Tim Price shared an interesting story during our quarterly conference call for those subscribed to The Price Report – an investing “war story” if you like.
Following the collapse of Lehman Brothers in September 2008, Tim had a meeting with a high-net-worth client in Edinburgh. The man was a pharmaceuticals analyst for a large Swiss investment bank, a sophisticated investor with a sizeable portfolio – and his outlook was grim.
Seeing the banking system in disarray, he was preparing for a decade-long depression, and was loading up on gold and long-dated US investment bonds.
At the time, Tim was a big fan of a specialist investment fund called the Wealthy Nations Bond Fund, which only owned bonds from creditor nations – countries which on a net basis, own more assets than they owe to foreign lenders.
The fund paid a yield of 8% back then, which was roughly double what the US government bonds paid. Considering the US is the world’s largest debtor nation (owes more to foreigners than it owns domestically – it ceased to be a creditor in 1985) Tim asked the man why he was happy to accept such a lower return, while taking more credit risk.
His reply left a lasting impression:
“Because they’ve got all the nukes.”
Today, just as then, the developed world faces a deflationary environment. And as we wrote last week, the central banks that kept the global economy “dancing” for a while have much less room to provide stimulus as they did before.
I find Tim’s story interesting, for it contains a paradox. His client implies that the US government’s debts are backed by its military strength. No matter the scenario, having the greatest military in the world will provide the US with funding – one way or another.
… Or so the theory goes. But what if the US military, instead of looting the world to fund its government, turns on its debtors instead? What if no shots are fired, and a bomb is detonated in the bond market instead?
The explosion I’m referring to here would be a devaluation of the US dollar. This would leave US bond investors with negative real returns (ie, losses), reducing the US government’s debt burden.
However, it would also accomplish something much more important. The dollar’s strength, thanks to its status as a global reserve currency, has actually weakened the integrity of the US military, by forcing its supply chains to countries with weaker currencies. China has taken advantage of this, hoovering up American jobs to boost its economy and making the US military dependent upon Chinese suppliers.
This problem is the foundation of my thesis that we are at the beginning of Cold War II, a generational struggle between the US and China that will be as tense and absurd as the last.
One possible solution would be to significantly devalue the US dollar (and screw the bondholders) in order to make the US manufacturing/industrial base more competitive and bring military supply chains back home. A possibility that is not out of the question, according to Luke Gromen who I interviewed at the beginning of this year. From Luke, in a recent note:
“If the people with haircuts like mine and very big guns want a weaker USD as a matter of US national security, I assure you, they’re going to get it, it’s just a matter of setting terms via political negotiations.”
When I get a moment, I’ll be working on this month’s issue of Zero Hour Alert. This issue will focus on the US/China problem outlined above, and how the second Cold War is manifesting itself. It’s looking pretty wild so far – even for me, this particular topic is a bit “out there”.
I can’t reveal too much about its contents, but I’ll leave you a clue, in the form of two questions:
What year did the first Cold War begin?
&
When was the first sighting of a “flying saucer” reported?
If you’ve been watching the news closely so far this year, you may know what I’m getting at.
All the best,
Boaz Shoshan
Editor, Capital & Conflict
Category: Market updates