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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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The three inflation-hedge crachesTHE THREE INFLATION-HEDGE CRASHES: 1977-1999 The period from 1972 to 1983 was a time in which the Western world was beset with a seemingly endless sea of economic and political troubles: 1. The major Russian crop failure of 1972 led to the Great Grain Robbery in 1972-1973 in which Russia secretly bought nearly all available supplies of U.S. wheat at a government-subsidized price of $1.65 a bushel; prices thereupon skyrocketed to more than $5 a bushel, setting off food price inflation. 3. Watergate destroyed the Nixon presidency in 1973-1974 in a long, agonizing process that seared the national consciousness; the sense that the presidency had lost its legitimacy caused moderates and conservatives to lose heart, liberals to lose their optimism about the inevitability of progress, and radicals to believe that the time for revolution was at hand. 4. U.S. defeat in Vietnam in 1975 launched a long era of national self-flagellation and finger-pointing, and a seeming breakdown in law and order. 5. Britains long decline accelerated in a decade of collapsing pro ductivity and labor chaos, leading to the 1979 election of a tough, principled conservative, Margaret Thatcher. She confidently predicted she would be joined in power by fellow conservative Ronald Reagan, whose optimistic new right-wing populism would transform Americas economy and whose strategic vision would make America a great power again. (She told me in a private conversation in 1978 that she expected to win three elections, and that Reagan would win two. She said that between them they would restructure their economies, rebuild their defenses, and, Who knows? By the time we leave public life, we may have won the Cold War. She was, among other things, one great forecaster.) 6. Inflation became entrenched globally in 1971; more and more cen tral bankers blamed the falling U.S. dollar for the problem; Paul Volcker, newly installed chairman of the Federal Reserve, met with them at the Belgrade IMF Conference in October 1979 and was told a new global collapse loomed unless the U.S. dollar was stabilized. Volcker proclaimed the imposition of transparent monetarismin which money supply targets would be announced in advance, and the Fed would enforce them, regardless of the impact on interest rates, the economy, or the dollar. That was the policy long favored by Milton Friedman. Interest rates skyrocketed, and the United States entered the first phase of a double-dip recession. 7. Reagan defeated Carter in 1980. His tax cuts and deregulation backed up the anti-inflationary monetary policies being pursued by Paul Volcker. 8. By 1981, Japan emerged as the virtually unchallenged industrial leader of the world, supplanting long-established companies in the United States, Canada, and Europe. Japans might reinforced a growing pessimism that the decline of the West, as predicted by Oswald Spengler in the book of that name in 1918, had now begun and would continue inexorably. It was against this tumultuous background that a trio of hard assets gold, silver, and oiland the shares of the companies that produced them took over leadership in global stock indices. Not all that glittered was gold, which shared the stage with silver and oil. In the 1970s some of the best of people went astray. The markers and guideposts that had worked most of the time since World War II seemed to have been lost in a fogor to have lost their ability to give reliable information. Investor survival could not be found in bank accounts, leading stocks, or bonds. A whole new collection of Pied Pipers and Shills Mountebanks appeared, warning of the collapse of the financial world and urging investors to profit from it with inflation hedges. The culmination of Club of Rome gloom, the failure of equities to recover strongly from the Nifty Fifty Crash, political and economic dysfunction, and the failure of central banks to protect currency values gave the world a new challenge: stagflation. Stagflation was an ugly new word to define an ugly new problem: rising inflation at the time of stagnating economies. In the 1970s, investors began to retreat from financial assets to hard assets. That process eventually would become a new form of mania. What began as reasoned hedging against unanticipated inflation became a mania to get rich from the coming collapse of currencies, banks, and financial systems. Polls showed that most Americans thought the nation had lost its way. Wall Street was a shrunken, frightened place, in part because the Nifty Fifty Crash had destroyed the investments it had peddled hardest, but also because of the SECs imposition of fully negotiated brokerage commissions. On May 1, 1975Mayday, as it was swiftly termed by terrified brokersWall Street was forced to slash all institutional commissions (by as much as 90 percent) and reduce most retail commissions. Not only had the stock market then endured a Papa Bear horror, but in the ensuing recovery, trading volumes were too light to make up for the collapse in institutional commission rates. The inflation hedge crashes were different than the other Triple Waterfalls of the 20th century: Wall Street was only modestly culpable. The hype, distortions, and misinformation that led to the spectacular run-ups in the inflation hedge assets were not, in large measure, hatched on Wall Street. Indeed, the arguments used by the extreme doomsayers (who urged people to load up on guns and gold) were that the Old Economy investments would not work anymore; the financial world was facing a new kind of inflation challenge caused by a massive rise in oil costs, which had led to a massive buildup of dollar deposits by oil sheikhs in leading banks, which had been massively loaned to Third World dictatorships and kleptocracies, leading to massive defaults that would trigger a massive global financial collapse. They shrilled that collapse would make paper moneywhose value was plunging because of double-digit inflation, anywayvirtually worthless. Gold (1975-1999) As the classic inflation hedge, gold became both symbol and star actor in the inflation hedge mania that produced three Triple Waterfalls. Because the motivations that drove them skyward and then sent them plunging were virtually the same, and because these Triple Waterfalls were virtually contemporaneous, it makes sense to consider them together. Their dramatic rises smashed investors beliefs in conventional financial assets, and their dramatic collapses smashed inflation psyches, restoring belief in conventional financial assets, thereby marking the end of the inflation/stagflation era. Golds price was frozen at $35 an ounce after the Bretton Woods Agreement in 1944 established the American dollar as the new global store of value. The United States held most of the worlds known supplies of gold, and it agreed to sell gold from its hoard to other central banks at $35. U.S. citizens were barred from holding gold bullion, and U.S. gold mines had to sell their output to the government at the fixed price. In August 1971, President Nixon closed the gold window, which meant the United States would no longer sell its dwindling gold reserves to other central banks. That meant the dollar was no longer gold-backed, even in theory, and it was the signal for an outbreak of inflation that the administration sought to halt with wage and price controls. They failed, disastrously. Golds price worked higher during the 1970s (see Chart 3-2), but when the U.S. dollars plunge against key global currencies seemed out of control, gold took off and a mania spread worldwide. Silver (1975-1999) Silver followed golds rise (see Chart 3-3), and then surged ahead of it when the Hunts, one of Americas wealthiest families, with a fortune built on oil, made a deal with Saudi partners to corner the world silver market. This was the only Triple Waterfall that was not driven primarily by Shared Mistake. Apart from the co-conspirators and some serious inflation fanatics, few economists, strategists, or institutional investors believed silver was worth anything approaching $50 an ounce. It could be said that the Shared Mistake that inflation could never be tamed fueled the whole bizarre run-up, but silver would not have been a preferred hedge against inflation without the short-lived Hunt-Saudi cabal. A personal anecdote recalls the excitement at the time of the peak of that Triple Waterfall. When my son Stuart was born in 1967, a friend (of leftist persuasion) gave him a piggybank for a young capitalist. I thought it was a fine idea, and began putting silver coins into it each day. I was a firm believer that silver prices were headed much higher, because the hoard of monetary silver in the United States was melting rapidly. By the time Stuart was four, the piggybank was heavy with dimes, quarters, and half-dollars. I explained to him that it was his bank, but he was not to touch it, because it would eventually pay his way to college. We established a ritual on his birthday, pouring out the coins and counting his wealth. By the time he was seven, there were no new-minted silver coins for his bank, but I had become adept at sorting out silver from dross and was able to add more coinsat a fast-dwindling rateuntil 1980. On his fourteenth birthday, in January 1981, when we counted out his savings, he had just over $100 face value, but with silver now selling at $51 an ounce, they were worth more than $2000. I recommended he sell. He said, Give me a day to think about it, Dad. The next day he authorized me to sell half his position. I took the bag of coins with me to a dealer in Toronto. I stood in a long line. People were cashing in everything silver they had. It was weighed by the storekeeper, who then paid cash. The man ahead of me in line had antique candlesticks. He knew they would be melted down within hours, but hed have his money. I got Stuarts $1000 and set off to a sales meeting in Toronto. I was trying to win the investment management of a union pension fund for our firm. Our investment performance compared very favorably to other Canadian investment managers during the 1980s, because we were great believers in endless inflation. In my presentation to the all-male union committee, I said Id changed my views on inflation because of what Paul Volcker was doing. I told them interest rates were about to peak, and long-term bonds were going to become the next winning asset class. For me, and for the consultant who had arranged for my appearance, this was a sea change. I had achieved notoriety in investment circles during the 1970s by telling audiences, The proper holding period for a long-term bond is the same as for a hand grenade after youve pulled the pin. They appeared uninterested in my presentation, so I decided to try a new tack, and told them about my sons piggybank and how he was cashing in his bet on inflation. That got their attention. They began peppering me with questions. The consultant called me a week later. Don, I dont know if you made up that story, but it got you half the business. When you told a committee of Italian fathers about your sons piggybank, they were sold. Postscript: The store on Queen Street went bankrupt days later. The silver bubble was about to burst. Although the price of silver on the commodity exchange would stay strong until March, that bankruptcy showed the flaw in the reasoning of the Hunts and their fellow speculators who thought they could corner the market. They reasoned that the amount of newly mined silver was grossly inadequate for the demand. Furthermore, there were only a few pure silver mines in the whole world. Most silver is foundin relatively small amounts per ton of ore minedmixed in with ore bodies mined primarily for lead and zinc, and some is also found associated with gold mines. Because even a 900 percent increase in silver prices would not mean great new production of lead and zinc to get that silver, silver had to keep going higher. The ultimate collapse in silver prices came because the Hunts grossly underestimated the amount of the potential meltdown of aboveground silver. |
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