What Happens If Central Banks FAIL in Their Giant Experiment?

I rarely recommend that you wade through a wordy speech by an economic theorist delivered to an audience of stuffy bankers.

But last week’s address by PIMCO Vice President El-Erian to the St. Louis Fed is one you absolutely MUST not miss.

And to save you the trouble of deciphering the economics code words, I dedicate most of this issue to the key points he makes — the same basic points that our colleague Mike Larson has been making for months.

First and foremost, four of the world’s largest central banks have gone absolutely berserk, running the money printing presses like never before in history:

Source: Chart lines — Pimco;

The Bank of Japan (BOJ) had already been printing money like crazy ever since their bubble economy burst in the early 1990s.

So when the debt crisis struck in 2008, the size of their balance sheet assets, which measure the cumulative total of a central bank’s money printing operations, was already the biggest in the world: About 20% of their economy.

Then, when the shock waves of the Lehman Brothers collapse struck Japan, what did they do?

They stepped up their money printing operations EVEN further — to about 30% of GDP. (See yellow line in chart above.)

Other than Brazil in the 1970s or Germany in the 1920s, no other major nation — or group of nations — on the planet had ever gone that far! (Until, that is, Europe, which I’ll get to in a moment.)

Meanwhile …

At the U.S. Federal Reserve, no Fed Chairman in history — not even notorious easy-money advocates like Arthur Burns or Allen Greenspan — had EVER run the money printing presses for any extended period of time.

But Fed Chairman Bernanke changed all that. Soon after the debt crisis hit in 2008, he nearly TRIPLED the size of the Fed’s balance sheet from about 6% of GDP to almost 17% of GDP.

And in the years since, he has pumped it up even further to about 20% of GDP! (Red line in chart.)

The Bank of England (BOE) has mostly been expanding its balance sheet in lock step with the Fed (green line).

But in the global race to print money, it’s the European Central Bank (ECB) which has been leading the pack in the past year or so,
suddenly expanding their balance sheet from about 20% of GDP to close to 30% GDP (blue line).

This is absolutely massive!

Heck, in the 1990s and 2000s, just the money-printing operations by ONE central bank (the Bank of Japan) changed the world:

Global investors borrowed abundant amounts of cheap money in Japan and poured it into risky investments around the world, helping to create some of the largest bubbles — and busts — in history.

Now, imagine FOUR central banks doing the same thing at the same time!

That’s what we have today! And that’s why the folks at PIMCO say it’s so dangerous.

PIMCO VP’s Critical Question:
What Happens If the Central Banks
FAIL in Their Giant Experiment to Cure
Global Economic Ills with Paper Money?

The answer lies in three simultaneous disasters:

The first disaster is that the money drug stops working. It runs into the law of diminishing returns — less economic growth despite bigger and bigger doses … and with time, even severe recessions!

That’s what we already see happening in several European countries. And it’s what could ultimately happen in the U.S. as well.

The second disaster is the drug’s inevitable side-effect — inflation. In recent years, we’ve see it primarily in asset inflation, especially food and energy. But almost any asset can get caught up in the funnel — like firewood in an F-5 tornado.

The third disaster is a series of deadly cancers that spread throughout the global economy:

* Instead of elected leaders running the world, central bankers take the wheel. Presidents and prime ministers become little more than back-seat drivers.

* Instead of a capitalist economy financed with savings, we create a debtist economy financed with paper money.

* Instead of financial markets for prudent investors, we create financial markets dominated by reckless speculators.

Why This Is So Urgent …

First, it’s right now: This is not our forecast of some future event. As Mike’s and PIMCO’s charts prove, the money printing has ALREADY taken place … and it’s continuing at this very moment.

Second, it’s so massive: The combined impact of four central banks doubling, tripling and quadrupling their balance sheets is immeasurable.

Third, the dangers it’s creating are so large: Several major economies, especially in Europe, are already struggling — or even shrinking — despite the unprecedented money printing. Imagine what might happen when the money printing stops working or begins to create serious side effects? And …

Fourth, the money printing opens up such dramatic money-making opportunities for investors:

You can make money when select investments surge in value — not only because of the money printing but also because they’re solid in their own right.

And you can make even MORE money when bubbles burst — as they inevitably do.

But there’s one catch …

To Make Money in This Bubble-and-Bust
World, You MUST Be a Contrarian!

You cannot follow the crowd and assume there’s “safety in numbers.” Quite the contrary, it’s the frenzy of crowds that creates the bubbles, and it’s the panic of crowds that brings on the busts.

You can’t just jump on a megatrend and stick with it for nearly a lifetime. That may have been possible in the past. But it’s virtually impossible in the bubble-and-bust world of the 21st Century!

You can’t expect diversification alone to protect you. Instead, the key to success is to carefully select cream-of-the-crop investments that can survive and thrive even in the worst of times.

Unfortunately, most of Wall Street’s investment “wise men” still don’t get it.

Their philosophy, strategy and tactics are largely drawn from their experiences of that big 50-year megatrend of the second half of the 20th Century called “the postwar boom.”

But those theories are almost entirely irrelevant to investing today!

Far MORE important is the investment wisdom learned in the FIRST half of the 20th Century — a period, which, like today, was dominated by giant bubbles and busts.

That’s when my father, J. Irving Weiss — along with his contemporaries — made most of their fortunes. And that’s when such fortunes would have been impossible without Contrarian Investing!

Dad’s view: If you follow the crowd, chances are you’ll lose. If you buck the crowd, the odds of winning will be greatly tilted in your favor.

In 1929, he borrowed $500 from his mother. And in the Spring of 1930, when nearly everyone on Wall Street was turning bullish again, he began shorting the most vulnerable stocks in the market. Ultimately, he turned that initial grubstake into more than $100,000.

Then, near the bottom of the bear market in 1933, precisely when the crowd of investors wouldn’t touch stocks with a ten-foot pole, he did the opposite: He bought bluechips with both hands — thousands of shares of General Motors, General Electric, Sears Roebuck and AT&T for just pennies on the dollar. (For Dad’s own story in his own words, go here.)

Dad rarely bragged about his successes. He figured it was no one else’s business. And he didn’t become more widely known as a contrarian investor until many years later.

J.P. Morgan — one of the earliest great success stories among contrarian investors — was another matter entirely.

He pioneered the practice of buying troubled businesses on the cheap and reorganizing them in order to return them to profitability and boost their stock prices.

In fact, his strategy was so effective, it came to be known as “Morganization.” By taking stakes in beaten-down companies, merging them with other firms and increasing their efficiency, he built massive railroad, electric power, steel and finance empires.

He founded the first billion-dollar company in the world (U.S. Steel) and is still considered one of the richest Americans who ever lived.

Why? Mostly because of his willingness to be a CONTRARIAN — buying what no one else wanted.

But it was Bernard Baruch, a contemporary and friend of my father’s, who most established some of the basic ground rules for contrarians.

Baruch earned the title “The Lone Wolf of Wall Street” because of his refusal to join any investment house.

He preached an objective, unemotional, fact-intensive financial analysis. He advocated sticking to areas that you know. And he was among the first to stress the importance of selling.

I leave you today with some of his words of wisdom:

“The main purpose of the stock market is to make fools of as many men as possible.”

“I made my money by selling too soon.”

“I never lost money by turning a profit.”

And above all: “Never follow the crowd!”

Good luck and God bless!

Martin