A Look At This Week’s Show:
-Eleven great years in gold: slow and steady
-Major supply sources are not keeping up with demand
-The East dominates the West in gold consumption
Posted on 11 January 2012.
Posted in PodCastsComments Off
Posted on 06 January 2012.
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, Happy New Year! It’s a strange one, though, I have to admit. We were sitting here talking about 2011. But, as we look into 2012, we have people right now actually looking at numbers and saying, “Hey, the recession is over. Was that really a recession? There are people who said it was greater than the Great Depression. Was that really greater than the Great Depression?”
David, I don’t know that we have really felt, yet, the default of the world sovereign system.
David: Kevin, this is what is so fascinating. Coming into the new year, there is, again, sort of a bifurcation, two different views, two very different camps – one that says, “Look, we have record earnings from the S&P.” Of course they are ignoring the fact that the majority of Dow 30 stocks have actually lowered expectations for the fourth quarter, and are looking at an incredibly slower start to 2012.
Kevin: 2011 was a loss year for the S&P, so for people who are thinking that this is a recovery, where was that in the stock market?
David: But there is also, on one hand, the sense of greater nervousness that the policy makers are really up against it. They don’t have many tools to use. The ones that they have tried using have at least kept us above water, but we are not returning to a healthy environment. Unemployment is still high. Those are the defined concerns of one crowd.
The other crowd is on the other side saying, “Hey, if we will just think more positively, we will be above this, and beyond it, in a New York second.”
Kevin: But for those who can print money, like the United States. We have exorbitant privilege, according to Barry Eichengreen, and I agree with that. We don’t necessarily feel the pain, though we can see what is on the news. Let’s face it. We’ve witnessed more social unrest last year than any time since the late 1960s.
David: Kevin, I think this is just an important recollection. Looking at 2011, and thinking about all the things that changed in terms of political power structures, it was a year of almost uninterrupted drama in the news headlines. We began in December of 2010 with the gentleman who immolated himself in Tunisia, set himself on fire, in response to sugar prices being too high.
Kevin: That reminds me of the 1960s. We were seeing those same images at that time.
David: It was in Tunisia that we saw the beginning of the end, if you will, for that regime – Tunisian riots, followed by a new government, then Egyptian rights, and a new government, then Libyan riots, along with western support, and a new government. We have Syrian riots, and the government now hanging by a thread. We had riots last year in cities like London, New York City, Moscow. Actually, throughout countries like China, Chile, Israel, and India – we are talking about mass riots, even on a larger scale, last year, than India normally sees – there are generally 70,000 instances of civil disobedience, not full-blown riots, but protests of one sort or another. In China, last year, it was even greater.
Kevin: Think about Greece and Italy, and the European countries, especially what we call the PIIGS countries – that’s not a very flattering title, but it includes Portugal, Ireland, Italy, Greece, and Spain.
David: Again, Kevin, if you look at 2011 and consider the political power structures that were upset – as you mention, we have Greece, which had a new government put in place in 2011, we have Italy, and a new government put in place in 2011, we have the same thing in Portugal, and we have the same thing in Spain, both with new governments in 2011.
It appears that whatever is in the air, frankly, is not very good for incumbents, or frankly, anyone at the end of a populist whip. It just depends on what issues they are focused on. And frankly, it doesn’t matter what your belief system is. If you are in charge during this period of stress and strain, you will be held responsible, or the finger is going to ultimately be pointed at you.
Kevin: David, there is something that has occurred in the last week that has almost sneaked under the radar. Back in 1913 we had the passage of the Federal Reserve Act, and it was probably the greatest change in U.S. history. It changed our entire monetary system, yet we don’t understand it, still. Many people don’t understand the Federal Reserve.
But what occurred during this particular holiday season, and in 1913 they also sneaked it in during the holidays, is that we have lost our constitutional rights. Congress voted for something, almost across the board, that takes away our constitutional rights. They can jail us right now, any of us, without any constitutional reason.
David: Kevin, just to give a preview, this is the kind of thing that can lead to civil war, and I am saying that in a strange way, because if you look at the causes and the causal chains, if you will, there are many other things, of course, that have to be in the mix. But when you take away the rule of law, and the defense of individual liberties by the rule of law, you have done something that creates an incredible amount of political and social instability and insecurity, and leaves everything on the table that would normally not be on the table in a law-driven society.
What are we talking about? Going back to what we saw in 2011, Kevin, we have seen people, by and large, act with decorum, and the idea here is that we certainly hope that frustration does not smolder into anger, or any greater violence. We have seen things fairly well controlled with Occupy Wall Street. We have seen the riots in London and Moscow, where we are not talking about bloodshed at this point – it was in North Africa, and perhaps in the Mediterranean region where we have seen a lot more violence and indignation.
If there is, in 2012, an escalation, if you will, of greater anger, greater anxiety, and greater violence, that would only serve to justify the entrance of police state tactics – intimidation, counter-violence, things that, frankly, we hope we never see. Particularly dire consequences, are even, as you mention, now in the mix here in the United States after the weekend signing of the National Defense Authorization Act.
Kevin: Which basically says that they can jail anyone, does it not, if they see them as a threat to the country? And they can hold them indefinitely.
David: Kevin, as far as I understand the presidential signing statement, which went along with the signing of the NDAA, he said, “Under my administration, my interpretation will be different, and this is what it will be,” and that essentially comes due at the end of 2012. So, if he is re-elected, I don’t know if the presidential signing statement is in place, or if he has to actually create another one, but the reality is that this is changing the structure of the relationship between the governed and the governing, in a very unhealthy way.
Kevin: And of course, it is in the name of safety, and I have to think back to what Ben Franklin said. “When the governing bodies have decided that safety is more important than liberty, we actually deserve to lose both.” Does that not happen? All these things are passed on best intention, are they not?
David: Certainly, and that is, I think, one of the issues here, that you are really talking about a subnote, wherein American citizens deemed to be a threat by the president, can be indefinitely detained without any due process whatsoever. There is no call to your lawyer, there is no court hearing. You could sit and rot in Gitmo for the next 30 years, and there is absolutely no recourse for you. That, Kevin, is expressly unconstitutional, and as such, my feeling is that every legislator who voted for it should be thrown out of office in any ensuing election.
This is the kind of accountability that needs to be appreciated between the governing and the governed. It is our job as citizens to voice concern. We talked about the book, Exit, Voice, and Loyalty, and it is one of those things where a citizen, or any member of a body, whether that is a company, or what have you, will either, out of a sense of loyalty, stay connected, give a voice, and that is like letting off steam and thus remaining connected to that body, or they will simply exit.
Exit, in terms of a body of business, means that you will no longer do business with a company that you don’t like, or you will leave as an employee because you don’t feel it is a just situation. But that exit, in terms of citizenship – I’m not talking about a mass exodus of people renouncing their citizenship – is protests. That’s why I started by saying, the document that was signed by the Executive Branch, if not addressed by the judiciary, would be the first in the causal chain of things, which five, ten, or fifteen years from now, could lead to civil war here in the United States.
Kevin: When the U.S. citizens lose the defense of the rule of law, they have lost everything that the constitution grants them, and at that point, they are at the whim of whatever leader is in power.
David: Right, because you are essentially having to live in fear of the arbitrary use of power against you. So, if you lose every reason to honor the powers that be, and in turn, fight, because you feel threatened by them, again, looking back to the causal chain of what originally got this going, the destabilizing event, which maybe only finds traction five, ten, or fifteen years later, Kevin, I think this is just it: The National Defense Authorization Act is just such a thing, and you were right to quote Ben Franklin, because we don’t deserve liberty, or safety, if we are willing to so superficially sacrifice liberty for something as surface-oriented as safety.
Kevin: Well now, David, where do go from here? This has been passed by Congress, and it has been signed by the president. When you are talking about exit, voice and loyalty, what do we do? We have to speak up somehow, and the only way, constitutionally, that we are allowed to speak up, at this point, is at the polling place, and with our freedom of speech.
David: I think there are two places to press that. One is that the current mix of Republicans and Democrats will have, with this act, destroyed the social contract with the stroke of a pen. I think, to communicate that back to them, again, just letting them know that they have lost your vote, and that you are pledging monetary support to anyone, anyone, that opposes them in the next election on the basis of this issue.
Kevin: David, that means throwing them all out.
David: I’m okay with that. It was almost a universal consent that we needed the NDAA, even with the baggage that came with it, and this is where legislators need to know that they are crafting laws that are supposed to be consistent with the constitution, and here is something that is so grossly anti-constitutional. Again, I am hurling an insult at both the Republicans and Democrats for being so small-minded in this way.
Kevin: It would be wrong to blame the Obama administration.
David: Absolutely not. This does not rest on his shoulders. He may have signed it into law, but guess how many hundreds of people, from all across this land, who purport to represent you and me, signed it into law first, who wanted it as an ideal?
Kevin, this is why we have three parts in our governmental system. We have found two that are lacking. We hope and pray that the judiciary will see this as unconstitutional and throw it out. If they don’t, then we need to make our voices heard at the polls. So as we come into this next year, Kevin, an election year, it is very important that we focus the attention of the governing on the real interests of the governed, and that is, that we have our constitutional rights respected.
I could care less about the issues raised by Occupy Wall Street, or the Tea Party, as it concerns fiscal issues. Those things will come and go, with long-term business and credit cycles. As much as I care about the solvency of this country and the stability of our dollar, nothing compares in significance to our constitutional rights being sacrificed for something as silly as safety.
Kevin: David, in this particular case, I know you don’t agreed with the ACLU very often, but the ACLU actually agrees with what you are saying right now.
David: They came out with a statement immediately after the signing, and we are talking about within minutes of the presidential signing on the 31st. While we were toasting with champagne and bringing in the New Year, the president was signing something that, as even the ACLU said, “This is an abomination in terms of our civil rights.”
Kevin: David, I’ll tell you something. After going out and talking to the guys at Occupy Wall Street, which we have talked about on this program before, and I wasn’t impressed, but one thing that I have seen about the protests here in America, maybe even in Western Europe, that is different as we look east, is that these people right now are focusing on “capitalism” and they are blaming the financial markets and they are blaming the big bankers. Of course, the big bankers should take some blame. But they seem to be completely leaving out blaming the politicians, and what we saw on December 31st means we should be looking at the politicians, not capitalism.
David: Kevin, that is exactly right. I think what we have allowed politicians to have is a free pass in 2011, at least in the U.K. and in the United States. The emphasis has been much more on the money mandarins, and I think, actually, we will see that change as we move into 2013 and 2014.
Kevin: When I talked to people in Occupy Wall Street, no one cared anything about protesting in Washington. They just wanted to protest in New York, because it must be the guys in the suits.
David: Kevin, I think that is a critical distinction between the global protestors and the emphasis placed on politicians, the pressure for real political change, and the protestors here in the “West” who are putting more of an emphasis on changes in banking, changes in fairness, changes in redistributive policies.
I think that is the real critical difference. The rest of the world seems to be going straight for the political class, and that on a wholesale basis. We would say that social unrest on a worldwide scale, not only was seen in the 2011, but it is going to continue in 2012, because we have newly enfranchised politicians who are being given the impossible task of maintaining stability in a totally destabilized world.
The great de-leveraging, or unwind, of 50-60 years of credit domination in the marketplace is what these politicians are up against, and as the West takes its three steps back, the developing world, the emerging markets, they take their steps back, as well. They take their lumps, as well. And regardless of who is in political power today, the same question is going to be asked by their constituents: “What are you doing for me today?” – even the ones who put them in power, rejecting the old power structures, because they didn’t feel like they were being tended to.
Kevin: David, sometimes we have a myopic mindset. We were just talking about constitutional rights. We have certain things that we value here in the West. As you look east, people don’t value the same types of things. When you have a society that has been ruled by a dictator or a tyrant, and they have been kept in order, be careful what you wish for, because that voting public may not have the kind of values that you would want to have running the country.
David: I think this is the illusion that we have when we think of a “democratically elected government” – that all of a sudden that is going to bring the virtues and full representation of the people. Again, bringing back this idea of the rule of law and how important that is to our democratically elected government in the United States, law is paramount. The constitution is paramount.
If you go back to Czechoslovakia, and Vaclav Havel, after the Velvet Revolution, what was the first thing that he did? He said, “I will not be in office in the next election, and I am setting my limit. I am setting my own term limit to two years. That is the time frame we have to create a constitution, something that will endure through the generations.” And that is, in fact, what gave Czechoslovakia its great success.
Kevin: I remember the patriots, the founding fathers, who did the same thing here in America. George Washington – they were trying to make him King George, and he set his own standard, and said, “No, I’m not going to do that. You don’t want another King, you want transitory power.”
David: And that is the nature of democracy, Kevin. Unfortunately, if you don’t have the substructure of the rule of law, you are really not talking about the greatest number of people who get to vote, you are talking about the loudest voices that get heard, and that is what becomes a representation of the people.
Kevin: So, in the years 2012 to 2103, we may begin to wince. It may really be painful, because what we are seeing is that these new democracies are really just old extremists now regaining power.
David: That is certainly the case, if you are looking at the Middle East, and this is where we see the Muslim Brotherhood in Egypt already asserting its power, and what was viewed as a charitable organization looking for peace and generosity, we find, that they, in fact, are having to reassert power, reassert dominance. All of the riots in Tahrir Square are happening again, already, because people are not having their expectations met. We are already seeing sectarian differences expressed. And while it worked last time – show up in the square, and if you are loud enough, people will respond – now they are being loud and the Muslim Brotherhood is saying, “If you are not quiet, we are going to shoot you.”
This is an issue where, again, Kevin, your comment is appropriate. The new democracies, which the West is so keen on seeing enfranchised, are really just the old extremists that have received the blessing of the West because the process involved “democratic elections.” But their priorities and their intentions were never questioned, and that should have been done at the front end.
Kevin: You know, David, we live in such a complicated time, too. Think of the James Bond movies. That is probably one of the best meters as to who your enemies are. Back in the old days, my son and I were talking about it. He is only 21, so he doesn’t really remember the Cold War, but in a weird way, the Cold War was comfortable, because you just had Russians who were the bad guys, and you just had two sides. But at this point, and we talked about this before, there is a lack of headship and we have old extremists coming into power, old tyrants being either shot or taken out of power. Nobody likes a Mubarak, necessarily, or a Khadafy, or a Saddam Hussein, but let’s face it, from a geopolitical standpoint, things are being destabilized.
David: It was just a simpler world. I’m not saying it was a better world, but it was easier to make judgments and define relationships in that Cold War polarity. There were the good guys and there were the bad guys, and everybody lined up accordingly. You were a friend of the good guys, which made you a good guy, or you were a friend of the bad guys, which made you a bad guy.
Kevin this is the point: Those who are democratically elected – and for us that is a moral victory, as we have seen democracy spread throughout the Middle East – now may, in fact, behold things, or believe in things, that we find very morally objectionable.
Kevin: David, let’s face it. Not everybody has a religious directive for world domination, but there are some of the people who are running some of these countries who believe that they have, because of their god, a reason to take over the world. So, yes, democratically elected, and we are talking about relationships based on trade or security, or what have you, but they may have a motivation that is far beyond what we can imagine.
David: Kevin, I think, as an indication of that, consider the al Qaeda-linked group in Nigeria that, over the weekend, was responsible for several bombings. It’s a militant group whose name translates “western education is sin.” That’s the literal translation.
Kevin: So it’s good to know the language if you want to know what the motive is.
David: And as long as we are talking about multicultural expression and a greater globalized, homogenized world, listen. You want to be homogenized with this? Great! Western education is sin. That would include everything that isn’t directly out of the Koran. Basically, we have excluded, by defining the only source of education as the Koran. That is problematic, I think, for many in the West. That is problematic for many in Europe. That is problematic for the whole world. But we have this flashpoint, Kevin, and I think this is something that we need to remain sensitive to – Iran, of course, with their nuclear rods and their surface-to-air missiles, and their saber-rattling over the Strait of Hormuz.
Kevin: And now, our drone.
David: Yes, of course, they have our drone, which they shot down. Of course, that’s not what happens when you shoot something down. It usually ends up in a thousand pieces.
Kevin: It sure looked like it landed well to me. There is an old saying when you are a pilot, “Any landing where you walk away from the plane is a good landing.” Well, there was nobody to walk away from the plane, but they could have.
David: Humpty-Dumpty – this would have been a magical Humpty-Dumpty story, where you definitely got it put back together again.
We have growing tensions in the Middle East, and I think this is one of the things that we will have to explore in 2012, the irony of destabilization by getting what we wanted. We chose safety, and we ended up with what? We chose democracy, and we ended up with what? There are probably about ten different themes which we can explore this year, Kevin, where we thought we were saying yes to one thing, and we got something else completely different.
That is the same strange irony that we have with the derivatives market. We have someone who is willing to leverage their balance sheet. If you look at the average U.S. financial institution, or global financial institution, and they are willing to leverage their balance sheet 10-to-1, 12-to-1, 17-to-1, 25-to-1 – massive leverage. Of course, massive profits, with very little capital involved. And they are willing to take that risk because they have taken out insurance policies to mitigate some of that risk.
Kevin: Which are called credit default swaps.
David: Credit default swaps is one of the key varietals. And guess what? We discovered in 2011 that credit default swaps aren’t worth the paper they are written on, if you get politicians involved. Why? Because most politicians have a legal background, and if you have a legal background you know that words are subject to interpretation, and we just discovered the reality that the word default is subject to interpretation. A 50% haircut is not a default as long as it is done on a “voluntary” basis. A curious loophole for the whole world of finance, which is leveraged to the gills on the basis of this insurance component that allows them to be “safe.” And again, the things that we asked for are not necessarily what they seem.
Kevin: That’s what I don’t understand, Dave. We have talked over the last couple of years about the danger of all these derivatives sitting out there that could be triggered at any moment if we saw a default. What we have seen instead of “default” – maybe it’s default with a small “d,” not with a capital “D” – these guys have basically said, “Let’s not call it default, let’s call it something else, so that those insurance policies don’t trigger.” These guys still took a 50% haircut, but David, that credit default swap cloud is still out there, and all it would take is the right word being used, and it would still be triggered. Isn’t that the case, or are the CDSs gone?
David: No, the CDSs are not gone. They are still there. There is very little reform that has taken place since 2008. As in our conversation with Rick Buchstaber, this was an amazing discovery from someone who is going before Congress and saying, “We have to change this, we have to regulate the market, we have to have these things traded on an exchange. And if we don’t, you have no idea what you are staring down the barrel of.”
Kevin, this was the question that was asked on Fox News last night, in the interview that I did with them. They asked, “2008, reasonable problems. What do we see in 2012?” And my response was, “2008 was a crisis, but 2012, 2013…”
Kevin: Is maybe the crisis.
David: The crisis.
Kevin: Now that scared the commentator a little bit, David Asman, and he even said that.
David: I think the issue here, Kevin, is that we think that we have gotten past the worst, when, in fact, we have changed nothing. And the things that have changed are actually creating other areas of destabilization, and now we are talking about politics and geopolitics. But as we discussed, negative feedback loops from one of these areas – politics, geopolitics, finance, economics – can end up having a negative influence on all, as they come back around and surprise.
Kevin: Let me ask you a question, David. This is 2012-related, but it is actually bringing it down to a more personal level, because we have been talking about the state of the world. You and I are not going to change the state of the world, but we are talking to people who are saying, “Okay, I have a family, I have a household, I have savings. Are we going to coast through 2012?” Granted, 2011, was pretty turbulent, but, for the most part, we have coasted through an entire year without really feeling the effects of these things. 2012 is different.
Let me ask you. From a personal point of view, for the people who are listening, who say, “Okay, what do I do right now? What should I look at with my finances?” Gold. Let me just take it to the base of the triangle, to start with, David. Gold had a good year, from $1300 to close to $1600 by the end of the year, but it also had fallen from $1900 in the last quarter. What are we looking for on gold at the base of the triangle, and maybe the rest of the triangle? Would you comment?
David: I think that applies specifically to the financial, and we could certainly talk about the social and political, as well, because these are areas, Kevin, where, as we suggested last week, we will see extreme regime change. We are coming into a period in time where, as Franck Biancheri suggested, in the context of crisis, time gets shrunk and compressed, and the amount of things that do change in a very short period of time will shock and amaze you.
2012 and 2013 will see social unrest, and will see political change as a result of that. But certainly, we also focus on the financial element. We sent out a news alert to everyone on our email list on Friday. Gold hit the 65-week moving average. This is a technical range that gold has recovered from every time over the last ten years. If we are still in a bull market, and we have good reason to believe that we are, then, as a buying opportunity, as a place to be reallocating, as a place to look and say, “Okay, well, now that that asset class has been fully compressed, what can we expect?”
Kevin, I think we are actually standing on a loaded spring when we are talking about the precious metals, coming into 2012 and 2013, again, because we have both the political change, and the social unrest, in the background, 2011 being a precursor in that regard. We have had a preview of coming attractions. We have seen it in sort of the fringe world, and coming to a theater near you, is Washington D.C., New York, San Francisco, Seattle, and if we are talking about Moscow, then throw in half a dozen other cities. If we are talking about London, then throw in half a dozen other cities in the U.K.
Kevin, where we are seeing social unrest, we will see social unrest on a more frustrated scale, on a more out-of-control scale, and the response to that, is a much more controlled, and frankly, unfortunately, more violent response. Those are the issues, Kevin, which I think serve now as the structure, the undergirding, for people making a decision like this.
I could choose dollars, and why would I? Because I see the systems, as they are, being called into question. I don’t know who is going to be in power next year. I don’t know, even if we have a free and fair election in 2012, that they will maintain power for six, or twelve, months. Those kinds of questions will emerge in the context of an unstable social environment.
Kevin, remember, the last time we had this much social unrest, and you brought up the 1960s, we have not seen that kind of social unrest in the U.K., or in Moscow, and I don’t think that is a Putin concern today, or a concern for this current administration, nor should it be. Because again, I think people can, and should, act with the requisite decorum, to pursue the rule of law, the application of the rule of law, and the healthy expectation of the governed, stating their opinions to the governing, in a healthy way.
But Kevin, this is the context where investors say, “All bets are off. All bets are off on the dollar. All bets are off on Treasuries. All bets are off on a healthy, functioning stock market. All bets are off in terms of free trade.” We can very easily see this morph into what was also the summer of 1931, where a regional banking crisis in Eastern Europe became a banking crisis in London, became a banking crisis in the U.S., and what was a severe recession became a major depression.
That is the environment, and whether you are looking at the political, whether you are looking at the economic and financial, it is a period of extreme dysfunction and chaos, and in that environment, Kevin, people scramble for control. I look at gold being at the 65-week moving average, and say, “If not now, when?” There is only one instance in the last ten years where this level was breached, Kevin, and it was in the fall of 2008. And by the way, the asset did recover by the end of the year, so in spite of a 30% decline, it did recover to a 5-6% positive return by the end of the year.
Kevin: David, wouldn’t you say, for the person who is saying, “All right, there may be chaos in your life, but my life is just perfect. Don’t worry about it, I think maybe it’s a recovery. You guys are just crying wolf. That’s all you’re doing, just crying wolf.” So let’s just say, we say, “Yeah, okay, that’s it, just crying wolf.”
David: Kevin, that’s the value of the perspective triangle, because it allows you to be right and wrong, regardless of the outcome. If it is a deflationary vortex that we get sucked into, and everything gets sold down to zero, guess what you have a third of your assets in? The one thing that people want the most – cash. Great! You’re a hero! Your cash, in terms of purchasing power just expanded a multiple, and you can buy the world for ten cents on the dollar, making the other two-thirds of the portfolio, which may have been hit hard, inconsequential.
Kevin: But let’s say it’s inflation.
David: In that case, your cash is worth nothing, your equity values succumb to the pressure in the market of an earnings crisis, and guess what? Your insurance policy in the form of physical metals pays off, and it doesn’t matter what happened to your cash, and it doesn’t matter what happened to your equity portfolio. It becomes inconsequential.
And if, on the other hand, the Pollyannas of the world today are saying that yes, we are in recovery, the recession is past, we have a bright future today and tomorrow; if they are right and we are wrong, guess what? You are leveraged on the upside and a third of your portfolio will, probably, over a 5-7 year period, make up for any losses that you have had in the cash position, and in the metals position, in your portfolio.
Kevin: So the answer to the question that I posed a few minutes ago, as to what a person should do with their own finances, still doesn’t change. It is a third in gold, a third on the left side for growth, and a third on the right side for cash, or at least something where you are aware of those percentages.
David: 2012 requires that you take a balanced approach to the markets. There are these different views, as we pointed out when we began the conversation today, Kevin, of extreme concerns and extreme happiness, that, in fact, the worst is behind us. When people have the facts all lined up on both sides, and they happen to be opposing and contradictory, you realize that no one knows what is going to happen next.
Taking a balanced approach, a diversified approach, which we find the perspective triangle to be … yes, I think that is the best way to approach this year – a most conservative one – certainly, in light of the facts as we see them.
Posted in TranscriptsComments Off
Posted on 02 December 2011.
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, yesterday you came in after a great holiday away – you had gone out of town and had a great Thanksgiving. But you had this pale, green look on your face. The stock market was up 300 points! Was it the food?
David: We had a great time visiting with family, fantastic food, and what evolved last week, while we were thinking about turkey and stuffing, and family time together, was the complete implosion in Europe. Wednesday, we had a failed bond auction in Germany, and how much press did it get Thursday, Friday, Saturday, or Sunday? As we came into the new market open on Monday, there was grave concern about the dissolution of the eurozone, in its totality, not just losing Greece. And we had Merkel and Sarkozy trying to patch some sort of a last ditch effort – conference, this, that, and the other – and guess what? Retail sales were great on Friday.
Kevin: We had a great black Friday, Dave? I mean, why wouldn’t spending more money, when we don’t have it, be good news?
David: Kevin, I guess what scares me is that people really aren’t engaged. Do people think that spending 52 billion dollars of money that you don’t have, on credit cards, to just feel like you are doing all right again, is somehow a revival of new growth in the economy? I’m all for improved retail sales. I’m all for retailers doing well. This is not a bah-humbug moment. I am not Scrooge. But this is the issue: We have people who are spending money that they don’t have, and it is really reminiscent of what the government is doing – they are spending money that they don’t have. And the whole crisis that we have in Europe, and in the U.S. – it’s the same theme over and over again. It doesn’t matter whether it is Main Street, Wall Street, or the folks in Washington, D.C., or any power center around the world. It seems that the problem and the solution are utterly confused, because the problem was spending money that we didn’t have, and now what are they doing more of? Spending money that we don’t have.
Kevin: David, it reminds me, and this is not necessarily a partisan issue – it reminds me of 2001 when Bush was saying it’s patriotic to go spend money because of 9/11. We need to get the Americans activated – go spend money. It just shows how tightly Keynesian economics has gripped a public who has never heard of John Maynard Keynes. It’s all about spending more money and good news, even though disposable income, I think, was down over 2%, from year to year. The disposable income was not there to make a Black Friday, or even Cyber Monday, a better day.
David: Kevin, my thoughts were bordering on the paranoid coming in on Monday, because my sort of crisis checklist was being put in place Sunday night. Moving into crisis mode, I was thinking about bank deposits, limiting them, checking the latest safety rating of my bank. I was thinking about insurance companies, limiting exposure to insurance companies and making sure that I’m with the most credible, if with any, insurance company at all. Pension funds – do I have the option of a lump sum? Take it and run, if that is the case. Literally, I was coming in Monday morning thinking this was a time to be battening down the hatches. And instead, the market went nuts, berserk, absolutely ecstatic – because guess what? There was an indication of a pulse with the consumer. And I was just thinking to myself, “Really guys? This is as deep as it gets.”
Kevin: And some of the quotes that were coming out of Europe and England were basically saying, “We may be days, or weeks, away from the end of the eurozone.” So people really are not connecting the dots.
I want to jump back, though, David, because even though we talk about the economy a lot, we do say the financial moves to the economic, moves to the political, and then it goes to the geopolitical. Iran – things are happening right now in Iran. It may not be to Americans, but it is to our ally, Britain, right now.
David: Kevin, I am reminded of a song lyric, “It only takes a spark to get a fire going.” On Sunday the Iranian parliament voted to expel the British ambassador, and reduce diplomatic relations with the U.K. On Tuesday morning, the British embassy released this statement, “There has been an incursion by a significant number of demonstrators into our embassy premises, including vandalism to our property. This is a fluid situation and details are still emerging. We are outraged by this. It is utterly unacceptable, and we condemn it. Under international law, including the Vienna Convention, the Iranian government has a clear duty to protect diplomats and embassies in their country, and we expect them to act urgently to bring the situation under control, and ensure the safety of our staff and security of our property.” It was an Iranian news agency that ran the story, and then immediately retracted it, that six embassy staff had been taken hostage.
David: So that leaves it uncomfirmed. On the one hand, we have the Iranian news agency saying it, and then obviously, we have a situation which would escalate to the next level, in terms of an international flash point, if, in fact, we have something reminiscent of the 1979 hostage crisis, where instead of the British citizens being taken hostage today, it was U.S. citizens, and what was an absolute disaster for the Carter administration.
Kevin: And David, there is such an irony here, because Ahmadinejad was one of those students back in the late 1970s, and now he is president of Iran, so to think that he is going to be just deeply concerned about an embassy being stormed. Gosh, this guy is vile.
David: Student political activism seems to be a great lead-in to a political career.
Kevin: David, if we are talking about the 1970s, we are talking about a period of time of high inflation, gold rising, and invasion from Russia. We are also talking about the Iranian hostage crisis. There seems to be some parallels. To bring us back to the economic in the 1970s, a similar type of period of time, interest rates were sky-rocketing because of inflation. That is not something we are seeing right now. We saw a failed German bond auction last week – you mentioned this earlier.
David: Just to make sure we are not confusing causal behavior, because it is not that inflation was driving interest rates, but interest rates were rising to take care of inflation.
Kevin: To get a positive rate of return.
David: Essentially, we are talking about risk premium. If you assume that you are going to lose value through a devalued currency, how do you make some of that back? You have to have some compensation for losses that you are taking, if you are willing to commit capital, and that is when you begin to see an increase in interest rates, in which people are viewing risk in this category, or that category. Maybe it is interest rate fluctuation. Maybe it is currency devaluation. Maybe it is political instability. Maybe it is your ability to collect taxes as revenues. That has been the crisis in Greece. They now have a dual crisis. Not only do they have too much debt, but they have no means of collecting revenue to pay and service their debt. We have all of these things which can drive interest rates higher, and the only place in Europe where we have seen stability in the bond market…
Kevin: The safe haven….
David: The safe haven, just like the U.S. treasury market, but for Europe…
Kevin: … was the German bund.
David: That’s exactly right. And what does it tell you when last Wednesday, we had a failed bond auction, 6 billion euros at offer, and close to 3 billion of it didn’t go?
Kevin: So they sold just a little over half. Now, here’s the thing, too, and we had a talk about this, for the understanding of the bond market…
David: 39% was not taken, and had to be monetized.
Kevin: Well, if you don’t sell bonds at the interest rate that you are willing to pay – let’s say you are the German Bundesbank – you have two choices: You can either raise the interest rates that you are willing to pay, which it seems the Germans were not willing to do last Wednesday, or just buy it back from yourself. That is something we in the United States have experienced for far too long with the Federal Reserve. Is Germany monetizing?
David: They are monetizing. Looking at the Bundesbank, go back to December 1907, and keep in mind, we have an assumption about the stability of the German banking system, and what was the old Deutschmark, and hopefully their influence in the euro, as the largest component part in the ECB, a 27% contributor to the ECB. They are the largest vote, if you will, with the European Central Bank.
Kevin: And they are considered the strong backbone.
David: But the issue is that we perceive them as such only because we, you and I, have the historical recollection of the hyperinflation, and assume that they do, too. We are now moving into multiple generations distant from those events, and a failure of collective memory. Kevin, going back to that December 1907 date, we find the Bundesbank with a leverage ratio of 75-to-1, not exactly the pristine, conservative, non-money printing, non-accommodating bank that they have postured and advertised themselves to be.
Kevin: So they were already highly leveraged back in 2007, before the crisis. Where are they now?
David: Of course, they keep on taking over these responsibilities, a cleanup operation, if you will. If German bonds aren’t bought, where do they go? Who is buying them? How do they get monetized? That does impact your balance sheet. Now they are not 75-to-1, they are 153-to-1, and we still have this impression that they are conservative, tried, true, staid – surely they have not forgotten the social ramifications and consequences of hyperinflation.
Kevin: Let’s put this in context for the person who owns a home. Let’s say you want to buy a home for $153,000, and you ask, “Well, how much do I need to put down to buy this home?” And they say, “Well, just bring in $1000. 153-to-1, we’re comfortable with that.”
David: And if it moves down in value $1000, your equity is wiped out.
Kevin: You’re done.
David: Yes. So virtually, no change in the value of the assets on your balance sheet, and you’re insolvent. This is the irony, Kevin, because the Bundesbank, being the strong anchor within the ECB, is on thin, thin, thin ice. We have December 9th coming up and the European Summit, which features a treaty restructuring for the ease of fiscal integration. Sarkozy and Merkel are trying to say, “How do we push this forward?” We are now at that crunch time where we are not sure there is any other solution except fiscal integration.
Kevin: Explain the ramifications of fiscal union. What makes that different, for the listener who is not familiar, with the monetary union that they have now?
David: Essentially, it is a handover, to Berlin, of control of all of Europe. This may sound extreme, but we basically are witnessing the potential winning of World War II by the Germans, in terms of the transfer of power and influence over all of Europe. How many people fought and died to keep that from happening? Obviously, the circumstances were different then, from now. We are talking about different leadership. We are talking about a different mandate, a different ideal being foisted on the world then, versus now. But this is the idea, Kevin, that we have very limited options and it is either to shrink the euro considerably, or to see deeper integration, and shrinking would be, to some degree, admitting defeat. So there is a pride issue. There are many, many complicating factors, but they are not going to shrink it. It appears that they are moving toward fiscal integration.
Kevin: And isn’t it interesting, David? It’s so important to have a rear-view mirror look at history when you are looking at what is in front of you, because we just now talked about how strange it is that Ahmadinejad, who runs Iran, was part of those student protests and the capture of hostages back in the late 1970s. We also have to look back in the mirror and say, “Germany wanted what is happening, back in the 1940s and the 1930s, and we are seeing it, however, brought about by monetary crisis.”
David: We are not saying there is anything wrong with Berlin calling the shots. We are just saying that Berlin is calling the shots, and that’s what it means. So if you have a problem with that, then you do. If you don’t, then you don’t. But that is what it means. Fiscal integration means, at this point, France and Germany – again what Ian McAvity called the Frank-and-Stein monster – coming together. It actually is more the “Stein” than the “Frank” because they are the ones who are the largest contributors to the ECB, and you have to follow the money on that.
Kevin: So David, until we see that fiscal union, or until we see some clarity, what is it that you recommend people do?
David: I think you have to learn to wait, Kevin. I think the stage we are in right now is battening down the hatches for a European storm, and it is important that people be positioned ahead of the storm, and then just have the ability to be patient.
Kevin: That’s so hard.
David: Kevin, you went out to New York just before Hurricane Irene hit New York. You were there preparing and helping your daughter get ready – cans of tuna, water, batteries for the flashlights. And then when everything was done, and you had gotten ready, then there was nothing.
Kevin: There was nothing more to do, and it was strange, because they say 12 million people, roughly, live in New York. Well, these people are doing things all the time. It’s why you live in New York. You don’t not do something. But they shut New York down on Saturday afternoon. I think I mentioned this in a prior program, the only thing you could do was just sort of walk around and wait, because we knew Irene was going to come 8 o’clock that next morning. The weather service told us exactly when it would be there. It was supposed to be one of the worst storms in history to hit New York, thank the Lord it wasn’t, but nonetheless, that waiting – you don’t know what to do with yourself. If a person has money, or assets, in an account, and they are just champing at the bit to move them around…
David: This is the time frame in which the fundamentals will ultimately speak, but the question is, when you will begin to see the market react to those fundamentals – you have no idea. That is what you cannot judge, and this is to borrow from a Keynesian idea, which I think has some relevance. He said, “The market operates this way: It’s like a beauty contest, and you don’t choose, when you are an investor, the most beautiful woman in the beauty contest. You choose who you think other people will view as the most beautiful woman in the beauty contest.”
Kevin: So you are investing for perception, not necessarily reality.
David: That’s right. So the reality already exists in terms of the very frail, frail market structure, both in Europe and in the United States, but the perception is that all is well, and we come into this week with the sense that all is well, that retail sales were up, this bodes very well. And if you will recall, Kevin, corporations were very wise, I think, several months ago, to not be overstocking shelves. Remember we talked about what was happening in the Long Beach port, what was happening all up and down the West Coast, as longshoreman basically had nothing to do. This is very uncommon coming into the holiday season, but you had purchasing managers saying, “We don’t see it. We don’t see it. We don’t think it’s going to happen. We think this is going to be a very slow season.” Statistically, Kevin, when you come out of the gates strongest in a selling season, like this last weekend, typically, you have already seen the best already, and you have a very negative taper from that point forward.
Kevin: What a contrast, though. I keep hopping back across the Atlantic, but during the time that people were doing their Black Friday shopping, the weekend news from Europe was the worst since 2008. It’s like a subprime crisis occurring all over again.
David: Yes, we have the British embassies in the eurozone which have been instructed to do scenario planning for helping ex-pats through a collapse of the single currency.
Kevin: So an ex-pat who is maybe living in Greece, or living in Portugal.
David: Or Italy or Spain. They are now doing scenario planning to figure out what they need to do if there is a collapse in the currency, if they see countries begin to leave, and this is an imminent thing. Their concern is that this could happen within weeks or months, and they may have a stranded ex-pat community without access to bank accounts and liquidity because they no longer have, via their credit cards or debit cards, the ability to move, the ability to purchase things, the ability to exist as they had previously.
Kevin: So it’s the British taking care of their own. This reminds me of a financial Dunkirk – preparing for Dunkirk. That’s when Hitler blitzkrieged across Europe, and Britain got their people out of Dunkirk in just the nick of time.
David: I think it is very interesting, Kevin, that we have the British embassies doing that scenario planning now. We have ICAP PLC, which is a large firm, facilitating settlement of currency trades between banks. They are testing systems for trading the old European currencies. These are stress tests in the event of a member state exiting and going back to their old currency, where they would be responsible, this company who is responsible, in large part, for the settlement of currency transactions in Europe, they would have to, then, get more creative, go back to the old ways of doing business, and converting between 1, 2, 3, 4, 5, or 10 currencies, but at least having one new variable in the mix.
Kevin: So, if someone is planning for the scenarios that could occur with Europe, I think it has been distilled by Jim Bianco down to three things. The first one would be to just disband the currency, completely. Right? Is that something that you see happening, David?
David: The disbanding – we have these two strong interests. We have the folks who have had a vision of a unified Europe since 1950, who are like bulldogs in terms of their tenacity. They will not let go of this idea, and I think they would be willing to sacrifice anything to keep that union, including inflation. It’s a small price to pay, and it’s a temporary price to pay, for something that took decades to plan and execute, in terms of political change.
I think this is where we go back to Franck Biancheri’s interview, when we talked to him about the fact that a crisis compresses time, and this, for them, speeds up the opportunity for a deeper integration. No, I don’t think we will see countries leave. That’s one element. We are talking about the powered elite in Europe holding on to a vision of Europe and not letting go of it until they have absolutely succeeded.
At the other end of the political spectrum are not the powerful elite, but we are talking about the grassroots. We are talking about the unemployed. We are talking about folks who may vote. Kevin, this is the point. We have the democratic element. We have the people who want to be enfranchised – one man, one vote, one election. They will have their voice heard, and they would say to themselves, “We are not being fairly represented. It appears that we are paying the price, and someone else is benefiting.” Whether that is the banking class, whether that is the political elite, and this is theme of Occupy Wall Street, but writ large globally, it is just the disenfranchised people, who do still have a vote, and get to say, “I’d rather have the peseta, I’d rather have the lira, I’d rather have the drachma, than stick with the euro and be the whipping boy for the Germans.” That, again, is not our opinion, but that would be the opinion of the disenfranchised, nonworking, unemployed, whether they are Italian, whether they are Greek, or Spanish, who are saying, “We’d give anything to leave.” We have that struggle of the powerful elite, and the disenfranchised, who do carry a vote, and live in a democracy, coming into conflict.
Kevin: And that conflict probably comes from the second solution. The second solution is austerity. Who feels the pain during austerity? Is it the rich or the poor?
David: It really is the people who feel austerity. That is where you begin to see the electorate hit the streets. It is one thing to be unemployed and feel like you can’t make ends meet because of inflation. You still don’t have a person to point the finger at. But when you begin to implement austerity measures, now you have a party to blame, you have a persona to blame, and that is when you can take to the street. That is when you can get either uptight, or actually violent. And that is where we see the second option, that of massive austerity, as off the table, because politicians are not willing to be that tarred and feathered character marched out in the political parade.
Kevin: It’s almost impossible to have austerity when you are, for instance, a Greek leader, like you said, or a Spanish leader, but if you have a single fiscally united union, and I don’t know how that happens, but that is the third option. If they fiscally unite, and that is what you talked about, everything being run through Berlin, do you see that possibly bringing about a long-term solution? Would it be a smaller Europe, like we have talked about before? A smaller European Union, maybe getting rid of the excess weight?
David: Jim Bianco, of Bianco Research, has done a great job talking about these three elements, and the issue with that third one, Kevin, a fiscal union, is that it is, essentially, a way of saying that Germany wins World War II, and that is something that, ultimately, I think, there would be a gut check to.
Kevin, essentially, what you are talking about is a rewriting of the script, because they only allowed for the giving up of monetary sovereignty. To give up fiscal sovereignty – what is fiscal? What does that mean? We use that word a lot. Just to refresh, that is when someone can tax you, and then take that revenue and spend it. They are the decision-makers, and not only how deep they can get into your pockets, but what they can do with that money on the other side. What we are talking about is the Italians saying, “Somebody in some other country is going to pick my pocket and spend it on their pet projects. Don’t like it.” Or we have somebody in Greece saying the same thing: “I don’t want the Italians picking my pocket and spending it on their road projects.” Or we have the Portuguese – it goes on, and on, and on, Kevin, so that you don’t have the sense of accountability for the leadership that you elected to represent you in the political structure. How is the money being taxed and spent? Now it is out of your hands, under a consolidated fiscal union, which implies: Fiscal union – one step toward political union.
Kevin: I think about Rome, David, because the last time we saw this region unite was under Rome, but there was no fiscal unification based on peaceful treaties and meetings in December, for instance.
David: It was a double-edged sword, that’s what got it done.
Kevin: It was the Roman military and a whole lot of bloodshed, and it took a lot of blood to continue to keep that thing together as long as they did. So what you’re saying is, if we do have a fiscal union, a Greek by birth, but a European by “not your choice.” Or a Spaniard by birth, but a European, not by choice, because you are talking about no vote on this. This is something that would be brought down from the top.
David: Yes, Kevin, when people feel disenfranchised, they do everything that they can to get re-enfranchised. We had this with the Basque separatist movement. If you go back and look at European history, and the different factions that represented “terrorists,” whether that was the IRA in Ireland, or Black September, there are all of these groups which had a particular view, and felt like they needed to be enfranchised, and the existing government did not adequately represent their interests.
What you are talking about is immediately creating the possibility for total chaos, wherein you have these individual factions who are saying, “Not on our watch. Not on my dime. This doesn’t represent me. We’re a democracy and you are not respecting my vote. If you won’t respect my vote, then I won’t respect your right to x, y, and z.” That is where you end up with total political chaos, verging on anarchy. But I think the anarchy of tomorrow is designed, and is orchestrated, and I want to know who is behind the scenes. Who will take advantage of that groundswell of energy?
Kevin: Let me throw this out to you, because you have brought up, many times, these guys that we call bond vigilantes, and I have asked you: What is a bond vigilante? But really, the bond market is so huge in comparison to stock markets, commodity markets – you name it – the bond market is the world’s money system.
David: And it is smarter than the equity markets.
Kevin: And last week, the bond vigilantes – talk about anarchy – said, “No, we’re not going to take the strongest bond in Europe, the German bond.” Tell me this: Italy has two bond auctions this week. If the bond vigilantes didn’t want the European Union’s strongest country’s bond, how about Italy?
David: And we have already seen it, Kevin. The first one is done, and we have one more later this week. Essentially, we have the potential for triggering the credit markets into an utter debt panic, this week, or next week. In fact, you could go week-by-week between now and the end of the year. The Italian Treasury issued 7½ billion dollars worth of bonds earlier this week and they have a similar offering later this week. What is particularly interesting about the 7½ billion dollar offering is that it was only a week to ten days ago that the news in the U.S. was, “Gracious me, rates are at 7%, we’ve got to do something to get them under 7%! There’s panic in the Italian market. The bond vigilantes are at work again. There’s chaos. We’ve got to do something. Where is the easy way to intervene?” Guess what it was this week, Kevin? Just shy of 8%.
Kevin: So it’s going up, and that is what is supposed to happen when risk increases.
David: Right, but what is emerging is that the façade of stability is being torn down, and people are saying, “Wait a minute. It’s not just the Italians who have wrecked their financial house, the Germans have done the same thing!” And that’s why you had the absolute failure of the bond market last week in Germany. Last week was the critical turning point in the European crisis because of the failed German bond auction.
Kevin, it would be like us coming to market with 20 billion dollars here in the U.S., and having a no-show by the Chinese, having a no-show by the Japanese, and having a no-show by the institutions here in the U.S. On top of this, we have U.S. money-market funds, who had been funding Europe up until last week, pulling 8 billion dollars in short-term funding. So we have European banks who have been financed in the short-term by U.S. institutions, and we have U.S. institutions, money-market managers, saying, “Wow, this is going from bad to worse, and we are going to have some serious egg on face, if we don’t stop our bad buying habits, and get some of that money back on our side of the pond.”
Kevin: David, it doesn’t sound like December is going to be a very merry time for Europeans.
David: It’s going to be both a time of giving, and receiving. It’s a time of giving gifts, and great hope and expectation, that perhaps something is received, as well (laughter).
Kevin: You know, I think of the Twelve Days of Christmas (the music of which begins playing in the background, and continues throughout discussion of Thirteen Days of Christmas), but in reality, we have bond auctions, and all these critical turning points.
David: And it makes it more like the Thirteen Days of Christmas (laughter) if you are counting all the bond auctions necessary and all the generosity which Europe is expecting.
Kevin: Okay, let’s take the first of December.
David: There is a Spanish auction, and a French auction early in December. Then again, December 5th.
Kevin: That’s the second day of Christmas.
David: Then there is a French auction again for shorter-term bills. Then there are Irish budget presentations to parliament.
Kevin: That’s the three French hens (laughter). Keep going.
David: Or the Irish hens.
Kevin: Oh, the Irish hens, yes.
David: And then there is the fourth day of Christmas, which is the Greek budget. They have to vote on that on the 7th, as well as the Portuguese auction, yet again looking for money. The fifth day of Christmas, there is the ECB Governing Council.
Kevin: Now that’s the five golden rings. They may finally get that.
David: And they will probably just cut rates to 1%, that’s sort of the expectation, that they will be forced to accommodate.
Kevin: How about the sixth day of Christmas?
David: December 9th, as if we weren’t doing anything in early December, the European Council Summit. We mentioned it earlier. This is where they are going to have to decide whether or not they can change and ratify these treaties in order to allow for greater fiscal integration.
Kevin: Dave, the seven swans a swimming, the 7th day of Christmas, which, in this case, would be December 12th.
David: The Italian auction for bills, the French auction the same day for bills, and then you have December 13th.
Kevin: We’ll call that the eighth day of Christmas. That’s eight maids a milking.
David: These are Greek maids a milking, and Spanish maids a milking. They are looking for treasury bills. The 14th day of December there is the Italian auction, again for bonds – the Spanish auction for bonds. Kevin, we are talking about over 100 billion dollars in capital that has to be raised in Europe between now and the end of the year.
Kevin: Maybe it will be their Black Friday. Maybe people will just come out of the woodwork and spend money.
David: You have to believe that they are hoping that, because by the time we get to the 10th day of Christmas…
Kevin: Which is the lords a leaping…
David: The French auction for bonds. Kevin, it goes on and on, because we have the Greek auction after that.
Kevin: That’s the 11th day, right.
David: We have the Portuguese auction after that on the 21st.
Kevin: We’ll call that the Twelfth Day. And then December 24th, let’s call that the Thirteenth Day of Christmas. We didn’t stop at twelve, but thirteen is probably more appropriate.
David: But before Christmas we have the Spanish auction for bills, and that’s not even the end of the year. We still have the French and the Italian auctions for bills and bonds on the 28th and 29th (music ends). Kevin, we are talking about liquidity starvation. We have institutions here in the United States which are pulling back. If you look at this, there are rings of the subprime all throughout it, as institutions are saying, “Listen, about our longstanding relationship. We love that. But we’re on hold for the time being. The folks upstairs said that we need our money back. That’s why we’re not extending you any more money, for the time being. We’ll be right back.”
That’s exactly what happened in 2008, when people started to limit the inter-bank lending – and guess what? The Fed stepped in during 2008 and in a short period of time, offered 7.7 trillion dollars into the marketplace to make sure that not only U.S. banks, but European banks, didn’t go under. Now we have adulterated balance sheets. Now we have more constrained activity by local fiscal authority, whether we are talking about the Spanish, or whether we are talking about the Greeks. It’s already happened. They can’t save themselves. The British can’t save themselves. They may have an issue in Iran. Kevin, we are just talking about an absolute mess! This is what I took in over the weekend, and yes, I had a little indigestion from too much turkey, so I’m not saying that all of this is European (laughter).
Kevin: Did the turkey cost you more? I think we need to talk about the United States here as we wrap up the show, because there are a lot of people who are listening to this, saying, “But that’s Europe.”
David: One final point, because we came back to the office Monday morning to the cheers of the Wall Street opening bell, and Dow futures were up 250 points, and everyone was ecstatic, because “People are spending money again, which means there are no problems anywhere else in the world, and there is no possibility for a negative feedback loop from Europe to the United States, because can’t you see? The consumer is out there spending. We’re on top of it.” Kevin, this is a joke. This is a joke. We are in very, very dangerous territory, in part, because people have deluded themselves.
Kevin: Yes, David, it was a mess. But I still had turkey. I still had stuffing, I had cranberry sauce. My wife is an amazing cook. It cost a little bit more. I don’t know about you, but I think somebody actually looked at the statistics.
David: Well, we did last year, and we are looking at it again this year, and in terms of the hedonic adjustment, the question is: How much better was your turkey this year than last year?
Kevin: It was awfully tasty, she tried new recipes – but it was more expensive.
David: It was more expensive. And did you get more for it, either in terms of poundage or pleasure?
David: Then this is the issue. There is a bite with inflation, and there isn’t something to offset that bite. 13.2% was the total increase in your turkey dinner, from last year to this year. So that is a sobering reality – but guess what? It doesn’t break the bank. The fact that we are spending an extra $5 or $10 more on a turkey dinner, when you throw in the 16-pound turkey and the gallon of milk and pumpkin pie mix and the whipping cream.
Kevin: Yes, but didn’t relish go down in price?
David: Well, it did. Actually, that was the sort of anchor. You had some miscellaneous ingredients in your 1-pound relish tray, (laughter) which was actually down 1.3%. You have to wonder, is that just the relish that has been sitting in a can for a year-and-a-half or two years and was up against any expiry date?
Kevin: Dave, at 13.2%, you’re right. On a year-to-year basis, you may be able to afford Thanksgiving this year, maybe next year, but at 13.2%, that means that turkey dinner doubles every five years. What is wrong with the system? You talked about it being a mess in Europe. It’s a mess here, and we haven’t even had the realization yet, because Europe has been the focus – we haven’t had the realization of the mess we are in now. We are worse than Greece.
Dave: Let’s finish there, Kevin, because I think when you look at the U.S. we are talking about recession recognition. We have the backdrop of high unemployment. We have growth expectations which are already built into the system, and we think that you could see, as people recognize that we are in a recession – not that we ever came out, but we have been in recession, and it has been papered over. It’s been covered up, the statistics have misled us. I think what we will find is a 7000-point lower Dow, and we are going to find an S&P which is plumbing the depth, and exploring for the 2009 lows.
Kevin: Are you making a prediction here, in 2012, that we could see the Dow, or will see the Dow, a couple of thousand points lower than it is right now?
David: Yes, Kevin, again, I didn’t respond to the Black Friday weekend bonanza the way the market did. I came in, as you described, with an ashen look on my face, and with grave concern, making a financial survival checklist, in terms of, “What about my bank deposits, what about the insurance company, what about pension funds, what about business liquidity, and any advice that we can give to clients?” If you were trying to arrange for business liquidity, lines of credit, anything like that – get that done now, or you will not have that opportunity January or February of next year.
Kevin: David, I will say this. It becomes wearisome to look at what is wrong with the world all the time. We are looking at, “This is wrong, this is wrong, this is wrong,” but what makes something wrong is that it is in contrast to what would be right. I think what we should encourage our listeners to do, as well as looking at what is wrong, is to say, “Okay, this is wrong. Do I have to participate in this, or is there something that I could make right with this situation?” In other words, what is the ideal that we are pursuing? You were talking about a checklist. Check your bank deposits. If a bank is wrong in the way they are investing your money, then you should come out of that bank. Wouldn’t you recommend that people even check their bank right now, again?
David: Between now and the end of the year, you can call us at 800-525-9556, and any of the folks in our office can give you a free bank safety rating, anywhere in the United States. It does not cover credit unions because they have a different FDIC reporting requirement. They don’t have FDIC insurance, so there is a bit of an issue there, in terms of the transparency of how they are invested. But banks, insurance companies…
Kevin: They can check those, too?
David: Absolutely. And if you ask me where the disaster lies in 2012 and 2013, it is the insurance companies and pension funds, because they have not had to seek any reforms, they have not had to clean up their balance sheets at all. Granted, the banks really haven’t either, but they have at least gained some liquidity. They have excess reserves of 1.6 trillion dollars. You can argue that U.S. banks are in a better position today than they were in 2008, given the fact that FASBI is not forcing them to disclose toxic assets and write them down. So as long as we can pretend that those things don’t exist, our banks are in a healthy place. The place where there has been no reform, whatsoever, is in the insurance companies, and in pension funds, where they continue to take outsized risks, and they continue to swing for the fences.
This reminds me of exactly what Jon Corzine was trying to do in trying to reshape and bolster earnings. How was he going to bolster earnings? By bringing in what he had learned at Goldman-Sachs, which is proprietary trading. He wanted that company, MF Global, to be a global financial force, trading its own book into the billions and billions and billions, so that it could be a cash cow for the owners, or the influential within the company. He drove it through the floor. He destroyed the company by taking outsized bets and doing it on a leveraged basis.
Kevin: And now people are just standing in line to get their money back.
David: But his basic assumptions were that there was a mispricing of risk with European paper, and that the risk was actually overblown, that there was not as much to be concerned about in Europe as the market was pricing in. So he thought he was buying value. And then as the prices of those bonds went lower, and the yields went higher, he added to the position, added to the position, added to the position, until he had over 11½ billion dollars’ exposure – and guess what? When it came for a margin call, guess whose money he used?
Kevin: The customers of MF Global.
David: Right – with segregated cash accounts! Kevin, the interesting thing, at this particular point, will be if people like Corzine get a free pass because of how much support they have given to the current administration.
Kevin: Well, to do a little bit of a background, not only did he run Goldman-Sachs…
David: I mean, Kevin, we are talking about fraud. You cannot take money out of someone’s segregated account and meet a margin call with it!
Kevin: David, but he is, financially, the largest contributor to the Obama campaign. It is huge for the 2012 campaign. In 2004, he made Obama. They said this was the creation of Obama – it was Jon Corzine.
David: The 2008 campaign, of course, you are exactly right, and going back to 2004, he was someone who helped cultivate the persona and brought him into the political limelight. The question is this: Who did he give the money to? Because he owed the money to someone, and he made someone else whole at the expense of segregated accounts. Kevin…
Kevin: Nobody’s talking about it.
David: Nobody’s talking about one of the biggest bankruptcies in U.S. history, and the man who single-handedly claimed responsibility on October 25th for being overexposed. Will there be ramifications? Or is there political protection, depending on who you make your campaign contributions to? This is what I suggested in our weekly comments Friday, maybe two weeks ago. We have endemic corruption in our political system at a level we have never seen in U.S. political history. The question is, will that be cleaned up, or will that be the status quo from this point forward?
Kevin: Okay, so Dave, we already have established that it is going to be very tumultuous over the next month, maybe the next few days, definitely the next year or two. What is it that we would encourage our listeners to do right now? We talked about staying the course, getting things put in position, and then waiting, and we likened it to waiting for a hurricane – you batten down the hatches. What does that mean? What does the financial triangle, or the perspective triangle look like right now?
David: Okay, let’s start on the left side – growth and income, your equity and bond portfolios. If you are in bonds, you are a fool. I am sorry, but I am not going to mince words. The stakes are so high in the interest rate and bond market today, that if you are sitting there passively collecting your coupon payments, and just knowing that if you hold it to maturity you are going to be fine, you will get blistered in this environment.
Kevin: When the interest rates go up.
David: I think 2012, 2013, 2014 – this time frame represents the turning of the tide in the interest rate market, and for someone who is not nimble, navigating this as a trader, in today, out tomorrow – you have no business being in the bond market today. I realize I am speaking in a vast generalization. There are good bond positions to hold, but I think the general interest rate environment is caustic and dangerous at this point.
On the equities side, because you have earnings, this reinforces a negative move lower in equities. Look at Jeremy Grantham’s comments out last week, Kevin, that we basically have seen a peak in earnings. This has been ideal, where you have seen a benefit, given higher productivity, laying off of staff and requiring more from your existing people.
Kevin: It sounds like a positive to me, Dave, for the stock market, if earnings are high right now, or better, in relation to the stock prices.
David: Well, what I am saying is that it is as good as it has ever been, so where do you go from here? Grantham is assuming that we have mean reversion. In other words, if this is as good as it gets, then we also have a bit of average sometime in the next 6-12 months. Which, the repricing of equities? Again, acknowledging this mean reversion? It puts 2012 as a very negative year for equities.
Kevin: This is where you said we could lose 2000 points in the stock market.
David: And here is the caveat: QE-3 adds positive upside potential to equities. So, on the upside, we have the potential of 2000 points. On the downside, we have the potential for a 4000-point loss on the Dow. You tell me if you are comfortable with 2000 on the upside and 4000 on the downside.
Kevin: Well, it doesn’t sound like it makes sense.
David: I’m not saying there isn’t upside potential there. I’m just saying that it is only there for the wrong reasons. It is only there with the junkie’s infusion of liquidity. I think that is where we are. It is a very tenuous situation. I would not be in equities unless it is a strictly managed portfolio, and carefully managed, in terms of the risks, with offsetting hedges and everything else. That is a dangerous place to be. The left side of the triangle is fraught with concerns coming into 2012.
Kevin: So that leaves us with the right side, with cash. Obviously, gold is the base, and we’ll end with the gold. But the cash – dollars, euros, yuan? Where can a person go right now for paper liquidity?
David: That’s a real challenge, because on the one hand, if you look at the U.S. balance sheet, you say, “Wait a minute. We’re no better off than the Germans, we’re no better off than the Greeks, and we’re no better off than the Spanish or the Italians.” It just is a question of perception, and as long as we perceive, and the world investment community perceives, that there is a greater threat with the euro, and with the European Union, and an unwind of that currency, and a lack of clarity as to what happens there – guess who is out of the limelight, and guess who gets buoyed in the process? The dollar!
Kevin: I know you guys have been betting on the dollar, even though you don’t see the long-term substance of the dollar. Short-term, you have had to stay in the dollar with your management.
David: And if you watch what has happened with foreign currencies, the ones that are commodity-based, which have better balance sheets, and a longer-term better play – guess what has happened to them recently? They have all been blistered, Kevin. It has been a very, very ugly go for anyone in New Zealand dollars, Australian dollars, Canadian dollars. This is a very difficult environment to be in.
The gem from the McAvity interview was this: You are going to lose somewhere. You have to lose somewhere, because you can’t place all of your eggs in one basket, because you don’t know, you don’t have the certainty and certitude, to make that particular bet. If you are in the deflation camp, I gave a speech for the Harry Dent folks a few weeks ago down in Florida, and the idea was, deflation is the deal, and you don’t really want exposure to anything except what is going to get positive play in a deflation – Treasuries and dollars. Period. Full stop. End of story. The problem is that we don’t now.
And we have the inflation camp on the other side who would say, with the clarity of a ringing bell, “We know what we know, what we know…”
Kevin: Sure. QE-3, QE-4, it’s going to be inflation at some point.
David: And that would argue for being in commodities, to some degree. That would argue for being in gold and silver, to some degree. That would argue for having something that will be inflation, or even super-inflation, boosted. The problem is you don’t know, with the certainty you think you have. You may think you have certainty, but that means you just haven’t studied enough philosophy.
Kevin: Well, Dave, then that takes us to the thing we have not touched up to this point in the conversation, and that is, this broad, ever increasing in size, base of the triangle, and gold. You have brought out in the past, inflation or deflation – all you need is instability, and gold really seems to be the only reliable source of preservation of wealth.
David: Kevin, it is actually a hedge against inflation, deflation, political turmoil, geopolitical turmoil, and political flight capital. There are so many things that drive the gold market – it’s not one element. And I think, of any asset class, that makes sense today. And I realize, this sounds like a Johnny-one-note phrase, but there is only one place that I would go with great confidence, and that would be gold. Even more than silver, I like gold. Why? Because I am afraid that those who love silver love it because it can make them money, and that is the wrong motivation to have, in an environment like this, in which you want to prioritize preservation of capital. I don’t care how much money you can make. Ultimately, the silver bugs will win out in the money that they make, but I think the better motivation in this environment is the money that you preserve, not the money that you make.
Kevin: So, of the two P’s in investing, preservation and profit, you would land solidly on P #1.
David: Preservation. Absolutely, with profit being a secondary motive. You will have the opportunity to profit if you preserve and walk out the other side with assets intact. Kevin, we have run two companies now for 40 years or more, and what we do on the wealth management side is really restricted to a particular kind of investor. We have a high minimum. It is something where someone says, “We like the way you think and work. We like the way you approach the markets. And we want to partner with you in that.” And we do have a minimum investment there, Kevin. And it is substantial.
On the other side, we have no minimum investment. Look at gold and silver. I remember taking a call back in 2004, a young college student. He was back working on the family farm, running the tractor during the summer months, and he had an extra $400, and he said, “Dave, I want to do something. What should I be doing?” I said, “Listen, it costs me more to book this trade, in terms of our overhead. It makes no sense for me to book this trade, but we have never had minimums. Why? Because if it’s the right thing to do, just do it. Just do it!”
And I think, Kevin, looking at 2012, it’s very difficult to say, with any certainty, what will happen. It’s very difficult to say, politically, what the landscape in Europe will look like. At the end of 2012, it’s very difficult to say what the political landscape will look like here in the United States. But there is one certainty – that you are not going to go broke owning gold, and if that was the easiest, or only, decision that you could make, muster the courage to make it.
Kevin: So, if you are like the young man on the farm, do something. If you haven’t done something, do something, because things are changing.
David: They are changing, they are changing rapidly, and I still have that ashen-gray color because I think the environment we are in is the ugliest we may ever see it in our lifetime.
Posted in TranscriptsComments Off
Posted on 21 October 2011.
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, both of us ride mountain bikes, and we ride road bikes. There are trails here in the Durango area where you ride up, and you ride up, and you ride up, and you think that you are going to hit the summit, because you can see it up there, and you are ready for the rest, but it turns out to be a false summit, and actually, there is a summit much higher beyond that.
David: Oh, yeah.
Kevin: Most of us have experienced that, but we are experiencing that in the opposite realm with the recession right now. What we heard about was the trough, and we were ready for the break, and it seems that it was a false trough. Actually, what is coming is much worse.
David: Kevin, we are starting from a much worse place, and that is, I think, the point, after 21 months of being out of the recession, technically, if you look at when it was declared over.
Kevin: When was the recession actually over, according to the officials?
David: Back in 2009. We have had some time where we have been on the mend, but here’s the thing: The concern now is that yes, we are, in fact, moving into a double dip. I remember doing a CNBC interview about 3 months ago, and I said, “Going back into a recession is a foregone conclusion. “ And they said, “Wait, wait, wait. What are you talking about? That’s not possible. Look at the statistics.” Well, these are the statistics coming into a renewed sense of urgency. Unfortunately, it is urgency that the economy is not on the mend.
Kevin: So these are the solid numbers.
David: Yes, the economy today has 9 ½ million fewer full time workers employed than at the peak in 2007. We have real GDP which is still below the level reached in the fourth quarter of 2007.
Kevin: And that is with all the stimulus money that came in.
David: That’s right. We have industrial production, which is almost 7% less than its December 2007 reading. We have real retail sales which are 13 billion dollars below their 2007 peak, and we have real personal income, which is more than 515 billion dollars below its 2008 peak. On top of that, we have the S&P index selling at 20% lower than it was in that same time frame. The folks at Hoisington Asset Management put those statistics together, and they are spot-on. We are heading into a recession, and we are heading into a recession, not from a position of strength, but already from a position of weakness, which really argues that this recession will look and feel more like a depression than the last round, even, in 2008.
Kevin: I just read an article written about the greatest depression, that is coming. This was in the Wall Street Journal, not something that is off the main beaten path. They are saying this could really be the greatest depression. Is it any wonder that there are a lot of people sitting around in parks, around the country, who are dissatisfied, angry, maybe they don’t know where to direct their anger, but there definitely is the feeling that maybe this wasn’t a recovery.
David: Kevin, it is understandable that they are frustrated. There is something wrong with the system. The question is: Is the frustration being expressed at a place like Zuccotti Park, or anywhere around the world, being focused on the right thing? This is where I would have concerns, that there is really not a clear dialogue. Dialogue is not ever really allowed. It is just more of an emotional rant, and that is fine. If you need to get things off of your chest, that’s fine. But for it to be productive, it is going to have to be more focused, in terms of what the issue is, and I hope they start looking at cause, and not just effect, because there are a lot of effects, but the real cause – that’s what we need to looking at.
Kevin: David, there are people who are actually holding signs, in and around those parks, that say, “We’re part of the 54% that pay taxes.”
Kevin: I asked my daughter, who lives just a few blocks away from there, if she has actually gone down there, and she said, “Dad, I’m too busy, I’m working.”
David: (laughter) Right.
Kevin: And there are 3+ million people in New York who are just going to work each day.
David: They are part of the market system, going to work each day, making things happen, and there are a few people who aren’t making things happen. The issue is this, and I’m not trying to make any low blows here, but we are talking about leaderless confusion. This is beyond Zuccotti Park. There is leaderless confusion in the White House. There is leaderless confusion…
David: … in Congress. There is leaderless confusion overseas, with the group that is in Brussels. Kevin, this is the issue: We don’t have anyone with clear vision as to where we need to go, and there seems to be a real lack of understanding of what the real issues are. I’m just going to take two stabs at it. One, I think that leadership confusion is a part of the issue. You don’t have decision-makers who are willing to take risks in being wrong, and we discussed that a little with Franck Biancheri. The risk is, in a leadership position, that you may be wrong, and we have folks who aren’t used to taking that kind of risk, and yet, they are in a position of leadership, which means they are really disqualified for the role, but that’s okay, we’ve put them there anyway.
Kevin: Would you say the second thing, then, is an uneducated public? The public doesn’t really know what to ask for, because they haven’t educated themselves on the problem.
David: That is certainly a part of the issue. When you back up a little bit, you can say that this is all about Wall Street, and I’m not going to argue that Wall Street isn’t greedy. Oh, my word.
Kevin: They can be corrupt.
David: But here is the issue: Following the rules is important, if you want to stay in business from one year to the next, and many of these shops have been around, not just years, but decades or centuries. Kevin, I think this issue here is that we have seen special interest groups and lobby groups bring pressure on our legislators and say, “Here’s really what the people want, here is what the people need.” To be quite honest with you, Kevin, they don’t represent us. They don’t represent “We, the people.” They do represent particular small enclaves, or constituency groups, but they don’t represent the broad swaths of America, and thus we see legislation change, unnecessarily.
Kevin: And it is being mistaken as an anger toward capitalism. It isn’t capitalism that people should be angry with, it is, as you said, the laws and the lawmakers. I think about Glass-Steagall in 1999, I remember we all just shook our heads around here, because that was a law that was put in place in the 1930s to keep bankers from speculating with money that was guaranteed to be paid back by taxpayers.
David: It is almost a slight repeat of history. We see 2010, 2011, and the angst and ire of the people who are gathering now in the streets and saying, “I can’t believe this was done to us. We were here in the 1930s, we were here in the 1920s, and by 1933, whistle, full-stop, the game is over. We cannot have investment banks and brokerage companies under the same roof, because we can see that they will take their own personal balance sheets, package up the trash, and sell it to the general public without remorse, and do it legally.”
Kevin: And get reimbursed for trash so that they can go do it again.
David: Yes. There was a broken piece in the system. It was fixed in 1933. Special interest groups, by 1999, came in and lobbied for the repeal of Glass-Steagall. More damage has been done in this decade as a result of the repeal of Glass-Steagall than probably any other single point. You can look at, certainly, the malfeasance with Fannie Mae and Freddie Mac, and we can cross both sides of the aisle. Republicans and Democrats have both supported legislation that has impaired our financial system, so there is an understandable frustration with the folks who are involved in the Occupy Wall Street, or Occupy Whatever Street, around the world.
Kevin: Is there an opportunity for people who actually do provide clear leadership out of this movement?
David: I think if they can define what the real issues are, perhaps. But it speaks to the willingness of the people participating to engage in a real dialogue, and to be very intentional and very thoughtful about the process. Look at cause and effect, not just effects. We can pretend that we understand the issue by saying, “Hey, somebody makes too much money.” What made that possible? Step it back 3, 4, or 5 steps, and realize that there is something structural there. There is no problem with someone making more money than I do, or than you do, or than anyone else does. The question is: Is it legitimized on a legal basis? If it is not, then of course, there is an issue. But we are talking about legal function within the system today.
Kevin: David, I was asked the other day at a coffee shop by a gal who is in college. She said, “Tell me about this Occupy Wall Street. What is going to come out of it? Is it valid?” I remembered Frederic Bastiat’s book from the 1850s. He was dying of tuberculosis, and it was a period of time in France similar to now, when people were dissatisfied. He wrote a book, simply about plunder, and the law. It is called, The Law. He said, “There is plunder, which is illegal, and then there is legal plunder.” He said, “There are only three possible outcomes.”
David: This is a book we had everyone in the office read almost six years ago. We are talking about a weekend read, or even an evening read, 60-70 pages. You can get it free online. In fact, I think we will put the link up so you can just click through and read it. You are right, he said that there are basically three kinds of plunder.
Kevin: Yes, the law, which is there to protect the rights that the people have, sets things up in one of three ways, but there are only three ways that the outcome of the law can serve.
David: Right. It is either, first: The few plunder the many. And that is the concern today, that the few are plundering the many. But the law is set up differently, in our opinion, and it is not set up to do that. The second option is that everybody plunders everybody, and that is Margaret Thatcher’s classic comment on socialism. “It works until you run out of other peoples’ money.” All you are doing is, everyone is plundering everybody, and then you wake up one day and realize, “Okay, we’re all broke.”
Kevin: It’s gone.
David: Then, the third option is that nobody plunders anybody, and that would be the focus of the law, that no one plunders anyone, that it is not a justification for the few to plunder the many, it is not a free-for-all where everybody plunders everybody.
Kevin: So the rich don’t plunder the poor, but the poor don’t plunder the rich either, which seems to be the outcry in Occupy Wall Street.
David: And that is what you have to be careful of, is that, in seeking a solution, you don’t just allow the pendulum to swing from the perception of one extreme to the actuality of the other extreme.
Kevin: David, we are continuing today answering the questions of our listeners, and boy, we have gotten some amazing ones. We were talking last night about how the sophistication of these questions has increased year-by-year. We are in year four right now of this program, and the questions are so well thought out.
David: It is not possible for us to handle this in one week, or two weeks. It is just going to be an ongoing conversation for several weeks, so bear with us. We will start with some general comments on the markets and where we are today, and then dive right into the questions, and we will take as many weeks as it takes to go through the questions. Thanks for providing them. If you still want to send them in, that’s fine, too, and we have a stack that may take us from now until next year this time. (laughter) Not exactly, but there are a few questions to answer.
Kevin: And they are thought-provoking. I will start with Alexander’s.
Thank you for your commentaries and enlightening people with what is really going on, not just the official propaganda. With huge U.S. debt, there are two ways out. Inflate the currency, or default on U.S. debt. I can roughly imagine inflation and its impact, but not default. What would default be like? How would the world react? What would happen to precious metals prices?
David, what does default feel like if we were to default, and do we even need to?
David: There is something that precedes that. Why would we default?
Kevin: You have brought this up before. Why do we need to default? Granted, we are bankrupt. (laughter) Most people would have to default.
David: Right, but there is something that has to change significantly before that is even in the cards. Defaulting on our debt assumes that we have already lost the world’s reserve currency status. The privilege that we have to inflate away our debt problems and our liability issues is there as long as, and it is a solution we will pursue, we maintain the world’s reserve currency status.
I can understand, as a foreign creditor, how they would like to see that change. But from an American perspective, we really don’t want to see that change, because it is a privilege, and a privilege is generally something you want to keep. Just like in football, you want to maintain an advantage. I never played football, I played ice hockey, I played Lacrosse, and I played soccer. In ice hockey, I played goalie. They would pull me out when there was a penalty play, because you wanted the advantage of one man up.
Kevin: They would throw one man out, and they would leave the net empty.
David: And then by pulling the goalie during the penalty play, you end up with two extra men on offense to pressure, and with that advantage, you were almost guaranteed to score. It’s the thing where if you can press for an advantage, if you can keep an advantage, you certainly do. I am a little confused as to why anyone in the U.S. would want to give up advantages that we have, and certainly, academics like to think in terms of fairness and in terms of equality and in terms of things like stability. These are the same folks that have no problem with their kids wearing safety helmets just to walk down the street, because what happens if you happen to slip and fall. We don’t want Johnny to get hurt, do we? Life is not like that.
Kevin: That’s true. You do have countries that still compete with each other. Our reserve currency status may not be fair, necessarily, to the rest of the world, but they have benefited from it, as well. I think about when my son was playing basketball when he was a little kid. Somehow the ladies in town took over and figured out that we shouldn’t clap for the kids, at least for one Saturday. So everybody would watch the kids run back and forth, and it was completely silent, and it was absurd. But somehow the county had agreed that one Saturday out of the season none of the parents could cheer for their kids.
Speaking of default, here we are, we are in America, and I don’t want to sound abrasive and bold, but we don’t need to default right now, because we are the reserve currency. But do we, in a way, have a gun to the heads of those who hold the dollars? Because if we did default, or if we were changed from the reserve currency status, either way, their portfolios just go to nil.
David: You are right, Kevin. It is just that it becomes a higher probability event if the reserve currency status is lost. We remain enabled with the “nuclear option.” Default is always there, we can do that, but it is unnecessary at this point.
Kevin: “As long as you leave us with the reserve currency status, we won’t default.”
David: Right, but if we do default, we are really talking about a complete recalibration of risk. The U.S. treasury market, which has been the benchmark for risk-free assets is now giving everyone a second look at what is, or is not, risky. If what you used as a baseline – let’s say you are a builder, and this plumb line, you finally discover, is off by three inches, but you have based everything else on this one particular plumb line, guess what?
Kevin: You are going to build around it.
David: Now you realize that everything you have done has been skewed, and you have to readjust everything. So you could see, Kevin, in the event of a default, the entire world financial system – 10, 15, 20% lopped off, like that – as it readjusts to the fact that what you assumed was a reasonable benchmark for risk-free assets, is, in fact, a risky asset, and everything else is, thus, that much more risky by comparison.
Kevin: So, a Greek default, or a South American country default, is quite different than a U.S. default. With that being said, you would probably still lean toward inflation, even if we don’t feel it fully as inflation, they are going to probably try to control their way through this default through inflation, correct?
David: Oh, sure. Look at the great pains that the Europeans have gone through to avoid European default. You don’t think at least half the effort, or maybe even twice the effort, would be made to avoid default of that form, a hard default, here in the United States? Much better to, for us, continue to throw stones at Europe, and do what we have always done, in terms of our foreign policy – destabilize the rest of the world so we really are the last man standing. If we can draw attention to the fact that Greece is weak, that the Germans have their problems, that Sarkozy, or the next administration, will have their issues, too, with a downgrade in French debt, which is being discussed right now, losing its triple-A rated status, these are issues, which, if we can continue to shine the spotlight on, we will be able to maintain a position of dominance, long past when we probably should have lost it.
Kevin: So, basically, we are not going to go through one of those Saturdays where nobody claps. We are going to probably still try to maintain U.S. hegemony.
David: I guess the point is, beyond the academic bias, which would almost like to foment a psychology informed by the idea of fairness and equality, everyone is special, and therefore, if you are in a developing country, or a developed country, “It just needs to be more fair.” The question is: Are there any politicians today who are thinking about how we can press for the advantage: “Pull the goalie out, put the extra man on. How do we win a point, here?” Again, I realize today, in the context of crisis, we are thinking in terms of, “How do we create global stability? How do we create global tranquility?”
But there still is the issue of who wants America to win. I think this could become an issue in the next election. Who is voting for America? Not for special interests globally, not for the banking interests globally. You see what I’m saying, Kevin. Whether it is Obama or the Republicans, someone in their party – who is it that wants America to win? We are going to have to press for the advantage, because certainly, everyone else is. That came through loud and clear in the discussion with Franck Biancheri.
Kevin: The question goes back to what Ben Franklin said. What are we willing to give up for security and stability? If we could give up our liberty, as Americans, and could give up our property, as Americans, for a relative degree of worldwide stability, is that something that we are willing to do? I can tell you right now, no, my family comes first. My family comes first, my country comes first. I’m not going to give up my liberty for stability.
David: You are not participating in line with what the global elite want, Kevin. This is not right. You need to be retrained. We’ll work on it over the course of time.
David: Kevin, I think this is the point, that privilege has led to a sense of complacency and weakness here in the United States. We now take for granted the influence and role that we have played in the world, and are very reluctant leaders, and it goes back to that leaderless confusion. Is there a person, is there a country, is there an organization, is there anyone, who is willing to step up and make decisions where they could be wrong, and they are a willing to deal with the consequences of that?
Kevin: This is an election year. This is the time to start asking that question.
David: Right, and the point that we talked with Franck about a few weeks ago was that we actually see half of the G20 leadership in transition in 2012, so it’s not just our election cycle, but it’s half of the real significant players in the world, that will see a change of leadership, as well.
Wrapping up with the question, like the policy that we saw during the Cold War, of mutually assured destruction, we can default, and that is like the nuclear option in the debt markets. We are not there yet. And we would only be moving that direction if we were losing reserve currency status, and that is not a foregone conclusion. We can see our influence slipping, but we have not lost that role, as of yet.
Kevin: So, default – low probability.
David: Low probability.
Kevin: I am going to move to the next question by Hatim. This is from Hong Kong, David. A lot of the questions that we are reading are from all around the world.
David: Kevin, he says:
This is my third year of listening to your program. Once again, I congratulate you on producing something really special and value-added. Because of the learning process, it took me a while to get on board with a very significant exposure to gold. I put this down to a background in conventional thought, since I have the dubious benefit of an MBA, followed by 30 years of muddle-headed thinking in the professional world of investments. They did not teach us about gold in business school 30 years ago. I doubt if they do today. So, after getting “on board,” my orientation now is when to get off the gold juggernaut, which seems to be just now getting under way. I know it’s too early to do this, but I always like to plan well ahead. You have stated in speeches and in your DVDs that a one-third reduction, in stages, would be the ideal paradigm, but if one could break it down into three stages, a lot rests on exactly when we reach stage 1, stage 2, and stage 3. If your listeners are like me, then much emotional effort has been put into the process of deeply understanding the gold argument. It would be a great pity if we did not get the full benefit of the coming rally and possible blow-off phase. The difference in returns, to your listeners, is immense, depending on whether one is thinking about 5000-dollar gold, or 15,000-dollar gold. I know that the attainable price could be fleeting, and could depend on prevailing circumstances, such as possible gold-buying mania, or the extent of global currency debasement, but in any case, my impossible-to-answer question is, based on today’s circumstances, in a nutshell: At what price is stage 1, at what price is stage 2, and at what price is stage 3?
Kevin: That is an excellent question, David. This is a question that we get all day long, every day. This is not something that Hatim is alone on, but is the answer just a mechanical number? We’ve talked about Dow-gold ratios, but is it a mechanical number, or is there more to it than that?
David: Kevin, I want to start with something that is very important for mature investors to develop into, and it hinges on two words that Hatim used: Full benefit. This is something that is a potential fly in the ointment, if you will. Getting the full benefit of anything is a dangerous, dangerous proposition, and this is why: I have dealt with hundreds, thousands, of investors all over the world, and people want the absolute best price on the purchase side, and they want to maximize the absolute best price on the sell side.
Kevin: That’s human nature.
David: Right, and that’s fine, but there is no such thing as certain knowledge about where the market is, and is going. If you take an appraisal of the information that can be had, which is limited, at best, then you know that you have to be satisfied and be comfortable with some medium-range return.
Kevin: Are you going for the better to be 10% late, or 10% early, rather than to try to time it exactly?
David: Yes, that would even be ideal, in my mind. It would be better to be 15% late, 15% early, 20% late, 20% early. We are still talking about capturing 60-80% of a major trend. If you can do that, from one generation to the next, capturing 60-80% of a move, think of the Dow moving from 800 points, to over 14,000, and tell me you are not satisfied with 80%, or even 60% of that move.
Kevin: Let’s say you bought at 1500 or 2000 and it moved to 10,000 before you sold. You still would be in the parameters of an amazing return.
David: This goes back to the issue, I think, in which we’ve talked about the Bass brothers, and we’ve talked about the Hunt brothers. The Hunt brothers had an ideal in mind, that they were committed to, whether it was a number, or a principle, or an idea, and when the price of silver hit high numbers, they knew the system was broken, there was no fixing it, and they stayed long commodities, knowing that they would come out the other side being the winners, buying the whole world for pennies on the dollar.
Kevin: They stayed long – pun intended.
David: That’s right, and they stayed too long. The Bass brothers were very pragmatic. They looked at 1980 gold prices and said, “You know what? With the advent of Volker coming in, this is a game-changer. The rules are in the process of change. We’ve got to anticipate the consequences of this,” and they moved out of all the tangibles they could, and actually deployed about two years later, into the equity market.
Here’s the thing, Kevin: They did call the bottom side of the equity market. They did not call the top side of the equity market. They sold way too early, and you can’t say that they were really impaired in that process. Their net worth was still increased a multiple of a multiple of a multiple. It was a major move forward for the Bass family, compared to the Hunt family, and we are not talking about paupers in either camp, but seeing these transitions and being able to capture them, yes, that is critical.
But I think it is also important to know that the Bass brothers, although they went long equities in 1982, did not stay long equities until 2000. They were selling aggressively all through the 1990s, and did not have to maximize the price on the upside, being satisfied with, what to them, was a very strong rate of return. This is, I think, a critical question: When you are going to prepare your taxes each year, when you are going to invest your dollars each year, do you want to be very aggressive, or do you want to be somewhere between not aggressive at all and very aggressive, right in the mid point? To borrow from Aristotle, as we sometimes do, “Virtue is the mid point between excess and deficiency.”
Kevin: David, last week we were sitting out on your porch, and I said to you, “Given the situation we are in right now, where we don’t know whether the currencies are even going to be around in a few years, with gold at a 1:1 ratio with the Dow, which you have historically said is a good time to pare back to one-third of your portfolio, and take your profits on the other, if we were at a 1:1 ratio on the Dow right now, given this situation, would you really sell gold?”
David: Without a doubt.
Kevin: I was thinking, “I don’t think I would.”
David: Well, things are getting worse and worse, and the justification for owning it is now crystal clear. What was once a theoretical construct in terms of potential risk that you needed to hedge for, is now a real-world crisis right in front of us. The horns are blowing. The lights are glowing. This is desperate.
Kevin: But you had pre-agreed with yourself that you were going to at least scale back some if we got to a 1:1 ratio in the Dow. What that would mean today is gold being $11,000 or $11,500, whatever it would be at the time.
David: Assuming that the Dow wasn’t a different price. Correct.
Kevin: I’m just saying, hypothetically, today.
David: I think, Kevin, how someone scales out, again, that 3-stage process that Hatim is talking about.
Kevin: Can you give us a general idea?
David: I think this is very critical, depending on your commitment to this investment class. For instance, if someone has 3% of their liquid assets in the gold market, and we find ourselves at a 5-to-1 ratio, should they be thinking about liquidating a part of their gold holdings?
Kevin: They need 27% more.
David: Yes, I think they have undershot a target, a reasonable target, and they should not consider selling at 5-to-1, they should not consider selling at 4-to-1, they should not even consider selling at 3-to-1. They are underexposed, in my opinion. On the other extreme, if someone is over-exposed to the asset class…
Kevin: Let’s say they have 70-80% in.
David: Okay, so you are describing me. (laughter) I don’t think you were trying to, but…
Kevin: You can’t help that it grew.
David: I know, but here’s the problem: I am over-exposed, and every tick higher in the gold and silver market, it is like climbing a very extended fireman’s ladder. Falling from the first rung – no big deal. Falling from 50-100 feet up, the consequences are more grave. So, yes, you need to, if you can, reduce your risk. It really does tie to the degree of your original commitment. If you are talking about 100% of a portfolio, do yourself the favor and be way early – 5-to-1, 4-to-1, or 3-to-1 in the Dow-gold ratio. Be very early, if you are over-committed. If you are under-committed, don’t worry about it until you are at a 2-to-1, or 1-to-1 ratio. And if you are somewhere in between, as we have suggested, being at a one-third allocation, take your liquid assets and have one-third of them allocated to precious metals.
Kevin: Always, no matter what the ratio is.
David: And here is the issue: If you have done that, then in the context of a bull market, you are looking for the trigger event. You are looking for something that allows you to say, “Okay, the insurance policy that I owned, also known as precious metals, now needs to be reduced, and I am taking the insurance compensation off the table.” You aren’t taking the insurance policy and blowing it up, but you are saying, “Okay, my one-third asset has grown into 50% of my total assets. I am over-exposed. I don’t need that much insurance, I don’t want that much insurance, and by the way, there is a good part of the world which is now selling at a discount. I can take a premium asset and move into a discounted asset, and my purchasing power is leveraged in that venue.
Kevin: Okay, so play the game with me, just for a moment. This is a little like Abraham talking to the Lord. “If there be ten good people,” you know, working your way down.” (laughter) Gold, today, is not 1-to-1, but let’s say gold was 3-to-1 on the Dow. Let’s say gold was $3000-$4000 right now. Do you start reducing your strategy? Today, given the environment that we are in right now, if we were at 3-to-1, David, would you start reducing your gold strategy?
David: I would, and it means that I’m leaving a lot of money on the table. If we, in fact, go to a 2-to-1, or a 1-to-1 ratio, then I’m leaving money on the table. This again, goes back to that issue of full benefit. Am I comfortable not capturing the entirety of the move with my entire exposure? I still maintain an exposure to the metals, I still maintain and am moving toward that idea of full benefit, but it is with a reduced amount. And that is absolutely necessary.
Kevin, I think this is one of the critical functions that investors should not underestimate. Today, with gold at $1600, $1700, $1800 an ounce, in a range between $1500 and $2000, this range – does that represent a threat to the current monetary system, or to the current fiscal decision-makers?
Kevin: But, gold at $10,000?
David: Gold at $10,000, you really have the telltale, which says, “The fiat money system is broken.” Honestly, if we see gold in dollar terms at $10,000, the Fed has lost all credibility. But let me ask you this, Kevin. Will you see a mea culpa from the hundreds – I think there are 600-700 Ph.D.s that work at the Fed – will you see a mea culpa and an admission that, “I guess we got it wrong, I guess our theories were inaccurate,” or will you see them fight like hell to see something happen with the gold market? Now, I am not talking about outright manipulation.
Kevin: It’s hard to publish an apology, and most of these guys are academics. They need to be publishing on a continual basis. Published apologies don’t sell well.
David: No, they don’t. Unless you’ve committed some grave, homicidal crime, and then you get to publish.
Kevin: Oh yeah, that’s right. McNamara. He sold a good book. Yeah.
David: (laughter) Well, the thing is, I think my concern is, Kevin, that at some point, the world monetary decision-makers, not just the Fed, but the central bankers from around the world, realize that all of them, in terms of their concepts, are broke. They are bankrupt. They have lost credibility. And one of the ways of re-establishing trust is to make a concession, and that concession is a partial remonetization of gold. I think that ownership, in this environment, will not be inhibited. I don’t think we are going to see a confiscation of the metal. But to prohibit volatility in the space which is supposed to be, now, the new anchor for this world reserve currency, which may be a basket of 5, a basket of 10, a trade-weighted basket of any number of currencies, including the U.S. dollar. I think gold is that critical thing that re-legitimizes fiat, and they are not willing to go back to a gold standard completely, but they will do it to the degree necessary to regain confidence.
Kevin: Until that doesn’t work, and then they probably have to go to something even more stern.
David: But how do you keep gold from being volatile? People go from owning it at $300 an ounce, to owning it at $5000 or $10,000 an ounce. How do you keep it from being volatile? Raise the tax consequences of owning it, not because you have a surtax each year, which I suppose you could do, but I don’t think that is very probable. We already, in the United States, are punished for owning it. It never sees the distinction between long-term and short-term capital gains. You pay a 28% tax when you liquidate, regardless of how long you have held it. Tell me it’s not possible, and with the stroke of a pen it is very easy to accomplish this – you move it from 28% to 50%, or you move it from 28% to 60%. A number that says, “Of course you can own it, we want your balance sheet to reflect health.”
But the sub-plot here is, Kevin, that you can’t receive the benefit of ownership. Here is the point: If you are trying to maximize returns in your gold portfolio, realize that it is a targeted portfolio. Today, no one cares, but lest we forget, in 1933 it was necessary to bring it in and control it. And then we went one step further in 1961, under Eisenhower, and it was no longer legal for U.S. citizens to own gold overseas. You could own gold legally in the United States up until 1933, and then it was illegal for domestic ownership, but nothing said that you couldn’t own it elsewhere.
In 1961, that was not the case – then, you were not allowed to own it overseas. There was no way to control that in 1961, it was very much an honor system. You weren’t allowed to own it, but there wasn’t really the network of control that we have today. Today, if they make it illegal to own anywhere, they are going to know about it, unless you are living in some backwater country, willing to risk your life, living in an environment where theft and chaos is more or less a daily event.
Kevin: David, this may seem like a silly question, because we know that right now, it is really our only safe place to be, but why does someone own gold if they are going to have that much control in the future?
David: I guess what this argues for, again, is realizing that this asset class is critical for the times. What I’m trying to say is that insurance is particularly critical for the times. We don’t know what the future holds, which is why we continue to own the insurance, beyond any particular price point. Reducing a metals position by a third, initially, and then by taking your remaining stock and reducing it a third, yet again, and then taking your remaining stock of metals and reducing it by a third, yet again, still leaves you with skin in the game, but you have been very decisive and strategic in taking some money off the table.
It is not just because we want to maximize our gains, but there is a growing risk as the price of gold goes up, which is not a risk that applies to other asset classes, and it is the growing political risk of owning the asset. You, as an investor, become a target to particular changes in legislation, and I’m thinking, particularly, in terms of tax legislation which will go from bad, to even worse. You may find yourself owning gold at $10,000, with the ability to only realize a $5000 price after tax, or let’s say that the tax penalty is at 75% of your gain, and you may, again, own it at a current market price of $10,000, but only be able to receive the after-tax benefit of $2500. Better to anticipate the change in rules. Better to be early, than late, because one minute late is something that is a true game-changer for someone who thought they had all of their bases covered.
Kevin: Is this not why we should continue to read and study, and hopefully our listeners will continue to listen, because we will be discussing these things as they progress. Dow-gold ratio is something we have talked about for four years on this program, and for twenty-some odd years with our clients, so this is not new. I do want to throw a caveat in, and it actually answers one of our clients’ questions. It is a simple, short question.
David: Before you go there, Kevin, I think it is important to underscore that what we are talking about moving from is an asset class that represents stuff. Gold and silver – it’s real stuff. When I imagine coming out of gold and silver, it’s not to move into fiat paper. It’s not to move into anything other than real stuff. When I look at a company like 3M – the land, the plants, the infrastructure – if you toured half a dozen of their facilities, if you toured dozens of their facilities, you would be amazed at the scale, the scope, of not only the acreage they own, the concrete they have poured, the steel girders they have erected, but we are talking about assets, we are talking about real things, and if I can exchange my real things for their real things…
Kevin: At pennies on the dollar.
David: … at a discount, it becomes compelling. I would not consider moving from stuff, to paper. Why? I think that is the challenge that most investors have – thinking about why they would sell their gold for money? That is not the point. We are talking about an exchange of value, from real stuff to real stuff, out of a premium asset, into a discounted asset.
Kevin: This bring up real stuff to real stuff, because gold assets – the stock portion of gold, what is traded on the stock market – actually represents mines. Those can be real, and we do have a question from Dawn, who says:
“How about a discussion of gold and silver stocks, versus gold bullion?”
Now the caveat is this: Any time we are talking about gold on this program, correct me if I am wrong, but we are talking about gold, real gold. I have had people call in and say, “Oh yeah, I’ve got my gold, I’ve got my gold stocks, I’ve already got it taken care of.” Wait a second. We aren’t talking about ratios changing with gold stocks. We are not telling you that that is your preservation hedge.
David: No. In fact, if you look at the last ten years, an investor has suffered greatly being in gold stocks. Depending on when your purchase was, if you purchased in 2000, 2001, 2002, that was an era in which I worked with Morgan Stanley on the west coast, and we bought a lot of gold stocks for clients in that period of time. Those people have done very, very well with those low, low-cost bases.
Kevin: But can that be counted as the bottom third of the portfolio.
David: It’s not a substitute, because we are talking about an industry that has, for 20 or 30 years, lacked the ability to attract top talent. We are talking about management teams which are not the best of the breed, so to say. There are much better people running companies like Heinz and Campbell Soup, and again, 3M, not because they are my favorite, but because they are just a huge company that has been around and done a good job for a long time. They have good management in place, and that is not the case with most of the gold miners. There is management risk, there is resource nationalization risk, and there is environmental risk.
There is a huge mine up in Alaska today that is not making headway, one of the best gold assets on the planet, literally, and they are not making any headway because they can’t make it past some of the pre-feasibility studies and environmental approvals. There are these issues where, in theory, it is a leveraged play on gold, but in practice, we are talking about, basically, higher beta, higher risk, for the same asset class. And the question we would have is, “Are you categorizing the purchase correctly?” If you want to own gold stocks, do it in the growth portion of your portfolio, the left side of the triangle, but don’t substitute that for insurance. Insurance is the base of the triangle and serves a very unique function. It is not for speculation. It is for insurance – period.
Kevin: A couple of weeks ago you said that gold stocks are starting to look attractive for the growth side of the triangle. You have said that you like gold stocks, to a degree. Why don’t you answer to that?
David: Kevin, let me give you an idea of what that looks like. If you take the current gold price, and then take one of the gold stock averages, XAU. Divide those into each other. We like these ratios, we like these relative comparisons. Take the price of gold today, and divide it by the XAU – that’s a gold share index – and you end up with 8.8. What we are really looking at is an under-valuation of gold stocks, which has only been at this level three times in the last several decades.
Kevin: Relative to gold bullion.
David: Relative to gold bullion. Gold bullion has been the better growth investment, up to this point, and that may continue to be the case. We don’t know. There is an argument made, and I remember a conversation with Ian McAvity, in which he looked at this in the 1980s and said, “We thought that was the case. We thought that, consistently, gold stocks outperformed. We did our regression models and figured that, actually, it’s not the case,” and so they launched the Central Fund of Canada, which is a blend of physical gold and silver, saying, “We’d rather have a little bit of upside to gold, with a silver component in the mix, than play the gold share indexes, or the gold share market, anymore.” Here is a guy, seasoned in the business, who says, “It was a good idea in theory, but it actually doesn’t play in practice all the time. It’s not consistent enough for us.”
You can catch these periods of time, though, Kevin, where you are at extreme under-valuation, and I think it could get a little bit more extreme. If we get to 9 ½ or 10, again, taking the gold price and dividing by XAU, at 9 ½ to 10, I think the downside is fairly limited, and the upside is fairly grand, in terms of the gold shares relative to gold. But understand, it is not the same thing as physical metals. We are talking about something that will keep you up at night. We are talking about something that, if you don’t have an ulcer, will give you one in a matter of days or weeks, and if you have a cast iron stomach, then you will get an ulcer in a matter of months. We are talking about risk upon risk, upon risk, and it really does take a different kind of investor to engage that market.
Kevin: David the volatility in gold shares is huge compared to even gold bullion. So do people focus on the wrong thing, at the wrong time? Let’s say they transition from gold bullion ownership, which is very long-term trend oriented, and then all of a sudden get whip-sawed in the shares market.
David: Sure, let’s take 2008 as an example, Kevin. Gold was off, at its worst, by about 30%, and it recovered by the end of the year, so that in the calendar year of 2008, gold finished up about 5%, even with the downside volatility. Well, with a maximum downside of 30% in the year 2008 in the physical bullion price, gold shares, many of them, were off 70, 80, even 90%.
Kevin: That will take your breath away.
David: It will not only take your breath away, it will tell you, instinctively – and this goes back the lizard brain, “I’ve got to survive,” fight or flight – you are fleeing.
Kevin: Your mouth gets dry.
David: You are concerned you are not going to be able to retire, with those kinds of losses, and reasonably so. But you can, experiencing that kind of volatility, say to yourself, “I think the trend has changed with gold,” and you would be mistaken. Just as someone who buys into the futures market or options market begins to shrink their time horizon, and doesn’t care about the long-term trend for gold, but is more concerned about the short-term trade – “What’s it doing today? What’s it doing tomorrow? What’s it going to do by the end of the week? I’ve got options expiration next month. If I expire, and I’m not on the right side of this, I lose everything!”
Kevin: David, we call that “noise on the mean,” because you are just paying attention to the noise. It has nothing to do with the major trends.
David: And that is where we would encourage clients to focus on the long-term trend. This is the importance of physical metals, even above gold shares or anything else. Going back to Hatim’s question. If you wanted maximum benefit, you would play the futures market, and you would be leveraged 5 or 10-to-1, and you could make a killing, but more often than not, you would get killed. You are fodder for a machine and a game that is played for the benefit of the house. Playing the futures market is not dissimilar to going to any of the major gambling casinos. The house is in business to make money for themselves, and you pretend to be a major player, and continually feed the profits of the house.
Kevin: But if you buy for the long-term trend, the house doesn’t play.
David: The house is not involved, which is why the physical metals is really where you want to consider core positions, and anything that you do beyond that is ancillary. It is secondary, and you don’t have to worry about the volatility as much because the commitment should, in fact, be less. You should not confuse the volatility of the gold shares, or the shortness in time frames, of the futures or options market, with the long-term trend and receiving the benefit of the long-term trend, which is what you are going to have with gold bullion.
All that said, yes, absolutely a fan of the gold shares. You want to buy them right. If you don’t buy them right, you will be playing the patience game, and will learn to hate gold, the physical metal, very quickly, by having bought it at an incorrect time.
Posted in TranscriptsComments Off
Posted on 14 October 2011.
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David McAlvany, finally back (laughter). You’ve been gone a long time. I have been interviewing you by phone now for, I think, three weeks. You are back from Europe. You talked to Franck Biancheri last week, and we have gotten a lot of comments on the program. He does have pretty strong French accent, so if a listener has a hard time understanding any of our interviews, we would direct them to the transcripts, wouldn’t we?
David: Yes, we do that every week, just as sort of an added service. Some people like to read versus listen, and that way you can pick it up and come back to it when you want to.
Kevin: And you can check us for errors.
David: Well, of course. Of course, the style is more conversational, and so it reads in a unique way.
Kevin: Let me ask you a question, Dave. During last week’s commentary, when we were talking to Frank Biancheri, we were getting a completely different insight than we are getting from the London news, or the U.S. news. You do have a group of people in Europe right now who are seeing this crisis as an opportunity, like that Chinese character in which crisis can also be interpreted as opportunity. Is that opportunity for Americans?
David: No, really, it is not. It is an opportunity for Europeans, and it is a good opportunity, and I think one of the conclusions that he comes to, and I don’t know that it is going to be as easy a journey. There is nothing fait accompli in 2015 or 2016, but what is moving that direction is greater integration fiscally, greater integration politically, and as he suggested last week, crisis compresses time. That said, it is a critical, critical idea that our listeners should wrap their minds around, crisis and time.
Kevin: These things can really rapidly change. Something that has been on my mind since I heard the interview was that he talked about a transnational referendum that would overwhelmingly pass, he says, from nation, to nation, to nation, versus what we saw with the Maastricht Treaty, or some of these other treaties, where they had to be passed by Greece, or Germany, or Spain. I guess the question that I have in my mind is, there is really no ruling government body that could pull that off right now. Is there a void that is being created that this crisis might bring about?
David: I guess that is the real question. How do they move forward fiscally? How do they move forward politically, when you still have the mechanisms in place to be nationally oriented, not on a broader pan-European cooperative basis running things, whether it is financially, or politically? I think one of the things that he does point out very well, and we reflect on it this week, as well, is that there is a banking problem, and there is a debt crisis. But that is not to say that the European Union is dead, or that the euro, as a currency, is dead.
I think this is a critical distinction to make, because oftentimes, we, here in the U.S., will like to say that they are all lumped in together – if one is impaired, the other goes, too. The surest bet in the world is to bet against the euro, as in the monetary unit, and I would disagree with that strongly – partially, because you have support from China – partially, because you have support from the G20 – partially, because you have a huge invested interest from the most powerful elite in Europe in seeing the euro succeed, in whatever form it ultimately takes.
Kevin: And partially, because the United States does not have a currency that necessarily offers a really grand alternative.
David: Kevin, we have talked about paradigm shifts in the past. Thomas Kuhn wrote The Structure of Scientific Revolutions, which is one of the best discussions of how that happens amongst academics. One of the things that he makes very clear is that you have to have a substitute model for the old model to be cast out. What is the new idea? This is one of the ridiculous things with the Wall Street protests currently taking place.
Kevin: Everybody is mad, but what about?
David: And is there an alternative solution? Are we talking about an environmental concern? Better green than greed? We have seen so many different placards, that what exactly this is about is not really clear. And furthermore, do they offer an alternative solution? If you have a problem, what is the solution? Now, to backtrack: With the currency system, we have defined the problem, not you and I, but there is a growing global consensus…
Kevin: Well, the markets are defining the problem now.
David: Exactly, and that problem is dollar monopoly reserve status. If that is the problem, then you have to have an alternative, so you do catch this strong bid for the euro, specifically, the monetary unit, as the operative alternative, or supplement to, the dollar monopoly system.
Kevin: Did you catch a little resentment in the voice of Franck Biancheri when he was talking about the established old world order that was established in 1945 with Bretton Woods? We actually reneged on that when we took ourselves off the gold standard completely in 1971. I think the rest of the world has a little bit of resentment of the fact that we had guaranteed them a reserve currency, which was a guarantee in gold, and that has been pretty much reneged.
David: And I think this is something that is pretty critical, Kevin, because from Bretton Woods forward, there was a trade-off with that. We were the world’s reserve currency, but we also gave the rest of the world access to U.S. markets, and a part of what has made this system work is a system of trade imbalance, where they run surpluses, we run deficits, and it seems to work pretty well. It is a complete recalibration, post Bretton Woods, to trade off this deficit/surplus exchange, and the recycling of those surplus dollars into Treasuries, something we have done for decades, into a new system altogether. This is where I think we run a great risk. We talked about this a little bit in our Friday comments at our Wealth Management website – the Chinese currency bill that is in front of our legislators this week.
Kevin: Right, blame the Chinese because they are the ones who are doing this to us.
David: They are manipulating their currency lower.
David: Implicit in that is a real problem, because if we take the Chinese currency and raise it, or force them to raise it beyond a normal orderly pace, guess what happens? One of our primary trade partners all of a sudden sees a diminishing trade surplus, and that diminishing trade surplus, those dollars which were going to be available to buy Treasuries, all of a sudden are no longer available, because they don’t exist anymore. It is in the category of “Be careful what you wish for,” because, on the one hand, we want to bring about greater global financial stability. That is the guise that this bill is under. “If these guys will just stop manipulating their currency…” That’s how some of our legislators have cast this. We may, in fact, find that we are sinking the Treasury market in order to create a greater sense of fairness in the world. How ironic would that be, that we get disaster while trying to bring about stability?
Kevin: David, the light really went on for me a year-and-a-half or two years ago, when we interviewed Paul Craig Robertson. He said that the way our economy is built is that we basically deficit spend with foreigners, China being one of the greatest ones of all – let’s say, 400 billion dollars’ worth of a trade deficit. That means they have 400 billion dollars more of our currency than we have of theirs. And then they turn around and buy our Treasury bills. That allows us to borrow money for the next year. He brought out that things have changed a little bit. It is no longer a 400 billion dollar trade deficit, so that it is equalizing out, it is now at 1.6 to 1.7 trillion dollars. There is not enough money, even if we keep these trade partners out there, to continue to fund the debt that we have.
David: Kevin, we have long said that the Chinese do not buy our Treasuries as an investment, but really, for political reasons, and it is interesting that there were certain foreign governments that, this last week, sold 66.6 billion dollars of U.S. Treasuries. That is from August 31st until today. This is what is interesting. If you look at a chart of the U.S. Treasuries, you see something that has gone up, and up, and up, and up, and up, in price, and there is, for someone – maybe it is a sovereign wealth fund, with a slightly different mandate, there is the investment motive, not simply a political purchase in the Treasury market – 66.6 billion dollars of liquidations by foreign entities since August 31st. If you look at the chart, it makes all the sense in the world. You are selling at record prices. Treasuries have never been this high, and yet, the market consensus is that we need to be moving out of equities and into bonds, because bonds are a safe haven asset.
Kevin: David, I think you mentioned recently that there is a misunderstanding, or a miscalculation, with this move into the dollar and the move into Treasuries, and that miscalculation is that the people right now are moving toward liquidity, but they are ignoring solvency. In other words, they are getting into something that they feel is liquid, because it is cash, or Treasuries, or what have you, but there is a solvency issue, just like we have seen in Europe.
David: This is the danger of logic, because they are buying on a logical basis. They are buying Treasuries because it makes sense to buy Treasuries. But consider this. They may be asking the wrong question altogether, and that is the problem. If they are buying on the basis of liquidity concerns, when in fact, liquidity is not the issue, but solvency is the issue, they bought Treasuries logically, but with a very faulty premise. That wasn’t the issue to begin with.
I think what we have seen, and this was a very interesting insight from Franck Biancheri last week, is that the Western media, the Anglo-Saxon media, has something to gain, and considerable gains to maintain, by casting the euro problem as something that is just disastrous. “You don’t want to buy European bonds, you want to buy U.S. Treasuries instead,” where there is now a gross competition for limited resources, and we really want to see those cash flows coming to us.
Kevin: David, I would like to shift gears here. We have asked our listeners to send in questions and they have definitely done so, and we would ask again if they would continue to send questions, because we treat the fall as a period of time where we open up the discussion to our clients, and to our listeners, and we ask if there is something they would like David’s insight on, or other guests, even. David, what is the email that a person should use to send those questions?
David: Yes, send those to email@example.com.
Kevin: I am going to go to one of the questions that a client has sent in because I think it brings up a great discussion. This was a letter that came in a couple of weeks ago. It says, “Here is a question for the Q&A podcast. All the experts say that spending cannot be allowed to fall. If it does, then a vicious cycle starts. Businesses don’t have much business, so they lay off workers, and that means there are more unemployed, which means less pending, which leads to less income for business, etc., etc., etc., and supposedly, we will continue to spiral downward until we get back, really, to the stone age,” this guy says. “What would be the Austrian rebuttal to this scenario? Obviously, we haven’t always had governments to prop up spending. In history, there have been downward spirals, but they have been temporary. Something eventually halts them, then reverses the downward spiral. What is that something?”
That’s a great question, because we are told by the Keynesians that they have to come in and print money, but when they didn’t do that, what stopped the spiral, Dave?
David: Just to give a preview, I think price is the ultimate “something” that stops the downward spiral. The Austrian response would point to the importance of savings and investment, in order to have sustainable economic growth and wealth creation. This is something that we can ask anyone we work with or live with, and this is very practical. “Does an individual grow wealthier by spending every dollar they earn?” That is essentially what the non-Austrians, or the Keynesians, would suggest. “We will create wealth by spending every dollar we have. In fact, we can even create more wealth if we spend money we don’t have.”
That, to us, is a little bit backward. We think that wealth is a product of thrift, and thoughtful investment, whether that is in ideas, or enterprises, that multiply access to higher quality, or even greater quantities, of goods. Again, if you start with thrift, and then look at thoughtful investment, that is different than, “You make it, you spend it.” What do you do next?
Kevin: The Keynesians have given us this incredible fear of this word called deflation. You can define deflation a number of ways, but let’s just figure that deflation means that your money, whatever the money is, buys more things, versus inflation, which means that your money buys less things.
David: Right. Or the other side of that, which is, those things are more expensive.
Kevin: So tell me, why is it that I should fear my money buying more things?
David: Actually, Kevin, if you look at Great Britain, if you look at America, we have had periods of deflation which have been hugely productive, and actually, in terms of economic growth, the best periods in time, because we had relatively constant incomes with declining prices, which means that for the guy who is on a fixed income, or for a gal who is making X amount per year, they get to buy more and more each year, versus less and less each year.
Kevin: Dave, could you imagine actually going to the store every year, and things costing just a little bit less? We have never had this in our lifetime.
David: But if you are seeing innovation, if you are seeing productivity gains, you should, to some degree, see that happen. Let’s look at the iPhone, which used to cost $500-600 dollars, and now you can buy, the old model, of course, but because there are new models that have come out, you can buy it for about half that much.
David: I like the iPhone. I don’t have one. I hate my Blackberry. I have a hate-hate relationship with my Blackberry. So there is a transition ahead for me to becoming a fully Apple-centered person. But this is the issue. It is getting cheaper and cheaper by the day. We have seen technology progress and productivity has enabled the distribution of a fantastic product at cheaper prices.
Kevin: Things should cost less.
David: Again, Kevin, that is just an issue of a price declining to the point where I am compelled to buy. Going back to that question: What is the something that stops this spiral? Kevin, if you came to me and said, “I’d like to sell you my house for a million dollars.” I’d say, “I already have a house, and I’m really not in the market.” But if you came to me instead, and said, “Dave, I need to sell my house. I’d like to sell it for $50,000. I just need something. I need some cash now.”
Kevin: And the house should be worth, $800,000, $900,000, a million bucks, whatever it is…
David: I’m going to at least stop and think to myself, “While I don’t need it, the price is compelling,” and I may give you some of my money for your house. Again, I’m not suggesting anything, you are not in financial straights, but the point is, it becomes compelling when the price is the right price. Now, what is the right price? That, really, is determined by the business cycle. Things get expensive, and things get cheap, and if you are buying low and selling high, that is how you make money. If you are buying high and selling low, that is how you lose money.
And there is a need for the business cycle, where there is something, almost, of a regenerative nature. Amongst the business community, you have good ideas and bad ideas. Without the business cycle, bad ideas get to live on, and good ideas sometimes cannot compete, because by the time those bad ideas, should they, in fact, be subsidized through government spending, or Fed liquidity creation, or things like that, then guess what? The good businesses end up being constrained, and can, in fact, fail, where the bad businesses succeed. And how does that really help business? How does that really help the economy? How does that really help employment? In fact, it doesn’t.
Kevin: Okay, Dave, I’d like to play just a little bit of a thought experiment with you. Let’s pretend we didn’t go off the gold standard, and the dollar actually just maintained value. And as we became more efficient, and as transportation and production became more efficient, prices actually came down. That is that dreaded deflation that I think the Federal Reserve wants you to fear. If that were the case, and you were a savvy businessman, you would go through expansion. If you were careful, you wouldn’t go into too much debt, you wouldn’t over-expand. You would save some, for when things began to fall. You were talking about this guy, maybe me, who needed to sell a house for $50,000. Well there is a reason I needed to sell the house for $50,000. I need that. I am not being forced to do it, I need the $50,000, and you can go ahead and pick up the house at a good buy. Now, what happens is, that stops the spiral of the business cycle, because then…
David: Savings come out of the woodwork and get deployed into something more productive than just sitting on the sidelines.
Kevin: And, I am not Darwinian, by any means, but it is an evolutionary type of thing, where the good ideas actually accumulate more and more assets and produce better ideas down the road.
David: Right. The two steps forward. What we are really talking about, Kevin, is the dreaded one step back, and if you can avoid progress the normal way, what we would see is two steps forward, one step back. Over a longer period of time, there is progress made. That is not to say it is without pain. This is something that I think we all recognize just in the way we live our lives. Relationships progress and mature, and they are not always easy. Sometimes it is champagne, and sometimes it is just getting by on bread and water. In terms of an emotional experience in relationship with someone, there is sometimes a reason to celebrate, and sometimes it is just really not fun.
I think you have those same sorts of ebb and flow in all of life, and the market is not any different, but to go from champagne experience, to champagne experience, to champagne experience, and to believe that that is real, that that is what life is about – that is, in fact, what the Fed holds to in terms of their original mandates.
Kevin: It produces malnutrition and hangovers (laughter).
David: You are more right about that than you know. You are spot-on. That is exactly what we are talking about — hangovers, which are far more severe than you would ever expect, and malnutrition, because in fact, assets are misallocated and you don’t have healthy growth. You have a very unhealthy, and a very skewed, economy.
Kevin: Just a reminder, we have had a slew of questions sent in, but if there is something that we have not covered, or you would like us to cover, send that to firstname.lastname@example.org and we will try to cover that question, and if you can get those questions to us in the next week or two, that would help us.
We have been talking in reference to a broad economy, and sometimes even I experience a victim mentality, where I am thinking, “Well, these darn Keynesians, they have been winning since the 1930s. They have been ruining my money, they have been taking this away, and I have no defense against this.” But David, we were talking last night, and thinking about this. Let’s talk about deflation as if maybe it has been actually happening over the last 10 years or so. We see people who are writing newsletters and talking on TV and saying, “Beware of gold, because if we have a deflation, you are really going to lose money.”
There is a misunderstanding there. They are treating gold like it is a commodity, like it is one of these other things, when in reality, for the last 4,000 years, gold really has been the underlying form of money. Just looking at this, when a person calls and says, “Hey, do you think we will have deflation?” My thought is, in reality, with money being what we just said it was – gold – we have had deflation for the last ten years. Just look take the price of a house.
David: Yes, take the price of a house. Take the value of the stock market. You have seen that your purchasing power, in money terms, what we are calling gold money terms, has gone up many-fold.
Kevin: Let’s just take a house ten years ago. Let’s say it was a nice house ten years ago, worth $300,000. At $300 gold, that is 1000 ounces of gold. That same house today, even if it has risen in dollar value a little bit, can be purchased for between 200-300 ounces.
David: Kevin, what you are talking about is your money, your savings, held in gold, now purchases five times what it used to. That is an indication of deflation. Other assets relative to what we would call cash, gold bullion – your cash now buys five times what it did. In equities, it is even more dramatic. The over-valuation coming into 2000-2001, now puts you at a purchasing power of between 12-15 times, today, what it was in 2000-2001.
So the dreaded deflation has been happening, and it has been to the advantage, not of the cash-holder, not of the greenback-holder, but to the gold-holder. I think what people often forget is that gold, as money, does very well in a deflation. We are not just talking about the last ten years, but if you want to go back into British history, this is the case. More often than not, gold does better during a deflation than it does during an inflation. The only exception to that is radical inflation, wherein the repricing is instant, like a hyper-inflation, and then gold is something of a protective measure. But in terms of a slow bleed – 2, 3, 4, or 5 percent – gold is actually much better in a deflation than in an inflation.
Kevin: That is what we have been seeing. It reminds me of a Gary Larson cartoon (laughter) because I’m thinking, “We don’t have to be victims here. Just let the Keynesians do what they want. Let them print money.” But I’m going to go ahead and take that printed money, and I’m going to buy gold, at least for now, and I’m going to put it in the base of the triangle, and I’m going to let myself enjoy the true business cycle. The Gary Larson cartoon I’m thinking of, and I’m sure a lot of people have seen it – Gary Larson is the guy who does the Far Side cartoons – is a picture of thousands and thousands of sheep, just standing out in a pasture, and one of them is standing up with his arms wide open, and he says, “Wait a second! We don’t all have to be sheep anymore!” (laughter)
David: When you look at what has happened in terms of deflation, the two areas where you have seen the greatest contraction relative to money, and our benchmark for money is gold, are equities and real estate, where you saw the greatest benefit in terms of credit expansion over the last 30 years. Corporate America was supercharged on a dope served up by the Federal Reserve, as was the real estate market. Now, where have you seen the greatest hangover? Equities and real estate. So where will we continue to see the greatest “de-leveraging?” Equities and real estate.
Kevin: With that said, you have continually talked about an exit strategy, and we are not really talking about, necessarily, exiting gold. We always recommend keeping a third of one’s assets in the metals. But if we are to employ the business cycle, just like this listener had asked about, there will be a bottoming of this, and you have talked about the ratio to equities when it may be wise to start taking some of your gold profit and go into equities. Would you recount that again?
David: Kevin, this is the benefit of a stressful period in time. It really tests the strength of a business model. There are some businesses that make it through stressful periods of time, and do very well on the other side, and there are other businesses that are not organized well, that have bad leadership, bad business plans, bad products. And guess what happens to them? They go the way of the dodo bird.
Kevin: Unless the government funds them.
David: Exactly. And then you have companies like Solyndra, and all kinds of other businesses which do quite well on the back of taxpayers, not on the basis of a clear business plan. That is the case where stress in the marketplace is actually very good for helping an investor refine where they should invest their capital productively. It is only in the context of stress, only in the context of the bottoming of a business cycle where an investor can say, “Now we understand the landscape. Now we can see who, under stress, has survived and does very well. I would like to re-allocate my savings (in whatever form that is, and for us that is gold) into something productive, and I see that the field has now been cleared.” We know who the clear leaders are. We know where we should be investing capital.
Kevin: And you are still thinking ahead.
David: Of course, of course.
Kevin: You are talking about maybe 2, 3, 4 years down the road.
David: Exactly. But we are seeing that process unfold, Kevin, where yes, today your purchasing power is 12-15 times what it was ten years ago – the gold-owner versus the equities owner. But that cycle will take us to 20, 30, even 40 times purchasing power when all is said and done.
Kevin: Isn’t that amazing? And that is a cycle. That Dow:gold ratio is a cycle you can go back and look at, all the way back to 1896, when they started measuring the Dow.
David: And that, again, is the agnostic view of investing, where it doesn’t matter whether you are in gold, or in equities, what matters is that you do have a sound understanding of what money is, because your money needs to be there when you need it to be there, and that is the point. To re-allocate from one to the other assumes that you have maintained your value while the rest of the world has been compressed, and it is normal for this compression to occur. Again, two steps forward, one step back.
Kevin: I think about Al Siebert’s book, The Survivor Personality. He is a military psychologist, and he interviewed people who had survived incredible hardships, whether they were military, or holocaust, or some sort of concentration camp-oriented. What he said was interesting. He said, “You don’t want to be, or think, in nouns.” In other words, you don’t want to think, “Well, I’m a doctor, and that’s all I do.” It is the same thing with investments. “Well, I own gold. I’m a gold buyer.” He says you want to be, or think, in verbs. You have to be able to flexible, even to the point of healthy schizophrenia.”
I think about the triangle. For years, we have not recommended 100% in gold. We have not recommended 100% in equities or cash. We have recommended a third, a third, and a third, and sometimes that third, like the gold third at this point, just like stocks in the 1990s, has grown to much more than a third of many of our clients’ portfolios. But there is a time to re-allocate. Here is this healthy schizophrenia. You don’t fall in love with any of the sides and just go exclusive with that, do you?
David: No, you don’t, and that is what allows you to view wealth on an intergenerational basis, to look at investing as a legacy project, wherein, you can give the skills to any generation, to look and say, “Listen, things change. We know that. Things change and you have to adapt to change. There are new ideas that will emerge. There are new companies that will emerge, that should be considered. There are new leaders that will emerge that will either hurt or help you, and we are not here to derive an investment thesis on the basis of our political views, or any other views. Just understand that things change, and that sometimes you will have wind in your sails, and at other times, you will be just focused on survival.”
We are talking about survival of an economic or financial nature. These are, again, those periods of compression that you would like to avoid if you can. Or expansion, which you would like to take advantage of, if you can. The question is: What causes those periods of expansion to occur? We have had credit growth for 30-40 years. Now we have credit contraction. We have had it for 10 years. We will probably have it for another 10. Maybe it will be shorter than that, only a 5-7 year contraction from this point forward, but there is a tremendous amount of debt overhang.
The U.S. economy is leveraged roughly 20-to-1, 53 trillion dollars in debt, 3 trillion dollars in equivalent assets. That, if you look at our money system, not the whole economy, but just our money system, is a high degree of leverage. There are going to be winners and losers in this game. The losers are going to be the ones that are over-exposed, and hold assets that are still in the midst of compression. The winners are going to be the ones that have cash.
Again, let me define cash. If you still have confidence in greenbacks, if you still have confidence in the Treasury market, you are making the judgment that liquidity is, now and in the future, the primary issue to be concerned with, and I would caution you to stop, and re-evaluate completely, because liquidity is a concern that comes and goes in a matter of days or weeks. Solvency is something that stays with you for weeks, months, years, or decades.
That is the issue we have in front of us as a country. That is the issue that we face, and the concern that many of the deflationists have. We still have an unwind of a massive amount of debt. That will occur. It has to occur. This is what happens in this kind of business environment. But, does that mean you go to the worst bet in terms of solvency on the basis of trying to solve a liquidity problem. Does this make sense, Kevin?
Kevin: Well, I’m just thinking, the rumors of the fat lady singing on this recession and this de-leveraging, are far overstated. The fat lady has not sung.
David: No, in fact, what we see in Europe, we see playing out here in the United States. It is just a matter of months before it begins to cascade here on this side of the pond. It is not out of the realm of possibility that we will see the stock market crater over the next few months, and there are characteristics in the fall of 2008 which are being mimicked now. Very uncertain. The earnings environment is fading quickly. There are a number of things which are unsupportive, in terms of the business environment. Now, what about the larger financial picture? The larger financial picture is as ugly as it has ever been. Kevin, this is a case in point. We have talked about Dexia. Dexia has now been nationalized.
Kevin: You were at Dexia. In fact, we had an account with Dexia, didn’t we, a few years ago?
David: Sure. Know when to hold ‘em, know when to fold ‘em. Know when to walk away, know when to run! (laughter).
Kevin: Explain to the listener who Dexia is.
David: Dexia is one of the larger Belgian banks, and Belgian French concerns, doing business in both countries. Now it is largely owned by both countries, as in, the governments have had to take over the bank. Kevin, what we pointed out in last week’s comments was that Dexia was truly on life support, but when the stress tests were applied this last summer, they came out smelling like a rose. There was no problem apparent at all, according to the stress tests. The same thing is happening right now with an Austrian bank, one of the largest, the Erste Group, which is now reporting billions in exposure, credit default swap exposure, and major losses, as much as 460 million immediate losses, but they are looking at several billion dollars in losses, given their credit default swap exposure. What is interesting is that they, too, went through the European stress test, and in the context of the stress test, nothing of their CDS exposure was revealed. Nothing at all.
Kevin: This is really scary. History does rhyme. It may not repeat itself, exactly, but you are talking about an Austrian bank that was a little bit over-rated, until it wasn’t. And if you go back to the early 1930s, Dave, I think we had the same thing happen at Credit Anstalt.
David: This is the unique thing, Kevin. We are trying to create confidence in the marketplace by creating these sham tests, saying, “Look at our measure. By our measure, everything is fine and healthy here.” If your tests are not legitimately rigorous enough to prove out who are the good bets and bad bets, if your effort is really just to save everyone, again, taking away from that business cyclicality, where the good banks are going to succeed, and the bad banks are going to fail, and the good banks will then come in and buy the assets of the bad bank and they will be that much stronger of an entity moving forward.
Kevin: It’s like a medical diagnosis. If you go in to get your physical, you don’t want the doctor to tell you that you are fine, if you are not fine.
David: “You’re doing just fine (your liver just failed). You’re doing just fine!” This is the issue, Kevin. They set up a sham test, and now have lost credibility, even more credibility, because the market gets to say, “Wait a minute. Dexia. You lied. Erste Group. You lied. Well, should we have the same appraisal that we do, in fact, trust you as it pertains to other institutions across Italy, and France, and Germany, and Portugal?”
Kevin: Maybe all institutions.
David: And that’s the issue. That’s the issue, Kevin, as we are losing credibility in the marketplace. This, too, is a part of the cycle, a breaking down of trust, until the point where no one has confidence anymore, and the few assets that remain are available, very inexpensively, if you have preserved value, if you have the ability to redeploy from a cash (bullion) position, and move into the companies that survive and will thrive during the next business cycle upturn. That may be 4-5 years hence, but the proper planning still has to take place today.
Kevin: Let’s conclude with this, Dave. We have had a lot of people calling and saying, “Gosh, gold has been awfully volatile over the last 3-4 weeks.” The early part of August, gold was in the 1600s, and then all of a sudden it went to 1700, 1800, 1900, and then fell right back down into the 1600s. So it got ahead of itself, probably, but you made a comment to all of us, and I think you probably ought to repeat it to the listeners. The questions were: How much further can gold go down? How much further can gold go up on the short run? And what are the chances of that, and what are the parameters that we should be looking for from a dollar price range in gold right now?
David: Just for perspective, I think the listener needs to remember that the gold price has collapsed in the last month, and it is still up 23% from last year this time.
Kevin: Yes, it started the year at $1298.
David: The press that it is getting that it’s over, the bull market is over, the bubble has burst – somebody needs to check their facts.
Kevin: It is the same people who tell us to fear deflation.
David: It is still up 23% from a year ago this time, Kevin. I think if we look at the technical analysis, there is 10% downside on the gold price.
Kevin: Okay, 10% down is a possibility.
David: With 50% on the upside.
Kevin: So that is a good bet.
David: It is a good bet. If you are 50% downside, 50% upside, you are in no-man’s land. You have equal probabilities of losses to gains.
Kevin: Flipping a coin for a bet.
David: Exactly. This is 10% downside, moving to the 65-week moving average as an outside possibility. I don’t count on it. I wouldn’t look for it. At our most recent drop to $1531, you were either cotton-pickin’ lucky, or why were you awake at 1 o’clock in the morning in European trade when it reached $1531 and opened the next day considerably higher? So you may see it go to low numbers, but the reality is, you may not capture those lower numbers if you are trying to pick the absolute bottom. That is why I think it is intelligent, and mature, for an investor to say, “I don’t have to have the absolute low, I don’t have to have the absolute high. But if probabilities are in my favor, 10% on the downside, and 50% on the upside…
Kevin: Then it’s time to buy.
David: It’s time to buy.
Kevin: Well, and you would also tell our clients not to buy on leverage or debt, because then the volatility does shake the trees and you have to drop it all.
David: That is absolutely right. We are talking about physical metals.
Kevin: Buying it one-on-one.
David: Exactly, exactly. No leverage. If you are playing leverage in this market, you really don’t understand what this market is about. This is an unwind of the Western financial system that has been built over a 50-year period, and you don’t know what all the implications are going to be. What in the world are you doing gambling with leverage? That makes no sense at all. That makes absolutely no sense at all. So for anyone who has a 5-to-1 leverage, 4-to-1 leverage, or 3-to-1 leverage, believe it or not, you’re the patsy. You may feel like you’re the most intelligent guy, trading your account…
Kevin: Even if it is gold or silver.
David: But you are the patsy because you haven’t appreciated just how severe the changes are that are coming, to the whole financial system, and we were privy to some of those changes in our conversation this last week with Franck Biancheri.
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Posted on 07 October 2011.
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, today, before our guest joins you, I would like to talk to you a little bit about the integration in Europe. We are hearing all the chaos with Greece not being able to make its payments, and of course, what kind of division that might be causing in Europe, but there are other opinions inside of Europe that are seeing this as just a natural progression toward more integration. Are you finding that?
David: Kevin, I think when you travel overseas, one of the things that you have to realize is that there is a lot more that you don’t understand, than that you do. Whether it is linguistic differences, cultural complexities, there are things on the surface that you can make a judgment of, but in fact, you may be making a prejudiced judgment, or simply inaccurate judgment.
It is important, in that context, to look at international issues from various perspectives, and to try to step into the shoes of someone who is there on the ground, simply looking at things from a “domestic perspective,” although for us it would be an international one.
Kevin: We have been looking at what is happening right now in Europe, but I think the bigger question probably would be to look a little further down the horizon, and what will come out of this, in the next 2, 3, 4, 5 years.
David: I think one of the things that I appreciate about our guest today is that when he is looking at politics, when he is looking at economics and finance, you will find that their whole work is one of anticipation, and it is one of looking ahead.
Let me just borrow a quote from our guest today, Franck Biancheri, “Forces of inertia require anticipation.” We need to look at the way we operate in the international realm, and realize that under the current leadership there are a series of reactions. An event occurs, and we have a reaction to it, we have a response to it. But there is very little anticipation. There is very little strategic thinking that appears to be done in Washington, D.C. today, and I think you will find that perhaps there is more anticipation in other parts of the world, whether it is conversations that we have had, Kevin, about the Chinese mindset in their five-year plans, and thinking in terms of a strategic five-year plan, and certainly how those five-year plans fit into a longer context of 50- and 100-year thinking.
I think this is something that is sorely lacking here in the United States, and may, in fact, relegate us to the dustbins of irrelevance, historically speaking. As we move forward 15, 20, 30, 40 years, our greatest weakness is that we are not forward-thinking, we are living “in the moment.” Again, as Franck likes to say, “Forces of inertia require anticipation.” Certainly, that compliments what we do with investors, trying to anticipate, trying to see what lies ahead, so that the savage adjustments which you can encounter in the context of crisis, are not a negative, but are either neutral or positive, being on the right side of the trend.
Kevin: David, I know you have been following the writings of Franck Biancheri for quite a while, and appreciate, even if you don’t necessarily agree with, each point, this anticipation that you are talking about. This is a forward look. In talking to Otmar Issing, as well, he had a lot at stake for this European Union to work. But he also looked far enough ahead to say that crisis would probably bring about tighter integration.
David: In retrospect, I think we will look at this period of 2012-2014 as either a window of opportunity, or a period where we moved into utter tragedy, not only here in the United States, but internationally.
Franck, thank you for joining us. There are many things that we want to discuss with you today, and I will start with my initial exposure to the group that you are part of, the Leap 20/20 group there in Europe, and it was with a report that you did on the precious metals market, and correct me if I am wrong, but was that in 2006?
Franck Biancheri: Yes.
David: And, quite an extensive report, looking forward, as you often do, anticipating changes in the metals market, changing popular response to things that are happening politically and financially. You have written, more recently, that a crisis contracts time. Change that would ordinarily take decades or centuries can occur in months or years. Perhaps that is where we could begin today, with the high points of change that you see over the next 5-10 years.
Franck: Yes, indeed, crises have this kind of effect on time which means that changes that people are thinking could take very, very long, can happen in a matter of moments, or years. Right now, what we can see and we can anticipate for the coming years, I think, is very clear. We are going to see, in the coming 2, 3, 4 years, first of all, a complete reshuffle of the international monetary system. Whether it will be an orderly one, or disorderly one, is something which will be decided by the leaders in the coming 2 or 3 years, but one thing is certain in our opinion is that by 2015, or 2014 even, the way the international monetary system has been shaped since 1945, and especially since 1971, based on the dollar only, is something which is going to vanish in the coming 2-3 years.
David: One of the things that we have observed is that the French have always been particularly keen on noting change in the monetary systems, and I don’t know why that is, but looking at Jacques Rouffe, and his advice given to de Gaulle, and even looking at how the U.S. 20-dollar gold piece traded at significant premiums in Paris in 1931 and 1932, in anticipation of a nearly 65% depreciation or devaluation of the U.S. currency, there has been this anticipation. When you look at the monetary system today, and say, “Okay, 2014, 2015, there will be a change that occurs,” is that a view that the euro would play a larger role, that gold would play some role? Where do you see the significant changes happening, and is that something that the IMF plays a particularly large role in?
Franck: We have seen that the impulsion to the change, if it is a constructive one, will come from the D20. The IMF, for instance, will just be a tool, if it is involved at all. But it will come from the D20, because the pressure will come significantly, and at the same time, both from Europe, the current situation between the euro and the dollar, Wall Street and London on one hand, and the eurozone on the other hand, is getting more and more tense, and more and more volatile, and will lead to, I think, some confrontations, pretty directly, next year, between the leaders of both the U.K. and the U.S. and the eurozone on the other side.
And some of it will come from the BRIC countries: Russia, China, India, are not going to tolerate more than the next 2-3 years, maximum, to have a monetary system where they play a bigger and bigger role, and have almost nothing to say.
So, essentially, what we are going to see is, if it is orderly, probably through or with the IMF, transformation of the SDR into something which will be a kind of new global currency, probably based upon a basket of the major ones, like the dollar, the euro, the yuan, the yen, the real, the major currencies, we can imagine now, and certainly, some part of gold inside, because gold is making its big comeback from supposedly an old-fashioned antique, obsolete, to something much more modern than people thought 40-50 years ago, and that will be an orderly one. If it is managed through the G20, using the IMF and the existing system to transform it by 2014-2015, into something stable, where the U.S. dollar will just be one among others inside this basket of currencies.
David: The potential for an orderly change, directed by the G20, I assume that your view is that the G20 will take on a larger role over the next year or so because many of its leaders will be replaced this next year.
Franck: Absolutely. We are saying that the next G20 in Cannes will bring nothing on the table, because it is still made of leaders that are at the end of their term. But from next year on, from 2012 onward, there will be significant change. I would say that most of the major countries within the G20 are going to have new leaders by the end of 2012, and that is going to provide a new impetus, and probably, as far as we can see with our contacts within the G20, diplomats and G20 advisors for the summit, we can see that there is an increasing demand for some action and ideas are seen to be there, about what to do and how to implement these changes. But it is not something which can be taken for certain, of course, and there is another option.
The disorderly option, will generate for several years, a complete chaos, where gold, definitely, will be the big winner, because it will affect all paper currencies, will be in a dire situation, and this will trigger a complete currency war, for at least 4, 5, or 6 years, before the system finds a new way to settle down and to reconstruct some systems. But the next two years, this will be the decision time, whether it will be disorderly or orderly, but in any case, the system as we know it, cannot go on beyond the next 2-3 years.
David: We could take a 100-year view to the changes that are taking place currently. You have shrunk down this decade, the 2010-2020 decade, as what you call the lynchpin decade, and have said, basically, this is of a critical nature, perhaps the most important decade in the next 50-100 years, and then you have shrunk it down ever further, to say that this next few years, this period of 2010-2014, which is now immediately in front of us, just a few years left of that, represents the end of the world before what you just referenced as the post-1945 world order, with the U.S. dollar and Washington, D.C. and New York, being the primary determinants of growth and success, and reference, if you will.
And then the last half of the decade, 2015-2020, the emergence of the world after. Help us understand what that looks like. We would assume ascendancy, and further progress, in China and India and Asia, generally. Perhaps in the U.S. there is some speculation, not so many would assume a rebirth of European primacy. Can you look at the important supportive factors for such an outcome, where Europe plays a more dominant role. Is it tied to the euro? Is it tied to greater integration of a fiscal and political nature?
Franck: Yes, time, I think, is really crucial, between 2012 and 2016. But we are now getting to the four years which are crucial. In this four years, if we are in the positive scenario, which makes an orderly process and not a disorderly one, of course we are going to see an increasing power and influence of China, Brazil, Russia, and India, so that is something which I think no one can even argue right now.
But as you mention, Europe, we are witnessing already, something which the markets are seeing every day, and they cannot identify. Europe, for the worst, or for the best, has become central within the crisis right now at this stage. Everybody is looking at what is happening in Europe, for 18 months now, with the Greek crisis, the euro crisis, whatever people call it, but one thing has become clear. What happens right now within the eurozone – or the euroland, as I call it – has become the most influential factor affecting world changes and financial markets, which, in fact, is not only a sign that there are troubles in Europe, it is also a sign that what happens in Europe now matters immediately for the rest of the world.
And I think that it is, right now, in a transition process, but it is a long-lasting trend that the crisis is provoking and accelerating a new phase of integration within Europe and around the countries sharing the euro currency. We have been seeing, in the last 18 months, an amazing feat of integration with the creation of the financial stability fund with a lot of new regulations with the move now to fiscal integration. So we are seeing a real rebirth, a kind of renaissance, of the integration process which was stopped for about 20 years, and this is creating, at the core of the European continent, a new group of countries which are, basically, a new sovereign which is emerging.
And this new sovereign emerging will be in the next 2-3 years, or I think, almost completed, and that will create, definitely, a new player which is crucial. Why is it crucial? Because it is, in many ways, at the center of the possible new world order, which can come out of this crisis. Why? Because Europe is able to talk and to discuss and to find common ground, with the U.S., and also with the BRIC countries.
So, in fact, it is a power broker. If the Europeans move one direction, they can form the majority of any of the international institutions, either with the Brits or with the U.S. For instance, for the U.S. it is something which is almost impossible, to make partnership and common proposals for the new structure of the world, with the BRIC countries, because they are so many issues where the U.S. is at odds with Russia, India, China, and so on, that it is a no-go in that direction, whereas Europe is able to make agreements or to find common solutions with both sides. And that is exactly, in a new world situation, where nobody is going to be the leading country, but on the contrary, it will be a mix of powers which are somehow, somewhere, about the same size, or similar influences. The main influential power is the one who can create majorities, and I think that Europe is exactly heading directly toward this situation, this position.
David: On the question of leadership, because you make the point about leadership, which is, if you do aspire to the role, to be right, you have to take the risk of being wrong, and it would appear, at least from the outsider’s perspective, that the present leadership within Europe is, and again, this is the perspective of Brussels, specifically, not particularly, leadership, on a country by country basis, but that the Brussels leadership is not particularly productive.
Franck: That’s the least you can say. First of all, Brussels is not in the game anymore. What is happening is that it is a euroland process – 17 countries sharing the euro, which are making the decisions right now. Brussels is mostly a spectator in many ways, or a side player. As we titled in one of our bulletins in May 2010, when the stability fund was created, it was a coup d’état, made by the eurozone countries within the EU.
So, in fact, when one wants to understand what is going on right now in the European integration, and for the future, one has to focus on what’s happening within the euroland countries and not anymore within the EU traditional framework, like Brussels, and so on. The political level at the national level is also very weak right now within the EU and within the euroland, because all of its leaders also are at the end of their mandates. So, what we have been anticipating, and we are seeing, very clearly, coming in the next 6-9 months, is that there will be a renewal of leadership in most of the major euroland countries: France, Spain, Italy, and Germany. In Germany, the coalition will never last into 2013, they will have election next year, as well.
So the euroland countries are going to see next year, by the end of 2012, the complete renewal of leadership. It is a very similar process, the G20, where you have also these countries with Russia, with the U.S., with China, where the renewal will take place. It’s a strange coincidence that in 2012, both in Europe and on the global scene, there will be this kind of transition of power. It will be a new generation of leaders, and leaders within Europe, which for the first time will be leaders who have seen the crisis taking place, and for the last 18 months to two years have been witnessing the lack of ambition and the lack of leadership that the current leaders have been showing.
If I can take an example, an image – I don’t know if you are familiar with was called the Euro missile crisis of the early 1980s. It was when the USSR tried to neutralize Europe with a system of missiles and NATO tried to make counter missiles, and, for a while, Europe seemed to be completely lost, because it was full of pacifist movements, preferring to “better red than dead” and so on. And at that time in 1981, the European project was completely failing. Three years later, with a new group of leaders arriving in 1982-1983 – Mitterand, Kohl, and so on – it was only three years later that there was what I call the first renaissance of the European project, which led to the single market, the single currency, and all those kind of things.
So, Europe is used to that kind of situation, where at one point, it looks like the leadership is completely gone and the project is going in no specific direction, or even going to collapse, and in fact, just 2-3 years later, the change of leadership leads, in fact, to reverse the process. And I think we are exactly on the same pattern, and that if we were to interview again in the second semester of 2012, it would be a completely different vision of what Europe is doing, and what euroland is heading for.
David: It seems that we are getting to that point where there is either greater integration and success as they move forward toward the vision of a unified Europe, or, and this is perhaps where we have some questions remaining, you see throughout Germany, voters continuing to send a particular message. Merkel’s coalition is losing ground, it seems that the efforts to bail out various European countries is not “popularly,” or democratically, acceptable. How do we, then, see a different form of leadership, whether it is France, Spain, Italy, Germany, which takes us in the direction of integration, rather than a fracturing of European interests toward more national or local concerns?
Franck: Well, I must say that I disagree with this analysis. I think the Anglo-Saxon media have been completely twisting what is happening in Europe, essentially, because a lot of media in the U.S. or in the U.K. do not understand what the EU is doing. When you take the U.K. news about Europe, it is like taking the USSR news about America during the Cold War.
David: Pravda, yes.
Franck: So, let’s be clear. There is no specific popular movement in Europe, Germany or anywhere else right now, which is against integration. It is just a typical, classical 15% of voters which have been euro skeptics forever, and “this never will stay forever,” and so on. The crisis just gives them a more vocal situation, and the media places a lot of emphasis on what they are saying. But when you look at the political situation in terms of majorities and political parties, you are seeing the overwhelming majority in the Bundestag, which has supported the extension of the financial stability fund. If there is a new leadership next year in Germany – the SPD/Green [coalition] probably could be the alternative to the CDU right now – is even more in favor of European integration than the CDU/SPD current coalition.
If you take France, the Socialist Party is most likely going to win the next presidential election. They are even more in favor of European integration acceleration than Sarkozy’s UMP right now. So when you look at the situation, politically speaking, in the eurozone countries, not only are the existing parties in power in favor of this integration, but the opposition parties are, most of the time, even more in favor of it. So, very honestly, coming from Europe, working and following these issues for more than 25 years now at different levels, I have a strong imagination, but I cannot imagine even one single possibility, right now, that there is any other way than this fashioning of integration taking place next year, as I was saying before. It is not wishful thinking, it is just a fact of life, and a fact of the political situation and the strength of the trends in each of the countries. The full integration parties are in power, and will stay in power, whatever happens in the coming years. So, in that sense, the story is already written.
The only thing which is questioning the process, is the democratic issue, and that is not dating from this crisis. It is a very old issue of the democratic difference within the EU for at least 20-25 years. But this democratic question is also something which is changing with the euro integration, is the fact that what we think, in the next two years, by 2014, the euroland countries are going to be obliged to present a new constitutional treaty to the population – the population of the euroland, not of the EU, but only the countries sharing the euro.
And this referendum, for the first time, will be a trans-European referendum, not a series of national referenda like they did last time, and it was a complete failure and a mess. So, in fact, not only are we saying that the next 2-3 years are going to see more European integration within the euroland and the emerging of a semi-state within the euroland, but it will also trigger, by force, the first democratic process involving public opinion to support this integration, and I have no doubt that in such a trans-European referendum, there will be an overwhelming majority in favor of this step.
The euro-skeptic forces on the continent within the eurozone are absolutely marginal. They are vocal right now because the politicians are unable to present a long-term future and a perspective. This shortcoming will be disappearing next year with a new bunch of leaders taking position in France, in Spain, in Germany, and so on. And I assure you, my job with LEAP is to be as objective as we can. I would not say negative things, I don’t think, about Europe, just for the sake of looking objective. I think I am objectively describing the situation, like we have done with our work for the past 5½ years, because it is exactly what we are seeing when we look at public opinion, political trends, and so on, taking place within the euroland.
David: Certainly, looking at the Anglo-Saxon media bias, and we would agree, whatever the media we are talking about, there is a bias, always. There always are reasons to be expressing opinions in the way that they are expressed. We have gotten a free pass. London has gotten a free pass, and New York and D.C. have largely gotten a free pass, with a focus on the euro crisis, with a focus on Greece. It has diverted a tremendous amount of attention from anglosphere deterioration, and what could be, very well, a collapse in the U.S. currency, and a collapse in the U.S. Treasury market, if people were looking, not just at liquidity concerns, but real balance sheet issues here in the United States.
One thing that seems to be troubling to me with the ECB – Trichet is moving on, Mario Draghi takes his place. Does this help or hurt the ECB? Is this almost a replay? Maybe we are adding too much from one portion of his CV, his stint with Goldman-Sachs. How much does he play to London and New York interests, as opposed to the interests of Europe?
Franck: Yes, that’s a good question. I think that it has been a very bad move in terms of the public opinion in Europe, to put a former Goldman-Sachs manager as the head of the ECB. I think it is a mistake, in terms of credibility of the ECB toward the European public opinion, but, then we have to give Draghi at least the benefit of the doubt for the first six months, to see whether he will act as a European-dedicated bureaucrat, or if he will act as a former Goldman-Sachs employee. I think that the constraints of his job will be extremely large, so he will not have that much room to maneuver in his own interests.
But I think that the ECB is getting into a position which now cannot go beyond alone. That is one of the jobs that the government has to do within the euroland in the coming six months and I think they are aware that they are having to move next year, at least, on that, that there is a need for political, economical, governmental balance to the ECB. And meanwhile, we have to have the governments taking responsibilities with eurobonds, and so on, of many issues which now are left only to the ECB to solve.
I think the ECB has done most of its job, and now the governments have to go forth to something else, with more integration and more balance of power between the ECB and the political level. That is why I think 2012 will probably also bring a lot of innovations like these eurobonds, whatever the German public opinion is saying right now, that eurobonds would be out by 2012. And that will diminish, a lot, the pressure on the ECB, and as well, the feeling that they are the only ones involved to do things, which is, in fact, true right now. Again, for Draghi, a bad public opinion move, and perhaps a real threat, I would say, for the common good of Europe, because he is coming from Goldman-Sachs. But I will wait for six months to be sure of that.
David: It looks like 2011, the last quarter, and 2012, are shaping up to be very, very interesting, and perhaps, incredibly volatile. One of the things that we have looked at, again, going back to my original introduction to your work, which was a special report on gold – gold has made a comeback in the last few years. It has done very well, and it is something that does well during periods of distress. It is something like an insurance policy. It pays during a particular period of time.
Seeing it play an official role in the international monetary system, I am having a challenge with this on the one hand, particularly just coming back from Europe, because amongst the banking community, gold is very unpopular. How does it play that role amongst central bankers? This is what has been considered the barbaric relic. What is their new-found motivation to have something that is an anchor, or ties their hands, so to say?
Franck: Well, gold may be unpopular with bankers, but I will say that bankers are even more unpopular with everybody right now. So, I think this is indicating where things are going to go in the coming years. The only way gold was depressed, or put out of any role in this monetary system, was due to the fact that the dollar was able to have liquidity enough to play the role of the anchor. Now, this role is finished.
David: So you take the dollar out as the anchor, and you have to have some sort of an anchor.
Franck: Yes, exactly. The credibility of the dollar … you should look at gold, as we were explaining in our last bulletin, if we look at the next three years, the only way the gold prices could go down would be either that the dollar finds a new credibility again as the sole reserve currency. Well, to be honest …
David: Low probability.
Franck: Yes, even zero probability, I think, in terms of this happening – or that the G20 find a way to create a new global currency, maybe with some gold inside, by the way, but a new global currency, to be the new basis for the monetary system. But, in the best scenario for that, it will never happen in the next three years. So, what we say is that, for the next three years, we don’t see how gold can go anywhere but up, because these are the only two conditions for gold to go down, and they will not be met, neither one nor the other, before at least 2014-2015.
So that gives three years, at least, where we think the trend is clear, and central bankers are just obliged, like everybody else, they are committed to this reality. One of their jobs is to be sure that they are able to preserve the value of the reserves of their country. And therefore, as we have seen in the past two years, most central banks in the world are now becoming buyers of gold when they have been selling it in the past. And this is the simple fact that there is no other option.
David: If for other reasons, we have looked at the 2014-2016 period as a major transition point, and up to that point is incredibly lucrative for someone who owns gold, the good news comes with bad news. Most people do not have 100% of their assets in the precious metals, so where you see a gain on the one side, you are likely to see losses on the other – whether that is equities, or dollar-based assets.
Franck: Of course.
David: Perhaps you have some thoughts on the Treasury market and the fact that here recently, yet again, there is a move to dollars, and specifically, to Treasuries, when there is concern with the euro, when there is concern with the eurozone, when there is concern, generally, with liquidity. What do you think changes people’s perspective on the validity of Treasuries as an instrument of stability?
Franck: I think that the trend we have been seeing recently is not the fact that there are troubles in Europe, and therefore people move to the Treasuries, that there has been a creation of what is supposed to be a deadly crisis in the eurozone, in order to have people moving and shifting to Treasury bonds. We are in a situation, basically, where the western world is trying to find funds by any means, in a world where these funds are less and less available. And therefore, the past quarters have been showing that Wall Street, or the U.S., has been more and more trying to push fear on Europe in order to convince international buyers to come to T-bonds, rather than going to eurozone bonds. Nevertheless, it doesn’t necessarily work so well, at least, in Europe and Asia.
But going back to the Treasury bonds market, I believe that by the end of this year, November and December, we are going to see another replay of this summer budgetary ceiling situation in the U.S., that there will be a new degradation of the ratings because there will be no solution found in Washington, and that what I think is already the recession taking place in this country, will show that there is absolutely no way out of the new long recession and painful one. We see that public opinion –the occupy Wall Street movement – is now starting to make headlines everywhere. We see that public opinion within the U.S. is is less and less ready to accept the way policies are made right now within this country, so, to make it short, I am saying that, by the end of this year, we are going to see that the U.S. is Greece, and that, in fact, the true Greece is the U.S., and that will have a devastating effect on the T-bond market.
David: Yes, this is very clear. And coming back to an earlier point in our conversation, this is really a reflection of leadership. I have garnered from reading various things that you have published, that you are not a particular fan of Sarkozy, or at least his leadership abilities, and I think we could say the same of our current administration, not to pick on even one personality, but to look at the whole stock in legislature. “To be right,” as you said, and I will quote you again, “You have to take the risk of being wrong.” And we don’t have people today who are concerned about doing the right thing for our country. They care more about their political legacies, I think, or at least, that is what their inactivity at these critical moments, is implying. So 2012 looks to be a very, very interesting year.
Franck: Yes, I think it is really a pivotal year, which is going to be, I think, in the history books as a year for the better. Extremely important changes will take place in the way the world economy is organized.
David: We will look forward to exploring some of those ideas with you over the next couple of days, and thank you for sharing your thoughts with us. If our listeners are interested, where might they find more information? I will let you direct them, if you will, to your website.
Franck: My website is Franck-Bianchieri.eu or there is my book, which they can find on the website of the publisher, which is Anticipolis.eu. The book is The World Crisis. And of course, there is the Leap 20/20 website where all this information on the crisis is posted every month, which is Leap2020.eu.
David: We will go ahead and include those links on our website and people can just click straight through. Thank you so much for joining us.
Franck: Thank you, David.
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