Matterhorn Asset Management

No country has ever abolished poverty by printing paper

by Egon von Greyerz

We have consistently warned investors that the USA and many other countries including the UK will have a hyperinflationary depression in coming years. In this Newsletter we discuss why hyperinflation will happen. We also look at why government debt will grow exponentially in the next few years and discuss who is going to repay the additional $30-50 trillion that the world is likely to print since this crisis started?

Hyperinflationary Scenario Confirmed

We are primarily discussing the USA in this Newsletter, but most of the discussion also applies to the UK and many more countries.

Our three most important indicators are now confirming that the hyperinflationary avalanche is set in motion. The three indicators are: US Dollar US, Treasury Bonds, and Gold. In our January 5, 2009 Newsletter we stated “the big surprise in the coming year will be long rates going up and bond markets falling rapidly”. We also said: “We expect the dollar fall to accelerate during 2009 against most currencies”. And finally we said back in January that gold is our favourite investment for 2009. So it should be no surprise to our readers that the US Treasury 30 year bond is falling rapidly (interest rates going up), that the US dollar has resumed its down trend and that gold is on its way to new highs.

The three indicators – US Dollar,T Bonds, and gold are all variations on a theme. The theme is clear, namely that the USA is on its way to bankruptcy and that the rest of the world is no longer prepared to finance pieces of paper that have no value and can only be repaid by printing more of the same worthless paper. As George Bernard Shaw said:

“YOU HAVE TO CHOOSE BETWEEN TRUSTING THE NATURAL STABILITY OF GOLD AND THE NATURAL STABILITY AND HONESTY OF THE MEMBERS OF THE GOVERNMENT. AND WITH DUE RESPECT FOR THESE GENTLEMEN, I ADVISE YOU AS LONG AS THE CAPITALIST SYSTEM LASTS, TO VOTE FOR GOLD”

We agree with Shaw – How can you trust a government that first creates the biggest financial bubble in history and then, as proof of their total idiocy, attempts to solve the problem by massively increasing the size of the bubble!

It is totally comprehensible that the rest of the world is not prepared to buy the currency which is not worth the paper it is printed on. The dollar is going to disappear into oblivion and run down into the Atlantic and the Pacific and if there is anything left, this will trickle down into the Gulf of Mexico. In the next few years there will only be one buyer of US Government debt namely the US Government itself. This will of course exacerbate the fall of the dollar and of US T debt in an ever faster spinning vicious circle.

So, Who is Paying the Bill?

Nobody, of course. The bill will never be paid. It is like a gigantic Ponzi scheme where the issuers and the arrangers – the government and the financiers – are the beneficiaries whilst the US people, who are burdened with this massive debt, become paupers.

So far in history no country has abolished poverty by printing paper. How can the government continue to issue paper that they know will never be repaid? Because it gives them temporary power and perceived glory. And by the time the debt is due for repayment, that will be the new government’s problem. The Government is socialising every entity that is powerful enough to effect their popularity or can line their pockets. But the people who are on their way to poverty and destitution are getting no help whatsoever.

The US Profit and Loss account is looking very grim

Deficits or losses derive from expenditure being greater than revenue. In 2009 the US budget deficit is forecast to be $1.75 trillion which is 50% of Government expenditure. But things can only get worse from here. We wrote in our May Newsletter that the average American is one month’s pay check from bankruptcy. With unemployment currently increasing by 500-600,000 per month, personal tax payments will continue to drop. Until two years ago consumers were using their home as cash machines. Between 2000 and 2007 a significant part of the growth in GDP derived from increased borrowing against houses. This has now stopped. Corporate tax payments are also falling precipitously. The fall in tax revenues will accelerate in coming years.

At the same time US government expenditure is growing exponentially with more people becoming unemployed, with government nationalising any major company which is in financial trouble and irresponsibly spending money that it hasn’t got. The government has lost all control of spending.

Any sensible person knows that there are two ways to balance a loss making entity. You either increase revenue or reduce expenditure – not really rocket science. The US government, like the UK and others, are now planning tax increases. But to tax a country with collapsing incomes is like trying to get water out of a stone. So the alternative solution and the only sensible one is to reduce expenditure to the level of revenue. This is the only way put the economy on a sound footing for future growth. But such a simple solution is much too sensible for any government to ever think of. And even worse this policy would not buy them the necessary votes. The simplest solution would be to take away the printing presses from governments. The issuing of money by government should be illegal. They should not be allowed to create fiat money that totally destroys the value of the currency.

“THERE IS NO MEANS OF AVOIDING THE FINAL COLLAPSE OF A BOOM BROUGHT ABOUT BY CREDIT EXPANSION. THE ALTERNATIVE IS ONLY WHETHER THE CRISIS SHOULD COME SOONER AS THE RESULT OF A VOLUNTARY ABANDONMENT OF FURTHER CREDIT EXPANSION OR LATER AS A FINAL AND TOTAL CATASTROPHE OF THE CURRENCY SYSTEM INVOLVED.”

Ludwig von Mises – Austrian Economist (1881- 1973)

How big will the debt bubble grow?

A study made by Reinhart and Rogoff has analysed every banking crisis in the last forty years. The study looked at the area of government debt to GDP. The average increase in debt three years into a crisis was just under two times with the maximum being almost three times the starting debt level. Both Finland in 1991 and Columbia in 1998 experienced increases in debt of almost three times. The US debt in 2007 when the crisis started was $9 trillion. However, the study covered crises in individual countries and cannot be compared to the global crisis that we are experiencing currently. Since we are now going through a world-wide crisis with global debt levels of a magnitude that has never occurred before, the increase in debt levels is likely to be substantially higher than in the study which covered single countries. We would therefore expect debt levels to reach minimum three times but more likely four to five times the debt level at the start of the crisis. This means that US Federal debt is likely to climb from a current level of $11 trillion to a minimum of $27 trillion and possibly as high as $36-45 trillion in the next few years. These are totally mindboggling figures and hyperinflation could make them a lot higher.

The US government so far has lent, guaranteed or committed to $12.9 trillion in the last 18 months Add to this asset purchases of $2.3 trillion, guarantees of the debts of Fannie, Freddie and Ginnie of $7.3 trillion and other guarantees of $6.6 trillion for the US banking system and the total becomes $29.1 trillion. With this level of US Government exposure already, it is easy to see how we get to the debt figures of $36-45 trillion. So far nothing of the US Government’s investment has been written off. But just taking AIG, Fannie Mae, Freddie Mac, General Motors etc, which will all require increased government funding of their losses, we can be certain that most of the Government money invested will be lost and much more will be required for future losses. And as we have said many times, there is a lot more to come in losses, from budget deficits, both federal and state, the banking system, derivatives of $1 quadrillion, pension funds, insurance companies etc.

Interest Rates and the US Dollar

The USA as well as the rest of the world have the highest debt levels in history by a big margin. At the same time many countries have interest rates which are near zero. This is a total dichotomy and the best proof that the US and many other countries don’t have a free economy but an economy totally manipulated by governments and central banks. In a free economy, demand and supply would be governed by market forces. If demand for a commodity like money was high, supply would be restricted by the price of the commodity, in this case interest rates. So high demand for credit would lead to high interest rates and thus restrict the amount of credit issued. But not in an economy like the US or UK (and many others) where the popularity vote is all that counts for governments. Therefore as soon as they are under pressure from voters due to a downturn in the economy, they lower the interest rates to nothing, turn up the printing presses and make unlimited amounts of fiat money available. This buys them votes and leaves the problem to the next government to sort out . It is clearly a lunatic and suicidal policy which will create misery for future generations.

We forecast in our January 5 Newsletter that the biggest surprise in 2009 would be the increase in long rates. Since December 2009 the US 30 year Treasury bond has gone from 2.5% to 4.5% – an increase of 80%. (see chart below) But this is just the beginning of interest rate rises. In the next few years we expect longer rates to go into the teens and possibly a lot higher in a hyperinflationary scenario. The rise in interest rates and the fall in the value of US Treasury bonds is a reflection of unlimited issuance of paper that nobody wants to buy except for the government itself. This is quantitative easing which is a fancy term for money printing.

An US interest rate of 15% is very likely and if this is applied on a Federal debt level of $40 trillion, it would give the US government an annual interest cost of $6 trillion. The 2009 US Federal budget is $3.55 trillion and this includes a budget deficit of $1.75 trillion. The potential future annual interest cost of $6 trillion totally dwarfs these figures and confirms that the USA is on the road to bankruptcy.

The US dollar and US T bond rates are now feeding off each other in an accelerating decline. A continued bear market in the dollar, which is now confirmed, leads to a sell off in bonds since foreigners will not want to hold their US dollar assets. And the selling of US dollar denominated bonds will lead to a further decline in the currency. This is why the dollar will go down substantially in 2009 and thereafter. It is this precipitous fall of the currency that eventually leads to hyperinflation. It is so obvious that printing an ever increasing quantity of an already worthless currency leads to its disappearance. The only riddle is why so few people see or understand this.

Geopolitics

The United States has 130 military bases in foreign countries. This is one of the principal reasons for the conflict between the US and the Muslim world. Throughout history an aggressor or invader has always created hatred and violent actions, especially when cultures and religion clash. Every major US military interference in the last 50 years has totally failed (Vietnam, Afghanistan and Iraq). It hasn’t only failed but created extreme dislike of US culture and values leading to acts of terrorism and a major threat to world peace. Pakistan and Afghanistan represent a major potential threat to world peace. The potential access to nuclear weapons by Taliban and Al Queda could have extremely severe consequences.

In the long run no religious or cultural conflict has been solved by weapons. The most effective way of changing a culture is by peaceful means through population growth. Colonel Gadaffi of Libya has stated: “There are signs that Allah will grant victory to Islam in Europe without swords, without guns, without conquest. We don’t need terrorists, we don’t need homicide bombers. Fifty million Muslims in Europe will turn it into a Muslim continent within a few decades”.

The native population of Europe is declining due to very low fertility rates. At the same time the Muslim population of Europe is growing fast due to immigration and high fertility rates. There are forecasts that projects a Muslim majority in Europe by 2050. William Rees-Mogg forecast back in 1991 in his book “The Great Reckoning” that this would happen . To quote from his book: “……. the result will not only be a migration of individuals, it will also be a migration of cultures and value systems. It will be a migration of Islamic power.”

So even if in the short run events in Pakistan, Afghanistan and the Middle East could have serious consequences for the world, the potential dominance of Muslims in Europe by around 2050 will have much more fundamental and long lasting effects on the power equation in the world.

Gold is your best Protection

Voltaire’s statement from 1729 that “All paper money eventually returns to its intrinsic value – ZERO” is now ringing as true as ever. We show in the graph below the decline of major currencies against gold since 1900. The US dollar, Euro (DM), Pound and Yen have all declined between 93% and 99% against gold in the last 109 years. With the money printing soon reaching Zimbabwean proportions it will not be long until the US dollar and the Pound as well as many other paper currencies will reach their intrinsic value or in other words become worthless. This is what happens when governments are allowed to issue unlimited amounts of fiat money.

Our preferred method for preserving wealth in this situation is to own physical gold and to store it outside the banking system. Also, from the point of view of capital appreciation, gold mining shares especially some of the juniors, represent incredible value and could appreciate manifold in the next few years.

Investing money is an “easy game” if you take the right decisions and you only need to make one good investment on January 1st at the start of every decade to turn $10,000 to $35 million in 39 years.

If you had put $10,000 into gold on the first trading day in January 1970, sold the gold on January 1st, 1980 and bought the Nikkei in January 1980, sold the Nikkei in January 1990 and bought the Nasdaq, sold the Nasdaq in January 2000 and bought gold you would now have $35 million. So you would have made 2,500 per cent over this 39 year period by only making one investment per decade.

Sadly though this is with the benefit of hind sight. But what it does show is that if you analyse the fundamentals and get into a trend at an early stage, you can ride it for a long time without getting hurt when there are major corrections. What is also interesting is that gold figures in two of the four decennial periods. Matterhorn Asset Management advised investors to buy gold for up to 50% of their liquid assets in 2002 when gold was $300. Today, at $980, investors have a gain of 266%.

The obvious question is should you get out of gold in January 2010 to follow the decennial pattern. Well, maybe not, but this is something we will advise our investors about in the coming months.

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