September 7, 2011; European Crises: Treating a Mountain Like a Molehill

Weekly Commentary • Sep 09 2011
September 7, 2011; European Crises: Treating a Mountain Like a Molehill
David McAlvany Posted on September 9, 2011

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin:  David, again, you are coming from a CNBC interview, and the question, as simple as it sounds, they continue to prod you, and say, “David, how high gold?  How high gold?”  You seem to shift things the other direction and look at currencies whenever that question is asked.  I wonder how many people understand that.

David:  Kevin, the primary question that was being asked was, if the Swiss franc is no longer an option as a safe haven, because of the recent devaluation of the currency, overnight devaluation and commitment to a euro peg at 1.2 or less …

Kevin:  What that means is they actually locked the currency; every time the euro drops or rises, the Swiss franc does exactly the same thing, just at 1.2 …

David:  That would be the maximum price that they would allow on the upside, and of course, they would accept a much lower price, as well.  But that was the question.  If the Swiss franc is no longer an option as a safe haven, where do we go?  I said, “Listen, there are really two issues in play.  First of all, there is the question of liquidity.  If that is what is paramount, to an investor, if that is the primary issue, liquidity-driven prices, then you have people go to Treasuries – 2, 5, 10-year Treasuries, or very short-dated, into the 30, 60, 90-day paper markets, or, and we have seen this in 2008, as well as presently, people buy German bonds – short-term denominated German bonds.  The reason why they go there is because there is depth in the market.  What I mean by that is, you can have many, many investors come in with trillions of dollars and see very little impact, in terms of the bid and ask spread, on those assets.   They are very deep, they can accommodate a huge influx of capital, without being pressured higher or lower in terms of price, so that depth of market is very critical for the liquidity concern.

Kevin:  So, if it is a liquidity concern, that is one thing.  The second concern would be what?

David:  A solvency concern, and this is in stark contrast to 2008 where, certainly, you had institutions which were facing solvency issues, as a result of not having liquidity lines…

Kevin:  But no governments.

David:  Exactly.  What we saw happen was, government stepped in and used their balance sheets to solve the crisis and take away the solvency issue as a systemic issue.  What we have now is central bank balance sheets, which have already taken it on the chin, and are worse for the wear after three years.  Now, the question is, liquidity concerns or solvency concerns?  Where will capital flow if it is concerned over one issue versus the other?

Kevin:  Let me ask you the question that CNBC asked.  Isn’t $1900 too much to pay for gold?

David:  My response was this:  It has more to do with the direction of currencies than it does supply and demand for the metal.  Certainly, supply and demand for the metal will take the price of gold higher or lower on a given day, and I think that trajectory is probably another $1000 to $1500 dollars higher.  Yes, on a short-term, 2-3 year basis, I see the price of gold moving higher.

Kevin:  That’s just supply and demand, that has nothing to do with currencies.

David:  Exactly, but why did gold, in Swiss franc terms, see a significant jump in price Tuesday of this week?

Kevin:  Clearly, it is the devaluation of the currency, Dave.  That’s what happens.  Gold is a constant, the currency is not.

David:  Exactly, so a one-day drop down between 8% and 10% on the Swiss franc, and the price of gold moves higher.  Was that on the basis of more people coming into the gold market?  No, it was just reflecting a devalued currency.  The question is, what is in the mind of the Swiss national bankers, moving forward?  What is in the mind of the ECB, moving forward?  What is in the mind of the Fed, moving forward?  If you can tell me what a Bernanke, or a Tramonte, or anyone else who is in this world of financial creativity is going to do with their currency, then I can tell you what the price of gold might be.

Kevin:  We know what is in their minds, because Bernanke has already written about, the European Central Bank has already had to do it even though they said they didn’t do it, and Germany is going to be voting on that, we are going to have to talk about that, too.  So we know they are going to print money.  That’s what they do.  The problem is, even if it is in their minds to print money, how much control are they going to have when the inflation actually starts to hit?

David:  That’s where the market does dictate how much appetite there is for paper money at a given point in time.  What I thought was really interesting, Kevin, with the devaluation of the Swiss franc, and the change in policy – they used to say they weren’t going to increase M3 money supply by more than 3% a year, and they have been perceived as a hard currency.  Why?  Because it has been over a decade since they walked away from having a huge gold backing for their currency.  They have essentially lived off the legacy of the 1970s, in which they were primarily gold-backed.

Kevin:  If you asked a person today if the Swiss franc is gold-backed, a lot of people still think it is.

David:  And so they have adopted monetary policies which imply stability, which imply discipline – the kinds of stability and discipline that would have been implicit to gold backing for that currency, in an earlier generation.  The gold backing is gone, but they have maintained some of the disciplines.  The disciplines, as of this week, are gone.  And so, investors ask the question:  “Where do I go?  If I don’t like dollars, if I don’t like German-denominated euro bonds, where do I go?”

Kevin:  All this currency devaluation that is going on is what we have called competitive currency devaluation.  The Swiss obviously had to devalue because they no longer were competitive in the marketplace.  It was costing so much more to buy Swiss products because the euro had devalued, the dollar has devalued, so what do you do as a government when your currency is too valuable?

David:  And you saw the market respond as it should, to the currency devaluation.  You saw a nearly 5% jump in the increase of the Swiss stock market.  These are companies that have seen their exports become very, very inaccessible to their European markets.  As the Swiss franc has been rising, things like chocolate bars, and watches – of course they make a lot more in Switzerland than just those things, but it is more and more expensive.

Kevin:  It reminds me, what is going on right now with these devaluations is like putting a Band-Aid on something that really, they are trying to hide, because in reality, there is a gross error that is occurring in Europe right now.  These guys are looking for this recovery, and they are thinking, “If we just do this temporarily, we are going to get back to that growth that we have had.”  But the error seems to be that that growth was fueled by the debt they can’t pay right now.  Isn’t that correct?

David:  Yes, every scenario aimed at resolving the crisis in Europe, has assumed a strong economic recovery.  That was a part of an increase in revenues, an increase in the growth dynamic.  So, yes, they would cut back a little bit in spending here, and adjust this and that variable, but an underlying assumption for every one of their scenarios has been a robust economic recovery.

Kevin:  Which, in the past, has been fueled by debt.

David:  Yes.  This is the built-in frailty to the plans attempted thus far, or the ones that are waiting in the wings for implementation.  Repeated bailout attempts in Greece.  This has illustrated a degree of misunderstanding on the part of central planners.  They are still, as you suggested, Kevin, crediting themselves with record growth.  The growth that we have seen in the last few decades?  They are not seeing the critical role that expanding credit over the same period of time played in those growth dynamics.  In the context of credit contraction, their efforts are frustrated, and they are moving from one stop-gap measure to the next, applying the same “brilliance” they did before.

Kevin, there are so many versions of conceit that are ultimately debilitating, this one proves fatal for Europe, to some degree, and certainly for investors, if they are not paying attention to it.  The credit cycle has changed.

Kevin:  An issue with this credit cycle changing, they continue to try to throw money at this, but they are also saying, “Austerity.”  They are saying, “We are going to tighten things up.  We are going to be able to pay our bills.”  Some of the issues going on in Europe right now are on the austerity side.  The Italian protests, what we have seen in Greece.  I mean, there is violence that is also coming up from below.

David:  Kevin, the euro issues to date, I think, are a precursor to crisis.  Not to minimize the severity of either the financial or the social dislocations we have seen thus far, but the combination of austerity-driven political discontent, what you described in Italy, and the monetary policy price destabilizations we are seeing.  These will become more acute in the future than even what we see in the present tense.

Kevin:  David, to what degree do these things really threaten the euro project?

David:  I think we are dealing with nothing short of an existential threat to the euro project, and I’m not talking about the existential philosophical movement where we are all of a sudden going to see everyone across Europe chain-smoking cigarettes and drinking espresso, considering their navels about how dark and noir the whole world is around them.

Kevin:  This is a little more serious.

David:  Existential, as in game over, no more, and the ECB will orchestrate all that it can via monetary policy.  This is the key thing to recognize.  They need to stimulate growth.  They need to jump-start the financial markets, and they are having to consider this because of the negative feedback they are getting on the austerity measures already suggested. So I expect to see more financial sector mergers, and this is very similar to what we saw in the United States in the heart of the U.S. sub-prime crisis a few years ago.  Politicians in Europe are treating this like it is a cross-border skirmish, and not as an all-out war.  They are under-estimating the gravity of the circumstance.

Kevin:  David, it reminds me, when you say that, of those old westerns, that stereotypical scene where you had a few cowboys fighting a few Indians and it looks like one side is winning, and then all of a sudden, from horizon to horizon, up on the hilltop (laughter) are 10,000 Indians ready to go.  I think the politicians right now think like you are saying.  They are fighting a skirmish, you hear this day-to-day type of thing.  You even hear it here in the United States, this assumption that, “Hey if we just fix it a little bit now, we’ll bend the rules just a little bit now, we’re going to win this war, and we are going to be back to the way it felt five years ago.”

David:  And there is a very shallow appreciation, in that analysis, for how grave the threat is to the European Union, as it exists today.  Not that it won’t exist in some form tomorrow, but I think the markets are going to get this.  They are going to realize this first, before the politicians do.  Again, that sort of echoes that theme of conceit.

No politician, no bureaucratic henchman that has already written their heroic obituary, or see themselves etched forever in the history books, wants to be undone at this point.  They are committed to a memory of their former greatness.  They are committed to a project that was visional in the beginning, and now is a nightmare, but they are not seeing it as a nightmare.  They are still committed to that old idea.

Kevin:  Even the ones who see what is actually happening – some probably saw this coming from the beginning.  I have to think back to the interview with Otmar Issing.  He knew that there were problems in the surrounding countries, in the extremities.  But he also probably knew that there would be a consolidation at some point, a pulling in of power, and possibly getting rid of the extremities.

David:  Right.  When we describe an existential threat, what we are talking about is an end of the EU project, as we know it, which is really just to say a consolidation – that ultimately we will see a consolidation amongst a few key players.  It is a little bit like the human body on a cold day.  There is centralized blood flow to the core to keep the vital organs functioning, and yes, it is at the expense of ever-colder fingers or toes, but the periphery is expendable, while keeping the vital organs alive and healthy, regardless of the pain involved, is critical.  There is a key differentiation there.

Kevin:  Sure.  The body knows to save the brain, the heart, the liver, the lungs.  Those are the things you save, even if you lose an arm.  I hate to say that Portugal is an arm, or Italy is an arm, or Spain is an arm.

David:  But Estonia is like a toe, I mean it is one toe that you can probably do without.  (laughter)

Kevin:  Dave, what comes from Estonia?  (laughter)

David:  Oh, the export market from Estonia?  You weren’t aware?

Kevin:  Getting serious here for a second, because people are trying to figure out, in the short term, what is going to happen.  What can Europe do right now to placate people?  Is there something they can do?

David:  Via the ECB, Europe can lower rates to close the gap between dollar debt rates.  We are practicing the zero interest rate policy.  They may, in fact, do something very similar, and close the gap between dollar debt rates and euro-denominated debt.  But here is the issue:  In doing that, they will have to neglect the Taylor rule.  We have talked about this on the program before.  The Taylor rule suggests where rates should be in light of inflation.

Kevin:  Just as an aside, I have had several calls resulting from the DVD, where the triangle is being presented and there is a blackboard, and underneath is this complicated little formula.  That’s the Taylor rule.

David:  It’s a shorthand version of the Taylor rule.

Kevin:  Which says what?

David:  Essentially the Taylor rule tells you where rates should be in light of the prevailing inflation.

Kevin:  To have a positive rate of return.

David:  Exactly.  According to the Taylor rule, U.S. rates are currently 2½ to 3 percent under the mark, so taking into account current day inflation, we should see interest rates a good 250-300 basis points higher, according to Taylor rules, the feedback you get from that.  In reality, it is U.S. rates that need to come up, not euro rates that need to come down.

Kevin:  Isn’t that a strange adjustment?  In other words, they are adjusting to us, Switzerland is adjusting to Europe.  It’s like the dominos are falling.

David:  Right, but all monetary authorities are reluctant to raise rates; quite the opposite, they are encouraged to lower rate structures so as to support growth and subsidize their respective economies via suppression of those borrowing costs.   They are trying to stimulate a flailing, or stumbling-about, economy, and the EU now has the freedom to do that.  Inflation expectations have ebbed here in the last few weeks, and concerns about a double dip have re-emerged, so the ECB has the political cover to now lower rates again.

Kevin:  And David, there is also the whole element of the voting populace.  Let’s face it.  If you are a voter, and a little bit of inflation is going to help you in the short run, they are going to give it you versus getting voted out.

David:  The longer austerity measures are entertained or implemented, the greater the political pressure will be brought against central banks to eliminate those austerity  measures and substitute some form of monetary policy measures, whether it is lowering interest rates, or putting together some sort of a spending initiative.  Nobody every says where the money is going to come from for a spending initiative.  We have that announced coming up this week, Thursday.  Obama is going to tell us how he is going to solve the economy by new shovel-ready jobs.  This didn’t work two years ago.  We still have unemployment issues.  In fact, they are worse than they were.  But don’t worry about the details …

Kevin:  But he gives a darned good speech.  As long as the teleprompter is working, he gives a darned good speech.

David:  The question is, how much shock can he bring to the listening audience?  Is it a trillion?  Is it 2 trillion?  Is it 3 trillion?  Is it 10 trillion?  I am being facetious, but he has to throw out a number that communicates to the market that we are basically going back to the 1930s-style jobs programs, the work programs, where we are building dams, we are putting in new roads, we are doing all of these things, and a certainly scrubbed version of history says that that aided in our recovery in the 1930s.  I say scrubbed because it had nothing to do with our recovery.  It certainly us from having mischief on the streets, but that is crowd control, that is not job growth.  That is not a return to a health economy.

Kevin:  But we have been taught that.  Germany has been taught some very tough lessons over the last century.  One of the things that has come down the pike here on this European situation is that Germany really does play a key role at this point, do they not, in the votes that they take in their court?

David:  Our belief is that the euro project will, in fact, be considerably stronger over the coming years, as the region shrugs off the weak participants and consolidates around a relatively healthy core.  The currency volatility alongside the political volatility will be entertaining, if not a little bit unnerving, but through this process, I think we will find a robust set of participants deeply committed to a common European vision, and with the ability to fund themselves, not via subsidies from other countries, but from within, from their own global trade.  This is an effort that is deeply supported by the powerful elite within Europe, and the moneyed interests from Asia and the Middle East.  What we are watching is the U.S. currency monopoly being broken, it is no longer tolerable, and keeping a second player alive is vital to these other global interests.  While they may say gold as a part of our reserve assets is important, they are not going to raise gold to a similar position, as they would, for example, yen, or euros, or what have you.  It may play some small bit part in the future, but this is the point.  You have the moneyed and powered interests throughout Asia and the Middle East, who want to break that dollar monopoly.

Kevin:  They don’t want it just to be the dollar any more.

David:  So, if it costs them something to maintain the Euro Project and support the Euro Project, that cost is an acceptable cost.  It is an acceptable loss, because they are facing a similar sort of loss on their dollar holdings as it is.  Better to get a “healthier system.”  That is not necessarily to the betterment of the U.S. system or the U.S. dollar, but for the rest of the world, that certainly is the view.

Kevin:  For the last few years, we have talked about China sitting on an awful lot of dollars, but China, actually, has been sending quite a bit of money into this European problem, and it seems like that probably is a very good investment for them to use their excess liquidity for right now. We have also talked about, and in fact, all through history, crisis is actually a way of propelling what the elite would like to have happen forward.

I am thinking of 2008, David.  We saw a tremendous crisis.  We saw a lot of things that a lot of people didn’t expect, even though, I hate to say it, it was pretty plain that it was coming, but we are seeing consolidations.  The bankers’ bonuses never really went down.  A lot of money has been printed since then.  We have had thousands of pages of regulations that really don’t change anything printed.  We are edging closer to a 2008 crisis right now, are we not, in Europe, and worldwide?

David:  We are, and I think the focus is a combination of liquidity and solvency concerns.  Liquidity is the easier one to solve.  There are some easy places to go, as we started the conversation today, and mentioned whether that is Treasuries or German bonds, but very different than 2008 are the solvency concerns, and I think this is where we begin to see a sort of Darwinian fitness test.  Who amongst the banks in Europe are going to survive and thrive, and who will simply go the way of the dodo bird.  Banks are leading on the downside in Europe.  If you look at European trade, stock markets there, banks are being decimated.

Kevin:  A little like we saw in 2008.

David:  Absolutely.  Since the end of July, we have seen about 7 trillion dollars in equity values which have disappeared.  Spain and Italy – they are only faring well due to the ECB monetization of debt.  In the case of Italy, market manipulation of the sort has brought borrowing rates from 6.2% down to 5%.  Of course, these are short-term fixes, but elsewhere you see Dexia, a large Belgian bank, their CEO jumped ship this week.

Anticipate, anticipate.  Listen.  If you are not listening, engage.  Consolidation across the European bank sector will take the place of recapitalizations.  That is the big question:  Can they force recapitalizations?  Christine Lagarde at the IMF has said, “Yes, we need recapitalizations of these banks.”  Who is going to put money into them?

Kevin:  Sure, it’s like Wachovia.  Wachovia went right into Wells Fargo.  We saw this with Merrill, as well.

David:  And we saw Buffet, very heroically, with the green mask and green cape, attempt to save the day with B of A and his 5 billion dollar purchase of preferred stock.  Kevin, you realize, he has a 3 billion dollar guarantee on that?  So, he actually only has 2 billion in play, around 6%, that puts his real rate of return double digit.  If you looked at the things that happened that week, he is at the center of Washington and Wall Street corruption.  The Oracle of Omaha is going to be ultimately drug through the streets, tarred and feathered, as the Devil from Omaha.  That would be my guess.  If people knew the details of the deals that he is penning, they would know that people were signing contracts with the devil.  (laughter)  Okay, I release this is controversial.  He is one of the brightest investors of our era.  However …

Kevin:  Dave, many of our listeners have read the books about investing, just like Buffet.  Unfortunately, they don’t have the information that Buffet has.

David:  Just like they didn’t have the information that Mr. Paulson had, either, when he was going short the most toxic part of the subprime market, and he actually got to put those pieces of paper together.  He structured the deal, said, “Here, you go and buy it.”  He didn’t tell anyone that he was going to be selling it short.  Was it brilliance, or was it a fabrication?  Entirely clever.  You have to give him that.  But brilliant investing?  Or just a manipulation of securities laws where he couldn’t get touched and be thrown in jail, but essentially was manipulating circumstances to his benefit.

Kevin:  Speaking of a manipulation of securities laws, let’s face it.  The banks would be bankrupt right now if they valued the assets on their books for what they are actually valued at.  These guys are doing just fine because they don’t have to do that.

David:  I think this goes back to the point of recapitalization.  It is much more probable to see massive consolidation across the European bank sector than it is a recapitalization, because if people aren’t willing to give them money – raising capital in today’s environment?  No sir, not at all.  Not on your life.  But if there are surviving entities, in 12-18 months you have as a free pass, in terms of the time, once you have consolidated two entities, you have to consolidate operations, you have to consolidate balance sheets, you have to consolidate income statements, and you basically are pushing forward any other negative disclosures on impaired assets.  It’s almost like a bankruptcy without a bankruptcy, a time out in the middle of the game to allow for some clear thinking before you re-engage in the play.  In this case, it is not a bankruptcy with all of the unintended consequences of that.  It’s just a straight purchase of assets.  Whether that is in French banks, German banks, Belgian banks, we are going to see the same kind of consolidation that we saw here in the U.S.  That would be my guess.

Kevin:  But you are still just pushing the problem forward.

David:  Exactly.  And the only thing that facilitates that, because, again, we are talking about the avoidance of disclosure on impaired assets.  That is the mark-to-make-believe, which is the primary reason, next to record low rates, that banks have fared well in the 2010 to early 2011 period, and going forward.  No one is counting assets at present values.  If there was an actual capital impairment, and a forced recapitalization, you would see a number of these bank institutions found insolvent instantly.

Kevin, we are watching in real time, something that ultimately will want to be a controlled event.  The market is going to determine who survives and who doesn’t in the European banking industry.  Before the market determines, you are going to see some matchmaking and perhaps a few shotgun weddings, in which someone else is determining who survives, and toward what end.

Kevin:  And again, it is because there are voters out there.  The voters could be the market, or the voters could actually be just German constituents.

David:  I think what you are alluding to is, over the weekend, Angela Merkel, in Germany, her party, and her coalition, lost elections in her home state, bringing it to the total of 6 losses this year.

Kevin:  She has played six games, and she has lost six times so far.  That is not a great series.

David:  Well, in baseball, three strikes, you’re out.  This is six strikes, and she is still in!  Kevin, these are German states that had previously voted for her coalition.

Kevin:  She was an incumbent in these states, then.

David:  Exactly.  It was a few months ago that we suggested these state elections were really the canary in the mine, telling the German elite that this sort of pan European vision was of less interest to them than simply a German vision of future job growth, prosperity.  The taxpayers were sending a message.  The voters were sending a message.  “We don’t care about being Europeans as much as we do about being a prosperous society.  Family, community, state, country – in a smaller context, we care about us, and the bigger, bigger, bigger picture of this pan European Union – not so much a priority for us.”  That’s what she has had to deal with.

Kevin:  David, this is just one more occasion where the politicians are disconnected, like you were saying.  They are thinking it is a skirmish, when really, it is a war.  They are treating it like it is a bridge loan that they can take for a short period of time and then everything will be better and they will own the new house.

David:  Yes.  “Normalcy shall return, we just have to buy ourselves some time, stress will dissipate.”

Kevin:   But David, the judiciary in Germany still has a say, and they are voting today.

David:  That’s right, the judicial decision on the constitutionality of the European bailouts is today.  Unfortunately, this is not so much a reading of the constitution by scholars interested in the meaning of the constitution or its implied intent.  It is a geopolitical negotiation, which is interesting to see the judiciary negotiating something for this pan …

Kevin:  Who are they negotiating with?  Are they negotiating with the rest of Europe?

David:  Yes, I think the courts will angle for more influence and control for the German parliament in the eurozone, and I think they will give their approval.  They will give approval, to get expanded power.  Yes, Germany has some upside by approving the bailouts, even if there are political ramifications.  It just means that they have got to put some lines in the sand and say, “Listen, here is what we find abhorrent and wrong.”  They have to take a very scolding and harsh tone, so that they give themselves some political cover.  Yes, we are approving them; however…” and then they will give their list of expectations and requirements.

Kevin:  Well, doesn’t it apply to some of the violations of the Maastricht Treaty?

David:  Yes, the critical factors which I think are being ignored are Article 104-B of the Maastricht Treaty, which states this:  “The community shall not be liable for, or assume, the commitments of central banks, regional, local, or other public authorities.”  The ECB is expressly limited from fiscal support.  They cannot provide support to individual countries.  Every country still has to raise their own revenue, pay their own way.

Kevin:  Yes, but they have been buying bonds, Dave.

David:  Exactly, and those bond purchases, arguably, are just such a prohibited activity, so that is the question.   That is what is in play in the courts:  Are we stepping all over our laws?  There are over 100 lawsuits arguing that the bailouts are in direct conflict with what is called German basic law.  Only about 15 of those claims are being heard by the German court.

The last thing I would mention on that is that the primary function of the ECB was to be a price stabilizer.  I think that would be in question, if they were to assume the role of lender of last resort, or sort of the euro guarantor, and that is what they are quickly moving toward becoming, which calls into question what the protocols are that they are supposed to operate under in light of.

Kevin:  David, we have read the book, When Money Dies.  We have looked back at the German inflations in the past.  Some of these people still remember the horrible inflation.  Bundesbank is a good example right now of somebody who asks, “What are you doing?”

David:  Right.  The huge disconnect between the ECB and the Bundesbank is that the Bundesbank remains in favor of the no bailout clause, and they are concerned about long-term credibility, they are concerned about currency stability.  Those are the issues that are near and dear to the Bundesbank heart, to anthropomorphize.  But that is, I think, a way that the ECB now is being pressured, again, the question of, how does the EU survive?  Who are the constituent parts?  And do they want to be the ones, essentially, shooting the wounded dog?  This is where, from a political standpoint, they do need to buy time, and if they want to see a healthy dissolution, it needs to be on the prerogative, and at the inspiration of, those member states who say, “No thank you, we don’t want to be a part.”  If they are construed as being kicked out, there are some very negative political or geopolitical ramifications.

Kevin:  David, for the listener today, the problems in Europe, the problems in America, they have to have a place to go with their money.  Are they going to be in the dollar?  Are they going to be in the euro?  The Swiss franc?  We know that our clients and our listeners are in gold.  We hope by now they are.  But what about the currencies?

David:  I think the dollar has been given every opportunity to rally.  The euro has levitated quite well in the context of European chaos, and these two have been in a very close trading range for many months now.  Both relatively stable, though both absolutely weak.  Kevin, it is a very difficult question.  I think those trends may reverse with the euro temporarily going lower, which creates problems for the Swiss, yet again.  They will be forced to devalue even more.  We may see the dollar go higher, if only by a few points, but adding 5 or 10 points, I think, would be reasonable expectation or outcome, given the stresses and strains in the market.  Again, this goes back to the question of what is being emphasized in the market?  What is the point of concern?  As a market practitioner, or as an individual investor out there listening, if your concerns are about liquidity, then the dollar should see some play, as the Treasury market should see some play, as well.  If your concern is more about solvency, then you may see some flow into Treasuries and German bonds, but you will also see some flow into the metals markets, as well, again, solvency being the primary concern, solvency and counter-party risk, something that people are trying to insure against more and more.

So, Kevin, will the Swiss franc peg give further support to the euro?  To some degree it will, as any depreciation in the euro would widen the gap to the franc and force the hand of the central bank to be buying euros and selling Swiss francs, so to some degree, the announcement this week by the SNB will be euro-supportive, but we will have to see.

Kevin:  David, you are just returning over the last couple of weeks from South America.  So that we are not completely myopic, just looking at Europe, looking at America, there are the BRIC countries, and there have been amazing gains, and sometimes amazing losses, in the BRIC countries – Brazil, Russia, India, China – and actually, some of the other unnamed countries that aren’t part of the acronym.  What is your thought on that?

David:  Kevin, I would think it is a mistake to think of these four countries as a whole.  Each of these countries is moving in light of its own strengths and weaknesses, and we are sort of clustering them, because of the Goldman acronym, BRIC, and it is easy to think about them as emerging countries, and countries that share some similar thematics.  But as we discussed a few weeks ago with Alexander Landia, there are unique components within the Russian market.  They can’t pay their bills completely.  They are running in the red if oil is not above $115-120 a barrel.  So they have their own set of issues.  Brazil has its own set of issues.  Certainly, a success story today, if you look at the banking industry, it is the Brazilian banks that are carrying pretty high market caps compared to the European, and even U.S. banks.  India, of the four, would be the one that I am probably most encouraged by long-term, but they need to seek some major reforms – bankruptcy reforms.  What I mean by bankruptcy reforms in India is this:  There are companies that have existed for 24, 25, 30 years, and never produced a thing, in India.  And they have carried employees of anywhere from 100-2,000 employees.

Kevin:  That sounds like our government.

David:  Yes, well, they show up.  They can play cards, they can do whatever they want, and they are paid, and they eat at a canteen, but the bankruptcy laws in India are such that an enterprise that is no longer an enterprise, in other words, a company that is not making money any more – you can fold the company but it doesn’t mean you can fire the employees.  We are talking about state-owned enterprises that should have been destroyed, disbanded, gone the way of the dodo bird long, long ago.  These inefficiencies are allowed to be carried within the Indian marketplace because bankruptcy code is not supportive of a restart.  Certainly, in the U.S., this is where we probably have the greatest advantage of anyone in the world.  An entrepreneur can start and fail, and start and fail, and start and fail, and then talk about running for presidency.  That is the story of a Donald Trump, and the story of a great comb-over, and the story of a great start-over.  (laughter)  The bankruptcy code is really helpful, in some instances.  India would see a new lease on life if they could get a hold of their corruption, if they could rein in their bankruptcy code – there are some structural things that need to change.  That’s India.

China.  Massive problems in China.  Massive problems.  I think we have talked about those, ad infinitum.

Kevin:  Part of it is the real estate bubble.

David:  I’m getting closer to a steak dinner with my dad, (laughter) because my favorite leading indicator in China is off 50% in the last year.

Kevin:  For those who don’t remember the bet, this was about 6-8 weeks ago, your dad bet you a steal dinner that China was going to be the next great place and it was going to happen soon, and you said no.

David:  No.  I have already picked out the place.  (laughter)

Kevin:  It’s in Beijing, probably, right?

David:  That’s not a bad idea.  Oh my.

Kevin:  It would be a cheaper steak, if you are right.

David:  (laughter)  Yes, well, Kevin, I think investors are being reminded that with the possibility of higher returns, again, going back to those BRIC countries, with the possibility of higher returns comes the absolute certainty of higher volatility and lower liquidity.  That is where we are seeing some of these countries off 10, 18, 30%, in the last year.  You have to have a catalyst for growth.  If the catalyst isn’t there, as much as the demographic story is supportive, as much as the long-term story in terms of population growth is supportive, these things take a long, long time to develop.  I wouldn’t be betting on any of them today, perhaps with the exception of India.

Kevin:  Volatility feels great on the upside, and terrible on the downside, but we also have governments and government decisions that come in sometimes with volatility.  Just look at yesterday.  When you are making a lot of money, that feels good, but when it goes down 30% or 50%, it feels horrible.

The New York Stock Exchange invoked something yesterday, Rule #48, which allows them to shut down the exchange and open it quietly.  In Rule #48, the first two paragraphs are probably worth listening to, because a lot of listeners who have money in the markets don’t realize that, at some point, if things get too volatile, they don’t have liquidity.  They can’t get in or out.

David:  And it is described as arranging for the fair and orderly opening, or re-opening, following a market-wide halt of the trading at the exchange.  That is the way it reads.  And it goes on to say, “Absent relief, the operation of the exchange is likely to be impaired, a qualified exchange officer may declare an extreme market volatility condition with respect to trading on or through the facilities of the exchange.”  In other words, you invoke Rule #48.  It’s a timeout.

Kevin:  You’re done.  We’re not trading.  I remember when China shut down their markets for a week back in 1987 because it was just too volatile.

David:  It’s a little bit like huge traffic across a freeway, and if you could stop time and freeze frame, then you could look around and say, “Is there a point where there is going to be a break here, and we can re-engage?”  And then they count and decide which companies they are going to open trade with, and sort of do a soft start, if you will, and reintroduce volume back into the exchange, but on an orderly and controlled basis.

Kevin:  And that happened yesterday.  David, coming full circle, the CNBC interview was asking, “Are gold and silver in a bubble?”  Again, each time you are interviewed by what I would consider mainstream media, they continually want to prod you and make you say things that would be bubble-esque, a little like the bubble that we had with the real estate market, or the bubble that we had with tech stocks.  I am going to ask you again:  Are gold and silver in a bubble?  Is this bubble mentality?

David:  I think George Soros’s comments a year or so ago were accurate.  Gold will be, and I would put emphasis on those two words, will be, the greatest bubble I think we have ever seen.  Is it there now?  No, it is not.  Kevin, I would encourage any of our listeners to just take a casual poll amongst their friends and family members, work colleagues, and see how many, out of group of 10, out of a group of 15 – you determine the sample size – have a significant stake – 3, 5, 10% of their liquid assets, or more – in the physical metals today.  I think you will find that very, very few people are participating, and again, I think this is where we are on the cusp of moving into the third phase.  The third phase, for me, is that final phase.  It could last 2, 3, even 4 years, where we see blow-off dynamics, not unlike what we saw in the technology arena, circa 1996 to 2000.  You already had top calling then, you had Greenspan step in and say, “Listen, look at the market moves to this point, and there is irrational, irrational, exuberance, in the equity markets.”  And yet, from 1996, 1997, 1998, 1999, we plugged higher, and higher, and higher.

Kevin:  Until March of 2000.

David:  In that final stage, so I think we are on the cusp of that final stage, if we haven’t entered into it.  But yes, the easy money has been made, the big moves are still ahead.  I would encourage our listeners to crystallize their questions.  We are coming into the fall season.  Each year, we take questions and spend one, if not two, weeks, looking at your questions.  What is on you mind?  What are your primary concerns?

Kevin:  David, that is one of the most fascinating times of the year for me, because listening to the questions of people who listen on a weekly basis and process and re-listen.  We have people who call in and who have re-listened, and taken pages of notes.  It is very humbling when you hear that, but it is fascinating, because these people are engaged, and they are asking questions that really need to be heard by more than just themselves.

David:  Yes, we want to review your concerns, we want to review your interests, we want to review the questions, the things that we may have discussed that need further elaboration.  If it is on your mind, pen it down, send us an email, and we will look at addressing that, along with everyone else’s here in the coming weeks.

Kevin:  And how about the DVD?  There may still be people listening right now who haven’t seen the DVD.

David:  We have sent out tens of thousands of copies already.  If you haven’t gotten a physical copy and you would like to, you can order that at our office.  Call 1-800-525-9556, or go online and request a free copy.  You can also download it online.  Just go to and you can navigate around to find it there.

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