WHAT IS A LIFE HEDGE?

In Chapter 6 of The Great Credit Contraction I discuss the importance of the Five Flag Theory and a life hedge is an essential competent of this concept. A life hedge is a backup location where you can relocate yourself to maintain the lifestyle you have designed. Implementing provident living principles requires one to put in place a contingency plan for their personal location.

When one is unprepared for and effected by those events which are possible, although not probable, then one’s lifestyle gets designed for them and in many cases they do not like it. Just ask the cold, starving masses in Japan, Haiti, Chile, Thailand, etc. who failed to adequately hedge against natural disasters. A life hedge is a form of insurance for yourself and your family against the flock of black swans. While charity is nice I guarantee you that no one cares more about whether you are fed and comfortable than you do. With the current system unraveling it is important to prepare for survivalism in the suburbs as the veneer of order is extremely thin.

For example, if you had to take the last plane out of your city then (1) where would you go and (2) how would you maintain your standard of living?

In the Information Age the ability to have a ‘location independent’ lifestyle has becoming increasingly available to more people. By designing your lifestyle to be location independent and having multiple locations you frequent then you will be able to have continuity of lifestyle despite the tumultuous and unpredictable events, from natural disasters to political unrest from supply chain disruptions to currency collapse, that can and will occur during this transition from the Industrial to the Information Age.

When considering a life hedge there are a few elements to consider such as plentiful water, good sun exposure for gardening or photovoltaics, not on a flood plain, panoramic views, minimal noxious weeds, away from potential real estate developers, low housing costs, access to and ability to produce food, low population density, compatible neighbors, and many more.

Doug Casey has been preaching the end of the world for 30 years and with La Estancia being his pet project and personal life hedge he has made sure that La Estancia De Cafayate is an excellent well-rounded choice when it comes to its survival characteristics.

INTERVIEW WITH DOUG CASEY, JUAN CARLOS ROMERO AND JUAN ESTEBAN ROMERO

LA ESTANCIA DE CAFAYTE

Even if you never use La Estancia De Cafayate for its retreat value it will still add considerable utility via the golf, polo, wine and networking opportunities. At every event I have attended I have learned a tremendous amount from the others there. With so many successful, creative and productive people with a similar philosophical and practical outlook the environment is ripe for business opportunities. Since one has to be somewhere why not be around other successful, creative and productive people with whom you can plan and plot great business ideas and opportunities to accomplish?

The first time I visited La Estancia De Cafayate was in 2008. At the time I thought the probability of success was about 15%. Doug’s idea was rather crazy; raise a first class country club from the desert sand in the middle of nowhere and a thousand miles from the closest large city.

But after three years I would say the probability of success is now 100% because enough lots have been sold that the development has no debt and enough cash in the bank to finish all major projects. Additionally, this is the crown jewel of Salta and its success or failure reflects tremendously on Mr. Romero’s reputation. The clubhouse, many vineyards, roads, polo field and utilities are finished. The Health Club and Spa are under construction along with the incoming Grace Hotel and a regular flight from Salta to Cafayate.

So much of the initial risk with the development is gone. World conditions have continued to deteriorate which increases the attractiveness of this type of life hedge. Information technology makes it easier than ever to be in the middle of nowhere yet in the thick of it all when it comes to business or trading. The lots are selling at a quicker pace.

I think the probability of it selling out and becoming a very exclusive community which high powered individuals frequent on a regular basis has greatly increased which adds additional utility for those who may be seeking the opportunity for networking for business opportunities, etc. Plus, how does one put a value on having cool like-minded neighbors?

FAILED WORLDWIDE FINANCIAL SYSTEM

The fractional reserve banking and fiat currency conspiracy system failed in 2008. Only inertia coupled with quantitative easing is keeping the system from unraveling faster. But the effects of massive inflation are well known to result in shortages and rationing. World political and monetary authorities can print little colored coupons but that creates neither wealth nor food. Why are gold, silver, oil, and food rising so quickly?

The Federal Reserve’s insane monetary policies sustaining the unsustainable are going to cause tremendous problems. Food is going to become a lot more expensive and this will continue to feed political instability. The chaotic fingers of instability are getting even more unpredictable.

The financial crisis will lead to economic, social, political and geo-political crises of increasing intensity. The FRN$, the world reserve currency, will be the last layer to evaporate in the great credit contraction. So far the United States has largely been insulated from the effects of the financial crisis on daily life. But when the FRN$ currency crisis comes, hyperinflation being a form of deflation, the United States will be ground zero. Then things will get dicey real quick. You may want to know how to vanish.

Are you going to watch this mess on the Internet or out your front porch? La Estancia De Cafayate is well positioned should the more dire forecasts about Peak Oil or this worldwide financial crisis come to fruition. Even if the end of world does not happen it will still be a fun place to spend time and have a great batch of people to spend it with. After all, it is not so much where you go but who you go with.

CONCLUSION

How many more wake up calls does one need before they take action and secure a life hedge? Bear Stearns, Lehman Brothers, Iceland, Greece, Portugal, Haiti, Japan, the FRN$ and so many others. When the time for performance has come the time for preparation has passed. I think La Estancia De Cafayate deserves serious consideration if you are looking for a life hedge and we would appreciate the opportunity to help you in that regard so feel free to contact us. For example, Bill Rounds is fluent in Spanish and can help with any legal documents.

The past week has showed the dark side of media coverage and analysis of current events and a test on just how much information you stuff down the public’s throat. In the narrowness of my own world the financial industry has a tendency to produce an extra amount of hyperbole in situations of geo-political tensions and/or natural disasters with unknown consequences. In some sense this is a reflection of one of the oldest theories of finance and economics in the form of the efficient market hypothesis and how it tends to break down in the context of extreme uncertainty. Still, I swear that if I open one more report whose authors are turning self-made nuclear scientists overnight I will bin it!

Yet, the long term consequences of the ongoing upheaval in North Africa and the Middle East as well as how Japan manages to rebound from the worst crisis for the country since the Second World War are important for investors. In the following and with a promise of no mention whatsoever of nuclear fuel, rods, or Chernobyl I will evaluate some of the potential effects on Japan’s economy (and indeed, Edward has beat me to it over at JEW, so do have a look there too).

Saving for a Crisis?

In some sense it is too early start putting a numerical figure for the costs of reconstructing in Japan, but it also almost certain that the economy retains the capability to rebuild itself and thus to stage a strong “technical” growth rebound.

Yet, the crisis may also lead to a number of structural changes.

As a first point I would note that the earthquake is likely to speed up the path towards the inflection point at which the BOJ starts monetizing the marginal flow of Japanese government bonds (JGBs) or Japan starts to borrow externally. In principle, I would hold these two scenarios to be one or the other, but in reality we could see a combination.

Two points are important.

1)      Japan owes much of its growth rate and indeed its ”survival” to a very strong net international investment position. This is crucial to understand. Japan owns much more assets abroad than foreigners own in Japan and this adds a positive income flow which adds to gross national income (GNI).

2)      A strong net investment position essentially translates into positive external savings and  leads to a positive income balance which, alongside the trade surplus (or deficit), makes up the current account . This means that when we speak about Japan as export dependent it is a misnomer. Japan is much more dependent on positive net foreign asset income (the income balance) than the exports of excess widgets. If the CA/GDP is about 3% in Japan 2% is the income balance and 1% is the trade surplus (as a rule of thumb). Obviously, on the margin export flows matter a lot but added together over time the ”national wealth effect” from the income balance is higher.

In relation to the reconstructuring efforts, the standard story goes that Japan would have to repatriate these foreign assets effectively selling foreign assets and getting USD, EUR, AUD etc and converting them back into JPY. This would then lead to JPY appreciation which would further crimp the Japanese economy.

Now evidently, this week’s snappy moves in the JPY has nothing to do with this as this is likely to be a slow process but structurally this may become important and a real challenge for Japan. According the initial judgement of the situation by Fitch, the Japanese insurance industry (and indeed the global re-insurance) existing capital buffers should be plentiful.This suggests that this is a non-issue, but given the evolution of savings in Japan relative to the demand for JGB financing there is alreadt a very large future claim on these foreign assets. More specifically, Fitch is arguing in the context of potentially downgrading Japanese insurers on the capital loss of paying for the rebuilding efforts and thus the analysis can not be directly related to Japan’s foreign assets.

Megan McArdle is less sanguine;

(…) while the global reinsurance industry will bear some substantial losses, in many cases, the losses will be borne by the government–or by people and companies whose insurance does not cover the damage that was done.  The nuclear industry was required to buy insurance through a special industry insurer with liability limits that now seem laughably small–about $2 billion.  And many of the damages simply aren’t insured at all.

In a cynical way, this squares off well with Fitch’ concrete assessment of the insurance industry in that they are likely to dodge the main costs. On the other hand, as Megan also points out, this is certain to put an even stronger strain on Japan’s already overstrained government finances.

Indeed, even if the reconstructing would not drain anywhere close to all of Japan’s foreign assets it would constitute a de-facto claim on these assets either directly or because it would lead to a higher flow of JGBs in the primary market in need for buyers.

There is an alternative of course. As I have argued before, it would be infinitely more attractive for Japan that the BOJ printed money to fund the reconstructing so that the export machine did not falter, but this again would bring the point closer at which the BOJ would effectively be the only bid for the marginal flow of JGBs. You might call this the obviously irresponsive reply, but remember that Japan is still stuck in deflation and thus the cost of such policies is effectively zero at this point.

The big macro picture here is then that Japan may now be forced to run down its only source of savings and essentially its main source of economic growth.

The metaphor here is very simple. Let us say I am unemployed and only earn very little income from the bits and bobs of small jobs I can find (i.e I have a low ”trend growth in income” as Japan does). However, my uncle left me a pool of money and these are all parked in tasty dividend stocks which gives me some income each year so that I can live well.

Now, my house burns down and I have no insurance. What do I do?

Well, I do the only thing I can. I would need to sell those stocks in order to build a new house with the proceeds, but then once my house is rebuilt, my portfolio of dividend stocks will be much smaller and I will earn less dividend income (and I will still unemployed!). This, in a nutshell is the issue for Japan. When I have no more dividend stocks, I go to the bank and they either charge me an interest rate I can’t pay or tell me to bugger off altogether.

And I would re-emphasize that Japan is in a really tight spot  since domestic growth and savings are in a structural downtrend and deflation is now a reality in Japan. So it will become very difficult to rebuilt those external savings.

Now for the good news. On even the worst estimates, it is very unlikely that the rebuilding efforts will eat away all Japan’s external savings and let us remember that Japan won’t sink into the Pacific. But with the power grid in need of major structural overhaul, the ensuing and looming disaster with the nuclear reactors at Fukushima, the general knock to economic growth, the already already public debt overhang etc one would be complacent if one did not think a little about straws and camel backs. Indeed, this is also the conclusion made by Edward;

Serious as the short term impacts may well be, in the longer run the shadow which will be cast by what is currently happening in Japan could well be very long indeed, in a way which few today can even contemplate (although see this for a good first pass). The justification for this assertion is not only our increased awareness of our collective vulnerability to the impact of natural disasters, there is also Japan’s pioneer status in one very new and very global phenomenon – population ageing – to think about. As we will see below, the optimistic (I would say denial) prognosis is that Japan will soon valiantly overcome this latest bout of adversity in a similar way to which they overcame the post WWII devastation. The Japanese will surely be valiant in their efforts (one only has to think of the spirit of sacrifice of those poor workers who have been asked to handle directly the reactor problem), but their ability to overcome adversity will not be comparable to that registered in an earlier epoch when they had the wind behind them rather than gusting straight into their faces.

Shock and Awe by the BOJ?

Even before the earthquake roiled Japan, comments were beginning to emerge that the BOJ was going to be forced into a shock and awe jolt of QE that would trump even that of the Fed. The reasons here though would be the same as they would be now. Essentially, the BOJ is fighting a war on three fronts.

1. General freeze in money markets and general cash/liquidity levels in the economy
2. Backstopping the JGB market which could take a severe knock here. I think Ben is very right to point to the risk that the CDS on Japan is very sticky, once it goes up it does not go down. I mean, why should it really?
3. The JPY.

On the first, I think time is working for the BOJ and after last week’s extreme bout of uncertainty due to the unravelling of the nuclear reactors, pressures should already be easing. I would then hold this to be ”managable”.

On the second, it could get very serious, very quickly and I would be looking closely at the BOJ balance sheet. In this week’s G&F Chris Wood points towards how the earthquake has given the BOJ room for movement;

From a valuation perspective, the Topix is now trading below book value again at 0.96x price-to-book . Global investors should use this opportunity to overweight Japan if they have not already done so. GREED & fear’s bull case rests on two foundations, as discussed here recently (see GREED & fear – An ode to the BoJ, 3 March 2011). The first point is the extent to which Japanese corporates have proven they can live with a stronger yen. This is why it is not necessary any more to believe in a weakening yen to assume an outperforming Japanese market. Second, there are clear indications that Japan has commenced a new property upturn which increases the collateral value of the banking system. On this point the earthquake has “helped” in the sense that it has prompted the Bank of Japan to increase its assets purchase programme of private sector assets, and not just JGBs. Thus, the BoJ doubled its asset purchase programme to Y10tn on Monday, with the maximum amount of purchases in index-linked ETFs and J-REITs both doubled to Y900bn and Y100bn respectively.

Two effects need to be noticed here. One is the effect from the BOJ expanding its balance sheet on equity markets and secondly, there is the need to support the structural deficit spending. On the latter, it is noteworthy that CDS on Japanese long term government debt has been creeping up especially as it may prove quite sticky. This means that the BOJ may need to massage the curve on the long end it stands to reason that mounting concern over long term debt sutainability in Japan could lead to a strong steepening of the curve. This is to say that the long term default risk of Japan could rise very quickly since in the end, they will default at some point so in theory it could simply go parabolic. I am not saying that this will happen, but think about the Eurozone. The ECB is effectively the only buyer of peripheral bonds … it could be the same for Japan and long dated bonds.

Naturally, they could move the financing down the yield curve which could mask some of the default risk as duration changes, but in the end it would be the same. But here I am shooting blanks since I don’t know the maturity schedule of Japan’s government debt portfolio.

Structurally, the BOJ faces two main challenges with the JGBs. One is to soak up the annual excess issuance of JGBs relative to domestic demand and secondly there is the flow in the secondary market as pension funds run down their balance sheets to fund pension payouts.

On the third, nilly willy intervention in the spot market will work for about five minutes and then it will get bid down again. In this context, it was interesting to see that the violent move in the JPY prompted the G7 to intervene. Whether they have the clout to lean against the market here is debatable, but ironically they may soon have to back off if the BOJ starts monetizing debt as the rest of the world tightens.

Japan will Move On

In the end, we should all already be vindicated by the strong resilience shown by the Japanese people in the face of their current tragedy. I am certain that Japan will move on as a people and as a society. However, as a macroeconomy things are looking increasingly grim. We don’t yet know what will really come of the attempts the by G7 to keep a lid on JPY appreciation and failing that, we don’t really know what the world will look like with a BOJ engaged in QE far and beyond what the Fed is currently administering.

The point here is not to kick a country which is already down but simply to face up to the realities that the costs of this truly exogenous shock will weigh down on an already unsustainable economic system. So although Japan may now see the opportunity to push the reset button in a number of corners of society, there is no economic equivalent.

GROUNDED FLIGHTS

With the vast majority flights in Europe grounded there should be a noticeable effect on economic activity. The effects on tourism, collaboration and business will likely be long-lasting. This is an example of why individuals and businesses should work to minimize their risk to geographic location and discrimination.

Despite the obvious that you have to be somewhere; in my own situation I have largely completely eliminated the effect of geography on my own lifestyle and, to a large extent, my businesses and investments. Volcanos, hurricanes and earthquakes are not the main risk I desire to minimize but instead geographic discrimination like what recently happened in Colorado.

GEOGRAPHY AND YOUR HEALTH

Since you have to be somewhere, why not choose a physical location that is good for your health? As opposed to coloured coupons like Icelandic kronars or FRN$s, physical commodities such as wheat, corn, oil, soybeans, water, etc. must also be somewhere. Many highly populated areas, like Linfen, China; Sukinda, India; La Oroya, Peru; Norilsk, Russia; Chernobyl, Ukraine; Tokyo; Mexico City; Los Angeles; Sao Paolo; and etc., are extremely polluted and prolonged exposure to the pollutants can be hazardous to your health. Additionally, some of the inhabitants may actively be your liability.

Can you image breathing that ash? Can it possibly be good for your health?

EYJAFJALLAJOKULL, KATLA AND FAMINE

Oftentimes when Eyjafjallajokull erupts the other much more volatile and powerful volcano Katla also flares up. Oftentimes it seems that natural phenomenon seem to coincide with social, political and economic factors and the overall effects are exacerbated. When it rains it pours. For example, as The Guardian observed:

The Laki volcanic fissure in southern Iceland erupted over an eight-month period from 8 June 1783 to February 1784, spewing lava and poisonous gases that devastated the island’s agriculture, killing much of the livestock. It is estimated that perhaps a quarter of Iceland’s population died through the ensuing famine. … Across the Atlantic, Benjamin Franklin wrote of “a constant fog over all Europe, and a great part of North America”.

What was happening during this time frame? Well, France was engaged in wars and running large government deficits. What do government deficits lead to? Taxation through inflation.

It was no different in France. For example, as Olwen Hufton observed in Women And The Limits Of Citizenship on page 25, the Society of Revolutionary Republican Women was particularly interested in “combating hoarding [of grain and other staples] and inflation.”

And what does inflation lead to? Price controls.

It was no different in France. For example, as Robert Scheuttinger observed in Forty Centuries Of Wage And Price Controls on page 45, The Committee of Public Safety first attempted to set the price for only a limited number of grain products but, by September of 1793, it expanded the “maximum” to cover all foodstuffs and a long list of other goods.

And what do price controls lead to? Shortages and rationing.

It was no different in France. We all know, or should know, the story. Louis XVI, Marie Antionette and others of the distant central government were insensitive to the plight of the middle class and poor who were suffering from disease, pestilence and starvation which were largely an effect of the governmental interference by the ruling class.

And what do shortages lead to? If severe enough then starvation and death.

It was no different in France. Marie even callously said, “Let them eat cake.” When someone loses everything and has nothing else to lose then they often lose it. In this case, the French People lost it, heads rolled, leadership changed and the French Republic was born. The black swan of the French Revolution was completely predictable.

WHY HOARD

So it begs the question: Why did people hoard grains and other staples? Because they were safer and more liquid. They also hoarded gold and silver; taking their capital to geographical locations with less political risk. This series of events; government deficits, inflation, price controls, shortages, starvation and death, have played out, at some point in time, in every populated geographic location on earth. Since you have to be somewhere; why be in these geographical locations during those times?

CONCLUSION

In the next few months I was planning on taking a trip to Europe. This trip may have to be canceled if Eyjafjallajokull or Katla keep burping. I am fortunate enough to choose where to be at what times.

Iceland has already experienced the collapse of their banking system and currency. There has been civil unrest in Iceland. I bet many Icelanders wish they had a life hedge.

I do wonder what effects these volcanic eruptions might have on Europe’s food production over the next few years? With floods in the Midwest, droughts in South America and Australia, desertification in China and tremendous inflation taking place through quantitative easing to fund government deficits for bailing out failed financial institutions; I wonder what effect there will be on the worldwide food production and distribution system. So beware Goldman Sachs; you never know when those black swans will fly in and the current flight 10 landing at gate B5 is just a minor distraction from the real issue.

DISCLOSURES: Long physical gold, silver and platinum with no interest in GS, the problematic SLV, gold ETF or the platinum ETFs.

Of all weather-related disasters in the United States—tornadoes, lightning, floods—hurricanes cause more than half of the damage inflicted, according to the National Science Board (NSB) in its report Hurricane Warning: The Critical Need for a National Hurricane Research Initiative, and this cost is rising each year. Although it’s tempting to blame that rising cost on inflation, it’s actually caused by the ever-increasing infrastructure being constructed on vulnerable coastlines. Granted that not all hurricane damage occurs on the beachheads, and Ike’s swath of destruction slicing north from Texas all the way to Canada and Greenland is a graphic illustration of that; nevertheless it’s a fact that 50% of the U.S. population lives within 50 miles of a coastline of some description, and with the continued investment in infrastructure in these regions, this escalation of devastation can be expected to continue.

My neighborhood escaped with only shingles and branches down, but Galveston, High Island and the Bolivar Peninsula were smashed, and the people who refused to evacuate may never be found. The Chase Tower, the tallest building in the state at 75 stories, was severely damaged, and showers of glass turned downtown into a hard-hat zone. But the 1,600 offshore platforms and 26 refineries in Ike’s path weren’t battered as much as originally feared, with currently only 49 rigs reported lost or seriously damaged and twelve refineries already restarting.

Effects on GDP

The Houston-Galveston area’s economy will take a hit alongside its people and businesses. Asset losses will require months to tally, with early estimates running between $8 and $18 billion of insurance claims. According to the NSB’s report, actual economic losses due to hurricanes are estimated to be double the insured loss, as unemployment and lost industrial production will also weigh on the area. With three million barrels per day of refinery capacity trying to restart, 93% of the Gulf of Mexico’s offshore crude oil production shut in and more of Houston’s industrial and business facilities without power than with it, that hit to local and national gross domestic product (GDP) could be severe.

The diagonal swath of destruction that sliced across the eastern U.S. will push those costs even higher, and the third quarter national GDP reading will take a hit that could drive it into negative territory. Disaster relief funds will drive up the federal deficit and lower the scorecard even further.

After Katrina and Rita struck the Gulf Coast in 2005, national GDP fell from 3.8% in the third quarter to 1.3% in the fourth.

Of course, the rebuilding of Galveston, Houston and all storm-smashed areas will contribute to GDP readings. Sales of home repair materials, dry goods, ice, take-out food and healthcare services will surge; regional unemployment will fall as construction workers, utility repair workers, engineers, insurance personnel, healthcare workers and fast food clerks are hired to meet each area’s needs. Industrial output will initially slump as electricity and services are restored and employees are diverted from production to clean up and safety checks, but each area will soon be back in business.

Far-Reaching Effects

Research conducted by Bradley Ewing and Jamie Brown Kruse of Texas Tech University suggests that while the short-term effect of a severe storm on regional unemployment figures is adverse, the longer-term effect may be positive as communities rebuild, putting people back to work and constructing a more resilient infrastructure.

However, those who point to that fact as some sort of consolation prize for these areas miss the point. These are not new funds generated from the expansion of the local economy; these are funds diverted from other uses, and discretionary purchases will slump as people concentrate on the necessities. Even if a flattened building is covered by insurance, it’s a loss to the insurance company, making the nation poorer as a net result.

The calculated losses from hurricanes do not include now impossible alternative economic scenarios, and no amount of rebuilding can make up for what is lost. Like the financial fiasco drubbing Wall Street, somebody has to pay for it.