This article is a summary of comments by Jim Rickards, who was interviewed recently by Eric King, over at King World News. Mr Rickards is a writer, lawyer and economist with a long and very distinguished record in the global capital markets. He is Senior Managing Director at Omnis, Inc., a consulting firm in McLean, VA and is the leading practitioner at the intersection of global capital markets and national security. His advice to clients from 2002 to 2006 included early warning of impending financial collapse, the rise of sovereign wealth funds, the decline of the dollar and the sharp rise in gold prices years in advance of these events. I strongly encourage readers to listen to the whole piece, but for those who can’t spare the time, here is a record of the salient points…
Although Ben Bernanke has been reconfirmed as Chairman of the Fed, his position will be weakened because of the unprecedented number of votes against his re-appointment. Wall street loves Bernanke because he’s giving away free money. Notice that very big investors such as Warren Buffett lobbied hard for Bernanke’s re-election.
The group of fiscally challenged Europeans known as PIIGS (Portugal, Italy, Ireland, Greece and Spain) vary widely in the amount of gold they own – Italy has over 2000 tons, Greece over 100 tons, while Ireland owns only 5 tons.
Greece’s debt to GDP ratio is only about half that of Japan’s. Its deficit to GDP ratio is comparable to that of the US. If the ECB lets Greece default, where does the rot stop? The crown jewel of European unification is the monetary system – symbolised by the Euro. They will do all they can to preserve it.
Much has been made of India’s purchase of 200 tons of gold. India would like to buy 800 more tons. According to Jim’s best information, China would like to buy 3000 tons. Russia would like to buy another 1000 – 1500 tons. We are looking at over 5000 tons of demand from these 3 countries alone! Annual world production is about 2300 tons, but this is all spoken for. These official buyers will have to be satisfied by official sellers. Now the US has over 8000 tons; European countries collectively own over 10,000 tons, but the Europeans, the largest official sellers of gold in the world, are reducing their sales, while the US sells virtually none. There is a huge demand/supply imbalance, which implies support at some level for the price of gold.
The IMF has over 3000 tons in total, but only 200 “discretionary” tons available for sale.
The government paper securities market works as follows via the repo market – a kind of swap market: I’m a dealer, I can sell some govt bonds without owning them – I’m going short, in other words, or I have what’s called a reverse repo position. I borrow the bonds, sell them to my buyer, and at some later stage I have to buy replacement bonds and return them to the entity that lent them to me – I unwind the repo, as this process is called.
Now let’s consider gold. The market works exactly the same way. As a dealer, I own some gold and I lend or sell it to you, you can sell it or physically deliver it to someone, you now are short some gold, so you go into the marketplace at a later date and buy back the gold, and re-deliver it to me.
But suppose this is done as a secured lending arrangement – i.e. I am not selling you the gold – I’m lending it to you. I’ve got it on my books as a kind of secured loan; the ultimate buyer has it on his books as a physical possession. So the gold is being counted twice. Everything balances as long as the person in the middle’s short position is taken account of. The problem comes because the market is unregulated and opaque – we have no information about the short positions in the middle, or indeed much else.
Now the evidence for actual swaps between central banks is fairly limited (GATA might disagree – Ed.) – but if they do exist in any quantity, and there is any kind of call to cover the short positions, a superspike in the gold price would occur.
Central banks hate deflation.
The consumer won’t spend if he/she thinks prices are going lower. The problem feeds on itself – it’s a positive feedback loop. There is no mechanism in the tax system to handle deflation. Deflating prices, if one’s salary remains constant, mean an increase in the standard of living, but the govt can’t tax it.
At what point does the Fed stop printing money and let deflation prevail? The job of the Fed, in their minds, is to cause inflation (print money in other words. In the words of Marc Faber, Mr Bernanke is a money printer). The current deflationary forces though are very powerful – we have just had the greatest asset bubble collapse in history. It follows that the Fed is likely to be required to engineer the greatest inflation in history. However, the job is complicated, because all fiat currencies are fighting to be devalued at the same time.
China is refusing to adopt the mantle of the strong currency, that everyone devalues against. However, there can be devaluation against gold. Roosevelt did it in the 30’s.
Deflationary forces are too great – they will overwhelm the efforts of the central banks which won’t be able to devalue against each other, so they will bid up the price of gold.
Inflation means transferring wealth from creditors to debtors. In deflation, the flow is in the opposite direction, from debtors to creditors. This is true, so long as the debtor does not default. If the debtor defaults, the loss is transferred – instantaneously -back to the creditor. In fact, for this reason, creditors actually prefer inflation – they’d rather get paid in cheaper dollars than not get paid at all.
The Japanese experience – US better or worse off?
The Japanese had a bad time of it through the 90’s – and they may not be out of the woods yet. The US has a lot more gold, a much bigger base of natural resources and a number of other advantages over Japan. However, the consumer is tapped out. Prices are likely to drift lower until eventually they get so low that the consumer starts to be interested again. A great P/E compression occurred in the 30’s.
The characteristic behaviour of a bubble is well known across many disciplines. It is very difficult to know when a bubble will break – but the dynamics imply that a bubble will return to where they began, roughly speaking. House prices will probably go all the way back to 1995 levels.
Also, check out the link on Jim Rickards’ interview page at King World News to the piece – The Frog, the Scorpion and Goldman Sachs. This is an interesting summary of the Goldman business model of data mining – gathering data from it’s customers – to determine the likely direction of the markets and making a buck from this – all the while being tax payer supported. Very profitable!