Finding Certainty in a World of Economic Instability

By Ferris Eanfar, Managing Partner, Vision Bancorp

Description: /images/articles/chaos.jpgFrom London to Athens, Dublin and Madrid, the Euro Zone has been rocked by riots and political turmoil because global banks and Western politicians have driven their economies into the ground. Although the situation in The Middle East is even more tragic, most Americans have believed their lives are relatively unaffected by the suffering in distant places with names like Cairo, Tripoli, Damascus, and Tehran.

However, regardless of the reasons, the Euro Zone is different from the perspective of global investors. Riots and burning cars in global banking centers like London and Dublin strike fear into financial markets because it reinforces an underlying suspicion that something in these Western societies is fundamentally broken. This suspicion is metastasizing into a conscious collective fear that is sending shock waves throughout the global economy and cracking the very foundations of Western Civilization.

In Periods of Crisis, Normalcy Bias is Your Worst Enemy.

Normalcy bias may be the most lethal killer during any crisis because it causes people to blindly assume that things will get better without any substantive evidence to support their assumption. This causes people to waste precious time at precisely the time when immediate and decisive action is needed to survive. Normalcy bias results in unnecessary deaths and financial losses during natural and man-made disasters because it leads to a lack of preparation to deal with the violently shifting conditions that occur during a disaster, which leads to inadequate shelter, supplies, evacuation and contingency plans.

/images/articles/normalcy-bias-lemmings.jpgNormalcy bias causes people to severely underestimate the impact of a crisis. They blindly assume crisis conditions will improve despite being exposed to well-substantiated reasons to believe that inaction will lead to severe damage. This creates cognitive dissonance in their minds, which can only be eliminated in two ways: a) Become a victim of normalcy bias and ignore the warnings and evacuation recommendations or b) overcome the normalcy bias and escape the danger.

 

 

Europe’s Fires Will Spread to the U.S.

/images/articles/recession-global-financial-crisis.jpgThe Euro Zone is deteriorating rapidly and there is no rational reason to believe that conditions will improve any time in the foreseeable future. The World Bank, IMF and ECB will not be able to magically solve the structural economic challenges that are causing the problems in the Euro Zone. Even relatively strong countries like Germany are being pulled down into the flames and will not escape unscathed due to the interconnected economies within the European Union. Europe is burning, but it is a relatively small smoldering ember compared to the raging economic and political infernos that are very likely to start sparking up all over the United States later this year.

When contrasted with Europe, in the United States there appears to be relatively less frustration with deteriorating economic conditions, but that is probably only because the welfare checks have generally continued to flow to over 45 million Americans, keeping the most severely impacted people relatively docile. However, as welfare benefits expire, unemployment continues to rise, and persistent budget deficits force American politicians to cut welfare spending for all but the most needy individuals, we will see a dramatic increase in the number of riots and violence in the U.S.

Comparing the Great Depression with Economic Conditions Today

When you walk down most streets in America today it may not seem like a Great Depression is upon us, but there is no escaping the reality that the fundamental social and economic conditions throughout the world today actually have more catalyzing force to trigger a global economic crash than the conditions that triggered the Great Depression that began in 1929. Major market collapses are rarely perceived as obvious trends when we are living through them. Not until years after the event when historians impassively summarize the speed and magnitude of a crash are we able to clearly see the trends. This is because historians are compelled to conceptually compress all the discrete events that comprise the “crashing process” into a singular “crash” so that the events and accompanying lessons can be more easily understood by our posterity.

Most Americans and Europeans are currently living the story of the frog in the frying pan: When the water is gradually heated to the boiling point very few frogs perceive the heat; so they do not try to escape the frying pan until it is too late. Historian John Brooks captures this psychological process in his description of the Great Depression years in 1929-1933:

“[The Great Depression] came with a kind of surrealistic slowness . . . so gradually that, on the one hand, it was possible to live through a good part of it without realizing that it was happening, and, on the other hand, it was possible to believe one had experienced and survived it when in fact it had no more than just begun.”

The following table compares the economic conditions in the U.S. and most other countries around the world today with the conditions at the beginning of the Great Depression:

Adverse Economic Conditions

Today

Great Depression

The banking system collapsing.

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Tidal wave of foreclosures sweeping the country.

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Tumbling housing prices.

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Bear market ravaging Wall Street stocks.

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High unemployment (over 20%; “official” rate is bogus).

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Overall deflationary asset spiral (CPI inflationary).

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Interest rates recklessly low.

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Consumer confidence abysmally low.

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Debt-to-GDP ratio greater than 100%.

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Huge trade deficits.

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Huge foreign reserves deficits (-$3.8 trillion w/ China/Japan).

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Rapidly decreasing manufacturing capacity.

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The economic conditions that led to the global economic collapse in the late 1920s were bad, but there is no question that the fundamental economic conditions today are significantly worse.

The following chart illustrates the debt problem in the U.S. by providing some historical context and by identifying the sources of debt that are crushing the U.S. economy. Any one of the sources of debt depicted in the chart, which are even higher in 2011, would be enough to drag down the productivity and economic prosperity of a nation. However, when combined, these massive amounts of debt represent an insurmountable national crisis that is virtually guaranteed to end in economic collapse, devastating wars, widespread riots, and a prolonged economic depression that is likely to last at least a decade.

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The following chart simplifies the data in the previous chart to help illustrate the magnitude of the debt problem in the U.S. today. The debt problems are even worse in the Euro Zone nations and elsewhere where riots have already begun to erupt frequently.

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Sources: U.S. Treasury, Census Bureau, Bureau of Labor Statistics
The following chart illustrates how the Nixon Administration’s decision to abandon the gold standard in 1971 has culminated in economic disaster.

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U.S. Treasury Bonds are NOT a Safe Haven

/uncle-same-life-support.jpgInvesting in U.S. Treasuries is not a safe strategy at all. Bill Gross of PIMCO, the world’s largest mutual fund, has already dumped all his U.S. Treasuries, and he said, “I cannot conceive of lending money to the U.S. government for 30 years” because of the growing debt burden and unprecedented spending by the U.S. government. Warren Buffet and many other prominent investors are jumping out of the Treasuries game as well.

Anybody who thinks U.S. Treasuries are still a safe haven is suffering from a severe case of normalcy bias. The cumulative debt burden illustrated above has resulted in U.S. federal government debt exceeding 100% of U.S. GDP, total U.S. debt (government, consumer, and corporate) exceeding 300% of GDP, and various other problems. Even if we ignore all the political factors that significantly diminish investor confidence in the U.S. Government’s ability to manage its finances responsibly, which the ratings agencies include in their analysis, the U.S. debt burden alone will force all the ratings agencies to downgrade U.S. Treasuries. Truly independent ratings agencies like Weiss Ratings have already announced multi-notch downgrades of U.S. Treasuries and have accused Moody’s, S&P and Fitch of negligently under-stating the risks associated to investing in U.S. Treasuries.

The inevitable ratings downgrades on U.S. Treasuries will continue to occur, which will mandate increased interest rates for the U.S. Government thus making it much more expensive for the U.S. Government to fund its endless budget deficits. This will inevitably push the national debt to nearly $20 trillion by 2015. In fact, this is probably an optimistic figure because it does not take into account the inevitable rating downgrades and corresponding financial burden from interest rate hikes, nor the inevitable increases in consumer household debt and corporate debt between now and 2015.

“Inevitable” is the operative word here to emphasize that no amount of wishful thinking or “but, what if . . .“ theories will reduce the inevitability of these risks to global investors. The risk of direct default and/or indirect default (through inflating away the debt) by the U.S. Government is inevitable, which means that U.S. Treasuries will perform terribly over the next 10 to 30 years. The recent investor flight into Treasuries is merely a knee-jerk response based on the market’s collective normalcy bias, i.e., millions of people still insist on assuming the full faith and credit of the U.S. Government will protect their investment, but there is absolutely no rational reason to believe that U.S. Treasuries will keep pace with inflation, which will inevitably result in real investor losses caused by the ongoing economic crisis now and into the foreseeable future.

Economic growth in the U.S. and most Western nations will be flat or negative during the next decade as both private and public credit freezes. Even if Western nations suddenly adopted a savings mentality like there was up until the 1980s, it would take at least a decade to save enough money to start lending in volumes that would significantly increase economy-wide productivity. It is not enough for a handful of large companies to squeeze a few more percentage points of profitability from automation, workforce reductions and other efficiency gains and call that “economic growth”, which is what self-interested politicians and bullish pundits have been trying to do since the 2008 spasm of this ongoing global economic crisis.

The United States Has Lost Control of Its Destiny

The following chart illustrates the declining value of the U.S. Dollar since 1973. When the USD declines in value, two major consequences occur: 1) all your existing cash and non-cash assets become worth much less (asset deflation) and 2) everything you buy and consume on a regular basis becomes much more expensive (CPI inflation) because the U.S. is completely dependent upon foreign countries to produce everything you see in your homes and supermarkets. Literally everything in mainstream America today is dependent upon the manufacturing and petroleum production capabilities of other countries that do not have America’s best interests at heart.

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The following chart illustrates two critical dynamics that have forced the U.S. to relinquish substantial control of its economy: The U.S. trade deficit and the corresponding sell-off of U.S. assets to foreign investors. This correlation between the trade deficit and foreign-owned U.S. corporations, real estate, and other assets is an inevitable consequence of running long-term trade deficits. The reason these consequences are inevitable is because nations holding USD-denominated foreign reserves can only use those reserves in two ways: 1) Buy U.S. Treasuries (finance our debt) and 2) buy U.S. companies, real estate, and other assets.


Sources: U.S. Census; U.S. Treasury
The massive sell-off of U.S. assets over the past 30 years to foreign investors, amounting to over $20 trillion (only U.S. securities depicted in the chart above), has forced U.S. policy makers to lose their ability to effectively act in the U.S.’ own self-interest, which has resulted in the U.S. effectively losing its sovereignty. This is one of several reasons why U.S. politicians have been impotent to avert the economic crisis that is threating the U.S. economy today despite the fact that hundreds of economists and business leaders have publicly predicted everything that is happening today. Given the conflicting interests imposed upon American policy makers from domestic and foreign special interest groups, there is no rational reason to expect these trends to change in time to avert an economic collapse. In fact, this trend will certainly accelerate.

During an Economic Crisis Commodities are Precious

/images/articles/commodities1.jpgThe only reason anybody would continue to keep their cash and cash equivalent assets tied to the sinking U.S. Dollar is if they are (1) ignorant, (2) in denial, or (3) brain-dead. Normalcy bias is one of the most powerful delusions, which often keeps people tied to the U.S. Dollar until it is too late and their portfolio is totally worthless. Do not allow normalcy bias or the falling U.S. Dollar consume your wealth and destroy your ability to afford the quality of life you desire.

At my firm we tell clients to immediately convert their funds into Swiss Francs to protect their principle and then invest the funds in an investment vehicle that is primarily focused on gold. The gold investment vehicle does not necessarily need to be 100% backed by stored physical gold as long as:

  1. The asset manager’s overall strategy does not depend on the rise and fall of the stock market, which is sometimes called a “non-correlated” or “negative beta” fund.
  2. The asset manager has access to deeply discounted commodities pricing.
  3. The asset manager’s strategy is exclusively focused on buying and selling gold and other strategic commodities that will provide an effective hedge against the falling U.S. Dollar, inflation, and realistic potential to capture some profit from the buying and selling of the actual physical commodities.

Your Hedging Strategy is Paramount

/images/articles/profit_from_returns.jpgIn today’s unpredictable economic environment and into the foreseeable future, if you can consistently protect your principle from the falling U.S. Dollar and inflation and capture a few percentage points of profit you are doing very well. However, for a gold and commodities-based strategy to work, the asset manager must have direct access to the physical product and must have a strong and proven hedging strategy that can generate returns regardless of which direction the market moves; otherwise the unpredictable fluctuations in the spot price of gold and other commodities will create too much acquisition risk and your portfolio could still be crippled by negative returns.

Also keep in mind that your returns will not suffer significantly when the price of gold occasionally falls as long as the firm can acquire gold substantially below the London Bullion Market spot price. This will enable the firm to make profits regardless of the price of gold as long as the fund manager adopts a strict “First-In-First-Out” inventory management policy to ensure optimal timing of the transactions and maximum profitability for their investors.

Advantages of Investing in Gold

To illustrate the advantages of investing in a properly structured gold investment fund, below is the same table of current adverse economic conditions presented previously. However, this time each adverse condition is accompanied by a brief explanation of how investing in a gold fund helps your portfolio perform well even in the worst economic conditions.

Gold’s Wealth Protection Advantages During Adverse Economic Conditions

Investing in Gold
Helps Because . . .

The banking system collapsing.

Your funds are invested in gold which has perennial value dating back to thousands of years. FDIC is worthless during a depression.

Tidal wave of foreclosures sweeping the country.

Parking your funds in gold until you are ready to purchase real estate ensures optimal returns across your portfolio.

Tumbling housing prices.

Gold will appreciate significantly relative to deflating housing prices. So if you are only purchasing real estate as an investment, gold would be a much better investment.

Bear market ravaging Wall Street stocks.

Gold prices generally move inversely to stocks, which means your gold will appreciate while the stock market declines.

High unemployment (over 20%; “official” rate is bogus).

Your retirement funds are safe in gold. So if you are unemployed or retired your wealth will still remain stable.

Overall deflationary asset spiral (CPI inflationary).

While other asset classes deflate, gold retains its purchasing power (real value). Gold is also a natural hedge against CPI inflation.

Interest rates recklessly low.

Prolonged low interest rates cause widespread inflation. Gold wealth naturally rises to offset the impact of inflation.

Consumer confidence abysmally low.

As consumer confidence wanes, economy-wide conditions deteriorate, which causes gold to appreciate.

Debt-to-GDP ratio greater than 100%.

More quantitative easing and loose monetary policy will be employed to resolve debt problems, but these will create widespread inflation. Gold is a natural hedge against inflation.

Huge trade deficits.

Persistent trade deficits depress the value of the USD, which causes inflation as imports become relatively more expensive. Gold is a natural hedge against inflation.

Huge foreign reserves deficits (-$3.8 trillion w/ China/Japan).

Substantial foreign ownership/control over U.S. industries creates significant economic unpredictability across all asset classes. Gold retains its relative value regardless of the impact that foreign entities have across the global economy.

Rapidly decreasing manufacturing capacity.

GDP, national security, and available jobs all decrease when manufacturing declines, which creates significant economic volatility and weakness. Gold retains its value and is a natural hedge against economic volatility.

 

/images/articles/economic__collapse-1.jpgConclusion: Creating Financial Certainty by Snatching Profits from the Jaws of Inflation & Deflation

Many people are confused about whether the U.S. is facing an inflationary or deflationary environment. The answer is “yes” to both. The Consumer Price Index (CPI) has and will continue to rise faster than in previous years because of inflationary pressure caused by the Fed’s aggressive quantitative easing and a declining USD relative to other global currencies. This will cause prices of imported and domestic consumable goods to rise significantly as foreign nations seek to offset the weakening USD.

However, virtually every hard asset you own except for precious metals is going to continue to suffer constant downward deflationary pressure for the foreseeable future. This virtually guarantees that all asset preservation strategies will be worthless because virtually all markets are going to fall, which means that all passive portfolio diversification strategies will fail to preserve your wealth.

Western nations will continue to see violent and sporadic bear market rallies and the people afflicted with normalcy bias will jump into them believing they have reached the end of the recession. They will be wrong and they will lose money. The only strategy that is guaranteed to work in this environment is active participation in the physical commodities markets where buying as low as possible and selling as high as possible can be repeated over and over again, regardless of what price the commodities may be trading at during any given period.

Active participation in the commodities markets means directly buying the physical commodities (or futures contracts) from suppliers and selling them directly to buyers, not purchasing securities that merely represent fractional ownership of a company that produces commodities. In an economic crisis environment, consistent profits can only come from the actual sale of commodities, not from the sporadic or non-existent appreciation of securities. Additionally, futures trading on the automated exchanges does not offer consistent price arbitraging opportunities due to the inherent price discovery efficiency of high frequency algorithmic trading systems. As a result, the only guaranteed strategy to make significant and consistent money in even the worst economic environments is to have unique access to deeply discounted physical commodities and sell them at substantial premiums directly to buyers.

Unfortunately, very few people have direct access to commodities suppliers for any valuable commodities, which means most people will not be able to profitably participate in the commodities markets. That means the only truly safe asset preservation strategy available to most people is to invest in a hedge fund that actively buys and sells commodities. However, hedge funds are typically very exclusive investment vehicles reserved only for select accredited investors; so most people will not have access to this form of investing. But for those who qualify, it can transform a nightmarish economic collapse into a very satisfying investing experience, yielding stable and positive returns.

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About the Author:
Mr. Eanfar is a Managing Partner at Vision Bancorp, which specializes in commodities-backed asset management, commodities trading. His professional experience spans diverse environments including technical development, media, finance, military and government affairs. Mr. Eanfar can be contacted at the website: https://visionbancorp.com.

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