Podcast

Paul Brodsky: Central Banks are Nearing the 'Inflate or Die' Stage

So hold tightly to your gold
Friday, July 6, 2012, 6:46 PM

"It's impossible to have a political solution to a balance sheet problem" says Paul Brodsky, bond market expert and co-founder of QB Asset Management.

The world has simply gotten itself into too much debt. There are creditors that expect to be paid, and debtors that are having an increasingly difficult time making their coupon payments. No amount of political or policy intervention is going to change that reality. (Unless a global "debt jubilee" transpires, which Paul thinks is unlikely).

Looking at the global monetary base, Paul sees it dwarfed by the staggering amount of debts that need to be repaid or serviced. The reckless use of leverage has resulted in a chasm between total credit and the money that can service it.

So how will this debt overhang be resolved?

Central bank money printing -- and lots of it -- thinks Paul.

At this point, the danger posed by the instability of our monetary and fiscal house of cards is so great that trying to time an investment program to when this avalanche of printing will occur is too risky, in Paul's opinion. It's time to shift your remaining capital into hard assets and sit on the sidelines to watch the carnage play out.

On The Imbalance Between Debts and Money Supply

We are seeing -- not only in the US but in Europe and in Asia, as well -- separating bank assets and base money. Base money is comprised of currency in circulation plus bank reserves that are held at central banks -- at the Fed or that is at the ECB, the Bank of Japan, so on and so forth. This is how the global economy rolls, as they say.

Bank assets are loans mostly. And the amounts globally are staggering: something approaching $100 trillion in global bank assets. And in the US we think that is somewhere around $20 trillion held in the US and abroad. And the numbers for the monetary base are much, much lower. Specifically in bank reserves -- that is the amount of reserves that are collateralizing, if you will, all of those $100 trillion in bank assets -- something about $8.5 to $9 trillion dollars. So that gives you a sense of perspective as to how much the global banking system is leverage. We are in a baseless monetary system

The marketplace forces deleveraging, and there are two ways to deleverage. One is to let credit deteriorate on its own in the marketplace. And the other is to manufacture new currency or bank reserves. Those are the only two ways to deleverage a balance sheet.

What policy makers do not want to see is bank asset deterioration. That would lead to all sorts of bad things. You would see banks fail. You would see bank systems fail. You would see debtors fail and it would just feed on itself in an accelerating fashion. And so monetary policy makers have no choice but to deleverage in the other way, which is to colloquially print money; to manufacture electronic credits and call them bank reserves.

And to the degree that that extends into the private sector where debtors begin to fail en masse, that would increase failures of the bank assets in turn. And it would end the mortgage bond securities market, for example, and the leveraged loan markets, and end the private sector shadow banking system. So it does not work for anybody to have credit deteriorate. The only way to deleverage an economy is as we are saying: to create new base money with which to do it.

On The Wisdom of Owning Gold & Hard Assets

The point here is you can either monetize debt or you can monetize (sell) assets. Or you revalue an asset on the balance sheet already of the Treasury or the Fed. And obviously that asset, we think, is gold. And that is the monetary asset that they have always reverted in the past. And that is the one we think that currencies, currently baseless currencies will be devalued against.

And so that we think is the mechanism that is ultimately going to play out whether in the marketplace or through some policy administered devaluation. Currencies are going to be devalued and that is where we sit right now. Timing this is impossible. We think the amount it would have to be devalued by, getting back to your original question, has got to be the amount of or something close to the amount of the gap (tens of US$ trillions) between bank assets and bank reserves. So it is a significant number.

And Treasury ministries, being the ultimate issuers of obligors on the hook for currency repayment, we see them as lending the gold to their central banks so that this mechanism, this asset monetization devaluation can take place. And so we think it is the only way out ultimately. And we will see that happen either in the marketplace or through proclamation at some point. And it is really what has to happen.

And so there is no physical limitation on the amount of currency that central banks may manufacture. And so this is a completely viable way to deleverage the system -- by purely destroying the currency that we have. It is debt currency, so we are going to destroy the debt in real terms behind them but not destroy them in nominal terms. That is the net effect of all this.

Click the play button below to listen to Chris' interview with Paul Brodsky (44m:37s):

Transcript: 

Chris Martenson:  Welcome to this Peak Prosperity podcast. This is your host, Chris Martenson, and today we get to welcome back Paul Brodsky, co-founder and co-managing member of QB Asset Management. Prior to QB Asset Management, Paul spent several decades trading bonds and other securities for such Wall Street firms as Drexel Burnham Lambert, Kidder Peabody, and Spyglass Capital. If our economy or financial markets fall into true crisis, the bond market is where the real action will play out. And the European bond market is now flashing warning signs that such a crisis may be in the process of unfolding.

Paul, thanks for returning as a guest.

Paul Brodsky:  It is my pleasure, Chris. Glad to talk.

Chris Martenson:  Awesome. Well, let us begin with your macro outlook: recovery or recession, healing or hemorrhaging? Where are we in your estimation in the macro global story?

Paul Brodsky:  Obviously, it is what seems to be a very complicated complex series of discrete entangled events that are playing out in the political sphere as well as the economic and monetary policy sphere. And where we come down on this whole thing is, it is impossible to have a political solution to a balance-sheet problem. And this is nothing new. We have been discussing this and writing about this for years now, since probably 2006. And it appears to us that there is debt, there are coupon payments, and no amount of political or policy intervention can take that away, unless there is a formal jubilee, which obviously we do not see. But where we think this is going – and it seems to be accelerating – is that politicians, policy makers, and the public are starting to recognize that this issue cannot be mandated away.

There are creditors that expect to be paid, and there are debtors that are having an increasingly difficult time paying them. So we are looking at balance sheets. We are thinking that the fundamental driver of value across asset classes reduces to this gap. We are seeing – not only in the U.S. but in Europe and in Asia as well – separating bank assets and base money. Base money, as I am sure many of your listeners know, is comprised of currency in circulation plus bank reserves that are held at central banks. That is at the Fed, or that is at the ECB, that is the Bank of Japan, so on and so forth, Bank of England. This is how we work. This is how the global economy rolls, as they say.

So the amount of bank assets – of course, bank assets are loans, mostly – and so the amounts globally are staggering. Something approaching $100 trillion in global bank assets, and we think that is somewhere around $20 trillion held in the U.S. and abroad. And the big numbers for monetary base are much, much lower specifically in bank reserves – that is, the amount of reserves that are collateralizing, if you will, all of those $100 trillion in bank assets, something about eight and a half, nine trillion dollars. So that gives you a sense of perspective as to how much the global banking system is leveraged. And it also kind of leads into a sense of where incentives are bank incentives to lend that does not only go to the private sector but that also goes to the public sector.

I mean, we are in a baseless monetary system. And money, as you have written about so often and so frequently, is lent into existence, and it all has to happen through the banking system. The fact that this mechanism that we use to create and issue and distribute currency is so highly leveraged, well, we think it just flows through to real economy. And I should say that is a very broad view of what we feel are the drivers of economic data, of economic behavior, because it goes directly to incentives both in the public and the private sector, in business as well as consumption and as well as monetary and fiscal policies.

Chris Martenson:  One of the ways that you can get out of a balance sheet difficulty – let’s say you have got a lot of loans on there – the classic way is to grow your way out. And so we are seeing a number of key thrusts right now – global growth, obviously, is on my macro view. All my dashboards say it is at stall speed in the U.S., and it is actually in negative territory elsewhere, for the most part.

And so here we are, what is it? Thursday, July 5th, and what we are seeing is, China just cut rates. The European Central Bank (ECB) has now got interest rates at historic lows. The main deposit rate is at three-quarters of a percent. Deposit facilities at zero. The Bank of England just tossed a little bit more money into the game over there. So we are seeing a lot of efforts to stimulate our way out. In your view, we have a balance-sheet problem. We have levered up; we have probably overextended ourselves. From my view, it looks like several decades of borrowing at a faster rate than our income was growing, and that is a math problem that catches up with you. Is it your estimation that that has caught up with us?

Paul Brodsky:  I think it has, and I think it is accelerating, Chris. When we talk about growth, when we look at growth, the world and certainly the capital markets have been trained to look nominally, in a nominal sense. And we can look at – you brought up, before, sovereign yields, In the U.S., we clearly have – even if you use the BLS (Bureau of Labor Statistics)’s version of the Consumer Price Index (CPI), which is the official version, of course – we have negative real yields out in ten years. If you were to use a CPI version that shadowed government statistics used John Williams’ [version], that calculates CPI in the same manner they did prior to 1980 it comes out to something approaching 8% negative real yields.

This is a very fundamental issue. When we talk about growth, if we were to take – and generally, when we talk about growth, people are thinking output growth with obviously GDP – when we apply these inflation rates to nominal output growth, nominal GDP, we come up also with negative real growth. And so it is very, very easy to see the gumming up, this viscous sense of growth.

There are two ways to produce growth in GDP. One is through increasing unit sales and through increasing transactions within consumption. And that is the healthy way. That implies that there is economic activity. The more transactions, the more consumption, the more unit sales there are. That obviously leads to higher employment. The other way is through higher prices. You can have higher prices and you can have a slowing economy. Yet you can still have what looks nominally to be output growth. And so we have seen that since 2008.

As oil has come down, and as gasoline prices have come down more recently, obviously we are seeing output growth in nominal terms come down as well. And that is all good for consumers. But it really does not make up for the lack of incentives on the part of employers to hire and the lack of incentive on the part of public and private potential borrowers to borrow to expand their businesses or to expand their consumption. So we are seeing the real economy contract. And this is not only in the U.S. This is obviously in Europe, and it is going on in Asia as well, as we are seeing in China and in other sovereign nations.

Chris Martenson:  Well, almost all of these bailout efforts – I have seen the ones directed at Greece, the ones in Spain, etc. – almost all of them have baked into their proposals as to how they are supposed to work a rapid resumption to real growth. I saw, I think it was just six months ago when they were first starting to really bite into the Greek bailout, charts that said there was an expectation that Greece basically flatlined this year and would be back to two, three, four percent growth starting next year. And that clearly does not seem to be in the cards. So, without this growth, what happens to these balance sheets?

Paul Brodsky:  I think the only solution has to be creating more bank reserves, creating more base money. First it is bank reserves; second it is going to be probably physical currency. We have – when we look at – and let us come back to the United States because we have very good data and it is easily consolidated. When we look at the United States, we see bank reserves held at the Fed of about $1.7 trillion dollars. It used to be zero. They used to not keep reserves at all, the banks. And we had a completely fractionally reserved banking system. Now, since QE (quantitative easing), we see about $1.7 trillion in reserves, as I said, on bank assets of about $20 trillion.

When we further look at deposits, it is about $10 trillion. Actually, theoretically, it is really $20 trillion, because for every asset there is a liability. So we could say it is $20 trillion. That is still tremendously fractionally reserved. In other words – and the bottom line on all that is there are $18 trillion dollars in deposits – however, it is backed by not quite $2 trillion dollars in reserves. That does not really mean that there is going to be a bank run tomorrow, because everyone does not need all their money at once. And it does not really mean that there should be a bank run tomorrow. But what it does mean is that the pressures on the banking system are so great to produce returns on deposits that are already highly levered that, as you say, the math just cannot work.

And this, we feel, is the nexus of the problem. It all comes back to the banking system. We found it very interesting watching yesterday’s testimony by Bob Diamond and the vitriol that the politicians, the British politicians, seem to throw at – not necessarily Bob Diamond, because he is a decent guy, and he was very forthcoming, it seems, but – seem to be throwing at the banking system. And we think that that is the beginning of what we have been calling for, where you are going to start to have a food fight among the banking systems and governments and policy makers; not monetary policy makers but fiscal policy makers. They are going to start to fight for control over how their economies work. And we feel that that is probably the beginning. We would not want to be senior bank management anywhere in the world right now, because they are going to have a tough row to hoe.

Chris Martenson:  So let me back up for a second and go all the way back to this $1.7 trillion in bank reserves held that the Fed – and you say there is $20 trillion in assets on the books of the banks right now that looks highly levered. I have heard some analysts say that those $1.7 trillion in reserve assets sitting around over at the Fed – that is like hot money that some day could just come racing out of the gate and go do things, like if the banks really wanted to start lending against that. Are you saying that is already fully lent against?

Paul Brodsky:  Well, it is high-powered money, as they say. It is net-zero, and theoretically they could use that as collateral, if you will, off which to lend further. But they already have lent $20 trillion on it. And so, the incremental earnings that they will produce from lending more on that are dubious, number one. And number two, the $20 trillion in assets that they have on the books, which are loans made to the public, imply leverage in private-sector balance sheets. So the incentives there to expand private-sector balance sheets also seem dubious. We are already leveraged. And if we are to leverage further, which we certainly could, there is going to have to be much more incentive to do that.

The reason that I suggested that the first phase is bank deleveraging is because we think that banks are going to have to delever before anything approaching a helicopter drop. That is a poor phrase, because there is nothing like that, but it obviously fully implies distributing new currency to the public – to debtors, not to creditors – not to creditor banks, but to the public. That would obviously shift obligations from private sector borrowers, probably, to the Fed, making the Fed and other central banks that do it the “bad bank.” And that would then, in all likelihood, initiate a new round of credit expansion, which we have come to think of as an “economic cycle.” But we think that the lack of incentives for growth provide the largest hurdle that we are seeing now.

Chris Martenson:  This is certainly an extraordinarily unusual period of time, at least compared to the last four decades, where in the U.S., we saw total credit market debt just double, double again, and do it so reliably so that it is a perfect exponential curve from 1970 through to 2008, where we had this breakage in that model. And right now, credit creation is stalled. We are not really advancing nor declining, and that is because non-financial debt is still sort of increasing as we watch governments, especially the U.S. government, go deep into hock to try and keep this going. And the shadow banking system looks like it is shedding its debt loads at a pretty rapid based. They are sort of at a standstill, more or less.

But what we are not doing is continuing to grow our credit markets at these very high percentage rates, six, seven, eight percent per year, just very reliably. And so that alone is a giant shift in how debt is operating, how money is operating, what the kind of flows that we are used to seeing, how we have structured all our markets around these types of flows. So are you suggesting here that – if we are going to get there, you said there are two things: one, increase bank reserves, and two, increase physical currency? Let us get to that in a minute. But the idea here is that you are saying until and unless we can get those animal lending spirits back in the game we are going nowhere, even with the risks of forced deleveraging waiting in the wings potentially?

Paul Brodsky:  I think that is right. I think the market has forced the deleveraging. I do not think it is – the market place forces deleveraging. And there are two ways to deleverage. One is to let credit deteriorate on its own in the marketplace. And the other is to manufacture new currency or bank reserves. And those are the only two ways to deleverage a balance sheet. And so that is what we are seeing. That is what we should expect in the future. It is already a well-entrenched trend that we are seeing, of deleveraging. What policy makers do not want to see is bank asset deterioration. That would lead to all sorts of bad things, as your listeners would imagine. You would see banks fail. You would see bank systems fail. You would see debtors fail. And it would just feed on itself in an accelerating fashion. And so monetary policy makers have no choice but to deleverage in the other way, which is to colloquially print money, manufacture electronic credits, and call them bank reserves.

And to the degree that that extends into the private sector, where debtors begin to fail en masse, that would increase failures of the bank assets, in turn, and it would end the mortgage bad securities market, for example, and the leveraged loan markets, and in the private sector, the shadow banking system. They would start to fail, as well, and those creditors reduced to pensioners. Because if a money manager or a pension fund owns mortgage-backed securities, for example, it all reduces to the pensioner that is behind them. So it does not work for anybody to have credit deteriorate. The only way to deleverage an economy is as we are saying: to create new money with which to do it; create new base money with which to do it.

Chris Martenson:  We are seeing that Europe is doing what it can do. First they chewed through German savings, and now I guess they are going to get down to the business of maybe printing a little more. They are easing, for sure. We will see if they get to printing. Bank of Japan obviously has been very aggressive at getting through its program of keeping its currency weak, if possible, through printing. The Fed punted on its last FOMC (Federal Open Market Committee); I guess they just went for a little more Operation Twist, but that really is balance-sheet neutral. Do you think there is more balance sheet expansion in the Fed’s future? And secondarily, are they going to be late to the game? Should they have already begun that process, say, at the last FOMC meeting?

Paul Brodsky:  Well, it depends what they are looking for. Obviously, we think that they should have deleveraged years ago. And in a practical sense, I do not want to get into fractional reserve banking, its merits and risks. I do not want to get into heart money and its merits and risks. That is not what we are talking about today. But in the current framework of what we have and what we are dealing with, practically speaking, they should have deleveraged years ago. They should have printed money and destroyed currencies years ago, certainly in 2008. If their goal was to induce growth as quickly as possible, they should have deleveraged years ago. So I do think that once Operation Twist runs off, if not sooner, they will go to QE. I think that the Fed has had somewhat of the ability to delay because we have seen this nominal growth. We have not gone into recession.

We have had issues in Europe that make the U.S. seem healthy by comparison. And all the focus seems to be on Europe, in terms of risk. However, the marketplace and the markets are not forcing the Fed to act. Banks have been reporting positive earnings and are expected to. And so there is no proverbial gun to the head of central bankers suggesting that they move quickly. There has not been a significant swoon in the capital markets. We see stocks keeping their bid over time. We are seeing low interest rates – which in our view are not sending the signal that deflation is coming, and we can get back to that – but are very synthesized. And we are seeing real estate just – it has stopped trading, and so we are not seeing a terrible quick fall in nominal prices of housing.

And we are seeing new foundage drifting in buying more commercial real estate. So I do not think there has been a gun to central bankers heads to go in and do QE. I think the outcome is absolutely set in stone. And that is, they have to do that, and they have to do it until such time as they transfer enough of the obligations to their own balance sheet to make the banking system healthy again.

Chris Martenson:  I will not hold you to this, but if you have any back-of-the-envelope calculations, how big of an expansion do you think that is, when all is said and done?

Paul Brodsky:  Well, I think they are going to have to get close to the $20 trillion. I do not know how; in bank assets, I think they are going to have to, for all the world, look as though they are reserving bank assets. So whether they can, whether they are allowed by the markets to do it incrementally, or whether they have to have some policy-administered deleveraging, which obviously would be a devaluation of the currency, is up to the markets. I cannot say what extent that goes to. What we have been seeing so far is the mechanism of debt monetization. A central bank just cannot print money out of thin air and distribute it. They have got to buy something for which they print money. And then they print the proceeds and distribute the proceeds. That is the way it works.

And so what they have been buying is debt. They have been buying Treasurys, they have been buying mortgage-backed securities, and they have been buying what seems to all the world to be high-quality debt. And they have been manufacturing the new money and then distributing that. Now they have been distributing in the U.S. only to banks. They have not been distributing it only to debtors or to society. But that is the way of the mechanism they use to print money. A devaluation would entail buying assets and printing new currency with which to buy assets.

As a mind exercise, I do not think this would ever happen, but if the United States – let us go to Europe. If the ECB or Greece tomorrow decided that it was going to sell Mykonos to China so that China could put a deep water port to have their aircraft carriers, and they were going to charge China – let us make up a number, let us say a trillion dollars – for Mykonos, or some other island, to do that. Well, they would be out of debt; they would have sold. But the point here is they would have sold an asset. They would have received yuan, or they would have received dollars– a trillion dollars in China’s bank reserves. And they would be out of debt. They would be the most solvent of all the European members. Will that happen? Obviously not. It will not be allowed.

The point here is, you can either monetize debt, or you can monetize assets. In this very poor example, Mykonos or an island would be an asset. The same true in the United States. You could do this anywhere. You can sell assets. You can sell Alaska for $16 trillion and retire the U.S. Treasury debt. Obviously, no one has $16 trillion to buy it, and we would never do that. Or you can sell or revalue an asset on the balance sheet already of the Treasury or the Fed. And obviously that asset, we think, is gold. And that is the monetary asset that they have always reverted to in the past. And that is the one we think that currently baseless currencies will be devalued against.

And so that, we think, is the mechanism that is ultimately going to play out, whether in the marketplace or through some policy-administered devaluation. Currencies are going to be devalued, and that is where we sit right now. Timing this is impossible. We think the amount it would have to be devalued by – getting back to your original question – has got to be the amount of or something close to the amount of the gap between bank assets and bank reserves. So it is a significant number.

Chris Martenson:  That is a big number. So as a first step, you are thinking, probably a little more of the same, where in this example what is happening is the central banks would continue to buy dead instruments, also known as assets – confusingly, in this story, because what we call assets and debt are the same thing in the banking world. For some people that is confusing. At any rate, the first step would be a little more balance sheet expansion using the typical vehicles, trying more of the same, just basically keeping our noses just above the water line. As a second step, you are saying we have to – obviously we can revalue against an asset, so Mykonos, or Alaska, or what do banks have? Well, they really only have two things on their balance sheet. They have a whole bunch of debt instruments, and they have got gold. That is it. So gold in this – this is Alaska, and you are saying what we would do is see as a probable – the only way out of this, you are saying, there is really – it is inflate or die.

I will make it very simple. The “die” part is, we have this market-forced deleveraging. It is a self-feeding spiral to nowhere good. It is a very destructive process. It is going to be avoided at all costs. Let us be honest: Central banks do not actually have any physical limits on what they can do, maybe only political limits or market limits. And if they coordinate well enough, there are really no market limits. Because which market would rebel?

Is that roughly correct? You are saying that in this story we do not know when, timing is hard, but we are going to have to devalue the currencies. It is really the only way out of this particular story at this stage as you see it?

Paul Brodsky:  That is exactly right, Chris. And if Treasury ministries literally owned the gold, being the ultimate issuers or obligors on the hook for currency repayment, we see them as lending the gold to their central banks so that this mechanism, this asset monetization, devaluation, can take place. And so we think it is the only way out ultimately. And we will see that happen either in the marketplace or through proclamation at some point. And it is really what has to happen. And this could not have happened.

By the way, let me also tear down a bit the analogy of the 1930s to today. The reason that central banks could not do this in the 1930s was because gold was already money. It was already backing money. Today, as you point out, that is not the case. And so there is no physical limitation on the amount of currency that central banks may manufacture. And so this is a completely viable way to deleverage the system. It is by purely destroying the currency that we have. It is debt currency so we are going to destroy the debt in real terms behind them but not destroy them in nominal terms. That is the net effect of all this.

Chris Martenson:  Destroy them in real terms but not nominal terms.

Paul Brodsky:  In other words, the purchasing power of the currencies will be destroyed, yet you will still have the dollars, you will still have the euros, you will still have the yen in your pocket. And actually you will have quite a bit more. So the nominal price of assets denominated in these currencies, if anything, would probably rise, certainly not fall, because there will be more currency chasing these assets. However, the purchasing power of things that you can buy with these currencies will fall dramatically. So if shares of General Electric or IBM or Google or Apple rise 10% or 15%, that is all great. And it will keep the nominal balance sheets solvent of pension funds and investors.

However, you may have a head of lettuce at the supermarket for $30. So clearly, leveraged financial assets will not keep pace in our view with the general price level. And that is the crux of the matter. It is solving for real returns as opposed to solving for nominal returns.

Chris Martenson:  Interesting. So if we hold gold as one of these assets, are you making the case here that this is a good time to get involved in other hard assets? Commercial real estate came up already in this conversation. Is this time to take advantage of generationally low interest rates, lock up some assets, and wait for this inevitable devaluation? Is that one way to protect yourself?

Paul Brodsky:  It is a bit tricky. Real estate used to be real. And by that I mean, since the advent of mortgage-backed securities market – and certainly I was a part of that – and new technologies and innovations, what we have today is the ability of private investors to act as creditor. So, in effect, a pension fund that allocates a certain percentage of its capital to large mutual fund or money manager, who then takes that capital and invests in the mortgage-backed securities market, is acting as creditor. And this has made the funding of real estate very broad-based. Many of these funders of real estate today, both residential and commercial, are leveraged. They are actually borrowing effectively from the banking system money, and with that credit, they buy more mortgage-backed securities.

Buying the mortgage-backed securities in turn increases or at least maintains the equity value of the real estate of the building, if you will. So, in effect, the asset values that underlie the market, where it is priced today, are in large part contingent upon the overnight funding of those assets. So what was once upon a time a term-funded – meaning 30-year, whatever it may have been – and a very well-funded or outright for cash when more homeowners owned a greater percentage of their homes in equity, has become really a financial asset. And that all reduces the marginal value of a home, or the marginal value of commercial real estate reduces to the overnight funding provided by the banking system. I do not know if that is too obtuse, but if you think through it, a hedge fund that goes out and buys MBS, mortgage-backed securities, or commercial mortgage-backed securities, or leveraged loans that are backing real estate, or something of that nature can only – that hedge fund’s NAV (net asset value) relies upon the ability to fund itself overnight through the banking system.

So what is the value of the home or of the strip mall that flows through to the hedge fund? It completely depends on the funding, and it has become overnight funding; it is not term funding. So is it a long-winded way of saying, is commercial real estate or is housing, residential real estate, a good place to put your money? Well, it depends on A) if it is term-funded and B) if the bid for that real estate relies on overnight funding. If it is term-funded, then that is good. You bought it well; it is funded well. You are not going to be taken out of your property if things get squirrely overnight. That is good. However, if the value of your asset, if the value of your real estate, relies on the continued overnight funding of anyone that might potentially come into buy your real estate, then we would argue that you may have a difficult time because it is a market. So we are not too sure that real estate is the cleanest way to play inflation. It has become a very mismatched funded market over the last 20 years.

Chris Martenson:  So, of course, extraordinary timing issues, but for the sake of argument, it is October, say. And all of a sudden there is an announcement. Federal Reserve in cahoots with ECB, Bank of England, maybe Japan, they all get together and they say, Hey, we’ve decided to sort of really go into this next round of printing, and we’re gonna do it pick a number $5 trillion as the next starting point. That’s what we’re doin’. We’re gonna wade right in. We’re gonna buy more assets, in this case mortgage-backed securities, more sovereign debt, whatever is lying around out that that they want to go and grab. In my world, that is a moment where, like a starter pistol, that says get rid of your cash reserves, go buy stuff, of which real estate might be an example.

Paul Brodsky:  It may be. Again, though, you could be right, and certainly there might be a very good trade there. At the end of the day, real estate has always come down to demographics. And whether or not you will have more investors or home owners coming into borrow, to buy real estate at whatever prices they are at, seems to me to be unknown. So you may be right, but it is not as clear to me as other types of investments, only because the real estate market is already a very leveraged and mismatched market. It is certainly going to be better than other forms of investment, I would argue, such as any bond with duration to it, and potentially cash, where we see great risk. So it could be better, but we do not have any real insight into the amount of leverage necessary or releveraging necessary to drive up collateral values or asset values.

Chris Martenson:  Yes, well, I am with you on that. I still recommend very strongly gold as the first order in this story, the first piece that we should talk about, mainly because I am a little bit Austrian when it comes down to where we are in this story. I truly believe that quote from Von Mises that when you are in a credit bubble, there are really only two paths forward, a voluntary abandonment of the credit expansion or a final catastrophe of the currency involved. So maybe catastrophe is a strong word, but if we include in that a pretty significant devaluation, I think that is in the cards, as well.

And the reason I like gold is, it has got all this history and everything, but it is money. It is an alternative money and money-like asset that is not simultaneously a liability somewhere else in the story. And on that basis it is simpler. It is easier to understand. As you have mentioned, there is a lot of thing impinging on the real estate market ranging from demographics, timing, how it is funded these days. So it is beholden to liquidity cycles, local geography, you name it. There is complexity in that. Gold is a relatively simple story, and also, I think, more profound in many ways because it is pointing to what I think the heart of this crisis really is, which is, it is a monetary crisis at heart.

We have run a debt-based money system right to its very edge, and we are going to keep pushing because we do not know what else to do, so we will do that. And I can not see any other way around that unless we are willing to, at the global level, say, hey, we are willing to talk about whole brand new currency systems that are maybe predicated on something other than this thing that we have been doing for the past 100 years.

I do not even see the beginnings of this conversation anywhere but at the bare fringes of the blogosphere. So I am not too worried about that cropping up. I just think we are going to continue within the system as it is designed. The sorts of solutions and policy ranges that we have will increasingly be both less palatable and desperate looking, as we are well past the stage of twine and band-aids and chewing gum. We are just doing whatever is necessary. When I talked with Steve Keen a couple weeks ago, he said that the main policy at the central banks right now really reduces to one word. It looks like panic to him. So they are just trying stuff. And that is my great faith. We will continue to try something long after it is been proven to be, shall we say, self-destructive in some way.

And gold to me is really the cornerstone of sidestepping almost any possible policy response I can envision happening next, and maybe even advancing our positions a little bit. But wealth preservation being the cornerstone of my philosophy at this stage, where if we are where I think we are in this story, one possible statement is he who loses least wins most. And that certainly was true in other great inflationary epics back in Weimar and Zimbabwe. There are so many examples we could just start rattling off. So I am wondering if, in closing, you agree with that view? Is it a question of simplicity, and is this really a monetary crisis at heart?

Paul Brodsky:  I agree with that unequivocally, Chris. And I would say that you can invest in gold when it is undervalued relative to baseless money. Ordinarily, you would save in gold because it is money. And as you suggest, today gold, in our view, is a wonderful investment, because there is a fundamentally ridiculously cheap arbitrage where that is, again, in our view, collapsing the spread between bank assets and bank reservers. It is that simple. And we think it has to happen.

And we think that, as you point out, central bankers are beginning to recognize that there is no other policy that can overcome that because you have debt payments to make. There is no fiscal policy. And I think politicians are soon to understand that neither austerity nor stimulation, tax code changes, I mean, anything – can promote enough growth to get out of this debt track. And so I would agree completely with your assessment, and that is the way we are proceeding. And, again, it is a terrible challenge to try and time this – and so we stopped trying. We do not any longer. We just are holding on and watching as it plays out.

I think it is very important to keep in mind that policy makers are holding the burned match, not investors in precious metals, gold, and other natural resources, scarce natural resources. They are holding the burning match because they are the ones that are trying to perpetuate the leverage, not us. Not those of us that are invested in gold. And so I think that the prudent thing to do is to take a step back and to hold it in either bullion form or precious metal miner form, because that is gold in the ground – physical gold in the ground, without anyone in between you and your gold – and just wait, and watch how it plays out hope for the best. But there is only, in our view, one outcome that we will see.

Chris Martenson:  Fantastic. As always, this is just very interesting, and I am so glad to have your depth of knowledge and be able to talk through these issues. There is a lot of complexity out there, but I think we have to understand that in order to know where we are in the story. It is a complex story. It is a complex system. But it has a simple solution at the end. So thank you again for your time. And if people – anybody is interested in your fund or following you more closely, how would they do that?

Paul Brodsky:  Well, I would suggest they maybe contact you – we do not take investors from the public and we do not hold ourselves out to be investment advisors. So I am happy to provide information to you, and I think that might be the best way to go about doing it.

Chris Martenson:  All right, well, fantastic. Thanks again and enjoy your upcoming weekend.

Paul Brodsky:  Thank you, Chris; you, too.

About the guest

Paul Brodsky

Paul Brodsky is co-founder and co-managing member of QB Asset Management. Paul spent several decades trading bonds and other securities for such Wall Street firms as Drexel Burnham Lambert, Kidder Peabody, and Spyglass Capital, where he actively managed mortgage-backed derivative funds for over a decade (over 85% of investor capital in that fund was returned by June 2006, before the wide-scale credit contraction occured). QB Asset Management serves accredited investors; more information on the firm and its investment strategy can be obtained by emailing Paul

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26 Comments

Travlin's picture
Travlin
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Missing

The podcast is missing.

Travlin

[fixed -- Adam]

pjvandal's picture
pjvandal
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sorta fixed

it's there, but it cannot be downloaded either via the direct amazon s3 link or through iTunes because amazon s3 apparently requires authorization to access the file.

MasterOfMyDomain's picture
MasterOfMyDomain
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Download not working

Download link still seems to be broken. In Firefox I receive this:

This XML file does not appear to have any style information associated with it. The document tree is shown below.
      <Error><Code>AccessDenied</Code><Message>Access Denied</Message><RequestId>6B6418AD3123FDB4</RequestId><HostId>da12bDZ0kC+2cUGfdmFTzOQnr7obqEksWdRflHDFAN/25Hias8qAEhHH2IiPDYGZ</HostId></

In IE 9 I get a 403 (forbidden).

cmartenson's picture
cmartenson
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Works for me...

is anybody still having a problem?  This loaded and played right away for me when I clicked.

We'll work hard to figure out the glitch and prevent it from happening again.

Have a great weekend,

Chris M.

Adam Taggart's picture
Adam Taggart
Status: Peak Prosperity Co-founder (Online)
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Posts: 1860
Download fixed

pjvandal & Master - try it now. The Download link should be working for you.

MasterOfMyDomain's picture
MasterOfMyDomain
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Works!

Thanks for the quick fix!

pjvandal's picture
pjvandal
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working now

thanks!

kito's picture
kito
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brodskys calculations

seems to me that brodskys calculation regarding the need to bridge the asset/reserve gap misses the point....the banks real problem lies with the hundreds of trillions in derivatives (they say its "netted/hedged" but as jpm has proven, thats not the case) that will cause the system to implode...........having reserves to cover the depositers due to bad loans is not going to help that bank when its on the hook for another 10x that amount in "hedged investments"........ brodsky also makes the assumption that the law of diminishing returns wont apply to massive lsaps/qes......even if the cbs had a chance to print to the moon, each round would bring less and less of a positive market response...there will come a day, not too distant, where printing will make no difference....

Erik T.'s picture
Erik T.
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Speaking of podcast glitches...

I'm curious... Did you guys ever get to the bottom of the question as to whether it would be possible to set up the enrolled member-only podcasts on either iTunes or some other mechanism that automatically puts them on your iPhone/iPod?

My (admittedly vague) recollection was that a member here voiced the opinion "Yes, there is a way to do that thru iTunes and still restrict it to paid subscribers only", and in response to that comment Adam agreed to research further and implement if possible.

What's the scoop - is this possible, and if so, has an iTunes subscription channel for enrolled members been set up, or will one be soon?

My apologies if this was already answered elsewhere, but I don't remember seeing anything further so thought I'd ask...

Thanks,

Erik

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UselessEater
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Adam Taggart's picture
Adam Taggart
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No

No, we haven't yet been able to set this up, Erik. Has the team you're working with at FinancialSense successfully been able to do this on iTunes for their new premium podcasts?

Erik T.'s picture
Erik T.
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Question for Chris and/or Paul

To Chris (and Paul if he's following the thread):

I would very much appreciate your perspective on last week's rather limited coordinated CB easing event.

Prior to last week, I was pretty much on the same page Chris has been on, thinking "Surely, they must know that for an easing to have meaninful effect, it needs to be BIG, and that means it will need to be a coordinated affair with all major CBs participating. The logic of that argument (best articulated by Chris, but very much in line with other opinions I respect) make perfect sense.

But last week totally confused me. It seems to me that to do a coordinated easing (as they clearly did last week, small as it was) effectively means the CBs have "played their hand". To do what they did then come back a week or two later with a much larger easing wouldn't make sense. So my gut is that there cannot be another coordinated CB easing for at least a few months now. I base that argument on NOTHING more than my gut feel that CBs tend to avoid taking actions frequently, and because I figure if they were going to do something BIG, they would either do it or wait till they were ready to do it. But doing what they did last week just doesn't jibe in my mind with a forthcoming much larger coordinated easing event.

So did the CBs just shoot their wad or what? And if so, does that pretty much lock in one side of Chris' prediction that EITHER there will be a major market crash OR a major coordinated CB easing event within the next 6 months? Seems to me like it did. Chris?

Thanks,

Erik

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RJE
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I'm with Erik T.,absolutely.

I'm with Erik T.,absolutely. Please respond to this very logical sequence of thought.

Regarding this podcast: "complex", yet in the end "simple". "Gold is money", it is "Alaska", and who wouldn't want to own a part of "Alaska".

Erik has made a srong case against a coordinated CB action near term and should be talked about.

Incidentally Erik, just a great interview over at Financial Newshour, a can't miss on Mondays.

Respectfully Given

BOB

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Returning to the Gold Standard

The US (and the EU) should return to the gold standard, setting the price of gold to $7000/ounce or whatever amount it takes to make every 'printed' dollar convertible using the 261m ounces of gold (supposedly) held in 'reserve'.  This would initially be inflationary since everyone holding an ounce of gold would suddenly have $7000 instead of $1600 (approx current market value) and gold miners would go into overtime to dig up more 'dollars', thus vastly increasing the money supply.  This would amount to a devaluation such as Mr. Brodsky is talking about and would have the effect of reducing the debt burden needed to avoid a punishing deflation.  Lenders would be repaid with cheaper dollars but that is better than not being paid at all (bankruptcy).  Workers would be paid with cheaper dollars but that is better than losing their jobs. Eventually, prices and wages would catch up to gold and, in the mean time, Congress could get its fiscal house in order.  Would they do it?  What other choice is there?

Oliveoilguy's picture
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Returning to Gold Standard

wootendw wrote:

The US (and the EU) should return to the gold standard, setting the price of gold to $7000/ounce or whatever amount it takes to make every 'printed' dollar convertible using the 261m ounces of gold (supposedly) held in 'reserve'.  This would initially be inflationary since everyone holding an ounce of gold would suddenly have $7000 instead of $1600 (approx current market value) and gold miners would go into overtime to dig up more 'dollars', thus vastly increasing the money supply.  This would amount to a devaluation such as Mr. Brodsky is talking about and would have the effect of reducing the debt burden needed to avoid a punishing deflation.  Lenders would be repaid with cheaper dollars but that is better than not being paid at all (bankruptcy).  Workers would be paid with cheaper dollars but that is better than losing their jobs. Eventually, prices and wages would catch up to gold and, in the mean time, Congress could get its fiscal house in order.  Would they do it?  What other choice is there?

What would happen to Silver in your senario? Would it be officially recognized as Money? If you added in the value of the world's above ground silver reserves you could somewhat reduce the dollar price of gold at revaluation.

Arthur Robey's picture
Arthur Robey
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A virtual solution to a virtual problem.

Prof. Steve Keen has not changed his mind. On RT he repeats his belief that there will have to be a private debt jubillee.

That might solve the problems of the virtual world of money, but how will it change the real world of the exponential growth and decay of real things? (Population, oil, rescources and others.)

sand_puppy's picture
sand_puppy
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Will there be an asset stripping deflation prior to hyperinflati

This is taken from zerohedge.com by "All Risk No Reward."  I am putting it here because it represents another angle on what is happening--one that I am not sure how to evaluate.  I would love to hear the assessment from those of you with more background in macroeconomics.  The question for me personally is this:  "Is it wise to take out a home mortgage loan for my primary residence at this point in time?"

-------

"For another view, the Money Power is reaching a point where they have to determine who gets their limbs cut off.

1. Hyperinflation will cut off the limbs of the debt holders and the cash holders

2. Debt deflation will cut off the limbs of debtors and nation states.

TBTF mega banks can't fail, by definition, so they don't really care which way it goes.

The problem the "straight to hyperinflation" folks have is that it requires:

1. The private banking cartel that makes the call to determine they will cut off their own limbs in order to bail out debtors.

2. That same banking cartel has to be dumber than a box of rocks for issuing 3.6% 30 year mortgages ahead of this "imminent hyperinflation."

3. You can't just "lose confidence" in the money anymore than you can "lose confidence in your mortgage" or student loan or car loan.  The debt holders won't let you do that, so YOU NEED MONEY OR YOU LOSE YOUR ASSET. [ie--They will reposses your car and house if you do not participate fully in the earn-money-in-dollars-and-make-loan-payments game.]

If you lose the assets, the debt has to be written down - and that's deflation by definition.

Hyperinflation is the end game - of that there is little debate.

The operative question, for those who understand the system enough to even formulate the question, is, "will there be an asset strripping deflation ahead of the hyperinflation?"

I believe there will be.

That doesn't make gold bad - it isn't so long as it is in your possession and you can defend it.

But you also have to consider that it might be h*ll on Earth to get physical gold because a societal asset stripping deflation is gonna be WICKED...  it won't be a gradual decline in prices.  We are talking about 50-90% of bank credit and investment digits being zeroed out - and the insiders have been preparing for this eventuality the last 4 years.

UselessEater's picture
UselessEater
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The LIBOR Scandal Is a Sham Engineered by Central Banking Elites

Here's another interesting take on it

The LIBOR Scandal Is a Sham Engineered by Central Banking Elites?

and of interest

Wall Street Banks Decline Bernanke's Twist, Hoard Treasurys

as Zero Hedge Notes

Actually as shown here, ST Bond holdings have soared as dealers buy what Fed sells: more here

 

kloren's picture
kloren
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Posts: 9
Is it possible for some to be very basically evil, to the core?

I, too, agreed with the concept that it is too late for a small QEx, only a huge one with all the CBs coordinating, but IF you think that their purpose is to creat chaos, not just destruction of the world economy, then any type of confusion can contribute to chaos.  The more confusion they can create the better, think they.

Their view, of course, is that chaos opens the door to a new world order.

Lots of evil bit players can have, each of them, a "coordinated" push to the brink and over even with their random efforts.

Perhaps the only prediction is that more chaos will appear.

With that "WHO" decides on which world order may appear?

The planet certainly needs a better system of survival and paths toward survival.

rhare's picture
rhare
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We are the answer....

kloren wrote:

With that "WHO" decides on which world order may appear?

The planet certainly needs a better system of survival and paths toward survival.

The answer to the WHO is us.  We need to stop putting our trust to solve problems in the hands of others (governments,bankers,...).  We have to act ourselves, in our own best interests.  Only when all participants act voluntarily and on their own behalf do you end up with a "fair" system.  It's only through the force of government limiting our choices for money that has allowed the system to go haywire. Without that force currency users would quickly change whenever a currency was being abused.

The only way to get to that point is through education.  We have been told by those that wish to control us that we need them.  That we have to have control or the wold will fall apart.  We have to expose the lies and get people to trust in themselves.

Oliveoilguy's picture
Oliveoilguy
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Posts: 378
"will there be an asset strripping deflation ahead of the hyper

"will there be an asset strripping deflation ahead of the hyperinflation?"

Not a chance.

Since the ultimate "debt holders" are the Central Banks and because they have a controlling influence in the world, they will never allow a prolonged deflation.  Bernanke has staked his career on this very issue.

Cnetral Banks will target a modest inflation over a period of years and hope to devalue their currencies as the way out of debt. This might work for a while, but will require ever increasing monetization of debt.

Chris Martensen is calling for a coordinated Central Bank Intervention. I agree, that coming soon.

The Central Banks are in too deep to change course. They will attempt to inflate at all costs.

Finally we will see hyperinflation.

sand_puppy's picture
sand_puppy
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asset stripping deflation ahead of hyperinflation?

I appreciate your thought, oliveoilguy.  Two additional questions:

1.  Please explain how it works that the Central Banks are the ultimate holders of debt.

2.  Why is my local bank willing to loan me $300,000 at 3.6% interest for 30 years.   Even modest inflation will make their return on investment zero or negative.  Isn't there someone at the bank who realizes that this is likely and has the wisdom to stop making long-term low interest loans that are sure to make the bank lose money?

Appreciate your help in understanding this.

JustamereBear's picture
JustamereBear
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Posts: 4
Missing element in most calculations

It seems to me that few if any discussions of this nature even think of the derivatives on bank balance sheets. It is true that as long as both ends of the derivative contract perform exactly as per the contract, the banks have little or no risk. I have been in isolation preparing, and haven't been able to, or interested much in following details in the financial world. For example, if one end of the contract fails to perform, usually the bank is on the hook (as a result of their greedyness) for at least the end that failed to perform. (usually more) Last I heard the estimates of derivatives outstanding usually used the word QUADrillions. Because the world financial system went bankrupt 17 Aug 2008, I don't think there will be much time for hyperinflation. The governmernts have been colluding massively with the banks to relax reporting rules so they  appear to be solvent. They aren't, and as what is happening in much of Europe, (largely unreported in N America) shows, the papering over problems are not nearly enough to hide the magnitude of the gaps in the system. More ineffectual bailouts. (Which won't stop the bank and CURRENCY runs which are already out of control.)

While the trigger event may be different (and may not) I like the scenario painted by Allen Curries novel "Operation Phoenix" at www.AllenCurrie.ca as I expect there will not be time for hyperinflation, just collapse.

I would dealy love to have some inside information about Greece who had zillions in derivatives. IMHO, Greece has much further to fall.

It is interesting to note that the last time the Fed DID NOT interfere with a depression (1920/21) the depression was very vicious, but lasted less than 18 months. Iceland, who refused to bail out the bank(s), less than three years later is recovering nicely with a lower unemployment rate than the European average. (Which is not to say it is now the land of milk and honey) They had huge pressures, including being placed on terrorist lists, by nearly every other country in the world to do it the way the US is doing it. On the other hand, it is generally agreed that government interference extended the "Great Depression" from 1934 onwards.  Governments seem to value the banking system (read their treasury) more than democracy itself. Let the peasants eat cake, but make sure they pay for our (and the banks) stupidity. Peasants get no vote in this matter.

J'Bear

Oliveoilguy's picture
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Posts: 378
asset stripping deflation ahead of hyperinflation?


Oliveoilguy's picture
Oliveoilguy
Status: Gold Member (Offline)
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Posts: 378
asset stripping deflation ahead of hyperinflation?

I appreciate your thought, oliveoilguy.  Two additional questions:

1.  Please explain how it works that the Central Banks are the ultimate holders of debt.

2.  Why is my local bank willing to loan me $300,000 at 3.6% interest for 30 years.   Even modest inflation will make their return on investment zero or negative.  Isn't there someone at the bank who realizes that this is likely and has the wisdom to stop making long-term low interest loans that are sure to make the bank lose money?

Appreciate your help in understanding this.

Sand_puppy,

Central Banks are the "Ultimate printers of Money" and in exchange for "Federal Reserve Notes" that they create they aquire Treasury Notes (Debt). They also hold Mortgage Paper (MBS) and GSE debt. Since much of this debt on their balance sheet is worth very little, they will most likely hold it for a long time. With all that bad paper, they must surely favor inflation.

On question #2  "Why is my local bank willing to loan me $300,000 at 3.6% interest for 30 years?"  It makes no sense.

RJE's picture
RJE
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Posts: 1369
By there very nature

By there very nature recessions are Deflationary (we are in a recession), and not a stretch that Peak Oil will by its nature cause Recessions and logically more frequent. So how do we get an absolute Hyper-Inflation? I can see high inflation but hyper-inflation with our suppose gold reserves?

For now I will study both sides (inflation-deflation) because I just don't see for the foreseeable future how debt destruction can be avoided on a massive scale. Anyways, prepared to change my mind on a moments notice. If I was only married to the idea of Inflation then I would own gold only, but if we get the market correction that is now anticipated then large profits would be left on the table. Gold will remain a nice position in my portfolio (20%) but as an insurance. The remainder of cash will drift in and out of oil E&P.

Regards

BOB

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