The Death of Money (39 page)

The use of neofascist tactics to suppress political money riots would require no new
legislation. The statutory authority has existed since the Trading with the Enemy
Act of 1917, which was expanded and updated by the International Emergency Economic
Powers Act (IEEPA) of 1977. President Franklin Roosevelt used the Trading with the
Enemy Act to confiscate gold from American citizens in 1933. He did not specify who
the “enemy” was; presumably it was those who owned gold. Every president since Jimmy
Carter has used IEEPA to freeze and seize assets in U.S. banks. In more dire future
circumstances, gold could be confiscated, bank accounts frozen, capital controls imposed,
and exchanges closed. Wage and price controls could be used to suppress inflation,
and modern digital surveillance could be used to disrupt black markets and incarcerate
black marketeers. The money riots would be squashed quickly.

In the ontology of state power, order comes before liberty or justice.

■
Seven Signs

Investors must be alert for the indications and warnings of which path the economy
is traversing. There are seven critical signs.

The first sign is
the price of gold
. Although the price of gold is manipulated by central banks, any
disorderly
price movements are a signal that the manipulation scheme is disintegrating, despite
efforts at leasing, unallocated sales, and futures sales. A rapid price rise from
the $1,500-per-ounce level to the $2,500-per-ounce level will not be a bubble but
rather a sign that a physical buying panic has commenced and that official shorting
operations are not producing the desired dampening effect. Conversely, if gold moves
to the $800-per-ounce level or lower,
this is a good sign of severe deflation, potentially devastating to leveraged investors
in all asset classes.

Gold’s continued acquisition by central banks
. Purchases by China in particular are a second sign of the dollar’s demise. The announcement
by China in late 2014 or early 2015 that it has acquired over 4,000 tonnes of gold
will be a landmark in this larger trend and a harbinger of inflation.

IMF governance reforms.
This third sign will mean larger voting power for China, and U.S. legislation to
convert committed U.S. lines of credit into so-called quotas at the IMF. Any changes
in the SDR currency-basket composition that reduce the dollar’s share will be a dollar
inflation early warning. The same is true for concrete steps in the SDR infrastructure
build-out. If global corporate giants such as Caterpillar and General Electric issue
SDR-denominated bonds, which are acquired in portfolio by sovereign wealth funds or
regional development banks, this will mark the acceleration of the baseline SDR-as-world-money
plan.

The failure of regulatory reform.
A fourth sign will be bank lobbyists’ defeat of efforts by U.S. regulators and Congress
to limit the size of big banks, reduce bank asset concentration, or curtail investment
banking activities. Glass-Steagall’s repeal in 1999 was the original sin that led
directly to the housing market collapse in 2007 and the Panic of 2008. Efforts are
under way in Congress to reinstate Glass-Steagall’s main provisions. The bank lobbyists
are mobilized to halt such reforms and also block derivatives regulation, higher capital
requirements, and limits on banker bonuses. Bank lobbyists dominate Congress, and
there is no reason to believe reform efforts will achieve more than superficial success.
Absent reform, the scale and interconnectedness of bank positions will continue to
grow from very high levels and at rates much faster than the real economy. The result
will be another systemic and unanticipated failure, larger than the Fed’s capacity
to contain it. The panic’s immediate impact will be highly deflationary as assets,
including gold, are dumped wholesale to raise cash. This deflationary bout will be
followed quickly by inflation, as the IMF pumps out SDRs to reliquefy the system.

System crashes.
A fifth sign will be more frequent episodes like the May 6, 2010, flash crash in which
the Dow Jones Index fell 1,000 points in minutes; the August 1, 2012, Knight Trading
computer debacle, which
wiped out Knight’s capital; and the August 22, 2013, closure of the NASDAQ Stock Market.
From a systems analysis perspective, these events are best understood as emergent
properties of complex systems. These debacles are not the direct result of banker
greed, but they are the maligned ghost in the machine of high-speed, highly automated,
high-volume trading. Such events should not be dismissed as anomalies; they should
be expected. An increasing tempo to such events could indicate either that trading
systems are going wobbly, moving to disequilibrium, or perhaps that Chinese or Iranian
army units are perfecting their cyberassault capabilities through probes and feints.
In time, a glitch will spin out of control and close markets. As with the systemic
risk scenario, the result is likely to be immediate deflation due to asset sales,
followed by inflation as the Fed and IMF fire brigades douse the flames with a flood
of new money.

The end of QE and Abenomics.
The sixth sign will be a sustained reduction in U.S. or Japanese asset purchases,
giving deflation a second wind, suppressing asset prices and growth. This happened
in the United States when QE1 and QE2 were ended, and again in 2012 when the Bank
of Japan reneged on a promised easing. However, as asset purchases are curtailed,
a new increase should be expected within a year as deflationary effects develop. This
would be another iteration of the stop-go monetary policies pursued by the Fed since
2008 and by the Bank of Japan since 1998. Continual flirting with deflation makes
inflation harder to achieve. A more likely scenario is that money printing will continue
in both nations long after 2 percent inflation is achieved. At that point, the risks
are all on the side of much higher inflation as the change in expectations becomes
difficult to reverse, especially in the United States.

A Chinese collapse.
The seventh sign will be financial disintegration in China as the wealth-management-product
Ponzi scheme collapses. China’s degree of financial interconnectedness with the rest
of the world is lower than that of the major U.S. and European banks, so a collapse
in China would be mainly a local affair, in which the Communist Party will use reserves
held by its sovereign wealth funds to assuage savers and recapitalize banks. However,
the aftermath will include a resumption of Chinese efforts to cap or even devalue
the yuan in foreign exchange markets to promote exports, create jobs, and restore
wealth lost in the
collapse. In the short run, this will prove deflationary as underpriced Chinese goods
once again flood into global supply chains. In the longer run, Chinese deflation will
be met with U.S. and Japanese inflation, as both countries print money to offset any
appreciation in the yen or the dollar. At that point, the currency wars will be reignited,
never really having gone away.

Not all of these seven signs may come to pass. The appearance of some signs may negate
or delay others. They will not come in any particular order. When any one sign does
appear, investors should be alert to the specific consequences described and the investment
implications.

■
Five Investments

In the face of extreme inflation, extreme deflation, or a condition of social disorder,
which investment portfolio is most likely to remain robust? The following assets have
a proven ability to perform well in inflation
and
deflation and have stood the test of time in periods of social disorder from the
Thirty Years’ War to the Third Reich.

Gold.
An allocation to gold of 10 to 20 percent of investable assets has much to commend
it. The allocation should take physical form as coins or bullion in order to avoid
the early terminations and cash settlements that are likely to affect paper gold markets
in the future. Secure logistics, easily accessed by the investor, should be considered,
but bank storage should be avoided, because gold stored in banks will not be accessible
when most needed. An allocation above 20 percent is not recommended because gold is
highly volatile and subject to manipulation, and there are other investable assets
that perform the same wealth-preservation functions. A useful way to think about gold’s
insurance function is that a 500 percent return on 20 percent of a portfolio provides
a 100 percent portfolio hedge. Gold does well in inflation, until interest rates are
raised above inflation rates. In deflation, gold initially declines in nominal terms,
although it may outperform other asset classes. If deflation persists, gold rises
sharply as governments devalue paper currency to produce inflation
by fiat. Gold offers high value for weight and is portable in the unfortunate event
that social unrest requires flight.

Land.
This investment includes undeveloped land in prime locations or land with agricultural
potential, but it does not include land with structures. As with gold, land will perform
well in an inflationary environment until nominal interest rates exceed inflation.
Land’s nominal value may decline in deflation, but development costs decline more
rapidly. This means that the land can be developed cheaply at the bottom of a deflationary
phase and provide large returns in the inflation that is likely to follow. The Empire
State Building and Rockefeller Center, both in New York City, were built during the
Great Depression and benefited from low labor and material costs at the time. Both
projects have proved excellent investments ever since.

Fine art.
This includes museum-quality paintings and drawings but is not intended to include
the broader range of collectibles such as automobiles, wine, or memorabilia. Fine
art offers gold’s return profile in both inflation and deflation, without being subject
to the manipulation that affects gold. Central banks are not concerned with disorderly
price increases in the art market and do not intervene to stop them. Investors should
focus on established artists, avoiding fads that may fall out of favor. Paintings
are also portable and offer extremely high value for weight. A $10 million painting
that weighs two pounds is worth $312,500 per ounce, over two hundred times gold’s
value by weight, and will not set off metal detectors. High-quality art can be acquired
for more modest sums than $10 million through pooled investment vehicles that offer
superb returns, although such vehicles lack the liquidity and portability of outright
art ownership.

Alternative funds
. This includes hedge funds and private equity funds with specified strategies. Hedge
fund strategies that are robust to inflation, deflation, and disorder include long-short
equity, global macro, and hard-asset strategies that target natural resources, precious
metals, water, or energy. Private equity strategies should likewise involve hard assets,
energy, transportation, and natural resources. Funds relying on financial stocks,
emerging markets, sovereign debt, and credit instruments carry undue risk on the paths
that lie ahead. Hedge funds and private equity
funds offer various degrees of liquidity, although certain funds may offer no liquidity
for five to seven years. Manager selection is critical and is much easier said than
done. On balance, these funds should find their place in a portfolio because the benefits
of diversification and talented management outweigh the lack of liquidity.

Cash
. This seems a surprising choice in a world threatened with runaway inflation and
crashing currencies. But cash has a place, at least for the time being, because it
is an excellent deflation hedge and has embedded optionality, which gives the holder
an ability to pivot into other investments on a moment’s notice. A cash component
in a portfolio also reduces overall portfolio volatility, the opposite of leverage.
Investors searching for an ideal cash currency could consider the Singapore dollar,
the Canadian dollar, the U.S. dollar, and the euro. Cash may not be the best investment
after
a calamity, but it can serve the investor well
until
the calamity emerges. The challenge, of course, is being attentive to the indications
and warnings and making a timely transition to one of the alternatives already mentioned.

On the whole, a portfolio of 20 percent gold, 20 percent land, 10 percent fine art,
20 percent alternative funds, and 30 percent cash should offer an optimal combination
of wealth preservation under conditions of inflation, deflation, and social unrest,
while providing high risk-adjusted returns and reasonable liquidity. But no portfolio
intended to achieve these goals works for the “buy-and-hold” investor. This portfolio
must be actively managed. As indications and warnings become more pronounced, and
as greater visibility is offered on certain outcomes, the portfolio must be modified
in sensible ways. If gold reaches $9,000 per ounce, there may then come a time to
sell gold and acquire more land. If inflation emerges more rapidly than expected,
it may make sense to convert cash to gold. A private equity fund that performs well
for five years might be redeemed without reinvestment because conditions could be
more perilous by then. Precise outcomes and portfolio performance cannot be known
in advance, so constant attention to the seven signs and a certain flexibility in
outlook are required.

Although the scenarios described in this book are dire, they are not necessarily tomorrow’s
headlines. Much depends on governments and central banks, and those institutions have
enormous staying power even
while pursuing ultimately ruinous policies. The world has seen worse crises than financial
collapse and lived to tell the tale. But when the crash comes, it will be better to
be among those who have braced for the storm. We are not helpless; we can begin now
to prepare to weather the inevitable outcome of the hubris of central banks.