We live in an odd financial world

Mar 9, 2015

- By Bill Bonner

Bill Bonner
Gualfin, Argentina

Dear Diary,

Today, we're going to revisit yesterday's subject - something so surprising and counter-intuitive that almost no one expects it or is prepared for it.

We're talking about a sudden disappearance of dollars. For a brief period -- perhaps 3 days...maybe 3 months - Americans will wonder what happened to their money. The greenback will become more precious than gold...perhaps even a matter of life and death.

But we'll come to that in a moment.

First, a reader wrote to ask about our Trade of the Decade. We remind investors that the trade in question is not based on any particular insight or forecast. It is founded not only what we know, but what we don't. We simply take a look at what has gone up the most in the last 10 years and we sell it. On the other side of the trade, we look for what has gone down the most, and we buy it.

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At the beginning of this decade, the best trade we saw was to buy Japanese equities, which had gone nowhere but down for the preceding 20 years and to sell Japanese bonds, which had gone nowhere but up.

The trade had a not-so-hidden logic, too. Japan was clearly borrowing itself into bankruptcy. At some point, people would realize that Japanese government debt was not worth what they had thought. They'd sell bonds. But what would they do with the money? They almost had to buy stocks.

So, how are we doing so far?

The Nikkei index has gone up from 10,654 to 18,703. In yen terms that's a gain of 75% since the beginning of 2010.

Japanese government bonds, on the other hand, have not gone down as expected -- yet. They're still going up. But the index only went up from 139 to 147, or just about 6%. That leaves us with a net gain of around 69%.

Not too bad. But if we are keeping score in dollars we have to adjust for the drop in the yen, which takes our gain down to around 30%.

Still, we're happy with that. And we're going to be a lot happier when investors finally wake up and realize their Japanese Government Bonds are worthless. There's still a lot of juice in this trade...

Stay tuned...

Meanwhile, let's return to the line of thinking we took up yesterday.

We remind readers that we live in such an odd financial world that it is hard to tell up from down and backward from forward. Central banks and central governments issue more and more debt. And yet, the price of debt goes up...so that the yield on $5 trillion worth of debt is now negative! In other words, lenders pay borrowers to take their money. Go figure.

Likewise, the world economy is slowing down. Corporate profits are falling. Yet equity prices are so high that it would take a miracle to give investors a decent rate of return over the next 10 years.

Our chief researcher, Stephen Jones, tells us that the rate of stock market increases is slowing. There aren't many examples from the past, but they suggest that gains will go lower and lower, until they become negative:

    On October 3, when I last wrote the note, stocks were up 17.2% from one year earlier. Today, March 5, stocks are up 12.2% from a year earlier. Forecasts are always tough, and there is not a lot of precedence at these high valuation levels, but this slowdown appears likely to continue, and thus position us with 0% year-over-year returns sometime over the coming year. Again, precedents are few, but they have resulted in roughly 50% market declines.
Whether that 50% haircut happens next week or 5 years from now, we don't know. But when it happens it is likely to set in motion a surprising and alarming series of events, which will lead to a temporary, but violent monetary shock. People will go to their banks to get cash. But the banks won't have any cash. The ATMs will run dry.

There will be a "run on the banks," to use the old-fashioned term. People will line up, desperate to get cash. Not because they fear the bank will fail...but because they need cash to pay for the necessities.

"Wait a minute," says French colleague Simone Wapler (or words to that effect). "Governments are trying to get stop people from using cash. In France, transactions of more than 3,000 euros, in cash, are forbidden."

In America, too, cash is suspect. Ask your bank for 'too much' cash and the bank is obliged to report you to the feds. And if you are stopped by the police, and they find a lot of cash, they are likely to confiscate it. "You must be doing something illegal," they'll say.

So, what would cause cash to come back into style ...suddenly and overwhelmingly? What would cause a panic into dollars?

Again, stay tuned...

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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