Not all of these seven signs may come to pass. The appearance of some signs may negate or delay others. They will not come in any particular order. When any one sign does appear, investors should be alert to the specific consequences described and the investment implications.
■ Five Investments
In the face of extreme inflation, extreme deflation, or a condition of social disorder, which investment portfolio is most likely to remain robust? The following assets have a proven ability to perform well in inflation and deflation and have stood the test of time in periods of social disorder from the Thirty Years’ War to the Third Reich.
Gold. An allocation to gold of 10 to 20 percent of investable assets has much to commend it. The allocation should take physical form as coins or bullion in order to avoid the early terminations and cash settlements that are likely to affect paper gold markets in the future. Secure logistics, easily accessed by the investor, should be considered, but bank storage should be avoided, because gold stored in banks will not be accessible when most needed. An allocation above 20 percent is not recommended because gold is highly volatile and subject to manipulation, and there are other investable assets that perform the same wealth-preservation functions. A useful way to think about gold’s insurance function is that a 500 percent return on 20 percent of a portfolio provides a 100 percent portfolio hedge. Gold does well in inflation, until interest rates are raised above inflation rates. In deflation, gold initially declines in nominal terms, although it may outperform other asset classes. If deflation persists, gold rises sharply as governments devalue paper currency to produce inflation by fiat. Gold offers high value for weight and is portable in the unfortunate event that social unrest requires flight.
Land. This investment includes undeveloped land in prime locations or land with agricultural potential, but it does not include land with structures. As with gold, land will perform well in an inflationary environment until nominal interest rates exceed inflation. Land’s nominal value may decline in deflation, but development costs decline more rapidly. This means that the land can be developed cheaply at the bottom of a deflationary phase and provide large returns in the inflation that is likely to follow. The Empire State Building and Rockefeller Center, both in New York City, were built during the Great Depression and benefited from low labor and material costs at the time. Both projects have proved excellent investments ever since.
Fine art. This includes museum-quality paintings and drawings but is not intended to include the broader range of collectibles such as automobiles, wine, or memorabilia. Fine art offers gold’s return profile in both inflation and deflation, without being subject to the manipulation that affects gold. Central banks are not concerned with disorderly price increases in the art market and do not intervene to stop them. Investors should focus on established artists, avoiding fads that may fall out of favor. Paintings are also portable and offer extremely high value for weight. A $10 million painting that weighs two pounds is worth $312,500 per ounce, over two hundred times gold’s value by weight, and will not set off metal detectors. High-quality art can be acquired for more modest sums than $10 million through pooled investment vehicles that offer superb returns, although such vehicles lack the liquidity and portability of outright art ownership.
Alternative funds. This includes hedge funds and private equity funds with specified strategies. Hedge fund strategies that are robust to inflation, deflation, and disorder include long-short equity, global macro, and hard-asset strategies that target natural resources, precious metals, water, or energy. Private equity strategies should likewise involve hard assets, energy, transportation, and natural resources. Funds relying on financial stocks, emerging markets, sovereign debt, and credit instruments carry undue risk on the paths that lie ahead. Hedge funds and private equity funds offer various degrees of liquidity, although certain funds may offer no liquidity for five to seven years. Manager selection is critical and is much easier said than done. On balance, these funds should find their place in a portfolio because the benefits of diversification and talented management outweigh the lack of liquidity.
Cash. This seems a surprising choice in a world threatened with runaway inflation and crashing currencies. But cash has a place, at least for the time being, because it is an excellent deflation hedge and has embedded optionality, which gives the holder an ability to pivot into other investments on a moment’s notice. A cash component in a portfolio also reduces overall portfolio volatility, the opposite of leverage. Investors searching for an ideal cash currency could consider the Singapore dollar, the Canadian dollar, the U.S. dollar, and the euro. Cash may not be the best investment after a calamity, but it can serve the investor well until the calamity emerges. The challenge, of course, is being attentive to the indications and warnings and making a timely transition to one of the alternatives already mentioned.
On the whole, a portfolio of 20 percent gold, 20 percent land, 10 percent fine art, 20 percent alternative funds, and 30 percent cash should offer an optimal combination of wealth preservation under conditions of inflation, deflation, and social unrest, while providing high risk-adjusted returns and reasonable liquidity. But no portfolio intended to achieve these goals works for the “buy-and-hold” investor. This portfolio must be actively managed. As indications and warnings become more pronounced, and as greater visibility is offered on certain outcomes, the portfolio must be modified in sensible ways. If gold reaches $9,000 per ounce, there may then come a time to sell gold and acquire more land. If inflation emerges more rapidly than expected, it may make sense to convert cash to gold. A private equity fund that performs well for five years might be redeemed without reinvestment because conditions could be more perilous by then. Precise outcomes and portfolio performance cannot be known in advance, so constant attention to the seven signs and a certain flexibility in outlook are required.
Although the scenarios described in this book are dire, they are not necessarily tomorrow’s headlines. Much depends on governments and central banks, and those institutions have enormous staying power even while pursuing ultimately ruinous policies. The world has seen worse crises than financial collapse and lived to tell the tale. But when the crash comes, it will be better to be among those who have braced for the storm. We are not helpless; we can begin now to prepare to weather the inevitable outcome of the hubris of central banks.
AFTERWORD
When I wrote Currency Wars in 2011, I diagnosed various dangers in the financial system and prescribed concrete steps policy makers might take to mitigate those dangers. I identified ways to reverse monetary and fiscal policy blunders around the world, particularly in the United States. My tone was cautionary but hopeful. I specifically said it was late, but not too late, to undo the damage caused by bankers and restore the financial system to a sound footing that would support commerce instead of trying to siphon it dry.
In the two and a half years since I completed Currency Wars, conditions have indeed changed—but not for the better. Elites who in former times were self-sacrificing have become self-serving. The world has passed the point where there is much prospect of soft landings; there are no easy exits from the policy mistakes that have been committed. All that remain are hard choices.
The hoped-for mild, middling inflation that becomes self-sustaining and seems to lift all boats with money illusion is not in the cards. There is only high inflation, deflation, disorder, default, and repression on offer. Exact paths and outcomes cannot be predicted, but severe consequences can be foreseen. These consequences may play out over considerable periods of time, but the underlying processes have already commenced.
The collapse of the dollar and the collapse of the international monetary system are one and the same. Threats to the dollar are ubiquitous—lost confidence, financial war, regional hegemons, hyperinflation, and more. These threats are looming larger and may even converge as inflation erodes confidence and emboldens enemies in a
feedback loop that gains energy like a hurricane on warm water. The savings of everyday citizens are in the path of the storm.
Policy makers may not be alert to the dangers surrounding the dollar, but savers and investors show much better sense. A tide in the direction of hard assets is perceptible and growing stronger.
It may be too late to save the dollar, but it is not too late to preserve wealth. We live in an ersatz monetary system that has reached its end stage. In our time, the aureate has become brazen—the golden has become brass. A return to true value based on trust is long overdue.
ACKNOWLEDGMENTS
My sincere thanks go to Melissa Flashman and Adrian Zackheim for first encouraging me to write on the challenging subject of international economics several years ago and for supporting me in this task ever since. The Death of Money would not exist without their help and guidance.
There is scarcely a manuscript that cannot be improved by good editing, and I was fortunate to have one of the best editorial teams around to help with The Death of Money. Will Rickards deftly handled the daunting burden of first-draft editing. Hugh Howard did a fine job as development editor, enlivening didactic structures. Janet Biehl’s attention to detail as copy editor rivaled that of Sherlock Holmes, with felicitous results. Niki Papadopoulos, senior editor at Portfolio, was an inspiring muse and rode herd on the entire process. The quality of this book owes a lot to all of them. Any remaining errors are entirely my responsibility.
I am fortunate to have close friends among economists and market professionals, who provide me with candid advice when I need to try out new ideas or explore those of others. I have benefited greatly from their acumen, and I thank John Makin, Dave “Davos” Nolan, Peter Moran, Chris Whalen, Bob Rice, Sorin Sorescu, Benn Steil, Steve Cordasco, John Cassarini, Roger Kubarych, Steve Halliwell, Komal Sri-Kumar, Don Young, Richard Duncan, and Art Laffer for their generosity of time and spirit to help me make sense of an opaque financial landscape.
I owe a special debt to Ken Dam, who literally wrote the book on the IMF, gold, and SDRs. His 1982 classic, The Rules of the Game, is the indispensable source for understanding the IMF today. I follow humbly in his footsteps.
My many invitations to discuss finance in the public square of television, radio, and the Internet have helped to sharpen my analyses in ways that have contributed to this book. My sincere thanks go to Deirdre Bolton, Lauren Lyster, Adam Johnson, Vielka Todd, Max Keiser, Stacy Herbert, Kathleen Hays, Demetri Kofinas, Amanda Lang, and Annmarie Hordern for inviting me onto your programs and holding my feet to the fire through countless discussions of the euro, gold, the Fed, China, and the new depression.
Today a book on finance is as much about Washington as it is about Wall Street, and I am grateful to my friends in public policy, national security, and the media in Washington who have guided me through thickets inside the Beltway. Thank you to Taylor Griffin, Charles Duelfer, Joe Pesce, Mike Allen, and Rob Saliterman for your friendship and great advice.
Of all the research challenges I faced in writing this book, the most daunting involved the mysterious inner workings of the global gold market. I would not have been able to meet this challenge without the assistance and guidance of gold market professionals and friends Alex Stanczyk, Philip Judge, Chris Blasi, Ben Davies, John Hathaway, Ronni Stoeferle, Mark Valek, and Jan Skoyles. Thank you all.
Some of my most valuable guidance came from friends and family who read early drafts of this book, not as experts but as everyday citizens concerned about the economy and the country as a whole. I am grateful to Glen Rickards, Joan and Erv Hobson, Diane Rickards, Gwendolyn van Paasschen, and Bruce Orr for their feedback and early warnings about passages that were too dense or took too much for granted.
My immediate family was a continuous source of support and encouragement. My daughter, Ali; my son Will; my son Scott; his wife, Dominique; and their children, Thomas and Samuel, never cease to amaze me as they grow, prosper, and confront the same economic challenges I write about in this book. They are the future, and their generation gives reason for hope despite the hurdles put up by my own generation. I am deeply indebted to my wife, Ann, for her love, consolation, and endless encouragement. I’m grateful to my entire family for your immense patience during my long stretches of antisocial behavior known as writing. I love you all.
NOTES
Introduction
“Suddenly Americans traveling abroad . . .”: Janet Tavakoli, “Who Says Gold Is Money (Part Two),” Financial Report, Tavakoli Structured Finance, August 30, 2013, http://www.tavakolistructuredfinance.com/2013/08/tavakoli-says-gold-is-money.
Chapter 1: Prophesy
“It was the most blatant case . . .”: John Mulheren, conversation with the author, CIA Headquarters, September 26, 2003.
His conviction was based on testimony . . . : John Mulheren’s 1990 conviction was overturned by the Second Circuit Court of Appeals in 1991. This complete exoneration allowed his return to the securities industry.
September 5, 2001, was the day Osama bin Laden learned . . . : Elisabeth Bumiller, “Bin Laden, on Tape, Boasts of Trade Center Attacks; U.S. Says It Proves His Guilt,” New York Times, December 14, 2001, http://www.nytimes.com/2001/12/14/world/nation-challenged-video-bin-laden-tape-boasts-trade-center-attacks-us-says-it.html. The September 5 reference is to the New York time zone where markets were still open. Bin Laden made the remarks in Afghanistan on September 6, 2001, local time, 9.5 hours ahead of New York.
“I say the events that happened on Tuesday . . .”: Tayser Allouni, “A Discussion on the New Crusader Wars,” October 21, 2001, http://www.religioscope.com/info/doc/jihad/ubl_int_2.htm.
as well as family and friends: National Commission on Terrorist Attacks upon the United States, The 9/11 Commission Report (New York: W. W. Norton, 2004), pp. 222, 237.
A normal ratio of bets . . . : For options trading data, see Allen M. Poteshman, “Unusual Option Market Activity and the Terrorist Attacks of September 11, 2001,” Journal of Business 79, no. 4 (July 2006), pp. 1703–26, http://www.jstor.org/stable/10.1086/503645.
“Exhaustive investigations by the Securities and Exchange Commission . . .”: National Commission on Terrorist Attacks, 9/11 Commission Report, p. 172.
the pre-9/11 options trading was based on inside information: See Poteshman, “Unusual Option Market Activity”; Wing-Keung Wong, Howard E. Thompson, and Kweechong Teh, “Was There Abnormal Trading in the S&P 500 Index Options Prior to the September 11 Attacks?” Social Science Research Network, April 13, 2010, http://ssrn.com/abstract=1588523; and Marc Chesney, Remo Crameri, and Loriano Mancini, “Detecting Informed Trading Activities in the Options Markets,” Swiss Finance Institute Research Paper no. 11-42 (July 2012), http://ssrn.com/abstract=1522157.
The leading academic study of terrorist insider trading . . . : Poteshman, “Unusual Option Market Activity.”
These techniques have proved reliable . . . : Erik Lie, “On the Timing of CEO Stock Option Awards,” Management Science 51, no. 5 (May 2005), pp. 802–12, http://www.biz.uiowa.edu/faculty/elie/Grants-MS.pdf.
“There is evidence of unusual option market activity . . .”: Poteshman, “Unusual Option Market Activity,” p. 1725.
“Companies like American Airlines, United Airlines . . .”: Chesney, Crameri, and Mancini, “Detecting,” p. 19.
“The system was blinking red”: George Tenet quoted in 9/11 Commission Report, p. 259.
“Get down to Disney World . . .”: George W. Bush quoted in Andrew J. Bacevich, “He Told Us to Go Shopping,” Washington Post, October 5, 2008, http://articles.washingtonpost.com/2008-10-05/opinions/36929207_1_president-bush-american-consumer-congress.
“CIA’s Financial Spying Bags Data on Americans”: Siobhan Gorman, Devlin Barrett, and Jennifer Valentino-Devries, “CIA’s Financial Spying Bags Data on Americans,” Wall Street Journal, November 14, 2013, http://online.wsj.
com/news/articles/SB10001424052702303559504579198370113163530.
Chapter 2: The War God’s Face
“We studied RMA exhaustively . . .”: Quoted in “The Dragon’s New Teeth,” Economist, April 7, 2012, http://www.economist.com/node/21552193.
This classified plan, called “Air-Sea Battle” . . . : Greg Jaffe, “U.S. Model for a Future War Fans Tensions with China and Inside Pentagon,” Washington Post, August 1, 2012, http://articles.washingtonpost.com/2012-08-01/world/35492126_1_china-tensions-china-threat-pentagon.
“In the near future, information warfare . . .”: Major General Wang Pufeng, “The Challenge of Information Warfare,” China Military Science, Spring 1995, http://www.fas.org/irp/world/china/docs/iw_mg_wang.htm.
The People’s Liberation Army of China made this doctrine . . . : Colonel Qiao Liang, and Colonel Wang Xiangsui, Unrestricted Warfare (Beijing: People’s Liberation Army, 1999).
“Economic prosperity that once excited . . .”: Ibid.
China had been a net seller . . . : Floyd Norris, “Data Shows Less Buying of U.S. Debt by China,” New York Times, January 21, 2011, http://www.nytimes.com/2011/01/22/business/economy/22charts.html?_r=0.
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