The Austrian Way: When will the financial system collapse upon itself?

Those of an Austrian economic mindset find the construction of today’s financial system unfit for purpose, flawed and guaranteed to eventual failure.

You know, all that fiat money stuff, bubble economics, 30 times leveraged investment banks, global debt proliferation, proto-Keynesian print-print-and-hope economic management et cetera. If you’re thinking this way, you’ll likely see the thing as the biggest experiment in money ever conducted, a giant Ponzi scheme and maybe the largest rent-seeking apparatus you’ve ever understood.

Whilst systems based on confidence – and bubbles for that matter – take a long time to build, with lots of reflexive reinforcement needed along the way (if you’re a fellow Soros fan), they can disappear in the blink of an eye. You might think of a growing balloon in search for its eventual meeting with a sharp and problematic pin.

As a result lots of goldbugs, perma-bears, considered structural bears, monetary thinkers and Bogpaper oddballs seek to position themselves and their capital accordingly, in mind of the some-day arrival of the pin.

However, this allocation of our time, energy and capital isn’t an easy one to get right.

The long lives of sup-optimal and flawed systems

Even when nations, bubbles and bond markets are built upon nothing it can take decades for the final reckoning to arrive and everything to unravel.

Tim Price of MoneyWeek was reminding us the other day of the Soviet Union.

The USSR lasted many, many decades longer than it should have done. It was riddled with bad economics, rent-seeking and contradictions, but it outlasted the predictions of many smart thinkers by 80 years.

Being early in investment can be as bad as being wrong.

Mike Burry, John Paulson and a few other visionary or lucky investors had to wait years for their credit default swaps to pay out on the eventual busting of the sub-prime bubble. Even though their positions where highly asymmetric and efficient to finance, their investors felt the pain, called for explanations and often nearly withdrew their capital from these fund managers as a result. You might also argue these money runners also depended upon their investment bank counterparties and their prime-brokerage departments honouring their contracts too!

Being a big short on today’s Bretton Woods II financial system is an aggressive stance and one that has risk. A few doyens of the gold markets are calling for a balloon pop between 2014-2015, but accurate prediction of things is highly difficult.

What the hell to do?

Chuck Prince, ex-CEO of Citi, said that ‘whilst the music is playing, we’ll keeping dancing’, and his meaning here has relevance for us all.

Whilst the system lasts, being wholly short, only allocated to gold, guns and whisky or whatever, means you miss out from new housing bubbles and other rising tides.

Smart fund managers like Kyle Bass and the aforementioned Soros do have some gold and a range of other carefully thought out hedges, but whilst the music is still playing they also have lots of other equities, bonds and other more Bernanke-loved investments.

It is possible to play both games at once, to keep riding the Western obsessions of property and financially-engineered stock broker favourites, whilst also having your financial crisis insurance at the ready.

It’s about surviving and making money

Whilst the system might be wrong, ill-conceived, selfish and inequitable, it is what it is and might last much long than we think too.

The UK has just reported pretty impressive new growth in its property market, with rising house prices, much improved bank-lending and warming levels of re-financing. As a structural bear I wonder if the BoE and its partner central banks are succeeding in re-inflating a new property bubble to keep our finance, insurance and real estate (FIRE) dependent economies ticking along.

Bernake et al have declared war on savers, gone on all in on flawed economic notions and are going to do whatever they can to keep their plan for things alive.

I firmly believe that in the long run Austrian ideas will win out and that Greenspan, Bernanke, Krugman, Eichengren et al will be fully exposed as utterly wrong-headed. But how long do we have to wait?

Being too short brings risk, volatility and difficult periods – like the last 18 months for gold and silver prices.

What’s your hedge then pal?

I spend my life aggressively allocating my energy, time and capital to benefit from a future great wealth redistribution, monetary reset or crack up boom, but this isn’t the right thing for many others. The young, free and normally solvent can swing for balls others might want to leave alone.

This all makes me think of the most sensible investment allocation ever recommended (IMHO) – where Swiss bankers for centuries urged their wealthy clients to lay the solid foundations of their wealth with 10 per cent in gold. I have since read interesting studies where academics and traders have suggested that just £10,000 in gold can act as an effective hedge for up to £250,000 other, more traditional assets.

Having 10 per cent in gold is like being partially short, but mostly long today’s system. A greater allocation to such hedges is more aggressive, whilst a lower one is the opposite.

We don’t know this system will end. We can see the players in this most fast-paced of global currency wars building their hands. Fellow Austrians might mostly see a final reckoning, but knowing when and positioning yourself accordingly continues to be a most tricky task.

How do you stack your chips?

  • Maneno

    What kind of gold – bullion; mining shares; other ?

    Why not agricultural land or housing ?

    Liquidity shouldn’t be an issue if you really believe its long term should it ?

    • http://gravatar.com/theaustrianway The Austrian Way

      Hi Maneno,

      The recommendation I’d read of many times was allocated bullion, generally held in Swiss vaults. I’ve heard Singapore is now more popular than Swtizerland for bullion, as the city state is better at respecting the privacy and property rights of investors.

      Agriculture and land are also good options, I simply hadn’t gone further than the bottom 10% allocation here.

      With your point about liquidity – do you mean that there should be no liquidity issues with gold? If so, I’d agree. I note some monetary analysts holding the opinion that you will not sell your gold at the end of this bull market, but ‘spend it’ instead.

  • Baron

    You quite right, the fundamentals point to an eventual collapse, but then, what was it we all are supposed to be in the long run?

    The shorting using gold cannot work unless one assumes just a transient implosion of the financial system. Anything more serious and gold becomes almost a hindrance. If others discover you have it they may strip you of it if they have a better gun than you.

    To guess what one should be in for the eventual Armageddon is a fool’s game. What seems certain is that it wouldn’t take more than a week of hunger for the West to morph from civilisation to barbarism.

    • http://gravatar.com/theaustrianway The Austrian Way

      Hi Baron,

      Thanks for reading and for the comment. I’m agreed with you on the prediction point – it’s impossible, like trying to guess when an avalanche will happen.

      On the gold, guns, food point – I’m also in generally agreement. Gold is just part of it and there are other excellent assets to hold. I have met a surprising number of old, now retired traders who were independents on the floor of exchanges etc, who quite often tell me of their back-up plan of a farm in NZ, Canada, Chile etc!

      All that we can do is find some form of mixed allocation that offers us portfolio performance at different points in various cycles. The Permanent Portfolio by Harry Brown is an interesting concept here and I find Jim Rogers about the best macro thinker for achieving such things as well.

  • Michael

    What’s the best strategy?

    1) Get out of debt. For most, this means paying off the mortgage.
    2) See above and if you are not in debt, don’t go into debt even if it means you may miss out on the latest “housing boom”. So what, all the easy gains have been made, why cause yourself extra anxiety trying to chase another 10% when your downside risk is so high.
    3) Once out of debt, save 3 months of living expenses in fiat across several banks. Also, always have worth having 2 weeks of cash on hand stashed somewhere.
    4) Get yourself some PMs. 10 ounces of gold would put you in the top 0.1% of gold owners worldwide. If you’re a bit more adventurous, Silver & Platinum have some merits but due to their industrial uses, they won’t be remonetised but could provide some spectacular gains in the interim.
    5) Play the markets. The Jim Rogers strategy is best and be prepared to keep your powder dry for long periods if there is no value in the markets but when you spot value, go all in (his book Investment Biker is GREAT read for insights and ideas). 2009 presented a brilliant opportunity to buy but at this stage, you want to be out waiting. The Central Banks will not stop their stimulus so the “price” of the markets may or may not crash but there is little value.

    Pensions is a tough one – in the end they’ll almost certainly all be confiscated “for your own good” but it is hard to turn down a one for one employer match. The Partner contributes, I don’t – it’s horses for courses and probably dependent on age. I’d also highly recommend getting out the cities. The cities will not be anything like the blitz if/when Armageddon does arrive and if the worst comes to worst, 50+ years of the welfare state & mass immigration have destroyed the social glues that hold us together.

    Wake up others and get people voting for parties that can at least identify our predicament. If I hear the effin Tories talk about austerity while borrowing £120 billion p.a. my head will explode. As we are so far down the abyss, the election of UKIP will not stop the collapse but at least it can start a honest national conversation about why we’ve sunk so low and how we can pick ourselves up.

    Finally enjoy life – whether you “stack” or play the “ponzi” (which I still do to an extent) doesn’t really matter. All that matters is to keep on keeping on. The greatest theft that anyone can take away from you isn’t money, it’s time. Time spent loving your wife, your kids, your family. The smell of a terrific autumns morning when summer is trying to hold on. A Sunday afternoon watching cricket. A Ramble in the countryside. So that’s what I do during the time I am preparing. If Armageddon does arrive, I get my shot as seeing a few more days on the planet with a great base to rebuild from. If it doesn’t I haven’t wasted my time and I’m still doing OK. People forget why we are all here.

    • http://gravatar.com/theaustrianway The Austrian Way

      If there was an award for best comment, you’d get it Michael!

      I couldn’t agree more with the sentiments. A little study of monetary history shows you the tides we move in – after that all we can do is enjoy the ride, not over-think ourselves into anxiety racked states and use our precious time to the maximum. Beautifully put by you Sir!

      • Michael

        Thanks Austrian – you know you’ve come full circle when you start differentiating your monetary savings between “fiat” and precious metals. It’s a tough journey to make but one well worth making. I did nothing but read and school myself up for a good 3 months after watching a “money-as-debt” video – really understanding the Austrian school was like removing all the fog from the window screen and being able to see clearly the road ahead (and the road travelled). Everything just made sense . Emotions of shock/fear/anger we’re common early on once you realise that the only outcome of this massive experiment is the mother of all depressions or as Mises put it “a final and total catastrophe of the currency system”.

        Once you have that knowledge though, it is great to be able to cut through the smoke and mirrors of the MSM and be pro-active. Prepare, educate, inform and most of all, enjoy life. On that note, it’s time for a pint!

  • http://unplugthehftbots.com BigSimes

    I too have been wondering how much hedging for the financial Armageddon is required. $10k worth of gold is good. My avenue are small cap gold explorers and producers – if Fiscal Fisting Armageddon slams down, their share prices should rocket up. But if the world goes Mad Max, I’ll know I should have allocated 10k to a personal weapons stash and bitchin’ V8.