Since the onset of the global financial crisis governments and central banks have been attempting to bring about economic prosperity by creating money and pushing it out into the global economy. After almost six years however, they have failed to produce a lasting recovery, or indeed anything close.
Policymakers around the world are trying to prevent the “great reset” by re-inflating the global credit bubble. However, by trying to sustain the unsustainable, principally via their policy of QE Infinity, what they have done is create massive distortions in the economy and financial markets, most notably in sovereign bonds.
The fact is, this policy of massive money printing is incredibly reckless and our view that this will end badly was echoed by many of the speakers at last week’s Ira Sohn Conference. The annual conference brings together the world’s smartest investors to share their insights with an audience of more than 3,000 people, comprised of portfolio managers, asset allocators and private investors. Most speakers manage large proprietary investment portfolios that have outperformed the market for many years and do not share their insights in any public forum, but they volunteer their time to raise money for the Sohn Conference Foundation.
This year’s speakers included William Ackman, Kyle Bass, Stanley Druckenmiller, David Einhorn and Paul Singer.
Paul Singer, the founder and CEO of hedge fund Elliott Management Corporation, said that central banks have accelerated QE because they think it is essentially a free lunch, but that their actions are creating significant risks in the system.
He noted that QE has caused a distorted recovery in which financiers are doing well while the man in the street continues to suffer. He pointed out that the world needs growth that isn’t related to monetary policy. We need “innovation, not currency depreciation”, especially if we’re going to confront entitlement obligations that are “utterly unpayable”. “The ultimate question for a fiat money regime is at what point does confidence in money disappear?”
Earlier this year, in a piece entitled “The Fed, Lost In The Wilderness”, Singer wrote about how the policies of the Fed have led to “lower and lower discipline, and less and less conservative stewardship of the precious confidence that is all that stands between fiat currency and monetary ruin”. He was critical of the Fed’s policy of QE saying, “Monetary debasement in its chronic form erodes people’s savings. In its acute and later stages, it can destroy the social cohesion of a society as wealth is stolen and/or created not by ideas, effort and leadership, but rather by the wild swings of asset prices engendered by the loss of any anchor to enduring value”.
Another speaker at the conference, Kyle Bass, founder and principal of Hayman Capital Management, focused on Japan noting that the BoJ is engaged in a far bigger programme of QE than the Fed, since it’s doing about 70% of what the Fed is doing in an economy around one third the size. Japan’s Shinzo Abe is “adding a ponzi scheme to a ponzi scheme… the beginning of the end has begun.”, Bass said, predicting that the yen will drop to 120 against the US dollar in the next couple of years.
Those that have studied the writings of Austrian economists understand the common sense notion that printing money does not create real wealth or prosperity. If it did then Argentina and Zimbabwe would be G8 nations. Indeed, it was the creation of unprecedented amounts of money and credit that led to the 2008 bust, and we are seeing more and more signs that monetary policy is creating a new credit bubble just like the one that culminated in the collapse of investment bank Lehman Brothers in September 2008.
Risky lending practices have returned to Wall Street, with banks now packaging up new forms of collateralized debt obligations (CDOs), known as collateralized loan obligations (CLOs). Margin debt at the NYSE has also risen dramatically in recent months and is now only slightly below the level it reached in 2007, and the junk bond market has also reached record levels.
As mentioned previously, we live in a world where all currencies are fiat and every fiat currency since the time of the Romans has ended in devaluation and eventual collapse. Indeed, there have been 34 hyperinflations in the last 100 years – most of which took place in the 20th century with fiat currencies – and it’s not only the currency that collapsed but also the economy that created it.
Ultimately all these efforts to maintain our broken monetary system will manifest in a currency crisis, however identifying the precise trigger or predicting when it will happen is extremely difficult.
When will it end?
The most likely trigger still looks to be the bursting of the bubble in government bonds, but as Jeremy Siegel, professor of finance at the University of Pennsylvania’s Wharton School, pointed out in a recently Bloomberg interview, “I think bonds have been in a bubble for a couple of years. If you’d have asked be a couple of years ago if they would still be at 170 (the yield on a 10-year US Treasury) I’d have said no, but one thing we know is that bubbles last a lot longer than any of us can imagine.”
When asked what the trigger might be for a bursting of the bond bubble he simply said, an improvement in the US economy and a reduction in bond purchases by the Fed. Right now however there is no sign of this and the appetite among investors for sovereign debt is huge. In fact, due to the fact that central banks are crowding out other buyers, there may soon be shortages.
In the short-term then, this tightness of supply is helping to drive bond prices higher and yields lower. Twelve months ago, for example, Greek 10-year bonds were yielding 27.58%, today they are yielding just 9.45%, and Portugal’s 10-year debt was yielding 11.42%, whereas it’s now down to 5.43%. In this zero interest rate environment (ZIPR), investors are so desperate for yield that they are now buying the debt of Rwanda.
Gold will have its day but in the meantime investors should make hay
Thus far, central bankers, led by Ben Bernanke, have pulled off the ultimate feat. They have served up just the right amount of monetary stimulus which has given us this ‘Goldilocks’ recovery in which the forces of inflation and deflation are canceling each other out. Ultimately these efforts to maintain our broken monetary system will manifest in a currency crisis and it is then that money will flee from low yielding debt instruments into hard assets such as gold and silver (and stocks).
The gold story is a long one, and as Hugh Hendry, chief portfolio manager of Eclectica Asset Management, once noted, the mistake a lot of “gold bugs” make, is that they skip right to the last chapter of the gold story in which all fiat currencies (the US dollar in particular) have their value destroyed by high (or even hyper) inflation.
Gold investors will have their day, but the “great reset” may be postponed for a lot longer than most people (ourselves included) thought possible.
One analyst who believes that we could potentially see a five year bear market in gold is Martin Armstrong of Armstrong Economics. Armstrong, who is best known for the development of the Armstrong Economic Confidence Model which helped him forecast the crash of 1987 to the exact day, believes that this will depend upon the annual closing price of gold for 2013, and that a close beneath $1,310 an ounce for the year could mean that a low in gold is not established until 2016.
Physical gold that’s held outside the banking system still plays an important role in investors’ portfolios. In the meantime however, investors should look to take advantage of a macro environment that is bullish for equities.
As macroeconomic research firm Variant Perception noted recently, “low inflation, central bank support and relatively robust economic data have created a Goldilocks scenario for equities”.
When fixed income, which is the world’s largest asset class, is yielding almost nothing, it has a significant impact on other asset classes since money goes in search of returns elsewhere. In fact, as noted recently central banks are also now buying equities for this very reason.
All of this is why we continue to hold gold but have also increased our exposure to stocks (particularly dividend paying blue chips); in order to make hay while the sun shines.