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Germany – 1923“He unfolds his pocket handker-

chief and lets an object fall ringing on the table. It takes me a while to recognize it. I gaze at it with emo-tion. It is a gold twenty mark piece. The last one I saw was before the war. ‘Those were the days!’ I say. ‘Peace reigned, security prevailed, insults to His Majesty were still punishable by imprisonment, the steel helmet was unknown, our mothers wore corsets and their blouses had high, whale-bone stiffened collars, dividends were paid, the mark was as untouchable as God, and every quarter you content-edly clipped the coupons for your government bonds and were paid in gold. Let me kiss you, you glittering symbol of a vanished era!’”

– The Black ObeliskBy Erich Maria Remarque

America – 2023A man is about to be arrested…

charged with a crime… and put in jail. He knows it’s about to happen

because when he went to buy a pack of cigarettes his “money card” didn’t work.

When they come for someone, they first cut off his money.

Cash was made illegal in 2017, at the bottom of the Great Panic. Now, with-out money, he cannot travel. He cannot buy gasoline. He cannot buy food. He cannot buy a bus ticket or stay in a ho-tel. He cannot pay a lawyer to defend him; he has no access to “money.”

But he couldn’t call a lawyer any-way; his phone has been cut off too.

What’s more, each time he tries to use his money card, it signals his lo-cation to the money police. Within a few minutes he is picked up. Usually, he is never heard from again.

Sometimes, they don’t pick him up at all. Then, what can he do?

He depends on the charity of his

family and friends for a while. But, ef-fectively, he disappears.

What was his crime? You never know. Maybe he sent a contribution to a group that was “too conserva-tive.” Maybe he went to an “unap-proved” website to read the news. Maybe he tried to buy a gold coin.

But it is not he who went rogue. It is the government.

Maybe he forgot to fill out form JKx47836554. There are so many forms to fill out. Everyone is bound to overlook one or two. So, the author-ities can “disappear” anyone they want to.

There’s Always Money in the Banana Stand

VOLUME 2, ISSUE 9 SEPTEMBER / OCTOBER 2015

A Plan to Make Cash IllegalDear reader,

In this month’s issue, I look for good intentions. More specifically, I look for roads that are paved with them. We know where they lead.

Among the paving stones – at least, as advertised – is a plan to make cash illegal.

As crazy as that sounds, a town in England recently tried it out. The Man-chester Evening News has the story:

On Saturday, scores of pubs and shops on Beech Road, Chorl-ton [Manchester], attempted to trade – as far as possible – with-out accepting notes or coins.

The experiment was organ-ised by card payment provider Handepay, which supplies more than 22,000 businesses across the country with card payment terminals, to test whether we are ready for a cash-free society.

Most of those who did em-brace the project still gave cus-tomers the option of paying cash but said people were keen to get behind the scheme.

Claire Lockhart, general man-ager at the Horse and Jockey pub, said: “We are finding that not as many people are carrying cash around now anyway and we de-cided it was an interesting ex-periment because this certainly seems to be the way things are heading.”

Also in England, a bizarre reali-ty-TV show, The Hunted, describes the hell to which it leads. My friend, Rob Marstrand, explains:

At some point during a nor-mal day, the hunted are told that they are now on the run. Then

they have an hour to get their stuff together and start fleeing before their home is raided. The idea is to evade capture for as long as possible.

Pitched against them are “the hunters.” These are all genuine, professional government types – spies, military, police, hackers, and such. They have access to all the methods and technology used by real government security agencies when they hunt for ac-tual fugitives from the law.

In a way this show is a silly sort of exercise. But in another way it’s an important reminder of how much we are already tracked and monitored by our govern-ments. If your country’s govern-ment goes rogue in the future then just how long do you think you could escape its tentacles?

Of course, the hunters ransack the contestants’ houses. They find the traces – the mobile phones, bank statements, social contacts – that they can use to track their targets.

British streets are also armed with cameras, many of them with facial recognition technology. The “hunt-ed” have to keep their heads down. And they can’t drive their own cars… or any rental cars either. The tag numbers would be quickly picked up and reported.

But the biggest problem is money. They can’t use credit cards or ATMs. So, they can’t get cash… and without cash, they can’t survive for long.

Money Is Only an Intermediary

In the search for good intentions, many are the roads you can take. Two of them are illustrated in the quota-tions at the beginning of this letter. The first is a historical fact. The other

a worry about the future. But all these roads end up in more or less the same diabolic place.

They also begin in more or less the same place, which is not too far from where we are now. But let’s back up to where we left off in a previous letter…

I thought I had discovered an im-portant insight. “It is the economy that gives money value, not the other way around,” I wrote.

This was merely a rediscovery of the important insights given to us by others. “Supply creates its own de-mand” is the way Lord Keynes sum-marized it, which makes me wonder whether he really understood it.

It would be more correct to say, “Supply is the source of demand.” You can’t buy things, in other words, unless you have something to trade for them. “Products are paid for with products,” said Jean-Baptiste Say.

Importantly, money is only an in-termediary. Like a claim ticket from a parking lot, it is just information, not wealth itself. Here’s Say again:

Money performs but a mo-mentary function in this double exchange; and when the trans-action is finally closed, it will al-ways be found, that one kind of commodity has been exchanged for another.

I add to that insight. If you get a claim ticket from a parking lot, you have a form of money. You have in-formation that gives you the right to take back your car. But counterfeiting claim tickets doesn’t stimulate the economy. All it does is allow some people to steal other people’s cars.

Is this really any different, in sub-stance, from what the Fed is doing when it adds money and credit to the system?

This money and credit finds its

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way into parking lots, luxury real es-tate, and all sorts of nooks and cran-nies of the economy. But wherever it goes it does the same thing as a counterfeit parking lot claim ticket – it claims other people’s goods and services.

Coming to the point: Our aim in this issue is to figure out how to make sure they don’t take your car. Or your money.

So, let’s look at what might hap-pen. But first… a welcome.

Quite a few new readers have joined us in the last month. I want to slow down and give them time to get on the bus. And also let them know where this bus is going.

I don’t try to give “hot tips” in these pages. First, because I don’t have any hot tips. And second, be-cause hot tips don’t pay.

In the investment world, the pros talk about getting an above-market gain from a stock as “alpha.” The al-pha investor gets the alpha return from the alpha stock. It sounds good, but in practice, there’s not much ev-idence that this is possible on a reli-able basis.

Instead, most of the evidence sug-gests that amateur alpha hunters end up with a lower rate of return than you would get by simply buying and holding almost any investment cat-egory. Why this is so is the subject of many research projects – one of which showed that the best investors are, in fact, dead or inactive.

But for today’s purpose, we’ll skip the whys… and go right to the what that really works.

What works is being in the right place at the right time. I call it beta. It’s the return you get from having your money in markets that are doing well.

In a broad example, if you had simply invested in the 30 Dow stocks in 1982… then did nothing else for

the next 33 years… today, you would have multiplied your money some 16 times. Not including dividends. Al-most no one – with the exception of a very few alpha hunters – did that well.

And you could have done even bet-ter if you’d dropped stocks in 1999, bought gold, and sat in gold for the following 10 years – which I suggested.

And if you were really smart (which I wasn’t), you would have sold out your gold in 2010 and gone back into stocks.

The point is, we’re on a beta quest here at The Bill Bonner Letter.

We’re not alpha hunters. And sometimes, the best you can do in Be-ta-land is not lose money.

Of course, wealth is relative. If you can hold on to your wealth while oth-ers are losing theirs, you come out ahead. I suspect that this is one of those (fairly rare) times when the best we are likely to do is to avoid losing money. Even if I’m wrong, it is proba-bly best to believe it.

With U.S. stocks trading at a Shill-er P/E of 25… after a 66-year credit expansion, there is probably little more upside potential. But there’s a lot of downside.

My guess is that those who do best

in the coming 10 years will be those who manage to hold on to the most gains of the last three decades.

Money Is a Dangerous Distraction

Now back to our discussion of how to hold on to your money…

Monsieur Say’s insight about where purchasing power comes from – output, not money – is important.

First, it helps us understand why artificially increasing “aggregate de-mand” – as the Fed has been trying to do for the last seven years – is futile and counterproductive. Printing up more claim checks doesn’t put more autos on the lot.

Second, it gives us a hint about how we can avoid losing wealth when the beta outlook turns bad.

I should warn readers that brevity may be the soul of wit, but it is one of the many talents I lack.

Readers write to suggest that “I give them the bottom line” right away. I wish I could. But I never know exactly what the bottom line is until I get there.

There is no way I know of to sim-plify our journey and go directly into the future. We are not running

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a TV station. Nor are we running for president. Simpleminded narratives – ones that are easy for the masses – will do us no good. We’re not trying to convince anyone. We’re not trying to win a Pulitzer. We’re (modestly) just trying to do the hardest thing of all – to understand.

In the interest of economizing your time, however, I will try to sum-marize what I believe I have learned in the last month…

Money is a dangerous distraction – for an economy and for an individ-ual. You can have a pile of money, and still grow poorer.

The coming crisis will almost sure-ly be a “money” crisis. The best way to survive it is to have your wealth in something other than money.

A small stash of cash could help you survive the first stage. But a large cash stash – or a claim on a fixed stream of income – will probably be a danger to your wealth as the crisis develops.

An Episode in Monetary Absurdity

In the vast panorama of the fi-nancial world, with all its jargon and complexities, I keep coming back to the humble ATM. It is where most people now go to get cash.

My hunch is that it is going to be like a gas station during the first en-ergy crisis of 1973 – the point where the rubber of individual lives meets the aforementioned road of global fi-nancial claptrap.

I’ve already dramatized one of the things that could go wrong. You are standing in front of the ATM. You ask for cash. But the ATM has no cash to give you.

In a financial panic, people tend to want cash. It steadies their nerves. With cash they can buy the things they need… or turn their cash into

other financial assets. But there isn’t enough actual cash to satisfy the po-tential demand. ATMs would run dry.

Then, without cash, the economy could only run on credit. But credit is a “whole ’nother thing.”

It is not the same as cash. It is a promise to pay, not actual payment. And in a real financial crisis, promis-es fall fastest and hardest.

People wonder if the buyer will still be solvent when the bill comes due. They wonder, too, if the credit card company or lender – the bank that makes the credit available – will survive the crisis. And they wonder how much the currency will be worth when they finally get their money back. They sell off these promises in order to get cold, hard cash.

Typically, a financial crisis marks the beginning of a credit contraction. Lenders panic, stopping all credit transactions. Interest rates rise as doubt increases. Then, the amount of credit outstanding falls – as many old loans go bad and fewer new ones are offered.

The ATMs should work again – along with the credit system – as soon as the panic subsides and order is restored.

It might take a week. It might take a month. Or three months. You should be prepared with a quantity of cash for this purpose. It is cheap insurance.

But this period is also the time when the authorities fill the holes that the crisis exposed.

The banks will run out of mon-ey and will need to be recapitalized. Large companies will be on the edge of bankruptcy. Tax revenues will col-lapse. Loan guarantees, medical care, pensions, and general spending com-mitments will all need to be trimmed or funded.

Where will the money come from? There are only two sources. Both

involve theft.

Either they take it directly from account holders – as they did in Cy-prus and Argentina. Or they counter-feit money… and take it from almost everyone – as they did in 1920s Ger-many.

That’s why you don’t want to have your money trapped in a bank ac-count during a serious financial crisis. As long as you can get your hands on your money, you can react to protect it.

But if it’s locked up in a bank… or other financial institution… you may be forced to experience the crisis as a victim and not just an observer.

Here, we are entering the territo-ry of disaster scenarios. Like the road from Salta to my ranch in Gualfin, the scenery is dramatic but the road is treacherous. It washes out in rainy season. It disappears completely in fog. There are miles of road on the edge of 200-foot cliffs, with no guard-rails. One mistake and you are part of the scenery.

This is not to say that the odds of catastrophe are higher than the odds of “normalcy.” Generally, they are not. Otherwise, catastrophe would be normal and normalcy would be cata-strophic.

In any case, I can’t know what will happen. But I would be doing you a disservice if I didn’t spend some time trying to figure out what this ca-tastrophe might look like.

I see several possibilities. Each one could cut you off from your mon-ey. Most likely, they will come – like bad news – in groups of three:

1. A deflationary crunch… with falling asset prices… a rush to cash… and panic among the authorities

2. A ban on cash. First, there won’t be enough to go around, and second, the feds will want to

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be able to force people out of cash and into consumption and investment (more below)

3. Rising levels of inflation… maybe even hyperinflation

In this report, I also include a brief look at a cyber-attack that might shut down the system. That is not includ-ed in my list of 1-2-3 because it is an exogenous event… not part of a caus-al chain that I can logically examine. It is more like an earthquake or a so-lar flare (either one of which could shut down the ATM system), which are simply beyond the scope of this letter.

You should take all of these cata-strophic visions in the spirit that they are intended, like the prediction of a concerned mother to a wayward son: “If you keep going like you are, you’re going to end up in jail,” she might say. She doesn’t know whether he will get jail time, but she thinks he will be better off if he believes that he will.

I don’t know how this episode in monetary absurdity will end. But I do know, as well as I can know anything of this sort, that it will end in some hellish place.

The Coming Deflation in Asset Prices

The economy of 15 years ago was already distorted by excess consumer spending and excess investment in the tech sector. That bubble blew up in 2000.

The excesses in the tech sector were largely purged with an 80% sell-off in the Nasdaq. But consumer credit increased, led by the mortgage-finance industry, which boosted households’ collateral, making further borrowing and spending possible.

Meanwhile, consumer price in-creases were relatively subdued, thanks to China’s growing role as a

supplier of goods to the U.S. econ-omy. China’s participation became a key factor in the U.S. economic growth of the ’90s, but the full effect wasn’t felt until the mid-’00s… and later.

China sold products and received dollars in exchange: The dollars were generated by America’s rapidly swell-ing mortgage credit industry.

Homeowners “took out” equity (which had only appeared because so many people were bidding for houses with cheap money) and spent much of it at Walmart.

The money was then sent to China to pay for more inventory.

Chinese manufacturers exchanged the dollars with their central bank for yuan.

The Bank of China had no alterna-tive but to create yuan simply to keep up with the incoming dollars.

This, of course, created a ready supply of funding for new capital in-vestments – roads, malls, factories… entire cities – which were the favored money pits of local governments and their cronies. All required exten-sive financing and left China with a debt-laden economy, which was al-most a reverse image of the U.S.

Where the U.S. had far too much consumer debt, China had far too much business and local government debt. Where the U.S. had far too many households far too ready to spend far too much money on things they didn’t need, China had far too many entrepreneurs and crony business-men far too ready to build factories to supply them.

The U.S. tried to get rich by spend-ing money it didn’t have. China tried to get rich by providing products to people who couldn’t pay for them!

Note that this commerce also left the Bank of China with trillions of dollars. What could it do with them?

The only practical thing was to buy U.S. assets, particularly U.S. Treasury debt, adding further buying pressure to the upside for U.S. capital markets.

This symbiotic excess blew up in 2008. It has never recovered.

U.S. households could not resume their role as irresponsible buyers; with house prices down, they had no further collateral. Student loans (based on the delusional collateral of education) and car loans (based on the resale value of automobiles) have both risen to all-time highs.

But overall, U.S. household sector debt has fallen from 2008.

Meanwhile, China could not resume its role as the world’s growth engine.

Europe went into on-again, off-again recession. America’s households were already saturated with debt. And emerging markets would soon be clobbered by falling prices for resources. This left no buyer for China’s huge output.

Since the 1990s, the world economy has depended on debt expansion. Growth – even the feeble growth of the last few years – requires someone to go further into debt. But after 2008, the U.S. household sector was unwilling and/or unable.

The slack was taken up by government, corporate America, and the oil industry, in particular. But already, oil has dropped to $45 a barrel, eliminating the industry’s collateral. And corporations – which have used credit to boost their own share prices – are probably the next to go.

Their collateral – at least as measured by their share prices – is in danger of a severe smack-down at any moment. We’ve seen hints of it already. There is much more to come.

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Doses of Heroin or Indignation

In this century, each time the U.S. economy faced a slowdown and a correction – 2000 and 2008 – the authorities intervened with more and easier credit. Like doses of heroin or indignation, credit has less and less effect.

While the recovery of the early ’00s was weak, the recovery following ’08 was the weakest on record. And since adding money (or credit) does nothing to boost real growth (on the contrary, it distracts investments away from real output and

into gaming the system), the result is a more vulnerable economy.

That vulnerability can be expressed as the relationship between capital asset prices and the real output of the society. Cheap money (as we saw a couple of months ago in the work of Knut Wicksell) bids up asset prices; it does not improve an economy. As asset prices go higher, the more dangerous is the threat of a correction.

Above we see the phenomenon that U.S. household net worth has been rising exponentially faster than GDP over the last few decades.

China and the U.S. may still be complicit, but neither model works. The U.S. cannot grow its economy by expanding consumer debt; China’s export-led growth model doesn’t work either. It needs buyers, and there aren’t enough of them.

Both countries have made heroic (if foolhardy) efforts to keep expanding debt. Both have made spectacular increases to their central bank’s liabilities. And now the question in both countries is: How will these bubbles be deflated?

Daiwa Securities, Japan’s second largest brokerage, has done some thinking about it. In the chart at bottom left, it looked at China’s capital stock compared to its GDP. This is similar to our U.S. chart of Net Worth/GDP (top left).

Real output is out of line with the stated value of China’s capital stock. It is easy to adjust the value of the capital stock – it has already been marked down 42%!

But this has consequences for GDP too. Factories, malls, and towns will not be built while borrowers’ collateral is falling in price. Output will go down. How much? Daiwa’s analysts conclude (almost outdoing us in catastrophilia):

Of all the possible risk sce-narios, the meltdown scenario is, realistically speaking, the most likely to occur. It is actually a more realistic outcome than the capital stock adjustment scenar-io. The point at which the capi-tal stock adjustment is expected to hit bottom is at a much lower point than in the previously dis-cussed capital stock adjustment scenario. […]

[T]he actual economic growth rate will continue to register considerably negative performance. If China’s

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economy, the second largest in the world, twice the size of Japan’s, were to lapse into a meltdown situation such as this one, the effect would more than likely send the world economy into a tailspin. Its impact could be the worst the world has ever seen.

Of course, Daiwa could be wrong. But China’s exports are already off 13% this year. World trade is already slowing. Emerging markets are suffering; their major buyer appears to be headed into a slump. Brazilian GDP is expected to fall almost 3% this year.

In this light, questions about when the Fed will begin raising rates seem irrelevant. It probably couldn’t sustain a program of tighter money even if it wanted to.

China depends on a cheap dollar almost as much as the U.S. does. If the Fed raises rates, the dollar will rise (and with it the yuan). China will lower its yuan in order to protect its exports. This will cause prices in the U.S. to fall… bringing the dreaded deflation that the Fed is trying so hard to avoid.

So far, the U.S., the source of so much economic trouble, has been largely immune to its results. But that is not likely to last more than a few more weeks. Global excess liquidity, as measured by Richard Duncan, is expected to turn down sharply in this quarter.

The world economy is already in recession, or close to it. U.S. corporate profits have already peaked out. The smart money is already exiting U.S. equities.

The gap between household net worth and real output will close in the U.S. as it has in China.

It is hard to raise real GDP. But it is easy to lower asset prices. Our own analysis predicts a roughly 50% cut in the S&P over the next 10 years. Al-most all of that could happen in the

next few months. But when it does, we should be prepared for the next phase.

The Feds Ban CashThe good intentions behind the

drive to prohibit the use of cash are a totalitarian’s dream, with the customary do-gooders singing its praises like angels lauding the invention of penicillin. A ban on cash would make it possible to monitor every financial transaction, they tell us, to tax transactions and immobilize accounts, and to eliminate bank runs.

Tracking, of course, greatly reduces illegal activity – including black mar-ket transactions, tax evasion, financing terrorism, and money laundering.

According to Willem Buiter, chief economist at Citigroup, in his 2009 paper titled “Negative Nominal Interest Rates: Three Ways to Overcome the Zero Lower Bound,” allowing people to use cash amounts to “a subsidy to criminal (illegal/underground) activity.”

Bernie Sanders, on the other hand, sees it as a device for raising money for government:

[A] financial transaction tax: a small excise tax, typically a few hundredths of a percent, on trades of stocks, bonds, derivatives and other securities. An itty-bitty, one-basis-point transaction tax (a basis point is one-hundredth of a percentage point, or 0.01 percent) would raise $185 billion over 10 years, according to new estimates by the nonpartisan Tax Policy Center.

And macroeconomists are breath-ing hard with bubbles of saliva form-ing at the corners of their mouths; they are dreaming about how they could use a ban on cash to further manipulate the economy.

They believe recessions happen as the result of a character flaw in the common man. Occasionally, he goes a little crazy and saves his money. If he had no choice but to keep his money in a bank, reason the economists, it would be easy to impose a “negative interest rate” – a tax – that would force him to put his money to use.

Already, the move to ban cash is remarkably far along. The Bank Secrecy Act in the U.S. requires extensive reporting as well as delays and controls on cash withdrawals.

As part of the act, banks are re-quired to file Suspicious Activity Re-ports (SARs) to rat out customers who attempt certain “criminal” cash trans-actions (generally, those in excess of $10,000). It goes even further than that. While it remains legal to make cash withdrawals of less than $10,000, it becomes illegal if it can be proved you made those withdrawals to evade the reporting requirement. This is called “structuring,” and it’s the reason why disgraced former senator Dennis Hastert was indicted earlier this year.

And, of course, the feds can confiscate any money involved in these transactions.

You can see how the reporting re-quirement has increased over the last few years. The chart on the next page shows the rise in SARs.

The attack on cash began a long time ago. U.S. Treasury Secretary Donald Regan, in 1989, recommended recalling all $50 and $100 bills. Any-one who turned up with more than $1,000 would be forced to disclose where the money had come from. If you couldn’t show that it came from lawful activity, Regan’s plan was to confiscate the cash.

All over the world, governments have been chipping away at the convenience of using cash.

Until 1945, there were $500 bills,

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$1,000 bills, $10,000 bills, and even a $100,000 bill, which was used in in-terbank transactions. Now, of course, the largest U.S. bill is the $100 note. And it is worth only about eight bucks in 1945 terms.

In France, a law just went into ef-fect this month banning cash trans-actions involving more than 1,000 euros.

Just as the war on drugs has gone on for decades – with no benefit to anyone except drug warriors (who get money for fighting drugs) and drug dealers (who get higher prices thanks to the drug warriors) – the war on cash is likely to continue for a long time.

A large bureaucracy has developed to fight the war. And the banks don’t want to give out any cash anyway. But it is also likely that the feds will escalate the war soon.

That will be when a panic – or a financial crisis – pinches their rev-enues and threatens their entire debt-driven economy. Banking cro-nies will have their backs to the wall; they will plead with the feds to halt cash withdrawals.

Of course, the Fed will cooperate. After all, it is the leader of a cartel set up to protect the banks. Emergen-cy restrictions will be announced to halt the outflow of cash. Then, this “emergency” measure will probably become permanent.

Who will oppose it? Not Wall Street. Not Congress. Not

big business. Not the Wall Street Jour-nal or the New York Times. Not aca-demia.

Almost none of our elite institu-tions, policymakers, or opinion set-ters will oppose it. Instead, they will all see it for what it really is – a way for them to protect themselves and the system.

They will understand that without

such measures, we, too, could begin spiraling down, out of control. They will be frightened. They will be des-perate.

And even the common man – pan-icked by the rapid meltdown of as-set prices and unable to understand what is going on – will welcome the authorities’ efforts to “bring things under control.”

And so, a new era of financial repression and government deci-sion-making will begin.

(N.B.: Just because something is illegal doesn’t mean it is unpopular. The price of alcohol rose during Pro-hibition. And as far as we know, no drug dealer ever complained that the War on Drugs had crimped his prof-it margins. The War on Cash is likely to have similar consequences; cash – which will fund more and more “black market” activity – may become more valuable than before.)

High Rates of Inflation Coming, Too

Now we are ready for the third phase.

In our imagined future, asset pric-es have fallen in an alarming way. People rushed the ATMs and drew out

all the money they could. The system broke down. Then, the feds closed the ATMs, prohibiting further disburse-ments of cash. A date has been set when cash in circulation will no lon-ger be accepted as legal tender.

Now, the good intentions come out in a torrent, like the effluent from a backed-up sewer. The Fed must flush more spending (more “aggre-gate demand”) into the system!

Willem Buiter once suggested throwing money out of helicopters, if necessary. Larry Summers has called for trillions in government spending on infrastructure projects. Financial Times’ lead economist, Martin Wolf, has suggested paying for those proj-ects by direct funding from the cen-tral bank.

Various schemes are under con-sideration: QE4... A tax rebate... A general tax credit... A tax on bank deposits... Direct monetary funding of federal government expenses... A credit for buying stocks, houses, cars... Who knows what they will come up with?

The purpose will be to put more money into the consumer economy and raise consumer prices. The un-intended consequence will be to de-

press real output in the longterm by distorting the price signals that the Main Street economy depends on. But nobody is going to care about that.

Instead, what they’re going to start to care about is rising prices. The monetary stimulus efforts of the last seven years caused overinvest-ment in Chinese capital projects, the oil industry, steel, and U.S. equities.

The next stimulus efforts will focus more directly on consumer demand while the supply side will be largely neglected. Rising interest rates will cut off funding to long-term capital investment. Supplies will (relatively) fall; prices will rise.

This episode of price inflation is like-ly to be more dramatic than in the ’70s. The Fed’s financial footings are five times larger than in 2008. Its Treasury balance is 50 times greater. More impor-tantly, there are far more who depend on the credit-fueled system – people receiving money from the government.

Inflation is a monetary phenomenon, as Milton Friedman pointed out. But hyperinflation is a political phenomenon.

The quote at the beginning of this letter refers to the period of German hyperinflation in the early ’20s. Germany’s gold had been called away in reparations to Britain and France (who then sent it to America in payment of their war debts).

With little real money available to it, Germany improvised. It printed paper money.

People were naturally distrustful and eager to exchange the paper for something real. This increased the velocity of money, and prices rose. Higher prices increased the demand for more currency, which further re-duced confidence in the paper. Once under way it was hard to stop.

In early 1921, it took about 77 German marks to buy one U.S.

dollar. Two years later, it took 421,050,000,000,000! The following year, the old mark was retired. You could trade one trillion marks for one new Reichsmark.

Inflation has been a fact of life in the U.S. for a long time. Over the last 10 years, the price of beef rose 72%. Eggs and electricity approx-imately doubled. Health care costs rose 44%. More than likely, the cost of living would have risen much more had it not been for maladroit U.S. policy.

Where will it stop? You will remember the inflation of

the ’70s. That peaked at about 13% per year. It stopped because Paul Volck- er made it stop.

He drove the fed funds rate to over 18%. He announced that he was going to squeeze inflation out of the system and he made good on his promise.

Even so, it was a close call. Volck- er was widely criticized for having caused the “worst recession since the Great Depression.” An effigy of him was burned on the Capitol steps to dramatize the discontent.

Had it not been for Ronald Reagan’s steadfast support, he would have been turned out of his post. A more cooperative, Janet

Yellen-type Fed chief would have been put in place. And the outcome would have been far different.

But that was 35 years ago. An entire generation has grown up since. Conditions have changed.

U.S. federal government debt in 1979 was under $1 trillion. Now it is $18.2 trillion. Total U.S. debt – public and private – in 1979 was $4.3 trillion. Now it is $60 trillion.

Stocks, bonds, real estate, col-lectibles – all asset prices now de-pend on this big growth in credit… and the availability of more. Wall Street, the Pentagon, people on dis-ability, half of all voters, big busi-ness, economists – most of Amer-ica’s elites, as well as its poorest people – also depend on continued inputs of cheap credit.

Today, it is unlikely that any Fed chief could do what Volcker did.

Total debt was 150% of GDP in 1980 – about where it had been for the previous 30 years. Now, it’s over 300%. Squeezing that much debt out of the system will be too painful to do voluntarily.

Under Volcker’s guidance, for example, stocks sold down to the point where the entire Dow could be bought for a single ounce of gold

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(briefly). Were that to happen today, it would mean a loss of 93%!

More likely, the feds will not stop consumer price inflation until it is well advanced. They will hesitate. They will procrastinate. They will not want to tighten. They will prefer to stimulate growth in supply rather than dampen demand.

This, of course, is a barren policy. But it will serve to put off any clamp-down on inflation until prices have at least doubled and the real burden of U.S. debt is cut in half.

Even if that is their goal, it would not be at all surprising if they seriously underestimated the speed of price hikes.

A Cyber-AttackWhat else might go wrong?If you were, say, China – just to

pick a name out of a hat – and you had twice as many engineers grad-uating from your universities as the U.S., you might be tempted to use some of them for “national defense” or economic mischief.

You might also be encouraged by the fact that about half of the top PhD graduates in math and science, from America’s best universities, are foreign born. And many of them are Chinese.

Would you challenge the U.S. at its own game – trying to match it in aircraft carriers, long-range bombers, and fighter jets? Would you prepare your armed forces for a Norman-dy-style invasion or an Iwo Jima-style last stand?

Or would you focus on the place where you might be able to get an advantage? Would you look to the fu-ture rather than the past?

I don’t know the exact numbers. But with the money the U.S. spends supporting 150 military golf cours-es, or one F-35 fighter plane, China

could put thousands of computer hackers to work.

As you may remember from last month’s issue, featuring our tech ex-pert Jeff Brown, one skilled hacker was recently able to break into a Jeep Cherokee’s computer system and wrest control of the vehicle from the driver. So what are the odds that one of those Chinese hackers could figure out how to disrupt the F-35’s control system?

I don’t know. But I wouldn’t want to be flying one when I found out.

And rather than target military hardware, he might be tempted to look at softer tissue… such as the del-icate fabric that holds the entire U.S. financial system together.

“The threat of shutting down the whole system… stock markets, ATMs, and banks… is real,” writes our own researcher, Jackson Cusick. “Ben Lawsky, head of New York’s Depart-ment of Financial Services, fears a hack that could be similar in size to the mortgage meltdown of 2008.”

Lawsky is concerned that within the next decade, we will experience an Armageddon-type cyber event that causes a significant disruption in the financial system. He is echoed by NSA director and head of U.S. Cy-ber Command Admiral Michael Rog-

ers, who says a big concern for Cyber Command is the interest that foreign countries have in breaking into the U.S. power grid.

Meanwhile, the Cambridge (Uni-versity) Center for Risk Studies warns that a cyber-attack could shut down U.S. power grids, costing the nation as much as $1 trillion. At least two major banks – HSBC and NatWest – have already been immobilized by hackers. And last year’s attack by the “Carbanak” malware – the world’s largest ever cyber-crime – took mon-ey from 100 different banks in 25 dif-ferent countries, a total estimated at about $1 billion.

You’re probably thinking, as I am, that breaking into a computer system is just a matter of having a hacker smarter than the people who wrote the security code. But the JPMor-gan hack – one of the biggest data breaches in history, involving 83 mil-lion accounts – may have originated from the theft of a single employee’s login credentials.

Fundamentally, the weakest link in the whole chain is the human.

According to testimony from a congressional researcher, a major U.S. bank suffers an attack every 34 seconds. Although most of those

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attacks are stopped, an increasing number are succeeding.

With that kind of volume it’s puz-zling that there is not more disrup-tion and theft going on.

Fortune magazine reports:

“Cyber warfare is a great al-ternative to conventional weap-ons,” says Amy Chang, a research associate at the Center for a New American Security. “It is cheap-er for and far more accessible to these small nation-states. It allows these countries to pull off attacks without as much risk of getting caught and without the repercussions when they are caught.”

Approximately 140 countries now have some sort of cyber-warfare pro-gram under development. Overall, the total cost of hacking – including those trying to stop it – is estimated at 1% of global GDP.

The U.S. probably (but not neces-sarily) spends the most on cyber war-fare, just as it does on all other forms of warfare. But it is also the most vul-nerable. It has the most to lose. It is the “big bad wave” for every hacker – amateur or professional – surfing the Internet. And it is also the most dependent on digital systems.

So, if you wanted to bring the U.S. to its knees, and you could draw upon

some of the world’s best cyber-engi-neering talent, what would you do? Shut down the power grid… the water flow… the traffic lights… the Internet itself? Would you bring trading to a halt on the NYSE? Would you wipe out people’s bank accounts? Would you scramble GPS signals and ground aircraft?

I don’t know. But it wouldn’t be at all unlikely that ATMs ceased to work – at least for a while.

Gold Coins and the Funeral Business

What can you do to protect your-self?

Remember, “There’s always mon-ey in the banana stand.”

This was a joke on the popular TV show Arrested Development. Cash had been hidden in the family’s fro-zen-banana stand. George, the fa-ther, tells the family repeatedly that “There’s always money in the banana stand.” But they don’t realize that he means it literally. He has hidden $250,000 in the stand, which goes up in smoke when it burns down.

But there’s no ambiguity in Jean-Baptiste Say’s version. To him, “There’s always money in the ba-nana stand” means the only source of wealth is real output.

Yes, you should have some mon-ey in cash. And yes, you should own gold, too. Gold is cash. It is still the

best form of cash and still the best bet for preserving wealth over the long haul.

But the bulk of your wealth – if possible – should be in banana stands or other things that produce products or services. Farmland. Timber. Min-ing concessions. Hotels. Apartment houses. Dry cleaners. Car washes. Pawnshops. Basic things that people want and need.

In the story at the beginning of this letter, in the midst of the hyper-inflation in Germany, the narrator worked for a funeral parlor. Money became worthless.

But people still died, and their relatives still wanted to mark their graves with tombstones – including the black obelisk.

When the crisis was over, two things were still valuable – gold coins and the funeral business.

Regards,

Bill BonnerParis, FranceSeptember 23, 2015

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