Our Listeners Questions Answered Part II

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About this week’s show:

• Will the Dollar be destroyed in 2015?
• Will China make its currency Gold convertible?
• Is the Fed Manipulating the Stock Market?

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“There is a growing consensus amongst sophisticated and informed investors that the game is rigged. Again, going back to the analogy of the con game, fabricated money is fabricating confidence, and that confidence will break, no one knows when, but as and when it does, it’s catastrophic in nature.”

– David McAlvany

Kevin: David, as promised, we are now moving into part two of Your Questions Answered, referring to our listeners. We had a great response. A lot of questions came in.

David: Kevin, on a routine basis, we will get on the phone with our listeners, and they will have a variety of questions that go well beyond the general ones that are asked here, taking on more of a consultative role, whether it is to a family office, or an individual looking for a specific input for their resources that they manage or steward. That has been, also, interesting. In complement to what we have done with these questions, I have been on the phone for the last two weeks nonstop, talking to listeners, as well as our existing clients, as they want to press in a little bit further, and have the detailed explanation of how it applies to them. So, if that includes you, certainly feel free to set something up in the new year and we can certainly visit on more specific questions.

Kevin: That sounds good. I’m going to start with Fred’s question here. He says:

“I have been hearing that the U.S. dollar will be destroyed outright by the end of 2015, deliberately. The New World Order intends to launch a one-world cashless currency, and that cannot happen while the dollar is the world’s reserve currency. One thing is certain, China, Russia, Iran and others hate the U.S. dollar, and China has been stockpiling gold. Where do you stand on the issue?”

David: I am not sure that any of us knows exactly how this will play. Major transitions in the world monetary system are not something that happens just every day, and we know a number of things about a new monetary regime. Starting in 2001 the Treasury Department has started to play a significant role, almost as an extension of the State Department, in terms of foreign policy application, and the dollar has been a major tool. Now, there has been a backlash to that. We are seeing, certainly, certain reserves. We have the Russian reserves, which have been moved, in some part, to Hong Kong, and the Hong Kong dollar gives them dollar stability, if you will, without being in the dollar system.

So, all that to say, there is a move away from the dollar system, and we see that, as we have noted in the Commentary for a couple of years now, an increase in the side agreements between countries looking for trade and invoice settlement. By taking the dollar out as the settlement currency and seeing trade and invoice settlement happen between two countries, there is an efficiency gained. Visiting with a business owner in Australia recently, he described one of his good friends who imported shoes into Australia from China, and the trade agreement that had been there always included the U.S. dollar. Now it was going from Australian dollars directly to the Chinese currency, and it was saving – saving – in efficiency, as much as 7%.

But let’s look at this very carefully, because I think that while we can make a case for, not only the diminished use in terms of trade and invoice settlement and the diminished reserve holdings in U.S. dollars – important still, the U.S. economy is one of the largest in the world – and what has been proposed by Barry Eichengreen, and I think this is very significant. Eichengreen is essentially the consultant, if you think in terms of the powers that be, a new world order, those who are very, very connected in terms of foreign policy, trade policy, domestic policy, you are talking about a very small group of people.

Who do they get their information from? Who advises them? Who do they consider to be the experts in the room that they would turn to and say, “How exactly are we going to manage these transitions?” Eichengreen is one of the chosen golden boys, if you will, in the world of economics. So, his views expressed in the book Exorbitant Privilege I think go a long way toward describing what the new monetary system would look like, and it certainly is more oriented toward an equal weighting in light of what your contribution is to global GDP.

So, think of this real quickly. If you are the heavyweight, in terms of contributing to global GDP, you still have a role. It may be a diminished role from what it was 10, 15, 20, 30 years ago, and that, again, is where, yes we see a declining trend in terms of interest in the U.S. dollar, but to say that that dollar will be eradicated, or destroyed outright, I think neglects the size and scale of the U.S. economy, and I think what we do see is that GDP today, coming from the emerging markets, is now coming over 50% for the first time ever.

So, should they have a greater representation? This is exactly what Eichengreen argues, that they not only should, but will, have a greater representation in terms of a basket of currencies trading almost as the SDRs were envisioned so many years ago. So, yes, it’s bad news for the U.S. dollar, but I don’t know that it is catastrophic news for the U.S. dollar, destroyed outright. Quite frankly, when we appraise any situation, appreciate this. It is always easiest to consider it in the extreme, and to then make decisions based on that. When it is not in the extreme, quite frankly, there is not enough emotional impetus to make critical strategic decisions. And so, why do we swing to one extreme or the other? The dollar will exist and will be the strongest currency. Without question, that is one extreme, the other extreme being, it simply won’t exist any longer.

Kevin: David, a good example of that is, I often hear people say, “We’ve been thinking this is going to happen for many, many years, since we have gone off the gold standard. Why hasn’t it happened yet?” And actually, slowly, but surely, the dollar has lost about 90% of its buying power, but everyone is still waiting for this catastrophic one-day event.

David: What I am interested in is the reality that we are moving toward a greater digital reality in terms of currency. Not only can you create money and credit with a few keystrokes today, but you can also create a block to any flow of money to any country with a matter of keystrokes. As I have visited Europe the last few years, what I have witnessed is a change in the use of cash. There are many more limits today being placed on cash transactions, and a part of that is, government wants to know everything that is happening. Who is doing what, when, and why?

And to me, that is an interesting thing. When we use credit cards, we are entering into the digital world, and we are, basically, allowing for the perfect picture of our consumptive habits to be painted, for anyone who wants to know that. That may be private companies that literally data mine, and know then how to personalize marketing to you, or it can also be the “big brother” that knows exactly what, when, why, and how you buy.

It is interesting to me that we are, in fact, moving closer to a new world order, not in the sense that we have a change in the monetary regime, but all of us the world over are moving toward digital behavior, online behavior, and our consumptive patterns are now no longer discrete, private, just between us and the end purchaser in an exchange relationship, but it is out there for the world to know. That is a significant change, and I think that, probably, is a greater threat in terms of control of buying and selling.

Kevin: David, as you know, this is an internationally listened-to show, so I would like to read the question from Nigel from New Zealand. He says:

“Please share your thoughts on the state of the New Zealand economy, as our local media only captures the rock star economy we enjoy, and 99% of the people, like the sheep that we are famous for, seem to follow the crowd of popular opinion, and have their heads in the sand when it comes to our economic status. Like all Western countries, the government here keeps talking up our economy – strong dollar and housing values – especially in Auckland, although our government credit card and mortgage debt is at an all-time high, and the four big Australian-owned banks are making record profits. I imagine that when the credit bubble bursts we will face the same fate as all other countries that are financially over-extended. What is your opinion and advice for anyone living here?”

David: I think Nigel provides an answer, if you will, to the questions that he poses, and I would agree. You have the New Zealand economy, and the Australian economy, both of which are resource-rich, but thus, price-sensitive, because of the resources in question. You are dealing with supply and demand dynamics relating to the resources which they produce, and it means that they are much more sensitive to, not only global growth, but also Chinese growth. And to the extent that you have an increase in global growth, and an increase in Chinese growth, thus you have an increase in the trajectory for those economies.

We are beginning to see, not only a decline in commodities, in general, but also, a decline in the growth trend for China. And it is no surprise that you are seeing a softening up in terms of trade with those countries. Nigel’s point is particularly important when you look at the impact into the banking system, and in the real estate markets, because you really haven’t seen much of a correction there. Australia, four major banks, 90% of all lending and deposits are held with those four major banks, and 70% is tied to real estate. That is a very skewed balance sheet and a very sensitive one.

Kevin: Sort of vulnerable.

David: It is, particularly when you look at the central banks piling in on that theme of lowering interest rates and distorting the perception of financial reality thereby. So, you look at record profits with the banks, you look at a very healthy financial system, and yet you have some very core components within both of those economies, Australia and New Zealand, which are already going out with the tide, so to say.

Kevin: David, our next question is from George. He says:

“Do you consider that within the next five years the Chinese may make their currency convertible into gold? If that possibility were to exist, and it were to be implemented, how would that implementation affect the world markets, both the equity markets and the debt markets?”

David: Let’s start with the piece on China, because I think there is, to some degree, the world’s central banks, including the PBOC, that look at the Keynesian idea of credit growth equaling economic growth as a viable approach to reshaping their economy. And so, seeing sort of the democratization of credit within China, seeing an expansion of credit use by households, these are things that I think we can expect to see, and quite frankly, if credit growth is one of the primary drivers of economic growth, then I am not sure that the Chinese are going to look for what Barry Eichengreen has called the golden fetters, where you bring in gold as a part of the system.

Now, the reality is that they want their currency to be considered, not only on a regional basis, but on an international basis, more credible, so the fact that they have been adding to gold reserves adds to that credibility. As far back as recorded on monetary matters goes, gold has been the legitimizer of the currency. So yes, it makes sense that they are adding what they are adding. They are going to have to before their currency becomes more significant on the world scene, address the issues of depth and breadth. There is not enough of their currency to matter, to play a significant role internationally. Perhaps there is more of a role that it can play on a regional basis, but for that to happen, there is sort of a chicken-and-egg question – which comes first? Currency reform with gold backing, sort of adding legitimacy?

And I would suggest that there will be considerable gold purchased, on an ongoing basis, in anticipation of breaking the peg to the U.S. dollar, and allowing the currency to float, but not have the same kind of volatility that you would see with a normal emerging market currency, and that gold backing will do a lot, I think, to lower the volatility post peg. But back to that chicken-and-egg equation. You also have bond market maturity. It goes hand in glove. You have to have a deep bond market in order to see the currency become more useful.

So, convertible to gold, I think it is too limiting for the PBOC at this juncture, but that doesn’t mean they won’t continue to increase their gold reserves and add to the legitimacy of their currency by shooting for a 10, 20, 30 percent reserve backing. That would put them as one of the greatest contenders in terms of solid currencies the world over. And trust you me, if there is ever a reason to doubt the viability of the euro, or the stability of the U.S. dollar, in that moment of doubt, the question will be, what currency does the world turn to? Is it gold, a currency without nationality attached to it, or is it a viable currency in the world of fiat that has the greatest amount of gold backing it? And there, I think you will see a new world order, if you will, in the world of currencies, in light of who owns what. Gold – as my father has always said, “He who owns the gold makes the rules.”

Kevin: Our next question is from Matt: He says:

“Is there something more at play than inept central planning? Perhaps globalists pushing us into a huge catastrophe so that they can usher in a new world solution? This may sound like I’m on the fringe, but there is substantial evidence to support this.”

David: That question is an interesting one, and I think that this next week’s interview with Nazli Choucri from Massachusetts Institute of Technology will shed some light on that. What she explores in her book Cyber Politics and International Relations” really is asking the question of where are we going from here? We have a free flow of information and opinion in a way that we haven’t had in a long, long time, and the powers that be are wondering who, ultimately, is going to control the information flow, and of course, information flow includes information relating to finances for individual companies. Of course, information flow today is no different than cash flow or money flow yesterday, because everything is flown through the digital ether in ones and zeros.

There was an interesting Bloomberg article a couple of weeks back dealing with the tracking of people, and how, voluntarily, we are giving up privacy for convenience. It is interesting to me because, on the one hand, you have this notion that central planners are planning, but on the other hand, you have private citizens who are compromising for the sake of a better life, what we consider to be “the good life.”

Kevin: So personal borders are falling, national borders are falling. What we are seeing is, we don’t really understand what the borders are anymore, do we?

David: Yes, so it is really that no one is really prioritizing privacy in the way they used to, and quite frankly, people are, and have been for decades now, conditioned for control. Catastrophe, as we have seen, is really a means to the end of scaling up that faith. If you remember, and I think this is one of my favorite interviews, probably, in the last five years, when we talked to Robert Higgs about his book Crisis and Leviathan, how, essentially, from 1914, 1930, even into the modern era, looking at 2001 and the events here in the United States with 9/11, the major moves forward in terms of people control, and it’s sort of the nature of government.

You might chalk it up to central planning or globalists, but it is essentially the nature of government to grow, and they only get to grow in a major way, ratcheting forward their control of people when there is crisis. So, between the voluntary giving up of freedom and privacy, and then the crisis orientation that government has of taking advantage of, and pushing forward their agenda, we have both. But I would venture to say that you can’t blame it all on government or central planners. We have a large part in asking, in a moment of catastrophe and crisis, “Please keep us safe, please save us.” That tends to be the voice of the victim, too often heard on the other side of catastrophe.

Kevin: David, the next question is from Mark in Toronto, and it applies directly to a question of the triangle and the asset strategy that you talk about so often.

“David, I have been listening to your podcast for several years, and very much enjoy it. My question is about the triangle asset allocation which you promote, which is one-third equities, one-third cash, one-third gold. You clearly are extremely intelligent, but such a lopsided allocation seems to be putting your clients’, and your own family’s wealth, at unnecessary risk and volatility. You seem to have an almost religious zeal for gold, with unquestioning faith that it will ultimately prove to be a great store of wealth, relative to other alternatives. What if your faith in gold is misplaced? There is no guarantee that it will appreciate from current levels, nor that any relative gains will persist, nor that your timing to buy and sell will be optimum. It strikes me that you are making an outsized bet on an outcome that is far from certain. Perhaps a much more moderate allocation might be better, say 5% to 10% gold, and then a mix of cash, bonds, equities that suit your clients’ and your family’s need for income, while reducing portfolio volatility. I look forward to hearing your response, and please keep up the podcasts, they provide a useful and unique perspective on investing in this crazy world.”

So David, the triangle, and the allocation. How do you feel about that?

David: Mark, as you know, we are very open to critique and anything of a critical nature is, in our opinion, helpful in the process of sorting out why we hold to the positions that we do. Several things: First, I would say that our views on gold would not be associated with faith. Quite the opposite, we would take the other side of the coin and say that we are skeptical of the means and the measure of the men using those means in their attempts to save the world and make it a better place.

As a skeptic, I would say that the financial and monetary experiments going back, not only through the last ten years, but the last 50, 100, 200, and you could stretch it back even several thousand years, are fairly consistent in the record that people think more highly of themselves than they should. And so, the results of the effort are great until they are terrible, and when they are terrible, they are catastrophic. So, why we have a third of our liquid assets in gold, in particular, is to insure the other two-thirds of our liquid assets. The interesting thing is that when you do the math, for most people, their primary assets are not liquid. Their primary assets are illiquid, be that real estate or business interests.

So, looking at the old European model of having 5-10% of your assets in gold and silver, gold particularly, that would be a net worth figure, and in fact, one-third of liquid assets translates to between 10 and 12.5% of net worth. So, I actually don’t think that is a number that is too large, having 10-12% of total net worth in gold, which does translate to about a third of liquid assets. It represents an insurance policy. It represents something that is, in the scheme of things, small, but in the context of crisis gives an outsized return to replace what has been lost, either in the equity portion, or on the cash portion, whether that is because of general market volatility, or because of monetary debasement.

Kevin: David, our next question is from someone who is addressing, specifically, the coin in the U.S., Saint Gaudens coin. He says:

“Since the St. Gaudens are selling so close to bullion’s price, which is a better buy, and does the coin value have more worth long-term?”

David: This is an easy question, on the one hand, a difficult question on the other. Coins like Saint Gaudens come with a much higher fee structure, and you might say, “On that basis, I just wouldn’t be interested.” But call this an insider perspective, in the sense that I will buy for my own account, without having to pay any additional fees, we have our basal wholesale costs, and I will do that on a particular rationale. And I think the rationale holds, regardless of the fee structure in question. When I am buying bullion, it is because the premiums on those coins are too high and don’t make sense. When I am buying Saint Gaudens and Libertys it is because those premiums are too low, and don’t make sense.

The value of owning coins like that in a particular environment is simply this: If you have bought with premiums low, they give you the ability to compound ounces when the premiums then return to higher levels. So, for instance, if I am paying, let’s say, 25-40% over the basal value of the coin, that may seem like a high premium, but not if its ordinary behavior is to trade at 150-250% over its basal gold value. And so, I am willing to give up some degree of ounces up front to own it, if the premiums are low, in order that I might, with a higher premium, be able to own more gold ounces for free, translating those higher premiums into free gold ounces. Does that make sense?

Kevin: It definitely does. Dave, this ties right in with the next question, because not only do you subscribe to buying when premiums are low and selling when premiums are high, thus compounding your ounces, but this question is related to gold and silver, and I am reading:

“At some point in the future, when the silver and gold ratio returns to one that is more commensurate with a historical ratio of 16-to-1, would you recommend that I convert my silver to gold? If so, why would you recommend doing so, and what percentage of my physical silver holdings would you recommend be converted to physical gold?”

David: Great questions, because there are a couple of things I want to comment on. First, I would say that the historical ratio is 30-to-1, to be precise, 31.4-to-1 is the 200-year average. And I think that, historically, you don’t see 16. The in-ground ratio is between 16 and 17-to-1, and at market extremes we have seen it trade to a 15 or 16-to-1 ratio, so it is not out of the question that we would see those numbers again in the future, but I wouldn’t look at that as the normal number. The normal number is probably 30-to-1, with of course, tremendous volatility, at a low side of 16, 15, and at a high side of 100.

So, what percentage of the physical silver holdings would you recommend being converted to physical gold? That really is a question of volatility tolerance, because silver is almost a micro-cap relative to the gold market. It tends to, when the wind blows, you will see some volatility with gold, like the trunk of a tree, and you will see lots of volatility, like the waving of a small branch moved by the wind, on a much more dramatic basis, so volatility is a big deal to consider.

Let me look at this from a slightly different perspective. Just as we were talking about maximizing premiums on coins like a Saint Gaudens or Liberty just a minute ago, you are really talking about maximizing a precious metals portfolio, and the proper construction up front is very important for being able to maximize the volatility, not only in the gold and silver price, but in the premiums that exist and in the relative relationship between gold and silver. And so, if you look at, more generally, your portfolio, as a precious metals portfolio, with a certain allocation to gold and silver, a standard mix would be two-thirds gold and one-third silver, because of the volatility of silver. That is a fairly plain vanilla approach, but does give you the ability to take that one-third silver, and as the extremes of the ratio play out, you can enhance the total ounces in precious metals that you have.

The more aggressive approach would be more silver, and certainly we have a growth-oriented contingency within our client base that would prefer 50% silver, even 75% silver, with a smaller percentage in gold, and you might ask why. Why would you do that, knowing that silver, not only has vulnerability in the context of deflation, but greater volatility, and this boils down to, “What is the ratio today?” You can’t say, I’m open for greater growth, therefore, I will put down my money more in silver than gold because I am open to greater growth. It is a fool’s errand to do that unless you have the ratio on your side. Today it is 70-to-1. I would say, if the ratio is 60 or higher, from 60-100, you could probably increase the percentage allocation to silver. And below 60, you have got to be thinking the other direction, not only a greater allocation to gold, but ultimately, the silver that you have, you are going to be swapping at 4 ounces of gold, again, to maximize the arbitrage between gold and silver.

One final point, and this ties back to the Saint Gaudens and Libertys, but it is specifically silver-related. Junk bags of silver, dimes, quarters and 50 cent pieces, these are generic bullion products, in the United States, what were coin of the realm and regularly minted prior to 1965. 90% of the value of the coin is tied up in silver. It is one of the cheapest ways to buy silver. Just like the Saint Gaudens or Libertys, if you are looking at a 100-ounce silver bar, or a 1000-ounce silver bar, versus junk silver, you would always choose junk silver if the premium is low. If the premium is low, you have the potential to see anywhere from a 10-30% additional gain above and beyond the silver price because of the premium that comes into those bags on the basis of supply and demand.

So again, the way that we, at ICA, structure a precious metals portfolio, is in light of these internal arbitrage dynamics, and it is something that we certainly are keen on managing for our clients so it’s not something that they have to manage on their own, but a part of the embedded, trusted relationship that our advisors have with our clients. And I think, quite frankly, it is something that we have set ourselves apart by over the years within the industry, by being able to handle these things, not just be able to talk to them, and speak about them, but execute them quite well, through four decades of business. So, junk bags are just one example. You don’t have to go into something borderline high-faluting like the Saint Gaudens or Libertys to see the same sort of premium gain potential. It can be a bullion product, just the appropriate bullion product. The principle still applies in terms of premium gain.

Kevin: Our next question from Glen. He said:

“I bought and read James Rickards’ book, The Death of Money, after he appeared on your show. In the book, Rickards recommends putting about 20% of your wealth in precious metals, about 30% in cash, and the balance in fine art, real estate, and hedged private equity funds. My wife and I are very close to having the recommended 20% in precious metals, and have quite a bit of cash or cash equivalents on hand. We have a middle class income, and very little debt outside of our mortgage. However, we don’t have the money needed to purchase fine art or invest in hedge/private equity funds. We could purchase real estate, but really don’t want the debt that would likely come along with it. Besides, I think real estate investors are going to get crushed when interest rates start rising again, and we would rather wait for better opportunities. Without asking for specific investing advice, David, what are your general thoughts on how working middle class people like myself can diversify their assets outside of precious metals and cash?”

David: First, great commentary and questions appreciated. The 20% that Rickards mentions in his book, he is actually recommending more than we recommend in precious metals, because again, we generally refer to one-third of liquid assets. He is talking about 20% of your entire net worth picture, so that is 20% of a much bigger picture, if you will, which makes for a larger allocation to metals. And his rationale is pretty clear. At 20% in metals, if you assumed catastrophic losses in your other assets, those are the circumstances, catastrophe, quite frankly, where gold tends to see multiples of growth. And he is assuming five-fold multiples of growth in your underlying metals in the case that you are wiped out in your other asset classes.

Essentially, it serves, not as a speculative investment, but as an insurance against the demise of the financial world as we know it. He is pretty keen on the risks, derivative-related, that we have in the world today. Fine art, real estate, hedge or private equity funds, certainly those have a certain barrier to entry in terms of real estate, not particularly, but fine art and hedge fund or private equity fund money. It requires a certain net worth, it requires a certain qualification as a qualified investor, and so, no, it is not open to everyone. Nor do I think it is necessary. It may be nice, but it is not necessary. When I look at gold and silver as an alternative to your more conventional assets, I see it playing the role as an alternative asset, perhaps even the way private equity or hedge funds would, although it is not actively managed.

So, you have, I think, frankly, some benefit to an “alternative asset class” by being in precious metals. Diversifying outside of those two, you could look at real estate just from a non-leveraged perspective, and what you are giving up in a real estate investment is liquidity. But that is really it. The question is, for you, personally, what is the number, in terms of a rate of return which justifies, in your mind, giving up liquidity? For me, it is double-digit, or it is not at all. I would rather have too much cash, or too much gold, than be in low-yielding real estate. But if it is not low-yielding real estate, if it was somewhere between 9% and 12%, that is a threshold where I am willing to consider giving up liquidity and looking at real estate. So, it may mean that you have to lower your purchase in terms of the allocation of real estate. Maybe you are talking about a single apartment unit instead of an apartment complex.

Would I want to buy real estate with very much debt? No, I don’t know that that is advisable unless you are talking about less than 50% loan-to-value. If it is less than 50% loan-to-value, and you know that your income is sufficient for debt service, those are the conditions that need to be considered, Glen. If you have sufficient income, that is an important variable, and if the loan-to-value is less than 50%, that puts you in a conservative camp, because most real estate investors prefer loan-to-values of greater than 50%, trying to maximize the leverage as much as possible, 70, 75, 85, if they can maximize using someone else’s money they do that, not realizing it gets them, in the context of a deflation, certainly, in a real pickle.

Kevin: Dave, I think Glen’s sensitivity to the interest rate threat is spot-on. That is something a lot of people don’t take into account when they are not only looking at buying real estate as far as their own loans go, but as far as the real estate value, the underlying value. What happens when interest rates rise and people can’t afford it anymore? But, he is asking for other investments and that ties in with Joseph’s question, which I will read now:

“Hi, my name is Joseph. I am a regular listener of your podcast, and really appreciate all that you guys do for the regular Joes like me. So thank you. Now, on to my question. My family and I have saved enough to start a small business of our own, nothing fancy, just a small sandwich/coffee shop, that serves good food and atmosphere. This has been a dream for us for years, and we figure we can create several jobs for young people and the local economy. That is supposed to be a win-win, right? Well, our fear is what may happen to our business, and thus our savings, when and if the dollar collapses, and if there is financial havoc in our country. Is this just a really bad time to start a small business, no matter what it is? Should we just buy precious metals with our money and hold on until something bad happens to our economy and our currency? What if that day doesn’t come for years, or another decade or two? We are financially ready to become business-owners, but we are really confused, and terrified, and don’t know what to do. Do you have any advice for people like us?”

David: Well, this is sort of at the heart of who we are and what we do. Being able to weigh in on a question like this is weighty for us, and we feel privileged to even offer an opinion here. A couple of things can be said. Number one, if you had your money in precious metals and were sort of waiting it out, here are a couple of things to consider. The best compound of returns over the past decade, at 12.5% per year, gold saw those annual returns, 12.5% per year, for over a decade, 2001 through 2011. If you owned your own business in that time frame and were managing it well, managing costs and had the variables necessary for success in place, you are talking about compounded returns of 20-60% per year.

There is no doubt that the best investment that anyone can ever make is in their own business. You will never see internal rates of return in the stock market, in the bond market, in the commodities market, consistently, at a level that you will in a business that you control. Of course, you are hitting on a variety of risks and concerns which are reasonable, and it is difficult for me, not knowing specifics, to be able to really parse this out. But I know, in our small town here in Durango, I can tell you half a dozen locations that I would never open up a coffee shop and a sandwich shop because there have been three dozen of them in the last 25 years, and it is the wrong location. However, good economy or bad, there are locations in our town that seem to work.

And so, there are some nuances that need to be thought through in terms of starting your own business. Location is certainly a critical variable. Having the right staff is a critical variable. I think of President Truman from Kansas City. He started his own clothing shop, a man’s haberdashery. He wanted to own his own business, and he actually borrowed some money to go into business. He was in debt to the tune of about $30,000. He actually did very, very well with his business, but there was one thing that he overlooked. The person who was his primary clerk was stealing from him.

So, there are things that you have to suss out. As a family-owned business, that is much less likely to occur, but the people who work with you are critical. The people who run and operate your business alongside you are absolutely critical. As a company we would not be the same business if it were not for the people working with us inside of our business. Yes, there is stress. Yes, there is strain and pressure, because you are no longer in an 8-to-5 scenario. There is not a single hour of the day that you don’t think about your business. Vacations? They simply don’t exist. Even if you change location, you are still thinking about your business and the operations that are, or are not, occurring. So, certainly, stress levels, just specific to the operations of the business, will be there.

As to your question about the economy, it is very difficult to say what will and will not operate well in the context of crisis. Be thinking in terms of what is basic and what is essential. Your price points may have everything to do with this. I know a pizza joint here in town that changed their prices on their pizzas by two dollars and watched a dramatic decrease in the flow of people into their restaurant. The difference between $15 and $17 for a personal pizza made all the difference. So, how you are priced, given changes in the economy, may have everything to do with your success. Is it sort of frou-frou, high-faluting food that only could be afforded, or appreciated, in a booming economy?

My grandfather was in Chicago and worked his way up as a bread truck driver to being president of Tasty Bread Company in Chicago, Illinois, and the advice that was given to him when he started that bread truck route was simply this: People will always be eating bread. If you want a job that is not going away, just understand that at some price, or any price, people will always be eating bread. And that the basis of his decision for going into the bread business, and working his way up through the company ranks. A very successful business career, and it was based on, “What are the essentials?”

So, Joseph, without laboring over this much longer, I think, looking at what you are offering, is it basic enough that people want it? Is it the equivalent of a comfort food at the right price, where in the context of crisis, roll the clock back to either 2000-2001, or 2007-2008, and you will notice, in terms of the menu choices that were on offer, in not just country restaurants, but city restaurants, as well, people wanted comfort food. I think there are ways to approach it, Joseph, that could be very successful, and I think long-term, the internal rates of return in owning your own business do argue for taking the risk. Location, location, location. Be aware of the variables that will go into supporting your success or making it much harder to succeed.

Kevin: Our next question, Dave, comes from a professor from Shorter University:

“I have a friend, who, when speaking with a stock broker in charge of some of his annuities, heard the stock broker say that he felt quantitative easing, QE, was continuing in a covert way, despite the public announcement that QE is ending. I am wondering, since my friend’s conversation was more recent, if there are ways the Fed could surreptitiously be continuing quantitative easing without the public’s knowledge, as though the zero federal funds rate isn’t a type of quantitative easing, in itself. I am wondering if you may have any thoughts on the book Aftershock’s economists’ claims that the Fed may be manipulating the stock market outright, as evidenced by the sudden recovery from the 2010 flash crash, hitting at, but not proving such manipulation, according to these economists. Thank you so much for your brilliant show. You have so many great things to discuss that I completely understand if you can’t get to things like this, but I just wanted to fulfill my listening duty.

David: Price stability is a new mandate that the Fed has taken on, and not the old price stability of managing inflation, but actually, managing prices within the marketplace, and that is, I think, the new nuance within the central bank community. It is not just managing the money supply so that we have more or less inflation, it is now managing the markets, and it has required extraordinary measures. I am going to tie your first question into your last question, or near last question dealing with the Fed manipulating the stock market outright. We have evidence of over 14 central banks around the world buying equities and index futures on a routine basis. They are directly intervening and propping up prices.

It is fascinating to me to watch sentiment begin to fade in the stock market. Even in the last 3-4 weeks, we have had the opportunity to see between 500- and 1000-point declines, not in one day, but over a longer period of time, and each time the market bounces. Is there a compelling story and a particular data point which is changing the mind of the market and driving prices higher, or is it that direct intervention by the world central banks, 14 that we know of, buying equities and index futures, to drive prices higher, and buoy public sentiment? I think it is the latter. I think they are attempting to buoy public sentiment because they realize that from a fiscal standpoint you have many of the world’s governments that cannot afford to be the spender of last resort, and thus, they must bring the consumer back into the marketplace to buy hand-over-fist.

And until they have successfully brought the consumer back into the marketplace to buy hand-over-fist, whether it is with money they have, or money they don’t have, simply putting it on the credits cards, they are going to be in the awkward position of debauching their balance sheets further, and putting themselves in a very precarious position in terms of credit ratings, moving into 2015 and 2016. So, yes, the manipulation of the stock market serves the purpose of a grand PR campaign, convincing the general public that yes, they can come out of their shells, they can loosen their belts a bit, and come back into the marketplace and spend like it’s 1999.

Kevin: Our next question from Joshua:

“David, I have a question for you for the Q and A show. I was at the forum you did with Mike Gallagher in Greenville, and it was good to talk to you then. The Fed has discussed reducing the size of its balance sheet after growing it for the last six years. Much has been said about how the Fed can never do this without crashing the U.S. economy or destroying the dollar. What are the implications for the Fed to simply allow the bonds to expire at maturity without rolling them over into new bonds? Wouldn’t that allow the Fed to reduce the size of its balance sheet over time without crashing the dollar?”

David: Just a distinction, real quickly, if they were to reduce the size of their balance sheet, it would, arguably, be dollar positive and U.S. economy negative. So, I wouldn’t say that those two things go hand-in-glove if they reduce their balance sheet and reduce QE that you have both a declining dollar and a declining U.S. economy, just a minor distinction. As their balance sheet is reduced, it does represent less liquidity in the system, and that does represent pressure, or headwinds, for the U.S. economy. But, as their balance sheet is reduced, and/or QE is let up upon, it actually represents strength, not destruction, for the U.S. dollar, because again, it is the notion of money-printing which is so dangerous to the long-term purchasing power of the U.S. dollar. The more that is out there, the more it takes to buy the same goods and services. That is why QE and monetization of assets is inherently inflationary and bad for the stability of the dollar.

One more comment on QE and then we will talk about the natural reduction of the balance sheet, just by maturing debt. The description that Ben Bernanke gave to quantitative easing, the effects. He said, upon its initial launch, that it was the equivalent of a drop in interest rates, and yet the Fed has tried to recant and say, “Oh no, ending QE does not represent an increase in interest rates. They don’t want it to be seen, in any way, as a tightening of monetary policy, when in fact, it is that. And of course, that plays back right into the notion that we have more economic headwinds as they tighten, assuming that the economy is not fully on its feet, and can’t generate sufficient growth outside of the free lunch that the Fed has provided already.

The least disruptive course for reducing the size of their balance sheet is allowing for the paper that they have, the IOUs that they have, to just roll off their balance sheet as they mature. That is a very intelligent way to go about reducing the size of their balance sheet. As that occurs, it is reducing liquidity in the system, so it gets back to that question of how much liquidity do we need in the system to keep it growing. As we have talked about with Richard Duncan in the past, we need roughly 2.2% growth net of inflation to avoid recession. We have seen the expansion of their balance sheet in the context of QE.

So, the big question is, do we have sufficient credit growth elsewhere to offset this reduction in total liquidity in the system? And again, what represents the new liquidity coming in to be that 2.2 net inflation number? Quite frankly, I don’t think it is possible, I think it is pie in the sky, that A, they can stop QE, and B, that this natural system of allowing the maturity of those bonds to sort of roll off their balance sheet isn’t going to have a major impact in terms of economic growth. So, I see it as constrictive to the U.S. economy as a natural tightening in monetary policy, and too early in terms of the health of the economy to sustain that tightening process in the monetary arena.

Kevin: Our next question is from Loren:

“Hi guys. Thank you for your insight. I do have a couple of questions when buying gold. Does buying gold Eagles, gold Maple Leafs, gold Krugerrands, Dutch guilders, or British Sovereigns really make a large difference with regard to storage and in future trading? Also, does buying recent current gold minted in the U.S. expose us to government oversight? Coins minted in 2013, 2014, etc. One additional question: In preparation for the eventual market economic correction, do you have an opinion regarding reverse reacting ETFs?”

David: I think, dealing with the products in question, there are advantages to each, and some of this depends on where you live in the world, too. I think that if I lived in the U.K., I would own British sovereigns, exclusively. The reason for that is that British law mandates that those coins minted by the crown don’t have a capital gains tax when you liquidate them. So, as a person living in the U.K., why would I buy gold American Eagles or Krugerrands, when upon liquidation I am going to pay a capital gains tax, and I can avoid that completely if I owned a product that was, again, minted by the crown and considered currency? We do not have that same advantage here in the United States, and there are very few jurisdictions where that would actually apply. That is something that we could hope for, it is certainly something that has been discussed here in the United States, but has gained no traction.

So, we would hope for it, and if that were the case, would you have a better reason to own American Eagles? Yes, but today, that is a bit of a pipe dream. It doesn’t exist, even as something that the Senate or the House would consider in current legislation. So, we are actually at the point in time where reducing tax take is not something that most of our legislators would even consider. Fiscally, they need every penny, and would probably increase taxes, not decrease taxes on gold, as we move forward.

This is another consideration. Smaller is better when you are dealing with considerably higher prices. You might think that a one-ounce coin that costs $1200-1400 dollars is not much money, but at $5,000-10,000 on a per-ounce basis, assuming that the price of gold sees those levels in the next decade, one ounce is all of a sudden a fairly significant commitment by someone who would be buying you out of that ounce. In that respect, smaller is better, and you are going to find much more liquidity, a much broader audience of people, who can continue to afford something that is a fraction of that cost because of the fraction of the gold in the coin, itself. So, I like Dutch Guilders and British Sovereigns. Of any of the gold I own, I actually own more European fractionals than anything else. Part of that is because of the size and that practical nature. A part of it is, I think of the Swedish coins that I own. I own coins in mint condition, never circulated, from the 1860s to 1880s, and I paid virtually bullion prices for them. That seems to be a little bit like buying a 1957 Chevy straight out of someone’s barn that hasn’t been used in decades and just needs someone to run a little gas through the engine before you can take it out for your first ride.

Kevin: For the price of a Ford Fiesta (laughs).

David: Why wouldn’t you do that? I guess I’m a little bit biased because of the kinds of products that we have gained access to in Europe. Now, does it make a difference in regard to storage and future trading? You want to go down as many well-trod paths as possible. So, for instance, in Asia, 24-karat gold is what you would want to store if you expect to trade it in the future in the Asian context. Having spent some time with the man who popularized Maple Leafs, and has done so for the last 30 years, Maple Leafs are very popular in Asia. They are a 24-karat gold coin, and they have high visibility in that market. If I were storing, or considering the future liquidation of ounces in Asia, it would need to be something like that, perhaps kilo bars, but Maple Leafs certainly fit the bill. If I were in Europe, listen, European gold coins fit the context, as do Krugerrands, because they have been so well-circulated in the European context. In the U.S., it comes down to either the practical trading of gold, which, if that were necessary I would want smaller coins, or coin of the realm. People recognize silver Eagles. People recognize gold Eagles. So, I guess, as I mentioned at the outset, there are advantages to each. Happy to visit with someone on a one-on-one basis to figure out, in light of your individual context, what makes the most sense. That is more or less how we operate in the office. Who are you, where are you, where are the assets going to be domiciled, and what makes the most sense for you? Our advice is going to be in light of your personal variance.

Kevin: I know you said this earlier in the show, Dave, but just as a repeat, any question that hasn’t been fully answered, or needs more detail, we are here at 800-525-9556, so please give a call. The next question is from Nathan:

“One of the things we learn from history is that a government that is losing control of a situation begins to act like a drowning person, irrationally grabbing at anything, even potential rescuers, in an attempt to keep his head above water. The recent crackdowns on the protestors in Ukraine are a vivid example of this. Knowing this, what is the best way to buy gold? Ideally, the best way would be to purchase it anonymously. If the government doesn’t know you have it, they won’t come demand that you give it up, but purchasing anything anonymously these days is pretty much impossible unless you actually go into a coin shop and pay cash. And the second question is like the first. What is the best way to store gold. Obviously, we would like to keep it out of the reach of the drowning government. Do we bury it in the back yard? Keep it in a safe deposit box? Store it in the United States? Store it outside of the United States? And I guess I have one last question. What is the best way to buy and store gold for those of us whose investment portfolios are in the tens of thousands, as opposed to the hundreds of thousands?”

David: A wonderful series of questions there. Let’s start with the notion of anonymity. Quite frankly, it doesn’t exist. Privacy doesn’t exist in the modern world and this has been a trend now for probably 30 years. We mentioned that to some degree in an earlier question when we were talking about Nazli Choucri’s book Cyber Politics and International Relations, how essentially everything across the internet is there for scrutiny filtering. Your idea of taking cash and going to a coin shop and buying gold, just be aware of a few things. Number one, a coin shop that does that is not going to be around for very long. Money laundering and anti-money laundering policies, which we are all required to participate in, mandate the filing of form 8300s for all cash transactions.

We do not receive cash as a company because we feel that filling out the form 8300s is intrusive. But that does mean that funds that come to us in business are already within the banking system, so bank wires, personal checks, things of that nature, are how we settle business in our business. Yes, that is less anonymous, but it is also less intrusive than a form 8300, which is required by law for an organization that is taking cash for the purchase of metals. If an outfit is not filing an 8300, then they are flying beneath the radar, and it simply is a matter of time before they are out of business. So be aware that that is a relationship which is not a permanent relationship. This has all been in place since the increased scrutiny on money laundering going back to the 1980s.

The second part of the question, and quite frankly, this is where I think anonymity comes into play, the person that owns gold and has possession of it has taken an asset, and it is from that point forward, off the radar. The beauty of gold, and one of the abiding characteristics of gold is that it is a private financial asset, not tied directly into the financial system. And as such, once you are in possession of it, it is strictly off the radar. There are many, many valuable reasons for that.

Kevin: David, the second part of the question involves storage of gold. We get that question all the time. What would you answer to that?

David: All of the above: Backyard, safety deposit box, inside the United States, outside the United States. I think of the choices that I make on a daily basis, and we are privileged here in the United States to be free agents and have law which is not a club today, but something that largely protects us. That may not always be the case. Law may be abused, as we have talked about, Frederic Bastiat’s short book, The Law, in which he describes how law can ultimately become that which punishes honest citizens, as opposed to that which supports and upholds their rights. But today we still operate with a high degree of autonomy.

I think the reason that you consider all of the above is that we know, being historians not only of politics and economics and finance, is that, as Nathan so well describes, governments operate like drowning people. This goes right back to Robert Higgs’ book Crisis and Leviathan. If you want to understand the nature of government, you have to read that book. I re-read that book three days ago, and I am simply astounded by the insights into the nature of government, and the desperate measures that they will go to in order to survive.

And so, it is not an indictment of the current administration, or of any administration, or of any government. It is an indictment of any system in the 5,000 years of recorded history that has continued to grow, and by necessity, has thus required more of the citizenry in order to grow and maintain itself and survive. I think this is one of the reasons why private individuals operate inside the system, and outside the system, by having part of their wealth which is private and portable.

This is the important nature of gold, and it, quite frankly, goes even further back to one of the questions that came from Toronto. Mark, how much of your financial resources do you need in a form that is private and portable? In a normal context, not very much. In an abnormal context, probably more than you would like to imagine. And this is, I think, a question that I cannot answer for anyone. What are your concerns about the system as it is today, and what it looks like tomorrow? And how much of your resources do you want directly tied into the financial system?

If your assumption is that we have normal operating stock, bond, money markets, normal operation financial markets, including banks, where depositors are safe with their deposits in the bank, then it makes sense why you, as in individual, would have less allocated to gold. If you have greater concerns about the stability of the system, as we know it, then 5-10% may be a paltry amount, in terms of the amount of personal assets that you want both private and portable.

In the tens of thousands versus the hundreds of thousands, back to Nathan’s question, and to wrap up there, I think there really is no limitation. The services we provide for offshore storage are in the tens of thousands, not the hundreds of thousands, and that can be done. And of course, you can take delivery. We are not respecters of size and scale in our own business. Even if the embedded costs of transacting a $500 trade, a $1000 trade may cost us something to actually do the trade, so that we don’t profit at all, we still think it is worth doing, because if someone is interested in owning precious metals, we want to facilitate that for them. So, $1000 trade, am I going to turn away a high-schooler who has been working on the tractor on the family farm and has $1000, $1500, $500 dollars and would like to own silver? Absolutely not. So, physical delivery, that, I think, is a first priority. Once you have checked that box, then consider having assets elsewhere.

Kevin: Our next question from Dave, to Dave, is referencing the interview we did with Adam Ferguson, the author of the book When Money Dies. Quoting Adam Ferguson, he says:

“Inflation is theft.” This is certainly true, but my question is, does that mean, logically, that it follows that deflation is restitution?”

David: Yes, clearly tongue-in-cheek, but discounted prices serve the same as an increase in purchasing power. So, let’s think about the practical consequence of deflation. You have a discounting in prices that you pay for goods and services. That is an increase in your purchasing power. For every dollar that you have, and you are looking at lower prices, you have an increase in purchasing power. That is the equivalent of an increase in income, only it is an increase in income via deflation, and not an increase in taxable received or earned income.

And this is one of the quandaries of a system, which, like the 1860-1914 period, you actually had stable prices, and deflation in many categories, which allowed for an improved quality of life at cheaper prices from one year to the next. But the problem was, that improved quality of life didn’t come with an increase in taxable income. 1913 changed the game, at least here in the United States, we had not only the imposition of the income tax, but the creation of the Federal Reserve, so the money-printing machine was created in 1913, which allowed for an increase in nominal incomes, but it also, at the same time, was mirrored by the tax collection scheme, graduated income tax, 1913. To me, part of the system bias against deflation is that it is good for you and me, and it is not good for the tax collector.

Kevin: And the system is set up for tax collection and creation of money.

David: That’s exactly right.

Kevin: David, our last question for today’s show is from Mr. Wise. He said:

“My question has to do with the mechanics of market breakdown. With the Federal Reserve propping up the markets, and any attempt of a market correction being nullified, the latest taper tantrum is a good example, how can the markets actually fall significantly if the Fed just prints up more and more money to purchase stocks. I know the when question is impossible to answer, but I would like to know what you think the mechanics of a true market-led correction would look like. Is the market greater and more powerful than the Fed? How is this system ever going to break down?”

That is a great question, Dave, because so many people are seeing the manipulations in the market, and in many ways, people have thought maybe the Fed has grown larger than the invisible hand of market forces.

David: To me, it is no different than your traditional con game. You are producing data which creates confidence, and you continue to produce data and feed that data to the con participants, and they continue to buy it, until they don’t buy it. And money-printing is simply a fabrication of money which goes toward the same end, which is creating confidence. And it works until it doesn’t work. So, the Fed can certainly continue to print, the Fed can certainly continue to do things which prop up the equity markets and bond markets, and we don’t really know at what point people scratch their heads and say, “This is non-reality.”

The danger is, and we have talked about game theory before – who makes the first move? Whoever does make the first move causes the system to unwind. It only takes one person to recognize that there is a fire in the theater. You don’t even have to say it, but you begin to watch people move silently to the doors, and that, in itself, is enough of an indication. No one has to say, “Fire, fire! This is a total scam! I can’t believe they’ve done it! You’ve got to get out while you can!” What we see today is large constructive interests in the equity market already moving to the sidelines. We see people looking and saying, we don’t like what we see. We realize that as long as we are answerable to clients, that we must continue to play the game, but with our own money we are moving to the sidelines.

There are many reasons why hedge fund managers may decide to get out of the business. If you are a bad hedge fund manager you might just decide to choose another career. But one of the best hedge fund managers in our generation got out of the business in 2011 – Stanley Druckenmiller. He used to clear trades for the Quantum Fund, and then successfully ran Duquesne Capital for a number of decades, making, for his family, billions of dollars.

To stop managing money for other people is a very considerable thing. You no longer have to answer anyone’s questions about participating in the up moves, about being the momentum player who may be involved, or not involved, and relative to the market, how have you done? Well, you’re not doing well enough. He no longer has to take any criticisms because what he has done is that he has essentially said, “I don’t have to be in the system, and I don’t have to be in the markets, if I don’t want to, and you can’t complain about it, because I’m not managing your money anymore.”

There has been a move, like Druckenmiller’s, to the sidelines, a conservative move where you can do what you need to do, and not play the game, because there is a growing consensus amongst sophisticated and informed investors that the game is rigged. Again, going back to the analogy of the con game. Fabricated money is fabricating confidence, and that confidence will break, no one knows when, but as and when it does, it is catastrophic in nature.

Kevin: Dave, just for the sake of time, we are going to have to leave a few questions unanswered, but they won’t always go unanswered. Let’s just make a commitment that by the end of January we answer the rest of the questions that we haven’t covered yet, because these questions are so well stated, oftentimes these questions are also in the mind of a person who maybe didn’t take the time to sit down and send it to us. But we have some guests coming up here in the next couple of weeks. We have this interview with Nazli Choucri that you talked about, as far as this change in the cyber world, and then after that, I am really looking forward to the interview with James Grant, who wrote the book The Forgotten Depression. After those interviews, we’ll get back together and answer a few questions, and try to have them done by the end of January.