- How will America weather the coming sovereign debt default? To describe it as cataclysmic would not be an exaggeration. Inflation is a certainty, hyper-inflation is not impossible. Forbes reports:
A crushing burden of debt threatens to sap America’s growth for years to come.
Not too long ago, a billion dollars in a governmental budget was a lot of money. Then we got into hundreds of billions. People understood that this was a lot, just because of all the zeros. Now, unfortunately, the number has become small: the world “trillion,” as in $1.2 trillion for health care reform, seems so tiny. But it has 12 zeroes behind it, which is so easy to forget.
Rob Arnott, who always does terrific research, wrote in his recent report that “at all levels, federal, state, local and GSEs, the total public debt is now at 141% of GDP. That puts the United States in some elite company–only Japan, Lebanon and Zimbabwe are higher. That’s only the start. Add household debt (highest in the world at 99% of GDP) and corporate debt (highest in the world at 317% of GDP, not even counting off-balance-sheet swaps and derivatives) and our total debt is 557% of GDP. Less than three years ago our total indebtedness crossed 500% of GDP for the first time.” Add the unfunded portion of entitlement programs and we’re at 840% of GDP.
The world has not seen such debt levels in modern history. This debt is not serviceable. Imagine that total debt is 557% of GDP, without considering entitlements. The interest on the debt will consume all the tax revenues of the country in the not-too-distant future. Then there will be no way out but to create more debt in order to finance the old debt.
It assures a period of economic devastation. In a last, desperate attempt, politicians at the federal and local levels will raise taxes to astronomical heights to raise revenues. And that only assures destruction of the economy. Forget the fable of economic recovery. Unless there is a change in Washington by next year’s election, there will be no way to turn back.
Japan’s recession is now 19 years old. It has the highest debt-to-GDP level (227%) of any industrialized country. The Fitch rating agency is talking about a potential downgrade of Japan’s debt. Japan’s stock market is still down 75% from the high in 1990. We predict it will make new bear market lows next year. That will make it a 20-year-long bear market on the way to 25 years. The bulls in the U.S. should consider that possibility in the formerly great United States of America.
I do not believe the bullish theory that the U.S. situation is different than Japan’s. Ours is so much worse. Is it any wonder that our biggest creditors, China, Russia and the Middle East, are diversifying out of the dollar and into gold?
- This is an interesting interview by KingWorld News of John Hathaway. It is a must listen for all involve in gold investing. Click here!
- John Hathaway, Portfolio Manager and Senior Managing Director of Tocqueville Asset Management L.P., has written an excellent article on gold, A Contrarian’s Dilemma, excerpts :
For good measure, we believe that the U.S. Federal Reserve, watch dog of the dollar’s purchasing power, no longer seems displeased to see a rise in the metal’s price. Their game is reflation and they are not terribly choosy about which assets become overvalued as a result. They are happy to inflate any and all asset classes that would serve as collateral for a renewed binge of bank lending.
We believe that the crossing of $1000 marks the end of the second phase and that we have entered the third stage, or the beginning of the end. The first two stages took a full ten years. The latter two stages will take years but we doubt a full decade.
Gold seems as undervalued at around $1200 as it did in 2001 at less than $300. The outlook for the dollar and the paper currency system pegged to the dollar has undergone drastic change. Gold is a bubble only for those who maintain faith in the ability of politicians and financial authorities to swim against the tide of deflation. For the rest of us, it is protection against monetary damage still to come. The bull market in gold still has much going for it, even if it is no longer a contrarian’s dream. It may be overbought, as bull markets often become, but we believe it is too soon to jump ship for the next great contrarian idea. The implications of gold’s continuing strength remain a mystery, even to most of those who have jumped aboard the bandwagon.
Cultural lag is the key to understanding why gold, ridiculously undervalued for an extended period, could be on its way to becoming an investment bubble, perhaps several years from now. In our view, public expectations are about to pivot in a way that will ultimately take gold to valuations that cannot be explained by dispassionate and reasoned discourse.
The idea that paper currency is a poor store of value is just beginning to build up a head of steam among top investment thinkers and has not filtered down into public behavior. Faith in the government’s competence to achieve desired outcomes is badly frayed.
The preconditions for a tectonic shift in the investment climate of opinion are just beginning to coalesce. Irrational exuberance lies ahead for gold. It will be a replay of the “nifty fifty” of the 1970’s, when sages warned that there would be a “shortage of stocks”. The 1980 peak of $860/ounce, set against Cooperman’s quip that bonds were “certificates of confiscation” will seem quaint. The heights of internet, housing, leverage, hedge funds, and all other financial excesses will pale in comparison to what lies ahead for the U.S. dollar, all currencies tied to it, and how the end game becomes reflected in the price of gold. Warnings of a bubble in gold are coming from the same quarters that failed to spot the aforementioned. We welcome the skepticism.
The attraction of gold becomes obvious when the deficiencies of alternatives become inescapable. National currencies are political tools, first and foremost. When political agendas become confined to the preservation of an untenable status quo, the integrity of currency is imperiled. It costs nothing to print more dollars. The estimated cost to produce an additional ounce of gold is $800-$900. Gold is scarce. That is why it is called a “precious” metal.
Gold and its significance are misunderstood: The sudden popularity of the metal does not mean that the reasons for its uptrend are well understood. For many, if not most, it is enough that gold is in the midst of a powerful uptrend. It has suddenly attracted hot money, momentum players, and late comers looking for quick profits. We expect these investors will flee at the first sign of disappointment. Their presence makes the metal’s uptrend more prone than ever to shakeouts that will dampen enthusiasm. Corrections are inevitable and could be as frightening as the mid 2008 decline from $1000 to $700. However, the bull market has evolved from early stages marked by apathy and disinterest, where few understood that a bull market was underway. In its current, more dynamic phase, market pullbacks will be regarded as buying opportunities from different quarters, including central banks and other investors that have insufficient exposure. As long as world governments remain locked into the mode of flagrant currency debasement, we are quite comfortable in asserting that gold is under-owned and will be met with buying interest on pullbacks.
- Why am I so positive on gold despite the current sharp correction? Gold has been money for millenia. All fiat currencies eventually become worthless pieces of paper. Where are the currencies of the Babylonian, Grecian, Roman, Chinese… empires? They are gone, totally debased by the profligate governments/empires. Gold has withstood the test of time and will come through once again as real money. There is no doubt where the USD is headed. It is only a question of when? Chris Mayer writes:
Here we get to John Paulson, a presenter at the Grant’s Fall Investment Conference and ……. Gold is his favorite today. As to why, Paulson presented a simple, but compelling case. First, the monetary base has exploded in a way we’ve never seen before. The monetary base is essentially the Federal Reserve Bank’s currency and reserves. The Fed, by buying up securities in this crisis, has pumped a lot of money into the economy.
You’ve probably seen this chart (top of post), or some variation of it. Still, there haven’t been noticeable signs of inflation as a result of that big spike – not yet. As Paulson explained, that’s because this base money has not yet been lent out and multiplied throughout the economy. Yet the monetary base and money supply are highly correlated, “almost 1-to-1 between the two,” Paulson said.
That means that as the monetary base expands, the money supply surely follows, though there is a lag. (Money supply is a broader measure of money than just the monetary base, as it includes personal deposits and more. The monetary base is like a kind of monetary yeast. It makes money supply rise.) If money supply grows faster than the economy, that will create inflation, says Paulson. As it is impossible for the economy to grow anywhere near that vertical spike in the monetary base, Paulson contends inflation is coming.
The U.S. is not alone in its money-printing exercise. The supply of most currencies is expanding rapidly – even the normally tame Swiss franc. In the race of paper currencies, they are all dogs. Hence Paulson’s interest in gold, which no government can make on a whim.
Therefore, in the content of the exploding monetary base, gold seems relatively cheap. In other words, as the money supply rises, so does the price of gold, eventually. As a result, says Paulson, “gold has been a perfect hedge against inflation.” There is some slippage over time. The gold price can change faster or slower than the money supply. But when the market gets worried about inflation, the gold price usually changes much faster – as happened in the 1970s. In 1973 – to pick a typical year – inflation was 9% and gold rose 67%. That was a pattern common in the 1970s.
The potential for inflation this time around is greater than it was in the 1970s, given that the growth in the monetary base is so much greater than it was in the 1970s. Gold could do much better this time around, reaching “$3,000 or $4,000, or $5,000 per ounce” as Paulson said.
Future historians will look back at the present day and see clearly how this unfolded. They will see the litany of news items that pointed to the dollar losing its top perch: China and Brazil are settling up trade in their own currencies. The Russians and others are openly calling for a new monetary standard. Even mainstream outlets are discussing alternatives to a dollar-based standard, a province once solely occupied by cranks and gold bugs. Not a week goes by without these kinds of stories.
As for a replacement waiting in the wings, Grant offers up gold. Indeed, a kind of “de facto gold standard” seems to be taking shape. The SPDR Gold Trust, the largest gold-backed security in the world, is now the sixth largest holder of the metal in the world. Anybody with a brokerage account can easily buy gold today through the trust, which trades on the NYSE under the ticker GLD.
It’s still early. Most people still own no or very little gold. As it becomes clearer what’s happening, they will buy more gold, especially as it is now easy to do so. The gold supply, too, is limited against the vast pool of dollars. As Paulson points out, global money supply is 72 times the value of gold. I’m betting that gap will narrow. It only has to narrow a smidgen and the gold price flies.
As Grant eloquently put it: “Gold is a speculation. But it is a speculation on a certainty: the debasement of the currency.” Gold stocks, too, are a speculation. But they are a speculation on an inevitably higher gold price.
Disclaimer – I am not a financial advisor. This is not an advice to buy, sell or hold any stocks or bonds or any precious metals. I am long gold and silver.