September 25, 2013; Funny Money Redefines Reality…Temporarily

Weekly Commentary • Sep 27 2013
September 25, 2013; Funny Money Redefines Reality…Temporarily
David McAlvany Posted on September 27, 2013

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: Welcome back, Dave! (laughter) You’ve been an island guy, you’ve been a London guy, foggy day in London town, while it poured rain here in Colorado.

David: It was the best of times, it was the worst of times. I’m not sure much changed in the few days that I was gone. We did have a great Dickens tour through the south end of London, where Dickens spent most of his childhood, and that was fantastic.

Kevin: And I heard from your wife that that is the same area that Shakespeare overlapped, as well.

David: The original Globe Theater, that’s where it was.

Kevin: And Dave, when I asked if you guys went to the Tower of London, you said, “No, not this trip, but you went to the klink.” (laughter) I’ve already heard this, but you have to tell the listeners just what the klink is, because that’s where that word came from, when they put you in the klink.

David: Yes, it’s one of the oldest prisons in Europe, and fairly gruesome. It was run by the Bishop of Winchester, that and his 26 brothels. He was quite an entrepreneur, along with being a bishop. But it was an interesting thing, in that time frame, if someone was thrown in jail, their family took care of them. That’s the only food and water you would have received, your family coming to bring that to you. And, of course, the jailer received a commission, or a portion of that, and of course, a part of what he kept, if he kept his 10%, then 10% of 10% went to the bishop.

It was kind of an interesting world. Let me just say, I am so glad that those people who got on the Mayflower did, when they did, because actually they were a part of the group that spent time in the klink. This is the prison that has taken that word and made it universal. When it is said that you get thrown in the klink, it comes from London. It comes from the south side of London.

Kevin: And it was very creative torture for the people who were going against the establishment, let’s say, and in this case, it was the bishop. The establishment was the bishop.

I think about today, Dave. We’re in a period of time right now where the very rich are getting richer. The Bishops of Winchester are getting richer. The middle class is paying for the prison that they have been put into. I look at what is happening in the art world right now. You have the middle class barely paying their bills, yet we have these pieces of, in my opinion, questionable art, that are selling for close to 50 million dollars apiece right now.

David: (laughter) Yes, it is a sign of the times. You have the middle class struggling to pay bills. I suppose you could say they are avoiding the temptation to charge it today in the hope of paying it back, on the basis of there being a better tomorrow. Like the Robber Baron days, there is a disproportionate accumulation of wealth amongst the 1%. This isn’t a social justice rant, it’s just a recognition that in the “recovery period,” the last five years, the return to previous values in both real estate and equities, which benefited the 1%, 95% of the benefit has gone to the 1%.

Kevin: Yes, we’re seeing the bankers, and we’re seeing the big hedge funds, things like that, the money seems to be flowing there. Yet, we see more and more unemployment.

David: Let me give you an example. J.P. Morgan’s bonus structure this year will be one of its biggest ever, following last year, one of its biggest ever, and it is interesting that the fines J.P. Morgan has paid in the last five years under Dimond’s watch have totaled 28 billion dollars in fines and fees for, we won’t say malfeasance, because once you pay the fine, it’s unquestionably wiped from the slate, the slate is wiped clean, you’re given a fresh start.

Kevin: All these things are settling out of court, aren’t they Dave? They’re saying, “Yeah, we’ll go ahead and pay the fines, just shut up and get us out of court.”

David: And the reason why this is a recurrent theme is that there is no such thing as the klink today. There is no real ramification to actions. Pay a few bucks and move down the road, and you don’t have real market ramifications, so why not do the same things over and over again? Even if it puts you in a pickle in the first place, it frankly doesn’t matter. There are no consequences to actions taken.

Kevin: And you’re doing it with free money. The Federal Reserve, we saw last week, has to continue to print money and throw it into the economy. We’re not experiencing the recovery. They even said it themselves on Wednesday, Dave, that we’re not experiencing the recovery that they thought, so they have to keep printing 85 billion.

David: But the world of art is really the tip of the iceberg for the great divide between the rich and the not-so-rich, (laughter) the rich and the poor. When you look at world standards, we actually have it quite well. Being in the middle class, being even in the lower middle class, in this country, beats the socks off of being wealthy in a lot of other places in the world. Lest we forget how well we have it here, it was May 14th this year that an abstract expressionist painting by Barnett Newman sold at auction, to a private party, for 43.8 million dollars. This year we also had Jeff Koons’ sculpture, TulipsTulips is three tons of stainless steel. It actually does resemble actual tulips, if you can believe it, modern art that resembles, somewhat, what it is supposed to. That was at Christie’s auction, it sold for 33.7 million to Steve Wynn. I don’t know if it is going to be on display at one of his hotels.

Kevin: And Koons is still alive. Koons is a guy who is about five or seven years older than I am. That’s really rare to have tens of millions of dollars worth of artwork being sold while the artist is still alive.

David: Right. We also had, in May, a piece by Jean-Michel Basquiat, his work sold at Christie’s for 48.8 million, including commission. The subject matter was dust heads, you have two contorted bodies hallucinating on angel dust. Sounds like a classic, no?

Kevin: (laughter) What little I know about him, I do know that he died of a heroin overdose. He started as a graffiti artist in the lower east side of Manhattan, and died of a heroin overdose. When I look at his art, and again, I want to be careful, maybe I don’t have an eye for art, maybe it was worth 48 million, but it looked to me like drug graffiti on the side of a building.

David: These are all 20th century modern works, and this is, I think, the challenge. Not all the artists are even dead yet. They are still producing. Time will tell if they stay in the canon of collectible art. But what it underscores is a competition amongst the world’s super-wealthy, the super-rich, to prove that they can and will spend with reckless abandon.

Kevin: So it’s not necessarily that it’s true art, it could just be that, “Hey, I’m going to pay a little bit more than you did for something that’s a little bit better.”

David: It’s the story that’s told along with it. So and so owns this and such on the Upper East Side, and it’s hanging on his wall, and do you also know that he paid 23 million dollars for that condo? It is sort of bragging rights of the super-rich, but you are talking about tens of millions of dollars for art that has yet to prove itself. Jim Grant pointed out that modern art is valued in terms of modern money, and I think we can hang a question mark over both. Modern money has its own issues. Modern art may, in the future, as well. There is more and more of that modern money sloshing around. Of course, it’s in the centers of finance first and foremost, it’s amongst the super-rich, compliments, I guess, you can tip the hat to Ben, in general…

Kevin: Sure, it’s printed money.

David: To the world’s central banks, in general, this is ultra-cheap money. This is an inflation of price in the art world which goes beyond what I can wrap my mind around. It goes beyond reason, at least as I understand reason, rationality, at least as I understand rationality (laughter), and is at least challenging, if not unjustified, to say, “Really? 50 million dollars?” Understand, at the same time, we’ve got the old masters which can sell for 100 to as much as 250 million, so in perspective, modern art is still cheap, compared to some of the older masters.

But again, time has winnowed, and time has separated out the wheat from the chaff, in terms of those, and it will ultimately sort out the keepers in the art world. The modern art scene has not been sifted by time, and I would be interested to know what is of value 20, 50, or 100 years from now, and I think there is a parallel here to modern money and modern art, because I don’t think the dollar that we have today will be the dollar of 20, 50, or 100 years from now.

Kevin: Well, Dave, not just the dollar. I look at the stock market, I look at the bond market, I look at the various markets. A number of guests that we have had, Mark Faber, Jim Rickards, John Williams, these guys are basically saying, “There is no price discovery in the market. Nobody knows the real price of anything because money is not real right now.” Let’s take the stock market as an example.

David: It’s a confusion of value, to say the least, in the stock market. The old phrase, “Price is what you pay, value is what you get,” well, the NASDAQ is a picture of current confusion. You have deteriorating results in the first quarter, and they were followed by even worse numbers in the second quarter, and it doesn’t matter.

Kevin: Wall Street keeps going up.

David: It doesn’t matter, Wall Street continues to draw investor attention to the sector. You have a recent Barron’s survey in which 9 out of 10 analysts listed tech in the top 2 or 3 favorite sectors. You would assume that these analysts are looking at the numbers. And what are the numbers saying? First quarter they were terrible. Second quarter they were twice as bad as the first quarter, and the best we can come up with is rising prices in response.

Kevin: So you’re not talking about stock valuations, which continue to go up, you are talking about actual income, revenue, the stuff that companies are made of.

David: Yes, 37% of tech companies in this last quarter experienced a decline in revenue in the quarter. 51.5% of tech companies had their pre-tax profit decline. 42.9% of tech companies had net income profit decline in the quarter. So, on average, we’re talking about the sector seeing a decline in pre-tax income of 6-1/2%, net income of close to 7%. These analysts, we should start calling them enthusiasts instead of analysts, because frankly, I don’t know what they’re analyzing, because it certainly is not the numbers. The numbers say sell. The numbers say follow the leaders.

In other words, the insiders continue to sell shares, and yet, Wall Street and the media continue to raise their pom-poms, rah-rah, and herald the new future. Listen, I’m not trying to be a Luddite, here, I’m just saying the numbers don’t make sense. At some point they will. At some point it will make sense to load the boat with technology shares, but today, they are not making enough money. I guess my point is really simple here. It’s that funny money redefines reality, and it does it on a temporary basis, but it does utterly redefine reality.

Kevin: So it could be modern art, it could be a stock, it could be Amazon. You told me the other day that is 324 years from actually breaking even on the stock price, the price-earnings ratio.

David: The price-earnings ratio, at 324, you are paying for 324 years of earnings up front. You tell me if it’s worth it. Again, this takes an imagination. Clearly, when you are investing, it takes the ability to see something in the future that, hopefully, someone else does not see yet, and that gives you something of an advantage. The question is, are you that forward-thinking that you know where we’re going to be in 324 years, with Amazon as the industry leader? (laughter) I mean, come on. So, again, I think that’s the issue. This is a temporary suspension of reality. We’re in that time frame right now.

Kevin: For the person who doesn’t want to suspend reality, for the person who says, “Look, I’m not going to play that game, how incredibly frustrating is it, Dave? Right now you have no idea what to put money into.

David: It’s very frustrating because to make money you have to move with the crowd, and you have to check your concerns at the door. This is an exact parallel, frankly, to where we were 2006 and 2007. I remember when my dad and I were preparing our speeches in 2006 and we discussed the issues of derivatives, we discussed the strange and very unhealthy explosion of financial instruments. We’re talking about the CDOs, the CLOs, the CESs, the credit default swaps, and all the variations on those same things, because you had your CDO squareds, (laughter) and it was just massive proliferation of garbage paper, and we scratched our heads and thought, “You know, this is not going to end well.”

And yet, even when caution was warranted, and fundamentals were no longer supportive, and the price ceiling was being tested, and moved above, the mainstream media, Wall Street, the average investor, guess what? You made money hand-over-fist following the proverbial pied piper. And I think the mantra then was “Shut up, get invested, and make a bunch of money!” This is, again, where analysts become enthusiasts, and you’ve just got to shut up, get invested, and make a bunch of money.

The question is: Is the quality of analysis there, and if not, is the general opinion of Wall Street one that you should be following at this juncture? The hows and the wherefores back in 2006 and 2007 were utterly insignificant. They were of no consequence, and the nay-sayers were very easily slandered as being behind the times, or out of touch, or unaware of the shifts in paradigm which had already occurred. So, maybe I can repeat, “Shut up, get invested, and make a bunch of money.” This is where the frustration is. My frustration is the same today as it was then. Gold was between $500 and $700 and it seemed like new rules might apply to the financial markets. Did they? No. But in that moment there was a suspension of reality, as market valuations simply didn’t matter. The real numbers didn’t matter. The risk has been taken out of the picture by financial engineering.

That was the story then, it must be the story now, because we see the same thing re-emerging in terms of leverage, the derivatives market continuing to expand, etc. And it’s the skeptics who are losing out, because the rewards seem to be a no-brainer. You put money in the market, you make money. If you’re not in the market, you’re not going to make money. You have to always be in the market. This is what you hear all the time.

Kevin: Yes, but it’s interesting, Dave, you and I have been through an awful lot, but if I just go back to the year 1999 -2000, and then we go to 2006-2007, the early part of 2007, these people are doing this, and it makes no sense, yet when the crash comes, and when they hand it all back, and then some…

David: And then some…

Kevin: And then some, because of the margin, you hear in the news, “Well, who could have seen that coming? That was a black swan, that’s something that couldn’t have happened. And so, if we’re setting ourselves up for this again, for the person who is frustrated and finally gives in, weakens in the knees and says, “You know what? I’ve had it. I can’t sit in gold any longer, I can’t sit in cash any longer. Those don’t make sense any more, I’m going to go into the stock market, don’t tell me about the black swan next year,” I’m sorry, it wasn’t a black swan, they’re all over the place.

David: No. Back to technology for just a second, because the U.S. Commerce Department notes that technology investment over the 10-year period ending 2011, and frankly, it hasn’t changed much since, was the weakest, in terms of capital spending, since World War II. So you don’t exactly have tailwinds in the technology space.

And again, little has changed since 2011. The reality is simple. One, we have a weak global economy, and two, we have weak capital spending, and the fundamentals, which argue for caution are there. The fundamentals are there that say you should be very cautious here, and yet, the NASDAQ motors higher on a wave of analyst enthusiasm.

Kevin: Which is the technology market. NASDAQ really shows us what technology is doing. Our view, you have cheap money that has to be put to use somewhere. Valuations and future projections are brought out, and frankly, they get polished up. For instance, there are a number of companies now, that when they are doing their sort of road shows, they use non-GAAP accounting versus GAAP accounting, that is, Generally Accepted Accounting Principles, so that they can sell the story better. And magically, the crowd moves on it.

Kevin: Well, they want to hear it. They want to hear that, Dave. In fact, speaking of wanting to hear, nobody really understands what they want to hear with the Fed anymore, because if they taper, maybe that says things are getting better. If they don’t taper, maybe it says things are getting worse. But they’re not tapering, they’re giving us free money. We were in a meeting last week, a number of us here at the office, and we broke the meeting so that we could watch Ben Bernanke’s speech. The thought was that there would be at least a condolence taper.

David: Something, yes, taken off the table.

Kevin: A little bit. But when he said there would be no taper, of course, we saw the stock market’s first reaction. “Yay!” And it went up. Gold, of course, rallied at that point, and it has come back down since then, but people, I think, are getting to the point where they say, “Tell us bad news so that we can get good news.”

David: Right, because the non-taper, this is the big news right now. Of course, that could change tomorrow, it could change next week, next month. But the reality remains that the economy cannot do without the extraordinary accommodation from the Fed, both via interest rates, and that is, setting interest rates at a very low level, and asset purchases, that is, the 40 and 45 billion dollars in asset purchases in both the mortgage market, and in the treasury market. We have the weakest economic recovery in modern history, and somehow people have convinced themselves that there will be no impact on the stock market or the economy, as, and when, there is taper.

This is the issue: Can we afford to taper it? I hope that we do. Our view is that if we want a strong dollar, then tightening, and taking the painful consequences of those actions is highly recommended. But this is where we live. We live with a Fed chief who has in mind the nightmare scenario of 1937. The Fed tightened too soon, the rest is history, we had a second installment in the Great Depression, and it is considered an unnecessary installment if you were just to do things differently.

Now, it may seem counterintuitive that we would like to see taper, but if you consider the nature of us as red-blooded Americans, we would like to see the U.S. dollar strengthened, we would like to see our place on the world stage improve, not decrease and decline. The politics of the last three weeks have been absolutely insane. To watch Putin run circles around “the guy” who was supposed to be our leader in Washington, and the leader of the free world, is a joke.

Kevin: Dave, did you see the cover of The Economist magazine this week? It has a lion on the front, and it says, “The West.” It talks about how the West has been de-toothed. The teeth for the lion are sitting in a jar right in front of him, and it is basically saying that we have lost the power to influence the world at this point.

David: And at least in this round, it’s Putin who has the jar.

Kevin: The thing is, it does seem like we’re running out of options. We’re running out of options politically, we’re running out of options strategically. I mean, let’s face it, the Russians were not going to let us take away their warm water port over in Syria by intervening in the wrong direction. Obviously, Obama didn’t study that early enough.

I look at interest rates, Dave. We’ve talked about the artificially low interest rates, yet we have connections with bankers, and one banker, in particular, said, “The regulators are running us through scenarios as to what would happen to the bank if interest rates rose 100 basis points? What would happen if they rose 200 basis points? Even 400 basis points? They are starting to be concerned about what would happen. We have quantitative easing on the monetary side, and then we have the interest rate side, if this fix breaks and interest rates rise quickly. Dave, what would happen? We seem to be out of options if that does happen.

David: There are two stories here, because the commercial story, or the corporate story, is actually a pretty positive one. And this is where corporate executives and CFOs across the country have gone ahead and fixed their balance sheets, they’ve polished up their balance sheets nicely. They’ve taken debt that they owed and had to repay in 2 years, 3 years, and 5 years, and they’ve refinanced it.

Kevin: They got burnt and they “learnt.”

David: They did. They got burned in 2008, having to roll commercial paper on 30, 60, and 90-day bases, and they figured they wanted to buy as much time, and as cheaply as they possibly could, and since the Fed has been serving up artificially low rates, they figured why not take advantage of something that is unnatural, and improve their balance sheet stability considerably in the years ahead?

So you have corporate America that has refinanced their debt on longer and longer terms, at record low rates. The U.S. government has done quite the opposite. It has continued to increase its debt, but it has done it, primarily, on the short end of the curve. In other words, we have to refinance most of our debt in a 2-5 year time frame, as opposed to corporate America, which is 15 years and beyond.

Kevin: So Dave, that’s the positive on the commercial banking side, at least for the guys who saw what was coming and fixed it while they could. But what about the bond market? I’m talking about the government, the treasury bond market. What happens if we have a 100, 200, 400-basis point rise in interest rates?

David: It’s game over, anything above 200 basis points. We can probably afford another 100 basis points, but anything north of 200 basis points, that’s two full percentage points higher, and the total stock of debt that we have, the interest payments that we have to pay on that would take our budget and completely blow it to smithereens. So that’s a real challenge. We have this continuation on the same path. We continue to see the Fed expand their balance sheets. We continue to see the U.S. Treasury increasing the national debt exponentially, and this brings us back to the notion, “Are we going to see a stronger dollar?” Probably not. “Are we likely to see a weaker dollar?” Probably, when you look at what the Treasury is doing, when you look at what the Fed is doing, and continues to do.

And by the way, this is in stark contrast to the ECB. The ECB, the European Central Bank, topped out their balance sheet at over 3 trillion euros, and it is now edging closer to 2 trillion euros. They have actually done a considerable job in de-leveraging and moving forward, I think, on a healthier basis. We have yet to do that. That is not to say that Europe doesn’t have its challenges, and clearly, with the Merkel re-election, there are a number of things that have to be addressed.

I had an interesting conversation on the subway in London this last week, with a lady who is 50% of Greek heritage, and 50% of German heritage, and she said, “I’m obviously torn. I have family who live in Athens, and they have done very well over the last 5-10 years, as Greece came in and their debts were re-valued with lower rates, and real estate took off, just as it had in Portugal and Spain, when rates were revised and there was a whole new lease on life in the mortgage market and the housing market in those countries, as well.

The standard of living has improved for my family in Greece, but they don’t have any future guarantees. Retirement is subject to a series of questions. Will they get any at all? The bird in the hand is that they have beautiful homes.” She said, “Contrast that with my family in Germany. The still can’t afford beautiful homes. They’ve never had an increase in pay over the last 10-15 years. It’s been culturally unacceptable to go into debt, so they still live in a hovel of a home. But guess what they do have as a guarantee? Future income.”

Kevin: Yes.

David: So you have social stability on the one hand, without much to show for it in terms of an improvement in standard of living, versus the improvement in standard of living, off the charts, and yet, future instability and uncertainty. And this is the tear between the north and the south, if you will, or the core versus the periphery, if you will, and that will continue.

Meanwhile, the ECB has done a lot to improve their ability to deal with the next round of crisis. If there is a next round of crisis, Europe is in a reasonable position to deal with it, from a balance sheet perspective. We are not. We edge closer and closer to 4 trillion, that is, the Fed balance sheet, getting to 5 trillion.

I mean, what is the trigger point for panic on the part of international creditors, looking at the U.S. dollar and the U.S. treasury market and saying, “Thank you, no more?” Is it the Fed balance sheet hitting a tipping point of 5 trillion? Is it getting to a debt ceiling debacle which cannot be recovered from? We can do more damage, self-inflicted damage, here in the next several weeks in the U.S., given the position we have put ourselves in.

I would hope we would do the hard thing at this point: Taper like there is no tomorrow. Walk away from it. Deal with higher rates, and the consequences of them. Deal with higher unemployment. Deal with a cratering in values in real estate, and begin the process of repair, long-term repair of the economy.

What are we opting for? We’re opting for a politically palatable solution. The politics of voter pain and market panic have to be recognized here, and the fact that we still have a mid-term election in front of us. Again, the politics of voter pain and market panic have to be factored in. That, along with the passing of the baton from Ben Bernanke to whomever will be his successor, we need to see a slow transition, a healthy transition, and that will include little to no change in the rules until these things are gotten past.

Kevin: David, we can wish that the Federal Reserve and our government will take the right steps, as painful as they are. The likelihood is, that is not going to be the case anytime soon. That’s what last Wednesday proved when Bernanke continued to throw 85 billion into the market. But buying the recovery story, that’s a hard one to buy when even the Federal Reserve says, “We can’t stop tapering, because it’s recovering, but it’s not recovering quite fast enough.” I mean, is there a recovery or not?

David: You have the mass media, and you have the general public, who have come to believe that QE may not be necessary at this point, because they are buying the recovery story, and it has proven ineffective toward jobs creation. It has allowed banks to re-leverage. You have the top 25 banks and holding companies today that carry 296 trillion dollars of derivative exposure. The kind of leverage that they have on their balance sheets is not exactly healthy. Capital ratios have improved. There has been some improvement to their balance sheet. A lot of that has had to do with them playing the market spread, so to say. Compliments of Alan Newman, those numbers on derivatives, 296 trillion dollars, that’s 17.6 times our economy, 17.6 times our gross domestic product. For comparison, the numbers were first recorded in 1991 on derivative exposure, and they were, at that point, equal to 1.2 times GDP.

Kevin: And now its 17.6.

David: 17.6

Kevin: Wow.

David: So GDP has grown since then, but derivatives and systemic risk have grown even more, on an exponential basis.

Kevin: Okay, so recovery or not, let me ask you about the dollar, because what our dollar buys, I still go to the grocery store…

David: One qualification, because here on the issue of job recovery, and when I say, ineffective toward job creation, that’s a contentious issue, because we’ve come from north of 10% down to 7.3%, and the proof is in the pudding. You could say, take that number to the bank, there’s been an improvement in the employment picture. The problem is, the unemployment rate is closer to 11.2, not 7.3.

Kevin: John Williams pointed that out a couple of weeks ago. We’re not looking at the right numbers.

David: Right. But if you just wanted to factor in one thing, if you don’t remove the people from the work force, that is, labor participation, which has been in decline, that positively skews the unemployment number. If you throw those people back into the mix, you’re looking at 11.2%. And that’s far closer to reality.

What am I saying there? Again, you’ve had the total labor force, which has shrunk, and the number of people employed, these are the two numbers that are divided, the total labor force and the number of people employed. We haven’t had that many re-employed.

What we have had is the total labor force shrink. If you add back the people who have just simply walked out of the labor force, and keep the number of jobs that we have today, we have 11.2% unemployed. So the improvement in that number has nothing to do with new jobs created. That’s why I’m saying it’s ineffective. QE has been ineffective toward job creation. That’s not to say the statistic hasn’t improved. But the statistic, as we’ve explored with a number of our guests in recent weeks, is balderdash. It’s unmitigated balderdash.

Kevin: That just points out the impossibility of the Fed having the dual mandate. Bernanke talked about unemployment, and he talked about monetary creation, both in the same speech, because that’s what they do, that’s what the dual mandate is. And we’ve talked before about how that mandate, they don’t work with each other.

This takes me to my question on the U.S. dollar. If they keep printing a trillion dollars a year, and continue to put that into the economy, what does that do to the dollar? Give me some short-term thinking on the dollar, and then some longer-term thinking on the dollar.

David: Technically, the dollar is vulnerable. It is well supported in this area, right around 80, 80-1/2. Arguably, it’s a place for a bit of a rally, but bear in mind, a move below 79, if you are looking at the U.S. dollar index, would signal a new lease on life for the gold market in dollar terms, and it would also signal a structural breakdown in the U.S. dollar. I think if you are expecting a fight, this is a reasonable place to put up a fight, in terms of support of the dollar. Technically, it’s on the verge of a significant breakdown. The U.S. dollar has moved from being 70-1/2% of global currency reserves, going back to the year 2000, we were 70-1/2% of total currency reserves, now we’re 63.1% at the end of 2012.

Kevin: So, we’re seeing the decrease that we’ve been talking about. The world is moving away from the dollar, whether we like it or not.

David: So the question remains, what would speed the process of currency diversification, reducing demand for dollars, bringing the existing stocks out of the woodwork, back into the marketplace? That’s always the dual issue. As with treasuries, as well, new ones need a home, but we hope the old ones stay put, and are not disgorged.

Kevin: Dave, there’s a frustration that is coming out, I can hear it in my clients’ voices, we’ve talked about it before, the price discovery in the stock market, bond market, but the gold market as well. We’ve talked about the stocks of gold being decreased, the physical gold, being decreased dramatically this year, yet we still see the gold market floundering, at least on paper. Even Jim Rogers has said, “You know, gold may go down below $1000 before it goes back up to $1900.

David: (laughter) I read those comments, as well, and he is definitely a commodities enthusiast. I have a lot of respect for him, I think anyone who wants a healthy view of economics, not in the econometric modeling version, but sort of street level analysis, should read his book, The Investment BikerThe Investment Biker is his world tour, as in, on the back of a motorcycle, going around the circumference of the globe, and seeing firsthand, various issues, currency devaluations, price fixing, various things that different governments around the world will do, at various times of crisis or non-crisis, and what the consequences are. Does it help develop financial markets and capital markets? Does it impair the development of financial and capital markets? Listen, I like Jim, he’s been on our program before.

Kevin: You met him at a meeting just a couple of months ago, with him on the same stage.

David: Again, projecting gold below $1000, I suppose anything is possible, but you should also consider his other recent advice on moving to Angola so that you can live like a king.

Kevin: (laughter) That doesn’t sound safe to me.

David: Well, and his wife had a very reasonable response, reminding him that he was free to be a king, and she would keep her queenness someplace else.

Kevin: He could fly solo, yes.

David: Exactly, exactly. Ethiopia was also on his list of places that would be interesting, both as an investment, and a place to live like a king. Listen, gold below $1000, take that with a grain of salt, along with a healthy dose of property rights in either of those places, human rights, or general political stability. Yeah, you won’t find me in any of those camps. I hear land in south Sudan is also reasonably priced right now. (laughter)

Kevin: (laughter)

David: This last week I spent some time with my dad, and my boys never tire of his stories from Angola, flying in under the Russian radar to meet with the head of Unita, Jonas Savimbi, of the giant black mamba crossing the road, stretching from head to tail, all completely across the road, and seeing hardened by battle men of incredible courage and tenacity shake in their boots as they watched this snake, one of the most deadly snakes in the world, cross in front of them. Stinger missiles provided by the U.S. government to help fight against the Russian Hind D helicopter gunships, the battles that were raging in the 1980s in that region. (laughter) We just had a rehash of all of these stories, because my boys always ask the black mamba story.

So, I wonder if Jim was just reading a recent travel brochure, because honestly, Angola, although there has been some change since the 1980s, is still a very unsafe place. Africa, I think, holds tremendous opportunity, but it is certainly set next to tremendous risk.

I think gold, on the other hand, is simply cash. I think this is what many people miss, that you can make a case for gold going lower. The flip side of that, if you go back to our interview and discussion with Charles Volin, who updates the website on a regular basis,, his argument is, and I think it’s a good one, that gold is cash, and gold is money, so if you see the price of gold going lower, what you are really looking at is the differential between that currency and another currency. So, if gold is going under $1000, you have to make the case for the dollar going up by 20-25%. So, show me a very watertight case for the dollar improving by 25%.

Kevin: So, what you are saying is, that would be a loaf of bread going from $4 a loaf, back down to $3. We haven’t seen that in our lifetimes, Dave.

David: No, and this is, I think, the challenge. It’s one thing to argue the negative side of the story on gold, it’s the other, and it’s a very challenging one, to argue the positive side on the U.S. dollar. It flies in the face of our only solution, in terms of the exponential growth in debt. We are not defaulting on our debt, except via inflation. It is to our continued advantage to devalue our currency. Even if it’s a small percentage each year, this is the only way out for us.

I’m not saying that it is an ethical or moral way out. I am saying it is the pragmatic path already chosen, and it is one that we’ve seen, for not only the last 10 years, but the last 30 years. We’ve seen a slow, and at certain points, a rapid, but over a long period of time, a slow degradation of the U.S. dollar. And I think getting below that 80 range, getting below that 79 range, you could begin to see a precipitous decline, down to as low as 52 on the dollar index. That defines the end of a bull market in gold. It defines the end of a bear market in the dollar, and I think you could see a major dollar move higher, once we’ve seen a major depreciation.

The question is, can the folks who are orchestrating that decline make it a gradual and orchestrated slow pace, or will it ultimately get out of their control? Will it ultimately become something that they can’t control, on the basis of capital flight? We expect that we will see some degree of capital flight. We’ve already seen, in recent months, the treasury flows, the TIC reports, which would indicate that foreigners are wanting out of U.S. treasuries, and I think we’ve already passed that tipping point.

Kevin: You talk about gold being cash, and that’s exactly right. You can go back thousands of years, and gold does maintain a buying power, 350 loaves of bread per ounce, what have you. But David, it is interesting, if you step away from the chart right now, and just step back, a lot of times we look at the chart and we say, “Oh my gosh, what’s it doing today, this week, this month, this year?”

But if you just step back away from the painting, we started this commentary with paintings and art, it’s like the Mona Lisa, if your nose is up against it, it is just a smear of colors, and you really can’t tell what it is. But when you are there in the Louvre, and you move back, you see the masterpiece for what it really is.

Step away from the gold chart. Let’s take the last 10 or 12 years. We’re quadruple, Dave, what we were at the beginning of that chart. So, what we’re really looking at here is gold doing exactly what it was supposed to do. The dollar has lost its buying power, gold has increased in value, relative to the dollar, and will increase in the future, based on the fact that they are printing this much money.

David: I think it’s quite simple, and as you’ve said, you step back away, and you see it for what it is. Having just taken a few days off, and coming back into the office now, I’m going to have to re-emerge and re-engage a stressful environment. I’ve had a great opportunity to relax with family, and unwind, and it’s interesting.

I look at the gold market today with a lot less concern than I did just a few days ago, mainly because my stress levels are lower, and I realize that I bring a lot to the equation. I bring a lot in terms of my perspective. Why would I be more or less relaxed? Because it’s doing what it’s supposed to do, it’s not just doing it on my time frame. So I realize that the stress and strain has a lot to do with my preconceived expectations, and notions of what it’s supposed to deliver, and when I need it to be delivered.

And when I take away those expectations, as you say, just step back and look at the ten-year gold chart, it’s okay, it’s done a great job. And I can’t make the case for a radically higher dollar. I can make the case for a technical bounce higher. Absolutely, I can make the case for a technical bounce higher. How much higher? 5%? 10%? Can I make the case for the dollar moving higher by 20-30%? No. And that’s what would need to occur for gold to be taken under $1000.

The last time we were under $1000, keep in mind where the dollar was. Keep in mind where the stock market was. I think we’ve done quite well. That era of 2006-2007 where we were $500 on the ounce, $700 on the ounce, we’re 2-3 times that number now.

Kevin: Dave, I think you hit it exactly right, as far as the stress on any market, but especially the gold market, because gold is gold. No matter, anytime in history, if you would go in a time machine, you’re not going to go with dollars, you’re not going to go with euros, you’re going to go with gold if you have to buy something, if it’s a random drop somewhere in history. Well, we’ve got our random drop right now. If we just remove the false expectations of our own timing, and what we think should happen, it’s going to do very well on its own, thank you very much.

David: There are times that you just simply want cash, unencumbered, unhypothecated, unleased, un-anything. Simply cash. And gold is simply cash.


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