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November 1, 2012

November 1, 2012

Bonds, Debts, & the History of Default

All of the ancient and modern economic powers have defaulted on debts they have owed to their creditors.  Some have defaulted many times.  Below is a partial list of sovereign nations that have defaulted on their obligations, and failed to repay national debts in just the last 200 years.

A very partial list:
Brazil, numerous times
China, three times
Russia, numerous times
Japan, three times
France, three times
Germany, three times, and some German states, 5 times
Greece, numerous times
Spain, numerous times
the U.K., four times
the U.S., five times (and up to 19 individual states in the period 1841-1842 and 1873-1884)

(For a more exhaustive and instructive list, visit:Wikipedia Sovereign Default you’ll be shocked.)


Europe from the Dark Ages Forward

Let us now switch to events within Europe.  For centuries after the fall of the Roman Empire, western European influence ebbed between Frankish, Anglo Saxon, and Viking peoples, but there was no economic power base.

After the Dark Ages, the first economic powers to emerge were those in what is today Northern Italy, namely Venice and Genoa.  It wasn’t long before this power was ceded to Germanic states (eventually both the northern Italian and Germanic states were undone by Spain’s failure to pay their debts… sound
familiar?).  From the Germans, the mantle passed to the Dutch.  Holland became a banking and insurance center, and for a short time after winning sea battles against the Spanish became the richest country in Europe per capita.  Amsterdam was for a time the trading center and economic capital of northern Europe.

By the mid-18th century Holland had given way to Britain as the economic capital of Europe due to the loss of several wars.  Leadership went to Britain by the mid 1700s, and Britain gradually became the world’s preeminent economic power.  Aided by their embracing of the Industrial Revolution, their naval superiority, and the wealth from their expansive colonial empire, the English reigned supreme for over 150 years.  The English pound was recognized and accepted around the globe, however, by the 1900s, they did not have the wealth to repay their debts, and after WWII, the U.S. forgave them.

The U.S. is facing the same situation — paying for military and social programs that far outstrip its ability to repay.  We unequivocally predict that the U.S. will fail to repay bondholders with dollars equal in value to those they spent to buy their bonds.  The U.S. will pay its debts to bond holders by devaluing the currency to the point where U.S. government bonds are repaid in much lower buying-power dollars.  Economic power will be ceded once again.

How to Hasten the Decline?  Drive Business Away

Recent U.S. legislation has made it very hard for foreign banks to do business here.  Many refuse to do so, because if they do business with a U.S. customer, and make errors in the overwhelming documentation they must complete, or if the government simply “finds” a problem, the foreign bank can lose its assets in the U.S.  This is wild, and very, very unwise — bureaucracy run amok.

What Does History Tell us About Governments & Their Need for Money?

1)  Many nations gain economic power, and then through unwise behaviors — losing wars, repressive politics, over- taxation, or civil strife — eventually lose their power and fall to second-class or lower status.

2)  Nations that are in the process of losing power often find themselves in need of money.

3)  The politically powerful often take this opportunity to discriminate against a specific group or groups.  It may be that they discriminate against a religious or ethnic group (that is usually rich).  They almost always discriminate against those who have lent the government money, and more often than not, they discriminate against those rich who do not have political power.

4)  Finding themselves under attack and their lands and assets confiscated, the rich emigrate to new lands.  Thus, they deprive their home country of the largesse of their riches, and the largesse created by their business acumen.  The emigration of the rich is often an emigration of a cognitive elite.

5)  Finding that higher taxation or confiscation does not solve their money problems, governments either renege on their debts, or devalue their currency in order to be able to repay their debts with a sum that is nominally the same, but really of lesser value — through money printing.

In our observation, the latter is already happening in the United States.

Why are People Crowding into Government Bonds? 

There is no doubt that trillions and trillions of dollars have been put into the government bond markets.  When we see the history of governmental debt reneging, what is the logic of owning government bonds?  Ostensibly, it is security that people seek when they buy government bonds.  We argue that when a nation is in trouble financially, its bonds are not a safe investment.  History shows that well-run companies provide better security because they have assets that will be divided among creditors if the company fails.  We are unaware of any occasions on which government assets, such as land, buildings, or natural resources, were liquidated, and the proceeds given to individual citizen creditors.

Is it unpatriotic to make rational investment decisions?

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We are fundamentally bearish on bonds.

The economy will be hurt by inflation, not by deflation.  We advise our readers to not get sucked into the belief that we will experience deflation.  Central Bankers are not allowing it.  Do not fight the wrong war.  $16 trillion of U.S. Federal government debt is currently outstanding; add that to the many other types of government guaranteed debt and the numbers are huge.  If the U.S. economy deflates, the government will have a larger debt burden to deal with; if inflation wins the day, the government is benefitted.

Today, many individual investors are afraid of stocks and have left the equity markets.  This is an undeniable fact.  In our opinion, longer term bonds are a terrible investment — do not make the mistake of believing bonds will always offer safety.

As we have been consistently saying for years: deflation will not come, because every major central bank in the world is working to create QE and to stimulate inflation to counteract the deflationary tendencies of banking system shrinkage.  They have been successful, and we will see a rise in inflation in 2013.

Today, with such a huge amount of money ‘hiding’ in government debt, a bubble has formed, and smart money is shifting out of bonds into gold, real estate, and stocks.  The public, on the other hand, is plowing into bonds and bond funds at exactly the wrong time…

How to Invest for Income Without Bonds

If you’re an income-oriented investor who is concerned about the low rates of interest on bonds, we suggest you consider keeping a portion of your portfolio in cash and acquiring dividend paying stocks.  While short maturity bonds and short maturity bond funds may be among the most conservative investments, those who are willing to accept some risk should consider dividend paying stocks of companies with strong fundamentals (don’t just look for the highest yields). Dividends from good companies can provide yields that are much higher than you can earn from bonds and certainly higher than you can get in the bank.  Those of you with questions please contact Aubrey Ford at aford@guildinvestment.com.

To read the full analysis on Bonds, Debts, & the History of Default please login to your account: 

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3D Printing — Rapidly Changing the World of Manufactured Objects

In 1774, Scottish engineer James Watt began producing a steam engine that would inaugurate an unprecedented transformation of society and catapult productivity.  In 1913, Henry Ford set the first modern assembly line in motion…

“Making stuff, real stuff, could move from being a capital intensive industry into something that looks more like art and software.  This should favor the American skill set of creativity.”
— Rich Karlgaard, Editor, Forbes Magazine

To learn more about 3D printing and how it will affect developed countries and industries, become a Gold Subscriber today.  Please click the follow link to learn more about Gold Subscription.

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Guild Basic Needs Index
(September 2012)

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