Friday, 24 May 2024

By Nick Hubble Editor, Strategic Intelligence Australia

[4 min read]

Dear Reader,

Central bankers have declared victory in the war on inflation. But the gold price is screaming, ‘Liar, liar, the money’s on fire!’ It just hit another record high.

If inflation were back in the bag, gold would be trending the other way.

So, whom do you believe?

Has inflation finished with you? Or has it just begun?

You might find the answer in the “In Gold We Trust” report. It’s free and comes out every year.

Although the title is a bit of giveaway, it still has a lot of useful analysis.

And, best of all, a lot of historical context. This is something investors often fail to take into account at their peril, especially during inflationary periods.

You see, inflationary bouts tend to defy human awareness in a clever way.

They tend to be gentle enough to avoid panic, and last long enough to remain hidden in plain sight.

It’s an insidious combination. Boil the frog slowly, and all that.

As Ronald Reagan should’ve said, 'Inflation is as violent as a mugger, as frightening as an armed robber and as [stealthy as a cat].'

Thanks to its insidious nature, investors fail to panic about inflation when they should. Before we know it, our portfolio is being taxed for a 50% capital gain while its real value has halved.

Which probably sounds a bit drastic. But consider the last three years’ action alone.

Inflation in Australia pushed prices up more than 15% between June 2021 and March 2024. If you believe the government’s statistics, that is.

The ASX200 is up less than 7% since June 2021.

Throw in your marginal tax rate on that capital gain and you add insult to injury.

Repeat the process for a decade or so of inflation and you will know what hit you when it’s too late. Unless you’ve already woken up to what’s going on.

The gold price, by the way, is up about 40% over the same timeframe.

It has also outperformed stocks over many longer time horizons too. That’s because we live in an inherently inflationary system.

It’s the age-old lesson of inflation…

Hard assets beat paper profits

It’s not just gold that’s hurtling higher, of course. Silver and copper are on a tear too. Even after a severe correction this week, inanimate lumps of metal are outperforming stocks.

And that’s the big hint, really. Read your history books and you’ll notice inflationary periods are full of this type of price action.

But it’s not quite that simple. Inflation doesn’t just steadily rise and persist, allowing you to get a grip on it. It jumps around all over the place.

Fortunes are made and lost speculating. Not investing in productive things, mind you. Just taking punts on the price of plain old stuff.

That’s what makes inflation so dangerous to an economy. It rewards unproductive behaviour. And wreaks havoc with the sorts of long-term investments needed to raise productivity – the true source of prosperity.

You can choose to join the speculation mania. Or evade it.

The best way to opt out is to buy assets which resist this boom and bust behaviour. Preferably by being incredibly boring. And what’s more boring than a lump of metal like gold?

But buying and burying gold is not the only way to profit.

The best in the business of inflation speculation was Hugo Stinnes. You might want to learn a trick or two from him if you agree inflation is merely taking a breather.

I wrote about him back in April 2021. That was weeks before the inflation scandal began…

***

The Inflation King

Hugo was born in Mülheim, into a wealthy family which owned a coal mine and other businesses. My ancestors likely worked for him as coal miners and I was born in the neighbouring town.

Understanding what was to come of the Weimar monetary policies, Stinnes borrowed heavily in Papiermark – literally the “paper money” of Germany at the time. And he used the proceeds to buy up mines and other capital intensive real assets like shipping, forests and steelworks.

His business empire rapidly expanded under the load of debt. In fact, he even became a banker just to leverage up his own businesses even more. (The Japanese were a fan of this tactic in the 80s, but that’s another story.)

Hugo became Germany’s largest employer in the process of his expansion – about 1% of the entire German population worked for him. And he was a key figure of the political scene too. He was known as the Inflationskönig – inflation king. But it was all a big gamble on what would happen next.

As inflation exploded under Weimar policies, Stinnes’ debts became easy to pay off. That’s because those debts were denominated in money, but money became worth less and eventually worthless. The value and output of his real and productive assets meanwhile soared in price during the inflation, making it easy to repay the fixed debt with vast cashflow.

All this happened 100 years ago. Although, it’s beginning to happen again. Central banks are printing vast amounts of money to try and finance out of control government deficits.

***

Rising commodities over the past few months are signalling another wave of inflation is coming. Perhaps it’ll even arrive this year.

Am I suggesting you should leverage up to the hilt and buy copper ingots?

No!

Inflationary periods are too volatile for that. All sorts of chaos and crashes happen along the way.

But you might want to consider speculating in the stocks of mining companies. The sorts of firms Stinnes might’ve bought himself.

By the way, the reason why inflation will make a comeback is the same as in Stinnes’ day. And it’s the same reason inflation ebbed and flowed repeatedly in the 70s too.

Government debt remains a problem. And inflation shocks remain the only solution to that problem. More on that soon.

How to protect yourself from
inflation’s comeback

If inflation were a simple devaluation of money, it’d be easy to protect yourself from. You just borrow money at a fixed rate and buy real assets like gold and silver.

But it’s not that simple. Any gold and silver investor back in the 70s will tell you.

Inflation can suddenly plunge, as it has recently. Interest rates can surge too.

Sometimes, the inflation occurs in assets. That’s what happened in 2009. Sometimes it occurs in consumer prices, like in 2021.

Inflation can benefit businesses by allowing them to raise prices. Or it can destroy them by raising their costs. The wave of bankruptcies in the Australian home builder sector is a prime example of what can go wrong.

So, if you want to go beyond owning precious metals like gold and silver over the long term, the challenge for investors expecting inflation is surprisingly difficult.

You need an experienced hand to guide you through the ups and downs.

Until next time,

Nick Hubble,
Editor, Strategic Intelligence Australia

Nick Hubble found us at Fat Tail Investment Research in 2010 after a stint inside Wall Street’s most notorious bank, Goldman Sachs, during the 2008 GFC. That’s where he saw the true nature of the investment banking business. Since then, he’s been the editor of the Daily Reckoning Australia and the UK-based Fortune & Freedom and Gold Stock Fortunes.

He’s delighted to work as Investment Director and Editor for Jim Rickards’ Strategic Intelligence Australia. Here he helps turn Jim’s big-picture views into specific actionable advice and ideas for Australian investors.

By Bill Bonner Editor, Fat Tail Daily

[4 min read]

‘Economic power, measured on the basis of GDP calculated according to the current rules, is fictitious.’  

Emmanuel Todd 

We began this cogitation by wondering what was wrong with ‘the West’. Even with 30 times more GDP firepower it still can’t win a war against Russia. 

Then we noted that economies can look good on paper — the Soviet Union, Nazi Germany — but actually be destroying wealth, rather than creating it.  

We’ve seen, too, that much of Wall Street’s activity — supposedly trading capital assets — is little more than reckless gambling in meme stocks, NFTs, cryptos, and even good companies where the price bears no relationship to the real value. That is, these are not real capital assets at all — but phantoms and frauds. And if you looked at the trading activity in numbers alone, you’d get a very false idea of how much America’s businesses are worth. 

Looking more closely, we began to wonder more broadly. How come we have to pass our bills onto our children — $35 trillion in government debt alone? How come the average guy hasn’t had a real salary increase in half a century? And in today’s news, Fortune: 

‘... a new American Airlines flight attendant will have a projected annual salary of $27,315 before incentives and taxes are collected. 

‘The union has also been calling out the low starting pay, which for a single-income household, meets the qualification criteria for the federal Supplemental Nutrition Assistance Program (SNAP), or food-stamp benefits, in several states including Massachusetts and New York.’    

Is capitalism failing? 

If we had a nickel for every time an economist proposed that ‘capitalism has failed’, we’d have to reinforce the floor joists. Capitalism never fails. It just adapts to whatever restrictions and circumstances we foolishly impose on it.  

In the economy of Henry Ford, the US was a freer, ‘more capitalist’ nation. It respected the three things that make capitalism’s win-win deals possible — property rights, enforceable contracts, and real money (backed by gold). 

Today’s economy still has property rights, and contracts are still enforceable in government courts, though capitalism today is subject to much more meddling and intervention today than it was a hundred years ago.  

Credit Money

The big difference is that today’s economy functions on credit, not on real money (cash). The change occurred on a now-familiar day, August 15, 1971. Thenceforth, foreign governments could no longer ‘settle up’ with the US by trading dollars for gold. 

The change was scarcely noticed. Even today, more people remember who won the 1971 world series — the Pirates — than the switcheroo that distorted the whole world’s money system.  

Henry Ford got rich by making something people wanted. No government subsidies were needed. No vast ‘industrial transition’ was announced. No grants given. No tax breaks. No program to set up filling stations all across the nation.  

Ford sold his cars at a profit. And he increased his workers’ wages, in real money, backed by gold. 

If Ford wanted to make more money, he had to produce more cars... better cars... and make them more efficiently. That’s how an honest capitalist economy works. You get by giving, not taking. 

And today, yes, there are still a few genuine capitalists around. Elon Musk, for example, who is said to ‘sleep on the factory floor’ from time to time. And our new neighbour in Ireland, James Dyson, personally oversees the development and manufacture of hair dryers, vacuum cleaners and so forth. 

Most would-be billionaires, however, head not for the real economy of things, but for the financialised fantasies of Wall Street. They set up hedge funds...or go into venture capital...or do mergers and acquisitions; their hearts may be sooty, but their hands are clean.  

Why Wall Street? Because that’s where the new credit-based money is. In Henry Ford’s day, credit came from savings...and savings came from work. You had to earn it — by creating more real GDP — before you could save it. You couldn’t just create new money or new savings ‘out of thin air’. Because, ultimately, you had to square up with gold.  

But all that changed in 1971. Today, the big banks just borrow credit money from the Fed — often below the level of consumer price inflation. Thus, did the US begin another Misguided Economic Experiment... and another one that was destined to fail.  

The new money system was based on an illusion — that the ‘credit’ provided by the feds was every bit as good as old-fashioned savings. That led to another, even more dangerous illusion, that the Fed could increase the amount of credit available as much as it wanted... and that it, rather than willing buyers and sellers, should determine interest rates. Naturally, they tended towards lower rates, not higher ones. 

Donald Trump is a ‘low-interest rate guy’ for a reason; that’s the way you make money in a fake money system. You borrow cheap, gamble on ‘assets’ (such as New York property) and, then based on the inflated values of your collateral assets, you’re able to borrow even more.  

After 1971, activity (GDP) continued. But the new credit money and artificially low interest rates made it possible to buy things that didn’t really contribute to the nation’s wealth. The feds’ debt, for example, memorialises $35 trillion worth of spending. Every penny of it was recorded in the GDP. But like the Nazi’s bombs... or the Soviet’s soap... most of what it bought was fake, worthless or transitory. 

​​So too, much of the public’s $65 trillion in debt — all registered as GDP — was misspent. That is, the EZ credit made it possible for consumers and businesses to buy things they didn’t really need with money they didn’t really have. ​ 

But wait. The hamburger, eaten in 1995, and now recalled in monthly credit card payments, was real. It was consumed. It was enjoyed. Was it ‘fictitious’? 

No. But the GDP boost it gave was only half the story. That which credit giveth, repayment, default or inflation must taketh away. When the bill is finally paid, GDP should be reduced by a like amount (as money is taken out of the consumer economy to repay the loan). So, as long as debt is growing (with unpaid bills)...it gives us a false sense of real GDP. 

It is as if you bought your neighbour’s car. GDP would go up. But later, suppose you returned the car and got your money back. Economically, it was a roundtrip to nowhere. No real increase in output. GDP recorded the sale as a plus... but not the repayment as a minus. ChatGPT explains: 

‘United States Gross Domestic Product (GDP) does not include debt repayment. GDP measures the total value of all goods and services produced within a country over a specific period, typically a year or a quarter. It includes consumer spending, business investments, government spending, and net exports (exports minus imports).’ 

In other words, GDP only reflects half the transaction! 

Now, imagine that you borrowed the money to buy the car...and kept it. But still not paid for. GDP shows a ‘fictitious’ gain. It is ‘fictitious’ because there is an equal and opposite reduction to output still unrecorded. 

Total US debt — now reaching $100 trillion — represents increases to output that still haven’t been paid for. How much of that is bogus GDP? Impossible to say. Some of that will be repaid. But the traditional relationship of debt/GDP is 1.4 to 1. So, the US should only have about $40 trillion of debt. Much of the rest is probably unpayable...about $60 trillion of phantom GDP, waiting to make the final leg of the roundtrip to nowhere. 

Hang on to your hat. It could be a wild ride. 

Regards,

Bill Bonner,
For Fat Tail Daily