2011 — An Interesting Year

“Of all the contrivances for cheating the laboring classes of mankind, none has been more effective than that which deludes them with paper money.”
—Daniel Webster

The “Big Move”

As we wrap up 2010 we’re often asked what we see coming in the future from a global financial perspective. Our initial response is to reiterate that we have no crystal ball, and that as in life, things tend to unfold at their own pace — not exactly when you expect or want them too. And this is where hard work, continual learning, judgement, objectivity, and perhaps as important as anything — patience, are all required. We believe in seeking for, and investing in the long-term “big move.” We’ve observed that it’s quite common for many investors to miss the “big move” in long-term bull markets because they get shaken out of their positions. It’s our opinion this is typically caused by them being led by their emotions or ingrained belief system — rather than a rational, studied, and reasoned approach to their investing. The “big move” is typically not sexy, and it rarely involves immediate gratification. Often, it is not recognized (or admitted to by cynics) until it’s over. Most of all it requires having courage in the conviction of your beliefs, because the long-term “big move” is rarely straight up, and often fraught with periods of volatility and pull-backs. But to us, if played right — the “big-move” in the financial markets, and other aspects of life, is where the potential greatest rewards are.

To us the “big-move” has been, and in our opinion will continue to be based on the accelerating trend of global currency debasement. This parade is being lead by the pied piper of money printing, the United States. As other countries print/debase their currencies either because of their own over-indebtedness, or just to keep their export prices competitive — we continually seek investment opportunities focused on helping our clients take advantage of what we believe is the death of paper money.

Nothing Has Changed

It’s our belief the most profound truths are beautiful in their simplicity. As we analyze the current world economic scenario — we feel that nothing has changed. And by that we mean that governments of “developed” nations continue to step on the money-printing and spending accelerator, as they drive towards the economic cliff. It’s continually intriguing to us to watch politicians and central bankers in their attempts to manipulate economic scenarios, and maneuver through ever-worsening crises which they, in our opinion, have created. We also believe economics is not so much about numbers and formulas. After all, in 2008 we saw some very large investment banks and hedge funds run by people heavily educated in “economics,” and very good in math and formulas — either crashing and burning and/or requiring large-scale taxpayer bailouts (via Federal Reserve Bank money printing). To us economics is simply another extension of life, and most importantly determined by human nature. When Voltaire wrote, “Paper money eventually returns to its intrinsic value — zero” he based his observation on history. And we believe history IS the study of human nature.

As we look back to the Romans watering down the precious metal content of their coins during the demise of the Empire, the massive money-printing during the French Revolution, the hyper-inflation of Weimar Germany, or the debasement/collapse of the Argentine Peso during the last decade — two conclusions are drawn by us. The first is our belief that a currency NOT backed by gold (i.e. where the currency cannot be redeemed by the citizens of it’s country and foreign creditors alike for gold) — has NO integrity. Without the threat of currency redemption for gold — there is no restraint on the overspending (and resultant money-printing/currency debasement) by governments. The second conclusion we draw is that as inflation/government money-printing accelerates, it is the sign of a badly run country — and is a warning that economic, and perhaps political crisis may draw closer. Roman currency debasement preceded the collapse of the Empire and the barbarians; massive money printing during the French Revolution in the midst of chaos lead to more chaos and ultimately Napoleon and destruction; Weimar hyper-inflation destroyed German savings and preceded Hitler and disaster; and more recently, Argentines lost the vast majority of their hard-earned savings denominated in collapsing Pesos.

As the United States continues to lose it’s grip on spending, going ever more heavily in debt, all while continuing to print ever-increasing amounts of Dollars — we continually examine the potential consequences and plan accordingly on behalf of our clients .

Euro Crack-Up

We’ve always thought the European Union was flawed. We seriously question how long it can stay together. After all, how can countries with different cultures, personalities, work ethics, and spending/savings habits unify economically? In Europe first it was Greece, and now the debt-crisis contagion has spread to Ireland, Spain, Italy, and Portugal. Once again the EU (i.e. the Germans) are being asked to bail out the poorly run countries. We wonder how long German citizens will tolerate this one-sided deal. We think not much longer. It’s our opinion that if the Germans go — the EU is over.

State and Municipal Fiasco

We’ve long been keeping a close eye on state and local governments which increasingly seem to be broke. With much of their tax revenues dependent on real estate property values which have been hammered — certain populous states are in real fiscal trouble. We believe this is another major economic crisis which could begin manifesting in 2011. In a recent report, noted analyst Merideth Whitney (who correctly forecast the banking disaster before the credit crisis hit) now warns of a potential trillion dollar bailout for overly-indebted states and municipalities.[1] Per Whitney:

“You have to look at the states and the risk that the states pose, because the crisis with the states will result in an attempt at for at least the third near-trillion-dollar bailout… That has consequences on the dollar, that has consequences on just about everything. It certainly has consequences on the U.S. recovery.”[2]

Only time will tell how this all unfolds.

2011

It’s our opinion that 2011 is going to be a very interesting year. We believe the global economic situation in the “developed” world will continue to worsen. This includes the United States. In the U.S. and Europe fiscal mis-management continues. Politicians are not making the tough choices. Where are the spending cuts? When will large financial institutions who make bad bets be allowed to fail — or at least face the consequences of their bad decisions without tax-payer bailouts like any other business? With large inventory back-logs and poor jobs data, we believe housing is far from out of the woods — with a second leg down a distinct possibility. While the Fed has said it will withdraw stimulus — we’ve never believed them and still don’t. $600 billion more of recent Fed quantitative easing, and further comments by Chairman Bernanke indicate the end is not in sight.[3] And to us that means additional money-printing by the Fed, and the accelerating debasement of the U.S. Dollar.

Do the wheels come off in 2011? We shall see. As our clients know, we seek opportunities accordingly. Our goal is, and always has been, to dispassionately get on the right side of the trade. And it’s our opinion that no matter what the scenario, there exists the right side to every trade.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group
www.ernharth.com

Go to www.ernharth.com/economic-commentaries to read past articles from our Economic Commentary series.

1. cnbc.com, “States are Poised to be Next Credit Crisis for US: Whitney” September 28, 2010
2. Ibid
3. FT.com (Financial Times), “Bernanke Hints at Further Stimulus” October 15, 2010