November 2008 The ‘Solution’
It’s the end of the world as we know it.
MARKETS It’s the end of the world as we know it.
AT A GLANCE It’s the end of the world as we know it and I feel fine.
Sasha Solunac It may not be the end of the world, but it likely is the end of the world as we knew it.
However, unlike the members of the band R.E.M., there’s nothing to feel fine about.
Especially for those who make their living in the financial sector. At the risk of sounding like
doomsayers, we don’t believe the heady days of disproportionate wealth creation through
finance, for the sake of finance, are ever coming back. The prevailing hope that things will
eventually return to normal on Wall Street, Bay Street, London, and the other financial
centers of the world is, we believe, nothing but wishful thinking. Those days are over, never
to return in the form that we knew them.
For what is ‘normal’? Were the decades of the 1990’s and 2000’s, which witnessed
unprecedented prosperity in the financial sector, normal? Logic dictates that the answer is
no. As we’ve been opining for a number of years, there was “too much finance”. So much
so that the “financial system was a farce”. The financial sector became far too large in
relation to the real economy. The compensation of those who worked in the financial sector
became increasingly disproportionate, and abhorrently so, relative to the wages being
earned in the real economy making real things. Too many financial instruments were being
derived on other financial instruments, becoming too far removed from anything that even
remotely resembled real assets or real economic activity. These were abnormal times, and
were therefore unsustainable times. The heyday of finance was nothing more than a
pyramid scheme, only viable until it was unable to reel in the last sucker. The world has
finally come to the realization that pushing paper to other paper pushers for the sake of
paper pushing doesn’t, in fact, constitute real value-added economic activity. The myth of
the financial system as an unbridled source of wealth has been exposed.
The pyramid has crumbled and the world is now a different place. The solutions that worked
Sprott Asset Management in the past aren’t working this time. In the past, financial crises were ‘solved’ by throwing
money at the financial system. Although more money by far has been thrown at this crisis
Royal Bank Plaza than at any other in history, it just doesn’t seem to make an iota of difference. Not for the
South Tower financial system (except to delay the ultimate day of reckoning), and certainly not for the
200 Bay Street economy.
Suite 2700, P.O Box 27
Toronto, Ontario From the standpoint of the financial system, the need for massive bailouts (most recently
M5J 2J1 $300+ billion for Citigroup and the announcement of a new $800 billion TARP 2) continues
unabated in spite of all the ‘solutions’ that have already been adopted, such as sharp rate
T: 416 943 6707 cuts, aggressive unconventional monetary policy measures, central banks around the world
F: 416 362 4928 taking the role of buyers and guarantors of last resort, and numerous other lifelines that have
Toll Free: 888 362 7172 been extended to save the banking system. Furthermore, previously announced bailouts
www.sprott.com “Too Much Finance”, Markets At A Glance, March 2005.
“The Financial System Is A Farce”, Markets At A Glance, October 2007 and
“The Financial System Is A Farce, Part 2”, September 2008.
Sprott Asset Management p.1
(AIG being the prime example) seem to require a bottomless pit of government funding to
keep afloat. The price tag of the AIG bailout seems to increase with the passage of time,
initially $85 billion… now $150 billion. Nor have the ‘solutions’ made an iota of difference
from the standpoint of the economy. For over a year now, central bank rate cuts haven’t
done a thing to lower borrowing costs for individuals or corporations, let alone increase the
availability of lending. The real rates of interest for anything other than government bonds
has gone through the roof. In spite of all the financial stimulus, the global economy
continues to flounder and worsen with each passing month. It wouldn’t be a stretch to say
that of the trillions of dollars spent globally trying to prop up the financial sector, not even a
dollar has made its way into the real economy. As far as we can recall, never have such
aggressive financial measures been met with such a tepid economic response.
Everything that has been tried to date has backfired. Why? We believe it’s because all the
solutions thus far have focused on trying to save the financial system, but all the financial
system has done in return is suck more and more money into the vortex. Too many
resources are being wasted trying to prop it up, financial and political. Perhaps it’s high time
to let the financial system go and leave it to a market-determined fate. Papering over
losses, or refusing to recognize them, or having governments buy toxic assets that no one
else wants, doesn’t seem to change the fact that losses are losses. Like we said, it’s the
end of the world as we knew it. When the facts change, the solutions need to change as
We posit that any real, effective solution needs to concentrate on the real economy.
Therefore, first and foremost, greater efforts need to be made to save the economy, not the
financial sector. Only the economy can turn the financial sector around and make it
prosperous, not the other way around. Finance, at its foundation, should always be, and
has historically always been, a support industry of the real economy. Therefore, ideally, it
should be peripheral to the economy and not the main component of it. It should never have
been allowed to become the monstrosity that it was over the past decade.
In this context, the G20 needs to pool their resources to support the real economy. They
need to concentrate on what works. Supporting the financial sector doesn’t work. We
believe that supporting commodity prices will. We realize that that the solution we propose
is ‘talking our own book’, but it is our book because it is what we believe in. By now it should
be clear that plunging commodity prices, thereby cutting the output of real things, is not the
ticket to global economic recovery.
To be sure, this would be an unconventional idea. One that many of our readers will
doubtless disagree with. But unconventional times require unconventional measures. Many
would argue that the crashing of commodity prices is actually a good thing for the global
economy. We beg to differ. The only thing it’s done is create an environment where
absolutely nothing works from an economic or investment point of view. Not financials. Not
commodities. Nothing. When the financial pyramid scheme started to unwind in early 2007,
at least there were segments of the real economy that were still expanding, providing
employment, profits, and investment opportunities. Nowadays nothing is working and the
world as a whole is poorer for it.
Sprott Asset Management
Royal Bank Plaza The problem with the world today, and what is making the financial crisis worse, is that it is
South Tower in a deflationary death spiral, led by the plunge in commodity prices. It’s a negative
200 Bay Street feedback loop that is difficult to reverse once it gets started. It’s affecting everything on the
Suite 2700, P.O Box 27 aggregate demand side of the economic equation, including all-important consumer
Toronto, Ontario spending. As is well known, consumers are disinclined to spend when there is deflation.
M5J 2J1 The world is in desperate need of some inflation, and it needs it now. We’re not talking
about destructive hyperinflation, which can only occur from out of control monetary policies,
but rather the reversal of the negative vortex that commodity price deflation is causing
T: 416 943 6707
throughout the world. In the current environment, inflation would be good. Inflation would
F: 416 362 4928
make the repayment of debts and mortgages less onerous. Inflation would help turn around
Toll Free: 888 362 7172 plunging housing prices. Inflation would put a sail under the stock markets. Inflation would
help get new projects, which have been mothballed due to falling prices, restarted.
Sprott Asset Management p.2
In this regard, infrastructure projects are a great idea from a policy standpoint, and are being
adopted the world over. They stimulate the real economy and help reverse the deflation that
the flailing financial sector is unable to do. Unfortunately, projects of this magnitude will take
a year or more before they have any real economic impact. A quicker solution is to stop the
decline in commodity prices now. It’s a short term yet, we believe, effective solution for what
ails the world today. Longer term, of course, governments should have no involvement in
commodity markets, letting free markets decide. But right now, to quell deflation, the G20
should be thinking of buying commodities, even if it means stockpiling them.
We believe this would be a far more effective, and much cheaper, solution than the trillions
of taxpayer dollars currently being squandered on the white elephant that is the financial
sector with its glut of toxic assets. We believe that going forward, the financial sector won’t
be as important as the real economy. The future, as we see it, will return to normalcy, where
real economic activity dwarfs financial activity. In the interim, there is a global economic
crisis to deal with. One of the solutions to this crisis, with a greater likelihood of working than
any that have been tried thus far, is to reverse the deflationary impact of falling commodity
prices and save the real economy today.
The information contained herein may not be reproduced, quoted, published, displayed or transmitted without the prior
written consent of Sprott Asset Management Inc. (‘SAM’). The opinions expressed are solely those of the author. They
are based on information obtained from sources believed to be reliable, but it is not guaranteed as being accurate. The
report should not be regarded by recipients as a substitute for the exercise of their own judgment. Any opinions
expressed in this report are subject to change without any notice and SAM is not under any obligation to update or
keep current the information contained herein. SAM accepts no liability whatsoever for any loss or damage of any kind
arising out of the use of all or any part of this report. SAM is the investment manager of the Sprott Funds. Important
information about these funds, including management fees, other charges and expenses is contained in its simplified
prospectus and/or offering memorandum. Please read them carefully before investing. Mutual funds are not
guaranteed; their unit values and investment returns will fluctuate. Performance data represents past performance and
is not indicative of future performance. Performance comparisons are drawn from sources believed to be accurate. This
is not a solicitation.v
Sprott Asset Management
Royal Bank Plaza
200 Bay Street
Suite 2700, P.O Box 27
T: 416 943 6707
F: 416 362 4928
Toll Free: 888 362 7172
Sprott Asset Management p.3