Everything is predictable. Yet, we have no idea what will happen. That is the curious paradox of our world. We all know we’re going to die. But none of us knows just how or when or where. As Woody Allen says, don’t tell me when I’m going to die, just tell me where…I’ll avoid the place.
What is predictable is that big trends will run their courses. What is unknowable is how, when, and where.
Earlier this year we identified 5 major trends that were reshaping the world. ‘The 5 E’s’ we called them.
We stopped writing about them because we could never remember what they were. Here, we attempt an update:
Major economic trends: E1 - the rising cost of Energy
Energy… is the world running out of oil? No. There is plenty of the stuff. At today’s oil prices, every producer in the world is busy adding capacity. Non-importers are busy trying to reclaim old wells; squeeze oil of sand, or tar or rock; or find substitutes. In the U.S. ethanol is becoming a major swindle. It takes more energy to produce a gallon than you can get from it. And it costs more to make a gallon than a gallon is actually worth. But it’s the kind of boondoggle that Congress likes, since it gives a way to spread other people’s money around under cover of national emergency.
The emergency is said to be that the U.S. economy depends on cheap oil. To some extent this is true. The typical family spends all that it earns – and a little more. It resides far from its work, drives a big SUV and lives in a house that needs large inputs of energy. As the price of energy rises, the amount of money the family has left over goes down. It must either spend less – which would cause an immediate recession – or go deeper into debt – which would cause a worse recession eventually.
Oil is unquestionably getting more expensive. And – with no further house price gains against which to borrow - American consumers are probably beginning to cut back on their discretionary spending. Walmart, where the lumpen go shopping, has seen its stock go down to the lowest level in 5 years. Middle-American sit-down restaurants – Red Lobster, Outback Steakhouse, Appelbee’s, etc – are seeing the worst fall-off in sales in industry history. Retail stocks, generally, are down. Builders are down. Transports are going down. All of which looks to us like the beginning of a consumer-led economic slump.
But the big trend we’re talking about is Energy. And energy, we believe, is getting more expensive – putting in jeopardy the lifestyles and finances of the people who hold it most dear – Americans. Part of the reason for this is obvious. More people use more energy every year, whereas the earth’s supply of ready fuel – which took millions of years to lay down – is being rapidly used up. In India, or China, energy is feature of capital development and economic growth. In North America, it is a consumer necessity. But where Asian economies earn the money to pay for energy…the typical American – like the typical Brit - faces higher energy costs with no way to pay them. Result: his standard of living will go down.
What is predictable is that big trends will run their courses. What is unknowable is how, when, and where.
Earlier this year we identified 5 major trends that were reshaping the world. ‘The 5 E’s’ we called them.
We stopped writing about them because we could never remember what they were. Here, we attempt an update:
Major economic trends: E1 - the rising cost of Energy
Energy… is the world running out of oil? No. There is plenty of the stuff. At today’s oil prices, every producer in the world is busy adding capacity. Non-importers are busy trying to reclaim old wells; squeeze oil of sand, or tar or rock; or find substitutes. In the U.S. ethanol is becoming a major swindle. It takes more energy to produce a gallon than you can get from it. And it costs more to make a gallon than a gallon is actually worth. But it’s the kind of boondoggle that Congress likes, since it gives a way to spread other people’s money around under cover of national emergency.
The emergency is said to be that the U.S. economy depends on cheap oil. To some extent this is true. The typical family spends all that it earns – and a little more. It resides far from its work, drives a big SUV and lives in a house that needs large inputs of energy. As the price of energy rises, the amount of money the family has left over goes down. It must either spend less – which would cause an immediate recession – or go deeper into debt – which would cause a worse recession eventually.
Oil is unquestionably getting more expensive. And – with no further house price gains against which to borrow - American consumers are probably beginning to cut back on their discretionary spending. Walmart, where the lumpen go shopping, has seen its stock go down to the lowest level in 5 years. Middle-American sit-down restaurants – Red Lobster, Outback Steakhouse, Appelbee’s, etc – are seeing the worst fall-off in sales in industry history. Retail stocks, generally, are down. Builders are down. Transports are going down. All of which looks to us like the beginning of a consumer-led economic slump.
But the big trend we’re talking about is Energy. And energy, we believe, is getting more expensive – putting in jeopardy the lifestyles and finances of the people who hold it most dear – Americans. Part of the reason for this is obvious. More people use more energy every year, whereas the earth’s supply of ready fuel – which took millions of years to lay down – is being rapidly used up. In India, or China, energy is feature of capital development and economic growth. In North America, it is a consumer necessity. But where Asian economies earn the money to pay for energy…the typical American – like the typical Brit - faces higher energy costs with no way to pay them. Result: his standard of living will go down.
Major economic trends: E2 - the Experimental monetary system
The second Big E we’d like to discuss is our Experimental monetary system. It bears on the price of energy, of course, and on everything else. It is quite possible for the price of gasoline to go up, for example, even with no change in the supply/demand equation for energy itself. This is because the price is measured with a tape that stretches. As demand rises for energy resources, producers begin to see their oil and gas as precious assets. Sellers begin to ask what they are getting in return.
Worldwide, oil is calibrated in dollars. But what is the dollar calibrated in? More and more oil producers are beginning to ask. And the answer is that the dollar floats in the air like a willow leaf. If the winds are favorable, it stays up. If it gets caught in a downdraft, it falls.
We say that this is an ‘experimental’ financial system, because nothing like it has ever existed. Not that this is the first experiment with lighter than air money. No, the U.S. Treasury did not invent pure-paper money. In the modern era, it has been tried many times – but never with happy results. And never, ever on such a grand scale. Now, practically every currency in the world is backed by dollars. And the dollar itself is backed by nothing. In fact, the whole world’s financial system rests on the shoulders of a single currency – which everyone knows is a shirker.
Typically, paper currencies are backed by gold…sometimes by gold and/or silver…and occasionally by land or something else that is presumed to have real value. The reason for this is obvious: if you open up a central banker you find that he has the same internal organs as everyone else. Thus, is he just as susceptible to influence and temptation as the rest of us.. Historically, people were reluctant to take a currency that did not have sufficient precious metal backing. They didn’t trust it. They figured that the people in control of it would succumb to the temptation to print up too much money, so that each bill would lose some of its value. They knew central bankers could create as many pieces of paper as they wanted. They could also default on their promises. Lie. Cheat. Steal. They could do anything. But they couldn’t create gold. And gold doesn’t lie. It is what it is. It doesn’t sneak out of town. It doesn’t cook the books. It doesn’t go up in smoke.
The U.S. dollar was back by gold, albeit imperfectly, until 35 years ago. The 15th of August 1971 the Nixon administration cut the last vestigial link between the dollar and gold. We recall the era nostalgically. We were on a transcontinental road trip and we remember driving into Albuquerque, NM, in the middle of a gasoline price war. Every gas station we passed quoted a lower price until we had arrived almost in the middle of town and there found regular gasoline for 25 cents a gallon. We cannot remember ever seeing it so cheap – before or after. Now, it is 1,200% higher. And we do not believe the change is solely a function of shifting consumer preferences or declining stocks of oil. In other words, gasoline is not a dozen times higher simply because there is less of it available or more people using it. In fact, output is higher than ever. It’s more expensive largely because it’s measured in dollars…and the dollar has been stretched out by inflation. As the quantity of dollars increases, each one represents a smaller piece of the world’s wealth.
The science of modern central banking is really nothing more than trying to figure out how to surreptitiously inflate the currency. When people catch on, the magic no longer works. Instead of increasing production, in response to greater apparent demand (more dollars), businessmen merely increase prices. Stagflation it is called. We won’t dwell on it here.
We only bring it up to show that this experimental monetary system is unlikely to be a permanent money system. No money system is ever permanent. And one not firmly attached to things of real value – such as gold –cannot be expected to last long. Thirty five years is already a record. Our guess is that it has only a few years left. In other words, this is a trend that is going to continue until it comes to an end. And the end it comes to will be the same as all such experiments. The world’s dollar-based monetary system…with the dollar floating on nothing but air…will collapse and be replaced with something else. When, how…at what cost? We don’t know… but judging from the way in which the quantity of dollars, debt, and derivatives has increased over the last 10 years, we guess that the change will come in crisis…within 10 years…and accompanied by much pain.
The second Big E we’d like to discuss is our Experimental monetary system. It bears on the price of energy, of course, and on everything else. It is quite possible for the price of gasoline to go up, for example, even with no change in the supply/demand equation for energy itself. This is because the price is measured with a tape that stretches. As demand rises for energy resources, producers begin to see their oil and gas as precious assets. Sellers begin to ask what they are getting in return.
Worldwide, oil is calibrated in dollars. But what is the dollar calibrated in? More and more oil producers are beginning to ask. And the answer is that the dollar floats in the air like a willow leaf. If the winds are favorable, it stays up. If it gets caught in a downdraft, it falls.
We say that this is an ‘experimental’ financial system, because nothing like it has ever existed. Not that this is the first experiment with lighter than air money. No, the U.S. Treasury did not invent pure-paper money. In the modern era, it has been tried many times – but never with happy results. And never, ever on such a grand scale. Now, practically every currency in the world is backed by dollars. And the dollar itself is backed by nothing. In fact, the whole world’s financial system rests on the shoulders of a single currency – which everyone knows is a shirker.
Typically, paper currencies are backed by gold…sometimes by gold and/or silver…and occasionally by land or something else that is presumed to have real value. The reason for this is obvious: if you open up a central banker you find that he has the same internal organs as everyone else. Thus, is he just as susceptible to influence and temptation as the rest of us.. Historically, people were reluctant to take a currency that did not have sufficient precious metal backing. They didn’t trust it. They figured that the people in control of it would succumb to the temptation to print up too much money, so that each bill would lose some of its value. They knew central bankers could create as many pieces of paper as they wanted. They could also default on their promises. Lie. Cheat. Steal. They could do anything. But they couldn’t create gold. And gold doesn’t lie. It is what it is. It doesn’t sneak out of town. It doesn’t cook the books. It doesn’t go up in smoke.
The U.S. dollar was back by gold, albeit imperfectly, until 35 years ago. The 15th of August 1971 the Nixon administration cut the last vestigial link between the dollar and gold. We recall the era nostalgically. We were on a transcontinental road trip and we remember driving into Albuquerque, NM, in the middle of a gasoline price war. Every gas station we passed quoted a lower price until we had arrived almost in the middle of town and there found regular gasoline for 25 cents a gallon. We cannot remember ever seeing it so cheap – before or after. Now, it is 1,200% higher. And we do not believe the change is solely a function of shifting consumer preferences or declining stocks of oil. In other words, gasoline is not a dozen times higher simply because there is less of it available or more people using it. In fact, output is higher than ever. It’s more expensive largely because it’s measured in dollars…and the dollar has been stretched out by inflation. As the quantity of dollars increases, each one represents a smaller piece of the world’s wealth.
The science of modern central banking is really nothing more than trying to figure out how to surreptitiously inflate the currency. When people catch on, the magic no longer works. Instead of increasing production, in response to greater apparent demand (more dollars), businessmen merely increase prices. Stagflation it is called. We won’t dwell on it here.
We only bring it up to show that this experimental monetary system is unlikely to be a permanent money system. No money system is ever permanent. And one not firmly attached to things of real value – such as gold –cannot be expected to last long. Thirty five years is already a record. Our guess is that it has only a few years left. In other words, this is a trend that is going to continue until it comes to an end. And the end it comes to will be the same as all such experiments. The world’s dollar-based monetary system…with the dollar floating on nothing but air…will collapse and be replaced with something else. When, how…at what cost? We don’t know… but judging from the way in which the quantity of dollars, debt, and derivatives has increased over the last 10 years, we guess that the change will come in crisis…within 10 years…and accompanied by much pain.
Major economic trends: E3 - where are we in the Economic cycle?
Now, let’s talk about the next Big E – Economic Cycles. Here we are talking about the normal ebb and flow of prices, as well as the big epochs in economic history. Temperature changes from day to night and from winter to summer, for example. There are also extraordinary periods that can last decades…or thousands of years….like Ice Ages and times when the ice melts. Nicholai Kondratief described economic patterns of as waves of growth and decline that lasted about as long as a human life. His work was mostly bogus, but the patterns are real. We know that from boom to bust in the stock market is usually a period of about 18 years. The bull market began in 1982…or 1975…depending on how you look at it. It ended in 2000, as much as a quarter of a century later. The bear market that began in 2000 was held off – but not reversed -- by the biggest flood of liquidity in human history. But that bear market is still waiting to fully express itself. And it will probably carry stocks down to about 5,000 on the Dow…or lower…before it is over. And it probably won’t be over until 2015 or so.
We know that the bond market has similar patterns of boom and bust that last a very long time. Bonds fell from after WWII until Paul Volcker took charge at the Fed and managed to bring inflation under control 30 years later. Then began a long bull market in bonds – with falling yields and rising bond prices –that either came to an end in June of 2003…or is still going. Looking at the chart, we think that bull market in bonds is over after lasting almost a quarter of a century. If we’re right, we could be looking at falling bond prices for the next 2 decades.
One of the great illusions that begs correction is the idea that the Fed can control market cycles. It cannot. It can influence them…but then, only in a bad way. For example, after the boom/bubble of the 1990s, U.S. markets badly needed a rest. Consumers needed to catch their breath…and pay down their debt a little. But after the terrorist incident of 9/11 the feds had the vision of Japan’s 10-year slump haunting their sleep. They panicked and put out so much new liquidity that it stopped the correction in its tracks. Instead of paying down debt, consumers contracted more. And instead of allowing the markets to take a rest, it set them off on a 5-year wind sprint, leaving consumers more exhausted than ever. Now, they have their tongues hanging out and their pockets turned inside out. And now, the U.S. faces not only a bear market in stocks and an economic slump…but the worst thing economic problem a country can face: the destitution of the masses.
A bear market is when money goes back to its rightful owners. No one cares, particularly, when speculators, punters, players, and gamblers are the ones taking losses. But it is another thing entirely when the middle and lower classes are wiped out. That is what happened in Germany in the 1920s. It is what happened in Argentina just a couple years ago. It is what happened in France prior to the French revolution. You’ll remember, a crowd of hungry peasants appeared at the palace gates. Marie Antoinette wanted to know what they were complaining about. ‘They have no bread,’ explained an attendant. ‘Well, let them eat cake,’ was the witty remark that leaped to her lips… Later, the mob leaped at her throat.
Globally, central bank policy is still loose. Rates at the world’s major central banks are still 2 percentage points below their 15-year average. But cycles cannot be held off forever by manipulating central bank lending rates. Real rates – adjusted for inflation – have a life of their own. And cycles have lives of their own too. None lasts forever. And it appears to us that the bullish cycles that have boosted housing prices, stocks, bonds and investor and consumer confidence are now either over or ending. For the next 15 or so years we should be seeing falling prices for stocks, bonds, housing, and other financial assets. And it wouldn’t be too surprising if we also saw a revolt of the masses…who will be hit especially hard. What form it will take…where it will lead…and when it will come…we have no more idea than anyone else.
Major economic trends: E4 - the Exodus of money from West to East
Let’s go on to another of our Big E’s – The grand Exodus of money and power, from West to East. One of the biggest trends in economic history was the rise of the West – centered roughly in Manchester, England, and Manchester, New Hampshire – beginning in the 18th century. Then, in the 19th century, all of Europe and European outposts in the New World spurted ahead of the rest of the world.. By the end of the 20th century, the average worker in Western Europe or America earned about 20 times a much per hour as a similar worker in China or India.
But the averages masked the new trend. Wages in India and China are rising sharply. Those in America and Europe are stagnant. Yesterday’s Financial Times tells us that real hourly incomes in America are lower today than they were 5 years ago. In India, they have almost doubled.
Meanwhile, China is growing faster than at any time in the last 10 years – with a GDP growth rate over 11%. India is not far behind. Both economies are graduating hundreds of thousands of new chemists and civil engineers, whereas American universities turn out young people trained in sports therapy and theatre design. And while both economies are plagued by the usual assortment of bullies and bureaucrats, their parasites are much cheaper than ours…which, along with low wages, gives them a tremendous advantage.
Is the Chinese economy dangerously exposed to a slowdown in U.S. consumption? Yes. Is the Chinese economy laden with contradictions, obfuscations and swindles? Yes. Are the Indians burdened by inefficient transportation and nerve-fraying business frustrations? Yes. But if they had not these sorts of problems they would already be rich. Instead, they are still poor, but definitely on the upswing compared to the West.
Will this trend end soon? Certainly, it will see some setbacks and countertrends. Prosperity is a matter of more than just money. It will take time to knock down all the obstacles. But why should it end? We can think of no reason. At least at the bottom, pressure from Asia should hold down wages in the West for another 20 or 30 years. And buying from Asia should push up prices for things that Asian labor cannot produce: food, raw materials, Old Masters painting, antiques, and gold, to name just a few.
Major economic trends: E5 - the decline of the American Empire
And finally, we come to the last of the Big E trends, the one for which this conference was conceived – the Empire. We Americans don’t like to think of our country as an Empire. Instead, we imagine it as a kind of proto-democracy…with people coming together in local schoolhouses in town meetings where important issues are discussed. We are too modest for empire, we say to ourselves. Besides, empires need emperors, and we don’t have an emperor, we have an elected president, and a society that believes in individual liberty, not collective glory. And empires need people in funny hats. And we Americans don’t wear hats…except maybe baseball caps that advertise where we went on our summer vacations. What’s more, America is a democracy…where the people decide what kind of government they want. And no one ever ran for high office on an Empire platform. So, we couldn’t have an empire.
But it is a strange and wonderful world we live in. And sometimes we get what we did not intend and what no one in particular ever wanted. If you look at the next presidential press conference you will find the American eagle on the lectern. The eagle is, of course, a symbol of empire – it comes from the Roman era, when the eagle was on all the Roman standards. And if you listen to the president’s remarks you will find he spends a lot of time talking about war in exactly the same places where the Romans did their fighting – the edge of the empire, Mesopotamia, where Roman soldiers died by the thousands taking and retaking ancient Babylon. And there, too, where the soldiers of the British Empire washed up again, on the same river banks…done to death by the same desert tribes.
And at the end of the conference, especially when some new offensive has been announced, you will hear how liberty and modesty die, to the sound of thunderous applause.
America began as Rome did, humbly. It began as an idea – that anyone who wanted to could come to this New World and make do as best he could. You needed no passport, no visa, no blood test, no police record. You just showed up and you were on your own.
The rot set in almost immediately and before long it led to a war between the states to determine who got to tell whom what to do. Then, the country tried to develop itself into the kind of nation-state that had proved so successful in Germany and France. A pledge of allegiance to the flag was developed. A system of social security…and many other collectivist programs were put in place, in imitation of Bismark’s social welfare programs in Germany. Whatever you were before or hoped to be in your private life was set aside in favor of being 100% American. Foreign-sounding names and customs were viewed with suspicion. The only foreign language taught in the schools was English.
But all the while, the empire was developing too. In WWI, the British were exhausted by the expense of the war. Woodrow Wilson foolishly took the English bait – a lead role in the imperial theatre in exchange for military help. Naturally, all the European powers stabbed the naïve yankee in the back as soon as he landed in Le Havre. And then they set the stage for an even worse war later. In the next war…and then the Cold War…America played a bigger and bigger role in the world, Finally, with the fall of the Soviet Union there was no one left on stage. The U.S. was left as the only hegemon, the world’s only superpower, a country with such a huge military advantage over the rest of the world that it practically had to play an imperial role whether it liked it or not.
Of course, we have to ask ourselves: what happens to empires? The list of defunct empires is about as long as the list of defunct currencies. They all go away, in other words.
The Roman Empire lasted for nearly a millennium, it is true. But it did so by reinventing itself…almost by becoming an entirely new empire from time to time. There were civil wars, mass murders, coups d’etat, rebellions, insurrections, revolutions. Blood ran in the streets of Rome on many occasions – long before the city was sacked by barbarians.
When Octavian took over from his great uncle Julius Caesar in 43 BC, for example, he had 130 senators killed. That may sound like a good idea to many of us today. In ancient Rome it was almost common. But it would be a major change in Washington today.
Octavian also had as many as 3,000 leading citizens knocked off. Cicero, who had mocked him, tried to make a getaway. The old man was being carried in a litter when he was overtaken by a centurion on the 7th of December 43 BC. He was reading Euripedes’ ‘Medea’ when the guards caught him. He put down the book it is said, stuck his head out the window and said: “Here, veteran, if you think it is right, strike.’ The centurion cut his head off.
What we know about Empires is that they become decadent, just like everything else in life, and eventually die. And they die in predictable ways. Typically, they become too expensive to operate…and attract too many parasites, hangers-on, and hustlers. The costs rise while the output – in terms of what you get for the money – goes down. Weakened, they either collapse from the inside …or are defeated from the outside.
In America’s case, we don’t see any external enemies ready to bring the empire down. But on the inside, we see big problems. Rome may have lasted nearly a thousand years, but Rome didn’t have the Federal Reserve system, the dollar, or the U.S. Congress. Between the three of them, the country is probably broke already. The measure of indebtedness - $65.9 trillion – far surpasses our ability to pay it – more than $200,000 for every man, woman and child in the country. Either these debts are repudiated in some way…or some form of revolution is likely to occur. Most likely, they are greatly reduced by inflation…as U.S. standards of living fall and millions of households go broke. Of course, we can imagine much worse. Superpowers may not go so gently into that good night. We just have to wait and find out.
Everything is predictable. But we have no idea what will happen next. That is what makes the world so entertaining and makes our business so much fun.
Of course, we have to ask ourselves: what happens to empires? The list of defunct empires is about as long as the list of defunct currencies. They all go away, in other words.
The Roman Empire lasted for nearly a millennium, it is true. But it did so by reinventing itself…almost by becoming an entirely new empire from time to time. There were civil wars, mass murders, coups d’etat, rebellions, insurrections, revolutions. Blood ran in the streets of Rome on many occasions – long before the city was sacked by barbarians.
When Octavian took over from his great uncle Julius Caesar in 43 BC, for example, he had 130 senators killed. That may sound like a good idea to many of us today. In ancient Rome it was almost common. But it would be a major change in Washington today.
Octavian also had as many as 3,000 leading citizens knocked off. Cicero, who had mocked him, tried to make a getaway. The old man was being carried in a litter when he was overtaken by a centurion on the 7th of December 43 BC. He was reading Euripedes’ ‘Medea’ when the guards caught him. He put down the book it is said, stuck his head out the window and said: “Here, veteran, if you think it is right, strike.’ The centurion cut his head off.
What we know about Empires is that they become decadent, just like everything else in life, and eventually die. And they die in predictable ways. Typically, they become too expensive to operate…and attract too many parasites, hangers-on, and hustlers. The costs rise while the output – in terms of what you get for the money – goes down. Weakened, they either collapse from the inside …or are defeated from the outside.
In America’s case, we don’t see any external enemies ready to bring the empire down. But on the inside, we see big problems. Rome may have lasted nearly a thousand years, but Rome didn’t have the Federal Reserve system, the dollar, or the U.S. Congress. Between the three of them, the country is probably broke already. The measure of indebtedness - $65.9 trillion – far surpasses our ability to pay it – more than $200,000 for every man, woman and child in the country. Either these debts are repudiated in some way…or some form of revolution is likely to occur. Most likely, they are greatly reduced by inflation…as U.S. standards of living fall and millions of households go broke. Of course, we can imagine much worse. Superpowers may not go so gently into that good night. We just have to wait and find out.
Everything is predictable. But we have no idea what will happen next. That is what makes the world so entertaining and makes our business so much fun.
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