The End of Gold, Part Three 30 comments
David Bailey
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When there was a lot of response to my last posting, I felt I should devote some extra time to the opposing view. I want to be fair and thorough and I always find it useful to try and look at a question from different vantage points.
I only found one argument for the pro-gold case that holds any “promise”. As of this writing, nobody knows all the details, but I have to admit that - potentially - it's a real doozy. Despite days of wading knee-deep in strict, “Austrian School” screeds and wild, Hyper-Monetarist predictions of crumbling currencies, I still believe that gold shows every sign of being in an anti-bubble, deflation is still the predominant economic threat, and the structural place of gold in a fiat money world has not changed and is not likely to. But I sure saw a reason somebody might want to bet on gold. I'll bet you saw it, too.
It all hinges on whether or not President Obama has indeed found for his Treasury Secretary the only man in the world who thinks the main flaws with the original Paulson Plan were that it was not expensive enough, not ineffective enough, and that it created too little moral hazard. You will bet on gold – and be wise to - if you really think the Administration will ultimately create the $2 trillion nightmare, the GSE From Hell, the hideous government golem some propose to call the “Aggregator Bank”.
Call her: “Aggie Mac”
If you hate Fannie (FNM) and despise Freddie (FRE), you'll absolutely loathe Aggie. If you think the GSEs we have are market-distorting monstrosities run by criminals, I'm guessing you won't like a new GSE that's a market-spiting money-murderer run for the benefit of criminals. After all, Fannie and Freddie only bought loans and mortgage-backeds that were possibly fraudulent. That's disgusting enough. Aggie Mac would buy the stuff everybody already knows is fraudulent. I'm pro-stimulus. I even agree with George Soros when he says that “The government ought to take the GSEs out of limbo and use them more actively to stabilise the housing market.” But this is ridiculous.
Aggie Mac is the half-baked, half-witted answer from people who say the challenge in this “bank rescue” business is pricing the “toxic” mortgage-backed garbage. Of course that's nonsense. The market has told us very clearly what the fair price for these "assets" is: effectively nothing. There are plenty of world-class experts in distressed assets. They will not touch this junk with a ten-foot pole. Rightly so. The market in private-label RMBS is frozen because these bogus securities are so shot-through with malfeasance they can't be priced. A “no-trade equilibrium” obtains in this markets for a very logical, very sound, very well-understood economic reason. Some guys got a Nobel Prize for figuring it out, but it's just plain common sense: Fraud drives prices to zero.
But I guess some yahoos over at the Super GSE Think-Tank believe they can wave a magic money-wand at “the market” (to whom, exactly, do they refer?) and some little elves and fairies will appear, bearing a desperate need to buy phony bonds and hundreds of billions of dollars with which to do it. Where these geniuses learned their “economic theory”, I don't know, but I wonder if I can sell them a few hundred metric tons of Chinese powdered milk. I'll bet I can still get it cheap. Maybe they'll think that if they buy it, people will suddenly think it's safe. I also know of some folks who'd like to sell them some peanut butter – lots and lots and lots of peanut butter. Can we have a “bad bank” for peanut butter? How about an E. coli ground beef aggregator?
Supporters of the Aggie Mac concept point to the Swedish plan. They start by ignoring the first, most-crucial step. I saw PBS's resident economics "genius" Paul Solman describing it the other night. [I have to admit it worries me a little when the "liberal" media latches naively onto the idea of giving big, nasty corporations almost unimaginable amounts of taxpayer money]. Mr. Solman had on a Swedish economist who explained the first step which Mr. Solman of course completely ignored. Therefore, let me quote the wise Swede:
"What Sweden did was first, to make sure that they know all the losses in the banks."
Emphasis his. Still it was apparently too nice and understated a Swedish way of saying something very, very important for American “economists” to note. Translated it means: "First, we went behind closed doors and very politely got the banks to admit all their fraud to us." Of course nobody used the word “fraud”. That's not the European way. But if the Swedes are subtle, they're not stupid. What they did not do was go to the banks and say: “Just tell us what assets you'd like us to take off your hands.” To have done that would have been to take on an unmanageable nightmare you could never sell to anyone. That would have been idiocy, or, Aggie Mac.
Without significant truth-telling, a “bad bank” plan is just plain bad. Really bad, because of course the Swedish plan also involved this second little step called “nationalization”. This gave the Swedish buyers of the now-transparent fraudulent debt a great deal of control over the remaining, clean institutions. How anyone thinks he can emulate a plan while ignoring these two, huge components is beyond me. Well actually not. It's called “mark-to-model”. It worked so great the first time, Aggie Mac figures she'll try it again – with government models this time.
That should be fun.
Professionals (albeit undercapitalized professionals) have already modeled these bonds. They are called “bond insurance companies”. Yet banks are not making bond insurance claims and potential buyers clearly don't feel the bond insurance will protect them. Why? Well, you can't collect a bond insurance claim on a fraudulent bond. Nobody should even have to say this, but all the Aggie Macs in the world won't make mortgages and MBS buyable so long as folks know there may be fictitious borrowers, fictitious collateral, phony property assessments, phony FICO scores, phony loan agreements, phony syndication agreements, phony securitization agreements creating phony corporations, tax-cheating in their tax-havens, their phony bonds, with their phony structuring, getting phony ratings from corrupt rating agencies, insured by uncollectable bond insurance and “hedged” by phony CDS written by the insolvent or near-insolvent. Have I missed anything? Again, a fraudulent good or service is designed to deceive. People don't want to be deceived. Therefore they won't buy. It's just that simple.
We won't get a market until we can produce an assurance that the fraud has been wrung out. That takes hard accounting work, transparency and rock-solid guarantees. Nobody with any common sense thinks it works any other way. For that reason, I doubt that this awful Aggie Mac nonsense will ultimately get much traction. We don't yet know the plan. Apparently Secretary Geithner doesn't even know the plan. But even if it turns out that Geithner is nothing more than a toy of the banks, I think President Obama is too smart to ask the taxpayers to be suckers for such a blatant rip-off. Harry Reid? Maybe. Barack Obama? I don't think so.
But for the sake of looking at how Aggie Mac could make the goldbugs' day, let's look at how bad is the bad version of the “bad bank” that's been kicking around – the no-truth, no-nationalization, mark-to-model bastardization of the Swedish plan. The economic theory here is really quite astonishingly bad. The Administration wants to stimulate the economy. In fact, it wants to stimulate inflation. If one concludes - as many economists have - that the threat to the economy is deflation, this is highly reasonable. Yet even in theory Aggie Mac fails to be stimulative and fails even to be inflationary. Instead, it makes the jump straight to hyperinflationary. But how could awful Aggie Mac do such a terrible trick?
It's not easy. Hyperinflation has been ubiquitous throughout the third world, but it's very hard to create in a major currency and has never been created in a major, international currency. Small country currencies sometimes fall under the control of a crooked elite using their nation's banking system as a personal printing press. When that happens, the easy availability of larger, “harder” currencies mean the small currency is quickly undermined and pretty soon a bottle of beer costs folks what used to be three months' salary. The U.S. dollar, on the other hand, is both the currency of the largest economy on earth *and* used to buy and save by people across the world. The immense and fast-growing "Eurodollar" economy has been an inflationary America's saving grace, in my view. Americans may act as though the value of our currency is completely unimportant to us, but foreigners have decided that the dollar is really important to *them*. We may even be have helped them accept the dollar by printing so darn many. Pretty sweet deal.
How do you screw it up? Just throwing huge piles of new money at a world currency won't produce hyperinflation, but it is almost always stimulative. With such a huge amount of money involved, theory tells us that a plan will only fail to be stimulative if the immense cash-dump is on a group of unregulated people who have shown a really extraordinary talent for useless speculation and no motivation to produce solid credit or growth, no matter what the inducement. That's our banks. So far, so good.
But certainly huge piles of money are at least always inflationary? Theory tells us no, not absolutely always. Look at that double-size monetary base we already handed the banks and the way it just sits there at the Federal Reserve, inflating nothing. As an economic matter, the paying of huge amounts of money for nothing is highly deflationary. Paying huge amounts of money for nothing – like over-valued real estate and loans to under-qualified borrowers – is how we got our deflation threat in the first place. And now we propose to pay a huge amount of money for an unmanageable, unsaleable loan portfolio full of fraud with a fair market price of zero. Wow, that is special.
But to produce a dollar-based hyperinflation, you still have to create an international plan to undermine trust in the currency worldwide. To do that, you would have to create a sort of “Crooked International Bank Reinvestment Act”, specifically rewarding mismanaging malfeasants who had printed trillions in counterfeit loans and sold them across the globe. You would have to simultaneously:
- Give a bunch of huge, crooked, dollar-based, international, financial institution some truly enormous amounts of cash.
- Free them from the consequences of fraudulent loans.
- Put no meaningful structures in place to assure the cash into good loans rather than crazy loans and wild speculation.
The Aggie Mac plan would, of course, do all three. It would give these banks a “get out of jail free” card, a printing press, plenty of paper and say: "please print real money this time." This is not generally a good plan with international loan counterfeiters who almost crashed the dollar as recently as this summer.
Without rooting out the mechanisms for fraud and putting the remaining system under tight-enough control to be trusted again, a "bad bank" Aggie Mac would be an economic failure and, possibly, hyperinflationary suicide. As I say, I suspect President Obama is too smart to fall for this brazen scam, and I'm even more confident the American people won't have it. But, if not and some huge Aggie Mac monster really does rise from the inky depths of idiocracy, swim the stinking swamp of stupidity and cross that broad plain of pecuniary perversion that is America in the 21st century, I have this piece of financial advice for you at which you may already have guessed:
Buy gold, buy buy buy, and buy some more. Buy banks and real estate and when they spike, sell and pile your profits into even more gold. Then move that gold – and yourself - to another country.
I very seriously doubt the Aggie Mac idiocy will come to pass, but if it does, I'll see you at gold $5000.
Disclosure: no positions - yet.
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This article has 30 comments:
Meanwhile gold is spiking today!
On Feb 11 10:27 AM market ace wrote:
> Gold is not the answer to everything as some indicate, but anyone
> not holding some position in it is missing the boat big time. People
> also should not get too excited about gold at $5,000/oz as then a
> cup of coffee will probably be $500. Every thing in economics always
> over reacts so with all of this gov't wasteful spending inflation
> will be back big time.
While being myself libertarian and against gov intervention, I liked this article. It is humorous and you are not bashing gold bugs while making a sensible argument.
gold bug bashing would have hurt you considering the huge Gold rally just a few minutes ago. Paper gold at 940.
David wrote "Buy gold, buy buy buy, and buy some more. Buy banks and real estate and when they spike, sell and pile your profits into even more gold. Then move that gold – and yourself - to another country.
I very seriously doubt the Aggie Mac idiocy will come to pass, but if it does, I'll see you at gold $5000.
David, looks like you are "closet goldbug" but you still haven't come out yet...Disclosure: no positions - yet.
What are you waiting for? Holding paper gold, like GLD in the end will not protect you from the fraudulent fiat USD. Holding real gold and silver will! So come out of the closet already and change the title of this essay from the The End of Gold, to.... GOLD the NOW and FUTURE MONEY!
Disclosure; the proud owner of GOLD AMERICAN EAGLES
My view is that downturns come in four varieties - slight deflation we never notice, stagflation, deflation and hyperinflation (which invariably leads to or includes severe stagnation). Certainly for the U.S. and the world, a dollar hyperinflation would be the worst and - I think - the most unlikely. So naturally I am extremely reluctant to go with the "gold or die" thesis. By the same token, I certainly recognize the validity of it in the most extreme scenario.
I think we have a lot of deflation to go through before we get to a hyperinflation but I've written before that once rates went to zero, hyperinflation was "on the table" at least in theory. And as I've written several times, even without hyperinflation, the gold market could go back into bubble mode of its own volition and there is no question that bubbles make people LOTS of money. The only thing I have trouble imagining is stable gold prices for the rest of the year. So, place your bets, I guess.
I just feel that it's no accident someone as smart as Peter Schiff has been wrong about the dollar, bonds, etc.. I think people are really underestimating the deflationary threat. The narrative for gold buyers is totally locked in at the same time the fundamentals have crumbled, in my view. It reminds me for all the world of this summer and the Chinese oil demand narrative, but that's for next time.
Finally, several people have asked when I would get in. My view is that if gold breaks out above $1200, there will be plenty of room for it to go. I'm in no hurry.
I never knew that a "bad bank" could be so bad. BTW I bought the domain badbank.us recently. Make me a good offer and I may sell it. Don't want to sell the gold coins though.
Well I suspect the opposite, especially given the structure of the "stimulus" bill.
More importantly I keep seeing folks saying that the "American people won't have it", etc. Please, Please, Please let me know how and where to exercise the option implied by this.
1) There are no federal elections for 2 years.
2) Only party players (dems and repubs) who toe-the-line get offered
up for election.
No. The American people will have it -- because they don't have any choice.
(We, as a country, are to the point where we need direct democracy via electronic voting if we are "to have a choice". The "wisdom" which representative democracy provided in days before polls and political pressure has disappeared from our political system.)
I believe the US will devalue the dollar about 50% over the next 4 years, and then work extremely hard to strengthen the dollar so that it doesn't fall further.
A 50% devaluation of the dollar will wring out a lot of excesses in the system. The mountain of debt of different forms (govt, consumer) that the US currently has is far too big to pay off. There are two alternatives, one is for the US simply to default, the other is to devalue the dollar to the point where our debt burden becomes manageable. The latter is the obvious course. That is the cours the treasury and Fed are embarked on even if they probably would never say so and may not even be aware that is what they are doing.
Gold should do well over the next 3-5 years. Once the dollar stabilizes at its lower level then gold will probably flatten out or decline slightly.
Inflation will also help with the housing crisis. Real estate prices are still too high. But it is a big problem for them to fall in nominal dollars because it puts more and more people underwater on their mortgages.
If you devalue the dollar, however, then real prices for real estate can continue to go down even as nominal dollar prices of real estate stabilize.
Basically, it means you are devaluing the debt held by creditors until it has declined enough in value that the debtors are able to make the payments on their mortgage and other debt.
And creditors should be happy as well, because they are better off getting 50% back than losing 100%.
I do not buy the notion that deflation is an inexorable process that can't be stopped.
Print enough money and I guarantee you will lick deflation.
And, I also guarantee that the Fed will do that up the yin yang, and we will have heavy inflation, not deflation.
50% inflation over 4 years would bring 11 million homeowners back into above-water territory on their home mortgages, and it would cut trillions in debts. Precisely what is in the books. The fix is in people, get ready.
On Feb 11 12:51 PM lance sjogren wrote:
> And the other thing:
>
> I do not buy the notion that deflation is an inexorable process that
> can't be stopped.
>
> Print enough money and I guarantee you will lick deflation.
>
> And, I also guarantee that the Fed will do that up the yin yang,
> and we will have heavy inflation, not deflation.
$1300 by April, $1500 by end of 2009 and $2000 in 2010. GLD is up from $70 to $93 in 4 months and most gold miners are up 100% in the same time period. Sit on the sidelines and do nothing. Your loss.
In 'let's print $3 trillion worth of green paper' times it gets even more valuable.
Gold - $1200 by May, $1500 by end of year and $2000 in 2010.
Check out my call in October - article posted here. I picked the bottom clean and am riding the up gold wave fully loaded right now.
Stay on the sidelines and miss the opportunity or buy in and push my holdings higher.
I have been listening to the anti-gold crowd for three years now and all the while making money long the yellow. Wake up.
But of course, in the end, the high rates needed to combat that inevitable inflation, will create yet another recession. Think 1982.
On Feb 11 02:15 PM wengem wrote:
> Lance & sickofthehype... correct me if I'm wrong, but if inflation
> went as high as you say, wouldn't interest rates also go through
> the roof? As a result, only those homeowners with fixed rate mortgages
> would benefit. Anybody with a variable rate would get slammed...
> unless the lenders voluntarily let them off the hook by refinancing
> them into a fixed mortgage at the pre-inflation rate. And if they
> were willing to do that, then why not just let the underwater homeowners
> off the hook now?
There's only one way to avoid deflation, and that is to reflate.
Reflation is easy. The Fed buys lots of assets such as Treasuries and Agency debt. There is no limit to how much buying the Fed can do.
So, the only way deflation can be more than a temporary blip is if somehow Bernanke and Obama change their minds and decide deflation is not so bad after all. That's not going to happen.
They have both the WILL and the WAY. The dollar will reflate!
While they're reflating the dollar, there's no way they will put the brakes on until inflation fixes some of the difficult problems we're currently in, such as falling tax revenues, excess government debt, excess corporate debt, and excess personal debt. It is the single medicine that will fix all that.
The only question is, will we be able to get it back under control afterwards?
There is a fine tighrope walk between the "benefits" of inflation and the "perils" of higher interest rates.
I don't know about hyper-inflation, but unless Bernanke and Obama lose their minds, we can safely expect plenty of garden-variety inflation.
On Feb 11 12:46 PM lance sjogren wrote:
> I don't subscribe to the hyperinflation scenario.
>
> I believe the US will devalue the dollar about 50% over the next
> 4 years, and then work extremely hard to strengthen the dollar so
> that it doesn't fall further.
>
> A 50% devaluation of the dollar will wring out a lot of excesses
> in the system. The mountain of debt of different forms (govt, consumer)
> that the US currently has is far too big to pay off. There are two
> alternatives, one is for the US simply to default, the other is to
> devalue the dollar to the point where our debt burden becomes manageable.
> The latter is the obvious course. That is the cours the treasury
> and Fed are embarked on even if they probably would never say so
> and may not even be aware that is what they are doing.
>
> Gold should do well over the next 3-5 years. Once the dollar stabilizes
> at its lower level then gold will probably flatten out or decline
> slightly.
1. Job losses in all countries in the world. When thousands of people are losing jobs, how is that they have cash to make an "investment" in gold.
2. Strengthening of the dollar. If you compare between June 2008 and Feb 2009, the dollar has actually strengthened by more then 20%. So if the gold price was, say $ 900 in June 2008, considering the strength of the dollar , the real value of gold today is $1080.
3. Crash in the consumption demand in Asian markets, specifically in India and Middle east. In India, for Jan 2009, demand has collapsed by 90% in Jan 2009. For long, India has been consuming 70% of the total gold output every year which has nosedived in 2009.
4. Retails sales in terms of jewellery has crashed in Belgium as well as India.
I think gold is hyped up today the way oil was done when it reached $147. Two months later, I think oil prices have crashed that Gulf nations are running for cover.
Historically, 1 oz of gold was 10 times the barrel. Now that has been broken.
The funniest part is for two days last month, the price of gold was higher than platinum- the rarest metal on earth!!!.
If anybody can come up with data regarding phyiscal consumption in terms of tonnes in the US and Europe markets, then we will clearly know whether speculators and middle men are trying to make a living by hyping up gold now.
"Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. "
On Feb 11 10:55 AM silverwood wrote:
>
> David wrote "Buy gold, buy buy buy, and buy some more. Buy banks
> and real estate and when they spike, sell and pile your profits into
> even more gold. Then move that gold – and yourself - to another country.
>
>
> I very seriously doubt the Aggie Mac idiocy will come to pass, but
> if it does, I'll see you at gold $5000.
>
> David, looks like you are "closet goldbug" but you still haven't
> come out yet...Disclosure: no positions - yet.
>
> What are you waiting for? Holding paper gold, like GLD in the end
> will not protect you from the fraudulent fiat USD. Holding real gold
> and silver will! So come out of the closet already and change the
> title of this essay from the The End of Gold, to.... GOLD the NOW
> and FUTURE MONEY!
>
> Disclosure; the proud owner of GOLD AMERICAN EAGLES
>
>
actually, you have pretty good company re deflation: mish, elliottwave, numerous people on minyanville, etc
and they almost always qualify their views via a time frame; ie, things go up, then go down, then up again (usually) - and especially so gold and silver
re silver (one of two of my favorite insurance metals):
it's my personal suggestion re your last sentence in part 1 of your series:
"...If you can find a better deflation play than going short gold - make it."
hope you continue w/part 4 etc as things unfold
thank you much!
They still don't know how to price the dud assets and they can't take them off the bank's hands unless they price them at their true value.
Why not create a web site where all mortgage debtors can register their interest in buying back part of or all of their debt.
The Bad Bank's task is to unscramble the MBS's and relate them to actual debtors.
Then a true market price will emerge (as opposed to the panic pricing now) and the banks get a dose of truth -serum that will allow them to clean the deck and get new capital on board.