The next bubble: cash.

This is deflation, a contraction of money and credit. Hardy anybody argues about that anymore. So what happens next? Will Obama and the bailout maniacs inflate a new bubble in green energy in their new, green deal? Maybe, but it would only be a limited bubble, not the worldwide craze in any and all non-dollar assets that we saw the last time around.

Don’t assume that any new bubbles at all will form for a long, long time. The mood has shifted from risk to hoarding. Now that people have been burned by everything from dot-coms to gold miners and are scared to death of losing their jobs, they are going to hang onto the one thing that still works: Washington Wallpaper, the little notes that promise, “I owe you nothing but more of these IOUs.

Deflation will rage, until it doesn’t. We are still early in this phase, since among the public there is still a healthy fear of the dollar and paper money in general. But over the next year, as commodities and foreign currencies slide still lower and consumer prices stay solidly and noticeably negative, people will forget about the deficit and the $100 trillion in debt at just the wrong time.

This is the rule of maximum pain for the maximum number. The dollar is not yet ready to fail because it is too feared and despised. But when people let their guard down and sell for $450 the Krugerrands that they are paying $900 for today, take all that they have, because then the real fun will begin.

Just as the public will get too complacent about holding I-owe-you-nothings (Doug Casey’s phrase), Congress and Obama will get too complacent about printing them up, and the whole debt-based money system will come crashing down. I don’t pretend to know how it will play out (hyperinflation or just plain-old, “sorry, we can’t pay” default), but it will be visibly ugly, and I am glad I’ll only be watching it on TV. This won’t be pretty anywhere, but the US is not a civilized country anymore, and it has a most uncivil government.

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22 thoughts on “The next bubble: cash.

  1. This isn’t deflation so much as it is destruction of value. Yes prices are going down, but money supply is increasing at faster and faster rates. Over time, the correlation of M2 and M3 to inflation is extremely strong and I would use money supply as an indicator rather than current prices. Once prices find their normative level, prices will skyrocket in an effort to clear the market of all the excess money that has been injected by the Fed. The only thing that will stop it is a devaluation or re-structuring of the USD.

  2. Hi Mike,
    Hope you are getting settled into your new country and home.
    I seem to remember that you were anticipating an initial DOW bottom of around 7000, followed by a significant bounce, followed by a continued decline. Given the current moment, with its avalanche of bad economic news, a DOW hovering at 8,000, and a sour holiday season coming, I was wondering if you have revised your estimate on the initial low. Do you think it could go as low as 6000 before we see a significant bounce?


  3. Hi Bjorn. Thanks for the kind words.

    I’m really an amateur at technical analysis, and nothing about the economy this fall has surprised me, only the speed and brazenness of the bailouts. So I don’t really have very much new to go by for an initial bottom target, but am just waiting for what looks like capitulation. Because I do think that a sustained (and highly-shortable) rally is likely after this, maybe 7000 is not low enough to set us up for that situation, but that 6000 would do the trick. A strong argument for 6000 is that there are still so many egregiously overpriced stocks out there that would have a hard time rallying from near current levels against the economic headwinds.

    I can tell you that am still steadily closing out index puts as we plumb these depths, and that I have a ton of 2010 options left, especially on individual stocks.

  4. Pingback: Not Stocks and Not Real Estate Part 2 | MAS o Menos

  5. There won’t be a default on debts. USA makes jack right now, and if there’s a default, USA won’t get anything coming in from China or Canada or anywhere. Maybe the ardent redneck will be gung-ho to start over, but that takes time, at least a year. Do you have enough food for that long? 99% don’t. Those that do will have to watch their backs, day and night. I know a few that do have supplies to last that long, but government will take over everything they have long before the year is over. Redistribution of wealth doesn’t just include money, you know. So no, there will be no wholesale default on debt.

  6. 800 billion more in new bailouts from Paulson this morning, then a 700 billion stimulus package to be signed by Obama on January 20, then Pelosi has a 75 billioln bailout for the auto industry, so that they can make more cars that nobody is buying, and then there was yesterday’s 320 billion bailout for Citi, WHEW…that was a mouthful!

    And remember what Bush said yesterday: if anybody else needs a bailout, we’ll give it to them! No limits! Whee!

    This is going to end VERY, VERY BADLY.

  7. Hi Mike,

    I’ve been reading through your blog and I’m very impressed with your writings, they’re very enjoyable. I see that you have offered advice to some readers and I’m wondering if you might have any comments on my own situation.

    I’m 25 and had the good fortune to both hold an overpaid consulting job over the last couple of years *and* avoid buying into the bull market mentality in which most of my coworkers and friends were simmering. I made some pretty good money speculating on the Bear Stearns, Lehman and AIG collapses, and then the collapse in the S&P itself. (I actually interviewed with Lehman’s securitization banking division back in 2006, but they chose some poor sap from Brown University instead, and not a day goes by that I don’t thank the Fates for sparing me his outcome.)

    I’ve been a bear for years but I only just finished “Conquer the Crash” and what it really impressed upon me, so much more than the guys like Schiff or even Daily Reckoning, is that being nimble and anticipating both financial and political developments will be the only way to come out relatively unscathed, and having the means and a plan in place is _job number one_.

    So, now I’ve got some money that, at the moment, represents wealth, and I want to make sure it stays that way, and hopefully make it go up too. Right now I’m puzzling over the challenges of preserving it as someone with only moderate means, and any comments you could give would be greatly appreciated.

    As far as my own situation goes, I have about $100,000 in (currently) liquid net worth. Aside from PMs I don’t own any hard assets such as real estate. About a third of that $100K is in precious metal investments of various kinds, including $7K in physical metal held in my own possession inside the U.S., and a regrettably high amount in various forms of “paper gold,” including $10K in GLD and a Fidelity gold fund and $15K in a Perth Mint certificate. Most of the rest is in cash in my EverBank account (for checking and short-term liquidity) and Interactive Brokers accounts (for speculation).

    I know that my short-term cash liquidity is too low and I’m working to remedy that.

    Anyway, on to the questions!

    - To hold gold offshore, I’m planning to draw down $10,000 of that Perth Mint certificate, which is after all just a claim on the Perth Mint’s liabilities, and transfer it into GoldMoney for offshore storage purposes. Do you have any thoughts on GoldMoney as a solution for those with moderate means to hold gold offshore?

    - If you have any knowledge of the risks of EverBank or Interactive Brokers, or somewhere I could turn for such analysis, I would greatly appreciate it. I went with EverBank because they’re advertised on Daily Reckoning but given where the rates on their products are, I’m nervous. If you have alternate U.S. banks and brokers to recommend that would be great also, as I’m now convinced of the need to diversify and distribute my funds as much as is possible and feasible given the costs of doing that.

    - Do you have any thoughts on Australia as a “backup” safe haven in case the U.S. gets its Obama Youth?

    - Any other suggestions tailored to the ~$100K crowd?

    Thanks a bunch!

  8. Hi. Thanks for the encouraging words. I apologize for not writing much lately, but what is left to say? We’ve crashed, we’re in deflation, the Fed is in panic mode, and yes, we are to get a new New Deal and an Obama Youth — nice turn of phrase.

    I’ve been thinking of doing an ‘I told you so’ post where I refer to predictions made back in August, but who cares?

    Anyway, I can’t of course offer specific investment advice to anyone, since suing people is one of the few sources of income that remain in Amerika, but I can offer general comments…

    With a good job and real savings, you are doing as well as 1 in 10,000 25 year olds, so congrats. If you are reading this blog and Prechter, even better, since you’re in survival mode.

    First, let me tell you something about owning small amounts of gold: there is no need to use any paper/electronic claims. Coins are highly portable, liquid, discrete and fully legal. Goldmoney and bullionvault appear to be great services, but for just a few dozen ounces in total, why bother for now? If it would make you feel better to diversify, pick one of them and not any other paper methods. Nothing else comes close.

    I have never visited, but I have done my own research on the Land of Under, and it appears to suck, just like the rest of the formerly white, English speaking world. It and New Zealand have “social democratic” police states that tax and regulate to extremis, and they fully exploit the terror BS. Australia has even started to censor the internet: they have a list of blocked sites, to which citizens can suggest additions. And don’t forget, Murdock owns its media too. Bloody lovely place.

    My suggestions for safe havens are as follows: for cities, consider Hong Kong, Singapore, Tokyo (if you speak the language and can get a job there…) and those Switzerland, though the place is getting more and more EU-ified. If civilization is not as important to you, and it may not be if you are 25 and single, consider the Caribbean islands not owned by empires, and Uruguay (by credible accounts, the most civilized nation in Latin America — congratulations, right?).

    A comment on civilization: developed nations have lots of quality consumer goods and services, and cities full of bright and interesting people, but they also come with strong governments, and all governments are to be feared, especially in a depression. The less-developed world tends to have crappier goods services and lots of dumb and dishonest people, but inept governments. The Nazis were only so bad because they were organized.

    I don’t know much about the soundness of EverBank or IB. I don’t use either, nor can I recommend any US institution. I’d guess I’d be wary of EverBank and just use a Treasury only MMF for savings, and have a checking account at a big evil bank. Forget about interest, other than as a warning sign. IB does look like the best broker, and if you are going to trade you may as well use them in the absence of a good reason not to.

    Oh, you also didn’t mention cash. If all banks are offering is risk, why give them all your money to keep? If you want more liquidity, there you go.

    Other suggestions for the 100k crowd…. ? Don’t be in a hurry to get married — try telling your wife you think you would be safer in Uruguay!

    Don’t buy anything. Pretend you’ve already lost your job. Stuff is a pain to ship if you ever want to leave.

    Acknowledge fully that the US is not America anymore and that if you chose to stay your life will be nothing like that of your parents or grandparents.

    Learn Mandarin. It’s not nearly as hard to speak as to read.

    The Russians are our friends, if not our governments’. Take your next vacation there.

    Don’t put anything in an IRA, and cash out if you have one.

    Try to get your folks to read Conquer the Crash — they probably have more money than you.

    Keep out of politics and don’t stick your neck out. History has to play itself out. Stay out of its way.

    Assume the worst. The US WILL get its Obama Youth, so make your plans now. Do serious research. Make calls. Visit. Be ready to go as soon as you lose your job or TSHTF.

    Guns and gold won’t save anyone from what is coming. Think to yourself — would that have been a good strategy for someone living in Germany in 1935? Much, much better to get the hell out.

    If you are ambitious, just work on leaving. If you like the simple life, maybe you’ll be ok by just laying low in the US.

    Glad to try to help. These kinds of questions always spur me to keep thinking things through.


  9. What non-US broker do you use that lets you do equities, futures, forex, options (leaps) etc? i am having a hard time finding..

  10. Thanks for that. The Russians are our friends, eh? Fascinating. What makes you say so? I’m eager to believe it, given their large share of the market in beautiful women. I remember reading that some advisor there was into von Mises, but that’s all I really know.

  11. Nice blog. Been tracking for last few months. Great insight on the markets, etc. Opened my mind in a lot of ways.

    Now then, scary stuff going on for sure, however, I am not so convinced that moving to random nations is a sound idea. Let’s be honest here, the US still runs the global show. Push comes to shove, if all hell breaks loose, the wealth, in terms of infrastructure/capital (both human and otherwise) and overwhelming military might rests squarely with the USA. Singapore? WTF is Singapore gonna do if there is a naval blockade and a complete financial crisis? Or Tokyo for that matter. We are Japan’s military. H.K., I don’t think you will want to live in part of the P.R.o.China during this massive meltdown either. The Caribbean? How are they going to sustain themselves without tourists or protect against rouge forces? Latin American??? I suggest you see the documentary “Manda Bala(Send a Bullet)”, it is about Brazil(the big boy of S.A.) to get an idea of how corrupt/fucked up things can get down there (and this is pre-crisis). I think Sweden or Finland might be a better option. Harsher physical conditions(scares the pussies away), highly developed nations, more sparsely populated, and although socialist, strong on individual rights. Hell, even Alaska for that matter.

    But, why not stay here and lead the revolution! Your financial ideas have a better shot at being heard here then some tiny, tightly controlled nation-state, and it will be more “interesting”. ;-)

    My main point is that while the USA is nose diving into the abyss financially, it is important to remember that effectively it has managed to enslave the rest of the world towards its own objectives for a very long time, during which the vast majority of wealth has been poured here at little cost to us(think of Marx’s vision of the capitalist(USA) and the factory worker(rest of the world)). I am not saying this will not change eventually in the very long term. But I really doubt the security offered by such financial hubs/safe, if there is a global conflict with which you worry about, they will be scared to death and defenseless. And along these lines, I don’t personally envision China will ever be the “next superpower”. It just isn’t that type of nation, at least not yet(Han-Chinese-centric and 400million piss poor, too much internal crap). Furthermore, you honestly think the world will want to be dominated by one ethnicity(we know how such things play out)? Or people will flock to live/start a business in such a nation-state (esp. without individual rights)? “I am moving to the land of opportunity and pollution: CHINA! Where all things are made!” Sorry for the trolling…but I think people get a little carried away with the China stuff. These things don’t happen overnight.

    BTW, if you live in the Americas, I think a better/more practical language to learn would be Spanish. It’s a warm culture too.

    May I recommend the following album(and song) by the Hold Steady: “Stay Positive”.
    Again, thanks for the good site, and best of luck…!

  12. Sorry, I don’t have advice for anyone on brokers. Just keep it under 600k and don’t have a margin account.

    Graphite – Just speaking from experience, the Russian people are great. But no, the country is not oriented toward a liberal economic philosophy — on the contrary, the people seem to yearn for a new tzar. The government is has a much stronger hand in the economy than in the US. That is another way of saying that the rich in Russia use force even more than the rich in the US. Foreign policy wise, the US is clearly the aggressor, having scammed Russia in the ’90s and now trying to surround her with bases and puppet govts… but this is neither here nor there as far as this blog goes.

    UChicago guy — Thanks for the encouragement and critique.

    Points well taken on the reasons to remain in the states. It is very hard to leave and live a secure life if you don’t have big money. If you do, you can negotiate your own deal with a Swiss canton and sit pretty.

    I already know Spanish — I lived in Latin America for 6 months this year, and I agree that it is a scary and volatile place, and that is in good times. I’m learning German because because it is (sort of) the language of my favorite city. Scandinavia? It’s totally stagnant, and they have all kinds of big brother and anti-speech laws, so they’re not so really so big on rights…

    It’s true, there is no perfect place, and there are no guarantees. The rationale for leaving is that the US has clearly been in decline, though Asia has been on the ascent. NYC’s air was as bad as HK’s in the ’60s — this is the kind of thing that gets fixed over decades after people get more money and other needs are met.

    The #1 economic reason for staying is the opportunity and security available simply because a place is your native land. You know people, you can jive with people, and you know how to read the tea leaves.

    Of course there is also the (still and for some time to come) relatively good quality of life in the US and the fact that your friends and family are there.

  13. Yeah, it just seems like making preparations to leave will be necessary for anyone who’s ambitious. No, you don’t have to believe that dictatorship will come *tomorrow*, but every month they seem to close off new avenues for moving one’s wealth (and someday, perhaps, one’s person) outside the country.

    What’s the danger of having a margin account? (I never use the margin, but do have the permissions to trade with it if I want.)

    Any suggestions on offshore banking centers?

  14. Read the fine print in your margin agreement. It usually allows your broker to lend the securities that you think you own. They are held in the broker’s name, not yours, and they just owe them to you, so if the broker goes under (perhaps from too many unmet margin calls in a crash) you stand in line at bankruptcy court like everyone else. This happened to a lot of hedge fund clients of Lehman’s. If you have a cash account, SIPC is supposed to give you your securities back (up to 600k if I remember), but don’t count on that either.

    Yes, it is easier to get your body out than your money. And the timing of all of this is the hardest part. It is better to be early than late, of course, but you have to have somewhere that is ready for you to go — a residence and a job or assets to support you and yours. Both are tough to secure, especially in places that are likely to be better off than the US of A, which are few, since the whole western world seems to be descending into some kind of dark age. This is like the un-enlightenment. What was that song again? … think positive.. I’ll look for that.

    The good offshore financial centers of course are HK, Sing, Cayman, London (may as well be NYC, for all intents and purposes), Lichtenstein and of course Switzerland. None are ideal, though with its quality of life Switzerland is as close to that as you will find in this world, if you can manage to make a place for yourself there.

    It is conceivable that the US doesn’t crash and burn, but just crashes and smolders in corruption for decades, living off the fruits of the former free market, like most of western Europe since WWI. Paris is still today even a nice place, though a shell of its former self.

  15. And yes, fascism and dictatorship can creep in under the radar — you don’t just wake up one day and find that all of your freedoms are gone. What did Jefferson say? “…when a long train of abuses and usurpations, pursuing invariably the same object evinces a design to reduce them under absolute despotism.”

    Make no mistake that we contend with individuals who know just how to boil a frog.

  16. yes.
    I know English ( native) Spanish( fluent) and am learning Chinese( newbie). Working on a speech pathology degree.
    Sux though, I have less than 200 dollars in the bank and cant get my parents to read “conquer the crash” or practice Spanish for the life of them. My mom is too concerned about reading her bible than about finances. Everyday I feel skrewed and it’s hard to concentrate , even in school. I had a rough semester and I feel guilty about it.

  17. Mike,

    I just found your blog through Calculated Risk. Good stuff.

    I’d like to know why you think IRAs (perhaps Roth IRAs also) are a bad idea? I liquidated mine a few years ago but I have a family member with a Roth containing conservative investments (CDs mostly).

    I live in Russia and Russians are indeed great people. I don’t hear much anti-American rhetoric from them either. I can’t say that about some other places I’ve lived. I do, however, hear a lot of hateful remarks about Russia and Russians from American expats here. There’s lots of nationalism and bigotry in the expat community, unfortunately.

  18. Mike,
    I’ve *really* enjoyed your blog. I come back each week for a visit. Thanks very much.

    A question for you, if I may: The demise of the dollar (by 40% at best?) seems to be on the horizon – at least in a few years. [In fact, just saw something about the falling dollar in John Hussman’s weekly commentary/2008 annual report as well:

    We’re a young family with 2 kids under 3. We rent and live close to our jobs. We don’t plan to buy for a few years (until daycare expenses go away). The challenge: We have school loans of about $50,000 at 7.7% interest rate (still have 10 years to go), but are living *very* frugally so that we are able to save about $20,000 each year. We have an 8-month emergency fund.

    Does it make more sense to focus on paying off our school loans over the next 3-4 years – and save half as much each of those years — or should we save the money for when the dollar loses value – because we’ll need more dollars to get by? (and hope the really bad armageddon and defaulting scenarios don’t come to pass.)

    I’m thinking we should go ahead and try to pay down the loans and deal with the dollar crash when it occurs. Perhaps I am too optimistic. I’m hoping we can make it through the next few years if we do things the old-fashioned way: Pay down our current debt, live frugally, and grow and can our own food in case all hell breaks loose…

    Many of your commenters appear to be dealing with large sums of money. We’re just small timers. Am I missing something from this puzzle in terms of how I’m viewing our cash reserves?

  19. Clarification: The key passage from the Hussman Fund prospectus is “My expectation is that the U.S. is likely to experience a steep decline in the foreign exchange value of the U.S. dollar, even though inflationary pressures may be postponed for several years.”

    Do we use the window of the next few years paying down our debts or preparing for the time when the dollar buys less?

    Gold seems an overly risky speculation. It may rise – but maybe not. What are some options for the buy-and-hold type of people?

  20. Hi guys. You have it exactly right here:

    “I’m hoping we can make it through the next few years if we do things the old-fashioned way: Pay down our current debt, live frugally, and grow and can our own food in case all hell breaks loose…”

    7.7% is very high interest in this deflationary environment. Paying off those loans should be of high priority, and if you are able to do that in three years while saving as well, you are doing great. The dollar is not likely to crash anytime soon for the following two reasons:

    1) So many people are expecting it — markets almost never do what the majority think. Anti-dollar sentiment reached a peak last year, and now popular opinion has a long ways to swing in the other direction.

    2) There is still 40-50 trillion in dollar denominated non-government debt in the US, and people are increasingly desperate for dollars to pay back that debt. It doesn’t matter what you think of the dollar if you have debt and not enough dollars to pay it off.

    Hussman has become lost. He lacks a solid understanding of what is happening in the markets now, and his fund’s value reflects that. He thinks stocks are undervalued, though by any reasonable historical comparison (not to the last 20 years, but to the last 200), they are still horribly overpriced. He has also been blindsided by the strength in the dollar and emergence of deflation.

    Let me congratulate you. You are aware of what is happening and your gut reaction is exactly what you need to do. You will come through this in a far better condition than 99% of your peers, financially and emotionally, since you have acknowledged the problem and solution.

    Some people here are wealthy, some are not. Money makes no difference in understanding.

  21. Here’s how to benefit from inflation, if and when it comes: Pay off your loans. Save in dollars, and some in gold, but from lower prices. Buy just a little gold each year, and spread out your purchases across the year.

    But the best way to make inflation work for you is to buy a home with a low, fixed-rate loan. If you pay off your loans by 2011, home prices will be a lot lower then and you will easily be able to afford what you want with your savings and cash flow.

  22. 1920-192l ‘recession.” see
    W.Harding’s comments. FRB did very little then.
    ‘Cured itself.”
    re: gold: what do firms that send you gold you purchawe
    invest in, oil?

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