December 24, 2008
Hola One and All,
Christmas at GTMO is hard to explain. After all, we are on a communist island, and Castro made Communism the State religion years ago. Those poor Cuban kids. Sigh.
Anyway, I suppose the only public Christmas celebrations will be in our little corner of Cuba. As a result, the Naval Base goes all out. Christmas decorations and lights are everywhere.
Still, it’s a little odd. Santa Clauses, candy canes, and manger scenes don’t exactly go with iguanas, banana rats, and detainees. Still, something good happens here during Christmas. Maybe it’s because we are away from home and deployed to an “island on an island” that we forge a special kind of bond amongst friends. Everyone is smiling. Every house and hooch are open to anyone who happens to stop by. People are offering to take each others’ shifts. The chaplains are seeing a few more troopers in the pews. Small gifts are being exchanged with a hug and a peck on the cheek. It doesn’t replace home, but it’s nice.
In the spirit of the season, this week’s missive should be Christmas-y, but instead I drifted to WWII movies from 30 years ago and little German Frauleins from the 1920’s. Go figure.
To get in the spirit though, please feel free to pour some Christmas spirit into your eggnog before reading this week’s missive. And should you feel the urge to toast those in harm’s way, I will raise my glass in accord. Merry Christmas, Happy Hanukkah, and Cheers.
Signed, Your Wondering-If-Now-That-Castro-Is-Near-The-End-Of-His-Life-If-He-Misses-Christmas Soldier,
Greg
In the 1978 movie, Force 10 from Navarone, British Major Keith Mallory (Robert Shaw) and American Lieutenant Colonel Mike Barnsby (Harrison Ford) are given the mission to sneak into the bowels of a German Dam and blow it up from the base. The explosives expert Sergeant Dusty Miller (Edward Fox) gives them each a backpack of dynamite to do the deed.
Mallory and Barnsby steal some German uniforms and manage to make it to the inner workings inside the dam. They then acknowledge that they are about to die, and light the fuses. Out of instinct, they run as the explosives go off…and except for a few small pops and a cloud of dust, nothing happens.
Panicked, Mallory and Barnsby race up the stairs. Simultaneously, the Germans race the down the stairs to investigate. In the confusion, Mallory and Barnsby manage to escape and get to the adjacent hillside where the rest of the team is waiting. Mallory and Barnsby then start screaming at Miller for not giving them enough explosives to complete the job.
Miller, meanwhile, is resting against the back of tree smoking a pipe. He calmly says, “Gentlemen, let nature do her work.” Sure enough, the small explosives have done enough damage to the dam’s structural integrity that the water pressure behind the dam begins to crack the foundation. Soon it is chaos, as the dam breaks and a torrent of water races downstream just as a German armor division is crossing a vital bridge. The wall of water destroys the panzer-laden bridge and our heroes begin the long trek back to allied lines as the credits roll.
So what does this have to do with investing?
Gentle readers, monetary and fiscal explosions are going off and seemingly nothing is happening. In October, a $700 billion bailout bill was agreed to and “nothing happened.” Credit remained frozen. Banks wouldn’t lend. The stock market continued to tread water.
Meanwhile, AIG, Citi, GE Credit, and others received billions, but again to no effect. Then, trillions (with a ‘t’) were committed to shore up Commercial Paper Programs, Term Auction Facilities, Money Market Funds, FDIC Insurance, Discount Window borrowing, Overnight Loans, and Secondary Credit Programs…and that money disappeared into the maw.
The Federal Reserve then dropped interest rates to 0-.25% and world markets yawned. Now, the Federal Reserve is buying 10-year Treasury Notes directly from the government in what is called “quantitative easing,” (but is really just printing money) to buy the nation’s ever mounting debt.
Despite all these efforts, nothing seems to be happening.
So, we are doing what Mallory and Barnsby did. We are demanding even more explosives. Early next year, we will see a stimulus package that will be north of $850 billion…perhaps even over a trillion. 2009 treasury debt issuance is already expected to be over $1.5 trillion…assuming someone will buy it…at 0% interest!
But, what if something really is happening and we just don’t see it manifest yet? What if the pressure is building? What if the dam is destined to break, (as it likely is) but we just don’t know when?
I believe that despite the best intentions of our leaders, there will be unintended consequences to our current “stimulate or die” philosophy that will turn our heroes into goats and our desired happy ending into a nightmare. Unfortunately, in the financial world, we have seen this “movie” before…and, like Force 10 From Navarone the site was Germany.
So let’s return to the days of yesteryear and look at 1920’s Germany and a depression scenario opposite of the American depression scenario. As a reminder, our US Depression was deflationary. Prices and economic activity fell. Dollars were in short supply.
From that, Americans learned that the best economic remedy was to “accelerate through” deflationary depressions via massive government spending and stimulus. (As an aside, this may not have been the best remedy, but that is what we believe today…and this thinking dominates current US economic thought.)
The Germans, meanwhile, experienced a hyper-inflationary depression. Economic activity slowed, but prices soared. Reich Marks (RM) were in abundant supply. In this environment, “accelerating through it” brought only more pain. Let’s examine the facts.
The Weimar (pronounced Vy-mar) Republic of Germany was established following WWI in the city of Weimar (seems logical). The Germans were the losers of WWI and owed billions of Reich Marks (RM) in war reparations…mostly to the French. Let’s now defer to Wikipedia for a quick recap of what happened.
———
By 1923, the Republic claimed it could no longer afford the reparationspayments required by the Versailles treaty, and the government defaulted on some payments. In response, French and Belgian troops occupied the Ruhr region, Germany’s most productive industrial region at the time, taking control of most mining and manufacturing companies in January 1923. Strikes were called, and passive resistance was encouraged. These strikes lasted eight months, further damaging the economy and increasing the expense of imports. The strike meant no goods were being produced. This infuriated the French, who began to kill and exile protestors in the region.
Since striking workers were paid benefits by the state, much additional currency was printed, fueling a period of hyperinflation. The 1920s German inflation started when Germany had no goods with which to trade. The government printed money to deal with the crisis; this allowed Germany to pay war loans and reparations with worthless marks and helped formerly great industrialists to pay back their own loans. This also led to pay raises for workers and for businessmen who wanted to profit from it. Circulation of money rocketed, and soon the Germans discovered their money was worthless.
————-
And while reading about this is interesting, what most people of that generation remember are the visuals. Women with wheel barrows full of money trying to buy a loaf of bread…or Germans burning RM instead of coal because coal was more valuable. See below.
What stunned the world at the time was how quickly inflation took hold. Just prior to the great unraveling, there was actually a hint of deflation. Prices were stable, the economy was slowing, and unemployment was rising.
But you must remember that like the US today, Germany’s economy was credit based and the word credit derives from the Latin word credere “to believe.” Once belief in the value of the RM was questioned, the psychological dam broke. Germans raced to change their paper RM for tangible goods as the RM was rejected and debased.
In 1921, lunch at a German diner cost RM 10. By 1923 that same lunch cost over RM 1,000,000. Barter followed. Prostitution ran rampant. Gasoline was siphoned, copper pipes were stolen, murder rates rose, and drug and alcohol use soared. When RM trillion notes were issued, it was over. Society broke down for all but the richest of the rich.
So what are the parallels to today?
Like the US, Germany was a first world nation. They had industry and agriculture. They had an innovative and hard working population. They had an active cultural scene with orchestras, symphonies, operas, cabarets, and fine restaurants. They looked a lot like us today.
Unfortunately, like us today, their industrial base began to lag…albeit for different reasons. They had debilitating strikes and the vengeful French. We, of our own volition, exported much of our manufacturing base to Asia. Our massive trade deficits are a testament to our “production deficit.”
War reparations crippled German finances. Meanwhile, wars in Iraq and Afghanistan strain our Treasury today. Whether money goes to pay for reparations or for “surges,” the economic result is the same.
Next, while the German government paid striking workers directly, we pay for bloated welfare and entitlement programs…and our programs are bigger. One in six workers is already employed directly by Government (Federal, State, or Municipal). And, depending on how wide you throw the net, over 40% of American workers receive Government compensation either directly or indirectly. More bail-outs and massive infrastructure spending program will ensure this trend continues.
The point is this…
Often times, nations are the victims of their own experience. They believe that history repeats, when it merely rhymes. They then apply the wrong remedy…failing to notice that the circumstances and the facts have changed from one era to the next.
In the 1930’s we were a manufacturing giant. We had a positive trade deficit. We still maintained the gold standard as backing for our money. We had the luxury to “accelerate through it,” without crushing the currency.
Today, none of the above is true. Accelerating through our economic travails via government spending and borrowing is tantamount to exploding dynamite in our own dam while pressure on the dollar builds. We in the US are applying 1930’s US Depression models to a situation that looks far more like the 1920’s in Germany.
My concern is that we are reaching an inflection point where all of this printed money begins to work its way into circulation. When that occurs, inflation will come upon us like a promise. The economic dam will start cracking, the pipes will shudder and spew, the dam’s turbines will freeze. Then instead of our “movie” ending with the credits rolling across the screen, debits will roll instead.
