No matter how hard global central bankers try to inflate away the intractable debt-bomb that continues to explode in slow motion, they just cannot seem to make any headway.
The folly of QE-1 and QE-2 have done nothing but exacerbate the contrived bubble in monopoly bonds, which is the only fuel known to financial alchemists that enables a fraudulent debt-based Wall Street-Washington-Centric and global economy to function.
Ever since the big end-game bang in 2008, the powers that be are doing everything possible to preserve their totalitarian monopolies.
We all failed BIG-TIME in allowing these statists to re-write the rules and elevate their powers in assigning those responsible best capable of fixing things. They fixed things all right - for themselves. While we had them begging on their knees, we should have let everything fail once- and-for-all, liquidating all of the egregious debts brought about by the grand masters of the financial universe and their enabling fraudulent monopolies. Had we done so, our world would not have ended - THEIR world would have ended, and more likely than not, we would already be well on the road to recovery instead of serfdom. The next time they come calling - and they will come calling - DON'T BE FOOLED AGAIN.
Back to the surrealistic point: Crying out-loud, what banker in their right mind would lend to overleveraged and unfit borrowers at such ridiculously low interest rates. Short of putting bankers at gunpoint or some twisted operational statist equivalent, the excess reserves building in the system are going nowhere until things change and RESET themselves in dramatic fashion.
Short and Near-Term Outlook:
Yes, something certainly appears to be afoot throughout the whole of the financial sphere. Markets seem to be reaching inflection points whereby they are either going to break down dramatically or crack-up in similar fashion.
With tension and compression building to such levels, we suspect the desired statist outcome would be for an erratic non-directional rollercoaster resolution as opposed to a definitive and sustainable run in either direction. Only time will tell which, but no matter the outcome going forward, it is likely to garnish some headlines and attention.
In the chart above, we see gold bumping up against its short-term downtrend at the 1596.50 print high. The rise from 1554.40 harbors potential to affect an impulsive five-wave advance however, the jury remains out, as we show only three-waves of advance thus far.
Bear in mind the failure of a similar five-wave advance, albeit smaller, from the 1564.40 pivot low. At present, gold continues to render lower lows and lower highs, confirming its downtrend of the past 10-months.
The chart is self-explanatory for most however, we will enumerate some contingencies that should enable one to maintain a clear grasp of measure and status over the short-term.
As long as 1554.40 holds pivot low, we cite a 43-pt. buy trigger contingent upon a breakout and sustained trade above the falling green trendline trajectory so noted.
As long as gold is able to sustain trade and closes above 1582, a price target of 1667 shall remain defended.
Upon resumption to the downside, so long as gold is able to maintain trade and closes above 1578, the potential for another leg up shall remain.
As long as 1639.70 holds pivot high, we continue to monitor an elected sell trigger of 77-pts, which carries a downside price target of 1520.
Upon resumption to the downside, especially if 1596.50 holds pivot high, sustained trade and closes beneath the 1578 level will raise odds for a retest or breach beneath the 1554.40 low.
Upon decisive resumption to the downside, as long as 1625.70 holds pivot high, a breach and sustained trade beneath 1556 will trip a 75-pt sell trigger citing a downside target beneath 1485.
"I would today argue there is a momentous unappreciated cost to central bankers' "reallocations" and "incentive distortions:" they've nurtured one massive, and now hopelessly unwieldy, "crowded trade" throughout global risk markets. And, as seasoned traders appreciate, once a trade becomes "crowded" the nature of how a trade - how a market - performs tends to turn highly unpredictable, erratic and, in the end, unsatisfying. Over time, fundamental developments are overshadowed by the brute force of market technicals. For example, "crowded" short positions will tend to "melt-up" into dramatic short squeezes before eventually collapsing. And crowded longs tend to turn highly speculative, yet inevitably susceptible to air-pockets and abrupt downdrafts. Locate a "crowded trade" and you've found a captivating place where it's easy to lose money. In general, crowded trades fuel speculation, unpredictability, and Bubble Dynamics - along with a lot of frustration and eventual disenchantment."
The US and Global economy is turning Zombie-Japanese
If the statists succeed in temporarily solving the incalculable debt-crises by somehow unleashing yet more debt-based money to kick-the-can further, or succeed in gracing us with the potential splendor of experiencing more green shoots than had graced us the last time around, then gold is going to head much, much higher.
We suspect those embedded at the helm of debt-based power, and those entrenched with monopoly control of debt-based money creation would rather preside in totalitarian dominance over a prolonged Japan-style deflationary period as opposed to allowing the system to reset, and affecting the needed repairs to the many structural flaws inherent within it.
As long as markets continue to react similarly to the current statist prescriptions, gold shall remain under the gun of downward deflationary pressures. One needs look no further than the results of what 20-years of zombie-induced deflationary monetary policies have brought to Japan.
Since peaking at $1,920 dollars an ounce in September of 2011, trends in gold have turned down in all three time frames.
Granted, the super long-term secular uptrend remains intact, and it shall remain wise regardless of price, to continually apportion and occasionally rebalance physical possession of gold to a ratio of 10% - 20% of one's entire net worth.
"All the benefits and architectural innovations of the ECB stand in place now as a kind of safety net for the Eurozone for whenever the $IMFS collapses under its own weight. And the signs of this happening sometime soon are ominous and many.
It is easy and convenient for the financial press to blame the Eurozone problems on the euro itself. But I am here to show you that they are actually caused by the dollar system, counter intuitive as that may seem...
The pressure on the $IMFS is building EVERYWHERE! From Greece to California, from the ECB to DC. And what exactly is all this pressure? It is unsustainable deficit spending... DEBT!
And what is the ONLY solution to this? What is the pressure release valve? It is different depending on whether you are a sovereign net creditor/saver or if you are a sovereign debtor.
For the creditor/savers the ONLY solution is CUT OFF THE CREDIT and thereby FORCE AUSTERITY.
If you are a debtor, the ONLY solution is DEVALUE THE CURRENCY, or more precisely, ALLOW the currency to hyper-depreciate.
Yes, default is an option, but not for a sovereign that prints its own money, and not for any too-big-to-fail entities under the umbrella of such a sovereign...
The US dollar MUST devalue (one way or another) against the entire physical world. Think about this.
The euro, on the other hand, might just hyper-depreciate against only one specific asset. An asset that happens to also be a MONETARY asset held by its member debtors.
The hyperinflation of the dollar is already a done deal. It has been since the 90's at least. Massive quantities of perceived dollars already exist stored in debt held globally and inside the US. Europe knows this. They have known this was inevitable since at least the mid-90's when they changed plans and went with higher gold reserves for the new ECB. They have always been willing to wait for it to happen naturally, unless the EU itself faces an existential threat from debt brought on by the $IMFS. And in this case, I believe their only option is a targeted hyper-depreciation of the euro.
By "targeted", I mean that the euro devaluation would be targeted to go only into gold. Gold can absorb a devaluation if you do it carefully, and in turn devalue the debt without causing inflationary havoc.
Of course this would cause the hyper-depreciation of the dollar as well. Only the dollar's collapse would be against all of creation, not just one asset."
Since 2007 our analysis has suggested the likelihood of economic outcomes that most have considered unlikely: significant and ongoing monetary inflation, policy-administered currency devaluation, substantial global price inflation, and an eventual change in how the forty year old global monetary system is structured. Most observers have viewed such outlooks as tail events – highly unlikely, unworthy of serious consideration or a long way off. We remain resolute, and believe last week’s movements in Frankfurt and Washington towards perpetual quantitative easing confirmed and accelerated the validity of our outlook. A summary reiteration seems in order.
We all know QE began a few years ago in the US and UK with the first rounds of base money creation. This debt monetization came on the heels of Treasury’s 2008 TARP bailout, ironically the broad recognition of a tail event – a credit crisis that had been quietly building for years. Since then, global central banks have been taking turns diluting their currencies through repeated base money issuance, devaluing one at a time against the others. While prices of goods and services bought on credit have since been soft, declining or rising only mildly to reflect the natural demand for credit; monetary inflation has pressured prices of unlevered items with inelastic global demand properties higher, most notably precious metals and natural resources.
(We caution against believing that an increase in aggregate global demand, bad weather, impending conflict in the Middle East, or overzealous futures market speculators have been the cause of higher commodity prices. Such conditions represent a natural and ongoing state and commodity supplies adjust. Rather, we argue there is now far more paper chasing basically the same global supply/demand equilibrium for various commodities, and so resource producers are demanding the same purchasing power in exchange by raising nominal prices.)
Logic and history do not support a correlation linking base money growth to sustainable real output growth. At best, there is a lag period that may ultimately result in temporary nominal output growth. While base money inflation may ostensibly bring forward the time until a new credit cycle can begin (because it de-levers bank balance sheets), such a policy raises global resource pricing coincidentally. Resource providers have incentive to raise prices immediately, yet there is no such market-driven incentive among consumers to increase borrowings.
The money flow today is viscous, to say the least. Against this backdrop, there should be very little pretense among objective observers that last week’s perpetual QE announcement could actually provide real economic stimulation. From a policy management perspective, central bankers are no doubt aware that consumer demand is unaffected by base money inflation unless and until a new credit cycle emerges. As we have seen, newly created base money is not finding its way to debtors or to fully-reserved private sector creditors, but is instead being parked on the balance sheets of under-reserved banks (and ironically called “excess reserves”). In reality banks are de-levering their loan books with newly-created reserves they have lacked.
The specific (but not fully articulated) goal of the Fed and ECB is nominal money stock growth via unreserved bank credit growth. This is pro-leveraging in general and is usually a win/win for banking systems and broader economies; however, it is lose/lose when unreserved bank credit ceases to grow or begins to contract, as is currently the case. So, nominal base money growth, to which central banks have now gone all-in, is orchestrated with the primary goal of restoring nominal bank credit growth and, only tangentially, nominal output growth.
Is what’s best for banks best for their economies? From 1982 to 2007 the two objectives were aligned, at least temporarily. Increasing unreserved bank credit growth allowed the majority of households and businesses to use leverage to build capital and the appearance of sustainable wealth in real estate and financial asset portfolios. In the current economic environment; however, it seems impossible to determine whether banks even have the ability to expand their balance sheets further, thereby providing the basis for a new cycle of credit expansion, or whether consumers have interest in assuming more debt. Nevertheless, policy makers and most professional observers see base money creation as the only option remaining to sustain over-leveraged economies, and so they seem united in looking the other way while the non-bank private sector (primarily unlevered savers) effectively bails out the global banking system, and while the takers of credit (debtors) continue to languish.
The balance sheets of non-bank creditors and debtors are not being improved and base money inflation can do nothing for sustainable real demand, real income, or real returns on most financial assets, and so the economic merit of QE is rather dubious. Simply, central banks cannot de-leverage credit systems in real terms (a relative concept) by promoting the expansion of the credit stock in nominal terms (an absolute objective).
Let’s further summarize and explore current events:
• Further base money creation through debt monetization is the most politically viable means of de- levering banking systems, which seems to be the true priority of central banks. The only economic rationalization for QE∞ is eventual flow-through credit expansion from banks to the rest of us, which theoretically could temporarily increase financial asset prices and economic activity.
• Last week, Chairman Bernanke said:
“The tools we have involve affecting financial asset prices. Those are the tools of monetary policy. There are a number of different channels. Mortgage rates, other rates, I mentioned corporate bond rates, also the prices of various assets. For example, the prices of homes: to the extent that the prices of homes begin to rise, consumers will feel wealthier (and) they’ll begin to feel more disposed to spend. If home prices are rising they may...be more willing to buy home(s) because they think they’ll make a better return on that purchase. So house pricing is one vehicle. Stock prices: many people own stocks directly or indirectly. The issue here is whether improving asset prices will make people more willing to spend (i.e. more willing to borrow – Ed.). One of the main concerns that firms have is that there is not enough demand...if people feel their financial position is better (then) they’ll be more likely to spend...”
To which we would inquire in response: “what exactly does Mr. Bernanke expect consumers to spend and what does he expect consumers to demand?” Plainly, the Chairman hopes easier credit conditions would bring higher financial asset prices, which in turn would induce consumers to assume more debt with which to consume goods, services and even more assets. The implication is obvious: the Fed’s only hope is now reduced to trying to re-ignite a credit bubble ahead of commodity price increases, which in turn increases input costs for finished goods, reduces economic activity, and transfers wealth to resource providers from resource consumers. As noted above, real growth cannot be orchestrated through this policy. (Could the Fed be guilty of relying on an econometric model that adjusts supply and demand in one currency, without considering the incentive of global resource producers to migrate away from currencies being diluted?)
• As the Fed continues monetizing MBS, mortgage and other tertiary market yield spreads (including equity dividend and earnings yields) should continue tightening to Treasuries. We would expect policy makers to greatly encourage further declines in nominal mortgage rates in the hope of a renewed housing boom. This would imply the need to further drop Treasury yields with five to seven year durations to maintain a positive spread. Financial asset markets should generally continue to rise in nominal terms (the outcome Chairman Bernanke targeted in his comments last week). Since the economic efficacy of such a financial scheme relies on both homebuyers’/refinancers’ willingness to assume more debt for larger or newer homes, and on further Treasury yield subsidies, it seems obvious that $40 billion/month in MBS purchases should be considered the minimum for future QE.
• We believe QE via debt monetization in this manner will not provide economic stimulus. Homeowners use rational cost/benefit analyses. Lower home re-financing rates or potential home equity gains would have to be perceived by the public to be worth the risks of potential illiquidity and equity losses, risks they recently experienced. Given already record low mortgage rates, low home equity levels, a zero-bound rate structure, an overcapacity of existing homes, and an aging US population, we would argue that significant re-leveraging will not occur in the US housing market. Central banks would need to find another outlet for consumer credit to successfully stimulate economic activity.
• Most of the largest global sovereign economies rely directly on a finance-based model for nominal output growth – a model wherein increasing public and private balance sheet leverage drives nominal GDP higher, which further helps to service outstanding nominal debts with the creation of incrementally new nominal debts. Output growth in more commercially-driven economies, notably China and Germany, also relies greatly on further consumer leveraging in finance-based economies.
• Without a black swan innovation that affects the capital producing potential for a great number of workers in finance-based economies, it is highly unlikely that developed and developing economies can experience real output growth (nominal growth adjusted for debt growth and purchasing power loss across all currencies relative to items in relatively fixed supply with inelastic demand properties).
• We continue to believe the logical economic outcome is global stagflation – stagnant or contracting global real output coincident with substantially rising prices of commodities and rising input costs of finished goods. A trend towards stagflation seems to have been firmly set in motion already.
• Unlike 1979-1980, monetary policy makers will not be able to resurrect the purchasing power of their currencies by raising interest rates (or this time by withdrawing base money from the system), because the balance sheets of governments, banking systems and households are already deeply indebted, impaired, and unlikely to be meaningfully improved without currency devaluation. Tightening credit in the current environment would most certainly bring on a deflationary depression.
• Once banks are deemed to be sufficiently de-leveraged through debt monetization, we believe central banks will begin monetizing assets as a means of explicitly devaluing their currencies. As we have argued, the asset of choice will be the only monetary asset already held by global treasury ministries and central banks and the one with recent precedent collateralizing global currencies – gold.
• The policy-administered currency devaluation we have envisioned would involve a central bank publicly tendering for gold at an increased exchange rate (i.e. price). For example, the Fed would purchase gold with newly created US dollars, which would bring the ratio of USD-denominated credit- to-base money back into line, thereby de-leveraging the system. (This inflation would increase prices and wages relative to outstanding debt balances, greatly reducing the burden of debt repayment.) Global currencies might be re-pegged to the US dollar which would in turn be exchangeable for gold at the higher price, as per the Bretton Woods system. Of course, other central banks might try to make their currencies exchangeable directly into gold at another exchange rate. (We await the arbitrage.)
• Were a USD devaluation and re-pegging to occur as of the end of 2014, following 2 1⁄4 years of $40 billion monthly MBS debt monetization, we estimate our Shadow Gold Price would approximate $15,000/ounce. (The SGP divides the quantity of USD base money by the quantity of US official gold holdings, as per the Bretton Woods monetary regime.) Over the weekend, Bank of America analysts implied USD base money inflation would increase much more than the Fed announced, to about $5 trillion by the end of 2014.1 This figure would imply an SGP a bit over $19,000/oz.
We are often asked when we see our scenario playing out. Our answer has always been twofold: first, current conditions and policy responses confirm it is playing out now; second, it is impossible to say when the parabolic “catch-up” phase gets underway because that depends on the interplay between the general public’s understanding of the forces behind consumer goods and service price inflation, the pressures on real returns in most financial assets, and the reflexive political pressures and policy responses to them.
Nevertheless, we suspect last week’s events, in which both the ECB and Fed committed to open-ended base money creation – against a geopolitical environment in which China’s USD reserves are being held astride an increasingly dynamic domestic political regime and in which the petro-dollar regime of the past forty years seems under attack – may be the catalyst that begins to raise public awareness of the link between monetary inflation and price inflation.
Inflation indexes such as the CPI are contemporaneous indicators of price level changes. If our analysis is right, very little capital will be properly positioned when consumer price indexes begin to flare. The relatively tiny current universal allocation towards perceived “inflation hedges” seems to bear this out.
We believe significant real Alpha will be generated by those properly positioned first for significant monetary inflation and monetary regime change, and second for significant price inflation. We believe nominal returns using this sequencing will be substantial (far greater in fact than were available to short positions in sub-prime loans in 2007). We do not take responsibility for investors reading our comments that may invest directly in perceived inflation plays including real estate, precious metal ETFs, inflation-indexed structured products, or various commodities that for one reason or another we do not endorse. We take full responsibility only for the performance of our funds.
47% of US investors dependent on the Fed believe they are victimized by government, who believe they are entitled to enough liquidity to profit when risk is laid-off onto others, to society, to you-name-it…
On September 13th, the Fed announced QE3, a policy of open-ended bond purchases which would add $1 trillion annually to the Fed’s balance sheet. The Fed’s decision to provide liquidity ad infinitum, i.e. QE etc, was framed in reasonable and carefully chosen language:
…These actions, which together will increase the Committee's holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative… Read here.
The measured wording gave the Fed sufficient cover to mask its increasingly desperate condition, i.e. how to keep its fatally-wounded credit and debt ponzi-scheme functioning while searching for a solution that doesn’t exist.
CAPITALISM’S CONSTANTLY COMPOUNDING DEBT IS THE DEVIL’S WHIP OF GROWTH
In capitalist economies, capital, i.e. money, is introduced by central banks into the economy in the form of loans; and because interest constantly compounds, economies must constantly expand in order to pay down and/or service those loans. This is why economists in capitalist systems are obsessed with growth.
Capitalism is, in actuality, a smoke and mirrors shell game where credit and debt have been substituted for money; and, as long as capitalism expands no one is the wiser because the fraud is so subtle. Capitalism, however, is no longer expanding. It is contracting.
Capitalism reached its peak in 2008 when Greenspan’s historic credit bubble burst. What investors believed was a finely-tuned balancing act between credit and debt orchestrated by Fed Chairman Alan Greenspan turned out instead to be a speculative bubble fed by Easy Al’s easy credit from the Fed’s 24/7 discount window.
While Greenspan presided over the greatest credit expansion in the history of capitalism, Greenspan also presided over two of its largest speculative bubbles - the 1996-2000 dot.com bubble and 2002-2007 US real estate bubble. Greenspan would later refer to evidence of these bubbles as ‘froth’; to those who lost homes and fortunes, it was blood.
(Click on images to enlarge)
THE 1990 JAPANESE NIKKEI – THE MOTHRA OF ALL BUBBLES
The collapse of Greenspan’s two massive bubbles followed the spectacular collapse of the Japanese Nikkei. The catastrophic crash of Japan’s stock market in 1990 was the world’s largest since the US stock market had collapsed in 1929.
In Time of the Vulture: How to Survive the Crisis and Prosper in the Process, I wrote: …fueled by excessive amounts of liquidity, [the price of Japanese real estate and stocks] exploded upwards. Japanese real estate prices increased 70 times over and stock prices increased over 100-fold, with the Nikkei reaching a market top at 38,992 in January 1990.
As with all speculative bubbles, the Nikkei collapsed - and the collapse of the Nikkei in 1990 unleashed deflationary forces not seen since the Great Depression of the 1930s. Prices of stocks and real estate in Japan began a long and steep multi-year descent.
Commercial real estate lost 80% of its value in the next decade and the Nikkei fell from 38,992 in 1990 to 8,237 in 2003. Deflationary cycles are long and protracted and if not stopped will become deflationary depressions, an economic phenomenon for which there are no ready answers.
In 1990, Japan escaped a complete deflationary collapse only because Easy Al’s credit bubble was underway in the West. Rising credit-driven Western demand combined with Japan’s high savings rate helped slow Japan’s inexorable descent into deflation. Nonetheless, after 1990, Japan would need to borrow increasingly large amounts of money in order to survive and borrow it did.
After the 2008 economic rendering, the central banks of the US, the UK and Europe have joined Japan in the desperate need to constantly increase money-printing to keep their economies afloat; and while reviving growth is their announced goal, the unspoken intent is to avoid a fatal deflationary collapse in demand.
As Credit Suisse recently noted: …Japan’s titanic struggle with private sector de-leveraging has spread to the rest of the developed world. Rapid succession of asset bubbles (at least 12 since 1980) led to the global private sector de-leveraging causing deflationary “winds”, regularly stalling global growth and leading to waves of expansionary public sector response.
While the extent of an asset price collapse in Japan was far more severe than either the Dot.com or Subprime crises, the basic dynamic of subsequent response (i.e., private sector moving from borrowing to net lending, forcing public sector into stimulatory monetary and fiscal policies) was essentially the same in Japan in the 1990s as it has been in the US, the UK or Eurozone since 2008. Read here.
The Fed, the Bank of England, the European Central Bank and the Bank of Japan are all having to print more and more money to keep their economies functioning
CENTRAL BANKES ARE NOW PRINTING MONEY AD INFINITUM
EVERYTHING ENDS; EVEN AD INFINITUM
On September 18th, Ambrose Evans-Pritchard’s commentary in The Telegraph UK was titled Japan launches QE8 as 20-year slump drags on. Evans-Pritchard noted that QE8, Japan’s latest round of quantitative easing, i.e. money-printing, is only the latest of Japan’s serial attempts to avoid a deflationary collapse.
Although Japan has survived deflation’s endgame for over 20 years, the US, the UK and Europe will not be so lucky - nor, this time, will Japan. With all major economic zones deflating simultaneously, the West’s demise will be far quicker than Japan’s protracted agony; and when the West collapses, this time Japan will collapse with it.
The US, Japan, and Europe are all trapped in deflation’s ever-widening net, i.e. a constantly expanding liquidity trap.
We’re trapped too - unless we own gold and/or silver.
QE3: THE BANKERS’ MONETARY DEATH MARCH
In 1949, the Austrian economist Ludwig von Mises wrote in Human Action:
The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved
Von Mises words, written in 1949, are being played out today. In the intervening years, bankers did not abandon credit expansion. They did the very opposite. After WWII, bankers continued expanding credit until what von Mises called a crack-up boom occurred - where excess credit and money drive valuations to all time highs (from 1982-2000 the Dow rose from 777 to 11,723, a increase of 1400% in 18 years).
The collapse of financial markets in 2008 signaled the beginning of the end; and ever since then, central bankers have been printing more and more money hoping to stave off a final collapse.
Money-printing, however, will not prevent capitalism’s systemic collapse. It will, in fact, do the opposite. Collective central bank money-printing will trigger a final and total catastrophe of the currency system as von Mises predicted.
In August 2008, in Gold and the Collapse of Paper Money , I wrote:
We are about to see a variation of [the Great Depression], except this time it will be worse because this time sovereign monetary defaults will accompany the defaulting of debt and the contracting of credit. This time money itself will be a victim. Fiat paper money systems have always ended in failure. This time is no exception.
QE3 is the beginning of the bankers’ monetary death march. Central banks in Japan, the US and Europe are now openly engaged in massive monetary debasement, printing more and more money in the futile hope they can reverse the deflationary collapse now in motion. They can’t.
They can, however, in trying to do so, instead destroy the currency system.
On October 6, GoldMoney posted my podcast with Robert Wenzel of EconomicPolicyJournal.com. In that podcast, Wenzel expressed concern about the future inflationary implications of the build-up of excess reserves on the Federal Reserve’s balance sheet. Excess reserves represent balance sheet cash parked at the Federal Reserve Board by commercial banks.
Being the banks’ own money, they can gear up their balance sheets on it whenever they choose to do so. However, putting aside the gearing potential of excess reserves, we should at least treat it as cash, despite it being regarded as out of public circulation. There is therefore a strong case for it to be included in the True, or Austrian Money Supply quantity.
TMS is basically cash plus instantly encashable accounts. The chart below is of TMS plus excess deposits at the Fed from 1960 to the present day.
Worryingly it conforms to a hyperbolic curve, which is already going vertical in the fashion of a hockey-stick. Where this measure of money has deviated from the hyperbola it has done so by increasing faster than the hyperbola itself. But if it had not been for the creation of a new class of money market deposit accounts in December 1982 together with the Super NOW accounts a month later, it would have followed the hyperbola almost exactly. These new accounts represented a sudden transfer of money from broader money to TMS, and similarly, other deviations from the hyperbolic trend can be often attributed to swings of money to and from broader monetary measures.
Not surprisingly, the pace of money creation is now having difficulty in keeping up with the hyperbola, which today is accelerating at over $300bn per month. Not even the Fed’s creative powers with QE3 of $85bn per month can keep up with it.
But does it have to? An accelerating monetary trend is basically an indication that ever-greater amounts of money are required to achieve a monetary objective; we normally associate such a curve with a collapse in purchasing power of the money involved; but so far this is not happening. In this case it simply indicates the increasing amounts of money required to fund government obligations and to keep multiple market bubbles from deflating. The effect on prices for goods comes later.
We can be sure the Fed doesn’t want to look at things this way; but now that the increase in TMS plus excess reserves is beginning to lag behind the curve, it indicates that monetary policy is failing. Alternatively, it shows the difficulty for monetary policy alone to rescue us from our economic ills.
Confirmation of this alarming discovery is to be found in the chart below, which is of gold from 1900 onwards, and has its own hyperbola. I first published this chart, which was sent to me by an astute reader, last December.
The green hyperbola is the lower bound, established by the Roosevelt devaluation in 1934, the failure of the London gold pool in 1968, and the end of the recent price consolidation this year. The blue hyperbola was shown on the original chart, and together they represent confirmation of the ultimate collapse of paper money.
"Gold is the only money the world has ever known"
Sounds like a simple thought, but it isn't. To understand the following you must rethink your basic
knowledge of money and investments. Get your aspirin ready.
What will change is how we view money and wealth.
Everything else in Freegold flows from that!
My purpose in writing this post is to state my personal view of the concepts of money and wealth as clearly as possible. I think that my view is useful in both understanding our unfolding present landscape as well as profiting from that early understanding. There are other views of money and wealth which are much more widely accepted, and I hope to explain why I think their biggest flaws are found in their useless conclusions and the destructive prescriptions to which they logically lead.
Anyone who chooses to read this post is free, of course, to take it or leave it, because all I care is that you see and consider it. If there's one thing I know, it's that I cannot claim credibility for myself, that judgment is up to you. So think of this post as a "stack of rocks" marking this spot on the trail. And since I can't say it any better than FOA did a decade ago, here's what I'm trying to say:
FOA: "I (we) expect none of you to consider anything said here as credible. Everything is given as I understand it. If you came with a notion that I am someone who sees the future, grab the children and run far away. For these Thoughts, and my ongoing commentary, are meant to impact exactly as the "gentleman" said they would. People hear them, and whether believed or not, the words leave a mark. A mental mark on the trail, if you will. And later, after the world turns, our little "stacks of rocks" will be easier to understand next time you are passing this way. In fact, your ability to find your own way will forever be enhanced for having seen this path in a different light."
There is no authority for the money concept
The first thing that is important to understand is that money (and later banking) was never designed, patented, invented and then rolled out such that we can pull up the original plans and put centuries-old debates to rest. It simply emerged over thousands of years. There is no original set of rules and definitions. There is only reality, a menu of different perspectives from which you can choose to view reality and the conclusions that are logically drawn from each perspective, and then how useful those conclusions end up being in hindsight.
Economists and philosophers, from John Locke to Adam Smith and Jean-Baptiste Say, to Marx and Menger, Mises and Keynes, Friedman and Hayek, to Minsky and Rothbard, have, for centuries, been adding their perspectives to the debate and collective understanding of the emergent concepts of money and banking. This has led to several formal schools of thought on the subject which I argue can be generally divided into two camps—the easy money camp and the hard money camp.
I'll tell you right up front that I think my perspective is far more useful, especially right now, than those offered by either camp. But one of the revelations that I found most vexing while walking this trail was that, in terms of describing money, the easy money camp has always been closer to reality than the hard money camp. Even so, the usefulness of the (macro and micro) conclusions (and prescriptions) coming out of both camps has run the gamut over the last few centuries due to what I think is a fundamentally flawed view of the big picture—a flaw which, in and of itself, has set the two camps perpetually and unnecessarily at odds with each other.
I make no prescriptions here, only observations. Even the personal action I endorse for savers—buying physical gold bullion coins and bars—is not recommended beyond what you understand. In other words, I don't even need to recommend it. If you understand, you will do. But if you do without understanding, your results may vary.* So I'm only sharing my perspective and, if it makes sense to you, you'll know what to do with it.
The goal of this post is to present a lens through which you can see the true role of money and wealth/savings in your daily life today and in the Freegold future. Only time reveals all things, including the full extent of any reward for understanding changes ahead of time and then acting with the full force of that understanding. But I can tell you, from personal experience, that there is an immediate reward from understanding something and then acting upon that understanding. And that reward is peace of mind.
In as few words as possible
Since I'm writing at length here, I thought I'd start out with a kind of abstract for those who can't stand long posts. Blondie once asked me how I would describe money in as few words as possible. My answer was: "Money is credit." I followed that up with a little more detail: "More specifically, it is the recording of current balances of credit. It can be recorded in your head, represented on an institutional ledger, or carried in your pocket as pieces of paper or metal with numbers recorded on them. But notice that it's the recorded numbers and not the paper/metal in your pocket that constitutes the money."
But you can't possibly understand the pure money concept without also understanding the wealth concept. The pure concept of wealth is really simple. It's only attribute is possession (or at least unambiguous ownership of something tangible, if it's not in your immediate possession). Your wealth includes all of your owned possessions, from the air you breathe down to your comfy, worn-out slippers. Value is subjective—it's in the eye of the beholder. Value comes from utility (usefulness) to the user. If something in your possession has no use to you, no value, then it is likely that you won't go to the hassle and expense of continuing to possess it. You'll probably just throw it away. So possession is the distinguishing characteristic of wealth, which also puts wealth squarely in the physical plane.
What sets your gold apart from your stinky slippers and other items you possess is that it is the most tradeable—tradeable wealth! Imagine that! It is tradeable because someone else values it too, unlike your slippers. But not only does someone else value it, but almost anyone anywhere in the world values it nearly equally, even the Giants! How many of your other possessions would measure up to the quality standards of a Giant? None, I imagine. This is what FOA meant by "equal footing".
That's basically it in a nutshell. Those who have been following the comments know that Blondie prefers the term "credibility" more than "credit". It's a fine line, and I could go either way. In this post I'll use both words almost interchangeably, but I think I'll stick with "credit" as the closest proxy for the pure concept of money.
Okay, I guess a few more words are needed
Think of it like this. Value is subjective—it's in the eye of the beholder. You value your slippers, but no one else does. Gold is the one item in the world that comes closest to having a relatively objective value because your knowledge that others value it for the same reasons you do is the very reason you value it in the first place. It's the reason behind gold's utility as a store of value or, phrased another way, a wealth reserve. Salience is a good descriptor.
Credibility, like value, is also subjective. But unlike value it's not something you can claim for yourself. Only someone else can judge you credible. Ergo, credibility must be earned. It is subject to the judgment of others. Credit is like spendable credibility. Money is the fungible exercise of credit (accepted everywhere, even by those who don't understand why you're so darn credible even when you're wearing such ugly slippers). A bank doesn't really give you credit. You earn it before you ever walk into the bank.
If you want to buy a house, you don't need to have saved the full price of the house. All you need to have is earned credit/credibility. You walk into the bank, the bank checks your credit and, if it is not found wanting, facilitates the fungible exercise of your credit/credibility. And then, because it's now fungible, it circulates!
The real world operates on massive amounts of credit. And by real world, I mean the businesses that make everything in your life. Credit is not just about consumer credit cards, evil speculators maxing out their margin and housing bubbles. And the hard money view of "money" as something we all want to hoard is just as pedestrian a view as thinking credit (or debt) is something intrinsically bad.
Money has always—ALWAYS—been credit/debt. That's not bad at all. Debt is simply credit (or credibility) fungibly facilitated and then exercised!
Here's what I think.
What will change is how we view money and wealth. Everything else flows from that. But it is not our change in view that is causing the transition. It is the other way around. The transition will cause a widespread change in view. What is causing the transition is the de facto failure of the present system.
In the future, I think that if you are saving for something known, especially something with a known currency price like a down payment or a car, you'll save currency or "money". But if you're saving for the unknown future, you'll apply your new found understanding of the difference between money and wealth and you'll probably choose gold, the most salient and liquid of the tradeable wealth items.
This view even scales up from the individual to the national or regional level. I think that short-term trade imbalances—due to known factors that are expected to be short-lived—will be recorded in currency or even debt terms. But structural or long-term imbalances will be settled in gold through the open market, effectively eliminating structural or long-term imbalances.
Gold is real, tradeable wealth. Money is not wealth, no matter how well it is managed. You will understand this distinction in the future and you will act upon that understanding.
Today I hold gold for the expected revaluation, because the weight of gold that I find I can still buy because the former system is still functioning is so vastly disproportionate to the relative shrimp I am. But even after the transition, I expect that I'll still feel the amount of gold I possess is vastly disproportionate to my "size". So I expect that I will, at that time, apply my new understanding of wealth and trade some of my gold for other tradable wealth items that are better suited for display and enjoyment in life than gold.
There's a reason I keep mentioning other "hard assets" like antiques, fine art, classic cars and high-end real estate when talking about Giants today. That's because those items are the closest thing we have to "Freegold-like savings" today. And yet they are only accessible to the Giants because of their nose-bleed prices. But they are still quite inferior to Freegold. They are not as portable, durable or liquid as gold, but most importantly, they are not divisible like gold which, as FOA said, puts us shrimps "on equal footing" with the Giants!
Another recent debate in the comments was whether our central plannerz of the future will target consumer price inflation, monetary inflation or the price of gold to achieve stability.
Here's what I think.
I think that this whole question is somewhat "old paradigm" thinking. In the "new paradigm" I think I'd say that the real economy will manage the money supply since, as I proposed above, "money is a reflection of the amount of credibility in the economy currently being exercised and circulated."
Of course the monetary base will still be subject to abuse by governments in places where, unlike the Eurozone, the government retains ultimate control of the central bank. But like I said above, I think you'll find that the risk of fiat currency abuse is worth the innumerable benefits, especially once there is a systematic and foolproof way to protect yourself from the worst of it!
And remember, this is why Wim Duisenberg so proudly stated that the euro "is the first currency that has not only severed its link to gold, but also its link to the nation-state." I don't really think the euro architects came up with this ground-breaking idea because they thought they were smarter central plannerz than the Superorganism!
FOA : In this light we should know that our real things in life will not change all that much. Your tools, chairs, clothes and cars will remain yours. Houses and land, TVs and boats, all will retain the exact same "value" they always had. What will change is our ability to use our currency and paper assets as a medium to measure the "real value" that's always so inherent in these items, yet so well hidden in our perception of today. Yes, the currency price of things will greatly change, even as their "use value" moves little. Such is the nature of dying paper money systems. Such is the ending of a currency timeline!
ARI : So you see, learning how the world works is all about each man coming to the understanding about the real wealth we all require to best ensure our survival. Knowing that Gold is the master proxy for our life's day-to-day and year-to-year shifting requirements for food, clothing, shelter, and energy, it simply makes more sense to gather in Gold for later use than to gather in clothes (that we may outgrow,) food (that may spoil,) houses which are more than our needs, or energy (that we can't store.) You see, time bears witness to this undeniable fact: Gold can be called wealth because it is an enduring wealth proxy in exchange for our life's needs. Currency, on the other hand, serves a specific modern economic purpose--to be borrowed and inflated in placation of man's immediate desires. It is not wealth, it fails as a proxy for the Gold it tries to immitate. Do not confuse the two.
Understanding how the world works is easy as soon as you understand the Wealth Hierarchy. Like this: Earn money/currency, buy what you need, save Gold, enjoy what life has to offer.
Mark Twain wasn't writing about the gold market when he made his famous quote about historical recurrence, but he could have been, as the gold market has been "rhyming" every 21 months.
Every 21 months there has been a major peak in the gold market, going back to the start of this bull market, over 13 years ago. Gold is now 8 months from the next scheduled 21-month peak, which should arrive in July 2013.
The gains in each cycle have ranged between 80% and 97%, from the low of each cycle up to the top. This is surprisingly little variation, at least as far as financial markets are concerned. This is about as steady as it ever gets.
If it happens again, gold will be around $2,700 in mid-2013.
So far this particular 21-month cycle is tracking well, as gold is primed and ready for launch into the final major growth phase.
This chart shows the monthly fractal dimension of the gold market, which is a specific measurement of the linearity of a price pattern. Essentially it is telling us whether a market's movements more resemble a line, with prices moving from Point A to Point B (fractal dimension of 1), or whether the movements are more haphazard, with the movement more resembling a plane (fractal dimension of 2).
Although not a lot of people stop to think about it, when we enter a market we are attempting to capture just this type of linear movement, with a market moving from our entry at Point A to a profitable exit at Point B. This is where the fractal dimension comes in, to let us know when the probabilities of capturing such a move are in our favor, and also when the linearity of a trend is "maxed out." It's very valuable information.
When the fractal dimension of a market is high, it is loaded with available energy and ready for a major trend. Right now the fractal dimension of the monthly gold chart is as high as it's been during the entire bull market, meaning there is more energy now embedded within the pattern to power a strong trend than at any other time in the past 13 years. An 80%+ rally is definitely within reasonable expectations for this cycle.
There are specific reasons why the number 21 is so important in market cycles, having to do with the fractal nature of financial markets. Something is fractal when it is self-similar in all sizes and time-frames -when the small parts look like the big parts. The patterns are the same at every scale.
A fractal system is therefore governed by scaling factors, and in markets these scaling factors describe the way prices expand and contract. But here's where it gets really interesting: time in markets also scales according to fractal patterns.
86.6 is the universal scaling factor for time in markets. I realize you have to take my word on this in such a short article, but it's not a coincidence that the human life span is 86.6 years, as we are also governed by this cycle. One-quarter of 86.6 is 21.65, which is why the drinking age is 21, and also why the retirement age is 65 years, the ¾ point of our human cycle.
Fortunately you don't have to just accept my word that the gold market is organized along this 86.6-based fractal time scale. The chart below shows a spectrum analysis of the cycles in the gold market, performed by a clever left-brained individual named Sergey Tassarov back in 2007.
In my opinion, the other cycles identified here are harmonics of the dominant 21-month cycle, similar to the way in which musical notes have overtones.
Let us start by looking at the economy from 10,000 feet above: After 40 years of boozing on easy money and feasting on fantastical asset price inflations, the global monetary system is approaching catharsis, its arteries clogged and instant cardiac arrest a persistent threat. Most financial assets are expensive, and many appear to be little more than securitized promises with low probability of ever delivering payment in full. Around the globe, from Japan to the US, a policy of never-ending monetary stimulus consisting of zero interest rates and recurring rounds of ‘quantitative easing’ has been established aimed at numbing the market’s growing urge to liquidate. Via the printing press, the central banks, the lenders-of last resort, prop up banks and financial assets and simultaneously fatten the state, the borrower of last resort, which, despite excited editorials against the savage policy of ‘austerity,’ keeps going further into debt almost everywhere.
‘Muddling through’ is the name of the game today but in the end authorities will have two choices: stop printing money and allow the market to cleanse the system of its dislocations. This would involve defaults (including those of sovereigns) and some pretty nasty asset price corrections. Or, keep printing money and risk complete currency collapse. I think they should go for option one but I fear they will go for option two.
In this environment, how can people protect themselves and their property?
My three favourite assets
My three favourite assets are, in no particular order, gold, gold and gold. After that, there may be silver, and after a long gap of nothing there could be – if one really stretches the imagination – certain equities or commercial real estate.
We are, in my assessment, in the endgame of this, mankind’s latest and so far most ambitious, experiment with unconstrained fiat money. The present crisis is a paper money crisis. The gigantic imbalances that threaten to unravel the system momentarily are the direct consequences of years and decades of artificially cheap credit and easy money, and are simply unfathomable in a hard money system. Take away fiat money and central banks and our current problems would be inexplicable. (If you are still under the widespread but erroneous impression that the gold standard caused the Great Depression you may want to consider that the strictures of hard money were systematically disabled and the disciplinary power of a true gold standard increasingly weakened with the establishment of the Federal Reserve in 1913, and the introduction and spreading of lender-of-last resort central banking in the US financial system. In any case, we are now in the Greater Depression, and this one is entirely the responsibility of central banking and unlimited fiat money.) Whenever paper money dies, eternal money – gold and silver – stage a comeback. We have already seen a major re-monetisation of gold over the past decade, as the metal again becomes the store of value of choice for many investors. This will continue in my view, and even accelerate.
Gold is money A frequent allegation against gold is that its non-monetary applications are minor and do not justify the present price, and that gold doesn’t pay interest or dividends, quite the opposite, storing and insuring it incurs running expenses. Gold is an instrument with a negative cash yield.
None of these objections stand up to scrutiny. They are either wrong or irrelevant.
It is investment goods that are supposed to offer cash yields – interest income or dividends. But gold is not an investment good, it is a form of money. Gold is the oldest form of money still considered a monetary asset today, and the only truly global form of money (besides silver but silver is today still more of an industrial commodity than a financial one). Gold is – importantly – inelastic money. It cannot be created nor be destroyed by politicians and central bankers. It can, of course, be taxed and confiscated, and I come to that later.
The main alternative to gold is therefore not bonds, equities and commercial real estate but cash, i.e. state paper money. The person who ‘invests’ in gold is holding money. The cash in your wallet or under your mattress does not give you a cash return either. Neither does gold.
Sometimes I get asked, what if people suddenly stopped considering gold to be a monetary asset and a store of value? Would its price not drop steeply? – That is a fair point. But this applies to your paper money, too. In fact, it applies to paper money more so.
Every monetary asset – whether gold, paper tickets from the state, or electronic book-entries at your bank – receives its value (exchange value or purchasing power) from the trading public, and from nobody and nothing else, not from the state, nor from any non-monetary uses of the monetary asset, if it has any at all. If the public stops treating the item in question as money, or uses it less as money or only at a discount, it looses its monetary value. That is also always the case with state paper money. It is a sign of our hopelessly statist zeitgeist that many people believe that the state ‘assigns’ value to its paper money and somehow supports this value. This is not the case. The truth is that the paper tickets in your wallet have purchasing power (and thus have value beyond their paper content) for one reason and one reason only: the public accepts them as a medium of exchange, the public accepts them in exchange for goods and services. The public also determines what the exact purchasing power of those banknotes is at any moment in time and at any given place. The state does not even back its paper money with anything. If you take your paper tickets to the central bank, what do you get in return? – Change.
Paper monies come and go. In fact, throughout history every experiment with paper money has ended in failure, with over-issuance the predominant cause of death. Pound and dollar are the two oldest currencies around today but through most of their history they were linked to gold or silver, which restricted their issuance. Our system of hundreds of entirely unrestricted local fiat money monopolies dates back only to 1971, at least in its present form. In the 20th century alone, almost 30 hyperinflations of paper monies were recorded.
By contrast, gold has been money for 2,500 years at least. Should you be more concerned about the public not taking your gold any longer, or your paper money?
Gold is hard, apolitical, and global money, supported by an unparalleled history and tradition. That is the asset I want to own when our assorted finance PhDs in the central banks, the bureaucrats in the Treasuries and Ministries of Finance, and our sociopathic welfare politicians have manoeuvred the system to the edge of the abyss. Which is now.
Remember, paper money is always a political tool, gold is market money and apolitical. Paper monies come and go, gold is ‘eternal’ (as far as we can tell presently).
You have to be clear in your mind why you buy gold.
At every moment in time, all your possessions – all your wealth – can be split into three categories: consumption goods, investment goods, and money. For most of your possessions the category is pretty clear: The clothes you wear and the car you drive are consumption goods; your investment funds or your equity portfolios are investments; the banknotes in your drawer are money. For some things it is not so clear: An expensive painting might be an investment but if you hang it in your living room and enjoy looking at it, it is also a long-lasting consumption good. The house you live in could be both but in most cases it is more of a long-lasting consumption good than an investment: you use it up over time, albeit slowly, and you cannot easily liquidate it. You have to live somewhere.
The wealth you are not consuming in the here and now but want to maintain for the future can thus be held in the form of money or investment goods. Money gives you (usually) no return but has other advantages, namely that it allows you to maintain your purchasing power, at least if it is proper, hard money, and simultaneously retain complete flexibility. You are not committing yourself today to any investment good (or consumption good); you remain on the sidelines to wait how things turn out. But as you hold a monetary asset – a store of value and medium of exchange of (almost) universal acceptance – you can re-enter the markets quickly and easily. Somebody will always buy the gold from you in the future (which is far from certain in the case of most of your consumption and investment goods, and also in the case of that other form of money, state paper money).
Why gold now?
It seems that this is an opportune time to be on the sidelines, to be not engaged in the markets for equities, bonds and real estate, or to at least keep one’s exposure to these markets very low, since years and decades of unprecedented money growth have inflated and gravely corrupted the prices of standard investment goods. Sadly, these prices now rely increasingly on the kindness and efforts of manipulating bureaucrats to simply sit still and avoid a painful descent.
Central bankers state – openly and unashamedly – that they now consider it part of their mandate, if not the chief part of it, to keep asset prices at elevated levels and, if possible, even boost them further. Naturally, this will require ever more aggressive money printing and eternally super-low interest rates, and certainly argues against holding much paper money. Those who like to bet on the bureaucrats may claim that it makes sense to hold the very financial assets the prices of which central bankers are manipulating. As long as the central bankers are not ashamed of running the printing presses ever faster, they will simply get their way. Well, even under the rosiest of assumptions, this argument does not support investment in bonds. It could, in principle, be an argument for equities and real estate as ‘real assets’ of a sort but even in respect to these assets I consider it unsound, as I will explain later. Be that as it may, the beauty of gold is precisely that it allows you to remain on the sidelines and keep your powder dry. By holding gold you remove your wealth to a considerable degree from the rigged game of artificially inflated and openly manipulated financial markets. You commit internal capital flight from the fiat money system, and you simultaneously bet on the further debasement of paper money. The bet is this: The central bankers are trapped. The state, the banks, the pension funds, the insurance companies, the investment funds – they all would be in a right mess – or an even deeper mess than they already are – without cheap money from the central bank. Ergo, the policy of super-cheap money will have to continue until the bitter end.
There are a few more things to say about gold but before I do this let us talk about the worst asset.
Bonds – the worst asset class in my view
Bonds are ideal assets for you if you suffer from a financial death wish. Let me put it like this: After 40 years of almost relentless and of late accelerating money production we have too much debt. When you buy bonds you buy debt, and there is a lot of it to go around. And it is not even cheap. In most cases, it is ridiculously expensive, in particular when considering that most of it will never get repaid.
This is especially true of the sovereign bonds of major governments, which are probably among the worst ‘assets’ on the planet, yet are bizarrely still considered ‘safe haven’ assets, a ridiculous concept to begin with. What are the prospects in the long run for government bonds? Remember that most sovereign states are now credit-addicts, desperately relying on low rates and cheap credit to fund their incurable spending habits, and increasingly leaning on their central banks to provide the daily fixes. If the central banks stop printing money and thus stop funding the governments, they go broke. If the central banks keep funding the governments they will have to keep printing money, and this will certainly lead to higher inflation at some point, and that point may even be soon.
As an investor you will ultimately lose money through default or through inflation, and if it is a hyperinflation there will be default at the end of the hyperinflation. For the bond investor the choice is between death by hanging and death by drowning.
If that sounds overly dramatic then ask yourself in what scenario you win or even get your money back. Only if the present policies lead to a slow and steady return to self-sustaining growth that is inflation-free and allows the central banks to slowly and painlessly remove accommodation and deflate their overgrown balance sheets, and if the political class then grows up and gets sensible, departs from its free-spending ways, gets the fiscal house in order, and starts paring back the debt.
Yeah, and pigs might fly!
That this scenario is evidently the basis of much strategizing by professional money managers does not say much about its soundness or even remote probability. It is simply the scenario in which the financial industry comes out unscathed, with its size, reputation and income-stream intact. It is also the one scenario in which you need little money – neither paper money nor gold – but can stay fully invested in equities, bonds and real estate, as the rosy outlook of seamless crisis resolution and onwards growth forever will ultimately justify today’s lofty valuations. This is the scenario the financial industry favours and has an overwhelming desire to believe in – as do all politicians, central bankers and assorted Keynesians and other interventionists. Good luck to all of them! I fear this is wishful thinking rationalized with poor economics.
Every day that the markets are open the US government borrows an additional $4billion, roughly. For 5 years running the country’s budget deficits were considerably in excess of $1 trillion. Britain is among the world’s most highly indebted societies if you combine private and public debt, and despite all the blather in the press about ‘austerity’, the public sector keeps going more into debt. Japan has long been a bug in search of a windshield.
Bond investors may counter that it is all about the timing. Until death arrives, you collect coupons. – Well, hardly. With yields for the bonds of major bankrupt nations now in the 1 to 2 percent range, if that much, there is, in my view, little point in sitting on a gigantic powder keg and hoping the fuse is long enough. When this one blows, the fallout will be substantial. Why are bonds not selling off?
As David Stockman has pointed out, much of the US Treasury market is not owned but rented. The big primary dealers and many hedge funds hold government bonds as trading positions funded with cheap money from the Fed. That is the true reason for the Fed’s new communications policy. Ben Bernanke now goes so far as to promise to keep rates and therefore the trading community’s funding costs near zero, not only for the near-term, but even beyond the tenure of his own chairmanship at the Fed. The goal is to make sure that these leveraged renters of Treasury debt stay engaged and help funding the state.
Then there are the big bureaucratic asset management entities that have historically always provided a reliable home for government bonds: insurance companies, pension funds, sovereign wealth funds, foreign central banks. Built-in risk-aversion and intellectual inertia are here working in support of over-valued bond markets. Here, the big investment decisions are made by committees of professional fund managers who are often in charge of obscenely large amounts of money. To beat the market and achieve superior returns is an objective located somewhere between the hugely improbable and the completely impossible. They are destined to fail, and in this position of nerve-shredding uncertainty they all cling to the same straws: 1) do what everybody else does; 2) stick to what has worked in the past; 3) stick to the industry’s assumed wisdom, such as ‘never fight the Fed’; ‘government bonds are safe assets because the government can always pay’, and so forth. The last point has no basis in theory and history, and looks increasingly like a heroic assumption today, but that is the fund manager’s line and he is sticking with it.
That government bonds are a safe investment can, of course, not be left a matter of simple opinion but has to be enshrined in the laws of the land, and the state’s rapidly expanding finance constabulary is already working on it. Via legislation and regulation, the state is busily building itself a captive investor base for its own debt.
The state regulates the banks and has long been telling them that if they want to lend their money securely they should give it to the state. Everywhere, state-imposed capital requirements for banks can best be met by buying government bonds. The advantages are obvious: Spanish banks heavily increased their exposure to ‘safe’ Spanish government bonds over the past year, from about 13 percent of their balance sheets to 31 percent. And what is safe for the banks is certainly safe for insurance companies, pension funds and other ‘socially important’ pools of saving. ‘Capital controls’ is such a nasty term. Much nicer to call it ‘regulation’, and the masses have now been sufficiently indoctrinated with the idea that the financial crisis was caused by lack of ‘regulation’ so that the state can now safely and calmly tighten the screws.
I fear that to a large degree this is even welcome by the asset management industry. In an unstable and increasingly uncertain world, being told what to buy lifts a great responsibility of one’s shoulders. Although individually many money managers complain about stifling restrictions and regulations, it is usually the case that any outsized boom industry, when faced with the end of its boom, happily embraces state involvement to avoid getting trimmed back by market forces too harshly. Rather than seeing the return of the ‘bond vigilantes’ who instilled fear and loathing in debtors in the 1970s and 1980s but who roamed the financial landscape of a different age, one in which grown-ups were still allowed to smoke in public, we will most likely be treated to the sad spectacle of timid money mangers being herded into officially sanctioned asset classes by the cocksure financial market police.
All of the above may help explain why expensive assets may keep getting more expensive but these are, in the end, mitigating factors only that will, at the most, postpone the endgame but not change it.
One popular way to rationalize investments in bonds is that they are deflation hedges. Whenever the forces of liquidation and cleansing get the upper hand, bonds do well. This may be the case in the short term but any extended period of deflationary correction must be poison for sovereign bonds in particular: tax receipts will drop, non-discretionary state spending will balloon, and credit risk will rise. The bond market’s pendulum of doom will simply swing from the risk of higher inflation to the risk of default.
Gold versus other ‘real assets’ (equities and real estate)
It is often argued that equities and real estate are also good inflation hedges, and I know many people who prefer them to gold. I see the rationale but disagree with the conclusion. Gold may no longer be cheap because what I explain here has been a powerful force behind gold for a decade. But I would argue that equities and real estate are in general much more overvalued as the current financial infrastructure is designed to channel new money into financial assets and real estate but not into gold, and our financial infrastructure has been operating on these principles for decades. How many people do you know who not only own gold but bought it on loan from their bank? Now ask yourself the same question with respect to real estate. – Gold is the great ‘under-owned’ asset. Its share in global portfolios is miniscule. It plays hardly any role in institutional asset management.
It is true that during deflationary phases when the inflationary impetus from central banks slackens a bit and the urge of the markets to liquidate comes to the fore again, gold often sells off in sympathy with equities. But I believe that any risk of a more extended period of deflationary correction poses a much bigger problem for equities, and by extension real estate, than for gold.
Additionally, ask yourself how equities and real estate will fare in an inflationary crisis or a currency catastrophe. Which companies will make money, pay dividends or even survive? Which tenants, whether residential or commercial, will keep paying the rent? I am not saying that all these equities and all the real estate will become worthless – far from me to forecast a ‘Mad Max’-style end of civilisation. It is indeed to be expected that certain equities and select pieces of real estate will turn out to be decent instruments for carrying wealth through the valley of tears, and for coming out at the other end with one’s prosperity intact. But which ones? It strikes me that the variance of outcomes is much greater in these hugely heterogeneous, highly inflated and widely held sectors than anything that can come from holding the eternal money and homogenous commodity gold. If you consider any major economic crisis, whether inflationary or deflationary, gold beats equities and real estate in my book. (Equities and real estate are superior to bonds and paper money, however, and this is why I listed them above as potential holdings.)
Additionally, there is one aspect of real estate investing that is, in my opinion, frequently overlooked or under appreciated, and that is this one: Your property is like a marriage agreement with the local taxman, as my friend Tristan Geschex keeps reminding me. The War On Wealth is intensifying, as are the fiscal problems of most states. Both go hand in hand. Real estate is low-hanging fruit for the state, and taxation on it will most certainly increase. What market value and rent-income your property will manage to sustain through the vagaries of the crisis will most probably be subjected to confiscatory taxation from a bankrupt state. The ownership of gold could potentially also be restricted or heavily taxed. This is certainly a risk. But as I said, gold is still the under-owned asset, and there is still a chance that you can find arrangements for your gold holdings that lessen the tax implications. When the winds of change alter the political landscape in your country of residence and bring the War On Wealth to a cinema near you, you may still – if you are quick and lucky – pack your things, take your gold and move somewhere else (as long as they let you), maybe even obtain a different citizenship (as long as they let you), but owning property means having nailed your wealth to the ground and having signed up for whatever the local purveyors of snake-oil (politicians) manage to sell your fellow voters.
Paper money versus gold
Under what scenario would paper money beat gold, i.e. would the paper-money-price of gold drop sharply? – The answer is clear, in my view: If the central banks stopped the printing press and stopped depressing interest rates artificially and fully accepted the consequences for other asset classes and the economy. If the central banks decided to defend the value of their paper money and credibly assigned a greater importance to this objective than to the now dominant ones, which are sustaining a mirage of solvency of banks and states, funding the governments, propping up asset prices, and creating short-term growth spurts.
The big gold bull market of the 1970s ended harshly in 1980, when then Fed-chairman Paul Volcker stopped the printing press, let interest rates shoot up, and looked on as the economy slipped into recession. The paper dollar enjoyed a revival and the gold price tanked.
My view is that this is exceedingly unlikely to happen today. The global financial system is considerably more leveraged than it was 32 years ago, and presently much more dependent on never-ending cheap money from the central bank. In 1980, the total debt of the US government was less than $1 trillion, today the annual budget deficits are bigger than that. The fallout from an end to free money would be huge, and most politicians would deem the consequences unacceptable. Today, there are also no other strategies available that could cushion the impact. In the early 1980s, then-president Reagan countered hard money with an easy fiscal policy, and simply let the budget deficit balloon throughout his tenure. Today, the bond market would be quickly in trouble without support from the central bank, and the government would soon face its very own Greece-moment. But even if this were indeed to happen, I think that gold would still do better than equities and real estate, and certainly bonds, which would suffer hugely from rapidly rising default risk. The deflationary correction is also a huge threat to the over-stretched banking system, which means you may not want to hold your paper money in form of bank deposits. Again, gold seems to be a decent self-defence asset, even in this scenario.
How to own gold
Personally, I believe one should hold gold in physical form (bars and coins), not through ETFs, derivatives or gold accounts. If one wants to have it held within the banking system (not ideal but there could be reasons for it), one should insist on having it in allocated form, that is, clearly allocated to one’s name and identified by serial numbers. Or, have the gold delivered and keep it in a safety deposit at a bank. Alternatively, there are now a number of specialised asset managers or gold dealers around that offer storage facilities as well.
I think the risk of gold confiscation is small in most countries at present but things may change. The risk of taxation on gold or restrictions on gold ownership is somewhat higher. The safest places to hold gold are probably Switzerland (still) and Singapore at present but if you live in the wrong place or have the wrong passport, having your gold there may not protect you from the long arm of your government when it begins to show interest in your gold. It is no surprise that people who really care about their wealth, which are often people who are very wealthy, now consider changing residency and even changing citizenship as an important component of their estate planning. The last time the US government confiscated private gold, in April 1933, it only grabbed what was held within the territory of the United States, and many people probably kept their gold by simply burying it in the backyard. Believe me, the next time private property will be confiscated, the process will not be handled so amateurishly.
In any case, these are just my opinions. As I said, food for thought….
In the meantime, the debasement of paper money continues.
Collapse Is What Is Really Taking Place Around The World
Collapse Is What Is Really Taking Place Around The World
Fasten your seat belts, here is what Egon von Greyerz, founder of Matterhorn Asset Management in Switzerland, had this to say: “Eric, I’m looking around the world and what is happening in France is quite amazing. We all know Hollande is in charge and he is now threatening French steel producer ArcelorMittal. Business is weak and they are looking to lay off some employees.”
“ArcelorMittal is the biggest steel producer in the world, and Hollande is telling them if they lay off employees that he will nationalize the business. So if this steel producer moves to take normal action during a slowdown they are literally going to be nationalized. This is astounding.
A couple of days ago I spoke to an author and journalist in France who is very well known....
“He told me he is in Athens now and is observing what is going on in Greece. He said to me, ‘Athens is nothing compared to what we have in France now with the trouble we are seeing with the unions, poor people, people in the streets.’
Still, there is no austerity in France compared to Greece. He expects France to be a lot worse than Greece will ever be. That’s one European country and this will be the case in many other European countries. The UK will be terrible economically, but the social unrest will also be very, very severe and extremely difficult in the UK.
So we are seeing it everywhere. Mervyn King, head of the Bank of England, he now says UK banks will need another 35 to 50 billion pounds of capital. He says the banks in England are under capitalized and the risks are major. Here you have a central bank chief who openly says the banks are at risk of failing. Of course this is the risk worldwide with banks, but it is refreshing to see a central bank governor actually saying it officially. Sadly this is the case with almost all countries in the world.
Turning to Japan once again, as I said in the last few interviews, Japan is one of the biggest risks in the world because of their economic position. The Bank of Japan had a loss in the last quarter of 230 billion yen, which is about $3 billion. Their balance sheet is also continuing to expand, it’s up to roughly 156 trillion yen or about $2 trillion.
Moving to the US, GDP was better at 2.7%, but again that was just inventory buildup and government spending. GDP is still weak if you take those two elements out. Consumption is very weak and inflation in the US is running at 1.6%. Anyone who buys food and fuel knows inflation is a lot higher than 1.6%. Also, if you used the real ‘deflator,’ GDP would be negative.
Consumption will continue to head lower because people are worse off now. There are 127 million people in the US dependent on government welfare. This is against a full-time working population of 115 million people. So there are 115 million people working full-time and 127 million depending on the government.
The bottom line is there are less and less people to pay for the welfare. This is why the deficits will continue and grow much worse than they are today. Also, if you look at median income in the US, it’s down 8% in the last three years, and disposable income is down a staggering 25% if you adjust for inflation in the last ten years.
If you look at the real estate bust in the US, take states like Florida, California and Arizona, 50% of homeowners have negative equity. Las Vegas is as high as 70% negative equity. Again, it means that the banks are never going to get the money back. This simply means that the government has to print more money.
This is the same problem in developed countries all over the world. Therefore, governments will print increasing and virtually unlimited amounts of money. So currencies will continue to reflect that activity. The dollar, euro, yen, and the other currencies have already fallen 80% in real terms vs gold over the last ten years. These currencies will continue to fall another 80% to 100% vs gold in coming years.
So investors have to look at how to preserve their wealth and the way to do that is with physical gold. Investors are always asking, ‘What percentage of my money should be in physical gold?’ I told people in 2002 to put 50% of their money into gold. That would now total 85% since gold has gone up more than any other asset.
If you ask me today, ‘Is 85% a good level?’ I think it is because I don’t see any better way for people to protect their wealth against the wealth destruction and the risks we face going forward. But every investor has to decide for themselves what is best for them.
What is important here is whatever percentage the investors buy must not be paper gold. It must be physical gold and it must be outside of the banking system. Remarkably, only 1% of the world’s assets are in gold today, so, sadly, not many people are thinking about wealth preservation. This tells me we are still early in this bull market for both gold and silver.”
No matter what confidence game is being run, confidence is the necessary pre-requisite. This is why confidence indicators are so closely monitored by central bankers. If consumers and businesses lack confidence, they will not partake of the central banker’s credit; a necessary step in the indebting of otherwise willing victims. The credit trap is at the core of the bankers’ ponzi-scheme of credit and debt; and although today’s markets are awash with liquidity, bankers are increasingly loath to lend and customers are increasingly reluctant to borrow.
Central bankers are well aware of the precarious health of their illicit franchise. Credit and debt-based economies must constantly expand to pay constantly compounding debts; but now, instead of expanding, economies around the world are slowing and contracting.
This is why central bankers are concerned with a rising price of gold. After gold exploded upwards in 1980 during a virulent episode of inflation, the price of gold was understood to be an indicator of monetary distress.
The more distressed the bankers’ prey
They’re far less likely to borrow today
After gold’s explosive ascent in 1980, central bankers began seriously ‘manage’ the price of gold. A lower price of gold would indicate not only an abatement of monetary problems but investors would be less inclined to trade their paper banknotes for the safety of gold when they could more profitably leverage their paper banknotes in the bankers’ paper markets.
Since the early 1980s, supplies of newly mined gold have constantly fallen short of market demand for gold; but notwithstanding supply and demand fundamentals, gold prices nonetheless fell for 20 straight years. In 1980, the average price of gold was $615. By 2001, it was only $271. Clearly, the free market price of gold was being distorted by ‘outside’ forces.
This highly profitable collusion incentivised bullion banks to borrow large amounts of central bank gold; then sell it on the market allowing the banks to invest the funds in the interim and profitably exit the trade when the gold price was lower because of the artificial depression caused by the additional supplies of gold.
This constant downward pressure on the gold price continued from 1981 until 2001. Indications that the profitable gold-carry trade was coming to an end happened in 1999 when the Bank of England ‘inexplicably’ sold 415 tons of gold reserves at the then bottom of the market.
The sale of almost half, i.e. 40 %, of England’s gold reserves has been subsequently revealed to have been triggered by a large—probably American and probably Goldman Sachs—investment bank’s short position in the gold market.
The bank, expecting to profit from the continually falling price of gold, had made a large bet that gold prices would continue to fall; but, prices had stopped falling. This exposed the bank to losses so large that the bankers’ prevailed upon the Bank of England to sell 410 tons of its gold to force gold prices lower.
Cropped photo of Bank of England gold vault
The photo of the Bank of England’s gold reserves is intended to bolster the confidence of investors as to the supplies of gold held by central banks. In truth, the photo is cropped to make it appear that the bank’s gold supplies are larger than they actually are.
Photoshop version of perhaps the more likely size of Bank of England gold vault
The empty space to the left of the rows of gold bullion were once filled with rows of gold bars sold in 1999 to insure that bullion banks could exit their gold trades without taking massive losses. A photo of gold vaults at Fort Knox—and/or the New York Fed—would show an even greater erosion of gold stocks and similarly vacant storage space.
In 1949, US gold reserves totaled 21,775 tons. In 1971 when the US was forced to end the convertibility of US dollars to gold because of diminishing supplies, US gold reserves had declined to only 7,000 - 8,000 tons; the loss of America’s gold was due solely to the post-war US global military presence and to the overseas expansion of US corporations.
2001: GOLD BEGINS MOVING UP
Even the sale of 415 tons of England’s gold in 1999 was unable to contain the growing demand for gold. This demand was exacerbated by the collapse of the US dot.com bubble in 2000. In the next few years, central bankers responded by selling 1300 tons of gold owned by the Swiss National Bank to suppress the now rising price of gold but to no avail—gold continued to rise.
2012: GOLD ENCOUNTERS RESISTANCE AT $1800
Gold is a leading indicator of monetary distress
The price of gold has risen for 10 years as systemic monetary stress has increased. In July 2011, because of EU monetary disarray, the price of gold rose from $1500 to $1900 in only two months, an almost vertical 27% rise.
Since September 2011, however, gold has been in an extended trough. This is not due, however, to an abatement of systemic stress. It is due to measures central bankers put in place to prevent a wholesale flight to gold from developing at that time.
What happened in July and August 2011 is what central bankers had feared, an almost vertical ascent in the price of gold that could cause investors to exit the bankers’ paper markets and turn to gold in a lemming-like rush for the safety of gold bullion.
This would be the death knell in the bankers’ confidence game. In my article, Gold: Stage Three Up Down Up Down Up (October 22, 2012), I explained how the bankers moved to prevent this feared event from coming true. It worked—for awhile.
In December 2012, it is clear the bankers drew a ‘line in the sand’ in September 2011 to prevent another rapid ascent in the price of gold. To some, this ‘line in the sand’ presents a major barrier to gold’s advance. But, in reality, the bankers’ line in the sand represents the bankers’ desperate last ditch attempt to prevent the inevitable from happening.
The systemic distress that drove gold’s 27 % rise between July and September to $1900 has not abated although the lower price of gold would imply otherwise. The present price of gold below $1800 is due solely to central bank emergency measures to contain the price of gold and China’s reluctance to let gold rise too far too fast before China can buy as much gold as possible before the next economic crisis.
2013: GOLD WAITS FOR THE END OF THE BANKERS’ CONFIDENCE GAME
Speculation abounds as to the trigger event that will set off gold’s vertical ascent. It could be the collapse of the global derivatives market or a credit event such as Credit-Anstalt’s collapse in 1931, the Austrian bank owned by the Rothschilds or perhaps Japan’s inevitable descent into the deflationary conflagration it has resisted since 1990.
It could be any number of events or causes. It could be triggered by a black swan event, a geopolitical crisis or a natural disaster on the level of the earthquake that struck off the coast of Japan in March 2011. Whatever the trigger, in the end the banker’s 300 hundred year-old con game will collapse from a simple lack of confidence.
We Are Headed To A Historic Collapse Of The Financial System
We Are Headed To A Historic Collapse Of The Financial System
“Nobody who has ever watched the Navy’s Blue Angels acrobatic team perform ever walked away with anything but admiration and amazement. The performance showcases generations of technology, courage and skills of the pilots as well as the practiced teamwork and coordination that allow them to fly such tight patterns.
The separation of the planes during the formations and acrobatics can be as little as 18 inches. Pilots are trained to focus on the planes next to them to maintain the separation. It involves complete trust in the lead plane and it’s pilot....
“The monetary Blue Angels of our day have closed their formation. With our Federal Reserve in the lead plane, the major central banks have pulled into a tight formation with the Fed. We see such feats of daring do as interest rates being driven to zero.
We see currencies, countries and institutions that should have failed by now being supported by the unlimited printing of money. Budgets and debt ceilings are passé. Crises come and go. Fiscal cliffs, debt ceilings and the like come to the fore. Nothing is ever resolved, but deadlines are moved and new plans for resolution are just around the corner.
While the central bankers might see themselves as Blue Angel equivalents, the reality is that they are engaged in precision balloon acrobatics. That image might trigger a smile, and even thought we know that balloons cannot be flown with any precision, it still represents an appropriate analogy. The balloons do rise, but chaotically. The hot air that fills the balloons is the electronic printing press.
The precision monetary team is floating countries, companies and markets. There are a few balloons such as the gold, silver and oil markets that tag along, much to their dismay. Releasing hot air from those balloons is considered a necessity to keep all eyes focused on the “right” balloons. Gold and silver balloons tend to rise at a much faster rate under these circumstances throughout history, so great effort must be made to tether them as best is possible..
Nobody knows how high the central bank driven balloons can go. The supply of hot air once appeared to be limitless. Perhaps it is. At some altitude, however, a vessel under pressure will pop in the absence of the counter force of atmospheric pressure. To the central bankers, they are floating us skyward to a new reality. It is more likely that our fate will be the black emptiness of outer space or a quick return to earth as the balloons pop. Only time will tell.
In 1982, the Air Force’s Thunderbirds Air Demonstration Team was at an air base in Nevada, preparing for one of their shows in Arizona. They were practicing what is called a four-plane line abreast loop. The loop begins with the planes climbing together to a high altitude. They would next roll over backwards and then descend straight down toward to surface at a very high speed. The last phase of the stunt was to pull out of the dive and level off at 100 feet.
Tragically, that never happened. It was initially believed to be pilot error, but a subsequent investigation showed that it was a mechanical failure involving the lead plane. True to their training, the other pilots followed the lead plane into the ground. All of the brave and accomplished pilots involved died that day. All were justified in their belief that their technology and their skills would not fail them. In the end, it was a component failure in a very complex piece of machinery that triggered the accident, not lack of competence or design.
Our central bankers have similar convictions and beliefs that the monetary system is known and can be effectively guided by pulling various levers. Using these beliefs and tools, central bankers are maintaining a tight grip on markets. The continuation of the savage attacks on the gold and silver markets, the “successful” sovereign debt auctions, interest rates maintaining low to negative levels, as well as an elevated S&P 500 are all signs that they are firmly in control.
There are two likely resolutions to this death-defying monetary show. The first is that we experience an historic, catastrophic, global, monetary collapse caused by an unpredictable failure in the system. In that case, the central bank acrobatic team flies the global economy into the ground while never doubting the wisdom of their ways. Our monetary pilots, focused on maintaining formation with the Fed, plow us all into the economic terra firma.
The second is that the academics and bureaucrats take us into a post-sovereign, post-money world. In so doing, they show us that central planning was the correct way all along. Past attempts were just bungled. Control is maintained, and a new world financial order emerges. The accrued obligations on the books vanish. The distribution of resources and wealth are controlled and allocated by a central power, not markets.
There is no successful version in history of the second outcome. The first outcome is always the way. What people have done throughout history to protect their wealth is to own tangible assets. As central banks continue to inflate away the value of their currencies and assets tied to those currencies, they are simultaneously gobbling up tangible assets such as agricultural land, oil, gold and silver.
A growing population will maintain the long-term value of scarce resources even if there are declines following a monetary collapse. Gold and silver will return to the historic role of sound money. Holders of those metals will see a dramatic revaluation to the upside. If history is our guide, the new wealthy will be those who had the wisdom to get out of paper money before the end of the current system.
There is an historic race going on for access to and control of oil and precious metals. You need oil to have a functioning economy, and we are on a heading for a troubling confluence of declining global production and accelerating global demand. The price of energy must rise.
You need precious metals to reestablish a believable monetary system. For investors, your only protection is to imitate the behavior of the global powers. It is imperative that you acquire resource-based assets, gold and silver, as the smart money is doing. A wealth preservation approach of this kind is the only chance that your money will weather the turmoil and financial destruction that lies ahead.”
It is tempting to believe that extraordinary events must have been carefully orchestrated by someone. This is the main ingredient in conspiracy theories—denial that extraordinary events are caused by the ordinary.
The reason I bring this up is to help you put Freegold in the proper perspective to understand my use of the term "window" as in "window of opportunity". Freegold will certainly be a high impact, extraordinary event as I understand it, and completely unexpected by most people. But that doesn’t change the fact that it could be, and was, seen coming a mile away.
Extraordinary events are caused by the ordinary all the time, and Freegold will be a good example. It has been rolling in like the tide longer than most of us have been alive. If there was a "conspiracy" surrounding Freegold, it was a conspiracy to forestall the inevitable, by those who had the most to gain, until structural foundations could be retrofitted enough to withstand the storm of transition.
With a long view, we can see several times when massive amounts of resources were expended to keep the wheels on the bus at times when it looked like they were falling off. A popular view is that central bankers do this to retain their own power and influence. But a different view exposed by the Gold Trail reveals that it was being done for a purpose: to buy time in order to retrofit the system to withstand the inevitable transition to Freegold.
Look at this chart of the 1980 spike in the gold price. Notice the steep climb in September 1979 with a spike on October 2nd.
(Click to enlarge)
The wheels were coming off the bus. The general fear among European central bankers gathering on October 1st for an IMF meeting in Belgrade was that the global financial system was on the verge of collapse. You might recognize the names of some of the central bankers at that time. Jelle Zijlstra was the President of the Dutch central bank (DNB) and the BIS, and Alexandre Lamfalussy was an advisor to the BIS, soon to become its General Manager.
Fed Chairman Paul Volcker arrived in Belgrade early and left early, departing on the first day of the meeting, "his ears still resonating with strongly stated European recommendations for stern action to stem severe dollar weakness."  But don't think this was about the price of gold. Gold is the linchpin of the system, but that spike in gold was to the collapsing system like a fire alarm is to a raging inferno. You can't put the fire out by simply turning off the alarm.
Those central bankers looked into the abyss, and then took emergency measures to buy the time needed to retrofit the global monetary and financial system so that it could weather the storm they saw coming. One thing was that Volcker was pushed to take quick action that, reportedly, was not embraced by the Executive Branch. But that wasn't even the half of it. Those European central bankers also decided to support the dollar's exchange rate by buying dollars:
FOA: "My point was that their actions can only be justified from a position of "buying time". Most of the major World and European countries had economies and currencies that could stand on their own in a competitive world. Yes, their transition from a dollar reserve would have been painful. But, compare that loss to the percentage of lifestyle gain they paid as a tax to the US by artificially maintaining the dollar exchange rate. Their Central Banks support polices were a decision to waste their citizens' productive efforts in a process that held together a failing currency system.
It seems the only explanation for the continued support of the dollar came in the form of "buying time": time to recreate a world reserve currency. But this time, make it subject to a whole group of diverse nations of conflicting political wills. In this format no one country can call the shots for the world. In addition, take away the need to compete with gold. Let gold be a supporting "reserve asset" that trades in a free market, unlent and non monetary so as to circumvent its manipulation."
You can see that post-1980 European CB support for the dollar in stark relief here. And the other thing they did was to encourage and support the development and expansion of a vibrant and explosive paper gold marketplace for the purpose of absorbing the demand for gold in support of the dollar. Again, this was the European central bankers supporting the status quo in order to buy time for...
FOA: "On January 1 1999, the Euro was born. On the headlines of almost every paper, the new Euro currency immediately became the topic of speculation. How high or low would it go,,,,,,, will it last,,,,,, what good is it,,,, and on and on. Yet, completely hidden from view and outside most speculator interest, one important item was overlooked. Once this competing reserve currency was formed, the two major power blocks of the world no longer shared the purpose of maintaining a paper gold market! Established, maintained and supported for the purpose of absorbing the demand for gold, its price damping effects were no longer needed."
This is a good example of a major, multifaceted, coordinated, long term (20 years!) European central bank effort to forestall the inevitable transition for the good of the entire global monetary and financial system, and by none other than those who stood to gain the most from the transition. Evil bastards!
ANOTHER: "The CBs were becoming the primary suppliers by replacing openly held gold with CB certificates. This action has helped keep gold flowing during a time that trading would have locked up… Westerners should not be too upset with the CBs actions, they are buying you time!"
Then came the 90s when, as ANOTHER stated above, those European CBs became suppliers to the gold market as the whole "paper gold thing" didn't work out quite like they thought it might:
ANOTHER: "The BIS and other various governments that developed this trade ( notice I didn't use conspiracy as it was good business, as the world gained a lot ) , thought that the paper gold forward market would have allowed the gold industry to expand production some five times over! Don't ask where they got this, as they are the same people that bring us government finance and such. But, without a major increase in gold supply, the paper created by this "gold control operation" will either be paid by, 1. new supply. 2. the central banks. 3. rollover existing. 4. cash? 5. or total default! As the Asians started buying up everything last year ( 97 ) , number 5 and 5 started looking like the answer! When the CBs started selling into this black hole of demand, the discussion of #5 started in their rooms also."
For example, Wim Duisenberg, who followed Jelle Zijlstra as the head of the Dutch CB and later became the first President of the ECB, oversaw the sale of Dutch gold in two significant tranches of 400t (announced January 1993) and 300t (announced January 1997), and by decade's end had allowed for the lending of up to 15% (150t) of CB gold reserves.
But then, in a surprising policy reversal, he led the European central bankers in their Joint statement on gold, also known as the CBGA or the WAG. This statement was a very simple press release which, in essence, reversed the gold policy of the previous two decades and put the paper gold market makers on notice that they (the European CBs) would no longer be the lender of last resort for gold:
In the interest of clarifying their intentions with respect to their gold holdings, the undersigned institutions make the following statement:
1. Gold will remain an important element of global monetary reserves.
2. The undersigned institutions will not enter the market as sellers, with the exception of already decided sales.
3. The gold sales already decided will be achieved through a concerted programme of sales over the next five years. Annual sales will not exceed approximately 400 tons and total sales over this period will not exceed 2,000 tons.
4. The signatories to this agreement have agreed not to expand their gold leasings and their use of gold futures and options over this period.
5. This agreement will be reviewed after five years.
One could say that a window of opportunity for something had just opened. That was 9/26/99. On 9/29/99 the paper gold market imploded. The price of gold quickly rose 22% over a two week period (which would be like gold spiking to $2,030/oz. next week) and, for a brief moment in time, the lease rate spiked and the GOFO plunged signaling backwardation in the gold futures market.
There was a rumor that the Fed and the BOE were active in silencing the fire alarm that time:
"In front of 3 witnesses, Bank of England Governor Eddie George spoke to Nicholas J. Morrell (CEO of Lonmin Plc) after the Washington Agreement gold price explosion in Sept/Oct 1999. Mr. George said "We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake.
Therefore at any price, at any cost, the central banks had to quell the gold price, manage it. It was very difficult to get the gold price under control but we have now succeeded. The US Fed was very active in getting the gold price down. So was the U.K."
In 2004, the European CBs renewed their "Joint Statement on Gold" as promised, but for some reason the BOE didn't participate this time:
In the interest of clarifying their intentions with respect to their gold holdings, the undersigned institutions make the following statement:
1. Gold will remain an important element of global monetary reserves.
2. The gold sales already decided and to be decided by the undersigned institutions will be achieved through a concerted programme of sales over a period of five years, starting on 27 September 2004, just after the end of the previous agreement. Annual sales will not exceed 500 tons and total sales over this period will not exceed 2,500 tons.
3. Over this period, the signatories to this agreement have agreed that the total amount of their gold leasings and the total amount of their use of gold futures and options will not exceed the amounts prevailing at the date of the signature of the previous agreement.
4. This agreement will be reviewed after five years.
Then, in 2008, something happened.
2013 – Year of the Window
I'm pretty new to this trail. I only started hiking it in 2008, a year that, like 1979 and 1999, the wheels almost came off the bus. Were massive resources expended at a loss just to keep the wheels on the bus that year? You be the judge.
I have relayed my own personal experiences buying gold from my local dealer in October and November of 2008 as anecdotal evidence of a tight supply (that I encountered) while the price was plunging from $900/oz. down to a low of $713/oz., and then plentiful supply at the bottom. I don't know. Did someone go massively short physical and long paper gold (or futures) in November of 2008 in order to support the paper gold market as the linchpin holding the wheels on the bus? Did somebody willingly take losses in order to delay the inevitable a little bit longer?
These charts are like a seismograph that records an earthquake, an explosion or some abrupt disturbance in the force. I do not think they are predictive. I do not think they are even descriptive enough to tell us what happened. They simply show us, in hindsight, that something happened. It is up to us to decide what we think happened.
So what happened in late 2008 as a result of the financial market collapse that began two months earlier? And did the European CBs do anything to forestall the transition once again? I don't know. But it is noteworthy that when they renewed their Joint Statement on Gold eight months later the #3 line about limiting gold leasing was gone and in its place was a line about IMF gold sales:
In the interest of clarifying their intentions with respect to their gold holdings the undersigned institutions make the following statement:
1. Gold remains an important element of global monetary reserves.
2. The gold sales already decided and to be decided by the undersigned institutions will be achieved through a concerted program of sales over a period of five years, starting on 27 September 2009, immediately after the end of the previous agreement. Annual sales will not exceed 400 tonnes and total sales over this period will not exceed 2,000 tonnes.
3. The signatories recognize the intention of the IMF to sell 403 tonnes of gold and noted that such sales can be accommodated within the above ceilings.
4. This agreement will be reviewed after five years.
One thing that I was missing back then (2008-2009) was the wider perspective of someone who had been hiking this trail a lot longer than I had been. Then, in late 2009 or early 2010, Belgian put me in touch with Aristotle and we started emailing.
Ari had been following ANOTHER and FOA since their very first comments on Kitco back in 1997, and he is also the only person I know of who exchanged private emails directly with FOA during the Gold Trail years. He is also the one commenter from "back then" who, in my opinion, "got it" better than anyone else.
Somewhere around the turn of the century, or perhaps even right after FOA disappeared, Ari decided to subscribe to the Central Banking Journal, a quarterly trade publication put out by and for central bankers. It costs about $800 per year to subscribe. He has read every single issue of this boring trade publication, cover to cover, for more than a decade now. And I mention this simply to illustrate for you his extreme focus on central banking policy discussions, at least since FOA went away.
Ari has been hiking this trail a lot longer than I have, he understands it better than I do, and he thinks that central bank policy discussions are relevant to the potential timing of FOA's "changing world financial architecture" aka Freegold. As I mentioned just last week, my July 2010 post Timing Is Everything came directly from a curious email exchange in which Ari introduced me to the idea that, perhaps, the European central banks are somehow supporting the paper gold market at certain times.
Then, later in 2010, he introduced me to another idea: that 2013 might be the new "window" being targeted by the central bankers for transition to the new "world financial architecture" (aka Freegold). So, yes, I have had my eye on 2013 for two years now, and I decided on this name (year of the window) back in November. Fonoah can vouch for that since I mentioned it in an email.
What I'm trying to do here in this post is to share with you the nuances of my perspective and my reasoning behind the chosen name. Being a "window of opportunity" does not mean that I think they plan to "pull the trigger" or "push the button" or whatever. Nor does it mean that I think the wheels will fall of the bus this year. It's more a question of whether "they" will sacrifice valuable resources in an increasingly costly attempt to forestall the inevitable next time the wheels start to come off this 100 year old bus. And as I mentioned last week, we may get a glimpse of their state of mind in this regard by the end of the week.
If you think that the IMF can unilaterally forestall the inevitable with more gold sales, consider that the IMF has "pledged" gold, similar to the ECB and the BIS. It is not a sovereign nation with its own reserves. When we see sales by these types of entities, they are likely the visible result of a group decision rather than a unilateral action, which would explain the mention of IMF sales in the most recent CBGA.
Could the Fed do it? No, only the U.S. Treasury could, and as FOA said they eventually would, that would be the sign we are looking for—the U.S. Treasury selling U.S. gold to defend its dollar! What about the BOE? What's Gordon Brown up to these days?
I'm going to share with you Aristotle's thoughts on this, beginning with that email back in 2010. I haven't heard a peep out of Ari in a few months, so I can't speak to his latest thoughts, but the following covers roughly the last two years on that ever-elusive topic – "timing":
ARI (via email Dec. 2, 2010) - For the past half-decade, many international policy stirrings gave every indication to me that 2010 was to be the targeted year for assertively rolling forth the freegold paradigm. But as I've said previously, I feel that the ongoing financial crisis that began with the subprime fiasco has caused instability of such magnitude that the central bankers have been forced to delay briefly and "play it safe" -- one does not dare rock the boat (if there remains any choice in deciding the matter) when the financial waters have become so turbulent and choppy. As for the new timeframe, I'd say that the reported EU plan "to make private bond holders shoulder some of the pain from any sovereign debt restructuring after mid-2013" is as good an indication of a benchmark as any I've seen. Plus, that timing nicely accommodates my additional view -- embracing a culturally significant standpoint -- that the December 2012 conclusion to The Hobbit will forever cement the desire for gold into the minds of all western moviegoers, resulting in a perfect storm of the golden variety. ;-)
On the point of the midyear "benchmark" mentioned above, it's almost spookily funny that the song lyrics mention "You just gotta ignite the light and let it shine; Just own the night like the Fourth of July". Indeed -- 2013. (Or sooner, if *necessity* precludes all freedom of choice in the matter!)
ARI (hinting at his "timing thoughts" in a comment on Mar. 14, 2012) - Gather up the last easy bits of your treasure seeking exploits... the next 24 months will bring reverberations through our (global) culture as profoundly as is yet possible in this largely jaded and detached age of ours. Even now, can you hear the distant pulsing of air beneath the dragon's wings?
Gold. Get you some. --- Aristotle
FOFOA (via email May 11, 2012) - In that 2010 email, I believe you had your eye on the ESM set to begin in July 2013 when the EFSM is set to expire. But did you know that the ESM is expected to be ratified this July and run concurrent for a year?
I was curious if you still had your eye on the ESM as a “window of opportunity” and if this hastened timeframe portends an earlier window.
ARI (via email May 20, 2012) - Spurred on by the inquiry of your May 11th email, I took some time to read the latest progress on these treaties (both the 2011 original and lately amended 2012 ESM, plus the auxiliary Treaty on Stability, Coordination and Governance in the Economic and Monetary Union) last weekend, but somehow failed to get back with you on my thoughts. Probably because I came away with nothing very sound or profound as a result of my reading. I can't bring myself to imagine that the hastened timeframe for start of the ESM necessarily portends a more imminent transition to our freegold environment so much as it strikes me as a sign of how much the ongoing European ructions have kept the euro area member states focused and in frequent contact. Avenues for earlier-than-expected adoption were thus available and easily taken.
I took (and still do take) the facility of the initial European financial stability programs to make somewhat expedient new loans for the benefit of distressed euro member states until mid-2013 as an emergency measure and temporary bridge to give legacy bond holders (especially the banks) some time and space to regather their wits and come to better grips with the new reality. With the sunsetting of these expedient funds, the relatively cushioned ride of old bondholders on the backs of the stronger taxpaying populations should be nearing its end as any new funding (to be arranged now through the ESM) will come with stricter conditionality and will ensure the ESM holds preferred creditor status -- secondary only to the IMF.
Thus, banks (and any other sensible parties) who hold, or are potentially in the market for, European sovereign debt will be well advised to consider their place in the overall pecking order going forward, and of the real risk posed by national bonds after all.
A snip from The Telegraph today shows the likes of HSBC and Deutsche Bank still trying to think through it all and work out how to cope...
(Telegraph.co.uk) -- A note from HSBC staff this week said they are increasing their holdings of the yellow metal in the face of “deteriorating” economic momentum, in addition to adding cash and Treasuries (US government debt).
“In the continuing absence of plausible alternative growth drivers, we believe that this increases the chances that central banks will engage in further QE,” explained Fredrik Nerbrand, the bank’s global head of asset allocation.“This is likely to be accompanied by increased inflation expectations; hence, we increase our exposure.”
Not all are convinced gold is about to climb again, however. Analysts at Deutsche Bank think the increasing speculation about a Greek exit from the euro adds to the downside risks.
The argument is that, with gold showing a strong opposite correlation with the US dollar at the moment, if the euro falls, the dollar rises and gold drops backs.
However - stay with it - they see an actual 'Grexit’ as bullish for the euro. By implication, it would be for the gold price too.
The City is not singing gold’s swansong yet, but it is certainly braced for more volatility.
FOFOA (via email May 27, 2012) - Here’s a passage from your 12/2/10 email:
"For the past half-decade, many international policy stirrings gave every indication to me that 2010 was to be the targeted year for assertively rolling forth the freegold paradigm. But as I've said previously, I feel that the ongoing financial crisis that began with the subprime fiasco has caused instability of such magnitude that the central bankers have been forced to delay briefly and "play it safe" -- one does not dare rock the boat (if there remains any choice in deciding the matter) when the financial waters have become so turbulent and choppy. As for the new timeframe, I'd say that the reported EU plan "to make private bond holders shoulder some of the pain from any sovereign debt restructuring after mid-2013" is as good an indication of a benchmark as any I've seen."
Regarding the highlighted portion, check this out:
Sweeping reforms to shift the burden of rescuing failing banks from taxpayers to bondholders
Sweeping reforms to shift the burden of rescuing failing banks from taxpayers to bondholders are to be unveiled by the European Commission, despite fears it will further rattle nervous bank investors.
When a bank is deemed to be failing, regulators will win extensive powers to write down non-guaranteed deposits and senior unsecured bondholders, according to draft proposals obtained by the Financial Times.
While the broad thrust of EU bank resolution reforms are well known, its publication has been delayed for more than a year over fears the so-called “bail-in” tools would make it even harder and more expensive for banks to raise money.
There remain extreme sensitivities over the details. The FT has seen three recent drafts that show fundamental elements of the scheme are still being rewritten, with just a few weeks before the expected publication date.
The latest version includes one big political concession. Rather than forcing banks to raise an EU minimum of debt that can be “bailed in”, national authorities will have discretion to tailor requirements.
If approved in the final version, the increased flexibility could leave a patchwork of different regimes and requirements across Europe.
However, it would placate some countries opposed to the original commission measure, which forced big banks to raise bail-in debt covering 10 per cent of their liabilities. To meet this, Barclays Capital estimated listed banks would need to issue €600bn-€1tn of debt that can be bailed-in, which is more risky for investors.
Michel Barnier, who oversees EU financial services, is determined to unveil the plan in early June, within days of the Greek elections and at a time when most European banks are shut out of funding markets. He said the plans were “well thought through” and would not unsettle markets because they were “long term”.
“This is not a bad framework,” said one big European bondholder. “But it’s not going to be well received. This is a terrible time to release it.”
Experts on the reforms say the response will be unpredictable. “The commission may have decided that things are already so bad that nothing can make them worse,” said Bob Penn, a partner at Allen & Overy.
“But it is not going to help share prices or funding. It is not going to help ratings or funding costs. It will help the regulatory arbitrage business, as people duck and dive to avoid things.”
Under the plans, when a bank is judged to be failing and at the point of collapse, regulators will assume emergency powers to sack the management, restructure the bank’s assets and write down unsecured creditors.
EU members will also be required to establish resolution funds, which would be mainly bank funded and could include existing deposit guarantee schemes. National funds would, under normal circumstances, be required to lend to other country’s schemes if necessary.
Other draft changes include setting bail-in implementation for 2018, a later date than expected. Short term debt of less than a month maturity is protected, along with guaranteed deposits.
Regulators are also given some leeway in sparing derivatives counterparties should closing out positions during a debt writedown threaten financial stability or put a clearing house in danger.
ARI (via email May. 27, 2012) That article is a good catch, FOFOA. Much more so than the considerably less-consequential ESM treaty timeframe and implementation that we knocked about a few days ago, this article truly bites at the meat of the original matter mentioned in that 2010 email. And here we see how interminably these things can remain in flux, such that there is now in draft an extension of the timeframe from 2013 to 2018 as cited near the conclusion. You know... I can see where language to that effect could be more popular (among the banks and bondholders) from a simple delaying standpoint, but I would seriously question the likelihood that such a stretch could/would actually be made -- given the greater benefits to be had with fully-fledged freegold in the meanwhile coupled with the favorable cultural and political inertia to be had respecting the timeframe that commences mid- to late 2013 and into early 2014. But if we're looking at a serious attempt to hold the current course for five more years... jesus, that's a lot of stimulus and geopolitical rhetoric and nonsensical economic posturing just to get there -- not to mention five whole more years of the same ol' jaggedy march higher in MTM gold... (which is surely great for the young acquisition-minded, but equally frustrating for the established/retired gold holder.)
Well, there you have it, the full extent of my "timing" discussions with Ari. As most of you should know by now, I don’t do timing anymore. But seeing as the beginning of a new year is the traditional time to make (mostly failed) predictions, I do dip my big toe into the hazardous river of broken crystal balls once a year. And now, hopefully, you understand my reasoning for calling this The Year of the Window.
As for my specific prediction, here it is again from last week's post:
If the recorded price on Friday, January 4th, 2013 is EUR 1,246 or lower, it's game on for Freegold meaning that the window of opportunity is now open because official support for paper gold has apparently ended. In other words, there may be no system support the next time something breaks. But if the recorded price on January 4th is EUR 1,389 or higher, it's six more months of kick the can. And if it's anywhere between EUR 1,246 and EUR 1,389 (which it is today) then the €PoG will be too ambiguous to be predictive one way or the other.
For the full explanation you'll have to go read the post. But even if the €PoG doesn't hit one of those targets, whatever it does between now and Friday is still interesting to me (and I normally couldn't care less about the price of paper gold). So once again, here's a chart of euro gold so that we can keep an eye on it this week:
This year I'm featuring the videos of Freegoldtube that I used in posts throughout the year. If you watch only one, make sure it is his magnum opus, The Ecstasy of Gold, at the bottom. And if you appreciate the very time consuming work he puts into these videos, please be sure to let him know because I think that his drive to continue making Freegold videos may have stalled. How many blogs have someone like Freegoldtube making videos like this?
Uncivilized times call for uncivilized investments.
Charlie Munger, Warren Buffett’s partner in crime at Berkshire Hathaway, told CNBC recently, “I think gold is a great thing to sew into your garments if you’re a Jewish family in Vienna in 1939, but I think civilized people don’t buy gold. They invest in productive businesses.”
In a way, Munger is correct. Gold is uncivilized in the sense that it functions best when civilization functions worst. The more uncivilized a society becomes, the more civilized gold becomes.
So the easiest way to dismiss this statement is to say that maybe it’s 1939 again and maybe this time “we’re all Jewish families in Vienna.” But let’s not let Charlie off the hook so easily. Instead, let’s “unpack it,” in the words of our tutors at St John’s College in Santa Fe, New Mexico. To ‘unpack it’ we need to focus on two key words in Charlie’s statement: “productive” and “civilized.”
Charlie might be right if the world were, indeed, civilized. But maybe the modern world isn’t as civilized as he thinks. Part of what made the world so uncivilized in 1939 was unsound money. The abandonment of the classical gold standard in 1914 made the expansion of the Warfare state possible. The equally unsound system that emerged from World War I — including the Treaty of Versailles — virtually guaranteed that monetary and fiscal instability would lead to political instability. Radical parties like the Nazis flourished.
Gold, on the other hand, is sound money. You are not buying it for a capital gain. You are buying it, by our reckoning, as a way of preserving purchasing power. You extract paper from the fiat money system and turn it into something (bullion) you can later exchange for whatever currency emerges when the financial system becomes more civilized.
Interestingly, for more than a decade Berkshire has underperformed gold — the investment asset Buffett recently called “forever unproductive.”
Since 1997, Berkshire’s shares have declined relative to this forever unproductive asset. The nearby chart depicts the trailing 10-year return of gold since 2007. Thus, the first data point on this chart shows the return an investor would have received from buying gold or Berkshire Hathaway in 1997. Moving across the chart to the right shows subsequent 10-year time frames. Bottom line: Based on a 10-year holding period, there has not been a single moment since late 1997 what an investor would have been better off buying Berkshire Hathaway instead of gold.
No wonder Charlie is so cranky!
This lengthy underperformance by Berkshire may explain Buffett’s and Munger’s very vocal and public hostility toward gold. Or maybe that’s just a function of both men living most of their adult lives in an era where the monetary system was not disintegrating. They are unable to imagine it.
But the chart above isn’t an indictment of the investment acumen of Buffett and Munger. It’s an indictment of the world’s fiat monetary system! A civilized society with civilized people has sound money. An economy with sound money has price stability. This stability allows for long-term planning and investment. This stability rewards investors for identifying which businesses are the most productive and efficient users of shareholder capital.
For these exact reasons, William McKinley campaigned for President in 1896 and again in 1900 as a champion of the gold standard. He won...twice. But just 12 years after his assassination in 1901, the Era of Incivility began: The Federal Reserve came into being. Just 20 years after that, FDR confiscated all privately held gold. And 38 years after that, Nixon cut the dollar’s last remaining ties to gold, thereby establishing today’s very uncivilized “fiat money” system.
In an uncivilized society, where the value of your labor is stolen through inflation (made possible by an unsound money system) long- term planning and investment become much more difficult, if not impossible.
If you accept that we live in civilized monetary times where productive labor is actually rewarded, your brain has been tranquilized by the Big Lie of our times. Munger wants you right where you are. The less you think about how uncivilized the current monetary system is, the less likely you are to question it or disrupt it (which would be inconvenient for Charlie).
But if you live an era that subverts accurate valuation of productive businesses — an era that subverts the productivity of the economy itself by encouraging debt and consumption, owning gold seems prudent, not wacky.
Uncivilized times call for uncivilized investments.
"If you don't know history, then you don't know anything. You are a leaf that doesn't know that it is a part of a tree." Michael Crichton
Question -- Central banks the world over are spewing out their respective currencies over the world. If this continues, won't there be an eventual panic out of fiat currencies?
Answer -- The answer is yes, but before that, interest rates will be rising, and that will halt the machinations of the various central banks. Political pressure will force the central banks to curb their currency creation.
But I want to talk about something else. The action of the big money, the sophisticated money, tends to lead the markets.
In view of that, let's ask ourselves what the "big money" is doing now. We hear that classic art pieces like the Klimpt painting and Munch's "The Scream" are going for well over $100 million. We hear of wealthy individuals buying wildly-priced apartments in New York and London and Hong Kong.
All of this adds up to the "big money" placing their paper money in rare one-of-a-kind tangible items. These are items that will be considered items of wealth even if their respective currencies go the way of all fiat currencies, which is a way of saying these items will be deemed items of great value even if their respective currencies become worthless.
But what of you and I, what of the man on the street? You and I can't afford to buy expensive collectibles. How can we protect our purchasing power if the purchasing power of our fiat currency continues to plunge? Ah, this is the basic question. You and I can't buy a thousand acres of land in Montana. What can we do instead? The answer is that we can do what the Chinese and the Indians and the Vietnamese are doing, we can go to what I call "the common man's rout," we can buy gold and silver.
Joe six-pack can buy one gold coin a month or an even smaller denominated coin. So in a strange way, gold is the "poor man's protection" against a collapse in the purchasing power of his respective fiat currency.
Think about it -- in the entire history of man, no fiat currency (with nothing but a government promise behind it) has ever survived! And you think our current Federal Reserve notes will be the great exception? If the current Federal Reserve notes survive for another sixty years they will be making history, they will be doing what no other intangible fiat currency has ever done.
Ah, you see, the smart money know this. Which is why you are seeing great works of art, rare collectibles, classic cars, arable land, apartments in upper East side Manhattan, gem quality rubies, emeralds, diamonds and sapphires going for prices that most experts can't believe.
Smart money doesn't care what a one-of-a-kind red diamond costs. Smart money knows that this same diamond will be an item of great value a hundred years from now.
So my advice to my beloved subscribers is -- follow the smart money, follow the people who can buy the best advice on the planet, and think ahead, think ahead to the time when there will be a panic out of Federal Reserve notes and a frenzy to own items of tangible value.
Think of "the poor man's item of eternal wealth," think of gold.
Paul Singer On How Money Is Created... And How It Dies
Paul Singer On How Money Is Created... And How It Dies
When we launched our series into the US Shadow Banking system in the summer of 2010 we had one simple objective: to demonstrate just how little the process of modern (and by modern we mean circa 2004 not 1981) money creation was understood. Here was just one example where some $17 trillion (back then, now less)in credit money was rapidly liquidating, an amount greater than the entire M2 and even M3 (had that series still be in circulation) and yet not one academic, pundit or self-professed money expert had or has still accounted for the massive impact of this monetary abstraction on the markets and the economy, which as most know "grows" (to use one of the most misunderstood words in all of economics) primarily by expansion (or contraction as the case may be) of credit, both traditional, which is Bernanke's domain, and "shadow", courtesy of America's #1 export: "financial innovation."
It is now three years later and we are happy to report that almost not one person, not those that hide their complete lack of understanding of the money creation process behind big words, circular arguments, and three letter "monetary theory" acronyms, and certainly not those who set monetary policy, have understood a single thing of what we have been trying to explain all this time, which is merely the modern monetary reality but not from some textbook theoretical perspective, but from a purely practical, where money is nothing more than 1s and 0s in some server, standpoint.
However, one person has. That one person is Paul Singer. Paul is not some fringe blogger, some academic with a chip on his shoulder and an inferiority complex, nor some lunatic gold bug. Paul runs Elliott Management, one of the five biggest hedge funds in the US, which at last check had some $21.1 billion under management. And having managed money successfully since 1977, and witnessed numerous cycles of growth and contraction, not to mention money creation and liquidation, we would argue that his opinion on virtually all matters finance and money-related is second to none. It is certainly orders of magnitude more relevant and correct than that of the shamanistic central planning hacks who sit down every month in Marriner Eccles building to form a circle of depraved (and arguably deferred genocidal) cluelessness, and after a theatrical vote a la Stalingrad circa 1954, determine the cost of money (at least they did in the Old Normal) without even understanding what money actually is.
So for anyone who wishes to know what really happens in the modern world when money is created - and that would be most people who pretend to be informed on this, and other modern financial topics as nowadays it is all about money creation (and soon, destruction) here is, from Paul Singer's latest monthly letter, an extended discussion on the nature of money, how it is created, and most importantly, how it dies.
The concept of “money” used to be simple: items of recognized value, initially in the form of shells, livestock, and then precious metals. At some point, someone decided to print currency on paper, but it was widely understood that it had to be backed by something real, like gold or silver. That history is oversimplified, but it illustrates this central truth: Money that is created at will, rather than grown in the field, mined from the earth, or otherwise subject to supply limitations, can be easily degraded. Nobody would want to own something that may or may not have value and purchasing power in the future. What, then, determines the value of money?
The worldview and ethics of those in charge of the printing presses are obvious answers that are often overlooked. Another is the confidence (or inertia!) of the people who hold and trade the money, or claims denominated in money.
Fast forward to the modern era, which features central banks, so-called “fractional reserve banking,” leverage, and derivatives. Central banks allowed commercial banks to create money by making loans while keeping small amounts of reserves on hand or at the central banks. As money market funds, bank CDs, and other like instruments were created and then became a sizeable portion of the global financial system, things got even more complicated. An obvious clue that the very definition of money, to say nothing of the appropriate ways to analyze and adjust monetary policy, have departed from the understanding and control of monetary authorities, can be found in the proliferation over time of acronyms to describe what used to be called simply “the money supply”: M1, M2, M2A, M3, MZM, and several others.
Add modern derivatives, which entered the scene in a significant way only some 30 years ago, and the picture becomes even murkier. To demonstrate this, in slow motion, consider the creation of a credit default swap (CDS), and then a mortgage collateralized debt obligation (CDO).
Assume an investor wants to be long the credit of IBM. The investor offers to sell to a dealer a CDS on IBM. The dealer purchases the CDS and either keeps it or lays off the risk by booking an offsetting transaction with someone else. Actual securities issued by IBM are not part of these transactions – the CDS is just a contract between the investor and the dealer. As IBM’s credit quality is perceived to change, the price of the CDS will fluctuate and money will change hands between the investor and the dealer (based on the “mark to market”). This position is basically a borrowing by the investor who now “owns” a security referencing the credit of IBM, and who has put up only a small deposit – a tiny fraction of the notional credit exposure that the investor is long. It also represents a highly-leveraged loan by the dealer. Although the investor/borrower does not receive the full proceeds of this “loan,” he or she bears the full risk of loss on the underlying asset. It is as if the investor borrowed money from the dealer, added a small amount of his or her own money, and purchased an IBM security with the total amount of money. Interestingly, such borrowings also have the effect of impacting the price of the actual underlying assets (in this case, IBM credit) due to arbitrage pressures. In effect, these transactions by investors and non-bank dealers represent many of the characteristics of the creation and dissipation of money, but they are outside the traditional and commonly-understood mechanics of fractional reserve banking. Most economists would not consider these transactions in the context of money supply, but we think that they are being mechanistic and not seeing the actual effects of the basically unlimited ability of private derivatives transactions to have many of the same effects as are caused by the creation and destruction of “money.”
The ecosystem of mortgage securitizations has similar characteristics. It starts with the tranching of pools of mortgages into mortgage-backed securities (MBS) and then the referencing (via derivatives) of low-rated tranches to form new securities called synthetic CDOs. Based upon fanciful assumptions about diversity that prevailed pre-2008, the bulk of synthetic CDOs that referenced low-rated mortgage-pool tranches magically turned into AAA-rated securities. These instruments, even in subprime mortgage securitizations, were consequently treated by regulators as zero-risk-rated. Until the music stopped, these high-rated securities had many of the powerful multiplier effects of money. Furthermore, the institutions that packaged and sold the MBS, and those that put together the synthetic CDOs, performed many of the functions of banks (conjuring credit out of small reserves) even if they weren’t banks. Finally, the entire process caused demand for houses to increase and prices to rise.
The purpose of this part of the discussion about money is to show that things have gotten really complex and subtle in the modern banking and derivatives era, and that the old model of money as being solely or mainly the product of bank reserves and bank loans is woefully inadequate.
Now one more element should be added to this mix: quantitative easing, or QE. The government spends money on roads, bureaucrats’ salaries, entitlements, etc. To pay for such spending, Treasury sells a security to the public, and it has an obligation to repay the purchaser when the security matures. The security might be a Treasury Bill, a 30-year bond, or anything in between. The Federal Reserve (or the Fed, as it is commonly known) has the ability to set short-term interest rates, which has incentive/disincentive effects on bank lending and consumer spending. In a nutshell, that model has prevailed as the status quo since the Fed was created in 1913, up until 2008.
Since the crash of 2008, there has been an additional dynamic at work. Namely, the Fed is purchasing massive amounts of Treasury securities, either directly or on the open market. To be clear, the cash outlays by Treasury for government spending are the same as in the preceding paragraph. The difference is that post-crash, there are far fewer securities outstanding that the Treasury must pay off at maturity, because trillions of dollars of such securities are owned by another department of the federal government. We think this process is the effective equivalent of money-printing.
For those who think otherwise, we pose the following question: If QE did not have the effect of printing money, why would the Fed do it? We do not think that QE is merely a duration swap. If the government simply wanted shorter duration and cheaper borrowing costs, the easy course would be for the Fed to set interest rates at zero and for the Treasury to issue only 30-day Treasury Bills to pay for government spending. One possible outcome of such an approach would be that the price of long-term bonds would be uncontrolled, and could possibly fall precipitously, thereby driving up long-term interest rates. Instead, the government adopted a zero interest rate policy, or ZIRP, and Treasury’s borrowing rates dropped as the Fed purchased its bonds, elevating the prices of virtually all other securities. All of this contrivance is intended to be an indirect way of supporting economic activity, and perhaps it has done that to some degree. But it is causing massive distortions of risk-reward in stocks and bonds, as well as significant expansion of future risks of both inflation and severe losses in asset prices. These losses would be experienced by both the Fed and by investors.
The Fed’s explanations of these policies are delivered with equanimity and aplomb. However, in our view, the inventions of modern finance have “gotten away from them” and are not adequately understood by the money-printing overseers. A “smoking gun” is the complete failure of policymakers (and financial-institution executives) to predict or understand the circumstances surrounding the 2008 financial crisis – neither the inner workings/interconnectedness of the institutions involved nor the risks inherent in the system.
Recently released minutes of Fed meetings in 2007 make it clear that they did not understand the modern financial system: its structure, the instruments that comprised it, the implications of the leverage and risk-taking afforded by untested derivative products, and the vulnerability and opacity of the major financial institutions. It does not mean that the Fed has no credibility when it acts or makes pronouncements today. But it certainly means that they should not have a great deal of presumptive credibility, especially about elements that are experimental and untested or that they got so wrong recently (like QE, and the risks of a system comprised of modern highly-leveraged financial institutions laden with derivatives positions, respectively).
It is critically important for investors to try to understand what global QE is actually doing, where it may lead, and what will happen when it slows, stops or shifts into reverse. What we urge most strongly is that the current atmosphere of calm and stability, and the lack of virulent inflation, must not be relied upon to continue forever.
There are certain words and phrases in official communications that give some hint of the uncertainty that exists about key elements of central-bank policies: confidence, anchored inflationary expectations, and velocity are prime examples. Our takeaway is that when investors lose confidence in ZIRP-soaked, QE-ridden, faith-based paper money, the consequences could be abrupt and catastrophic to societal stability. We do not know exactly what to do about it, except to urge policymakers to STOP substituting QE for sound tax, regulatory, labor, environmental, and fiscal policies.
Due to the combination of;
- the lagged nature of inflation in wages and consumer prices, - the vital (if possibly more ephemeral than policymakers think) role of “confidence,” and
- the fact that each particular brand of paper money is competing with other currencies that are similarly mismanaged
the world is in a position today in which the major central banks see only the beneficial effects of QE and not the risks. Bonds that otherwise might be collapsing and repudiated are at sky-high prices with stingy yields. Reported consumer inflation is near historic lows. Consequently, central bankers think that what they got away with yesterday will also work today and next week. Investors either have not figured out that they are long seriously overpriced promises or think that they will all have the luck and perspicacity to reject such instruments before they plunge in price.
The reason we combined derivatives and QE in this discussion is that both are proud inventions of modern financial science, both have many of the characteristics of money-creation, and both are undertaken without any real understanding by public or private sector leaders of their nature, power, interconnectivity, and ultimate consequences. QE is exceptionally dangerous and way past its tipping point. We do not believe it can be unwound without serious consequences. Central bankers think (hope?) that it can be easily unwound at some future date, but they may not be right.
When the rejection of long-term bonds and paper money starts at some unpredictable future time, it may be fast and difficult to contain or reverse. History is replete with examples of societies whose downfalls were related to or caused by the destruction of money. The end of this phase of global financial history will likely erupt suddenly. It will take almost everyone by surprise, and then it may grind a great deal of capital and societal cohesion into dust and pain.
We wish more global leaders understood the value of sound economic policy, the necessity of sound money, and the difference between governmental actions that enable growth and economic stability and those that risk abject ruin.