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April 21, 2012

What Are The Options?

1)  Growth.  Growth is not an option.  Most economists acknowledge that we would need to grow at a rate of 20+% annually to grow our way out of our problems.  This is impossible in a mature economy burdened with an aging populace and a combined "true" public and private debt in excess of 600% of GDP.

2) Austerity.  Austerity is not an option.  Direct federal government expenditures make up 23% of GDP.  Include the indirect (multiplier) effect of government spending that is re-spent into the economy and you are looking at a government-related GDP contribution of 35%.  To balance the budget, the government would have to spend half of what it currently spends - a direct hit to GDP of 10+%, with an indirect effect of 15% (worse than the Great Depression).  To actually amortize the existing debt would take much more.  And this is just analyzing the "on balance sheet" debt of the federal government.

3) Direct default.  Direct default is a very bad option.  Our national debt is held primarily by federal and state "intergovernmental agencies" (60%) , foreign central banks (30%), and banks and other investors (10%).  What would happen to each in the even of default?

1)  Central Bank bankruptcy (no loss there)

2) Social Security and Medicare bankruptcy (social backlash)

3) Probable retaliatory write-offs of all foreign obligations owed to the US and expropriation of all public and private US assets on foreign soil (triggering additional protectionist sentiment if not outright war)

4) Federalization of banking institutions holding sovereign debt assets (both domestic and foreign) in excess of tangible common equity (virtually all banks)

5) Loss of pension and investor capital through outright government default, expropriation of foreign assets, and decline in the value of assets triggered by the ensuing financial depression/chaos (more social backlash)

(Additionally, since the US would no longer be a credible borrower, post-bankruptcy the US would have to balance its budget and re-institute sound money backed by some form of universally recognized (and portable) collateral.  Additionally, the government would need to effectively end all social programs because it would need to keep spending on defense in order to deal with heightened external threats and internal social unrest.)

4) Printing money.   Printing money is also a bad option but a better option than outright default.  Since foreign countries, banks, and investors always had the option of trading treasuries for dollars, they recognize they have nobody to blame but themselves for making a poor choice of investment.  Printing money starts out fairly benign and ends up in social unrest when the Ponzi scheme ends with the Central Bank buying up all the remaining treasuries (thereby releasing a flood of dollars into the economy virtually overnight).  Anti-US sentiment arises from inflation caused by the role of the dollar as the world's "reserve" currency, but you don't see obvious financial retaliation beyond a dumping of US treasuries.  What you do see is social upheaval as that flood of dollars works to find its way into non-financial assets.

Decline in the BRICS Dependency on the Dollar and its Interesting Effect on Gold

Most people understand that as the reserve status of the US dollar declines foreign countries will no longer need to hold as many dollars in order to affect their international transactions.  This is one of the most worrisome aspects of the dollar - that foreign central bank holdings of US treasury obligations will diminish, leaving the Fed as the buyer of last resort.

What many people are not seeing is the next move down the chessboard for these same central banks, who have been accumulating gold as a hedge against the decline of the dollar.  It makes sense that as the need for dollar reserves diminishes so will the need for the hedge.

This is not to say that gold's value as an asset or as a hedge against inflation in the US (and in any nation whose currency is pegged to the dollar) will diminish.  It's simply to say that the utilization of gold as a hedge against F/X positions will diminish along with dollar supremacy.


The Fork In The Road

We are in a bus going 90 mph on a narrow road which forks on January 1, 2013.  The current itinerary has us taking the road toward fiscal responsibility and recession.  But I am in the camp that the drivers of the bus will suddenly (and at the very last minute) veer off course  and onto the road of money printing and hyperinflation.  Either way, the scenery isn't going to be pretty.

On January 1, 2013, the current plan is for the following tax increases and austerity measures to go into effect (these measures do not require a vote, they just are):

1)  The expiration of the Bush tax cuts (hit to investors)

2) The additional tax on investment income to fund Obamacare (hit to investors)

3) The expiration of the payroll tax reduction and unemployment benefit extension (hit to workers)

4) The implementation of the across-the-board spending cuts brought about by last summer's debt ceiling/super-committee debacle (hit to government employees)

Of course, the anticipation of measures 1 & 2 will only serve to derail an already rocky recovery fueled exclusively by stock market equity gains.  All those investors who (thanks to Jim Cramer et al) have been piling into the "safety" of dividend-paying stocks will just as suddenly start piling out as they realize that not only will their dividend income no longer qualify for capital gains treatment but be subject to medicare tax as well!

Measure 3 will result in workers making $50,000 having $1,000 less per year to spend at a time where every penny counts.

Measure 4 will result in increased unemployment in the public sector and a reduction in governmental contribution to GDP

Well, it'd be worth it, wouldn't it?  To put us on the path to fiscal solvency?  The problem is, it won't  Taken as a whole, these measures wouldn't even cut our current annual deficit of $1.4 trillion by 20%.  We would still need to borrow over a trillion a year!  So why do it?  Because it might (and I say might) reassure our creditors that we are serious about dealing with our issues and lull them into continuing to hold/buy our bonds (at least for a while).

So why do I think the drivers of the bus will chose the other path instead, and why do I think the other path is hyperinflationary?

The petri dishes that are Japan and Europe have proven up what happens to countries who elect to get off the growth gravy train.  Debt doesn't really go down, but debt to GDP skyrockets and you end up in a worse place than if you hadn't instituted austerity measures in the first place.  It become hyperinflationary because when the jig is up and the world becomes convinced that you are taking the money printing path they refuse to buy your debt instruments at any price.

QE1, QE2, and QE2.5 (Operation Twist) have laid the groundwork for hyperinflation.  By buying up long-date treasuries and selling short-dated treasuries, Bernanke has insured that foreigners and the public mostly own very short-term paper.  In point of fact, the average maturity of US treasuries is less than four years.  Because so much paper is short term, it would require a huge amount of money printing to buy up all of the new and rolling debt coming out over the next four years.  I also believe that QE3 will be the tipping point in which the world becomes completely convinced that quantitative easing in the US has become structural (ie. QE will be henceforth be required to infinity and beyond)

There is lots and lots of hot money sitting on the sidelines waiting to see which way this game plays out, the reason being that the strategies for each path are 180 degrees apart.  If we go the route of austerity, the last thing a person should want to hold are hard assets (you'll be able to pick them up cheaper later on).  If we go the route of hyperinflation then hard assets are the best investments to be holding (and you'd better be holding before TSHTF because you won't be able to buy them during).

So how will you know what to do before everybody else does?  Other than buying PMs on the understanding that any pullback will only be temporary,  I believe we may get an indicator of what the drivers are thinking this summer when the debt ceiling limit gets increased.  If the government only raises the debt ceiling by enough to get through the election (say $500 billion) then austerity is still on the table.  But if the debt ceiling is raised to $20 trillion or more (even removed altogether) then you can bet that 11th hour deals are in the works to extend the Bush tax cuts (good for investors) in exchange for  extended benefits and postponement of austerity (good for workers) as was done on 1/1/2011, thus setting the stage for structural QE.

The Effect of Deposit Insurance (or Lack Thereof) on Gold and Silver as Money

Ben Bernanke says gold isn't money.  Most Americans, lulled by a false sense of security provided by the FDIC, choose to trust Bernanke over their own  common sense.

Very few countries offer adequate deposit insurance, and many countries (like Thailand) are in the process of reducing the deposit insurance they historically provided.  The theory is that offering deposit insurance creates a "moral hazard" because depositors no longer act as watchdogs over financial institutions.  It doesn't matter whether you place your deposits in a good bank or a bad bank - you get your money back regardless.  And bankers don't have to worry about that pesky little thing called fiduciary duty - they can take all sorts of risks without their conscience bothering them.

Recent studies show that the depth of any given country's financial crisis is directly proportional to the degree of deposit insurance it provides.  In other words, the greater the insurance coverage, the worse the financial collapse.  For countries with full deposit coverage, systemic banking failures historically occurred almost half the time.   And the problem with systemic banking failures, as Iceland found out, is that deposit insurance becomes irrelevant when the entire system collapses.

People in China and India are huge buyers of gold and silver.  China offers no deposit insurance and India offers 100,000 rupees (about $2,000).  It is cultural in these countries to not trust banks, and there is insufficient reason provided by the governments to do so.

And so, as long as deposit insurance continues to be either nonexistent, inadequate, or morally hazardous, gold and silver will be considered money by the vast majority of people in the world.

Gold and Silver Channel Check

Despite the sell off today in PMs and stocks occasioned by the most recent FOMC meeting and lack of immediate QE3, we all know there are trillions of paper dollars, euros, yen, rupee, and yuan musically circling the chairs that represent the few desirable assets remaining in the system.  (Fact: there are fully 4 times as many financial assets (bonds) in the system as tangible assets (shares, real and personal property, metals, etc.)  But rather than go ahead and grab one of these chairs now, "smart" money prefers to either sit in cash or engage in high-frequency trading, currency arbitrage, or derivative investment that might possibly result in the kind of payoff that made Kyle Bass both rich and famous in 2008.  The theory is:  We all know the system is doomed, just not doomed today.  We can trade shares of Bank of America today for a pop because there will be  plenty of time to take a real chair once we're more certain of how this game plays out.

Chris Duane is famous for saying "I'd rather be 7 years too early than one day too late."  I couldn't agree more.  Just-in-time inventory management doesn't only apply to groceries, iPhones, and auto manufacturing.  Gold and silver dealers practice JIT, too.  To be both specific and personal, it took me 4 months last summer to actually get the admittedly large ($100,000) delivery of physical gold maple leaf coins a client of mine wanted and paid for in May.  It also took a certain amount of hostility on my part as well, as the price of gold just kept going up and up and the dealer kept pushing back delivery.

Today I went to the Dallas Gold and Silver Exchange, a large bullion dealer here in Dallas, to pick up a few more coins.  On hand they had a whopping 6 gold 1oz Canadian Maples, 13 gold 1oz American Eagles, 60 silver 1oz American Eagles, and 176 silver 1oz Canadian Maples (that had just been delivered from the mint).  That's $32,000 of gold and $8,500 of silver for those of you who don't want to whip out your calculators. One determined buyer could wipe out their entire inventory on hand in a single transaction.  This determined buyer nearly did.  And you want to wait to buy?  You think you can sell into strength and buy back on weakness?  You think you can day-trade paper PMs now and wait until the 11th hour to convert to the real thing?  You really want to be a participant in that final, futile stampede?

Every time I do my channel checks on physical PMs I am reminded full square of how foolish it is for people to do anything other than buy and hold PMs and how lucky I am that they are.  Every time I get paid fiat I buy real   Pullbacks are buying opportunities as surely as Ben Bernanke and his banking minions have no choice but to continue to finance our exponentially growing deficit.

April 10, 2012

New Blog Site

I am now blogging at http://dont-tread-on.me/

It's a great site for people interested in accumulating silver...check it out!