By Chris Mayer
I borrowed the title of today's column from Robert Friend,
the successful international investor at Recon Capital. At
last week's Grant's Investment Conference, Friend used this
title to provide a context for his bullish remarks about
oil and oil stocks.
He's a big fan of the integrated oil stocks, especially
Marathon Oil, because they are still valued as if oil were
trading for $40 a barrel. But if, as Friend believes, oil
deserves to trade near $60, the stocks of most integrated
oil companies offer great bargains.
Friend is also bullish on Brazil, both its stocks and its
currency. [If you harbor a soft spot for Brazilian
investments, you might want to check out the October 11,
2004 column from our archives entitled, "The Caipirinha
Connection"] Brazil's currency, the real, has appreciated
over the last several months, crushing the "hard"
currencies of Canada and Australia, as well as trouncing
the British pound and Euro.
Vale do Rio Doce (NYSE:RIO) is Friend's favorite investment
in the country that introduced the Samba and the g-string
to the rest of the world. "Vale" is the largest iron
producer in the world and maintains vast reserves of iron
ore, bauxite, copper/gold, kaolin, manganese, nickel and
potash. It is also the largest logistics and transport
company in Brazil.
Paying Homage to the "Barbarous Relic"
Like Friend, John Hathaway, manager of the Tocqueville Gold
Fund, advocated investing in the resource
sector...particularly in gold.
He launched into his presentation by displaying the image
of the Zimbabwe dollar. In 1999, about six Zimbabwe dollars
were worth one U.S. greenback. Today, it would take 50,000
Zimbabwe dollars to buy one U.S. dollar.
The U.S. is not Zimbabwe, of course, and Hathaway in no way
meant to imply that it was. But he did mean to imply that
the endgame for the U.S. dollar might closely resemble that
of its Zimbabwean counterpart. The greenback is a dying
currency, says Hathaway, which loses a little more of its
value with each passing year.
All paper currencies, Hathaway asserts, succumb to "a
process of monetary elimination." That's why gold continues
to excel throughout the ages...and that's also why Hathaway
believes gold is on the verge of a major new bull market.
The Federal Reserve...Gold's Best Friend
James Grant, the conference host and keynote speaker,
presented a talk entitled "Man's Inner Bubble," which, he
pointed out, had nothing to do with gastrointestinal
functions.
In the span of forty very entertaining and amusing minutes,
Grant argued that easy credit fuels EVERY U.S. asset
bubble, and that the Federal Reserve is the original source
of all easy credit. Therefore, the world might be much
better off without the Federal Reserve...or a Federal
Reserve Chairman.
Grant pointed out that before the creation of the Federal
Reserve in 1913, prices "sometimes sagged." Throughout the
19th century, therefore, prices tended to drift lower – as
productivity gains and innovation drove the cost of living
down. Post-1913, however, the Federal Reserve has presided
over the continuous depreciation of the U.S. dollar.
The appointment of Ben "Helicopter-drop" Bernanke as the
new Fed Chief will likely accelerate this trend. In fact,
any Fed Chief who thinks that the Federal Reserve is an
inflation-fighter ought to be lashed to a mast and forced
to stare at the following chart until his eyeballs burn
with memory of it.
The key difference between the pre-Federal Reserve American
economy of the 19th century and the post-1913 variety is
that the pre-fed dollar derived its value from a strict
connection to gold. Indeed, many dollars were actually
minted in gold itself. Such a tether limited the production
of new dollars and served to contain inflation...But the
last remaining tether to monetary responsibility snapped in
1971, when President Nixon eliminated any connection
whatsoever between dollars and gold.
To help the audience appreciate the dubious benefit of the
Federal Reserve's stewardship, Grant presented a snapshot
of life circa 1890, compared to today. First, there were
some stark differences. Inflation was a negative 1.2% in
1890. The population of the country was 62 million. The
Federal Government was in surplus. There were 25
professional baseball teams, spread over 3 leagues.
Railroad stocks dominated the Dow Jones Industrial Average
(with 10 of the 12 stocks).
But, there were also some remarkable, and ominous,
similarities.
Interest rates were low. High-grade bonds yielded only
3.68% and the savings rate was 4%. Investors, groping for
yield, took bigger risks causing a boom in speculative
Western securities.
Grant shared some quotes from Hallie Farmer (published in
1924), in a report published in the Mississippi Valley
Historical Review. Credit was easy and lending standards
were loose. "Competition existed not between borrowers but
between lenders," Farmer notes.
This created a boon for debtors. An example from Farmer:
"All the [rail] roads offered lands at low prices and one
easy terms...The Union Pacific offered eleven years'
credit. One-tenth of the purchase price was to be paid at
the time of sale; deferred payments bore interest charges
at 6%, but for the first three years the purchaser was
required to pay interest only."
Sound familiar? It's not so far removed from the
unconventional mortgages we see in our mortgage bubble
today. There was a boom in housing then as well, with the
total mortgages outstanding nearly tripling from 1880 to
1890.
In the 1890s, too, they had their share of securities
fraud. Grant related how the bonds of Capitola township in
Dakota were sold to Eastern investors and changed hands
many times before it was discovered that no such township
existed.
Farmer's diagnosis of 1890 applies today. "The prosperity
of the period was a prosperity based upon credit," he
wrote.
Today's prosperity is no different, says Grant. Easy credit
fueled the stock market bubble, the housing bubble and
every other bubble – great and small – that the Greenspan
Fed has nurtured. And presumably, as America's bubble
economy deflates, the dollar's value will suffer...despite
the very best efforts of the Federal Reserve and its new
"inflation-fighting" chairman.
But let's not forget that bad news for the buck is gold
news for the gold price and the oil price and for the price
of every other hard asset. Make way for the "new reserve
currencies."
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