Sunday, June 10, 2012

the credit bubbles

A Shocking Fall

by Egon von Greyerz – Matterhorn Asset Management

This month we will discuss what is likely to be a major change both in sentiment and in the economy in the next few months. The autumn of 2009 will be full of shocking surprises in the banking sector, in financial markets and in the world economy. The events that we outlined in our previous newsletter, “The Dark Years Are Here” are going to start unfolding. There will also be shocking falls in stockmarkets, in the dollar and in bond markets. But these falls will create major opportunities for investors which we will also discuss.

The syndrome of hope and false expectations

Some readers might feel that we are prophets of doom and that there is only gloomy news coming out of Matterhorn Asset Management. For people who want only good news we suggest that you listen to politicians or read the newspapers or your average stockbroker’s forecast. This is where you find the good news. But if you do listen to these people, remember that virtually nobody warned you about the events in the last couple of years, and that today most of these people are saying that the worst is over. And this is also what stockmarkets are telling us, isn’t it? These “optimists” whether they are politicians, bankers or from the media all make their living based on good news and this is why they will continually tell you lies and never warn you about the risks.

Investments are all about managing risk and our responsibility is to understand risk and warn investors when risk is unacceptably high. We have done this for many years and we will continue to do it. Sadly most investors base their investment decisions on hope. When government, private and corporate debt explodes the risk to the economy becomes very high. And when bank credit is growing exponentially and bank leverage is 50 times or more, this is very high risk. When derivatives reach $ 1 quadrillion with virtually no reserves against this astronomical exposure then investors should run for cover.

Investing, whether it is real estate or stocks, has been an easy game for many decades. Governments have in the last 100 years and especially since the early 1970′s printed money and expanded credit at a rate which has never been done before in world history. This has led to a massive asset inflation and a destruction of the purchasing power of most currencies. Risk taking and leverage have paid off handsomely. But this is now changing. In the next few years the leverage will hit back with a vengeance and the deleveraging of asset bubbles and credit bubbles will have a devastating effect on the world economy. This will lead to a massive deflation of assets and credit. Governments will continue to print money at an accelerating rate. Eventually the money printing will lead to a collapsing currency creating hyperinflation in many countries and especially the US and the UK. But even with hyperinflation many assets such as real estate and stocks will decline in real terms.

Governments living in cloud cuckoo land

Never before have governments in the world expanded deficits and credit to the extent that we are seeing now.

In 2009-10 government budget deficits will be at least $5.5 trillion. This amount needs to be raised by all the countries running deficits. The US, of course, has the biggest black hole and will need at least $3 trillion during this period. But these sums, which are unlikely to be sufficient, are just budget deficits and do not take into account the likely rescues of banks, other financial institutions, corporate failures, pension funds, insurance companies, cities, states, local government etc.

The US has lent or committed $13 trillion to prop up its collapsing financial system and economy. Virtually none of these funds have been written off yet and there will be a lot more to come in the next couple of years. It is still our view that the total cost to the US alone of the current crisis will be at least $25-30 trillion.

And where is the money coming from? Well, this is where Alchemy comes into the picture. Governments believe that they have found an unlimited source to prosperity. They have found the Holy Grail. Especially the US and UK governments, being the biggest culprits, believe that they can manufacture endless amounts of money and that this will create eternal wealth for their economies.

How do they do it? Governments use fancy terms like Quantitative Easing in order to confuse the people. In simple terms it means borrowing money that doesn’t exist or just printing money. To borrow money that doesn’t exist must be fraudulent and both against the law and the constitution. Yes of course the government is breaking the law and the constitution. But not only that , they are actually stealing money from the people, money that the people doesn’t have, but that they will have to work for generations to pay off.

But governments are not just creating money out of thin air. They are also looking after their affairs better than any other group in the economy. The only net increase in jobs in the last few years has been in the government sector, both in the US and the UK. Whilst the rest of the economy is suffering and cutting down, government is adding hundreds of thousands of jobs. Also pay and pensions in government jobs are superior to the private sector. So the main growth sector in the economy in the last few years has been the government sector that produces nothing but consumes 50% of GDP. No wonder we are all in trouble.
Government spending has gone from 10% of GDP in 1932 to almost 50% in 2008

There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a 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

The Dark Years are here

by Egon von Greyerz – Matterhorn Asset Management

In this newsletter
we will outline what is likely to be the devastating effect of the credit bubbles, government money printing and of the disastrous actions that governments are taking. Starting in the next 6 months and culminating in 2011-12 the world will experience a series of tumultuous events which will be life changing for most people in the world. But 2011-12 will not be the beginning of an upturn in the world economy but instead the start of a long period of economic, political and social upheaval that could last for a couple of decades.

We will discuss the three areas that we for some time have argued will determine the fate of the world for the foreseeable future, namely the coming unemployment explosion, the next and much more serious phase in the credit markets and finally the likely hyperinflationary or just inflationary effect this will have on the world economy and investments.


Let us first go back in history and analyse what creates an empire and the prosperity that comes with it.

The British Empire started in the 17th century and reached its peak in the 19th century during Queen Victoria’s reign. By the end of the 19th century The British Empire included nearly 20% of the land surface of the world and 25% of the world’s population. So Britain which is less than 0.5% of the world’s land surface area controlled an empire which was more than 50 times greater. So by using slave labour and by stealing the resources of 20% of the world, it is no wonder that Britain was the wealthiest nation for several centuries. But like all empires, Britain carried the seeds of its own destruction. All empires – e.g. Mongolian, Roman, Ottoman or British etc. – eventually overstretch their resources both militarily and financially. This combined with decadence and illusions of grandeur eventually leads to the collapse of an empire.

The US empire was slightly different from the point of view that it never conquered the world although the US was itself a colony conquered from its original inhabitants. But the US has intervened in many areas (e.g. Korea, Vietnam, Afghanistan, Iraq etc.). Also, there are US military bases in 120 countries. Initially the US was an economic superpower based on an entrepreneurial spirit and a very strong production machine backed by fierce military power. But after the Vietnam war the US had overstretched its resources and by 1971 Richard Nixon abolished the gold standard in order to be able to start money printing in earnest. The money printing phase is normally the last stage of an empire before it collapses and this is where the US is now. The US dollar became the reserve currency of the world when the US was strong economically. But as the US economy started to weaken in the 1960-70′s the US government found a much better method for maintaining a strong economy. It started to print paper that it sold to other nations or exchanged for goods and services. For almost 50 years this has been the most clever way ever devised of maintaining the living standards of an economically deteriorating nation without even having to spend any resources on building an empire. It is a Ponzi scheme which has worked for several decades but slowly the world is now waking up to the fact that they are holding worthless paper printed by the US Government. (We realise this is a much simplified version of empire building and destruction but it is nevertheless an accurate analysis).

The US is haemorrhaging financially and economically. It has lent or committed almost $13 trillion in the last 18 months to prop up the financial system. The estimated government deficit in the current year is almost $2 trillion or 50% of the budget. All the money committed so far has only achieved two things: Firstly it has created some short term hope which together with totally illusionary sightings of green shoots have generated a small stock market correction (which we forecast in our January Newsletter) and some belief that the crisis is ending. Secondly, all the funds printed so far to save the system have gone to Wall Street but has done nothing whatsoever for the real economy. Every single sector of the real economy is deteriorating whether it is production, unemployment, corporate profits, real estate, credit defaults, construction, federal deficits, local government and state deficits etc.

And what is the government doing about it. They are doing the only thing they know which is to print more money.
This is total lunacy! How can any intelligent person believe that printed pieces of paper can solve an economic catastrophe?
If that were the case we could all go home and write out pieces of paper or use Monopoly money to spend in the shops or repay our debts.

How can the US government, the UK government and most other governments not understand that the only way to run an economy is to cut your coat according to your cloth. This is why the emperor had no clothes because the country had run out of gold thread to make the cloth. Until now the US as well as other countries have been able to buy the cloth because the world has been foolish enough to accept worthless pieces of paper as payment. But this is coming to an end very soon and many countries will be without both coats and cloth.

What governments are doing with people’s money is to totally destroy its value. Purchasing power in the US and many other countries has declined more than 95% in the last 100 years. While it might buy votes short term it will only generate massive misery long term. And this is what many countries are starting to experience now. But sadly it will get a lot worse. We are still only in the first phase of this tragic saga. The second phase is likely to start in the next 6 months.


The real unemployment in the US is 20% or 30 million. These are the real unadjusted figures calculated on the same basis as the official figures before the method of the calculation was changed in the 1990′s. Reported government figures, especially in the US, are continually manipulated in order to suit the political aims of the government. Therefore, one should not give any credence to the published figures. Most governments mislead the people most of the time.

With 20% unemployment in the US we are already approaching the levels in the 1930′s when peak total unemployment reached 25%. The 20% current level is the non-farm unemployed and is still a lot lower than the non-farm peak figure in the 1930′s which was 35% unemployed.

Since we are still in the early stages of this crisis, it is our firm opinion that non-farm unemployment levels will reach 35% at least in the US in the next few years.

But even the current figure of 30 million unemployed is a catastrophe. Adding dependants to every unemployed person there are currently 100 million people affected by unemployment in the US. In the next three months 3 million unemployed will fall out of the social security safety-net. These are the people who were laid off in the second half of 2008. Including their families this means that around 10 million people will become destitute between now and September with no social security and no savings. If we then add the 4 million that were made redundant in the first half of 2009 that will result in an additional 13 million people including families will become destitute around Christmas. This is a disaster of unimaginable consequences that will affect the whole fabric of American society.

The consequences will be social, political, financial and the effects on the US economy will be of a magnitude which is substantially greater than during the Depression of the 1930′s. We must remember that none of the problems in the financial system have been resolved but only put on a very temporary hold. The rise in unemployment combined with the reduction in consumption will lead to the next and much more severe banking crisis.

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