This week, we look at… possible defaults of the 3 major foreign debtors, Peak Gold, Fake Gold and what one might invest in after gold tops out – not yet, we hasten to add!
Martin Hutchinson is an experienced international banker. In the article below, he considers the possible effects of holding large amounts of foreign debt. London, Washington and Tokyo need to watch out….
by Martin Hutchinson – November 09, 2009
Of the world’s six largest economies, three currently have budget and public debt positions that if allowed to fester will push those nations into bankruptcy (the seventh largest, Italy, also has a budget and debt position that is highly vulnerable, but its problems appear chronic rather than acute). Given the proclivities of modern politicians for delaying pain and avoiding problems, it is likely that festering is just what those positions will do. So which major country, the United States, Japan or Britain, will default first on its foreign debt?
The other three of the six top economies, Germany, China and France, appear to have fewer problems but are not out of the woods entirely. Germany has substantial public debt because of the costs involved in integrating the former East Germany, but those costs are now mostly past and the current government is highly disciplined – thus Germany is now the most stable major economy. France is less disciplined; its debt level is similar to that of Germany but its current budget deficit is much higher, at around 8% of Gross Domestic Product (GDP) in 2009, according to the Economist forecasting panel. However, its problems pale in comparison to those of the deficit-ridden trio. China has huge amounts of hidden debt in its banking system, which could well collapse, but its direct public debt is small, as is its budget deficit, so it is unlikely to enter formal default.
The worst budget balance of the three deficit countries is in Britain, where the forecast budget deficit for calendar 2009 is a staggering 14.5% of GDP. Furthermore, the Bank of England has been slightly more irresponsible in its financing mechanisms than even the Federal Reserve, leaving interest rates above zero but funding fully one third of public spending through direct money creation. Governor Mervyn King has a reputation in the world’s chancelleries as a conservative man of economic understanding. He doesn’t really deserve it, having been one of the 364 lunatic economists who signed a round-robin to Margaret Thatcher in 1981 denouncing her economic policies just as they were on the point of magnificently working, pulling Britain back from what seemed inevitable catastrophic decline. King’s quiet manner may be more reassuring to skeptics than the arrogance of “Helicopter Ben” Bernanke, but the reality of his policies is little sounder and the economic situation facing him is distinctly worse.
Britain has two additional problems not shared by the United States and Japan. First, its economy is in distinctly worse shape. Growth was negative in the third quarter of 2009, unlike the modest positive growth in the U.S. and the sharp uptick in Japan. Moreover, whereas U.S. house prices are now at a reasonable level, in terms of incomes (albeit still perhaps 10% above their eventual bottom), Britain’s house prices are still grossly inflated, possibly in London even double their appropriate level in terms of income. The financial services business in Britain is a larger part of the overall economy than in the U.S. and the absurd exemption from tax for foreigners has brought a huge disparity between the few foreigners at the top of the City of London and the unfortunate locals toiling for mere mortal rewards. A recent story that the housing market for London homes priced above $5 million British pounds was being reflated by Goldman Sachs bonuses indicates the problem, and suggests that the further deflation needed in U.K. housing will have a major and unpleasant economic effect.
A second British problem not shared by the U.S. is its excessive reliance on financial services. As detailed in previous columns, this sector has roughly doubled in the last 30 years as a share of both British and U.S. GDP. In addition, the sector’s vulnerability to a restoration of a properly tight monetary policy has been enormously increased through its addiction to trading revenue. The U.S. has many other ways of making a living if its financial services sector shrinks and New York is only a modest part of the overall economy. Britain is horribly over-dependent on financial services, and the painful if salutary effects of London costs being pushed down to national levels by a lengthy recession are less likely to be counterbalanced by exuberant growth elsewhere.
The other question to be answered for all three countries is that of political will. If as is certainly the case in Britain, deficits at the current levels will lead to default (albeit not for some years since the country’s public debt is still quite low), then to avoid default tough decisions must be taken. Britain is in poor shape in this respect. Its current prime minister, Gordon Brown, is largely responsible for the underlying budget problem, having overspent during the boom years, largely on added bureaucracy rather than on anything productive or value-creating. However, the opposition Conservatives, likely to take power next spring, are led by a center-leftist with a background in public relations and no discernable backbone or principles.
Britain has a history of such leaders, which it has managed to survive – the ineffable Harold Macmillan, in particular, who wanted to abolish the Stock Exchange and contemplated nationalizing the banks when they raised interest rates, was a man of outlook and temperament very similar to David Cameron’s. Macmillan was notoriously prone to soft options that postponed economic problems, firing his entire Treasury team in pursuit of soft options in 1958 and leaving behind an appalling legacy of inflationary bubble on his retirement in 1963. If Cameron is truly like Macmillan, his government’s response to economic and financial disaster will be one of wriggle rather than confrontation. With neither party providing solutions to an economic crisis, the British public is likely to discover that, unlike in the crisis of 1976, no solutions will be found. Default (doubtless disguised as with Argentina as “renegotiation”) would in that case inevitably follow.
The United States is in somewhat better shape than Britain. Its deficit is somewhat lower, at 11.9% of GDP in calendar 2009, although its debt level is higher if you include the direct debt of Fannie Mae and Freddie Mac, as you should. It also has lower overall levels of public spending, although spending is rising rapidly. Furthermore, it has a much more diverse economy and a healthier real estate market, so that further likely downturns in California and Manhattan real estate and the financial services sector can be easily overcome.
U.S. pundits like to whine about the impending deficits in social security and health-care, but the former is easily overcome by adjusting the retirement age while the latter could be greatly mitigated by simple cost-containment measures, such as limiting trial lawyer depredations, making the state pay for the “emergency room” mandate to treat the indigent and allowing interstate competition for health insurance. All those changes would be politically difficult, but they are clearly visible and involve no damaging cuts in vital services, unlike the changes that would probably be necessary in Britain.
The other U.S. advantage is political: it has an alternative to overspending. Last Tuesday’s election results were a useful shot across the bows of the overspending consensus that had developed in both the Bush and Obama administrations (as well as among the ineffable barons of Congress) since 2007. Whereas voter concern about spiraling deficits and public spending has no satisfactory outlet in Britain, it can now express itself clearly in the U.S., producing either a sharp change of policy by the current administration and Congress or a change of administration in 2012. Since the likelihood of a reversal of policy towards sound budgetary management is greater in the U.S. than in Britain, the probability of eventual default is less.
Japan has already had its change of government, throwing out the faction of the Liberal Democrat Party (LDP) that regarded politics as the art of creating pointless infrastructure. Unfortunately, the Japanese electorate, faced in August with a no-good-choices problem similar to that of U.S. voters last year and British voters next spring, replaced a long-serving overspending government with another committed to a different set of spending priorities rather than to ending the spending itself. The Democratic Party of Japan (DPJ) has cut back sharply on the infrastructure “stimulus” but is showing signs of replacing it with social spending. It is also committed to economically dozy policies such as reversing postal privatization, organized with such great political effort by Junichiro Koizumi in 2005.
Japan does however have a couple of advantages that may enable it to avoid default. First, its public debt carries very low interest rates, mostly below 2% per annum, and is owned almost entirely by its own citizens. What’s more, state-owned entities such as the now un-privatized Postal Bank lend vast amounts of money to the government, acting as conduits to the less efficient bits of the public sector in the same way as do China’s state-owned banks. This is appallingly bad for the efficiency of the economy and for living standards, but it postpones default and makes it less likely.
Second, it’s not inevitable that the LDP’s wasteful infrastructure spending will simply be replaced by wasteful social spending. Finance minister Hirohisa Fujii is reputed to be a budgetary hard-liner. Further, at least part of the DPJ’s spending will take the form of handouts to families with children. Those may increase domestic consumption compared to exports and thereby balance the Japanese economy better, increasing its growth potential marginally. Nevertheless, since Japan’s public debt is currently around 200% of GDP, Japan is much closer to the default precipice than either the U.S. or Britain. Thus, while the better structure of Japan’s economy and its debt make Japan’s probability of default lower than Britain’s, it’s likely that if both countries defaulted, Japan would do so first.
We have not experienced a debt default by a major economy since the 1930s. That three such defaults are currently conceivable indicates both the severity of the current downturn and the wrong-headedness of the policies taken to address it. If it happens, a major sovereign debt default of this kind will cause the seizure of global capital markets, prolonging downturn for a decade or more.
We’d all better hope the urge for fiscal responsibility hits London, Washington and Tokyo pretty damn soon.
The Bears Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long ’90s boom, the proportion of “sell” recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.
Martin Hutchinson is the author of “Great Conservatives” (Academica Press, 2005). Details can be found on the Web site www.greatconservatives.com
· Peak Gold
Regular visitors to our site will know that we have discussed peak oil, and have directed readers to Chris Martenson’s Crash Course, where the concept is discussed in detail. In addition to oil, other commodities may also be approaching their peak (maximum possible) rates of production. Please not that this does not mean that that these commodities are running out – it means two things –
(1) the worldwide production rate has reached its maximum value, and
(2) to obtain further supplies is becoming, and will become, increasingly expensive.
· The following comes to you, courtesy of Zapata George
Is gold going to follow the way of crude oil? Do we have a “peak” of easily found gold behind us? It’s starting to look that way. Big, smart gold producers, like Barrick, mentioned in the article below, are taking off what hedges they have on to sell future production and are not planning any new hedges. At the same time, India recently bought one half of what the World Bank had for sale, and a number of federal banks have ceased their sale of gold. So, it appears as though with a peak of production that occurred in 2000 and has been in decline ever since, combined with falling ore grades, we may have another commodity peak. Remember, Mother Earth does not provide us with infinite amounts just because we “want” it. Economics 101 doesn’t seem to have taken this into consideration.
Here’s the article:
By Ambrose Evans-Pritchard, International Business Editor
Published: 7:20PM GMT 11 Nov 2009
Global gold production is in terminal decline despite record prices and Herculean efforts by mining companies to discover fresh sources of ore in remote spots, according to the world’s top producer Barrick Gold.
Aaron Regent, president of the Canadian gold giant, said that global output has been falling by roughly 1m ounces a year since the start of the decade. Total mine supply has dropped by 10pc as ore quality erodes, implying that the roaring bull market of the last eight years may have further to run.
“There is a strong case to be made that we are already at ‘peak gold’,” he told The Daily Telegraph at the RBC’s annual gold conference in London.
“Production peaked around 2000 and it has been in decline ever since, and we forecast that decline to continue. It is increasingly difficult to find ore,” he said.
Ore grades have fallen from around 12 grams per tonne in 1950 to nearer 3 grams in the US, Canada, and Australia. South Africa’s output has halved since peaking in 1970.
The supply crunch has helped push gold to an all-time high, reaching $1,118 an ounce at one stage yesterday. The key driver over recent days has been the move by India’s central bank to soak up half of the gold being sold by the International Monetary Fund. It is the latest sign that the rising powers of Asia and the commodity bloc are growing wary of Western paper money and debt.
China has quietly doubled holdings to 1,054 tonnes and is thought to be adding gradually on price dips, creating a market floor. Gold remains a tiny fraction of its $2.3 trillion in foreign reserves.
Gold exchange-traded funds (ETFs) – dubbed the “People’s Central Bank” – have accumulated 1,778 tonnes, making them the fifth biggest holder after the US, Germany, France, and Italy.
Ross Norman, director of theBullionDesk.com, said exploration budgets had tripled since the start of the decade with stubbornly disappointing results so far.
Output fell a further 14pc in South Africa last year as companies were forced to dig ever deeper – at greater cost – to replace depleted reserves, not helped by “social uplift” rules and power cuts. Harmony Gold said yesterday that it may close two more mines over coming months due to poor ore grades.
Mr. Norman said the “false mine of central banks” had been the only new source of gold supply this decade as they auction off reserves, but they are switching sides to become net buyers.
Barrick is moving fast to wind down the remaining 3m ounces of its infamous hedge book over the next twelve months, an implicit bet on rising gold prices over time.
Mr. Regent said the company had waited too long to ditch the policy, which has made the company enemy number one among ‘gold bug’ enthusiasts. The hedges oblige Barrick to deliver part of its gold into futures contracts set long ago at levels far below today’s spot prices.
The strategy worked well in the falling market of the 1990s, but has cost the company dear in lost profits this decade. “Hindsight is always 20/20,” said Mr Regent, who was appointed from the outside earlier this year.
Barrick bit the bullet in the third quarter, taking a $5.7bn charge against earnings on hedge contracts. Liberation is at last in sight. In 2001 the hedge book topped 20m ounces.
Mr Regent said the hedge policy has weighed badly on the share price and irked investors, becoming a bone of contention at every meeting. The financial crisis brought matters to a head as markets fretted about counterparty risk. “It was clear to me that there were a significant number of institutions who wouldn’t invest in Barrick because of the hedge book,” he said.
Barrick produced 1.9m ounces of gold last quarter, down from 1.95m a year earlier. Costs have been “trending down” to $456 an ounce, though rising energy prices pose a fresh threat. Total reserves are 139m ounces, far ahead of rival Newmont Mining at 86m.
The hedge book venture has not been a happy one, but those who predicted that Barrick would eventually “blow up” on its contracts may owe the company an apology.
· Fake Gold?
Rob Kirby, who is a member of the Gold Anti-Trust Action Organization (GATA) and a frequent contributor to www.financialsense.com , has published an article concerning the possible circulation of fake gold bars, originating from the US….
Here is a summary of his findings. For a more complete discussion, check out Financial Sense.
1. As I reported to you a few weeks ago, there were reports of 400 0z bars of gold found in the Bank of England filled with tungsten. It was reported to you that tungsten has the same specific gravity of gold, so it is easy to manufacture a fake brick. Only an electrical test could determine which bar is real.
2. Kirby also identified that the GLD list in London had the bar list go from 1381 pages to under 200 and then back to 800 pages, even though the gold inventory of GLD was increasing from 1080 tonnes to gold to its present value of 1118 tonnes.
3. During the week of Oct 1.09, there were irregular physical gold settlements and the Bank of England had to intervene on behalf of JPMorgan and Deutsche Bank, as these two banks did not have the physical gold backing its delivery.
4. China is known as the knock off capital of the world. Everyone thought that they were the manufacturers of these tungsten bricks. The Chinese were the ultimate buyers of these tungsten bricks and they decided that they needed to get to the bottom of this fiasco. In their interrogation process they found the perpetrators and put them behind bars and in the process discovered that it was the USA who orchestrated the manufacture of these fake bars.
5. The USA manufactured anywhere between 1.3 to 1.5 million bars of 400 0z weight or roughly 16,000 metric tonnes. The USA allegedly holds 8,000 metric tonnes of gold and the world roughly 30,000 metric tonnes.
6. Approximately 640,000 of these tungsten bricks of 400 oz weight were shipped to Fort Knox. The weight in oz is 256 million oz, which is roughly the 8,000 tonnes of gold that Fort Knox supposedly holds.
7. The remaining 8,000 metric tonnes were shipped to international centres and sold on the international market. Many of these bars ended up at the GLD.
8. Kirby has documents which show that his folks have copies of original shipping documents with dates and EXACT WEIGHTS OF THE TUNGSTEN BARS SHIPPED TO FORT KNOX.
9. This may help explain why Rothschild’s left the gold market in 2004 as they probably knew that many of the bricks at the B of E were fake.
10. It may help explain why no news came out on the raid at the Nymex in Feb 2004 where the District Attorney was investigating Stuart Smith, VP of operations at the Nymex. A search warrant was issued; he abruptly left and to this day has not been heard from.
The above will help explain why I cannot balance supply and demand of gold. We know that demand is somewhere around 4500 tonnes of gold and supply around 2400 tonnes and
thus the deficit has been funded with supplies from central banks. The above ground gold supplied by the central banks came through the leasing process. The leasing of gold started in 1988 and with a deficit of 2000 tonnes per annum, the world should have run out of gold a few years ago. It did not.
Now we know why!!!!!! Everything now makes sense and the balance of “gold” supplied into the market was in reality tungsten bricks.
· Investment after gold tops out? (No, not yet)
OK, so you’re smart and you’ve made a lot of money investing in precious metals, so what’s next? Eric deCarbonnel of Market Sceptics has put together an investment fund to invest in farmland in Russia.
A sign of things to come? We think so…
from Market Skeptics by Eric deCarbonnel
This is a quick entry to:
1) Let everyone know that I am organizing a trip to visit Black Earth farmland in Russia
2) Promote Regia Russia Agro Investment Ltd (the fund I launched to invest in Russian agriculture).
3) Highlight that now is the time to invest in agriculture
4) Announce that I am lowering the minimum subscription for Regia Russia Agro Investment Ltd.
1) *****Trip To Visit Black Earth Farmland In Russia*****
I am organizing a trip to visit Black Earth farmland in Russia. So far, at least 5 people are coming on trip. Please Email me if you are interested.
Dates for Russia trip
The plan is for investors to arrive in Moscow on the Saturday December 5 and leave Russia on Friday December 11. We will visit Black Earth farmland in the middle of the week (December 8th and 9th).
2) Regia is the only Russia Ag fund aimed at retail investors
When I became bullish on Russian agriculture in May 2009 and looked for an investment that I could recommend on my blog, I was surprised to discover that there are no “quality” funds for small investors. Instead, there were only a couple of institutional funds where the lowest minimum investment was at least a million dollars, out of reach for 99.999% of my readers.
At the time I thought, “This is a waste,” and decided to, if there was enough interest, start a fund to create an investment alternative for retail investors.
Today, Regia Russia Agro Investment Ltd is up and running and receiving subscriptions from international investors (Please Email me for a copy of PPM). For U.S. investors, a US Domestic LLC (ie: Regia Russia Agro Investment LLC) is being set up as a feeder fund (which should be ready before the end of November).
3) Now is the time to invest in agriculture
As I have been writing about for a while, the world is facing a food shortage and dollar collapse in 2009/10, both of which are bullish for agriculture. Right now, Black Earth farmland (ultra-fertile agricultural land found in Russia and Ukraine) is available at $270 per acre, less than a tenth of what comparable land sells for in the US and Europe. Now is the time to invest to take advantage of this amazing investment opportunity.
There is a delay of around one month between the time that Regia Russia Agro Investment Ltd receives subscriptions and when Black Earth farmland can be acquired (negations to acquire land can’t begin without first having the funds). When the global food shortage becomes really obvious (December/January timeframe), a panic will begin and money will pour into agriculture (and out of the dollar) around the world, very quickly raising prices. To maximize returns on an investment in agriculture, it is key to invest now while the market is still calm (ie: before dollar/food panic).
4) Lowering Minimum Subscription
As a result of gold’s recent appreciation, the minimum subscription amount is being lowered to 3000 grams of gold (1 gram of gold per share), which is about $106,500 right now ($35.5 per gram). As gold continues to appreciate, the minimum investment will be lowered as appropriate.
Under compelling circumstances, the minimum subscription amount can be waived for international investors.
There is a 10% discount to the Offering Price (.9 grams of gold per share) for first 100,000 gram of gold invested in fund.
Please Email me for a copy of PPM.
Regia Russia Agro Investment Ltd is using Goldmoney to receive subscriptions. GoldMoney is a digital gold currency founded in 2001 by James Turk which allows the instant transfer of gold, silver and platinum between user holdings.
Here is the link for opening a Goldmoney account. The process is simple and transparent.