By Kyle Bass
[UPDATE: This column is excerpted from an earlier draft of Bass's October 2 investor letter, the full version of which is available here.]
The good news is the recession is officially over. And what a recession it has been. Real GDP has dropped 4% peak-to-trough, S&P 500 revenues have decreased 18%, and home prices have lost 31.3% nationwide. Broad-based unemployment figures (including numbers for the underemployed) reached 16.8%, which translates into 17.2 million Americans out of work and another 9.1 million working part-time jobs insufficient to pay the bills. After losing an average of 579,680 jobs every week since October 2008, the headline unemployment figure improved in July from 9.5% to 9.4%.
Never mind that in August the Bureau of Labor Statistics revised its prior estimates, and a portion of the July “improvement” was accomplished by adjusting the participation rate—think increasing the denominator to reduce the percentage—and unemployment increased its upward trajectory to 9.7% in August.
Bernanke and crew have done a masterful job of pulling out all the stops—and then some—to save the U.S. and world banking system from overall failure. Having gone from potential systemwide failure to valuations well above 10-year averages, the S&P 500 now trades at twice its book value and 23 times its earnings per share, and credit spreads relative to Treasuries are back to pre-Lehman levels.
If only the story could end on such a happy note. Unfortunately, this is where the really bad news begins.
Western democracies, communist capitalists and Japanese deflationists are concurrently engaged in what may be the largest global financial experiment in history. Everywhere you turn, governments are running enormous fiscal deficits fueled by printing money. The greatest risk of these policies is that the easing persists until the currency value equals the printing costs, which are slightly above zero.
There have been 28 episodes of hyperinflation for national economies in the 20th century, with 20 of them occurring after 1980. Peter Bernholz, a professor at the University of Basel in Switzerland, has spent his career examining the intertwined worlds of politics and economics with special attention to money.
In his most recent book, “Monetary Regimes and Inflation: History, Economic and Political Relationships,” he analyzes the 12 largest episodes of hyperinflation—all of which were caused by financing huge public budget deficits through money creation. Bernholz’s conclusion: The tipping point for hyperinflation occurs when deficits exceed 40% of government expenditures.
According to recent Office of Management and Budget projections, U.S. federal expenditures are projected to be $3.653 trillion in FY 2009 and $3.766 trillion in FY 2010 with unified deficits of $1.580 trillion and $1.502 trillion, respectively.
These projections imply that the U.S. will run deficits equal to 43.3% and 39.9% of expenditures in 2009 and 2010, respectively. History suggests that this is dangerous territory.
Beyond the quantitative measurements associated with government deficits and money creation, there exists a qualitative aspect that may be far more important. Unfortunately, the qualitative perceptions of fiscal and monetary policies are impossible to control once confidence is lost. In fact, recent price activity in metals, the dollar and commodities suggests that the market is anticipating the future.
The greatest concern is that, with the exception of Japan, the major global currencies have experienced money supply growth between 15% and 55% in fewer than three years.
Imagine a game of Monopoly where the participants are playing with one bank of money. Then, halfway through the game, the banker decides that money is too tight and the game is slowing down or a few players are about to go broke. In Godlike fashion, the banker adds two more banks and distributes monies to participants as he or she deems fit.
In this scenario, did the real value of anything change? Does bartering for property increase or decrease prices? Did each unit of money become worth more or less? How did the banker allocate the extra money? Was the process fair? All things being equal, quantitatively speaking, the players are no better or worse; however, depending on how you were positioned prior to the additional banks’ injections, and how you play the rest of the game, you’ll either feel fortunate or cheated.
As a player in today’s real-life game, how are you positioned?
Kyle Bass is the founder of Hayman Advisors.
Some previous AR coverage of Bass: