First, bad news for China is bad news for the world economy. We are already in a bleak environment, with difficulties in Europe, Japan, the US, . . . → Read More: Uncomfortable times in real estate in store?]]> Patrick Chovanec has a fascinating article in Foreign Affairs, titled China’s Real Estate Bubble May Have Just Popped. This is interesting and important from two points of view.

First, bad news for China is bad news for the world economy. We are already in a bleak environment, with difficulties in Europe, Japan, the US, and India. It will not be pretty if China runs into trouble as well. I am reminded of the feeling of carefully watching real
estate in the United States in 2006, with a sense that the future of the world economy was going to turn on how it turned out.

Second, it made me think about real estate in India. As with China, one often sees buyers of real estate in India have the notion that
this is a safe financial asset. This is a questionable proposition. Real estate is perhaps not an asset
class with a positive expected return in the first place; and it is certainly not a convenient asset class with features like liquidity,
transparency, diversification and easy formation of low-volatility diversified portfolios. I find it hard to explain the prominence of
real estate in the portfolios of even educated people in India.

In the article, Chovanec says:

For more than a decade, they have bet on longer-term demand trends by buying up multiple units — often dozens at a time — which they then leave empty with the belief that prices will rise. Estimates of such idle holdings range anywhere from 10 million to 65 million homes; no one really knows the exact number, but the visual impression created by vast `ghost’ districts, filled with row upon row of uninhabited villas and apartment complexes, leaves one with a sense of investments with, literally, nothing inside.

This has not happened in India. So in this sense, the situation in India is not as dire. But his second key message seems uncomfortably
close:

As 2011 progressed, developers scrambled for new lines of financing to keep their overstocked inventories. They first relied on bank loans (until they were cut off), then high-yield bonds in Hong Kong (until the market soured), then private investment vehicles (sponsored by banks as an end run around lending constraints), and finally, in some
cases, loan sharks. By the end of last summer, many Chinese developers had run out of options and were forced to begin liquidating inventory. Hence, the price slashing: 30, 40, and even 50 percent discounts.

Part of this looks familiar. There is a lot of leverage in Indian real estate development and speculation. Real estate speculators and
developers are finding themselves in a bit of a scramble hunting for credit. One hears about very high interest rates being paid by
developers. Other sources of financing are also weak. This reminds me of the dark days before the global crisis, when borrowing by real estate companies was the canary in the coal mine.

If business cycle conditions and financial conditions worsen, the problems of borrowing by real estate developers and speculators will get worse. How might this turn out? Perhaps the borrowers will merely get uncomfortable. Or, a few firms could really get into trouble, and start liquidating inventory. That would have substantial repercussions.

Suppose there is a situation where there are many people who have speculative positions in real estate, but significant selling of
inventory has not yet begun. The longs would then be nervously looking at each other, wondering who would be the first one to sell, to take a better price and exit his position. The ones who sell late would get an inferior price. In such a situation, conditions could change sharply in a short time.

On a longer horizon, I would, of course, be delighted if real estate prices are lower. This would help shift the supply function of
labour, reduce the cost of setting up new businesses, etc. But that’s more about the long-term policy changes, which would remove barriers for converting land into built-up housing, while rising vertically into the sky with FSI in Indian cities ranging from 5 to 25.

The Euro is broken. This was its destiny. This is the destiny of all fiat currencies. These bureau-rats cannot . . . → Read More: European Bank Runs And Underestimated Physical Gold Demand]]> The demand for gold is vastly underestimated. About 18 months ago I wrote about Euro Gold and the Euro Zone and Euro Evaporation Leading To Credit Default Swaps and IMF Gold. One key excerpt was:

The Euro is broken. This was its destiny. This is the destiny of all fiat currencies. These bureau-rats cannot stop this anymore than Cnut the Great could command the tide to halt.

And here we are.

THE GREAT CREDIT CONTRACTION

The Great Credit Contraction has been in relentless advance for years. This is a massively deflationary period as capital, both real and fictitious, burrows down the liquidity pyramid into safer and more liquid assets. The fictitious capital that does not move fast enough evaporates. Poof goes trillions of wealth!

FRACTIONAL RESERVE BANKING

Fractional Reserve Banking is the banking practice in which banks keep only a fraction of their deposits in reserve (as cash and other highly liquid assets) and lend out the remainder while maintaining the simultaneous obligation to redeem all these deposits upon demand.

Fractional reserve banking occurs when banks lend out any fraction of the funds received from demand deposits. Despite being a form of embezzlement and fraud this practice is universal in modern banking.

This mismatch between time, borrowing short-term and lending long-term, is what creates the potential for a bank run. But an even larger looming problem lurks in ‘cash and cash equivalents’. Yes, those pesky Tier I, II and III distinctions.

As a bank’s assets evaporate their ability to make new loans, even extremely short-term loans like overnight, becomes impaired. When an entire banking system knows that all the major players have assets on their balance sheets, assets which are not accurately priced or accounted for, then there is an extreme reluctance to lend.

This is what happened when Lehman Brothers evaporated. The credit markets seized up. People acting in their own self-interest according to principles of praxeology moved into safe and liquid assets and refused to lend.

Liquidity dried up overnight. Mortgage backed securities, auction rate securities and plenty of other assets which had for decades been treated as ‘cash equivalents’ were suddenly shunned. The bid evaporated from a loss of confidence, the prices plunged, investors were snookered and bank balance sheets were massively damaged.

EUROPE’S WORTHLESS BANK DEPOSITS

The European banks have balance sheets with trillions of Euros in value recorded but assets which every rational non-ignorant person knows are severely impaired. The credit markets are freezing, trust is evaporating and as a result liquidity is drying up.

Sure, the central banks of the world have joined in a massive illegal effort to lubricate the system but it will fail. Years ago when QE1 was announced I wrote The Federal Reserve Will Fail With Quantitative Easing. They are still failing just on a grander scale.

To recapitalize and lubricate the European banking and financial system would take at least €25 trillion and maybe upwards of €100 trillion. The failure is a mathematical certainty. The gears of industry are seizing up.

The Greek and Italian democracies were assassinated by banksters Lucas Papademos, Mario Monti and Mario Draghi who will attempt to prolong the failed banking and financial system by privatizing the gains and socializing the losses with inflationary tactics and bailouts in a vain attempt to prevent the credit liquidation. They will only succeed in prolonging and exacerbating the necessary correction.

What holders of capital should understand is that European bank balance sheets are caught in an unrecoverable credit contraction spin, the appropriate emergency maneuver is to Run To Gold and only a few will make it with their purchasing power intact.

The vast majority of assets will become charred wreckage as their purchasing power evaporates into worthlessness. Sure, there may be a few near miss recoveries between now and the ultimate failure but why take the risk?

LATENT GOLD DEMAND

There is massive latent gold demand as a ‘cash or cash equivalent’ asset. Why should a holder of capital store their wealth in bank deposits with counter-party risk when they can completely eliminate it by moving into unencumbered physical gold bullion?

Plus, by moving into physical gold bullion they eliminate the risk associated with fiat currency becoming worthless through the deflationary event called hyperinflation. Really, hyperinflation is just the next step in The Great Credit Contraction after capital has moved almost entirely down the liquidity pyramid.

The money managers allocating trillions of FRNs, Euros, Yen, etc. have not even begun moving into the monetary metals. In most cases it is only beginning to become acceptable to speak of them. Some fallaciously argue there is not enough gold to go around.

Sure, there is enough gold for it to be used as the world reserve currency but it is only a matter of price. A price that Jim Rickards argues the case for in Currency Wars of being between $8,000 and $54,000+ per ounce.

CONCLUSION

The European banking and financial system is imploding before our eyes in a massive credit contraction which is just the latest wave in The Great Credit Contraction. The European banks are in an unrecoverable deflationary spin. There is only one acceptable emergency recovery procedure and that is to Run To Gold.

Because so few have, therefore, the real gold demand is completely hidden and obscured from view. It will come when people lose confidence in the current banking and financial system by turning to and using alternatives that do not possess the same kinds of risks. In the Information Age bank runs happen with the click of a mouse and not lines outside the physical branches.

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.

Thomas E. Ricks (in Foreign Policy) and Lawrence Wright (in New Yorker) on Pakistan.

C. Rangarajan on the debate about the debt management office and about inflation targeting (the latter is an interview with Tamal Bandyopadhyay).

Saurabh Mishra, Susanna Lundstrom and Rahul Anand have a fascinating piece on the sophistication of . . . → Read More: Interesting Readings for May 20, 2011]]>

Thomas E. Ricks (in Foreign Policy) and Lawrence Wright (in New Yorker) on Pakistan.

C. Rangarajan on the debate about the debt management office and about inflation targeting (the latter is an interview with Tamal Bandyopadhyay).

Saurabh Mishra, Susanna Lundstrom and Rahul Anand have a fascinating piece on the sophistication of India’s service exports. Many people suffer from what I call `the widget illusion’, where somehow it is good to make tangible things, and making intangible things is considered wrong. It is high time we get away from such notions.

Kenya’s experience with mobile phones and payments is important for us in India. Read William Jack and Tavneet Suri on this, on voxEU.

I found there are interesting links between this article in The Economist, and the ideas on system-driven credit in a UID world in
this committee report.

Do you use up the power of monetary policy to stabilise inflation, or do you use up this power to manipulate the exchange rate? Some
people think that manipulating exchange rates, and thus fueling export growth, is a shortcut to high GDP growth. Nicolas Magud and
Sebastian Sosa (on voxEU) say that the potential payoff from exchange rate misalignment is small.

A working paper: Liquidity considerations in estimating implied volatility by Rohini Grover and Susan Thomas.

A working paper: Improving the legal process in enforcement at SEBI by Dharmishta Raval.

A working paper: Has India emerged? Business cycle facts from a transitioning economy by Chetan Ghate, Radhika Pandey, and Ila Patnaik.

Mobile trucks that sell food, and link up to customers using twitter: is India is ready for this?  See Caroline McCarthy on CNet News.

A first response on the killing of UBL by Steve Coll.

Robert S. Boynton has an article in the Atlantic about how modern communication technology is actually making a small difference to breaking down the North Korean government.

Henry Shukman has a great story in Outside magazine about the 3000 square kilometres of `Chernobyl Exclusion Zone’ which has turned into a miracle for biodiversity. I often wonder what would happen if 3000 square kilometres of prime Gangetic land became true forest.

Perhaps 10% of blind men can teach themselves how to see.

Michael Lewis has a persuasive sounding article, about how a Richter 7.9 earthquake that hits Tokyo will devastate the world
economy. This was written in 1989. By and large, these things did not happen in the recent Richter 9.0 earthquake. Yes, the
recent quake did not frontally hit Tokyo, but then Richter 9.0 is way bigger than 7.9 (this is log scale). It is a useful exercise,
for everyone interested in finance, to read this article and understand how such journalistic thinking goes wrong.

Is research funding going into randomised trials yielding a good bang for the buck? My personal view is that a better use of money is to build datasets like this which are then placed into the public domain, and used by hundreds of researchers.

FOFOA agrees with Marx that “the history of all hitherto existing society is the history of class struggle” but says that he got the classes wrong:

The two classes are not the Labour and . . . → Read More: Debtors vs. Creditors]]> Those interested in this issue, which I have covered in this and this post, will find FOFOA’s latest post useful.

FOFOA agrees with Marx that “the history of all hitherto existing society is the history of class struggle” but says that he got the classes wrong:

The two classes are not the Labour and the Capital, the rich and the poor, the proletariat and the bourgeoisie, or the workers and the elite. The two classes are the Debtors and the Savers. “The soft money camp” and “the hard money camp”. History reveals the story of these two groups, over and over and over again. Always one is in power, and always the other one desires the power.

What is the relevance of this to gold? FOFOA argues that:

… when the soft money guys are in power the transfer of wealth happens slowly and gradually, and wealth flows from the Savers to the Debtors. But when “soft money” collapses – and it ALWAYS collapses – there is a very RAPID transfer of wealth in the other direction, from the Debtors back to the Savers.

… By selling your debt-financed paper savings and buying physical gold today you are making the conscious CHOICE to join the camp of the true Savers.

I know that the chart is difficult to read but you only really need to look at the . . . → Read More: Profit Margins, Down to Earth?]]>

One of my good friends who runs a small investment boutique pointed me towards today’s chart of the day from Bloomberg showing the flight phoenix of US corporates’ profit margins.

I know that the chart is difficult to read but you only really need to look at the trend and thus the fact that profit margins recently have defied gravity. However, the old tale of Icarus may turn out to be cautionary here and the coverage by Bloomberg (and the reason my friend put it forward) also flags the fact that the current level of corporate margins essentially is a lagging indicator and the real issue is that profit margins tend to be mean reverting over time.

(quote Bloomberg)

Profit margins for U.S. companies are likely to tumble from last quarter’s record, a decline that will lead to much lower earnings than analysts expect, according to economist Andrew Smithers. “The corporate sector’s outlook is extremely bad,” Smithers, founder and chairman of the investment-advisory firm of Smithers & Co., said last week in an interview. “I can’t see any way out of it.”

As the CHART OF THE DAY shows, profit before interest, taxes and depreciation — accounting adjustments for wear and tear on buildings and equipment — amounted to 36.4 percent of U.S. corporate output in the first quarter. The calculation was based on data compiled by the Commerce Department. The percentage was the highest since the department’s quarterly data started in 1947, as the chart depicts. Smithers, whose firm counsels more than 100 clients on international asset allocation, included a similar illustration in a June 18 report.

So, what is the problem here? Well it makes sense if you think a little about it that profit margins might be in for a correction since much of the gain in the past 1 1/2 years has been due to cost cutting. Market pundits have had this debate before as stock markets soared in 2009 while unemployment kept on climbing. In this sense, the underlying point is quite simple. The first leg of the recovery for corporates (and thus in some sense their stock value) came through trimming the cost side and now, the second leg should start to kick in in the form of increasing final demand to beef up margins , but If the underlying demand is not there, well; herin lies the rub.

In this way, it was always going to be an issue as to where final demand would come from once government stepped back its spending binge and companies had exhausted their initial trimmings on the cost side. As such, we are only now returning to “normal” where we will see what the cruising speed of our economies (in this case the US economy) really is and what Mr. Smithers really points to here is that this implies a much slimmer margin on earnings and thus, strictu sensu, a lower stock price. Personally, I don’t expect a double-dip in the US in 2010, but there might well be one in 2011 which would square off nicely with the points made above. The meta theme I am working with here is that we are going to experience lower trend growth and higher volatility of growth going forward which, by definition, means more frequent moves into negative territory. Coming back to the issue of mean reverting profit margins, my friend makes the following remark;

I think the process has to do with the fact that companies did slash costs right away, faster than selling prices. Now reality catches up. Either final demand does not recover enough and companies are forced to lower prices and compete with little further room for cost cutting or demand recovers and companies have to replenish part of their cost.

Now, based on this argument and coming back to the main rule of thumb, profit margins should start to trend down on mean reverting alone and this remains a very strong empirical fact to think about in this context. Recently, Edward Harrisson made a similar point worth pointing out in the context of a slowdown or perhaps even a recession in 2011.

Long-story short: high margins mean-revert as do P/E ratios. That means share prices will be doubly under pressure in the next recession. Moreover, with households also likely to pull back given still high debt levels, there is a lot of downside for shares going into that downturn which I believe could begin as early as 2011.

Not very comforting this and as a final perspective on this topic I thought that I would mention a recent report by Fitch (login required) in which the rating agency is much less sanguine about a record low high yield default rate in 2010 attributing it to much of the same reasons above.

Fitch Ratings finds that fundamental and rating trends support the contraction in defaults, but the extent to which defaults have fallen is also a product of other dynamics. These include the timing of the recession’s impact on corporate credit quality; the strong demand for yield product in a low interest rate environment which has greatly benefited corporate borrowers seeking to refinance debt; and the deliberate and quick action on the part of U.S. companies to cut costs and boost liquidity in response to the downturn and deep fears of a prolonged period of sluggish growth.

The perspective from credit markets is interesting since it remains one transmission through which mean reversion of profit margins would materialize. In the end then, it seems that while profit margins for now may be defying gravity they, like the proverbial apple, will eventually come down to earth with a corresponding effect on stock prices.

“Nonetheless, if a bubble poses a sufficient danger to the economy as credit boom bubbles do, there might be a case for monetary policy to step in. However, there are also strong arguments against doing so, which is why . . . → Read More: Bubbles and Macro Risk]]> Frederic Mishkin says not all bubbles are a threat to the economy (link):

“Nonetheless, if a bubble poses a sufficient danger to the economy as credit boom bubbles do, there might be a case for monetary policy to step in. However, there are also strong arguments against doing so, which is why there are active debates in academia and central banks about whether monetary policy should be used to restrain asset-price bubbles.

But if bubbles are a possibility now, does it look like they are of the dangerous, credit boom variety? At least in the US and Europe, the answer is clearly no. Our problem is not a credit boom, but that the deleveraging process has not fully ended. Credit markets are still tight and are presenting a serious drag on the economy…”

GOLD . . . → Read More: Gold Party Intermission Nearly Over]]> The recent gold bull upleg is in the midst of a predictable slight correction and consolidation.  When that finishes it is highly probable, based on seasonality and technicals, that the next part of the upleg will commence.  The Federal Reserve and Washington are only making matters worse through their extremely damaging policies.

GOLD PARTY BARELY STARTED

Back on 9 September 2009 I wrote:

200 day relative price of gold is at 1.08x … Based on seasonal trends gold and silver will be strengthening, with the strongest months in September and November

This upleg in gold and silver will have significant strength because of the long period of consolidation just like in 2004 and 2006 which provided the foundation for the uplegs in 2005 and 2007 that took gold from $400 to $700 and $650 to $1,000, respectively.  If the current upleg is similar to the previous two then the 200 day relative prices for gold and silver at the top of this upleg would be about 1.5x and 1.7x, respectively.

This puts $1,300 gold and $25 silver within range without greatly exceeding previous trading norms

Back then the price of gold was $996 and the 200dma was about $920.  Today gold’s price is about $1,030 with a 200dma of about $950.  While the probability for a profitable trade is not nearly as high as it would be should the price relative to the 200dma be significantly below the 200dma there is still room for the price to run as we enter winter.  The October intermission is likely coming to a close.

OCTOBER INTERMISSION

Dr. Greenspan testified in 1998 that, ”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.”

One of the key reasons to keep the price of gold suppressed through central bank gold leasing is to keep interest rates low.  This will be particularly helpful for the $182,000,000,000,000 of certificates of confiscation that will be sold during the week of 26-29 October 2009.  Another reason is that NYMEX November options expired 27 October 2009.

PHYSICAL PREMIUMS RAISED

The physical coin dealers are fairly wise to the machinations of Wall Street.  When the paper price of bullion falls precipitously then the dealers often raise the premiums.

For example, a reader asked me a few weeks ago when would be a good time to buy gold American Eagles.  I suggested after the next drop and if lucky then he may be able to acquire them around $1,025 spot but the premium would likely increase.  He reported his shopping to me a couple days ago after the recent drop in price and informed me the premium had been raised from $37.95 to $41.95 per coin.

SILVER BACKWARDATION

On 12 September 2009 I observed that “the London SIFO, the Silver Forward Mid Rates, have been trending towards backwardation.”  It is interesting to observe the continuing trend and brief entry of silver in backwardation in the LBMA on 9 October 2009.  It seems like the physical silver market is getting a little tight.

QUANTITATIVE EASING

The big issue is whether the Federal Reserve will be able to, as Ben Bernanke said on 8 October 2009 in The Federal Reserve’s Balance Sheet:  An Update, ‘tighten the stance of monetary policy and eventually return our balance sheet to a more normal configuration?’  Back in March 2009 when Bernanke started this lunacy I asserted that The Federal Reserve Will Fail With Quantitative Easing.

Bernanke asserts:

Although the Federal Reserve’s approach also entails substantial increases in bank liquidity, it is motivated less by the desire to increase the liabilities of the Federal Reserve than by the need to address dysfunction in specific credit markets through the types of programs I have discussed. For lack of a better term, I have called this approach “credit easing.

What Bernanke is trying to do is get capital to take on additional risk by moving up the liquidity pyramid.  But The Great Credit Contraction has begun.  While there may be differences in the velocity at which capital moves down the liquidity pyramid the overall direction has not changed.  Washington and the Federal Reserve are tiny actors compared to the total size of the market.

Their policies are aimed and designed to grant special privilege to banks like JP Morgan and Goldman Sachs.  Through government assistance the banks are able to move their capital down the liquidity pyramid.  In effect, they have privatized the gains and socialized the losses.  While there may be a case for a rise in the FRN$ in the short term the ultimate destiny is known:  the fiat currency graveyard.

EXACERBATING THE GREATER DEPRESSION

As Murray Rothbard observed on page 18 of his 1963 America’s Great Depression:

It is true that credit contraction may overcompensate, and, while contraction proceeds, it may cause interest rates to be higher than free-market levels, and investment lower than in the free market.  But since contraction causes no positive malinvestments, it will not lead to any painful period of depression and adjustment.

Mr. Rothbard continues the observation that government policy can hobble the adjustment process by: “(1) Prevent or delay liquidation, (2) Inflate further, (3) Keep wage rates up, (4) Keep prices up, (5) Stimulate consumption and discourage saving and (6) Subsidize unemployment.”

In the present case, mark-to-market rules, like FAS 157, are not implemented, delayed, ignored or willfully violated.  The financial markets are now undergirded by fair-value lying standards.  For example, Section 132 of the Emergency Economic Stabilization Act of 2008 is titled “Authority to Suspend Mark-To-Market Accounting” and restates the SEC’s authority to suspend the application of FAS 157.

The Austrian definition of inflation is an increase in the money supply.  The Adjusted Monetary Base, the very lowest layer of power money, shows a tremendous increase over the past year.  The effects are most likely masked by the tremendous slowing in the velocity of money.

In an effort to stimulate consumption and discourage savings that will result in keeping prices and wages high the Obama administration has unveiled a $1 trillion stimulus package.  The Geithner toxic asset plan will only serve to hasten the destruction of wealth from the economy as the system evaporates.

The Federal minimum wage rose in July 2009.  Unemployment will be subsidized by extending benefits for 13 weeks and delaying the income tax payments.  Legacy industries, like the auto industry, are receiving bailout money to keep wage rates up and people employed doing nothing all day long because of the huge over capacity of automobiles.  With Cash-For-Clunkers automobiles which have value are destroyed to reduce supply of alternative goods to new cars made by Government Motors.  This is a prime example of what Washington DC is:  A giant wealth destruction machine.

Therefore, like heroin to cure a hangover the quantitative easing from the Federal Reserve and the lunatic policies from Washington are not improving the situation for average people but instead exacerbating the greater depression.  Now is the time to Raze The Fed and while doing the spring cleaning who needs Washington?

CONCLUSION

The current correction and consolidation of gold appears to be within trend and expected based on the seasonality.  November is the strongest month and this recent correction on low volume is laying a strong foundation for a large move upwards.

The Federal Reserve’s quantitative easing programs have not been helping the situation but instead exacerbating the greater depression.  All in an effort to save the inefficient, barbarous and archaic relics of a fiat currency and fractional reserve banking system that is destined for extinction and replacement.  The Crash of 2008 was just the start of The Great Credit Contraction and it will last for decades.

DISCLOSURES:  Long physical gold and silver and no position the problematic SLV or GLD ETFs.

BNN HOST:  A note that caught out eye from RunToGold.com saying “Gold price rise pretends another round of the Credit Crisis. … Gold in Q2 2010 . . . → Read More: Gold Rising As A Currency]]> On 9 October 2009 I was interviewed by Business News Network, Canada’s premier financial channel, live from the NASDAQ in Times Square New York about the rise of gold.

BNN HOST:  A note that caught out eye from RunToGold.com saying “Gold price rise pretends another round of the Credit Crisis. … Gold in Q2 2010 $1,300.”. Joining us to talk about that prediction, Trace Mayer, financial blogger and author of The Great Credit Contraction. He is in the city so nice the name that twice New York, New York. Very happy to be with us, Trace.

TRACE: Oh Thank You.

BNN HOST: You said the credit crisis has not been calmed but intensified. Why?

TRACE: Yes, one of the reasons is that the FASB mark-to-market has just obfuscated the toxic assets. So it is preventing the credit liquidation. So we still have the same bad assets that have not been liquidated in the market on the balance sheets. But people do not necessarily know where they are lurking.

BNN HOST: So the idea that the stimulus package and government back stops, things of that nature, have really delayed the inevitable more than anything else?

TRACE: Yes. They have delayed it and they have just pushed it off. And because people continue to make misallocations of capital because of that government intervention.  It will only lead to bigger crisis later.

BNN HOST: Ok. When is later though?

TRACE: Well, we have been pushing this off for decades now.  It seems to have really picked up in 2007 and the next round appears to be coming pretty soon. Mostly because of the move into gold. We see it closing at $1,050 this week and it now has a 3 week moving average above $1,000 and so there is a lot of strength. And a reason is because gold functions as a currency.

BNN HOST:  Really the only currency that does not have obligations.

TRACE:  Yes, it is a currency that at all times and in all places remains money. And there is a difference between money and currency. Gold is money because it can never become worthless.  As you say it is no one’s liability.

BNN HOST: What is really moving gold on a day to day basis though, more speculation than actual demand. Is that accurate?

TRACE: Yes, there is a lot of speculation along with the central bank gold price suppression scheme. Because gold is a competitor to their fiat paper franchises they have a heavy vested interest in interfering with the gold market. So in the short term we do see a lot of central bank interference.  But now it appears that Greenspan’s Call which is leasing gold should the price rise has been counteracted by the Beijing Put which appears to be putting quite a floor in the gold market.

BNN HOST: You have an interesting graphic in the report of the Day, an inverted pyramid, explain this to us.

TRACE: Yes. This inverted pyramid is the liquidity pyramid and shows the different assets in the world economy. And what has happened over hundreds of years is capital moved up the pyramid into less safe and less liquid assets. And that was the great credit expansion. And now we have reached the top and economic law shows that capital moves down the liquidity pyramid. And that is the great credit contraction; capital moving into safer and more liquid assets.

For example, capital is moving out of auction rates securities or commercial mortgage backed securities and into Treasury Bills. And eventually it will move from Treasury Bills into the monetary metals. And the reason for that is that fit currency and central banking are barbarous relics that are not really needed in the Information Age. We could have gold and silver and platinum circulating as currency in ordinary daily transaction (Goldmoney). We do not need these archaic devices anymore. And it may take some creative destruction for that to happen. But I think that the market will pull through because there are more efficient ways of handling our currency in our ordinary day to day transactions.

BNN HOST: So as we get more and more concerned with the top of that pyramid, the derivatives play, you are talking about $1,300 bullion. How do you get to that figure?

TRACE: $1,300 bullion comes from looking at the 200 hundred day moving averages and where gold has consolidated and where it goes based on the usual uplegs.  It looks like we are following the same thing that happened in 2004 with the rise in 2005, the consolidation in 2006, which went to the rise in 2007, and the consolidation in 2008, and it looks that it will lead to a similar rise in 2009 and 2010 which will take gold to $1,300 which should be a little bit above its 200 day moving average. But in the same trading ranges as we saw in 2005 and 2007.

BNN HOST: We have a 10 year chart on the screen but you look back even five or seven years ago; more so I suppose take it back 10 – 20 years. Looking at gold on an inflation adjusted basis and gold is dirt cheap by comparison.

TRACE: Yes. The reason for that, we hit on it earlier, was Alan Greenspan testified twice before Congress “that central banks stand ready to lease gold should the price rise.” And the reason that central banks leased gold since early 1995 and onward, and actually before that they were in the market, is to keep the interest rates suppressed.  So we have had this inflation in the system and the consequences have been masked by the central bank gold leasing. But it seems that the central banks are now losing control over their physical bullion, the market is asserting itself and we are seeing this rise in price as a result. Because when you own gold in effect you are fighting every central bank in the world.

BNN HOST: Are we also not fighting the U.S Dollar. What is your expectations Trace for the green back?

TRACE: That is a very excellent question. The dollar is the world reserve currency but as Alan Greenspan and said, “This rise in the gold price is the first real step towards a move away from fiat currency.  And so we do not know how long it will take but the dollar has tremendous problems. And now it has appeared to become the carry-trade currency.  So we are seeing a lot of people sell the dollar to fund purchases and buy other assets and that puts further selling weakness on the dollar.

BNN HOST: Trace, we appreciate…

TRACE: And will probably persist for a long time just like the Japanese Yen.

BNN HOST: Well, we are going leave it there. Thank you so much for your insights and all the best to the Columbus Day Long Weekend.

TRACE: Oh. Thank you.

BNN HOST: Trace Mayer, Financial Blogger and Author of The Great Credit Contraction.

DISCLOSURES:  Long physical gold, silver and platinum with no position in the problematic GLD or SLV ETFs.