Archive for August, 2009

Will the government confiscate gold?

Sunday, August 9th, 2009

Recently, some of our readers (who are more pre-disposed towards gold) have expressed their concern about possible government decrees against gold (see Pre-empting strong states). They fear a repeat of the American government’s decree against gold in 1933, during the height of the Great Depression. Today, we will address some of the concerns.

First, will the government confiscate physical gold?

The short answer is: very unlikely. The long answer is that we have to distinguish the difference between confiscation and nationalisation. In 1933, the US government nationalised gold. They did not confiscate gold. When governments nationalise X, they take X away from you but pay something in return as compensation. When governments confiscate X, they take X away from you and gives you nothing in return. It is more likely for governments to nationalise than to confiscate gold.

Second, what is the primary objective of any governments when they nationalises gold?

Remember the analogy we used in Recipe for hyperinflation,

… imagine you are the only person in town who has the authority to create money out of any piece of paper with your own signature. Wouldn?t this make you a pretty powerful person in town? With such power, you can acquire anything you wish at the expense of others. Likewise, the paper money that we have today is exactly such money. Look at any piece of paper money today and you will find the words of a government decree (e.g. ?This Australian note is legal tender throughout Australia and its Territories?) and perhaps a signature or two.

The objective of a gold-nationalising government is to maintain their monopoly on money, which is an extension of maintaining their power. Therefore, gold will only be nationalised if the government perceives a threat to their monopoly on money.

In the case of the US, will they nationalise gold in the near future? Not now, at least. To understand why, consider this fact: it is said that 70% of the world’s currency are US dollars. Half of these US dollars are located outside of the US. So, what if the US government decides to nationalise gold tomorrow? That will send a signal to the rest of the world that the US dollar is in trouble. What will foreigners then do to their US dollars that are located outside the US? They will then sell their US dollars to buy gold. The result: the US dollar will crash in value and gold prices will soar (in US dollars).

If the US government’s objective is to preserve the US dollar as the world’s reserve currency, then nationalising gold will backfire on that objective spectacularly.

When will the US government nationalise gold? It will happen when people no longer wants to accept US dollars as money, for example in the case of hyperinflation. When that happens, the US government will surely nationalise (or maybe confiscate) gold. By then, the bulk of wealth transfer will have already occurred and any gold investor worth his salt will already (1) have his gold stashed outside the US or (2) sell his gold to acquire real assets or (3) emigrated out of the US.

Looming Black Swan that can bring the market back into panic

Thursday, August 6th, 2009

The Panic of 2008 ended in March 2009, when the S&P 500 fell to a low of 666 points. After that, the stock market, emboldened by optimism of “green shoots” of recovery, embarked on a powerful rally that was briefly interrupted by a small correction in June.

Today, the stock market is in an extremely technically overbought level. In lay-person’s speak, the stock market has arrived at a very bubbly level. This implies that the market is overdue for a trend reversal. But that does not necessary mean it is imminent because we have respect for this market rally.

For investors, what should they do?

If you have substantial long positions in the market, we believe this is the time to put on your hedges (e.g. long put options, short deep-in-the-money call options, stop losses, guaranteed stop losses, short CFDs on long positions, take some chips off the table, etc). For those who missed out on the March-June rally, Marc Faber advised at his latest market commentary that they should wait for a correction before entering the market.

What can possibly trigger a major correction? We looked high and low and found one possible Black Swan in one corner of the earth- Lithuania. In fact, this Black Swan may even trigger more than a correction- it can trigger another panic though it is hard to quantify how great that panic will be, given the propensity of the Fed to print money. As this news article reported,

Lithuania?s new president has admitted that her country could be forced to seek help from the International Monetary Fund if it fails in efforts to raise more money from foreign capital markets to prop up its teetering economy.

The fate of the Baltic economies is being watched across Europe amid fears that they could trigger devaluations and defaults in eastern and central Europe.

Sweden and other Nordic countries are especially sensitive because their banks expanded aggressively in the region and now face a rising tide of bad loans.

As the RBA’s most recent statement on yesterday’s interest rate decision said,

There is tentative evidence that the US economy is approaching a turning point, but conditions in Europe are still weakening.

The “green-shoots” can hardly be found in Eastern Europe (more generally, the “emerging” economies). Many European banks are highly leveraged to Eastern Europe.The following is the list of emerging market debt exposures of European nations:

Austria – 85% of GDP (Central & Eastern Europe)
Switzerland – 50% of GDP
Sweden – 25% of GDP
UK – 24% of GDP (mainly Asia)
Spain – 23% of GDP (mainly Latin America)

In contrast, the US amounted to only 4% of GDP.

Richard Karn wrote in his soon to be released book, Credit and Credibility,

Today, although the situation has improved in step with global equity markets, Western European bank exposure to Central and Eastern Europe alone exceeds $1.6 trillion.

The recent news of Lithuania can be a portent of more Black Swan contagion in Europe.

The following is the list of Central European refinancing needs in 2009 as a percentage of foreign exchange reserves:

Estonia – 346%
Latvia – 341%
Lithuania – 204%
Poland – 141%
Croatia – 136%
Bulgaria – 132%
Romania – 127%
Ukraine – 117%
Turkey – 110%
Hungary – 101%
Czech Republic – 89%
Kazakhstan – 82%
Russia – 34%

As Richard Karn continued,

Because the European central bank has not embraced quantitative easing and Western European banks have written down so little debt, especially compared with their US counterparts, a number of commentators contend the banking crisis has yet to fully hit Europe. Essentially, because European banks employed more leverage, they have less freedom to mark down debt, which makes them vulnerable in these conditions. In addition to the situation in Central and Eastern Europe, Western European banks face substantial US property losses they have yet to recognize, and are exposed to euro zone corporate debt to the tune of $11 trillion, equaling 95% of the combined economy, compared with US exposure of roughly 50%. If this were not enough, a significant portion of the Russian banking industry is under considerable stress, with $280 billion of a total $400 billion in debt to European banks being due in the next four years, and the issues regarding repayment and threats of non-payment that rattled markets regularly earlier in the year have yet to be resolved.

A contagion from Europe can easily trigger another global panic. That’s the reason why Kevin Rudd is not ready to declare “Mission Accomplished” for Australia with regards to the global recession (unlike the sheeps in the financial markets).

Watch this space.

Chinese-American military posturing, post-GFC (whatever that is)

Tuesday, August 4th, 2009

In our previous article, we gave a rough road-map of what can possibly happen in the short to medium term. Today, we are going to straining our vision to look further ahead. Since we are looking too far out into the future, we are essentially guessing. Our guesses of the long-term are as good as yours. Therefore, please feel free to pitch in some of your ideas in the comments below.

Currently, the US and Chinese economies are like two partners in an unhealthy co-dependency relationship. Simplistically speaking, one lends and produces and the other borrows and consumes. As with any unhealthy relationships, this state of affairs is unsustainable. In the long run, we believe it is only a matter of time before the Chinese economy decouples from the US economy. To imagine how such a scenario will look like, consider what we wrote in Can China really ?de-couple? from a US recession?,

The needs of the Chinese consumption economy is different from the US consumption economy. Some Chinese are rich. But some other parts of China are unbelievably poor. Wealth distribution in China is rather uneven and there are still many pressing social and environmental issues to be solved. Currently, the Chinese export economy is tooled towards US consumption. To re-tool and re-configure the Chinese economy towards its domestic needs requires a period of adjustment in which capitals are destroyed and built.

A de-coupled Chinese economy will be driven by its own internal consumption and trade with its neighbours. When such a day arrives, it is doubtful that the US dollar will still remain the world’s reserve currency because the Chinese will no longer have any reason to accumulate them.

The loss of reserve currency status will be a serious problem for the US. As we wrote in How does the US export inflation?,

Through this convention, the US can expropriate resources from foreign countries by buying their goods and services with its own printed money.

Without the ability to expropriate resources from foreign countries, the US government will not be able to honour its unfunded liabilities to its own citizens (see Is the GFC the final crisis?). What can the US government do? It can repudiate its unfunded liabilities to its own citizens and protect the US dollar (to still function as money) or fulfill them by destroying the US dollar (hyperinflation). It cannot remain solvent and protect the US dollar simultaneously unless it finds a way to expropriate resources from foreign nations by force (i.e. go to war).

But war is out of question in an age of nuclear weapons. A military dwarf can be on the same par as a military giant just by possessing nuclear weapons (and a way of delivering them). With mutually assured destruction (MAD) no nuclear armed nation can be at a military advantage from another nuclear armed nation.


… the nuclear armed nation has a way of neutralising the other nuclear armed nation’s means of delivering nuclear weapons. Well, the US Pentagon is working on that as we speak- missle defence shield system. That’s the reason why American’s missle defence shield project is highly provocative. A working missle defence shield gives the US dollar a military backing, which is highly useful in forcing the status quo to be maintained.

The Chinese, on the other hand, mindful of their humiliation in the 19th century due to their weakness militarily, will not be standing idle (and surely, they will not mind if they can take over the role of America). Last year, they shot down one of their own satellites in space, which is said to be quite technically challenging.

We believe the ability to shoot down any satellite is a very powerful way to neutralise any missle defence shield. In a missle defence shield system, the challenge is to shoot a missle with another missle, which is like shooting a bullet with another bullet. That requires sophisticated communications between base stations and anti-missle missle, navigation and tracking capabilities- all done on real time. Without satellites, all these complex tasks will not be possible. And the Chinese had demonstrated that they can shoot down any one they wish.

In addition, the Chinese and Americans are now preparing cyberspace as another military frontier.

As we wrote in Nations will rise against nations,

Therefore, outwardly, the world may be at peace. But inwardly, we believe there will be jostling for power, influence and resources between the major nation blocs. Bigger nations will use smaller nations as pawns, international armed non-state groups will intensify their activities and inter-ethnic conflicts will arise. We have no doubt that there will be plenty of Black Swans appearing in the days to come.

Is the GFC over? And what about the recession?

Sunday, August 2nd, 2009

In our previous article, we wrote about the coming looming disaster that will eclipse the Global Financial Crisis (GFC). This prompted one of our readers to ask,

Editor, you believe that the GFC is over?

What about the recession?

We realise that there’s plenty of room for misunderstanding regarding our stand on the GFC. So, we are writing this article in the hope that all misunderstandings will be clarified and also provide a road map to help you understand the big picture.

First, we believe that 2007 will be the year of peak prosperity in the real economy. The decade leading to 2007 was indeed a time of euphoria for many. It is a time of low price inflation, thanks to the massive ramp up of China’s industrial productive capacity, flooding the world with cheaper and cheaper Chinese made products. It is also a time of low interest rates (thanks to Alan Greenspan) and cheap credit (thanks to the advances in ‘innovation’ from Wall Street). Consequently, through the current account deficit of the US, the world was flooded with liquidity to send a high tide of ever-rising asset prices. As we wrote back in June 2007 at Epic, unprecedented inflation,

Today, the world is experiencing an unparalleled inflation of asset prices. This is the first time ever that the world is experiencing asset price inflation in all asset classes (e.g. property, bonds, commodities, stocks and even art!) and in all major nations (e.g. US, China, Japan, Australia, UK, Russia, etc). We will repeat this point again: never before had such a universal scale of asset price inflation ever happened in the entire history of humanity! Today, even artwork is also in a ?bull? market (if you consider artwork as an asset class)!

All these confluence of factors made the world go merry in drunken excesses. But unbeknown to most except the contrarians, the rot was already setting in (see our guide, What causes economic booms and busts?).

Then, as we all know, the GFC struck. Our long-time readers are certainly not caught by that- they’ve been warned as early as January 2007 at Spectre of deflation. The panic culminated in the Panic of 2008 (which ended with a final low in March 2009).

Currently, emboldened by the ‘green shoots’ of recovery, there is another powerful rally in stocks and commodity prices all over the world. Optimism returned, speculations returned and confidence turned up again.

So, is the GFC over?

It depends on what you mean by GFC and which part of the world.

If by “GFC” you mean another panic in scale and intensity as the Panic of 2008, then we believe it is ‘over’ (notice the quotation marks). Statically, the Panic of 2008 resulted in a more oversold condition than the 1987 and 1929 crash. That is, the selling pressure was worse than 1929 and 1987. Therefore, based on statistical probability, another panic that is worse than the Panic of 2008 is unlikely to return for quite a while yet.

Does that mean stock prices will never revisit the March 2009 lows? That depends on how successful the Keynesian reflation attempts (government stimulus, printing of money, bailouts, etc). If deflationary pressures gains the upper hand against governments’ reflationary efforts, then stocks can still drift lower to below the March 2009 low in say, a couple of years time. In such a scenario, this current “green shoots” rally will certainly meet with a major correction- currently, prices are at extremely overbought territory. After that major correction, then can be a counter-rally, than correction than counter-counter-rally (i.e. a saw tooth movement) until the ultimate low. If March 2009 turns out to be the ultimate low, we may end up with indecisive whipsaw movement for quite a while. The stock market may end up hyperinflating if governments are too ‘successful’ (see Can we have a booming stock market with economic calamity?).

So far, we are focusing on the financial markets. The real economy, on the other hand, will continue to grind down slowly, thanks to never-ending government stimulus (see Are governments mad with ?stimulating?? and Preserving jobs at all costs leads to economic stagnation). It is unlikely to fall off the cliff in the same manner as during the Panic of 2008. We remembered someone saying that had the real economy continue to deteriorate that way (i.e. fell off a cliff), the world will return to the stone-age in a few decades time. As the real economy grinds down, we expect price inflation on the street will continue to make life more difficult.

Now, can you see that asset prices in the financial markets and the real economy are walking on two different independent tracks? This observation has yet to be noticed by the mainstream. Many investors still think that rising asset prices imply a recovering economy and falling asset prices imply a deteriorating economy. As we have taken great pains to point out to our readers, asset prices and conditions in the real economy can go in opposite direction (as they are doing right now) for an extended period of time. We are more certain of what will happen to the real economy than what will happen to asset prices.

So, what follows next? We will continue this story in the next article. Keep in tune!