By The Gold Report, on January 26th, 2012
 Fayyaz Alimohamed, CEO of Altair Ventures Inc. and publisher of the Acamar Journal, offers historical perspective and predictions on the global economic crisis. In this exclusive Gold Report interview, he foresees a “mania” in junior mining stocks and recommends holding physical gold outside the banking system as a safety net.
The Gold Report: Fayyaz, in June 2008, using readily available economic data, you wrote that the global economy was on the verge of financial collapse. What do those sources tell you about where the global economy is headed today?
Fayyaz Alimohamed: In November 2006, I predicted that the U.S. was headed into a recession. Seven months later, the Bear Stearns funds cracked, beginning the crisis. By June 2008 it was obvious to me that the crisis would escalate into a crash.
Today, the U.S. cannot meet its gargantuan future unfunded liabilities. Europe and Japan face debt levels that ensure eventual sovereign debt defaults and declining standards of living. There is potential for all of this unwinding to seriously affect an entire generation.
These economies cannot grow their way out of their problems and the cuts needed to balance budgets would create massive social turmoil because the cuts themselves would lead to sharp drops in gross domestic product, creating vicious negative spirals. The current solution being utilized is more debt and quantitative easing. That can only keep things afloat until it can’t anymore. I would say that we will have the next major crisis within the next two years.
TGR: I would like to flesh that out a bit. What do you believe will trigger the next crisis?
FA: Genuine reform has not been implemented. This crisis was caused by unprecedented levels of consumer and corporate debt and Wall Street greed. When the crisis happened, government rescued distressed debt by massively increasing its own debt. For example, the Federal Reserve and the European Central Bank are using their balance sheets at about a 30:1 leverage. This is the same sort of leverage that Wall Street banks had recklessly indulged in. When government debt was substituted for corporate and consumer debt, the whole system rolled over into a much more dangerous phase.
TGR: Do you think the European debt crisis will remain the dominant theme in 2012 or will other themes take center stage?
FA: The European crisis is simply a proxy for a global debt crisis. It happens to be focused on Europe because Germany has not been as eager as the Federal Reserve to print money. Germany remembers the hyperinflation of 1924, when unbridled money creation led to prices doubling every two days.
Today, governments have a preponderant influence on the economy, while large corporations, through lobbying, have inordinate influence over the government, to the detriment of other stakeholders. As the danger of a deflationary depression increases, governments are attempting to reinflate the economy; they may well overreach and create hyperinflation.
Thus, the broadest theme by far is debt and the reaction to debt. We just saw France’s debt downgraded and a negative watch put on the European Financial Stability Facility. This negative spiral will continue. Even though the U.S. has tepid signs of economic growth, it is at the cost of enormous amounts of stimulus being put into the economy.
Given that the U.S. and Europe are its two largest export markets, China also is headed for a hard landing unless it can increase internal consumption substantially.
TGR: Much of the discussion of the European crisis has centered on Greece. But a recent auction of six-month Italian bonds was priced at an interest rate of 6.5%—the highest rate of a bond auction since Italy joined the Eurozone 13 years ago. What do you make of that?
FA: In literature, readers are invited to enter into a “suspension of disbelief” to go along with the story, even if implausible. Before the 2008 crisis, that was the mindset of investors. Now they want to believe that governments can solve these problems.
Greece was not the primary cause of the European crisis. It was caused by German, French and U.S. banks. These banks are all insolvent if they were to mark their assets to market and not to theoretical models. But, we are suspending disbelief because we all have skin in the game and need things to work out.
The drive for austerity ensures that Portugal, Ireland, Italy, Greece and Spain (PIIGS) will continue to see their economies shrink, leading to lower tax revenues and the continued inability to meet budget targets, which will require larger debt relief. It is a vicious downward spiral that will lead to declining standards of living.
Greece, Portugal and Ireland would be much better off leaving the EU, defaulting on their debts and devaluing their currencies. That is a time-honored tradition. After some pain things will work out, as they did in Argentina and Russia in the 1990s.
Investors want to believe that heavily indebted countries can solve the problems of other heavily indebted countries; that an insolvent banking system can be rescued by governments through more debt issuance and debt monetization.
TGR: The European Central Bank has floated the idea of euro bonds, backed by all 17 members of the Eurozone, as a solution to this problem. But Germany does not want to go down that path unless the indebted countries adopt more severe austerity measures. Do you think we’ll ever see euro bonds?
FA: We are really into the realm of absurdity. For example, the European Financial Stability Facility is a private company authorized to borrow €450 billion (B) from the private sector backed by a guarantee from all the EU members who are already heavily in debt and being downgraded periodically. One proposal I saw was that it would use the €440B of debt as collateral to borrow another €1–2 trillion of debt to lend to the PIIGS!
Can this type of thinking ever end well?
As Europe enters a recession, the problems will only get worse. Euro bonds issued by indebted countries just mean France and Germany are putting their own balance sheets at risk. It may provide time, but it does not solve the problem. The question is, should they bailout the PIIGS or take the same money and bailout their own banks? There are no good solutions.
A final thought on yields: when I studied economics we were taught that U.S. Treasuries were the risk-free asset to be used as an absolute benchmark. Given the recent downgrade and outlook, perhaps the economics profession should start looking for another risk-free benchmark, just as the U.S. dollar replaced the pound sterling.
TGR: Given all of this, how are you protecting yourself?
FA: One of the primary measures of protection is a healthy cash balance. You have to be in a position where you are able to ride out any crisis and also to take advantage of valuations in case of a crisis. If the crisis is as bad as I think it will be, you will be able to find and acquire assets at generationally low prices.
The other way to protect yourself is to invest in precious metals. I believe precious metals will do well whether we continue to stagnate or actually see another crisis. I think silver and gold equities will do very well in the long run.
TGR: Investors have been seeking greater security for at least seven months. How long do you think that risk-off sentiment will last?
FA: Brian, U.S. domestic stock funds have seen net redemptions for five straight years. Due to negative real interest rates, equities are undervalued in historical terms. This is tempered by the dangerous, rising systematic risk. Fund managers are paid to perform or else they face redemptions. So, the bias is for stocks to rally as we are seeing now, unless the second phase of the crisis clearly emerges, which in my opinion is inevitable.
Ironically, in another crisis, governments will likely turn to quantitative easing with a vengeance, which means that, despite a crisis in sovereign debt, we will see a substantial rally in commodities, particularly gold and equities, as substantial sums of newly created money finds its way into the system and money leaves the bond markets. You may find prices rising while the economy is being undermined.
TGR: Fayyaz, your background is in insurance and finance, how did you find your way into the gold and silver space?
FA: From 2001 onward, I realized that the U.S. seemed to lack the political will to deal with its increasing levels of budget and trade deficits. In fact, the Fed was creating asset bubbles that were bound to end badly. At the same time, I knew from history that fiat money generally ends badly, starting with Kublai Khan. I came to anticipate the decline of the U.S. dollar and the rise of gold. I believe that the price of gold will be much higher in the coming years and that gold will become part of the monetary system in some capacity.
Gold is interesting in another way. Throughout history booms have been localized geographically. As an example, the average Canadian investor is unlikely to invest in, say, Argentinian real estate or in its stock market even if they are booming. The Internet bubble was the first time that a global audience became aware of an asset category that was rising dramatically, ironically thanks to the Internet itself. But you could not participate unless you had a U.S. brokerage account. Gold is the first truly global asset boom that investors at all levels can participate in. Today investors are more savvy and more heavily invested across markets and categories but gold is fundamentally money and all investors and savers can buy it. Local yet global.
TGR: Investors also have different tools.
FA: That’s right. They can do a lot of research. They have a lot more liquidity. The potential impact on the market for gold as an asset class is phenomenal. It appeals to all levels of investors. Someone buying a few grams of gold in China creates demand that directly helps the value of your gold holdings. I mean, how many people sleep with a barrel of oil tucked under their mattress?
TGR: Not if you could help it.
FA: Historically, gold and silver equities leveraged the returns on gold. In 2011, mining companies were producing gold at an average cash cost just under $600/ounce (oz) and were getting about $1,600/oz in revenue. Cash flows are very impressive and price earnings are healthy. Mining companies continue to buy juniors with good assets, especially at these low share-price values. I moved into the sector to take advantage of this bull market in gold. And, I believe we will see a mania in junior mining stocks before this is over.
TGR: And, when will that be?
FA: I think we will see this happen within the next two years as people begin to realize that solutions to the global economic situation are not forthcoming. There will be more and more nervousness and gold will find a larger and larger audience.
We now have a situation where central banks, which were net sellers of gold for 20 years, became net buyers in 2009 and are accelerating their buying programs. We are seeing tremendous support for gold from central banks, institutional and retail investors across the world.
TGR: Do you have positions in any gold and silver juniors?
FA: Yes, one is Colombia Crest Gold Corp. (CLB:TSX.V; EAT:FSE). This company has a huge land package in a prolific gold belt, surrounded by several large deposits including Sunward Resources Ltd.’s (SWD:TSX.V) 8 Moz Titiribi project. IAMGOLD Corp (IMG:TSX: IAG:NYSE) took a 19.9% stake in October 2011, which validates Colombia Crest’s exploration program. With many large, prolific gold targets, the company will commence a 5,000m drill program next month. It also has a high-grade gold resource in Bolivia, a $25 million (M) market cap and $6M in cash. There is good upside potential as the company gets decent drill results.
TGR: Is there one project that will attract notice to Colombia Crest Gold?
FA: It has two projects in Colombia called Venecia and Fredonia.
TGR: And are they underground mine systems or bulk tonnage targets?
FA: I think Colombia Crest has a number of prolific targets. Some will be potential heap leachable targets and others are underground and, therefore, higher grade. So, the company has a dual approach in the Antioquia Province.
TGR: As far as management goes, are there people onboard that you are confident in?
FA: I mostly talk to Hans Rasmussen, the president and CEO. He strikes me as being very focused. He is a geologist and geophysicist and has worked with a number of senior companies. He was brought in by a group of investors to sort out various issues and he created the opportunity in Colombia. Rasmussen is the kind of person that you can have confidence in.
TGR: Do you have another junior name?
FA: I would also mention Coral Gold Resources Ltd. (CLH:TSX.V) with a 3.4 million ounce (Moz) Inferred resource. Its Robertson property in Nevada sits adjacent to Barrick Gold Corp.’s (ABX:TSX; ABX:NYSE) 14 Moz Cortez Pipeline mine, which produces gold at a cash cost of $312/oz. The preliminary economic assessment just came out, showing a net present value at a 5% discount at $1,500/oz gold of $147M for just three of its multiple zones. Its market cap is about $15M. Coral is a natural takeover target. I believe there is good value here for a patient investor.
TGR: Coral has not put out any news since February 2011. The lack of news for almost a year has done nothing but erode shareholder confidence. What is the problem?
FA: From what I understand, unlike nearby exploration companies, Coral has had its mine for a couple of decades and is a past producer. The company was given some very rigorous regulatory environmental conditions to meet regarding migratory patterns of birds and insects and such. Coral had to study these for a given period of time, which delayed its drilling permit. I think that situation is now on the verge of being resolved.
If that happens, Coral has the cash and is ready to drill. You should see movement in terms of activity and, potentially, share price appreciation.
TGR: Let’s move to silver. Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.A) is led by Bob Archer, a real veteran. The company is producing from its Guanajuato mine in Mexico. In 2012, the company plans to produce 1.72 Moz silver, up from 1.5 Moz last year. It also expects to produce 10–11 thousand ounces (Koz) gold, up from 7.8 Koz in 2011. That news, although good, was not met with much enthusiasm from the market. What are your thoughts?
FA: I think a 20% year-over-year increase is very healthy for any producer. The company’s profit margins are excellent. It has a 30% net margin for the year to date. So, it should generate very decent cash flows going forward. Great Panther has $40M in the bank. It is growing the resource at the San Ignacio project, is looking for acquisitions and it is mining a recently discovered high-grade zone in Cata.
Overall, the junior sector has stagnated over the last few months and I think Great Panther has just been part of that process.
TGR: What are your thoughts on what Bob Archer has done there?
FA: I think Bob has delivered tremendous value for shareholders. He is very competent and is a man of integrity. I think his share price is closely linked to the price of silver, which is generally true for most silver producers. Guanajuato has a rich history. It was mined by the Spaniards and has been in production for 400 years. It was once considered the richest silver mine in the world. Bob has taken it from when silver was down to $4/oz, resurrected it, capitalized it, built out infrastructure and delivered tremendous value.
TGR: In your time in this space, what have you learned that the average retail investor ought to know?
FA: This is a very volatile sector, subject to investors jumping in when there is a bullish trend and a lot of enthusiasm, and those same investors not wanting any part of equities when there’s a pullback in prices.
Given the overall increase in volatility in the markets, investors really should take a look at gold and silver. If they are bullish, any pullbacks in the commodity prices or in the associated equities should be seen as buying opportunities. When there is a lot of enthusiasm, it should be seen as creating selling opportunities.
You also have to have physical gold and silver in your possession. We learned a lesson with MF Global. We saw $1B of segregated funds in clients’ accounts vanish. My understanding is that some of those funds were comingled and used to settle MF Global’s liabilities to other financial institutions. There is this whole issue of counter-party risk, which gold does not have. That should be a cautionary reminder to people. You need to have physical cash balances. You need to have physical gold and silver outside of the banking system as a safety net because, as Warren Buffet said, we are in uncharted waters now.
TGR: You grew up in Pakistan, where gold is part of the culture, given as gifts at weddings and such. Do you think you would have that same opinion about physical gold as a personal asset if you had grown up somewhere else?
FA: Not in my case. I had no involvement or affinity with gold. I was a finance professional. My involvement with the gold sector is purely intellectually driven, from looking at trends within the macro economy and realizing that gold and silver really are hedges against turmoil and currency debasement.
But that is a very good question and it points up the importance of watching out for biases in the commentaries that you read. People have vested interests and they do tend to have agendas, both in the mainstream media and elsewhere. For your own protection, you need to be sensitive to those influences and to study track records at key inflection points before relying on other people’s judgment.
TGR: Fayyaz, thank you for your time and your insights.
Fayyaz Alimohamed is president, CEO and director of Altair Ventures Inc. and publisher of the Acamar Journal. He has over 20 years of experience in investment management, finance and consultancy. He previously worked at the Aga Khan University Hospital, Financial and Management Services Ltd. (a management consultancy set up by Morgan Grenfell & Co. Ltd. and Booz Allen Hamilton Inc.) and as the chief financial officer of the Key Capital Group before becoming director of investments for the Cupola Group, a large operating and investment conglomerate based in Dubai. He holds a Bachelor of Science (Honors) degree in economics from the London School of Economics, University of London, and is a Certified General Accountant (CGA).
By Simon Grey, on January 18th, 2012
Now, with the property worth roughly $60,000 less than the balance of their mortgage, Martin, 68, has been giving serious thought to just walking away, a process lenders call “strategic default.”
“Guilt and morality are one side, and objective financial analysis are on the other side,” Martin said. “They’re coming to two opposite conclusions. I wonder how many other people are struggling with the same question.” [Emphasis added.]
Actually, there is nothing at all immoral about walking away from an underwater mortgage. Yes, people (particularly Christians) are generally morally bound to pay their debts. But here’s the thing: If you default, your debts will be paid.
In a general mortgage agreement, the borrower agrees to borrow a certain amount of money at a specified price (called interest) from a lender. Since houses tend to be expensive, lenders don’t generally give out unsecured loans; in fact, lenders generally demand some type of security—also known as collateral—to secure the loan. In general, a mortgage is secured by the property being purchased with the mortgage.
This means that if a borrower misses a specified number of payments (known as default), the lender has the right to confiscate the property pledged as security as compensation for the loan. Stated another way, if you default on your loan, your lender will confiscate your pledged property. In essence, by confiscating your property, your debt is considered paid in full by the lender. You therefore owe the lender nothing, for the lender has stated, per the terms of the contract, that ownership of property offered as security will suffice as repayment in lieu of currency.
That the lender may take a loss on the loan is the concern solely of the lender. The lender has a moral responsibility to do due diligence on each loan, in order to maximize profit. If a lender fails to anticipate a declining housing market, that is his own problem. If a lender fails to anticipate high inflation, that is also his own problem. The borrower is not responsible for ensuring the lender’s profits, the lender is. If the lender is a fool, it is not the borrower’s job to save the lender from his foolishness.
As such, it is not inherently immoral to walk away from an underwater loan. If the lender contractually accepts the property used as security as sufficient for repayment, then there is no problem with using that property to repay the loan. The only question the borrower has to ask himself is which payment method is cheaper—cash or property—and act accordingly.
Note: obviously, this is a general moral guideline, not specific legal advice. Treat it as such. If you are considering a strategic default, consult with an attorney first.
By Thomas Knapp, on January 2nd, 2012
The saying is attributed to Ahmed Ibn Abu al-Hassan al-Nuri.
No, I’m not a scholar of Sufism. I came across the quote in Kim Stanley Robinson’s Mars trilogy years ago, and it spoke to me in a certain way — not as a moral or religious principle per se so much as a practical strategy for avoiding undesired entanglements, particularly vis a vis the state.
The jury’s still out on how well that works, by the way.
Anyway, I thought I’d throw it out there for discussion.
By Doug Gentry, on December 30th, 2011
Was it Popeye’s friend, Wimpy, who kept asking for a hamburger on credit? Today’s credit markets are anything but robust, with reduced demand and supply for borrowed funds. Always eager to find obscure terms for modern dilemmas, economists refer to this condition as a liquidity trap. With a little prodding from Facebook friend and neighbor, Patrick, we’ll give the concept a once over.
Jumping to the conclusion (and resisting the academic approach of a slow, careful warm-up) there is bad news and good news about liquidity traps. The bad news is that they make it difficult for the Federal Reserve to execute monetary policy. Creating 100s of billions of dollars has a muted impact on our economic recovery. The good news is that the liquidity trap dampens the significant inflation we might expect with the creation of all that money.
OK, back to the beginning. During times of slow or no growth and high unemployment the Federal Reserve can create/inject money, largely by increasing reserves that banks have in their accounts with the Fed. They can do this by buying U.S. treasury bonds on the open market, or even by buying troubled/toxic assets from banks. This increase in the supply of money allows interest rates to fall, which in term spurs demand for more consumption and investment. This is classic monetary policy. With mild downturns this is often enough to increase growth and kick start the economy. For the most recent 2007-2009 recession the Fed took these actions, a number of times in a number of ways, and those actions were not sufficient. Now the target short term interest rate – the Fed Funds rate – is essentially at zero. The Fed can’t lower the interest rates any further. Here’s a graph of the Fed Funds rate since 1980. The big peak at the beginning of the graph was the result of aggressive Fed action to contain inflation. Now, though, the rate has sunk to the very floor.
 Fed Funds Rate – St. Louis FRED database One thing that is happening is that while reserves are building up in our financial system, the banks are holding on to them rather than increasing their lending. Some argue that the banks are using the added funds to improve their balance sheets, which were hurt by the dramatic loss in value of securitized mortgages and other derivative assets, and to build up enough cash to pay executive bonuses. The banks argue that demand for credit by qualified borrowers is low. I don’t put much credence in the latter explanation. One apt analogy for this situation is that the Fed is trying to push on the end of a string, in order to get the economy going.
There is another layer to the liquidity trap concept, and that has to do with the buying public’s (people and business) expectation for inflation. The theory goes that if buyers expect inflation in the future, they will increase buying now. They expect the value of their cash or savings to go down during inflationary times, so they seek to use it now, while its value is still high. This works with traditional monetary policy where an injection of money would be expected to increase inflationary pressures.
On the other hand if purchasers believe that inflation will be controlled, then there is less pressure to buy now. That’s what is happening now. Despite what some politicians suggest, inflation is not right around the corner, and buyers are in no hurry to convert their cash into goods. We see evidence of this with the continuing low interest rates on U.S. bonds. Expectations of high inflation would push those interest rates up. Low inflation expectations, even in the face of increasing money supply is another symptom of a liquidity trap.
This scenario played out, to grim effect, in Japan in the 1990s, as their central bank poured money into the banking system and no one responded. Their “lost decade” was one of almost zero growth.
This paper by a New York Federal Reserve staff economist explains things in more detail, complete with impenetrable equations.
By Simon Grey, on December 30th, 2011
In Academically Adrift, Arum and Roksa paint a chilling portrait of what the university curriculum has become. The central evidence that the authors deploy comes from the performance of 2,322 students on the Collegiate Learning Assessment, a standardized test administered to students in their first semester at university and again at the end of their second year: not a multiple-choice exam, but an ingenious exercise that requires students to read a set of documents on a fictional problem in business or politics and write a memo advising an official on how to respond to it. Data from the National Survey of Student Engagement, a self-assessment of student learning filled out by millions each year, and recent ethnographies of student life provide a rich background.
Their results are sobering. The Collegiate Learning Assessment reveals that some 45 percent of students in the sample had made effectively no progress in critical thinking, complex reasoning, and writing in their first two years. And a look at their academic experience helps to explain why. Students reported spending twelve hours a week, on average, studying—down from twenty-five hours per week in 1961 and twenty in 1981. Half the students in the sample had not taken a course that required more than twenty pages of writing in the previous semester, while a third had not even taken a course that required as much as forty pages a week of reading.
One of the subtle cultural shifts arising from the education bubble has been how people are inclined to view college. It used to be that people went to college for an education. Now people go to college in order to ensure having a good job later on.* In essence, the role of college has shifted from education to credentials.
As such, it should not be surprising that colleges dumb down both their admission requirements and their curriculum, for the goal is not education. Rather, the goal is giving students customers a piece of paper that says they are smart. This claim doesn’t have to reflect reality in any meaningful way because most students don’t bear the direct costs of their “education.” Therefore, students are considerably more willing to spend their parents’ money and their future income on degrees that become less and less valuable.
Basically, then, the dumbing down of academic standards is proof of the education bubble because the free and cheap money subsidizes marginal students who would otherwise have no business being in college. This subsidy is then seen in the dumbed-down curriculum, for students expect to have something to show for the time and money they’ve put into college, and it’s easier to satisfy customers by giving them a degree regardless of their actual accomplishments.
*One thing that always puzzles me is how parents think that four to six years of extended adolescence is better for their children’s future than having an actual full time job is. But that’s for another post.
By Simon Grey, on December 15th, 2011
Researchers with the Federal Reserve Bank of New York found that investors who used low-down-payment, subprime credit to purchase multiple residential properties helped inflate home prices and are largely to blame for the recession. The researchers said their findings focused on an “undocumented” dimension of the housing market crisis that had been previously overlooked as officials focused on how to contain the financial crisis, not what caused it.
More than a third of all U.S. home mortgages granted in 2006 went to people who already owned at least one house, according to the report. In Arizona, California, Florida and Nevada, where average home prices more than doubled from 2000 to 2006, investors made up nearly half of all mortgage-backed purchases during the housing bubble. Buyers owning three or more properties represented the fastest-growing segment of homeowners during that time.
“This may have allowed the bubble to inflate further, which caused millions of owner-occupants to pay more if they wanted to buy a home for their family,” the researchers noted.
Investors defaulted in large numbers after home values began to drop in 2006. They accounted for more than 25 percent of seriously delinquent mortgage balances nationwide, and more than a third in Arizona, California, Florida, and Nevada from 2007 to 2009.
Sweet Keynes but the banksters just do not have a clue. Somehow, the FRB of New York has come to the hilarious conclusion that somehow, mysteriously, those who “flip” houses are the root cause of the recession. Talk about clueless.
The question that the NY FRB is apparently too stupid to ask is: Why would some people suddenly decide to “flip” houses? Answer: because it’s generally profitable due to the increased demand for houses as a result of a)artificially low interest rates from The Fed, b) massive fraud among the banks in regards to loan application, c) the Federal Government’s willingness to subsidize market risk, and thus eliminate moral hazard, through the agencies Freddie Mac and Fannie Mae, and d) the general tendency of the government to encourage and subsidize home ownership through, among other things, federal income tax breaks. Basically, the government as at the root of most of the problem here, and the Federal Reserve played a major role.
Of course, the FRB is not going to admit to wrongdoing, particularly since greedy businessmen make for a more compelling villain in this narrative. But blaming people for responding to incentives at the margin, as clearly happened in this case, is indicative of just how worthless mainstream macroeconomic analysis clearly is. Quite simply, it takes an astonishing amount of either dishonesty or short-sightedness to come to the conclusion that greedy businessmen are to blame for the current recession instead of the incentive system in which they operated.
The shallowness of this analysis, if honest, is simply evidence that those who are currently in charge are simply too stupid to merit the power with which they’ve been entrusted. If, on the other hand, they are liars, the case for their removal from power is not in any way diminished. In sum, there is no excuse for those presumed to be intelligent, and thus deserving of power, to be offering analysis this putridly vapid; they must be summarily dismissed and the system must be dispatched with.
* Cf. Dr. Sowell’s book Applied Economics.
By Simon Grey, on November 9th, 2011
Seriously, what’s so difficult about allowing student loans to be discharged in bankruptcy? Today, President Obama is effectively giving college students and their parents his middle finger. Whereas Jobs’ prank was harmless and symbolic, the President’s plan to bail out student loans will derail the entrepreneurial dreams and financial security of countless young people. [Ed. - this claim is utter bulls**t.Bailing out student loans will increase their financial security because they will no longer be slaves to the banks. And, with less debt, they can actually become entrepreneurs.]
By executive order, the President’s unconstitutional “We Can’t Wait – Pay As You Earn” plan modifies the existing Income-Based Repayment Plan so that, effective in 2012, graduates may cap their loan payments at 10percent instead of 15 percent of their discretionary income. Anything remaining after 25 years (formerly 20 years) becomes fundamentally the taxpayers’ responsibility. And, if a student wants to become a public servant (i.e. work for George Soros) his loan will be forgiven after just 10 years.
Obviously, Obama is playing for political points with this plan, presumably to mollify the OWSers, so I understand outrage for that reason. But what I don’t understand is how anyone thinks that student loans weren’t already the taxpayers’ responsibility. The government guaranteed student loans a long time ago, which is one of the reasons there’s a college bubble—private lenders face virtually no risk on the loans. In fact, the government guarantee of repayment is why default was taken off the table as an option: the government didn’t want taxpayers to take it in the shorts.
Neo-con bomb-lobbing aside, Obama’s plan is pretty terrible. It shouldn’t wreck the economy(at least no more than seeding a college bubble would), and it’s better than a jubilee for the loans, but there is still a much better solution available: the federal government should stop guaranteeing student loans and allow them to be discharged in bankruptcy. This way, college student wannabes won’t be as inclined to pursue worthless degrees and banks won’t be as inclined to fund the pursuit of worthless degrees. You don’t need bailouts, you don’t need special debt laws, all you need is the ability to discharge student debt during bankruptcy. Problem solved.
By Simon Grey, on November 8th, 2011
If you weren’t sure about the existence of a college bubble, here’s proof:
When the number of psychology majors increase by 135% over25 years, you can be reasonably sure that there’s a college bubble because a) psychology is not a science, it’s a form of bovine fecal matter and b) economies don’t need psychologists in order to grow and thrive. In essence, more than doubling the number of psychologists in the economy is not going to cause massive growth.
So why are there so many psychology majors? Simple: The ease of obtaining student loans makes it appear that there is more demand for psychologists than actually exists. And why do current students believe there is more demand for psychologists than actually exists? Again, simple: the government has incentivized the extension of student loans by guaranteeing repayment thereof. When a student defaults, the government pays the lender then goes to collect the remaining debt. Sometimes the government uses the banks’ collections agencies to collect the loan, which then makes defaulting on student debt a very attractive proposition for the bank that originated the loan.
So how do we know that the increase in psych majors proves there’s a college bubble? Easy: the government’s involved, and is actively encouraging the pursuit of a college education. Plus, does anyone think that so many would pursue a psych degree if they couldn’t finance it so easily?
By The Gold Report, on November 3rd, 2011
 Exponential debt increases coupled with limited natural resources mean that we are in a predicament. This is the message The Crash Course Author Chris Martenson delivered at the Casey Research/Sprott Inc. summit, “When Money Dies.” As an economic researcher, Chris considers the “Three E’s” that shape our future: Economy, Energy and the Environment. In the below presentation, “Unfixable,” Chris explains to Energy Report readers why these indicators suggest a global economic slowdown. Read on.
The next 20 years are going to be completely unlike the last two decades. How the world works, how stocks grow, the very nature of investing and how our economy functions—all of these are due for fundamental, earth-shaking change. As investors, we have to adjust the way we look at the world.
We want growth. We need economic growth. It’s all you hear about when the treasury secretary talks about how we are going to get the economy growing again or when the president talks about jobs. When our money system is growing, things are reasonably happy. When it is not growing, things are very unhappy. As long as everything is growing, our economy functions reasonably well. And when it stops growing, it throws giant fits and gets into trouble. That is why we are always chasing growth. And there is a reason for that: Money. But what is money?
I don’t care what color it is or whose picture is on it or what counterfeiting measures you have in place. All money in the world today shares one characteristic: it is loaned into existence. It seems like a simple enough statement, but this has enormous implications. Because it is borrowed, we pay interest on it. That interest drives a peculiar feature in our money system (by “our” I’m referring to all fiat currencies in the world because all of them operate by this same loaning principle). When you loan money into existence, you have to pay both the principal and the interest back. That means there is always more debt than money in the system.
We are constantly growing our money supply because our population is growing. In the past, we had a seemingly endless supply of resources, energy and land to occupy—all of that has been OK. But we are coming to a point where it’s not OK anymore.
Consider a chart of total credit market debt. It tops out at about $52 trillion (T). Each of those big, blue, upside-down triangles mark a doubling of credit market debt. From 1970 to about 1977, total credit market debt doubled. It doubled again by 1983. Then it doubled again and again and again. Over four decades, we had five doublings of our credit market debt. In order for the next 20 years to look like the last 20 years, we would need two complete doublings of credit market debt. Let me put those numbers in: $52T to $104T to $208T. That is an absolutely obscene amount of credit growth. This is not how our economy is supposed to function. It was a result of the abandonment of the gold standard, and it is not sustainable.
The second thing I want to point out is the blue line. That is a curve fit. It is an attempt to mathematically model what is going on with that red credit market debt line. It shows that our money system, our credit system, has been growing nearly perfectly exponentially.
Debt:GDP Explosion
Another way to evaluate the economy is by looking at the debt:GDP ratio, because if you have a lot of income, it is OK to have a lot of debt: GDP is our income. Something really unusual is happening: The ratio is skyrocketing in an unprecedented range, with the exception of a blip during the Great Depression when manufacturing dived. We are in the middle of a very interesting experiment in this country. We can’t dig through the data series and say, “Oh, the last time we did that, this is how it turned out.” We don’t have any historical examples of any country in history getting out from under a debt:GDP load this high without going through some kind of a massive currency adjustment. There is one example from 1815 to 1900 where England got out from under 260% debt:GDP load, and it did that by cutting war spending after the Napoleonic Wars with help from the Industrial Revolution. Nothing on our horizon indicates that we are going to cut spending or increase our overall economic output by huge amounts. So we have to ask the question: How do we get out from under that? This debt:GDP imbalance is a global phenomenon. It is not just a U.S. problem.
That is why the economy must grow. In order to be happy, in order to service those debt loads, it must grow. Exponential growth, the kind that starts out nice and easy in a linear fashion and then shoots up suddenly, is what I am really worried about. It is everywhere. Human population grew rather sedately for a long period of time and, recently really accelerated. Oil consumption has increased on the same model. Starting in the early 1940s, it really turned up. The more we produce, the more we use. The same is true on the environmental side; water use, forest loss, species extinction, fisheries exploited—all of this turned up aggressively in in the 1940s and 1950s. We could look at miles of roads paved, numbers of McDonald’s hamburgers served; it doesn’t matter. We are surrounded by all of these nonlinear, very J-shaped curves. This is really critical if you believe in boundaries. There is only so much arable land. There is a limit to how much water is in an aquifer. There is a limit to how much oil is in the ground. We can argue about whether we are close to those limits, but we can’t argue about the fact that the limits exist. So we need to understand how we are using these things.
I like to use a thought exercise to explain exponential growth. I have this magic eyedropper. A drop of water from this thing is going to double every minute. So one drop will become two drops in one minute. In another minute it will be four drops. After about six minutes, it will be enough to fill a thimble. If we started this experiment at noon on the pitcher’s mound of Yankee Stadium and you are handcuffed to the highest row of the bleacher seats, how long would you have to escape from your handcuffs? By 12:50 that same day, the park would be completely overrun with water. In fact, at 12:45 this is still 97% empty space with a little water in the infield. You have 45 minutes to sort of fool around, but the next five minutes are critical. That is the power of exponential increases. If you have that sense that world events are speeding up, you are right. They absolutely are.
A Peak Problem
Dating back three million years from the australopithecine humanoid precursors to 1960, we put 3 billion people on the planet. It took 40 years for the next 3 billion to arrive. Someone who is 22 years old today has been alive when half of all the oil in the world that has ever been burned has been burned. We are burning oil at roughly 2–3% more per year than when we were in a healthy economy. This is a predicament.
Do you know the difference between a problem and a predicament? A problem has solutions. A predicament has inevitable outcomes that have to be managed. If you are in a predicament seeking solutions, you are wasting time. A lot of our efforts at the national level right now are centered around seeking solutions to predicaments. That concerns me greatly because it means we are actually wasting our time, wasting resources and not looking at things the right way.
Our predicament right now concerns energy. U.S. oil production peaked in 1970 and has never returned to its former days of glory—and it never will. As a result, we import two-thirds of our liquid petroleum needs to run our society. No matter how much we drill at this point, there is absolutely no chance that we are going to return to our former production highs. In fact, out of the 54 oil-producing countries, we have about 45 that have gone past peak. No country has ever managed to get back to a former peak and exceed it.
World Discovery by Decade
 Source: Chris Martenson
The peak year for oil discover was 1964. The green in the chart represents history. The red is projections for what we think we might find going forward. There could be some wiggle room, but I think it would be a stretch to think that we are ever going to get back to that peak that we saw in the 1960s.
Here is the thing about oil: If you want to produce it, you have to find it. Our finds were 40 years ago. Interesting fact: The U.S. peaked in its domestic discoveries in 1930 and hit a production peak in 1970, a 40-year gap. World oil discovery peaked in 1964 and world oil production for conventional oil peaked in 2005, 41 years after its find peak. It has not yet been exceeded. It might, but it hasn’t, even though oil prices have tripled. If there is ever an incentive to get your oil out of the ground, it’s when prices triple. That’s what market theory tells us. Somehow, we haven’t done it.
The U.S. Energy Information Administration issued a shocking statement in its 2008 World Energy Outlook. It said that oil from currently producing fields peaked in 2006. It factored in natural gas, non-conventional oil and crude oil yet to be found and developed as possibilities for filling the country’s growing energy needs. The problem is that in order to get energy out of the ground, you have to put energy into the equation. If we take a barrel to find a barrel, then all we are doing is using energy to go explore and get energy out of the ground—there is none left over to go into our gas tanks. There is none left over to grow food, or for anything else. By the time you are using one barrel to find one barrel, you are spinning your wheels.
The same lopsided equation is operational in shale beds. If we decide to switch to natural gas, we will need to retrofit our cars, build filling stations and pipelines. This will take a lot of money and about 10 or 20 years to build out. There are going to be companies that make a lot of money aggressively attempting to expand into that, but we are already behind the eight ball.
When we first started drilling for oil in the 1930s, we were getting 100:1 returns from these little wooden drilling derricks going down maybe 1,000 ft, hitting spindletop. At that point we were putting in one barrel and getting 100 back. In the ’70s, we were getting maybe 25:1 back. In the 1990s, we were getting 18:1 or even 10:1. We were drilling deeper, more remotely. The substance was a little heavier, and more sour. We went after the good stuff first: light, sweet and near the surface. Now, we are drilling in a deep ocean environment. Some of our efforts are down to 3:1. Ethanol will make it even worse. As we fall down this energy cliff and get progressively less and less energy back for our efforts, the amount of energy available to us to run our economy drops rather precipitously.
Natural Erosion
This same dynamic impacts natural resources. Some 150 years ago, we found giant nuggets of copper the size of cars sitting in streambeds. Eventually we went after smaller nuggets. Then we went after copper ore grades of 10%. Now we have huge open-pit mines with ore grades of 0.2%. Regardless of whether copper is $4/lb or $3.50/lb or $35/lb, think about the energy required to take 500 lb of copper ore from the bottom of that pit, haul it up a quarter mile, run it through a crushing machine, smelt and refine it to get that 1 lb of copper out. Would we be doing that if we didn’t have liquid fuels, if we didn’t have diesel to run big trucks? I think the answer is no. And this is after just 150 years. What happens over the next 150 years? How about in 500 years? If we continue to deplete all of our mineral reserves at 2% growth in extraction per year, which has been our 40-year historical run, how long will they last? We might find more, but sources will be more remote, further away from infrastructure needed to extract them, refine them and move them to market. The end product will be more diluted and lower quality, with deeper costs attached.
We have a world where we will face exponentially rising costs if we continue to run our economy in the way it has been running. That is not a great strategy at this point. Our economy must grow by design because of how our money and debt systems operate, but it is connected to an energy system that can’t grow. This is the definition of a predicament. No matter what policies we pursue or how clever our technologies get, there are certain things that we just can’t undo. When you take oil out of the ground and you burn it, it is gone. And we are burning it up at a faster and faster pace.
Coming to terms with this reality has actually been a fairly liberating idea for me. It has allowed me to understand what is important in my life. And it has been very helpful in my overall investing philosophy. Even though it is not a terribly uplifting story for a lot of people at first, I do think that it helps to clarify where we are in the story and what is happening.
This was a summary of Chris Martenson’s presentation. For the complete audio collection of the Casey Research/Sprott Inc. Summit “When Money Dies,” click here.
Chris Martenson is a scientist, financial and economic analyst and writer at www.ChrisMartenson.com. He earned his MBA at Cornell University and a Ph.D. from Duke University. As one of the early econobloggers who forecast the housing market collapse and stock market correction years in advance, he launched a video seminar and later published a book entitled The Crash Course. To learn more about Chris and his work, including the Crash Course, go to chrismartenson.com.
By Simon Grey, on September 26th, 2011
Freakonomics asked if forgiving student loans en masse was a good idea. Here was their conclusion: 1. Distribution: If we are going to give money away, why on earth would we give it to college grads? This is the one group who we know typically have high incomes, and who have enjoyed income growth over the past four decades. The group who has been hurt over the past few decades is high school dropouts.
I guess it would help to define “high income.” Everything I’ve seen suggests that college grads generally start with relatively income when joining the workforce and that it eventually increases over time. And, once you adjust for inflation, grads today are earning less than grads of, say, thirty years ago, on the average. The only way the above claim is true is if one compares the college grads to those with less education. Also note that income growth, though a trend, is not promised to continue indefinitely. Also note that going to college is the recommended course of action, while dropping out of high school is not. In essence, those who have played by the rules, so to speak, are in a tough bind because they have played by the rules. It is cruel to argue that they don’t deserve consideration because they are still better off than those who didn’t follow the rules.
2. Macroeconomics: This is the worst macro policy I’ve ever heard of. If you want stimulus, you get more bang-for-your-buck if you give extra dollars to folks who are most likely to spend each dollar. Imagine what would happen if you forgave $50,000 in debt. How much of that would get spent in the next month or year? Probably just a couple of grand (if that). Much of it would go into the bank. But give $1,000 to each of 50 poor people, and nearly all of it will get spent, yielding a larger stimulus. Moreover, it’s not likely that college grads are the ones who are liquidity-constrained. Most of ‘em could spend more if they wanted to; after all, they are the folks who could get a credit card or a car loan fairly easily. It’s the hand-to-mouth consumers—those who can’t get easy access to credit—who are most likely to raise their spending if they get the extra dollars.
Can we get rid of this whole nonsensical stimulus thinking? All money circulates. Ceteris parabis, the money will be spent at some point. The only concern is over timing, not necessarily net effect. And there is no objective reason to prefer immediate results to delayed results. This point, though technically true, is irrelevant.
3. Education Policy: Perhaps folks think that forgiving educational loans will lead more people to get an education. No, it won’t. This is a proposal to forgive the debt of folks who already have an education. Want to increase access to education? Make loans more widely available, or subsidize those who are yet to choose whether to go to school. But this proposal is just a lump-sum transfer that won’t increase education attainment. So why transfer to these folks?
This is simply asinine. No one thinks that forgiving loans makes education more desirable. People think that the student loan system is fraudulent (i.e. people were talked into loans under false pretenses). The reason most people support loan forgiveness is because they see it as a reasonable redress to the outrages of the system. Also, note that the current system does a remarkable job of subsidizing marginal students, which is the problem in the first place.
4. Political Economy: This is a bunch of kids who don’t want to pay their loans back. And worse: Do this once, and what will happen in the next recession? More lobbying for free money, rather than doing something socially constructive. Moreover, if these guys succeed, others will try, too. And we’ll just get more spending in the least socially productive part of our economy—the lobbying industry.
Don’t or can’t? How many grads have to take on subpar jobs because they can’t afford to wait for better jobs or undertake risky ventures? These kids have been sold a lie, and many they have no recourse (and I mean this literally as they can’t even default out of their loans). The government guaranteed repayment of student loans, and, in order to prevent getting hit in the shorts, has made it impossible to discharge this debt through bankruptcy. As such, banks have little incentive to ensure the loan’s recipient’s ability to repay. In short, the government has created the mess, under the guise of helping the underprivileged. They have turned the underprivileged into slaves. Shouldn’t the slaves be able to lobby their master? Or is that too much to ask?
5. Politics: Notice the political rhetoric? Give free money to us, rather than “corporations, millionaires and billionaires.” Opportunity cost is one of the key principles of economics. And that principle says to compare your choice with the next best alternative. Instead, they’re comparing it with the worst alternative. So my question for the proponents: Why give money to college grads rather than the 15% of the population in poverty?
This is simply stupid. The 15% of the population in poverty already receives money. To the tune of billions of dollars per year. How much more do they need? You’d think hundreds of billions of dollars would be enough to cure poverty, but apparently the federal government sucks worse at charity than it does at disaster relief in a chocolate city after a hurricane.
This is nothing more than a grossly ignorant appeal to emotion. The poor already get money from the federal government. And why are corporations more deserving of billions of dollars? The government has already lined the pockets of their Wall Street cronies through student loans. Shouldn’t this be redressed?
Conclusion: Worst. Idea. Ever.
More like: Worst. Rebuttal. Ever.
However, I don’t find the idea of student loan forgiveness all that appealing, in part because students still deserve to face the consequences of their (admittedly stupid) decision to go to college instead of getting a real job. In order for a lie to work, one party must tell it and another party must believe it. If you believe a lie, you need to live with the consequences. But if you take advantage of those who have believed a lie, then you deserve the consequences thereof as well.
My proposal, then, is very simple: allow grads to default on their student loans. Grads’ credit scores will take a hit, which is a reasonable consequence t their decision to essentially waste four years of their life. And banks would be forced to write a bunch of bad loans, killing their profits, which is a reasonable consequence to their decision to loan money to people that didn’t deserve it.
The current system is broken and remarkably unfair to those it purports to help. Correcting this problem doesn’t require forgiving all students of their loans. Allowing grads who find that a college degree is worthless to default on their loans should be sufficient to clear the market.
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