I’ll save any of my own commentary and just hat tip ZeroHedge for the lead in and let them do all the talking. well said and a great paper by QBAMCO, quickly becoming a must read on the ongoing debt crisis:
That the two heads of QBAMCO, Lee Quaintance and Paul Brodsky, have traditionally been in the non-conformist camp is no secret. They are two of the fund managers who will, when all is said and done, save and probably increase their clients’ purchasing power (we won’t call it money because money’s days in its current version are numbered), unlike the vast preponderance of momentum chasing sheep who only find solace in their great delusion in even greater numbers (aka the ratings agency effect: “we may be wrong, but we will all be wrong”). In their latest letter, the duo does not uncover any great truths but merely keep exposing ever more dirt in the grave of the current monetary system. They also make short shrift of all the neo-Keynesian hacks who pretend to understand the fault-lines of modern monetary theory: “We would argue a system built upon unreserved bank credit expansion is inequitable, regressive, opaque, the source of asset boom/bust cycles and the root of virtually all the financial, economic and political chaos we are experiencing today. We assume this is in the process of being more widely intuited by global societies. Those that understand monetary identities are best prepared to shift wealth in advance of the necessary de-leveraging that must take place to restore equilibrium.” Just as interesting is their observation that the 10 Year only trades where it does (2.6%) due to the ability of the big market players to lever up their return by 10, 20 times. Devoid of all theoretical textbook mumbo jumbo, they may well have hit the nail on the head: “the majority of bond investors driving marginal pricing such as primary dealers, hedge funds and central banks are quite a bit more leveraged. We would argue the Note is not trading at 49 because levered investors have incentive to collect 25% or more in current income (2.74% x 10 or 20) while awaiting their annual bonus or performance fee (or, in the case of the Fed, propping up the economy).” Translated: take away infinite leverage (thank you ZIRP) and the 10 year would be priced more fairly around 12.13% (dollar price of $49.20). Needless to say, their observations on gold, which this week borrow heavily from David Rosenberg are spot on. In a process first used by Dylan Grice, the QBAMCO duo defines the concept of the Shadow Gold Price, and then derives what the fair value of the metal is: roughly $9,250.
But perhaps most notable is the duo’s take on the upcoming “tipping point”, or, in the parlance of our times: revolution.
If the economic manner in which the US is operating is not in the sustainable best interest of its owners — Americans increasingly becoming poorer and unproductive in real terms — then it seems logical there will be forced change. As just proven, the political dimension in the United States and around the world has the legal authority but not the political will to act preemptively to re-balance global economic equilibria by reinstating monetary discipline. Only the power of popular dissention can force authorities to pull the ripcord on the current system.
We do not think there will be a political coup d’état or that Western democracy and capitalism will be threatened. We do believe the “revolution” that must occur, (if it is indeed a “revolution” at all), will be only monetary in nature. The most likely path is that an event will force global monetary and financial market seizure. This seizure would force a recapitalization of nominal asset prices to reflect their real values. People, businesses and nations in possession of durable assets and resources, like primary homes, cars, inventory and scarce resources, will continue to own them while a new system of quantifying their value is worked out.
We think precious metals will increase their purchasing power vis-à-vis all baseless currencies. We also think consumable natural resources with inelastic demand properties will, at a minimum, retain their purchasing power (which is to say enjoy substantial price appreciation in fiat money terms – far more than financial assets relying on existing leverage or future systemic leverage growth).
What happens next?
So when will financial markets better reflect sustainable economics than a series of dubious political constructs that have placed valuations in a constant state of disequilibrium? Well, how about this: when the milk to Dow Jones Industrial Average ratio widens to the point where only equity holders are oblivious to milk prices?
Imagine an island with ten people on it and each person has $100 and a $200 equity portfolio consisting only of shares in the island’s coconut milk farm. The people on the island consume 20 coconuts-worth of milk a day. The island’s milk output and wealth cannot be increased with the addition of money, only with the addition of consumer demand. Now imagine that 9 out of 10 people on the island do not own shares in the coconut farm. The 1 owner of the farm can sell shares in it and increase his cash position with which he can then…well, buy more milk. But how much more milk could he want to buy when he can only consume 2 coconut’s worth a day?
Applied to the contemporary global economy, the frenzy around nominal growth, valuations and budget deficits misses the fundamental point of finance-based economics: money and credit can grow in leaps and bounds while consumer demand can only grow linearly. The increase in money and credit supply may drive up the apparent valuations of dairy farms, but no amount of new money and credit supply can increase the global demand for milk beyond its natural growth rate. A billionaire does not buy 1,000 times more milk, computers or medical care than a millionaire, who in turn does not buy a million times more of these items than a pauper (or the government on behalf of the pauper).
We repeat: the “debt problem” is a currency problem and the currency must and will collapse. The global monetary system exists at the pleasure of the Fed, which legally exists at the pleasure of Congress, which as we have learned only has the political will to control the Fed at the pleasure of the Fed’s shareholder banks. It is the Fed and nothing else that determines the solvency of Treasury. Analogously, it is the Fed that ensures the ultimate solvency of the fractionally-reserved banking system – the system that shorts dollars via perceived “lending” today and covers those dollars once devalued as the Fed creates them tomorrow. Ultimately, Congress, the Fed and Wall Street will have to answer to the masses that buy milk and pay and staff its military.
There is a light at the end of the tunnel that is both another train and, leaving emotions aside, an investment opportunity for the willing and able. This is change we can all believe in, and it seems closer than most think.
Translated: currency collapse is coming. Whether one wishes to call it “hyperinflation” is of course, one’s right.
Much more in the full letter: