and truly over.

Are we entering a 1930s (deflationary) or 1970s (inflationary) environment? I don’t know. It could be a bit of both…deflationary shock from a massive collapse on Wall Street followed by an inflationary surge from a panicked money-printing Fed.

What I do know is that now is the time to get your house in order…the decade ahead is going to be nothing like the one we’ve been through.

Over the next three weeks, I’d like to share what I’ve learned from 36 years in this business.

My prudent approach to managing finances was far from fashionable during the greatest speculative boom in history. With hindsight, we know that period was a time when caution should have been thrown to the wind.

Now is the time when caution should be treasured…not tossed.

Lessons learnt from 36 years in financial planning

The past four decades have been an exciting time to be involved in investment markets.

From its humble beginnings in the early 1980s, the investment industry has evolved into a multi-multibillion-dollar industry.

This phenomenal growth has not been without its fair share of heartache and setbacks. Each market downturn and product failure provided valuable learning experiences.

There have been many drivers contributing to the industry growth — compulsory superannuation, massive credit expansion, baby boomers moving towards retirement — but in my mind, the industry’s success was largely underwritten by the US share market’s 35-fold increase in value.

This history-making performance supported the industry’s narrative ‘In the long run, shares always go up’. Investors and industry players had little reason to doubt the legitimacy of this storyline.

While the market went from high to high, interest rates were falling from 18% to zero. Without these dynamics at play, it’s my contention the investment industry would not have prospered to the extent it has.

The bursting of this massive credit bubble will give rise to a new set of dynamics. Ones that I suspect — in time — will see social mood switch from overly optimistic to extremely pessimistic.

The global economy is undergoing structural transformation…the end of globalisation is a huge game-changer. In due course, the bubble economy is going to deflate in almost every corner of the world.

Based on the established principle of ‘For every action, there is a reaction’, the next decade (or possibly two) is unlikely to be as friendly to share investors.

The tailwind of credit injection now becomes the headwind of credit rejection.

So after 36 years in the investment industry, what have I learned to prepare me for the difficult market conditions that appear destined to confront us?

Humility

Being respectful is an important quality of life. Pride and arrogance often lead to spectacular falls, as demonstrated by the long list of failed entrepreneurs.

The world’s central bankers would do well to exercise a little humility. The hubris on display from the Fed chairpersons past and present has been particularly galling.

Consider this extract from the CBS 60 Minutes interview with former Fed Chair Ben Bernanke, conducted 5 December 2010:

60 MINUTES: ‘Can you act quickly enough to prevent inflation from getting out of control?’
BERNANKE: ‘We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time. Now, that time is not now.’
60 MINUTES: ‘You have what degree of confidence in your ability to control this?’
BERNANKE: ‘One hundred percent.’

100% confidence in his ability to control the economy — what conceit.

This is the same Ben Bernanke who told us in March 2007:

‘…the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.’

And, two months before Fannie Mae and Freddie Mac collapsed and were nationalised, Bernanke said:

‘They will make it through the storm.’

Janet Yellen and Jerome Powell have proven to be just as clueless as Bernanke.

Bubble? What bubble?

The latest Buffett Indicator (named after Warren Buffett, who called it ‘probably the best single measure of where valuations stand at any given moment’), is in a valuation stratosphere all on its own:

I lack the academic pedigree of the Fed’s FOUR HUNDRED PhD economists, but the school of hard knocks has taught me to respect markets. My cautious outlook and simple approach on portfolio construction is borne from being taught very painful lessons from markets.

When this bubble does burst, the Fed is going to suffer irreparable reputational damage…of that I am certain.

However, for investors who mistakenly believed the Fed has the power to control market forces, their damage will be…financial.

When it comes to protecting your hard-earned capital, a little humility goes a very long way.

There are no new ways to go broke — it is always too much debt

‘Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works.’

John Mills, On Credit Cycles and the
Origin of Commercial Panics, 1867

155 years ago, John Mills recognised the folly of man, money, and mania. Nothing has changed. Debt is the common denominator in all financial disasters.

Those who live by the creed ‘You have to bet big, to get big’ can be lucky…but they’re in the minority.

The majority end up wrecked on the rocks of financial reality.

Hyman Minsky said, ‘Stability breeds instability.’

The longer a trend is established, the greater the certainty in the investors’ minds it is going to continue…forever.

This is a repeatable pattern.

I witnessed it firsthand during the last speculative boom.

The following spreadsheet from the Reserve Bank of Australia (RBA) website shows the volume of Margin Lending from June 1999 to March 2009.

In June 1999, total margin lending stood at $4.713 billion. Fast-forward to December 2007 (the peak of the Australian share market), and total margin lending had increased to a mammoth $41.589 billion — nearly a ninefold increase in the decade.

The quarterly data provides a fascinating insight into the greed mentality that gripped investors during the 2003–07 bull market. Four straight years of 20%-plus returns per annum bred complacency.

The longer the boom continued, the more investors borrowed to participate in what they (incorrectly) perceived as a perpetual growth machine:

The Storm Financial debacle should be a warning on how badly this ill-conceived ‘borrowing to invest’ strategy ended.

Belief in the myth of perpetual growth cost many Storm Financial clients their life savings and their homes…and they were at a stage in life when they could ill afford losses of this magnitude.

Be prudent.

If you have debt, make sure you’re able to weather a sustained period of negativity.

My preferred creed is ‘Slow and steady wins the race’.

The best luck is bad luck

Success without bad luck is a disaster waiting to happen. Bad luck and misfortune teach you to appreciate the good times. Success without setbacks is conditioning you for a Minsky moment — your continual success will inevitably breed your failure.

You’re not an investor unless you’ve lost money. The secret is to avoid the ‘Oh sh*t...life-altering loss range’, like those invested with Storm Financial.

These ‘ouch’ moments (should) teach you the respect I mentioned above — sometimes we (mainly males) need more than one lesson.

Don’t beat yourself up over your loses, look at them as ‘school fees’.

Looking back at my ‘bad luck’ experiences, I recognise they resulted from not really understanding the investment, acting on impulse and/or greed.

Thanks to the lessons learnt, these days my approach to investing is much more disciplined and very simple.

Never bet the house. Be emotionally equipped to handle downside. Never be afraid to take profits.

The adage of ‘The harder I work, the luckier I become’ is so true…you have to work hard on creating and retaining long-term wealth.

We are fast approaching a time when the work you’ve put into understanding why this period of speculative mania cannot continue will reap you substantial dividends.

Until next week…

Regards,

Vern Gowdie,
Editor, The Daily Reckoning Australia

Dear Reader,

Good Friday, 2022

As long-time sufferers of this blog know, we are part-time residents of a country ahead of the US. Whatever dumbbell thing US politicians, opinion mongers, and the Establishment Elite do in the US…the Argentines have already done it, more than once…and with style.

And so…when we’re down here, we keep our eyes open…and learn something.

This morning, for example, we have a crew of five masons and labourers working on a low stone-and-adobe wall. It is meant to hide the irrigation canal from the house:

At least three of them are skilled stonemasons. They’ve been working for three days assembling stone and adobes, sand, mud, and cement. They begin at 7:30 in the morning. They take a two-hour break for lunch…and work until about 7:00 in the evening. It looks like they will spend three weeks on the job.

They bid US$3,000 to get the job. After materials, that works out to about US$33 per person/day. They will consider that a very good wage.

In the US, a mason should earn about US$25 an hour. Or around US$50,000 per year. Why the big difference? What makes a mudslinger so much more valuable in the US than in Argentina?

Unions, socialism, and demagoguery

Could it simply be a matter of public policy? Like the US, Argentina has abundant resources and a European culture. And until the 1940s, it was on a similar path of development with income per capita much like England or France.

But Argentina had more Italian immigrants than the US. They were fond of trade unions, socialism, and demagoguery. They poured into Buenos Aires early in the 20th century and quickly became the dominant base of voting power. Ever since, the political maths always adds up to the same thing: promise the Buenos Aires mobs more free stuff…and get elected.

Like the US, the Argentine government routinely spends more than it can afford. Typically, it borrows the rest…and then stiffs its creditors 10 years later.

Private lenders are naturally wary. If they’re going to lend any more money to the gauchos, they need high interest rates to make up for the high likelihood that the latter won’t pay. This limited how much the Argentines could borrow.

But then, along came the Great and the Good…central bankers from the US and Europe…who decided that the world would be a better place if it had lower interest rates…and more money sloshing through its accounts. The idea is that money begets output. And more output equals more real wealth.

On the surface of it, any dope can see that the proposition is fraudulent. The whole thing is backward. The great French economist Jean-Baptiste Say explained it in the 19th century: You don’t actually buy products with money, said he; you buy them with other products.

You have to give to get, in other words. You provide something of value to others…so they’ll provide something of value to you. Each person, trying to get more for himself, is thereby forced to give more…and thus (as if guided by an ‘invisible hand’) contributes to the material progress of the entire world.

Money is just a ‘medium of exchange’. It is like a claim ticket for a car in a parking garage. The attendant can give you two tickets; you still won’t have two cars.

A century of debt

But persisting in the old fallacy — that money itself is the source of prosperity…and that printing up more money will ‘stimulate’ output — central bankers provided the world with so much new credit that even the Argentines could borrow at low rates. Naturally, they were happy to let others err on their behalf.

The Wall Street Journal reported in 2017:

‘Argentina sold a 100-year bond on Monday, the latest sign of investor hunger for yield as the country joined a small group to sell so-called century bonds. The Argentine government raised $2.75 billion through the debt issue with a yield of 7.9%, the country’s Ministry of Finance said.’

A one-hundred-year bond? From Argentina?

Your editor laughed out loud. Statistically, the country would go broke 10 times before the bond was repaid. But for a few months, the joke was on him. In December of 2017, the ‘Century’ bond traded above par. And then gravity took over. By 2019, the bond had lost 60% of its value.

And then, on Thursday, the gauchos announced a new central bank lending rate. Not because they wanted to, but because the IMF — the only lender still dumb enough to talk to them — insists upon it. From Bloomberg: ‘Argentina Raises Key Rate To 47% as Inflation Hits 20-Year High’:

‘Fourth rate hike this year as prices rose 6.7% m/m in March

‘IMF agreement calls for real positive interest rates

‘Argentina’s central bank raised interest rates for the fourth time this year after inflation data published earlier in the day showed prices increasing at the fastest monthly pace in 20 years.’

Yesterday, the 10-year Argie bond yielded 49%. If you could earn 49% on a 10-year bond, how much would a bond with a coupon of 7.2%, maturing in 2117 be worth?

Not much.

But while Argentines slide smoothly into poverty, Americans stumble. With no IMF to discipline them, their central bank lends deeply negative rate — about MINUS 7.7%.

And pity the poor US mason. He’s being crucified on a cross of paper money. If he is lucky, he may get a 5% wage increase this year. Correctly measured, consumer prices are rising at about a 13% rate. This will mean a pay cut for him of about 8%...or a loss of US$2 per hour.

That’s just the way it’s supposed to work. Inflation is a tax…a way of ripping off the working classes. It worked for Argentina’s political bosses. It will work for the US’s jefes too.

And perhaps on some Good Friday, in the glorious future, you’ll be able to hire an American bricklayer — in the post-dollar money of the time — for about US$33 per day.

Happy Easter,

Bill Bonner,
For The Daily Reckoning Australia