History inevitably repeats itself, and I know of no historical cycle more deeply embedded in human society than the cycle of debt and energy.
It’s evident in the biblical 7-year cycle.
It’s evident from the research of cultural anthropologists — Roy Rappoport’s among the Tsembaga in New Guinea … Napoleon Chagnon’s among the Yanomami Indians of Venezuela and Brazil … and even my own field work among Japanese immigrants in São Paulo and the Amazon.
The cycle of debt and energy helps explain World War I … the Great Depression … World War II … and the price surges of the late 1970s.
The cycle also yields some good hints on what’s happening now and some valuable insights on what you can do about it. But first, let me share with you how I started my first in-depth research on the subject.
Los Angeles Hilton,
Winter of 1970
Elisabeth and I had just gotten married, and we were living with my parents in New York City.
At dinner one evening, Dad casually announced he was planning a Weiss Investment Seminar at the Hilton Hotel in Los Angeles, and he invited us to join him.
I did the research and made the charts.
Elisabeth, who thought she was going along just for the ride, wound up handling the registrations and giving out the name tags.
And from his podium at the LA Hilton, Dad gave one of the most resounding, hard-hitting and prescient seminars of his 60-year career.
Dad’s theme: Each new economic cycle in the U.S. begins with low debt, high savings, low energy costs and low interest rates. Each cycle ends with huge, unwieldy debts, low savings, high energy costs and high interest rates.
Dad’s theory: Money supply is just the tip of the iceberg.
The far bigger and more powerful force is credit inflation — big debts. It’s credit inflation that drives up demand for energy. And it’s credit inflation that ultimately drives up interest rates.
On the podium at the LA Hilton, Dad thrust his pointer at a giant debt chart we had pasted to the wall.
He talked forcefully about the danger of government debt … municipal debt … corporate debt … consumer debt … and worst of all, short-term debts.
He said short-term debts are especially dangerous because their cost adjusts higher almost immediately as interest rates rise.
“Every time there’s a rate hike by the Fed,†he warned, “the borrowers will have to make bigger and bigger payments. That creates even more demand for money.
“Listen! We all know that bigger doses of money supply pumped into the economy lead to inflation, especially in oil and energy. That’s well known and widely accepted.
“What many people don’t understand,†he declared, “is what happens when bigger doses of credit and debt are pumped into the economy.â€
His main point:
“More credit and debt generate huge demand for energy. Plus they create the demand for even more money to pay off the debts. And ultimately, that greater demand for money means that the cost of money — interest rates — inevitably has to go up as well.â€
That’s When Dad Made His Now-Historic Forecast
He dashed up to the blackboard. In large, flowing script he chalked up the words …
100 Bill = 1%
“In past cycles,†he explained, “for each $100 billion in new debts added to the economy, the level of short-term interest rates went up by one full percentage point before the cycle was over.
“Now, after adjusting for inflation, $1 trillion in net new debts has been added. So, if the ratio holds up in the next cycle, the short-term T-bill rate will have to leap from about 7% where it is today to as high as 17% where I think it will eventually peak.†(See chart of short-term T-bill rate in previous photo).
Precisely ten years later, in 1980, that’s exactly where the 3-month T-bill rate peaked: At 17%. Meanwhile, the price of crude oil rose by over tenfold.
Other world events played a role. But behind both the energy price explosion and the interest rate spike, the big driving force was the credit inflation which Dad talked about at the Los Angeles Hilton in 1970.
The ultimate consequences were devastating:
The Arab Oil Embargo of 1971.
The Iranian Revolution of 1979.
The worst bond market collapse in the history of our country.
A big price to pay just for the privilege of driving bigger cars, owning bigger homes and living higher on the hog!
What about today? Much has changed in the 36 long years since Dad gave his historic speech in 1970 …
Change #1
U.S. Interest-Bearing Debt
Has Grown to $41.7 Trillion
Just this past Thursday, the Federal Reserve released its Flow of Funds Report for the first quarter of 2006.
The exact time of the release was noon Eastern Time, and a few moment later, I looked at the numbers.
Immediately, my mind flashed back to the giant debt chart that towered behind Dad during his Weiss Investment Seminar in LA.
And I chuckled.
Even adjusting for inflation, today’s numbers make America’s 1970 debt pyramid look like an anthill by comparison.
Back then, the wall at the cavernous LA Hilton was plenty tall for the chart. Today, to accommodate a similar chart, using the same scale, we would need a wall ten stories high.
Just the total in interest-bearing debts in the U.S. today — without even including derivatives and other kinds of obligations — is $41.7 trillion, according to the Fed’s just-released numbers.
This is the biggest credit inflation of all time! And with it, you can expect some of the greatest price increases in your lifetime, especially in energy.
Change #2
Mortgages Are Now
The Biggest Single
Kind of Debt in America
Back in the 1970s, the U.S. government and large corporations were relatively bigger debtors. Today, the biggest concentration of debts is in mortgages — $12.3 trillion at the end of the first quarter, according to the Fed’s numbers.
That’s more than double the total debt of the U.S. Treasury Department, and over five times more than the debts of every city and state in America.
Who owes all that money? Over three-quarters of it — $9.5 trillion — is owed by single-family homeowners. These homeowners are more deeply buried in debt than at any time in history.
And most are at the mercy of some of the most troubled companies in America today, which leads me to …
Change #3
Two Shaky Companies Now
Control the Mortgage Market
Just two government-sponsored enterprises — Fannie Mae and Freddie Mac — control the lion’s share of the mortgage market: $3.6 trillion worth.
And the larger of the two — Fannie Mae — is in deep doodoo.
Its accounting stinks to high heaven. Its leadership is mentally constipated.
And its entire business model is in danger, especially as interest rates move higher and Americans begin to default on their mortgages.
The big concern: A sudden shortage of money in the mortgage market.
An even bigger worry: A panicky reaction by the Fed to pump in even more money and credit, causing still more inflation.
Change #4
Adjustable-Rate Mortgages
Are a Short Fuse on a
Ticking Time Bomb
Remember how Dad was especially concerned with short-term debts? Remember his forecast that interest costs could rise uncontrollably, creating a surge in the demand for money to repay debts coming due?
Today, we have a similar situation: With so many Americans taking out adjustable-rate mortgages, they have effectively migrated from long-term debts to short-term debts.
As soon as rates rise, their monthly payments go up. And between this year and next, we estimate that about $2 trillion in home mortgages will be adjusting to higher rates. In that sense, maybe things aren’t really very different from 1970.
Change #5
Demand for Energy is Broader!
Supply Threats are More Varied!
Back in the 1970s, huge amounts of debt drove up the demand for energy.
Soon, the price of oil skyrocketed — first in the wake of the Arab Oil embargo of 1970 … and later during the Iranian Revolution.
And now it’s happening again.
But this time, the demand for oil is far broader — not just from the U.S. and Western Europe, but also from the vaster populations in Asia.
And the supply threats are also more varied — not just from the Middle East, but also from Africa and Latin America.
Behind it all, however, we have the same underlying pressure that Dad spoke about so eloquently in 1970: A giant machine pumping high-octane credit into the economy, driving up demand for energy and ultimately creating a price explosion.
What to Do
If we see another cycle like the late 1970s, we’re in for both:
- Dramatically higher energy costs, and …
- Some of the highest interest rates in history.
My recommendations:
First, keep a big chunk of your money safe in short-term Treasury bills.
Second, allocate a solid portion to hedging — and profiting — from rising natural resources.
Third, with funds you can afford to risk, go for the very large profits that are available with specialized options. These investments give you tremendous leverage. But they strictly limit your downside exposure to the funds you invest (plus any commissions you pay your broker).
Our service that focuses on interest-rate options is sold out. We have hit our limit of 1,000 members and we cannot accept any more.
However, Larry still has slots left in his Energy Options Alert, but only a few.
He’s just written a fresh new report on some high-powered energy investments that are nicely timed to take advantage of the recent correction.
If you’re interested in getting a copy, call us at 877-719-3477. We’ll be glad to email it to you at no cost.
Good luck and God Bless!
Martin
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About MONEY AND MARKETS
MONEY AND MARKETS (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, and Tony Sagami. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Colleen Collins, Amber Dakar, Ekaterina Evseeva, Monica Lewman-Garcia, Wendy Montes de Oca, Jennifer Moran, Red Morgan, and Julie Trudeau.
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