What the Autumn may Bring ...

History has a habit of repeating itself. Markets also, follow a similar pattern as history can show. As Summer draws to close, as we enter Autumn, I feel we are in for another action packed time, similar to the close of 2008. Optimism is in the air all around with a complete turnaround of sentiment. When the majority are optimistic, its best to go against the tide and September and October are historically torrid times for the markets. There is evidence all around the globe that imbalances still exist - many worsening as time passes. China is in a rampant bubble driven by the Communist party. Many Eastern European nations are close to currency crisis, exposing many Western European countries who have lent them money. Sterling continues to worsen, as the UK leads the developed world in printing money and debauching the currency. Liquidation is put on hold, as governments believe they can avoid the inevitable. There have already been ominous signs for this month, with the classic August stock market volatility. Central Banks are planning their next moves, in the US there have been rumors regarding a second stimulus package as the first one runs out.

If we take a look at the VIX (the volatility index) it has been moving downwards since the events last October. Notice how quick it can move upwards as last year shows.


There was always going to be a market rally. Nothing ever moves straight up, or straight down. There are always periods of consolidation. If we look at Sterling, it has rallied quite substantially since its dramatic decline last year. Does this mean it has reached a low? I'm afraid not, all the fundamentals point for it to resume its bear market run, and if I was a trader I'd be looking to put shorts on Sterling as the next few months should see a deterioration once more. Sterling looks once again a basket case currency as it did during the sixties and seventies with a new generation that is fooled with the same rhetoric past politicians used to say to justify the devaluations.

30-40 years ago the politicians always justified the devaluations. We need to buy time, it will make our exports more competitive, we need to 'invest' to keep jobs and so forth. Roll forward 30 years and the same fallacies are being told. The idea that a devalued currency can bring prosperity is sheer madness, if it was that easy then no one would have to innovate or increase productivity. Over the long term this policy never works. You need a strong currency and a strong government to put the breaks on and say 'Ok, we tried to inflate, it didn't work, therefore we will stop the printing'. As painful as this would be it works. People adjust, they become more competitive, make better products, start investing. This is how you become wealthy and give your exports the edge. This is what Japan and West Germany did.

After the Second World War both these nations had worthless currencies. War torn, people had resorted to bartering rather then use government money, they had no currency reserves and their people were living in poverty. Nations usually have to get in this state before politicians get a spine and change their ways and that's what happened. Germany abandoned the flawed Reichmark and introduced the Deutsche Mark with a new emphasis on maintaining a sound currency, and so began Wirtschaftswunder, the great Germany economic miracle. Britain meanwhile became the sick man of Europe and was synonymous with the term 'Brain Drain', despite getting more American Aid than the Germans from the Marshall Plan. Germans on the other hand enjoyed a booming economy, one that had low inflation during the stagflationary seventies.

Japan also took a similar route. Their goal was to get Western Currency, and the only way they knew how to do that was to sell quality products that Westerners wanted to buy, and in return they got their pieces on paper. Did they debase the Yen to achieve this? They did the exact opposite and they created quality products. Westerners used to joke about Japanese products (similar to what they say about Chinese ones now as China tries to emulate Japan) but what do people think of when they see Sony, Toyota or Seiko now? They did this while the Yen appreciated, innovating, increasing productivity and smashing the Americans once dominance of export markets during the 1950's and 1960's. The only reason Nissan or other such companies placed their factories here in the UK is for shipping costs and the 'enlightened' tariffs governments have imposed to 'save' jobs. Even if the Chinese or whoever could do it cheaper.

Of course Japan and Germany are different entities now. Their first and second generations built their wealth and generally as the generations move on it gets wasted. They aren't the countries they used to be. Nations such as China are where Japan were back in the 1960's, a generation who still remember Communist hardship, whose parents still remember the mass poverty and killings. Following a similar model they had no currency reserves and now have amassed $2 Trillion Dollars, and are still amassing them. They have high savings rates like Japan once had and are becoming a huge creditor nation. All of this takes huge personal sacrifice. Sacrifice many current western generations are not willing to make.

So will anyone take similar action as the above for the UK? I don't believe so. Things haven't got that desperate yet. They will keep debasing telling the public the reasons above, a noose will slowly tighten around the government. Spending out of control, exports unable to pay for imports, international investors dumping the currency, tax increases on businesses driving out talent, with the process going full circle. Of course the markets will force their hand eventually. We are a way off yet, but I feel this is what it will take. A real crisis. We should see currency controls at some point in the future as the government attempts to bolster Sterling. They may even start with limiting the amount of foreign money you can take abroad.

People in the UK, I feel, are putting too much trust in David Cameron and the Conservatives, that they will win the election next year and all will be fine, however I personally think the trust is misplaced. Tory Party members have recently attacked the NHS and David Cameron has shown what he feels. He wants the NHS and is willing to spend more money on it. I don't think he has the conviction to scale back government significantly and even if he did the damage is already too bad. Mr Cameron seems to want to mimic Labour as close as he can and won't want to upset the public too much. Even if he was like Thatcher, back then the deficit wasn't as bad, we had oil and gas, and we weren't monetising our debt on the scale we are now. Thatcher would recoil in what needs to be done under our current circumstances.

In a nutshell the world still has plenty more deleveraging, which means Governments will be looking to carry on with printing more money. The UK has continued with QE and for some reason this shocked the markets recently, but it shouldn't have shocked any regular readers to this blog. It will keep on going, £200B, £300B and so on. I don't know how much but I do know there is no way they will sell it all back to the market like many believe. Not when the nation is running deficits for the next decade at least. Now the path has been embarked upon it becomes very hard to stop, and as our politicians were all too weak to take the pain from the credit crunch there is no way they will stop the monetising of government debt. You see people still don't understand and tell themselves "Well we will just wait a bit until the credit crunch passes then we will sort out this or that". It doesn't work like that. The easiest path would have been to take the pain fully as soon as the credit crunch hit. Once you postpone it, you make it worse and then politicians keep saying we will wait until this next crisis passes etc. Then the markets force their hand, and then a nation faces real hardship with no alternatives left.

In times like this there is only one asset for amateur investors - Gold. It reveals all the lies the government and media tell us. Its price tells you what is really happening. Recently the asset has been mentioned in the press, with commentators talking about it, however they still don't understand its value. They ask the wrong questions such as "Why would you place value in Gold?", rather than "Why do you place value in Sterling?". Ignorance and historic naivety, its amazing how well we have been conditioned away from Gold and Silver, free market money. Over a hundred years ago our ancestors would have gasped in horror at the financial system we live in. Four Pounds used to buy an ounce of Gold back then, now its more like 570. Gold may have made the news but what do commentators say when they mention it? Should people sell at these high prices. People are interviewed selling the stuff. When did you ever hear these people call a bubble, and now they seem to think Gold is in one. It will be in a bubble when they are all telling people to buy the stuff, its a safe investment, supply and demand and all that jazz. There's a long way to go until that moment happens.

Gold also tells you the truth of real prices. While people were hysterical regarding house prices, did they realise what was actually happening to the true price? Of course in Sterling prices shot up 200-300% but what about another currency, for example Gold, true historic value. In Gold house prices were stagnant as Gold climbed a similar amount during the same period against Sterling. You could have saved yourself all the hassle of estate agents, mortgage brokers, Tenants, property maintenance and so on, and bought gold in a few minutes online and sat back. Sterling lost its value which gave the illusion that houses were worth more. In other words we never had a housing boom. We had good old currency debasement, mass inflation. Its the same with Oil and so forth. Oil jumped ahead last summer due to demand being larger than supply, but its now still up around 300% since its low 10 years ago in say dollars, but in Gold it hasn't moved.

The governments in recent months have allowed the banks to use false accounting laws. If the market did this the company executives would be sent to jail, but when the Government changes the rules its fine, just like before the S&L crisis blew up. Central Banks have all sorts of worthless paper on their balance sheets. They are monetising the deficits. The banks they have nationalised are trying to lend further money to the economy. Easy money, ruins society. It always has throughout time. The decline of the Roman Empire as they debased their Gold Coins. The Spanish Empire as the Conquistadors drove out the Islamic Moors from what is now Andalucia and continued their conquests by discovering the Gold laden lands of South America, again easy money same effects. Latin American nations throughout the 20th Century had government after government who pursued similar mistakes, despite places like Argentina being richer than the US 100 years ago. Italy and Britain during the sixties and seventies played with easy money and look where it got them during the seventies devaluation sagas. What remained of British Industry collapsed, as companies thought they could keep selling on price, rather than quality and innovation, but eventually costs go up also as companies become sloppy relying on further devaluations to bail them out.

Politicians are too tempted to play the easy money card as the great deflationary juggernaut, China, exports low cost products, recycling their money back to the West to encourage further easy money policies here. China have studied their history well and know full well how destructive easy money is to society, and realise what they are doing to the West.

Unfortunately when Fiat currency exists it is a lot harder for the Government to face the pain and do what is right for the long term. Easy money means easy living for the short term, but it just impoverishes society in the long run and puts a greater burden on future generations. We should have another scramble for cash over the coming months, but I suspect this will be the last scramble for the fiat currencies. After that only true money that has a historic track record such as Gold will be desired. What will the Autumn bring ... we will all have to wait and see.

Interest Rates are Prices

A while back I posted on Interest Rates and Capital using explanations of supply and demand. It was to my astonishment that I noticed an article published by a popular newspaper. Rather then heap praise on the recent lowering of interest rates and accepting at face value what the central bankers were saying, it actually challenged these concepts and the so called 'wise men'. There is no logic to having a centralised committee setting prices such as interest rates. Rather than determined by the market these prices are adjusted by these central institutions. Despite all the propaganda that central banks are now 'Independent' its still the same as when politicians have control over interest rates. They always try to keep them as low as possible for as long as possible. Creating inflationary booms is the best weapon politicians have at creating artificial prosperity. Until the public balks at the inflation or the scale of malinvestment becomes too large, then these prices are risen by the powers that be.

A good question would be, how should interest rates be set? Who would set them if Central Banks were not in control? That simple micro-economic concept called supply and demand would set it. The great Austrian economist Eugen von Bohm-Bawerk noted that the setting of interest rates is a time preference, peoples preference to get money upfront in the current time frame. Many sections of society view making money off money as immoral, historic notions of Usury, the reason why Jewish people have been casted outside society due to their role in money lending. Karl Marx in his critique of Capitalism stated that charging interest was 'exploitation' of the workers (everything he wrote was one big exploitation, his Communist Manifesto is heavy on that concept) with no inherent purpose. Of course Bohm-Bawerk's time preference explained this concept. If I saved then I have produced more than I have consumed during that time period. I may give this to a bank who I charge interest, as they may wish to make use of these savings. The bank in turn may lend it out to a business at a slightly higher rate as they may have immediate plans to hire more people to expand their business in the current time frame however they do not have sufficient capital to do so. They are therefore paying for this privilege. Time preference also applies to entrepreneurs and labor. Labor was not exploited, again as Marx falsely assumed. Labor gets paid upfront for what it does. I go to work and I don't risk my capital, my time - I get paid for what I produce, regardless of what happens in the market. Entrepreneurs don't. They risk their capital, their time and in the end they may not earn a penny. Again time preference explains this, do you want to get paid upfront for less, or potentially earn more later down the line if you succeed.

So how would interest rates fit in with the above example. Interest rates are set based on peoples time preference. If no one saved and lots of people wished to borrow for the current time frame, then interest rates would go up as a shortage of genuine capital would be evident. Similarly if there were lots of savers and few borrowers, interest rates would fall, deterring saving and spurring consumption or investment. The above is just a supply and demand concept, one that Governments always like to abuse.

Once the above is understood the whole economic crisis becomes quite simple to explain. It was the setting of these prices, outside of the markets control, that caused all sorts of industries to exist that were never sustainable in the long term. It's the reason why unemployment is on the rise, why businesses are failing in mass. Many economists are still blinded by such simplicities. BBC's Robert Preston drones on about regulatory structures, but its akin to a doctor putting a plaster on a cancer patient, its the wrong diagnosis. The free market interest rate article sums up this process:

"This illusion creates waste, because it makes people overestimate the available resources. Ventures that would have been unprofitable if interest rates were not artificially low are now embarked upon, drawing scarce resources away from better uses. According to Friedrich von Hayek and other advocates of the Austrian theory of the business cycle, it is this interference with interest rates and the money supply that causes an unsustainable combination of consumption and investment — a boom that inevitably leads to a bust."

We got into this mess because of low interest rates and expansive monetary policy. So how do we try and navigate out of the current situation? By using exactly the same policies as before. Putting another plaster over the other plaster of the cancer patient. A similar re-run of the seventies, more inflation to try and solve the previous inflation. Recession after recession.

This is of course a great magic act that Governments have. Through the inflationary boom, all the 'robust' growth is down to the Governments policies. During the bust it's suddenly the free markets fault, it peoples 'psychology', speculators and so on, but never the government. Blame the banks if you will, but the majority just play this game knowing the rules, profits in the boom, bailouts in the bust (we could also go into the practice of fractional reserve banking - again governments rules, banks just playing the game).

Bubble China

The most recent example of a Government creating an artificial inflationary boom is China as I write. Rather than causing the economy to readjust painfully due to the lack of Western or Japanese demand for their export products, the government have begun on a program of recklessly expanding the money supply, around 30% per annum. This is causing all sorts of incorrect investments may it be the stock market, real estate or certain sectors. The end game? They can't put off their depression merely buy time and make it much worse when it arrives. China's Banks are now copying the Wests - reckless lending fueled by cheap money and their economy will suffer eventually. The Communist party is scared that the depression would be so bad that its people would begin asking for democratic change like I mentioned in my Building Bridges post. We will have to see when.

As bad as the dollar is, where's the alternative? Governments are all bad, its just some are worse than others. There is nothing good I can see around the world right now. We are in a classic bear stock market rally all over the world at the moment. It doesn't matter what the news is, it just goes up. Japans Nikkei after 1990 rallied on numerous occasions, sometimes rallying as high as 70%, but where did it go? Right back down hitting new lows (its real lows we may have to watch, not the nominal price). The sign of a long term great bear market is the size of the rallies, so in my opinion this is truly a great bear market we are in. Lost decade? Only this time global?