egon von greyerz: there will be no double dip

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"Paper money eventually returns to its intrinsic value ZERO" - Voltaire 1729

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August 16, 2010 @ 1:06 pm

THERE WILL BE NO DOUBLE DIP..

by Egon von Greyerz Matterhorn Asset Management

No, there will be no double dip. It will be a lot worse. The world economy will soon go into an accelerated andprecipitous decline which will make the 2007 to early 2009 downturn seem like a walk in the park. The worldfinancial system has temporarily been on life support by trillions of printed dollars that governments callmoney. But the effect of this massive money printing is ephemeral since it is not possible to save a world

economy built on worthless paper by creating more of the same. Nevertheless, governments will continue toprint since this is the only remedy they know. Therefore, we are soon likely to enter a phase of moneyprinting of a magnitude that the world has never experienced. But this will not save the Western World whichis likely to go in to a decline lasting at least 20 years but most probably a lot longer.

The End of an Era

The hyperinflationary depression that many western countries, including the US and the UK, will experience islikely to mark the end of an era that has lasted over 200 years since the industrial revolution. A major part ofthe growth in the last 100 years and especially in the last 40 years has been built on an unsustainable build-up of debt levels. These debt levels will continue to swell for another few years until the coming hyperinflation

in the West leads to a destruction of real asset values and a debt implosion.

In the last 100 years the Western world has experienced a historically unprecedented growth in production, ininventions and technical developments leading to a major increase in the standard of living. During the sameperiod government debt, as well as private debt have grown exponentially leading to a major increase ininflation compared to previous centuries.

[1]

Until the early 1970s the growth in credit to GDP had been going up gradually since the creation of the Fed in1913.. But from 1971 when Nixon abolished gold backing of the dollar, virtually all of the growth in the

Western world has come from the massive increase in credit rather than from real growth of the economy.The US consumer price index was stable for 200 years until the early 1900s. From 1971 to 2010 CPI went upby almost 500%. The reason for this is uncontrolled credit creation and money printing. Total US debt went

from $9 trillion in 1971 to $59 trillion today and this excludes unfunded liabilities of anywhere from $70 to$110 trillion. US nominal GDP went from $1.1 trillion to $14.5 trillion between 1971 and 2010. So it has takenan increase in borrowings of $50 trillion to produce an increase in annual GDP of $13 trillion over a 40 yearperiod. Without this massive increase in debt, the US would probably have had negative growth for

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most of the last 39 years.

Total US debt to GDP is now 380% and is likely to escalate substantially.

[2]

The coming hyperinflationary depression and the credit and asset implosion that is likely to follow will mostprobably lead to the end of a 200 year era of growth for the Western world. If only the excesses from the

1970s were corrected we might have a circa 20 year decline. But more likely we will correct the era all the way

back from the industrial revolution in the 18th century and this could take 100 years or more.

So after the tumultuous and very painful times that we are likely to experience in the next few years, theWest will have a sustained period of decline. All the excesses in the economy and in society must beunwound. These abnormal and unreal excesses are not just corporate executives, bankers, hedge fund

managers or sportsmen earning $10s to $100s of millions but also a total collapse of ethical and moral valuesas well as a breakdown of the family as the kernel of society.

Most people believe and hope that this major trend change could not happen today with all the measures thatgovernments have at their disposal. But very few people comprehend that it is precisely the government

interference, controls and regulations as well as money printing that have created the problems in the firstplace. Power corrupts, and the more pressure a government is under the more they intervene. Because theybelieve that their interference in the economy will save the country read Obama, or the world read GordonBrown. Little do they understand that each interference, each regulation or each dollar or pound or

Euro printed will exacerbate the problems of the economy manifold.

Governments now have two options; continue to spend and print money like the US or introduce austerityprogrammes like Europe. Whichever way they chose will not matter since they have reached the point of noreturn. The economy of the West cannot be saved by any means. But governments both in the US andin Europe will still apply the only method they know which is to print money.

Government is Stealing from the People

Very few people understand that money printing is a form of robbing the citizens of their money and theirwork. Money is supposed to be a medium of exchange for goods and services equalling the value of the goodor the service produced. For example, an individual works extremely hard to earn an annual wage of say$40,000 which he receives in the form of paper money. The government, due to its mismanagement and

incompetence simultaneously prints $40,000 in order to cover its deficits. So the government has by pressinga button produced the same amount of money that a man had to work a year for. This is what is currentlytaking place all over the world and which will accelerate in coming months and years leading to a totaldestruction of paper money. Paper money has completely lost its function as a medium of exchange or

a store of value. This is why gold is gaining and will continue to gain value against perishable paperthat is called money.

Deflation Inflation or Hyperinflation

The only reason that the US could build up such a major debt is that the US dollar has been the reservecurrency of the world and therefore the US has been able to finance its debts and deficits internationally. TheUS has now reached a point when debts have to increase dramatically for the country just to standstill. Like

all Ponzi schemes this one will also come to an end and this very soon. The US dollar will decline dramaticallyand lose its reserve status and the US government will be unable to finance its deficit in any market. Thisprocess will lead to endless money printing, collapsing treasury bonds (substantially higher interest rates) andthe dollar becoming worthless in a hyperinflationary black hole.

Let us just reiterate that hyperinflation arises as a result of money printing leading to a currency

collapse and not from demand pull. The slight deflation that we are experiencing currently is aprerequisite for hyperinflation. The fear of a deflationary implosion forces governments to printmoney, leading to a collapsing currency which historically has always been the cause of

hyperinflation.

Real M3 (source: Shadow Government Statistics) is falling at an unprecedented rate. This is the precursor toeconomic decline, quantitative easing and inflation (see early 1970s in the chart).

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Many experts make the analogy between the deflationary period in Japan since the 1990s and the US today.In our view the US is in a totally different situation for the following reasons:

In the early 1990s Japan could still export their production to the rest of the world.

In the current downturn all countries (even China and India) will suffer and there will be no one toexport the problems to.The ability to export made Japan a creditor nation with major payment surpluses. US are a majordebtor and have been for 25 years.Japan had a very high personal savings ratio at the time (which has now disappeared). US has had a

declining savings rate for years (the US savings rate is now going up which it always does in adownturn).The balance of payments and the personal savings surpluses made it possible for Japan to finance theirbudget deficit without resorting to QE. Very soon he US will only be able to finance their deficits with QEand so will most of the rest of the Western world.

Japanese unemployment in 1992 was 2% and went slowly up to 5% by 2000 where it is now. Real USunemployment is 22% and increasing.Many major sovereign states are now virtually bankrupt and the financial system is on life support. Thiswas not the case in the 1990s.

The above are some of the reasons why the current US situation is totally different to Japan. QE will

accelerate in the US and worldwide.

What will make this process so much more complex than the world has ever experienced is that the samedevelopment is likely to take place in many countries around the world simultaneously. It will most probablyhappen in the UK, the rest of the EU and most other European nations. Due to the total interdependence of

the world financial system, it will be difficult to forecast which countries can withstand the coming worldwidetsunami of money printing but many Asian countries probably stand a good chance.

Can we be wrong in our forecast of a hyperinflationary depression? Yes, of course we can. But the alternativecan only be a deflationary collapse which would be unacceptable to (dropping money from) helicopterBernanke and deficit demagogue Obama as well as most other governments.

Conventional wisdom and most experts say that we will not have inflation but deflation. Theproblem with most conventional wisdom is that it is only conventional without an ounce of wisdom.

When have the worlds so called experts, politicians etc ever been right on the current crisis? Theywill be wrong this time again.

The conventional wisdom experts also say that it will be years before we can see inflation or hyperinflation.In our view it can happen a lot faster. The world economy is resting on a foundation of matchsticks. All that isneeded is a change in confidence or psychology for this fragile foundation to crumble. Falling currencies,

rising bond yields and falling stock markets could very quickly result in a vicious and fast spinninghyperinflationary circle. The frailties of the financial system could make this happen like a flash fire.

Wealth Creation

Banks and the financial industry have throughout history existed in order to finance production and trading ofgoods. But in the last 100 years and especially in the last 20-30 years it has become a major industry in itsown right and an important but unproductive part of the economy in many countries. Today, the financial

industry is too a great extent involved in trading for its own and clients accounts, creating a raft of obscureinstruments that only benefit the banks and as well as financing consumption rather than investment. All ofthese areas are totally non-productive and the only beneficiaries are the participants in the financial industry.And the rewards have been absolutely astronomical. In investment banking, hedge funds and private equity in

particular, the most massive wealth has been created. Many players have become billionaires or createdfortunes of tens to hundreds of millions of dollars in the last 10-15 years just by shuffling money around. Inthe past fortunes were created by building factories and industries. But today any normal employee workingin Wall Street or the City in London will, by just showing up to work, make hundreds of thousands to millionsof dollars. This is the proof of a world totally out of balance when people dealing in money become

the richest segment of society. Since this activity contributes very little to the prosperity of a nation(but very much to its participants) it is not sustainable. The biggest reason why it exists is the massive

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amount of money that governments have created or printed and the fact that the financial industry hasdeveloped into a fractal wealth creation machine for the benefit of its participants.

For the last 40 years in particular the rich are getting richer and the average person has seen very littleincrease in real income. In the US, the real annual income of the bottom 90% of US families has increased byonly 10% since 1970. And in the expansion between 2002 and 2007, median US household income dropped$2,000. The perceived increase in wealth for the majority of Americans derives from an increase intheir debt level not from an increase in real earnings. So the improvement in living standards thatthe average American and many other Western countries have enjoyed in the last 40 odd years isprimarily based on debt debt that can never be and will never be repaid with normal money.

On the other hand, management has achieved a major increase in income and wealth. In 1973, chief

executives in the US earned 26 times the median income. Today they earn 300 times. This enormous wideningof the gap between the top few percent in society and the masses is morally and socially unacceptable. Whenthe bad times start in earnest, this is likely to lead to major social unrest and violence directed against theprivileged.

The Focus will Shift

For a major part of 2010 the focus has been on the problems within the EU starting with Greece, then Spain,Portugal, Italy etc. The problems in Europe are major and many European countries as well as the Europeanfinancial system will lead to massive money printing. Although the problems in Europe are very serious, theUS economy is in a much worse state. The diversion of the focus away from the problems in the US economyonto Europe has suited the US Administration perfectly. It can hardly be a coincidence, for example, that US

rating agencies downgrade the Sovereign debt of Greece and Spain on the same days as Treasury auctionsare held. But the problems in the US economy are deteriorating at a rapid rate; factory orders, consumerconfidence, existing home sales, retail sales, the ECRI index (Economic Cycle Research Institute) are all falling

more than expected and real unemployment, personal bankruptcies (will exceed 1.6 million in 2010), tradedeficit, state and federal deficits are all increasing.

The ECRI index is an important leading indicator. It has now fallen for 10 straight weeks.

[4]

There are three insurmountable problems in the US economy that are of a magnitude and gravity whichcan only be remedied by money printing:

Federal and state deficits will soon escalate at an exponential rate. The US Federal debt has increasedfrom $ 8 trillion in 2006 when Bernanke took office to soon $ 14 trillion. Many forecasts expect this debtto go up to nearer $ 20 trillion in the next 5 years. In our view it will be substantially higher. Add to thatinterest rates of 15% or higher and the American people will work just to pay taxes that dont evencover the interest payments on the federal debt. This is why the US will either default or more likely print

unlimited amounts of money.

The real unemployment rate is now 22%. Since 2007 over 8 million Americans have lost their jobs

and it will get a lot worse. Non-farm unemployment in the 1930s reached 35% and we would expectthis level to be reached in the next few years.

The financial system is bankrupt. Banks are failing at a much faster rate than last year. In the first 7months of 2010 circa 110 banks have failed. More seriously the assets of the failed banks are onlyworth an estimated 30-50% of their balance sheet value. Banks are valuing their toxic debt at phoneyvalues with the blessing of the government. But even debt that today is considered safe will soon turn

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toxic with the consumer coming under enormous financial pressure. Add to that the OTC derivativesheld by US banks of at least $ 400 trillion. A big percentage of these are worthless and there are

virtually no reserves to cover potential losses.

Within the next few years, the three areas above are likely to result in the biggest money printing programmein world history and simultaneously lead the US (and many other countries) into the abyss.

Markets

There has probably never been a period in world history which has caused the amount of wealth destructionthat we are likely to see in the next few years. If we are correct in our assumption that the West will see acorrection of the excesses of the last circa 40 years but more probably of the last 200 years, since the start

of the industrial revolution, we could see a total annihilation of the assets that have been fuelled by the creditbubbles. The spike in asset values in the last 100 years, which is unprecedented in history, is likely to be

corrected by a waterfall which could start at any time. We will issue a separate report in the next 10 dayscovering our market predictions and the importance of physical gold for wealth preservation purposes.

Matterhorn Asset Management AGBahnhofstrasse 28aCH 8001 ZURICH

Switzerland+41 44 213 62 45 - Tel+41 43 456 97 11 - Faxmatterhornassetmanagement.com

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Copyright 2010 Matterhorn Asset Management. All rights reserved.

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egon von greyerz: there will be no double dip

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