Can you discredit doomsday?December 29, 2008
This week I had a short discussion with a family friend who happens to be a financial advisor. He was asked for his take on the whole financial mess, below is a summary of what transpired. Keep in mind he has been in the business for a long time and is very mainstream. There isn’t a single original bone in his body, he strikes me as the kind of guy who will read all the research provided by his firm and believe every word of it. He’s smart, educated (PHD) and generally quite unremarkable in every other way. He began with the following, “Listen, don’t believe what you hear from all the doomsdayers” and proceeded to discuss the collapse of the Soviet Union. He said after the collapse in 1989 it took 18 years for Russia to recover, but they recovered and ultimately it wasn’t such a significant event. I couldn’t believe what I was hearing. Is his argument against a doomsday scenario that the Soviet collapse went well? That 18 years (not sure where that number came from) is a reasonable amount of time to recover from a systematic collapse and we should hope to be so lucky? No big deal, right? I didn’t even have to point out the ridiculousness of his argument, because someone else did. He had no answers, no explanations and no forecasts. I couldn’t take it anymore, so I jumped in with my two cents. I talked about the 350% debt-to-GDP ratio, the inability of the federal government to repay its debts to foreigners, the fact that modern civilization has never before experienced the collapse of a reserve currency backed by nothing, and of course the case for gold. He responded with a story about some guy he knew 30 years ago who bought into the gold bubble just before it burst back in the late 70s and never made his money back. He asked me what the price of gold is today, I said about $850 per ounce. He then asked about the price last month, I said about $810 per ounce. Then as if I hadn’t responded at all, he said “Gold costs $850 today, it cost $850 last month” and laughed off my argument. At this point (I hope it didn’t show on my face) I completely dismissed his ability to carry a serious discussion. I described the history of gold over the past 100 years. The price of gold was fixed, then re-valued by FDR during the depression, then we had the Bretton-Woods agreement and the “guns and butter” Vietnam era that resulted in massive inflation, the French converting dollars to gold causing Nixon to close the gold window, and the subsequent boom in the price of gold. I told him it developed into a bubble that was eventually broken with 20% interest rates. I asked, what would happen to the US if interest rates were raised to 20% today? I paused to let it sink it. He thought for a bit, no answer. I reminded him of the size of America’s national debt and discussed how the government used to be financed with 30-year bonds owned by Americans, but today the average maturity is about 3 years and much of it owned by foreigners. If Japan or China started selling treasuries the game would be over tomorrow. America has no capacity to repay its existing obligations at current levels, let alone the massive new stimulus packages around the corner with 20% interest rates. American consumers and businesses didn’t have anywhere near the same level of debt relative to GDP back in the 70s, the debt bubble is immensely more significant today. Gold may not go up in a straight line, but if you’re patient, it can make you extremely wealthy. I told him either America will receive help from abroad of it won’t. If Asians refuse to rescue America with a massive reverse Marshall plan, America will have no choice but to inflate. Inflation helps the debtor, not the lender. It’s easier to repay your obligations with a devalued currency in abundant supply, the dollars you repay are worth much less than the dollars you borrowed. In effect, America would default by deliberately debasing its currency. At this point, something magical happened, he looked at me intensely and it clicked, I saw the expression on his face. He was converted. What is the moral of the story? Everyone recognizes the significance of this crisis but even so-called experts haven’t taken the time to connect the dots. There is a cultural opposition to gold based on its poor performance from 1980 to 2000, even though it has performed well for almost a decade. That residual opposition can be defeated with a little logic. The gold bull market has barely begun.
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“This week I had a short discussion with a family friend….. He’s ….. generally quite unremarkable in every other way.”
Let’s hope he doesn’t know your blog address.
So far I’ve talked to three separate sets of investors who are convinced “it will come back”.
“He’s smart, educated (PHD) and generally quite unremarkable in every other way.”
Yeah, I know the type.
School is a great place to learn to obey and do what you are told. Unfortunately, learning how to “connect the dots” is something that can’t be taught.