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Central Iran Desert Tour

There has probably never been a period in world history which has caused the

amount of wealth destruction that we are likely to see in the next few years.

By Egon von Greyerz   August 16, 2010    Matterhorn Asset management

No, there will be no double dip. It will be a lot worse. The world economy will

soon go into an accelerated and precipitous decline which will make the 2007 to

early 2009 downturn seem like a walk in the park. The world financial system has

temporarily been on life support by trillions of printed dollars that governments

call money. But the effect of this massive money printing is ephemeral since it is

not possible to save a world economy built on worthless paper by creating more

of the same. Nevertheless, governments will continue to print since this is the

only remedy they know. Therefore, we are soon likely to enter a phase of money

printing of a magnitude that the world has never experienced. But his will not

save the Western World which is likely to go in to a decline lasting at least 20

years but most probably a lot longer.

The End of an Era

The hyperinflationary depression that many western countries, including the US

and the UK, will experience is likely to mark the end of an era that has lasted

over 200 years since the industrial revolution. A major part of the growth in the

last 100 years and especially in the last 40 years has been built on an

unsustainable build-up of debt levels. These debt levels will continue to swell for

another few years until the coming hyperinflation in the West leads to a

destruction of real asset values and a debt implosion.

In the last 100 years the Western world has experienced a historically

unprecedented growth in production, in inventions and technical developments

leading to a major increase in the standard of living. During the same period

government debt, as well as private debt have grown exponentially leading to a

major increase in inflation compared to previous centuries.

Until the early 1970s the growth in credit to GDP had been going up gradually

since the creation of the Fed in 1913.. But from 1971 when Nixon abolished gold

backing of the dollar, virtually all of the growth in the Western world has come

from the massive increase in credit rather than from real growth of the economy.

The US consumer price index was stable for 200 years until the early 1900s.

From 1971 to 2010 CPI went up by almost 500%. The reason for this is

uncontrolled credit creation and money printing. Total US debt went from $9

trillion in 1971 to $59 trillion today and this excludes unfunded liabilities of

anywhere from $70 to $110 trillion. US nominal GDP went from $1.1 trillion to

$14.5 trillion between 1971 and 2010. So it has taken an increase in borrowings

of $50 trillion to produce an increase in annual GDP of $13 trillion over a 40 year

period. Without this massive increase in debt, the US would probably have

had negative growth for most of the last 39 years.

Total US debt to GDP is now 380% and is likely to escalate substantially.

The coming hyperinflationary depression and the credit and asset implosion that

is likely to follow will most probably lead to the end of a 200 year era of growth for

the Western world. If only the excesses from the 1970s were corrected we might

have a circa 20 year decline. But more likely we will correct the era all the way

back from the industrial revolution in the 18th century and this could take 100

years or more.

So after the tumultuous and very painful times that we are likely to experience in

the next few years, the West will have a sustained period of decline. All the

excesses in the economy and in society must be unwound. These abnormal

and unreal excesses are not just corporate executives, bankers, hedge fund

managers or sportsmen earning $10s to $100s of millions but also a total

collapse of ethical and moral values as well as a breakdown of the family as the

kernel of society.

Most people believe and hope that this major trend change could not happen

today with all the measures that governments have at their disposal. But very few

people comprehend that it is precisely the government interference, controls and

regulations as well as money printing that have created the problems in the first

place. Power corrupts, and the more pressure a government is under the more

they intervene. Because they believe that their interference in the economy will

save the country – read Obama, or the world – read Gordon Brown. Little do

they understand that each interference, each regulation or each dollar or

pound or Euro printed will exacerbate the problems of the economy

manifold.
 

Governments now have two options; continue to spend and print money like the

US or introduce austerity programmes like Europe. Whichever way they chose

will not matter since they have reached the point of no return. The economy of

the West cannot be saved by any means. But governments both in the US and

in Europe will still apply the only method they know which is to print money.

Government is Stealing from the People

Very few people understand that money printing is a form of robbing the citizens

of their money and their work. Money is supposed to be a medium of exchange

for goods and services equalling the value of the good or the service produced.

For example, an individual works extremely hard to earn an annual wage of say

$40,000 which he receives in the form of paper money. The government, due to

its mismanagement and incompetence simultaneously prints $40,000 in order to

cover its deficits. So the government has by pressing a button produced the

same amount of money that a man had to work a year for. This is what is

currently taking place all over the world and which will accelerate in coming

months and years leading to a total destruction of paper money. Paper money

has completely lost its function as a medium of exchange or a store of

value. This is why gold is gaining and will continue to gain value against

perishable paper that is called money.

Deflation Inflation or Hyperinflation

The only reason that the US could build up such a major debt is that the US

dollar has been the reserve currency of the world and therefore the US has been

able to finance its debts and deficits internationally. The US has now reached a

point when debts have to increase dramatically for the country just to standstill.

Like all Ponzi schemes this one will also come to an end – and this very soon.

The US dollar will decline dramatically and lose its reserve status and the US

government will be unable to finance its deficit in any market. This process will

lead to endless money printing, collapsing treasury bonds (substantially higher

interest rates) and the dollar becoming worthless in a hyperinflationary black

hole.

Let us just reiterate that hyperinflation arises as a result of money printing

leading to a currency collapse and not from demand pull. The slight

deflation that we are experiencing currently is a prerequisite for

hyperinflation. The fear of a deflationary implosion forces governments to

print money, leading to a collapsing currency which historically has always

been the cause of hyperinflation.

Real M3 is falling at an unprecedented rate. This is the precursor to economic decline, quantitative easing and inflation. Many “experts” make the analogy between the deflationary period in Japan since the 1990s and the US today. In our view the US is in a totally different situation for the following reasons:

In the early 1990s Japan could still export their production to the rest of

the world. . In the current downturn all countries (even China and India) will suffer and

there will be no one to export the problems to.

The ability to export made Japan a creditor nation with major payment

surpluses. US are a major debtor and have been for 25 years. Japan had a very high personal savings ratio at the time (which has now disappeared). US has had a declining savings rate for years (the US savings rate is now going up which it always does in a downturn). The balance of payments and the personal savings surpluses made it possible for Japan to finance their budget deficit without resorting to QE.

Very soon he US will only be able to finance their deficits with QE and so

will most of the rest of the Western world.

Japanese unemployment in 1992 was 2% and went slowly up to 5% by

2000 where it is now. Real US unemployment is 22% and increasing. Many major sovereign states are now virtually bankrupt and the financial system is on life support. This was not the case in the 1990s. The above are some of the reasons why the current US situation is totally different to Japan. QE will accelerate in the US and worldwide.

What will make this process so much more complex than the world has ever

experienced is that the same development is likely to take place in many

countries around the world simultaneously. It will most probably happen in the

UK, the rest of the EU and most other European nations. Due to the total

interdependence of the world financial system, it will be difficult to forecast which

countries can withstand the coming worldwide tsunami of money printing but

many Asian countries probably stand a good chance.

Can we be wrong in our forecast of a hyperinflationary depression? Yes, of

course we can. But the alternative can only be a deflationary collapse which

would be unacceptable to (dropping money from) helicopter Bernanke and deficit

demagogue Obama as well as most other governments.

Conventional wisdom and most experts say that we will not have inflation

but deflation. The problem with most conventional wisdom is that it is only

conventional without an ounce of wisdom. When have the world’s so called

experts, politicians etc ever been right on the current crisis? They will be

wrong this time again.

The “conventional wisdom experts” also say that it will be years before we can

see inflation or hyperinflation. In our view it can happen a lot faster. The world

economy is resting on a foundation of matchsticks. All that is needed is a change

in confidence or psychology for this fragile foundation to crumble. Falling

currencies, rising bond yields and falling stock markets could very quickly

result in a vicious and fast spinning hyperinflationary circle. The frailty of

the financial system could make this happen like a flash fire.

Wealth Creation

Banks and the financial industry have throughout history existed in order to

finance production and trading of goods. But in the last 100 years and especially

in the last 20-30 years it has become a major industry in its own right and an

important but unproductive part of the economy in many countries. Today, the

financial industry is too a great extent involved in trading for its own and clients’

accounts, creating a raft of obscure instruments that only benefit the banks and

as well as financing consumption rather than investment. All of these areas are

totally non-productive and the only beneficiaries are the participants in the

financial industry. And the rewards have been absolutely astronomical. In

investment banking, hedge funds and private equity in particular, the most

massive wealth has been created. Many players have become billionaires or

created fortunes of tens to hundreds of millions of dollars in the last 10-15 years

just by shuffling money around. In the past fortunes were created by building

factories and industries. But today any normal employee working in Wall Street

or the City in London will, by just showing up to work, make hundreds of

thousands to millions of dollars. This is the proof of a world totally out of

balance when people dealing in money become the richest segment of society. Since this activity contributes very little to the prosperity of a

nation (but very much to its participants) it is not sustainable. The biggest

reason why it exists is the massive amount of money that governments have

created or printed and the fact that the financial industry has developed into a

fractal wealth creation machine for the benefit of its participants.

For the last 40 years in particular the rich are getting richer and the average

person has seen very little increase in real income. In the US, the real annual

income of the bottom 90% of US families has increased by only 10% since 1970.

And in the expansion between 2002 and 2007, median US household income

dropped $2,000. The perceived increase in wealth for the majority of

Americans derives from an increase in their debt level not from an increase

in real earnings. So the improvement in living standards that the average

American and many other Western countries have enjoyed in the last 40

odd years is primarily based on debt – debt that can never be and will

never be repaid with normal money.

On the other hand, management has achieved a major increase in income and

wealth. In 1973, chief executives in the US earned 26 times the median income.

Today they earn 300 times. This enormous widening of the gap between the top

few percent in society and the masses is morally and socially unacceptable.

When the bad times start in earnest, this is likely to lead to major social unrest

and violence directed against the privileged.

The Focus will Shift

For a major part of 2010 the focus has been on the problems within the EU

starting with Greece, then Spain, Portugal, Italy etc. The problems in Europe are

major and many European countries as well as the European financial system

will lead to massive money printing. Although the problems in Europe are very

serious, the US economy is in a much worse state. The diversion of the focus

away from the problems in the US economy onto Europe has suited the US

Administration perfectly. It can hardly be a coincidence, for example, that US

rating agencies downgrade the Sovereign debt of Greece and Spain on the same

days as Treasury auctions are held. But the problems in the US economy are

deteriorating at a rapid rate; factory orders, consumer confidence, existing home

sales, retail sales, the ECRI index (Economic Cycle Research Institute) are all

falling more than expected and real unemployment, personal bankruptcies (will

exceed 1.6 million in 2010), trade deficit, state and federal deficits are all

increasing.

The ECRI index is an important leading indicator. It has now fallen for 10 straight

weeks. There are three insurmountable problems in the US economy that are of a

magnitude and gravity which can only be remedied by money printing:

Federal and state deficits will soon escalate at an exponential rate. The

US Federal debt has increased from $ 8 trillion in 2006 when Bernanke

took office to soon $ 14 trillion. Many forecasts expect this debt to go up to

nearer $ 20 trillion in the next 5 years. In our view it will be substantially

higher. Add to that interest rates of 15% or higher and the American

people will work just to pay taxes that don’t even cover the interest

payments on the federal debt. This is why the US will either default or

more likely print unlimited amounts of money.

The real unemployment rate is now 22%. Since 2007 over 8 million

Americans have lost their jobs and it will get a lot worse. Non-farm

unemployment in the 1930s reached 35% and we would expect this level

to be reached in the next few years.

The financial system is bankrupt. Banks are failing at a much faster rate

than last year. To date circa 110 banks have failed. More seriously the

assets of the failed banks are only worth an estimated 30-50% of their

balance sheet value. Banks are valuing their toxic debt at phoney values

with the blessing of the government. But even debt that today is considered safe will soon turn toxic with the consumer coming under enormous financial pressure. Add to that the OTC derivatives held by US banks of at least $ 400 trillion. A big percentage of these are worthless and there are virtually no reserves to cover potential losses.

Within the next few years, the three areas above are likely to result in the biggest

money printing programme in world history and simultaneously lead the US (and

many other countries) into the abyss.

Markets

There has probably never been a period in world history which has caused the

amount of wealth destruction that we are likely to see in the next few years. If we

are correct in our assumption that the West will see a correction of the excesses

of the last circa 40 years but more probably of the last 200 years, since the start

of the industrial revolution, we could see a total annihilation of the assets that

have been fuelled by the credit bubbles. The spike in asset values in the last 100

years, which is unprecedented in history, is likely to be corrected by a waterfall

which could start at any time. We will issue a separate report in the next 10 days

covering our market predictions and the importance of physical gold for wealth

preservation purposes.

 After the tumultuous and very painful times that we are likely to experience in the next few years, the West will have a sustained period of decline.

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