Posts Tagged ‘Great Depression’

Will gold mining shares hedge against deflation again since the Great Depression?

Sunday, January 31st, 2010

During the Great Depression, gold mining stock prices were the only bright light in the darkness. As one of our readers found a 1931 newspaper quote,

Gold mining stocks have been among the strongest performers since year-end; earnings this year seen exceeding both 1930 and 1929; miners are benefiting from stable price as production costs decline.

As we quoted the most deeply buried Austrian School 1936 classic (originally written in German), Crises & Cycles by Wilhelm R?pk in Which industry?s profitability grew as the Great Depression progressed?,

Leaving aside the industry of manufacturing books on crises and cycles, there are two big industries likely to prosper inversely to the depression, the armaments industry and the gold-mining industry.

Does that mean that gold mining shares are going to do well in times of deflation because it did well during the deflationary period of the Great Depression?

No.

Here, we have to be careful in applying the lessons learnt from history correctly. There is a reason why gold mining shares did well during the Great Depression. Unfortunately, that reason does not apply in today’s context. What is the difference between today and the Great Depression?

The gold standard.

You see, back in 1931, one ounce of gold was defined as approximately US$20. Back then, as we introduced the history of money in our book How to buy and invest in physical gold and silver, currencies (e.g. dollar, pound, franc) were merely warehouse receipts for physical gold. In a sense, the central bank was a government granted monopoly gold warehouse.

In other words, the Federal Reserve was the only institution in the world that would buy and sell gold at a guaranteed fixed price (because the US was the only country still under the gold standard). The were two implications:

  1. There was an infinite ‘demand’ for the produce of gold mining companies.
  2. The price of the what the gold mining companies produced had a minimum price.

As the Great Depression was a period of deflation, prices of everything were falling. That means the costs of gold mining companies were falling as well. So, if you have a business in which the things that it produces:

  1. Have infinite demand
  2. Have a guaranteed minimum price
  3. Are getting cheaper to produce

Wouldn’t that be a windfall for you business? Indeed, that was the fortunate position faced by gold mining companies back then. That’s why their share prices were rising. Today, no country is under the gold standard and thus, currencies are backed by nothing. Therefore, gold mining companies are facing an entire different situation:

  1. Their produce have finite demand
  2. Prices of their produce fluctuate
  3. Costs of producing are increasing

Even if real deflation is to happen today, falling cost of production will be accompanied by a fall in price of gold.

So, if you find any experts, tip-sheets and research reports justifying buying gold mining shares as a hedge against deflation by using the example of the Great Depression as the basis of their recommendation, then you know what to do.

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Posted in Gold, History | 6 Comments »

China devaluing their currency

Monday, December 8th, 2008

A couple of days ago, one of our readers, Zoo said that

Anyone read anything about China devaluing their currency? Just read a rumour that they are telling the USA they may embark on a currency devaluation within the next 14 days.

Four days ago, in this news report,

The [Chinese] central bank has shifted the central peg of its dollar band twice this week in a calculated move that suggests Beijing aims to offset the precipitous slide in Chinese manufacturing by trying to gain further export share abroad.

So far, devaluation is not a official government policy yet. But it has already sent shivers down the spine of many observers. To understand why, read on…

Firstly, many regard such a move by the Chinese as deflationary. If it is deflationary in the sense that Chinese-produced goods merely become cheaper, then it is not so much of a problem. After all, it is such kind of deflation (or rather, disinflation) that allows much of the Western world to enjoy low interest rates, low inflation and high asset prices over the past several years. But if it is deflationary because of trade, employment and currency flow reasons, then it will be a more serious problem.

One thing is clear- President-elect Obama will not be happy with such a Chinese move. Obama called China a “currency manipulator” during his election campaign, which if becomes an official view of his administration, will carry penalties under US trade laws. The US retaliation will most likely come in the form of tariffs on Chinese goods. This will have an eerie echo of the 1930 Smoot-Hawley Tariff Act in which the US

… raised U.S. tariffs on over 20,000 imported goods to record levels. In the United States 1,028 economists signed a petition against this legislation, and after it was passed, many countries retaliated with their own increased tariffs on U.S. goods, and American exports and imports plunged by more than half. In the opinion of some economists, the Smoot-Hawley Act was a catalyst for the severe reduction in U.S.-European trade from its high in 1929 to its depressed levels of 1932 that accompanied the start of the Great Depression.

It is said that the Smoot-Hawley Tariff Act helped to worsen the Great Depression. This time, it will be a severe reduction in trade between China and the US (plus the Europeans as well). A sudden freeze in global trade in the midst of a global financial crisis is hardly conducive for global cooperation that is necessary to fight this crisis.

This is just round one.

As the situation deteriorates, the Chinese government may respond with a ‘bugger it’ attitude and liquidate its hoard of US Treasuries. The outcome will be as we wrote before in China unwilling to hoard US dollars?what?s the implication?. The Chinese had threatened that in August 2007 (see China threatens economic nuclear bomb) and the US had almost gone along that path in April 2007 (see US shooting own foot with tariff on Chinese goods).

Such developments will be the economic equivalent of a nuclear war between two superpowers. The world will not benefit and it will be an economic disaster in the global scale. As in the 1930s, there will be trade blocs led by China, Europe and America, which can even develop into overlapping political and currency blocs. The US dollar is likely to crash (see What if the US fall into hyperinflation?) in the sense that it will no longer become the world’s reserve currency. Such an environment can lead to military conflicts as the chaos of 1930s arguably contributed to the Second World War of the 1940s.

The official Chinese government stand is currency stability. But beneath this serene official stand, it is likely that factions are vying for the Emperor’s favour. We can only hope that there are no miscalculations.

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Posted in Looking Forward | 6 Comments »

Marc Faber: Asset Markets May Rebound Within 3 Months

Tuesday, November 25th, 2008

Back in Bear market rally on the works?, we explored the possibility of a stock market rally in the context of a bear market. We wrote,

At such extreme levels, it is very possible that we will see a counter-trend rally soon. But please note two things:

  1. It does not mean that prices cannot go down further in the short-term. Who knows, perhaps there will be more panic selling in the days to come, thus bringing the technical indicators into even more extreme levels?

More than a month had passed and everyone could see that the panic selling had intensified. It is only since a couple of days ago that there was some kind of bounce. Naturally, many investors are extremely wary of this. Many of them will take this opportunity to sell.

Interestingly, Marc Faber had this to say in this interview:

What you could see in the next three months is a very strong rebound in asset markets, in equities, followed by a selloff in bonds and eventually a sell-off in the dollar.

Why is the reasoning behind Marc Faber’s view?

Firstly, based on statistical probability, the market for stocks, non-government bonds and commodities are at a level that is even more oversold than the infamous 1987 crash. Therefore, based on history’s lessons, a rebound is likely to happen soon. As we mentioned before in Bear market rally on the works?, even during the infamous bear market of the Great Depression, there were many multi-month rebounds before stocks bottomed out in 1932. The only argument against this line of reasoning is the Black Swan argument (see Failure to understand Black Swan leads to fallacious thinking). Who knows, perhaps 2008 will go down in history as the worst ever bear market that is unprecedented in the entire history of human civilisation? In that case, as Marc Faber cautioned,

Statistically a rebound should happen, but if it doesn’t “the air is out” and the world faces an economy “worse than the depression of ’29 to ’32,” he said.

Next, the key to understand why a rebound can happen is that

But “I assure you if you throw enough money at the system, eventually you can reflate, especially in the United States,” Faber added.

What is happening is that despite the gigantic deflation in asset prices all over the world (around US$60 to $100 trillion of ‘value’ had gone up in smoke), governments are trying their hardest to pump liquidity (money and money substitutes) into the financial system and spending their way into budget deficits. Consequently, financial institutions are sitting on a huge pile of cash as they sell their assets and hoard it. The problem with ‘cash’ (the safest ‘cash’ is Treasury bills and government bonds) is that they have practically no return. Therefore, it is only a matter of time before the overwhelming volume of liquidity burst the seams and triggers a rally. As Marc Faber said,

If the market continues its sell-off, there will be more capital injections and more liquidity creation and one day it will trigger a huge rally where people rush out of cash into assets because they will become not concern about deflation but concern about the monetary impact of this liquidity injection on asset prices and so they rush in to hard assets whether it’s land or raw materials, in particular gold.

In such an environment, we will happen to the value investing philosophy? We will talk more about that soon.

In the mean time, what do you think will happen to the global equity market in 3 months time? Vote and express your thoughts here! (Today, we will do something a little different- we will close the comments for this post so that you can vote and comment here instead. You need to register first before you can comment and vote).

P.S. In 3 months time, we will re-visit this vote and see whether you, our dear readers, are right or not. 🙂 We will close the vote in 10 days time, so hurry with your votes.

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Posted in Looking Forward | Comments Off on Marc Faber: Asset Markets May Rebound Within 3 Months

Fading glory of the financial services and ‘wealth’ management industry

Sunday, November 2nd, 2008

October has just passed and it will go down in history as one of the worst months in stock market history. Even many veteran traders have not seen anything that bad before. As Marc Faber said in a recent Lateline interview (on 13 October 2008),

As of last week, world stock markets became oversold. Statistically probably the most oversold condition in the last 50 years or so.

One good gauge of fear in the stock market is the Volatility Index (VIX) indicator. As you can see from the chart below, the VIX spiked to its record high level (since 1990) at above 80 in October.

VIX indicator since 1990

Consequently, such intense level of fear had provoked the government into making up policies as they go and then tweaking away the side effects as an after-thought. For example, when the government gave unlimited guarantee to bank deposits, fearful money began to defect away from investment funds into banks. As these funds reacted by freezing redemptions from investors, prompting a crisis on their investment business. Some of these investment managers then pleaded with the government to guarantee their investment funds. We could sense the underlying sarcasm of the government officials as they replied by ‘taunting’ these investment funds to become banks if they want to fall under the protective umbrella of the government.

The global financial market had never been subjected to so much fear for a very long time. The sheer terror of a global financial meltdown had provoked knee-jerk reactions from governments, regulators, central banks, investors, traders and the humble savers. Beneath the raging waters of fear, panic, reactions and counter-reactions, the many decisions made on the spur of the moment by governments, regulators, and central banks will be judged by history to be turning points. These decisions will have many long-term side effects that are not immediately apparent. At this point in time, although there are signs that the panic is starting to melt away and calm gradually returning to the market, the lingering smell of mass ‘wealth’ destruction will still remain for a considerable period of time.

As we mull through the long-term ramifications, our thoughts are drawn to the future of the investment and financial service industry. The first effect we can think of is the loss of trust and confidence on the idea of ‘wealth’ management. Much of the panic selling in October was contributed by investors redeeming their money from managed funds and stuffing them towards the proverbial cash under the mattress (i.e. treasury bonds, guaranteed bank deposits and even gold). The number one priority was not return on their money. Rather, it was return of their money.

Our stand is that the trust and confidence on the idea of ‘wealth’ management through ‘investments’ in financial assets was a misplaced one. The whole idea of ‘investments’ was based on a massive bubble. As we said before at Have we escaped from the dangers of inflation? in February 2007,

Today, the global spigot of liquidity (see Liquidity?Global Markets Face `Severe Correction,? Faber Says on the concept of ?liquidity?) is wide open, spewing out huge amounts of money and money substitutes into the financial system.

…

With all these flood of fiat money inundating the global financial system, we look at all these skyrocketing financial asset prices with a yawn. Price bubbles of all sorts are found everywhere in the world?from Chinese stocks, junk bonds to private equity booms. Back here in Australia, it looks to us that nowadays, everyone is ?playing? the stock market, many using leverages like CFDs and margin lending. We hear stories of novices ?investors? opening a trading account to ?learn? how to trade. The logic is simple: central banks around the world are hard at work ?printing? money. These monies first go to the financial system, creating price bubbles. The bubbles then attract speculators, gamblers and punters into the asset markets the way bees get attracted to honey. Soon, word get round to the masses and they want a slice of the action too.

Over the years, central bankers are creating copious amount of money and credit out of thin air. The masses then take on the delusion that these fiat money are real wealth. As we asked before in The myth of financial asset ?investments? as savings,

Can the printing of money, which spawns the growth of an industry to shuffle it, cause a nation to be richer in the long run?

There were so much money and credit conjured from thin air that an entire industry (i.e. financial service and investment industry) has to be bloated beyond its fundamental use in order to shuffle them. As we said before in Connecting monetary inflation with speculation,

Thus, by further inflating the supply of money and credit in the financial system at such a time, there comes a situation whereby there are excess liquidity without adequate avenues for appropriate investments.

Thus, the global credit crisis is a return back to reality as the masses wake up their idea that all these ‘wealth’ are illusionary. As we quoted Ludwig von Mises at The myth of financial asset ?investments? as savings, real wealth is based on real capital formation. Shuffling money and competitive chasing after assets with fiat money do not make a nation any richer.

Alas, there are still many who still do not get it, even when the threat of a Great Depression II is gathering at the gates of the global economy. For example, in Australia, the Opposition Leader, Malcom Turnbull still speak of the ‘savings’ trapped in investment funds due to the Australian government’s unintended side-effect bank deposit guarantee. The fact that he is using the concepts of savings and investments interchangeably to refer to the same thing shows that he has no idea about what he is talking about.

Dear readers, to be a successful investor, you have to understand the difference between savings and investments. We urge you to read The myth of financial asset ?investments? as savings. The entire superannuation and wealth management industry is based on the myth that investments (especially ‘investments’ in financial assets) are savings. Consequently, the build-up of mal-investments that such a myth introduced brought about the financial crisis that we have today. Real investment brought about real capital formation, which is the cornerstone of real wealth in the future.

As far as we can see, the bull market (in real terms) on financial assets is over. What comes next is either deflation or stagflation. The implication is that peak glory (2001-2007) of the financial service and wealth management industry will be history.

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Posted in Looking Forward | 26 Comments »

Government’s contradictory messages

Wednesday, October 22nd, 2008

Back in Can China save Australia?, we mentioned about SBS’s Insight program, Greed. As we read the transcript of that program, we cannot help but realise that while the government officials are busy trying to deal with this crisis, they are sending out contradictory messages as a side effect.

For example, take a read at this:

JENNY BROCKIE:  But what sort of possibilities are we talking about here? I mean unemployment going up to 10%, 20% in the event of this taking hold in Australia? What could happen?

LINDSAY TANNER:  Definitely not. None of us can see into the future and the international crisis is obviously so unprecedented that it’s very hard to make predictions, but the fundamentals in Australia are very strong. We’re better off than virtually anybody else in the world to deal with these problems and we remain optimistic that we will be able to ride through this buffeting in reasonable shape.

On one hand, Lindsay Tanner ruled out the possibility of Australia’s unemployment going north of 10%. Yet, on the other hand, he said that no one knows the future and make predictions. If you notice, by saying “Definitely not,” he is already making a prediction!

Incidentally, in Jobless rate may double as China slows, JPMorgan Australia’s chief economist Stephen Walters said that

“We now expect the jobless rate to more than double to 9% in late 2010, from the current 4.3%,” Mr Walters said. “Softer growth in one of Australia’s leading export destinations means Australia’s export volumes will be lower, as will be the terms of trade.

“That said, on our forecasts, there will be 1 million unemployed Australians by the second half of 2010.”

The current way of measuring the employment rate includes those who are under-employed (see Nearly 600,000 Australians under-employed). When the economy slows down, it is those kinds of jobs that will be shed first, especially jobs in businesses that depend on discretionary spending (e.g. retailing). Therefore, a figure of 1 million unemployed people is not so unthinkable after all.

The next contradictory message from the government is on spending:

JENNY BROCKIE:   OK, there are quite a few things in what you’ve said that I’d like to pick you up on because we live in very contradictory times at the moment. You’re saying we should be thinking about thrift. You’ve just released a $10.4 billion package and you’re telling people to go out and spend. I mean, should Siobhan keep spending, keep getting into debt? What’s the message the Government is sending at the moment?

We believe that the government’s $10 billion stimulus package is a misguided Keynesian policy that will not solve the problem.

Firstly, as we said before in Will Australia?s own pump-priming work?, it is far too little to combat the deflationary force.

Secondly, even if it is big enough to induce the masses to spend, it is the wrong medicine. If such policies are carried out to the extreme, the outcome will be hyperinflation (see Bernankeism and hyper-inflation). As we explained in Supplying never-ending drugs till stagflation,

Students of the Austrian School of economic thought will understand that indiscriminate ?printing? of money will worsen the plague of mal-investments and structural damage in the economy. Like drugs, the more you ?print? money, the less effective it will be in stimulating economic growth (see What causes economic booms and busts?). Eventually, it will come to a point that the economy will not respond positively anymore no matter how much money is being ?printed.?

Without the liquidation of mal-investments and restoration of the structural imbalances that is brought about by deflation, applying bigger and bigger stimulus packages will only function in similar ways to drugs- more and more for less and less effect. The reason why Keynesian reflationary pump-priming worked during the Great Depression was that it was applied after the cleansing effects of the deflation had done its work. But today, in reaction to the financial crisis, governments all over the world are doing so before the purge of fire. As a result, the much-needed economic correction that the economy had to have will not happen.

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Posted in Economics/Finance, Looking Forward, Market Observations | 12 Comments »

Bear market rally on the works?

Monday, October 13th, 2008

Back in What is the meaning of ?oversold?? Part 1: Technical analysis perspective, we explained that

In technical analysis, there is a class of indicators called the ?momentum indicators.? Examples of this indicator include stochastic, Relative Strength Index (RSI) and so on. Basically, these indicators measure the momentum of price movements. If the momentum is far too much on the upside, then it can be said that the prices are ?overbought.? Conversely, if the momentum is far too much on the downside, then they are ?oversold.?

The theory behind momentum indicators is that at the either extremes (i.e. oversold or overbought), it is a matter of time before exhaustion sets in and cause prices to reverse. In that sense, these indicators are contrarian in nature because it tells the technical analyst to sell when prices are overbought and buy when they are oversold.

One month has passed and the selling momentum had intensified and brought prices even lower. Many technical analysis indicators have now approached extreme bearish levels.

At such extreme levels, it is very possible that we will see a counter-trend rally soon. But please note two things:

  1. It does not mean that prices cannot go down further in the short-term. Who knows, perhaps there will be more panic selling in the days to come, thus bringing the technical indicators into even more extreme levels?
  2. In all likelihood, such a counter-trend rally will still exist in the context of a bear market.

In the infamous Great Depression bear market from 1929 to 1932, stock prices did not fall straight down. As we explained in Second lesson of ?29 crash?bear rebound,

Back in 1929, the bear market rally lasted for around 6 months from November 1929 before resuming a downward trend.

You may want to take a look at the stock charts from 1929 to 1933:

29to32percentchart
Source: Financial Armageddon

Notice that many of the bear market rallies last more than a month, the longest being 6 months.

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Posted in Looking Forward | 11 Comments »

Hedging against deflation

Monday, October 6th, 2008

The recent nationalisations, collapses and runs on banks in the US and Europe brings a new dimension of economic uncertainty to many people. The last time such things occur in the developed Western world was during the Great Depression in the 1930s. For this current generation of economists, financial analysts and money managers, a credit crisis is something that is supposed to occur only in textbook studies of the past. But recent financial market events brought such abstract history into real life. Suddenly, the idea that cash is no longer safe is a rude surprise for many. If cash is no longer safe, then where else can you hide?

This is what is technically called “deflation.” Deflation is not as simple as just falling prices. It is, as we explained in Will deflation win?,

A falling money supply is the definition of deflation, for which the symptoms will be falling asset prices, which if prolonged enough, will lead to falling consumer prices. But before we go off to celebrate falling prices, remember that this is an evil type of deflation because it is the type that is associated with bad debts, bankruptcies, unemployment, falling income, bank runs and so on.

We recommend that you read our guide, What is inflation and deflation? for more information about this topic.

So, if you are particularly concerned about deflation, how should you protect yourself? As we said before in Should you hold gold or cash in times of deflation?,

You see, the ?cash? that you had deposited in a bank is an asset to you but a liability to the bank. In times of severe economic conditions (e.g. during the Great Depression), can your bank honour its liabilities? If it can?t, then your ?cash? is in grave danger.

The key thing to remember is that as long as your asset is a liability of someone else (e.g. bank), you have a counter-party risk. If your counter-party defaults, your asset is gone. In this evil kind of deflation, counter-party default is the greatest risk to your wealth. Therefore, there is only two ways to protect yourself:

  1. Choose your counter-party wisely.
  2. Keep your wealth in a physical form such that it is nobody else’s liability.

We will first explain point (1). Basically, the only supposedly risk-free counter-party is the government because it has the executive power to tax and print money (note that we used the word “supposedly”- the Russian government defaulted on its bonds in 1998). If you store your wealth in the form of government debt (e.g. Treasury bonds), you will be guaranteed a periodic payment from the government. As we explained before in Measuring the value of an investment,

For example, if you pay $100 for a newly issued 10-year government bond that pays 6% per annum, you are sacrificing $100 of today?s consumption in order to receive $6 per year for the next 10 years. That 6% is your rate of return on your investment. Now, let?s say you decide to sell your government bond to Tom at $90. The rate of return for Tom is 6/90 = 6.67%. Let?s say Tom sells the bond to Dick at $110, the rate of return for him will be 6/110 = 5.45%. Thus, the rate of return of the bond is inverse to the price paid for it.

In times of deflation, government bonds will be so highly sought after that its free market value will rise. Consequently, its yield (rate of return) will fall. On the flip side, government bonds are completely useless during inflation. In times of hyper-inflation, government bonds are as good as toilet paper.

Now, point (2) is already explained in Should you hold gold or cash in times of deflation?. But we would like to add a few more points:

  1. Gold was an excellent hedge during the days of the Great Depression because the US was still under a gold standard. The government would print a specific amount of US dollars to buy the gold that you presented to them. As we quoted Wilhelm R?pk in Which industry?s profitability grew as the Great Depression progressed?, the gold mining industry prospered during the Great Depression because

    So long as there exists at least one country [the US] on a full gold standard, an essential condition of which is freedom to buy gold from or sell gold to the central institution at a fixed price, there is literally an unlimited demand for the commodity at that price. In other words, not only is a minimum price for the product of the industry guaranteed, but there is, besides, no limit to the amount the market will take.

  2. The case for physical gold as a deflation hedge is weakened if the government insures bank deposits. In the US, the FDIC insures up to $100,000 of bank deposits. In Australia, there is NO government deposit insurance.
  3. But if for whatever reason, you (1) distrust the government’s deposit insurance, (2) have more than the amount that is insured by the government, (3) believes that the government will print lots of physical cash to provide for cash withdrawals in a bank run, (4) put a freeze on cash withdrawals to prevent bank runs, (5) government does not insure bank deposits (e.g. Australia), (6) can only trust storing your wealth in tangible form (6) etc, there is still arguably a case for holding gold as a hedge against deflation.
  4. The US government outlawed gold ownership during the Great Depression. It may happen again this time.

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Posted in Bonds, Gold, Investor Education | 14 Comments »

Is this the beginning of the loss of confidence in fiat money?

Sunday, September 21st, 2008

Events from the past week are tumultuous. It started from the nationalisation of Freddie and Fannie (we were mulling about the implication of nationalisation 2 months ago in How do we all pay for the bailout of Fannie Mae and Freddie Mac?). Then came the bankruptcy of Lehman Brothers and takeover of Merrill Lynch. Then we have the nationalisation of AIG. Gold prices surged by more than US$100 in two days (it had declined since), which was the most rapid surge in 26 years. At the same time, the Dow plunged by more than 400 points. It looked as if there was a panic from stocks straight to gold, which meant even cash was distrusted.

Then we have another massive rally in stocks for the past two days when there was hope that the US government, in conjunction with the Federal Reserve are doing something to solve the root of the rot in the financial system. Reports come out that they are planning to use taxpayers’ money to buy up bad assets at sale price. As always the case, the devil is in the details. At this point in time, there is no definitive figure on the cost. Make no mistake about this: this is no trivial task. As this New York Times article reported, Ben Bernanke warned the Congressional leaders,

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program ?Good Morning America,? the congressional leaders were told ?that we?re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.?

Mr. Schumer added, ?History was sort of hanging over it, like this was a moment.?

When Mr. Schumer described the meeting as ?somber,? Mr. Dodd cut in. ?Somber doesn?t begin to justify the words,? he said. ?We have never heard language like this.?

By now, it should be clear that this global financial disaster has the potential of even surpassing the Great Depression of the 1930s!

Is this crisis a surprise? If you listen to the mainstream economic schools of thought, central bankers, mainstream financial media, captains of the financial industry and so on, it looked as if this looming financial disaster is something that no one can see coming. The common underlying excuse (that was un-said, un-written but implied) goes something like this: “No one could ever foresee this! It’s impossible! Only hindsight can tell!”

Now, we would like to make it clear that this is completely false. Please note that we are not accusing individuals of lying. Instead, our point is that this excuse is a sign of collective mass delusion. If you look at the 6000 years worth of the history of human civilisation, you will find that humanity is repeatedly capable of mass delusions. Always, only the minority could see through the lie. In this case, students and practitioners of the non-mainstream Austrian School of economic thought SAW IT COMING. Some of them sounded the alarm as early as 2004! To press our point further, let’s us show you the chronicle of our warnings in this blog since 2006…

  1. In May 2008, when the world was in denial about the precarious state of the global financial system, Satyajit Das warned that the credit crisis was just the end of the beginning (see Is the credit crisis the end of the beginning?).
  2. Back in November 2007, if you look at the list of major US financial institutions that was compiled by Nouriel Roubini at How solvent are some of the major US financial institutions?, only half of them are left standing. Interestingly, Merrill Lynch was the safest among the insolvents and today, it failed to live. If Merrill Lynch was insolvent, what about the remaining ones today (i.e. Goldman Sachs, Morgan Stanley, Citigroup)?
  3. In June 2007, in Epic, unprecedented inflation, we warned that

    How much longer will the roaring global economy fly? We do not know the answer, for this boom may last longer than what we anticipated. However, please note that in the entire history of humanity, all bubbles (and we repeat, ALL) burst in the end. Thus, a global painful hangover will ensue?the greater the boom, the more painful the eventual bust. This is the theme that we had repeated many times.

    Thus, do not be surprised if a second Great Depression were to strike.

  4. In the same month, the Bank for International Settlements (BIS) warned that the world was in danger of another Great Depression (see Bank for International Settlements warns of another Great Depression).
  5. Back in January 2007, in Spectre of deflation, we wrote that

    But we smell danger.

    It is a danger in which many in the finance industry failed to fully appreciate?deflation. Such complacency is beyond our belief. In the 1990s, Japan experienced it, with dire consequences for their economy. At least, the ordinary Japanese had their savings to fall back on. For many Americans, with their negative savings rate, what can they fall back on? Have they not learned from the mistakes of others in the past?

  6. In the same month, Trichet, the president of EU central bank warned of a coming asset re-pricing (see Prepare for asset repricing, warns Trichet).
  7. Back in November 2006, in How will asset-driven ?growth? eventually harm the economy?, when the global economy was still booming in apparent ‘prosperity’, we quoted the late Ludwig von Mises (the in which the Mises Institute of the libertarian Austrian School of economic thought is named after) and warned that

    That collective error in judgement resulted in the economy misallocating scarce resources into housing sector?in the case of the US, a significant proportion of the jobs created during the asset-driven ?growth? was related (both directly and indirectly) to the housing boom. Since economic resources are always scarce, any misallocation of it implies an opportunity cost on the other sectors of the economy. The result is a structural damage to the economy that can only be corrected through a recession.

    This is the reason why we believe a recession is on its way.

  8. In October 2006, we quoted the late Dr. Kurt Richebächer (an Austrian School economist) and questioned in The Bubble Economy,

    9. These are some of the serious questions we would like to ask:

    1. As the US spends its way into economic ruin, its economy is being damaged structurally. How much longer can the US sustain its colossal debt?
    2. Right now, the US housing bubble is deflating. Will it eventually burst and wreck havoc on the rest of the economy?

Other contrarians who sounded the alarm long ago (and we quoted often) include Marc Faber, Jimmy Rogers, Robert Shiller, Peter Bernstein, Nouriel Roubini and our local Aussie economist, Professor Steve Keen.

Our readers should, by now, appreciate the colossal magnitude of this financial crisis. When you listen the media, the phrase “since the Great Depression” is often mentioned. Make no mistake about this, this has the potential to be worse than the Great Depression (note: we are NOT predicting that it will happen).

The world’s stock market is rallying in the hope that the US government’s plan to nationalise the financial industry will be successful in stopping the core of the rot. New legislations has to be rushed through Congress by the end of next week to change the rules to make the plan legal. As in everything done in haste, we believe there will not be enough thought put into them to understand the long-term ramifications. It is probable that once the changes are in place, they will not be revisited again.

As we warned in Recipe for hyperinflation,

There is no way any politician can sell the message that America needs a severe recession (or even a depression) to cleanse the economy from the gross excesses, imbalances, blunders and mal-investments. Thus, it is very likely that they will have to fight deflation till the very bitter end, till the last drop of blood from their last soldier. Since the current structure of ?rules? will be too restrictive in such a war against deflation, there will be popular momentum towards the bending and rolling back of these ?rules.? If they press on relentlessly till the final end, there can only be one outcome: the US dollar will be joining the long list of failed fiat paper money in the annals of human civilisation.

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Are commodity prices at a longer-term or short-term peak?

Sunday, September 7th, 2008

In just a couple of weeks ago, we mentioned in Will deflation win? that deflation is gaining the upper hand. For those who are following us for a very long time, this development is hardly surprising. You may want to read that article to gain an understanding of what is happening.

Today, we will provide additional commentary from Marc Faber about the current situation. Recently, he was interviewed (you can see that a partial transcript of that interview here). Regarding commodities, he has this to say:

The second half of 2008 of this year would not be favourable for commodity prices… As far as I?m concerned, we peaked out in commodity prices, and later on we will have to see whether it?s a longer-term peak or a short-term peak. But we don?t know yet.

Now, let us put this comment in context. Around a couple of months ago, Marc Faber told his subscribers that commodity prices have peaked and it’s a time to sell commodities. The question is, whether this is a longer-term peak or just a short-term peak. As you can read from our earlier article, Will deflation win?, it is in this context that commodity prices are falling.

At this point in time, you may wonder why there is a feel of uncertainty in Marc Faber as he said, “whether it?s a longer-term peak or a short-term peak. To understand his doubt, let’s turn to our earlier article, China?s slowdown & its implication for Australia,

At this point, we have to ask these crucial questions: (1) Is this Chinese slowdown merely a temporary blip for the sake of the Olympics (i.e. after the Olympics, the break-neck growth will resume again)? (2) Or is it, as we explained in Will China slow down from 2009?, a chance to catch a breather for a while? (3) Or worse still, a pre-cursor to a major economic correction, as we explained in Can China really ?de-couple? from a US recession??

At one extreme, if point (1) is true, we may see a resumption of the up trend in commodity prices in the short-term. If point (2) is true, commodity price may stagnate or drift lower in the short to medium term. If point (3) is true, which is the worst case scenario, we will see a depression in commodity prices at least in the medium term. This worst case scenario can play out as a Greater Depression (that rivals the Great Depression of the 1930s).

But having said that, if point (3) (severe deflation) is to occur, the wild card will be how the governments and people choose to handle it. If they react by repealing the credit-system mechanism (see Understanding the big picture in the inflation-deflation debate for what this means), then the end game will be hyper-inflationary type of Depression (see What if the US fall into hyperinflation?).

Thus, it is in this backdrop of uncertainty that Marc Faber is advising investors to hold their fire and wait and see. Of course, all these has to be viewed in the context of the long term as we describe in Are we in a long-term inflationary environment?.

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