Gold Far From Bubble Phase: Marc Faber

Marc Faber With more than 40 years as an economist to his credit and claiming gold as the “biggest position in my life,” Gloom Boom & Doom Report Publisher Marc Faber assures us that gold is nowhere near a bubble phase, but cautions that corrections of 40% are not unusual in a bull market. At the end of March, Faber will share his secrets for surviving corrections at the World MoneyShow in Vancouver. In advance of that appearance, he sat down with The Gold Report for this exclusive interview where he discusses his bias for portfolio diversification in terms of geographies as well as asset classes.

The Gold Report: After Standard & Poor’s (S&P) downgraded a cluster of Eurozone countries in January, you came out saying that downgrades should have been even deeper, depending on the country’s credit-worthiness. S&P did give below-investment-grade ratings to Portugal and Cyprus—BB and BB+, respectively—but you indicated that some of these countries warrant CCC ratings. Do you anticipate additional downgrades?

Marc Faber: If you accounted for the unfunded liabilities of most European countries, as well as the U.S., the quality of the government debt would be significantly lower. In other words, yes, I do expect to see more and more downgrades over time.

TGR: Could that happen in 2012?

MF: Yes, and some thereafter.

TGR: Have the markets priced in further downgrades already or should we expect a bigger impact in the next round?

MF: I don’t think the market has priced it in because the yield today on U.S. 10-year government bonds is 2%, and 3% on 30-year bonds. If the market were priced properly based on the quality of these bonds, the yields would be far higher.

TGR: Did yields change much with these recent downgrades?

MF: Yes, particularly in the U.S., where investors perceive U.S. government bonds as safe. The U.S. will pay the interest as long as it can print money. But suppose you buy a 10-year government bond that yields 2% and inflation is perceived to be 5–7%. To what extent would investors still buy these bonds? That question will arise one day.

TGR: You’ve discussed investors leaving the European markets in favor of a “safe haven” in the U.S. Would U.S. bonds continue with such low yields with the European downgrades?

MF: For a while, yes, but at some point people will wake up and realize that the U.S. will default through a depreciating currency—in other words, through printing money—or by not paying the interest on the bonds. I don’t think the U.S. will stop paying the interest, but printing more money will weaken the currency and produce higher inflation in consumer prices, asset prices and commodity prices. So being in U.S. government bonds will result in losses to investors through currency depreciation.

TGR: You’ve pointed out that negative real interest rates force people to speculate, which creates enormous market volatility. That seems to be happening now, but apparently investors are keeping a great deal of money on the sidelines as well. If that comes in, would it make the markets even more volatile? Or would you say the smart money will stay on the sidelines and the speculative money is in play already?

MF: I think there is a lot of money on the sidelines. Some will stay there, because people who don’t trust the system anymore will just keep it there. Some will be invested, but it may not go into equities. It could go into some other asset class, perhaps hard currencies such as gold and silver, or real estate, which is now relatively inexpensive in the U.S.

As for volatility, it increased sharply last year, but has diminished over the last three-months. I expect we’ll see increasingly very high volatility in all asset classes in the next few years. The money in an environment of negative real interest rates will flow. It might flow into fewer and fewer stocks, or into fewer and fewer assets that could go ballistic on the upside.

TGR: Which asset classes would you expect on the speculative upside?

MF: We had the NASDAQ bubble 12 years ago, the housing market bubble probably five years ago, and I would say also a bubble in commodities in 2007–2008, when oil spiked to $147. What’s next, I’m not so sure. I could imagine some stocks, maybe some precious metals, in a bubble stage—not the entire market necessarily.

TGR: Could you delineate characteristics of stocks that will appreciate versus those that will stagnate or lose value?

MF: If we look at the market, we have some stocks where the outlook is perceived to be particularly bright, and then there are others—for instance, Eastman Kodak Company (EKDKQ:OTBPK)—that are at the opposite end of the spectrum. It depends on the fundamentals and the imagination of investors. I wouldn’t necessarily buy up, so I’m not saying it will go down. Maybe it will go up further. But in general if you buy the company with the largest market capitalization in the world you’re not going to make a lot of money.

TGR: What captures the imagination of investors?

MF: Basically mania fed by excessive liquidity, with more and more people convinced that something is the Holy Grail. It was the NASDAQ in 2000, Asia before 1997, housing from 2000 to 2006–2007, or more recently China. Exactly what it is, I don’t know. But when a market has been strong, the media write about it and people are attracted to it. Then some useless academics write books about why stocks, or real estate, always go up, and so forth. The media again write that up, and more people flow into that sector.

TGR: A couple of weeks ago James Turk told us that he thinks the low price for gold in 2012 was already established early in January. What makes you think it will pull back?

MF: The big rally into Sept. 6, 2011, took the gold price to $1,922/ounce (oz) and then it dropped until the end of the year, touching $1,522/oz on Dec. 29. It has rallied, and is now above $1,700 again, but I don’t think the correction is entirely over. Corrections of 40% are nothing unusual in a bull market.

As an adviser, my duty is to always inform people of investment risk. I’m not saying I expect gold to collapse, but telling people the gold price will go up leads them to leverage up and speculate. If the gold price drops $50/oz, they’re wiped out. All I’m saying is that, in my opinion, the gold price correction is not yet entirely completed. I see significant support around the $1,500/oz level, but it could drop lower. It depends on global liquidity and on money printing by central banks. We could have a big correction if global liquidity tightens or they stop printing money.

TGR: Over what timeframe are you looking at the correction?

MF: This year the gold price may not exceed the $1,922/oz high that we reached on Sept. 6. Maybe it will. I’m not a prophet. I’m just telling people that I’m buying gold and holding it. I don’t speculate in gold. If you buy gold, you better understand that the price could always move to the downside. If you don’t understand that, don’t invest in gold—or in anything.

TGR: Investment show commentators have been talking about gold being in one of those mania bubbles you described because it’s been increasing for 11–12 years. Do you agree?

MF: No, gold is not in a bubble. It wasn’t in a bubble in 1973, either, but it still corrected by 40% then. I don’t believe gold is anywhere near a bubble phase. A bubble phase is characterized by the majority of market participants being involved in a market space. I saw a gold bubble in 1979–1980, when the whole world was dealing—buying and selling gold 24-hours a day, globally.

TGR: But not since then?

MF: No. If you went to an investment conference in 1989, 90% of the people there would have told you they owned shares in Japanese companies. In 2000, 90% of them would have said they owned NASDAQ shares. Only about 5% of the participants at an investment conference today would tell you they own gold. Very few people in this world own gold.

I don’t believe that we’re in a bubble.

TGR: Should people who aren’t yet in gold or want to add to their position wait for a correction?

MF: I have argued for the last 12 years that investors should buy a little bit of physical gold every month and put it aside without concerns about corrections. If you don’t own any gold, I would start buying some right away, keeping in mind that it could go down.

For the last 40 years in my business I’ve seen people always lose money when they put too much money into something and then it goes down. They panic and sell, or they have a margin call to sell—and lose money. I own gold. It’s my biggest position in my life. The possibility of the gold price going down doesn’t disturb me. Every bull market has corrections.

TGR: What do you think about silver as an alternative precious metal to hold?

MF: Gold and silver will move in the same direction, up together or down together. At times, silver will be stronger relative to gold, and at other times gold will be stronger relative to silver. My friend Eric Sprott thinks that silver will go ballistic. I don’t know. I own gold.

TGR: You’re on record as recommending that investors maintain diversified portfolios, with 20% to 30% each in gold, real estate, equities and cash. Focusing on equities, as we’ve discussed, means tremendous volatility. What are your thoughts? High value? Large cap? Dividends? Something more speculative, perhaps gold mining shares?

MF: Because I live in Asia, I am quite familiar with the Asian markets and economies. I have a bias toward Asian equities, especially because I can find deals in places such as Malaysia, Thailand, Singapore and Hong Kong—stocks that give me 4–7% dividend yields. With yields at those levels, at least I’m paid to wait. Even if they’re cut 5%, I’d still get better cash flow than I would from, say, U.S. government bonds. Consequently, I feel reasonably confident owning such shares.

Because I have allocated only 25% of my portfolio to equities, if the markets were to drop 50%, I would have funds elsewhere in my portfolio to buy more equities. That’s not a prediction for a 50% market decline; it’s just to say that I’m positioned in such a way that I could put more money in equities through a) my cash flow, b) my income and c) my cash position. And I do own some gold shares through stock options, because I’m a director of several exploration companies.

TGR: Given that you’re satisfied to, in essence, being paid to wait with dividend-paying stocks, do you consider yourself a buy-and-hold investor?

MF: With my asset allocation of 25% in equities, I can afford to hold them. If I had 100% in equities, I would be more inclined to take profits from time to time.

TGR: Let’s get back to Asia for a moment. Headlines in the U.S. have focused lately more on what’s going on in Europe, with Asia basically relegated to page 2. What’s your perception of the markets and economies there?

MF: We don’t have recessions yet, although there have been slowdowns in economic activity and some corporate profit disappointments. The big question is whether we have a problem in six months to one year’s time that results from a meaningful slowdown or even a crash in the Chinese economy. That may happen.

Second, it’s not everywhere, but in some cases I see bubbles in the real estate market, as there are in everything that relates to luxury—luxury properties, paintings, collectibles, the luxury department stores and shops, the Swiss watch companies. They’re all doing very good business. I think there’s a bubble essentially in everything at the high end of the market. That concerns me a little bit. It may continue for another year or so but will not last forever, so I’m relatively cautious.

Having said that, lots of companies in Asia do not cater to the high-end consumers but to the rising middle class. I believe they are reasonably well positioned to weather even a recession.

TGR: If China’s bubble in those luxury goods and real estate bursts, would the Asian markets go down in tandem?

MF: Yes, I think so. Last year the Chinese markets—by the way, also India—grossly underperformed the U.S., so maybe the market has already discounted a Chinese slowdown to some extent. But because I happen to think that it hasn’t discounted the Chinese slowdown entirely, yes, I think the markets are still vulnerable.

TGR: Are your investments in the Asian markets focused on companies that are not catering to the high-end, like food and items that the middle class buys?

MF: Yes, I have a mixed portfolio of both industrial and residential real estate, healthcare companies, retailers, food companies, agricultural companies, finance companies and banks. So, it’s fairly broad.

TGR: Are those financing companies and banks Asian-based or internationally based? That sector is certainly out of favor in North America.

MF: I have no Chinese banks, but I own banks in Singapore and Thailand and finance companies in Singapore, Thailand and Malaysia. Actually, I’m also positive about some financial stocks in Europe and America. Simply because of the money printing, these financial institutions are benefiting at the expense of honest people who have savings that yield nothing while their cost of living is progressing at 5–10% per annum.

I took a taxi the other day from New Jersey to Manhattan. The Lincoln Tunnel has raised its toll by 50%, from $8 to $12. But the government, brainwashed by incompetent academics at the Federal Reserve, will tell you that inflation is 2%.

TGR: You mentioned liking finance companies in Europe and America because of money printing. How does that benefit them?

MF: I don’t like them. In investing, it’s not a question whether you like or dislike something. It’s a question of price. The best company or the worst sector may be overvalued at one price and undervalued at another. I happen to think that having weakened to around the 2009 lows last fall, when the S&P dropped to 1,074 on Oct. 4, the financial sector was very cheap. Since then, there have been big rallies for Citigroup Inc. (C:NYSE), Bank of America Corp. (BAC:NYSE) and other banks. I saw opportunities there, but with the market rallying so much, I believe it is now overbought and due for a correction. We will see whether it’s just a correction or a resumption of a downtrend.

TGR: Which do you think it will be?

MF: I don’t know. We haven’t seen a correction yet. I think it’s about to start. Then we will have to see the shape of the correction, which could last a month. After that, we’ll have to look at the shape of the recovery—the number of stocks that will participate, the number of new highs and so forth.

TGR: You’ve indicated that your portfolio allocation includes real estate. Do you consider real estate a good value in North America now?

MF: I travel around the world all the time and I’m interested in the formation of prices so I have an idea about trends in prices. You have to consider real estate prices in the context of currency valuations. For example, five years ago, homes in Australia and Canada were inexpensive and now they aren’t, but not necessarily because prices have gone up. Although prices don’t necessarily track with whether a currency increases or decreases in value, in those two cases, the value of the currencies also has increased.

The U.S. does have areas where real estate is incredibly low relative to other parts of the world. I can buy homes in Atlanta and Phoenix for less than I’d pay in Thailand, and because the GDP per capita in the U.S. is of course much higher than in Thailand, on a relative basis, those homes in Atlanta and Phoenix would be attractive.

As a foreigner, I am not interested in investing in U.S. real estate for various reasons, including taxation, management and regulation. But if I were a U.S. citizen, I would say now is a relatively good time to buy real estate and rent it out and net a yield of maybe 6–8%. Many of my friends who own rental apartments do very well on rental income. Many of the people who no longer qualify for mortgages can rent.

TGR: In terms of asset diversification, to what extent ought the average U.S. investor focus on international equities or real estate?

MF: I think U.S. citizens should focus very much on diversifying their assets internationally. Only Americans still believe that America remains the most important economy in the world. Everybody else knows it has become relatively less significant over the last five years. Everybody, including Americans, should be global investors, and Americans should have at least 50% of their money outside the U.S. I would argue that a global investor should have maximum 40% in Europe and in the U.S., with the rest in Asia, Latin America, Africa, etc.

It’s very difficult for Americans to open bank accounts overseas, but buying real estate overseas is one way to diversify, and that’s not a problem. Maybe the U.S. will close this loophole one day, but for now U.S. citizens may buy real estate in South America, Europe or Asia—anywhere in the world. That’s what I would do.

TGR: Do you consider investments in stocks that are based in international areas part of the diversification?

MF: Basically you want exposure to rapidly growing economies. This is best achieved by buying companies that have large exposure in the emerging economies rather than the U.S. and Europe. The Coca-Cola Company (KO:NYSE) is a U.S. company but the bulk of its business comes from outside the U.S.

TGR: You’re scheduled to speak at the World MoneyShow, coming up in Vancouver March 27–29. We understand that in your presentation, entitled “The Causes and Investment Implications of Dishonest Money,” you’ll be discussing unintended consequences of large fiscal deficits and expansionary monetary policies. Would you give us some highlights of what you plan to cover?

MF: Basically I will try to explain that instead of smoothing out the business cycle, government interventions have created more economic and financial volatility and have had very negative consequences for the U.S. in particular. And as I pointed out earlier, these measures, such as some of the fiscal and monetary measures we’ve talked about, are based on erroneous economic sophism.

TGR: What do you think people will learn from listening to your presentation?

MF: That in this environment of money printing, cash and government bonds are not very safe and that you have to navigate through different asset classes. Under normal conditions, cash and government bonds are essentially the safest investments—not investments with the highest returns, but the safest. That is not the case today.

TGR: And we appreciate the pointers you’ve made about some of those different asset classes. Thank you very much.

Swiss-born Marc Faber, who at age 24 earned his Ph.D in economics magna cum laude from the University of Zurich, has lived in Hong Kong nearly 40 years. He worked in New York, Zurich and Hong Kong for White Weld & Co., an investment bank historically managed by Boston Brahmins until its sale to Merrill Lynch in 1978. From 1978 to 1990, Faber served as managing director of Drexel Burnham Lambert (HK), setting up his own investment advisory and fund management firm, Marc Faber Ltd. in mid-1990. His widely read monthly investment newsletter, Gloom Boom & Doom Report, highlights unusual investment opportunities. Faber is also the author of several books, including Tomorrow’s Gold: Asia’s Age of Discovery (2002), which spent several weeks on Amazon’s best-seller list and is being translated into Japanese, Chinese, Korean, Thai and German. He also contributes regularly to leading financial publications around the world. Much also has been written about Faber. Nury Vittachi, one of Asia’s most popular writers and speakers, published Riding the Millennial Storm: Marc Faber’s Path to Profit in the Financial Markets (1998). The Financial Times of London described him as “something of an icon” and Fortune called him a “congenital contrarian and shrewd Swiss investment advisor.”

Coming Full Circle

The newest bubble appears to be (wait for it…) real estate. Specifically, farmland:

The latest Grant’s Interest Rate Observer reports that farmers in Sioux County, Iowa bidding on a 74-acre tract forced a winning bid price of $20,000 an acre, far higher than the previous record price of $16,750 per acre set in October.

The price surge of Iowa dirt is the highest since 1977, with prices up 31% in the 3rd quarter from a year ago, and prices 7% higher from the just the previous quarter.

At the height of the housing bubble, farmland located close to major metropolitan areas was developed into suburbs. When the housing bubble popped, some of these developments were not yet finished. Now, thanks in large part to (quelle surprise) federal subsidies, there’s a strong chance that the farmland that was converted into housing developments will now be converted back into farmland. Now Lord Keynes’ ditch-digging plan can be enacted on an even grander and presumably more efficient scale!

A Monetary Policy that Encourages Malinvestment

Thorsten Polleit, of the Frankfurt School of Finance & Management, penned an article in The Free Market newsletter of the Ludwig von Mises Institute titled “The Many Names for Money Creation.”

It starts off almost humorous, reading more like an interesting, mood-lightening sidebar to a banner article titled “We’re Freaking Doomed (WFD)!” as he notes that the dire economic conditions are such that “euphemisms have risen to great prominence. This holds true in particular for monetary policy experts, who are at great pains to advertise a variety of policy measures as being in the interest of the greater good, because they are supposed to ‘fight’ the credit crisis.”

He then illustrates how the term “unconventional monetary policy” is meant to convey the happy virtues of “courageous and innovative”, as opposed to the bad old “conventional” monetary policy, which is now “outdated.”

In a similar vein, he notes that “Aggressive monetary policy” is meant to signify “bold and daring action for the greater good,” and “quantitative easing” is just a confusing term used to make it difficult for people to see “what such a monetary policy really is – namely, a policy of increasing the money supply (out of thin air), which, in turn, is equal to a monetary policy of inflation.”

A policy of inflation! Yikes! What was in that article “We’re Freaking Doomed (WFD)!”?

From the perspective of the Austrian school of economics (the only true economic theory!), this is not going to be the ordinary kind of inflation, either, but the really nasty, evil kind, where “monetary policy pushes the market rate of interest below the natural rate of interest (the societal time-preference rate), thereby necessarily causing malinvestment rather than ushering in an economic recovery.”

In other words, the Fed and the government are making it worse.

And if you want to know about malinvestment, then ask my boss, who never tires of telling me that I am the only employee, alone, apparently in the whole freaking history of employees, that has a consistent negative value to the company, meaning that the bottom-line of the company would be immediately improved if I was, to coin a rhyme, removed.

So I asked her, “What’s with that ‘improved if I was removed’ stuff?” to which she asked, “What are you talking about? You are the one that said that in the previous paragraph, you moron!” to which I asked, “What?” and then she asked, “What?” and then we just looked at each other, confused as hell.

There was an awkward silence, as I struggled as if I was in some weird parallel universe, since her point was that she is, only now, realizing that I am, as an employee, a huge mal-investment, but I can’t be fired since I am too old and too savvy not to sue the hell out of all of them for my termination, even though their case is air-tight and I should have been fired long ago.

And, as I never cease saying, some other, much worse mal-investments, such as the stock market bubbles, and the bond market bubbles, and the derivatives bubbles, and the debt bubbles, and the housing bubbles, and the bubbles in the sheer, staggering size of governments, were NOT my fault, but are all the fault of the Federal Reserve creating the money that made it all possible

Now, as if playing right into my hands, Mr. Polleit writes, “Sooner or later the dependence of the people on government handouts reaches, and then surpasses, a critical level,” which I assume we have reached.

The worse news is that he figures that “People will then view a monetary policy of ever-greater increases in the money supply as being more favorable than government defaulting on its debt, which would wipe out any hope of receiving benefits from government in the future.”

The terrifying point of all of this is when he writes, ominously, “In other words, a policy of inflation, even hyperinflation, will be seen as the policy of lesser evil.” Hyperinflation! Gaaahhh!

Hyperinflation! Immediately, I go into We’re Freaking Doomed (WFD) mode, which usually involves a lot of hyperventilating and a feeling of panic until I realize that all I have to do is buy gold and silver to keep what is going to happen to everyone else from happening to me, and make a lot of dollars in the process, which always makes me feel better, leading to euphoria, as in, “Whee! This investing stuff is easy!”

A Monetary Policy that Encourages Malinvestment originally appeared in the Daily Reckoning.

The Economic Future of Ireland

The economic and financial crisis of 2008/2009 hit Ireland heavily. The asset price bubble and the subsequent deflation have added to the uncertain macroeconomic outlook. How did the country went from the times of the “Irish miracle” to the prolonged economic slowdown? Following the beginning of the 2008/2009 economic and financial crisis, Ireland was hit by an unprecedented economic slowdown. In 2008, the GDP declined by 3.0 percent on the annual basis. In 2009, the GDP further declined by 7.1 percent in real terms. The unemployment rate increased to almost 12 percent.

Prior to the outburst of the economic crisis, Ireland enjoyed stable and predictable levels of public debt. In 2007, the country was known for having stabilised the public debt at 25 percent of the GDP – the lowest level of any Western European country. In 2009, the debt-to-GDP ratio increased to 64 percent of the GDP. Once known as the sick man of Europe, Ireland’s economic policymakers have implemented a set of fiscal policy measures aimed to boost the long-term economic growth and abolish the economic policy based on the state intervention, high tax rates on labor and capital and export-led growth.

Ever since the 1960s, Ireland pursued a soft version of industrial policy targeted at the promotion of inward foreign direct investment and the education of highly skilled workers. In addition, Ireland reduced the corporate income tax rate to 12.5 percent and provided a thorough technical assistance and to multinational companies located in Ireland. Indeed, U.S. multinationals such as Microsoft, Dell and Intel were encouraged to locate in Ireland mainly because of its geographic proximity to key European markets, skilled English-speaking workforce, membership in the EU, relative low wage level and favorable corporate taxation.

In early 1990s, the results of a precise set of economic policies were spectacular. By the end of 2006, the unemployment rate dropped to 4.6 percent from 18 percent in early 1980s. Between 1992 and 2005, Irish GDP increased by an average of 6.9 percent while the investment grew by 8.6 percent on the annual basis. The largest contribution to GDP growth was domestic demand (5.3 percentage point). Hence, Ireland’s public finance enjoyed a favorable outlook mainly due to the rapid decline of debt-to-GDP ratio from 1980s onwards, and from a relatively low demographic pressure on the budgetary entitlements.

During the Irish boom, Irish banking and financial sector were highly dependent on the wholesale funding. Due to largely positive macroeconomic outlook from 1990 onwards, Irish banking sector received high and consistent credit ratings from agencies such as Moody, S&P and Fitch. In turn, the reliance on fragile wholesale funding resulted in overleveraged balance sheets. After the failure of Lehman Brothers in September 2008, the short-term outlook on Irish banking sector signaled a significant rise in credit-default swaps which raised concerns over the ability of banks to provide the wholesale funding for a mountain of short-term debt liabilities. And since the overleveraged balance sheets downgraded the outlook on Irish banking sector, the institutional investors demanded higher risk premium to extend the funding channel to the Irish banks.

The Directorate Generale for Economic and Financial Affairs of the European Commission downgraded the macroeconomic forecast of Irish GDP growth. By the end of 2009, the economic activity plummeted by 7.1 percent. The housing market crash was largely a result of the asset price bubble channeled through the overinvestment in the construction sector which represented 12 percent of the GDP. Nothing could explain the deflationary pressures in the aftermath of the financial crisis than excessive housing prices during the pre-crisis Irish economic boom. After 2008, Ireland’s household savings rate increased to the level above 10 percent which is a result of the adjustment in the household balance sheet. In fact, between 2001 and 2007, the share of household debt in the GDP nearly doubled.

Meanwhile, the mountain of liabilities in the Irish banking and financial sector raised the concern over its solvency. The Irish Government immediately facilitated a bailout plan for the troubled banking sector. Consequently, the large budget deficit resulted in excessive debt-to-GDP ratio which grew by 39 percentage points between 2007 and 2009. In the annual European Economic Forecast (Spring, 2010), the European Commission estimated that by the end of 2011, the debt-to-GDP ratio could reach as high as 87.3 percent. while the cyclically-adjusted government balance is estimated to increase up to -10.2 percent of the GDP. The contraction of domestic demand which, by all measures, is the main engine of Ireland’s economic growth led to a rapid increase in the unemployment rate which increase from 6.3 percent in 2008 to 11.9 percent in 2009. By 2011, the European Commission forecast that the unemployment rate is expected to further increase by 1.5 percentage point compared to 2009. In World Economic Outlook, the IMF estimated that the unemployment rate in Ireland would increase by 1.1 percentage point by the end of 2011. In 2009, Ireland experienced net outward migration for the first time since 1960s in the wake of expected 13.8 percent unemployment rate in 2010.

The macroeconomic forecast for 2011 is favorable. The European Commission upgraded GDP growth estimate to 3 percent. Meanwhile, the investment is expected to increase for the first time since the 60 percent cumulative decline of the construction sector. The positive contribution of net exports to the gradual narrowing of the current account deficit could be an important measure to alleviate the rising pressure over debt-to-GDP ratio. On the other hand, Ireland’s Department of Finance revised the macroeconomic forecasts and estimated that by the end of this year, the GDP would grow by 1 percent on the annual basis.

The essential measure of Irish economic recovery is the retrenchment of wage rates in the public sector and the adjustment of public sector wages to the cyclical dynamics of economic activity to prevent the possibility of excessive inflationary pressures in the course of economic recovery. Current measures of retrenching public sector wages successfully anchored the inflationary expectations. According to the IMF, the annual inflation rate is estimated to peak at nearly 2 percent by the end of 2015. The falling wage rates in the private sector could induce the reallocation of resources in the tradeable sector, further adding to the contribution of net external trade to the GDP growth.

The key measures to alleviate the consequences of economic and financial crisis in both real and financial sector are the immediate narrowing of Ireland’s excessive budget deficit and public debt in the share of GDP. High public debt is mainly the result of government capital injection into Anglo-Irish Bank which represents about 2 percentage points of net deficit increase in 2010. The entire consolidation package represents 2.5 percent of the GDP.

Deutsche Bank recently published Public Debt in 2020 and estimated the levels of public debt by the end of that year for both advanced and emerging-market economies. The analysis by Deutsche Bank predicted the effect of a combined negative shock in real interest rate, primary government balance and real GDP growth. If the combined shock of all three variables were to change by about one-fourth standard deviation from the estimated growth rate, the public debt in 2020 would reach 154 percent of the GDP. If the combined shock of all three variables increased by one-half standard deviation from the baseline estimates, the public debt in 2020 would increase to 197 percent of the GDP. The difference in the estimated increase is due to higher intensity of the combined shock. In addition, to restore the debt-to-GDP ratio to pre-crisis level, Ireland would be required to increase the primary government balance to 6 percent of the GDP.

Given the enormous magnitude and burden of public debt and overleveraged corporate and financial sector, the immediate facilitation of measures to alleviate the public indebtedness is necessary. Ireland’s economic future is constrained by the persistence of budget deficit which adds to the future burden of public debt. Prudent efforts to reduce the burden of both debt and deficit are of the essential importance. Nevertheless, Irish policymakers should not neglect the economic policies that created the Irish miracle as well as the policy errors that caused the deepest economic decline in Western Europe during the 2008/2009 economic crisis.

China Desperate for Gold

Reported by
Sales by overseas central banks could see a sharp fall in gold prices, the Financial News reported Wednesday, citing Zou Pingzuo, a central bank researcher.

“Investors should be careful about investing in gold. Gold prices could fall sharply because of intensive gold sales by the U.S. and other overseas central banks,” Zou said.

To me this a sign of desperation by the Chinese. There has been no indication by the US to sell and all recent talk is about central banks buying. They are trying the old scare tactic of central bank selling to try and push the gold price down. They want to buy as much gold as they can but don’t like the current high price.  I think they are hoping this “bubble” will deflate and they can continue with their sneaky “get out of dollars and buy gold”. What happens when the Chinese realise the price isn’t going to drop? Will they be forced to go all out and start buying whatever physical they can?

Gold and Silver Versus Market Index Bubbles

Below is a chart Nick of Sharelynx has been working on to show how much of a bubble gold and silver are in (or not).

Note that the x-axis does not have time on it because each bubble had a different timelength (some of the bubbles are 20 years, others 5 years). This does skew/stretch the time, but Nick’s emphasis with this chart is more on the percentage growth factor rather than how long it took to get to those bubbles.

Protecting yourself from World War III: Debtors vs Creditors

Steve Keen is an Australian Post-Keynesian economist credited as having “seen it coming” in this survey of research by economists or financial market commentators. Keen was one of only eleven researchers who qualified, which included Schiff, Roubini, and Shiller.

Steve Keen is a follower of Hyman Minsky’s “Financial Instability Hypothesis”, which he summarises as:

1) Capitalist economies periodically experience financial crises;
2) These are caused by debt-financed speculation on asset prices leading to bubbles in asset prices;
3) These bubbles must eventually burst because they add nothing to productive capacity while increasing the debt-servicing burden;
4) When they burst, asset prices collapse but the debt remains;
5) The attempts by both borrowers and lenders to reduce leverage reduces demand and causes a recession;
6) If the economy survives such a crisis it goes through the same process again, with another boom driving debt up even higher, followed by yet another crash; but
7) This leads to a level of debt that is so great that another revival becomes impossible since no-one is willing to take on any more debt;
8) Then a Depression ensues.

A plausible but dismal explanation. Consider this comment on Steve’s latest blog post:

“This is one of the great questions for all of history, how to get out of this. For one thing, one persons debt is another persons asset or in many cases their money. … It is clear that everyone that has something is going to take a haircut on it. Either by a systematic bankruptcy or by a natural one.”

As Steve Keen says:

Some form of price chaos has to be expected though, whatever is done. One side-effect of the bubble has been an enormous dislocation in prices, not just with overvalued financial assets, but also with drastically overinflated incomes for the financial class, and concomitant price distortions all the way through commodities.

How do you protect yourself from this economic World War III? Simply swallow the red pill and step outside the Financial Matrix: bail out of your “has something”s into precious metals and sit by and watch the annihilation as everyone else takes “a haircut”.

Deflation and Helicopter Ben: the U.S. economy on the line

There’s been a lot of chatter in the financial news this
past week concerning deflation, with one blogger for the Motley Fool []
even proclaiming, “Clearly deflation is here.” But is it?

Are we there yet?

Deflation is defined as falling prices over a lengthy and sustained
period of time, often combined with a decrease in the money supply. Therefore,
an unusual one-time tick lower of the monthly Consumer Price Index []
does not qualify. Granted the core CPI measure also fell slightly, which is
even less common because it doesn’t register the volatile effects of energy and
food prices.

Instead, the October decrease in CPI is the unwinding of the
run-up in prices during the first half of the year, the one that culminated
with gasoline at $4.50 per gallon and crude oil at $147.27 per barrel. Keep in
mind that, although retail prices fell 1.0% in October, they nevertheless
remain 3.7% higher than they were in October 2007, almost double the Federal
Reserve’s unofficial “soft” inflationary target of ~2%.

Analysis of the cycle

The disastrous deflationary spiral known as the Great
Depression actually began in August 1929 when the U.S. slipped into recession,
arguably due to a poorly-timed tightening of interest rates by the Federal
Reserve. Not long after, an asset bubble burst (in this case, the overly
leveraged stock market), leading step by step to loss of wealth, defaults on
loans, undercapitalized banks, and bank failures. As banks deleveraged by
reducing the ratio of credit to deposits, they ceased writing loans, causing a
credit crunch which further damaged businesses and the underlying “real” economy.

At the same time, nervous depositors yanked their money from
banks and dumped it in the Mattress Savings and Loan, withdrawing it from
circulation and slowing the economic recovery further. Meanwhile, fiscal policies
enacted by the Hoover administration were ineffective (and sometimes
ill-judged) and the Federal Reserve’s monetary policy is generally considered
to have been nothing short of disastrous. To be fair, they were hampered by the
rigidity of the gold standard then in effect.

As economic historians (and just about everybody else) like
to point out, that same description holds true for the current U.S. situation.
However, there are a few important deviations. For example, investors are hoarding
money in Treasury securities rather than mattresses, and the Federal Reserve
has aggressively loosened monetary policy since the initiation of the crisis in
the summer of 2007.

One of the most important of these deviations is the abandonment
of the gold standard in 1971. A strict adherence to a gold standard is
inherently deflationary, as there’s only so much gold to spread around while
the population worldwide is increasing. As pointed out by Ben Bernanke, the
head of the Federal Reserve System and an expert on the economics of the Great
Depression, the strictness with which a nation stuck to the gold standard was
directly related to how deeply that nation was affected [].

Real-world defense

In a speech delivered November 21, 2002 [],
Bernanke stated that the first line of defense against deflation is to prevent
it by maintaining an interest rate above zero, which is why the Federal Reserve
does everything in its power to ensure you spend more for food and clothing
this year than you did last year.

Should the first line of defense fail for whatever reason,
the second is to inject sufficient liquidity (money) into the economy to shock
the system back to health. In his November 21 speech, Bernanke mentions the
famous solution offered by Milton Friedman (the father of monetarism) of
throwing money from helicopters, as good a liquidity injection as any other. The
comment earned Bernanke the nickname of “Helicopter Ben” among journalists for
some time.

As the Great Depression and other recessionary episodes
(such as the Lost Decade in Japan) have shown, slow or inappropriate monetary
policy can exacerbate a downturn into deflation or delay recovery significantly.
Seven decades of economic research and study are now being applied in a
real-world model by a student of the first round. We’ll find out if it works.