“The problem with the French is… they don’t have a word for ‘entrepreneur.’” — rumored to have been uttered by President George W. Bush to British Prime Minister Tony Blair

“I get up in the morning,” our friend Juan Enriquez told us during an interview one day late in 2011, “I read the paper and see all the bad things going on with the debt, deficits, wars and the economy. Then I step into a lab and see all the potential breakthroughs the scientists I work with are about to unveil.”

We began following Enriquez with a camera crew not long after our I.O.U.S.A. documentary project had run its course. Among other eccentric pursuits, Juan was a development economist who ran the Urban Development Corp. in Mexico City and later helped finance the mapping of the human genome with Craig Venter.

During I.O.U.S.A., we kept hearing the tandem refrain from men like Buffett, Volcker and Rubin that “Deficits don’t matter” and “We’ll grow our way out of this.” We wanted to learn from entrepreneurs on the front lines… who, in fact, is going to help grow our way out of the debt crisis?

Enriquez’s greatest fear at the time was that the political world would overwhelm the entrepreneurs — and the financial markets they depend on — before their discoveries could get put to good use. In fact, Juan’s bipolar view — debt, deficits and war versus inspiration, innovation and achievement — inspired the theme of our 2013 Agora Financial Investment Symposium in Vancouver: “A Tale of Two Americas.” It was the final Vancouver Symposium we hosted, in fact.

“When you look at the world,” a symposium regular said at the time, expressing a similar sentiment:

“you see one contradiction after another. Cyberwarfare, rogue political leaders, random acts of terror, the militarization of police and expanded surveillance equipment and drone usage make for a future resembling an Orwellian nightmare.

“But at the same time, you can track breathtaking technological breakthroughs in oil exploration and new technologies that will revolutionize our health care, computing, automobiles, communication and agriculture… the many items we use every day.”

China is one such contradiction. For years in these pages, we’ve focused on their economic rise, despite having questions about its sustainability. But despite their economy slowing recently, China’s innovators are making leaps and bounds. It’s estimated that this year, the country will graduate 17,000 postdoctoral fellows in science, math and engineering. That’s a 60% increase from 2010.

They’re building supercomputers that rival IBM’s and 3-D printers big enough to print air wings. The Chinese also granted 217,000 patents last year — a 26% increase in the past two years alone.

German economist Joseph Schumpeter famously observed a similar bipolar disorder during the great credit bust of the 1930s.

“Lack of outlets, excess capacity, complete deadlock,” he wrote in Capitalism, Socialism and Democracy:

“in the end regular recurrence of national bankruptcies and other disasters — perhaps world wars from sheer capitalist despair — may confidently be anticipated. History is as simple as that…

“The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation — if I may use that biological term — that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.”

In his day, Schumpeter witnessed the triumphs of radio, frozen food, the gas stove and the traffic light — all technologies we currently take for granted. But his observations of “how” these innovations come about remain as relevant today as ever.

“Existing structures and all the conditions of doing business,” Schumpeter concluded, “are always in a process of change. Every situation is being upset before it has had time to work itself out. Economic progress, in a capitalist society, means turmoil.”

In an ideal world, entrepreneurs and innovators, the risk-takers, would be free to embrace the turmoil at their own peril. But no… in the real world, we have the meddlers, the world improvers, (ahem) bureaucrats.

Yet two years on, the tug of war between government meddlers and entrepreneurs hasn’t been clearly decided one way or the other. And so, determined to find answers, we pick up our investigation where we left off last.

Over the next few days, we’ll examine the forces of innovation… the countervailing forces emanating from the paper pushers in Washington, D.C., and the net effect both will have on your wealth, the job you hold, the way you raise your children, where you live, how long you live and much, much more.

To kick us off, we feature an edited excerpt from a seminal conversation I had with Juan Enriquez on camera back in 2011.

Read on…

How Innovation Builds and Destroys Society

A Conversation Between Juan Enriquez and Addison Wiggin

Addison Wiggin: I wonder if, to start, we could walk through the different revolutions that have taken place since the founding of the country.

Juan Enriquez: Sure. These days, when your iPhone becomes obsolete every six months and you’re standing in line again to get the newest, greatest whatever, it’s almost impossible to comprehend that during most lifetimes nothing changed in human history.

When you think of the agricultural world and you think of how a peasant lived in Rome and in France over a 2,000-year period, there was almost no difference. How your time was spent — how you’d go out to your crops, how you’d do other task, how you’d be born in a house and usually wouldn’t move more than a few dozen miles from that house — didn’t change much.

This way of life went on for generations and generations and generations. But what the industrial revolution did is all of a sudden it accelerated everything.

With the Industrial Revolution all of a sudden things started to accelerate. Change started becoming prevalent. The speed of introduction of dyes, textiles and more just exploded.

Later, cars meant that you no longer did it at walking speed or horse speed, you did it at ten miles an hour, 50 miles an hour, 100 miles an hour.

Now with the digital revolution what’s started to happen is we’re doubling the amount of data generated by all humans across all time about every five years. Which means every song ever written, every word ever written, every poem, every photograph, every film ever written in human history is going to double over the next five years.

These waves of change that some of us have gotten used to and some of us are terrified by, are accelerating in how fast they’re coming… how quickly they make countries, industries and jobs appear and disappear… and how they up-end your life.

Addison Wiggin: That makes many people fearful. We’ve seen that expressed mostly in political terms. There’s a pessimistic phase underway in politics as people express their fears of change in a negative way.

Juan Enriquez: Today there’s a lot of geographical mobility. You’re not living in the same house your parents grew up in for the most part. Often you’re not living in the same community. And until the housing crash it was common for families in the United States to move time and again and again and again. Now, the housing crash has made it harder to leave one house, sell it and buy another house. But that’ll start happening again. People will start moving.

And when those people arrive in a completely new community, they may be working for a new business because their last one merged or was bought out or went broke. They’ll have completely new neighbors, a completely new community and they’ll be overwhelmed because your kids come home with some gadget or idea that you have no idea how it works, where it came from, how to apply it.

Plus they’ll have to learn all this new technology at work, in their car, in operating a phone, in watching TV, in figuring out a remote, etc.

For a lot of people, instead of being an opportunity and something that they celebrate, these changes become something really scary. So people try to root themselves.

And there’s a whole bunch of hucksters out there who are selling bills of goods that are really dangerous. Those bills of goods say if only we keep the foreigners out we’ll be safe. Don’t bring any more smart college students or Ph.D.s; kick them out of the country.

There are people who say if only women knew their place, then things would go back to the way they were. There are people who are telling you if you get more and more and more conservative in your religious or ethical beliefs, and if you’re able to impose your beliefs on a broader swath of society, then all this will stop.

The answer is no. That’s the way you destroy a society.

These waves of change may or may not occur specifically in your community, in your state, in your country or in your region. But they’re going to occur because this technology’s going to come. And if we don’t learn to live with it, if we don’t learn how to teach our kids about these changes, we become one more of those societies that became archeological ruins.

What we have to remember is all of the greatest societies in the world — all of the greatest civilizations — eventually got scared of change, quit adapting and adopting and became ruins.

Ruins are wonderful to climb… they’re wonderful to photograph… they’re wonderful to visit on cruise ships… but they’re irrelevant as economies and cities and past civilizations and opposed to current ones.

Addison Wiggin: I’m interested in the tension between politics and innovation. Can you expand on that?

Juan Enriquez: In any society that is changing at a very rapid clip, there are always going to be people that say “slow down the train or stop the train, I don’t want any more change. I wanna go back to the good old days.”

The first problem with that is, the good old days really weren’t for the most part the good old days. The amount of violence in human history a century ago, two centuries ago, five centuries ago, a millennia ago, is on order of magnitude greater than what we live with today. The average lifespan just over a century ago was about half of what it is today. The average state of education and health in women was not particularly good in the good old days.

People have this Pollyanna image in their minds of where we were and where we came from. That becomes accentuated particularly when these upheavals of jobs, cities and civilizations come through.

In that environment there you see the politics of conservatism. It’s the politics of “if only things went back to the way they were.”

If only women weren’t so vocal. If only there weren’t so much change. If only these folks with brown skin and strange accents weren’t walking around our streets — then things would go back to the white picket fence. Things would go back to the nine-to-five job. Things would go back to having one job across your entire lifetime and security.

The answer is no. That’s simply not coming back. It’s simply not going to happen. That’s not the way the world is working, today. But it’s a very tempting vision…

We have an incredibly ironic situation today. The billionaire is paying less in taxes than every person who’s working for him. And when you see an elevator operator who is barely making ends meet paying less a billionaire over here, and you see the maid paying more over there. And you see the waiter, and the cook, and the secretary all paying more. And you’re cutting school systems, and you’re telling smart foreigners not to come here. Or you’re telling people that the way this society gets ahead is by restricting other people’s rights, by putting more regulation onto them, by having a privileged class in a society.

That’s a place where problems and injustice begin to spread so broadly that you are going to have a revolution. It’s going to be a serious revolution, too, because the gaps have gotten too wide.

Addison Wiggin: Can you characterize the revolution that would happen in response to injustice? In our discussions you’ve mentioned you were fearful that the political revolution that could happen and impede the benefits of a scientific revolution.

Juan Enriquez: One of the things that is hardest to understand and wrap your mind around is the cost of not acting. Part of why regulation and politics can be so damaging and insidious is because they can sound perfectly rational and at the same time have some absolutely horrifying effects. Let me give you a couple of examples…

We’ve put out exactly the same number of medicines per year since 1985. But during that period — when we’re putting out 25-35 new medicines per year — the research budgets have absolutely gone through the roof.

The cost of bringing a medicine to market has gone from about $40 million to about a $1.2 billion. When you think of the change in the cost per medicine — how many dollars you have to invest to get that new pill — productivity has just dropped off a cliff. It’s just two or three orders of magnitude what it was a decade or two ago.

Why is that happening?

Well, part of it is because discovery’s getting harder. But part of it is because we’ve gotten so scared and focused on regulation, that what sounds perfectly reasonable becomes completely unreasonable.

One of the things people want is completely safe medicines. If we applied that same mindset to staircases, we wouldn’t have staircases. If we applied that to automobiles, automobiles would cost a million dollars or two million dollars or five million dollars each. And they’d be like armored tanks surrounded by plastic balls that could only be driven on Sundays when certain people weren’t on the road.

I’ll give you a second example. People thought when airbags were being introduced that maybe airbags when they blow up will hurt pipe smokers. And so they didn’t deploy airbags for a while. It was possible that pipe smokers could be hurt when the airbag inflates, but the cost of not deploying those airbags — in terms of thousands of lives saved by airbags every year — I think significantly exceeds the potential number of pipe smokers who would be hurt.

What we have to do when a politician comes up with an easy solution or says regulate more, or let me protect you more, or let me give you more, we have to ask the question: What is the cost of acting and what is the cost of not acting?

That is particularly important during a period where the national debt of the United States has grown to an absolutely unmanageable level. It’s particularly important in the United States during a period of time when what we’ve promised people we will give them — in retirement benefits, in medical benefits, in a whole series of other benefits — is going to exceed the entire budget of the United States. All of the budget — from every source, from every taxpayer in the reasonably near future — and we’re talking in less than a decade.

So, we have to adjust, we have to help regulation become reasonable. We can’t keep putting out hundreds of thousands of pages every year that try and regulate every aspect of every potential thing a human does. We can’t have the Congress micromanaging every aspect of the budget to gerrymander their own constituencies. Because if we do that we will kill entrepreneurs and we will kill new industries.

Those industries will go offshore. The life science revolution, for example, if we get scared of it or if it gets politicized and as a result, gets too hard to do it here, you’ll get the same thing that happened with computers and software. They’ll get made elsewhere.

You’ll get the same thing that’s happening with some of the high-end operations for hip replacements or spinal work. It’ll get done in Thailand, it’ll get done in India, it’ll get done in Canada, it’ll get done in Mexico. We have to be really careful with this stuff.

Addison Wiggin: I’d like to push you on this one idea. Is your fear that that would happen before benefits from, say, the life science revolution could be spread to groups on the margin? That that acrimony would grow quicker than the economy could accommodate new groups of people?

Juan Enriquez: I’ll tell you the thing that truly worries me about the United States in an absolutely fundamental way. This has always been a country that is reasonably moderate, open, welcoming, accepting, and that allows generations of people to rise up and do very well.

We saw that with waves of German, Irish and Hispanic immigrants and with very gradual improvement in African-American populations. But at this point we can go horribly off track if we think the only choices we can make in this society are either “you’re on the side of Howard Stern or you’re on the side of Rush Limbaugh.”

When politics becomes a caricature of either Howard Stern or Rush Limbaugh, and you’re voting 100% on this side or this side, then countries divide and fight. At that point, all this incredible opportunity to build things and all these incredible discoveries go horribly wrong because it becomes illegitimate to even talk to one another.

When you have congressmen and senators who are proud of the fact that they have never sat down to lunch with somebody from the other side, or when you have somebody say “I have a perfect 100% voting record on one side,” what they’re telling you is, “We know the absolute truth. I will never consider the other side, I will never vote with the other side and the other side has absolutely zero to offer me.”

The way you destroy a great country is you move it to the extremes and you eliminate the middle. But the real secret to building jobs, to solving the debt problem, to solving the medical problems, to getting people back into schools, to getting those schools to work is actually to work together with people. Some of those people you’re going to profoundly disagree with, but they are fundamentally decent people. We keep forgetting that.

We keep forgetting — in the same way we have an uncle who we may violently disagree with over politics at the Thanksgiving dinner table, but who’s a fundamentally decent person — who we can work with. That’s the way we have to treat politics. Instead, we’ve eliminated most of the moderates and we’re doing it systematically. We’re putting them up against the wall and we’re shooting them. That’s how you destroy a great country.

One of the things that’s incredibly fun sometimes to watch is full-contact sports. It’s one side against another side. That really works well when it’s football or boxing or full-contact cage fighting. But entertainment translated to politics is really dangerous.

When it’s one side against another side in politics and it’s extremes of being 100% behind Howard Stern or 100% behind Rush Limbaugh, there’s no middle ground. Only one side or the other is going to win. And, in the end, the two people end up really beat up.

But in this case, it’s society that ends up really beat up. It’s society that ends up polarized and not able to fix its schools, or not able to discuss tax policy, or address the deficit, or the other basic issues that affect you and I and everybody else in the society.

Those divided societies end up being societies that don’t survive as nations. Because when you play cage fighting and there’s no quarter on either side and there’s no middle ground and there’s no talking between those two, then countries divide.

By the way, three-quarters of the flags that fly today over the United Nations did not exist 75 years ago. You’re seeing these splits happen in Spain with the Basques and the Catalans and the Galatians. You’re seeing it happening in the U.K. with Northern Ireland, with Wales and with Scotland. You’re seeing it happen in Northern Italy, in Finland, in Canada, in Belgium and in Holland, but we think we’re immune.

We think we can treat everybody else in an absolute winner take all style without consequences. Where “I’ll beat everything out of you. I’ll insult you, I’ll insult your daughters or I’ll insult your kids, I’ll call you ignorant.”

That’s actually really dangerous and our politicians today are being incredibly irresponsible in doing it. They are people who can split a nation by convincing half the nation that the other side are fundamentally evil, Godless, killers or bad people. That’s the wrong way to fix our problems.

Addison Wiggin: Thanks Juan. That’s a good place to stop for now. More to come, later…

Regards,

Addison Wiggin
for The Daily Reckoning

P.S. We’ll have more on this topic all week in the email edition of the Daily Reckoning. Click here now to sign up for free.

The post Innovate or Die appeared first on Daily Reckoning.

“All of the gold in the world was confiscated in 2020,” writes Jim Rickards from the year 2024, “and placed in a nuclear bomb-proof vault dug into the Swiss Alps.

“The mountain vault had been vacated by the Swiss army and made available to the World Central Bank for this purpose. All G-20 nations contributed their national gold to the vault. All private gold was forcibly confiscated and added to the Swiss vault as well. All gold mining had been nationalized and suspended on environmental grounds.”

During a long conversation, not long after we teamed up with Jim, we asked him to speculate on what the world would look like after the House of Cards comes tumbling down. What he came back with a week or so later was a dystopian vision even Orwell would appreciate.

“The purpose of the Swiss vault was not to have gold backing for currencies, but rather to remove gold from the financial system entirely so it could never be used as money again. Thus, gold trading ceased because its production, use and possession were banned. By these means, the G-20 and the World Central Bank control the only forms of money.

“Some lucky ones had purchased gold in 2014 and sold it when it reached $40,000 per ounce in 2019. By then, inflation was out of control and the power elites knew that all confidence in paper currencies had been lost. The only way to re-establish control of money was to confiscate gold. But those who sold near the top were able to purchase land or art, which the authorities did not confiscate.”

Rickards’ America 2024 — replete with microchips embedded in your arm for access to national health care, the abolition of all paper currencies and the digital redistribution of all wealth — caused a stir on the discussion board and in the Daily Reckoning inbox.

“It is hard to grasp a future so bleak, so dystopian,” writes reader Dale Holmgren, “until you realize what’s happened so far. The neighborhood I grew up in 50 years ago in a medium-sized manufacturing city in the Midwest had jobs and was safe. Now there is the noise of guns many nights, and most of the residents are on welfare. Despite this poverty, the price of homes is 500% higher now than then.

“Back then, the national debt was $317 billion. Today, it is $17 trillion. The national population has increased by 77%, while the national debt has increased 5,400%.

“Fifty-six percent of Americans have a subprime credit rating. Total U.S. debt — that is, its government, businesses and people — has gone from about $1.5 trillion to $60 trillion. We are awash in debt. It has infested and infected every aspect our lives.

“Considering the above, is Mr. Rickards’ cautionary tale so outlandish?”

Debt and leverage.

For over a decade, we’ve been on a quest to understand what the endgame of central bank and political meddling in the U.S. economy — and, by extension, the global economy — is likely to be. Jim’s dystopian account of the world in 10 more years is nothing if not entertaining in a macabre sense: a cautionary tale should the policies and models used by the Fed and Congress persist.

For some light background reading, Jim recommended Simply Complexity: A Clear Guide to Complexity Theory, by Neil Johnson. “It’s the best single book I’ve read. Johnson’s one of the founders in the field. This guy’s the real deal. He’s a Ph.D. and Cambridge scholar but has a very clear writing style. He has a whole chapter on finance. And the book is written for average smart people. So you don’t have to say gee, hm, how does this fungus relate to the stock market?”

Rickards quoting from Simply Complexity at random:

“The method that your pension fund manager or stocker broker uses to manage risk, and the contents of your portfolio, will always have one huge built-in limitation. No matter how clever he or she is, it can only be as good as the model he or she employs.

“Financial markets are complex systems. They cannot be described accurately by anything other than the theory of complex systems.

“Standard finance theory may therefore appear to work for a while, but it will eventually fail. And this is far from being a minor flaw since it is precisely these moments when your money is most at risk…

“At this stage, your emotions are probably mixed. On the one hand, it’s fascinating stuff from the point of view of the science of complexity. But on the other hand, it sounds like terrible news for a pensionist in that we cannot trust the standard models of finance.”

“So the standard model that most of the finance world uses to calculate how markets move is not accurate.”

“I don’t know how you can be more blunt,” Jim said looking up after reading from the book.

“At the most basic level,” we asked, continuing what amounts to an interview, “the standard models don’t work because they don’t include feedback loops.”

“Correct,” Jim replied, “They assume equilibrium.”

“And efficiency,” we added.

“They assume efficiency, too,” Jim continued. “Efficiency, equilibrium, random distribution, stochastic method. And all four of those things are wrong. Complex systems are not equilibrium systems. There are feedback loops, and the output is not ordered. Except when sometimes it is. That is the tricky part. The outcome looks ordered until it isn’t.

“As you say,” we agreed, having made similar statements about rising debt and leverages right here in these pages many times, “it’s not a problem until it’s a problem.”

“Right,” Jim went on. “But you can be guaranteed that it will be a big problem. The idea that the crisis is all behind us is dangerous… ‘Oh, that’ll never happen again’… Yeah, right. 1998 was strike one. 2008, strike two. Strike three, you’re out. The next one’s gonna wipe everything out. That’s coming.

“But it doesn’t mean there’s nothing you can do.”

For brevity’s sake, we paraphrase Jim from here:

You have to stop short of saying, “Well, it’s going to melt down on this day.” If that day comes and goes and it doesn’t happen, then you look like an idiot. Instead, go back and read what I said in The Death of Money. There are many possible triggers for the meltdown. If it’s not one, it’ll be another. Either way, you’re going to get the same result.

So set your goals now. Warren Buffett’s bought a railroad. You might be able to do that. But if you’re an individual investor, you can buy some oil, natural gas or hard assets. But do some of those things now. It doesn’t have to be 100% of your portfolio. If I’m completely wrong, you won’t be hurt… and if I’m right, it’ll save your life.

“My mission,” Jim says with a spark of passion, “is to help everyday Americans not be ripped off by people who know better that won’t be honest with the American people. Essentially bankers, government — both parties.

“Christine Lagarde, current head of the IMF, is not a complexity theorist, but she knows it’s all going to crash. And she won’t say that. Janet Yellen actually might not know it’s going to crash, because she’s too much of an egghead. But there are enough people in positions of real power who see what I see and won’t be honest with people about it. And they are perfectly prepared for all those people to lose all their money.

“And I think that’s despicable.”

“Look,” Jim ended somewhat abruptly, “I gotta run. But I’ll come back. I didn’t get my crabcake this time around. I’ll be back, and we’ll cover a lot of the specifics…”

Regards,

Addison Wiggin
for The Daily Reckoning

P.S. In today’s email edition of The Daily Reckoning, we unveiled a way to meet Jim Rickards in person. Jim also wrote to readers to explain why the Fed’s bad models take so long to die. If you’re not subscribed though, you missed out. Signing up is free. Just click here, enter your email, and you’ll begin receiving our daily reckonings. If you like Jim Rickards, it’s the surest way to get content from him that you can’t find anywhere else.

The post When Genius Fails Again, Part III appeared first on Daily Reckoning.

Where were we?

Ah, yes… the sword of Damocles hanging over the global economy.

By June of last year, total world derivatives were estimated at $1.5 quadrillion — (again, 14 zeros!) — an increase of 194% over the avalanche that triggered near financial collapse in the Panic of ’08.

The derivatives book has grown. And so have the banks!

The “too big to fail” banks at the helm during the 2008 crisis are now consolidated and nearly twice as big today as they were eight years ago. We’ll get back to that fact in a moment…

We did a postmortem,” Jim Rickards says, referring again to the fiasco that beset Long Term Capital Management (LTCM) in 1998. “We later said the only mistake we made was we weren’t a bank. If we had been a bank, the Fed would have bailed us out. But we weren’t a bank. We were a hedge fund. We were a bunch of rich guys in Greenwich. Nobody cared about a hedge fund.

“It started with Russia, then it metastasized. So there comes a time when it’s not about the markets anymore. It’s about you. The market is systematically trading against you. How it started doesn’t matter. Where it’s going doesn’t matter. You are not gonna be allowed off the mat.”

And when that happens… everybody wants their money back. Everybody. Things go from bad to worse in a hurry.

“Our agreements,” Jim continues, “which I had written and negotiated, were so tightly drawn that nobody could call us for margin unless there had actually been a mark-to-market loss. There was no extra margin. So when cash went to zero and we actually defaulted, there would be nothing left.

“At that point, we took the whole balance sheet and gave it back to Wall Street… At the time, I said, ‘Look. All that would happen to us is we would have slept in the next day. You guys would have to unwind $15 billion of equities and a trillion dollars’ worth of fixed income on five continents. Good luck.’

“If that had happened, all the Wall Street banks would have failed, starting with Lehman. Lehman was always the weakest one. It would have been Lehman, and then all the dominoes would have fallen. You would have had ’08 and ’98.”

Jim was subsequently retained by the consortium of Wall Street banks that had bailed LTCM out… because he and his team were the only ones who could unwind the trades left on their balance sheets.

“So I did my job,” Jim remembers, “We came out clean, which we should have. That wasn’t a credit to me. That was a credit to everybody. But there was a lynch mob. I mean, the House committees wanted to hang us. The press wanted to hang us. They hired helicopters to fly over our houses. We had camera crews outside. Nobody remembers any of this, but that’s the way it was.

“And I was going through the trauma of having lost all my net worth. If you talk to psychologists, they’ll say the three most difficult things in life are death, divorce and losing money. Fortunately, I only had one out of three. But it was traumatic.”

And so Jim set out on what he describes as a “10-year odyssey” to solve the problem of risk in the financial markets. (He relays much of that odyssey here.)

Here’s where the story takes a turn for the dire. After a 10-year search, including his much vaunted stint with the CIA, Jim is convinced the risk-assessment model the Federal Reserve and the big Wall Street banks are using is flawed.

“My former partner,” Jim says, “our colleagues and myself almost destroyed the world using a certain view of the world. He was on faculty of the Haas School of Business at Berkeley, and had the office next to Janet Yellen’s. He knows Janet very well. After Long Term breaks up. I go through this 10-year odyssey. I figure out that everything those people believe is wrong. This isn’t a belief system. It’s empirically wrong.

“Meanwhile, Janet Yellen goes on to the San Francisco Fed, makes her way to the Board of Governors and becomes chairwoman,” carrying in her back pocket the flawed worldview that took down LTCM nearly 20 years ago.

“It didn’t have to be this way,” Morgan Stanley’s own Stephen Roach lamented as early as 2005. “The big mistake, in my view, came when the Fed condoned the equity bubble in the late 1990s.

“It has been playing post-bubble defense ever since, fostering an unusually low real interest rate climate that has led to one bubble after another. And that has given rise to the real monster — the asset-dependent American consumer and a codependent global economy that can’t live without excess U.S. consumption.

“The real test was always the exit strategy.”

By 2008, that exit strategy included massive consolidation among the world’s biggest banks.

In the late 1990s, JPMorgan, to use just one example, was more than five different banks: The old J.P. Morgan, Manufacturers Hanover Bank, Chase, Chemical Bank and Wachovia. Today all of those banks and more have been mushed together into one $1.6 trillion mega-bank: JPMorgan.

“The so-called Big Four institutions,” a commentator on CNBC reminded us in March, “JPMorgan, Bank of America, Citigroup and Wells Fargo… [have] some $8.2 trillion in total assets. That’s 154% more than the rest of the top 50 banks combined.”

The Fed’s “fixation with the markets,” says Roach, now a senior fellow at Yale University, reiterated this year, “has created a deadly trap… Central banking has lost its way.” The bankers have failed to learn “the lessons… of what they put the world through a decade ago.”

It’s not a stretch to suggest having the entire financial system resting on a few mega-banks turns the global economy into a house of cards. One push and it all falls down. Especially if they’re relying on the wrong model to predict where financial markets are headed.

“After 10 years of research,” Jim summarizes. “I am a thought leader in the application of complexity theory to capital markets. So that’s my contribution. Not every system is complex. My watch is not complex. It’s not gonna turn into a butterfly and fly away. But a complex system might, all right? So my watch is complicated. But it’s not complex.

“A lot of people use those words interchangeably, but in science, they don’t mean the same thing. Complicated means it has a lot of moving parts. Complex means it has feedback loops, so the moving parts can decide to be something else. It’s called adaptive behavior.”

The nuclear meltdown at Fukushima, Rickards says, is a tragedy ripe for understanding how complex systems work. “It started as an undersea earthquake, right? So tectonic plates, that’s one complex system. It snaps, right? Causes a tidal wave. Wave motion is another complex system, right? Hits a nuclear reactor, which is another complex system. And the Tokyo stock market crashes…

“You could do a complexity study on earthquakes, tidal waves, nuclear reactors and stock markets. But what we have with Fukushima are four complex systems, each with an individual cascade, cascading into each other.”

Jim’s not the only thinker trying to apply complexity theory to financial markets, but it’s a very short list. The real hard-shell complexity theorists have gone after biology, climate, earthquakes, forest fires, traffic patterns, cities — they’ve gone after a lot of other problems.

“If you say, ‘A nuclear reactor can melt down,’ everybody understands what that means. You don’t need a physics degree or an economics degree to get it. Three Mile Island. The China Syndrome. Fukushima. Nuclear reactors melt down. Well, you know what? There is no difference, mathematically or dynamically, between a reactor meltdown and a stock market meltdown. There is no difference.

“In the real world, if you put on a trade and you lose money, and you put it on again and lose money, you might not do it the third time. That’s adaptive behavior. Like you change your behavior, your approach to markets must change too.

“The complexity theorists haven’t gone after finance,” Jim says, “because they don’t have the financial chops. The few who have — and there are some — stumble because they’re brilliant physicists but they don’t really know capital markets that well. Because capital markets are a whole world unto themselves.”

When the next crisis hits the financial markets, a similar cascading event is all but predictable. Maybe Morgan Stanley will collapse… then Goldman Sachs… then Citibank close behind… then Bank of America and JPMorgan… until the whole system melts down.

With $3.55 trillion in toxic assets on their books already, will the Fed have enough baking soda on hand to neutralize the reaction? Jim takes a look at six areas where he thinks the Federal Reserve’s economic models are empirically wrong, below.

Tomorrow, as part of our ongoing effort to put Jim’s groundbreaking idea at your disposal, I’ll be unveiling a new opportunity for you. It’s not a newsletter… a book… a video… or anything else we’ve attempted.

But it will be worth your while to pay attention. The event is specifically designed to help you keep your family and your money safe when and if the “house of cards” comes tumbling down.

Watch this space tomorrow…

Addison Wiggin
The Daily Reckoning

P.S. Be sure to sign up for The Daily Reckoning — a free and entertaining look at the world of finance and politics from every possible angle. The articles you find here on our website are only a snippet of what you receive in The Daily Reckoning email edition. Click here now to sign up for FREE to see what you’re missing.

The post When Genius Fails Again, Part II appeared first on Daily Reckoning.

“They had the Ph.D.s,” Jim Rickards was saying, “They had the prizes. They had the Nobel Prizes. They had the faculty positions. They had the thousands of students. They had the prominence, preeminence. And they were all twice as smart as I was.”

Jim was referring to his colleagues, during and after, the collapse of Long Term Capital Management (LTCM) in 1998. Jim not only had a front-row seat as a leading attorney for the firm, but during the bust, he lost 92% of his own net worth… in one week.

“Statistically, they had IQs of 165… they really were twice as smart as I was,” Jim went on “but you guys must’ve got it wrong. You couldn’t — you can’t possibly understand risk. All your models, and all your theories, and all your teaching, and all your learning, and everything you guys stand for can’t be right. Because if it was right, this wouldn’t have happened.”

Not long after the phenomenal meltdown of LTCM, it became obvious to me, and many others, the whole financial system was a house of cards built on leverage and debt.

I moved my family to Paris at the time to help Bill Bonner found The Daily Reckoning. Our goal was then, and remains now, an effort to pull back the curtain and let everyday investors see what goes on in the boardrooms of Wall Street’s biggest banks and in the corridors and meetings rooms of the Capitol in Washington, D.C. We founded Agora Financial with the same mission.

Several years ago, I had a meeting with Jim Rickards. He was slated to speak at our annual symposium in Vancouver, British Columbia.

Jim had already made a name for himself in the research and publishing world, having written Currency Wars and its follow-up The Death of Money, both on subjects I’d written about extensively myself. His experience working with the CIA’s financial risk assessment unit, Project Prophesy, had already made him somewhat of an overnight Internet sensation, too. If you hadn’t been living under large mossy objects in the prior years, it wouldn’t have been difficult for you not to recognize him.

But even then, it was Jim’s back story that captured my attention. Having been inspired by the big bust at LTCM, I was shocked to hear Jim’s day-by-day, firsthand account of the week that it all came crashing down.

“We were there on Sunday. We were there for the whole day. Things were printed out at the time. We didn’t have the Internet,” Jim continued motioning to his iPhone. “So we were turning pages, like here’s our Italian bond position. Here’s our French equity basket position. Here’s our Japanese JGB position. Bum, bum, bum. We had a $1.3 trillion extended balance sheet. This is a hedge fund. This is not a bank. $1.3 trillion in 1998 dollars.

“At the end, Peter Fisher [then head of open market operations at the New York Federal Reserve], his face is white, looks to us and says, ‘I knew you guys could destroy the bond market, but I didn’t realize you could destroy the stock market.’”

At its peak, LTCM was leveraged 250-1. And they had made derivative bets totaling $1.25 trillion that connected them to nearly every market on the globe. Then came the Asian Crisis and Russia’s default on its national debt in August 1998, and the models showing a likely reversion to the mean for trillions in outstanding trades were simply proven wrong.

In an instant, LTCM’s derivative bets started going bad and the firm took $1.85 billion in losses.

“Peter Fisher told us, ‘You guys are gonna close every stock market in the world and every bond market in the world, and take down the banks.’ Now, it looks that way.

“Monday morning, he has breakfast with David Komansky, CEO of Merrill Lynch; Sandy Warner, who at the time was CEO of J.P. Morgan; Jon Corzine, who was CEO of Goldman; and the — oh, it was like the — I think it was the No. 2 guy at Citigroup, down at — Derek Lawn, I think. But we gotta do something. So they cogitate for three days.

“So Wednesday afternoon, we get a term sheet. This is the beginning of the consortium. Fourteen Wall Street banks send us a term sheet for the bailout. Now, they didn’t bail us out. They bailed themselves out, because we were on our way to zero.”

Unlike today’s activist Federal Reserve, the Fed at the time didn’t get involved. “The Fed would say,” Jim recalls, “‘We served warm Cokes, but that’s all we did. We let these guys figure it out among themselves.’ They were Big Brother. But nobody in those days thought the government could do it. I mean, they had the resources, but nobody thought the government had any business bailing out a hedge fund. That idea was way off the table.’”

David Stockman, another friend and colleague, was a partner at Salomon Bros. in the late 1980s when LTCM founder John Meriwether was still at partner at the firm.

“When Meriwether left,” David told us during a meeting we hosted in Baltimore this past Wednesday, “and Rickards and all the rest of them joined him, I knew him pretty well. When he launched Long Term Capital Management, he raised something like a billion dollars, which in those days was unheard of.

“Meriwether had a cocktail party, and he invited to come, so I went. I met Myron Scholes. I had heard of him… I mean Black-Scholes was something I knew of even then. I was speaking to him over a couple of drinks, and I said, ‘What is your strategy in terms of your targets and expected returns and level of risk, and what are you telling these investors?’ Because it was quite a phenomenon that they raised a billion dollars in something like two months.

“And he said, ‘Well, our target return is 45%.’

“I said, ‘Wow! You’re going to take a hell of a lot of risk for that, aren’t you?’

“And he said, ‘None.’

“Because they had a black box. And it worked for like four or five years. The made huge returns, and more money piled in… until 1998, and then the thing blew sky-high.”

The episode is famously described in Roger Lowenstein’s When Genius Failed. Maybe you’ve read it. About 30% of the book is Jim dictating events as they happened directly to Lowenstein.

“What happened,” Stockman helps to explain, “when the crisis came in 1998 — the new Greenspan era — there was a flight from so-called risk on into Treasuries, and Treasuries rallied like never before. What it did was it destroyed their firm in a couple of weeks. Because the hedge that was supposed to be generating offsetting income against the prop trades that were failing actually went against them.

“If you’re massively short the Treasury as a hedge and the Treasury bond is rising, you’re getting killed by your hedge… even as you’re losing a ton on all your various fancy prop trades.

“There had never been one of these massive flights to safety — it never had happened before. So therefore, in their model, there was no case where they would lose money, let’s say, on a high-yield bond, and there was a high-yield bond market then — Russian bonds or whatever.”

It had become a new feature of the Greenspan bubble era. There was never a case where the Treasury would rally when interest rates were rising. It had never happened before. The economic models at LTCM — despite the Nobel Prizes in economics, despite the prestigious chairs at Harvard, Berkeley and Chicago, despite the billions in trades under their belts — couldn’t predict the event. Nor could they help the traders out of a jam. LTCM crashed like a burning zeppelin.

“I had made millions at Greenwich Capital,” Jim Rickards laments, “And then I made millions more at Long Term Capital. I was the highest-paid lawyer on Wall Street. I wasn’t making $25, $30 million. I wasn’t a trader. But for a lawyer to be banging out a couple million dollars a year, I was probably the highest-paid lawyer on Wall Street, other than maybe a litigator who was doing tobacco cases. And I put all that money into Long Term.

“Now, I know that’s stupid. I get it. But I was like, ‘Hey. I’m a lawyer, OK? You guys, you won a Nobel Prize. You’re the head of the finance faculty at Harvard. You’re the head of finance faculty at Berkeley. You’re the head of the finance faculty at the University of Chicago. I’m the dumbest guy in the room. I’m a lawyer. I got all this money. What better thing could I do than give it all to you?’

“So I’m all in at land Long Term Capital, right? A big stack, it was all in Long Term Capital. So that week… I lost 92% of everything. I ended up 8 cents on the dollar. So I wasn’t broke, but I got, like, six figures out of what I put in. Meanwhile, believe it or not — I had actually paid off my mortgage. Big house in Connecticut. I had no debt. But I went and took out a mortgage so I could put more in, because I’m like, what could be better than investing in the Feds, right?

“And I didn’t think about diversification.”

According to the Bank for International Settlements (BIS), on the eve of disaster at LTCM in June 1998, there were about $70 trillion in total world derivatives.

In June 2007, prior to the meltdown of Bear Stearns and the ultimate demise of Lehman Bros. a year later, there were roughly $510 trillion in derivatives outstanding — up 628% from the risky decade before.

By June of last year, by one estimate, total world derivatives were $1.5 quadrillion — that’s 14 zeros — an increase of 194%. What will happen the next time these geniuses fail?

More to come…

Addison Wiggin
The Daily Reckoning

P.S. Be sure to sign up for The Daily Reckoning — a free and entertaining look at the world of finance and politics from every possible angle. The articles you find here on our website are only a snippet of what you receive in The Daily Reckoning email edition. Click here now to sign up for FREE to see what you’re missing.

The post When Genius Fails Again, Part I appeared first on Daily Reckoning.

“To contract new debts is not the way to pay old ones.”

— George Washington

If the history of United States federal budgets — and the debts that grow out of them — tells us anything, it is this: The dollar’s in it up to its eyeballs.

Today’s level of debt and continuing deficit spending is only the visible portion of that problem; beneath the surface we face an unavoidable day of reckoning for our great national pastime: spending money.

Since long before Lord Keynes opened his mouth in the 1930s, the attitude in Washington and among academics has been that we don’t really have to ever repay debt. It can be carried indefinitely for future generations to worry about. Most today would claim that debt doesn’t matter or even that it is a wise policy to spend more than you bring in. The mind boggles.

Early on in U.S. history, we Americans learned from our British ancestors that empires could be built on a foundation of debt — and continued indefinitely. In the early part of the eighteenth century, Sir Robert Walpole introduced an innovative system for financing Britain’s colonial expansion and ever-growing military might. Government, Walpole demonstrated, is able to create a revenue stream by issuing bonds and other instruments. The interest is paid regularly, and eventually, upon maturity, the face value is paid off — and for every maturing bond, a new one is issued.

This simple method for the expansion of revenue through debt was the venue by which Britain built its empire, from the 1720s through the next 100 years. Among those who observed this phenomenon of endless debt financing was the first secretary of the Treasury of the United States, Alexander Hamilton.

In the early days of the American nation, a host of fiscal problems faced Hamilton and the other Founding Fathers. The War for Independence left a large debt; there was no unified currency, and each state issued its own money; the currency itself was of dubious value; and inflation made it difficult to imagine how the young nation would even survive. Hamilton’s view was that growth and expansion would be possible with the use of debt:

“Hamilton’s rationale for a perpetual public debt included his belief that it would help keep up taxes and preserve the collection apparatus. He believed Americans inclined towards laziness and needed to be taxed to prod them to work harder.”

Not everyone agreed. In Thomas Jefferson’s view,

“It was unjust and unrepublican for one generation of a nation to encumber the next with the obligation to discharge the debts of the first. After all, the following generation cannot have given their consent to decisions made by their fathers, nor will they have necessarily benefited from the deficit expenditures.”

During the nineteenth century, American debt did not grow substantially. When Jefferson began his first presidential term in 1801, the nation had an $83 million debt, mostly left over from the costs of the war. During his two terms, Jefferson reduced the debt to $37 million even after spending $15 million on the Louisiana Purchase.

In James Madison’s term of office, the ill-fated War of 1812 ran the national debt up to $127 million by 1816. James Monroe and John Quincy Adams were both able to reduce the debt during their terms of office, and by 1829 the debt had fallen to $58 million. And then, during Andrew Jackson’s presidency, the national debt entirely paid off. For the first time in its history (and the last) the United States had no national debt.

Over the next decade, the country ran up $46 million new debt and by 1848 the national debt had risen to $63 million. However, in all fairness, one advantage of this was that the Mexican War resulted in U.S. expansion all the way to the Pacific and the acquisition of the entire Southwest, including California. Under the Franklin Pierce administration, the debt was paid down to $28 million; but it never got that low again.

The Civil War exploded the national debt up to $2.8 billion, or 100 times higher than it had been in 1857. Debt in 1860 was $2 per capita; at the end of 1865, per capita debt was $75. The temporary tax measures in place during the war were repealed, and by the end of the nineteenth century the debt had been reduced to $1.2 billion, less than half of its 1865 level.

Given the case expansion of U.S. territory and the wars the country fought to create and then hold together the United States, this does not seem large debt level. In fact, in its first 110 years, the United States had shown its ability to fund expansion while reducing debt over time. And this was accomplished without an income tax. In fact, in 1869 and again in 1895, the Supreme Court ruled federal income taxes unconstitutional.

The story was quite different in the twentieth century. By the end of World War I, the national debt had risen to $26 billion. Even though the debt level had been reduced over the next decade, the Great Depression caused further deficit spending, and FDR’s New Deal Tripled debt levels up to $72 billion.

World War II created yet higher debt levels. By 1945 the country owed $260 billion — small by today’s standards but gargantuan in its time. One outgrowth of that war was a new one, the Cold War. Military spending took the national debt up to $930 billion by 1980, and under Ronald Reagan’s administration it rose to nearly $2.7 trillion. In Bill Clinton’s eight years, the debt more than doubled to $5.6 trillion. And by the end of 2007, the debt had passed $9 trillion — a nearly tenfold increase since 1980. The debt almost doubled during George W. Bush’s eight years — from $5.7 trillion to $10.7 trillion.

In other words, the national debt is growing exponentially. We may blame the War on Terror, the inheritance left by the Cold War, or the new international market and its competitive forces, or a combination of these realities. In any event, it is clear that the levels of debt keep setting new records, virtually on a month-to-month basis.

[Ed. note. Back in 2005, we wrote, “The U.S. debt is growing at a rate of $1.4 billion a day, $1 million a minute; the most famous debt clock in the country, located on Times Square in New York City, will become obsolete once it hits the $10 trillion mark.” That figure seems so quaint now. Today, the growth rate of government debt is clocks in at $16,668 per second and over $60 million per hour. The total national debt exceeds $18 trillion and is 104% of the total economic output of the country for a single year.

Whatever became of the debt clock in Time Square? The display ran “out of digits when the U.S. gross federal debt rose above $10 trillion on Sept. 30, 2008,” reads the Wikipedia citation on the clock, “An overhaul or complete replacement adding two more digits to the clock’s display is currently being planned.” Apparently, even those maintaining the clock have lost any urgency on the matter.

We return now to our classique…]

I love the following comments, issued in a joint October 2007 statement by Henry Paulson, then secretary of the U.S. Treasury, and Jim Nussle, then director of the Office of Management and Budget under George W. Bush.

Paulson: “This year’s budget results demonstrate the remarkable strength of the U.S. economy. This strength has translated into record-breaking revenues flowing into the U.S. Treasury and a continued decline in the federal budget deficit.”

True, but: We still have a deficit.

Nussle: “Our short-term budget outlook is improving, but beyond the horizon is a huge budgetary challenge — the unsustainable growth in Social Security, Medicare, and Medicaid; … for the sake of our children and grandchildren, Congress should begin to take action prevent this fiscal train wreck.”

This chart shows the shows the level of the U.S. national debt from 1929 to the present:

In reviewing all of this history, we make a distinction between debt levels and deficit spending. Many people are still confused about the differences, and some, even experts, use debt and deficit interchangeably.

A debt is the amount of money owed. A deficit is the shortfall in a current budget. For example, if we begin the year in with a $6 trillion national debt, and during the year we spend $1 trillion more than we bring in, we are running a deficit of $1 trillion. By the end of the year, that deficit will have increased the debt to $7 trillion….

Hence our forward progress, today, to a total national debt of $18 trillion and beyond.

Fun facts for your weekend: If you broke down the debt as of today, Friday, Feb. 13, 2015, into $1 bills, you could wrap them around the Earth 70,585 times. Stack them on top of each other and you would make a pile 1.2 million miles high… the equivalent of five lunar flights to the moon.

Of course, we don’t use paper for our paper money anymore. Only electronic digits. What you can’t see… can’t hurt you, right? Riiiight.

Regards,

Addison Wiggin
for The Daily Reckoning

P.S. Be sure to sign up for The Daily Reckoning — a free and entertaining look at the world of finance and politics from every possible angle. The articles you find here on our website are only a snippet of what you receive in The Daily Reckoning email edition. Click here now to sign up for FREE to see what you’re missing.

The post Attention to Deficits Disorder appeared first on Daily Reckoning.

Jim Rickards is no ordinary hedge fund manager. Lots of guys can boast 35-year careers on Wall Street.

Only Rickards is also a lawyer who was the chief negotiator during the 1998 rescue of Long-Term Capital Management — in which 14 of the world’s biggest banks ponied up $3.6 billion to prevent a global financial meltdown. And only Rickards is a consultant to the Pentagon who walked senior military planners through their first-ever “financial war game.”

His best-selling book Currency Wars opens with a two-chapter account of this war game — held at the Warfare Analysis Laboratory in Laurel, Maryland — a strategy room whose website boasts “14 plasma displays for defense exercises” and “3-D scenario modeling and visualization.”

The financial war game was made more intense by the fact it took place amid the market panic in late 2008 and early ’09. We won’t give too much away here; suffice it to say Team Russia announced it would accept only gold in exchange for its oil and gas — no dollars. Then Team China made its own move to “tighten the noose around the U.S. dollar’s neck.”

As it happened, on the second and final day of the war game, Russia’s Vladimir Putin declared of the dollar, “The one reserve currency has become a danger to the world economy: that is now obvious to everybody.”

Rickards believes the real currency war presaged by Putin began in early 2010. He labels it Currency War III.

“Currency wars,” Rickards writes, “are fought globally in all major financial centers at once, 24 hours per day, by bankers, traders, politicians and automated systems — and the fate of economies and their affected citizens hang in the balance.”

Both previous currency wars both took place within the last century. Currency War I erupted from the ashes of World War I in 1921 when Germany began its epic devaluation of the mark — the one memorialized in pictures of wheelbarrows full of paper money that weren’t enough to buy a loaf of bread.

Thus did the rest of the world race to devalue their own currencies to remain “competitive.” France leaped first in 1925, devaluing the franc. Britain abandoned the gold standard in 1931. The United States infamously devalued the dollar against gold in 1933 — from $20.67 an ounce to $35. France and England devalued again.

“In round after round of devaluation and default,” Rickards writes, “the major economies of the world raced to the bottom, causing massive trade disruption, lost output and wealth destruction along the way.”

Currency War I ended in a whimper in 1936 with a three-way deal between the United States, Britain and France. Germany by that time was goose-stepping to its own drummer, and a shooting war followed three years later.

Currency War II blew up in 1967 when Great Britain devalued the pound against the dollar. Soon the dollar itself was under pressure — a matter complicated by the fact the dollar was still tied to gold in international trade.

The rest is monetary history: France turned in scads of dollars for America’s gold, nor were the French alone. The Treasury’s gold supply dwindled from 20,000 metric tons in 1950 to barely 9,000 when President Nixon “closed the gold window” in 1971. The entire world was now on a floating fiat currency standard.

The dollar sank throughout the ’70s, but soared in the early ’80s under Federal Reserve Chairman Paul Volcker. The world’s other principal currencies, the Japanese yen and West German mark, went on a roller-coast ride the whole way. Exhaustion set in. The Plaza Accord of 1985 set the dollar on another downward trajectory, and the Louvre Accord of 1987 resulted in equilibrium — more or less.

“There was relative peace in international monetary matters,” Rickards writes, “yet this peace rested on nothing more substantial than faith in the dollar as a store of value based on a growing U.S. economy and stable monetary policy by the Fed.”

That faith finally broke in early 2010.

On Jan. 27, 2010, President Obama fired the first volley of Currency War III in his State of the Union speech. He announced the National Export Initiative. Its aim — to double U.S. exports in five years.

“The traditional and fastest way to increase exports had always been to cheapen the currency,” Rickards writes in Currency Wars. And everyone around the world knew it.

Later in 2010, the Federal Reserve stepped in with a second round of “QE,” or money printing. “By using quantitative easing to generate inflation abroad, the United States was increasing the cost structure of almost every major exporting nation and fast-growing emerging economy in the world all at once.”

And so began another race to the bottom, a new round of competitive devaluations. “We’re in the midst of an international currency war,” declared Brazil’s finance minister Guido Mantega in September of 2010, “a general weakening of currency.”

No one will be left untouched by Currency War III, but Rickards says it will take place in three major theaters. In two of the theaters, the combatants have mutual aims. The third is the most likely source of outright conflict.

The Atlantic theater is the balance between the United States and the eurozone. “The euro and dollar,” writes Rickards,” are best understood as two passengers on the same ship… moving at the same speed, heading for the same destination.”

The euro topped at $1.59 in July 2008 and bottomed at $1.10 in June 2010. As we go to press, it’s at $1.29 — essentially where it was in early 2007, and again in early 2011.

That relative stability is no accident: Washington aims to prop up the euro to the point of the Fed engineering a secret bailout of European banks in 2008 — $3.08 trillion in loans that became public only in 2011.

The Eurasian theater of the war, meanwhile, is the balance between Europe and China. “China has a vital interest in a strong euro,” Rickards writes — not least because the European Union is China’s largest trading partner, larger even than the U.S.

Bottom line: “Europe, China and the United States are united in their efforts to avoid a euro collapse despite their mixed motives and adversarial postures in other arenas.”

Which brings us to the Pacific Theater — the big show.

The U.S. trade deficit with China was less than $50 billion in 1997. By 2006, it swelled to $234 billion. Politicians grandstanded about American jobs “lost forever to China” and Chinese leaders “manipulating” their currency.

Never mind that the evidence linking currency value to jobs is, er, slim at best. Even if the yuan doubled in value, Rickards points out a Chinese furniture maker would be making $236 a month — and a furniture maker in North Carolina still wouldn’t be competitive.

If we still had a gold standard — or even the Bretton Woods system in place between 1944-71, such yawning trade gaps would be impossible. The flows of gold between creditor and debtor nations — consider our example at the start of the issue — would, naturally, maintain an equilibrium.

Meanwhile, manipulation is a two-way street: “China’s policy of pegging the yuan to the dollar,” Rickards writes, “was based on the mistaken belief and misplaced hope that the Fed would not abuse its money printing privileges.”

Fool me once…

“Given the choice,” Rickards writes, “between uncontrolled inflation with unforeseen consequences and a controlled revaluation of the yuan, the Chinese moved steadily in the direction of revaluation beginning in June 2010, increasing dramatically by mid-2011.”

You can see the result in the chart nearby. Through mid-2010, it took 6.8 yuan to equal one U.S. dollar. But with the conscious decision to strengthen the Chinese currency, it now takes barely 6.1 yuan to equal a dollar.

Thus, “the United States had won round one of the currency wars.” There will be more to come.
“Everything’s a cross rate,” Jim says. “There’s a dollar euro cross rate. There’s a dollar yen cross rate. There’s a dollar Chinese yuan cross rate, Swiss francs and so on. And it’s dynamic. The dollar could be going up against the Euro, which it has been lately but going down against the Chinese yuan.

“Is the dollar going up or down? Well, the answer is compared to what? And this is what we do in currency wars. We look at this. We understand these dynamics. We understand that any two currencies are a zero sum game.”

Regards,

Addison Wiggin
for The Daily Reckoning

P.S. We cheated a bit today. In the Daily Reckoning’s e-letter, you could’ve caught an exclusive sneak peek of Jim’s welcome video for his new Currency Wars Alert. While Jim gets into a groove, it’s only for Agora Financial Reserve members. But if you subscribe to receive the Daily Reckoning sent to your mailbox for free each day, you’ll get a special opportunity to join it on Monday. Click here to sign up for free.

The post The Currency Wars of the 20th Century appeared first on Daily Reckoning.

As economist Hyman Minsky showed, booms actually play an important economic role — they focus resources on an up-and-coming sector and speed its development. Investors are not crazy to put money into a boom at the beginning; they are crazy to do so at the end, when prices have become absurd. The bust phase of an investment mania comes about when reality begins to nag, profits are not realized, and confidence turns to trepidation. . . and then fear.

A big bust is often accompanied by rapid reductions in the money supply and a contraction of credit, as creditors fear lending to riskier and riskier clientele. Following the deflation of the John Law’s Mississippi bubble in 1720, despite the aggressive efforts of Philip II to stop it, the money supply in France decreased rapidly. The savviest investors physically removed the gold and silver coins from the country.

Having lost confidence in the paper money, spooked merchants and traders engaged in widespread hoarding of the coins, stuffing them in mattresses and burying them in holes in the ground. And bank credit shrank. Another edict stating that all notes bearing a value between 1,000 and 10,000 livres could only be used to buy government bonds, Compagnie des Indes shares, or be placed in bank accounts further reduced the money supply.

Once thought to be greater than the king himself, Law was forced, under protection of the royal guards, to live in the Palais Royale. At one point, when a mob saw his carriage pass, instead of trying to get a glimpse of the man, it attacked the carriage and smashed it to bits. Luckily for Law, he was not inside.

Later, Law was given permission by Philip II to leave France altogether — disgraced and in debt to the tune of 6.7 million livres. By the time of his death in Venice in 1729, Law, the man “ of cool calculation and dazzling innovative ideas” would, by outward appearance, be “ but a shadow of his former self. . . reduced to an aging trembler with a pronounced tic. ” But, always the schemer, Law held one more surprise for French and British ambassadors sent to review his estate.

An inventory of Law’s wealth in 1729 revealed 81 boxes of paintings, sculptures, musical instruments, and furniture. Among the 481 paintings, were originals by some of the great masters. The first page of the inventory, Trinity College Dublin professor and Law biographer, Antoin Murphy, tells us, lists 22 paintings including a Titian, a Raphael, four Tintorettos, and a Paolo.

“Flicking through the inventory, other great names appear, ” Murphy writes, “ including Holbein, Michelangelo, Poussin, Leonardo da Vinci, and no less than three Rubens! ”

Not surprisingly, following the collapse of the Mississippi Scheme, John Law was the target of enough satirical engravings to fill a popular collection — published in 1720 in Holland, under the title, The Great Mirror of Folly.

One famous engraving — a frontispiece for a short play about the mania — depicts a crowd of share speculators surrounding Law on the rue Quincampoix. The caricature of Law in the scene shows him ingesting gold and silver coins fed to him by the Duc D’Orleans, converting them into paper internally, shall we say, and a frenzied group of investors collecting the bills that fall from his backside.

One of the central tenets of Law’s theory had been proven wrong. Once confidence is shot, a central bank cannot manage the money supply. Still, the idea persists. John Law died in disgrace, but central banking was a big a hit. The first modern central bank with any staying power, the Bank of France, was set up less than a century later following another financial disaster: the French Revolution.

There are minor investment manias, and there are major ones. Over the nearly 300 years following the Mississippi mania, the setting for investment manias has repeatedly changed, but the love interest, the dialogue, and the dramatic tension have largely remained the same.

“ The saga of the Mississippi scheme [and the South Sea bubble] is historically relevant, ” writes Marc Faber, “because it contains all the major features of subsequent manias: shady characters, corruption, fraud, dubious practices, the creation of money and the extension of risky loans in order to keep the speculative orgy going, the catalyst, which leads to the initial collapse — usually the revelation of some fraud, the inability of a large speculator to come up with the money to meet a margin call, the revelation that insiders had cashed out, or some adverse economic or political news — and then panic during which greed and euphoria are replaced by fear and the speculators ’ desire to get out at any price. ”

Regards,

Addison Wiggin
for The Daily Reckoning

P.S. Be sure to sign up for The Daily Reckoning — a free and entertaining look at the world of finance and politics from every possible angle. And while the articles you find here on our website represent our commitment to high quality commentary, they’re only a snippet of what you receive in The Daily Reckoning email edition. Click here now to sign up for FREE to see what you’re missing.

The post A Short History of Speculative Excesses and Wealth Preservation appeared first on Daily Reckoning.

“Don’t let anybody tell you,” Hillary Clinton recently told a crowd in Boston, “it’s corporations and businesses that create jobs. You know, that old theory ‘trickle-down economics.’ That has been tried. That has failed. It has failed rather spectacularly.”

I just received my issue of the Laissez Faire Letter by email this morning. My favorite section is one called “They Said What?!”

Hillary Clinton’s quote, while undoubtedly taken out of some wildly rhetorical context, stands out. How can you read it… and not read it again… just for the pleasure of the deep belly laugh it will give you?

Go ahead… read it again. I dare you.

This morning, we were parsing the election results with friends and colleagues. Yeah, yeah… we don’t vote, so why bother, right? It’s still great entertainment. Even if you vote, you have to admit the theatrics are amazing.

If you weren’t paying attention, let me give you a quick election breakdown: The Senate majority is now Republican. The GOP picked up seven seats — in Iowa, North Carolina, Montana, Colorado, Arkansas, South Dakota and West Virginia.

The dastardly, old-fart Republicans increased their hold on the House, too. Somehow they managed to get out of their rockers and wrestle away 11 seats from the people-and-peace-loving Democrats. The cranky old elephants can now move those rockers onto the hallowed porches of governor’s mansions in red states like Illinois, Massachusetts and Maryland, too. From the bands playing and the “free” booze flowing here in Baltimore City, you would have thought the Republicans even knew how to throw a party.

As we were discussing the results, we turned to Dave Gonigam, elusive editor of The 5 Min. Forecast.

Daily Reckoning: Maybe we’ll finally get a Senate vote on “Audit the Fed,” eh?

Dave replied: Something watered down, perhaps, for show.

Me: Good point.

Dave: I suspect the pressure will become very intense on Rand Paul to “tone down the foreign policy stuff,” lest he “tear the party apart” at a moment of opportunity and hand 2016 to Hillary. My biggest nightmare is that he somehow pulls it off in 2016, and then the big crisis comes and “libertarianism” is discredited for decades…

I said: You’re probably right. That was the downfall of capitalism after Reagan.

He said: Ever read Rothbard’s “Ronald Reagan: An Autopsy”?

Me: I haven’t…

Dave: He said Reagan was the worst thing that ever happened. The ’70s were the zenith of mistrust of government… Vietnam, Watergate, you actually had CIA dirt uncovered by the Church Committee… then Reagan comes along and restores people’s trust that government can still work.

I thought: Hmmn… good point.

Dave: “So there will be no misunderstanding,” Ronald Reagan said in 1981, in his first inaugural address, “it is not my intention to do away with government. It is rather to make it work — work with us, not over us; to stand by our side, not ride on our back. Government can and must provide opportunity, not smother it; foster productivity, not stifle it.”

“Ronald Reagan called himself a conservative,” Bill Bonner commented in the book we co-authored, Empire of Debt. “This part of his inaugural address made us think he really was one. But people come to believe what they must believe in order to play their roles — even conservatives. Reagan’s real revolution lay in redefining conservatism as an activist, imperial creed. First, the neocons took over foreign policy.

“Soon, Americans were stirring up trouble everywhere, from Latin America to Afghanistan. Then, they took over domestic policy. In a few cases, the ghastly remnants of previous improvers — such as 70% top marginal rates — were knocked over. In more cases, new edifices were built up. But the major failure was that the sharp tax cuts of 1981 were not followed by sharp spending cuts. Instead, spending went up. And not just on defense. Reagan had pledged to abolish the Department of Education.

“Instead, he increased its budget by 50%.”

The Reagan revolution transformed the Republican Party. Rather than continuing to fight a rearguard action against leftist activists, Republicans were emboldened to take the lead, becoming activists themselves. This they did by relying on a monumental fraud.

“It’s amazing that Democrats, in particular,” our friend Steve Forbes wrote back in July, alluding to the same fraud, “throw rose petals at Bernanke’s feet for practicing what liberals always — and falsely — accuse Republicans of: trickle-down economics.

“Bernanke wants high stock and bond prices to create a ‘wealth effect’ that will trigger investment, which will, in turn, trickle down to the masses via greater economic growth.”

For fun, let’s recap the way this essay began: “Don’t let anybody tell you,” Hillary Clinton recently told a crowd in Boston, “it’s corporations and businesses that create jobs. You know, that old theory ‘trickle-down economics.’ That has been tried. That has failed. It has failed rather spectacularly.”

What’s fun about politics is how spectacular the politicians are at confounding, conflating, confusing and abusing the “issues” to their own ends.

Let’s break down Hillary’s statement:

“Don’t let anybody tell you it’s corporations and businesses that create jobs.”

Well, one might be tempted to ask, if not whipped up into a crowd frenzy, who does create jobs?

“You know, that old theory ‘trickle-down economics.’”

Otherwise, known as the political straw dog of the Clintons since ol’ Bill ran for president in 1992. Even though the record most likely shows he was the most laissez faire president in the last 53 years…

“That has been tried. That has failed. It has failed rather spectacularly.”

It hasn’t actually been tried. But why would we want to? Hillary is only arguing out of both sides of her tuchis. Her implication that government — not business — creates jobs and “trickle-down economics” requires you to first believe that all good things come from government.

Far be it from us… a group of ne’er-do-wells with keyboards and frequent-flier status (still, believe it or not)… to disagree.

“Here at home,” our essayist from yesterday, the former congressional stalwart Ron Paul, said on RT, “we don’t have true democracy. We have a monopoly of ideas that are controlled by leaders of two parties. And they call it two parties, but it’s really one philosophy… I think the status quo is pretty strong right now, and I imagine the status quo is going to win the election tonight.”

“Addison,” we quote a reader from Texas who corresponds frequently, “you, like Mencken, are quick to belittle American ideals and offerings, but, I might add, also as quick to plop your ass down, bitch and do little to try to improve our situation.

“Admittedly, the American system has been going to hell, basically from the get-go, but to my knowledge, there has been nothing better offered in the ENTIRE world in my lifetime. Remember that there are millions who fight for the right to vote in the rest of the world. And for that matter, there are thousands who die basically every day trying to get here to share that which you and yours simply bitch about. Nor do you mention that billions of people overseas vote 85-97% in every election. And true, it usually doesn’t improve their lot, but by God, they tried to do something.

“Unlike you, who sit around griping about that which you gleefully partake of, but which you have not improved in any way.”

Allow me to respond with an anecdote. (Brace yourself if you don’t have a little extra time right now.)

In 2006, I had the good fortune to be sitting at dinner, at a beachside cafe in Cannes, with the good doctor Richebacher. If you’re a longtime Daily Reckoning sufferer, as our friend Bill would say, you know Dr. Richebacher by name. And you probably also know… he was kind of a crank.

He was a special kind of crank, though.

Kurt wrote a newsletter for more than 40 years. Not by accident.

After World War II, Kurt had made a name for himself as the best ­known financial journalist in Germany — a razor­-sharp critic of what he saw as the stupid economic and fiscal policies of the post­war German government. By 1957, he’d become one of the top commentators in London on British economic policy.

But it all really began for Kurt Richebacher in 1964. That’s when he took over the post of chief economist and managing director of the massive and world­-famous Dresdner Bank.

Kurt advised billion-­dollar banking clients what to watch for in the unfolding world economy. Kurt didn’t avoid controversy. He just told it like it was, giving the bank’s uber-­rich clients every possible insight they needed to protect and grow their money. The clients couldn’t get enough of it. But German Chancellor Helmut Schmidt wanted it to stop.

So much that he personally begged Jurgen Ponto, then the chairman of the Dresdner Bank, to put Richebacher on a leash. But Ponto knew what Richebacher had to say was too important.

So Ponto defied the chancellor and protected Richebacher’s right to publish his scathing observations. However, on July 30, 1977, Jurgen Ponto was murdered. This tragic turn of events — a kidnapping gone wrong ­– forced the creation of one of the most respected financial advisory letters ever produced, The Richebacher Letter.

Without Ponto, Dr. Richebacher made a clean break from the bank and published his viewpoints entirely on his own.

At his Dresdner farewell party, former Federal Reserve Chairman Paul Volcker was one of the guests. Another was famous Wall Street economist Henry Kaufman.

When I was having dinner with him overlooking the Mediterranean, we had spent several weeks trying to assemble what would then have been the first critique of the Bernanke Fed, even before Bernanke had officially taken his seat behind the googly-eyed Greenspan.

We never finished his manuscript. Within a few months, the octogenarian Richebacher grew ill and passed away. When he died, he willed his library to us. It’s an adjunct to my office in 808 St. Paul Street, here in Baltimore:

The Richebacher Memorial Library

In addition to his books, which still contain margin notes written in German, he left me with a lifelong motivating insight.

At dinner that evening on the beach in Cannes, I had a burning question for Dr. Richebacher.

“After 40 years,” I genuinely wanted to know, “why do you continue to criticize bankers, politicians… corporate leaders? After a while, doesn’t it just get old? Aren’t you successful enough that you don’t have to do it anymore? I mean… look at this place.”

“Addison,” he said in his thick German accent, marveling at our waitress walking by, “what good would it do for me to write about all the things that are going right with the world? We should simply enjoy those things.”

As, we suggest, should you.

Cheers,

Addison Wiggin
for The Daily Reckoning

P.S. If you haven’t signed up to receive our Daily Reckonings by email, click here. We do our best to make each one the most informative and entertaining 15 minute read of your day.

The post The Tragedy of Common Politics appeared first on Daily Reckoning.

“What ass first let loose the doctrine that the suffrage is a high boon and voting a noble privilege?” — H.L. Mencken

“Can you bring it in on Tuesday?”

“Sure, why not?” I replied. The “check brake” light had come on in my Land Rover, and we were trying to agree on a service appointment time with the dealer.

“Well, it’s Election Day.”

“Oh… I don’t vote.” From the look on his face, you would have thought I just spit on a kid.

“Hey… maybe it’s the cynic in me… but I just don’t believe them.”

So began one of my favorite debates of the year.

“It’s jerks like you who don’t vote,” a reader writes, “who gave us Obama in the first place.”

Ha!

What if we did vote… but voted for Obama? How would you know?

Blaming us for who sits in the White House is ire as misguided as a drag queen getting upset by not being able to attend a secret KKK ceremony. Given the nature of politics, what makes you think the candidate you are voting for can deliver? Politics as an enterprise became fetid long before our time.

“If someone asks you to vote for him at the next election,” wrote Henry Miller, “ask him, I beg you, what he can do for you that you cannot do yourself. Ask him whom he is voting for. If he tells you the truth, then go to the polls and vote for yourself…

“Does the man who asks for your vote find you your job, does he provide your family with food and shelter, does he put clothes on your back, does he provide the education you need… does he even bother to see that you get a decent burial? The only time he is concerned about you is when you can make money for him. No matter how little you make, he wants part of it…

“From childhood, you were taught that it is right and just to delegate your powers to someone else. You never questioned it because everything you are taught in school has one purpose: the glorification of your country.

“Somehow, though it is your country, you seem to have no part in it until the time comes to surrender your life.”

Richard Cobden, a member of the U.K. Parliament over 110 years before Miller, implored: “Can you by legislation add one farthing to the wealth of the country?

“You may, by legislation, in one evening, destroy the fruits and accumulations of a century of labor; but I defy you to show me how, by the legislation of this house, you can add one farthing to the wealth of the country.”

Yet so pervasive is the idea that it’s your duty to vote, CNN ponders this morning whether voting should be made compulsory in the U.S., as has been proposed in Australia. What if, instead, choosing to not vote (which “just encourages the bastards,” as P.J. O’Rourke famously said) is the hallmark of a successful society that doesn’t need politicians to make it prosperous?

Ironically, as Ed Yardeni points out in this morning’s Business Insider, Election Day is one of the best days to trade in the stock market.

Our friend Jim Rickards gets us back to the crux of the “problem” by tweet this morning:

If you live in a battleground state, as we do in Maryland, you’ve been inundated with third-party attack ads, “Get out the vote” campaigners, late-night phone calls, placards at every stoplight, do-gooders carrying signs. So much time… so much money… so much ill will.

Just for fun, try to explain an attack ad to an 8-year old.

And what’s it all for, anyway?

Is Larry Hogan really going to be a better governor than incumbent Lt. Gov. Anthony Brown? PACs from all over the country are convinced… and are sending armies of acolytes in to sway “voters” one way or the other. What’s really at stake, especially if you’re in the middle class, is not what the new governor can do for you, but what can you do for him and his party.

And let’s not forget the race card. One of my favorite political ads in the Maryland race depicts an African-American woman from the reasonably affluent Mount Washington neighborhood saying she’s been a lifelong Democrat, but this year, she’s voting for Hogan, a rather stocky white guy, who you wouldn’t ordinarily associate with the “black vote.” Brown, the outgoing governor’s pick, is a younger, fit-by-comparison African-American man. The ad is so obviously calculated that only a political strategist from another state could get giddy with pride over the impact they hope it will have.

Still, the race for governor appears about as important and relevant as the one for class president in your local high school freshman class. In my son’s class, they voted in a kid that nobody knew yet because his name is James Bond.

And yet… the stakes are, umn, higher when you get outside of school politics.

“Military spending is not a farce, just rampant corruption,” a reader writes, pivoting slightly to yesterday’s Daily Reckoning, but still very much on theme. “All the spending, and especially top-secret military budgets, produce fantastic profits and huge political payoffs. Very often, there is no oversight whatsoever.

“The core of the problem lies with the ruling elite. They make great returns on defense stocks, but also get to invest overseas and get even greater returns because of unbridled labor and resource exploitation. Our military makes these investments safe for them, and they don’t even have to pay for it.

“The middle class does it for them at the same time their jobs are outsourced overseas because of the whole process! That last part is the real farce, as most Americans are willing participants and are too stupid to understand what is happening to them.”

Happy Election Day. Don’t encourage the bastards.

Warm regards,

Addison Wiggin
for The Daily Reckoning

P.S. I still managed to get the service appointment at Land Rover. But I noticed this morning they weren’t quite as friendly as they usually are. Oh… and I’ve been summoned for jury duty in Baltimore City for the 5th time next week.

P.P.S. If you haven’t signed up to receive our Daily Reckonings by email, click here. We do our best to make each one the most informative and entertaining 15 minute read of your day.

The post Vote or Die! appeared first on Daily Reckoning.

“If you see fraud and do not say fraud, you are a fraud.” – Nassim Taleb, Antifragile

Words to live by.

We don’t go looking for fraud, as a matter, of course. It’s just so easy to find, we can’t help ourselves.

From this morning’s Guardian: “Obama fixates on economic growth to boost Democrat’s midterm chances.”

Tomorrow is election day. And we can think of no greater fraud than politicians on the campaign trail… from either party. In this case, however, it’s the commander in chief who’s out pandering would be voters.

“Low personal approval ratings,” the Guardian tells us, “have kept the president away from the most competitive swing states this election but, in a series of last-minute speeches to more sympathetic audiences in Maine and Rhode Island, Obama is attempting to build a more positive narrative by focusing on buoyant GDP figures.”

Without much else to go on, White House officials “jumped on” Thursday’s reported 3.6% growth in the third quarter of 2014.

“This morning,” Obama told a crowd of some 3,000 supporters in Portland, Maine, “we learned that our economy grew at a strong clip over the summer — even stronger than we’d expected. In fact, over the past six months, our economy has grown at the fastest pace in more than 10 years. So the truth is America is outpacing most of the rest of the world.”

Indeed.

Like we said, we can’t help ourselves.

As you’re probably aware, we recently partnered up with Jim Rickards to help us parse these types of reports. We thought, meh, why not pass them through the lens of a CIA currency wars analyst?

Yesterday Jim tweeted this comment:

Conveniently, the seasonal adjustment on government spending on the military has been overlooked.

“You always have to go behind the numbers,” Mr. Rickards warned new lifetime readers of his Strategic Intelligence report on Thursday in a briefing, “and break it down a little bit. A big slug of that was government spending and a lot of that was military spending.”

“I hate to be a cynic — and look, it’s strong data, there’s no denying that. But you know the election is a couple of days away. This is the last GDP report, the last important economic report before the election.

“Military spending is the most discretionary item of all.”

“The government can’t make you buy a dishwasher or refrigerator but they can make the military go out and buy a jet plane. I work closely enough with the government in various capacities that I know how these things operate.”

We hate to be cynics too, but for kicks we looked further behind the numbers with the help of Doug Bandow writing at Forbes:

• “America accounts for nearly 40 percent of globe’s military outlays”…
• “The cost is high — about $627 billion budgeted this year, though it will end up higher with the latest Mideast war.”

“The war lobby minimizes the magnitude of America’s military spending through statistical legerdemain,” Bandow asserts:

“For instance, National Review’s editors argued that inflation-adjusted outlays are down 12 percent since 2010. Washington Post columnist Robert Samuelson noted that expenditures constitute just 3.4 percent of GDP, compared to 5.5 percent during the Cold War, and the percentage is headed downward.

“But Washington does not spend in isolation. It is allied with every major industrialized state save China and Russia, including Europe, Japan, and South Korea. Other allies include Australia, Israel and the Gulf States. Friendly powers include Singapore and Taiwan. The U.S. leads the world in military spending. Of the next fourteen nations, ten are allies, two are independent (Brazil, India), and two are potential antagonists (China, Russia). America and its allies collectively account for two-thirds of the globe’s military expenditures.

“While Washington’s inflation-adjusted outlays have fallen since 2011, they previously rose significantly — almost 165 percent between 1998 and 2011. It is only natural for expenditures to fall as Washington wound down two wars.

“Even today the U.S. spends more on the military in constant dollars than in 2008.”

With respect to the the president’s higher-than-expected third quarter GDP numbers? Bandow adds this helpful perspective:

“The percentage of GDP tells us little about real resources without taking into account the size of the economy. Samuelson warned that by 2019 the outlays per GDP ratio would fall below that in 1940. However, military spending should be based on the threat environment, not statistical ratios. The GDP today is 13 times the GDP in 1940; spending even an equal percentage would yield 13 times the real resources.

“America’s GDP this year is more than seven times that in 1944, at the height of World War II and nearly seven times that in 1952, at the height of the Korean War. Today’s GDP is roughly 3.5 times that in 1968, at the height of the Vietnam War and almost twice that in 1989, the peak of Ronald Reagan’s Cold War military build-up.

“Washington today spends more in real resources on the military than in any of those years except 1944. Real outlays today are about two-thirds the level even then, during America’s greatest war.”

Several years ago, we grew tired of grousing about military spending — and goosed GDP numbers for that matter — and decided to “make the empire pay” as it were.

The iShares Aerospace and Defense ETF (NYSE:ITA) which we recommended is up 11% since Oct. 14th… and up 109% since you originally had a chance to buy it in 2010. Today, our military historian Byron King analyzed the new global arms race all this military spending has wrought. With no real let up in sight, ITA is likely to continue to be a good play.

Cheers,

Addison Wiggin
for The Daily Reckoning

P.S. I invite you to sign up for our daily reckonings at no charge. Each day, I’ll write to you with one big idea you won’t find in the mainstream. One way for you to profit… One way to understand the world of finance, economics and politics… or, at the very least, one thing to point and laugh at. Click here and enter your email address to start receiving our missives each day.

The post Military Spending: An Unnecessary Farce appeared first on Daily Reckoning.