Category: simonblack

[Editor’s note: This letter was penned by Tim Price, London-based wealth manager and author of Price Value International.]

“Gross: Global yields lowest in 500 years of recorded history. $10 trillion of neg. rate bonds. This is a supernova that will explode one day.” – Tweet from Janus Capital.

Bill Gross’ warning is, of course, tautological. A supernova is an exploding star. What he probably meant to say is that the bond market is a star that will turn into a supernova one day. But then so what? At some point our own sun will die and the planet Earth will likely be engulfed by it as it explodes. Since that’s not likely to happen for roughly 5 billion years, we can probably renew our monthly travel cards with a sense of equanimity.

But then Bill Gross has form here. It was Bill Gross, modeller of sunglasses and billionaire bond investor, who suggested back in January 2010 that the UK Gilt market was “a must to avoid” and that UK Gilts were “resting on a bed of nitroglycerine.”

In January 2010, 10 year Gilts yielded 4%. They now yield roughly 1.25%. In 2010, the UK national debt was just under £1 trillion. It now stands at over £1.6 trillion. If Gilts were resting on a bed of nitroglycerine six years ago, they are now bouncing up and down, in spiked running shoes, on a bed of picric acid and octanitrocubane whilst firing flaming napalm arrows at a dartboard made of pure antimatter.

The pitiful yields available from the likes of UK Gilts and US Treasuries are bad enough. But if there’s money figuratively burning a hole in your pocket, may we suggest the iShares Swiss Domestic Government Bond 1-3 year exchange traded fund, instead. This little peach of a product owns just two bonds. 53% of the fund is invested in the Swiss 3% bond maturing 8 January 2018. This bond yields minus 1.06 percent. The remaining 47% of the fund is invested in the Swiss 3% bond maturing 12th May 2019. This bond yields minus 1.04 percent. How many did you want again?

As George Cooper of Equitile tweeted some months ago,

The combination of indexing, ratings agencies and syndication means that collectively the investment industry does not provide effective discipline to borrowers.

George is being polite. Not only does the investment industry not provide effective discipline to borrowers, it allows something to happen that should be beyond the scope of rational investment markets. It actively supports negative interest rates rather than abhorring them. Allocating the blame is only part of the issue. Who, after all, is really at fault – the investors in iShares’ Swiss government bond fund, for buying an investment product of questionable utility, or iShares, for constructing it in the first place? The answer, of course: Mario Draghi. And Janet Yellen. And Mark Carney., (George Cooper is interviewed on Bloomberg for his thoughts on the wisdom of central bankers here.)

So we might collectively come to the conclusion that while the bond markets have become essentially uninvestible, the duration for this environment of uninvestibility might prove to be longer lasting than anyone, including Bill Gross, ever anticipated. The pragmatic solution is surely to seek out real assets that should hold up tolerably well in deflation but which offer the potential for participating in any ultimate reflation – rather than being destroyed by it. As we view the world, the assets that would seem to fit the bill are not bonds but equities. And rather than blithely tracking the indices with all the risk that that entails, we prefer to go the extra mile and insist on owning stocks that offer a ‘margin of safety’ by dint of trading at especially attractive valuation discounts versus the rest of the market.

The good news: such value stocks exist, albeit not necessarily in those markets that are most obviously appealing to index trackers. (The US, for example, accounts for roughly 60% of the MSCI World Equity Index, but is a) not cheap, and simultaneously b) extremely well covered by the analyst community.)

Even better news: the valuation discount to growth has rarely been bigger. We highlighted the following chart at the end of May.

Source: Bloomberg LLP

The chart shows the performance of value stocks versus growth stocks – as defined by MSCI – since 1975. When the red line is rising, value stocks are outperforming. When the red line is falling, value stocks are underperforming. And as Rob Arnott of Research Affiliates points out in his April research note ‘Echoes of 1999’, for the three year period ending in March this year, value has endured its worst performance relative to growth for forty years:

Historical experience shows that starting valuations similar to those we see today in value stocks have led to their prolonged, massive outperformance, making a strong argument for rebalancing into a deeper value tilt and avoiding the popular, bull-market growth stocks.

It’s hardly rocket surgery. If bonds are outrageously expensive, which they are, buy stocks instead. And if growth stocks are expensive, which by and large they are, buy value stocks instead.

Human nature doesn’t change, which causes markets to oscillate between cycles of greed and fear. Though they may not seem like it, especially at their extremes, or when they’ve persisted for some time, those cycles represent opportunity. In his first edition of ‘Security Analysis’, Benjamin Graham quoted Horace:

Many shall be restored that now are fallen, and many shall fall that are now in honour.

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“Global yields lowest in 500 years of recorded history. $10 trillion of neg. rate bonds. This is a supernova that will explode one day.”

Those were the words of famed bond fund manager Bill Gross.

(Gross was actually the first portfolio manager inducted into the Fixed Income Analyst Society’s “Hall of Fame”. And yes, there really is a hall of fame for that.)

Gross wrote that more than $10 trillion in government bonds actually have NEGATIVE yields, and that interest rates are at the lowest levels in financial history.

For example, the British government just issued its lowest-yielding bonds since 1694.

This has very dangerous implications.

Goldman Sachs recently calculated that a mere 1% rise in US Treasury yields would trigger over $1 trillion in losses, exceeding all the losses from the last crisis.

(Bear in mind that interest rates need to rise by at least 3x that amount just to reach their historic averages… so this is entirely plausible.)

Most of those losses would be suffered by Western banks, the majority of which have insufficient capital to withstand such a major hit.

Gross describes this potential risk as a ‘supernova’.

Now, he may have used that word because it’s a really cool-sounding superlative to describe the impact of this risk.

But coincidentally, ‘supernova’ is the perfect analogy for our financial system.

Remember that a supernova is an ultra-bright flash of light that results when a star explodes at the end of its life.

The explosions are so powerful that astronomers can see these incredible stellar events even from distant galaxies.

In 2015 the brightest supernova ever recorded was found in a galaxy some 3.8 billion light years from earth.

The supernova was over 500 BILLION times brighter than our sun. Incredible.

But given the star’s extraordinary distance from our planet, the explosion actually occurred 3.8 billion years ago… a long time ago in a galaxy far, far away.

It took all that time for the light from that supernova to reach us.

That’s what’s happening now in our financial system.

The financial supernova happened years ago. But the light… and the consequences… are finally starting to reach us.

Given these risks, let’s discuss some rational alternatives to the banking system:

1) Physical cash

This is an easy option for just about anyone. Holding cash completely eliminates the risk of keeping your savings in a shaky bank.

You can secure your cash by storing it in a safe at your home, or at a non-bank private vault facility.

It means your savings won’t be gambled away by your banker on the latest investment fad.

You can’t have your account frozen by any one of dozens of government agencies.

And if something goes wrong with the banking system, your savings will survive untouched.

But cash is no panacea. While it dramatically reduces the risk to your savings posed by potential challenges in the banking system, you may also want to consider…

2) Precious metals

While cash is a great hedge against problems in the banking system, precious metals are a fantastic hedge against problems in the broader monetary system.

If the market ever wises up and realizes that all these pieces of paper passed off as money are simply worthless claims on bankrupt governments, OR there comes a day when central banks print the straw that breaks the camel’s back, you’ll want to make sure you own gold and silver.

Gold is a real asset with a 5,000 year history of value and marketability, three times as old as the oldest paper currency still in use (the British pound).

Now, like any form of savings, gold by itself doesn’t produce a rate of return.

Cash in a bank account earns about 0%. Cash in a safety deposit box earns 0%. Gold in a safety deposit box earns 0%.

So in order to earn some return on your savings, it’s necessary to consider owning…

3) Safe, cash-producing assets

For large investors like Bill Gross who have billions of dollars to manage, finding safe returns is next to impossible.

But for smaller investors like you and I who have thousands or even millions to invest, there are countless options.

For example, we’ve introduced our premium subscribers to an opportunity where they can generate up to 6% on Peer-to-Peer loans that are fully secured at a 2:1 margin by real assets like gold and silver.

This is a fantastic, low-risk way to generate a reasonable rate of return on your savings.

Of course, if you have a longer-term view, you can do even better if you consider owning…

4) Deep-value investments

Yesterday we discussed this simple idea with a powerful track record:

Own profitable businesses managed by talented people of integrity, and buy them when the share price is below the company’s intrinsic value.

Share prices go up and down day to day. But over the course of several years, wonderful, well-managed businesses perform extremely well in any environment.

In the event of inflation, they go up in value. In deflation, they produce valuable cash flow. Even in a crisis, they’re the first to recover.

Great businesses often pay steady dividends as well, so you can expect to earn healthy cash flow while honest, talented executives look after your savings.

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This morning as I glanced at the headlines, I had to sit back and wonder– when did the world get so crazy?

Interest rates across the West are at zero or negative.

Bankrupt governments are selling 100-year bonds with tiny interest rates, while others have convinced investors to pay for the privilege of loaning them money.

What really gets me is that people aren’t laughing. Serious investors are buying up the $10+ trillion worth of negative-yielding debt issued by bankrupt governments as fast as they can.

After all, everyone else is doing it.

Yesterday I told you how, at age 20, I borrowed a bunch of money and did what everyone else was doing at the time– buying Internet stocks at the height of the dot-com bubble in 1999.

I lost everything within a year.

And ever since I left the military more than a decade ago, I’ve dedicated a huge portion of my time, money, and effort toward learning from the sharpest people I could find.

I traveled to nearly 120 countries to build relationships with brilliant mentors in order to learn what I never could in school.

For example, I never went to business school.

But based on what I learned from my business mentors, I’ve been able to build five successful companies that now employ over 125 people on four continents.

From my investment mentors, I learned how to not be such an idiot… how to ignore the crowd and focus on the core fundamentals of a business.

One of my value investing mentors explained to me, for instance, that if you’re going to invest in the stock market, you should buy a single share as if you’re buying the entire business.

And he laid out six rules to follow when making any investment:

1. Always consider the risks before even thinking about how much you can make

Sometimes it’s worth taking huge risks where there’s a good chance you’ll lose everything.

Startups are a great example; there was a 95% chance that Google was going to fail when it first launched. But the return has been more than 100,000x the initial investment.

Clearly that kind of return is worth the risk.

Conversely, if you buy and hold 5-year Japanese government bonds right now, you’re counting on the second most bankrupt government on the planet to pay you back.

Bear in mind that Japan’s government is so broke they spend 40% of tax revenue just to service the debt.

And in exchange for taking on such substantial risk for five years, your reward is a whopping NEGATIVE 0.25% per year.

In comparison, it hardly seems worth it. Know the risk, and make sure the reward is worth it.

2. Don’t invest unless you know WHY

Before making any investment, have an objective. After all, there are a lot of different reasons to invest.

Sometimes you might be seeking income, i.e. buying rental real estate for the cash flow.

Capital appreciation is another common goal; people are typically looking to turn a $100,000 investment portfolio into $500,000.

But there are other reasons as well: Asset protection. Hedging against financial/systemic risks. Reducing taxes. Estate planning. You can even invest to gain citizenship.

To accomplish any goal requires careful planning and disciplined execution, whether you’re trying to lose weight or save for retirement.

But you can’t ever create a plan unless you start with a clear objective.

3. Invest in people of integrity who have a track record of success.

Most investments are ‘managed’. Apple is managed by CEO Tim Cook and the Board of Directors.

Investments in government bonds are essentially ‘managed’ by the Treasury Department and all the politicians and bureaucrats.

Any investment with dishonest or incompetent management will ultimately become worthless. It’s simply a question of time.

A great asset managed by competent people of integrity will be a winner.

4. Buy assets that generate vast amounts of cash flow.

No exceptions. A profitable business (or any asset that produces safe, strong cash flow) makes sense in any environment: inflation, deflation, stagnation, etc.

5. Avoid excessive debt.

Borrowing can be a good thing, especially when interest rates are low like they are today.

But too much debt leaves a company (or government) vulnerable and unable to pay its stakeholders.

6. Know the value of what you’re buying, and never overpay for it.

The bonds of bankrupt governments are selling at record levels right now. Tech companies like Uber that lose hundreds of millions of dollars have valuations in excess of $60 billion.

None of this makes any sense.

There’s something to be said for investing in growth, especially when you can get in at a very early stage (like being an early investor in Google).

But paying out the nose to buy losing companies or bankrupt government bonds makes no sense.

Know exactly what a company is worth. With stocks, for example, you can look at a company’s “net tangible assets” — all of its physical, disposable assets minus its liabilities.

For example, if a company has $1 million in cash, $1 million in inventory, and $500k in debt, then its net tangible assets equal $1.5 million.

Buying well-managed, profitable companies that sell near (or even below) the values of their net tangible assets provides a substantial margin of safety.

This is a core principle of value investing. The whole concept is to essentially buy a dollar for 80 cents.

If you’re just getting started and you don’t yet understand a lot about finance, definitely learn about value investing.

The idea is incredibly simple, and its proven long-term track record outperforms all the other popular hotshot strategies.

Learning about value investing means learning about the inner workings of business, money, and cash flow.

It’s a fantastic foundation to your financial education, which is truly one of the best investments you can make.

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The year was 1999. I was 20 years old. And like most 20 year olds, I knew EVERYTHING.

Or at least I thought I did.

I was a young West Point cadet at the time, and I’d just received a bank loan of more than $22,000.

This is something that every cadet in his/her junior year is able to do; banks line up to give us lump sum loans secured by our future earnings as Army officers.

I had grown up in a lower middle class household, so when a bank offered me $22,000, I jumped. It was more money than I had ever seen in my life.

I didn’t have a plan about what I would do with the money, other than some fantasy of turning it into millions of dollars.

Nor did I have any real investment education or experience.

But hey, I knew everything. So I took the money and went into debt.

That turned out to be a HUGE mistake.

Rather than take time to invest in my own education and learn from the most successful investors I could find, I assumed that I knew everything and proceeded to dump the entire loan amount in the stock market.

I so desperately wanted to be rich, and I tried everything, including buying all the hotshot Internet stocks that were going to the moon.

At first the portfolio did well, and it only encouraged my arrogance. Every dollar I made reinforced the absurd self-belief that I was a masterful investor and knew what I was doing.

Now, go back and read the first line of the article: “the year was 1999.” The dot-com bubble was at its peak.

Warren Buffett had famously warned investors that the market was in a massive bubble. And I remember thinking, “Who is that stupid old man, and what the hell is a bubble?”

But again, I knew everything.

Then the bubble burst. And not only did my profits evaporate, but even the principal amount started to shrink.

Desperate to recoup my investment losses, I started making even dumber decisions, like buying collapsing dot-com stocks on margin.

In other words, I borrowed even more money and combined it with the money I had already borrowed to buy the shares of terrible companies with no assets. Genius.

Unsurprisingly, within about a year of taking the original loan, I had lost it all. Every single penny.

Back then I considered $22k an unbelievable amount of money, and I thought I’d never recover.

In fact I spent the next several years of my life paying the loan back– precisely $404.33 per month.

Each month was a painful, humbling reminder of my arrogance and stupidity, and it motivated me to go out and properly educate myself.

But I learned that real education wasn’t taught in a traditional school system.

Sure, I could calculate the area of an isosceles triangle and recite the photosynthesis equation.

But none of my schooling had taught me the first thing about money, banking, business, or investment.

So I started finding mentors.

In 2001 I read Robert Kiyosaki’s seminal work Rich Dad, Poor Dad and was inspired to start investing in real estate.

After reading a half dozen other books on the topic to become knowledgeable, I looked in the county database to find the top 20 property owners in my area.

I contacted each of them and offered to buy them lunch. Most didn’t respond. A few declined. One guy accepted. Just one.

But I learned more in a few hours with him than I would have in years of school.

And the relationship that we kept up afterwards proved invaluable. It was like having a seasoned coach to help guide my decisions and keep me from making huge mistakes.

This was a big Eureka! moment for me– I realized how important and valuable it was to learn from experienced, successful people.

Think about it: with such a globalized world and our modern technology, there are countless opportunities to build a business and generate additional income.

These days it’s completely realistic to create $5,000 to $10,000 per month or more with a part-time side business… as long as you have the proper business education.

It’s the same with investing.

Did you know, for example, that generating just 1% more per year can turn into literally hundreds of thousands of dollars in additional gains for your retirement savings over a few decades?

With proper investment education, it’s completely realistic to not only avoid stupid losses, but to generate MUCH higher long-term returns… as well as create steady sources of passive income.

In our daily conversations we often discuss the concerning trends that freedom-minded people face.

Dozens of governments are totally bankrupt.

Most western economies are built on pitiful foundations of debt and consumption, rather than savings and production.

There’s been a sustained, long-term decline in freedom, and an alarming erosion of the middle class.

Central bankers have made interest rates negative, and there’s now over $10 trillion worth of bonds issued by bankrupt governments with negative yields.

It’s total madness and gets crazier by the day.

But with proper education, it’s possible to understand both the risks AND the solutions, like holdings some physical cash and precious metals to make sure you don’t become a refugee of our bankrupt financial system.

This is a major part of becoming a Sovereign Man: realizing that YOU have the power to create your own freedom and financial independence, no matter how crazy the world gets.

And it all starts with proper education. After all, the best investment you can make is the one you make in yourself.

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[Editor’s note: This letter was penned by Tim Price, London-based wealth manager and author of Price Value International.]

“Suffice it to say that volatility and risk are not the same thing, but that for reasons which remain obscure most of the investment world chooses to treat them as if they are. The only one that makes any sense at all is that the mathematicians who came to dominate the financial world from the 1950s onwards were desperate for something they could calculate, and the variance of past periodic returns seemed like the best candidate.”
– Guy Fraser-Sampson, ‘Intelligent Investing’

Some people in finance have a sniffy attitude towards academics, writes Buttonwood in the latest Economist magazine. For good reasons, we might add. (Why are academics so bitchy ? Because the stakes are so low. And as Jerry Pournelle observed, you won’t learn much about capitalism at university, and you shouldn’t expect to. Capitalism is a matter of risks and rewards, and a tenured professor doesn’t have much to do with either.) So far, academia’s biggest contributions to finance have been Modern Portfolio Theory, the Capital Asset Pricing Model (CAPM) and the Efficient Market Hypothesis. With contributions like that, who needs asinine overly simplified wrong models ?

From the get-go, Buttonwood’s piece (‘Risk and the stock market’) launches from a dubious platform:

“Risk is linked to reward; it is virtually the first lesson one learns about finance. Safe assets pay low returns; if you want higher returns, you have to risk your capital.”

But QE has subverted the relationships between supposed safety, returns and risks. As Jeremy Siegel points out,

“You have never lost money in stocks over any 20-year period, but you have wiped out half your portfolio in bonds [after inflation]. So which is the riskier asset?”

Today, for example, all German government bonds out as far as 9 years to maturity carry a negative yield. Anybody buying them and holding them until redemption is guaranteed to lose money, even before inflation. Safe? Or extremely hazardous?

And as Berkshire Hathaway’s Charlie Munger points out, using volatility as a measure of risk is madness. Risk, for Berkshire and for ourselves, is either the risk of permanent loss of capital or the risk of inadequate return.

So it is hardly surprising that two papers in the Journal of Portfolio Management find fault with financial theory. The first, ‘Risk Neglect in Equity Markets’, by Malcolm Baker of the Harvard Business School, found that – as conventionally defined – more risk led to lower returns, not higher ones. Baker took two portfolios from 1967. One consisted of the 30% of US stocks with the lowest beta (volatility relative to the market as a whole), the other of the 30% of US stocks with the highest beta.

By the end of the study, $1 invested in the high beta portfolio had grown to $18. But $1 invested in the (less risky) low beta portfolio had grown to $190. You could drive a truck through the difference in compound returns, which equates to some 5.5% a year. Not only is the low beta portfolio the stand-out performer in returns, it also displays lower volatility and its maximum drawdown (peak to trough loss) is 35% versus 75% for the high beta portfolio.

Baker’s study is not alone. In ‘What Works on Wall Street’, James O’Shaughnessy selected the 50 most expensive stocks in the US stock market on the basis of a variety of metrics (price / sales; price / cashflow; price / book, and price / earnings), together with the 50 cheapest stocks using the same metrics. Each portfolio of 50 stocks was rebalanced annually to ensure that the focus on outright expensiveness and cheapness remained consistent over time. The results are shown below.

Value of $10,000 invested in various value strategies, over 52 years

Source: ‘What Works on Wall Street’ by James P. O’Shaughnessy

Financial theory would have suggested that the ‘expensive’ portfolio enjoyed higher returns. O’Shaughnessy’s study, like Baker’s, showed exactly the opposite.

Take price / book. The ‘growth’ portfolio, which had a starting value of $10,000, ended up after 52 years being worth $267,147. But the demonstrably cheaper ‘value’ portfolio, with the same starting value, ended up being worth over $22 million.

Perhaps value trumps growth. (We clearly believe so, which is why we established a global fund of unconstrained value managers.) Perhaps financial theory is wrong.

The second paper cited by Buttonwood examined the role of tracker funds – cheap, passive market-tracking vehicles. The index-tracker owes its existence to the validity of the Efficient Market Hypothesis – the theory that active managers cannot beat the market over time. One problem with trackers is that they are dumb. They “dilute the purpose of the stock market, which is to allocate capital to the most attractive companies”. Another problem with trackers is that they are dangerous. Firstly, they cause herding, as trackers collectively buy or sell the market’s respective winners and losers. Secondly, they offer no escape route for the investor in the event of a market sell-off. The market-tracking investor is destined to go down exactly in line with the market. This is a particular problem if stock markets are currently priced above their fair value, which certainly appears to be the case for the S&P 500, which stands roughly 60% above its long term fair value, according to Robert Shiller’s cylically adjusted p/e ratio, or CAPE.

The third problem with trackers is that the Efficient Market Hypothesis is wrong. Warren Buffett made the same observation when he wrote about the Superinvestors of Graham and Doddsville in his appendix to Ben Graham’s reissued ‘The Intelligent Investor’ in 1984. There is a class of managers that has meaningfully outperformed the market over many years, whilst simultaneously taking on less risk, because everything they buy offers a ‘margin of safety’ by comparison to more expensive (and therefore riskier) stocks. They are called value investors and we are extremely happy to be invested right alongside them.

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In a bizarre story disclosed over the weekend, we learned that Belgium’s Princess Astrid was robbed by two assailants on a motorbike.

The thieves apparently approached her while she was sitting in traffic, smashed in her window, snatched the Royal Handbag, and sped off with over 2,000 euros in cash.

I have no doubt that was a harrowing experience for the princess, as it would be for anyone.

But as I researched a bit more, I learned that Belgium’s royal family is lavishly paid, particularly for a small country of just 11 million people.

King Philippe of Belgium receives more than 10 million euros per year. His father, the ‘retired’ king receives a pension of nearly 1 million euros annually.

Princess Astrid, the King’s sister, receives about 300,000 euros per year, in addition to usage rights of the royal properties.

In order to pay for this largesse, Belgium suffers some of the highest tax rates in the world, as high as 50% if you earn even a modest income.

In addition there’s 13% employee contributions to Social Security (plus employer contributions of 35%), and a Value-Added Tax of 21%.

Businesses in Belgium are subject to a 30% corporate tax rate, a 3% ‘crisis surcharge’, and my personal favorite, a 5% ‘fairness tax’.

In total the Belgian government’s tax revenue eats up about 45% of GDP, which means that the government takes almost half of all economic output.

This is an astounding figure… though it’s less than other governments in Europe like France or Denmark.

Now, with due sympathy to the princess, I wonder if having 2,000 euros stolen by motorbike bandits is philosophically much different than having 50%+ of your income stolen by the government.

Both of these events can occur at gunpoint. Both carry severe penalties if you resist.

At least with the bandits it only happens once, or rarely, in a lifetime. With the government it happens every single day.

Every time you spend money. Every time you earn. Every time you invest. The government’s there taking its share.

US Supreme Court Justice Oliver Wendell Holmes Jr. once wrote that “Taxes are what we pay for civilized society.”

Of course, Holmes wrote that statement at a time when tax rates were about 3.5% (not a typo), so it’s completely taken out of context.

But the quote still serves as a rallying cry for Social Justice Warriors who want to take more of your paycheck.

The entire premise of income tax is that ‘your’ money isn’t really yours after all. It’s theirs.

They have first right to take as much as they like from your earnings, leaving you with whatever leftovers they choose.

Income tax is like a financial Primae Noctis. And yet governments always seem to want more.

I don’t get it. There are so many examples of low-tax countries that are thriving.

Even in Europe, for example, Estonia has a profits tax as little as 0%. And yet they consistently run a budget surplus.

Ireland has had a low-tax regime of just 12.5% on corporate profits for years, and they recently announced a new tax regime for certain companies as low as 6.25%.

Go figure, these low tax rates have attracted substantial investment (and jobs) from huge multinational companies, all of which has boosted the Irish economy.

So the Irish government essentially takes a small slice of a rapidly expanding corporate pie, as opposed to Belgium and France’s huge slice of a shrinking pie.

It’s not rocket science. If you create reasonable incentives, businesses will invest, the economy grows, and everyone wins.

But despite these obvious examples, bankrupt nations don’t want to do that. Instead they do the exact opposite, driving productive citizens and businesses away.

A few days ago, for instance, the European Commission released details of a tax directive that will create a pan-European tax system, complete with a brand new Tax ID number for all the good citizens of Europe.

The proposal also aims to increase taxes across the board if they feel that a member state (like Ireland) doesn’t charge enough tax.

According to the proposal, other European countries like Ireland and Estonia “distort competition by granting favourable tax arrangements.”

Apparently it’s not ‘fair’ that high-tax France and Belgium have to compete with low-tax Ireland and Estonia.

So rather than the bankrupt countries getting their act together to attract business, the solution is to penalize everyone and make the entire continent less attractive.

It’s genius!

The directive goes on to demand more onerous reporting, attack anyone who takes legal steps to reduce what they owe, and even threaten businesses with exit taxes if they try to leave Europe.

This really is like a return to the feudal system.

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On July 1, 2005, the Chairman of then President George W. Bush’s Council of Economic Advisors told a reporter from CNBC that

“We’ve never had a decline in house prices on a nationwide basis. So, what I think is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.”

His name was Ben Bernanke. And within a year he would become Chairman of the Federal Reserve.

Of course, we now know that he was dead wrong.

The housing market crashed and dragged the US economy with it. And Bernanke spent his entire tenure as Fed chairman dealing with the consequences.

One of the chief culprits of this debacle was the collapse of the sub-prime bubble.

Banks had spent years making sweetheart home loans to just about anyone who wanted to borrow, including high risk ‘sub-prime’ borrowers who were often insolvent and had little prospect of honoring the terms of the loan.

When the bubble got into full swing, lending practices were so out of control that banks routinely offered no-money-down mortgages to subprime borrowers.

The deals got even sweeter, with banks making 102% and even 105% loans.

In other words, they would loan the entire purchase price of a home plus closing costs, and then kick in a little bit extra for the borrower to put in his/her pocket.

So basically these subprime home buyers were getting paid to borrow money.

Of course, we know how that all turned out. By 2008 the entire system crashed, and the post-game analysis had some pretty obvious conclusions:

Bad things tend to happen when you pay people to borrow money, especially when they’re not particularly creditworthy.

Thank goodness no one in finance engages in such risky behavior anymore!

Or do they?

Today, subprime is back.

There’s been a lot of talk lately about a growing bubble in the subprime auto loan market, and even student loans.

But the biggest subprime bubble of all is the negative interest loans being made to sovereign governments.

All over the world now there are governments that are issuing sovereign bonds with negative yields… and many of these governments are totally bankrupt.

Japan, with its debt level at more than 220% of GDP, is the latest entrant into the world of negative interest bonds.

Japan’s debt is so high, in fact, that it takes 41% of government tax revenue to service.

Even in Italy, one of Europe’s most notoriously and hopelessly bankrupt countries, the government bonds have negative yields.

‘Negative yield’ means that an investor who loans money to government will get back less money than s/he invested once the bond matures.

In other words, the government is getting paid to borrow money.

So it’s not much different than when banks paid subprime homeowners to borrow money ten years ago based on a misguided premise that home prices always go up.

Now they’re just paying subprime governments to borrow based on a misguided premise that governments will ALWAYS pay. (just like Greece!)

The key difference is size. At the peak of the housing bubble ten years ago, there was about $1.3 trillion worth of subprime mortgages in the financial system.

That $1.3 trillion bubble was enough to bring down several major banks and cause cascading damage across the global financial system.

Today’s bubble is EIGHT TIMES the size of the last one, with more than $10.4 trillion worth of government bonds that yield negative interest.

And what’s even more concerning is how quickly it’s growing.

In January 2016, the total amount of government bonds in the world with negative interest totaled $5.5 trillion.

One month later in February the total had grown to $7 trillion. By May it was $9.9 trillion. And today it’s $10.4 trillion.

So this gigantic sovereign bond bubble where governments are being paid to borrow money has practically doubled just in the last several months.

This isn’t a cause for panic or to assume that the financial system is going to crash tomorrow.

But it’s clearly a disturbing trend… the proverbial powder keg in search of a match.

And when future pundits write the history the financial crisis to come, whether it happens today, tomorrow, or years from now, you can bet they’ll wonder how the entire system failed once again to see something so dangerous… and so obvious.

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“Offshore”. It’s practically a dirty word now. The O-word.

The mere concept of “offshore” is automatically associated with criminal activity, tax evasion, and terror financing.

Consider the notion of offshore banking.

The immediate image that comes to mind is some moustache-twirling billionaire tax cheat hiding his ill-gotten gains in a nefarious island bank.

The media crusade over the Panama Papers only reinforces this absurd stereotype.

But the reality is far different than the fiction that’s being peddled.

In the US, the epicenter of the movement against financial privacy and freedom, the banking system has become a pitiful shell of the sturdy pillar it’s supposed to be.

Just think back to 2008.

After years of raking in huge profits as they loaned their depositors’ savings out in the most reckless and irresponsible sub-prime home loans, the banks crashed.

Then they went to the government with hat in hand, telling us the world would come to an end if they didn’t receive a massive rescue package.

Despite nearly $1 trillion in a taxpayer-funded bailout, the biggest bailout of all came from the Federal Reserve.

The Fed spent years conjuring trillions of dollars out of thin air and ‘loaning’ it to commercial banks at 0% interest to help them recapitalize.

But in bailing out the banks, the Fed had to expand its own balance sheet so rapidly that they rendered themselves nearly insolvent.

In the meantime the Fed has also had to continue funding the US government’s addiction to debt, which has doubled since the financial crisis and now exceeds 100% of GDP.

The US financial system, therefore, is comprised of an insolvent government, a borderline insolvent central bank, and commercial banks that have a history of making reckless decisions with their depositors’ funds.

Meanwhile, over in Europe, many of the commercial banks themselves are outright insolvent and have had to resort to cash and withdrawal controls to trap their depositors’ funds in a failing system underpinned by negative interest rates.

It’s insane. The world’s most developed banking systems are dominated by debt, insolvency, negative interest, and reckless abandon.

What could possibly go wrong?

Given this ridiculous financial reality, it should be clear that banking overseas has nothing to do with tax evasion.

Tax evasion is pointless and stupid anyhow. If your goal is to reduce what you owe, there are countless ways to legally do so.

For example, instead of committing tax evasion, a US investor who wants to reduce his/her taxes could move to Puerto Rico instead.

Becoming a legal resident of Puerto Rico can eliminate US federal income tax obligations.

Meanwhile, the island has an incentive law reducing the rate of tax on certain investment income to 0%. And you don’t even have to live there year round.

So, Option A is risking jail time by committing tax evasion. Option B is moving to a beachfront paradise for part of the year and legally paying zero tax. Duh.

That’s ultimately the point of going offshore: it gives you more power, more freedom, more control, and more safety.

Banking overseas, for instance, can be MUCH safer.

There are many jurisdictions abroad, like here in Hong Kong for example, where the banks are highly capitalized and maintain strong, conservative cash reserves.

Hong Kong banks are also backed by a deposit insurance program that’s actually well-funded, which itself is backed by a government that has zero net debt and is swimming in cash, plus one of the best-capitalized central banks on the planet.

What a night and day difference.

In the Digital Age, geography is an irrelevant anachronism. It shouldn’t matter if your bank is across the street or across the world.

The most important characteristic of a great bank is its financial stability.

Is it liquid? Is it solvent? Are its lending and investment practices conservative? Is the country’s banking system robust and sustainable?

Most of the West gets fairly poor marks in these key questions.

But if you expand your thinking to the entire world, you’ll find there are much better, safer options abroad.

Don’t buy the popular myth. Having a foreign bank account isn’t about being a tax cheat.

It’s completely and totally legal as long as you follow your country’s disclosure rules.

(US taxpayers—this could include FinCEN Form 114, IRS Form 8938, and/or 1040 Schedule B.)

This is ultimately about keeping your capital safe by holding your savings with a strong, conservative bank in a sustainable, debt-free financial system.

It just makes sense.

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All governments make absurd claims. But North Korea definitely wins the award for the most comical.

Kim Jong-Il, North Korea’s “Dear Leader” from 1997 through 2011, had some priceless gems, including:

• He never once in his life needed to urinate or defecate
• He wrote over 1,500 books for North Korea’s universities
• He could control the weather with his mind, making rain or shine as his mood suited
• He learned to walk at the age of 3 weeks, and talk at the age of 8 weeks

And my favorite (this one is actually true)– Kim Jong-Il once kidnapped two South Korean film directors and forced them to remake a version of Godzilla in North Korea.

You can see the movie here.

His son and current ruler, Kim Jong-Un, has also made a number of bold claims, including that he invented the cure for HIV, SARS, MERS, and Ebola.

And according to his research, North Korea is apparently the second happiest country in the world after China.

These claims are all obviously fictional and completely incredulous. And yet, somehow the US government seems to believe at least one of them.

You see, Kim Jong-Un also claims to be a genius hacker, and that his people are genius hackers too. It almost seems like a headline ripped from the Onion.

The reality, of course, is that there’s almost no Internet in North Korea and the population has more experience with land mines than land lines.

And yet while we can all agree that the Kims’ other claims are preposterous, for some reason the US government believes the hacker threat to be real.

Now every major hack that occurs is automatically blamed on the North Koreans.

Recently one of the biggest bank heists in history transpired after the SWIFT messaging system was hacked, and $81 million was stolen from the central bank of Bangladesh’s US dollar account at the New York Federal Reserve.

The finger was immediately pointed at North Korea.

So now western governments, including the United States and the UK, have sprung into action to defend the financial system against North Korean hackers.

Work has already begun on more obtuse banking regulations and procedures that will force you to jump through bizarre hoops in order to prove that you’re not a nefarious North Korean hacker.

This is so typical. Years ago they made people afraid of men in caves ‘who hate us for our freedom’. Then they proceeded to dismantle many of those freedoms in order to protect us.

It’s the same cycle, only they’ve created a new enemy for us to fear: the North Korean hacker.

And now, in order to protect us from the new boogeyman of the week, they have to create new rules and dismantle more financial freedom.

All of this nonsense is based on the supposed technological prowess of North Korea.

Yet just a few days ago North Korea had a failed missile launch attempt that was so screwed up it was almost comical. This, after four other failed missile attempts last month.

Oh yeah, and these guys are such network security experts that an 18-year old kid from Scotland was able to hack North Korean servers in just minutes.

How’d he do it? By correctly guessing the server login information—username: “admin”, and password: “password”.

Yes, you read that correctly. This crack squad of North Korean hackers used “password” as their server password.

So we’re supposed to believe that these guys are the guys that hacked $81 million out of the Federal Reserve system?

Either they’re fabricating this stuff entirely to justify restricting our freedoms even further, or government incompetence truly has reached an all-time low.

Both ways, a healthy bit of skepticism is in order.

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[Editor’s note: This letter was penned by Tim Price, London-based wealth manager and author of Price Value International.]

JW: “..Someone like Neil Woodford, star investor, who set up his own fund; he says the fundamentals of the economy will be unmoved [by Brexit] either way..
RA: “Well I’m afraid that every, every serious economic forecaster would not agree with that..”
JW: “Are you saying he’s not serious?”
RA: “Not for economic forecasts, clearly.”
JW: “He’s an investor on behalf of pensioners.”
RA: “I’m talking about every major economic forecaster. A weaker economy means lower wages, lower profits, lower dividends, lower investment returns and lower pension contributions as well as lower pension fund investments. This isn’t some kind of conspiracy, this is consensus here… What do pensioners want more than anything else? They want certainty.”

– Today presenter Justin Webb discussing Brexit pensionocalypse with Baroness Ros Altmann, 27 May 2016.

Carve-up, n. “An act or instance of dishonestly prearranging the result of a competition.”

Just two hours before it was barred from issuing any more fatuous propaganda about Brexit, the UK Treasury last week managed to surpass themselves. They warned that if the UK left the EU, the hit to each individual British pensioner would amount to £137 per year. Those with an additional pension pot worth £60,000 would apparently be worse off to the tune of £1,900. (The “forecasts” arrived conveniently alongside news that net migration into the UK had risen to a third of a million people in 2015.)

Economist (UCL, LSE) and pensions minister Ros Altmann was duly wheeled out to defend this nonsense. The interview on Radio 4’s Today programme was entertaining, if nothing else. Memo to Planet Altmann: pensioners may want certainty, but they’re not going to get it, in or out, no matter how confident you are in the “forecasts” of economics bodies like the IFS, the OECD, the NISR [National Institute of Statistics Rwanda?], the IMF, the Bank of England, the LSE.. Just when you thought it was impossible for the fractious Brexit debate to plumb new depths, Ros Altmann got her spade out. Rubbishing fund manager Neil Woodford because he doesn’t happen to swallow the government line about Brexit triggering economic and financial market meltdown is simply ridiculous. The phrase “credible economic forecasts” carries as much intellectual weight as phrases like “military intelligence”. The British economist Joan Robinson was surely right when she observed that

The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.

Modern economics has a long and inglorious history of believing its own PR.

Conventional (neo-Keynesian) economics is a bastard science. It is not, in fact, a science at all. When the Frenchman Léon Walras, who had serially failed at every job to which he had previously turned his hand, walked with his father one evening in 1858, he was advised by Walras Sr. to have a crack at “the creation of a scientific theory of economics”.

Walras Jr. had previously botched careers in academia, engineering, creative writing, journalism, and banking. That he had been rejected, twice, from France’s prestigious Ecole Polytechnique due to poor mathematical skills tells you everything you need to know about the birth of modern economics.

But Walras Jr. did not give up. Rather, he flunked again. Before Walras, economics had not even been a mathematical field. Eric Beinhocker in ‘The Origin of Wealth’ takes up the story:

Walras and his compatriots were convinced that if the equations of differential calculus could capture the motions of planets and atoms in the universe, these same mathematical techniques could also capture the motion of human minds in the economy.

In other words, Walras hijacked a bunch of principles from the realm of physics and then misapplied them to a grotesquely oversimplified model of his own economy. Modern economics, in other words, was born out of physics envy.

Walras was not alone. Beinhocker points out that he was “not the only economist during his era raiding physics textbooks in search of inspiration”; the British economist William Stanley Jevons is also cited for ‘borrowing’ from the theories of gravity, magnetism and electricity in an attempt to turn economics into a mathematical science.

It isn’t, and never can be.

We have involved ourselves in a colossal muddle,

wrote the British economist John Maynard Keynes in his essay ‘The Great Slump of 1930’;

..having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps for a long time.

Keynes was right to warn about the baleful prospects for wealth. The Great Depression would run on for the best part of a decade.

But words matter, and their meanings matter. Keynes’ metaphor of economy-as-machine is not just inaccurate, it’s inappropriate. The economy is not some simple machine that can be driven back to equilibrium (an illusory state that doesn’t even exist in the real economy). The economy is as complex as human nature because the economy is human interaction on a global scale. The economy is us. And by extension, the financial markets are us, too.

Keynes would be proven right about the slump in wealth. But the ‘economy as a machine’ metaphor is invalid, just as Walrasian economics is invalid. The great insight of the so-called Austrian or Classical economic school, inspired by the likes of Ludwig von Mises and Friedrich Hayek, is that the economy is far too complex to be compared to a simple mechanism. The economy is subject to all of the hopes, fears, frailties and illogicalities of human beings. Good luck modelling that.

Not that it has stopped economists from trying.

A key prediction of traditional economics, for example, is that the economy as a whole must at some point reach equilibrium – a prediction made by both the general equilibrium theory of microeconomics as well as by standard macroeconomics. So how long does it take for the economy to reach that equilibrium?

In the 1970s, the Yale economist Herbert Scarf determined that the time to equilibrium scales exponentially with the number of products and services in the economy to the power of four. The intuition behind this relationship is straightforward: the more products and services, the longer it takes for all the prices and quantities to adjust.. if we optimistically assume that every decision in the economy is made at the speed of the world’s fastest supercomputer (currently IBM’s Blue Gene, at 70.72 trillion floating-point calculations per second), then using Scarf’s result, it would take a mere 4.5 quintillion years (4.5 x 1018) for the economy to reach general equilibrium after each exogenous shock. Given that shocks from factors such as technological change, political uncertainty, weather and changes in consumer tastes buffet the economy every second, and the universe is only about 12 billion years old (1.2 x 1010), this clearly presents a problem.

The essential problem of traditional economics is that it assumes a largely closed system of, in Eric Beinhocker’s words, incredibly smart people in unbelievably simple worlds. The reality, as objective non-economist modern commentators tend to agree, is that the economy is closer to being a complex, adaptive, dynamic system – not unlike a living organic being, vulnerable to illnesses and other sudden exogenous outbreaks.

The yin to Keynes’ yang is the great Austrian economist Ludwig von Mises. As part of his magnum opus, ‘Human Action’, Mises wrote about the impossibility of economic calculation in the centrally planned economy:

The paradox of “planning” is that it cannot plan, because of the absence of economic calculation. What is called a planned economy is no economy at all. It is just a system of groping about in the dark. There is no question of a rational choice of means for the best possible attainment of the ultimate ends sought. What is called conscious planning is precisely the elimination of conscious purposive action…

The mathematical economists are almost exclusively intent upon the study of what they call economic equilibrium and the static state. Recourse to the imaginary construction of an evenly rotating economy is, as has been pointed out, an indispensable mental tool of economic reasoning. But it is a grave mistake to consider this auxiliary tool as anything else than an imaginary construction, and to overlook the fact that it has not only no counterpart in reality, but cannot even be thought through consistently to its ultimate logical consequences. The mathematical economist, blinded by the prepossession that economics must be constructed according to the pattern of Newtonian mechanics and is open to treatment by mathematical methods, misconstrues entirely the subject matter of his investigations. He no longer deals with human action but with a soulless mechanism mysteriously actuated by forces not open to further analysis. In the imaginary construction of the evenly rotating economy there is, of course, no room for the entrepreneurial function. Thus the mathematical economist eliminates the entrepreneur from his thought. He has no need for this mover and shaker whose never ceasing intervention prevents the imaginary system from reaching the state of perfect equilibrium and static conditions. He hates the entrepreneur as a disturbing element. The prices of the factors of production, as the mathematical economist sees it, are determined by the intersection of two curves, not by human action.

Keynes was looking for a lever to move the economy. But the lever does not exist. The economy as machine does not exist. The metaphor he used is not grounded in objective reality.

We do not know precisely what might happen if the UK were to vote to leave the EU. It is intellectually and morally unacceptable for economists to pretend that they do.

Notwithstanding Ros Altmann’s hypothetical pensioners and the hypothetical behaviour of post-Brexit financial markets, doubt may be uncomfortable, but certainty is absurd. The tone and content of the Brexit debate, thus far, has been a disgrace – and the economists are amongst the guiltiest parties.

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