Nick Barisheff is the founder, President and CEO of Bullion Management Group Inc. (BMG) and the author of$10,000 Gold: Why Golds Inevitable Rise Is the Investor’s Safe Haven (www.10000goldthebook.com). Widely recognised as an international bullion expert, Barisheff speaks to Vivek Kaul in a free wheeling interview on the future of gold and why the current fall in its price is going to go away soon. As he puts it “I would not be surprised to see gold hit new highs before year end.”
Excerpts:
Has your book $10,000 Gold released at an inappropriate time, given that gold price has taken a big beating in the recent past?
I began collecting notes and research for the book soon after I decided to go into the precious metals business in 1998. Although the material was updated many times over the years, the core long-term trends, that I feel are responsible for gold’s rising price, are still in place today as they were in the late 1990s when gold was trading below $300 an ounce (1 troy ounce equals 31.1 grams). The book will be just as relevant in two years as it is today for this reason. It is about long-term, irreversible trends. Those simply won’t change until there is a complete purging of debt as the trends I follow are all trends that result in greater debt as debt is directly related to the price of gold.
What do you think are the reasons behind the recent fall in the price of gold? How soon do you expect it to start going up again?
Estimates put the sales on the COMEX on Friday April 12th, and Monday April 15th between 125 and 400 tonnes. The most telling evidence that this was a deliberate paper gold attack at the highest levels was the size and speed of the sales that then triggered sell stops and margin calls. (This article provides additional details: http://news.goldseek.com/GoldSeek/1368648060.php)
In contrast to the lows in paper gold, unprecedented buying of physical gold was triggered. If this were truly a natural correction or the indication that gold bull had turned into a bear, then the physical market would be panic selling not panic buying. Over the long term, these artificial declines in the price of paper gold are good for gold as it lets a lot of big players enter the markets. I do not expect this “correction” to extend over a long period of time as it is artificial. However, it is possible this was coordinated to correspond with gold’s slow summer season. I would not be surprised to see gold hit new highs before year end.
One of the major myths about gold is that it is not a good inflation hedge. You suggest that its a great inflation hedge. Can you explain that through some numbers?
The best way to see how gold works to maintain purchasing power and is therefore a good hedge against inflation is to think in terms of ounces rather than the more relative dollars or euros. As I mention in the book, it took 66 ounces of gold to buy a compact car in 1971. Today it would take about 10 ounces. We can see the same ratio with houses and even the DOW. (the Dow Jones Industrial Average, one of America’s premier stock market indices) Today you can buy 3 average size houses for the same amount of gold you would have needed to buy 1 house in 1971 even though the prices of houses have risen significantly in dollar terms since then. That’s how gold serves as a hedge against inflation and maintains its purchasing power. One of the best books on how gold maintains its purchasing power over long periods is the Golden Constant.
Gold bugs have been suggesting people to hold gold because they expect very high inflation to come in given all the money that is being printed by central banks all over the world. But inflation hasn’t set in as yet. What is your view on that?
To begin with, real inflation is running at a much higher level than official figures indicate. I’ve explained this in detail in the book. If we use the original basket of goods used to measure inflation before the Clinton government began understating inflation through substitution and other deceptive metrics, it is running at about 10 percent. (For a more detailed description please see: http://www.shadowstats.com/article/no-438-public-comment-on-inflation-measurement)
Can you elaborate on that?
As I mentioned above, real inflation has set in, but it’s hidden through doctored government inflation reports. Anyone who eats, heats their home, drives a car or sends their children to college knows this, but governments need to hide this fact because, for each official point in inflation they would have to pay out hundreds of billions in indexed pensions. As well, the method they are currently using to keep the bond market strong is through low or negative real interest rates. I have discussed in several recent articles, the methods governments use to secretly rob pensioners and savers through these low interest rates using a program called “financial repression”. Richard Russell, the famous newsletter writer, once stated that gold will preserve wealth equally well in an inflationary or deflationary environment as it is the ultimate store of wealth. This is also confirmed by the data in the Golden Constant.
So where will all this money printing that is happening ultimately lead us to?
All world fiat currencies eventually end in hyperinflation followed by complete collapse. Throughout all of history there has not been a single example that did not follow this pattern. The U.S. dollar will fail for the same reasons the others failed, because politicians cannot resist the urge to print unlimited amounts of unbacked currency. This eventually appears as inflation brought about through currency debasement. The main reason this positively affects the gold price is because gold is not rising in value, currencies are losing purchasing power against gold. Therefore, gold can rise in price as high as currencies can fall. As Voltaire said, “Paper money eventually returns to its intrinsic value—zero.”
What is the link that the oil, ageing population and population growth have with the price of gold?
As I write on Page 71 of my book “Ultimately, we are most concerned with one measure when it comes to the price of gold: government debt. How will decreasing oil supplies impact gold? They will impact gold in the same way as the other irreversible trends: the rising population, the aging population and outsourcing. All create the need for more debt to compensate for slowing growth, and increased government debt equals more currency, lower purchasing power and a higher gold price.”
Can you elaborate on that?
The debt based model depends on perpetual growth as it, like a spinning top will collapse if it stops moving. When natural economic growth does not come through productivity, manufacturing of the production of natural resources, then the government must fuel growth through debt creation. Dr. Chris Martenson does an excellent job of demonstrating how much of the growth of the past century, growth that led to a population explosion, was due to cheap land-based oil. The trends described in your question along with the huge interest payments necessary to finance the debt are costing the government many more dollars to grow the GDP. In 2012, it cost the U.S. government $2.47 to grow the GDP by $1.
And that is a problem?
Stimulus works while the major portion of the population is working. Right now baby boomers in the US are retiring at a rate of 10,000 a day. Despite the claims of energy independence because of shale oil in the United States, the world’s growth has been fueled by cheap land-based oil, located mainly in the Middle East. Oil sands and shale oil are extremely expensive to produce by comparison and are therefore inflationary. Apart from money printing creating inflation, the rising price of oil will also be inflationary as it is used for virtually everything. The trends described in the book all impact growth negatively, they reduce taxation revenues, cause inflation and require ever greater government expenditure leading to ever increasing government debt. Therefore, this creates a need of more currency debasement, which naturally causes the value of gold to appear stronger against currencies.
Anything else that you would like to tell our readers regarding this?
We can also add that over the past three thousand years the most effective solution to runaway inflation brought about through currency creation is the re-establishment of some type of relationship between currencies and gold. It doesn’t need to be a 1:1 relationship, but whatever percentage it is, it will cause gold to trade much higher. We are in uncharted territory here. Several reputable analysts are calling for $10,000 gold for this reason, such as Société Générale’s Edward Alberts and the man Barrons labeled “Mr. Gold” because of his proven understanding of the gold market—Jim Sinclair, who stated he expected gold to eventually trade at $50,000 an ounce. Again, this is easier to understand why currency debasement will result in rising gold prices when we realise gold is not rising in value, currencies are losing value against gold.
You suggest in your book that the Chinese government is buying gold big time, though there is very little evidence available for the same. Can you get into that in some detail?
China leads the world in gold production. All of that domestic production remains in China. We know that China and India purchased 2000 tonnes of the 2,700 tonnes of global production in 2012. This includes the public as well as official purchases and unofficial purchases by sovereign wealth funds. In the past, we know the Chinese government purchased its gold in a circumspect, but secretive manner. They accumulated through sovereign wealth funds that can bypass the red tape and the transparency required of official central banks. It is safe to assume they are still doing this. In 2009, China announced its official gold purchases after the fact. In 2009 the world thought China had 454 tonnes, the same as it held at the time of the country’s last official announcement in 2003. In 2009, they announced they had 1,054 tonnes.
Why are they being so secretive?
Of course, China is not interested in having the world know how much gold they have at this point because it is trying to accumulate as much as it can. I believe China hopes their yuan will replace the U.S. dollar as the next world reserve currency. If the Chinese follow the pattern of announcing every 6 years, we may be in for a major surprise in 2015, especially since Ji Xiaonan, who chairs the supervisory board for the Chinese State Council’s biggest state-owned companies stated in 2009 that China planned to add 10,000 tonnes to their gold reserves before 2019.
Gold has always been seen as an anti-dollar. People who have no confidence in the paper dollars being printed by the Federal Reserve buy gold. To what extent do you think the US will go to protect the dollar and discredit gold?
The U.S. government is highly motivated to maintain its reserve currency status and to maintain pricing of oil in US dollars. The US is the world’s largest debtor nation and the only reason the United States has been able to run up such a large debt is because it had the world’s reserve currency thanks at first to the Bretton Wood’s agreement in 1944. When they broke the peg with gold in 1971, the dollar’s status came under scrutiny, but there were no other currencies challenging it at the time. In 1973 the Americans secured their position as world’s reserve currency when OPEC agreed to denominate oil in U.S. dollars alone. This is now being challenged as China has entered into trade agreements with Japan, Australia, Brazil, Korea, and numerous others to bypass the US dollar and settle trade with each other’s currencies. This is a direct threat to the US dollars reserve status.
The interview originally appeared on www.firstpost.com on May 24, 2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
debt
IMF, debt and the death of traditional banking
Vivek Kaul
Some of the earliest banks started operating in Italy somewhere in the twelfth and thirteenth century. These banks were essentially banks of deposits. Merchants deposited their money in the form of gold and silver coins and bars with these banks for safekeeping. The bank in return issued a receipt against this deposit. The receipt could be shown when the coin money was to be withdrawn. Hence, the earliest banks were “banks of deposits” or “store houses of wealth”.
As time went by some banks developed a reputation for probity and honesty. This led to merchants who had accounts with these banks simply transferring receipts of these banks when they had to pay one another instead of going to the bank showing their receipt and withdrawing their gold or silver to pay each other.
Hence, these receipts started functioning as “paper” money. In sometime people running these banks also figured out that their depositors do not all come all on the same day asking for their deposits back. So in the intermittent period they could either lend out the gold/silver to others or simply print fake deposit receipts not backed by any gold or silver bars or coins, but which looked exactly like the original deposit
receipt. Of course they charged a fee for this.
A similar trend seems to have played out in London in the seventeenth century where merchants took to depositing money with the goldsmiths. This happened after King Charles I seized around £130,000 in bullion, deposited by the city merchants at the Tower of London in 1640.
Like the Italian bankers the London goldsmiths also figured out that they could keep lending the gold that was deposited or simply issue fake receipts, and make more money in the process. As Hartley Withers writes in his all time classic The Meaning of Money:
The original goldsmith’s note was a receipt for metal deposited. It took the form of a promise to pay metal, and so passed as currency. Some ingenious goldsmith conceived the epoch-making notion of giving notes, not only to those who had deposited metal, but to those who came to borrow it, and so founded modern banking.
This is how banks evolved from being just banks of deposit to being banks which gave out loans as well. And to this day they work in the same way. This change also gave bank a right to create money out of thin air, something only the governments could do till then.
Let’s try and understand how that happens. Let us say an individual/institution/government deposits $1000 with a bank. Let’s assume that the bank in turn keeps 10% of the deposits (for the ease of calculation) and lends out the remaining 90% or$900 in this case. It thus manages to create an asset from someone else’s money. So we also have a situation here were the money supply has increased by $1900 ($1000 money deposited with the bank + $900 loan given by the bank).
The $900 loan gets deposited with another bank which in turn lends $810 (90% of $900) and keeps $90 with itself. The $810 is deposited in another bank and leads to a loan of $729. So the banks can keep creating money out of thin air and the money supply can keep going up.
This ability of banks to create money out of thin air is believed to be behind the boom and bust cycles (also referred to as business cycle fluctuations) that the world economy has seen over the last three decades. As J write in The Chicago Plan Revisited, a research paper released by the International Monetary Fund (IMF) “sudden increases and contractions of bank credit that are not necessarily driven by the fundamentals of the real economy, but that themselves change those fundamentals.” When banks feel optimistic, they create money out of thin air by lending it and in the process create the boom part of the business cycle. But when the banks feel pessimistic about economies they may call back their loans or not give out loans at all, and in the process create the bust part of the cycle.
The IMF authors feel that this ability of the banks to create money out of thin air needs to be reined in. The ability to create money should rest only with the government. For this to happen they have revisited The Chicago Plan. The plan was first proposed in the aftermath of The Great Depression of the 1930s.
“During this time a large number of leading U.S. macroeconomists supported a fundamental proposal for monetary reform that later became known as the Chicago Plan, after its strongest proponent, professor Henry Simons of the University of Chicago,” write Benes and Kumhof. Over the years Irving Fisher, who was America’s greatest economist of that era, also came to be closely associated with it.
This plan strikes at the heart of how conventional banking works. A bank raises money as deposits and lends it out as loans. The Chicago Plan separates the deposit and lending functions of the bank. So when $1000 is deposited with the bank, the bank will have to hold the entire money with it and act as a “bank of deposit”. It will not be able to lend this money out. So bank deposits cannot fund its loans. This also eliminates the chances of bank run totally. Even if all the customers of the bank come and demand their deposit from the bank at the same time, the bank can easily repay them.
The question that crops up here is that if the bank does not lend out its deposits how does t fund its loans? As per the Chicago Plan the loans will have to be funded separately from sources which are not subject to bank runs. Hence, loans would be funded out of retained earnings of the bank. They could also be funded out of the bank issuing more shares to investors. And a third source of funding, which is at the heart of the Chicago Plan, would come from the government.
The bank will have to borrow money from the government to fund its loans. The government can ‘print’ this money that it will lend to banks. Hence, this is the way the government can control money in the economy. When it wants to expand money supply it can lend more and vice versa. Banks cannot create money out of thin air because they are not allowed to lend their deposits.
“The control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending,” write the IMF authors.
Also, the government will lend against certain assets of banks. These assets can be included while calculating the net debt of the government and deducted from its total debt. The government can also buy back government bonds held by banks against the loans it will give to banks to fund their loans. Either ways the net debt of the government could come down dramatically.
The government could also use the same method to buy out private debt from these banks. It could buy back private bonds against cancellation of government loans to these banks. And why would the government do that? “Because this would have the advantage of establishing low-debt sustainable balance sheets in both the private sector and the government, it is plausible to assume that a real-world implementation of the Chicago Plan would involve at least some, and potentially a very large, buy-back of private debt,” write the IMF authors.
That’s the plan. But the bigger question that the plan does not answer is how much can governments be trusted when it comes to printing money?
A slightly shorter version of this article appeared in Daily News and Analysis on October 24, 2012.
(Vivek Kaul is a writer. He can be reached at [email protected])
http://money.msn.com/investing/no-debt-no-cuts-no-new-taxes
If PIIGS have to fly, they will need to exit the euro
Vivek Kaul
I’ve long said that capitalism without bankruptcy is like Christianity without hell. – Frank Borman
If you have been following the business newspapers lately, you would have probably come to the conclusion by now that a break-up of the euro will lead to a huge catastrophe in Europe as well as the rest of the world.
Yes, there will be problems. But the world will be a much better place if the countries like Portugal, Ireland, Italy, Greece and Spain opt out of the euro. To know why read on.
How it all started
The European Coal and Steel Community was an economic organisation formed by six European nations in 1958. This gradually evolved into the European Union (EU) which was established by the Maastricht Treaty in 1993. The EU introduced the euro on 1 January 1999. On this day, 11 member countries of the EU started using euro as their currency. Before the euro came into being the German currency deutschemark used to be the premier currency of Europe. The euro inherited the strength of the deutschemark. The world looked at the euro as the new deutschemark.
The move to euro benefitted countries such as Portugal, Italy , Ireland , Greece and Spain (together now known as the PIIGS). Before these countries started to use euro as a currency, they had to borrow money at interest rates much higher than the rates at which a country like Germany borrowed. When these countries started to use the Euro they could borrow money at interest rates close to that of Germany, which was economically the best managed country in the EU.
Easy money and the borrowing binge
With interest rates being low, the PIIGS countries as well as their citizens went on a borrowing binge. Greece took the lead among these countries. The Greek politicians launched a large social spending programme which subsidised most of the key public services. In fact a few years back, the finance minister of Greece claimed that he could save more money shutting down the Railways and driving people around in taxies. In 2009, Greece railways revenues were at around $250 million and the losses of around $1.36billion. All this extravagance has was financed through borrowing.
Greece was not the only country indulging in this extravagance, other PIIGS nations had also joined in. Also other than the low interest rates, the inflation in the PIIGS countries was higher than the rate of interest being charged on loans.
As John Mauldin and Jonathan Tepper write in Endgame – The End of the Debt Supercycle and How it Changes Everything “In plain English, that means that if the borrowing rate is 3 percent while inflation is 4 percent you’re effectively borrowing for 1 percent less than inflation. You’re being paid to borrow. And borrow they did. And the European peripheral countries (PIIGS) racked up enormous amount of debt in euros.”
This was because loans were being made by German, French and British banks who were able to raise deposits at much lower interest rates in their respective countries and offer it at a slightly higher rate in the PIIGS countries.
The citizens of Spain borrowed big time to speculate in real estate. All this building was financed through the bank lending. Loans to developers and construction companies amounted to nearly $700billion or nearly 50% of the Spain’s current GDP of nearly $1.4trillion. Currently Spain has as many homes unsold as the United States (US), though the US is six times bigger than Spain. With homes lying unsold developers are in no position to repay. And Spain’s biggest three banks have assets worth $2.7trillion or that is double Spain’s GDP, are in trouble.
The accumulated debt in Spain is largely in the private sector. On the other hand the Italian government debt stands at $2.6trillion, the fourth largest in the world. The debt works out to around 125% of the Italian gross domestic product (GDP). As a recent report titled A Primer on Euro Breakup brought out by Variant Perception points out “Greece and Italy have a high government debt level. Spain and Ireland have very large private sector debt levels. Portugal has a very high public and private debt level.” Debt as we all know needs to be repaid, and that’s where all the problems are. But before we come to that we need to understand the German role in the entire crisis.
The German connection
Germany became the largest exporter in the world on the strength of the euro. Before euro became a common currency across Europe, German exports stood at around €487billion in 1995. In 1999, the first year of euro being used as a currency the exports were at €469billion euros. Next year they increased to €548billion euros. And now they stand at more than a trillion euros. Germany is the biggest exporter in the world even bigger than China.
With euro as a common currency took away the cost of dealing with multiple currencies and thus helped Germany expand its exports to its European neighbours big time. Also with a common currency at play exchange rate fluctuations which play an important part in the export game no longer mattered and what really mattered was the cost of production.
Germany was more productive than the other members of the European Union given it an edge when it came to exports. As Mauldin and Tepper point out “since the beginning of the Euro in 1999, Germany has become some 30 per cent more productive than Greece. Very roughly, that means it costs 30 per cent more to produce the same amount of goods in Greece than in Germany. That is why Greece imports $64 billion and exports only $21 billion.”
German banks also had a role to play in helping increasing German exports. They were more than happy to lend to citizens, governments and firms in PIIGS countries. So the way it worked was that German banks lent to other countries in Europe at low interest rates, and they in turn bought German goods and services which are extremely competitively priced as well as of good quality. Hence German exports went up.
The PIIGS countries owe a lot of money to German banks. Greece needs to repay $45billion. Spain owes around $238billion to Germany. Italy, Ireland and Portugal owe $190billion, $184 billion and $47billion respectively.
Inability to repay
When the going is good and everything is looking good there is a tendency to borrow more than one has the ability to repay, in the hope that things will continue to remain good in the days to come. But good times do not last forever and when that happens the borrower is in no position to repay the loan taken on.
Greece tops this list. It has been rescued several times and the private foreign creditors have already taken a haircut on their debt i.e. they have agreed to the Greek government not returning the full amount of the loan. Between Spain and Italy around €1.5trillion of money needs to be repaid over the next three years. The countries are in no position to repay the debt. It has to be financed by taking on more debt. It remains to be seen whether investors remain ready to continue lending to these countries.
In the past countries which have come under such heavy debt have done one of the following things: a) default on the debt b) inflate the debt c) devalue the currency.
Scores of countries in the past have defaulted on their debt when they have been unable to repay it. A very famous example is that of Russia in 1998. It defaulted both on its national as well as international debt. Oil prices had crashed to $11 per barrel. Oil revenue was the premier source of income for the Russian government and once that fell, there was no way it could continue to repay its debts.
If the country’s debt is in its own currency, all the government needs to do is to print more of it in order to repay it. This has happened time and again over the years all over the world. Every leading developing and developed country has resorted to this at some point of time. The third option is to devalue the currency and export one’s way out of trouble.
Exit the euro
The PIIGS countries cannot print euros and repay their debt. Since they are in a common currency area there is no way that they can devalue the euro. A straight default is ruled out because German and French banks will face huge losses, and Germany being driving force behind the euro, wouldn’t allow that to happen.
So what option do the PIIGS then have? One option that they have is to exit the euro, redominate the foreign debt in their own currency, devalue their currency and hope to export their way out of trouble.
A lot has been written about how you can only enter the euro and not exit it. The situation as is oft repeated is like a line from an old Eagles number Hotel California “You can checkout any time you like / But you can never leave.” A case has also been made as to how it would be disaster for any country leaving the euro.
Let’s try and understand why the situation will not be as bad as it is made out to be. A report titled A Primer on Euro Breakup, about which I briefly talked about a little earlier explains this situation very well.
The first thing to do as per the report is to exit the euro by surprise over a weekend when the markets are closed. Many countries have stopped using one currency and started using another currency in the past. A good example was the division of India and Pakistan. As the report points out “ One example of a currency breakup that went smoothly despite major civil unrest is the separation of India and Pakistan in August 1947. Before the partition of India, the two countries agreed that the Reserve Bank of India (the RBI) would act as the central bank of Pakistan until September 1948….Indian notes overprinted with the inscription “Government of Pakistan” were legal tender. At the end of the transition period, the Government of Pakistan exchanged the non-overprinted Indian notes circulating in Pakistan at par and returned them to India in order to de-monetize them. The overprinted notes would become the liabilities of Pakistan.”
Any country looking to exit Euro could work in a similar way. It will need to have provisions in place to overprint euros and deem them to be their own currency. Then it will have quickly issue new currency and exchange the overprinted notes for the new currency. Capital controls will also have to be put in place for sometime so that the currency does not leave the country.
Despite the fact that there are no exit provisions from the euro, after the creation of the European Central Bank, the individual central banks of countries were not disbanded. And they are still around. “All the euro countries still have fully functioning national central banks, which should greatly facilitate the distribution of bank notes, monetary policy, management of currency reserves, exchange-rate policy, foreign currency exchange, and payment. The mechanics for each central bank remain firmly in place,” the report points out.
Technical default
By applying the legal principle of lex monetae – that a country determines its own currency, the PIIGS countries can re-dominate their debt which they had issued under their local laws into the new currency. As the report points out “Countries may use the principle of lex monetae without problems if the debt contracts were contracted in its territory or under its law. But private and public bonds issued in foreign countries would be ruled on by foreign courts, who would most likely decide that repayment must be in euros.”
The good thing is that in case of Greece, Spain and Portugal, nearly 90% of the bonds issued are governed by local law. While redomination of currencies in their own currencies will legally not be a default, it will be categorized as a default by ratings agencies and international bodies.
Another problem that has brought out is the possibility of bank runs if countries leave the euro. Well bank runs are already happening even when countries are on the euro. (The entire report can be accessed here: http://www.johnmauldin.com/images/uploads/pdf/mwo022712.pdf).
The PIIGS coutnries can devalue their new currencies make themselves export competitive and hope to export their way out of trouble. This is precisely what the countries of South East Asia after the financial crisis of the late 1990s. As the report points out “history shows that following defaults and devaluations, countries experienced two to four quarters of economic contraction, but then real GDP grew at a high, sustained pace for years. The best way to promote growth in the periphery, then, is to exit the euro, default and devalue.”
The German export machinery
A breakup of the euro will create problems for the highly competitive export sector that Germany has built up. The PIIGS countries would start competiting with it when it came to exports. Given this they will not let the euro break so easily. As the bestselling author Michael Lewis said in an interview sometime back “German leadership does not want to be labeled as the people who destroyed the euro.”
But as Lewis also said “If you put Germany together with Greece in a single currency, it’s a little like watching an Olympic sprinter and a fat old man running a three-legged race. The Greeks will never be as productive as the Germans, and the Germans will never be as unproductive as the Greeks.” So it’s best for PIIGS countries to exit the euro.
In the end let me quote my favourite economist John Kenneth Galbraith as a disclaimer: “The only function of economic forecasting is to make astrology look respectable.”
(The article originally appeared at www.firstpost.com on May 19,2012. http://www.firstpost.com/world/if-piigs-have-to-fly-they-will-need-to-exit-the-euro-314589.html)
(Vivek Kaul is a writer and can be reached at [email protected])