Currency Du Jour & De Rigueur: It’s Still Rock And Roll To Me by Kopernik Global Investors
“What’s the matter with the clothes I’m wearing? “Can’t you tell that your tie’s too wide?” Maybe I should buy some old tab collars? “Welcome back to the age of jive. Where have you been hidin’ out lately, honey? You can’t dress trashy till you spend a lot of money.” Everybody’s talkin’ ’bout the new sound Funny, but it’s still rock and roll to me” -Billy Joel
Equities are aggressively priced. Bond prices are obscene. But we are told not to worry because we live in a low-risk, high-potential world. Omnipotent central bankers have the financial-markets’ backs, Neo-Keynesian politicians have eliminated the business cycle and will provide for all, the mapping of the genome and biotech industry in general will eliminate disease while creating untold jobs and wealth, robotics will replace menial jobs with material wealth, and commodities will be forever in oversupply. While we believe that Keynesianism and monetarism are in the process of earning their just notoriety for posterity, we are big fans of technological progress, but believe ‘twas ever thus.’ Progress is often erroneously used to justify dangerous securities price levels. We agree with Mr. Joel:
“It’s the next phase, new wave, dance craze, anyways It’s still rock and roll to me”
This Commentary is about cyclicality, a seemingly forgotten phenomenon. And yet, it is such an inescapable part of nature. This note appears to be timely; as we go to press, “Bloomberg reports momentum stocks, or shares with the most price appreciation in the last 2-12 months, are rising three times as fast as the S&P 500 this year, on par with the best years ever recorded.” That’s right, people are buying things because they have gone up a lot and selling things because they have gone down a lot! Trendiness is at near record levels in the marketplace! This is truly a market with an extraordinarily high level of peril and of opportunity. Before getting to a discussion of business cycles and market cycles, it makes sense to start with the most fickle and ruthless of all – the fashion cycle. Whether it be clothes, entertainment or currencies, tastes are unpredictable and ever changing. One day Nehru jackets are hip, later they’re the object of jokes. Blue jeans are in, then out, then in. Hemlines go up and down, some say with the stock market (there is a hemline index). Following fashion has become an industry unto itself.
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“Dirty little secrets Dirty little lies We got our dirty little fingers In everybody’s pie We love to cut you down to size We love dirty laundry” -The Fed Don Henley
With Don Henley’s help, we transition from the type of cloth that covers people, to the type of cloth that covers financial obligations, ‘legal tender.’ In the modern, designer crazy world, nothing seems to be more “de rigueur” than fiat currencies. And the U.S. dollar is the currency du jour! The left-handed compliment, “it’s the cleanest dirty shirt in the hamper!” is often bantered about in tones suggesting the highest praise. In fact, the dollar should require much more legitimate accolades to justify the lofty heights to which it has risen. At any rate, it’s hard not to recall Hans Christian Andersen’s famous parable, “The Emperor’s New Clothes.” Here’s a slightly doctored version of the ending:
So off went the Emperor in procession under his splendid canopy. Everyone in the streets and the windows said (In comparison to all the others), “Oh how relatively clean is the Emperor’s dirty shirt.” Nobody would confess that he couldn’t see any shirt at all, for that would prove him either unfit for academia, or a fool. No costume the Emperor had ever worn before was ever such a complete success.
“But he hasn’t got anything on!” a little child said.
“Did you ever hear such innocent prattle?” said its father. And one person whispered to another what the child had said, “He hasn’t anything on. A child says he hasn’t got anything on.”
“But he hasn’t got anything on!” the whole town cried out at last.
The Emperor shivered for he suspected they were right. But he thought, “This procession has got to go on.” So he walked more proudly than ever, as his nobleman held high the train that wasn’t there at all.
The story is apropos. The quantity of dollars has quintupled in recent years and yet we are told that it has lost no soundness and is perfectly safe. We are told to disregard the prices of tuition, healthcare, collectibles, stocks, bonds, housing, and art in deference to the CPI index that the government publishes. As our namesake, Copernicus, always did, we employ our own analysis. Exhibit number one, the data in the following table, addresses how “clean” the financials are that adorn the sovereigns of the contemporary era:
Glancing at the chart, several facts jump out. None of the “shirts” are clean. Maybe new Fab, with action enzymes, lemon-freshened borax, would help. And, in comparison to its hamper-mates, we’ll leave it to the reader to decide if the U.S. Dollar looks cleaner, the same, or dirtier. Or, perhaps the above chart details the apparel at a nudist camp. That being as it may, the world’s investment fashionistas, who had such contempt for the dollar four years ago, now effectively rave that it is “to die for.” Fashion being what it is, this will probably turn out to be a poor time to build a large inventory of greenbacks. “Green” could become “so yesterday.”
It appears that the dollar is overly esteemed, even before exploring the interesting topics of whether the U.S. has gone too far in its abuse of privilege regarding reserve currency status, whether the petro-dollar is under attack, or the possibility of the Yuan, the Euro, or SDRs (Special Drawing Rights) becoming reasonable alternates. The fashion cycle that we find most interesting, and of longer duration, does not pertain to the trendiness of one fiat currency versus another, but to the length of time that the public finds baseless money to be chic. It appears that credulity is also cyclical. Hans Christian Andersen’s tale, reprinted below using significant artistic license, continues to be a useful metaphor for the current tragedy that is central banking (feel free to skip the next few pages, we’re looking for humor in the current situation):
Many years ago there was an Emperor so exceedingly fond of “guns and butter,” as a previous Emperor had been a half-century prior. He spent all his money on both social programs and on policing the world. In the great city where he lived, life was always gay. Every day many strangers came to town, and among them one day came swindlers. They let it be known they were weavers, and they said they could weave the most magnificent fabrics imaginable and pass it off as money. Not only were their colors and patterns uncommonly fine, but currency made of this cloth had intrinsic value that was invisible to anyone who was unfit for his office, or who was unusually stupid.
“That would be just the currency for me,” thought the Emperor. “If I print it, I would be able to discover which men in my empire are unfit for their posts. And I could tell the wise men from the fools. Yes, I certainly must get some of the currency woven for me right away.” He paid the two swindlers a large sum of money and put them in charge of the central bank.
They set up two printing presses and began to print, though there was no substance backing what they printed. All the finest gold which they demanded went into their traveling bags, while they printed baseless chit far into the night.
“I’d like to know how these bankers are creating this value,” the Emperor thought, but he felt slightly uncomfortable when he remembered that those who were unfit for their position would not be able to see the value. It couldn’t have been that he doubted himself, yet he thought he’d rather send someone else to see how things were going. The whole town knew about the central bank’s power, and all were impatient to find out how stupid their neighbors were.
“I’ll send my Nobel prize winning academics,” the Emperor decided. “They’ll be the best ones to tell me how the economics work, for they are accomplished men and no one articulates their view better.”
So the acclaimed economists went to the Fed, where the swindlers sat working away at their baseless money.
“Heaven help us,” they thought as their eyes flew wide open, “we can’t see any value at all”. But they did not say so.
The swindlers begged them to be so kind as to come near to approve their excellent theories and beautiful programs. They pointed to the debt-based backing, and the poor old economists stared as hard as they dared. They couldn’t see anything of intrinsic worth, because there was none to see. “Heaven have mercy,” they thought. “Can it be that we’re fools? We’d have never guessed it, and not a soul must know. Are we unfit to be professors? It would never do to let on that we can’t see the value.”
“Don’t hesitate to tell us what you think of it,” said one of the Reserve Board Members.
“Oh, it’s beautiful – it’s enchanting.” The old economists peered past their gray beards. “Such a pattern, what spin! We’ll be sure to tell the Emperor how delighted we are with it.”
“We’re pleased to hear that,” the swindlers said. They proceeded to name all their strategies such as “quantitative easing” and “operation twist” and to explain the intricate patterns. The old professors paid the closest attention, so that they could tell it all to the Emperor. And so they did.
The swindlers at once asked for more money, more silk and gold thread, to get on with their printing. But, as Gresham’s Law predicted centuries before, all the gold went into their own pockets, and also was purchased by central bankers afar. Not an ounce of gold went into the economy, though they conjured new money as fast as ever. (Interestingly enough, our namesake Copernicus predated Gresham in predicting that undervalued money will disappear from circulation while overvalued money will flood into circulation.)
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