Here Come the Zeros, by Bill Bonner

Bill Bonner has been a daily contributor and the driving force behind The Daily Reckoning since 1999. His article "Here Come the Zeros" was published on 6th February 2009 and we reproduce it in full below. Read it for yourselves, and draw your own conclusions.

Zero is a perfidious number. Nobody likes it. Nobody wants to be “a zero.” Nobody wants to get a zero on a test…or zero returns on his investments. It is a line that leads nowhere…with no substance in the middle of it. You can add a zero…or multiply by zeros; it gets you nowhere. And is a zero? Is it something? Or nothing? No one knows.

Some remarkable news in the history of zeros appeared this week. Mr. Gideon Gono, head of the Reserve Bank of Zimbabwe, suddenly shifted from adding zeros to subtracting them. Within the space of 76 hours, Zimbabwe led the world in two opposite directions. On Monday, with prices rising at 231 million percent per year, Zimbabwe was the world’s hyperinflation record holder. On Wednesday, it led the world in deflation…with prices falling 99.999999999% overnight.

Once again, we are profoundly grateful to the nation of Zimbabwe and to its central banker. The latter has turned the former into a marvelous laboratory for bizarre monetary experiments.
The pile-up on the global financial highway has yielded its toe tags and broken mirrors. More than $30 trillion has been lost. Of course, the world’s monetary cops have been on the scene for about a year and a half - trying to get the traffic moving again. But just read the paper. Instead of a recovery…every day brings more skid marks and fresh collisions.

A little bit of the old juice from the central bank will cure a typical recession. It is nothing more than a pause in the inventory cycle, allowing businesses to clear their shelves before they are restocked. But this is not an inventory-driven recession; this is a balance-sheet depression. The problem is not really an absence of credit, but an excess of debt. Throughout most of the post-WWII period, private sector debt in the USA, for example, equaled about 80% of GDP. In the ’90s and ’00s, debt rose to 140% of GDP. The difference is about $6 trillion. Until this debt is reduced, Americans will be reluctant to borrow or spend.

And it is not just the debt itself that must be eliminated. There are too many factories producing too many goods for too many people who can’t pay for them. You can see excess capacity in the unemployment lines too. Suddenly, the world seems not to need so many sales clerks, or welders, or financial engineers. The United States alone may have $1 trillion of excess output capacity and 10 million people too many in the workforce.

Debt and excess capacity can be liquidated quickly - as they were in the panics of the 19th century - through bankruptcies and defaults. But, today, liquidation would have to take place over the dead body of U.S. Fed chief, Ben Bernanke. While that would be our preferred method; alas, it’s not going to happen.

Another way to eliminate debt and excess capacity is to work your way out of them. Unfortunately, that process takes a long time - especially with the feds keeping zombie firms alive and fighting the correction every step of the way. Japan has been working off its excess capacity for the last 19 years. Property prices in major Japanese cities began going down in 1991. They fell for the next 13 years, bottoming out in 2004, 87% below their peak.
Few policymakers will want to follow the Japanese example - certainly not those of the USA. Americans lack several things the Japanese had…such as patience, a favorable trade balance and a thick cushion of domestic savings. On the other hand they have one thing the Japanese did not have; America can pay its debts in a currency it alone controls. If it chooses, it can resort to a third way to get the traffic moving; it can inflate away the debt.

“We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation,” wrote Bernanke. But with $7 trillion in excess in debt and spare capacity, neither business nor labor has any pricing power. Normally, it would take a long time before inflation returns.

Mr. Gono’s experiment, however, proves that if a government is determined enough…it can always destroy its own currency. Only a few weeks ago, Zimbabwe produced a monetary freak — the world’s first one trillion dollar note. Then, it had a value of about 26 euros. Now, you can use it to buy a cup of coffee in Harare - provided you also have $3 US. On Wednesday of last week, banks were supposed to begin distributing the new currency - in which all 12 zeros on the trillion-dollar note have been lopped off.

The architect of this monetary madness was recently asked his views: “I sit back and see the world today crying over the recent credit crunch, becoming hysterical about something which has not even lasted for a year, and I have been living with it for 10 years. …I had to find myself printing money. I found myself doing extraordinary things that aren’t in the textbooks. Then the IMF asked the US to please print money. I began to see the whole world now in a mode of practicing what they have been saying I should not.”

Mr. Gono added so many zeros to the national currency, he practically gave inflation a bad name. But now it is inflation that people want - desperately.

And day by day, the world glances over Mr. Gono’s shoulder. First curious…then appalled…and finally, admiringly. We will do “whatever it takes,” says new US Treasury Secretary Tim Geithner.

Here come the zeros.

About Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt . Both works have been critically acclaimed and internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets , which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning .

Will the recession hit private education?

Last week The Times ran an article suggesting that there was a glut of private schools for sale as owners sought to get out amid falling pupil numbers. Another victim of the credit crunch, or business as usual? We reproduce the article below, together with a response from Peers Carter, founder of School Transfer, a company mentioned in the article - you decide...

Secretly for sale: the private schools fearful of a panic exodus

The Times: January 8, 2009 by Alexandra Frean, Education Editor

Smaller private schools are facing a spate of takeovers as pupil numbers decline in the economic downturn, but the children and their parents are likely to be the last to know about it.

At least 25 independent schools are discreetly seeking buyers, ranging from a £3.25 million primary school in the South of England, in a period mansion with a modern sports hall and IT suite, to a £1.35 million prep school offered as a “quick sale”.

Brokers acting as intermediaries for such sales say that they expect more schools to come on to the market over the next term, as parents decide that they can no longer afford to pay fees. They are advising schools against making their financial difficulties public for fear of a a mass desertion by parents. One school in the Midlands had to close within six months of the news of its possible sale leaking out.

Sue Fieldman, regional editor of the Good Schools Guide, said that although the right investor might find “ripe pickings” in the economic downturn, parents and pupils were likely to be the last to know about it. “Parents can end up feeling very aggrieved because they thought they were signing up to a particular school regime and they end up with another one,” she said. “That's why if parents get wind of a sale or any financial difficulties at the school, many would be out of the door like a shot.”

The small, family-owned schools were likely to be most vulnerable, she said. “The smaller prep schools are very vulnerable indeed. This is a shame because they are often very traditional schools that parents are very fond of. We always advise parents to find out who owns the school.”

Most sales of small independent schools are handled by two brokers, the School Transfer Company and National School Transfer. Patrick Carter, of National School Transfer, said that he was expecting to see more privately owned schools coming on to the market as pupil numbers declined.

“I'm certain it's going to happen one way or another,” he said. “Some parents are not going to be able to pay their fees. Now is the time, at the beginning of term with new fees to be paid, when it will become apparent what problems schools will be facing. The most vulnerable schools will be smaller and single-sex ones.”

Peers Carter, of the School Transfer Company, said that he did not expect a glut of smaller schools to come on to the market. “Schools are a brilliant proposition. There's nothing safer to invest in,” he said.

He added that buyers - which could include private individuals looking to invest a legacy as well as chains of schools backed by venture capital - could expect a return on investment of between 10 and 15 per cent.

Such optimism may be misplaced. After the last recession in Britain in 1991, independent schools experienced a steep dive in pupil numbers, losing 11,500 pupils in the following five years. At least two prep schools, Bramcote Lorne in Retford, Nottinghamshire, and Brigg School in Hull, have closed recently after pupil numbers declined. Both schools are part of the United Church Schools Trust and will now merge with other schools in the group.

David Hanson, the chief executive of the Independent Association of Prep Schools, has said that more schools would follow suit as the effects of the recession began to be felt. Two of the leading international chains, Cognita and Gems, say that they are in the market for acquiring new schools. Cognita, whose chairman is Chris Woodhead, the former Chief Inspector of Schools, says that it is in negotiations to buy up to 15 schools to add to the 46 that it already operates in Britain.

A letter from Peers Carter in response to the article above

Dear Sir

I understand the need of newspapers to keep up the relentless stream of bad news presumably it sells papers – but was it really necessary last week to write such a doom laden piece about the independent school sector?

Why did your report talk of panic amongst owners and secret selling? Was this to cause chaos amongst the parents and staff of these, usually excellent, establishments? As founder of one of the company's that was mentioned in the article, I can confirm again – as I did to your correspondent when we spoke - that we have seen no panic selling during this downturn, recession or whatever it is this week and that we have no more schools on our books now than we have had throughout the 24 years that we have been in business.

Not a single owner has approached us ‘panicking’ about likely effects of the recession. Yes, we have some businesses on our books, where the owners simply wish to retire or change lifestyle courses; where illness has made sale desirable or where for various financial reasons – be it demographics, overspending or simply exhaustion and lack of funds to keep up with current legislation and compliance – they wish to pass their businesses on to vibrant new hands. Nobody is panicking though as a result of the financial climate and I wonder why this word was used.

School owners are used to taking a long term view of their businesses and expect to take the rough with the smooth. As businesses go, schools are slow burners and they do not suffer – or enjoy – the dramatic ups and downs of many other types of business.

Parents who commit to independent education are not stupid. They realise before they start that they are signing up to pay fees for between eight and thirteen years. They are usually pretty sure that the project is sustainable for them and that they will be able to keep their children at the independent schools of their choice.

Of course, family and career circumstances can change unforeseeably and some parents will be hit by the recession and have to make painful choices. However, they will only make that decision after giving up nearly everything else first – holidays, expensive cars, bigger houses and so on. Grandparents are often pleased to help out for a few terms whilst adjustments are made if it prevents a child changing school unmnecessarily.

Your article did not mention any of this and yet it is so relevant to the overall picture. If things were as bad as it implied then why are companies like Gems and Cognita so keen to expand their involvement in the sector?

Lastly, why did the article talk about secrecy.

Moving on, I must point out that any business people with any sense sell their business secretly when the time comes. They have to unless it’s a corner shop. We advertise ourselves as confidential agents – always have done for 23 years. Parents and children need a sense of security for their children’s schooling. Instability or the threat of it is more likely than any recession to cause a stampede of parents and pupils. That’s why a company like ours offers a discreet and personal service and a seamless transfer of ownership so that parents and staff are reassured and the business remains stable.

Are pupil numbers down at independent school as the article said? (An article which was picked up and then repeated in other newspapers without question, incidentally.) Possibly. It happens. See paragraphs 3 and 4 above. Well established private schools have been through previous financial downturns – some have been around for many years and survived world wars and the depression.

Finally, I should point out that with my wife I have owned an independent school for over 30 years. It was established in 1905 . We also have a day nursery and our numbers at both are higher this year than ever before!

Point made?

Yours

Weak Sterling and the impact on oil

Today's warning from Gordon Brown on the oil price sparked a few thoughts in the Collective. Prices have tumbled from $150 to $40 per barrel in the last few months, and we've seen falls at the pump from around 120p to 89p/litre.

One of the reasons generally given for why prices at the pump don't fall in line with the market is the level of duty charged, and there is no doubt that the UK is one of the most heavily penalised Western countries.

However another reason, for which the UK government can also take great credit, is the slump in the value of Sterling.

In July 2008, crude cost around $147 per barrel, and at the same time the exchange rate stood at about $2:£1, so in Sterling £73.50 per barrel. Today crude is around $44 per barrel, but with Sterling having weakened this equates to £29.00.

In simple terms, oil has fallen in price to around 30% of its peak dollar price, but in UK terms it's only fallen to 40%. To put this in perspective, oil in the UK would be £7 per barrel (or 25%) cheaper if the currency hadn't crashed.

Thanks, Gordon.

Is it Boom or Bust for the UK Government, Darling?

One can only feel dismay at the government's latest proposals to dig the country out of the threat of a deep recession. Whilst the government is not solely to blame for the problems we face - there are undoubtedly global issues over which we had little control - the government has been responsible for fuelling an economy centred on rising consumer debt and the belief that house prices will always go up. Unfortunately we believe that having allowed house prices to boom out of control, some adjustment downwards is essential - it is, afterall, the best way to help first time buyers onto the housing ladder.

Yesterday's pre-budget report was meant to deliver a range of stimuli to the economy that would see a return to more stable economic conditions. The fundamentals of the package saw large increases to government debt in the short term, funded by tax increases a little way after.

None of that sounds particularly appealing, so the good news must be hidden away somewhere, isn't it? The Collective believes that the single biggest challenge to the UK economy at the moment is not just that we all stay in work; it's also that our wages are sufficient to fund the current cost of living. Therefore the policy changes should, in our opinion, have been designed to ease the burden on ordinary households. Will these achieve their aim?

To an extent this is true - a reduction in the standard rate of VAT should see some consumer prices come down. That being said, some of our largest expenditure is unaffected such as many types of food, and gas and electricity bills. The cost of a litre of petrol will also not change because, whilst this is affected by the VAT reduction, this is offset by a rise in duty.

What will be affected is the bigger ticket items - furniture, consumer electronics, cars. For us this is where the problem lies: the government is making cheaper those items which rely either (a) on the housing market or (b) being able to take some form of credit. If we have borrowed excessively to get into this mess, why is it good to borrow more to get out of it?

The government will further stimulate the economy by taking on massive debt to fund infrastructure projects. In their view, such expenditure will provide a catalyst for a recovery, but it seems to us to be full of risks. If excessive, ill-judged credit behaviour both by banks and consumers is a bad thing, why is excessive borrowing by our government a good thing?

Of course it's easy to criticise, and much harder to offer an alternative. We don't pretend to have all the answers, but here's a few suggestions of how to help the UK family:

• Reduce the VAT rate on domestic utility bills to 0% for 24 months
• Double the personal allowance, taking a far larger slice of low paid workers' wages out of the income tax arena

And how would we increase government revenues?

• Put airline fuel on a level playing field as regards fuel duty

Good luck in the coming months.

Enterprise Week

Last night's Wales@work programme on BBC Radio Wales asked the following:

Yesterday saw the beginning of Enterprise week in schools and colleges around the UK. Students from around the country are being challenged to come up with successful business ideas to teach them more about entrepreneurship and commerce.

• But are events like this worthwhile - can you really teach children how to become entrepreneurs? Or is it something that you are born with?
• And as these teenagers start out in the big wide world shouldn’t we be giving them a financial education as well as an academic one?
• In the current climate with money being tight shouldn’t our children be taught how to manage money and not get into debt?

So this week Wales@work goes on the road to Neath Port Talbot College to ask guests and a young audience whether business and finance is a worthwhile education.

We sent our thoughts to the show...

You can move towards an answer to all three questions by teaching children to understand "the bigger picture", and how debt and risk fit in to it. History talks about three ways to get wealth - steal it, earn it or marry it. Borrowing money without understanding its consequences was never the answer. However we shouldn't assume that debt is fundamentally bad - it isn't, but we have to recognize that it comes with consequences.

For example, businesses may take on debt as an investment in their future profitability; likewise our parents took on debt to fund the purchase of a long term asset (their house) which over the period of the debt (25 years) would increase in value. Debt to fund a short term lifestyle boost is plain daft - it doesn't deliver any long term benefits and simply makes securing debts for those things that do (such as a mortgage) more difficult. You wouldn't see a business taking out a loan to fund entertaining at a rugby international, for example (and nor would you find a bank willing to give one!). But that shouldn't stop individuals gearing up to drive future wealth creation opportunities - by all means borrow to set up a business, if you can demonstrate your belief that in doing so you'll be better off in the long term.

Being a successful entrepreneur is partly about identifying what you or your idea can do that gives you an advantage over what's already in the market, and then doing it profitably. It's also about knowing your weaknesses and either learning to address them, or getting people and resources around you to mitigate against them.

Fundamentally all of this is an understanding of risk - what's the risk of me not being able to pay my debts, what's the risk of my business idea failing - and having a strategy to deal with it.

Put it this way, borrowing money to buy a second property on an interest only basis only just covered by the rent is only GUARANTEED to deliver profit if you can say with certainty that (A) you will always have a paying tenant, (B) rent will go up at least in line with rises in interest rates and (C) property always goes up, not just in the long term but also in the short term. Sounds obvious, but amazing how many people didn't apply this thinking over the last 5 years...

Finally, for a broader look at how education stifles creativity, I can thoroughly recommend this lecture by Sir Ken Robinson.

Retentions, or how to get a free overdraft at your suppliers’ expense

Retentions are fairly common in building and construction, and represent a proportion of the total contract price which is retained for a period of time, typically 12 months, by the customer. The idea is that in the event of a snag occurring within this period, the contractor will fix it, otherwise he doesn’t get his retention. A South Wales SME sent us their recent experiences…

The SMEs has been chasing two retentions relating to work done it did in 2002 as sub-contractor to a listed plc. The plc was doing work for a university, and had sub-contracted some of it to the local SME. The SME is only owed, in total, £150 in respect of these two jobs, which was supposed to have been retained by the plc for a period of 12 months after completion.

The plc did not pay over the retention in 2003 and when chased early in 2004, said that it wouldn’t be paying until it had itself been paid by its client. This policy, known as “pay when paid”, is illegal, but the plc was banking on the SME not going to court for such a small amount of money. In 2006 the SME wrote again, and this time received no response.

In the last few weeks the new CEO wrote again to the plc, and received a phone call back. The commercial manager in the plc’s local office agreed that the retentions were due. He blamed the SME’s lax accounting for their non-payment, and said that he expected every supplier to write quarterly to chase retentions – their own money! He then suggested a “deal”, have one retention (£65) paid and write off the other (£85). The SME refused, and so was told that neither would be paid.

The commercial manager went on to make a number of accusations and excuses - perhaps the SME was on the verge of bankruptcy if it was bothered about £150; hadn’t the CEO got something better to do with his time; the member of plc staff who had previously dealt with this had been made redundant, so there was nothing he could do; it would be a shame if the two companies were to fall out over such a small amount and not have the opportunity to work together again…hmmm…. blackmail and threats, anyone?

Yes it’s only £150, but how many £150’s are there owed? The commercial manager proudly said that the total value of retentions held by his office alone was £1.3m – if just 5% of these are held unfairly then the office is using £65,000 of its customers’ money as a free overdraft. Multiply that by 15 offices around the UK, and it’s around £1m of free money in the plc’s bank account. Oh yes, and if we don’t get our money in 7 days we’re going to court.

How the stockmarket works

Once upon a time in a village in India, a man appeared and announced to the villagers that he would buy monkeys for $10 each. The villagers seeing that there were many monkeys around, went out to the forest and started catching them. The man bought thousands at $10 and, as supply started to diminish, the villagers stopped their effort. He further announced that he would now buy monkeys at $20 each. This renewed the efforts of the villagers and they started catching monkeys again.

Soon the supply diminished even further and people started going back to their farms. The offer increased to $25 each and the supply of monkeys became so scarce it was an effort to even find a monkey, let alone catch it!

The man now announced that he would buy monkeys at $50 each! However, since he had to go to the city on some business, his assistant would now buy on behalf of him.

In the absence of the man, the assistant told the villagers. 'Look at all these monkeys in the big cage that the man has already collected. I will sell them to you at $35 and when the man returns from the city, you can sell them to him for $50 each.' The villagers rounded up with all their savings and bought all the monkeys.

Then they never saw the man nor his assistant again, only lots and lots of monkeys! Now you have a better understanding of how the stock market works.'

Collective Thought is grateful to the person who wrote this joke and emailed it around. Thanks!