December 2, 2022

Oversold Gold Stocks Set For Strong Rally

By: Vin Maru

In spite of the recent down turn in the price of gold and silver, we still remain bullish on precious metals and its equities. Regardless of its paper manipulated price (if you believe this is currently happening), history has shown us that gold is money (not fiat currencies) and it is no one else’s liabilities. When it comes to gold, as always we suggest owning the physical metals outright fully paid for and stored safely where only you have access to it. If you have a significant holding in the physical, it may be wise to diversify your gold internationally in order to minimize country and political risk by reading Getting Your Gold out of Dodge (GYGOOD). Gold seems to be gaining strong support under $1650 which should most likely hold, so now is a great time to be adding to physical holdings.

We could be at transition period in this bull market where the paper gold price dictatorship comes into question and the democratic free market physical price will start ruling the golden kingdom. The dictatorship by Western central planners over the gold price is ready to be challenged and we may come to a point in history where only votes based on actual physical holdings will be counted. There will be no hanging chads counted on this financial election ballet, its either you own the gold legally and outright, or you have paper promises for imaginary gold (similar to government bond and fiat money) where the question around ownership will arise. Trust us; you don’t want to be one holding paper receipts in questionable gold backed investments engineered by most western financial institutions. Ask yourself, can you trust the source of gold dictatorship to protect your financial assets, especially when it comes to your gold holdings?

HUI and the Gold Miners

When it comes to owning the gold miners, we actually believe we hit the bottom of the market this past summer and then most recently this December. Back in the summer we suggested adding to positions and selling into a September rally for trading positions and then look to add back position in the November/December time frame.

Looking at the HUI chart below, it seems this past December low finished off the correction that started in October. If this does turn out to be the lows, then I see some really positive signs in the charts. Since the beginning of December, the RSI, and MACD have been turning up after being in negative territory and they both look like they have room and momentum on their side to move higher. This means the HUI has a good chance at starting an intermediate uptrend which should last at least a month to two and go towards an initial target of 475 before taking a pause.

What is most encouraging is seeing HUI start to make a new trend upward from May 2012 in a series of higher highs and higher lows, this is a positive development especially if the December lows of 425 hold. What would be more encouraging would be to see the HUI start a new uptrend right now, go to 475 and then blow past it to test the resistance seen at 525 in September. If the gold miners do catch a strong bid and can get past the 525 hurdle that is in front of us, then we can be confident that we really do have a strong rally in the miners and that the uptrend will continue to make higher highs and higher lows moving forward. Eventually it may blow past the old highs of 625 which may come sometime towards the end of this year, but most likely in early 2014.

If you plan on trading these markets, pay attention to the above mentioned numbers on the HUI for places to lighten up on positions and then buy back in on any pull backs in a series of higher highs and higher lows. If we are right on this pattern and uptrend, then the next wave up should take out the September high of 525 and more likely run to 575 (hopefully by spring) before we see a significant correction going into the summer doldrums maybe back towards the 450-475 level. Then I suspect we could see a strong yearend rally that goes well into the early part of 2014 and at that time I expect the HUI to be back close to all time highs. This is what I see happening technically on the charts and hopefully the fundamentals will allow this to play out over the coming year and a half; of course this is based on normal market activity and no market manipulations. This is the strategy we have been planning for TDV Golden Trader subscriber and how to play this new uptrend that could be emerging over the next year.

If you enjoyed reading this article and are interested in protecting your wealth with precious metals, you can receive our free blog by visiting TDV Golden Trader. Also learn how you can purchase and protect your gold holdings by getting a copy of our special report Getting Your Gold out of Dodge or protecting the stock investments you currently own with Bullet Proof Shares.

Cheers,

All Money Printing Schemes End Badly

By: GE Christenson

William H. Gross (manages the largest bond fund in the world – PIMCO) has much to say about Quantitative Easing and money printing. His latest article, Money For Nothin’ Writing Checks For Free, discusses Quantitative Easing (printing money) and the inevitable consequences. He notes that central banks have printed over six trillion dollars in the last few years. This begs the question, “Why not print even more?” Mr. Gross and many others have suggested that central banks should be hesitant with money printing schemes since they tend to end badly. He also quotes Sir Isaac Newton regarding the temporary success (and subsequent crash) of the English government’s money printing in the early 1700s South Seas bubble, “I can calculate the movement of the stars but not the madness of men.

What about the madness of men? Do YOU really believe the following are true?

  • Congress can NOT reduce spending! (Would the deficit be eliminated if members of congress lost their salary and benefits every year the government overspent revenues?)
  • We can solve an excess debt crisis by creating more debt! (Will vodka also cure alcoholism?)
  • Printing money (QE4Ever) will create economic prosperity! (It creates wealth for banks, but not for the economy.)
  • More government, at much more cost, will improve the economy!
  • 47,000,000 Americans on food stamps (SNAP) indicates a recovering economy!
  • Paper money will always have value and will always be accepted in payment for real goods! (History indicates otherwise.)
  • Loaning money to an insolvent government at about 3% per year for 30 years is a good investment when the government has assured us that it will devalue the dollars used to repay the loan!

What about the sanity of men? Is it more sensible to believe the following?

  • YOU can control your finances, wealth, and retirement.
  • Gold is real money.
  • Physical assets are safer than paper assets or digital “money” on a computer server. Avoid the train wreck.
  • Gold will retain its value, dollars will not.
  • If you own physical assets, you have less need to trust the safety of the stock market or the bond market.
  • Physical assets are much less vulnerable to the actions of central banks, the “Plunge Protection Team,” High Frequency Trading, and other market manipulations.

Conclusion

“A man sees what he wants to see and disregards the rest.” Simon & Garfunkel

If the government needs money for excessive expenditures, it sees loans and a central bank that “prints money” and disregards the inevitable inflation.

If a bank sees huge unrealized losses on mortgages, derivatives, and mortgage-backed securities, it sees bailouts from the Federal Reserve along with lobbyists purchasing favorable legislation and disregards the economic cost to the nation.

If an aware individual sees unbacked paper money being printed in quantity, he buys physical assets such as gold and silver and disregards the continual media noise and nonsense.

Avoid the madness of men, and seek the safety and sanity of gold and silver. We have been warned.

GE Christenson
aka Deviant Investor

Why The $1 Trillion Platinum Coin Idea Won’t Work

With the United States rapidly approaching the debt ceiling limit, a dysfunctional and divided Congress appears unable to agree on either spending cuts or an increase in the debt ceiling.  Absent some grand Congressional compromise, America’s nonstop trillion dollar deficit spending will rapidly push the nation to the brink of default before the end of next month.

Although the idea of default seems like a low probability to many people, if such an event were to occur, the result could be disastrous to both the markets and the economy.  Americans have always been able to come up with ingenious solutions before falling off the precipice and this time is no different.  The idea of minting a $1 trillion dollar face value platinum coin to cover our spending needs has quickly garnered national attention.

Predictably, opinions vary greatly as to the legality and efficacy of using a coin worth about $1,700 to fund a trillion dollars worth of spending.  The trillion dollar coin idea, ridiculed as irresponsible by some, is seen by others as a legitimate manner in which to resolve our deficit crisis.  For fiscal conservatives, the mere thought of proclaiming a common coin to have a trillion dollar value in order to remain solvent, is a wretched sign of how incredibly tenuous the financial condition of the United States has become.

In no particular order, here are some of the arguments regarding the trillion dollar coin.

U.S. Rep. Greg Walden (R-Ore.) announced that he would introduce a bill to stop the proposal to mint high-value platinum coins to pay the federal government’s bills.   Rep. Walden said, “Some people are in denial about the need to reduce spending and balance the budget. This scheme to mint trillion dollar platinum coins is absurd and dangerous, and would be laughable if the proponents weren’t so serious about it as a solution. I’m introducing a bill to stop it in its tracks.”

A Washington Research Group analyst said, “The President could assert that that 14th amendment negates the requirement for Congress to raise the debt ceiling.  Or Treasury could mint a $1 trillion platinum coin and deposit it at the Federal Reserve.  Neither are great options.  We see chaos if the market has to confront Treasuries where the debt is backed by Congress and those where it is not backed by Congress.  For banks, this might be as bad as an actual default. The economic uncertainty could cause lending to grind to a halt, the disruptions could cause unemployment to spike which means higher loan losses, and interest rates could skyrocket as the market is unsure whether one of these creative solutions is even legal.”

According to Bloomberg:

In general, the Treasury Department is not allowed to just print money if it feels like it. It must defer to the Federal Reserve’s control of the money supply. But there is an exception: Platinum coins may be struck with whatever specifications the Treasury secretary sees fit, including denomination.

This law was intended to allow the production of commemorative coins for collectors. But it can also be used to create large-denomination coins that Treasury can deposit with the Fed to finance payment of the government’s bills, in lieu of issuing debt.

What the law should say is that the executive branch may borrow to pay whatever obligations the federal government has, but may not print. Unfortunately, when we hit the debt ceiling, the situation will be backwards: The administration will not be allowed to borrow, but it can print in unlimited quantities.

Economist Paul Krugman, who believes that the United States effectively has no limit on its spending ability, thinks using a $1 trillion dollar coin would solve our debt limit crisis.

Should President Obama be willing to print a $1 trillion platinum coin if Republicans try to force America into default? Yes, absolutely. He will, after all, be faced with a choice between two alternatives: one that’s silly but benign, the other that’s equally silly but both vile and disastrous. The decision should be obvious.

Enter the platinum coin. There’s a legal loophole allowing the Treasury to mint platinum coins in any denomination the secretary chooses. Yes, it was intended to allow commemorative collector’s items — but that’s not what the letter of the law says. And by minting a $1 trillion coin, then depositing it at the Fed, the Treasury could acquire enough cash to sidestep the debt ceiling — while doing no economic harm at all.

The American Enterprise Institute explains how the platinum coin concept would work:

There are limits on how much paper money the U.S. can circulate and rules that govern coinage on gold, silver, and copper.  BUT, the Treasury has broad discretion on coins made from platinum.  The theory goes that the U.S. Mint would create a handful of trillion dollar (or more) platinum coins.  The President would then order the coins deposited at the Fed, who would then put the coin(s) in the Treasury who now can pay all their bills and a default is removed from the equation.  The effects on the currency market and inflation are unclear, to say the least.

According to CNN:

Normally, the Federal Reserve is charged with issuing currency. But U.S. law, specifically 31 USC § 5112, also grants Treasury permission to “mint and issue platinum bullion coins and proof platinum coins.”

This section of law was meant to allow for the printing of commemorative coins and the like. But the Treasury Secretary has the authority to mint these coins in any denomination he or she sees fit.

Why The $1 Trillion Platinum Coin Idea Won’t Work

The genesis of the trillion dollar platinum coin scheme derives from the law (Title 31, Section 5112, (31 U.S.C. § 5112(k)) passed by Congress under their constitutional power to coin money and regulate the value thereof.  This particular law was passed to give the U.S. Mint the authority to produce the American Eagle Platinum Bullion and Proof coins, without restriction to the American Eagle products program.

The Secretary may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time.

As argued in some of the commentary above, it seems clear that the law would allow the Secretary to authorize the U.S. Mint to produce a platinum of any stated denomination, including one trillion dollars.

The Federal Reserve would receive a coin on which would yield a profit of $1 trillion dollars based on the concept of seigniorage, which is the difference between the cost to produce the coin and the “face value” of the money stamped on it by the U.S. Mint.  However, under the rules of both the American Eagle program and other commemorative programs, the coin does not become “legal tender” until the U.S. Mint is paid for the coin with other legal tender or an appropriately valued amount of bullion.  Until the U.S. Mint was paid, the Federal Reserve would possess a rather beautiful coin worth only about $1,700, representing the intrinsic value of the platinum contained therein.

In the recent case of the government confiscation of 1933 Saint-Gauden Double Eagle gold coins from the heirs of Israel Swift, the court ruling confirmed the validity of the legal tender concept.  In the court ruling, Judge Davis cites precedents, including the government’s original case against Israel Swift in 1934, and confirmed that until a U.S. Mint coin is bought and paid for, the coin is not considered to be legal tender.  The concept of a coin not becoming legal tender until it was paid for was further confirmed in the sale of the Fenton-Farouk 1933 Double Eagle gold coin.  When the Double Eagle was sold on July 30, 2002, for $7.6 million, an additional $20 was required to be paid to “monetize” the face value of the coin in order for it to become legal currency.

Exactly how would the U.S. Mint be paid in order for the $1 trillion coin to become official legal tender?  If the Federal Reserve accepts the trillion dollar coin from the U.S. Mint, they would incur a $1 trillion liability to the U.S. Mint.  To offset the liability to the U.S. Mint, the U.S. Treasury would have sell $1 trillion in bonds which can’t legally be done due to the limits placed on its borrowing capacity by the debt ceiling limit.  The idea of a $1 trillion platinum coin becomes a fatally flawed solution that solves nothing.

So why can’t the Federal Reserve simply “print money” to pay for the $1 trillion coin?  As explained by Paul Krugman, the Fed does not legally have the power to print money, with one rather dubious exception.

First, as a legal matter the Federal government can’t just print money to pay its bills, with one peculiar exception. Instead, money has to be created by the Federal Reserve, which then puts it into circulation by buying Federal debt. You may say that this is an artificial distinction, because the Fed is effectively part of the government; but legally, the distinction matters, and the debt bought by the Fed counts against the debt ceiling.

Furthermore, Krugman admits that the platinum coin idea is a “gimmick” since the coin would effectively have the same value as other outstanding Treasury debt and the Treasury would have to eventually buy the coin back with additional borrowings.  Somewhat surprisingly, Krugman also concedes that despite the fact that much of the government’s current spending is financed by the Fed’s money printing, we cannot ignore the ultimate consequences of huge holdings of Treasury debt held by the Fed.

It’s true that printing money isn’t at all inflationary under current conditions — that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought. So even though right now that debt is just a claim by one more or less governmental agency on another governmental agency, it will eventually turn into debt held by the public.

The entire concept of the United States funding itself with a manufactured $1 trillion dollar coin of nominal intrinsic value is fraught with danger since it highlights the extent to which we are willing to debase the value of the U.S. dollar to continue massive deficit spending – at some point our creditors will begin to take notice.  Think of Japan and China who each hold more than $1 trillion in U.S. Treasury debt securities.

Aside from the fact that the minting of a $1 trillion dollar coin is probably legal, it is not a workable solution since the coin would be of no value until it was paid for as explained above.  As discussed in Bloomberg, instead of pursuing dubious policies that will ultimately alarm the nation’s creditors, the challenge of compromising on the debt ceiling should be viewed as an opportunity for Congress to take responsibility for the nation’s future fiscal policies.

Watch what he did, not what he says. President Barack Obama says he won’t agree to spending cuts in return for Republicans’ raising the debt ceiling. Yet he did exactly that in 2011. And he should do it again.

The debt ceiling ought to be raised because nobody has a plan to eliminate the deficit immediately, and there is no popular support for doing what that would take. A congressman who isn’t presenting and supporting a zero-deficit-now plan has an obligation to give the federal government the additional borrowing authority that continued deficits make necessary.

For liberals, that’s the end of the matter. The debt ceiling should be raised without any spending cuts attached, and ideally it should be raised to infinity. One common argument goes like this: Since Congress sets spending and tax levels, no good purpose is served by holding a separate vote making it possible for the government to follow Congress’s original instructions.

That argument would have more force if the federal budget were the result of a deliberate policy. Instead, more and more of our spending rises on autopilot because of decisions made long ago, and nobody is forced to take responsibility for the gap between revenue and commitments. Bills to raise the debt ceiling are the only occasions when congressmen and the president come close to doing so. They are thus appropriate moments to attack the trends that are driving our rising debt.

More On This Topic – “Creating Money Out of Thin Air”

Former U.S. Mint Director: The $1 Trillion Platinum Coin Ain’t Worth a Plugged Nickel

The $1 trillion platinum coin is a desperate gimmick of questionable legality and doesn’t even come close to solving our fiscal problems.

First, it may be legal to mint a platinum bullion coin with a $1 trillion face value, but it’s not legal to pass it off as actually worth $1 trillion if there isn’t $1 trillion of platinum in it. That’s because it’s a bullion coin and not a legal circulating coin. The face value of a bullion coin has no relationship with the metal content because the value is in the metal, whose price fluctuates daily.

Second, for a coin to be worth its face value, it has to be made as a circulating coin.

The Fed would pay the Mint face value for the coin. After deducting the cost of the coin, the Mint would return the balance to the Treasury. All this needs to be done before we run out of money. Good luck with that.

Third, the current law does allow the Mint to make a platinum proof coin and does not specify whether this applies to a bullion coin or a circulating coin. A proof coin refers to a mirror-like finish and is made for coin collectors. However, a proof coin must be accepted at face value. Some have argued that the law can be stretched to allow for a platinum circulating coin, but this would not be consistent with the intent of the original legislation.

But let’s ignore the law for a moment. Let’s assume that a $1 trillion circulating coin could be created. It would be no different than creating money out of thin air.

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Gold Will Benefit From The Coming Currency Turmoil

By:  Axel Merk, Merk Investments

Sidetracked by the discussion over the “fiscal cliff” and possibly a New Year’s hangover, it’s time to face 2013 in earnest. Is the yen doomed? Will the euro shine? What about Asian and emerging market currencies? Will gold continue its ascent? And the greenback, will it be in the red?

Before we look too far forward, let’s get some context:

  • “Central banks hope for the best, but plan for the worst” was our theme a year ago. With everyone afraid of the fallout from the Eurozone, printing presses in major markets were working overtime. We argued this would benefit currencies of smaller countries – be that the so-called commodity currencies or select Asian currencies – that feel less of a need to “take out insurance.”
  • While we were positive on the euro when it approached 1.18 versus the U.S. dollar in 2010, arguing the challenges are serious, but ought to be primarily expressed in the spreads of the Eurozone bond market. Then in the fall of 2011, we grew increasingly cautious because of the lack of process: just as it is difficult to value a company if one doesn’t know what management is up to, it’s difficult to value a currency if policy makers have no plan. In the spring of 2012, when we were most negative about the euro, we lamented the lack of process in a Financial Times column. European Central Bank (ECB) chief Mario Draghi appeared to agree with our concerns, imploring policy makers to define processes, set deadlines, hold people accountable. After his “do whatever it takes” speech in July 2012, he took it upon himself to impose a process on European policy makers in early August 1. We published a piece “Draghi’s genius” where we called for a bottom in the euro. We were inundated with negative feedback in the immediate aftermath of our analysis from professional and retail investors alike, confirming that were not following the herd, nor buying something that’s too expensive.
  • While we liked commodity currencies in the first half of the year because of printing presses in larger economies working overtime, we grew a little cautious as the year moved on, partly because of valuations. Each commodity currency has its own set of dynamics, as well as their own Achilles heel: in the case of the Australian dollar, we had some concerns about its two tier domestic economy (not all of Australia was benefiting from the commodity boom), but also about the perceived slowdown in China.
  • We studied the Chinese leadership transition with great interest; while 2012 may have been a year in transition, more on the dynamics as we see them play out below.
  • Back in the U.S., we squandered another year to get the house in order. The fiscal cliff was a distraction; we need entitlement reform to make deficits sustainable. Europeans have no patent on kicking the can down the road. But unlike Europe, the U.S. has a current account deficit, making it more vulnerable should investors demand more compensation to finance U.S. deficits (that is, higher interest rates).
  • Japan: the more dysfunctional the Japanese government has been, the less it could spend, the less pressure it could exert on the Bank of Japan. Add to that a current account surplus, and all this “bad news” was good news for the yen. Countries with a current account surplus don’t need inflows from abroad to finance government deficits; as a result, the absence of economic growth that keeps foreign investors away is of no detriment to the currency. Conversely, countries with current account deficits tend to pursue policies fostering economic growth to attract capital from abroad. However, in late 2012, we published a piece “Is the Yen Doomed?” What happened? Japan was about to have a strong government. More in the outlook below.

We believe the currency markets are well suited for decision-making based on macro-analysis. Just as throughout 2012 the themes were evolving, please keep in mind that our 2013 outlook may be outdated the moment it is published, as we update our views based on new information or a new analysis of old information. Still, those who have followed us over the years are well aware that we like to shift our views within a framework. Please consider our 2013 outlook in this context:

  • We believe the yen is indeed doomed. We remove the question mark. Prime Minister Abe’s new government sets the stage, but key to watch are:
    • Abe’s government will appoint the three top positions at the Bank of Japan, as the governor and both deputy governors retire. Recent appointees have already been more dovish. Japanese culture is said to prefer talk over action, but the time for dovish talk may finally be over (despite their dovish reputation, the Bank of Japan barely expanded its balance sheet since 2008; in many ways, of the major central banks, only the Reserve Bank of Australia has been more hawkish).
    • Japan’s current account is sliding towards a deficit. That means, deficits will start to matter, eventually pushing up the cost of borrowing, making a 200%+ debt-to-GDP ratio unsustainable.
    • Abe’s government is as determined as it is blind. Abe believes a major spending program is just what Japan needs. As far as the yen is concerned, Abe may be getting far more than he is bargaining for.
    • But isn’t everyone negative on the yen already? Historically, it’s been most painful to short the yen; as such, many have not walked their talk. We expect some fierce rallies in the yen throughout the year. Having said that, the yen looks a lot like Nasdaq in 2000 to us. Not as far as technicals are concerned, but as far as the potential to fall without much reprieve.
  • The euro may be the rock star of 2013. Boring is beautiful. Sure, there are plenty of problems, but the euro is morphing into yet another currency, but is still priced as if it had a contagious disease. While the Fed, the Bank of England, the Bank of Japan are all likely to engage in further balance sheet expansion (we refer to it as “printing money” as assets are purchased by central banks, paid for by entries on computer keyboards, creating money out of thin air), there’s a chance the ECB balance sheet may actually shrink. That’s because some banks have indicated they will pay back early part of the €1 trillion in 3-year loans taken from the ECB. Some suggest the ECB might print a boatload of money should the “Outright Monetary Transaction” (OMT) program be activated to buy the debt of peripheral Eurozone countries. Keep in mind that the OMT program would be sterilized, likely by offering interest on deposits at the ECB. As such, the OMT would lower spreads in the Eurozone and, through that, act as a massive stimulus. In our assessment, however, such a stimulus is far less inflationary than central bank action in other regions. It’s no longer a taboo to be positive on the euro, but most we talk to are at best “closet bulls.”
  • The British pound sterling. The Brits are getting a new governor at the Bank of England (BoE) in the summer, the current head of the Bank of Canada (BoC), Carney. One of the first speeches Carney gave after his appointment was made public was about nominal GDP targeting. Carney will have a chance to replace many of the current BoE board members. That’s the good news, as the old men’s club is in need of a makeover. The not-so-good news is for the sterling. British 10 year borrowing costs have just crossed above those of France. We’ll monitor this closely.
  • As the head of the BoC, Carney was particularly apt at talking down the Loonie, the Canadian dollar, whenever it appeared to strengthen. If Macklem, his current deputy, is appointed, we may get a real hawk at the helm of the BoC. We are positive on the Loonie heading into 2013, but will monitor developments closely, as there are economic cross-currents that, for now, Canada appears to be handling very well.
  • Staying with commodity currencies, we are cautiously optimistic on the Australian dollar (China better than expected; monetary policy more hawkish than priced in) and New Zealand dollar (more hawkish monetary policy on better than expected growth). We continue to stay away from the Brazilean real and leave it for masochistic speculators looking for excitement.
  • We are positive on Norway’s currency (joining the above mentioned rock star, with greater volatility), yet cautious on Sweden’s (priced to perfection is not ideal when things are not perfect, even in Sweden).
  • China: the new leadership has indicated that liquidity for the Chinese yuan may be their top currency priority. That’s great news, as we believe it implies policies that attract investment, not just from the outside, but also with regard to a development of a more vibrant domestic fixed income market. We are more positive on China than many; more on that, in an upcoming newsletter (click to sign up to receive Merk Insights)
  • Korea, Malaysia, Taiwan: all positive, benefiting from both internal forces, but also beneficiaries of actions in other large economies. If we have to pick a favorite today, it would be Korea, but keep in mind that the Korean won is the most volatile of these currencies.
  • Singapore: we continue to like the Singapore dollar. A year ago, we started using it as a substitute for the euro (rather than using the U.S. dollar as the safe haven currency). The currency may well lag the euro’s rise, but the lower risk profile of the currency makes it a potentially valuable component in a diversified basket of currencies.
  • Gold. We expect the volatility in gold to be elevated in 2013, but consider it good news, as it keeps the momentum players at bay. We own gold not for the crisis of 2008, not for the potential contagion from Europe, but because there is too much debt in the world. We think inflation is likely a key component of how developed countries will try to deal with their massive debt burdens, even as cultural differences will make dynamics play out rather differently in different countries. Please see merkinvestments.com/gold for more in-depth discussion on our outlook on gold.

And what about the U.S. dollar? While much of the discussion above is relative to the U.S dollar, the greenback itself warrants its own analysis:

  • Investors in the U.S. should fear growth. The spring of 2012 saw the bond market sell off rather sharply as a couple of economic indicators in a row came out positively. Bernanke wants to keep the cost of borrowing low, but can only control the yield curve so much. That’s why, in our assessment, he is emphasizing employment rather than inflation, in an effort to prevent a major sell-off in the bond market before the recovery is firmly established. Growth is dollar negative because the bond market would turn into a bear market: foreigners’ love for U.S. Treasuries might wane, just as it historically often does during early and mid-phases of an economic upturn as the bond market is in a bear market.
  • Good luck to Bernanke to raising rates in 15 minutes, as he promised he could do in a 60 Minutes interview. Sure he can, but because there’s so much leverage in the economy, any tightening would have an amplified effect. At best, we might get a rather volatile monetary policy. But we are promised by the Fed that this is not a concern for 2013.
  • Both of these, however, suggest volatility will rise in the bond market. Remember what got the housing bubble to burst? An uptick in volatility. That’s because leveraged players, momentum players run for the hills when volatility picks up. And a lot of money has chased Treasuries, praised as the best investment for over two decades. We don’t need foreigners to sell their U.S. bonds for there to be a rude awakening in the bond market; we merely need a return to historic levels of volatility. Why is this relevant to a dollar discussion? Because a bond market selloff makes it more expensive for the U.S. to finance its deficits. Please see our recent analysis of the risks posed to the dollar by a bond market selloff for a more in-depth discussion on this topic.

Axel Merk is President and Chief Investment Officer, Merk Investments. Merk Investments, Manager of the Merk Funds.

THE ONGOING COLLAPSE IN THE PURCHASING POWER OF THE DOLLAR IS IRREVERSIBLE – TEN STEPS TO PROTECT YOURSELF

By GE Christenson

  • Our financial system, as it currently operates, is unsustainable. Unproductive debt cannot exponentially increase forever. I assume this is obvious to almost everyone. Jim Sinclair says, “The financial system is simply FUBAR. It is that simple. The reason to own all things gold is that simple.” FUBAR has several meanings, but my interpretation of FUBAR is: “Fiscally Unbalanced Beyond Any Reconciliation.”
  • The U.S. government deficits are, on average, larger every year. This means that the total (official) national debt is not only increasing each year but also that the rate of increase is accelerating. Since 10/1/2000 the national debt has increased about 9.1% per year, but since 10/1/2007 it has increased 12.2% per year. Worse, this is only the official debt and does not even consider the net present value of unfunded Social Security, Medicare, Medicaid, and government employee pensions and liabilities. Depending on who is calculating the liabilities, the total unfunded liability is approximately $100 Trillion to $230 Trillion and the annual increase is perhaps $7 – $11 Trillion. (The entire U.S. GDP is about $15 Trillion per year – for comparison.) This will not end well.
  • In essence, the above two facts are incompatible – hence an economic train wreck is in process. What could happen? Follow the logic here.
  • When there is too much of something, it loses value. If we have too many eggs, the price drops. If too many autos are for sale, there will be lower prices for autos. Central banks around the world are currently producing amazing quantities of dollars, euros, yen, and most other unbacked paper currencies. Hence, their value will decrease against the commodities we need for survival – food, energy, and so forth.
  • There is too much debt in our financial system, whether measured in nominal value or as a percentage of GDP. Hence the value of that debt will decline. Some debts will default, bonds will decline in value as interest rates inevitably rise, and other debt will drop in value and purchasing power.
  • Politicians have made excessive guarantees for future benefits to Social Security recipients, Medicare recipients, government pensions, and others. Those guarantees cannot all be delivered as promised, hence they will decline in value and purchasing power, or the promises will not be fulfilled.

Why are the following ten steps necessary?

  1. The best time to start preparing was about a decade ago. The second best time is today. Make a plan and act. Start by reducing living expenses and eliminating credit card debt.
  2. Expect sweeping changes! I hope the inevitable currency collapse is slow and gentle, not rapid and destructive, but history suggests rapid and painful are more likely.
  3. Phase out of paper assets and into something real. Gold, silver, diamonds, farm land, rental property, and buildings come to mind.
  4. Perspective – Perspective – Perspective! It is better to be early than late. It is better to trust yourself than to depend upon a government agency for your food and shelter. To whatever extent you can, take charge of your own financial affairs, savings, and retirement.
  5. Plan on huge inflation in consumer prices for food, energy, transportation, medical costs, and more.
  6. The middle class will be hurt the most. Those who plan and prepare will, as always, survive and prosper. Make a plan!
  7. Government control over the economy will increase. Surveillance on individuals will increase; there will be much less personal and financial privacy. Act accordingly!
  8. Social change will follow a currency collapse. It might be violent. The government is preparing in many ways for social violence. Are you?
  9. Currency induced cost-push inflation appears inevitable. When? As a guess, well before 2016. Gasoline costing $8.99 or more per gallon is a distinct possibility. Don’t discount this just because it sounds extreme. It might be a low estimate.
  10. Economic manipulations, mal-investments, and unsustainable policies will self-correct. Plan on corrections and adjustments that will bring painful consequences. The bigger the bubble, the more catastrophic the collapse and the larger the collateral damage. The sovereign debt and paper money bubbles appear VERY large and ready to pop.

Summary

Unproductive government debt cannot increase forever, but our financial system currently depends upon ever increasing expenditures and debt. There are far too many dollars in circulation, more debt than can be repaid, and massive unfunded liabilities have been created by the promises made by politicians. The purchasing power of the dollar must decline, many debts will not be repaid, and many promises for future benefits will be reduced in value or will simply disappear. Hence, the FUTURE income stream from debt-based assets is increasingly risky. A few to consider are:

  • Social Security benefits. The government must borrow or print to pay current benefits. The value (purchasing power) of future benefits will almost certainly decline.
  • Municipal and state bonds and pension promises are increasingly risky. Will more cities and states default on their bonds? Why are their pension plans, on average, increasingly underfunded? Will your pension plan remain safe? Consider moving your IRA into physical gold and silver safely stored outside the banking system.
  • US government 30 year bonds and 10 year notes will decline in price as interest rates rise, and will also decline in purchasing power as the dollar devalues. Why would you lend money (long-term) to an insolvent government at less than 3% interest per year when that government has assured you it will debase the currency and reduce the value of the debt you bought? Is this a financial train wreck in process?
  • Mutual funds and money markets based on bonds and other debt are at risk. If the underlying debt defaults, the value of the mutual funds and money markets will decline. Counter-party risk is real.

Why is debt based future income increasingly risky? The payoff will be delayed, defaulted or executed in mini-dollars after inflation and counter-party defaults have ravaged the purchasing power of those paper debts. We have Been Warned!

Would you prefer hard assets with no counter-party risk? Reread the Ten Steps To Safety, and then take charge of your financial life to whatever extent you can.

GE Christenson
aka Deviant Investor

Gold Bullion Coin Sales Drop For Fourth Straight Year, 2013 Sales Off To Strong Start

According to the latest U.S. Mint report, sales of the American Eagle Gold bullion coins for December 2012 totaled 76,000 ounces, up 16% from December 2011 when 65,500 ounces were sold.  Sales for the month were down 44.3% from November sales which totaled 136,500 ounces.

Sales of the gold bullion coins can vary dramatically from month to month.  The highest sales month was November with sales of 136,500 ounces and the lowest sales month was April when only 20,000 ounces were sold.  Average monthly sales of the gold bullion coins for 2012 was 62,750 ounces with total sales for the year coming in at 753,000.   The gold bullion coins are available in one ounce, one-half ounce, one quarter ounce and one-tenth ounce.

Sales of the American Eagle Gold bullion coins have now declined for four straight years in a row.  The all time record sales year was 2009 when the U.S. Mint sold 1,435,000 ounces.   The value of the gold bullion coins purchased since 2000 totals almost $13.5 billion.

The U.S. Mint only sells the gold bullion coins to a network of authorized purchasers who buy the coins in bulk based on a markup and the market gold value.  The primary distributors who buy the coins then resell them to other bullion dealers, coin dealers and the public.  By using this type of distribution channel, the U.S. Mint believes that the coins can be made widely available to the public with reasonable transaction costs and at premiums in line with other bullion programs.

The 2013 American Gold Eagle bullion coins were first available to authorized purchasers on January 2, 2013.  Demand for the newest gold bullion coins was very strong with 50,000 ounces sold on the first day.  For the entire month of January 2012, a total of 127,000 ounces of the coins were sold.

Gold Bullion U.S. Mint Sales By Year
Year Total Sales Oz.
2000 164,500
2001 325,000
2002 315,000
2003 484,500
2004 536,000
2005 449,000
2006 261,000
2007 198,500
2008 860,500
2009 1,435,000
2010 1,220,500
2011 1,000,000
2012 753,000
Total 8,002,500

After a volatile year, gold ended with a strong note for 2012, up by 7.1% and rising for the 12th year in a row as global central banks ramped up the printing presses in an attempt to “stimulate” the world economy.  In his annual “10 Surprises ” list for 2013, Byron Wien, Chairman of Blackstone Group’s advisory unit predicted that gold would reach $1,900 as “central bankers everywhere continue to debase their currencies and the financial markets prove treacherous.”  Based on the way things are going and the speed at which central banks are joining the money printing race, Mr. Wien’s forecast is likely to prove extremely conservative.

Gold Has Outperformed Housing By 600% Since 2001

Anyone predicting that gold would outperform housing in 2001 would likely have been viewed as being seriously deranged.  After all, housing prices had increased for decades and by the peak of the housing market in 2007, real estate was believed to be a “can’t lose investment.”  The mantra that housing values only go up proved to be disastrous for many Americans as the over-leveraged real estate market imploded, shattering the wealth dreams of both naive homeowners and investors.

Despite the trillions of dollars of direct support from both the Federal Reserve and Congress, real housing values have yet to recover a fraction of their losses.  Mainstream press reports of a solid recovery in housing markets usually neglect to mention, that according to the Case-Shiller National Index, housing prices are still lower than they were at the turn of the century.

Courtesy: calculatedriskblog.com

Gold, meanwhile, unloved and ignored by most Americans is set to make its 12th straight annual gain.  From a yearly low of $255 per ounce during 2001, gold settled in New York trading on Thursday at $1,663.90, up 653% over the past 12 years.

Chart of the Day has some interesting data on the performance of gold versus housing, as represented by the Home Price/Gold Ratio.  Based on current prices, 105 ounces of gold will buy you the median priced single family home.  In 2001, a home buyer would have needed 601 ounces of gold to buy the same house.  Housing, when priced in gold, in down 80% from 2001.

Courtesy: chartoftheday.com

Despite gold’s proven ability to preserve wealth over time, most Americans still seem indifferent to allocating part of their portfolios into gold – something to think about as central banks ramp up the printing presses at an increasingly furious pace.

The Fed Is Confiscating The Wealth Of The Middle Class By Destroying The Value Of The Dollar

Americans need to take a serious look at how the purchasing power of the dollar is being destroyed.  Rampant poverty, declining real incomes and higher prices are all the guaranteed results of a Federal Reserve that remains committed to destroying the value of the dollar.   A dollar saved today that has less purchasing power a year from now equates to the “silent” destruction of the dollar, an event which has gone virtually unnoticed and unprotested by the American public.

Act #4 of the Fed’s endless money printing campaign directly monetizes over a half a trillion dollars of U.S. deficit spending annually.  In addition to financing the Federal debt with printed dollars, the Fed has also explicitly endorsed  an inflation rate of 2.5% as being “acceptable.”

Impact Of 2.5% Inflation

Even a relatively “benign” inflation rate of 2.5% rapidly erodes the purchasing power of savings. Over a short 5 years, the purchasing power of $100,000 in savings is reduced to $88,110 at an inflation rate of 2.5%.  At a 5% inflation rate, the value after 5 years is only $77,378.  We don’t even want to look at how much purchasing power would be lost over a decade.

Both consumers and especially savers need to become aware of the wealth depletion caused by purchasing power loss.  From my experience, most people find it conceptually difficult to see a real loss (in purchasing power) when there has been no change in the principal amount of savings.  As John Maynard Keynes wrote in 1920, “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.  By this method they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some.  And not one man in a million will detect the theft.”

Incredibly, the desperate attempts of central banks to prop up the over-indebted financial system via inflation and money printing is viewed as beneficial by some misguided economists.  Japan’s decision to go all in with “unlimited quantitative easing” was applauded in a recent Slate commentary.

That’s because Shinzo Abe, the overwhelming favorite to lead the Liberal Democratic Party to victory, is running on a bold platform of unlimited quantitative easing and more inflation. If this works—and the odds are that it will—Abe will not only cure a great deal of what ails Japan, he’ll light a path forward for the rest of the developed world.

But if he (Abe) does manage to stick to his guns, the odds are good that it will work. Monetary expansion should reduce the price of the yen and goose exports. More importantly, it will push domestic real interest rates down and spur investment. Creating firm expectations that yen-denominated prices will be higher in the future than they are today should encourage firms and households alike to acquire real goods sooner rather than later. And all this ought to encourage everyone to be investing and spending more.

Bernanke said Japan’s central bankers needed Rooseveltian resolve, but the moral of the story may be that it takes a politician—a Roosevelt—to have the clout and legitimacy to make central banks act decisively when an economy gets firmly mired at the lower bound. If Abe can be that Roosevelt, he’ll not only be a hero of Japan but possibly of the whole world economy. After all, if America’s old advice to Japan turns out to work in practice as well as in theory, then maybe we’ll finally get around to taking our own advice for ourselves.

Does anyone think that Japan’s temporary benefit of a lower currency will not be met with competitive devaluations by other nations?  Exactly how will Japanese consumers be able to spend more if prices increase and wages remain stagnant due to the limiting effects of wage globalization?  The Slate author firmly espouses the lunacy of currency debasement as a wealth enabler despite the fact that no nation in history has ever printed its way to prosperity.

The fact that central banks have firmly committed themselves to money printing on an unimaginable scale is not a cause for hope but rather a clear signal of desperation.  Policy makers have run out of options and in an attempt to forestall the collapse of the financial system, have turned to the last resort option of unlimited money printing.

Gold Demand In Asia Remains Insatiable

As gold demand in Asia soars, vault companies are racing to keep up with storage demand.  In July, Gold and Silver Blog reported on a massive new gold vault being constructed in Hong Kong by Malca-Amit due to unrelenting physical demand for gold in Asia.  The new vault was designed to hold 1,000 metric tonnes of gold and as of July, had already taken in 2,400 tonnes of gold owned by gold exchange traded funds.

It turns out that Malca-Admit should have built a much larger vault.  As demand for physical gold continues to increase, other companies have joined the race to provide secure depositories for wealthy investors.  The Wall Street Journal reports that demand for high-security vault capacity in Asia is soaring in Singapore, Hong Kong and Shanghai.

Brink’s Co., for example, has increased its storage space for precious metals in Singapore more than threefold over the past year, to 200 square meters, and is building a bonded warehouse in Shanghai to store high-value consumer goods and precious metals.

“We are growing, and driving that growth is the storage of precious metals and also bank notes,” said Jos van Wegen, the company’s senior manager of global services in Singapore.

Comprehensive data on the volume of high-security storage capacity in the region isn’t available. But demand for gold is clearly rising.

China’s gold demand in the third quarter of this year was 176.8 tons—16% of global demand and up 47.1% from the same period three years ago, according to the World Gold Council. Hong Kong’s demand totaled 6.9 tons in the third quarter this year, up 56.8% from the third quarter of 2009.

Singapore imported 36.7 tons of gold in the first 10 months of this year, well down from 62 tons in the full year 2011. The government’s announcement in February that, in a bid to become a gold-trading hub, it would scrap a 7% goods and services tax on gold, silver and platinum hurt imports for much of the year. Fourth-quarter gold-import figures for Singapore are expected to be stronger, World Gold Council executives say.

While physical gold requires storage space, it does offer a lot of value in a relatively small package. At around $1,690 a troy ounce, a metric ton of gold is valued at $54.3 million, but would take up only slightly more space than a standard case of 12 wine bottles—though most gold is stored in ingots.

Malca-Amit, a company that stores and transports diamonds and precious metals, has lockups in Hong Kong and Singapore, and is preparing to open one in Shanghai in the first quarter next year. The Shanghai vault will also hold art and luxury goods such as high-value mobile phones and designer handbags.

Malca-Amit’s Singapore vault, capable of holding 600 tons of gold, is almost full, and the company is seeking more space. The amount of gold stored there has increased 200% from a year ago, it says.

Its recently opened Hong Kong vault can hold 1,000 tons of gold, which would be worth more than $54 billion. It is almost large enough to hold the official reserves of China, which total 1,054 tons, according to World Gold Council data.

Malca-Amit has gold-storage sites in New York and Zurich, but the focus of its expansion is firmly on Asia, executive director Joshua Rotbart said. Some Asian investors who are storing their gold in the U.S. and Europe are keen to move it closer to home as more storage space becomes available, he said.

The recent price weakness in gold is apparently viewed as a buying opportunity by sophisticated Asian investors seeking to protect their wealth from the torrential flood of printed money being produced on a global basis by central banks (see Central Banks Pledge Unlimited Money Printing).

On a recent visit to the Chinatown section of Bangkok, I witnessed first hand large crowds of customers in Chinatown’s numerous retail gold stores.  Gold has never defaulted on its promise as a means of wealth preservation, something clearly understood by the citizens of a country whose history goes back thousands of years.

Customers at Bangkok retail gold store

Chinese Gold

Chinese Gold

The Hidden Risks Of Money Printing

By Axel Merk

While Treasuries are said to have no default risk as the Federal Reserve (Fed) can always print money to pay off the debt, hidden risks might be lurking. As oxymoronic as it may sound, the biggest risk to the economy and the U.S. dollar might be, well, economic growth! Let us explain.

The U.S. government paid an average interest rate of 2.046% on the $11.0 trillion of Treasuries outstanding as of the end of November. Treasuries include Bills, Notes, Bonds and Treasury Inflation-Protected Securities (TIPS). At 2.046%, the cost of carrying the Treasury portfolio currently costs the government $225 billion per annum; about 6% of the federal budget was spent on servicing the national debt. 1

While total government debt has ballooned in recent years, the interest rate paid by the government on its debt has continued on its downward trend:

We only need to go back to the average interest rate paid in 2001, 6.19%, and the annual cost of servicing Treasuries would triple, paying more than Greece as a percentage of the budget. Not only would other government programs be crowded out, the debt service payments might likely be considered unsustainable. Except for the fact that, unlike Greece, the Fed can print its own money, diluting the value of the debt. In doing so, the debt could be nominally paid, although we would expect inflation to be substantially higher in such a scenario.

These numbers are no secret. Yet, absent of a gradual, yet orderly decline of the U.S. dollar over the years – with the occasional rally to make some investors believe the long-term decline of the U.S. dollar may be over – the markets do not appear overly concerned. Reasons the market aren’t particularly concerned include:

  • The average interest rate continues to trend downward. That’s because maturing high-coupon Treasury securities are refinanced with new, lower yielding securities.
  • Treasury Secretary Geithner has diligently lengthened the average duration of U.S. debt from about 4 years when he took office to currently over 5 years.

For the U.S. government, a longer duration suggests less vulnerability to a rise in interest rates, as it will take longer for a rise in borrowing costs to filter through to the average debt outstanding. The opposite is true for investors: the longer the average duration of a bond or a bond portfolio one holds, the greater the interest risk, i.e. the risk that the bonds fall in value as interest rates rise.

Debt management by the Treasury only tells part of the story on interest risk. When the Treasury publishes “debt held by the public,” it includes Treasuries purchased in the open market by the Fed. By engaging in “Operation Twist”, the Federal Reserve stepped onto Timothy Geithner’s turf, manipulating the average duration of debt held by the private sector. Notably, the private sector holds fewer longer-dated bonds, as the Fed has gobbled many of them up.

However, investors may still be exposed to substantial interest risk in their overall fixed income holdings as, in the search of yield, many have doubled down by seeking out longer dated and riskier securities.

The Fed, many are not aware of, employs amortized cost accounting, rather than marking its holdings to market, thus hiding potential losses should interest rates go up and its portfolio of Treasuries and Mortgage-Backed Securities (MBS) fall in value.

Quantitative easing to increase interest risk

Whenever there’s a warning that all the money created by the Federal Reserve is akin to printing money, some dismiss these concerns as the money created out of thin air to buy securities has not caused banks to lend, but park excess reserves back at the Federal Reserve. As of December 14, 2012, $1.4 trillion in excess reserves is parked at the Fed. Substantial interest risk might be baked into reserves:

Consider that the Fed has been paying about $80 billion in profits to the Treasury in recent years. Think of it this way: the more money the Fed “prints”, the more (Treasury & MBS) securities it buys, the more interest it earns. That’s why Fed Chair Bernanke brags that his policies have not cost taxpayers a cent, even if the activities may put the purchasing power of the currency at risk. Now, Bernanke has also claimed he could raise rates in 15 minutes. In our assessment, it’s most unlikely he would do so by selling long-dated securities; instead, in an effort to keep long-term rates low, the most likely scenario is that the Fed will pay a higher interest rate on reserves. Up until the financial crisis broke out, the Federal Reserve would have intervened in the Treasury market by buying and selling securities to move short-term interest rates. In the fall of 2008, the Fed was granted the authority by Congress to pay interest on reserves.

As interest rates rise, not only will Treasury pay more for debt it issues, it may also receive less from the Fed. Interest rates would have to rise to about 6% for the entire $80 billion in “profits” to be wiped out assuming a constant $1.5 trillion in reserve balances ($1.4 trillion in excess reserves and $0.1 trillion in required reserves that also receive interest); that assumes, the Fed does not grow its balance sheet in the interim (in an effort to generate more “profits” for the Fed) and would not reduce its payouts in the interim as a precaution because bonds held on the Fed’s books may be trading in the market at substantially lower levels.

Should interest rates move up, the Treasury may no longer be able to rely on the Fed to finance the deficit (while the Fed denies the purposes of its policies is to finance the deficit, the Fed is buying a trillion dollars in debt as the government is running a trillion dollar deficit).

Biggest risk: economic growth?

In our surveys, inflation tends to be on top of investors’ minds, no matter how often government surveys show us that inflation is not the problem. Should inflation expectations continue to rise – and a reasonable person may be excused for coming to that conclusion given that the Fed appears to be increasingly focusing on employment rather than inflation – bonds might be selling off, putting upward pressure on the cost of borrowing for the government.

But if we assume inflation is indeed not an imminent concern (keep in mind that the Fed is also buying TIPS and, thus, distorting important inflation gauges in the market), we only need to look back at the spring of this year when a couple of good economic indicators got some investors to conclude that a recovery is finally under way. What happened? The bond market sold off rather sharply! A key reason why the Fed is increasingly moving towards employment targeting is to prevent a recurrence, namely a market-driven tightening, pushing up mortgage costs.

The government should be grateful that we have this “muddle-through” economy. Let some of that money that’s been printed “stick;” let the economy kick into high gear. In that scenario, the “good news” may well be reflected in a bond market that turns into a bear market.

Historically, when interest rates move higher in an economic recovery, the U.S. dollar is no beneficiary because foreigners tend to hold lots of Treasuries: should the bond market turn into a bear market, foreigners historically tend to wait for the end of the tightening cycle before recommitting to U.S. Treasuries.

The point we are making is that for bonds to sell off and the dollar to be under pressure, we don’t need inflation to show its ugly head; we don’t need China or Japan to engage in financial warfare by dumping their Treasury holdings. All we may need is economic growth! And while Timothy Geithner has studiously been trying to extend the average duration of U.S. debt, Ben Bernanke at the Fed has thrown him a curveball.

Perception is reality

One only needs to look at Spain to see that a long average duration of government debt is no guarantor against a debt crisis. Spain has an average maturity of government debt of 6 years, yet it does not take a rocket scientist to figure out that borrowing at 6% in the market is not sustainable given the total debt burden. As such, markets tend to shiver when confidence is lost, even if, technically, governments could cling on for a while when the cost of borrowing surges.

History may repeat itself

It was only 11 years ago that the US government paid and average of 6% on its debt. Sure the average cost of borrowing has been coming down. But no matter what scenarios we paint, if the average cost of borrowing can come down to almost 2% from 6%, we believe it is entirely possible to have the reverse take place over the next 11 years. Given the additional risks the Fed’s actions have introduced, the timing could well be condensed. But even if not, we believe it is irresponsible for policy makers to pretend interest rates may stay low forever (except, maybe, Tim Geithner’s steps to increase the average maturity of government debt; but as pointed out, his efforts may be overwhelmed by those of the Fed).

Fiscal Cliff

What’s so sad about the discussion about the so-called fiscal cliff is that even the initial Republican proposal results in approximately $800 billion deficits each year. Financed at an average 2%, this would add over $900 billion in interest expenses over ten years; financed at an average 4%, it would add almost $2 trillion in interest expense over ten years. Mind you, this is a politically unrealistic, conservative proposal. Democrats pretend we don’t even have a long-term sustainability problem, only that the wealthy don’t pay their fair share.

In our humble opinion, both Republicans and Democrats are distracted. In many ways, the simultaneous increase in taxes and cut in expenditures of the fiscal cliff is akin to European style austerity: if the cliff were to take place in its entirety, we would a) suffer a significant economic slow down; b) continue to run deficits exceeding 3% of GDP before factoring in any slowdown; and c) still not have fixed entitlements.

Entitlements

While our discussion focused on $11 trillion in Treasury securities, the so-called “unfunded liabilities” go much further than the $5 trillion in accounting liabilities set aside. Depending on the actuarial assumptions, unfunded liabilities may be as high as $50 trillion to $200 trillion or higher.

In our assessment, the only way to tame the explosion of government liabilities over the medium term is to tame entitlements. But it is very difficult to cut back on promises made. As Europe has shown us, the only language that policy makers understand may be that of the bond market. As such, unless and until the bond market imposes entitlement reform, we are rather pessimistic that our budget will be put on a sustainable footing. Put another way, things are not bad enough for policy makers to make the tough decisions.

Different from Europe, however, the U.S. has a current account deficit. As a result, a misbehaving bond market may have far greater negative ramifications for the dollar than the strains in the Eurozone bond markets had for the Euro. In the Eurozone, the current account is roughly in balance; while there was a flight out of weaker Eurozone countries, that flight was mostly intra-Eurozone towards Germany and Northern European countries.

So while the default risk of U.S. Treasuries may be less than that of Eurozone members, the risks to the purchasing power of the U.S. dollar might be substantially higher. On that note, while the Fed has indicated to buy another approximately $1 trillion in assets over the next year, we would not be surprised to see the balance sheet of the more demand-driven European Central Bank shrink as some banks pay back loans from the Long-Term Refinancing Operation (LTRO) early.

In early January, we will be publishing our outlook for 2013; Please also sign up for our newsletter to be informed as we discuss global dynamics and their impact on gold and currencies. Additionally, please join us for our upcoming Webinar on Tuesday, January 15th, 2013.

Axel Merk

Axel Merk is President and Chief Investment Officer, Merk Investments.