To 321gold home page

Home   Links   Editorials

June 2009 Volume 6 Issue 1
US Treasuries=Sub-Prime Debt
Gold at $2,000

Acamar Journal
Posted Jun 4, 2009

[Editor's note: Readers in a hurry, can click here to jump to Gold at $2,000]

US Treasuries=Sub-Prime Debt

I began writing the Acamar Journal in 2004, warning that debt levels in the US were at record levels and unsustainable. Much of what has happened was predicted in previous issues of the Journal.

I warned of a financial crisis and a coming recession in November 2006, well before the financial crisis first began in July 2007. In June 2008, I highlighted an RBS report which warned that a stock market crash would occur by September, which it duly did.

Now that the crisis has happened, what next?

Since this recession has been compared to the Great Depression of the 1930s, let's see what happened to the stock markets then. The Dow Jones peaked in Sept 1929 and then fell 48% by November.

It then rose 50% in a bear market rally off that November bottom. The rally lasted till April 1930.

The rally generated expectations that the worst was over. President Herbert Hoover told a group that had come to ask for a stimulative public works program in June 1930, "Gentlemen you have come sixty days too late. The Depression is over."

He was wrong. By June 1932, the Dow Jones had lost 89% of its value from the 1929 peak and the Depression lasted until 1939 when World War II began.

I cite this example to show how the current rally is generating similar expectations. There is talk of "green shoots" suggesting that the economy will resume growth in the last quarter of 2009 or early 2010. The banks have passed the stress tests conducted by the government, though I think the results are not credible.

The US has now committed to over $13 trillion in bailout packages, consumer stimulus, AIG, Freddie Mac and Fannie Mae guarantees, TARP and other programs. These are funds that the US Government will have to borrow to try to solve the crisis.

Here's my problem with this. The crisis was caused by excessive debt and leverage. The solution cannot be far more debt. That's like giving a drug addict more drugs to cure him. It won't work, and it will make the eventual problem worse.

The current US deficit is estimated at $1.75 trillion, which is almost four times larger than the record $485 billion from last year.

My question is: who will fund this?

China has spent the last 20 years accumulating massive foreign exchange reserves due to its massive trade surpluses. But it has only accumulated $1.9 trillion over three decades.

Even with oil around $60, there are not enough Petro-Dollars available to write this kind of a cheque.

And here's the real shocker:

The head of the Federal Reserve Bank Of Dallas, Robert Fisher, gave a speech in May 2008 (Storms on the Horizon) in which he said that the US government's unfunded liabilities are now $99.2 trillion (for future Social Security and Medicare obligations). This is in addition to the Federal debt of over $11 trillion.

With 111.6 million households in 2006, each household's share of this future debt is $888,750. For each family!

Total credit market debt (combined government, corporate and personal debt) is now an all-time record of over 350% of GDP, as of Q4 2008. This does not account for growing federal and state government debt this year nor does it take the unfunded liabilities into account.

The reality is that the US is essentially insolvent.

This brings us to Bernie Madoff. The former chairman of Nasdaq ran a $50 billion Ponzi scheme. For years he pretended to earn impressive returns for his investors; the reality was he didn't invest anything, he just took money from new investors to pay old investors and lived very well off the difference.

The US government is running a similar investment plan through its issue of new US Treasuries.

The US will never, ever repay its debt. It can't, the numbers are too large. Each year, it rolls over the principal and interest by issuing new bonds, with the debt growing ever larger.

The Fed announced last month that it will begin to "monetise" US debt, which means it will buy US Treasuries and Agency debt, ostensibly to keep interest rates down.

Here's one of the major reasons why:

The Chinese have virtually stopped buying US Debt, have warned the US to ensure that it protects the value of the approximately $800 billion it already holds in US debt and have proposed that the US dollar be replaced as the world's reserve currency.

This monetisation strategy, formally known as Quantitative Easing, has engendered sharp criticism from China's People's Central Bank. In a quarterly report, it says "A policy mistake made by some major central bank may bring inflation risks to the whole world. As more and more economies are adopting unconventional monetary policies, such as quantitative easing (QE), major currencies' devaluation risks may rise." It warns of its concerns of a bond crisis due to this policy approach.

Japan is a major holder of US bonds. And Japan's opposition party has announced that if it comes to power it will not buy US bonds if they are denominated in US$, only in Yen!

My concern is that the Fed's actions seems to indicate the last stages of a Ponzi scheme going bad, when there are no longer enough new buyers and the desperate con man has to improvise to keep the scheme going.

And another bubble appears to be OTC derivatives. These unregulated contracts were recently valued at $684 trillion, which is an unfathomably high number compared to global assets. Derivatives are what Warren Buffett once called "weapons of mass destruction" but he indulged in derivative contracts anyway, leading to Berkshire Hathaway's recent 96% profit drop.

And if this US Treasury or derivatives market blows up, then the global economy will be decimated as these are the mother of all bubbles.


Gold at $2000

In May 2008, Schroder Investment Management predicted that the price of gold could rise to $5,000 or more within the next few years due to inflation.

Schroder was a $277 billion global fund based in London, so it was a major bullish call on gold from a blue chip financial institution.

When the crisis hit in July 2007, investors ran for safety to the US dollar, US Treasuries and gold.

The Fed has announced that it is going to create significant amounts of new money out of thin air to buy new US debt. This will dramatically increase the supply of US dollars and US Treasuries, reducing their value.

So, if another crisis hits, where will investors run to? Or if there is no further crisis but when high levels of inflation start to show up due to the massive increase in money supply? Gold is the asset class that will benefit the most in these situations.

Wall Street hates gold. It always has. Partly because Wall Street exists to sell paper (stock, bonds, commercial paper, derivatives, etc.) whereas gold is a real asset and a potential competitor for investor funds.

Also, mining is part of the Materials Industry group in the S&P 500, which includes timber, paper, etc. Before the crash the entire group comprised only 0.75% of the S&P 500, which meant that mining was irrelevant to analysts as it was simply too small. While it is up to about 3.3% now, that is simply because financial and other major industry groups have fallen so dramatically in market valuation.

No wonder that in late 2007, one of Goldman Sach's top ten investment ideas for 2008 was to short gold. Inevitably, in 2008 gold surged to an all-time high of $1,034.

Governments also hate gold. Like Wall Street, they also peddle paper (money and bonds). Under the gold standard, the supply of money was tied to the amount of gold the country held, which restricted government's ability to issue endless sums of largesse in pork barrel spending and forced it to live within its means. Historically gold supply only rises by an average of 1-2% per year (though it has been declining steadily in recent years). Under a gold standard, the boom created by easy money since the Reagan era (with excess debt and leverage) would not have occurred and we would not be facing the financial crisis that we do. This crisis has shown how very easy it is for people who saw themselves as middle class to drop into penury and how illusionary is the prosperity that is debt based.

Once President Nixon removed the US$ from the gold standard, we had massive inflation in the 1970s (and which we will face again in the coming years). Paul Volker, the Fed Chairman who had to raise interest rates above 20% to choke off inflation, was asked what he would have done differently during his tenure as the head of the Fed. He said he would have capped the price of gold (which rose from $35 in 1971 to $875 in 1980).

This type of comment is why many investors believe that governments suppress the price of gold, since the rise in the price of gold is an indictment of government policies regulating sound money and inflation. Rising gold prices can undermine confidence in a fiat based monetary system, as gold itself has been money or tied to money supply for most of human history and is viewed as an alternate monetary asset.

Simon Johnson, former Chief Economist of the International Monetary Fund (IMF), has recently warned that the US political system is being dominated by a financial oligarchy, which is distorting economic policy in favour of the banking sector. ("The Quiet Coup")

And Dick Durban, the senior-most Democrat in the US Senate said last month in an interview: "And the banks - hard to believe in a time when we're facing a banking crisis that many of the banks created - are still the most powerful lobby on Capitol Hill. And they frankly own the place."

Not many people realise that the Federal Reserve is not a part of the US government but that it is a private bank and is owned by other US banks. Americans expect the Fed to work on their behalf but the reality is that the Fed is the most effective tool the banking industry has to serve its interests.

And finally with Goldman Sachs' alumni running the US Treasury (Hank Paulson, Tim Geithner, Neel Kashkari, Robert Rubin, to name a few), the primary focus of the rescue package has been to not only save the banking sector but use the crisis to transfer hundreds of billions of dollars from taxpayers to the banks.

Thus economy policy is not focused on saving Main Street, but on self-servingly helping Wall Street.

As a result, the roots of the crisis have not been resolved. Meredith Whitney, the analyst who focused attention on the banking crisis, says she expects housing prices to fall another 30%. GDP and unemployment numbers continue to surprise on the downside. Commercial real estate and credit card debt defaults will create the next large wave of losses.

The IMF estimates total global banking losses at $4.1 trillion, with the US share being $2.7 trillion. US Banks have written of about only $510 billion so far.

The IMF's estimate of banking losses made just one year ago was only $1 trillion!

According to the stress tests conducted on 19 large US banks by the US government, they require only $75 billion of new capital.

Professor Nouriel Roubini, who predicted the entire financial crisis, has criticised the tests as the worst case scenario laid out was the current economic situation. He says that the stress test results will not be credibly interpreted as a sign of bank health.

A stock market rally makes people think things are getting better. But insiders (directors and senior managers of US companies), the people who should know what's really happening, are selling their shares at the fastest rate since October 2007 when stock markets peaked, according to Bloomberg.

The reality is that there is more pain to come and things could get really ugly.

Interestingly, China recently announced that it has almost doubled its holdings of gold in its official reserves. At 1,054 tonnes, China is the fifth largest holder of gold but it accounts for only 1.8% of its reserves (the US has 80% of its reserves in gold and the average European country has about 50%).

In November 2008, the Guangzhou Daily reported that China's central bank is considering raising its gold reserve by 4,000 metric tons to diversify risks brought by the country's huge foreign exchange reserves. 4,000 tons represents about 20 months of global gold production.

No wonder then that when the IMF proposed to sell 400 tons of gold to raise cash, China and India suggested that it sell all of its gold holdings (3,217 tons), presumably so that they could buy it!

So between another round of the financial crisis, inflation and dollar devaluation, the demand for gold continues to rise and we will see the price of gold over $2,000. And I believe that it will happen within the next 12-18 months.


Acamar Journal

The Acamar Journal is intended to provide factual and timely research on general economic trends, opinions about trends in specific industry sectors, information on specific companies, references to other publications and reports that may be of interest to investors, and information on general trading strategies. Zabina Ventures Inc. ("Zabina") is not a registered investment dealer or adviser.

Although the statements of facts in this report have been obtained from and are based upon sources Zabina believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions and estimates included in this report constitute Zabina's judgment as of the date of this report and are subject to change without notice. Zabina makes no warranties, express or implied, as to results to be obtained from use of information in this report, and makes no express or implied warranties of merchantability or fitness for a particular purpose or use.

This report is for informational purposes only and is not intended to be advice, or an offer or a solicitation with respect to the purchase or sale of any security. This report does not take into account the investment objectives, financial situation or particular needs of any particular person. Investors are advised that investing in securities entails certain risks, and they should obtain individual financial advice and undertake extensive due diligence based on their own particular circumstances before making any investment decisions.

Zabina may from time to time perform corporate communications or other services for companies mentioned in this report. Zabina and/or its principals may be compensated for such services, in the form of fees and/or options. In addition, Zabina or any individuals preparing this report may at any time have a position in any securities or options of issuers mentioned in this report. Directors, shareholders or employees of Zabina may be a director or officer of officer of a company mentioned in this report.

Copyright © 2004-2011. All rights reserved.

321gold Ltd