By Bron Suchecki, on May 19th, 2009
Currency = Shares in the political state
Bonds = Issued by Government are nothing more than a derivative option
Shares = In the corporate world are a hedge against domestic inflation
Gold = Is the hedge against Government instability
Currency is an instrument that represents the total wealth of a nation. It is nothing more than a individual common stock share whose value will rise and fall dependent upon how the world believes and trusts in the management.
So bonds are simply an option on the currency and you hope that the interest paid offset the depreciation in the value of the bond/currency for the duration it was held. Of course, buying government debt is the one bet you can make that is a guaranteed loss. It is only a question of how much capital you lose.
Shares/stocks of private corporations reflect a hedge against inflation. Most stocks will only keep pace with inflation that is real, not manipulated statistics.
Gold is just starting to come into its own. Its role is obviously not the hedge against inflation as is stocks, but the hedge against the instability of government. For when all else fails, gold becomes the only store of wealth.
By Trace Mayer, on May 19th, 2009
BRAZIL IS MONSTEROUS
Brazil with 3,285,618 square miles (8,511,965 square kilometers) and around 200 million people is the fifth largest country in the world and about 11% larger than country-continent Australia. With 5 World Cup wins Brazil leads the board ahead of Italy with their four wins and a purported 2,451.8 tons of gold and Germany with their three wins and an overtime March bailout via the ECB of Deutsche Bank’s naked short gold derivatives.
 OUT OF CONTROL
 The festival of Carnival with its spectacular street parades, vibrant music and scantily clad beautiful women has become one of the most potent images of Brazil. But the Real has lost its neurotic nature of decades ago with a rapid climb in value against the FRN$ over the past several years.
With a GDP of almost $2T Brazil’s economy may be twice California’s considering their Controller John Chiang recently reported, “Sales taxes were $452 million lower (-50.9%) than last April, and personal income taxes were down $5.7 billion (-43.6%). Corporate taxes were $142 million below (-8.6%) April of 2008.”
Indeed, California leads the United States and California is completely out of fiscal control. Meanwhile the party-hearty Brazilians are beginning to dream and have achieved tremendous self-sufficiency as typified with its ethanol fueled automobiles.
BRAZIL STRENGTHENS TRADING PARTNERS
This week Luiz Inacio Lula da Silva, Brazil’s President, is visiting Turkey, China and Saudi Arabia. As the first BRIC member this is an important development. With its sensible financial sector, premier domestic energy super-major Petrobras, hardy industrial base and bountiful and beautiful Amazonian gardens Brazil is a force to be reckoned with.
On 23 February 2009 I wrote about China’s Latest Hunting Trip where “Brazil accepted about $10B and in return guaranteed China up to 100,000-160,000 barrels per day at market prices. The oil will flow from Petrobras (PBR) to China National Petroleum Corp and Sinopec.” It seems Mr. da Silva is strengthening that commitment.
Even Brazilian supermodel Gisele Bundchen ‘wants to remain the world’s richest model and is insisting that she be paid in almost any currency but the U.S. dollar.’
THE AGE OF REAL THINGS
Ironically, the Industrial Age allowed for obfuscation of information and inefficiencies of epic proportions. It will be during the Information Age that there is a return to all things real. There is no concealing of a plane crash while its passengers are Twittering. The instantaneous transmission of information around the globe is putting tremendous strain on the inherently unsound, unstable and immoral financial and monetary system.
Indeed, the Internet pulls back the curtain and reveals the true state of things. Because of the grotesque malinvestment and the painful nature of a credit contraction it is natural for The Onion to report that Americans just want to be lied to about the economy. But it is the lies that are being dissipated. Reality is barreling down the tracks whether you want it to or not.
But there is real wealth in America and lots of it. But the costumed criminal clowns in Washington DC are intentionally exacerbating the greater depression and feverishly feeding any real wealth they can steal into the wealth destruction machine. Their reckless policies burden the FRN$ which continues evaporating the dreams of Americans which go up in flames like the dusty brown grasslands of Southern California. This prairie fire started raging on the coasts but is racing to the heartland and revealing which wealth is real and which is illusory.
But Brazil has a real economy built by real labor that grows or builds real things and generates real wealth. Consequently, Brazil can trade their real things to Italy for some of its real gold. But even the Brazilian Real is facing gold’s immutable justice.
ANOTHER ATTACK ON FRN$ HEGEMONY
 Many Central and South Americans espouse the ideology of revolutionary Che Guevera who was executed over forty years ago but whose life and legacy still remain a contentious issue. Che concluded the region’s ingrained economic inequalities resulted from monopoly capitalism, neocolonialism, and imperialism. But it seems South America has found a new ally against the West.
On 9 May 2009 the Buenos Aires Herald reported, “Argentina and Brazil yesterday agreed to a 1.5 billion dollar-equivalent currency swap aimed to boost each other’s currency standing.” Meanwhile as Businessweek reports, “Argentina signed a $10.2 billion currency swap with China in April.”
China is continuing its pursuit of natural resources. Through competition the yuan will reduce the liquidity of the FRN$ by decreasing the area’s use of and dependence on it. This is another attack on FRN$ hegemony and bearish.
CONCLUSION
Brazil is a monstrous self-sufficient commodity powerhouse. America has long been able to exploit the wealth of this fertile land to fuel its dreams. But California and by extension America are completely out of control. Brazil is forming relationships with other wealth generators which is attacking the liquidity of the FRN$. Gold and silver bullion are slowly beginning to circulate as currency in ordinary daily transactions and thus increasing in liquidity.
As The Great Credit Contraction intensifies capital will continuing moving into the safest and most liquid assets. Consequently, North Americans will have to wake up and work in order to finance their dreams. North Americans ‘love the money fire’ which underscores the reason it is called the American Dream. Because you have to be asleep to believe it and gold is the shrieking fire alarm and insurance!
Disclosures: Long physical gold and silver with no position in the Real, long-term US debt or Petrobras.
By Winton Bates, on May 18th, 2009
Your chances of success in life depend on your intelligence, your family background and your temperament, don’t they? Yes, to some extent. But over the last few days I have read about research findings which suggest that beyond a threshold IQ doesn’t make much difference, the important aspects of family background are only superficially related to wealth and the predictive importance of childhood temperament tends to diminish over time.
In “Outliers” Malcolm Gladwell tells the story of research conducted by Lewis Terman who identified 1,470 Californian children with very high IQs (over 130) in the 1920s. Terman believed initially that members of this group were destined to be among the future elite of the U.S. When they grew up, however, the majority had careers that could only be considered ordinary. It turns out that the relationship between IQ and success works only up to a point. Additional points of IQ beyond about 120 (remember the population average equals 100) don’t seem to have much impact on success.
Further analysis divided these genius subjects into three groups and looked for reasons for differences between the achievements of the most successful and least successful groups. The main difference seemed to be that the most successful performers came from the middle and upper class – the most successful group contained almost none of the children from the lowest socioeconomic class. Later in his book Gladwell points to evidence which suggests that the link to socioeconomic class has little to do with things that are directly associated with wealth or even with the quality of schooling. Research by Karl Alexander shows, for example, that the main difference between reading scores between elementary school children emerge during the summer vacation period while they are not at school. The wealthier parents tend to cultivate the interests of their children in reading etc. even during the summer vacation period. The difference seems to have more to do with culture than with income.
Gladwell’s main point is that it is impossible for superstars in any field to look down from their lofty perches and say with truthfulness, “I did this all by myself”. Gladwell argues: “They are the products of history and community, of opportunity and legacy. Their success is not exceptional or mysterious. … The outlier, in the end, is not an outlier at all” (p 285).
Something else I have read recently that relates to the determinants of successful lives is Joshua Wolf Shenk’s article “What Makes Us Happy” (The Atlantic Online, June 2009). Shenk’s article discusses George Vaillant’s research, based on the Harvard Study of Adult Development. This study of healthy, well-adjusted Harvard students began in 1937 and followed its subjects for more than 70 years. As with Terman’s study, the leading researcher originally involved in the Harvard study thought he would be studying a group of people who would have successful lives. Many did in fact achieve dramatic success, but by age 50 almost a third of the subjects had at one time or another met Vaillant’s criteria for mental illness.
One of Vaillant’s findings is that the predictive importance of childhood temperament diminishes over time: shy, anxious kids tend to do poorly in young adulthood, but by age 70 they are just as likely as the outgoing kids to be happy and well. One of the factors that he found to predict healthy aging is “employing mature adaptations” to life’s troubles. Mature adaptations include altruism, humour, anticipation (planning for future discomfort) and delaying attention to an impulse or conflict. The second most important factor that he found to predict healthy aging was the quality of relationships, including with siblings, friends and mentors.
Will Wilkinson comments on his blog: “What I liked so much about this essay, and about Vaillant, is the recognition that the complexity of human psychology, the complexity of coping and adapting to the challenges life throws up, makes relationships or “social aptitude” no simple thing.” I agree.
This brings me back to Gladwell’s book. One of the things from “Outliers” that will stick in my mind is Gladwell’s account of the Roseto mystery. In brief, in the 1950s the inhabitants of Roseto (Pennsylvania), whose ancestors came from a town of the same name in Italy, had a very low incidence of heart disease and their death rate from all causes was 30 to 35 percent lower than expected. Researchers ruled out all the obvious causes such as diet, exercise, genes and location. Their explanation was that Rosetans had created a powerful, protective social structure capable of insulating them from the pressures of the modern world. In Gladwell’s words, it was about “the mysterious and magical benefits of people stopping to talk to one another on the street and of having three generations under one roof” (p 10).
This is very interesting and very complex. I find myself reacting in three different ways. First, in statistical terms “outliers” are chance events; before getting too excited about sociological implications we should establish whether there is evidence that other communities which share similar characteristics to Roseto in the 1950s have similar health outcomes. Second, leaving aside the “mysterious and magical” factors, the most useful place to look for an explanation would be in the links between happiness (emotional health) and physical health. Third, perhaps it is time I had a closer look at the research findings behind those headlines a few months ago which claimed that scientists now have evidence that happiness is contagious.
By Ajay Shah, on May 18th, 2009
Nifty
Click on the above picture to see it more clearly. If you haven’t been watching the action: The application of existing circuit breaker rules meant that the market opened, went limit up, opened again, went limit up, and closed for the day.
What can be traded
The action on the currency, and look at Nifty futures trading at SGX (!).
By Bron Suchecki, on May 18th, 2009
Went to the post Budget Westpac breakfast talk by their Chief Economist yesterday. Short summary: worst environment in 70 years; recovery will be patchy and slow (maybe 3 years); but much more is being done this time compared to 1930s; we will get out of it and then business as usual; Australia better placed than US/UK re debt as % of GDP but current account deficit one of the worst in the world; Western Australia will hold up, but it will feel bad because growth will drop from 5% to 1% whereas the other states have already had to deal with and get used to decline; thought the first home owner’s grant will be our subprime as it is sucking in people who should probably not be given loans.
Interesting to hear this and feel the mood of the business guys there (I think 4 women in all). A big contrast to the views of the blogs I follow. There is still a bit of hope/expectation that this is a bit of a recession and just tough it out for a few years.
I feel we are at a pivot point, with Governments doing all they (think) they can to keep people believing it will just be a bump and people don’t want to hear really bad news so they want to believe it but still will be scaling back spending, you know, just to be safe.
Martin Armstrong recently told the story of a Japanese investor who bought into the market just at the peak. He asked why he did it and the answer was that the investor’s broker had been telling him to get in for 6 years and finally he thought he should. Martin then says it is when the last person has piled in that a bubble busts. I think it is the same on the way down – not until the last person has lost hope will the bottom be found. The green shoots are telling us we aren’t there yet. There are still greedy people out there wanting to make up their losses, or optimists that think we are at the bottom.
The question is whether Governments can pull the confidence trick off and keep the green shoots alive. If you don’t think this is at all possible, I would suggesting reading this post of mine from last year. I don’t think it is possible, but I also never underestimate the gullibility of the average person and their unwillingness to face unpleasant realities.
By Winton Bates, on May 15th, 2009
In the Australian federal budget delivered earlier this week, forward estimates of revenue and spending were based on Treasury projections of economic growth rates in excess of 4 percent coming out of the current recession. This projection has attracted attention because the projected growth rates are higher than those experienced in Australia during recent boom years.
It seems reasonable to me to suppose that growth rates might be somewhat above trend when an economy comes out of a recession. An economy that is not limited by capacity constraints obviously has potential to grow more rapidly than one approaching full employment.
However, the Treasury’s optimism about future economic growth prospects in Australia seems to me to sit oddly with their more guarded views about prospects for the world economy. In discussing the outlook for the world economy Treasury states: “Even when growth returns, the recession will leave a legacy of significant policy challenges across the world. The extraordinary measures being taken to combat the current crisis will have to be unwound carefully.” Governments will not find it easy to unwind these extraordinary measures. This means that commodity exporting countries like Australia should expect the world economy to give them a fairly bumpy ride in the years ahead.
Why is Treasury so optimistic about Australia’s growth prospects? The Treasury forecasters base their optimism on the growth rates experienced in Australia following recessions in the 1980s and 1990s. Their projected growth rate is about the same as that following the 1990s recession.
Even if it is reasonable to expect world economic growth in the 2010s to be as robust as in the 1990s, is it reasonable to expect that Australia’s productivity growth in the 2010s to be as high as in the 1990s? The 1990s was a period in which multifactor productivity growth in Australia was more than double the rate experienced in recent years. High rates of productivity growth in the 1990s stemmed to a large extent from productivity improvements in the services sector, which were associated with micro-economic reforms (neo-liberalism in the terminology favoured by Australia’s current Prime Minister).
Where will comparable productivity improvements come from during the 2010s? Perhaps the government has plans for extensive microeconomic reforms that it has yet to announce. But I wouldn’t bet on it!
By Trace Mayer, on May 15th, 2009
On 16 December 2008 in Oil Majors Should Just Buy Real Gold I wrote, “The entire eligible COMEX stockpile represents an immaterial 0.36% of the current assets of the five oil majors. The oil majors could drain the COMEX with a rounding error. It would be 14% of what Exxon Mobil was spending per quarter buying back stock. Why buy back stock when oil is so cheap compared to gold? Why not just buy physical gold and truck it away?” As the chart shows, Exxon and the other oil majors should have done that. COMEX stockpiles have also precipitously declined.
London and Zurich have been the loci of gold trading for centuries. The London gold vaults serve the needs of the London Bullion Market Association. On 11 May 2009 The LBMA reported, “Gold ounces transferred between accounts held by bullion clearers fell 7.6 percent to a daily average of 20.5 million ounces in April from a month earlier. … Ounces transferred in silver rose 2.4 percent to a daily average of 101.1 million.” This amounts to approximately $19B of physical gold and $1.4B of physical silver which exchange everyday.
THE EXCHANGE TRADED FUNDS
Many people think the GLD ETF claims to physically possess more than 32M ounces of gold. On 29 March 2009 Jake Towne wrote, “The inventory of SLV has leapt from 218 million ounces since January 1st, and reached 267 million ounces on March 26. This exceeds the limit of 264 Moz that the trust had set for the custodian, JP MorganChase. In the new prospectus (pg 8/44), the text reads:
The custodian has no obligation to accept any additional delivery on behalf of the trust if, after giving effect to such delivery, the total amount of the trust’s silver held by the custodian exceeds 264,550,265 troy ounces. If this limit is exceeded, it is anticipated that the trustee, with the consent of the sponsor, will retain an additional custodian… As a result, the new agreement may differ from the current one with JPMorgan Chase Bank N.A., London branch, with respect to issues like duration, fees, maximum amount of silver that the additional custodian will hold on behalf of the trust, scope of the additional custodian’s liability and the additional custodian’s standard of care.
I have not been able to find out who SLV has named as the new custodian.”
I have written extensively about the problem with the GLD ETF prospectus regarding the actual possession of gold.
CENTRAL BANK GOLD PRICE SUPPRESSION SCHEME
Dr. Greenspan testified before Congress in 1998, “Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise.”
Ad hominem attacks, those which appeal to emotions instead of reason or logic, are for the intellectually slothful mental midgets. Ideas can only be overcome by other ideas. When confronted by superior ideas it is common to lash out like a frightened animal, appeal to emotion and refuse to confront the fitter ideas. After all, when one will lose the fight the only option is to flight.
GFMS claims to be “the world’s foremost precious metals consultancy, specialising in research into the global gold, silver, platinum and palladium markets. … GFMS can claim to be the only genuinely independent researchers of the gold market, as we do not rely solely on financial support from one sector of the industry. You can trust us to give it to you straight.”
When questioned about debating the Gold Anti-Trust Action Committee about the central bank gold price suppression scheme Philip Klapwijk, Executive Chairman of GFMS, “replied with a very definite “NO!” He quoted Margaret Thatcher on the IRA in that he would not wish to give the GATA views the publicity that such a debate might generate.”
The truth will cleave its own way and GATA’s views are spreading as billionaire Adam Fleming recently hosted GATA on 7 May 2009 in London. ”Wednesday was a great first day of work for GATA’s delegation to London — GATA Chairman Bill Murphy; Sprott Asset Management’s chief investment strategist, John Embry; John’s wife, Nancy; and your secretary/treasurer.
We had interviews with the Sunday Times and Dow Jones Newswires and then in the evening made an hour-long presentation to a group of about 80 financial and mining people at the office of Fleming Family & Partners.”
Mr. Robert Landis, a graduate of Princeton University, Harvard Law School and member of the New York Bar, has asserted that “Any rational person who continues to dispute the existence of the rig [central bank gold price suppression scheme] after exposure to the evidence is either in denial or is complicit.”
POSSIBLE GFMS INVOLVEMENT IN THE GOLD PRICE SUPPRESSION SCHEME
As the ‘world’s foremost precious metals consultancy’ surely Mr. Klapwijk cannot be ignorant of GATA’s assertions. He implied familiarity by saying he did ‘not wish to give the GATA views the publicity’.
If one has superior ideas and arguments then why be so afraid of debating a hoard of Harvard trained attorneys? He should show GFMS’s independence and preeminence as the foremost precious metals research firm by rebutting GATA’s claims in a formal debate. Surely that would be good for GFMS’s business. Or is Mr. Klapwijk as Executive Chairman of GFMS complicit in the central bank gold price suppression scheme?
IMF ASSERTION OF COOKED CENTRAL BANK BOOKS
In a recent article by Rob Kirby of Kirby Analytics titled Forensic Examination of the Gold Carry Trade he found yet another very interesting passage from an IMF paper titled Treatment Of Gold Swaps And Gold Deposits (Loans), on page 4: “7. The current statistical treatment of gold swaps should be consistent with that of repos. The guidance of paragraph 85 (iii) of the Guidelines, which is applied to gold swaps by paragraph 101, results in overstating reserve assets because both the funds received from the gold swap and the gold are included in reserve assets. While the gold is swapped, it cannot be the case that both the claims and the gold are simultaneously liquid and readily available to the monetary authority.”
In other words, as GATA has long asserted the central banks “carry gold in the vault and gold out on loan as one line item; as a result report cash and accounts receivable as one in the same thing.” Additionally, central banks receive currency when they loan the physical gold generating the accounts receivable. Deceptively they carry both the currency and the accounts receivable on their balance sheet as assets.
Anyone reading the report should take seriously the disclaimer on page 1, “The views expressed in this paper are those of the author(s) only, and the presence of it, or of links to it, on the IMF website does not imply that the IMF, its Executive Board, or its management endorses or shares the views expressed in the papers.” I doubt the Executive Board wants to endorse a report that blatantly shows how the central banks are double counting their assets.
THE ARABS ARE TRUCKING OFF THE GOLD
On 13 May 2009 Emirates Business 247 reported that the Dubai Multi Commodities Centre has finished a state of the art vault which will become the new home for the Dubai Gold Securities’ ETF. Additionally, ”It’s a natural home for the central banks in the region to store their gold in Dubai rather than in London where they have typically held their gold. Particularly when DMCC has a state-of-the-art facility to store such precious metals,” said Jeffrey Rhodes the CEO of INTL Commodities DMCC, a Dubai-based gold dealer.”
As revealed by China’s recent announcement of an increase in gold reserves from 600 to 1,054 tons it appears that the Western central banks are overstating their physical gold reserves while the Eastern central banks are understating them. Now the Middle East is demanding physical possession of their gold. It will be interesting to see whether a failure to deliver occurs at a major exchange such as the COMEX or LBMA.
CONCLUSION
At all times and in all circumstances gold and silver are money. Even though the great credit contraction has begun there is a microscopically small amount of physical gold and silver bullion compared to the financial assets which have not yet evaporated. The GLD and SLV ETFs purportedly hold large amounts of physical bullion but their respective prospectus are riddled with risk. For decades Western central banks have bled gold through minor wounds.
But now Eastern and Middle Eastern central banks, ETFs and gold dealers are reducing their risk by taking physical delivery of bullion. In effect, they are digging into and ripping wide-open the wound and causing gold to spurt out like a failing dam. Gold is cash and to be bought when one does not know what else to buy. Like the Eastern and Middle Eastern central banks, individuals should only buy gold or silver bullion for physical delivery or use a trusted third party vaulting service that has the physical bullion in possession along with appropriate corporate governance like GoldMoney or your gold might learn how to vanish.
Disclosures: Long physical gold and silver with no position in XOM, GLD or SLV.
By Winton Bates, on May 14th, 2009
There is a standard joke among economists that equity markets have predicted about 10 of the last 5 recessions. As the joke acknowledges, equity prices embody predictions of future earnings and this implies that they also embody predictions of economic growth rates.
So, what is the rate of economic growth implied by current equity prices?
A good way to think about this is to consider why there is a difference between the current average dividend yield (annual dividends per share as a percentage of the current share price) and the real bond yield (bond yield minus expected inflation rate). This difference is required to cover two elements: the equity risk premium and the expected future rate of growth in dividends. If it is reasonable to assume that the expected rate of growth in dividends will be equal to the rate of economic growth over the longer term, the market’s expected rate of economic growth is given by:
y = (r – p) + x – d
where: y = expected real GDP growth rate;
(r – p) = real long term bond yield;
x = the equity risk premium; and
d = dividend yield.
So, it is a simple matter to calculate y if we know r, p, x and d. Unfortunately, however, there are a couple of thorny issues that need to be considered regarding appropriate numbers to use for the real bond yield and the equity risk premium.
When I last looked at this question (about five years ago) I decided that it would be more appropriate to use a long term average real bond yield than a current real bond yield. If the current bond yield is used, the results seem to become unduly sensitive to current monetary policy settings. In my calculations for Australia I used a real bond yield of 4.5 percent.
What rate of equity risk premium is appropriate? The equity risk premium is one of the few topics for which it could actually be reasonable to claim that if you laid all economists end to end, they still would not reach a conclusion. To cut a long story very short, I used the average equity risk premium implied by the relationship between GDP growth rates, average real bond yields and average dividend yields in Australia over the previous 20 years. This implied an equity risk premium of about 3.3 percent. (I am prepared to make available an unpublished paper discussing the methodology to anyone requesting it by email.)
When I did the arithmetic with the dividend yield prevailing in August 2003 (4.3 percent), I came to the conclusion that the expected real GDP growth rate for Australia implied by then current equity prices was 3.5 percent per annum. Since this was only marginally above the average growth rate for the previous 20 years, it did not seem to me to be unduly optimistic.
When I do this arithmetic now, with the current average dividend yield (6.6 percent on 18 November, 2008), it suggests that the expected real GDP growth rate for Australia implied by current equity prices is 1.2 percent per annum. That seems to me to imply that current share prices in Australia embody an unduly pessimistic view of longer term economic growth prospects.
Health warning:
There is a rumour going around among former work colleagues that when I was living off my earnings as an economic consultant I was heard to say, more than once, that free economic advice was not worth much. That rumour is true, but I have since changed my opinion. There is no truth at all in the rumour that I have been heard expressing the view that there are three kinds of economists: those who can count and those who can’t. I tried to say that once, but I ended up saying that I didn’t know whether I should be considered to be in the first or second category.
By Trace Mayer, on May 14th, 2009
The inherently unstable, fundamentally unsound and immoral worldwide financial system organized out of intrinsically worthless debt has exploded into derivatives and imploded into a greater depression. Several of the stronger voices in the financial press evade the D word which hangs over the world economy like the Sword of Damocles.
But Yahoo Finance! reports, “The Obama administration is asking Congress to extend its oversight of the financial system to include the shadowy market of derivatives, the kind of complex financial instruments that helped bring down the giant insurer AIG. … The global business world holds a staggering $600 trillion of these [over-the-counter] contracts.”
 The Obama administration is already doing everything they possibly can to intentionally exacerbate the greater depression. The use of political debt-based currency is destined to either implode in a deflationary depression or explode in hyperinflation. As the Treasury bubble predictably bursts interest rates will rise. The bond market is trembling as recognition that a 30-year bull market is coming to an end.
DERIVATIVES
Wikipedia gives a fairly clear definition of a derivative. ”Derivatives are financial contracts, or financial instruments, whose values are derived from the value of something else. … Because the value of a derivative is contingent on the value of the underlying, the notional value of derivatives is recorded off the balance sheet of an institution, although the market value of derivatives is recorded on the balance sheet.”
Wealth can be either a tangible or financial asset. Tangible assets have intrinsic value and can never become worthless while financial assets can. Often times financial assets are subject to counter-party risk. Counter-party risk is the risk of loss due to a counter-party’s non-performance and is contingent upon their financial ability to pay.
In the shadowy world of derivatives there are many counter-parties potentially liable for hundreds of trillions of dollars. These derivative assets infect the balance sheets of many public and private corporations, local and state governments and other institutions. Through the use of fair-value lying the value of the derivative assets is hugely overstated while the value of the derivative liabilities is hugely understated. Even worse is that the contingent liabilities have no basis in reality because they are based on nominal market value and not notional value.
Credit default swaps insure against a counter-party failing to make their payment. Currently premiums for credit default swaps are twice as high on British sovereign debt as Cadbury. In other words, a company that makes chocolate eggs is a better credit risk than a major western government.
APPLICATION TO PENSIONS
A good example of a derivative is a pension. For example, an individual works for Chrysler for 40 years and retires. Chrysler agrees to pay $2,000 per month for the rest of the retiree’s life. The value of the pension is derived from the value of the underlying (Chrysler).
Chrysler will use actuarial methods under GAAP, which can now be based on fair-value lying, to calculate the estimated pension liability. We will assume it is exactly 15 years or $360,000 which would then be adjusted to the net present value which we will assume is $150,000. This nominal market value would then be carried on Chrysler’s balance sheet as a liability.
On the other hand, the individual uses their own method of fair-value lying to calculate the value of the pension. They may be optimistic and overstate their expected remaining life span at 40 years and use a more friendly discount rate to arrive at a net present value of $450,000, or three times as much as Chrysler’s valuation.
Viewing the balance sheets systemically there is an asset of $450,000 with a corresponding liability of $150,000. But the value of that $450,000 asset is also contingent upon Chrysler’s ability to pay and therefore subject to counter-party risk.
If Chrysler goes bankrupt then there is potentially at least $300,000 of illusory capital in the financial system that evaporates. Of course, some creative investment bank who has loaned currency to Chrysler may actually profit from their bankruptcy and the greater the disparity of illusory capital and real capital then the greater their profit.
GOVERNMENT HELPLESSNESS
During the great inflationary credit expansion the use of illusions, irredeemable government or central bank tickets, as currency in ordinary daily transactions has become universal. Their legal tender status, which is in complete conflict with the United States Constitution, is massive government regulation and the chief cause of all the current financial problems. By violating the supreme law of the land Congress has created this massive mess.
 Now the Obama administration wants Congress to engage in more regulation and intervention. But why would these costumed officials be able to fix the problem they created? Indeed, the only real tools they have are either their little intrinsically worthless tickets, which function like their common stock, or their guns.
Indeed, if the Obama administration sincerely wanted to fix this mess then they would remove the 28% tax on gold and then repeal the legal tender status of the FRN$.
The common stock of America’s owner has recently declined to around 82 and is looking increasingly unattractive. As Vladimir Putin observed “The only problem: your results were poor and this will always be the case because the work you do is unfair and immoral. In the long run immoral policies always lose.”
But the truth of the matter is that the little tickets are subject to an incredible amount of counter-party risk. Federal government liabilities are estimated to be around $100T. When the tax eaters and soldiers no longer get paid with currency that will purchase anything and the purchasing power in their pensions are gone then things will get particularly interesting.
CONCLUSION
The golden Sword of Damocles has begun moving because the great deflationary credit contraction has begun. As the common stock of nations continues evaporating civil unrest will increase. The greater depression will make servicing debt increasingly difficult and many derivatives will continue to trigger and decimate entities during this deflationary crash. Confidence, already slightly eroded, will be completely destroyed as counter-party risk continues materializing. Corporations and governments will DEFAULT resulting in complete worthlessness of those assets. But who needs the dangerous costumed Washington clowns anyway?
Through all of this chaos and change there will be at least one brilliant asset. At all times and in all circumstances gold is money. Gold is the only major currency not subject to counter-party risk. Gold cannot default. Therefore, during deflation if the like-cash FRN$ is king then the real form of cash, gold, is emperor.
Disclosures: Long physical gold and silver with no position in TLT.
By Evelyn Black, on May 13th, 2009
 Sales of Ford Motor Company’s trademark pick-up trucks and SUVs were down 28% for the month of June, sending the DOW plunging into bear territory again, along with news of the worst inflation yet this year and oil prices today nipping at $143 per barrel. It’s sad really, but also more than a bit maddening.
I’m old enough to remember Ford’s slogan from bygone (and definitely better) days:
Ford Has a Better Idea!
Here and now I want to say to Ford, cool, let’s have it! Time for that better idea guys, and let’s make it snappy, shall we? Because so far, all I’m seeing is lots of panic and punditry, lots of CEO dithering and blathering, but a noticeable dearth of those famed better ideas. It’s as though the whole country has become mesmerized with helplessly watching the steady upward movement of oil prices, kind of like in those old black and white cartoons where some cute loopy farm animals lay around and wipe their brows as the temperature climbs higher and higher and the mercury finally busts out the top of the thermometer with funny sound effects.
I got an email from Common Cause today, which informed me that the 1927 Ford Model-T got 20 miles to the gallon, and the 2007 Ford Taurus gets 28 miles to the gallon.
That’s an improvement of 8 miles to the gallon in 80 years.
Now I know that designing automobiles is hard and complicated stuff and girls just can’t possibly understand it, (especially girls like me who work in call center bank jobs), and that we should really leave these issues to guys with engineering degrees and pocket protectors and CEOs in expensive suits, and not try to butt in where we don’t belong. Still, I’m thinking 80 years is enough time. They’ve had their chance and then some. I’m thinking that at this point, even a bunch of girls could definitely can do better than an 8 mpg improvement. It wouldn’t even have to be a bunch of particularly brilliant girls.
Seriously, we could set it up like on of those dippy reality show competitions that are all over cable TV right now, (there are, for example, dog groomer reality show competitions, interior designer reality show competitions, cooking host competitions…you name it, it’s on cable as a reality show competition). So why not a “design a better Ford” reality show competition, girls only! What do we possibly have to lose?
Say you put Kathy Griffith, Paris Hilton, Cindy McCain, Oprah, and Katie Couric in a little room and said, ” OK girls, here’s the deal: You have eighty years to design a cute inexpensive little car that gets at least 50 miles to the gallon. The first one to come up with a viable design gets out of this little room and wins a Tesla, a gift certificate at Tiffany’s, and a whole new wardrobe from Saks (with Stacy and Clinton from What Not to Wear not even in the same universe, let alone the same store.)” Here’s a Blackberry, $5000, and some paper for each of you. Have at it and may the best woman win.
I’m telling you, that show would be over in about three episodes, if not sooner. Ford would have its better idea, some lucky girl would have a Tesla, some diamonds, and a new wardrobe, and the day would be saved.
You’re welcome.
Not that I expect anyone from Ford to pay any attention to me mind you. That ‘you’re welcome’ was sarcasm in case you didn’t pick up on that. You see, I’ve had to interact with Ford Motor Company before, so I know exactly what we’re dealing with here, and trust me, it ain’t pretty.
Let me tell you a story by way of illustration.
 In 1991 my mother died and left me a small amount of money. I bought a house and an IMac, and I had just enough left to buy a small car. Now at that time, GM was building a horrible little car called a GEO Prism that got great gas mileage; well over 50 miles to the gallon. It was all over TV, but could I find a single GEO Prism on a single Chevy lot? I could not. I was shown a Cavalier. No, I said, I don’t want a Cavalier, I want a GEO. I went to another dealer who said, “We don’t have any GEOs right now, but if you give me your address and phone number, when we get one in, I’ll personally drive it over to your apartment and let you test drive it before any one else even sees it.”
That was just creepy.
At my third GM dealer, no one would even talk to me. Lots of guys in bad polyester doing not much of anything seemed to be roaming about everywhere, but the very whisper of the word GEO sent them scrambling into their little locked offices.
Fine, I thought, I’ll call Ford. So I did. I called the Ford dealer closest to me and asked for a salesman. I got one. Once the salesman was on the phone I said, “You have a small car called an Escort. Do you have any Escorts on your sales lot right now?” Yes, he said they had a gazillion Escorts. “If I come there right now, with cash, will you sell me one of your gazillion Escorts? And I warn you, don’t toy with me, you are my fourth dealer today, and I’m in no mood for BS.” He assured me he would be beside himself with delight to have the pleasure of selling me a Ford Escort in exchange for my cash money.
Half an hour later, I was driving around in a blue Ford Escort with a balding man in a red polyester leisure suit, who was busy regaling me with tales about what was wrong with each of his former three wives. Finally I stopped the car, looked him straight in the eye and said, “Stop it. I don’t care about your personal life or anything else about you. You are being very inappropriate. Please be quiet and only answer questions I ask you so that I can make this decision.”
We got back to his office. I decided to buy the blue Escort for $12,730. When we sat down to sign the papers, he said that he would have to go talk to his manager about the price. I said, “I’m offering you the sticker price. Don’t tell me that nonsense about your manager. Everyone knows you don’t really talk to your manager, just sell me the car for God’s sake.”
He went to talk to his manager anyway, grinning all the way. Then I saw them both grinning and looking at me. Ha, ha. They knocked $500 off the sticker price (unasked) and threw in an FM radio and cassette player. I said thanks, gimme the car.
About a month later, Ford Motor Company sent me a lovely brochure along with a questionnaire asking me how my recent buying experience went, and how could it be improved? So I told them. In detail. Why on earth, I wrote, do all car dealerships hire these creepy losers to stalk the lots when over 50% of the people buying cars are women? Are you trying to make us hate you? Because if so, it’s working.
I only recount this story to show that 1) Ford doesn’t want to have a better idea, it wants to sell trucks to guys, 2) an affordable car that got over 50 mpg was available over 15 tears ago, so what is the big issue with building one now? and 3) the women of America should forcibly take over Ford Motor Company right now and start running it intelligently while there is still time.
I’m thinking, if their stock falls much farther, taking them over shouldn’t even be all that expensive. It could easily be a bloodless coup, especially if we all wear heels when we show up.
Now, who wants to talk color palettes?
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