How to Make Money in a 'Fugly' Stock Market: Bob Moriarty

Bob Moriarty Despite the “fugly” future that Bob Moriarty, founder of 321gold.com, talks about in this exclusive interview with The Gold Report, he’s downright bullish on the U.S. dollar for the time being. He says it’s not only a safe haven but “the best investment to be in for the last six months.” As for equities, Moriarty makes it clear that he takes no pleasure in watching a company lose 25% of its value in a week when there is nothing wrong with the company. At the same time, he’s alert to bargains. Any time you have the opportunity to buy cash at a discount, he advises, “throw money at it.”

The Gold Report: Since the last time we chatted in July, Bob, a lot has happened. Congress raised the debt ceiling, as you predicted.

Bob Moriarty: Right.

TGR:Then the Super Committee failed to produce an agreement so we can look forward to the automatic debt reduction of $2.2 trillion.

BM: The Super Committee was totally illegal and unconstitutional in the first place and it was totally ineffective. They couldn’t reduce spending by $1.5 trillion over a 10-year period. Give me a break.

TGR: Okay. Moving on. . .Unemployment remains at about 9%.

BM: You say 9%? I don’t think so. How about 23%?

TGR: The list goes on. Occupy Wall Street protests have sprouted up all over the country. And of course, Newt Gingrich is the leading Republican candidate.

BM: That anyone could even consider Newt Gingrich for anything above the role of dog catcher is pretty terrifying.

TGR: There’s more. We’ve seen riots in Europe, with the epicenter in Greece. We’ve got a weak German bond market.

BM: Weak? It was a total failure; 39% coverage is a disaster. Germany is the bedrock of the EU, and if they can get bids for only 39% of bonds it’s over—over—for the EU.

TGR: The Italian bonds coming up should test that theory.

BM: Italian bonds are paying 8% or something like that. It can’t do it. The Greek two-year bond is paying 160%. The one-year bond is paying 270%. Greece has defaulted. Italy, Spain and France are going to default. It will be a series of cascading bank defaults. Dexia Bank failed a month ago. The banking system is under water. I’ve been saying that for years. It’s true.

TGR: So looking at this whole developing picture, from the crisis in Europe to the U.S. debt debacle, from stubborn unemployment, protests and riots to the upcoming presidential election—what do you make of all of this?

BM: The piece I wrote in early October captured it. I said things were about to get “fugly” and it’s time to head for the bunker.

TGR: In your Nov. 11 article, you stated specifically that you’d climb out on a limb and suggest that 2012 will go down in history as the year of bank failures. How do you see that scenario playing out?

BM: Okay. Here’s what’s important to understand and very few people understand this. If you start off with $1 million and loan it from one institution to another to another to another, you may have a net of $1 million. But if somebody defaults and that $1 million asset disappears, you get cascading defaults of every institution that had that $1 million asset. It’s really simple. The Greek default—and Greece has defaulted even though they won’t admit it—will cause a default in Spain and Italy, and that’s going to cause a default in France and that’s going to cause a default in the U.S.

TGR: And what happens when they default?

BM: The banks close. What can we do? We have more debt in the world than assets, so we have to write off the bad debt. Unfortunately, no government in the world is talking about that. The only people talking about it are Gerald Celente, Kyle Bass and me.

TGR: But bank foreclosure is more than writing off bad debt. That creates catastrophic. . .

BM: It’s a good thing if a business fails, because that means somebody who is efficient comes along and picks up the slack. We do not need to reward failure in the banking system. We need to reward success.

TGR: Could the banking system write off a portion of the debt?

BM: Nah, they are under water now. It’s a zombie banking system and has been since about the middle of September 2008. Just a while ago, at the end of November, the Federal Reserve disclosed $13 billion in profits to the banks from the trillions in loans they made back in 2008 that they’ve been lying about ever since. They were bailing out Barclays, Royal Bank of Scotland and lots of other banks that had nothing to do with the United States.

TGR: Is there a banking system that will survive these cascading defaults?

BM: The question should be: “Can you have a banking system that is sound and secure?” And the answer is yes. The Canadian banks are in a lot better shape than the U.S. banks. A sound, secure bank cannot have those zombie assets, such as the mortgages that we know people are not paying off. Half the mortgages in the United States are under water, with 25% in default. Those mortgages must be written off.

TGR: Couldn’t a component of the banking system—some of the regional banks in the U.S., particularly those that have written off some of those mortgages and are really more about loaning to local businesses and local communities—survive a banking system failure?

BM: The banking system in the United States is a network of giants and the regional banks really don’t exist anymore. I don’t have specific numbers but I think the big five banks probably represent 90% of the banking system. That leaves no fallback, really.

TGR: When the U.S. banks close, you’re in the Cayman, but what happens to the rest of us?

BM: Since Bretton Woods in 1944, governments have been spending money they don’t have and it’s time to pay the piper. A lot of people’s “assets”—Social Security, pensions, Medicare, Medicaid—will evaporate. They’ll disappear. We need to go back to a real world economy where people produce things of value. We need reasonable taxes. And we need a reasonably sized government that doesn’t spend beyond its means. This is true of individuals as well as governments.

TGR: How do people waiting in line for pensions, Social Security, Medicaid, etc. . .

BM: That money has to come from somewhere. Anything the government gives one group has to be taken from another group. The net is it costs you money to have the government provide healthcare, Medicare, Social Security. We would be far better off if the government didn’t provide these things. We didn’t have Social Security 100 years ago and people were fine. When I started working 40 years ago, people still had pensions from their employers. By and large they don’t have much of that anymore.

TGR: Unless they’re government employees.

BM: Yeah. Then you are going to get paid twice what the private sector is getting paid.

TGR: Your November article also said what you have been suggesting for months that cash is the best investment people can hold. In fact, you concluded with these words: “It’s time to stay in cash and head for the bunker.” As you mentioned before, “times are about to get fugly.”

BM: Right.

TGR: Do you include cash equivalents such as gold or precious metals under that “cash” umbrella?

BM: No, I mean cash. The best investment to be in for the last six months was cash, U.S. dollar cash. Even Gerald Celente had a six-figure account with MF Global and the money simply evaporated. Without cash, people who go to bed wealthy will wake up poor.

TGR: All the goldbugs say that will happen if you keep your money in fiat currencies too.

BM: That’s not necessarily true. At times, investing in fiat currencies is a good deal. If you were investing in U.S. dollars in March 2008, you would have been better off that fall than you would with any other single investment. Gold went from about $1,200/ounce (oz) to $700/oz, while silver went from $21/oz to $9/oz. The stock market crashed. The gold juniors crashed. Sometimes being in cash, U.S. dollars, is a good investment. It’s been a particularly good investment for the last three or four months.

TGR: Because your analogy goes back to 2008, when we had a severe crash, is it fair to extrapolate that you’re predicting another severe crash?

BM: We are going through a crash right now.

TGR: If that’s the case, why should anyone be in equities?

BM: You can’t ever invest 100% in anything. No one can guarantee the future. All you can do is hope you get it right 55% of the time. Cash, U.S. dollar cash, has been a good investment since this past April, and it’s still a good investment. Europe is about to blow up and the dollar is a safe haven. There is a lot of deleveraging going on. And, as in 2008, the U.S. dollar is a good place to be. And cash is better than having the money in T-bonds, with a negative interest rate.

TGR: You are expecting the banking system to collapse, and banks typically hold cash. What value is the cash if the banks fold?

BM: You can buy things with it.

TGR: So you’re saying people should physically hold their cash in their homes?

BM: I do. I have some money in the banks to pay bills, but mentally I have written off every cent in the bank. I accept the fact that I will go down to the bank one day and the ATM won’t work anymore and the bank will be closed. You can have cash sitting in the bank, too, but at the same time you have to understand the great danger with the banks. While I wouldn’t sit on a half million dollars in cash at home, if I had it in a bank I would be prepared. I think everybody should keep three to six months in liquid assets, and that certainly would involve cash and gold and silver. Cash and gold and silver will be very valuable when the banking system collapses.

TGR: If the banking system collapses, how long will it be before new banks emerge to take over the fundamental role of banking?

BM: It’s not “if” the banking system collapses; “when” would be more accurate. You simply cannot justify the banking system today. The sooner we get to whatever comes next, the better off we’ll be. My opinion is that all fiat currencies will crash, and when they do, we’ll go back to a gold standard.

TGR: How quickly can we develop a gold standard from the annihilated banking system?

BM: It depends on how big the riots are. Governments never act. They only react. If we have riots in every major city in the United States and hundreds or thousands of people a day are being killed, the government may actually take some action that would make sense. That would be to say, “We have a financial system that doesn’t work. We need to go to a financial system that does work.” Gold and silver work and they have worked for 5,000 years.

TGR: Do you see a situation where the government would start a national bank?

BM: God, I hope not. That would be adding fuel to the fire. I think that “unlimited stupidity” and “government” belong in the same sentence. But if the government started a national bank, that wouldn’t be unlimited stupidity―that would be infinite stupidity.

TGR: Earlier you made a point about having to be right only 55% of the time to move forward with a balanced portfolio. Let’s assume that an investor has some hard assets now, in safe havens, with some at home. At that point, does this investor turn to the market?

BM: Yes. I just bought 100,000 shares of a company that did a financing at $0.80 in April. It now has $0.46 per share in cash and its stock is selling at $0.23. If I can buy cash at $0.50 on the dollar, I’ll do it.

TGR: So you are looking for opportunities with a company’s value below its cash balance.

BM: Any time you can buy at a discount, that’s a good deal. If you can buy a dollar for $0.50, the upside is $0.50. We see this happening every 10 or 15 years. In the summer of 2001, a number of stocks that were selling for less than the cash they had on hand doubled or tripled or quadrupled when the market turned around. In September and October of 2008, something like 200 companies were selling for less than their cash on hand. A Russian silver company was selling for $0.20 on the dollar. You simply cannot get a more favorable environment than buying cash at a discount. Any time you have that opportunity, you should throw money at it.

TGR: So, what companies are you finding that have cash at a discount?

BM: People are going to have to look for them themselves. All the figures are available to everybody. I use Stockhouse and StockWatch and look at the ratios.

TGR: We’re hearing that capital is so hard to come by, yet we found at the San Francisco Hard Assets Investment Conference at the end of last month quite a number who were getting capital.

BM: Those deals had actually been set up for months. The last few weeks the financings literally just stopped. Everybody is in a total panic now. I watched stocks drop 25% and I have to tell you, it was pretty scary even though I was one of the guys forecasting it. When a company loses 25% of its value in a week and there is nothing wrong with the company, it’s scary. A lot of times I see things happening that scare me and I don’t want them to happen. I talk about them because I have an obligation to talk about them.

TGR: Could you talk about the kinds of companies that are actually building their value?

BM: In August 2008 the Philadelphia Gold and Silver Index, which is a measure of pure psychology, went to the lowest level it had ever been in history. Stocks were cheaper in August, September and October 2008 relative to gold than they had ever been. But gold was $700/oz. Silver was $9/oz. And they got clobbered. So it’s natural that big gold and silver shares got clobbered too.

Now, we have $1,700/oz gold and $32/oz silver, and stocks are cheaper today than in 2008. That is totally irrational. Those kinds of circumstances do not continue for very long. In 2008 platinum came down to the same price as gold. Platinum is $210/oz cheaper than gold today and that has never before occurred in my lifetime. I don’t think it’s occurred in history. That’s an example of something that would be a very good opportunity.

TGR: So if the juniors are on sale, are the majors also on sale?

BM: Yes.

TGR: How should investors begin looking at the whole plethora of mining companies to decide which ones really create the value?

BM: My priority would be junior production stories. You’ve got Timmins Gold Corp. (TMM:TSX.V; TMM:NYSE.A), Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BLV), Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:Fkft), First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:Fkft; FRMSF:OTCQX), Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.A) and Rio Alto Mining Ltd. (RIO:TSX.V; RIO:BVL; RIOAF:OTCQX). There are dozens, dozens of good production stories. Nobody quite knows where the price of gold and silver will go, but anybody in production now is literally minting money. You would have to be profitable. You couldn’t possibly not be profitable.

TGR: You wrote about Meadow Bay Gold Corp. (MAY:TSX.V; MAYGF:OTCQX) back in October. Is that still an interesting story to you?

BM: It’s a really funny story. It totally screwed up its drill program. It was drilling for an epithermal vein system and hit a porphyry system. The significance of that is that porphyries are really big, so instead of having potentially 1–2 million ounces (Moz), literally overnight it went to having 3–4 Moz potential.

When I made that same comment about screwing up the drill program with Meadow Bay’s chief geologist, he laughed, because if you’re going to screw up by finding a much bigger deposit than you thought you had, that’s a really good deal.

TGR: You’d called it a no-lose drill program. Did you know it was going to come out the way it did?

BM: It had announced one hole—a porphyry hole. As soon as I knew it was porphyry I understood the future was bright indeed. That’s a really good company and it is doing a really good job.

TGR: Do you have a preference toward production of gold versus silver?

BM: Silver has attracted a lot of attention with people who simply don’t know what they are writing about. And they attract all the nutcases. You can make a lot more money shorting silver than you can going long silver because people get totally irrational. There is no shortage of silver. We are not about to run out of it. The ratio over 100 years has been 47:1—47 ounces of silver per ounce of gold. In a financial collapse, the ratio actually goes higher. I could see silver going to 100:1 before it goes 30:1. But, the primary factor in the price of anything is the cost of production. Silver costs $6–8/oz to produce, so $32/oz silver is pretty expensive.

TGR: So you would want to look at junior production companies that would still be profitable with silver at $10/oz?

BM: The silver companies would still be extraordinarily cheap even if silver went to $15/oz.

TGR: Do you have any other companies with no-lose drill programs or other nice surprises in store on your radar?

BM: Dozens of companies have done exceptionally well. I just came back from two weeks in Colombia, where virtually everything is a slam-dunk. Sunward Resources Ltd. (SWD:TSX.V) is going to be announcing really extraordinary results. It already has about 8.6 Moz. That’s an extraordinary amount of resources for a company only two years old.

TGR: If Sunward is still drilling, how big might that get?

BM: A lot bigger.

TGR: Double?

BM: Could be.

TGR: In what timeframe?

BM: Two years.

TGR: Any others you’d care to mention in Colombia?

BM: Colombia Crest Gold Corp. (CLB:TSX.V; EAT:Fkft), Red Eagle Mining Corp. (RD:TSX.V), B2Gold Corp. (BTO:TSX; BGLPF:OTCQX), Bellhaven Copper and Gold Inc. (BHV:TSX.V), Solvista Gold Corp. (SVV:TSX.V) and Continental Gold Ltd. (CNL:TSX). But, there are 36 listed companies in Columbia, and I don’t think you could go wrong investing there.

TGR: So Colombia as a region is a good play.

BM: It’s a phenomenal play.

TGR: You’re also big on Africa.

BM: I used to be, but Africa is getting really stupid. Tanzania’s come up with suggestions and changes to the mining laws. Ghana’s started getting greedy. In every business cycle when the cost of the commodities goes up countries start thinking, “You know, we hate to see these guys making all this money so we need to make sure it won’t happen.”

TGR: So Africa’s fallen out of favor.

BM: Australia, Peru and Argentina are also getting stupid.

TGR: Do you hold better hope for the U.S. on the mining front?

BM: The U.S. has some really wonderful properties in Arizona, Nevada, Idaho and Oregon. The western part of the country was wealthy due to mining and we are going to go back to that. I think the U.S. will split up into a series of five or six nation states. Florida has nothing in common with California and California has nothing in common with New York. But again, the U.S. as we know it might not exist a year from now.

Take a look at what I said a few years ago about riots in the United States. Occupy Wall Street started in September. It was a peaceful demonstration. There was no crime. There was no violence. The police started it by barricading young women behind the net and then spraying them in the face with pepper spray.

Occupy Wall Street hit a nerve in Americans and spread all over the country. When it got to Oakland, the police decided they needed to up the ante, so they started firing teargas grenades in the face of an Iraqi War veteran from 10 feet away. If I did that, I’d be in jail for attempted murder. Since a policeman did it, he got away with it. They beat another protester so severely with batons they put him in the hospital in critical condition with a damaged spleen. They have pepper-sprayed priests, 84-year-old women and pregnant women. And these are all peaceful protesters.

The key to understanding what is going on is the police continue to escalate the violence. The next thing will be something similar to Kent State, where they plant an agent provocateur who will fire a gun into the air and the police will take that as permission to start shooting protesters. When that happens, it will literally start a civil war—and it could happen any day.

TGR: That’s not like citizens of one state going against citizens of another state because they have fundamental differences.

BM: No, it would be a civil war of peaceful citizens against a violent, corrupt, out-of-control government. We have every bit of that now. The police are the ones doing the escalation, and sooner or later Americans will start defending themselves. If it had been my son or daughter who was shot in the face, I don’t know what my reaction would be. Those protestors all have parents and brothers and sisters and friends. I’m shocked at the willingness of police to escalate violence against people who are no threat to them at all. It could get really bloody really quickly.

TGR: Why do you think this is Occupy Wall Street and not Occupy Pennsylvania Avenue?

BM: The term should be AWA—Americans with an Attitude. I think that these protests are underway in 113 cities, so obviously a lot of Americans in a lot of locations are angry.

  • 23% of Americans are angry because they’re unemployed.
  • 46 million Americans are angry because they are on food stamps.
  • 50% of mortgage holders are angry because their mortgages are under water.

Everyone knows they have been raped by Wall Street and the government. The common theme is anger. We are angry at big business and we are angry at government.

Big business owns government. You have to go after big business. Barack Obama and this administration are totally controlled by external forces. They are controlled by Israel, Wall Street and the media. But we do not have an activist government that’s actually doing anything. It’s totally corrupt, bought and paid for. Everyone in Congress, with the exception of Ron Paul, has turned into a pimp.

TGR: That’s why congressional approval is as low as what―18%?

BM: 7%. The devil does better than that. Someone did a survey a week or so ago comparing Congress to Satan and Satan came up with an 8% approval rate.

Convinced that gold and silver were at their bottoms, and wanting to give others a foundation for investing in resource stocks, Bob and Barb Moriarty brought 321gold.com to the Internet 10 years ago, and later added 321energy.com to cover oil, natural gas, gasoline, coal, solar, wind and nuclear energy. Both sites feature articles, editorial opinions, pricing figures and updates on relevant current events. Before his Internet career, Moriarty was a Marine F-4B pilot and O-1C/G forward air controller with more than 820 missions in Vietnam. A captain at age 22, he was the youngest naval aviator in Vietnam and one of the war’s most highly decorated. He holds 14 international aviation records, and once flew an airplane through the Eiffel Tower’s pillars “just for fun.”

Jubilee?

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.

The Sprotts: Silver Poised for Power Rally

Larisa Sprott Eric Sprott Opportunities abound in small- and mid-cap silver companies, according to Sprott Inc. Chairman Eric Sprott. In this exclusive interview with The Gold Report, Eric Sprott and Sprott Money Ltd. President Larisa Sprott say the fundamentals that drive the price of silver are as strong now as before the spring selloff—maybe even stronger—even though volatility is causing buyers to hold back a bit.

The Gold Report: The Greek economy is making headlines again, with the Greek Parliament recently voting in extreme austerity measures that include budget cuts of $40B plus a selloff of $72B in assets. When we spoke in March, Eric, you were quite worried about collapses in Greece, Ireland and Iceland. Do you see these new austerity measures as another step toward collapse, or do they signal a reprieve?

Eric Sprott: It’s the European troika advancing the money that’s really preventing the collapse, from the financial market point of view. The austerity program will create a collapse in Greece economically, but it at least gives them the opportunity to get the troika bailout. I refer to the troika as the ECB (European Central Bank), the IMF (International Monetary Fund) and maybe the BIS (Bank for International Settlements).

I think Greece is not much different from others that have gone before, whether Iceland or Ireland. Most governments in the world have taken on added monetary and fiscal responsibilities because of the financial collapse. For example, the U.S. wouldn’t be running a $1.5T deficit had there not been the collapse in 2008 because we wouldn’t have had the programs that we now have, trying to support the banking system that everyone thinks is too big to fail.

For quite a long time, my view has been that the banking system has been over-levered. The assets on the books aren’t worth what they would be in a normal monetary environment, and if they had to sell the assets, most banks in that situation would become insolvent. Who would you sell those assets to?

Imagine a Greek bank knocking on the door of any other bank in the world saying that they have Greek mortgages, loans to Greek companies and Greek bonds they’d like to sell. There’s no buyer, so the government basically has to step in, as happened in Ireland, Iceland, the U.K., the U.S. and Japan. It’s happened in almost every country, where the governments have come in to bail out the financial system.

This country with all of 11M people—as many people as live in Ontario—has almost taken down the whole system, as Lehman Brothers almost took down the whole system. What was Lehman? It was like a pimple, and on a relative scale, Greece is not a big situation either. But they want to prevent the falling of the first domino, because if the first one goes down, I can assure you what will happen. That’s what everyone’s guarding against. It would just spread amongst various banking systems.

TGR: Is there a possibility that Greece and other countries with debt issues could negotiate for pennies on the dollar to reduce their debts by 20%, 40%, or whatever? It would have an impact, of course, but not as bad as a default.

ES: That would be defined as a default for all intents and purposes. Some rating agencies have suggested that the voluntary rollover they’re talking about might still be officially a default because everyone knows that what they’re getting for what they’re giving up isn’t worth 100 cents on the dollar.

If a new party comes to power in Greece, they might say they’re going to rip up that agreement and take the default because Greece might be better off defaulting. Of course, the powers-that-be don’t want that. It’s as much the troika that doesn’t want it as the government in Greece. They’re all trying to prevent this contagion from starting.

TGR: But you’re suggesting that eventually the contagion will take hold.

ES: It’s kind of taken hold already, right? The weakest—Iceland and Ireland—have been knocked off already. Greece was the third weakest. Who knows where we go from here?

TGR: When we had our conversation in March, you said that sooner or later people will realize that it’s better to have real assets in physical metals than bank accounts.

ES: I’ve always believed that, and it’s even truer today. Would you rather have your money in a Greek bank or in gold? Would you rather have your money in an Egyptian, Irish or Icelandic bank or gold? Iceland took a devaluation; if the people in Iceland had their money in gold, they wouldn’t have lost a damn thing.

You also take a currency risk when you own a bank deposit. Even a U.S. resident who owns gold instead of a bank deposit would be better off, because the purchasing power of the dollar is going down on an international basis.

TGR: That’s why you called gold the investment of the last decade.

ES: Right.

TGR: And you’ve called this the decade of silver, saying that on the basis of the historical gold-to-silver ratio, silver may even triple the performance of gold. Do you still believe there’s the potential for outperformance at that level? And, if so, over what timeframe?

ES: It’s very difficult to pick timeframes, because so many events can transpire, but I really believe that silver will trade at a 16:1 ratio to gold. I certainly believe that gold can get to $1,600/oz. this year, and while I’m not suggesting that silver will make it to $100/oz. this year, it’ll certainly trade at a 16:1 ratio to gold within three to five years. By then, who knows? Gold could be at $2,500/oz.

TGR: The gold price has been climbing neatly along the 200-day moving average, while the silver price has been all over the place. Do you foresee a time where metals just go hyperbolic?

ES: Yes, I think that will happen. When people ask when I’d get off the gold train, I say that it would cause me to reconsider things if governments and central banks appeared to be getting responsible. I’d say if it evolved into a mania ala NASDAQ 2000, you might decide to exit the investment. Of course, if they made gold the official reserve currency, I wouldn’t need to own it anymore because I could convert my currency to gold or silver at any time.

So, it’s hard to define when it’s going to happen. Earlier this year, I was totally convinced that silver would easily make $50/oz., and for all intents and purposes, it has. I think silver will rally pretty powerfully from this little selloff we’ve had, and hit a new high this year.

TGR: Larisa, has Sprott Money seen a corresponding increase in silver to gold this year?

Larisa Sprott: When we last spoke in March, in terms of dollars, silver was outselling gold by a ratio of about 5:1—we were selling five times more dollars of silver than dollars of gold. The silver market has had a price correction and it’s been a volatile commodity over the last month or so. I’ve seen a rather dramatic shift in sales toward gold. In terms of dollars, gold is now outselling silver on a 3:1 ratio.

It’s not that people have lost their taste for silver, but they’re holding back on purchasing silver because of the increased volatility in the market. I think that once the silver price demonstrates less volatility, our sales will return to the aforementioned ratios.

TGR: Do people still tend to take possession of their purchases, or are more keeping it in your storage depository?

LS: They’re taking possession simply because at this time we only offer storage in the United States. Some of our U.S. clients fear that a 1933-type confiscation scenario will happen again, so they would prefer to store in Canada or internationally. I’ve even seen people drive from places such as Florida and Washington to take possession of their bullion so that they may store it in a safety deposit box in Canada.

We’re opening a storage depository in Canada, but that’s still three to six months out. I’ve had a lot of interest from clients who say that as soon as that facility opens they’ll be moving their bullion up here.

TGR: What else is new at Sprott Money?

LS: We are working on increasing our U.S. presence. We anticipate opening our New York office by October of this year. We are also minting a Sprott silver bar and coin set to be ready for sale in early 2012. And as a proud supporter of GATA (Gold Anti-Trust Action), I am pleased to announce that we will be selling the GATA gold coin at their upcoming conference in London this August.

TGR: We’ve seen that Sprott Money is the major sponsor of the GATA Gold Rush 2011 conference coming up in London in August. How did your organization get interested in GATA and what it has to say?

ES: When I started investigating an investment in gold and silver in 2000, among the most outspoken—to whom I’m ever so thankful—were the GATA people, who suggested that central banks, in a somewhat coordinated fashion, were suppressing the gold price. There seemed to be some compelling evidence for that because central bankers were huge sellers of gold, which retrospectively looks like the dumbest thing they could ever have done. With 20/20 hindsight, that decision looks like one of the greatest knucklehead moves of all time. Here we are 10 years later and where they were sellers of 400 tons of gold a year, now they’re buyers of 400 tons of gold.

GATA was prepared to challenge the system and to explore the data behind various government moves, why they did it and why they always advertised that they were selling gold, which almost necessitated getting the worst price possible instead of the best price. The whole attitude they were taking to gold seemed ridiculous.

The GATA people have been a big influence on the increasing interest in gold. They’ve been incredibly helpful in terms of keeping people focused on what’s going on in the precious metals markets. They had a wonderful conference in Dawson City in 2005.

The people who spoke there—and who will speak at this GATA conference in London—are all independent thinkers who aren’t swayed by the conventional. They’re typically contrarian. You have to work hard to be a contrarian, because you have to win what would seem to be very difficult arguments. They’re just top-notch people. When I look back over the last decade, I think those who were skeptical and outspoken are the true heroes.

If more people had listened to them, they wouldn’t have suffered the kind of financial damage that has transpired in the last decade. Certainly, if they owned gold and silver in lieu of any other investment, they would’ve been better off.

TGR: You noted that when the central banks started selling gold about a decade ago, they pretty much locked in the worst possible price by announcing their intentions ahead of time. Is it the same now that they’re announcing in advance their buying intentions?

ES: They only announce after they’ve bought. For example, in either 2008 or 2009, the Chinese Central Bank revealed that it had purchased 400 tons of gold over about four years, but that was well after the fact. Obviously those purchases were an active force in the market. China hasn’t announced anything in the last three or four years, but I suspect it’s been a buyer all this time. The Central Bank of Mexico recently announced buying 93 tons, which undoubtedly concluded its purchasing program.

There probably should be transparency in these transactions anyway. The central banks should be telling the populations they represent where they are investing their money.

TGR: You’ve indicated that GATA was founded on evidence of collusion among financial institutions that resulted in suppressing the gold price. We also hear about market manipulation through derivatives. Tell us a little bit about this.

ES: First, understand that commodity markets rarely settle in physical commodities; they’re really paper markets. Let me give you an example.

We produce 900 Moz. (million ounces) of silver in a year. When silver was up around $48/oz., between the London Bullion Market Association (LBMA), the COMEX, the SLV Silver Trust and some vehicles in China, we were trading 1 Boz. (billion ounces)/day silver in the paper market. We produce just a little over 1 Moz./day for consumption as an investment. So we trade 1 Boz. of paper silver and yet there’s only 1 Moz. of physical quantity available for investment. That makes you wonder.

They get after the silver speculators who are long. I can understand being long silver, because maybe those speculators think they’d like to own it. What are those who are selling the billion ounces thinking when there’s no physical silver to settle with?

TGR: What might change to slow this down?

ES: There should be position limits, and trading limits per day. What’s the net effect of trading 1 Boz. when the stuff doesn’t even exist on the face of the earth? The short position in the silver market was so concentrated amongst the four largest bank-owned firms that it was shocking. Why they should be short that much silver is beyond me.

TGR: Let’s talk a little about options for the individual investors.

ES: I’m very comfortable having a very large weighting in precious metals, which are way more likely to hold their value than paper assets. And I feel so involved in trying to get people to own more precious metals because I think it’s the one thing that will save them in a very difficult financial time. But most won’t take the steps of getting a little bit of insurance by owning precious metals.

TGR: If another financial trauma is coming, should investors be more weighted with the actual physical metals or should they continue with the equities too?

ES: People worry about the banking system, and I think ultimately they’ll put their money into gold and silver. If the prices of gold and silver go up because of that, notwithstanding a short-term decline in the market, ultimately people also will realize that gold and silver stocks are good things to invest in. But you may have to go through a six-month swoon.

We went through a swoon like that in 2008. Gold was probably $900 at the time. Owning gold and silver would’ve been very propitious. Today it’s $1,500. I think this next time around, as we see gold and silver gaining more recognition as to their intrinsic merits, that will get transmitted into the gold and silver shares.

TGR: As you look forward, are you holding or considering some equities that you feel will swoon less than the market?

ES: Let’s face it—if you use the HUI Index, precious metal stocks have gone up by a factor of about 12 to 13 times from the 2000 bottom. On a long-run basis, there aren’t many losers in those stocks, and certainly on a relative basis, they’re all winners.

Until a few months ago, any silver stock on the board had such a massive run that everybody could sell at a profit. It’s important to know that most people like to sell their winners. At the first sign of problems, you sell the stock that’s got the biggest profit for you. And, it’s very easy to sell it. Maybe it’s not so easy to sell some bank stock that’s still 60% from its high, but it’s not too tough to sell a gold and silver stock that’s 5% from its high because it has had a good run.

We get more volatility in this group because of that. Any stock that has gone up a lot will be more volatile than one that hasn’t. That’s just the way it is. The high flyers always get knocked down the most, because they’re easy to sell. That’s the situation we find ourselves in. Most of these stocks have been the best performers of the last decade.

Every time there’s a little hiccup in the market, people sell them. It doesn’t mean that the fundamentals have changed. That’s just the way people react in a market selloff. Give it time. People will get calm again about where they should have their money.

TGR: We were talking with Rick Rule and Brent Cook a couple of weeks ago about the fact that most juniors are off 10%–20% since April and May. They suggested it might be a good time to own some mid-caps and seniors. Considering the profit-taking you just described, do you agree?

ES: I’ve been investing in small-cap stocks for roughly 40 years, and the opportunities in small caps are far superior to those in big-cap stocks on a sustainable basis. It’s always been the case because they’re under-owned, under-followed and under-capitalized. You can do a lot in the small- to mid-cap area that you can’t do in the large-cap area. You can buy a junior gold stock on a relative valuation of probably a third of any major stock just because they’re seasoned and that’s where the big money goes. Opportunities abound in the small- to mid-cap area, so that’s where I’m going to stay. In a sustainable rally, I guarantee you they’ll outperform the large caps.

TGR: Peru is one of the best mining addresses on the planet, but we’ve seen a lot of decrease in share prices in some of the Peruvian mining equities. You have some interests there, too, that have been specifically affected by government action. Could you comment on that?

ES: Bear Creek Mining Corp. (TSX.V:BCM) has been one of my favorites because of its two ore bodies. It’s unfortunate the governments have made the decisions they’ve made. We see this in different places, not just in the less-developed countries, where governments come in and change the rules. If it’s not Ecuador, it’s Peru. If it’s not Peru, it’s Bolivia. Somebody’s always doing something.

TGR: In the case of Peru, though, this was an injunction signed by outgoing President Alan Garcia that halted Bear Creek’s Santa Ana silver project specifically.

ES: You take those risks with any country. People always ask if I think the U.S. government will confiscate gold. You hear chatter about the U.S. government nationalizing the gold mines someday. If you want egregiousness, that’s almost as bad as Ollanta Humala (Peru’s new president) declaring that one property is not going to continue to be owned by somebody. It could happen anywhere. That’s one of the problems you face when you’re an investor; you don’t know exactly what the political flavor is.

If I were a betting man, I’d bet the Santa Ana mine comes into production within the next 10 years. The stock market doesn’t like delays, but they don’t detract from the merits of the property. When people calm down and know the regulation is in place to try to prevent environmental problems, it will ultimately get the go-ahead.

TGR: Do you feel just as bullish on small caps in gold as you do in silver?

ES: Because I think the price of silver probably will outperform gold by maybe 2.5 times, I have to look much harder for silver equities than gold equities. That’s what we’ve done in the last 18 months. So I prefer silver junior equities to gold for sure.

When I look at the demand and supply fundamentals, it’s all in place as far as I’m concerned. Lots of times the market doesn’t corroborate your view for a while, but the important thing is the market corroborates your view along the way. Yes, we had to deal with that gut-wrenching selloff in the gold stocks in 2008, but when you look back at it now you wonder what the hell the market was thinking.

TGR: What are some of the good silver small caps you found in your search?

ES: We’ve been in lots of companies. We’ve been involved with Fortuna Silver Mines Inc. (TSX:FVI; Lima Exchange:FVI), First Majestic Silver Corp. (TSX:FR; NYSE:AG; Fkft:FMV), Argentex Mining Corp. (TSX.V:ATX; OTCBB:AGXM), SilverCrest Mines Inc. (TSX.V:SVL), Silver Quest Resources Ltd. (TSX.V:SQI), Aurcana Corp. (TSX.V:AUN) and Mirasol Resources Ltd. (TSX.V:MRZ). I’ve got a long list.

TGR: Those names have assets all over North America and South America.

ES: Most of them tend to be in North America, particularly Mexico, Central America and South America. But I own stocks in companies with silver in other places, too. One example is Minco Silver Corp. (TSX:MSV), which has its Fuwan silver deposit in China. I’ll buy a silver asset wherever it is located.

TGR: So clearly, you still do see this as silver’s time to shine.

ES: I do. And I’d refer readers who’d like to know about why I believe the robust fundamentals for silver are only getting stronger to the Caveat Venditor! article we’ve just posted to Markets at a Glance on our website.

TGR: We’ll be sure to check that out, too. Thank you both for your time.

Eric Sprott is chairman of Sprott Inc., CEO, CIO and senior portfolio manager of Sprott Asset Management LP and chairman of Sprott Money Ltd. He has more than 40 years’ experience in the investment industry. After earning his designation as a chartered accountant, he entered the investment industry as a research analyst at Merrill Lynch. In 1981, he founded Sprott Securities. After establishing Sprott Asset Management Inc. as a separate entity in December 2001, Eric divested his entire ownership of Sprott Securities to its employees. Eric has been stunningly accurate in his predictions, including foreseeing the current financial crisis. He chronicled the dangers of excessive leverage and the bubbles the Fed was creating, while also correctly forecasting the tragic collapse of the housing and financial markets in 2008. Eric’s predictions on the state of the North American financial markets, as well as macroeconomic analyses have been presented in Markets at a Glance, a monthly investment strategy newsletter.

Larisa Sprott joined Sprott Money Ltd.(www.sprottmoney.com) in the role of President in December 2009. As one of Canada’s largest owners of gold and silver bullion, the company’s goal is to facilitate ownership of precious metals to the general public. Larisa has more than 15 years experience in the financial industry, having worked at Sprott Securities Inc. (now Cormark Securities), first as an office administrator in the Vancouver office, and later in roles in research and corporate finance at the Toronto headquarters. Larisa then spent five years with Sprott Asset Management in the capacity of client services, sales and marketing. In November 2007, she became an investment advisor responsible for servicing and managing high net worth clients.

A Day in the Life (of a Slave)

Here’s a story for you:

Kenneth Wright of Stockton, California was almost knocked down by a S.W.A.T. team breaking down his door one morning. He says they then handcuffed him and put him in the back of a police car.

Federal agents confirmed that the Department of Education was behind the raid on Wright’s house. They were in search of his estranged wife, who had defaulted on her loans.

Though Karl Denninger, Vox Day, and Professor Hale have all weighed in on this story, I thought I would briefly add my two cents worth. Quite simply, this reminds me of a proverb:

The rich rules over the poor, and the borrower is the slave of the lender.

Quite simply, if you owe Uncle Sam money (seeing as how Uncle Sam guarantees the loans, this would essentially be the case) then this sort of thing can happen to you. As a slave, you have no rights. Your owner can do whatever he wants, and there is no recourse for you as a slave. Think carefully before you sign the dotted line.
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The Great Unravelling (Dubai Edition)

Although I certainly would not rank it alongside Macro Man’s dreaded vacation indicator or the incipient increase in the USD if and when the Economist finally decides to slot its decline on the front page, I still have the nagging feeling that whenever yours truly sit down at either a dull and difficult econometrics lecture or, as today, camps at school for a lab session in connection with a paper due next month, some event is bound to wreck havoc on markets while your author is busy estimating regressions. I would assume that some US market participants feel the same today as they give thanks before hauling in the Turkey.

In any case, this time around the skeleton that could be kept in the closet no longer is neither Baltic nor Spanish; it is Middle Eastern. At this point, I am of course simply trying to get an overview like the rest of you and not least deciding whether it will have any far reaching repercussions beyond today’s theatricals. However, in case you did not turn on your Blackberry today, they story is that the Dubai government has requested investors in the debt of the investment company Dubai world whether they wouldn’t be so nice as to accept a wee postponement of the payment of their debt. Especially, a payment due already the 14th of December in the form of $3.52 billion of bonds from property unit Nakheel PJSC looks as if it is near dead in the water.

(quote Bloomberg)

The price of Nakheel’s bonds fell to 70.5 cents on the dollar from 84 yesterday and 110.5 a week ago, according to Citigroup Inc. prices on Bloomberg.“Nakheel is now standing on the brink of failure given the astonishing amount of cash Dubai would have to inject on it in order to see the enterprise survive,” said Luis Costa, emerging-market debt strategist at Commerzbank AG in London.

Obviously, announcements of delay of debt payments smells an awful lot like default and with $59 billion worth of liabilities at Dubai World many a financial institution and investor are exposed here. Naturally, and apart from the internal mess this is likely to cause in the Middle Eastern region, I am looking closely at the notion of European banks being sucked in here too.

(quote Bloomberg)

The biggest creditors are Abu Dhabi Commercial Bank and Emirate NBD PJSC. Other lenders include Credit Suisse Group AG, HSBC Holdings Plc, Barclays, Lloyds Banking Group Plc and Royal Bank of Scotland Group Plc, according to a person familiar with the situation. Barclays slumped as much as 6.9 percent, the biggest intraday loss in a month, while RBS sank as much as 8.3 percent. Lloyds and Credit Suisse dropped more than 3 percent.

As ever, it will be most interesting to see which adventures European (and indeed US) financial institutions have been engaged in with the cranes of Dubai and thus how much more junk they will now have on their balance sheet (question: does the ECB by chance have collateral from Dubai World in the tank?!).

Naturally, this may all get a happy ending for the creditors if a) the Dubai government decides to foot the bill through a massive liquidity injection and b) it does not default in the process. Since the government itself, it appears, took part in suggesting the repay delay/restructuring the stakes were raised already from the get go especially as both Moodys and S&P have indicated, initially through massive cuts of companies and funds in the region, that they might consider the move to ask investors for a delay in repayment as a defacto default; a statement which together with the state of play naturally have seen credit default swaps soar for both sovereigns and companies across the region.

Globally, the reaction was equally strong with stocks across the board taking a hit and yields on developed economy government bonds dropping to reflect the knee-jerk move into “safety” assets by part of global investors. In this respect, I agree with the underlying sentiment expressed by Russel Jones from RBC Capital markets

(qoute Bloomberg)

“Dubai isn’t doing risk appetite any favors at all and the markets remain in a vulnerable state of mind,” said Russell Jones, head of fixed-income and currency research in London at RBC Capital Markets. “We’re still in an environment where we’re vulnerable to financial shocks of any sort and this is one of those.”

The key here is exactly whether this merely reflects the fact that markets and risky assets are naturally nervous and thus how it takes only a small (or large?) disruption for risk aversion to decline or whether there is a stronger and more structural theme at play here with respect to the potential real contagion the events in Dubai might have. At this point I am leaning towards the former simply because I have no reason or knowledge to claim the latter. I suspect that minds more informed than me will let us know soon enough as well as any untold stories will surface sooner rather than later.

More importantly (at least for me), it was interesting to see that old habits still linger in the context of FX markets;

(quote Bloomberg)

The yen climbed as high as 86.30 per dollar, the strongest since July 1995, before trading at 86.60. The U.S. currency strengthened against all but the yen among its 16 most-traded counterparts, appreciating 2.6 percent versus the New Zealand dollar and advancing 2.4 percent against the South African rand.

The Swiss franc weakened as much as 0.3 percent per euro, falling from the highest level since June, on speculation the Swiss National Bank sold the currency to curb its gains. The franc dropped 0.9 percent to 1.0057 against the dollar after yesterday reaching parity for the first time in 19 months. The SNB declined to comment.

Now, whether this is a story of unwinding of carry trades and low yielders reacting to risk aversion as I have tended to interpret it (a position which Cassandra, by the way, recently called disingenuous at best and ludicrous absurd puerile) or simply, as would be Cassandra’s point, systemic deleveraging and thus a retrenchment of funding liquidity (primarily in USD) is an open question which I intend to deal with in more detail in the future. For now, it will suffice to say that the USD acts as a carry trade funder along side the JPY with the Swissie apparently still supported by the bullying of the SNB. In short, if it walks like one and quacks like one … well.

For more background on Thursday’s Dubai Delights we can thank the job rotation schedule at FT Alphaville for having Izabella Kaminska at the rudder (among others) as she has been relentless digging up background and information on the situation in Dubai throughout the day. Over and above the tragicomic allure of the failed conference call scheduled for bond holders of Nakheel (a guy called Murphy springs to mind), I take notics of the “sterling connection” and specifically the idea that the Pound may suffer from the Dubai rout as the sheiks and the rest of their ilk will be forced to sell UK real estate assets (time to buy a Chelsea pent house then?) in order to kick up the funding needed. Here is Izabella;

In other words, if default is really on the cards, chances are Dubai World will have to start a major fire-sale of assets. Unluckily for the UK, the Middle East and the UAE have for a very long time viewed the British real-estate market as a safe-haven investment.

Whether the inflows from the window shopping of super affluent Middle Eastern investors in the UK real estate market have been a marked driver of the exchange rate is debatable, but Izabella digs up some comments by BNP Paribas who certainly seems to think that this is the case. So we better watch that one too then. Finally, Izabella headbuts Barclays Capital by juxtaposing an old note dated back only this month in which BC recommends a long position in everything debt related to Dubai (Sovereign as well as Corporate) with a more a current note in which this argument is, uhm, relaxed. A cheap shot you might argue … perhaps, but fun and interesting nonetheless.

Dubai Delights No More?

I have to say that it was not without a bit of the old Schadenfreude that I loaded up Bloomberg and Reuters this afternoon to learn that Dubai seems to be facing a great unravelling. We still need to get to full story of course at this point, and if the Dubai authorities step up, it may all turn out to be a storm in a tea cup. However, on a personal note the “Cranes of Dubai” always represented one of the clearest example of the excess and froth observed in the context of the economic boom that ended abruptly with the current financial crisis. With this in mind I am not the least surprised about this which of course is easy to state ex post, but then you choose whether to believe me or not.

More generally, it need not, naturally, put an end to financial and economic development in the region, but it is one thing to have and collect commodity windfall and quite another to spend it wisely and to productive means. One would hope that this serves as a timely reminder as we move on from here.

Why are T-Bills so popular

One of the puzzling aspects of the current economy is the soaring demand for US treasury bonds. On the face of it, T-Bills seem like a pretty terrible investment. The yields are low and given the massive government and current account deficits being run by the United States, it is highly likely that the dollar will lose value relative to other currencies.

But these loans aren’t investments, they are insurance. With the global economy in free fall nobody knows how bad things could get. There is a non-zero probability that we could be witnessing a true economic collapse. The sort of era defining event that will signal the end of the 500 year march of human progress and plunge us into a new dark ages. How will we know when it’s time to bust out the old amour suit. A good guess will be when treasuries fail. In other words if the US government defaults, we are all finished. The only assets that will be worth anything will be shotguns and canned beans.

Lets say things don’t get that bad, there is still a long way to fall. If the economy continues contracting at its current rate, by the end of 2010 things will be as bad as the 1930’s. An economic collapse of that magnitude will have profound political consequences. Which brings us back to the original topic of the post.

In a climate of extreme uncertainty, the long history of stability is a unique asset of the American economy. The Euro is the most obvious rival currency to the dollar, but with less than a decade of experience the Euro has never survived a severe crises. If this recession hits the depths of the 1930s, politicians in hard hit countries like Spain and Ireland will be under intense pressure to break free of the Euro. During the great depression, countries that abandoned the gold standard benefited immensely from their devalued currencies.

Developing countries don’t offer better security prospects. It is hard to think of a developing country whose economic and political stability wouldn’t be threatened by a severe depression. The communist party is the third largest party in India’s parliament and the nationalist BJP is the second largest. It is easy to imagine a severe downturn tipping the balance of power towards these parties at the expense of international investors.

Latin America has a long history of socialist governments taking power and appropriating private property. It is not hard to imagine these elements gaining strength in countries such as Brazil, Mexico and Argentina. Africa and the Middle East are considered risky places to invest for too many reasons to list here. It is uncertain if the Chinese government can maintain stability through a severe downturn.

That leaves the US and the other wealthy English speaking countries as the most likely economies to survive a severe downturn. The catastrophe in Iceland demonstrates the danger of lending too much to a small economy. Given the quantity of money looking for a harbor it is possible to imagine international capital overwhelming a country such as Canada or Australia. Simply put it is possible to imagine the US economy surviving a complete meltdown in Canada, but there is no way Canada survives a collapse in America.

So what does this all mean for the future. As long as complete systemic collapse remains a real possibility, investors will be rushing to loan money to the US government. But as investors gain confidence that recovery is in sight demand for American debt will dry up. One sign that a recovery is on the horizon will be a decline in the dollar relative to other currencies. As the economy rises from the grave the dollar will steadily weaken.

This should be encouraged. One of the driving forces behind global instability has been the huge amounts of foreign capital entering the US economy and the countervailing large trade deficit that Americans have run. If we emerge from this crises with a more balanced global economy that would be a good thing.

Armenian Currency Goes Poof

On 3 March 2009 in the space of a few hours the Armenian dram evaporated from about 300 per dollar to about 400 per dollar and 275,000 drams per ounce of gold to approximately 365,000 drams per ounce of gold.  This rapid 30% currency poofing is like when the Kazakhstan currency went poof but without the strategic geo-political considerations.  Nevertheless, extremely ominous financial troubles stir in Eastern Europe.  One knows the conditions are dire when Armenian Prime Minister Tigran Sargsyan advocates using the Russian ruble as a stable currency.

As fiat currencies represent the common stock of nations; Armenia’s future is omnious.  Trend Capital has reported that Ogtay Hagverdiev, of the Azerbaijani Cabinet of Ministers Economy and Finance and Credit Policy Department head, said. ”It will take time to restore the country’s economy. A revolt among the people may begin in the meanwhile.”

The Armenian government may soon default.  Rising prices, the effects of inflation, will soon begin.  Shortages, a common effect of currency problems, may appear.  Civil unrest may follow like in Iceland, Greece and China.

JUNCTION POINTS

Large buildings in urban environments are often constructed in such a way to reduce the effects, such as sound, of the outside. It can be inspiring to sit in perfect silence without any sound to be heard coming from the bustling outside streets. How is this silence possible with the hustle and bustle of a metropolis only a few yards away?

The answer lies in the construction. For example, an inner building can be built within the walls of an existing building with the walls of the inner building connected to the outside building at only a few junction points. This will greatly limit the effects of the hustling and bustling metropolis.

The investor can learn a lesson. The reduction of junction points with businesses, organizations and governments can greatly reduce various risks to one’s capital and their effect on one’s personal life. If the relationship is no longer mutually advantageous then any attachment through junction points should be easily severed.

Defining one’s throughput and then implementing the Theory of Constraints thinking process can be extremely helpful in developing the Four Hour Workweek.  This may allow one the freedom to live where, when and how they want. The transitions accompanying the great credit contraction will provide tremendous opportunity for wealth generation and accumulation. Being able to understand the environment will allow one to swim with, not against, the current.

As the great credit contraction grinds on more fiat currency illusions, like the Armenian dram, Kazakhstan tenge or British Pound, will evaporate either wholly or partially.  As poet John Greenleaf wrote, “For all sad words of tongue and pen, The saddest are these, ‘It might have been’.”

I am sure many Armenians, Kazaks and British, who had their life savings evaporate, wish they had a last plane account with an institution like GoldMoney where they could have kept their cash balances in a tangible asset because no matter what happens with its fiat currency price the gold or silver is still there.  When these currency devaluation events happen, and a golden sword of Damocles hangs over the US Dollar, it is extremely fast.