Being Positioned And Prepared For The Unexpected

When the time for performance comes the time for preparation has passed.

Gold has powered higher at an incredible and, for many, unexpected rate going from FRN$1,658.75 in the 5 Aug PM London fix to FRN$1,761.50 at 6am 9 Aug London time. The DOW:GOLD ratio has plummeted to around 6.15. Hope you are strapped in because turbulence is ahead!

I recently finished two weeks in London which ended with the GATA Gold Rush 2011 conference. I was in the room during the taping of the Jim Sinclair interview. How right has he been all along!

Now I am in Athens headed to the islands for an enjoyable two weeks. With all the turmoil I often wonder: Do the riots follow me or do I follow the riots?

One common theme on RunToGold is to assess the probability and gravity risks, analyze potential solutions or plans and then take action with provident living principles which may lead to survivalism in the suburbs or some other form of life hedge.

UNITED STATES LOSES TRIPLE A RATING

In April Treasury Secretary Timothy Geithner was asked concerning the risk of the U.S. losing its triple-A credit rating: Secretary Geithner replied, “No risk of that.”

Then the politicians bickered about the debt ceiling and came to a faux resolution. On 5 August 2011 the Wall Street Journal reported:

S&P removed for the first time the triple-A rating the U.S. has held for 70 years, saying the budget deal recently brokered in Washington didn’t do enough to address the gloomy outlook for America’s finances. It downgraded long-term U.S. debt to AA+, a score that ranks below more than a dozen governments’

Boom, Boom, Pow!

THE GREAT CREDIT CONTRACTION INTENSIFIES

In 2009 Mr. Sinclair said of my liquidity pyramid: “A very good, simple and clear representation of the problem lacking a practical solution.” Before his interview at the GATA conference I wanted to thank him for his gracious compliment. Regarding the liquidity pyramid Mr. Sinclair remarked, “Perfect.”

PREPARATION, CONFIDENCE AND CALM

I have received a tremendous increase in comments and emails from readers and friends. They all seem to want expert advice from someone who knows what is going on. Why do you think I wrote hundreds of articles on Run To Gold? When the time for performance comes when the time for preparation has passed.

I really wish I could provide some advice for those ‘caught between a rock and a hard place’ who are watching their pensions and retirement accounts evaporate. But I am off swimming in the beautiful islands of the Mediterranean Sea and do not have ready access to the phone.

Those darn crazy gold bugs do not look so crazy now. How right was Mr. Sinclair when he called $1,650 gold a decade ago when it was around $265? Good thing his thin skin is gold-plated.

But I have already written about the evaporating Euro, how retirement accounts could boost Treasuries and as I wrote in 18 January 2009 why and how the Treasury bubble will burst:

As the yields on Treasury Bills approach 0% they have the return of cash but do not have the benefits of cash as they may be impregnated with counter-party risk or have decreased liquidity.  In other words, Treasury Bills and cash have the same benefit profile but not the same safety and liquidity profile.

The Wall Street Journal reported 4 August 2011 that “Bank of New York Mellon Corp. on Thursday took the extraordinary step of telling large clients it will charge them [0.13%] to hold cash.”

Now the FRN$ moves one step closer to evaporating. Why pay 0.13% to hold FRN$ when you can pay a 0.18% storage fee to hold unencumbered allocated insured gold? Is it really wise or prudent to save five basis points to be in a potentially worthless fiat currency while being an unsecured creditor of an institution(s) that has needed trillions in bailouts? Treasuries are not looking so risk-free are they?

CONCLUSION

What is happening is no real surprise to those who understand monetary science and basic economic law. I laid out the case years ago in my book The Great Credit Contraction. Those persuaded have likely ensconced themselves within a financial forcefield of silver and gold.

As the storm rages and intensifies they feel no particular urgency or panic. They are prepared for Winter and can remain solvent much longer than the market can remain chaotic. After all, the melting point for gold is 1,947.52 °F which may be its FRN$ after this latest up leg.

For those who are new, I recommend Apmex for coins because of their A+ BBB rating and low premiums and GoldMoney if you want a third-party to store your metals.

DISCLOSURES: Long physical gold, silver and platinum with no interest in DOW, S&P 500, the problematic SLV ETF, gold ETF or the platinum ETFs.

Household financial choice of the hapless households of India

In February 2010, I had the opportunity to visit Pudhuaaru KGFS in Thanjavur. This is a remarkable project which helps us see the interface between households and the financial system in a wholly new light.

What a difference 17 months makes! On that visit, I had found a little tenuous Reliance CDMA cover at one place in Thanjavur city. On
this visit, I found 3g or Edge cover in many remote places. On that visit, the ride from the airport at Tiruchirapalli to Thanjavur took
two hours. This time, it got done in 30 minutes on the new NHAI road, with a peak velocity of 110 kph. While there are many reasons to be gloomy about the problems that India faces, some things are moving along merrily.

The KGFS approach to households and finance

KGFS emphasises the very important idea that for households to correctly engage with the financial system, this relationship must be
(a) rooted in high quality advice, (b) which is grounded in a state of strong information about the household. The first is achieved by
focusing on the incentives of the front line staff, by pushing them to think about household financial choice in its entirety instead of
thinking about one product at a time, and by having no sales commission.

The removal of asymmetric information matters in many ways. On one dimension, if credit is extended to the household, a state of high information helps ensure better credit decisions. But more generally, across an array of financial products, when the advisor knows a lot about the household, the advisor would be able to synthesise an appropriate mix of sophisticated financial products which add up to an improvement in household welfare. In time, the advisor will increasingly lean on an expert system to help him do this better: it’s a good approach today and it will get better in coming years.

I think there is enormous value in this approach. I believe that KGFS is doing a great job of building this kind of information about
households in their present rollout (which involves going into really small villages at three locations, in Thanjavur, in Uttarakhand and in Orissa).

The typical KGFS front-end is a three-man branch in a village, where the three employees live in that very village. Remote villages
in India are an environment of radical transparency. The households are relatively trusting. The three people in the outlet know an
incredible amount about the households that surround them. Households and dwellings in small villages are rather stable: there is relatively little action through migration / change in financial conditions, etc. If there was ever an environment where asymmetric information is being removed, it is this.

The line between household finance and small business finance cannot be drawn. An adaptation of the KGFS approach can be quite
effective with small business also: the KGFS branch would obtain a full picture of the firm, and deliver a portfolio of financial
services to it.

A nice feature of the places where KGFS branches are being rolled out is the lack of alternatives. At a time when Indian financial
regulation does not do much to check the behaviour of conventional financial distribution, a few high pressure sales agents can queer the pitch for the KGFS staff. By being in remote places that are being ignored by distributors, the KGFS staffpeople have the luxury of dealing with households without the households being tugged by various high pressure sales tactics of rival sales agents.

Urban households are being mistreated by finance

I also realised some limitations of this approach. Looking forward, India is urbanising. At first blush, it may appear that there is a big
problem with the utilisation of finance in rural India. But there are big problems with the utilisation of finance in urban India.

The urban middle class and upper class is deluged with sales pitches by a variety of sales agents of financial firms. But these
agents are almost always mis-selling, given their drive to push a product (through commissions) and given their lack of knowledge about the household’s overall financial problem. Almost all financial products that are pushed in India (i.e. sold and not bought) seem to be mis-sold. I also feel that when the conversation between a sales guy and the household is about a product and not the overall household financial choice, it is almost always leading to the wrong answers. It’s tantamount to a salesman who sells a drug without knowing anything about the patient.

What is out there, in urban finance, is a scandal, and I am embarrassed to be an accessory to the crime (in however peripheral
fashion). While in Thanjavur, I got the odd sense that at its best, a rural household that’s well connected to a local KGFS outlet is doing
better on utilising the power of finance, when compared with most urban households who are victims of the sales practices that are
mainstream in Indian finance.

In this sense, the real problem for India is not the tawdry state of financial inclusion of the very poor in remote places. The real
problem for India — one that influences the bulk of Indian GDP and the households that matter greatly for India’s growth — is the tawdry state of financial planning of the typical urban household.

The KGFS approach is valuable and important to the places where it’s being rolled out. But the burning challenge is that of fixing the
mainstream. The mode of India is not brutally poor and isolated; it is middle class urban. Improving the interface between middle class and urban households, and the financial system, matters on a GDP scale.

An unrelated rumination: How important is rural deprivation in thinking about India?

The discussion above is a recurring theme in Indian economics. A variety of incentives (development journals, first world aid agencies, government rhetoric) make it fashionable to emphasise rural deprivation. But India is changing and the sweet spot has shifted. The emphasis on poverty and rural is increasingly off-centre. To stay relevant, and do the most important things in today’s India, we have to keep our eye on the ball.

To fix intuition, it’s useful to look at the distribution of annual household income, over April 2010 to March 2011, from the CMIE
household survey
of 143,000 households:

Percentile Household income
10 45,700
20 59,900
30 72,800
40 90,000
50 112,200
60 142,500
70 180,000
80 240,000
90 348,500

As an aside, I think it’s useful for anyone who thinks about India to memorise these nine numbers. Or at least memorise these three
numbers: the 25th percentile is Rs.66,000; the median is Rs.112,200 and the 75th percentile is Rs.208,500.

Middle India today has a household income from Rs.66,000 a year (at the 25th percentile) to Rs.208,500 a year (at the 75th
percentile). The old-style Indian story of rural deprivation is (roughly speaking) about the 20% of households who are below Rs.59,900 a year (and the size of that group is shrinking). The main story of India is about the remainder.

An emphasis upon exotic poverty is as misplaced, in thinking about today’s India, as an emphasis on designer clothes. Perhaps a bit
worse, looking forward, since the extremeties of deprivation are being extinguished by growth, while designer clothes are a superior
good.

Urban households are a much harder problem

So it’s natural to ask: How can the KGFS approach be applied to urban India? When dealing with the urban poor and middle class, it
seems that things are much harder.

Rural households tend to be more trusting, particularly in an environment of ethnic homogeneity and the repeated game that prevails in the village setting. But in urban India, households are more skeptical given the lack of ethnic ties and given the greater
experience with people who have finked in prisoner’s dilemmas.

Rural households tend to be a stable household in a stable dwelling place. Urban households tend to be physically mobile with greater fluctuations in the household composition.

Until deeper reforms on consumer protection take place in Indian financial regulation, urban households will be constantly tugged by unscrupulous sales agents of financial firms pushing products based on high pressure tactics Even if a KGFS tried to be patient and thorough, the very presence of such high pressure sales tactics would contaminate what a KGFS and its ilk can do.

It is relatively easy to construct information about the economic environment of a farming household (though seasonality and revenue volatility is a serious concern). I feel it may be relatively hard to even put together a picture of an urban household, particular when there is informality of labour supply coupled with entrepreneurship. This makes it difficult to do financial planning for such households.

On the other hand, in urban India, the revenue per household would be higher, and perhaps households could be persuaded to pay for advice qua advice. Or, the government could move on giving out advice vouchers to households, thus spurring the rise of an unconflicted advice industry.

Summary

I think KGFS is a great approach and it will be fascinating to watch them execute their agenda in the really remote places of
India. What they are doing is path-breaking and important. This should help us set our sights higher on the problems of urban India. I
have traditionally felt gloomy, in the knowledge that most households in India are being scammed by the agents selling financial
products. As I look at KGFS, I find myself thinking: Can’t we do something like this in mainstream India? I think this is an
important question to ask. At the same time, there are some visible hurdles which suggest that this will be hard.

Credits

I am grateful to Bindu Ananth, Ramesh Ramanathan, S. G. Anil Kumar, Kshama Fernandes and K. P. Krishnan for many conversations which helped in improving this post.

Turning $400k into $1.2m

Late yesterday the bullion desk manager let me know that one of “my clients” had sold up. By “my clients” she meant clients I knew from when I worked on the desk, which was a long time ago.

This client bought $400,000 of gold about 15 years ago and sold it yesterday for $1.2 million. He and his wife are now in their seventies and are now drawing down on their nest egg.

Sometimes I’ve asked myself whether working at the Mint is of any benefit to society, whether it is a productive job – we don’t make anything useful like cars or food – we just melt and stamp and store metal.

It is days like yesterday however that give me a boost and make me feel like I am doing something useful.

Economic Events on August 9, 2011

At 7:30 AM EDT, the NFIB Small Business Optimism Index for July will be released, providing information regarding the health and confidence of small businesses in the United States.

At 7:45 AM EDT, the weekly ICSC-Goldman Store Sales report will be released, giving an update on the health of the consumer through this analysis of retail sales.

At 8:30 AM EDT, the Productivity and Costs report for the second quarter of 2011 will be released.  The consensus is that non-farm productivity decreased by 0.7% in the last quarter and labor unit costs increased 1.9%.

At 8:55 AM EDT, the weekly Redbook report will be released, giving us more information about consumer spending.

At 2:15 PM EDT, the FOMC Meeting Announcement will be made, which will provide insight into how long the Federal Reserve plans to keep their rates target at 0% to 0.25%.  It is assumed that there will be no immediate change in the Fed funds target rate, but any hint that rates could rise in the future could have an impact on the bond market and stock market.

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