Sunday, November 18, 2012

From the Man Who Bought One Million Dollars of Nickels

Kyle Bass of Kayman Capital Management is out with his most recent letter to investors in his hedge fund. Below are some of the key highlight,  as assembled by Zero Hedge, from the  letter. Of note, he hurls a grenade at Modern Monetary Theory (MMT) . He states, correctly, that fallacies such as MMT  are "leading the sheep to slaughter."

On central banks and the final round of global monetary debasement:
Central bankers are feverishly attempting to create their own new world: a utopia in which debts are never restructured, and there are no consequences for fiscal profligacy, i.e. no atonement for prior sins. They have created Potemkin villages on a Jurassic scale. The sum total of the volatility they are attempting to suppress will be less than the eventual volatility encountered when their schemes stop working. Most refer to comments like this as heresy against the orthodoxy of economic thought. We have a hard time understanding how the current situation ends any way other than a massive loss of wealth and purchasing power through default, inflation or both.

In the Keynesian bible (The General Theory of Employment, Interest and Money), there is a very interesting tidbit of Keynes’ conscience in the last chapter titled “Concluding Notes” from page 376:

[I]t would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital.

. . .
Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus[.] (emphasis added)
This is nothing more than a chilling prescription for the destruction of wealth through the dilution of capital by monetary authorities.

Central banks have become the great enablers of fiscal profligacy. They have removed the proverbial policemen from the bond market highway. If central banks purchase the entirety of incremental bond issuance used to finance fiscal deficits, the checks and balances of “normal” market interest rates are obscured or even eliminated altogether. This market phenomenon does nothing to encourage the body politic to take their foot off the spending accelerator. It is both our primary fear and unfortunately our prediction that this quixotic path of spending and printing will continue ad?infinitum until real cost?push inflation manifests itself. We won’t get into the MV=PQ argument here as the reality of the situation is the fact that the V is the “solve?for” variable, which is at best a concurrent or lagging indicator. Given the enormity of the existing government debt stock, it will not be possible to control the very inflation that the market is currently hoping for. As each 100 basis points in cost of capital costs the US federal government over $150 billion, the US simply cannot afford for another Paul Volcker to raise rates and contain inflation once it begins.
Hayek was, of course, right:
The current modus operandi by central banks and sovereign governments threatens to take us down Friedrich von Hayek's “Road to Serfdom”. Published in 1944, its message, that all forms of socialism and economic planning lead inescapably to tyranny, might prove to have been prescient. In the 1970s, when Keynesianism was brought to crisis, politicians were vociferously declaring that attempting to maintain employment through inflationary means would inevitably destroy the market economy and replace it with a communist or some other totalitarian system which is the “perilous road” to be avoided “at any price". The genius in the book was the argument that serfdom would not be brought about by evil men like Stalin or Hitler, but by the cumulative effect of the wishes and actions of good men and women, each of whose interventions could be easily justified by immediate needs. We advocate social liberalism, but we also need to get there through fiscal responsibility. Pushing for inflation at this moment in time will wreak havoc on those countries whose cumulative debt stocks represent multiples of central government tax revenue.

The non?linearity of expenses versus revenues is what will bring them down.
"Pavlov's Party" is ending, and when it does, it will happen so fast no reaction will be possible:
Through travel and meetings around the world, it has become clear to us that most investors possess a heavily anchored bias that has been engrained in their belief systems mostly through inductive reasoning. Using one of the Nobel Laureate Daniel Khaneman's theories, participants fall under an availability heuristic whereby they are able to process information using only variables that are products of recent data sets or events. Let’s face it – the brevity of financial memory is shorter than the half?life of a Japanese finance minister.

Humans are optimistic by nature. People’s lives are driven by hopes and dreams which are all second derivatives of their innate optimism. Humans also suffer from optimistic biases driven by the first inalienable right of human nature which is self?preservation. It is this reflex mechanism in our cognitive pathways that makes difficult situations hard to reflect and opine on. These biases are extended to economic choices and events. The fact that developed nation sovereign defaults don’t advance anyone’s self?interest makes the logical outcome so difficult to accept. The inherent negativity associated with sovereign defaults brings us to such difficult (but logical) conclusions that it is widely thought that the powers that be cannot and will not allow it to happen. The primary difficulty with this train of thought is the bias that most investors have for the baseline facts: they tend to believe that the central bankers, politicians, and other governmental agencies are omnipotent due to their success in averting a financial meltdown in 2009.

The overarching belief is that there will always be someone or something there to act as the safety net. The safety nets worked so well recently that investors now trust they will be underneath them adinfinitum. Markets and economists alike now believe that quantitative easing (“QE”) will always “work” by flooding the market with relatively costless capital. When the only tool a central bank possesses is a hammer, everything looks like a nail. In our opinion, QE just doesn’t stimulate private credit demand and consumption in an economy where total credit market debt to GDP already  exceeds 300%. The UK is the poster child for the abject failure of QE. The Bank of England has purchased over 27% of gross government debt (vs. 12% in the US). UK bond yields have all but gone negative and are now negative in real terms by at least ?1%. Unlimited QE and the zero lower bound (“ZLB”) are likely to bankrupt pension funds whose expected returns happen to be a good 600 basis points (or more) higher than the 10?year “risk?free” rate. The ZLB has many unintended consequences that are impossible to ignore.

Despite reading through Keynes’ works, we didn’t find a single index referencing the ZLB or any similar concept. In his General Theory, there are 64 entries in the index under “Interest” but no entry for the ZLB, zero rates, or even “really low rates”.

Our belief is that markets will eventually take these matters out of the hands of the central bankers. These events will happen with such rapidity that policy makers won’t be able to react fast enough.
On the lunacy of such "modern" "economic" "theories" as MMT (which may or may not stand for "Magic Money Trees")
The fallacy of the belief that countries that print their own currency are immune to sovereign crisis will be disproven in the coming months and years. Those that treat this belief as axiomatic will most likely be the biggest losers. A handful of investors and asset managers have recently discussed an emerging school of thought, which postulates that countries, as the sole manufacturer of their currency, can never become insolvent, and in this sense, governments are not dependent on credit markets to remain fiscally operationalIt is precisely this line of thinking which will ultimately lead the sheep to slaughter.
The inevitable end of that supremely flawed monetarist experiment - the Eurozone:
Each subsequent “save” of the European debt crisis has been devised by the Eurocrats coming up with some new amalgamation of an entity that is more complex than its predecessor that is designed to project size, strength, and confidence to investors that the problem has been solved. Raoul, a friend of mine who resides in Spain, put it best:

“Let’s just clear this up again. The ECB is going to buy bonds of bankrupt banks just so the banks can buy more bonds from bankrupt governments. Meanwhile, just to prop this up the ESM will borrow money from bankrupt governments to buy the very bonds of those bankrupt governments.”

The EFSF, the IMF, the ESM, and the OMT (and who knows what other vehicles they will dream up next) have all been developed to serve as an optical backstop for investors globally. The Eurocrats are sticking with the Merkelavellian playbook of hiding behind the complexity of these various schemes. All one has to do is review the required contributions to said vehicles from bankrupt nations to realize that the circular references are already beginning to show in broad daylight. Does anyone stop to consider that the two largest contributors to the IMF are the two largest debtor nations in the world? Are things beginning to make sense now?


In the end, the EMU won't look the same, if it exists at all.
And finally, a less than rosy outlook for the entire "developed" world.
Trillions of dollars of debts will be restructured and millions of financially prudent savers will lose large percentages of their real purchasing power at exactly the wrong time in their lives. Again, the world will not end, but the social fabric of the profligate nations will be stretched and in some cases torn. Sadly, looking back through economic history, all too often war is the manifestation of simple economic entropy played to its logical conclusionWe believe that war is an inevitable consequence of the current global economic situation.

The entire letter is here:

Kyle Bass


  1. The scariest part (besides WW3) is the fact that the breakdown will come like a thief in the night, and anyone not prepared will be in big trouble.

    The vast majority of people have no idea how fragile and tenuous our financial system is, and how quickly it could fall apart.

  2. Over the course of the next few years the question will change from "Who is John Galt?" to "Where is Galt's Gulch?"

  3. Bass has it right, the timing is the unknown. Also unknown is if war does occur the impact. If the war goes ultra hot, as in WW and use of NBC could be a global game changer. The present system in the U.S. will not last. Washington D.C. is corrupt, it has over promised, it has built a system based on phony money and phony premises. The recent corruption seen in the Petraeus scandal is an obvious example of how far the system has fallen. Billions are wasted on "Homeland Security" "The Global War On Terrorism" which in reality are grotesque money transfers. No small wonder it has infected the military top brass.

    So buckle up, the roller coaster is cresting near the top and ready for the ride down.

  4. MMT has exploded all over the ceiling. In a video that must be seen, Mike Norman attacks Lauren Lyster of "Capital Account" for agreeing that the precious metal money supply is determined by mother nature plus supply and demand. Watch the whole thing. It is truly worth it.

    "Capital Account" producer Demetri Kofinas then came to Lyster's defense with a post that was originally deleted by Norman:

    Mike DID delete a substantial post of mine. He probably also deleted it from the youtube video. How pathetic. I knew he would do that, which is why I have saved it, and am reposting it in this thread. Mike, are you for real? You make a video calling my host a bimbo who uses her legs and cleavage to get views, like a complete misogynist, and then you delete a thoughtful response to your vicious attacks? Here is the post. I'm sure you will run and delete it again:


    Your video is void of any class, and your comment that "Lauren doesn't invite [you] on" is false. Lauren and I BOTH invite you on. I wouldn't have you on the show if Lauren didn't want you there. So let's make that clear.

    Second, Lauren is not a hard money austrian, nor is she a voodoo MMT ideologue. She isn't a Keynesian and she isn't a Monetarist. She isn't a neoclassicist or a neoricardian. She is a television host for a financial news show, and a DAMN GOOD ONE at that. Contrary to your sexist and misogynist comments, our show is popular and gets hits exactly because Lauren is smart and articulate, which kind of makes sense if you give it a little thought...

    Lastly, you are MORE THAN WELCOME back on the show. Whether you want to appear on a show where you resorted to calling the host a bimbo on a home video of yours is up to you.

    You and I have had conversations before, and you know that I not only disagree with your brand of central planning, but I find it nonsensical, and so does our audience. Still, you attempt to erect straw men and then proceed to huff and puff and blow them down for your own personal aggrandizement. You know very well that Lauren doesn't think that "money comes from mother nature"...this is LAUGHABLE. Lauren's point, FYI, is that market forces of supply and demand for a commodity that serves the purposes of currency produce far more stable monetary outcomes than a currency which derives its demand value through the corrosive power of taxation and its supply from the decisions of a politburo of PhD's. Sorry if you don't understand why we prefer a currency whose value is determined by the market as opposed to a fiat currency, but this has ZERO to do with how our money system works. I know that you are enamored with MMT and its grounding in the current money system, but you fail to grasp, time and again, that Lauren and I are not arguing the mechanics. We are arguing the system itself. I, at least, think that a fiat money system where people like yourself can say "run trillion dollar deficits unto infinity until unemployment goes to zero" is the most dangerous economic idea on planet earth.

    And on a final note, you will notice that Capital Account guests like Edward Harrison and Steve Keen are not "Austrian"(whatever that means) and I consider them both personal friends. Incidentally, neither of them has ever called my show's host a bimbo. That probably has something to do with it.

    1. Dang, Bob. I just read through the comments on that page and just as is always the case, these people are not talking economics. They're talking something, but it certainly isn't economics, nor is it even logically consistent. However, you and I have been through these idiotic discussions with the MMTers before. This is nothing new to us.

      Unlike you, however, I've stopped banging my head against a wall trying to talk economics with these people. They don't care about economics, they only care about misguided ideology and belief. Oh, that and accounting (as if numbers on a balance sheet serve any other purpose other than a tool for calculation).

      I cannot count on all of my appendages how many times I've heard the phrase "down to the penny!" come from the mouths of these people. When they can't answer a question faithfully, they instead repeat (or in the case of our old friend Mammoth, completely plagiarize) everything and anything that ever came out of Mosler's mouth or pen. And if they have their own site, such as the case with Norman, they just delete you out of existence.

      Truth and knowledge is not their goal, propaganda and disinformation is. They're kooks.

    2. Bob, take comfort in knowing that he is not only wrong, but spectacularly and fundamentally wrong, and will pay the price for his ignorance.

    3. Also, just out of curiosity, how many market calls does Norman need to get completely wrong before he losses credibility? That he *has* made so many bad calls in the past, and that people still follow him, only gives more credence to the fact that those that follow him are living in a fantasyland, far removed from not only economics, but reality itself.

    4. The sad thing is that they can point at Austiran predictions of a "crack up boom" without realizing that we never give a time frame (aka 'thymology' which was specifically discouraged by Rothbard and Mises) but simply point out that it WILL happen once The Elite run out of schemes.

    5. For the record, I'm not trying to teach MMTers anything. People just want to be resistant to learning Austrian concepts. Just cuz. There's nothing anyone can do about it. I'm simply trying to learn and anticipate what they will say under any and all circumstances.

      Did Mike Norman predict the housing bust? Check out this 2006 video:

  5. And then there is:

    Norman [to Demetri]: You're a little snot-nosed twerp, I met you in New York. You probably read one book in your life and you got yourself a little job on some Russian TV show. That makes you an expert, huh?

    And I'm still waiting for your explanation on how the Quantity Theory of Money "proves" money creation by the state equates to inflation. Milton's waiting, too.

    Demetri: MIke, you are unreal guy. Is this what you do at other networks too? Aren't you the same guy that emailed me for a job at RT and now you are hating on the network? Aren't you the same guy making passes at our talent? Unbelievable...

    I posted a short statement, to wit: "The Keynesians' War on Women", which resulted in this:

    Mike Norman said...

    You are no longer welcome here. Your comments will be summarily deleted from now on.

    FYI, others have complained to me about your remarks in the past and asked me to ban you, but I declined saying this is a free and open site.

    However, I now agree with them.

    This is so cool.

  6. One conclusion I read into this great article is the fact that we are going to zero bound returns - dividends, rents,yields - as the inflation, taxation, regulation environment so distorts the markets that investors give up and withdraw their investments from the market place. Maybe that will be the safest form of protection after all.


    1. I think that's correct. And then the Keynesians/"market" monetarists will claim that it was the "free market" that failed due to a lack of enough fiscal and/or monetary "stimulus" as the case may be.

    2. They will claim that, but thank God the Internet will provide people searching for information on WHY the world has fallen apart will have ECONOMICPOLICYJOURNAL.COM and LEWROCKWELL.COM to help them understand.

      When it comes off the rails, the Austrians will have the upper hand since we've been predicting (just as gravity) that the system was unsustainable, while people like Krugman and Norman have been totally wrong.

  7. This quote from Keynes, "Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in capital until it ceases to be scarce ...", is the source of all of our troubles. Keynes fell for the money illusion. Thus he believed that capital, which he equates with money, can be created ad infinitum by resorting to the printing press.

    The veil of money prevented Keynes from understanding that capital consists of real goods. If one considers a barter economy, this fact is clear. It is confusion over the role of money that leads to error.

    Money is a medium of exchange. Capital is composed of real goods. Thus an increase in the quantity of money cannot increase the amount of capital.

    The only way to increase capital is via savings. Refraining from current consumption, which entails low time preference, is the only option. There is no magical, painless, way to increase capital and to simultaneously continue consumption unabated.

    A failure to understand this basic fact of economics is one of the fundamental errors of Keynesianism.

    1. Great point, Augustus.

      If 10 of us were stranded on a desert island with 20 tons of gold, we would still be dead within months unless we worked. No one would care that I had 2 tons of gold (+/-60M dollars) if I couldn't fish or make nets.

      If a meteor shower of pure gold landed in every yard in the world, it wouldn't make us all richer.

  8. Mike Norman accuses Austrians of believing in the quantity theory of money.

    Then there's this thread:

    But all opponents of the Austrian School are basically just like this. We've won the debate which we prove every day because our opponents will not debate us.

    In litigation, if one side fails to mention a point of error in the trial court or upon appeal, it is deemed abandoned and that point is lost. The same should apply to opponents of the Austrian School who fail (on purpose?) to ever mention, much less engage our positions on economic [mis]calculation, Cantillon Effects, the nature of exchange, the knowledge and information function of prices, the possibility of price distortions without a general price inflation etc...

    1. FYI - I linked above to my comments on the Mike Norman site wherein I inform Mike Norman that his statement about MV=PQ containing ONLY VARIABLES! (his language) was pure Austrian School. Those comments of mine have since been deleted by Mike Norman. Kinda like Romney and the Ron Paul delegates.

      Oh well. We've won the debate and our opponents will do what they have to do.

  9. In addition to Mike Norman having lost it last week, “market” monetarist Scott Sumner also lost it recently. Anonymous poster “Major_Freedom” constantly posts excellent and thorough critiques of Sumner on Sumner’s blog and Sumner pointedly ignores everything MF says. And everything that any Austrian has ever said. But then Sumner lost it:

    MF works hard each day to prove that he’s the most tasteless, classless, moronic and petty human being every to walk on the face of the Earth. It’s just my luck that he chose to make a fool of himself on my blog.

    The debate is over. We’ve won.