Jacqueline Doherty & Andrew Bary
Wednesday, 21 December 2011 12:23
Some lines just can't help but catch your eye. For example: 'There will be global hyperinflation that peels the skin off your face.'
The colorful language was penned by Lee Quaintance and Paul Brodsky, partners in QB Asset Management, in their monthly letter. It's even more intriguing, given that inflation, as measured by the consumer price index, was flat last month, and gold, while up 12% this year, is 15% below its August high.
But the QB duo is convinced that central bankers will start printing money to pay off public debts and keep the banking system solvent. They expect a managed global devaluation of all major currencies in six months to a year. It could be orchestrated through the International Monetary Fund, or the markets might require a gold-based solution, applied by the central banks.
QB's partners worry that the system's base money (bank reserves at the Federal Reserve and currency in circulation) is dwarfed by the claims on it. For every dollar of base money, there are $5.00 worth of bank deposits, including checking and savings accounts and time deposits. So, if everyone demanded the return of their deposits simultaneously, the bank could pay only about 20 cents on every dollar owed, Quaintance says.
Banks bet on the fact that everyone isn't going to come calling for their dollars all at once. But the QB partners argue that the system is at a tipping point. Leverage has grown exceedingly large. Making matters worse, banks have used the funds from deposits to make questionable loans.
The bad debt could be restructured so that creditors get cents on the dollar. The QB partners doubt this will happen because it would cause too much pain. The more likely outcome is that the central bankers print more base currency, reducing the buying power of the money already in circulation.
And voila! You have skin-peeling inflation. 'A full deleveraging of the banking system could mean that the dollar and other currencies will lose 70% to 80% of their purchasing power,' Quaintance says, arguing that all major banks in developed lands will suffer because markets are so interconnected.
How should investors prepare if they buy into this Grinch-y world view? Buy gold and unlevered assets, says Quaintance. The losers in this scenario: holders of cash and 'risk-free' Treasuries. Of course, cash and Treasuries are what risk-adverse investors favor right now.''