Part I of Britain’s Coming Financial Collapse, can be found here.
How will the financial collapse play out?
Richard believes that “it is going to be many years before inflation hits the system”, and that “we are in a deflationary environment and we are going to stay that way”. As a result he sees bond yields continuing to fall, since “there is no reason for bond yields to rise because there isn’t really the inflation everybody talks about, there is real deflation in the system” and “in a deflation the price of everything falls”.
The only prices he sees rising are those that are triggered by specific events such as “a frost in Brazil affecting the orange crop.”
Richard thinks that all the central bank money printing won’t lead to inflation or higher interest rates because “there’s no demand for money”. In Britain “you are going to see interest rates continuing to fall because there’s no real reason for them to rise. Everybody keeps talking about rising interest rates but there is no real reason for interest rates to rise because there’s no demand for money. As long as people remain in the doldrums and are unable to spend money and things get worse and unemployment rises, interest rates will fall. Which is exactly what happened during the depression, and it happens at all times of extreme trouble.”
“If you think, like I do, that things are going to get much much worse then there is no mandate for rising interest rates because you’re going to see even more people unemployed and even more businesses going under.”
Richard believes that “interest rates can go down a lot further than they have gone already” which will make it even harder for those living on fixed income.
Right now it’s certainly possible to make a strong case for deflation, since although the amount of money that has been created by central banks around the world is more than enough to produce a huge bout of inflation. That won’t happen unless the newly created money finds its way into the economy, and right now it’s just sitting in the banks. In addition, as the chart of money velocity below shows, the notes and coins already in circulation are changing hands at the slowest pace in more than 50 years.
Velocity of M2 Money Stock 1950 – 2013 (Click on the chart for a larger version)
Chart courtesy of the Federal Reserve Bank of St. Louis
However, unless governments are ready to throw in the towel and admit that their Keynesian meddling has failed, we can expect further measures designed to kick the can down the road.
Here at 247Bull.com we believe that governments want to create inflation, and that they will find ways of forcing banks to lend, or of getting the newly created money directly into the hands of consumers. However Richard thinks that that is simply not possible because, “the demand for money isn’t there”. He notes that “at the time that they announced QE3 in the US, there was still $1.5 trillion sitting idle at the banks not being used.”
“The banks are just saying thanks very much for the money but our clients aren’t good for the loans, because they’ve got no collateral and there’s no real business demand out there, so they’re just going to lend the money back to the Fed or the Bank of England and leave it there. So this idea that there’s going to be inflation because people are going to be demanding higher rates” is bogus, “the banks can’t raise their rates and frankly I don’t think they would want to anyway, as it just means more risk for them.”
Rather than letting the “great reset” happen, Richard believes (as we do), that we are going to see much more government intervention.
“Governments are going to take over more and more of the means of production. Pensions probably will be taken away from people… If you really want to see what can happen, look at Argentina where the government basically took away people’s private pensions and replaced them with government treasury bills.”
He notes that “government spending in the US already represents 47% of GDP” and that if we continue down the road we are on, “you’re going to wake up one morning and find yourself in a communist country, because what’s happening in the United States is that the government is drowning out private enterprise, with is taxes, with its rules and regulations, it’s just taking over the entire system. It is a very very grim situation indeed it is really a frightful statement of what has happened to the world, and it is all going to come to an abrupt end.”
Richard points out, that what the coalition government in Britain should do is what US President Warren Harding did during the Forgotten Depression of the 1920’s, i.e. nothing. Rather than intervening in the economy, cutting interest rates etc., he stepped back and let failing businesses and insolvent banks go under. Harding’s approach “led directly to the roaring twenties, and that was made possible not by the government interfering, but by doing nothing and allowing the forces of capitalism to play out and bring about a reset.”
“The mistake is trying to keep prices high rather than allowing them to drop to the level which makes them affordable for people.” Real household disposable incomes in the US and UK have fallen tremendously, and deflation would help by closing the gap between wages and the cost of living, and by making goods and services more affordable.
Richard believes that the Keynesian prescription of stimulus spending doesn’t work, and that it is actually “toxic to the system”. It is actually legalized counterfeiting when you print money. It never works, it never has worked and it’s astonishing to me that people still believe that it might work. I think they don’t know what else to do.”
When talking about the scale of Britain’s impending debt crisis, Richard warns us that, “If you really look at that seriously, and realise what it involves, you will see that there is no way out of this… We are looking at very very grim times ahead.”
“In Spain unemployment is 25%, and for the youth it’s 50%, and the debt situation in Britain is far worse than it is in Spain. The basic economic situation is much more perilous in the UK than it is in Spain, so it is just a matter of time before the level of unemployment seen in Spain comes to the UK. And it will, I’m absolutely certain of it. You’re going to see 25% or even 30% unemployment in the UK.”
What will happen to property prices in Britain?
Property prices in Britain are still considerably overvalued, and the bubble in property prices is linked to the bubble in debt. When the bubble in sovereign debt bursts, it won’t matter if you have a five bedroom house in Harrow or a one bedroom flat in Hackney, the price will fall, not just in real terms but in nominal terms as well.
As Richard points out, “property is just another asset there is nothing inherently special about property except that it is a depreciating asset. A piece of gold that you bought during the Roman Times is exactly the same piece of gold that you are looking at today, nothing has happened to it, it is still the same piece of gold. A property that you buy is a menace, because in the end it is going to fall down, it is going to degenerate. Taxes have to be paid on it, maintenance has to be done to it, etc.”
“When the crash comes, people will realise that there is no inherent value in owning property, and if they have to sell their property because their debts have caught up with them and they need to pay those debts off, they will have to sell and it is as simple as that. To hell will the mortgage, if they have to walk away, they will walk away from that too – which is what has happened in the States. We’ve seen the situation play out in United States, and that wasn’t because people needed the money. That was simply because a bubble in property prices burst, and then people found themselves under water in their mortgages so they just shrugged their shoulders and walked away. In Britain you’re going to see the same kind of reaction. If you can’t afford to own a house, if you can’t afford to maintain it, or if you can’t afford to pay the mortgage on it, it’s got to go.”
“If things are going to get really bad the last thing you need to own is a house, because that house will depreciate so dramatically in value, because nobody will want to buy it from you. And if you ever need the money, or you ever need to move, or if you ever find yourself under water on your mortgage, then you are on the streets. And that realisation will come eventually.”
How investors can protect themselves from the coming financial collapse?
Richard states that it is “investors who are not aware of the full risks and who fail to protect themselves that will suffer the most… The reality is there is no way out of this mess and each person has to decide for themselves how they are going to handle the situation.”
Because he sees the financial collapse as being deflationary he is bearish on just about all assets apart from cash and bonds. He is “extremely bearish on commodities”, he believes that gold “is not going to cut it”, and that ultimately “cash is king”.
He believes that bonds “really are the safest investment… it is just about parking your money somewhere until the time comes to spend it when things are really very grim and you have real bargains on offer, but that’s going to be several years down the road.”
Although we agree that Britain is in serious trouble and that we are heading for a major financial crisis which will be worse than the one experienced in 2008, our view on how the crisis plays out (and thus how to protect yourself from it), differs from Richard’s.
We believe that governments will continue to fight the natural process of deflation by devaluing their currencies via massive money creation. This will result in a period of high inflation and ultimately a loss of confidence in paper money.
As inflation spikes the bond bubble will burst causing investors to flee the bond market and take refuge in tangible assets that can protect their wealth. Therefore we continue to favour gold and silver (because they are the only real money), as well as other hard assets such as oil, copper and farm land.
During this period the primary aim of anyone with wealth should be to preserve that wealth. Ultimately you are looking to maintain purchasing power relative to everyone else such that you are protected from the worst of the crisis and so that you can purchase distressed assets when the time comes.
Every investor should have a view on whether or not our future will be one characterised by deflation or inflation – this will be the subject of a separate article. However for those that are undecided, a hedged portfolio made up of a 50/50 split between of paper assets (such as cash and bonds), and hard assets (such as gold and farmland), might be the best approach.
Those that want understand more about what’s coming and how they can protect themselves from it, should start with the following selection of books:
Reading list for those in the inflation camp
- Dying of Money: Lessons of the Great German and American Inflations, by Jens O. Parsson
- When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany, by Adam Fergusson
- Paper Money Collapse: The Folly of Elastic Money and the Coming Monetary Breakdown, by Detlev S. Schlichter
- This Time Is Different: Eight Centuries of Financial Folly, by Carmen M. Reinhart & Kenneth Rogoff
- What Has Government Done to Our Money?, by Murray N. Rothbard
- Currency Wars: The Making of the Next Global Crisis, by James Rickards
Reading list for those in the deflation camp
- The Great Crash Ahead: Strategies for a World Turned Upside Down, by Harry S. Dent
- The Age of Deleveraging, Updated Edition: Investment Strategies for a Decade of Slow Growth and Deflation, by A. Gary Shilling (Author)
- Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression, by Robert R. Prechter Jr.
And, The Era of Uncertainty: Global Investment Strategies for Inflation, Deflation, and the Middle Ground, by Francois Trahan & Katherine Krantz.
The bottom line
The bottom line is that Britain is broke, and those that take the time to look at the facts (particularly if they see the financial world from an Austrian perspective), arrive at the same conclusion. Despite this however, the vast majority of people think that the financial collapse Richard describes simply couldn’t happen, especially not here in Britain. History tells us a different story however.
In 1976 Britain’s public finances were in disarray. The Tories under Edward Heath had lost control of both the unions and the money supply, and the government was struggling to meet its spending obligations. The markets gave Labour the benefit of the doubt whist they undertook seven rounds of Cabinet meetings to agree cuts. However, when the government announced £1 billion of spending cuts coupled with a £1 billion rise in employer taxes, the markets pulled the plug concluding that Labour was not serious about addressing the deficit. In the months that followed interest rates spiked and the pound tumbled.
The book “Good-bye Great Britain”: 1976 IMF Crisis, by Kathleen Burk, reveals that the value of the British pound began to slide in March 1976, but that the slide quickly “turned into a rout” and “by September confidence in the pound had collapsed”. It was around this time that the Wall Street Journal ran the headline “Goodbye, Great Britain”, advising investors to get out of sterling.
In November 1976, faced with financial ruin, Prime Minister James Callaghan was forced to go cap in hand to the IMF for a £2.3 billion rescue package – the biggest ever issued up to that point. The loan was so large that the IMF had to borrow the money elsewhere in order to lend it to us.
“We used to think that you could spend your way out of a recession, and increase employment by cutting taxes and boosting Government spending. I tell you in all candour that that option no longer exists, and that in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy.” James Callaghan, Labour Party Leader, 1976.
That was just 37 years ago, at a time when Britain was running a budget deficit of 6% of GDP. Today Britain is running a deficit of 8.3% of GDP, and there is simply no way the IMF, or any other entity, can bail us out.
If you’d like to follow Richard Martin, he has a twice weekly radio programme called ‘The Wake Up Call’, which you can find on the Progressive Radio Network. For more details visit: www.prn.fm.