June 2009 Volume 6 Issue 1
Gold at $2,000
Posted Jun 4, 2009
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,
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
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
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
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
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
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 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
The Chinese have virtually
stopped buying US Debt, have warned the US to ensure that it
protects the value of the approximately $800 billion it already
holds in US debt and have proposed that the US dollar be replaced
as the world's reserve currency.
This monetisation strategy,
formally known as Quantitative Easing, has engendered sharp criticism
from China's People's Central Bank. In a quarterly report, it
says "A policy mistake made by some major central bank may
bring inflation risks to the whole world. As more and more economies
are adopting unconventional monetary policies, such as quantitative
easing (QE), major currencies' devaluation risks may rise."
It warns of its concerns of a bond crisis due to this policy
Japan is a major holder of
US bonds. And Japan's opposition party has announced that if
it comes to power it will not buy US bonds if they are denominated
in US$, 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
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
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
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
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
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
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
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
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.
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