• Podcast

    Keith Fitz-Gerald: The Perils of Underestimating Complexity & Mispricing Risk

    Magical thinking is dangerous
    by Adam Taggart

    Saturday, August 25, 2012, 3:16 PM

"If you’re rich you get a bailout. If you’re poor you get a handout. And if you’re middle class you get left out. " That's not a sustainable way to run the system, exclaims investment strategist Keith Fitz-Gerald.

A cancer at the core of our current economy is the magical thinking, "no pain, all gain" philosophy, pursued by those running it. They are doing all they can to remove the consequences of failure from the system — blind to failure's essential 'waste-clearing' function in a healthy free market.

Without the discipline of Darwinism, the individual actors in the system make all sorts of malinvestments that would never make sense in an efficient marketplace. But since the losses from these inane pursuits are socialized, there's no incentive to stop making them. At least, up until the point where the class who's back is burdened with paying for the socialized messes finally breaks.

This is the thing: let some of these things fail because when failure occurs you have an asset redistribution. The faulty assets are, in fact, bled out of the system. The quality assets are assumed by responsible parties. That is the law of capitalism. That’s the way it works.

So if we think back to the credit crisis and we think back to what happened in 2007 – 2008 they went screaming and yelling to congress, "Oh my goodness, we’re going to have to do this or the sky’s going to fall!" Well, the sky fell anyway. They pumped $700 billion into this, then a couple $ Trillion. Well, if the government multiplier that all these conventional economists talk about actually worked our economy should be screaming along at six or eight percent right now, but it's not.

And the reason it's not is because it's a complex system and despite all the pushing and pulling they’ve done on one end, they didn’t understand that all these other things would happen at the other end. Too big to fail? It's not too big to fail; it's too big to survive.

We have monopoly laws that we should have been using along the way but our regulators were asleep at the switch. They’re out manned, outdone, outclassed, at every turn of the road. Wall Street does not want to do anything that remotely resembles reigning itself in and it has no incentive to do so.

It sure as hell is not the free market that everybody likes to think it is. And that, to me, is extremely disturbing because they have removed the hand of risk from the marketplace and these businesses now have every incentive to screw up because they know that a) they won’t be held accountable for it and b) they’re going to get bailed out.


They have put so much debt onto this that our unborn great, great, great, great, great, grandchildren could not possibly pay this off. The only way they’re going to get out of this is to deleverage it and remove it from the system.

As an expert on Japan with deep personal ties there as well, Keith and Chris also discuss why that country is a great "black swan" candidate for the back half of 2012.

Click the play button below to listen to Chris' interview with Keith Fitz-Gerald (44m:22s):


Chris Martenson:  Welcome to another Peak Prosperity podcast. I am your host, of course, Chris Martenson, and today we have the pleasure of speaking with Keith Fitz-Gerald, chairman of the Fitz-Gerald Group and chief investment strategist for Money Map Press, where his daily analysis reaches 500 thousand readers in 35 countries.

I met Keith a few months ago while we were both involved in filming a video documentary for Money Map Press that’s out and available now. Keith’s specialty is in the science of complexity and in non-linear trends in the financial markets. His analysis helps individuals and policymakers predict future events and prepare for them. So we’re going to talk about some of that today. 

I have to say, I really enjoyed my time with Keith, and I’m excited to have him on the show to discuss complexity (something our economic financial and energy systems are increasingly displaying the weaker aspects of these days, I believe), as well as maybe the geopolitics of resources, and hopefully Japan, too, where Keith has both deep personal and professional insights. Keith, thank you for joining us.

Keith Fitz-Gerald:  It's an honor to be here, and I really appreciate it. It's great to be here.

Chris Martenson:  Oh, thank you. I’m sure my intro was too brief, so for those listeners who aren’t familiar with you, can you help fill us all in a little more about yourself, your background, and your current areas of interest or focus?

Keith Fitz-Gerald:  Oh, my goodness. I’ll tell you, your introduction was very kind, and I appreciate it very much. I actually began my career, more years ago than I can care to remember, at the consulting firm at Wilshire Associates. And as one of the world’s largest preeminent pension fund and financial firms, I learned what works on Wall Street, but more importantly what doesn’t work. Since then, I have pursued interests in global markets and have spent literally my entire career in the major financial centers of the world working with clients around the world. I’ve been very, very blessed to have enjoyed the path that I have.

Complexity, complex systems, those are core to how I view the markets. And that, I think, gives us an edge in terms of how we analyze things, because people are looking at them right now, in a very classic sort of linear sense in that moving averages are interesting; we have this stat and that stat. What they don’t realize about complex systems is that they feed on themselves and they are self-iterative. What this means is that very, very tiny inputs continue to cause reaction and action inside the system itself. Many times these actions are causing much of today’s consternation, but nobody realizes that’s what they actually are. 

Chris Martenson:  So let’s start there, then, with this complexity. It's presented fairly linearly in the press. You read about it. So the Federal Reserve wants to make employment go up, so what do they do? They lower interest rates. It's like it's a big lever, right? You push on it this way and interest rates go down – and guess what? Employment goes up. What you’re saying is, it doesn’t quite work that simply.

Keith Fitz-Gerald:  No, it doesn’t. There are all kinds of other inputs that go into it, and one of the things they have not yet focused on is that in their massive, what I call fiscal meddling, because this is the greatest fiscal meddling we have ever seen in recorded history. The United States went from being the world’s greatest creditor to the world’s single biggest recorded debtor ever.  They don’t understand that in keeping interest rates low and in stimulating the economy, they, in fact, are feeding the very problems that cause this financial mess to begin with. I have not yet seen anybody, other than myself and a few other people, argue that this crisis was not caused by a lack of liquidity. This crisis as caused by too much money in the first place. It's too much money splashing around in a punch bowl that is causing all these problems.

Chris Martenson:  Absolutely. And, of course, we’ve got 0% interest rates, which were supposed to be temporary, right? What are we, three and a half years into them, and they’re arguably not working, although you might try and argue the negative and say, well, at least the world didn’t completely fall apart. But here we are.

Keith Fitz-Gerald:  Well, that’s a pretty weak argument. I mean, that’s basically like airplane fees. They were supposed to be temporary to compensate for gas. Well, guess what? Three or four billion dollars a year later, you can pay five bucks for a pillow; seven dollars if you want a clean one. It's ridiculous abuse of the economic system. What you have to engineer, in my opinion, is the concept of failure. Capitalism works because of success, but people forget that implicit in that concept of success is the concept of failure. And until they start to reintroduce failure and introduce the freehanded risk, the markets are going to do what they’re doing now.

Chris Martenson:  Right, so with this mispriced money – which is, I think, the root of all evil in the financial markets – when money is mispriced, everything gets mispriced, not the least of which is risk. Risk is horribly mispriced at this point. Look at what you’re going to get back for loaning money to the U.S. government for 30 years, and you might say, well, that doesn’t really seem adequate. But that’s just beating on Treasurys. Talk about maybe, I don’t know, the junk bond markets priced where they are, or the municipal bond markets, or any of the bond markets, or equity markets. They all seem priced for some form of perfection. Maybe that’s mispricing risk a bit.

Keith Fitz-Gerald:  I think there’s a broader issue here, and I’ve made no bones about the argument that the reason this crisis – as opposed to any of the other crises we’ve lived through in the past – is so very painful for so many people is that the very definition of money is changing.  You can see that in the way they have manipulated interest rates by bringing them down. And by keeping the range so narrow between short-range and long-range, they’ve created a financial roadblock, for lack of better terms.

Here’s how this works: If you invest money, you’re assumed to invest it longer periods of time. You earn more because you’re taking more risk that conventionally accepted financial theory. Well, if you go out 30 years, you’re only getting one-and-a-half to three percent on your money. If you factor in the cost of inflation effectively, that’s a zero-investment return decision. And if interest rates on the short term are held so low, what you’ve done inadvertently is you have theoretically removed the time value of money.

Therefore, there is no incentive to invest it; there’s no incentive to lend it. The breakdown of the model of “borrow short and lend long” completely fails. You can’t make capital budgeting decisions. Everything from money market funds, for example – we’ve got a trillion dollars of assets sitting there – to pension funds where you’ve got hundreds of billions, trillions of dollars, you can’t price those models; chief financial officers can’t budget capital allocation decisions. I mean it just goes on and on and on, all because they have, by federal policy, now effectively removed time value from the calculation.

Chris Martenson:  So without any time value of money, there’s no point in investing it. And to me that’s – the big breakdown here is that it looked like what they wanted to do was classical financial engineering, economic engineering; they wanted to just apply a jolt of stimulus and have that kick-start the patient. But now that we’re this far into it, it feels like it's become structurally embedded, to the point that we’re having these sorts of knockout effects you’ve talked about, where the time value of money seems to have disappeared.

So who’s investing anymore? It's only investment that’s really going to get us out of this in the long term, if you believe we’re going to go through more conventional business cycles; we’re going to get ourselves out of this; we’re going to continue to grow. That has to come from productive assets, but you’re making it sound like what we’re really doing is we’ve locked the seed corn away and it's getting moldy.

Keith Fitz-Gerald:  I think that’s right. I mean, you don’t throw good money after bad. And at some point, these guys – and I will deliberately refer to them as these financial clowns – have got to understand that what they’re doing has never worked in recorded history, ever. It's not that it hasn’t worked in the last 20 years, 30 years, 40 years, 50 years – it hasn’t worked, ever. Whenever you debase your currency like this, the economy eventually fails.

Now, that having been said, there is another side of the coin here. So this is not all doom, gloom, and boom. The reality of it is that we have had similar inflection points throughout history, and we had many of the medieval, European banks going bankrupt in the eleventh, twelfth centuries. The Roman banks went bankrupt in the third and fourth centuries. We’ve had failures all over the map. History is littered – as legendary Jim Rogers pointed out to me one day in Singapore – history is littered with the bones of financial institutions. You have to rule out failure. And that’s where these guys are screwing up. They have this all-gain-no-pain philosophy. The problem is, is the patient going to last long enough to make it through the operation? I don’t think the patients even get to the operating room.

Chris Martenson:  So one of the chief stumbling points here, you’re going to say, is bailing out…anybody who’s made big mistakes. There is no too-big-to-fail in your mind, that creative destruction – this is a requirement of the system, and so by circumventing that basic requirement, what kind of a system are we operating in, then?

Keith Fitz-Gerald:  It sure as hell is not the free market that everybody likes to think it is. And that, to me, is extremely disturbing, because they have removed the hand of risk from the marketplace. And these businesses now have every incentive to screw up because they know that a) they won’t be held accountable for it, and b) they’re going to get bailed out.

the problem with that is, obviously, that this – if you’re rich, you get a bailout; if you’re poor, you get a handout; and if you’re middle class you get left out I just don’t think that’s a profitable way to run the system. They have put so much debt onto this that our unborn great, great, great, great, great, grandchildren could not possibly pay this off. The only way they’re going to get out of this is to deleverage it and remove it from the system.

Chris Martenson:  Well, how would they go about doing that? First of all, I assume these are not unintelligent people. They’ve got good degrees. They’ve studied history possibly as well as they can, and yet here we are. So is there a chance? Let’s speculate for a second. What were they looking at that made them throw so much caution to the wind to take so much established history and say we just – we’re going to have to go down this path, which is ultra cheap, mispriced money, taking risk out of the system where it shouldn’t, introducing additional risk in other places? This is massive, massive financial – and dare I say social – engineering. Why would they do that?  

Keith Fitz-Gerald:  I think you’ve hit the nail on the head. This concept of – they’ve got great degrees. The people I talk to who are for this and think bailouts are such a neat idea, by and large, are academics with very little real-world monetary experience. They are not stupid. They are not stupid by any stretch of the imagination. So don’t get me wrong, here.

What I’m saying, though, is that many have very different attitudes about money because they’ve never actually worked with it. Many haven’t run real companies. Many don’t know how a balance sheet functions. Many haven’t hired employees. They don’t know what it takes. And so they don’t understand how the money actually moves through the system, except in an academic sense of the word.

And if you look at Bernanke, he’s a great example of this. He’s a PhD. He’s extremely intelligent. He has gotten his PhD basically on Depression-era economics, and they tried to print their way out of that. Well, what’s ironic is that he evidently did not read the part of history where Morgenthau, who was Roosevelt’s Treasury secretary – got to Congressional testimony and said, we could have printed all the money in the world and it wouldn’t have worked. It didn’t work. So why they have gone about this, and why this sort of Keynesian economics has become mainstream thinking and is taught in every university today and widely accepted as political in policy dogma, is beyond me, because the reality of the situation is, we have abundant evidence – and it grows every day – that it actually doesn’t work. 

Chris Martenson:  It's certainly a very popular policy with politicians, because it says spend freely, and then when times get tight we’re going to enable you to spend even more freely because it calls for it. It sort of elevates to moral stature the idea that you need to spend beyond your means, especially during tough times.

I understand how it got entrenched. The mysterious part to me is that I do hear the people who look at the current situation and say there but for the Fed it could have been a lot worse, sort of speaking to the negative. I don’t really buy that, because I look at this and I say, for these trillions of dollars that have been injected both in liquidity measures – but also, let’s be frankly honest about this – there’s been several trillion dollars of high-powered money injected in. So we’ve got two types of liquidity in there. I’m underwhelmed. I am really underwhelmed.

And I’m looking at the landscape, and I’m saying to myself, this seems to me like the pressures are growing worse. Sovereign debt is getting more out of control, not less, not under better control. We’re not seeing the sort of wipeouts that I would expect to see where the bad debts are going away. They’re just sort of being hidden around. There’s this market-to-model stuff. We’re just shuffling. We’re biding time. Hasn’t enough time passed?

Keith Fitz-Gerald:  You know what they’re really doing, Chris? They’re not just shuffling; what they’re doing is rearranging the deck chairs on the Titanic. I’d rather get off the boat.

Chris Martenson:  Me too. Can we get on with it please?

Keith Fitz-Gerald:  Exactly. I mean, this is the thing: Let some of these things fail, because when failure occurs, you have an asset redistribution; the faulty assets are, in fact, bled out of the system. The quality assets are assumed by responsible parties. That is the law of capitalism. That’s the way it works. So if we think back to the credit crisis and we think back to what happened in 2007 – 2008, they went screaming and yelling to Congress, oh my goodness, we’re going to have to do this or the sky’s going to fall. Well, the sky fell anyway. They pumped 700 billion dollars into this, then a couple trillion.

If the government multiplier that all these conventional economists talk about actually worked, our economy should be screaming along at six or eight percent right now, but it's not. And the reason it's not is because it's a complex system, and all the pushing and pulling they’ve done on one end, they didn’t understand that all these other things would happen at the other end. “Too big to fail” – it's not too big to fail; it's too big to survive. We have monopoly laws that we should have been using along the way, but our regulators were asleep at the switch. They’re outmanned, outdone, outclassed, at every turn of the road. Wall Street does not want to do anything that remotely resembles reining itself in, and it has no incentive to do so.

Chris Martenson:  No, I think you’re being kind to the regulators, because there were certain instances where I think they were a little bit more than asleep at the switch; potentially complicit.

Keith Fitz-Gerald:  I would agree with that statement. I think there’s a very incestuous relationship between Wall Street, as regulators, and our leaders, and this concept that the insider trading crisis – the enrichment that Congress was doing. What they were doing, in any other universe would have been a tremendous violation of the insider trading laws. And yet, nobody went to jail, nobody got punished, they just passed a little law that they’ve been trying to pass for three or four years – and only after a 60 Minutes expose did the public get enraged because they figured out what was going on, did they pass this thing.

Chris Martenson:  Right, well, turning now to how we get out of this. I don’t want to make too much of an island nation of 300 thousand people; however, I will note that in the case of Iceland, which again only had a few billion dollars of losses to contend with, but they chose to stick those losses with the bondholders – where I would, and I think you would, rightly argue that they belong. And of course, the world was reading Iceland the Riot Act, saying the sun will no longer rise in the east. If you do that, your fish will all die and float belly up. Bad things will happen. And they did it, and nothing bad seems to have happened. Is that an instructive lesson, or is that just too small of an anecdote to really be extendable?

Keith Fitz-Gerald:  I think it absolutely is extendable. And I think the other thing that’s very, very interesting is that if you take a real look through history and you look back to the Asian financial crisis in the early 1990s, we were giving advice to Asia and to China, saying you’ve got to let these banks fail. You can’t bail them out. We were telling them to do the very things that we’re now not doing. And so it's like, is it the pot calling the kettle black? I don’t know, but is it hypocritical? You bet it's hypocritical.

Chris Martenson:  Right. Well, it's a very attractive thought to me, that the bond holders would have to eat the losses, because, of course – due diligence, caveat emptor, better luck next time, however we want to phrase that – without that learning process, I don’t understand how the feedback mechanism is supposed to work. And the losses seem to have been shuffled to all the wrong places, and the only thing I can think of that makes sense to me is that somehow those must have been really dark times. I’m sure when Hank Paulson was closing the door and giving them his little three-page memo on why he wanted 750 billion, I’m sure they were very worried about the whole system.

And so I want to come back to what that could have been. And I think we start at the beginning of this conversation, which is complexity. I truly believe that the system – with 700 trillion or quadrillion or whatever the notional value of derivatives is – that with the interconnectedness of all the banks across borders, with no firewalls really existing between countries anymore, that the system – is it just too complex to manage? Is that the theme? Is that how I interpret the actions? Because if the strategy hasn’t been panic, I’m not really clear on what it has been.

Keith Fitz-Gerald:  I think that’s a very valid question, and frankly, I don’t know the answer to that, but I do know the system. I believe the system is overly complex because we’ve tried to build in too many safeguards. There are a lot of people who will debate that and who will quibble over what defines safeguard or complex, or this kind of thing, and they’ve got very valid points. And I think history is going to simply play this out.

And again, right up front, I don’t know all the answers. I don’t pretend to. But it seems to me that in the interest of financial innovation, we have inadvertently created some sort of hybrid monster and let it out of the laboratory. If we’re going to rein this back in, we have got to remove some of the freedoms that we, in fact, put in place. I’ll give you a good example: The Glass-Steagall Act, when it was put in place, was put in place specifically to prevent banks from double-dealing, insider trading, trading against their clients, selling shares that had no value, all of which are issues today.

Every single one of those issues is there today and it's there today because in 1997, 1998, Glass-Steagall was taken down, and that allowed commercial and investment banks to combine. And then in 2000, with the Commodity Modernization Act, we removed yet another ball work, or dyke, or what do you call it, glass shield, and we specifically exempted many of the credit default swaps and exotic vehicles that were traded off balance sheet from regulation. Translation is that our leverage went from roughly ten-to-one at the end of World War II to as much as a 100-to-one coming into this financial crisis.

And when that happens, you have excess that has driven everything, and not the actual underlying growth itself. So you’ve got to get back to the underlying growth. You potentially repudiate all the derivatives; you outlaw these things. If there are insurance products, you treat them as insurance products and you regulate them accordingly. We already have those laws on the books. We don’t need all this new regulation to cover it. The government does not have to justify its own existence by passing new legislation. We have to use the laws we’ve got. And most of those laws, like antimonopoly laws – the know-your-customers rules that are in place for every brokerage house that exists today, for example – had they been applied to the credit default swaps and those kinds of things, those transactions would never have taken place. We can implement those tomorrow if we had the political will to do it, and we could rein this stuff in instantly.

Chris Martenson:  Well, it's interesting this idea of the leverage, then, which certainly did build up to extraordinary levels. Maybe it's backed off a bit. As I understand it right now, European banks were a bit more leveraged than their U.S. counterparts, and, of course, Europe’s suffering under a variety of issues around that right now. They leverage a somewhat sclerotic, bureaucratic method that doesn’t really allow a fast response to crises like the Federal Reserve just – what’d they do, make 21 thousand separate loans to everybody from Dexia to the Bank of South Korea during the height of the crisis? So they’ve got that to contend with, plus they’ve got unworkable math and social programs that are now coming due. There’s a variety of pressures pushing there right now. How do you see Europe playing out, say, over the next six months?

Keith Fitz-Gerald:  Well, it's interesting. At the beginning of this crisis, I said Greece should be kicked out of the union if they’re going to demonstrate that the euro has any kind of stability, and they’re going to keep – enforce – their own laws for inclusion in the EU. But they chose not to do that, and now Greece is going around hat-in-hand, begging for an extra two years. An extra two years for what? They’re still going to fail, they’re still going to lose their sovereign standing, and I think they’re still going to exit the EU.

And the EU economy is very quickly, if it hasn’t already, going to develop serious structural problems, and we’re going to see it develop into an economy of the “haves” and the “have nots.” And whether they can firewall this off or not, I don’t know. There seem to be lots of talks. Super Mario Andretti says we’re going to do anything to save the euro, yet Merkel says we’re not paying for it. It's the same old line, and we’ve seen it for four or five years now. They have meeting after meeting. They announce new solutions every week, and nothing actually gets done. This is where the free hand of the market steps in and says, gee, we’re sorry, but time’s up. And I think that’s approaching.

Chris Martenson:  And when that comes forward, here’s how I see it. What we saw in Greece is just a harbinger of what we’re going to see elsewhere. And so eventually the market manages to figure out that, Spain – under any circumstances – can’t possibly pay back ten-year debt at seven percent when their economy is going in the other direction exactly in negative territory. So the bond markets ultimately lay down the law, as it were. And I don’t think the ECB (European Central Bank) is set to move quickly enough with enough firepower to really offset that. The only thing I’ve really speculated on is that I think the world central banks – by which I mean the Bank of Japan, England, Federal Reserve, and the ECB – all have to kind of get together, hold hands, sing Kum-ba-yah, and do something really magnificent. Again, stopgap; [it] papers over something, which is that we have a multi-decade credit bubble that fundamentally has to be unwound. Somebody’s going to have to eat those losses. We just haven’t figured out or decided who that is yet.

Keith Fitz-Gerald:  Now you’re getting to the heart of the matter, which is, eventually somebody is going to have to take the loss. You cannot operate with nobody taking a loss for long. Yet that’s exactly what they’re trying to do.

Chris Martenson:  And so those losses, obviously, they start somewhere. Bond market’s as good a place as any for that to sort of kick off. 

Keith Fitz-Gerald:  And ironically, you talk about complex systems; what’s facilitating the bond market? And the only reason they can even get this paper and they can have these rates move the way they are is because the institutions are allowed to trade these credit default swaps. So they are trading all these credit default swaps, ostensibly as insurance against the failure of sovereign debt, when in reality – if you look, for example, at the J.P. Morgan trade and the whale, Bruno Iksil – they were speculating on this stuff. So the bottom line is, if the government says we’re not going to bail you jokers out, then the credit default swaps instantly become worthless. There’s no incentive to bet on them, those stop trading, you can rein them in, and we all ground out the excess. So the bailouts are simply enabling Wall Street to do its thing. 

Chris Martenson:  I’m shocked – shocked! – to find that happening.

Keith Fitz-Gerald:  It's a one-way bet. You almost can’t lose.

Chris Martenson:   That’s how Wall Street likes it, I guess.

Keith Fitz-Gerald:  They’re like the House in Vegas – as long as the odds are on their side, they’ll play the game all day long, but if you mess with their candy basket, they’re not going to like it. 

Chris Martenson:  No, no. Well, I like to make my bets on the long-term sweeps of things. Markets can remain irrational longer, and you can remain solvent, and all of those other aphorisms. Like that – but the big trends have always been my friend as we go forward. So here’s another trend that really caught my eye that I just I’d love to get your input on to help me understand this a little better: I track Japan. I actually pinged Japan earlier this year as my top candidate to be the black swan of 2012. Maybe that’s a little premature; it might be 2013. But what I was tracking was this unbelievably gigantic switch that’s happened where Japan had this export-driven economy, used the surplus to fund their current account surplus, which then enabled this extraordinary amount of debt and deficit expenditure – debt accumulation at the national level. Watching Japan tip over into a trade deficit this year and seeing their current account erode to hover around zero felt pretty profound to me.

And of course, we have all of these other things that are piled on there with the demographic shift, with the largest pension funds now selling some of those wonderful Japanese bonds in order to fund redemptions and payouts and things like that. So I just – I know you do tell people about your connection to Japan. I was really impressed to hear how deep that ran for you, and I’d love to talk about what you might think is really on the horizon there. 

Keith Fitz-Gerald:  You bet. Well, as you know, Japan is a country that I love deeply. It is my other home. I have lived there at least part time every year for more than 20 years. I’m married to a Japanese woman. We have a home in Kyoto. So I’m well acquainted with the on-the-ground perspective. And what I see over there is greatly disturbing. Every year here in the investment world or in Europe, I hear some analysts saying, well, this is Japan’s year. It's going to come back. Oh boy, this is going to be great. But the reality of the situation is that Japan is never going to regain its promise; the demographics are working against it. Thirty percent of the population is literally going to die by 2050. That has tremendous implications in terms of education, brain power, earning power, earning capacity. Right now the debt is at 250-some-odd percent; just government debt. If you factor in private and corporate debt, you’re looking at almost 500 percent of GDP. So really in recorded history we haven’t seen this before. And Japan has no immigration policy, so they can’t import workers. They’re an export-based economy, and that’s a decision they made shortly after World War II, that they would mortgage their future on exports. And so far it has worked, but then you hit the 90s, and boy, it kind of broke down. And we’re repeating those mistakes right here. So I’m not very optimistic on Japan’s recovery, and I certainly don’t think it's going to return to its glory days. Its neighbor, China, on the other hand, is the dominant player this century. 

Chris Martenson:   Absolutely. How do you explain the strength in the Japanese yen – which just by fundamental basics, where we might note things like how many of them are being printed up and routine efforts to weaken the currency on the part of official parties over there – how do you explain the strength in the yen? And secondarily, is it possible that with the Bank of Japan leaning on trying to get a weaker yen, is it possible they might succeed beyond their wildest dreams at some point?

Keith Fitz-Gerald:  Oh, yes. I think a weakening yen is one of the greatest trades of this century. And for folks who are savvy enough to get onto that trade, it should be a 150, 200 yen to the dollar by the time this is done. Now, the reason it's not so far is because of the EU crisis and the mess in the United States. As the world’s – as the stuff, for lack of a better term, has hit the fan, it hasn’t been equally distributed. People have run to the dollar, and they run to the yen because those are the only two currencies on the planet that are deep enough to absorb a lot of this liquidity safety run. And that’s what’s keeping it high. Most of the Japanese corporations that I’m familiar with, and having met with a lot of their C level executives over the years, they need 100 yen to the dollar to even remotely begin to be profitable. What they’d like to see is somewhere about 105, 120. In reality, if you factor in the debt, the quadrillion yen that they’re approaching – not trillions; quadrillion yen that they’re approaching – in terms of deficit and debt, that thing should be 150, 200.  

Chris Martenson:  And/or maybe – who knows what overshoot might bring to that particular situation. Again, though, we have a structural problem here with the numbers. When I do the math in Japan, we look at what they’re really going to require in terms of domestic savings in order to fund their current, I would say, embedded level of structural deficit spending, a condition the U.S. is rapidly approaching. Remember those trillion dollar deficits we’re supposed to be…

Keith Fitz-Gerald:  There’s no question they cannot afford the way they’re operating now the only thing that is saving them is this world rush to own the end as a result of the failure of Europe and the failure in the United States. 

Chris Martenson:  Once the yen starts weakening, then their toolbox is not that deep in terms of how you would defend the yen. You raise interest rates and – by rough calculations I’ve performed – at about three percent on its interest payments, Japan will be spending 100 percent of its revenue on interest payments. And so they just doubled their domestic sales tax, and they’re doing other things to try and raise revenue. But those efforts have been, shall we say, proven to be not quite as robust a politicians ever hope when they raise taxes…

Keith Fitz-Gerald:  But see, again, this is – there’s the problem right there. Not as robust as politicians hope. Very few of these guys have actually worked with real money, so logically rather than cutting expenses, they just assume they’re going to tax everybody else into oblivion. And we see that here in the United States as well. This concept of let’s just raise taxes on everybody. Well, you know what? I have never seen a budget yet that you can’t cut 20 percent out of. So get serious and figure it out. And that’s what we don’t have the willpower to do any more than they do. 

Chris Martenson:  It's almost like we’ve lost the muscle memory. We’ve been lying in bed too long, and we just don’t know how to use those muscles anymore. But we’re going to have to, at some point, and I guess you either do it on your own terms while time remains or you wait until the markets force you. From what I’ve seen in Greece, that’s a really painful process when you’re forced up against the wall: cut your budget, go. 

Keith Fitz-Gerald:  Unfortunately a lot of people say we’ve got to go to Greece to see what’s going to happen here. No, you don’t. You go to California. California is at the bottom of the barrel right now. The state’s functionally insolvent, they’re trying to raise taxes, the capital is leaving. If you look at what happens, all these people in Silicon Valley, when they make their nut, the first thing they do is move to Nevada. I mean it's just, you can see there what’s going to happen to the rest of the United States, and it is not pretty.

Chris Martenson:  Interesting. And of course, the larger backdrop across all of this for me is resources. There’s a very interesting quarterly report out by Jeremy Grantham where, again, wonderful data; he did some really nice work looking at the long sweep of prices and where we really are, noting things like the degrading or yields from copper and other things like that, saying listen, we’re in sort of a structural situation here that’s big. It's a very, very big story.

And against that, somewhere around March, there was just a spate of articles that came out in the U.S. that somewhere had this term embedded in them, “energy independence.” And sort of leading this was this idea that this fracking revolution in both oil and natural gas was really going to change the game. And so that’s the story, and I don’t know how many articles I had to read claiming that the idea of Peak Oil is dead. So can you help me square that up with the articles I read this week, which say the world is considering releasing strategic stockpiles, we’re not really happy with oil price where it is, Brent seems to be stuck solidly over 100, and maybe over 110? And those sorts of oil numbers in the price markets that I’m seeing are really not consistent with an overabundance of oil. In fact, they’re consistent with something else.

Keith Fitz-Gerald:  Again, I will absolutely take issue with these guys. I don’t think Peak Oil is dead at all. I think fracking is going to have massive unintended consequences, some of which we’re seeing now, like the damage to the water table; the diversion of resources that we could be using to grow food. I think that the industrial damage, the planetary damage, these are all things that we are beginning to have glimmers of that people don’t want to acknowledge.

The other thing that we need to consider in terms of oil is that – Let’s just say fracking worked – I mean just for kicks and giggles, you know – let’s just say it worked, and we brought on a huge amount of supply. Well, woop dee doo, because the world is still expanding in emerging markets, in particular, at double-digit rates. So unless you’re talking about 89, 90, 100 million barrels a day being brought online, there’s no reason in the world why prices are going to drop, because the demand isn’t fungible. It has to happen.

Chris Martenson:  It being a higher price is just – these are the prices we need to balance supply and demand, you’re saying.  

Keith Fitz-Gerald:  Yes, absolutely, because, again, people will say, oh, my gosh, we’re going to have alternative energy, and technology’s going to fix this! that’s great. Technology ultimately will [fix it]; I don’t dispute that. But it's going to fix it a lot farther into the future than we think. Let me give you an example as to why. Even if we have a perfectly fungible substitute for petroleum products today, for oil today, there are some 60 thousand industrial processes that are uniquely dependent on petroleum-based products. Every single one of those has got to be changed over. Even the most optimistic scientists that I’ve talked to say that’s going to take 30 years.  So oil is still going to be in demand. It's not going away.

We’re using more of it, particularly if you go to the emerging markets, you go to China, you go to Africa, you go to parts of Asia, other parts of Asia, South America. They’ve never known expensive energy because they haven’t had energy. So an average guy driving his car for the first time is not going to care that that’s what it takes to get oil. The guy burning his generator in Africa isn’t going to care what it costs him to run it beyond a certain point, because he’s going to be producing electricity for his village or being able to draw water from the well for the first time. There are other marginal inputs to the value equation that, in my mind, far exceed the price. So I think oil is going to be sharply highly in the years ahead.  

Chris Martenson:  I have a larger report, which I’m working on, around what the truth is behind all these fracking stories. And the truth is, we have liberated some more oil, but the difference between drilling a well that starts out at 400 barrels per day and then rapidly tails off to 100 barrels per day or less is not equivalent in way, shape, or form to a well that we would drill in the Gular field and we poke it down a thousand measly feet, and all this oil comes out under pressure. It's extraordinary; it's wonderful; it's beautiful. Theseshale plays drill down ten thousand, turn it sideways, drill another ten thousand; it's a twenty-thousand foot well and you’re getting a 100 barrels a day. The economics work; the energy return is still there, but it's not the same landscape we used to live in, not even remotely close.   

Keith Fitz-Gerald:  Right, not even that. That’s the key, not even remotely close.

Chris Martenson:  And so it's a different world, and that’s the thing I think I object to most when I see all these articles about energy independence, because they’re not-so-subtly saying, don’t worry, we can continue to live exactly as we’ve been living. I guess we were just worrying our pretty little heads about nothing. And that’s really ignoring the complexities involved. You don’t have to scratch that hard to actually find the complexities and even understand a world where we can’t seem to drill that stuff.

And here’s something most people miss: Those wells – we knew how to frack 20 years ago; we knew how to horizontal drill 20 years ago. What we didn’t have 20 years ago was oil reliably over $75 a barrel, which is what it costs to get the drillers interested to go after those plays. So we live in the $75 oil now.

Keith Fitz-Gerald:  I might be completely wrong on this, but my understanding is that we also didn’t have the pressure-based technology needed to inject all the other crap into the system that makes fracking possible.

Chris Martenson:  Well, we’re getting better at that stuff, and we can do these glorious 20-stage frack processes now, which we’ve gotten better at. So there’s been some refinement of the art, but even with all of that beautiful technology, you take oil back down below $50 a barrel, and guess how many of those wells are being drilled?

Keith Fitz-Gerald:  Exactly! You’re going to have huge stagnation in the field. And people are going to let the resources go, because it's not going to be profitable to operate them.

Chris Martenson:  Right, so we just structurally live in a world where, yes, there might be more oil, but at what price? I mean, if oil goes to infinity per barrel, guess what, there’s a lot of it out there. But can you run an ever-expanding credit based system where you need more debt piling up – – and this was the key to me – piling up at a faster rate than the economy? That is, your income stream was growing?

Keith Fitz-Gerald:  Yeah, that exponential curve, as you and I discussed in our video – there is no way that is sustainable. It is a mathematical impossibility that it sustains itself. At some point it crashes and burns. And that’s one of the things that I think is really tough right now is people are hearing those terms, they hear about these stories, they deliberately put on the blinders, and oh my gosh, I don’t want anybody to interfere with my reality. I like it just fine; kick me in the butt when it's over.  Well, those people are going to be sadly disappointed when somebody finally does kick them in the butt and they find out they’ve been left behind, because if you do invest through this, you have an opportunity to actually build legendary wealth. You can protect your assets. You don’t have to be taken to the cleaners again when all this happens.

Chris Martenson:  Surprisingly, I do run into some people who feel that somehow profiting from all of this is immoral or amoral at best. I look at it and I think we’re in a multi-decade period of adjustment. I don’t think this is all going to end next Tuesday at 8:31 in the morning.

Keith Fitz-Gerald:  No, I agree with that. This is this concept of – here in the United States, “long-term” to a U.S. businessman or a politician is next week. In Asia, for example, I’ve seen 100-year business plans personally. So they have a much different perspective of things. They’ve been around a few thousand years longer than we have. I think that people need to understand that time is a transition process, and it's not going to be anything close or short.

Chris Martenson:  Isn’t that funny? So it turns out we really have to start thinking temporally in a whole new way, and at the same time, there’s no more time value to money, so it creates quite a pressure point there for…

Keith Fitz-Gerald:  Isn’t that a predicament, yeah.

Chris Martenson:  ….I mean, how do you navigate? And so that’s what you do professionally is you help people navigate this uncertain territory. How do people follow you more closely if they’re interested in this view?

Keith Fitz-Gerald:  Well, thank you for asking. I think the easiest thing to do is to join the family of readers at www.moneymorning.com. And we have, as you mentioned in the onset of this show, we have more than 500 thousand people every day in 35 countries reading our work.

And there’s a couple things that they need to think about; five of them, actually. And I put these in all of what we do. Number one is they’ve got to think safety first. These markets are no longer about the return of your money. There’s a return on your money. They’re about the return of your money. So you’ve got to think safety first to produce a proper concentration of investments and dramatic stability in consistent returns, because that’s the twin problem you face is – a deficit and a slow- to no-growth environment over the next ten to twenty years as we deleverage.

The second thing you’ve got to do is to think about offense and defense at the same time. Those two things are not equal. And so the best choice for me, or the best choice for our readers, is companies I refer to as glocals. These are global companies with highly localized presence. Typically they’ve got world-recognized brands, diversified revenue streams, absolutely fortress-like balance sheets, and experience management. If it comes to placing my trust in the government that’s run by people with very little experience in money, or if it's real businessmen who are charged with making a profit and returning it to their shareholders, I’m going with the businesses and the shareholders and the profits every single time.

And then the third thing you want to do is you want to emphasize income, because studies show that up to 90 percent of total returns over time come from dividends and reinvestment. You’ve got to have that. Growth is an illusion that’s perpetuated by financial leverage; therefore, you’ve got to stick to those things that pay you – particularly in a zero-interest-rate environment – for the risk that you’re taking.

You’ve got to build in discipline. That’s number four. Build in safety brakes. This is not that hard to do, but the thing is, most people won’t do it, because they’ve been led down this merry path of set it and forget it.  “Buy in hope” is not a marketing strategy. It's an investment strategy. It's a marketing gimmick. So you’ve got to structure yourself in such a way that you’re not taking over the cliff, fiscal or otherwise, if you mess up.

And then, finally, you’ve got to remove emotion. Most investors are actually their worst enemy, because they second-guess each other and they fall in love with their assets. And when things are very, very scary, like they are now, they would rather stick their head in the sand instead of understanding that history shows beyond any shadow of a doubt that the time to build wealth and the time to begin thinking about making dramatic change is when the markets themselves are scared stiff in a dramatic state of flux. And that’s where we are now.

And as part of that, you’ve got to have resources, because if we’re going to argue on or discuss the assumption that Bernanke and all the central bankers are going to continue to print money as long as they can humanly do it, then that presupposes any of the combination of stocks and the cash for stimulus.  And to compensate for the equation it creates, you also need the real assets to preserve the value that’s going to be lost when those things work their way into the system.

Chris Martenson:  And those real assets, what are you talking about there?

Keith Fitz-Gerald:  Well, that’s the obvious stuff. That’s the gold, the silver, the rice, the corn, the sugar, the oil, energy to me – even though sometimes, electrical generation, people don’t consider that a commodity, but it is a commodity because the world needs it. It's not just it's nice to have; it’s a must-have. So in my mind, as we go through this great financial upheaval, you want to shift your thinking from what’s nice to have to what does the world have to have. And that’s the difference.

Chris Martenson:  Interesting. So the summary of this is: This isn’t your grandfather’s market anymore, is it? 

Keith Fitz-Gerald:  No, it really isn’t. And I talk with tens of thousands of investors a year, presentations around the world, and if there’s one thing I want them to take away is that this is not the financial markets you grew up with. You cannot apply the same old tired tactics, using models that are very clearly broken, and expect different results. You have to change your mindset, and you have to look for profits, protection, and potential all at the same time.

Chris Martenson:  Fantastic advice. Well, we’ve been talking with Keith Fitz-Gerald. You can find out more at www.moneymorning.com. Keith, it's been a real pleasure.

Keith Fitz-Gerald:  I appreciate your time, and you’ve been very gracious. The questions were brilliant and I enjoyed the conversation. Thank you.

Chris Martenson:  Thank you so much. I hope we can do this again.

Keith Fitz-Gerald:  I do, too.

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  • Sat, Aug 25, 2012 - 8:31pm


    Arthur Robey

    Status: Member

    Joined: Feb 03 2010

    Posts: 1413


    Silly Brain.

    Evolutionary programming can tame complexity.

    Steve Keen's Jubillee makes intuitive sense. (Requires kahunas.)

    Self-referential model making Left Hemisphere. What we have is a cultural psychiatric problem.  

    Lack of workers is being circumvented by technology. Who needs workers?

    Frungible energy source needs funding. What about focused beam fusion? I've got a better Idea. Why don't we fund the Banks? Print more paper. (See above, self-referential Left Hemisphere problem. Hall of mirrors effect.)

    You want me to invest? Have you seen the state of the Markets? They are corrupt, rigged. Not a chance. Not even after the Crash because "Economy" will no longer exist, either because we sink back into the swamp or because the opposite has happened and money has become detatched from other peoples labour due to automation and cheap energy.

    Perhaps both. The bi-farcation of humanity might become complete. See my Science fiction tale.

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  • Sat, Aug 25, 2012 - 10:33pm



    Status: Platinum Member

    Joined: Jun 29 2012

    Posts: 1305


    Time Value of Money

    Good discussion about the time value of Money as it relateds to manipulated interest rates. But can someone explain to me the time value of "real money" ie. Gold or Silver. Sorry if it's a dumb question, but I'm trying to understand all this stuff.

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  • Tue, Sep 04, 2012 - 12:45pm



    Status: Bronze Member

    Joined: Dec 28 2011

    Posts: 363


    Kick Out the Bankers

    I was a little offended by Mr. Fitgerald's comment about Greece.  Let's see, the BANKS sold Greece toxic mortgaged backed securities (wrapped up in AAA rating), then the BANKS bet against the very same, self instruments they sold, and now, of course, it's Greece's fault!

    Instead of commenting Greece should be kicked out of the Euoro, the comment should have been Greece should kick out the BANKERS.

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