Paul Brodsky

An Adult Approach – I (Investing in a Vulgar Age)

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The critical debt problems today are not just European, as most seem to believe. As we have written at length, the global monetary system is debt based and the amount of debt denominated in all currencies still dwarfs the actual amount of base money in the world. This leverage means that if global policy makers remain unwilling to de-lever the global monetary system by allowing debt to deteriorate, then they must de-lever it through continued base money creation (which shifts the debt to public accounts through the process of sovereign debt monetization).

And so it shall be. All major central banks are manufacturing base money. (We must draw your attention to our friend Michael Panzner’s latest book, Modern Central Banking: Simplified, which is available on Amazon. You’ll laugh, you’ll cry…but mostly you’ll laugh.) The public debate has become how fast or slow central banks should print, not whether they should. (We argue they should just go ahead and get it over with! De-lever the system already!) The graph below shows global base money growth is a firmly established trend.

Chart: The Eight Central Banks Balance Sheets

Source: James Bianco; “Living in a QE World”; January 27, 2012; posted at The Big Picture

The Fed has our Back(side)

In today’s global monetary system exchange rates are contingent upon popular confidence that equilibrium price levels can be agreed upon across currencies for goods, services and assets. Printing an excess of one particular currency would threaten the perception of that currency’s purchasing power value vis-à-vis other global currencies. It is okay, so believe overseers of the global banking system, for FX cross rates to fluctuate, but it is unacceptable for a major currency to fail. This would expose the dirty little secret that contemporary debt currencies cannot mathematically store purchasing power over time.

Whether or not it is officially proclaimed “a failure”, the global monetary system is already failing in real terms. Anyone can see this in the costs of global goods, services and labor across all currencies, which are rising much faster than global demand, and in the long established trend of debt deflation.

The problem for most investors today is that they no longer know how to invest with a real return objective. For forty years they have been taking the banking system at its word that the paper it produces stores value. Consider last month’s press conference held by Fed Chairman Ben Bernanke, in which he formally announced the Fed would target 2% inflation in the US. The Fed chose as its inflation benchmark the Personal Consumption Expenditures (PCE) index, calculated by the Bureau of Economic Analysis within the Commerce Department. Unlike the CPI, which is currently running at a 3% annual rate (even core CPI, which strips out food and energy prices, is running at 2.2%), the PCE was reported on January 30 to be running at 2.4% (1.8% core). Quick inspection of the PCE index (Bloomberg ticker “PCE DEFY” we kid you not!) shows it was “rebased to 2005” and that “to see this index with a base year as (of) 2000” we should “refer to the ticker PCE DEYO”.1 Alas, Bloomberg did not have the data for base year 2000 when we tried.

We are comforted that Chairman Bernanke and the Commerce Department are sanguine about something they are calling “inflation” not eating into the purchasing power of US dollars or into real returns on dollar-denominated assets. We would be happy to go along with the Fed except that we are investing to increase our future purchasing power and, frankly, we do not trust the Fed to watch out for our purchasing power. It seems obvious the Fed is not only changing policy by officially “targeting inflation”, (and framing the change as greater transparency which is in the public good), it is also shifting benchmarks to be able to better control the perception of low inflation so that it may manufacture more base money.

Merriam-Webster defines profane as follows: “to treat (something sacred) with abuse, irreverence or contempt, or to debase by a wrong, unworthy or vulgar use”. We do not think measuring inflation should be considered sacred but we do think policy makers are deliberately, without ego or malice, managing monetary affairs as it suits the banking system. If by massaging the perception of inflation they are breaching the public trust and displaying contempt for laborers and unlevered savers, (not to mention investors), well then it is just business. WTF.

Absolute Power

Such economic manipulation is to be expected. Mr. Bernanke represents a power structure with deep roots that supports the general theory that those that control a nation’s money control the nation.

“Let me issue and control a Nation’s money and I care not who makes its laws. The few who can understand the system will be either so interested in its profits, or so dependent on its favours, that there will be no opposition from that class, while, on the other hand, that great body of people, mentally incapable of comprehending the tremendous advantage that Capital derives from the system, will bear its burden without complaint and, perhaps, without even suspecting that the system is inimical to their interests.”2

It is becoming increasingly obvious today within developed economies that ultimate power remains with the monopoly issuer of our fiat currencies, much as it has for centuries. Sometimes power must exert itself, as this 1819 discussion in the British Parliament shows:

Commons Secret Committee: “In what line of business are you?”

Nathan Rothschild: “Mostly in the foreign banking line.”

Commons Secret Committee: “Have the goodness to state to the Committee in detail, what you conceive would be the consequence of an obligation imposed upon the Bank (of England, which Rothschild owned) to resume cash payments at the expiration of a year from the present time?”

Nathan Rothschild: “I do not think it can be done without very great distress to this country; it would do a great deal of mischief; we may not actually know ourselves what mischief it might cause.”

Commons Secret Committee: “Have the goodness to explain the nature of the mischief, and in what way it would be produced?”

Nathan Rothschild: “Money will be so very scarce, every article in this country will fall to such an enormous extent, that many persons will be ruined.”

Are we mad to compare old history with today’s monetary system? Well, let’s just say that nothing has changed in the structure of central banking and we have never been high on “this time is different” thinking. (We think even Rogoff & Reinhart who wrote the wonderful book of the same title would instruct that private central banks maintain the same control over the monetary system today). So, we should expect central banks to manufacture mass quantities of currency to ensure bank system solvency. Knowing this in advance is an even bigger gift for unlevered real asset investors than Ben Bernanke’s gift to levered carry-trade investors by promising to keep US interest rates zero bound through 2014.

We have not reached the end of history. Mankind evolves, as does capitalism and its many brands. But not that much. An objective look at our modern economic ecosystem shows clearly one unified global banking system that is actually made stronger by predictable, publicly aired tensions among competing political and economic theorists and practitioners. As long as lawmakers and we, the people that must obey them, continue quarrelling among ourselves, those that control money are free to do as they like. When the people revolt against the symbols of political power (storm the Bastille, storm the winter palace), then the people succeed in forcing those that control money to alter the political structure. Only when lawmakers take steps to limit bank system access to the nation’s resources by indenturing the factors of production (dumping tea overboard, storming the Eccles Building), can the nation’s capital shift back to the people.

Today we have an oligopoly of central banks issuing the world’s baseless currencies and, by having successfully promoted substantial household and sovereign debt assumption, can now dictate resource allocation and fiscal policy terms. Against this power there is fragmentation — (mostly) democratically elected officials overseeing republics of generally obedient populations. Lenin knew; “by continuing the process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens”. John Maynard Keynes himself agreed: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose”.

We argue that indebted governments have ceded that power to banking systems without conscience or public accountability. If the global banking system has ultimate power over how global wealth is perceived, (as it does), and it is the only institution powerful enough to keep indebted governments in control of their societies, (which it is), then the only reasonable strategy for an independent investor is to think like a Rothschild. Don’t fight the Fed – bet on it.

We will put more meat on the bones in a follow-up report, An Adult Approach II (Relative Real Value), and provide a truer sense of current and future US inflation and our sense of relative value within such an environment.

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[1] Bloomberg; PCE DEFY Index.
[2] Mayer Amschel Rothschild (1774-1812); written in a letter from London to Rothschild agents in New York; 1838.

Copyright © 2012 · Lee Quaintance and Paul Brodsky of QB Asset Management

Published by kind permission of the authors.

No part of this document may be reproduced in any way without the written consent of QB Asset Management Company, LLC.

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