It’s catastrophe — both physical and monetary — that’s on our mind this morning as the Federal Reserve wraps up its latest every-six-weeks meeting.
And no, we’re not even thinking of events here in Baltimore. (More about that later…)
Two years before President Nixon cut the dollar’s last tie to gold in 1971, he ordered the construction of a bunker for the Fed near Culpeper, Virginia — a 75-mile drive southwest of Washington. The Culpeper Switch, it was called.
The Fed’s post-apocalypse hideaway…
“The underground compound was supposed to serve as the country’s Federal Reserve headquarters in case of a nuclear war with the Soviet Union,” recalls Matt Novak in an article this week at Gizmodo. “It had its own air filtration system, its own power generators, and about a month’s worth of freeze-dried food for 400 people.” Not to mention a helicopter pad and gun range.
Also inside the bunker was $4 billion in currency… and an electronic nerve center connecting the nation’s banks.
Construction of the Culpeper Switch in 1969 cost $39 million — in today’s Fed-diminished currency.
Wisconsin Sen. William Proxmire — who made a career out of denouncing federal boondoggles with his “Golden Fleece” awards — thought the whole thing was silly.
And he was right. Only 75 miles from the nation’s capital, surely a Soviet target? “Under this doomsday scenario,” he thundered, “we would have $4 billion in cash and no people except a few lonely radioactive government officials.”
After the Soviet Union fell, the Fed gave up on Culpeper in the early ’90s. With no interested buyers to be found, the bunker was donated to the Library of Congress. Today it houses the library’s audio and video collection.
But that’s so 20th century. What about the slow-motion 21st century catastrophe wrought by Fed policy?
This morning, the Commerce Department issued its first guess at GDP for the first quarter of the year. If you’re a longtime reader, you know we think GDP is a statistical abstraction with no relevance to your life or well-being. But the power elite — starting with Fed governors — consider it the ne plus ultra measure of “economic growth.” They make big decisions based on the number. So we pay heed.
The “expert consensus” among dozens of economists polled for Bloomberg figured on a meager increase of an annualized 1%. Whoops, it was much worse — only 0.2%.
The strong dollar is making American-made goods more expensive for foreigners… and exports turned out to be the biggest drag on the number. Our Jim Rickards sums it up thus…
In other words, the Fed has dialed back on “quantitative easing”… while Europe and Japan have dialed it up, achieving some semblance of “growth” for the moment.
“This divergence in global growth masks a larger reality,” Jim elaborates. “Overall world growth is too slow to sustain sovereign debt burdens. Currency wars are being used to pass growth from one area to another. The currency wars are like a group of thirsty soldiers passing a single canteen, without enough water to satisfy everyone at the same time.”
So the Fed’s collective throat will stay parched for the moment. It’s already committed not to raise the fed funds rate during its meeting this week, making this afternoon’s Fed announcement the most anticlimactic in years.
And what of the months ahead?
“As long as Federal Reserve officials talk of hiking interest rates while other central banks aggressively ease policy, the U.S. dollar will remain strong,” says Dan Amoss — who heads up Jim’s research team.
“That’s the environment we’re in right now — and will probably remain in for a few more months.”
Jim and Dan have laid on several trades accordingly in our premium trading service Currency Wars Alert. But they’re ready to shift to weak-dollar mode as soon as Jim’s proprietary IMPACT system tells them to.
IMPACT was six months in the making. Extensive back-testing across 20 years turned up the opportunity for gains of 530%… 848%… even 2,196%… all in the space of months or even days.
IMPACT, by the way, stands for “International Monetary Policy Analysis and Currency Trading.” But don’t get the wrong idea: You won’t have to get mixed up in forex trading, obsessively watching a computer screen. “This is a brand-new way to make money,” says Jim — who shows you how it works when you click here.
Stocks are slipping as traders await the nonannouncement from the Fed. At last check, the S&P 500 was down nine points, at 2,106. Gold is steady at $1,210.
Crude has rallied nearly 3% to another year-to-date high at $58.70. The weekly inventory numbers from the Energy Department came in lower than expected.
“Yet another idiotic indicator,” is how blogger and money manager Barry Ritholtz describes the dire warnings about margin debt on the New York Stock Exchange at all-time highs.
“Margin debt,” he reminds us, “is when an investor borrows against the stocks he owns to buy more shares. Margin debt has reached an all-time high and, as we have been told repeatedly, this is a fatal sign for markets.”
Never mind certain screamers on the Interwebz have sounded this alarm in at least three of the last four years… and no crash materialized.
More to the point is that margin debt “is a coincidental, not a leading indicator,” says Mr. Ritholtz. Margin debt rises and falls with markets. The basis for making loans against equities naturally increases when the value of that portfolio goes up. Margin debt declines when the value of that underlying collateral goes down… As markets reach new highs, so too does margin debt.
“One day, this bull market will end,” he says. “History suggests that NYSE margin debt will be at all-time highs when that happens. But I strongly doubt its absolute level will give you much of a warning.”
It’s the one secret behind Warren Buffett’s fortune that almost no one talks about. “Food for thought,” says Chris Mayer, “ahead of the meeting in Omaha.”
Chris is headed to the Berkshire Hathaway annual meeting this coming weekend. And he’s been reading The Warren Buffett Philosophy of Investment by Elena Chirkova — noteworthy in part because it was first published in Russian.
“It’s tough to hoe fresh ground in Buffett-land,” says Chris, “but she does a great job with one key insight that most people overlook. And that’s Berkshire’s use of debt.
“This debt was in the form of insurance float,” says Chris. “Buffett owned, and still owns, insurance companies. It’s a big part of Berkshire’s business. As an insurer, you collect premiums upfront and pay claims later. In the interim, you get to invest that money. Any gains you make are yours to keep. And if your premiums exceed the claims you pay, you keep that too. That’s called an underwriting profit.
“Everybody knows this part of the story: Buffett invested the float. What people may not know is just how cheap that source of funds was over time. To put it in a thimble: Buffett consistently borrowed money at rates lower than even the U.S. government.”
How did he pull it off? “If premiums exceeded claims, then Buffett effectively borrowed money at a negative rate of interest,” Chris explains.
“He took in premiums. He invested the money. He kept all the profits. And when he repaid the money (by paying claims), he often paid back less than he borrowed.
“This is the key to Berkshire’s success. It’s hard not to do well when nearly 40% of your capital is almost free. This doesn’t mean insurance is an easy ticket to riches. Berkshire was smart about what insurance risks it took. That means it had to shrink when the risk and reward got out of whack, which it frequently did (and does).”
Still, it’s hard to beat using other people’s money to get rich… especially when you can borrow that money at negative rates.
Chris will report back from the Berkshire shindig next week…
Meanwhile, a reader has been playing with numbers in response to speculation in the mailbag about the inflation-adjusted return on Berkshire Hathaway since 1965. That is, how much lower is it than the nominal $10,000 turned into $180 million?
“Average inflation between the end of World War II and the turn of the millennium has been that the value of the dollar falls by half each 14 years. Find how many years, divide that by 14, use the result as an exponent and multiply by 2.
“1965 to 2015 is 50 years; divide by 14 is ~3.57. On my little (less than $10) TI-30Xa (markets calculations and scientific calculator), it is $10,000 x 50 x 2 to the power of 3.57 (Y to the X button) equals $118, 761.
“Now, what was the average annual income for a blue-collar worker in 1965? The U.S. federal government published numbers? And correct that for 2015, please. Or: Use a negative exponent and the current value of that $180 million goes down to ~$15.2 million in 1965 dollars (180 million times 2 to exponent -3.57).
“Just games for numbers.
“But if it had been possible and if I had any remote idea of possibilities, then I might have tried to buy a few shares. Of course, there were no ‘small retail investors’ then, because the brokerages charged very high minimum fees and required purchase of a hundred shares minimum.”
“Reference the Ogallala Aquifer,” a reader carries on our water theme, “I would imagine we will have to do what the Israelis have done — desalinate the oceans for drinkable water.
“But I understand that it quite expensive to process, and then we have to add shipping costs.”
The 5: “The desalination process is massively energy intensive,” says Jim Rickards, “so the plants are expensive to run and have a large carbon footprint.
“But the technology does produce fresh water for industrial use, irrigation and watering golf courses in places like Dubai.”
“Looks like your prediction is hitting close to home,” writes one of our longtimers about events here in Baltimore.
Presumably, he’s referring to our executive publisher Addison Wiggin’s observation that when the “mother of all financial bubbles” collapses, you’ll feel it first on the local level. Services you take for granted — the parks, the libraries, the trash pickup — start to suffer. From there, it’s a downhill slide until social unrest occurs — “maybe outside your front door.”
Indeed…
“I am concerned for those in Agora’s ‘charming’ Baltimore offices,” writes another long-suffering reader.
“If I find out anyone at Agora has been harmed as a result of going to the office to ‘meet a publication deadline,’ I will be saddened and angered, not impressed or grateful.
“As much as I would miss an issue or more of The 5, it’s not worth getting caught in the war zone where people are given ‘space to destroy.’ (I get that you guys are contrarians, but Baltimore? Seriously!? I’ve never understood that.)
“Please make taking care of yourselves a top priority.”
The 5: Thanks for the concern. All’s well at Agora Financial headquarters. The situation has settled down to a dull roar. Traffic here in the Mount Vernon neighborhood returned to near-normal volume this morning. Alas, the FlowerMart — a Mount Vernon ritual the first weekend of May — has been postponed till further notice.
Your editor came down with a cold yesterday. I’d managed to avoid one all winter… but the stress of watching events from afar on Saturday and up close on Monday was evidently more than my immune system could handle.
It could be worse… and for many people in Baltimore, it is.
Best regards,
Dave Gonigam
The 5 Min. Forecast
P.S. Colleague Chris Campbell has done yeoman’s work the last two days in our sister e-letter Laissez Faire Today chronicling events in Baltimore you won’t read about in The New York Times or hear about from Fox News. In today’s edition, you’ll learn how the cops tragically erred… and not on the side of caution.
Check it out here.
