Britannia Radio

Thoughts on the Greater Depression

The Daily Reckoning | Monday, October 4, 2010 Default or inflation? The only honest way out of this mess, A few sobering words on the downside of asymmetrical risks, Plus, Bill Bonner on investing for the (very) long run and more.. Everything Understanding the Dynamics of Asymmetrical Risk Eric Fry Reporting from Laguna Beach, California... In life, there are things, and there are treasures... Things are common. Treasures are rare. A few days ago, I lost one of my treasures - a cat named Uzi. Yeah, I know, Uzi was "just a cat." But that reality did not make her any less of a treasure. In so many different ways, that little cat made me smile...or laugh. She was just a cat, but she was precious to me...which is why I spent hundreds of hours during the last two years trying to keep her alive. I live next to an open hillside that is home to a variety of wildlife, notably coyotes. But this same hillside is also home to rabbits, mice, lizards, birds and numerous other varmints that excite the predatory instincts of a small feline. So it was next-to-impossible to keep Uzi off that hillside. She would hunt up there almost every day... And almost every day, she would return to the house with some sort of mauled "trophy." As long as Uzi conducted her hunting forays during daylight hours, the risks were very small that the hunter would become the hunted. But as soon as the sun dipped below the horizon, the balance of risk would shift dramatically against Uzi. At nightfall, nocturnal predators like coyotes and owls make the rules for small felines. The problem was; at nightfall, felines still make the rules for mice. And so Uzi was never keen to abandon the thrill of the hunt to return to the relative ennui of watching prime time television from my couch. Given the chance, she would roam the hillside at night. But she was rarely given the chance. I was obsessive about keeping her indoors at night. In fact, I was obsessive about locking her indoors well before sunset. On those rare occasions when she remained outside after sunset, I would scour the hillside until I found her. Sometimes the search lasted a few minutes; sometimes a few hours. But I would continue the search until I found her. Only twice during her two-year life, did I fail to find her. Once, she spent the entire night outside. Once she returned about 1:00 in the morning with a mouse in her mouth. On both occasions, I feared the worst. I assumed a coyote had found her before she found her way back to the house. Three nights ago, the worst came to pass. I searched for Uzi off-and-on from 5:00PM until 2:00 AM. Fifteen minutes after I walked back into the house the last time, I heard the chilling yelps of coyotes that had just captured prey. Their prey was my cat. I was heartbroken...and still am. But I will spare Daily Reckoning readers a feline eulogy. Uzi was, after all, "just a cat." Accordingly, some Daily Reckoning readers - probably the dog-lovers in the crowd - may be saying to themselves, "Wow! Eric's behavior is a little extreme. Why the big to-do about a cat?" The answer is two-fold - one part personal, one part universal. The personal part is that I loved Uzi. The universal part is that asymmetrical risks demand extreme vigilance. Investors take note... First, let's define our terms: An asymmetrical risk has nothing to do with the odds of a given risk, but everything to do with the consequences of a given risk. In Uzi's case, the odds that a coyote would kill her were relatively low, even on a hillside frequented by coyotes. In fact, the numerical odds were hugely in her favor. She spent more than fifty evenings on that hillside before finally encountering a fatal evening. So let's say the odds were 50-to-1 in her favor. But the consequences of that risk were massively asymmetrical. In our hypothetical 50-to-1 risk, Uzi returns to the house alive 50 times out of 51. But one time in 50, coyotes kill her. By the numbers, that's a good risk. In reality, that's a horrible risk. No investor would take a bet like that...at least not knowingly. But investors take asymmetrical bets every day. They accept miserly yields, for example, in exchange for buying the bonds or preferred stocks of bankrupt, or near-bankrupt, companies. In the "Bailout Era" of American finance, risks like these have tended to succeed most of the time. But when they don't succeed, investors lose everything. That's not a smart risk. Some asymmetrical risks are obvious - like playing Russian roulette...or buying a mortgage-backed security from a Goldman Sachs broker. But many asymmetrical risks are less obvious - like jaywalking at night...or placing 100% of one's net worth in a single currency. In all likelihood, the jaywalker will cross the street without incident and the single-currency investors will suffer no harm for lack of diversification. But if the jaywalker happens to encounter a vision- impaired driver or the single-currency investor happens to encounter an imprudent government, something bad will happen...something very bad. We investors cannot afford to turn a blind eye to risks, especially not to asymmetrical risks. We investors cannot afford to take risks that are likely to work, but are likely to wipe us out if they don't work. Understanding your potential rewards is worthwhile. Understanding your potential risks is everything. In today's column, an interview with Casey Research Chairman Doug Casey, Doug explores the potential risk of keeping all your assets in one economy...a risk greatly exacerbated by the fact that the US is hurtling into a period he fondly calls the Greater Depression. Please enjoy... The Daily Reckoning Presents Thoughts on the Greater Depression Doug Casey The Gold Report: Doug, at a recent conference you said that the US ought to default on its national debt now. Why that rather than letting it play out? Doug Casey: Several other things almost equally radical should be done besides defaulting on the debt. I recognize that an outright default is most unlikely, but the national debt should be defaulted on for several reasons. To start with, once the US government defaults on its debt, people will think twice before lending it any more money; giving politicians the ability to borrow is like giving a teenager a bottle of whisky and the keys to a Corvette. A second reason is that the debt is an albatross around the necks of the next several generations; it's criminal to make indentured servants out of people who aren't even born yet. A third reason would be to overtly punish those who have been lending money to the government, enabling it to do all the stupid and destructive things that the government does with that money. The debt will be defaulted on one way or another. The trouble is they're almost certainly going to default on it through inflation, by destroying the currency, which is much worse than defaulting on it overtly. That's because inflation will wipe out the relatively few people who are prudent in this country, those who are actually saving money. Because they generally save in the form of dollars, they're going to wipe them out financially. It's just horrible. Runaway inflation will reward the profligates who are in debt - people who've been living above their means. And punish the producers who've been saving and trying to build capital. That's in addition to the fact it will destroy millions of productive enterprises. A runaway inflation is the worst thing that can happen to a society, short of a major war. They just should default on it honestly, as it were. TGR: But your belief is we'll try to inflate our way out of it to pay for it. DC: Don't say "we." Say the US government. I don't consider myself part of the problem. Americans have to learn that the government isn't "us." It's an entity that has its own interests, its own life, its own agenda. It views citizens as milk cows - or perhaps even beef cows - strictly as a means to its ends. TGR: Whether it's overt or by default, doesn't that end up in the same place down the line? DC: There are two ways they can default - one by saying, "We don't have the money and we're not going to pay you," and the other by continuing to print up money and giving people the number of dollars that they're owed, except the dollars are worthless. The first alternative is by far better, for many reasons we can't fully explore now. But it's going to be traumatic either way. TGR: But the assumption that we could actually just print more dollars and pay off the debt implies that somewhere the debt will stabilize. DC: Oh no. It doesn't have to stabilize. To pay interest on the national debt, and to pay for additional spending, all the Federal Reserve has to do is buy bonds from the US government. It doesn't have to stabilize at all. The government is most unlikely to cut back on its spending, most of which has become part of the social fabric - Medicare, Social Security, unemployment benefits, food stamps, corporate bailouts, continuing foreign wars, domestic "security"...These people are crazy enough that it could get like Germany in the '20s or Zimbabwe a few years ago. TGR: At what point do we tip over and turn into a situation such as Zimbabwe or the Weimar Republic? DC: At the moment we're in an economic twilight zone or, if you wish, the eye of a hurricane. There is apparent stability in the economy. The stock market's high. The bond market's high. Only the real estate market is in visible trouble. Retail prices are level; they're not going up and maybe they're even going down in some cases. This is a temporary situation. We will inevitably - and soon - hit the other side of the storm. At some point those trillions of dollars created by the US government - and many other governments around the world have created trillions of currency units - are going to have an effect. When will that be? The timing is uncertain. But I think it's going to be soon. TGR: Will it be rapid? DC: If these things were perfectly predictable, it would be easier to dodge the bullet. This is an almost unique time in world economic history, and I think we're not only going to have economic consequences, but social and political consequences, and very likely military consequences. So hold on to your hat. TGR: To protect what individual wealth we may have, you've recommended selling real estate and renting, holding assets outside the United States, owning gold, etc. When we're out of the eye and in the thick of this economic hurricane, what types of equity investments should people be holding? DC: Now is a very bad time to have most kinds of equities; stocks in general are very overpriced, by almost every parameter. I'm not looking to sell my gold until I can buy solid blue chip stocks for dividend yields in the 8% to 10% area. That's after they cut their current dividends. Although it's certainly not the bargain it was 10 years ago. Nonetheless gold will go higher. Stocks will go lower. I don't know exactly when I'll sell my gold and buy stocks, but it will be when there's a panic into gold and when stocks are bargains. I'm sure I'll be afraid to make the trade when the time comes - but good trades almost always run counter to your emotions. Perhaps the tip-off will be when Newsweek or Time - if either still exists then - run a front cover with a golden bear tearing apart the New York Stock Exchange. I think it will be a generation before American real estate is a solid buy again. And the world at large will likely have quite a different character then. TGR: I take your point about equities in general, but are you also staying away from gold equities? Or do you maybe see an opportunity there? DC: They're a special situation; on the one hand they are a play on gold, but on the other hand they're stocks. There's an excellent chance that with the trillions of currency units being created, the government inevitably will wind up inflating other bubbles. There's a very good chance for a bubble in gold and a very big bubble in gold stocks. So I would say that they are an exception to other equities. We could see these juniors go up by an order of magnitude or more, even while most other stocks are going down. Historically, junior resource stocks are the most volatile class of securities in existence. TGR: Might other sectors also be in that situation? DC: My crystal ball is hazy, but it seems to me that junior resource stocks are the best speculative place in the equities market. There'll probably be others, but I don't see them very clearly at this time. I'm waiting to see what materializes. You have to look at all markets of all types, everywhere in the world, to find things that are overpriced, as well as things that are underpriced. Most of the time the trend in any given market is uncertain. I prefer to act only when, in my subjective opinion, the odds are greatly in my favor, and when the potential return is a multiple of my investment. In other words, most people invest 100% of their capital in hope of a 10% return. I prefer to wait until I can invest 10% of my capital for a 100% return. As to what's going to happen over the next few years, I feel confident that we've entered upon the Greater Depression in earnest. It will be an extended period of time when most people's standard of living drops significantly. But as I said, I think there's an excellent chance of a bubble igniting in resource stocks. That will build on the bubble that's going to come in gold. High levels of inflation make "investing," in the Graham-Dodd sense of the word, very hard. And inflation makes speculation almost necessary. Just don't confuse speculation with gambling - they're very different. Speculation is the art of capitalizing on politically created distortions in the market. TGR: What's your definition of resource stocks? For some, it's very broad and includes metals, agricultural commodities and such. Are you referring specifically to gold? DC: I'm most friendly toward gold; it's the only financial asset that's not simultaneously someone else's liability. I'm friendly toward silver, too, because silver is kind of poor man's gold. I'm very friendly toward oil because I do believe a good, solid argument can be made for what was first defined by M. King Hubbert as "peak oil." Also, oil is likely to be a major player in the next major Mideast conflict. I like uranium; nuclear is certainly the safest, cheapest, and cleanest form of mass power generation. There's an excellent case to be made for agricultural commodities in general, and live cattle in particular. I'm not very friendly toward base metals such as lead, zinc, copper, aluminum, iron and so forth. Usage of industrial metals could drop considerably in the ongoing depression. TGR: You mentioned earlier that you thought it would be a generation before real estate represents a good investment again. Many economic theories, though, tell us that real estate is a good thing to have in an inflationary environment. How do you reconcile those two schools of thought? DC: The problem is that we've just finished a decade-long real estate boom. Actually, there's been a property boom, largely driven by debt, since the end of World War II. There's been immense overbuilding and it's got to be absorbed. A lot of the overbuilding will have to be bulldozed, quite frankly, because it's completely uneconomic. I think the economic contraction we're going into is so serious that in this country you'll be able to buy real estate for back taxes, much like in the last depression. But it's much more serious than what happened in the 1930s when real estate taxes werede minimis. Now many people have to pay $10,000, $20,000, even $30,000 a year in taxes on their houses before they even start paying the mortgage and the utilities and maintenance. And municipalities are likely to try raising the mill rate, because they're largely bankrupt, and assessed values are way down. There's a great deal more I could say about what's yet to come in the real estate sector. But let me just say the real estate bubble has a long way to deflate yet. TGR: Is it both residential and commercial or is it worse in one sector? DC: That's tough. Is emphysema worse than Parkinson's? I suspect, however, that commercial is going to be worse than residential. People's shopping habits are one of the things that the Internet has changed and will continue to change. It makes more sense to buy things online and have them delivered to you, than to take the time and expense of going shopping, and the merchant having to deal with retail space, inventory, a geographically limited clientele and so forth. I wouldn't be surprised to see prices on a lot of commercial property come down 80% or 90%. You'll see a lot of properties permanently shuttered. That's a disaster for owners, who will still have to pay taxes. There will be no money for maintenance. TGR: We spoke earlier about inflation and the likelihood of the US government printing its way out of debt. Do you see a point in time where the United States or even other governments will go back to the gold standard? DC: It's both essential, and inevitable. That's because they have no reason to trust one another. They need a medium of exchange and a store of value that's not faith-based. All the other governments of the world know that the US is bankrupt and the dollar is nothing but a floating abstraction. Why should they hold billions or in some cases trillions of these things on their balance sheets? They're going to go back to gold because it's the only financial asset that's not simultaneously somebody else's liability. It's not because gold is magic in any way. It's just because it has characteristics that among the 92 naturally occurring elements make it uniquely well suited for use as money. It's durable. It's divisible. It's convenient. It's consistent. It has use value in and of itself. And it can't be created out of thin air by some government. It's a better combination of those things than any of the 92 elements. It's infinitely better than paper. So yes, I think they'll go back to gold within this generation. TGR: Thanks Doug! Casey Research and The Gold Report, for The Daily Reckoning Joel's Note: Gold, energy, tangible assets not entirely dependent on the strength of the United States' moribund currency...these are the assets in which you are likely to find some protection against the coming fallout of the "Greater Depression." Investors looking to explore this kind of strategy may wish to start with a risk free, three-month trial toCasey's Energy Report. To do so, simply click here now.) Bill Bonner A Market for Long-Term Investors Bill Bonner Reckoning from Baltimore, Maryland... What to do now... I really don't know I really don't know, what to do - The Rolling Stones Stocks are up...should you buy? Wait, stocks are up...maybe you should sell! Here's the report from The New York Times: The broader S&P 500 rose 8.8pc on the month and the Dow Jones was up 7.7pc. The last time Wall Street saw a stronger September, when the Dow Jones soared 13.49pc, was at the start of the Second World War, when traders anticipated a strong rise in demand for US manufactured goods and war materials. However, on Thursday the S&P 500 fell 3.53 to 1141.20 and the Dow dropped 47.23 to 10788.05 as new data on jobs and economic growth continued to indicate the economy was recovering at a slow pace. Gross domestic product, which measures the output of goods and services in the US, increased at an annual rate of 1.7pc in the second quarter and the number of Americans filing new claims for jobless benefits fell more than expected last week for the third time in four weeks. So you see, everything is looking up. Gold keeps going up too...it rose another $8 on Friday. Experts say it is going to $1,500 next year. Or maybe $2,000. Or $3,000. Maybe you should buy. China is buying. Insurance and pension funds are buying. Even central banks are buying. Wait a minute...maybe you should sell! But it's too early for the final stage of the bull market in gold. The average fellow is not buying gold. There's no frenzy yet. Nobody is worried that his savings will disappear. The final stage seems a long way away. Gold may not be ready for it's great blow-off...but the dollar seems headed for the basement anyway. You should get rid of the dollar. It's trash. It's headed for the dump. But wait. Aren't we in a period of major de-leveraging? Isn't this the Great Correction? Isn't everything going down? Shouldn't the dollar be more valuable? Maybe the dollar doesn't know we're in a major correction? But shouldn't you be holding onto dollars...saving dollars...hoarding dollars? What to do now? The more we think about it, the more we like the solution offered by Rob Marstrand. Rob has just taken the job as chief investment strategist for our family office. That is, he's advising us on what to do with our very long-term oriented family money. This is money that we're not going to spend. It is supposed to go to the next generation...and the one following. So, we're not looking for profits anytime soon. We're more concerned with not losing it. Rob told us about one vegetable producer in China. It's a huge company, but still growing like a teenager. And nobody ever heard of it. You can buy it for barely 4 times earnings - Great Depression levels, in other words. Another one of his discoveries is a company based in Singapore but with huge real estate holdings in the "other" BRIC - Indonesia. He reckons you can buy it for only about 60% of its break-up value. In other words, you can get the business for free. And since these companies are in emerging markets, we can expect that they will do better than stocks in the US. Maybe not this year. Maybe not over 5 years. But over 20 years? Well, who knows, but it seems like a good bet. Which do you think will be worth more, dear reader? Twenty years from now. A $20 bill issued by the US Treasury. Twenty dollars worth of US stocks? Or $20 worth of profit-making companies in high-growth economies? We don't know how much the stocks will be worth. But we have a strong hunch that a $20 bill won't be enough for a cup of coffee. Why? Because dollars don't cost much to produce - especially the electronic variety. And the feds are going to need a lot of them. They're spending $2 for every $1 in tax receipts. You can't do that for too long before your credit is shot. And what's behind the US dollar? Nothing but the full faith and credit of the US government. What to do now? Find solid businesses at bargain prices. Invest in real estate with good cash. Buy collectibles...jewelry...art - things you want to own no matter what the price. And more thoughts... We went to a charity gala dinner on Saturday night. It was to benefit Catholic schools sponsored by the Baltimore Archdiocese. "Why are we going," we had asked Elizabeth earlier in the day. "We're not even Catholic." "Don't be a curmudgeon. Our children went to Catholic schools. They got good educations. So we're helping the schools. They're having a silent auction. I gave a week at our house in Normandy. It will be fun to watch them bid on it... Besides we have two free tickets. There's a band. And there will be dancing. "Remember, we took dancing lessons. We don't want them to go to waste." Americans are good at fundraising. In comparison, the English are amateurs...and the French don't do it at all. We went to an event for the Conservative Party in London a couple years ago. There was a huge crowd, eager to elect David Cameron. The organizers might have made sport of it. They might have made fundraising fun. Instead, they seemed embarrassed to be raising money...and disorganized. The French don't even try. Anything worth doing, they figure, ought to be paid for by the state. They pass the plate at Catholic Mass in France, but the parishioners give little. The typical donation is a 2 euro coin. Then again, the churches are maintained by the government. And everyone thinks the church is rich. But the Catholics in Baltimore did a good job of it. Archbishop O'Brien made a simple and sensible appeal to the 600 or so gala goers. And then a young man gave a speech recalling how a scholarship had enabled him to get an education at the Catholic school. "I can tell you frankly, that it changed my life. I wouldn't be the man you see tonight were it not for that scholarship," he said. There was no need to say any more. Everyone present knew what he meant. The Baltimore public schools were little more than prep schools for prison. But here was a young man who grew up in the Baltimore ghetto (a photo showed his house...it looked very much like where we used to live!) He had no money. No father. And no future. But after he graduated from Catholic high school, he went to college and then to law school. A very impressive fellow; it was easy to imagine him running for Congress in a few years. Naturally, we all gave him a sincere applause. Many were probably thinking - "he's a credit to his race." But no one said it. That quaint sentiment went out of fashion 50 years ago. In fact, he was a credit to any race. And any religion. And with this success story in front of us, who could resist? Pretty soon each table was competing to see who could donate the most. Elizabeth dug deep into her husband's pockets. By the end of the evening, it was the most expensive free dinner we had ever had. Regards, Bill Bonner, for The Daily Reckoning