The long-term "irreversible" trends I've discussed in detail in
my upcoming book, $10,000 Gold, continue to develop. Many of the trends, such
as debt creation and the movement away from the U.S. dollar, are accelerating
and their consequences are appearing globally. Today we will interpret how
these developments will likely affect the price of gold over the coming year
and beyond.
Perhaps the most prevalent indication that something is amiss with the
world's economy is a sense of malaise that many have been experiencing--a
distrust in the financial system and the government. A U.S. Gallup poll,
completed at the end of November 2012, found politicians to be the second
least trusted individuals in society next to car salespeople. Sharing bottom
marks were bankers, journalists, business executives, state governors and
insurance salespeople. By contrast, nurses were the most trusted.
This level of distrust is global. Ask any Greek what he or she thinks of
bankers and politicians who, through their complex bond deals, have destroyed
the country's economy. Ask the people of Iceland, who ignored the bankers'
demands for more money and instead threw them in jail. Such distrust is a
tangible indication that the 41-year-old experiment in a global fiat currency
system is failing.
At this stage, it is no surprise to see that those who benefited from this
system are stepping up their PR campaign. Their goal is to bolster trust in
paper currencies. Such campaigns are broad-based. As James Rickards, author
of Currency Wars pointed out, the world is in the midst of an economic war
between countries, currencies and gold. Developing countries are challenging
the U.S. dollar's de facto reserve currency status, and many in the East are
turning to physical gold. The Western financial media insists on supporting
the status quo with their positive messages of imminent economic recovery,
but many are not buying it and the global appetite for physical gold is the
best indication of this.
It should come as no surprise that the U.S. petrodollar is facing
challenges. Reserve currencies go through cycles that last about a century as
can be seen from the reserve currency chart. They usually end when the
country that has this exalted privilege creates too much currency and goes
too deeply into debt, just as the United States is demonstrating.
As in any war, "Truth is the first casualty," but how do we
distill the truth from so much complex and contradictory financial
information? The answer is simple: by changing perspective; by using gold as
our measure for financial assessment. The gold vantage point is more comprehensive.
It allows us to see the hidden influences of inflation, for example. It helps
us to understand why governments are doing what they are doing, despite their
words to the contrary.
`The fiat experiment officially began on August 15, 1971, the day
President Nixon broke the U.S. dollar's final international peg to gold. This
allowed governments to create unrestricted amounts of currency with none of
the safeguards that gold backing otherwise demanded. Consequently, the debt
is now so large it is impossible to pay back. In the words of Congressman Ron
Paul, the United States is "technically bankrupt."
So let's start by looking at the most important influence on the price of
gold--global government debt.
Global Debt
Government debt creation through currency debasement causes paper
currencies to lose purchasing power against the more stable economic standard
of gold. In fact, there is a direct relationship between debt and the price
of gold. The Relationship to Gold and U.S. Debt chart, which was the centerpiece
of last year's Outlook for Gold, shows the gold price rising in near lockstep
with rising U.S. debt over the past decade.
The increase in central bank assets is a good indicator of how this debt
is growing.
Between 2007 and 2012 Bank of England reserves increased by 362 percent,
and the U.S. Fed's increased by 223 percent. Unfortunately, as the people of
Greece have discovered, most of the bailout cash stays in the hands of banks,
even though the taxpayer is expected to repay the lenders.
Although all the major currencies have lost purchasing power against gold,
the chart shows the dramatic demise of the U.S. dollar. Being the world's de
facto reserve currency, it is by far the largest and most important, and the
reason we give so much attention to the financial health of our southern
neighbour.
We can see that while backed with gold the dollar maintained purchasing
power. In 1934 it lost its domestic peg to gold and then, in 1971, its
international peg. The dollar has now lost 98 percent of its purchasing power
since 1934.
U.S. federal debt is now growing exponentially. In his first term,
President Obama added more debt than was added since the United States
declared its independence from Britain in 1776. Another milestone: In Obama's
first term, the U.S. debt to GDP ratio passed 100 percent. At the present
time, U.S. national debt is $16.4 trillion and GDP is $15.5 trillion.
Interest payments on the debt were $454 billion in 2011. The U.S. Treasury
"balance sheet" does not include the unfunded liabilities of
Medicare, Social Security and other outsized and very real obligations.
The actual liabilities of the federal government--including Social
Security, Medicare, and federal employees' future retirement
benefits--already exceed $86.8 trillion, or 550 percent of GDP. These figures
are kept from the public eye and are not listed on official balance sheets.
They can be found in obscure documents like the annual Medicare Trustees'
report. Some estimates put total U.S. unfunded liabilities at well over $200
trillion. In 1984, in what might have been the last serious attempt of the
U.S. government to address the problem of the rising debt, President Reagan's
Grace Commission report stated that:
"With two-thirds of everyone's personal income taxes wasted ((on
government excess)) or not collected (because of underground economy)), 100
percent of what is collected is absorbed solely by interest on the Federal
debt and by Federal Government contributions to transfer payments. In other
words, all individual income tax revenues are gone before one nickel is spent
on the services which taxpayers expect from their Government."
It is safe to say that most of what this 1984 report warned against--that
trillion-dollar federal debts would become reality if action was not taken
immediately--has become reality.
Political Options to Counter Debt
To address the issue of runaway debt, politicians have five choices:
- Growth through productivity and exports
- Austerity
- Default
- Print more currency
- Financial repression
One: Grow out of it through increased productivity and increased
exports. This is highly unlikely, as Western economies, and even China, are
poised for recession.
Two: Introduce strict austerity measures to reduce spending. This
has the unwanted short-term effect of increased unemployment, lower tax
revenues and reduced GDP, resulting in even higher deficits. And the voting
public hates it. The U.S. government has shown no willingness to take this
path.
Three: Default on the debt. This will make it difficult to raise
future bond issues at any reasonable level of interest rates.
Four: Issue even more debt, and have the central bank in question
simply create whatever amount of currency is required.
Five: Follow a program of "financial repression." The
four main pillars of financial repression are:
- Negative real interest rates and interest rate caps
through suppression of CPI
- Nationalization of industry
- Strict government control over investment criteria,
capital controls and lending practices
- Currency debasement through unrestricted debt creation
Obviously, governments around the world have chosen to fight this currency
war and their ballooning debt with options four and five. The fiscal cliff
fiasco of December 2012 proved that the majority of U.S. politicians will not
risk their careers by implementing the more direct, more responsible option
two or three.
Financial Repression and Negative Real Interest Rates
This is a topic for a more in-depth presentation, but as 2012 confirmed,
financial repression has become the unmistakable policy of governments
worldwide. We will be hearing much more about this policy over the coming
years. According to Bridgewater, the frequency of protests, strikes, and
social unrest increases sharply as soon as annual public spending is cut by
more than 3 percent of GDP. This unrest is appearing globally.
In Greece, where the government has attempted to implement austerity
measures, there is 20 percent unemployment in the 30 to 50 age group, and 58
percent youth unemployment. Greece's homeless rate has risen 25 percent since
2009, with 20,000 people living in the streets of Athens. Suicide rates,
violent crime and HIV infections are all rising quickly. This is what happens
when society begins to break down because of debt.
Youth unemployment is exceptionally high in most countries, especially the
United States, which further burdens its young people with crippling student
loans. Rising crime rates are another symptom of the increased stress
currency devaluation causes. This chart on Social Trends Incarceration of
Inmates since the removal of gold we can see the rapid rise in crime since
1971.
Despite the government job reports that put unemployment at 7.8 percent,
those who have stopped looking for work after years of failing go uncounted.
As soon as unemployment benefits run out, a job seeker is no longer
registered as unemployed by the official figures.
We can see that the job participation in the United States is plummeting,
due in large part to the aging population and outsourcing.
When we take into account the lack of participation, as the Shadow Stats
figures show, we see real unemployment in the U.S. is over 20 percent.
Financial repression involves restrictions on bank lending practices,
which dries up available financing and stifles economic growth and
development. This is a subtle form of nationalization, as it discourages
investment abroad. A more obvious form of nationalization comes as
restrictive trade laws. One example is the U.S.'s Foreign Account Tax
Compliance Act (FATCA), enacted in 2012 with the cooperation of fifty
countries. This makes it much more difficult for Americans to hold investment
funds based outside of the United States.
Larger government and further nationalization of industry are aspects of
financial repression policy. In the United States, distressed financial
institutions, automakers and healthcare are coming under the control of
government, especially under the Obama presidency. Most of the new jobs
created are government jobs, with five hundred thousand U.S. government
employees making over $100,000 per year (twice that of the average U.S.
workers' salary).
Financial repression is becoming a global policy as the currency war
amongst countries like China, Russia and the United States accelerates. China
has been using financial repression since 2000, with official inflation
pegged at 0.72 percent from 2002 to 2009. This creates negative real interest
rates of -7.2 percent, which gives China some of the lowest real interest
rates in the world and explains why it is such a large gold buyer. Negative
real interest rates can be determined by subtracting real inflation from
official inflation or Real Interest Rate = Nominal Interest Rate - Inflation
(Expected or Actual).
There is a direct correlation between gold buying and negative real
interest rates that are encouraged by financial repression. Negative real
interest rates, despite governments' incessant promises of economic recovery,
will likely be with us for years to come. This policy rewards borrowers, but
punishes savers.
Currency debasement, which results from creating too much currency and is
one of the elements of financial repression, is surreptitious in that the
public is less aware of the damage. Inflation caused by currency creation is
the "hidden tax". Everyone who eats, drives, heats their home or
sends their children to college is aware that life is becoming more costly by
the day. Yet government continues to issue inflation figures that show the
cost of living is stable. They have achieved this deception since the days of
Bill Clinton through "creative" accounting, such as removing food
and energy from the "basket of goods" used to measure inflation and
the CPI. Before 1995, the CPI measured a "fixed standard of living"
with a fixed basket of goods. Today it measures the cost of living with a
constantly changing basket of goods, measured with metrics that are
themselves constantly changing.
Fortunately, economist John Williams of ShadowStats.com keeps track of the
original basket and his figures show inflation at a more realistic level.
Further Consequences
Movement away from petrodollar
Last year saw several important BRICS and ASEAN agreements that exclude
the U.S. dollar. In March 2012, Brazil, Russia, India, China and South Africa
(BRICS) agreed to development banks that will allow these countries to trade
amongst themselves without using U.S. dollars.
In 2012, China also signed important trade agreements with Brunei,
Cambodia, Indonesia, Laos, Malaysia, Myanmar, Singapore, Thailand, Vietnam
and the Philippines, which are members of the ASEAN alliance. They will trade
in yuan rather than U.S. dollars.
China and India are rumoured to be circumventing Iranian trade sanctions
by trading gold for Iranian oil.
The foreign appetite for U.S. Treasuries is also waning and the Fed is
subsequently being forced to buy United States' debt. It is expected to buy
up to 90 percent of new debt created in 2013. This situation creates
restriction on available Treasuries, which will continue to push down
absolute yields. The developing world has had enough of the U.S. economic
domination that has been in force since the 1944 Bretton Woods agreement.
OPEC's backing of the U.S. dollar in 1973, which required oil to be traded
only in U.S. dollars, stopped the greenback's rapid slide that began when the
gold peg was removed two years earlier. As the developing world continues to
find ways around this petrodollar arrangement, the U.S. dollar will find
itself in serious trouble as its weak fundamentals, rather than its reserve
currency status, are used for valuation.
The Federal Reserve currently holds about 18 percent of the U.S. GDP on
its books, a number that could bulge to 28 percent a few years out depending
on the continuation of or increase in current programs, and growing distrust
in U.S. fiscal responsibility.
Increased Preference for Physical Gold over Paper Gold
Private investors are pulling out of the markets and are even showing
distrust in gold proxies such as gold shares and ETF shares in favour of the
most trusted asset--physical bullion.
By one estimate, physical demand will likely exceed ETF demand by five
times. This is almost a complete reversal from a few years ago, when ETFs
accounted for 80 percent of demand.
"Backwardation" occurred in the gold price in 2012, which means
the physical price exceeds the futures price. This indicates a stronger
interest in physical over paper gold. Backwardation is a rare event in gold,
as physical gold is one of the most liquid forms of money. Much of the
world's gold still exists and is available at the right price.
Last year, 2012, began with slow gold coin sales; however, November saw
the greatest volume in fourteen years, probably influenced heavily by Obama's
election, which guaranteed more spending and more debt.
Central Banks are Buying Gold
Perhaps the most significant consequence of runaway debt is that central
banks have been net buyers of gold for the past three years, beginning in
2009. According to GFMS, in 2012, net official sector gold purchases totalled
536 metric tons. This is up 17.4 percent on the year.
These figures do not include China's central bank buying, which in the
past occurred secretly through Chinese sovereign wealth funds that do not
require the same degree of transparency central banks do. We know that China,
as a country, bought more gold by August than the European Central Bank's
(ECB) entire 501 tonnes of holdings.
This past year saw significant central bank buying from countries like
Brazil, Iraq, Mexico, Thailand, South Korea and the Philippines, as well as
by established buyers like Turkey, China, India and Russia. In fact, central
banks bought more gold in 2012 than they have since 1964.
German Repatriation of Gold
Germany's call for repatriation of some it's gold from the United States
and France is another indication of the monetary role central bankers are
anticipating for gold in the coming years. Some gold watchers, like James
Sinclair, feel this is a game-changing event and another example of loss of
confidence in the U.S. government. When Venezuela demanded the return of its
160 tonnes of gold from the United States, it took only a few months to
acquire. Why does Germany have to wait seven years for the U.S. Fed to
deliver 300 tonnes? One obvious answer is the gold is not available at this
time.
Japan's Monetization as Forerunner to U.S. Monetization
Although the United States is monetizing its debt through the Fed's
purchase of Treasuries, Japan is even further along this road and we can
learn about the future of the U.S. economy by looking at Japan's example.
Japan, which has the worst balance sheet of any of the world's developed
nations, has survived partly because it is self-funded and is less dependent
on foreign bond purchases.
Japan's death rate now exceeds its birthrate. The population is aging and
retiring and therefore the Japanese public are becoming bond redeemers rather
than bond buyers. As well, Japan's relationship with China has soured
significantly over the Japanese government's decision to
"nationalize" the Senkaku islands, which the Chinese claim as their
own. The Japanese auto industry has suffered significantly. Japan has still
not recovered from the Fukushima Daiichi nuclear disaster caused by the 2011
tsunami. Because of these developments, Japan's central bank will buy 56
percent of the country's issued treasury bonds this year.
Complexity, Obfuscation and Scandal
This past year was also one of unprecedented complexity, obfuscation and
scandal. These are symptoms of the final days of an economic system. There
was the successful prosecution of a countrywide interest-rate rigging scandal
that affected all fifty states, known as the Municipal Bond Scandal, or more
specifically United States of America v. Carollo, Goldberg and Grimm. Then
there was an even larger interest rate scandal, one that affected the entire
world. Prosecutions in the Libor scandal, which was uncovered in July 2012,
have already begun. Last year banks paid $10.7 billion in fines for such
transgressions.
White-collar corruption has never been so apparent, yet regulators seem to
be no more interested in bringing this to the public's attention than are the
compliant media.
Despite the blatant flaunting of the law during the subprime crisis, no
major player has gone to jail or even been prosecuted. MF Global's robbery of
money from its client accounts, in broad daylight, not only went
unprosecuted, but in January 2013 a judged nixed customers' attempts to
depose MF Global's infamous CEO Jon Corzine. Mr. Corzine, of course, is the
former head of Goldman Sachs and a former senator then governor of New
Jersey. He is also a major fundraiser for President Obama. Wall Street alumni
continue to make their way into political positions as the relationship
between Wall Street and Washington becomes even more intimate. With the fox
guarding the henhouse, there is little chance of this trend changing course.
What Could Make Gold Prices Stop Going Up?
With an endless stream of "green shoots" reports coming out of
the mainstream financial media, gold continues to climb a "wall of
worry". This means that gold is still far from its exponential phase
when people start lining up for miles to buy gold as they did in 1980, and
despite temporary, healthy interruptions to its price ascent. However, many
are still asking what will cause the price of gold to stop going up.
Some mention U.S. resurgence after the much-ballyhooed shale oil fracking
program that releases natural gas from shale and is supposed to make the U.S.
energy independent. The United States did increase domestic oil production by
766,000 barrels per day during 2012, which resulted in the highest domestic
production in fifteen years. Foreign oil now supports just 41 percent of
American demand, down from 60 percent seven years ago. Fracking is a
dangerous and expensive practice that is unpopular with environmentalists and
primarily provides natural gas, which cannot be stored as oil is stored. It
will also require decades of infrastructure development. U.S. debt problems
are systemic and, as the recent fiscal cliff stalemate indicated, the country
may not have decades or even years to right its economic ship.
Negative real interest rates would have to turn positive. Yet for every
one percent of official inflation, the United States would have to add
approximately $160 billion to its federal debt as indexed pensions and other
inflation-sensitive obligations would become much more expensive, as would
borrowing to meet these costs.
Raising interest rates in this environment will be almost impossible due
to the massive amounts of global debt. In 1981 when Fed chief Paul Volcker
raised interest rates as high as 21.5 percent, with official inflation at 7.5
percent, it stopped the flow of currency into gold. This could never happen
today, as the United States owes far too much debt to make high interest
rates viable.
A deep recession in countries like India and China that are major gold
buyers could negatively impact the price of gold. However, history shows that
such harsh economic conditions in countries that believe so strongly in gold
may have the opposite effect and cause even more capital to flee to the
protection gold offers. People become even more serious about wealth
preservation in times of crisis. Little, short of discovering how to make gold
from salt water, will change the primary direction of gold, which for the
coming years is upward on its way to $10,000 an ounce and beyond.
Where is gold heading in 2013?
This year, 2013, will likely be a more positive year for gold than 2012,
if history is a reliable indicator. Over the past decade, since gold began to
regain its stature as money, U.S. election years have been lacklustre for
gold and the following year has shown a significant rise in price.
Currently, it takes very little for short-term optimism about gold to turn
bearish. This is further indication that gold has much further to rise. Each
time a hedge fund or government intervention causes a precipitous drop such
as we saw twice in December, gold sentiment becomes weaker. Mark Hulbert of
Hulbert Gold Newsletter Sentiment Index, or HGNSI, had this to say about
negative sentiment towards gold:
". . .of the last three decades has shown that, at the 95% confidence
level that statisticians often use to assess whether a pattern is most likely
genuine, gold tends to do better in the wake of low levels of bullish
sentiment (like now) than in the wake of excitement and enthusiasm".
- Mark Hulbert
This past year, 2012, showed a strong negative bias amongst most sentiment
indicators such as the Hulbert Survey and Market Vane. This is a strong
contrarian signal for the coming year.
The Gold and Debt over the next decade chart shows the projection of U.S.
debt, assuming gold will continue the same close relationship with debt as
demonstrated in the historical gold and debt chart discussed earlier.
Conclusion
Gold's price is directly proportionate to the massive amount of debt that
is being created to keep the current fiat system alive. This will likely
continue until a crisis, such as a severe global recession or hyperinflation,
strikes one of the major developed economies. Either event will be bullish
for the gold price, but for different reasons. The price is being driven by
the physical market in the developing countries, especially India and China.
China has to continue buying as much physical gold as possible if they expect
to eventually compete for world reserve currency status.
Some estimates state the Chinese hope to have at least 10,000 tonnes to
out-rank their main competitor for gold holdings--the United States.
In 2012, the world mined gold production was approximately 2,700 tonnes.
Of which India and China bought nearly 2,000 tonnes between them. Over the
past five years, emerging markets accounted for 70 percent of gold demand.
The question of who actually owns the United States' gold is debatable and
made particularly opaque by complex, highly secretive gold lease agreements.
The increased calls for gold repatriation and for audits of Fort Knox and the
U.S. Federal Reserve could shed light on this issue in the coming years.
This is the perfect time to hold gold and silver for wealth protection.
Fund redemptions, negative institutional sentiment, financial repression and
the raging currency war ensure gold will continue its climb towards $10,000
an ounce. I expect that gold will end 2013 between $1,900 and $2,000 an
ounce, and silver between $40 and $45 an ounce.
In a world where financial and geopolitical certainty is evaporating, no
one knows what Black Swan event could cause an explosion in the gold price.
Some have suggested it will be the failure of a major bank through derivative
exposure, or a Middle East war. A major downgrade of U.S. bonds might also be
the catalyst. In 2013, as has been the case since 2001, the best policy for
wealth protection remains to simply buy and hold uncompromised bullion until
we are once again on solid economic footing.
Thank you,
