Melbourne, Australia
Thursday, 3rd April, 2014
By Callum Newman

Editor’s Note: Don’t forget the normal publication of the Daily Reckoning is suspended this week to bring you the highlights of the World War D conference. Now over to latest dispatch…

From Callum Newman reporting on WWD:

--It’s hard to believe we’re writing to you on Thursday, but we’re still talking about what happened at World War D on Monday.

--Technology analyst Sam Volkering had the floor for the final presentation before the wrap up panel. It was time to leave behind the talk of government debt, credit, central banks, and instead focus on the opportunities.

--‘Benjamin Franklin was wrong, ‘said Sam. What he meant was that there was a third certainty in life besides death and taxes. And that’s technological change. Don’t forget that US tech entrepreneur John Robb told the crowd earlier that he thought tech would destroy or disrupt 95% of jobs in the entire economy. That was the canvas, if you like. Sam painted the picture.

-- Sam covered immersive tech and ‘augmented reality’. That’s the interconnection between the digital and physical world and the potential of products like Google Glass and Microsoft’s SurroundWeb. Technology that can literally overlay in front of your reality. This will radically change how we communicate with each other — again.

--Sam talked about developing payments systems. So imagine yourself walking down the street. You see a shirt you like in a shop. When you walk into the store, it registers on your smartphone that you’ve entered. When you pick the shirt off the rack, your phone registers that too. When you leave, you pay for it using your e-wallet. No sales staff required.

--Later he introduced how the global payments system will make moving money much, much easier between different countries. He called bitcoin the ‘big bang’ moment of cyptrocurrencies and showed the current explosion in the sheer number of them happening right now. This could be a major disruption to the banking monopoly, and the associated rip off fees and charges, all over the world.

--John Robb previously pointed out that the medical industry was one of the few areas where tech didn’t drive down costs. That’s not the fault of technology, but a protected industry. But the benefits are still coming regardless via personalised medicine and regenerative research. Sam showed the potential windfall for your health and the slowing of the ageing process. Then he introduced the bionic man, Frank — short for Frankenstein.

--Researchers and scientists from all over the globe have created a bionic man with a beating heart and the ability to walk. The only thing he’s missing is a liver and a brain. The feet and ankles — two of the most difficult areas of the human body for robots to replicate — actually represent how tendons and our Achilles heel move. And don’t forget that Frank, and thousands like him, might one day find themselves on the front line of a major battle.

--Robotic soldiers are an aspect of future warfare. Other aspects include hackers, viruses and cyber sabotage replacing conventional attacks.

--That’s just a brief touch on Sam’s speech. But we have more to cover, because the panel of keynote speakers came to wrap up Day One at World War D. We can’t cover it all, but there were some key points you might find interesting. A delegate at the conference asked about the risk the Chinese banking system posed to the rest of the world. Would any credit collapse there be contagious?

--Jim Rickards suggested that while there was less likelihood of contagion, the great unknown was what the Chinese banks would sell if they ran into financial distress to raise cash. ‘You don’t sell what you want in a crisis, you sell what you can. ‘He made the point that in 2007 Japanese stocks started to sell off and nobody could figure out why. It was because hedge funds were liquidating their positions to meet margin calls as the mortgage market began to go sour. Hmm.

--Rickards also rebuffed the idea that we’re living in a time of record low interest rates. Yes, he said, long term rates in the US at around 3% are low. But he said you had to distinguish carefully between nominal rates and real rates. He said interest rates were actually high in the US because with long rates at 3%, and inflation at 1%, you’re paying 2% in real terms. He then compared that to the early 80s on his own mortgage at the time, when he paid 13% rates but inflation was at 15%. In real terms, he was ahead.

--Rickards argued it was feasible for long rates in the US to fall as low as those seen in Japan. This could set off one of the biggest US bond market rallies in history. Short sellers beware. His model portfolio for now includes an exposure to gold, fine art, land, cash and hedge funds or private equity.

--There is, however, more to life than money. All the panel agreed that the militarisation of the police in the US was both astonishing and disturbing. The loss of liberty and the rise of neo-fascism was apparent now, and rampant. Rickards made the point that there are so many laws in the US — which nobody has a hope of reading or understanding — that practically everyone’s a criminal, without realising it. You can add in selective enforcement, as demonstrated when the IRS targeted members of the Tea Party.

--And as Rickards suggested, this trend is coming to a town near you.

Regards,

Callum Newman
for The Daily Reckoning

It’s All about Perceived Credibility
By Bernd Struben

--By the time you read this World War D will be over. The conference that is. That far-reaching event is winding down even as we write these words. But make no mistake. The ramifications of what’s been discussed here in Melbourne over the past two days will continue to resonate for years to come.

--The first day of World War D was a bombshell. We’d like to say the attendees were literally blown away, but we hate the misuse of that word. So we’ll just say that during the post conference cocktail hour they were very impressed, and they definitely left with a lot of new facts and insight to process.

--With that in mind we felt sympathetic for our old pal, and your very own Daily Reckoning editor, Greg Canavan. It was up to him to give the opening presentation of day two. But we needn’t have worried. Greg was more than up for the task.

--‘Our financial system no longer stands on its own two feet. It needs constant reassurance, a regular pat on the back from Janet Yellen. So how did money go from sound to unsound in one hundred years?’ he asked the audience.

--First you need to know where money comes from. And it turns out it doesn’t come from money printing, as we so often hear. It comes from you. Or to be precise, it comes from your credibility. According to Greg, here’s how it works:

‘You go into a bank and ask for a loan. They CREDIT your bank account with MONEY and then you have a DEBT outstanding. You spend this money on building a new house, or whatever, and in this way the money enters into the economy. Money = Credit = Debt. They’re interchangeable terms, especially in the modern financial system.’

--So how did we get so far down the rabbit hole? Well, as Greg explained, the bar for obtaining credit has gotten lower and lower over the decades. So much so that right before the 2008 meltdown, US households in particular had cashed in all their credibility, and then some. And we all know what happened next.

--Greg explained that 1914, indeed one hundred years ago, marked the beginning of the end of sound money. Back then the developed world was on the classical gold standard. Gold coin was legal tender and banks held gold reserves and created credit on top of those reserves.

--The gold standard kept a lid on debt growth and regulated interest rates. It was a sound monetary system, but not immune to crisis. The classical gold standard could not survive the stresses of global conflict. Just prior to the outbreak of the First World War, many Brits tried to redeem their paper notes for gold coins. It nearly led to a major liquidity crisis.

--You see, with the gold standard, when people take their gold out of the banks and hoard it, ‘money’ disappears. The monetary base contracts, interest rates rise and financial deleveraging kicks in. A patriotic plea saw the people return their gold to the banking system, and a crisis was averted. But from that moment on money was no longer gold. Money was debt.

--The next step toward unsound money came when the League of Nations met in Genoa in 1922. Instead of going back on the gold standard, they came up with a bastardised version which was highly inflationary. This led to the roaring 20s, a technological boom, and vast stock market speculation that culminated in the 1929 bust...and eventually the outbreak of the Second World War.

--Then came the Bretton Woods System, which Greg labelled, ‘The next chapter of our journey towards unsound money’. It was another version of the 1922 gold-exchange standard, and the end result was similarly chaotic. The US dollar was tied to gold at $35 an ounce, and all other major currencies were tied to the US dollar.

--The system worked well for the first 15 years or so, as the US owned most of the world’s gold and had a lot of stored credibility from the war. But US deficit spending picked up as a result of the Vietnam War, and despite the best efforts of the London Gold Pool to keep the gold price fixed at US$35 per ounce, it failed.

--Nixon closed the gold window in 1971 and ushered in a decade of monetary chaos. The gold price soared to briefly hit US$850 per ounce.

--With all links to the yellow metal removed, credit/money/debt as a percentage of GDP started rising in the 1970s. And this really took off in the 1980s when interest rates began to fall, regulations encouraged more debt, and financial innovation went wild.

--Greg drew our attention to two particularly risky innovations. ‘I refer to these — securitisation and shadow banking — as iceberg finance. ‘Greg’s chart showed securitisation as the tip of the iceberg and shadow banking as the menacing bulk lurking beneath the water line.

--We won’t go into all the details here, but the bottom line, as Greg explained, is that these two ‘innovations’ leveraged up the financial system to levels never before seen. It allowed debt to be collateralised and then used as an asset with which to create more debt.

--The monetary system has become increasingly unsound. Debt expanded to the point where credibility — both real and perceived had all been monetised. The bar for obtaining credit was on the ground, and anyone could walk over it.

--And anyone did. As a result, we got the worst crisis since The Great Depression, which was the first crisis on the road to unsound money. But it was the collapse of Lehman Brothers — the fourth largest investment bank in the US — that triggered the real panic. That’s because Lehman held lots of dodgy collateral created by the shadow banking system.

--Once Lehman fell, it threatened to take the whole system with it.

--Enter Uncle Sam.

--No one questioned the US government’s creditworthiness. Government debt was the only collateral in demand. The market couldn’t get enough of it. To help it digest trillion dollar deficits, the Fed started its now infamous quantitative easing (QE) program. As Greg explained, this was necessary because the creation of government debt works a little differently to commercial bank generated debt.

‘The policy of QE was an attempt to inject liquidity into the system at the same time as governments were soaking it up via their massive debt issuances.’

--With historically high debt levels it seems governments are well on their way to monetising all their credibility. Greg reckons they’re now well into borrowing against their perceived credibility.

‘Confidence in this perceived credibility is the only thing holding the system together right now. Confidence in governments and confidence in central banks. When the next crisis hits, that confidence will evaporate. Why? Because next time around governments and central banks won’t have enough ammunition to bail out the system again. They won’t have enough stored credibility to backstop the system. Physical gold will be one of the few assets remaining with any credibility.’

--Aside from using gold as a long term store of value, Greg offered some other ways to prepare yourself, ways to minimise the impact on your investment portfolios, and even ways you might profit from the end of an unsound monetary system.

It’s taken 100 years of monetary abuse to get where we are now. The outcome won’t be pretty.

Cheers,

Bernd Struben
for The Daily Reckoning