On Gold, Silver and Krugman's Misinformed Self-Congratulations

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Includes: GLD, SLV
by: Economic Disconnect

Gold and Silver Observations
I know you all have been waiting for yet another precious metal themed section, so here one comes.

China Pushing Silver Investment?
Economic Disconnect is a big fan of silver. Silver has on its resume the following (all data is from Wikipedia, so you know it is true):

- highest electrical conductivity of all metals
- Among metals, pure silver has the highest thermal conductivity
- the highest optical reflectivity
- Silver also has the lowest contact resistance of any metal

Now those are some fine qualities.

Silver was once the money standard, and even China was set on a "silver standard" for some time. Seems things run full circle as this video from the blog The Prudent Investor shows. Key point summary:

-Official Chinese television announced silver bullion now open for public investment

-500 gram, 1, 2 and 5 kilo bars are offered

-Chinese news aware of the gold/silver ration, making them about 100 times smarter than CNBC

So is this a big deal? I would say it could be - how is that for finality?

I think back to Treasury head Geithner's talk a while back in China when he said their US treasury holdings were "safe" and the laughter it garnered. If given a chance to put their own money to work, Chinese nationals may indeed look to silver as an investment. This is even more plausible when you consider how much China, as a country, has money tied up in US debt.

A step back may provide some clarity. Assume just 30% of the average retail investors decided tomorrow that gold and/or silver should make up just 1% of their portfolios, this would consume nearly all the gold and silver available and cause a huge price run up. Precious metal investing is a small time operation related to public investment, so any expansion can make a big difference. Hopefully there will be some way to monitor how this program fares.

Gold is Not Readily Fungible

The next tale comes from Jesse's Cafe, and it is a good find.

While checking out a video presentation by Max Keiser, a startling revelation about German gold reserves comes up. The entire video is worth a look, especially the section where Keiser is at the German Bundesbank on the day Bear Stearns collapsed. You can clearly see the fear and panic from the bank officials he does talk with:

Jesse offers the following commentary which as usual hits the bulls eye:

"The most fascinating thing that I learned is that all the gold 'in Germany' is in New York." Around 7:25 in the tape.

This is of particular interest because it has been repeatedly denied by Bundesbank in the past, when questioned about the rumoured gold swaps the the US Exchange Stabilization Fund for 1,700 tons of gold, now being held at West Point, NY with the designation "custodial gold."

Has the Bundesbank, like the Bank of England, sold (or lent if you will) half of its national gold reserves? Interesting.

The other side of this rumour is that Bundesbank desperately wishes a 400 ton IMF gold sale to help it recover the 1,700 tonnes of gold which it has lent out to the bullion banks, who subsequently sold it into the market.

Why does it matter? It matters because of the lack of transparency of various Central Banks with the size and timing of their gold sales, and its impact on the markets. Its never really the initial act, it is the subsequent cover up and dissembling that brings down careers and governments.

As I had written above, gold is not held by a large base. Central banks are the main movers of bullion (though the gold ETF is making moves up the ladder all the time). One may wonder why in the world, if fiat money is so perfect and amazing, that the central banks do not just dump all their gold. I think that question leads to a few answers and truths one would do well to keep in mind (I will not answer for you).

Gold expands as a base around 0-2% per year. The outstanding derivative notional bets on gold far outweigh what exists above ground. The central banks have long played with gold sales to target gold prices (why bother, gold is useless remember?) and the possibility that the German gold may be "on the lend" even while the metal itself sits in New York is one of those real world examples of how notional instruments get far ahead of reality. Of course you can always print more money, issue more bonds, or write more stock to cover such things. You cannot invent or print gold.

Don't Break Your Arm Patting Yourself on the Back
I think the current euphoria rankles me as it does because of the reliance on "confidence" measures to effect behavior. When an entire marketplace is built on perception and illusion it can be easier than one would believe to "make it so just by saying so".

In a NY Times op-ed Monday, my favorite Keynesian economist, Paul Krugman, begins a victory lap for big government spending which seems a bit premature (excerpts):

Averting the Worst
So it seems that we aren’t going to have a second Great Depression after all. What saved us? The answer, basically, is Big Government.

Just to be clear: the economic situation remains terrible, indeed worse than almost anyone thought possible not long ago. The nation has lost 6.7 million jobs since the recession began. Once you take into account the need to find employment for a growing working-age population, we’re probably around nine million jobs short of where we should be...

A few months ago the possibility of falling into the abyss seemed all too real. The financial panic of late 2008 was as severe, in some ways, as the banking panic of the early 1930s, and for a while key economic indicators — world trade, world industrial production, even stock prices — were falling as fast as or faster than they did in 1929-30.

But in the 1930s the trend lines just kept heading down. This time, the plunge appears to be ending after just one terrible year.

The thing to remember about Paul Krugman is that he is a political hack first, and an economist second. The cheerleading for big government in all of his writings colors his view.

The second thing to remember is that Mr. Krugman never asks nor answers any questions that have relevance. After considering the events of the 1930's Depression and how it compares to today's calamity does Krugman ask:
-Why the "hands off" approach during the Great Depression? In this I think there is a monster hole in Depression thinking. The US Federal Reserve could not just print money (we were on the gold standard) like they do today. Also, and this is key, public opinion was such at the time that making believe by having fake spending would not have worked as nobody would have bought it. I know, in the old days folks were a mistrusting sort and had more than a modicum of understanding.
-If the big government solution has been so effective, why does Krugman desire yet another stimulus? What's the matter Paul, maybe not so sure about this recovery?

The always great blog, Owner Earnings, does not post as regularly as they once did. When a new post is up, however, you would be well advised to check it out. From the most recent post the author compiles a list of "things that the government has done to prevent (delay) a depression" that is a must read review:

A list of things that the government has done to prevent (delay) a depression:
Banned short selling.

Eliminated mark to market.

Allowed Vikram Pandit to send a memo saying (lying?) that things were going well back in March. The rally started shortly after.

Reduced interest rates to 0%.

Extended unemployment benefits.

Running a $1 trillion budget deficit.

Reduced finance rates for banks via the Discount Window.

Bailed out Fannie Mae (FNM)

Bailed out Feddie Mac (FRE)

Bailed out AIG

Bailed out GM, though temporarily

Bailed out Chrysler, though temporarily

FDIC has spent billions closing down insolvent banks

Credit of $8,000 first time home buyers credit.

Credit of $4,500 via Cash for clunkers.

Credit of $600 via a rebate check.

Guaranteed $250,000 bank account balances via FDIC, up from $100,000

Guaranteed financial bonds

Guaranteed money market accounts

Guaranteed Bear Stearns assets

Bought preferred stock in financial companies

Bought agency bonds

Bought Treasuries

Expanding to the next logical step:

A list of things that the government has yet to do, but probably will do:
Bail out State governments (Bond guarantee?)

Bail out Local governments (Bond guarantee?)

Guarantee health care (which I would approve of)

Raise taxes (The republicans will try to force democrats to admit it before the 2010 election. The democrats will have to admit it once the 2010 election is over.)

Significant devaluation of the dollar. This is already playing out compared to the emerging markets, but will begin to play out more against the Euro and the Yen.

Significant reduction in Social Security and/or Medicare benefits.

Allow companies and or officials to either avoid telling the truth and/or flat out lie.

Manipulate or stop providing data that shows how bad things are. Transparency anyone?

I agree with Paul Krugman here, to make good on that entire list it would take Gigantic Government, not just a big one.

Adding to this list will soon be the commercial real estate bailout which may run another 1 trillion in losses (maybe more).

While Krugman, the president, and many others are trying to take a victory lap and proclaim the wisdom of their actions, I would ask you to review the above lists again. The entire financial system in the US is now government guaranteed. While there has been talk of "exit strategies" as of late, there really is no way out now. Every item above will soon become a ward of the state and carry a Fannie Mae like "implicit, but explicit" seal of approval. There will be no exit. If the government disagrees with me, I would ask them to stop any one of the above programs and see what happens. I triple dog dare you.

A visual: