Political Metals

On the Letters’ page of The Economist last week, Nils Sandberg from Cambridge University’s Judge Business School presented a common argument against gold’s current value.

SIR – Buttonwood discussed the possibility of gold as a bubble (April 30th). Of course it is—it has almost no real value and, as you say, no revenue or cashflow. It is an iconic commodity both emotionally as jewellery and intellectually as a stable investment, and has long been a guiding point for commodity inflation. But what gives it that place?

Gold has few uses beyond jewellery, and yet the trading of gold internationally is many times larger than that industry. Today it, like a share with no dividends, is a purely speculative investment and its value is entirely a function of such speculation. A high gold price does not cripple an industry or a nation; the current owners just get richer. A currency with a constant influx, the rise in value of gold is like a great Ponzi scheme where the future must always pay today’s bills.

Commodities with stable consumption and high volume production (like wheat and iron) are better indicators of real prices and as they continue to rise inflation is a risk. Gold is different. One day the money will dry up, and the house of cards will fold.

Nils Sandberg
Judge Business School
Cambridge

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Here’s founder & CEO of BullionVault, Paul Tustain’s response.

Tuesday, 31 May 2011

Would you – or China – rather own gold 8 years from now, or US Treasury bonds…?

According to him, gold is in bubble territory because it has few industrial uses. Disproving Mr Sandberg’s thesis is childishly simple.

• Take one $20 bill out of your wallet;
• Consider the industrial applications of the paper it is printed on;
• Now burn it.

Well, why didn’t you? After all, its value – according to Mr Sandberg’s thesis – rests on the paper’s usefulness in industrial processes.

Nevertheless it’s still interesting to understand why gold (like $20 bills) is valued above its manufacturing relevance. Unsurprisingly the answer lies in marginal utility.

Gold offers humanity one exceptionally useful property; it has an extraordinarily stable stock. There are 166,000 tonnes of the stuff above ground (worth about $8 trillion) of which about 88% is held as a value store of sorts, in jewelry (52%) and bullion (36%). The stock is growing by about 1.5% a year, from the combined efforts of all the world’s miners.

It is because gold is each of (i) geologically rare, (ii) elemental (i.e. incapable of being manufactured) and (iii) industrially useless, that it has this reliable stock quantity. Nothing else can do it; not silver, which is 80 times more common in the ground, nor platinum, which is far too useful as a catalyst to offer stock stability.

Reliable scarcity is the key property savers require of money, which otherwise fails to store value. But of course we don’t need gold to deliver reliable scarcity, we can usually create that reliable scarcity artificially, as we do with our modern currencies.

Now the marginal utility explanation. When new currency is too freely issued reliable scarcity becomes under-supplied, and savers go in search of it. Having seen artificial reliable scarcity fail in one currency, the promise of it in another is unconvincing, so they turn to natural reliable scarcity, and demand for it increases dramatically as governments print money. This is what drives gold up.

Mr Sandberg is right though, that gold will eventually go down again, when currencies’ artificial scarcity once more becomes reliable, and when those currencies start to generate a yield. But in the meantime it looks irrationally optimistic to hope that the US government – faced with a $21 trillion debt – will not print more and more money.

The question, therefore, is whether the savers who own $100 trillion of dated debt instruments in the bond markets will take fright at continuing money printing policies of the US and other governments. That $100 trillion of dated debt has already started running down the clock. It is shifting to the short end, where it behaves more and more like cash. Maybe its holders will demand cash (as is their right) at its redemption. The sums involved would swamp the $15 trillion of cash and near-term deposit instruments currently in issue.

People who choose to buy gold are increasingly aware of this possibility. We don’t know whether the Dollar, the Euro, the Yen and the Pound (all of which have started a debt market drift to the short end) will ultimately go into the currency death spiral. We are just mindful that it is the usual destiny of currencies driven by political expedience toward the printing press. It looks like a possibility at least.

To finish with here’s the brainteaser which the Chinese are currently wrestling with. Now that you know the US debt profile is slowly shifting to the short end, and represents about six times the currency in issue, you are required to choose today something to own in 2020. What would you (or China) rather have – a tenth of the US Treasury’s paper bond debts, or five times its very large gold reserve?

At current market prices these two are worth about the same. But in the intervening 8 years, the US government has budgeted to issue $8 trillion net of its own bonds, representing an increase in the stock of 57%. A further $1 trillion of gold will be mined worldwide, an increase in the global stock of 12%.

Paul Tustain
BullionVault

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… But 

who has been, and will be buying up all these debt?

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and while they’re printing all these money, they might as well print more food stamps. 

Maybe that’s why they say gold is useless. Who needs gold when you’re living out
The American Dream - Free Money, Free Food, Cheap Housing!

“Double dip” declared as U.S. housing prices tumble

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Source:  CNBC-TV18/MoneyControl

The rally in equity markets has clearly been surpassed by the rally that we have seen in several commodities, notably, gold but not necessarily only gold and silver. Juerg Kiener, MD & CIO of Swiss Asia Capital, in an interview on CNBC-TV18 spoke about how he sees these asset classes likely to perform especially vis-à-vis other asset classes.

Read more…

Richard Fisher

The concept of creating money out of thin air and the idea that in our debt-based monetary system, money is loaned into existence are discussed at length throughout this blog. It is the most fundamental reason people are exchanging their paper money (whose supply is unlimited) into hard monetary assets like gold and silver (whose supply is finite and very limited).

However, this concept is still very alien to some. It is so simple and “ridiculous” that many still cannot accept this to be true - that the money in our pocket is the result of our labour while at its source, it is free for the bankers who created it.

So, today’s post is short. Very short. Let’s hear from the horse’s mouth.

(Reuters: March 25, 2011) - Dallas Federal Reserve Bank President Richard Fisher said on Friday there were signs that liquidity was not just abundant, but excessive in the United States.

“Today we have abundant liquidity and the cost of money is zero,” he said, adding that no amount of policy accommodation or new accommodation would solve the U.S. economy’s problems.

“Today we have abundant liquidity and the cost of money is zero.”

“We did our job as a central bank, we may have done too much,” he told an event on ‘Which way for the U.S. economy’, organized by the Bruegel institute in Brussels. “We will no longer press on the monetary pedal.”

Fisher is regarded by economists as one of the most hawkish policymakers at the U.S. central bank.

Source [Reuters]

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Further reading / viewing

• Fractional Reserve Banking
• Central Banking and the Federal Reserve System
• The Printing Continues… QE3 within sight?
• Introduction to Political Metals
• Why Hold Gold
• Why Hold Silver

When the magnitude 9.0 earthquake hit Japan on March 11, it triggered an automatic shut down of reactors in the Fukushima nuclear plant. The quake also damaged and cut off external power from the national electricity grid. There was no power left to run the essential water pumps for the cooling system. As designed, the generators automatically kicked in to provide backup supply, but they were soon damaged by the Tsunami. Finally, the backup batteries kicked in to keep the pumps running, but after several hours, it ran out of power. The nuclear reactor core temperature rose, pressure built up, explosions followed, and finally the dreaded meltdown.

While the engineers and physicists are figuring out how best to contain the situation to prevent a potentially disastrous planet-wide contamination of air and water from a radioactive fallout, a meltdown of another kind is brewing….

Not unlike the nuclear fission chain reactions taking place at the core of a nuclear reactor, the world’s governments, central banks, and mega banks have been creating their own nuclear reactions (Governments issuing exponentially- accelerating piles of debt, central banks increasing money supply along the same exponential curve to match and mega banks creating financial derivatives in the quadrillions of dollars). Just as the continuously circulating water keeps the nuclear reactor’s core from overheating, so does the constant flow of these funny money keep the financial reactors under control.

But this flow is about to be disrupted again. The first disruption began in 2008, when the subprime mortgage crisis broke out. The financial power plant tripped, just as Fukushima did. Liquidity vaporised. The global financial system was at the brink of meltdown.

As “designed”, the printing presses at the Fed and ECB kicked in, just like the generators did. QE1 started to pump freshly created funny money into the system to prevent a meltdown. And it worked, temporarily.  You can see this effect by looking at an inverted chart of the Dow taken from this earlier post. As fresh liquidity from QE1 was flowing through, the Dow rose, causing the financial core temperature (inverse of Dow) to drop.

When the generators quit around March 2010, the core temperature started to rise. As designed, the backup batteries automatically kicked in, and the QE2 new money flow brought the temperature down again.

Now, note this. When the battery runs out, there are no more power sources left to keep the pumps running this time around. The QE2 backup battery power was designed to last till June, but we’re beginning to see signs of the battery wearing down (oval area). Here’s why.

Japan is the second largest foreign holder of US treasury debt, after China. Faced with the worst crisis since World War 2 and massive reconstruction cost ahead, Japan is not expected to be buying any more US treasury debt. They will instead be selling. China has already been reducing their holdings.  The US budget deficit is rising and the Fed is now not only the largest holder of treasury debt (above China & Japan), it will be the only major buyer left.

The U.S. debt situation is at a “tipping point,” Dallas Federal Reserve Bank President Richard Fisher said on Tuesday, and urged the U.S. central bank to refrain from any further stimulus measures. Source [Reuters]

If the Fed stops “further stimulus” (nice way of saying printing money), with China and Japan off the table and Europe on the verge of raising interest rates, the US Treasury market goes into meltdown and the dollar is history. On the other hand……

“If we continue down on the path on which the fiscal authorities put us, we will become insolvent. The question is when,” Fisher said in a speech at the University of Frankfurt (emphasis mine). Source [Reuters]

Either way, the dollar is dead, but they still have a choice over how it will die.

While you still have time, consider exchanging your paper money for some hard assets.

Incidently, silver hit a new 31-year nominal high today.

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When asked by Ron Paul what is his definition of the Dollar,  Bernanke answered:

The Dollar is what it can buy….food, gasoline & clothes - Consumers don’t want to buy gold”.

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The market, despite being suppressed, has proved him wrong! Gold was at it’s all-time high around the time he spoke. Gold’s cousin, silver, made another 31-year high today.

To a separate question from Sen. Jim DeMint about returning to a gold-backed economy, Bernanke said returning to a gold standard won’t work, one of the reason being there is not enough gold in the world to support the US money supply. WSJ reported:

Bernanke, appearing before the Senate Banking Committee, was pressed by Sen. Jim DeMint (R., S.C.) on the viability of a return to a gold-backed economy or the idea of the Treasury Department issuing bonds payable in gold. Bernanke, who has studied the issue, said a return to the gold standard wouldn’t work.

“It did deliver price stability over very long periods of time, but over shorter periods of time it caused wide swings in prices related to changes in demand or supply of gold. So I don’t think it’s a panacea,” Bernanke told DeMint.

Additionally, Bernanke said there were a number of practical issues that would prevent the return of gold as the world standard. Namely, there’s not enough gold in the world to effectively support the U.S. money supply.

Let’s do some arithmetic.

1. According to the most recent FED Money Stock Measure Report Mar 3, 2011, the narrowest measure of money supply (M1) stands at $1.8538 trillion.
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2. According to the most recent Status Report of US Treasury-Owned Gold Jan 31, 2011, the US Treasury owned 261,498,899 oz of gold, with a book value of $11,041,058,82. That works out to be $42.22 per oz (set since 1973).
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3. If all the gold held by the Treasury were allowed to be valued at current market price of about $1,400 per oz, every US$ would be backed by about 0.2 oz of gold.
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4. If today, the Treasury revalued its gold to $7,089 per oz, the USD will be fully backed by gold… and that’s only gold supposedly owned by the US, let alone all the “gold in the world” Bernanke talked about!
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Note: The US has revalued gold upwards (a politically correct way of saying they have devalued the USD) several times in recent history:

• 1913:  Roosevelt confiscated gold at $20.67
• 1934: Roosevelt re pegged gold (devalued the dollar by 69%) at $35.00
• 1971:  Nixon closed the gold window and re-pegged gold at $38.00
• 1973: Nixon re-pegged gold (devalued the the dollar by 11%) at $42.22

Herein lies the politics of gold (and silver). We’ve seen how the dollar has lost more than 98% of its purchasing power since the creation of the FED in 1913 (see Precious Metals or Political Metals?). Like a frog in a pot of rising water temperature, the general populace do not feel the heat of this devaluation. But if Obama were to suddenly re-peg gold at the above calculated price to return the US to a gold-backed economy, the glaring failure and fraud behind the FED system is out for everyone to see. The elites cannot let this happen (yet), hence they continue to hold the ball under water.

Or does Bernanke know something that we don’t when he insisted that there is not enough gold to back the US money supply? Is the gold at Fort Knox really there? Is the gold held by the NY FED swapped or encumbered? Why is the FED guarding so tightly records sought by GATA?

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Thus far, Ron Paul has not fired his silver bullet yet - to question Bernanke about gold and about auditing the FED. Let’s wait. He will.

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning … Henry Ford

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This is the most recent US Money Supply (M2) data and Adjusted Monetary Base as at February 24, 2011. To obtain a big picture view of the rate of monetary base expansion expansion since 1961, see Money Supply chart appearing in my previous post Investing in PMs or Holding PMs.

If this trend does not look bad enough,  the recent statement by Kansas City Fed President Thomas Hoenig may give an idea of where this chart will go beyond the “end” of QE2 in June 2011. With the recent sharp rise in oil prices downward pressure on the stock market and economy in general, QE3 may be just round the corner!

Feb 1 (Reuters) - The Federal Reserve could debate extending its bond-buying program beyond June if U.S. economic data prove weaker than policymakers expect, Kansas City Fed President Thomas Hoenig said.

Another round of bond buying “may get discussed” if the numbers look “disappointing,” Hoenig told Market News International in an interview published on Tuesday.

And the reason for the sharp rise in the adjusted monetary base can be seen in the 2 charts below. The first shows top holders of US federal debt as at October 31, 2010. The second as at December 31, 2010. When foreign nations slow down or stop buying US treasury holdings, the Federal Reserve becomes the lender of last resort. That’s when the QE programs run at full steam creating money out of thin air and lending it to the US government.

- Click on chart to see larger image -

It gets worse. China sold $34.2bn of US treasury bonds in December 2010, raising fears that ­Beijing is using its financial ­muscle to signal that it has lost confidence in American economic policy.

Higher inflation coming to a country near you.

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