Does holding cheap money make sense?

Jun 23, 2015

- By Bill Bonner

Bill Bonner
Paris, France

Dear Diary,

Dow up 103 yesterday. Gold little changed.

And here's a report from London. One of Britain's top bond experts is giving the same neanderthal advice we are. The Telegraph reports:

    The manager of one of Britain's biggest bond funds has urged investors to keep cash under the mattress.

    Ian Spreadbury... is concerned that a "systemic event" could rock markets, possibly similar in magnitude to the financial crisis of 2008, which began in Britain with a run on Northern Rock.

    The best strategy to deal with this, he said, was for investors to spread their money widely into different assets, including gold and silver, as well as cash in savings accounts. But he went further, suggesting it was wise to hold some "physical cash", an unusual suggestion from a mainstream fund manager.

    His concern is that global debt - particularly mortgage debt - has been pumped up to record levels, made possible by exceptionally low interest rates that could soon end, and he is unsure how well banks could cope with the shocks that may await.

    He declined to predict the exact trigger but said it was more likely to happen in the next five years rather than 10.

The markets seem to be in wait-and-see mode. Yesterday, we were waiting to see what happens in Greece. Today, we wait to see what happens in the bond markets.

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We watch them like we watch a stick of dynamite. For a long time, it might sit there...silent...still... And then, all of a sudden, kaboom!

About 2 months ago, it looked like bond yields had finally found their bottom. With $5 trillion of sovereign debt trading at negative yields, bond prices began to fall. (Yields moved up.)

Not for the first time did we think: The fuse is lit!

We were only 33 years old when this bond market made its last turn. Then, bond yields had been rising for the previous 33 years. If we had only imagined what would happen next!

"My partner knew someone who was managing money," a friend described how he got rich. "So we decided to put our money with him. I had never heard of him. But his name was Warren Buffett."

Either by genius, luck, or a little of both, Buffett was in the right place at the right time.

In retrospect, it seems so simple, so obvious. The feds had changed the money system 10 years earlier. Now, the payoff approached. Without the discipline of the link with gold, the financial industry could run wild; it could lend money no one ever made and no one ever saved. It could lend trillions of dollars that it got for nothing. And as long as yields were falling, it scarcely had to worry about credit quality. If a borrower got into trouble, it could lend a better rate.

Bonds had been in a bear market since the end of WWII, the aforementioned 33 years from 1949 to 1982. Yields had gone up, as bond prices trended downward.

By 1982, the US 10-year bond hit a wall, with a record yield of 14.92%. Yields have been going down ever since - that is, most of my adult life.

Falling yields and rising credit have affected almost everyone and everything in the economy ever since. Higher bond prices (lower yields...lower interest rates) make it cheaper to borrow. As it becomes cheaper to borrow, people refinance old debt and borrow more. They buy consumer goods. What was the biggest retail story in America? Walmart - with huge volumes of (often, Chinese-made) merchandise at Everyday Low Prices.

All you had to do was to buy Walmart, sit tight, and let the credit-fueled boom do its work. You could have bought a share of Walmart for $42 in 1982. Today, that share sells for $72. But wait, that is after the stock split, 2 for 1, seven times! This is a challenge to our math skills, but we think that roughly equals a return of $10,000 for every 100 invested.

Even better than the consumer retail sector was finance itself. Profits in the sector rose from about 10% of all US business total in the 1970s to 40% in 2007.

This illustrates the phenomenon known as the 'financialization' of the US economy. Instead of producing things to make money, the focus shifted to lending, speculating, and making money FROM money.

And behind this phenomenon was something almost no one noticed -- the new money. It looked just like the old dollar. You could spend it just like the old dollar. You could fold it, lend it, borrow it, and save it - just like the old buck.

Who noticed that it wasn't the same? And who cared? If it looked like a duck, waddled like a duck, and quacked like a duck, it must be a duck, right?

And now...44 years after this new money came into being... And after pumping out so much of this money that it floated US debt up 60 times previous much that the whole world is saturated by it...drenched in it...soaked to the bone... we are told that this strange money is precious, and that we should hold some of this cheap money, at home, where we will have access to it in an emergency.

Does that really make sense? More to come...of course.

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

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