More US dollars will have much lesser value

Oct 29, 2010

Baltimore, Maryland

Not much action yesterday. The Dow fell 12 points. Gold rose $19.

What else do you need to know? Nothing much has changed.

------------------- We made a huge blunder... -------------------If your recommendations are so good, why don't you put your own money and make millions.

This is the gist of a recent email that we received. And it made us realize that we are making a huge blunder.

You see, recently we have been writing to readers like you to try ValuePro, our long term portfolio recommendation service. This service is based on a time tested and proven stock picking process and has a goal of multiplying money 4x - 6x in 5 - 10 years. Despite this, response has been muted. Only several hundred have signed up.

Now we know why... we missed telling something very critical - the fact that we're putting a total of Rs 1.2 million of our own money behind the recommendations we make. (Our existing members know that Equitymaster invests Rs 100,000 in every recommended stock with a 10 trading day lag.)

So, we are putting our money where our mouth is. That's precisely why we are strongly recommending that you try ValuePro... Please read on for full details... Hurry! This opportunity is available only till November 1st.


US stocks are up about 6% so far this year. Gold has gone up three times as much.

The Wall Street Journal: "Gold vs. the Fed: the Record is Clear."

Yeah, the record is clear. The Fed's money has been losing ground against nature's money for the last 10 years. Roughly, if you'd stuck with gold you'd have 5 times the purchasing power you got from the US dollar.

That's pretty clear, isn't it?

But you could go back and look at the history of every pure paper money. Look at how it did against the yellow stuff. Same story every time. No exceptions. Once you let human beings print "money" at will, they will print a lot of it. And unless they repeal the laws of diminishing returns, marginal utility and supply and demand, the paper money will lose out.

The law of diminishing returns says the more you do something the less good it does you. We're not sure that's true of everything... Mae West had a slight twist on the concept. "Too much of a good thing is wonderful," or something like that. But for almost everything but THAT thing the more you do it, the less you get out of it. It applies to printing up $100 bills too.

The law of marginal utility is just another way of looking at the same concept. It tells you that when you get more and more of something, each additional unit has less value than the one that came before it. You can see how that works in the case of dessert, for example. The first chocolate pudding tastes great. The 10th one makes you sick. At that point, you're getting not only diminished marginal utility, you're getting negative marginal utility - which is what you get from bank credit too, but that's another story.

We once knew a very rich man. He ran for governor of New York. We asked him why he bothered. He didn't need to steal from the taxpayers; he already had enough money.

"Yes," he replied. "But that's just it. I've reached the point where the marginal utility of more money is extremely low. I need to do something else."

He didn't win the race.

But the point is, the fed's gazillionth dollar is going to be worth a whole lot less than its first dollar. The more they print, the more you wish you had gold.

And you know the law of supply and demand already. There is a certain amount of goods and services available. This amount can be increased. But not overnight. It takes time, investment, expertise...and so forth.

By contrast, the feds can increase the supply of dollars almost instantly. It can just add zero and multiply the supply by 10. These new dollars compete with the old ones for the available goods and services. Pretty soon, prices are rising - fast.

Oh...if it were only that simple. Trouble is, there's the velocity of money too. When the economy takes a cold shower, the velocity of money slows to a crawl. Then, the feds can add as much new money as they want. It doesn't necessarily get around the way the old money used to. Everybody holds onto it. The banks just keep it in their vaults. Householders keep it in their wallets and mattresses. Everyone figures he might need it.

When trouble hit in 2007, the banking sector had just $2.3 billion in excess reserves (money they held beyond the legal requirement) - barely enough to buy a drink in a good bar. Now they're swimming in it. They're got $976 billion in excess reserves. So how come consumer prices aren't going wild?

By the way, where'd that money come from? The Fed already gave the economy a BIG dose of paper money. The feds were afraid that the banks were failing. They were right to be afraid. They were wrong to try to do something about it. It would have been much better to let the chips fall where they may...maintain the integrity of the government's own finances and protect the dollar. There were plenty of sensible, well-funded bankers to pick up the pieces of the broken ones and make something good of them.

And by the way again. This is not just our opinion. Mexico and Chile went through a similar crisis in the early '80s. Mexico did what the US would do a quarter century later. It "allowed it archaic bankruptcy system to perpetuate the lives of money-losing businesses and allocated credit by government direction," says Grants Interest Rate Observer.

And Chile? It let companies fail and allowed its markets to clear.

And what was the difference in outcome? Chile was back on track a decade later, soon surpassing its pre-crisis growth trendline. Mexico, on the other hand, never fully recovered. It's still 30% below trend.

Just what you'd expect, in other words.

More news:

And more thoughts:

*** The Fed pumped $1.5 trillion into financial system in 2009. It bought up mortgage-backed assets, creating money - out of thin air - specifically to do so. You'd think that would create some pretty heady inflation, right?


According to the Bureau of Labor Statistics, consumer price inflation is as low as it's been in 60 years. Go figure.

Still, if we were gambling and guessing, we'd bet that the paper US dollar won't come out of this fight with gold any better than the Mark, the Pengo, the Austral, the Peso (many different denominations), the Continental, or any of the dozens of other paper currencies that has tusseled with gold. All lost. All are gone. Only gold remains. As the WSJ says, 'the record is clear.'

*** What's going on in Ireland?

Well, here's the latest report from the Irish Times:

"Irish bonds yields passed the 7 per cent mark this morning in early trading. This marks a new peak since the bonds crisis began.

"The yield on Ireland's 10-year bonds stood at 706 basis points (7.06 per cent) by 8.48am after closing at 668 basis points yesterday. By 1.30pm bond yields retreated to 682 basis points.

"The spread between Irish sovereign debt and the benchmark bund rose to 447 basis points after closing at 412 basis points last night. The spread was at 371 basis points by 1.30pm.

"Ireland was the second worst performer in Europe yesterday, after Greece, in terms of widening spreads.

"Yesterday news agency Bloomberg reported that bond investors were losing faith in Ireland's plan to lower the deficit as spending cuts threaten to undermine economic growth, reducing Government revenue.

"The report quoted Ralf Ahrens, head of fixed income at Frankfurt Trust, as saying there was a danger for countries such as Ireland with huge deficits that cutting spending would not be enough and the situation would deteriorate."

Yep. Too little. Too late. And the Micks and Paddies are the only ones.
Keep reading...


Tale of Two Cities

It was the best of times. It was the worst of times.

It is certainly the best of times for economists with a sense of humor. Absurdity and cupidity are right out in the open where you can laugh at them. Today's financial events - predictable consequences of clownish meddling and currency debasement - are funny enough. The official reactions practically double us up. Central bankers and finance ministers are proudly doing things that they used to be punished for. Henry II brought his bankers together in 1124. Those found guilty of debasing the coinage - an earlier form of quantitative easing - were either castrated or they had their right hands cut off. What can you say about that kind of monetary policy? It worked.

But as for today's monetary is the worst of times. Not in 3,000 years, says Nobel prize winner Robert Mundell, have we experienced such "monetary instability." What? What about when a German Mark lost nearly all its value in a single day? What about when the French replaced the old francs for new francs at 100 to one? What about the Hungarian pengo hyperinflation of 1947? Currency crises come around much more frequently than Mundell, the "father of the euro," thinks.

In England, the government of David Cameron has announced the biggest cutbacks since WWII. He's going to lighten the UK government expense load by 81 billion pounds over the next 5 years. Nearly half a million government employees are to be given the heave-ho. So far, the British public is taking the news like a donkey informed about original sin. "Carry on!" they said to each other as if it were the Blitz, as if there were something vaguely noble at stake.

In France, the government is implementing pension reforms, the highlight of which is to increase the retirement age for government employees from 60 to 62. This seems like such a timid reform. Anglo Saxons wonder what the frogs are so upset about. But they've taken to the streets. Early this week, one out of four French gas stations were out of fuel. Hundreds of autos were torched. Even school children were on the barricades. At least most of the manifestants were in it for a good reason - to get money. The deluded students thought they were upholding a matter of principle.

On the surface, the two nations seem to be taking two very different approaches to solving a problem. The English buckle down. The French rise up. The English submit to reality. The French stick to fantasy. In London it is the season of Light. In Paris, Darkness descends before noon.

"What separates civilized man from the wild beasts?" they ask in The City.

"The English Channel," comes the reply, followed by a good chuckle. On one side of the water, it is the spring of hope, or so they believe. On the other, it is winter of despair. And yet, they all hope to go to Heaven and sit on the right hand of God. That they are headed in another direction is the point of today's reflection.

The real problem in both countries is the same. The welfare democracies made promises they can't keep. "Government can have only two legitimate purposes:," said William Godwin, "the suppression of injustice against individuals...and the common defense against external invasion." Beyond that the decline in marginal productivity of government spending is remarkably steep. The courts and police protection have real and immediate payoffs. Retirement, unemployment, bailouts, payoffs, tariffs, subsidies, free food and lodging, committees, councils, regulations - all quickly have perverse outcomes. More and more people switch from producing to conniving and chiseling. The more something for nothing is available from the government, the more people do nothing useful to get it - including getting control over the government itself.

In both England and France, the spending cuts on the table so far are too little, too late. A three percent deficit was regarded as such a serious threat to the financial integrity of the European Union that member states who surpassed that level were supposed to lose their right to vote. France runs a budget deficit of nearly 8% of GDP. Its public expenses are about $1.5 trillion per year. Even if the projected of savings of $96 billion by 2018 (when the pension cuts kick in) were realized, the amount is trivial. But so are the savings to be realized by the Cameron government - also trivial, and likewise programmed so the presumed benefits are realized sooner while the costs are suffered later.

But at least give them credit for pretending. Over in the USA, the Obama government shows no interest in jettisoning any of the accumulated ballast of the last half a century of boondoggles, bailouts and bunkum. Instead, with new health care and regulatory programs, it is adding to them. The current budget deficit is close to 10% of GDP, with no plausible plans to reduce it significantly. Instead, the political elite dream that they will "grow their way out" of their financial problems.

They count on stimulus to rev up their economy. But what do they have to 'stimulate' with? Only the same quack elixirs that got them into trouble in the first place. The government either spends more money...or creates more of it to spend. More fiscal stimulus is off the table in Britain, and probably in America too. Instead, they both aim to get by with from a little help with their friends at their central banks. Ben Bernanke has made it clear that he is ready to provide more unconventional stimulus - via money printing. The smart money is betting that Mervyn King will do the same.

And the really smart money is getting out of town.

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

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