Fire and Ice

Some say the world will end in fire,
Some say in ice.
From what I’ve tasted of desire
I hold with those who favor fire.
But if it had to perish twice,
I think I know enough of hate
To say that for destruction ice
Is also great
And would suffice.

"Fire and Ice," Robert Frost

Former White House Budget Director David Stockman and I agree that the Pelosi-Boehner-Bush-Obama politicians in Washington have set America on a high-speed rail to horrific economic disaster. We just passed $15.5 trillion in debt, 101% of GDP, and we're still piling on another 8-10% of GDP in debt every year. We are identical to Greece, except that we have a printing press and they don't.

But Stockman and I draw very different investment conclusions from our view of how the disaster will play out. I believe the dollar will end in the fire of inflation; Stockman believes stocks will collapse in the ice of economic nuclear winter.

Stockman gives the AP an interview (read the whole thing; it will only take a minute and it's well worth your time) in which he says he doesn't own a single stock.

First, his assessment of the current situation:

[...]It's made up money. It's printing press money. When the Fed buys $5 billion worth of bonds this morning, which it's doing periodically, it simply deposits $5 billion in the bank accounts of the eight dealers they buy the bonds from.

[...] The consequences are horrendous. If you could make the world rich by having all the central banks print unlimited money, then we have been making a mistake for the last several thousand years of human history.

[...] At some point confidence is lost, and people don't want to own the (Treasury) paper. I mean why in the world, when the inflation rate has been 2.5 percent for the last 15 years, would you want to own a five-year note today at 80 basis points (0.8 percent)?

If the central banks ever stop buying, or actually begin to reduce their totally bloated, abnormal, freakishly large balance sheets, all of these speculators are going to sell their bonds in a heartbeat. That's what happened in Greece.

Here's the heart of the matter. The Fed is a patsy. It is a pathetic dependent of the big Wall Street banks, traders and hedge funds. Everything (it does) is designed to keep this rickety structure from unwinding. If you had a (former Fed Chairman) Paul Volcker running the Fed today — utterly fearless and independent and willing to scare the hell out of the market any day of the week — you wouldn't have half, you wouldn't have 95 percent, of the speculative positions today.

Sounds a lot like what we've been saying at the WCV for years, right? But here's where we part ways:

Q: How do investors protect themselves? What about the stock market?

A: I wouldn't touch the stock market with a 100-foot pole. It's a dangerous place. It's not safe for men, women or children.

Q: Do you own any shares?

A: No.

Q: But the stock market is trading cheap by some measures. It's valued at 12.5 times expected earnings this year. The typical multiple is 15 times.

A: The typical multiple is based on a historic period when the economy could grow at a standard rate. The idea that you can capitalize this market at a rate that was safe to capitalize it in 1990 or 1970 or 1955 is a large mistake. It's a Wall Street sales pitch.

Q: Are you in short-term Treasurys?

A: I'm just in short-term, yeah. Call it cash. I have some gold. I'm not going to take any risk.
Q: Municipal bonds?

A: No.

Now, to be fair, Stockman is a multi-multi-millionaire, so when he says, "some gold," he's likely talking about  millions of dollars in gold, so he'll still be fine in the case of dollar devaluation.  For us little people who don't have a million in gold, though, I think too much cash and no stocks is a dangerous game.

I simply can't envision a long-term strong-dollar scenario.  Nobody can afford a strong dollar, least of all the U.S. government.  If Bernanke's body were possessed by the ghost of Paul Volcker (I know, he's not dead yet) and interest rates shot up as Stockman fears, the economy would be hard-hit, revenues to the Treasury would collapse, and interest on the national debt would be unmanageable.  Interest rates that were considered "normal" only a few years ago would bankrupt the U.S.

Volcker had to jack Fed funds rates up to the high teens in 1980-81.  10-year Treasuries went to the mid-teens.  If the average interest cost on the national debt now rose only modestly to 5% (where it was 5 years ago and not nearly as high as it might go if the Fed actually started selling bonds), that would now cost $775 billion dollars a year.  That would be 31% of all federal revenues going to pay interest alone -- before considering that the higher rates would hammer the economy and the stock market thus pushing revenues even lower!

No central banker, much less Ben Bernanke, is going to sacrifice the stock market, the economy, and the U.S. government to defend the dollar.

Maybe I'm missing something and we'll get real Social Security reform, health care reform, and a balanced budget amendment right after the election.  But all the clowns in both parties in Washington are pushing in the opposite direction: more spending, bigger deficits, faster collapse.

From what I've seen of DC liars,
I hold with those who favor fire.

In case I'm wrong and a stock market collapse precedes dollar devaluation, I'll keep recommending being diversified across cash, stocks, and gold.  But please focus on where Stockman and I (and even bond king Bill Gross) adamantly agree: you should have lots of cash and gold, and no long-term bonds.