Aug 19, 2019
After being bugged unmercifully by a couple of my so-called friends, I finally sat down in early January to write a tome about investing in resource stocks. It took me sixteen days to write. And another four weeks to get the cover and layout right. I had some important charts in it that couldn’t be shrunk and still understood.
A couple of days ago I was reaching for a quote that I thought I remembered from the book so I picked up one of my test copies.
I read through the first two chapters and thought to myself, “Damn, this guy got it exactly right.” That was before I realized I was the person who wrote it eight months ago.
One of the great advantages of getting old, other than just getting old, after all the alternative is far worse… One of the benefits of getting old is that you get to hide your own Easter eggs. That is if you can still remember when Easter is.
I never did find the quote. But I did realize that what I wrote in January could have been written twenty minutes ago and not be more timely. So I thought it would be a nice idea to share it with you. This isn’t a sale pitch. If you have read the book you, too, will have already read it but have forgotten. If you haven’t and think it might be worth finishing, you are just going to have to figure out how to buy it by yourself.
These two chapters can be read in ten to fifteen minutes. This could be the most important thing you read this year. Or any.
State of the Financial Union
ON AUGUST 15, 1971, President Richard Nixon broke gold’s last tie to the world’s financial system. The dollar went from being as good as gold to being as good as paper, literally overnight. Since that time governments of all sorts have engaged in a frenzy of printing and spending money they didn’t have. It was as if Nixon granted the world an unlimited supply of paper and ink and told them it was possible to print wealth out of thin air.
To spend now reduces our ability to make future purchases. Borrowing in order to spend now does nothing more than bring consumption forward and lays a burden of debt on future generations. True prosperity never comes from consumption but rather from saving for an unknowable future. When you have already spent your own future, it’s foolish. When you have spent the futures of your children and grandchildren, it’s criminal. Thomas Jefferson said, “It is incumbent on every generation to pay its own debts as it goes.”
In the developed world today, when children are born the government handcuffs them with a debt burden they may never shed. Governments of all sizes and colors are forcing investors into making an important decision about their future. Each of us must decide. Do you want to be rich or do you want to be poor?
Stable civilizations are best measured by the size of their middle class. Every society has had rich and has had poor. That has been true forever, no matter where the country was located, or when. But as overall wealth grew, primarily due to the benefit of easy use of money and eventually nearly free energy, civilization grew and spread. But it remains accurate to say some will always be poor and others will always be wealthy. What matters most is the stability of government, and that mostly depends on the size of the middle class.
When governments declare war on the middle class, they are declaring war on themselves. Eventually the newly poor begin to envy the newly rich, and a revolution begins.
In any normal, rational time, investing in resource stocks would be the act of a gambler who hones his skills on the craps tables in Vegas and buys a handful of cheap lottery tickets on the way home from the bar in the faint hope of collecting a multimillion-dollar payoff.
It’s been my experience that resource companies are often run by idiots pretending to be managers who live the good life while sucking the financial blood out of the veins of helpless investors. It’s a dangerous business, where failure is the norm. Share prices run up and down faster than a bride’s nightie. I’ve run into charlatans, con men and fools. I’ve visited hundreds of mining properties and I’ve been lied to on almost every trip.
I find that wonderful, being lied to maybe 75 percent of the time. I used to be in the computer business. There I got lied to 100 percent of the time. So the liars in mining are at best amateurs in comparison.
But these are not rational or normal times, and investing in resource shares may be the only logical investment for those looking to hedge other potentially more dangerous alternatives. Remember, it was only a little over a year ago that every punter and his grandmother were tossing pesos into what I call the Bitcon pool. I passed on the whole madness, seeing it as nothing more than a variation of an electronic Beanie Baby.
At one point in late 2017 the total value of the 1,300 varieties of Bitcon amounted to over $800 billion. As of January 2019 the number of Bitcon look-alikes is up to 2,533 but the combined net worth of all of them is down to $136,368,981,000, roughly.
That means $663 billion flew off to Bitcon heaven. We were told to buy Bitcon in all its varieties because it was limited in supply. Nothing with 2,533 variations is limited or rare.
The United States Federal Government is adding to the national debt at a rate unparalleled in history. One day very soon those 2,533 variations of Bitcon may well seem a lot more logical than the debt of the US government.
When you look up and see what seems to be a layer of dark and foreboding clouds, it may well be nothing more than a bevy or wedge of black swans. No one can say just which black swan will land first, but it’s an easy prediction that with so many black swans circling, at least one is bound to be wheels-down soon. When that happens, The Great Reset begins.
The Great Reset
I READ THAT the total debt in the world today is in the neighborhood of $250 trillion. To me, and I suspect to most readers, the number is so large as to be meaningless. To put it in better perspective, we could perhaps compare it to the world’s yearly production of goods and services, estimated to be in the vicinity of $90 trillion. Now those two figures do not provide a complete picture, only a relative number.
Let’s use two smaller numbers, but with the same ratio. If you owe $35,000 but have an income of $12,600 a year, you have a debt problem. Now multiply that by every person on earth: young, old, infirm, all of the 7.7 billion breathing today. The level of debt in many countries is higher than at any point in history. We know that countries go broke regularly and always have done.
That’s in an environment of zero or negative interest rates. Now that becomes insane. If corporations and governments can’t maintain a reasonable balance between income and outgo with negative interest rates, just how do they expect to cope with normal historic interest rates?
When I was going to college in the early 1970s, I majored in economics. I was at both Columbia in New York City and Iona College in New Rochelle. I worked all day and attended night school. Being in and around New York City, both schools attracted top-notch economics professors from Wall Street. I learned a lot — mostly to ignore conventional economics and Keynesian theory.
If I would have submitted a paper even suggesting the possibility of negative interest rates, I not only would have flunked the course, I would have been ejected from the classroom.
“Negative interest rates, you say? Have you lost your cotton-picking mind? Out!”
“Now! Out! Get out of my classroom, you moron.”
Today you can read every day about what a great idea it is to loan money to governments that guarantee you will receive less in return. That’s quite goofy.
If you get nothing else from this book, learn at least one important element. It will justify the couple of bucks you may have plunked down for the sucker.
All debts get paid.
I will repeat myself because it’s such a vital element to understanding finance and investing.
ALL DEBTS GET PAID.
They are paid either by the borrower or by the lender.
I remember loaning a fellow some money while we were playing craps in the O-Club in Meridian, Mississippi, one Friday night happy hour in 1966. That’s already one serious mistake on my part, you are no doubt thinking.
Playing craps wasn’t a mistake. I have made a heap of money over the years shooting dice, starting on my first night in boot camp in San Diego in 1964, using a set of dice made from chalk. I suspect our young men and women undergoing the same rite of passage today probably forgo shooting dice, and that’s a pity. In combat and in investing, understanding the odds of every roll is vital.
In short, if you want to know how to invest at a profit, knowing the odds helps a lot.
Back to the O-Club in Meridian. My first loan ever was never repaid by the borrower. Eventually it sunk in that if he wasn’t going to pay, then what I believed to be an asset wasn’t. So I ended up paying, to my great surprise.
All debts get paid. If not by the borrower, then by the lender. Alas, we are told that if the US government goes into debt to the tune of over $1 trillion a year, most of it is owed to ourselves so it really doesn’t matter. It’s not as if we owe it to another country.
That’s really dumb thinking.
The US Treasury releases a financial statement each year. The 2016 statement showed that the US government’s 75-year unfunded liability just for Social Security and Medicare totaled $46.7 trillion. That’s money that we “owe to ourselves,” so a lot of writers suggest we ignore it. It’s not as if it’s a real debt.
Well, if you are planning on collecting Social Security or using Medicare 25 years from now, the government not paying its debts means no money for you. So if the government doesn’t pay its debt, you get to pay it instead, by forgoing Social Security or Medicare.
Have fun in your retirement years without the income or insurance that you were promised. Do let me know how you feel about debts to you not being paid, and if you think it’s important or not.
Professor Laurence Kotlikoff from Boston University suggests the total unfunded liability of the United States government is really more like $210 trillion. He came up with that number in 2015. It’s a lot higher today.
The fact is that virtually every government in the world today is functionally insolvent as a result of buying votes from the populace by making a series of financial promises that it cannot possibly keep.
That’s what the Yellow Vests revolution in France is all about. That has spread to Taiwan, Israel, Jordan, Lebanon, the Netherlands, Egypt, China, and even Brussels, home to Europe’s greatest stupidity in government.
It’s something I predicted in a book I published three years ago, titled The Art of Peace. In the book I suggested that all empires end when they begin to engage in military adventurism. That is to say, wars that you don’t need to fight. You just feel like showing off your strength, like a 14-year-old boy riding a bicycle on one wheel to impress a 14-year-old girl. It may look cool but you don’t really need to do it.
Anyone who has thought at all about it can see that of the various wars the US has engaged in since September 11, 2001, none of them has accomplished anything.
Anything worth doing is worth doing right. Anything not worth doing is not worth doing.
They have cost a lot of money, as yet unpaid, and have destroyed any good opinion the rest of the world may have had of the US as the home of the brave and land of the free. How about the land of the enslaved and hopelessly bankrupt?
I said in my book that the world was awash in debt that could never be repaid. The result would be the first worldwide revolution.
Rumblings from the masses have been going on for almost a year but became visible only when protestors in France, wearing the yellow vests or gilets jaunes that are required to be kept in every vehicle, began to demonstrate all over France in November of 2018.
I’ll say more on the Yellow Vests in a later chapter since they are so important to what is happening today.
No one ever wants to address the real issue. Just who is going to pay for the cradle-to-grave benefits all these governments have promised? The arithmetic doesn’t work.
Those folks in France know how to run a revolution about as well as they understand how a guillotine functions.
Just as a small matter of interest, one of the causes of the French Revolution of 1789 was the government getting involved in the American Revolution and bankrupting itself in the process, fighting a war that did nothing for France. Those running governments around the world today should think about how their heads would look on the end of a pike. It’s happened before.
I read a piece just today about a survey recently taken in Ireland by the European Broadcasting Union’s Generation What? research group. Questions were asked of 20,000 people about their attitudes toward various groups. A full 36 percent of them viewed politicians as corrupt and an additional 40 per cent believed they were partly corrupt.
In the 18–34 age group an incredible 54 per cent added that they would take part in a “large scale uprising against the generation in power if it happened in the next days or months.”
By and large, the Gilets Jaunes protests have been a mishmash of calm protestors angry at a system that ignores their problems and needs. There are no leaders. There is no single agenda. It’s just a mix of protestors spread over the whole of France. Almost all the violence comes from the police.
Yellow Vests walking in Oloron, France. (Robert Moriarty)
I spent a couple of months in Switzerland writing my last two books. When you ask the Swiss how their government works, they tend to get that “deer in the headlights” look. They know what you are asking; they just don’t know how to answer.
The government in Switzerland works by working. The president of the country has an entirely titular position, his biggest role being to preside over the Swiss Guards — who aren’t in Switzerland anyway, as they guard the Pope in Rome.
If you reside in Switzerland and you have a really great idea, or even a really daft idea, if you can convince eight cantons or 50,000 voters to support your concept, the country will hold a binding referendum on the matter.
A couple of years ago someone wanted to test the concept of a guaranteed basic income. Now that sounds at first like a wonderful idea: no working, free money. They got the signatures, a referendum was held, and the idea was promptly killed. It was Switzerland after all, and they know a daft idea when they hear it.
I sense that throughout the world, ordinary people feel hopeless in the face of big government. Major organizations have undertaken studies and concluded that in the US, voting doesn’t change anything. It’s a waste of time, a sop thrown to the masses to make them feel they have a voice. But people aren’t stupid and they know they don’t have a voice. For years, most Americans have supported withdrawal from Iraq and Afghanistan but no one in Washington listens.
With the coming of the Internet, people begin to realize we don’t really need big government. Politicians have always been prostitutes. They sell their souls for votes, but once in power all they do is line their own pockets and the pockets of those special interest groups who launched them into office.
Governance in the world today simply and clearly doesn’t work. It doesn’t represent the will of ordinary people and it needs changing. We are entering what I believe will be the time of the greatest financial disaster in world history. As we do, ordinary people across the entire world are beginning to demand both change and representation. The Gilets Jaunes movement is merely the opening round, not the end. It’s not only not the end, it’s not even the end of the beginning.
The banking system went on life support back in September of 2008. As bad as banks have been historically, since 2008 they have resembled nothing less than casinos run by the Mafia. Some banks, such as Wells Fargo, have been smacked with billions of dollars in fines for clearly stealing from their customers. In reality the fines are nothing more than a tax on fraud on the part of the US federal government. Certainly the customers who were defrauded by Wells Fargo didn’t get one cent of their money back.
The perennial bad boy of European banking, Deutsche Bank, maintains a notional derivatives book of $46 trillion, or 12 percent of the entire world’s derivatives exposure. We are told the figure is meaningless because the net exposure is far less than the notional value, but those saying that have skipped an important part of the issue.
The magic behind derivatives is a theory that you reduce risk by spreading it out. Actually you do the opposite; you multiply risk because you have introduced counter-party risk. Here’s how I explain counter-party risk, and why it increases at a geometric rate as size increases.
Imagine yourself as someone controlling trillions in oil wealth. You control a seemingly endless flow of cash and if someone pisses you off, you can whack them and expect to get away with it.
You walk into any casino in Vegas and go up to the craps table. You ask the dealer if you can make a million-dollar bet on one roll of the dice. He agrees. When you make the bet, one of two things will happen. You either win and get $1 million, or you lose and fork over a lot of $100 bills. You are so rich that you really don’t care.
But you like action, so you go to the biggest-grossing casino in the world, in Macau. But now you want to make a billion-dollar bet. That’s a big bet, so the floor boss has to check with the main office, but he takes the bet with a smile. Once again, at that point you can either win or lose. If the dice favor you, you walk out with a check for a billion dollars. If they don’t, you hand over another, far bigger pile of $100 bills.
Since that worked out so well, you ask the casino manager if he can make one more bet, this time for $1 trillion. This time the manager just smiles a broad smile and nods. He doesn’t have to ask anyone for permission. He really likes this bet.
At that point only one thing can happen.
You can only lose.
It doesn’t matter a rat’s ass what the dice do; there isn’t a casino in the entire world that can cover a trillion-dollar loss. The casino manager knew it the whole time and didn’t care. If you crap out, the casino is rich beyond their wildest imagination. If you roll a seven or an eleven on the first roll, the casino can’t pay anyway so they don’t care.
It wasn’t the nature of the bet that made it a good or bad bet; it was the size. And at some point as derivatives increase in size, you are no longer just incurring a financial risk but adding counter-party risk.
With Deutsche Bank holding $46 trillion in derivatives, when a systemic crash begins, the meaningless notional exposure may well become a very real net exposure. Let me give you another example, because frankly I suspect there are only three people in the entire world who actually fully understand derivatives and two of them are a bit confused.
You look at Deutsche Bank and read that its stock price has dropped by 80 percent in the last five years. Due to loan losses and built-in losses in its derivatives book, the bank is headed for the rubbish pile. If and when Deutsche Bank collapses, that particular rolling snowball is going to become the mother of all avalanches by the time it reaches the valley floor, sweeping every other bank in the world along with it.
You realize that’s a really bad thing to happen. The Dow and S&P might drop 20 percent in a day and gold might go up by $500 an ounce in a day. The S&P is trading at 2570 and gold is at $1,285. You buy puts on the S&P at 2100 because they sell for pennies. That way, should you be right and the entire system blows up, you have incredible leverage. Likewise, you buy calls on gold at $1,600 for exactly the same reason. They too sell for pennies.
Sounds like a good deal, right? Let’s say the unthinkable then happens and the stock market does plummet, taking the S&P to 1800. Gold goes to $2,000 an ounce as it is the last man standing.
At this point you need to think about how rich you just became. I can actually work it out in my head, it is so easy. You just lost everything you put into the puts and calls.
Those gold calls that sold for pennies are in theory worth $40,000 apiece. The S&P puts work out to $30,000 each. But your counter-party, no matter who it was, is broke. Counter-party risk kicked in as a result of the size of the movement in prices. And no one is going to bail them out this time. There isn’t enough money in the world unless the US goes into the Monopoly money business. Which is certainly an option.
The world’s financial system came within hours of collapse in September of 2008 because of what seemed to be some relatively meaningless derivatives. But when notional value morphs into actual value, the game is over. 2008 was just the opening round of the collapse of the world’s financial system. We are moving rapidly into the most dangerous part of the crash.
The London office of AIG was playing fast and loose with credit default swaps on sub-prime mortgages. As an example, a tiny hedge fund similar in nature to AIG insured UBS for $1.3 billion of sub-prime mortgages for a premium of $2 million a year. As long as the mortgages didn’t default, the hedge fund was raking in the dough and making an annualized return of 44 percent. Then, in 2007, mortgages began to be defaulted upon. UBS called in its insurance claim and the hedge fund refused to pay. So UBS made an insurance claim. It didn’t get paid, and found it was now on the hook for $1.3 billion. It didn’t get its $2 million back either.
The London office of AIG literally put the entire company at risk by doing the same thing on a far larger scale. In their minds, they were privatizing financial gains and counting on the government to bail them out in the event of losses. The US government did bail out AIG, to the tune of $85 billion.
While the full figure may never be known, the US Treasury was handing out bundles of $100 bills to every bank in the world like candy to kids on Halloween. The total cost was in the trillions of dollars, all borrowed. The actions of the central banks did nothing more than convince the banks that the government would always be there to save them.
But maybe not. Things continue right up to the point where they stop.
The world is awash in debt that no one actually believes will be paid; the middle-class is being crushed between the rock of higher taxes and the hard place of constant inflation. And they have had enough. All over the world, protests are growing daily. They will continue to grow until the system blows up. Then we have The Great Reset, where we return to a level of government the middle class can afford.
If you think about it, it’s very simple. There is only a certain level of government any country can afford. Once you go above that level you are asking for problems and are guaranteed to get them.
Now this may sound irrational because you aren’t hearing it from anyone else, but the only solution is to cut back on government until it returns to a level you can afford. There are no other options; you can’t print your way out and you can’t borrow your way out. You have to reduce government.
There are some actions you can take to protect yourself. That’s what this whole book is about.