The Great American Fluke Simple Storage Service
VOLUME 4, ISSUE 10
OCTOBER 2017
The Great American Fluke By Bill Bonner In the following letter, Dan Denning suggests that it is time to “sell” the U.S. As our minor contribution to the declinist genre, we offer three related, and equally disagreeable thoughts: First, America’s extraordinary success was a fluke. Second, the country is now firmly in the grip of a sour and ineluctable history. Third, most likely, Dow 1,000,000 will come sooner than anyone expects. But few investors will be very pleased about it. As to the first proposition, why was America such a success? The answer is simple: Americans got lucky. Their germs wiped out as much as 90% of the existing population, leaving them a vast, mostly empty, country rich in natural resources, geographically protected from Europe’s wars, to be settled by good people at a good time. Innovations developed by Europeans quickly took root in America and flourished. Some were technical – steel, steam power, railroads, internal combustion engines, electricity. Others, perhaps more important, were philosophical. English, Scottish, and French Enlightenment thinkers elaborated theories of liberty and limited government; these were taken up and applied in a virgin setting by Jefferson, Adams, Madison, and others.
classes (except in certain places, such as the Hudson River Valley and the Plantation South)… and no important religious divisions. The country was wide open and ready for business. The American experiment with limited government was set up at the end of the 18th century. In the 19th century it proved a great success. Successive waves of immigrants brought with them new ideas and energy, which propelled the U.S. to the world’s number one economy by the 1890s. Of course, by then the ‘foxes,’ as 19th century Italian economist Vilfredo Pareto called them, were already making their nests in Washington, setting up the institutions and bamboozles with which they would prey on the output of the Main Street economy. By 1914, they had already effected a hidden revolution. Three key changes were achieved in 1913. The Federal Reserve Act created a central bank. The 16th Amendment allowed Congress to impose an income tax. And the 17th Amendment changed the way senators were chosen. Previously, senators represented the states from which they came and were selected by state legislatures. Thereafter,
The result was an economy where people had access to the same capital and technology as Europe, but without the many constraints that hampered people in the Old World. Even today, where I live part of the year, in France, people are still reluctant to try new things. The price of mistakes – financial, professional, and social – is high. Americans, on the other hand, had little to lose. Most had little money. There were no inherited titles… no social 1
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senators were elected by popular vote. With those changes, the U.S. was ready to embark on its imperial adventure.
We don’t know what is going to happen. But we know this: America’s stocks and bonds rose for 100 years – mostly for the right reasons. The companies behind them were making money. And growing.
World War One, the New Deal, the Great Society, the Vietnam War – one step after another took the U.S. closer to its European imperial ancestors. Gradually, taxes rose to European levels. Regulations increased, with more and more privileges for favored groups, much like under the Ancient Regime in France. War became a way of life, as it had been in Napoleonic France and the British Empire.
So far in this 21st century, stocks and bonds are still growing… but now for the wrong reasons. They are being manipulated by the feds and the Wall Street suits. Currently, based on sales, U.S. stocks sell for more than twice their historic average. And maybe they will sell for even more in the future. But that is not something we want to bet on.
The foxes prospered. And the nation lost much of its competitive edge. By the 21st century, America was much like the old countries from which it was derived, with a ruling Deep State firmly in place. Though direct spending by government is still at only half the level of Europe’s socialist economies, when you include parts of the “free enterprise” sectors that are heavily controlled by the feds – medical (including pharmaceuticals), Wall Street, as well as the educational sector – the picture is roughly the same as France, with similar levels of growth, employment, and productivity.
All economies and markets have their seasons… their life cycles. They are born… they grow… they mature… and they decline. The decline may be enjoyable. Autumn can be more beautiful than spring. But for an investor, it’s not the same thing. In spring, you can look forward to a bountiful summer. In the fall, you feel the approach of a cold winter. There’s a time to arrive… and a time to leave. When markets have peaked out… when empires begin to degenerate… when the oysters develop a whiff of decay – it’s time to move on. And it’s better to leave a little too early than a little too late.
This, of course, brings us to our second point. History follows patterns. Once an elite gets in control of a country, for example, it almost never willingly reduces its own privileges. Nor, once it is powerful enough, can it resist the temptation to throw its weight around beyond its borders. If it has the economic and military strength, it becomes an empire, as the U.S. did, seizing the Philippines, Hawaii, and Puerto Rico in 1898. And then, it doesn’t cease being an empire until it is defeated… or goes broke, often both.
Rome was not finally destroyed until the early 5th century. But the best time to sell Rome was probably about 100 AD; after that it was almost all downhill for the next 300 years. Likewise, the sun didn’t finally set on the British Empire until 1997. But by 1914 the glory days of growth and dominion were over. And the Soviet Empire peaked out soon after it was born. It survived for 70 years, to 1989, but the bull market in the Soviet Union was probably over by the 1960s.
Failure is inevitable. Because the power of the elite grows by imposing win-lose deals on the rest of the country. And as the win-lose deals proliferate, the economy – which depends on win-win deals – slows. In other words, the source of the elite’s power is the same thing as the source of the economy’s weakness. As they go forward, the trend approaches its end.
Is it time to sell the U.S.? Is it too early? Should you wait another 100 years? Those are the questions Dan addresses below… and answers, with specific investment suggestions. Read on…
We want to buy the things that go up in price. We don’t really care why they go up. But at least there is some logic and predictability to companies that become more valuable as they produce more goods and services. As their profits go up, they are worth more. Everything else is speculation. And yes, we might speculate on how the Fed will react to the next financial crisis. Maybe it will go hog wild, buying equities and driving the Dow higher. Maybe it will launch itself into an orgy of money-printing, like Zimbabwe in 2006, and we will have Dow 1,000,000 before the end of the Trump administration. Maybe… maybe… maybe…
Regards,
Bill Bonner, Poitou, France September 27, 2017
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The New Trade of the Century: Sell the United States of America By Dan Denning, Coauthor, The Bill Bonner Letter Before you phone up customer service to cancel your subscription to The Bill Bonner Letter, I’m going to ask you to hear me out. The Dow and the S&P 500 are hitting record highs. The Fed is on the path to normalization. And Warren Buffett is predicting the Dow Jones Industrials will hit one million in 100 years. With all that, it might seem like a bad time to “sell” America.
The next Trade of the Decade was to buy Japanese stocks and sell Japanese government bonds. That has had mixed results, mostly because the extraordinary market interventions by the Bank of Japan have distorted stock and bond prices beyond all recognition. There are still a few years to run on this before we can say whether it worked.
But that’s exactly what you should do. And if you don’t, you’ll be making a big mistake. And not just for yourself. But for your children and grandchildren as well. It’s time to be realistic about the direction America is headed in and prepare accordingly.
In January of last year, Bill unveiled a Trade of the Century: buy Cyprus! Things couldn’t have gotten much worse for Cyprus. It was also very hard to find a way to easily buy Cypriot stocks. That’s part of what made it such an appealing trade. Not only were the stocks selling for a song, no one could easily buy them! If you managed to find a way, you wouldn’t have much competition.
If this were one of Bill’s previous Trades of the Decade—buy gold, sell tech, buy Japan—it WOULD be a bad time to “sell” America. There’s a lot of decline left in the American Empire. You don’t want to be early. But remember the purpose of those trades: to identify an abnormality or excess in the market was due for mean reversion and then profit on both sides of it.
Exchange-traded funds (ETFs) are often an easy way to get into a market like Cyprus, notwithstanding my criticism of ETFs in recent months (which still stand). There is no Cyprus ETF. But the VanEck Vectors Russian Small-Cap ETF (NYSE:RSXJ) has 24% of its assets in Cypriot stocks. It’s as close as you’ll get to an ETF proxy for Cyprus (with Russia in for good measure).
The New Trade of the Century is designed to do the same, but with specific portfolio advice. If that sounds like a hard thing to do, it is! But Bill’s been at it since 2000 and results so far are pretty good.
Since the day Bill’s Trade was published, the ETF has smashed the S&P 500. Even if Bill didn’t intend to give
Up 158% Since January 2016 If you’re new to The Bill Bonner Letter, I recommend you take some time to go back to the January 2016 report and read it at your leisure. Bill explains that the Trade of the Decade was originally designed as a learning tool, not an investment indicator. He was trying to put the big picture together, connect the dots, and then propose a long-term trend you could profit from over the next decade. In 2000, the trade was to short stocks and buy gold. The essence of that idea was to short credit and debt, which were overpriced, and buy gold, which was cheap. That may seem like common sense now. But not many people were brave enough to call it like that at the time. 3
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portfolio advice, it was exactly the right line of attack: find something hated and beaten down and find a way into it. On the other side, find something so over-bought and overpriced it will eventually mean revert.
gravity for long-term investors,” or the perfect mix of risk and return. Markowitz himself said a 50-50 mix would do. Vanguard founder John Bogle said that your bond allocation should be roughly equal to your age, meaning you should own fewer stocks and more bonds the older you get.
My Trade of the Century doesn’t replace Bill’s. And it differs in one important respect—it’s intended as portfolio advice. And it’s intended to challenge the investment orthodoxy that would leave 40% of your retirement assets in an asset class that could, given the trajectory of American public finances, be headed for a historic collapse. That threat is serious enough that it merits some specific tips on how you can realistically prepare for it.
Is it suicidal or just arrogant to disagree with all these investment legends? Neither. Their asset allocation models were built for a world in which the U.S. was the dominant economic power. Its companies were growing and were the most dynamic in the world. And its government (and its bonds) were the gold standard in a world that had gone off the real gold standard. If you’re practical, you’ll realize the assumptions between the traditional 60-40 model are no longer true. You’ll adjust accordingly. And, in lieu of bonds, you’ll have a larger position in hard assets and unconventional assets, which I’ll come back to at the end of the letter.
Be Practical About the End of the World As We Know It You might read this month’s Letter and think I’m nuts. Maybe you won’t find the threat credible. Even so, you do want to be prepared. And practically, the first step is protecting the money you have in the market.
Too Soon to Sell? Is it too soon to take practical steps to prepare for when U.S. government bonds are no longer the safest investments in the world? The truth is, low interest rates and a spendthrift Congress could stack on another $20 trillion in U.S. debt in the next decade. The S&P could double. Inflation would obviously play a key role in both scenarios.
You can do this with stop-losses or trailing stops that lock in gains or limit losses if the market moves down quickly. If you don’t know what any of that means, I’ll write about it more next month. In the meantime, our friend Richard Smith at TradeStops can help you too.
Yet, all of this would be the prelude to the catastrophe I’m going to warn you about (again) this month. Don’t call me Chicken Little just yet. Remember, our job here is to take the long view; to look past the latest headline or tweet and see what path our country is on.
Next, ditch the 60-40 conventional asset allocation between stocks and bonds. I wrote about this in the July Letter, where we recommended only a 19% allocation to bonds in your portfolio. Why the big reduction? Because bonds have been in a bull market for 30 years. There is NO bigger bubble in the world than the bubble in government debt. It’s an asset class that’s due for exactly the kind of mean reversion Bill has written about.
You may recall that I told you I was coming back to America via Queen Mary 2 from Southampton to New York. It turns out you have a lot of time to think when you’re in the middle of the North Atlantic on the world’s largest ocean liner. This month’s letter is the result of that thinking.
The 60-40 allocation doesn’t factor in the 30-year bull market in bonds (especially government bonds). The theory itself was the answer to the question of how much risk you should take to get the required return from your portfolio (the required return being a pool of capital you could live off when you retired and were no longer earning an income).
After you’ve seen the numbers I’m going to show you, and after you see how the pension crisis at the state level could become a national problem (and lead to an all-out assault on the Bill of Rights), and after you get your head around the fact that the U.S. dollar is ALREADY worthless.
Stocks should give you a higher return. But with higher risk. Thus the 60% allocation was “hedged” with a 40% allocation to bonds. They might not give you a big capital gain. But they’d preserve your capital and give you income, something that becomes more important when you retire.
It might not seem that way. You can still get a Big Mac and buy a beer with greenbacks. It has value now because people are still willing to accept it for real goods. But my point is that the only thing left backing the dollar is belief. There’s no gold. There’s only the full faith and credit of the United States government. What do you think that will be
Peter Bernstein called the 60-40 model the “center of 4
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worth when U.S. debt hits 200% of GDP?
complacency. Investors who allow faulty impressions of history to lead them to assume too much stock-market risk today may be inviting considerable losses.
Aside from the practical steps above, and a few more I’ll show you later, your best investment now is in non-financial security, the kind that comes from the right people and the right places. I promise I’ll get to that later.
Shiller’s point about history is important, since it’s largely what Warren Buffett relies on for his recent forecast that the Dow Jones Industrials would hit one million in 100 years. Past returns tell you more about how to manage risk than what you should expect from future returns. In most of America’s history, your biggest risk was NOT being in the market. That even includes periodic/cyclical bear markets.
And for what it’s worth, I’ve made that investment myself. I’m not just recommending you do it. I’m staking my livelihood and future on being right. And if, after all that, you still think I’m an America-hating, Buffett-bashing, ungrateful pessimist, well then, America, we have a problem.
By Shiller’s reckoning, there have been 13 bear markets in the United States since 1871. A bear market is arbitrarily defined as a loss of 20% or more. That probably stems from the 1987 crash. On October 19, 1987—Black Monday—the Dow Jones fell over 500 points. It was a 22.61% one-day decline.
Learning From History Let me back up a second, though, and focus on investment markets. After all, this IS an investment newsletter. And I would be remiss if I didn’t warn you—again—that the stock market is in dangerous territory.
That turned out to be a spectacular buying opportunity. Remember, when expected returns are low (think Cyprus), that is exactly the time to buy. From 1987–2000, the Dow rose over 582%. Shiller points out that most U.S. bear markets created excellent buying opportunities.
You may be tired of hearing that by now. But that’s exactly why I need to repeat it. Complacency will get you every time. Quantitative easing and low interest rates are like anesthia: they impair your conscious ability to assess risk. Consider this your monthly gentle slap in the face to wake up.
What’s interesting is how many of them there were. The U.S. endured bear markets in 1892, 1895, 1902, 1906, 1916, 1929, 1934, 1937, 1946, 1961, 1987, 2000, and 2007. A complete analysis of all of them is well beyond the scope of a single newsletter (read Russell Napier’s Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms for the definitive work on buying low). But there are two general points to keep in mind.
Robert Shiller is doing his part to make sure the American public knows what’s at stake. I wrote about Shiller at length in the May Letter. His Cyclically Adjusted Price Earnings (CAPE) ratio is a valuation tool. It’s designed to tell you whether stocks are cheap or expensive by looking at an inflation-adjusted earnings average over the last ten years (rather that one or two years, which won’t tell you the full picture).
First, bear markets—or what Austrian economist Murray Rothbard would have called a depression—are perfectly natural and healthy in free markets. In economic terms, market clearing events (stock market crashes and corrections) re-establish price levels that are in line with the real economy. Mal-investments are written off. Bad firms fail and no one bails them out. Capital—the result of real labor and productivity—moves from weak hands to strong hands. Then you have a recovery.
The more expensive stocks are now, the lower the expected future returns. The cheaper they are, the higher the future expected returns. It’s pretty simple and not terribly controversial (although it has its critics, which I will not get into here). What’s it telling you now? Shiller’s CAPE ratio currently reads 30.52. That’s higher than Black Tuesday in 1929 but still lower than the peak of 44.19 in December 1999. Shiller recently wrote that:
There were four bear markets between 1871–1906, before the establishment of the Federal Reserve System. None of them ruined the country. In fact, that was precisely the time in history where America began to emerge as an economic powerhouse. Competition produced winners and losers at the corporate level. But in the aggregate, everyone won and life got better.
The U.S. stock market today looks a lot like it did at the peaks before most of the country’s 13 previous bear markets. This is not to say that a bear market is guaranteed: Such episodes are difficult to anticipate, and the next one may still be a long way off. And even if a bear market does arrive, for anyone who does not buy at the market’s peak and sell at the trough, losses tend to be less than 20%. But my analysis should serve as a warning against
The bear markets change in nature when the Fed comes on the scene in 1913. Monetary policy starts to have a bigger
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effect on the real economy. But even then, the bear markets weren’t total wealth-destroying events. Even when they were correlated with wars or geopolitical tension, they almost always set the stage for higher returns—if you could hold your nerve and buy (assuming you didn’t sell).
What’s probably most telling from that chart is that investors in the United States have never faced permanent losses in wealth from declines in stock and bond prices. For over 130 years and almost five generations, history has been on America’s side. Why would that change now?
The 2000 crash certainly set the stage for higher returns right away. So did the 2008 crash. The S&P 500 has delivered a 17.5% annualized gain since 2009. The Fed managed to short-circuit a total system ‘reset’ and flood the world with liquidity. You are now in the second-longest advance in stock market history without a 20% decline.
The answer lies in the fiscal, social, technological, and demographic trends in America which I’ll get into briefly later. But the important point for now is that the permanent destruction of a country’s wealth can and does happen. It just hasn’t happened in America, yet. But that doesn’t mean it’s impossible. In terms of market action, prices, and values, I’ll close the monthly crash warning with a quotation from economist Ed Yardeni. It’s a realistic assessment of the status quo. The market is clearly expensive. All other things being equal, you wouldn’t expect to make high returns when you’re buying at these prices. Yardeni writes:
Based on all that logic, you should welcome 20% correction as a great buying opportunity, right? Wrong. Bear markets are a normal fact of stock market life which give you the chance to buy quality assets at a cheap price. But the next such bear market may be much different. It won’t just reallocate wealth from weak hands to strong. It will destroy it.
The valuation question has been hanging over the current bull market. Valuation ratios such as price/earnings, price/ sales and market capitalisation/revenues are uniformly bearish, showing that stocks are as overvalued as they were just before the tech bubble burst in 2000… On the other hand, valuation measures that adjust for inflation and interest rates, both of which are near record lows, suggest that the market is fairly valued — they are mostly in the Goldilocks range: not too cold and not too hot.
Why the Next Correction Will Be Different Check out the chart below. You’ll note that Shiller’s data omits the two bear markets in 1968–1970 and 1973–1974, when the Dow fell 37% and 46% respectively. Those declines weren’t considered corrections because they were more gradual and lasted longer. If you’re at or near retirement age and facing an imminent decline like that, time is not on your side.
Yardeni is cautious. He knows stocks are overvalued. But he also knows that if inflation and interest rates remain low, stocks could go higher. Here’s a prediction you can take to the bank: interest rates and inflation will rise again. And they will keep on rising out of sight to unimaginable levels. It may not be next month or even next year. But when they do, it will be in tandem with the kind of bear market that destroys American wealth permanently. At the heart of it will be the ‘safest’ investment in the world, the 30-year U.S. Treasury bond. You’ll want to “sell America” before that time comes. The next 20% correction might be a temporary buying opportunity. But the Trade of the Century still stands. Even if the greatest investor in the world disagrees.
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Buffett Is Wrong
secure gold in exchange for the fruits of your labors.
First, full disclosure on my opinion of Warren Buffett. He’s a great investment writer. His essays and annual letter to shareholders are not only brilliantly written, but they also give you great insight into how he and long-time partner Charlie Munger have turned Berkshire Hathaway into an investment goldmine.
They don’t make congressmen like that anymore, except maybe for Ron Paul. I recommend you read the whole speech if you can. It’s only five pages. And it’s in stark contrast to the pithy remarks Howard Buffett’s son, Warren, recently made about America.
But he’s not even the best Buffett in his family! That honor would have to go this father Howard Buffett. Howard Buffett was an old-school hard money libertarian from Nebraska. As a Congressman, he was an outspoken advocate for gold and honest money. Here’s what he said in a 1948 speech called Human Freedom Rest on Gold Redeemable Money (emphasis added is mine):
In case you missed it, Buffett told Forbes that the Dow Jones Industrials would go to ONE MILLION in the next hundred years. Why? Because of a great era of innovation? A return to sound money and individual liberty and free enterprise? No! Because anyone who thinks otherwise is a loser. Geez, do you think Buffett follows Donald Trump on Twitter? Sad! Buffett predicted the huge rise in the Dow and added that, “Being short America has been a loser’s game. I predict to you it will continue to be a loser’s game… When I hear people talk pessimistically about this country, I think they’re out of their mind.”
Politicians of both parties will oppose the restoration of gold, although they may outwardly seemingly favor it. Also those elements here and abroad who are getting rich from the continued American inflation will oppose a return to sound money. You must be prepared to meet their opposition intelligently and vigorously. They have had 15 years of unbroken victory. But, unless you are willing to surrender your children and your country to galloping inflation, war and slavery, then this cause demands your support. For if human liberty is to survive in America, we must win the battle to restore honest money. There is no more important challenge facing us than this issue -- the restoration of your freedom to
Does he have a point? Some of the numbers are on his side. The Dow traded at 81 a hundred years ago. It’s up 300 times since then. Heck, the market is up 265% since the March 2009 low. As Yakov Smirnov once said, “What a country!” Buffett added that, “This is not a ridiculous forecast at all if you do the math. It’s an amazing country we live in.” Billionaire investor Mario Gabelli agreed, even suggesting Buffett’s forecast was bearish. The math shows the market would have to go up 45 times from the recent levels (around 22,400) to hit a million in a hundred years. Gabelli points out that it would require a compound annual growth rate of around 3.9% to hit that target. And that’s nothing! The Dow has grown at a compound annual rate of 10.7% since 2008. Gabelli added that for the entirety of the 20th century, the Dow posted a 5.5% compound annual growth rate. By the numbers, then, Buffett’s prediction is modest. And it’s a reminder that most of the time, time is on your side if you invest early and wisely in productive enterprises. But he’s still wrong. Why?
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Three Ways to Make the Trade
Buffett assumes the next 100 years will be a lot like the last 100 years. But think about that. One of those hundred years upon which his forecast is based, America was a continent-sized economy, rich in resources, unsaddled with massive debts. And it alone was one of the Great Powers that escaped World Wars I and II without the destruction of its industrial base.
To avoid any doubt, let me be clear and say what my Trade of the Century means, at the very least, you should reduce your exposure to U.S. government bonds. That’s the most “actionable” way to make the trade. And it’s based on Bill’s idea that you look for abnormalities in the market that are bound to mean revert.
This gave it a historically unprecedented—and historically unrepeatable advantage—in global trade and military affairs. It was a creditor nation with the world’s largest and wealthiest economy. It had the world’s most powerful military.
But not owning something to avoid losses is different than profiting from its fall. There ARE ways you can speculate on falling government bonds prices. I hasten to point out that these are speculations. If your aim is to preserve your capital, then they are trades you’ll want to avoid.
Even more importantly, from an economic perspective, the demographics were incredibly favorable. The widespread adoption of consumer credit ran smack into the pent-up demand of the returning veterans from the way. They got busy having babies. And we had a Baby Boom.
If, however, you agree with the proof I provide below, the simplest way is to buy long-term put options on the iShares Core U.S. Aggregate Bond ETF (NYSE:AGG). Nearly 38% of the fund’s core holdings are in U.S. Treasury bonds and notes. Another 27% are in government agencies that lend to the U.S. housing market. Corporate bonds are held too.
Buffett was fortunate enough—as we all were—to be born in a country that found itself perfectly positioned to grow and prosper. To his credit, he turned his formidable intellect to the task of making hay while the proverbial sun was shining.
AGG is a proxy for U.S. government debt. It’s a liquid ETF that’s been around since 2003. I first wrote about it in 2003 in The Bull Hunter. You could always speculate on the direction of interest rates with CBOE options contracts as well. But if you think U.S. credits are due to mean revert something fierce, AGG is one way to play it.
In the last three decades, once the natural arc of American economic hegemony began to decline, Buffett put himself and his shareholders in the position to benefit from low interest rates and government stimulus. He’s become a high-profile cheerleader for a version of America that his father would scarcely recognize and almost certainly be ashamed of.
If you’re even more adventurous, check out the ProShares Short 7-10 Year Treasury Fund (NYSE:TBX). It’s designed to produce the inverse performance of the ICE U.S. Treasury 7-10 year Bond Index. If rates go up and bond prices fall, the share price of the fund should rise.
Buffett’s America Is Dead and Gone Let me put aside the moral point and make two final ones regarding Buffett. First, let’s acknowledge that 100-year forecasts are stupid. Neither you nor I nor Buffett is going to be around in 100 years. No investor has a 100-year time line. Why bother then? If you’re taking the long view, you might as well take the long view.
And if you’re feeling downright reckless, try the Direxion Daily 7-10 Year Treasury Bull & Bear 3x Shares (NYSE:TYO). That fund is designed to produce the inverse performance of the same ICE Treasury Index, but times three! How does it do that?
The second point is that Buffett is making a nostalgic argument based on a version of America that no longer exists. He’s talking about his own book. And he’s forgotten—or simply doesn’t believe—the fact that stocks and bonds are subject to certain kinds of shocks that permanently destroy the wealth of a nation.
That’s the part that makes it dangerous. It comes down to leverage and complex financial instruments. It’s NOT something I recommend for investors. In fact, if you’re retired, stay away at all costs. This is only for gamblers who have spare money to lose but like the idea of betting against Uncle Sam. There are other ways to be “short” U.S. government bonds. I’ve listed some direct ways above. Later, we’ll look at the other side of the trade and what you should be “long.” But first, let me address a point you may be thinking about: what if Buffett is right?
America faces just such a shock, perhaps not in Buffett’s lifetime (he turned 87 in August). But certainly in the lifetime of your children and grandchildren. That’s why the Trade of the Century is to sell the liabilities of a bankrupt government before it repudiates them and renders them worthless. 8
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Can Technology and Innovation Save Us?
Austria’s experience in the wars wasn’t just a bear market. It was a wealth extinction event, which of course is secondary to the massive suffering and death the wars inflicted. But these events DO happen, and it’s not only wars that cause them. A monetary crisis can do it, too.
Is it possible Buffett is right? There’s more than just blind optimism (or shallow patriotism) to his forecast. America HAS shown a remarkable talent for embracing innovation, turning it into profitable enterprise, and generally being a society that’s more focused on the future than the past.
The second image below (see page 10) shows, quite starkly, how the wars decimated the economic clout of the major European powers and transferred global market share to America’s stock market was just 15% of the total world market capitalization in 1900. By contrast, the six largest European stock markets—the UK, Germany, France, Russia, Austria, and Belgium—made up nearly 61% of total world market cap.
Having lived abroad the last fifteen years, I find these to all be admirable qualities. They’re also consistent with the ideas behind free markets and even the Austrian school. You never know what the future is going to bring. But if you give people the freedom to experiment, innovate, and adapt, prosperity flourishes even when you have constant change.
By January 2016, the roles were more than reversed. The U.S. remains the world’s largest equity market. Europe’s share of total world market GDP is much reduced. And China and the emerging markets are still minnows by comparison (although some of China’s largest firms like PetroChina, Alibaba, and Tencent are among the largest by market cap in the world).
But look at the three images below. Both show, I think, why it will be hard for America to repeat its success of the last 100 years. For one, the world is a much more competitive place. Secondly, the innovations most likely to drive another 100 years of great wealth creation are likely to run into both political and cultural opposition.
The final chart (see page 11) shows the change in the industrial balance of power between 1900–1916. This is important because if an economy is going to grow over a long period of time—the kind of growth that generates 5.5% CAGR, the leading industries, and companies will have to change over time. In the U.S. and UK, railroads dominated at the turn of the 20th century.
Both images are from a book called Financial Market History: Reflections on the Past for Investors Today. The first largely confirms Buffett’s point. The 20th century was a good century for America. In U.S. dollar terms, only Australia’s stock market—riding the “sheep’s back” during the 1950s with wool and grain exports to Asia and then the commodities boom from 2003–2008—has done better in terms of real returns. In local currency terms, both South Africa and Australia pipped the U.S.
Fifteen years into the next century, you see a lot more
It’s no coincidence that the top three performers of the 20th century were commodity producers (especially gold). You can also see that countries which managed to avoid major damage to their capital base in the wars enjoyed steady returns. I’m talking especially about Australia, New Zealand, the United States, and South Africa. At the other end of the spectrum, you have proof that some external shocks can deal death blow to stocks and bonds—even to countries themselves. This is the permanent loss of wealth I mentioned earlier. Local currency returns in Austria from 1900–2015 were less than one percent, largely thanks to a certain Corporal. In U.S. dollar terms, the returns were negative— over 115 years!
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sectoral diversification. Techs, banks, healthcare, and retail have each carved out a piece of the market. The Railroad Robber Barons have given way to the Silicon Valley Jobber Barons (digitization and automation fundamentally transforming the structure of the job market and driving down real wages). And now the important question: what about the next 100 years?
Relative Sizes of World Stock Markets January 1, 1900
What Could Power the Next 100 Years of Growth If you’re a Buffett-style optimist, you probably don’t have any idea what new industries will power American growth and American stocks for the next 100 years. But you’re convinced they’ll emerge here and U.S. investors will be the main winners from innovation and growth.
January 1, 2016
I’m not so sure, for two reasons. First, the biggest stocks in America, by market cap, are now tech stocks. Facebook, Apple, Amazon, Netflix, and Google… these are all roaring successes. But as technology companies, their competitive advantage is tenuous. In future letters, I want to go into this in greater detail. I believe that as America’s economy has shifted to information technology and away from industry and manufacturing, these tech giants will become immensely politically powerful (Zuckerberg for President!). But I don’t believe they can or will be the basis of 100 years of stock market gains and American exceptionalism.
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Source: DMS (2002, 2016); FTSE Russell 2015
promise for creating cures of genetic diseases, and thus becoming a huge business/investment opportunity. Probably the biggest of the next 100 years.
The only industries capable of delivering that kind of growth and prosperity are in energy, biotechnology, and materials science. And while America has the labs and the talent to compete in all three, there is plenty of talent around the world.
Yet, Silicon Valley could miss out on it entirely. Why? Silicon Valley’s great disruption was changing the format of information from analog to digital and then making it easier than ever to store, access, or transport that information. That’s evolved into Big Data and analytics that are behind the logistics success of Amazon and Google’s ability to
Take just one example with CRISPR and genetic engineering. CRISPR, without going into detail, is a technology that makes it possible to modify human DNA. It holds great 10
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know you better than yourself, based on your browsing habits.
Industry Weightings in the USA
But if the next great innovation in data and information will be biological and not technological, that innovation is far more likely to happen in China than America. Why?
1900
DNA is just information. Genetic disorders and diseases may be cured by new genetic tools. But to edit DNA means to literally alter the fabric of human life. Do you think that will be wildly popular in the United States? Do you think China will care? I expect the debate about editing human genes to end up in U.S. courts. The federal government may even get involved and try to stop it the more political/religious the issue becomes. There will be no such impediments to the birth of a new industry in China.
2015
As I said, the whole thing is a discussion for another day. And to be fair, America produced a fracking revolution that changed the balance of power in the global energy markets. The U.S. tends to embrace disruptive change. Maybe it WILL happen here. But we simply don’t know what innovations are going to emerge, or where they’ll come from. Buffett believes, as an article of faith in America, that they’ll come from here.
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Source: DMS (2002, 2016); FTSE Russell 2015
The Economy-Wide Manhattan Project These problems have been brewing in America for a long time. You don’t get $20 trillion in debt overnight. You do it by convincing yourself that you owe it to yourself. The big mistakes—going off the gold standard, believing we could have guns AND butter, exporting the American idea of democracy as if it were a universal ambition—were made by
The world is a much different place than in 1900, though. And America is a much different country. We’re nearing the end of this month’s letter. But we need to cover two more things that I hope will help you see why it’s time to “sell” America and make another investment instead. 11
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many people over the course of many years.
would be two results. First, the federal government could then step in to arrange bailouts—something Trump the dealmaker might greatly enjoy in preparing for the 2020 election, swapping federal bailout money for Illinois electoral votes.
I’ve tried to show you the trend over the last few months. Deficit spending, an aging population that will consume more government resources, and a Deep State that commands more wars and military spending… all these add up to an inevitable disaster for the feds. First the government will run out of money. And then it will have too much of the kind that is worthless (hyperinflation).
The second result would be even more dangerous: open season on the Bill of Rights. The Constitution is designed to be hard to change. It establishes a fundamental relationship between a free person and the government. The Bill of Rights specifically states what the government cannot due. It’s huge bias is for minority/individual rights.
Nor can we grow ourselves out of the debt we’ve taken on. Given how poor American political leadership is, you can be certain we’ll take on more debt. We’ll keep taking it on until the rest of the world has had enough (keep an eye on the Treasury International Capital flows data for changes in the appetite for U.S. debt). And then what?
Those rights are under assault as we speak. Congress and the Supreme Court permit and encourage expansion of police powers for search and seizure. And just since I’ve been back, I’ve read people calling for a reinterpretation of the Second Amendment to the right to bear arms would only be in the context of serving in a local militia to defend the country against a foreign invader (rather than a domestic enemy like, say, an out-of-control federal government).
Creditism: the Last Refuge of the Bankrupt My friend Richard Duncan, editor of Macro Watch, has suggested the path of “creditism.” This is where the government sells bonds or prints trillions of dollars to fund the kinds of industries that COULD deliver the growth we need to pay off the debt.
What’s worse, the First Amendment is probably on borrowed time anyway. Most Americans couldn’t name the five freedoms established there. And on America’s college campuses, The Washington Post reports that 40% of incoming freshman believe it’s acceptable to suppress speech you deem hateful with violence.
It would be an enormous gamble; a kind of make-or-break economy-wide Manhattan Project to deliver breakthroughs to solve the problems. I’m being deliberately vague because that’s how it sounds to me. A last-gasp effort to throw all the resources of the federal government behind a few targeted innovations.
The rule of law, shared values, a belief in individual liberty, limited government, and sound money—these were the bedrock of the America that Buffett built his fortune in. That bedrock is being attacked with a jackhammer in a barbaric act of cultural vandalism. The next 100 years will be rough for America as we know it.
It will never work. But it might be enough to take the debtto-GDP level from where it currently sits at around 105%, and up to 200% of GDP. That’s where it is in Japan. And you’d be surprised how quickly it could get there. A few trillion for driverless cars here, a war with North Korea, and some other random boondoggles to benefit the Crony Capitalists in Washington and New York… and you’re there.
Trade of the Century The investment takeaway from all of that is not to have 40% of your portfolio in bonds, and especially not in U.S. government bonds. The larger the tab we rack up, the more pressure it will put on the dollar. The growing economic power of the rest of the world means they won’t trade real assets (and labor and production) for paper which we print and give to them.
An Attack on the Constitution And that’s assuming the federal government doesn’t have to bail out states who have massive, unfunded pensions. Little known fact: the 10th amendment to the Constitution prohibits states from “impairing the obligation of contracts.” This effectively prohibits a state government—but not a township, city, school district, or municipality—from declaring bankruptcy.
On the flip side of the trade, emerging markets, or net creditor countries, will be worth looking at owning. Some emerging markets have large dollar-denominated debts. But others have trade surpluses and haven’t yet racked up huge entitlement obligations (Vietnam is a good example).
It would require a new interpretation of the Constitution to allow states to declare bankruptcy. If it were to happen, there
If we want our prosperity, we’re going to have to earn it. But
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1. Get out of the bear trap. In the event of a Great Renunciation of U.S. Government bonds, you simply can’t afford to have your financial markets in one country (the U.S.). I have no doubt that capital controls will be imposed on Americans at some point in the next ten years. It’s imperative that you set up a foreign bank account before then. I’ve chosen to do so in places where I happened to live (the U.S. and the UK). But look at Singapore and Switzerland too, or any place that will welcome capital as it flees America.
that’s not the modern American way. The modern American way is to demand it from the government, where the ruling politicians will take the money from the productive classes and give to those who vote for them. Sometime in the next 100 years—and probably much sooner—the world is going to call time on this arrangement and hold the U.S. accountable. For example, the government might have to borrow in a foreign currency and repay in a foreign currency. Or we might have to pay in gold. All of that would come after it was obvious the U.S. could never pay its debts and had no intention to do so. That’s the path we’re on. At some point, there will be a Great Renunciation, where we tell the rest of the world we’re not going to pay them. At that point, the dollar, once our source of strength and security, will become a global joke.
2. Real assets in low-tax U.S. States, where people will want to move as the state pension crisis goes federal. I was in North Carolina to visit family. And I’m in Colorado for the same reason. But I’m also looking to buy real estate in small communities where higher net worth Americans may relocate in the next great crisis. It’s just a matter of time before highly-indebted states begin imposing “exit taxes” on citizens who are fleeing high taxes. At some point, states may even try their own version of capital controls. I don’t know what that will look like. But I do know if you own real estate in Wyoming or a farm in North Carolina, you will have put at least some of your wealth beyond the reach of grasping states.
And bonds? They won’t be worth a continental. If you have all your wealth tied up in dollar-denominated assets when the Great Renunciation happens, I’m sorry to tell you you’re doomed. Between now and then, I hope to show you how to avoid that result. Which brings me to my final point.
Your Best Investment Now I moved back to America because it’s where my family is and I still love the place. This morning, for example, I woke up and took a sunrise walk in the foothills of the Rocky Mountains and counted by blessings for having the good sense to be born in right country at the right time.
3. Alterative assets. I’ll be working on this one, too. But it begins with acknowledging that the value of assets which you have no access to is zero. I picked this point up when reading The Mandibles on Queen Mary 2. Practically this means reviewing your agreements with the banks or other financial institutions which store or guard your wealth. What are their terms of access? Should you consider moving some of your cash out of major banks to credit unions or smaller regional banks? How can you do so without losing federal deposit insurance? What other hard assets act as a store of wealth that you can later reliquify when things have settled down? I welcome your ideas. Send them via email. I’ll keep your name confidential if you don’t want to share it.
But I also realized that a big part of my future wealth will be in the quality of the relationships I have with friends and family. As the systems and institutions which bind our country together slowly fray—or are torn apart—you will have to rely on smaller, more local relationships. None is more important than family. Investments in your friends, family, and community are not financial. But they ARE valuable. And optimistically, I believe that’s the only way to really make America great again. If it happens, it will be from the bottom up. Not from the swamp down.
Right now, you have a quiet period. In Bill’s vernacular, it’s the period between farce and tragedy. The comedy is over. Our situation is serious. But it’s not yet desperate.
The Other Side of the Trade
The farce will get worse in the lead up to the next presidential election. I fully expect one of the following to run for and be nominated of a major party for President: Mark Zuckerberg, Steven Spielberg, Kid Rock, The Rock, George Clooney, Jamie Dimon, and Kayne West.
Lest you think I’m being too touchy-feely about a serious financial matter, let’s address the financial side of the trade. If you “sell” U.S. Treasury bonds, what should you “buy?” This is an ongoing theme I have to do a lot more work on. But I can tell you what I’ve done and what I’m doing right now. 13
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Down the track, don’t rule out Ivanka Trump going head to head against Chelsea Clinton. And don’t forget Tom Hanks. He’s been around the moon. He invaded Normandy. And he even survived being stranded on a desert island! The man is a survivor and can surely lead our nation to salvation. Come to think of it, there may be some comedy left yet in the Old Republic. But don’t let the bread, circuses, and Twitter wars distract you from the big picture. You have one great trade to make that could determine the fate of your wealth and your family for the next three generations. Don’t blow it. Regards, be unprepared when the government begins to impose capital controls and we can no longer benefit from the kindness of strangers.
Dan Denning Coauthor, The Bill Bonner Letter P.S. The argument I made this month is that the United States government has been living on borrowed money for a long time. It’s only a matter of time before creditors require higher interest rates to loan to a government that has no intention of reducing spending. And that doesn’t include the massive projected increased in entitlement spending over the next twenty years. America will simply have to pay more to borrow and rates will rise.
The Idea of America, the one Bill wrote about years ago, begins with the people. The Deep State has perverted and corrupted that idea to their own ends. When I sailed under the Verrazano Narrows Bridge and into New York Harbor and saw the Statue of Liberty in the distance. I was glad to be home. But I realized there is a lot of work to do if the idea of America is going to survive the coming economic decline.
It’s not anti-American to point out how the government has failed. If you’re expecting answers or solutions from the top-down, you’ll be disappointed. More importantly, you’ll
P.P.S I’m always happy to read subscriber feedback. Drop me a note by clicking here.
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OCTOBER 2017
The Great American Fluke By Bill Bonner In the following letter, Dan Denning suggests that it is time to “sell” the U.S. As our minor contribution to the declinist genre, we offer three related, and equally disagreeable thoughts: First, America’s extraordinary success was a fluke. Second, the country is now firmly in the grip of a sour and ineluctable history. Third, most likely, Dow 1,000,000 will come sooner than anyone expects. But few investors will be very pleased about it. As to the first proposition, why was America such a success? The answer is simple: Americans got lucky. Their germs wiped out as much as 90% of the existing population, leaving them a vast, mostly empty, country rich in natural resources, geographically protected from Europe’s wars, to be settled by good people at a good time. Innovations developed by Europeans quickly took root in America and flourished. Some were technical – steel, steam power, railroads, internal combustion engines, electricity. Others, perhaps more important, were philosophical. English, Scottish, and French Enlightenment thinkers elaborated theories of liberty and limited government; these were taken up and applied in a virgin setting by Jefferson, Adams, Madison, and others.
classes (except in certain places, such as the Hudson River Valley and the Plantation South)… and no important religious divisions. The country was wide open and ready for business. The American experiment with limited government was set up at the end of the 18th century. In the 19th century it proved a great success. Successive waves of immigrants brought with them new ideas and energy, which propelled the U.S. to the world’s number one economy by the 1890s. Of course, by then the ‘foxes,’ as 19th century Italian economist Vilfredo Pareto called them, were already making their nests in Washington, setting up the institutions and bamboozles with which they would prey on the output of the Main Street economy. By 1914, they had already effected a hidden revolution. Three key changes were achieved in 1913. The Federal Reserve Act created a central bank. The 16th Amendment allowed Congress to impose an income tax. And the 17th Amendment changed the way senators were chosen. Previously, senators represented the states from which they came and were selected by state legislatures. Thereafter,
The result was an economy where people had access to the same capital and technology as Europe, but without the many constraints that hampered people in the Old World. Even today, where I live part of the year, in France, people are still reluctant to try new things. The price of mistakes – financial, professional, and social – is high. Americans, on the other hand, had little to lose. Most had little money. There were no inherited titles… no social 1
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senators were elected by popular vote. With those changes, the U.S. was ready to embark on its imperial adventure.
We don’t know what is going to happen. But we know this: America’s stocks and bonds rose for 100 years – mostly for the right reasons. The companies behind them were making money. And growing.
World War One, the New Deal, the Great Society, the Vietnam War – one step after another took the U.S. closer to its European imperial ancestors. Gradually, taxes rose to European levels. Regulations increased, with more and more privileges for favored groups, much like under the Ancient Regime in France. War became a way of life, as it had been in Napoleonic France and the British Empire.
So far in this 21st century, stocks and bonds are still growing… but now for the wrong reasons. They are being manipulated by the feds and the Wall Street suits. Currently, based on sales, U.S. stocks sell for more than twice their historic average. And maybe they will sell for even more in the future. But that is not something we want to bet on.
The foxes prospered. And the nation lost much of its competitive edge. By the 21st century, America was much like the old countries from which it was derived, with a ruling Deep State firmly in place. Though direct spending by government is still at only half the level of Europe’s socialist economies, when you include parts of the “free enterprise” sectors that are heavily controlled by the feds – medical (including pharmaceuticals), Wall Street, as well as the educational sector – the picture is roughly the same as France, with similar levels of growth, employment, and productivity.
All economies and markets have their seasons… their life cycles. They are born… they grow… they mature… and they decline. The decline may be enjoyable. Autumn can be more beautiful than spring. But for an investor, it’s not the same thing. In spring, you can look forward to a bountiful summer. In the fall, you feel the approach of a cold winter. There’s a time to arrive… and a time to leave. When markets have peaked out… when empires begin to degenerate… when the oysters develop a whiff of decay – it’s time to move on. And it’s better to leave a little too early than a little too late.
This, of course, brings us to our second point. History follows patterns. Once an elite gets in control of a country, for example, it almost never willingly reduces its own privileges. Nor, once it is powerful enough, can it resist the temptation to throw its weight around beyond its borders. If it has the economic and military strength, it becomes an empire, as the U.S. did, seizing the Philippines, Hawaii, and Puerto Rico in 1898. And then, it doesn’t cease being an empire until it is defeated… or goes broke, often both.
Rome was not finally destroyed until the early 5th century. But the best time to sell Rome was probably about 100 AD; after that it was almost all downhill for the next 300 years. Likewise, the sun didn’t finally set on the British Empire until 1997. But by 1914 the glory days of growth and dominion were over. And the Soviet Empire peaked out soon after it was born. It survived for 70 years, to 1989, but the bull market in the Soviet Union was probably over by the 1960s.
Failure is inevitable. Because the power of the elite grows by imposing win-lose deals on the rest of the country. And as the win-lose deals proliferate, the economy – which depends on win-win deals – slows. In other words, the source of the elite’s power is the same thing as the source of the economy’s weakness. As they go forward, the trend approaches its end.
Is it time to sell the U.S.? Is it too early? Should you wait another 100 years? Those are the questions Dan addresses below… and answers, with specific investment suggestions. Read on…
We want to buy the things that go up in price. We don’t really care why they go up. But at least there is some logic and predictability to companies that become more valuable as they produce more goods and services. As their profits go up, they are worth more. Everything else is speculation. And yes, we might speculate on how the Fed will react to the next financial crisis. Maybe it will go hog wild, buying equities and driving the Dow higher. Maybe it will launch itself into an orgy of money-printing, like Zimbabwe in 2006, and we will have Dow 1,000,000 before the end of the Trump administration. Maybe… maybe… maybe…
Regards,
Bill Bonner, Poitou, France September 27, 2017
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The New Trade of the Century: Sell the United States of America By Dan Denning, Coauthor, The Bill Bonner Letter Before you phone up customer service to cancel your subscription to The Bill Bonner Letter, I’m going to ask you to hear me out. The Dow and the S&P 500 are hitting record highs. The Fed is on the path to normalization. And Warren Buffett is predicting the Dow Jones Industrials will hit one million in 100 years. With all that, it might seem like a bad time to “sell” America.
The next Trade of the Decade was to buy Japanese stocks and sell Japanese government bonds. That has had mixed results, mostly because the extraordinary market interventions by the Bank of Japan have distorted stock and bond prices beyond all recognition. There are still a few years to run on this before we can say whether it worked.
But that’s exactly what you should do. And if you don’t, you’ll be making a big mistake. And not just for yourself. But for your children and grandchildren as well. It’s time to be realistic about the direction America is headed in and prepare accordingly.
In January of last year, Bill unveiled a Trade of the Century: buy Cyprus! Things couldn’t have gotten much worse for Cyprus. It was also very hard to find a way to easily buy Cypriot stocks. That’s part of what made it such an appealing trade. Not only were the stocks selling for a song, no one could easily buy them! If you managed to find a way, you wouldn’t have much competition.
If this were one of Bill’s previous Trades of the Decade—buy gold, sell tech, buy Japan—it WOULD be a bad time to “sell” America. There’s a lot of decline left in the American Empire. You don’t want to be early. But remember the purpose of those trades: to identify an abnormality or excess in the market was due for mean reversion and then profit on both sides of it.
Exchange-traded funds (ETFs) are often an easy way to get into a market like Cyprus, notwithstanding my criticism of ETFs in recent months (which still stand). There is no Cyprus ETF. But the VanEck Vectors Russian Small-Cap ETF (NYSE:RSXJ) has 24% of its assets in Cypriot stocks. It’s as close as you’ll get to an ETF proxy for Cyprus (with Russia in for good measure).
The New Trade of the Century is designed to do the same, but with specific portfolio advice. If that sounds like a hard thing to do, it is! But Bill’s been at it since 2000 and results so far are pretty good.
Since the day Bill’s Trade was published, the ETF has smashed the S&P 500. Even if Bill didn’t intend to give
Up 158% Since January 2016 If you’re new to The Bill Bonner Letter, I recommend you take some time to go back to the January 2016 report and read it at your leisure. Bill explains that the Trade of the Decade was originally designed as a learning tool, not an investment indicator. He was trying to put the big picture together, connect the dots, and then propose a long-term trend you could profit from over the next decade. In 2000, the trade was to short stocks and buy gold. The essence of that idea was to short credit and debt, which were overpriced, and buy gold, which was cheap. That may seem like common sense now. But not many people were brave enough to call it like that at the time. 3
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portfolio advice, it was exactly the right line of attack: find something hated and beaten down and find a way into it. On the other side, find something so over-bought and overpriced it will eventually mean revert.
gravity for long-term investors,” or the perfect mix of risk and return. Markowitz himself said a 50-50 mix would do. Vanguard founder John Bogle said that your bond allocation should be roughly equal to your age, meaning you should own fewer stocks and more bonds the older you get.
My Trade of the Century doesn’t replace Bill’s. And it differs in one important respect—it’s intended as portfolio advice. And it’s intended to challenge the investment orthodoxy that would leave 40% of your retirement assets in an asset class that could, given the trajectory of American public finances, be headed for a historic collapse. That threat is serious enough that it merits some specific tips on how you can realistically prepare for it.
Is it suicidal or just arrogant to disagree with all these investment legends? Neither. Their asset allocation models were built for a world in which the U.S. was the dominant economic power. Its companies were growing and were the most dynamic in the world. And its government (and its bonds) were the gold standard in a world that had gone off the real gold standard. If you’re practical, you’ll realize the assumptions between the traditional 60-40 model are no longer true. You’ll adjust accordingly. And, in lieu of bonds, you’ll have a larger position in hard assets and unconventional assets, which I’ll come back to at the end of the letter.
Be Practical About the End of the World As We Know It You might read this month’s Letter and think I’m nuts. Maybe you won’t find the threat credible. Even so, you do want to be prepared. And practically, the first step is protecting the money you have in the market.
Too Soon to Sell? Is it too soon to take practical steps to prepare for when U.S. government bonds are no longer the safest investments in the world? The truth is, low interest rates and a spendthrift Congress could stack on another $20 trillion in U.S. debt in the next decade. The S&P could double. Inflation would obviously play a key role in both scenarios.
You can do this with stop-losses or trailing stops that lock in gains or limit losses if the market moves down quickly. If you don’t know what any of that means, I’ll write about it more next month. In the meantime, our friend Richard Smith at TradeStops can help you too.
Yet, all of this would be the prelude to the catastrophe I’m going to warn you about (again) this month. Don’t call me Chicken Little just yet. Remember, our job here is to take the long view; to look past the latest headline or tweet and see what path our country is on.
Next, ditch the 60-40 conventional asset allocation between stocks and bonds. I wrote about this in the July Letter, where we recommended only a 19% allocation to bonds in your portfolio. Why the big reduction? Because bonds have been in a bull market for 30 years. There is NO bigger bubble in the world than the bubble in government debt. It’s an asset class that’s due for exactly the kind of mean reversion Bill has written about.
You may recall that I told you I was coming back to America via Queen Mary 2 from Southampton to New York. It turns out you have a lot of time to think when you’re in the middle of the North Atlantic on the world’s largest ocean liner. This month’s letter is the result of that thinking.
The 60-40 allocation doesn’t factor in the 30-year bull market in bonds (especially government bonds). The theory itself was the answer to the question of how much risk you should take to get the required return from your portfolio (the required return being a pool of capital you could live off when you retired and were no longer earning an income).
After you’ve seen the numbers I’m going to show you, and after you see how the pension crisis at the state level could become a national problem (and lead to an all-out assault on the Bill of Rights), and after you get your head around the fact that the U.S. dollar is ALREADY worthless.
Stocks should give you a higher return. But with higher risk. Thus the 60% allocation was “hedged” with a 40% allocation to bonds. They might not give you a big capital gain. But they’d preserve your capital and give you income, something that becomes more important when you retire.
It might not seem that way. You can still get a Big Mac and buy a beer with greenbacks. It has value now because people are still willing to accept it for real goods. But my point is that the only thing left backing the dollar is belief. There’s no gold. There’s only the full faith and credit of the United States government. What do you think that will be
Peter Bernstein called the 60-40 model the “center of 4
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worth when U.S. debt hits 200% of GDP?
complacency. Investors who allow faulty impressions of history to lead them to assume too much stock-market risk today may be inviting considerable losses.
Aside from the practical steps above, and a few more I’ll show you later, your best investment now is in non-financial security, the kind that comes from the right people and the right places. I promise I’ll get to that later.
Shiller’s point about history is important, since it’s largely what Warren Buffett relies on for his recent forecast that the Dow Jones Industrials would hit one million in 100 years. Past returns tell you more about how to manage risk than what you should expect from future returns. In most of America’s history, your biggest risk was NOT being in the market. That even includes periodic/cyclical bear markets.
And for what it’s worth, I’ve made that investment myself. I’m not just recommending you do it. I’m staking my livelihood and future on being right. And if, after all that, you still think I’m an America-hating, Buffett-bashing, ungrateful pessimist, well then, America, we have a problem.
By Shiller’s reckoning, there have been 13 bear markets in the United States since 1871. A bear market is arbitrarily defined as a loss of 20% or more. That probably stems from the 1987 crash. On October 19, 1987—Black Monday—the Dow Jones fell over 500 points. It was a 22.61% one-day decline.
Learning From History Let me back up a second, though, and focus on investment markets. After all, this IS an investment newsletter. And I would be remiss if I didn’t warn you—again—that the stock market is in dangerous territory.
That turned out to be a spectacular buying opportunity. Remember, when expected returns are low (think Cyprus), that is exactly the time to buy. From 1987–2000, the Dow rose over 582%. Shiller points out that most U.S. bear markets created excellent buying opportunities.
You may be tired of hearing that by now. But that’s exactly why I need to repeat it. Complacency will get you every time. Quantitative easing and low interest rates are like anesthia: they impair your conscious ability to assess risk. Consider this your monthly gentle slap in the face to wake up.
What’s interesting is how many of them there were. The U.S. endured bear markets in 1892, 1895, 1902, 1906, 1916, 1929, 1934, 1937, 1946, 1961, 1987, 2000, and 2007. A complete analysis of all of them is well beyond the scope of a single newsletter (read Russell Napier’s Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms for the definitive work on buying low). But there are two general points to keep in mind.
Robert Shiller is doing his part to make sure the American public knows what’s at stake. I wrote about Shiller at length in the May Letter. His Cyclically Adjusted Price Earnings (CAPE) ratio is a valuation tool. It’s designed to tell you whether stocks are cheap or expensive by looking at an inflation-adjusted earnings average over the last ten years (rather that one or two years, which won’t tell you the full picture).
First, bear markets—or what Austrian economist Murray Rothbard would have called a depression—are perfectly natural and healthy in free markets. In economic terms, market clearing events (stock market crashes and corrections) re-establish price levels that are in line with the real economy. Mal-investments are written off. Bad firms fail and no one bails them out. Capital—the result of real labor and productivity—moves from weak hands to strong hands. Then you have a recovery.
The more expensive stocks are now, the lower the expected future returns. The cheaper they are, the higher the future expected returns. It’s pretty simple and not terribly controversial (although it has its critics, which I will not get into here). What’s it telling you now? Shiller’s CAPE ratio currently reads 30.52. That’s higher than Black Tuesday in 1929 but still lower than the peak of 44.19 in December 1999. Shiller recently wrote that:
There were four bear markets between 1871–1906, before the establishment of the Federal Reserve System. None of them ruined the country. In fact, that was precisely the time in history where America began to emerge as an economic powerhouse. Competition produced winners and losers at the corporate level. But in the aggregate, everyone won and life got better.
The U.S. stock market today looks a lot like it did at the peaks before most of the country’s 13 previous bear markets. This is not to say that a bear market is guaranteed: Such episodes are difficult to anticipate, and the next one may still be a long way off. And even if a bear market does arrive, for anyone who does not buy at the market’s peak and sell at the trough, losses tend to be less than 20%. But my analysis should serve as a warning against
The bear markets change in nature when the Fed comes on the scene in 1913. Monetary policy starts to have a bigger
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effect on the real economy. But even then, the bear markets weren’t total wealth-destroying events. Even when they were correlated with wars or geopolitical tension, they almost always set the stage for higher returns—if you could hold your nerve and buy (assuming you didn’t sell).
What’s probably most telling from that chart is that investors in the United States have never faced permanent losses in wealth from declines in stock and bond prices. For over 130 years and almost five generations, history has been on America’s side. Why would that change now?
The 2000 crash certainly set the stage for higher returns right away. So did the 2008 crash. The S&P 500 has delivered a 17.5% annualized gain since 2009. The Fed managed to short-circuit a total system ‘reset’ and flood the world with liquidity. You are now in the second-longest advance in stock market history without a 20% decline.
The answer lies in the fiscal, social, technological, and demographic trends in America which I’ll get into briefly later. But the important point for now is that the permanent destruction of a country’s wealth can and does happen. It just hasn’t happened in America, yet. But that doesn’t mean it’s impossible. In terms of market action, prices, and values, I’ll close the monthly crash warning with a quotation from economist Ed Yardeni. It’s a realistic assessment of the status quo. The market is clearly expensive. All other things being equal, you wouldn’t expect to make high returns when you’re buying at these prices. Yardeni writes:
Based on all that logic, you should welcome 20% correction as a great buying opportunity, right? Wrong. Bear markets are a normal fact of stock market life which give you the chance to buy quality assets at a cheap price. But the next such bear market may be much different. It won’t just reallocate wealth from weak hands to strong. It will destroy it.
The valuation question has been hanging over the current bull market. Valuation ratios such as price/earnings, price/ sales and market capitalisation/revenues are uniformly bearish, showing that stocks are as overvalued as they were just before the tech bubble burst in 2000… On the other hand, valuation measures that adjust for inflation and interest rates, both of which are near record lows, suggest that the market is fairly valued — they are mostly in the Goldilocks range: not too cold and not too hot.
Why the Next Correction Will Be Different Check out the chart below. You’ll note that Shiller’s data omits the two bear markets in 1968–1970 and 1973–1974, when the Dow fell 37% and 46% respectively. Those declines weren’t considered corrections because they were more gradual and lasted longer. If you’re at or near retirement age and facing an imminent decline like that, time is not on your side.
Yardeni is cautious. He knows stocks are overvalued. But he also knows that if inflation and interest rates remain low, stocks could go higher. Here’s a prediction you can take to the bank: interest rates and inflation will rise again. And they will keep on rising out of sight to unimaginable levels. It may not be next month or even next year. But when they do, it will be in tandem with the kind of bear market that destroys American wealth permanently. At the heart of it will be the ‘safest’ investment in the world, the 30-year U.S. Treasury bond. You’ll want to “sell America” before that time comes. The next 20% correction might be a temporary buying opportunity. But the Trade of the Century still stands. Even if the greatest investor in the world disagrees.
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Buffett Is Wrong
secure gold in exchange for the fruits of your labors.
First, full disclosure on my opinion of Warren Buffett. He’s a great investment writer. His essays and annual letter to shareholders are not only brilliantly written, but they also give you great insight into how he and long-time partner Charlie Munger have turned Berkshire Hathaway into an investment goldmine.
They don’t make congressmen like that anymore, except maybe for Ron Paul. I recommend you read the whole speech if you can. It’s only five pages. And it’s in stark contrast to the pithy remarks Howard Buffett’s son, Warren, recently made about America.
But he’s not even the best Buffett in his family! That honor would have to go this father Howard Buffett. Howard Buffett was an old-school hard money libertarian from Nebraska. As a Congressman, he was an outspoken advocate for gold and honest money. Here’s what he said in a 1948 speech called Human Freedom Rest on Gold Redeemable Money (emphasis added is mine):
In case you missed it, Buffett told Forbes that the Dow Jones Industrials would go to ONE MILLION in the next hundred years. Why? Because of a great era of innovation? A return to sound money and individual liberty and free enterprise? No! Because anyone who thinks otherwise is a loser. Geez, do you think Buffett follows Donald Trump on Twitter? Sad! Buffett predicted the huge rise in the Dow and added that, “Being short America has been a loser’s game. I predict to you it will continue to be a loser’s game… When I hear people talk pessimistically about this country, I think they’re out of their mind.”
Politicians of both parties will oppose the restoration of gold, although they may outwardly seemingly favor it. Also those elements here and abroad who are getting rich from the continued American inflation will oppose a return to sound money. You must be prepared to meet their opposition intelligently and vigorously. They have had 15 years of unbroken victory. But, unless you are willing to surrender your children and your country to galloping inflation, war and slavery, then this cause demands your support. For if human liberty is to survive in America, we must win the battle to restore honest money. There is no more important challenge facing us than this issue -- the restoration of your freedom to
Does he have a point? Some of the numbers are on his side. The Dow traded at 81 a hundred years ago. It’s up 300 times since then. Heck, the market is up 265% since the March 2009 low. As Yakov Smirnov once said, “What a country!” Buffett added that, “This is not a ridiculous forecast at all if you do the math. It’s an amazing country we live in.” Billionaire investor Mario Gabelli agreed, even suggesting Buffett’s forecast was bearish. The math shows the market would have to go up 45 times from the recent levels (around 22,400) to hit a million in a hundred years. Gabelli points out that it would require a compound annual growth rate of around 3.9% to hit that target. And that’s nothing! The Dow has grown at a compound annual rate of 10.7% since 2008. Gabelli added that for the entirety of the 20th century, the Dow posted a 5.5% compound annual growth rate. By the numbers, then, Buffett’s prediction is modest. And it’s a reminder that most of the time, time is on your side if you invest early and wisely in productive enterprises. But he’s still wrong. Why?
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Three Ways to Make the Trade
Buffett assumes the next 100 years will be a lot like the last 100 years. But think about that. One of those hundred years upon which his forecast is based, America was a continent-sized economy, rich in resources, unsaddled with massive debts. And it alone was one of the Great Powers that escaped World Wars I and II without the destruction of its industrial base.
To avoid any doubt, let me be clear and say what my Trade of the Century means, at the very least, you should reduce your exposure to U.S. government bonds. That’s the most “actionable” way to make the trade. And it’s based on Bill’s idea that you look for abnormalities in the market that are bound to mean revert.
This gave it a historically unprecedented—and historically unrepeatable advantage—in global trade and military affairs. It was a creditor nation with the world’s largest and wealthiest economy. It had the world’s most powerful military.
But not owning something to avoid losses is different than profiting from its fall. There ARE ways you can speculate on falling government bonds prices. I hasten to point out that these are speculations. If your aim is to preserve your capital, then they are trades you’ll want to avoid.
Even more importantly, from an economic perspective, the demographics were incredibly favorable. The widespread adoption of consumer credit ran smack into the pent-up demand of the returning veterans from the way. They got busy having babies. And we had a Baby Boom.
If, however, you agree with the proof I provide below, the simplest way is to buy long-term put options on the iShares Core U.S. Aggregate Bond ETF (NYSE:AGG). Nearly 38% of the fund’s core holdings are in U.S. Treasury bonds and notes. Another 27% are in government agencies that lend to the U.S. housing market. Corporate bonds are held too.
Buffett was fortunate enough—as we all were—to be born in a country that found itself perfectly positioned to grow and prosper. To his credit, he turned his formidable intellect to the task of making hay while the proverbial sun was shining.
AGG is a proxy for U.S. government debt. It’s a liquid ETF that’s been around since 2003. I first wrote about it in 2003 in The Bull Hunter. You could always speculate on the direction of interest rates with CBOE options contracts as well. But if you think U.S. credits are due to mean revert something fierce, AGG is one way to play it.
In the last three decades, once the natural arc of American economic hegemony began to decline, Buffett put himself and his shareholders in the position to benefit from low interest rates and government stimulus. He’s become a high-profile cheerleader for a version of America that his father would scarcely recognize and almost certainly be ashamed of.
If you’re even more adventurous, check out the ProShares Short 7-10 Year Treasury Fund (NYSE:TBX). It’s designed to produce the inverse performance of the ICE U.S. Treasury 7-10 year Bond Index. If rates go up and bond prices fall, the share price of the fund should rise.
Buffett’s America Is Dead and Gone Let me put aside the moral point and make two final ones regarding Buffett. First, let’s acknowledge that 100-year forecasts are stupid. Neither you nor I nor Buffett is going to be around in 100 years. No investor has a 100-year time line. Why bother then? If you’re taking the long view, you might as well take the long view.
And if you’re feeling downright reckless, try the Direxion Daily 7-10 Year Treasury Bull & Bear 3x Shares (NYSE:TYO). That fund is designed to produce the inverse performance of the same ICE Treasury Index, but times three! How does it do that?
The second point is that Buffett is making a nostalgic argument based on a version of America that no longer exists. He’s talking about his own book. And he’s forgotten—or simply doesn’t believe—the fact that stocks and bonds are subject to certain kinds of shocks that permanently destroy the wealth of a nation.
That’s the part that makes it dangerous. It comes down to leverage and complex financial instruments. It’s NOT something I recommend for investors. In fact, if you’re retired, stay away at all costs. This is only for gamblers who have spare money to lose but like the idea of betting against Uncle Sam. There are other ways to be “short” U.S. government bonds. I’ve listed some direct ways above. Later, we’ll look at the other side of the trade and what you should be “long.” But first, let me address a point you may be thinking about: what if Buffett is right?
America faces just such a shock, perhaps not in Buffett’s lifetime (he turned 87 in August). But certainly in the lifetime of your children and grandchildren. That’s why the Trade of the Century is to sell the liabilities of a bankrupt government before it repudiates them and renders them worthless. 8
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Can Technology and Innovation Save Us?
Austria’s experience in the wars wasn’t just a bear market. It was a wealth extinction event, which of course is secondary to the massive suffering and death the wars inflicted. But these events DO happen, and it’s not only wars that cause them. A monetary crisis can do it, too.
Is it possible Buffett is right? There’s more than just blind optimism (or shallow patriotism) to his forecast. America HAS shown a remarkable talent for embracing innovation, turning it into profitable enterprise, and generally being a society that’s more focused on the future than the past.
The second image below (see page 10) shows, quite starkly, how the wars decimated the economic clout of the major European powers and transferred global market share to America’s stock market was just 15% of the total world market capitalization in 1900. By contrast, the six largest European stock markets—the UK, Germany, France, Russia, Austria, and Belgium—made up nearly 61% of total world market cap.
Having lived abroad the last fifteen years, I find these to all be admirable qualities. They’re also consistent with the ideas behind free markets and even the Austrian school. You never know what the future is going to bring. But if you give people the freedom to experiment, innovate, and adapt, prosperity flourishes even when you have constant change.
By January 2016, the roles were more than reversed. The U.S. remains the world’s largest equity market. Europe’s share of total world market GDP is much reduced. And China and the emerging markets are still minnows by comparison (although some of China’s largest firms like PetroChina, Alibaba, and Tencent are among the largest by market cap in the world).
But look at the three images below. Both show, I think, why it will be hard for America to repeat its success of the last 100 years. For one, the world is a much more competitive place. Secondly, the innovations most likely to drive another 100 years of great wealth creation are likely to run into both political and cultural opposition.
The final chart (see page 11) shows the change in the industrial balance of power between 1900–1916. This is important because if an economy is going to grow over a long period of time—the kind of growth that generates 5.5% CAGR, the leading industries, and companies will have to change over time. In the U.S. and UK, railroads dominated at the turn of the 20th century.
Both images are from a book called Financial Market History: Reflections on the Past for Investors Today. The first largely confirms Buffett’s point. The 20th century was a good century for America. In U.S. dollar terms, only Australia’s stock market—riding the “sheep’s back” during the 1950s with wool and grain exports to Asia and then the commodities boom from 2003–2008—has done better in terms of real returns. In local currency terms, both South Africa and Australia pipped the U.S.
Fifteen years into the next century, you see a lot more
It’s no coincidence that the top three performers of the 20th century were commodity producers (especially gold). You can also see that countries which managed to avoid major damage to their capital base in the wars enjoyed steady returns. I’m talking especially about Australia, New Zealand, the United States, and South Africa. At the other end of the spectrum, you have proof that some external shocks can deal death blow to stocks and bonds—even to countries themselves. This is the permanent loss of wealth I mentioned earlier. Local currency returns in Austria from 1900–2015 were less than one percent, largely thanks to a certain Corporal. In U.S. dollar terms, the returns were negative— over 115 years!
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sectoral diversification. Techs, banks, healthcare, and retail have each carved out a piece of the market. The Railroad Robber Barons have given way to the Silicon Valley Jobber Barons (digitization and automation fundamentally transforming the structure of the job market and driving down real wages). And now the important question: what about the next 100 years?
Relative Sizes of World Stock Markets January 1, 1900
What Could Power the Next 100 Years of Growth If you’re a Buffett-style optimist, you probably don’t have any idea what new industries will power American growth and American stocks for the next 100 years. But you’re convinced they’ll emerge here and U.S. investors will be the main winners from innovation and growth.
January 1, 2016
I’m not so sure, for two reasons. First, the biggest stocks in America, by market cap, are now tech stocks. Facebook, Apple, Amazon, Netflix, and Google… these are all roaring successes. But as technology companies, their competitive advantage is tenuous. In future letters, I want to go into this in greater detail. I believe that as America’s economy has shifted to information technology and away from industry and manufacturing, these tech giants will become immensely politically powerful (Zuckerberg for President!). But I don’t believe they can or will be the basis of 100 years of stock market gains and American exceptionalism.
www.bonnerandpartners.com
Source: DMS (2002, 2016); FTSE Russell 2015
promise for creating cures of genetic diseases, and thus becoming a huge business/investment opportunity. Probably the biggest of the next 100 years.
The only industries capable of delivering that kind of growth and prosperity are in energy, biotechnology, and materials science. And while America has the labs and the talent to compete in all three, there is plenty of talent around the world.
Yet, Silicon Valley could miss out on it entirely. Why? Silicon Valley’s great disruption was changing the format of information from analog to digital and then making it easier than ever to store, access, or transport that information. That’s evolved into Big Data and analytics that are behind the logistics success of Amazon and Google’s ability to
Take just one example with CRISPR and genetic engineering. CRISPR, without going into detail, is a technology that makes it possible to modify human DNA. It holds great 10
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know you better than yourself, based on your browsing habits.
Industry Weightings in the USA
But if the next great innovation in data and information will be biological and not technological, that innovation is far more likely to happen in China than America. Why?
1900
DNA is just information. Genetic disorders and diseases may be cured by new genetic tools. But to edit DNA means to literally alter the fabric of human life. Do you think that will be wildly popular in the United States? Do you think China will care? I expect the debate about editing human genes to end up in U.S. courts. The federal government may even get involved and try to stop it the more political/religious the issue becomes. There will be no such impediments to the birth of a new industry in China.
2015
As I said, the whole thing is a discussion for another day. And to be fair, America produced a fracking revolution that changed the balance of power in the global energy markets. The U.S. tends to embrace disruptive change. Maybe it WILL happen here. But we simply don’t know what innovations are going to emerge, or where they’ll come from. Buffett believes, as an article of faith in America, that they’ll come from here.
www.bonnerandpartners.com
Source: DMS (2002, 2016); FTSE Russell 2015
The Economy-Wide Manhattan Project These problems have been brewing in America for a long time. You don’t get $20 trillion in debt overnight. You do it by convincing yourself that you owe it to yourself. The big mistakes—going off the gold standard, believing we could have guns AND butter, exporting the American idea of democracy as if it were a universal ambition—were made by
The world is a much different place than in 1900, though. And America is a much different country. We’re nearing the end of this month’s letter. But we need to cover two more things that I hope will help you see why it’s time to “sell” America and make another investment instead. 11
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many people over the course of many years.
would be two results. First, the federal government could then step in to arrange bailouts—something Trump the dealmaker might greatly enjoy in preparing for the 2020 election, swapping federal bailout money for Illinois electoral votes.
I’ve tried to show you the trend over the last few months. Deficit spending, an aging population that will consume more government resources, and a Deep State that commands more wars and military spending… all these add up to an inevitable disaster for the feds. First the government will run out of money. And then it will have too much of the kind that is worthless (hyperinflation).
The second result would be even more dangerous: open season on the Bill of Rights. The Constitution is designed to be hard to change. It establishes a fundamental relationship between a free person and the government. The Bill of Rights specifically states what the government cannot due. It’s huge bias is for minority/individual rights.
Nor can we grow ourselves out of the debt we’ve taken on. Given how poor American political leadership is, you can be certain we’ll take on more debt. We’ll keep taking it on until the rest of the world has had enough (keep an eye on the Treasury International Capital flows data for changes in the appetite for U.S. debt). And then what?
Those rights are under assault as we speak. Congress and the Supreme Court permit and encourage expansion of police powers for search and seizure. And just since I’ve been back, I’ve read people calling for a reinterpretation of the Second Amendment to the right to bear arms would only be in the context of serving in a local militia to defend the country against a foreign invader (rather than a domestic enemy like, say, an out-of-control federal government).
Creditism: the Last Refuge of the Bankrupt My friend Richard Duncan, editor of Macro Watch, has suggested the path of “creditism.” This is where the government sells bonds or prints trillions of dollars to fund the kinds of industries that COULD deliver the growth we need to pay off the debt.
What’s worse, the First Amendment is probably on borrowed time anyway. Most Americans couldn’t name the five freedoms established there. And on America’s college campuses, The Washington Post reports that 40% of incoming freshman believe it’s acceptable to suppress speech you deem hateful with violence.
It would be an enormous gamble; a kind of make-or-break economy-wide Manhattan Project to deliver breakthroughs to solve the problems. I’m being deliberately vague because that’s how it sounds to me. A last-gasp effort to throw all the resources of the federal government behind a few targeted innovations.
The rule of law, shared values, a belief in individual liberty, limited government, and sound money—these were the bedrock of the America that Buffett built his fortune in. That bedrock is being attacked with a jackhammer in a barbaric act of cultural vandalism. The next 100 years will be rough for America as we know it.
It will never work. But it might be enough to take the debtto-GDP level from where it currently sits at around 105%, and up to 200% of GDP. That’s where it is in Japan. And you’d be surprised how quickly it could get there. A few trillion for driverless cars here, a war with North Korea, and some other random boondoggles to benefit the Crony Capitalists in Washington and New York… and you’re there.
Trade of the Century The investment takeaway from all of that is not to have 40% of your portfolio in bonds, and especially not in U.S. government bonds. The larger the tab we rack up, the more pressure it will put on the dollar. The growing economic power of the rest of the world means they won’t trade real assets (and labor and production) for paper which we print and give to them.
An Attack on the Constitution And that’s assuming the federal government doesn’t have to bail out states who have massive, unfunded pensions. Little known fact: the 10th amendment to the Constitution prohibits states from “impairing the obligation of contracts.” This effectively prohibits a state government—but not a township, city, school district, or municipality—from declaring bankruptcy.
On the flip side of the trade, emerging markets, or net creditor countries, will be worth looking at owning. Some emerging markets have large dollar-denominated debts. But others have trade surpluses and haven’t yet racked up huge entitlement obligations (Vietnam is a good example).
It would require a new interpretation of the Constitution to allow states to declare bankruptcy. If it were to happen, there
If we want our prosperity, we’re going to have to earn it. But
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1. Get out of the bear trap. In the event of a Great Renunciation of U.S. Government bonds, you simply can’t afford to have your financial markets in one country (the U.S.). I have no doubt that capital controls will be imposed on Americans at some point in the next ten years. It’s imperative that you set up a foreign bank account before then. I’ve chosen to do so in places where I happened to live (the U.S. and the UK). But look at Singapore and Switzerland too, or any place that will welcome capital as it flees America.
that’s not the modern American way. The modern American way is to demand it from the government, where the ruling politicians will take the money from the productive classes and give to those who vote for them. Sometime in the next 100 years—and probably much sooner—the world is going to call time on this arrangement and hold the U.S. accountable. For example, the government might have to borrow in a foreign currency and repay in a foreign currency. Or we might have to pay in gold. All of that would come after it was obvious the U.S. could never pay its debts and had no intention to do so. That’s the path we’re on. At some point, there will be a Great Renunciation, where we tell the rest of the world we’re not going to pay them. At that point, the dollar, once our source of strength and security, will become a global joke.
2. Real assets in low-tax U.S. States, where people will want to move as the state pension crisis goes federal. I was in North Carolina to visit family. And I’m in Colorado for the same reason. But I’m also looking to buy real estate in small communities where higher net worth Americans may relocate in the next great crisis. It’s just a matter of time before highly-indebted states begin imposing “exit taxes” on citizens who are fleeing high taxes. At some point, states may even try their own version of capital controls. I don’t know what that will look like. But I do know if you own real estate in Wyoming or a farm in North Carolina, you will have put at least some of your wealth beyond the reach of grasping states.
And bonds? They won’t be worth a continental. If you have all your wealth tied up in dollar-denominated assets when the Great Renunciation happens, I’m sorry to tell you you’re doomed. Between now and then, I hope to show you how to avoid that result. Which brings me to my final point.
Your Best Investment Now I moved back to America because it’s where my family is and I still love the place. This morning, for example, I woke up and took a sunrise walk in the foothills of the Rocky Mountains and counted by blessings for having the good sense to be born in right country at the right time.
3. Alterative assets. I’ll be working on this one, too. But it begins with acknowledging that the value of assets which you have no access to is zero. I picked this point up when reading The Mandibles on Queen Mary 2. Practically this means reviewing your agreements with the banks or other financial institutions which store or guard your wealth. What are their terms of access? Should you consider moving some of your cash out of major banks to credit unions or smaller regional banks? How can you do so without losing federal deposit insurance? What other hard assets act as a store of wealth that you can later reliquify when things have settled down? I welcome your ideas. Send them via email. I’ll keep your name confidential if you don’t want to share it.
But I also realized that a big part of my future wealth will be in the quality of the relationships I have with friends and family. As the systems and institutions which bind our country together slowly fray—or are torn apart—you will have to rely on smaller, more local relationships. None is more important than family. Investments in your friends, family, and community are not financial. But they ARE valuable. And optimistically, I believe that’s the only way to really make America great again. If it happens, it will be from the bottom up. Not from the swamp down.
Right now, you have a quiet period. In Bill’s vernacular, it’s the period between farce and tragedy. The comedy is over. Our situation is serious. But it’s not yet desperate.
The Other Side of the Trade
The farce will get worse in the lead up to the next presidential election. I fully expect one of the following to run for and be nominated of a major party for President: Mark Zuckerberg, Steven Spielberg, Kid Rock, The Rock, George Clooney, Jamie Dimon, and Kayne West.
Lest you think I’m being too touchy-feely about a serious financial matter, let’s address the financial side of the trade. If you “sell” U.S. Treasury bonds, what should you “buy?” This is an ongoing theme I have to do a lot more work on. But I can tell you what I’ve done and what I’m doing right now. 13
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Down the track, don’t rule out Ivanka Trump going head to head against Chelsea Clinton. And don’t forget Tom Hanks. He’s been around the moon. He invaded Normandy. And he even survived being stranded on a desert island! The man is a survivor and can surely lead our nation to salvation. Come to think of it, there may be some comedy left yet in the Old Republic. But don’t let the bread, circuses, and Twitter wars distract you from the big picture. You have one great trade to make that could determine the fate of your wealth and your family for the next three generations. Don’t blow it. Regards, be unprepared when the government begins to impose capital controls and we can no longer benefit from the kindness of strangers.
Dan Denning Coauthor, The Bill Bonner Letter P.S. The argument I made this month is that the United States government has been living on borrowed money for a long time. It’s only a matter of time before creditors require higher interest rates to loan to a government that has no intention of reducing spending. And that doesn’t include the massive projected increased in entitlement spending over the next twenty years. America will simply have to pay more to borrow and rates will rise.
The Idea of America, the one Bill wrote about years ago, begins with the people. The Deep State has perverted and corrupted that idea to their own ends. When I sailed under the Verrazano Narrows Bridge and into New York Harbor and saw the Statue of Liberty in the distance. I was glad to be home. But I realized there is a lot of work to do if the idea of America is going to survive the coming economic decline.
It’s not anti-American to point out how the government has failed. If you’re expecting answers or solutions from the top-down, you’ll be disappointed. More importantly, you’ll
P.P.S I’m always happy to read subscriber feedback. Drop me a note by clicking here.
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