Part 2 of the article from
mcalvany.com
II The McAlvany Intelligence Advisor
A WATERSHED: WHEN MONEY TURNS INTO CONFETTI CURRENCY
B. THE WORLD'S MONETARY SYSTEM IN THE YEAR 2000 The nations and peoples of the world today have chosen (or been led) into the use of "money" that is no longer money at all - just currency. It is only a medium of exchange with no store of value.
So the creation of new currency and how fast people, bankers, stock brokerage firms, or a government can print new currency or create new "credit" (debt) is left to man's imagination in a "high-tech" world of digital money and banking, and is truthfully only limited by what they can get away with. When politics and money are combined with no limitations, the answer is easy! The more currency in circulation, the better the economy appears to be to the common man (wealthy and poor voters alike), and everyone likes to "feel" rich.
So politicians are led to talk about money and are always creating new funds for the "social good" as they run for office, since money creates the "warm glow" in your constituency that assures electoral victory. There will be enough time later (it is assumed) after the election for leaders to then use some fiscal restraint.
But, it turns out, a politician (Republican or Democrat) never stops running for office! So, we're now nearing the conclusion of the year 2000 in a fast-paced high-tech monetary race for riches. Welcome to the new millennium - anything goes!
Everett Dirkson once said, "a billion here, a billion there, sooner or later it adds up to real money!" Today, world monetary progress is measured in 'a trillion here, a trillion there! And soon, very soon, as we mentioned earlier, the standard unit of political monetary measure will be sextillion. So, looking at our future, the question is easy: What happens when the rich get a lot richer (it takes money to make money), and the supply of high-tech digital currency "goes off the wall" - measured in sextillions?
C. THE CREATION OF CURRENCY OUTSIDE THE FED Is the explosion in the amount of new currency an exaggeration? A few current examples of currency creation, outside the Fed, help illustrate how easy it is to "make money."
1. On July 24, Deutch Telecom announced the $50 billion buy-out of Voice Stream (a Seattle-based American company). A $50 billion deal in America is a 200 billion mark deal in Germany, where the size shocked the Germans. Fifteen months earlier, Voice Stream did not exist as a public company, and its net loss for the first quarter of 1999 ($77.2 million) exceeded its revenue ($66.8 million). It seems even the Germans are betting the never-ending financial bubble will go on forever - or that huge new debt will be wiped out by even more rapid inflation.
2. Then consider the "insiders" at a company called SPYGLASS (NASDAQ). These people who founded the company, invested early in venture capital, or work for the company, sold $19.7 million of stock "into the market" between 8/99 and 7/00. Insiders paid as little as one cent a share, and as much as $11.10, and sold it as high as $91.37 a share. One founder acquired his initial stock at a penny a share, and sold 50,000 shared (a tiny part of his total stock ownership) for $11.38 a share. His creation of "new money" was $568,250 realized from his earlier cash investment of $500. This is how the money game works - huge monetary rewards for risk! There are thousands of companies like SPYGLASS, some giants like CISCO (where the stock appreciation in a decade was six cents a share to $60 a share), and some small or smaller like SPYGLASS.
3. Investment News (8/14/2000) wrote: "Corvis Corp appears to be defying gravity...but that may be an optical illusion. The company has unproven technology, no revenues, and only three prospective customers, but it has a market capitalization close to that of General Motors." A July 2000 IPO, Corvis "caught up" financially in its total "market cap" with all of the stock outstanding in General Motors….in a month and a half of trading on NASDAQ the company has no sales or earnings.
4. Reuters/CGES (8/24/2000) wrote: "This year's oil revenues for ten OPEC member countries are expected to rise by 62 percent according to the London-based Center for Global Energy Studies. The Center's chief economist, Leo Drollas, said the 10 countries would earn $201 billion compared to about $124 billion in 1999."
Year 2000 Revenue Increases
Saudi Arabia $27 billion
Kuwait $7 billion
UAL $8 billion
Qatar $3 billion
Now think! How would you feel about selling a year's production of your depleting oil for $201 billion, as you saw Germany's largest telephone company pay $50 billion for a dream company with no earnings?
5. Current statistics from the Credit Bubble Bulletin, by Doug Noland, 9/1/00, include: "Bank credit increased by almost $10 billion last week. Broad money supply (M3) expanded by another $21.4 billion last week. Over this 25-week period, 'institutional money funds' have expanded by $83 billion, or at an annualized rate of 28%, while 'large time deposits' have grown $75 billion, or at a rate of 22%. Year-to-date, these two 'institutional' components have increased a total of $178 billion, or at an 18% annualized rate.
"Not coincidentally, we see that five leading Wall Street firms - Citigroup, Goldman Sachs, Merrill Lynch, Morgan Stanley Dean Witter, and Lehman Brothers - continue to aggressively expand their balance sheets. These companies combined to increase total assets (and liabilities!) by about $220 billion during the first half of the year 2000, an annualized growth rate of 24%.
"During this five-year bubble period, total financial sector debt increased almost $3.8 trillion, or 99%. Total outstanding credit market debt increased $8.4 trillion, or 49%, to an astonishing $25.6 trillion. This unprecedented monetary expansion fueled enormous asset inflation, with stock market values surging $9.27 trillion, or 204%, to $13.8 trillion. Combining credit market debt instruments with total stock market value, total marketable securities surged $17.7 trillion (81%) to $39.4 trillion."
D. WHO RUNS THE WORLD AND ARE THEY TOO BIG TO FAIL? The Joke: There was a joke in financial circles a couple of years ago: "Who runs the world? Clinton? Greenspan? America? No, Goldman Sachs runs the world."
Last year, Jim Grant recalled in his newsletter, Grant's Interest Rate Observer, in an article entitled: "Too Big to Fail": "Although not a great book, Lisa Endlich's 'Goldman Sachs: The Culture of Success' (Knopf, $27.50) is a book of many line movements. One of these is the story of how Goldman blundered in the Penn Central failure of 1970, in part because it had incorrectly believed that Penn Central Transportation Co. would be bailed out by the federal government; allegedly, it was too big to fail.
"Fast forward now to 1994, and to a general, firm-wide sense of invincibility: 'Nothing was too large now,' Endlich writes. 'The firm's proprietary traders felt confident that they could handle a position of almost any size. Large, concentrated bets were now the focus. A home-run mentality permeated the trading floor.
"The sense of overconfidence extended to the higher reaches of management, Endlich continues. One trader of long standing had a disturbing conversation with a partner of considerable seniority in early 1994. 'The end came for me when I went for a drink with this partner,' he says. He had recently met with the Fed [a member of the Federal Reserve Board] and was feeling good about the firm. 'We're too big to fail,' he told me. 'A $100 million loss, a $50 million loss, it means nothing. We're too big now, they won't let us fail.'"
And today, when you look to see instant digital currency creation happening - anytime, anyplace, anywhere in the world, you could easily conclude that Goldman Sachs with a few friends like DLJ, Merrill Lynch, Citicorp, and a couple of German and Swiss banks really do run the world!
E. NEW WORLD REALITY/OLD WORLD REALITY: THE DANGER OF UNBALANCED FORCES You can't defy the rules of physics forever. When every person on a ferryboat runs to one side of the ship to see an "attraction," the unbalanced load distribution often causes the boat to instantly roll over without warning, and unless everyone has a life preserver, there is often great loss of life. It happens! Unbalanced forces, when they are extremely out of balance, can quickly turn everything upside down.
The extremes in our lives today, including the rapid growth in high-tech digital financial assets (currently), are the greatest ever. Unbelievably unbalanced forces will seek a return to normalcy, and may surprise most people with the abruptness of the change. Unbalanced forces also create the greatest investment opportunities of a lifetime. When everyone comes to believe "perception is reality," as today, then objects of true value are discarded or taken for granted as the crowd is caught up in the race for instant wealth and gratification.
Today in America, with an ever-increasing currency supply that may never end, it's easy to leave a basic investment or a basic job to take greater and greater risk to "make it happen." This leaves the ordinary needs of daily life in a discarded heap; unwanted by everyone except the few who think people will return to normalcy at some future date. So, for investors, there are bargains today that you will never see again in a lifetime.
These are the most exciting times ever. Money isn't what it used to be. It is a high speed game of exchanging electronic "chips" - one for the next, in the never-ending quest for greater "wealth" (represented on a computer print-out). But it should be remembered, as a successful "trader" sells and moves on to a more promising "story stock," someone else (who bought from the seller) always still owns what the other man discarded. And to sell, there must always be another buyer.
So too in the creation of more and more debt (bonds). One man's borrowing is another man's savings, and the debt will always be repaid, either by the borrower or the lender.
"Money, money, on the wall, who's the richest of them all?" The "ultimate end" in the money game can happen in a sea of currency, where everyone is a "paper millionaire." So how does it work out?
Does an OPEC country continue to sell its depleting real oil reserves at last year's price? Or, when a Venezuelan oil minister sees rich nations creating new trillions of dollars in buying power overnight in new digital high-tech currency, does he raise the price? When South Africa and Russia, two near-bankrupt nations, see more money everywhere except where they live, will they raise the prices on their depleting asset that has increasing need in the technological world - platinum? They do control the market! And if this begins a domino-effect in price increases for all raw materials where either basic reserves or production facilities are limited, isn't a rapid increase in inflation sure to follow? Yes!
Huge worldwide increases in currency supply are already showing up in the most expensive real estate markets, in luxury birthday parties for seven year olds, and in stock prices. When the price of world sugar (something nearly as common as sand on the beach) has doubled from a historic low in less than a year, are other "real things" and raw materials not apt to follow as they respond to the "money flood"? What is the ultimate conclusion to this inflationary bubble?
F. WHEN CURRENCY BECOMES A COMMODITY, COMMODITIES BECOME MONEY How does this all end? Does the creation of confetti currency go on forever? In the book, Insisting On The Impossible, by Victor K. McElheny, we may find a partial answer to this question. In the "preface to the Sloan Technology Series," the first paragraph helps define our high-tech currency confetti situation:
"Technology is the application of science, engineering, and industrial organization to create a human-built world. It has led, in developed nations, to a standard of living inconceivable a hundred years ago. The process, however, is not free of stress, by its very nature, technology brings change in society and undermines convention. It affects virtually every aspect of human endeavor; private and public institutions, economic systems, communications networks, political structures, international affiliations, the organization of societies, and the condition of human lives. The effects are not one-way; just as technology changes society, so too do societal structures, attitudes, and mores affect technology. But perhaps because technology is so rapidly and completely assimilated, the profound interplay of technology and other social endeavors in modern history has not been sufficiently recognized."
When anything moves from shortage of supply to an exaggerated surplus, sooner or later the "value" of the item in great surplus is diminished. "Currency confetti" is already a glut on the market, and the high-tech nature of our "money" makes it subject to rapid oscillations. At the extreme opposite, there would seem to be two possible scenarios for the ending:
1. A CRASH - caused by a breakdown in high-tech financial equipment or assumptions. As related in a new book, "When Genius Failed" by Roger Lowenstein, "The 1998 meltdown of Long Term Capital Management was a singular debacle. Markets around the globe plunged and the financial system itself seemed in peril - all on account of a tiny band of secretive bond traders who had been envied as the best and brightest of Wall Street."
Long Term Capital Management was led by Wall Street's most famous bond trader, John W. Meriwether (aptly named!) and the recent winners of the Nobel Prize in economics, Robert C. Merton and Myron S. Scholes. These three men led a group of geniuses into trading a leveraged portfolio of bond derivatives that controlled over $4 trillion of high-tech confetti assets. These assets were leveraged 100 to 1 or more in relation to the real high tech confetti currency that you and I know.
As the chart shows, it happened, even with the best and the brightest. And without the magic of Alan Greenspan, the Fed, and a lot of banks and investment bankers, the financial system as you and I depend upon it today would have disappeared overnight into a "black hole."
Ever since the crash of '87, Alan Greenspan and the Fed have been able to organize worldwide financial bailouts on a moment's notice anywhere in the world. As the "great liquefier" of bankrupt or illiquid markets, Alan Greenspan is a genius.
So, like LTCM, maybe technology gives us a chance to avert or dodge any future crash with the efficient application of more confetti currency, credit and debt.
2. BUT IF THERE NEVER IS A CRASH THAT CAN'T QUICKLY BE FIXED BY THE "GREENSPAN FED"- what does the ever-expanding creation of currency mean to you and me as we struggle to invest our "savings" in some real "store of value." Most people will not chose to speculate with their entire life savings, so each day it will become more obvious to people worldwide: when currency becomes a commodity, commodities (especially those with limited supply) become money.
An index of the raw materials that we use and consume in our daily lives, like Jim Rogers Raw Materials Index, may become a more important inflation (and currency dilution) indicator than the government's monthly CPI figures. For the year 2000, the Rogers Index is up 27.53% for the first eight months of the year. This index of the raw materials that are used in our daily lives compares to the 2.5-3% annual increase in the CPI reported by our government (and applied to COLA's that affect Social Security and government workers pay and pensions).
CONCLUSION As people begin to recognize the real inflation and our inability to use any saved "money" (now currency) as a "store of value," there may be a move and then a rush to reposition financial assets that have been saved into real stores of value. There are at least four choices:
a) Speculate with your life savings with the Meriwethers of the world - and see if you can beat them. The rewards for extreme risk are extreme profits. The penalties for failure are also extremely high.
b) Financial Assets all over the world may begin to move into "real things" that we need and use. A basket of commodities is one answer. A platinum coin or a bag of rice may be another answer, depending upon where you live in the world. If this happens, you will be able to quickly tell what's happening because raw material prices (like oil and natural gas and platinum) will continue to rise as the dollar goes down. [ED. NOTE: On 9/15/2000, oil hit $36 a barrel!]
c) A Good Business Idea - When you look at our economic history, a good business idea and its creation into a profitable business still may be the best investment and store of value. If you create what people use and need, "they will come." And the wealth of the world has been built on the creation of outstanding commerce. Don't totally give up on stocks. Raw material stocks in this new secular cycle, and creative new businesses (like American Superconductor and Ballard Power Systems) make sense if you can purchase shares during a sharp "market setback." At a highly discounted price, they could be a good long-term investment.
d) Go For The Gold - Gerald M. Loeb, in his classic book, republished in 1952, "The Battle For Investment Survival," said in his introductory chapter "Is There An Ideal Investment?": "In the history of the world we find the record of savings really saved through buying gold, hoarding precious stones, and other forms of 'hard wealth' privately secreted. In the future history of America most of us will, in my opinion, learn this lesson too late."
It's been 50 years since Loeb offered this advice. Gold is now selling at an inflation adjusted 68-year low. With what you now know, will Loeb ever be right?
[MIA Associate Editor Jim Deeds is a marketing executive with the Rogers Raw Materials Fund and can be reached at 1-970-385-9534.]
[ED. NOTE: Gold and silver, the most undervalued investment vehicles in the world today, will have their day in the not-too-distant future. Platinum has already exceeded $600 and palladium $700. Oil has reached $38 a barrel. As the sleeping, apathetic masses finally catch on to the real magnitude of inflation (the Clinton/Gore dishonest inflation numbers notwithstanding), there will be increasing investment demand for gold and silver. It will start as a trickle and end up as a flood (or stampede) as it did in the inflationary 1970s.
Investors who understand the confetti currency concept of inflation articulated in the article above and other issues of MIA should, like the surfers in Hawaii, position themselves in front of the wave. Gold and silver coins (now at their lowest inflation adjusted levels in decades) should be aggressively accumulated at this time. |
