Investment Capital Under Siege

Adam Hamilton    September 21, 2001    5059 Words


Just like building a majestic medieval castle, it takes a long time and a lot of hard work to build wealth.


The great castle-builders, the kings of old, had many challenges as they grew their monolithic castles.  They had to plan far ahead, had to forgo current consumption on more enjoyable pursuits, and had to somehow defend their castle building projects when invaders roared in to destroy their yet uncompleted fortresses.  While a great castle was being built, all kinds of demands and threats would rear their ugly heads in an attempt to stop progress and slay the project (and king).


The king’s subjects could revolt, demanding that the king spend more of the royal treasury to entertain and feed them rather than on castle building.  Hordes of barbarians could sweep into the kingdom and annihilate the unprotected populace that as yet had no castle to flock to for protection.  Even worse, the king’s local rivals, neighboring kings, could take advantage of the situation to derail the castle-building project through intrigue, subterfuge, or outright invasion and plunder.


Once the long odds were surmounted and the castle was finally completed, however, the king could count on far greater security.  Until the gunpowder age, large siege engines powerful enough to rapidly weaken and destroy the massive stone walls of a castle did not exist.  An opposing force would first have to invade a kingdom, camp around the castle, and prepare for a long siege that could stretch out over a decade.  While an invading army tried to starve out the king and his people, they had a huge logistical nightmare in procuring enough food and resources from the surrounding countryside to sustain a siege over the long-term.


Like the art of castle building, in accumulating wealth the lion’s share of the dangers emerge during the growth stages of a wealth building project.  The challenging process of nurturing, growing, and defending wealth is in many ways similar to the whole fascinating process of old of building a mighty castle fortress.


To build wealth, one has to prudently plan far in advance.  Present consumption of more enjoyable pursuits must be choked down dramatically, as the root of all sustainable real wealth is saving, not debt.  If one is not willing to set aside a substantial portion of current income to grow for the future, it is virtually impossible to build a fortress of wealth.  Just like the medieval kings facing all kinds of threats, both internal and external, when they were building their proud castles, an individual who seeks to build wealth also faces a difficult task.


Internal threats to wealth are legion.  People dependent on an individual investor, like families, can demand more money for current entertainment, vacations, diversions, stuff, and consumption.  Also, the investor himself faces tremendous peer pressure to “keep up with the Joneses”, living in big debt-financed houses, always driving shiny new cars, and wearing the latest hip clothing.  Similar to a king’s demanding peasants, investors seeking to build wealth face a myriad of internal threats to saving that can stop the wealth building process cold in its tracks.


Individual investors seeking to build wealth also face barbarian hordes in the form of hucksters and conmen trying to separate them from their hard-earned seed capital.  While in former times conmen were itinerant and hard to track down, today many have sprouted roots among the financial media.  These sharply-dressed hooligans have brainwashed the individual investor to such a terrible degree that rather than building wealth through hard-work, prudence, and saving, many individual investors have been deluded into believing that the markets always ascend to the heavens and make everyone rich.  Starry-eyed investors trapped in this warm and fuzzy enchantment surrender their dreams to the huckster barbarians after which they are soon destroyed and dashed upon the jagged rocks of financial reality.


The Wall Street hucksters endlessly claim that “NOW is always a good time to buy.”  They have told us ad infinitum almost every single day since the NASDAQ crash in March 2000 that “the bottom is near”.  These shameless men and women aggressively seducing capital to its doom like the mythical Sirens in a rapidly emerging mega-bear market even crossed a dark line after the terrorist tragedy to claim it was “our patriotic duty to buy stocks”.  What unmitigated gall!  No doubt many modern castle builders nurturing their small fortunes through emotional times took this dangerous advice and watched in horror this week as their “patriotism” was slaughtered on the merciless market altar.  Truly sad.


Ultimately, like the kings of old trying to build great castles, the modern investor trying to grow wealth faces his biggest threat from neighboring rivals.  In our modern world, the analogous forces are known as government.  The US government has placed investment capital under siege.


The biggest single obstacle to building a fortune is government.  Governments all throughout history share a common modus operandi, diametrically opposed to free markets and free men.  They steal wealth from the productive through taxation, give the filthy proceeds of heavy taxation to the faceless unaccountable bureaucrats who have no more understanding of finance than most six year olds, and then wastefully distribute it to the unproductive and lazy tax consumers through transfer payments in order to buy votes.  Governments punish hard work and reward slothfulness.


Taxation is the well-understood scourge of the citizen of the nation-state.  If crushing taxes and stellar levels of government spending and transfer payments could kindle prosperity, Rome would still be ruling the world.  And taxes are not the only way governments sabotage the creation of wealth.  An equally grave threat facing the investor seeking to build his wealth through these turbulent times has also existed for a long time.  The bureaucrats sheltered from the real world working in government have not surprisingly come to the false conclusion that through spending and outright market manipulation schemes it can “help” the free markets.


This fanciful notion, of course, is utter hogwash, as anyone who has ever read an economic history book knows.  Governments all throughout history attempted to manipulate markets and create endless New Eras, and every single attempt failed.  Not surprisingly, each attempt used virtually the same tools.  Governments raised taxation, increased borrowing and deficit spending, and attempted to prop up markets and the economy through the socialist Keynesian doctrines of unrestrained government spending.  Even though every single macro-attempt to pull this off in history has ended in dismal failure and enormous pain for nations, the slow-witted bureaucrats who make up government keep slamming their heads against this same wall over and over again, and the citizens suffer for it.


As the raging bear market in the United States has picked up steam in the last year, we have seen more and more blatant government attempts to manipulate all kinds of US markets.  Since the horrible terrorist atrocity, these anti-free market forces have dramatically increased their operational tempo, in effect creating very dangerous threats against those savers who seek to prudently accumulate wealth.


Unbelievably, the barbarians on Wall Street constantly seeking to liberate capital from hard-working Americans to line their own pockets loudly applaud each new market manipulation scheme.  They claim they are champions of free markets, yet they love government spending schemes, transfer payments such as government bailouts, and laws designed to prop up and artificially inflate US equity markets.  Since the terrorist strikes, the rank hypocrisy of many of the so-called free market proponents on Wall Street has become overwhelming.


The heart of government efforts to manipulate markets is nothing new.  The nexus of many of the schemes centers around America’s private central bank, the Federal Reserve.  Created in 1913 by stealth and subterfuge, the Fed was rammed through a late session of a holiday-thinned Congress right before Christmas.  Elite private bankers in America had taken lessons in wealth expropriation from their European central banking counterparts and realized they could siphon off enormous wealth from the American people if they could wrest the control of money away from the Congress.  As the coining of money was Constitutionally granted exclusively to the US Congress by our wise founding fathers, the Federal Reserve Act gift-wrapped and surrendered the incredibly important economic sovereignty of the United States to a secretive group of greedy elite private bankers.


Since 1913, the Federal Reserve has over and over again abused its enormous powers to bail out crony bankers from bad bets and has generally destroyed the value of the US dollar through rampant continuous inflation. About 15 years ago, however, the Fed began to cultivate tremendous respect amongst market players who believed in Keynesian doctrines of government manipulation of free markets.


Since 1987 or so, when a newly appointed Alan Greenspan appeared to single-handedly stare down and avert a potentially calamitous stock market crash, he and his Fed have been elevated by most market participants to godlike status.  When the Fed started indiscriminately slashing interest rates in 2001, the equity markets rejoiced and trumpeted the beginning of a new bull market in stocks.


Amazingly, only a very tiny minority of investors realize the supreme irony in the deification of the Fed.  If our free markets were burdened with communist-style command-and-control central committees that met in secret like the old Soviet Politburo and decreed the price of donuts or running shoes or automobiles, we would all roll on the ground laughing.  Pretty much everyone in the West who is not a university professor or leftist radical knows that centrally planned economies proved to be catastrophic failures in the twentieth century.  Yet, somehow, most investors seem to cling to the myth that a secretive communist-style command-and-control central committee known as the Federal Open Market Committee can magically set interest rates, the price of money, better than the free markets themselves.


Thankfully for truth and freedom, these myths of the relevancy and potency of our private central bank are rapidly being dispelled in the brutal market environment of 2001.  For the whole year even before the terrorist strikes, the Fed has proved to be as worthless in proactively managing the markets and economy as the old Soviet Politburo was in managing its vast territories.


While Greenspan and crew frantically tried to backstop long equity positions of mutual fund managers who had made poor decisions on deploying capital in overvalued stocks, the markets continued to plunge in 2001.  While Greenspan and his gang aggressively tried to hold up our increasingly shaky fractional reserve banking system and huge derivatives pyramids, debt conditions and systemic bank stress worsened.


Meanwhile, the ultra-important long government debt and foreign exchange markets merrily did whatever the heck they wanted to, making a big show out of thumbing their noses at the Federal Reserve and its command-and-control wishes.



While one-year Treasury yields where eviscerated in the “Greenspan Gambit”, crumbling almost 50% thus far in 2001 as the Fed hysterically slashed federal funds rates, the long bond yield has actually risen slightly this year.  The mighty dollar, defying all the odds, decided to rally throughout the first half of the year even as the Fed systematically destroyed the returns for investors in the gargantuan US debt markets.  The greenback has since topped and is beginning to fall rapidly.


The red one-year yields above are particularly interesting.  Maybe the Fed should rename itself to FREMA, the Federal Reserve Emergency Management Agency!  After eight short-term rate cuts, 350 basis points of interest rate reductions including three unscheduled EMERGENCY 50 basis point rate cuts, the Fed still fears for the fragile US banking system, derivatives pyramids, economy, and markets.  The Fed’s full-out assault on savers and those who rely on short-term debt investments for income has been brazen and bold.  Unfortunately, it has appeared to accomplish little outside of further impoverishing savers, who are the ultimate engines of growth for the US economy.


Saving is the root of all wealth.  As investors survey this horrendous market, they need to make crucial decisions about where to deploy their scarce capital.  After some income is saved and forms the nucleus of future wealth, the top priorities for maintaining and growing that capital are well-defined.  First, saved capital must be preserved and protected, and only then can it be enhanced and grown.  Just as a king building a castle had no hope of ever completing it if all his stones and building materials were frittered away or stolen, there is no hope of growing wealth if an investor is constantly spending or losing money.


So what is a prudent investor to do? 


The US equity markets remain grossly overvalued, with price to earnings ratios STILL at ridiculous extremes.  With the S&P 500 trading at 28.5 times earnings at the end of last month, the hyper-speculative NASDAQ 100 at 37.9 times earnings, and the venerable Dow 30 at 28.3 times earnings, the mean and vicious US equity bear is barely getting started.  Before the terrorist attack, there were still relatively few deep claw marks on the markets!  It is almost impossible to buy low and sell high to enhance wealth when virtually every popular market-darling company remains grossly overvalued by all historical and fundamental standards.  Buying overvalued stocks in a bear market is as counterproductive as slitting one’s own throat.  It is not the way to preserve and enhance capital.


The second obvious option is to buy bonds.  Traditionally, bond investors, also known as creditors or savers, have enjoyed the relative safety and small but predictable returns of the debt markets compared to the speculative froth of mania equity markets.  Unfortunately, Greenspan and his Fed have bombed short-term interest rates so much that it is almost impossible to earn any money in real terms in high-quality bond investments these days.  Short-term bond yields have been taken out behind the barn by the Fed and shot in the head.


Long-term bonds look even less appealing, as yields have refused to follow Greenspan’s lead and remain stubbornly high.  Potential selling pressure on these instruments in the coming months, especially the 30-year Treasury bonds, could be immense, hammering bond prices and further driving up yields.  There are several major strategic factors looming large that could decimate the long debt market, destroying investors’ capital as thoroughly as the bear market has mauled US equities.


First, with the US ready to go to war in Afghanistan, a rugged mountainous nation which tenaciously repelled the entire might of the Soviet Union for a whole decade in the 1980s, foreign investors are beginning to realize that there will be increasing calls for an Islamic Jihad against America.  With the unpleasant prospect of wave after wave of Mohammedan crazies infiltrating America to blow themselves up to slaughter the innocent and die for their bloody god of war, non-Americans are beginning to get a little nervous about leaving their wealth in America.  Holy wars rightfully tend to make capital markets very uneasy. 


Huge foreign holders of US T-bonds including the Europeans and Japanese may begin to liquidate their vast bond holdings as more and more violent groups target America.  Even the Arabs may begin selling their T-bonds if they fear US government asset seizures in the coming war on terrorism.


Second, with the US dollar already embarking on a serious downtrend even before the WTC attack, foreign savers who have long financed the huge deficit spending habits of the Americans are facing very large currency translation losses on their long bond holdings in addition to plunging bond prices.  These losses can compound and multiply quickly leading to frantic selling of US government debt. 


Finally, waging war is not cheap.  Since the US government is deep in debt and has been living well beyond its means for decades, that means any new war effort will lead to more borrowing of huge sums of money from bond investors.


This borrowed money for war coupled with the unprecedented inflation and debasement of the fiat US dollar by the Federal Reserve in the wake of the terrorist attacks is causing many bond investors and savers to realize that their wealth will eventually be expropriated through the insidious inflation tax so they are likely to begin selling their long bonds en masse well before inflation becomes readily apparent in official statistics.


While the bond investors definitely understand the true horrible nature of unrestrained spending and inflation, the talking heads and barbarians on Wall Street continue to herald this form of blatant government market manipulation as the savior of the already dead equity bull.  As the Fed has promiscuously injected hundreds of billions of dollars of capital into the markets since September 11, Wall Street commentators have shouted for joy as “liquidity comes to rescue the markets”.  Apparently these perma-bulls have slept through 2001 and think liquidity injections are something new and wonderful.



Money of Zero Maturity, the measure of the money supply for totally liquid money that can be spent immediately, has been ramped-up at the breathtaking pace of 13% this year up until September 3, the latest available money supply data when this essay was hammered out.  The Fed has injected over $600 BILLION of liquid cash into the economy so far in 2001, a monumentally inflationary achievement that even John Law would have been proud of, and it has apparently not done a bit of good for the equity markets.  The NASDAQ has hemorrhaged almost a quarter of investors’ hard-earned wealth since the initial surprise Fed rate cut.


If further debasing the dollar through fire-hoses of liquidity will suddenly save the markets after the terrorist attack, why didn’t it appear to help all throughout 2001?  I continue to be utterly amazed by all the popular market sages who zealously celebrate market manipulation through Fed cash injections as something wonderful and good following the attack.  If I had an ounce of gold for every time in the last 10 days since the attack that I have heard a talking-head claim that huge Fed liquidity injections are something new and bullish, I would have enough gold to start my own central bank!


The more opportunities I have to study books on economic and market history, the more struck I am that the government response to a market crisis is always the same.  The government and monetary authorities run the printing presses 24/7 to flood the system with funny money, they undertake vast new debt-financed government spending programs designed to “stimulate”, they increase social welfare nets further bogging down the productive through higher taxation, and they generally muck about in free market processes.  It happened in the US in the 1930s, Japan in the 1990s, and now again in America in the 2000s. 


Massive liquidity injections and government spending in a crisis are nothing new, and in history they have virtually always ultimately greatly deepened and drawn out financial crises.  Hath government bureaucrats no history books?!? 


In the graph above, the blue MZM line ends in early September, but I suspect that the trend will now turn up sharply, represented by the hypothetical dotted blue line.  Just as we certainly were not in a New Era during the mania days of the Internet Bubble in early 2000, popular misconceptions at the time aside, the odds are abysmally low that running the printing presses will stop the US equity markets from falling way down to fundamental fair value, far below current levels.  Government market manipulation has always failed in the past, and it will fail this time too and ultimately cause a lot more financial pain than if our government would get out of the financial arena like it should and concentrate on defending our country from external threats, like Mohammedan terrorists wielding Russian-made weapons of mass destruction.


The Fed, in its relentless shock campaign against American and foreign savers who invest in the debt markets, is basically telling them to “drop dead”.  Greenspan and his posse have all year long been shamelessly trying to smoke out the carefully preserved wealth of savers and force it into the overvalued equities casino.  Huge liquidity injections coupled with command-and-control interest rate directives have created an extraordinarily hostile environment for debt market investors, something we don’t see very often in history.


When the annual inflation rate is subtracted from the yield on “risk-free” one year US T-bills, it is quite evident that the real rate of return has been placed under siege by the Fed in 2001.  The consequences of this development for wealth preservation and enhancement are enormous.



The blue line represents real rates of return for a one-year time horizon. This graph and the following graph are updated versions of graphs explained in great detail in our earlier essay “Real Rates and Gold” if you would like to dig deeper.


Amazingly, the inflation rate used above is the watered-down government-produced Consumer Price Index.  With MZM rocketing up 13% in the first 8 months of 2001, is there really any rational investor out there who believes inflation in the US is only 2.5% per the CPI and is likely to “remain” low in the coming years? 


Inflation is caused by relatively more money chasing relatively fewer goods and services.  Anyone who eats, lives in a house, and drives a car intuitively KNOWS that prices are rising rapidly, yet the goofy Bureau of Labor Statistics continues to invent new mathematical sleight-of-hand statistical parlor tricks to obscure the true inflation rate and save the government money by robbing those on fixed pension incomes from their promised cost-of-living adjustments.


If we had instead used pure monetary inflation in this graph, which leads to consumer price inflation, the real rates of return would already be far below zero for savers choosing to invest in the bond markets.


With Greenspan nearly worn out and backed up against a wall and Wall Street and the politicians practically licking his boots and begging for more rate cuts, who wants to bet that we have seen the end of the current rate cutting extravaganza?  Not us.  More cuts likely are coming as the equity markets continue to implode. Sooner or later, even with official BLS illusions of low inflation levels, real interest rates will plummet below zero and be naked for the whole investment world to observe.  The implications of these coming market conditions are astounding.


In a negative real interest rate environment, one loses money by putting it in relatively conservative government or private-sector bonds.  If an investor has prudently saved and worked hard to build their wealth castle, the investor will find that in a negative real interest rate environment that he or she will actually have LESS wealth one year later as inflation smothers the small nominal rate of return.  Greenspan is relentlessly assaulting the enormous and highly important debt markets by making them a losing proposition.


Now there is little doubt that Greenspan and his ilk hope to smoke out bond money by eviscerating the entire debt market through rate cuts, inflation, and negative real rates of return.  But, to where will that enormous amount of capital flee?


Wall Street, the politicians, and old Greenspan himself pray it sloshes into embattled US equities.  Bond investors are a very intelligent group, however, and they know that investing in generally way-overvalued stocks in a post-supercycle bubble bust is the equivalent of committing financial hara-kiri, ritual suicide.  While Wall Street shills continue to entice naive small investors to their doom, big smart money sells into all the bear market rallies and is getting the heck out of dodge as the equity markets plunge to new lows.


Some of the bond capital will likely flee into foreign markets and foreign currency.  With the US dollar remaining enormously overvalued on a fundamental basis and still not yet reacting as it traditionally does to lower rates of return in the US markets thanks to lower interest rates, there is a very large amount of downside left in the mighty US dollar.  The waves of foreign selling as the coming Islamic Jihad against America spins-up to speed will help accelerate this dollar downtrend.  Although the WTC attack was horrible beyond belief, it was child’s play compared to the damage that could be done with a weapon of mass destruction.  Imagine how fast the dollar will be liquidated in global markets when the Mohammedan terrorists start to deploy nuclear weapons and anthrax plagues instead of conventional explosives as international terrorism enters the mega-death age.


Stocks are a basket case, Greenspan is assaulting bonds on multiple fronts, and the US dollar is headed for a precipitous fall in one way or another.  What is an investor to do?  How can prudent savers diligently building their wealth castles weather the coming storms and both preserve and enhance their capital?


Not surprisingly, although negative real rates of return are rare, they have happened before in the last four decades.  When the US government started to recklessly deficit spend in hopes of “stimulating” the economy and the Fed promiscuously ran its printing presses in the recent past, one often ignored investment class always shined brightly.  Gold.



As this graph clearly illustrates, the greatest gold rally in recent times in US dollar terms roared to life after the Fed first told bond investors to “drop dead” in the 1970s through its aggressive negative real interest rate policies.  Unlike the average stock investor, bond investors are often very sophisticated financial players and are not easily led astray.  Bond investors understand interest rates to a frighteningly intimate degree and they will NOT let the government confiscate their capital through inflation taxes and negative real rates of return.  Inevitably, in this type of environment, a portion of bond capital finds its way into gold.


Notice the third arrow on the graph marking the last time real interest rates flirted with zero in the early 1990s.  As the Fed squeezed the bond markets through its interest rate policies, gold embarked on its biggest and most significant rally of the whole decade.  Even after the initial exodus of savvy capital from bonds to gold, the ancient metal of kings stayed high for several years until once again real rates of return rose high enough to entice capital back out of gold.


Real interest rate levels have historically proven to be one of the most accurate indicators of strategic gold price action and capital flows into and out of gold.


With real interest rates ready to knife through zero like an oxy-acetylene cutting-torch through an empty can of soda, the potential for a significant and real rally in gold is now at its highest level since the 1970s.  If history proves to yet again be a valid guide, sophisticated investors will not allow themselves to be dragged into a floundering equity market like a bull with a ring in its nose.  Since the gold market is so infinitesimally small compared to the gargantuan debt markets, if even a small percentage of total bond investors begin buying gold to preserve and enhance their wealth through our increasingly uncertain and capital-hostile times, gold will take off like a rocket and not look back until way into the next interest rate TIGHTENING cycle, which as yet is not even on the horizon.


And this mega-bullish case is not even considering the hugely positive impact of gold bursting free from official government suppression as well as its stellar supply and demand fundamentals.  Central banks are burning through their gold hoards at an ever-accelerating pace vainly trying to protect their fragile fiat currency inflationary regimes.  With only 2,500 tonnes of new gold mined each year worldwide, and annual global demand that may be twice that, the commodity case for gold in pure supply and demand terms could hardly be more bullish.


Thanks to a few evil men who thought that killing innocents for their pet political cause was a one-way ticket to paradise, the psychological landscape surrounding the markets has changed dramatically since September 11.  Already negative economic and market trends that were in place are accelerating dramatically.  Now, the perpetual hope for an imminent economic turnaround in the States has been overshadowed by a new heavy and pervading fog of uncertainty.  Soon, this could evolve into raw fear as more terrorists seek flamboyant and destructive suicidal deaths on US soil and radical followers of Mohammed around the world issue Fatwa after Fatwa demanding Jihad against the Infidel West.


In this darkening environment, investors all over the world will face profound new challenges in continuing to preserve and enhance their precious and scarce saved wealth.  Like the kings of old struggling to build physical castles, investors will face attacks from all fronts, both psychological and tangible, both internal and external, and will generally face tremendous challenges.  With the government and Fed systematically attacking wealth on multiple fronts and trying to strong-arm it back into overvalued equities, we are entering a very difficult investment environment.


Like the kings of old, modern investors will have to be as wise as serpents in their quest to preserve and enhance their wealth.  It is always easier to lose money than to make it, and troubling times ahead will further skew those odds towards losses.  Savers and investors everywhere must be proactive in taking charge of their own financial well-being.  Like a king under attack while he was trying to build his castle, investors will need to circle their wagons, maintain much higher levels of vigilance and market intelligence, and be ever more wary of hucksters trying to separate them from their money.


As we watch events unfold in the markets post-attack, I strongly believe, more than ever, that every investment portfolio needs some physical gold as the siege on capital rages on.  Historically, even in the modern age, gold has shined brightly in both times of great uncertainty and eras of negative real returns on debt investments.  Today we are plunging into both contingencies at once!


At the same time a dark new reality is emerging, we may be on the verge of a new golden era for investors.  As in all bull markets, the brave and fearless contrarian investors who deploy their capital in gold early will reap the lion’s share of the rewards. 


Make no mistake, it IS a different world out there than it was a few weeks ago.  The investing future belongs to those who can fight off this siege on capital and preserve and enhance their wealth through the coming troubling times.


Adam Hamilton, CPA     September 21, 2001     Subscribe at