2009: Go for Gold! Beware the US Treasury Bubble

``The world is lurching through a serious monetary disorder. The proximate cause is the collapse of the housing bubble and the subprime-credit crisis, but the ultimate cause is the inherently unstable monetary system foisted upon us by a banking cartel. Central bankers are called upon to act as lenders of last resort, but in their efforts to inflate their way out of the credit collapse, they risk igniting a hyperinflationary bonfire that will destroy the world's major fiat currencies. Gold was money once, and could become so again.”- Robert Blumen, Is Gold Money?

Except for Ghana (up 60%), Tunisia (up 10.6%) and Ecuador, which escaped the wrath of a global financial meltdown, all of the stock market benchmarks were in the red for 2008.

Nonetheless the other asset outperformers had been the US dollar and US treasuries both of which benefited from the forcible liquidation and served as the “safehaven” amidst the present deflationary scare, see figure 2.

Figure 2: Bespoke Invest: Gainers and Losers

According to Bespoke Invest, ``While it has been a horrible year for stocks (S&P 500 down 39%), it's been much worse for oil, which as we all know was up nearly 50% for the year back in July. While most asset classes are down big, the US Dollar has risen 6%, and Treasuries have skyrocketed. As shown, the 10-Year Treasury Note is up a whopping 21% this year, prompting the majority of market participants to call it the next bubble.”

This chart excludes another winner though, gold which racked up 4.95% in 2008 based in US dollar terms.

Yet, gold didn’t just gain against the US dollar. It likewise gained against most of the major currencies except for the Japanese Yen and Chinese Yuan see figure 3.

Figure 3: courtesy of James Turk of goldmoney.com: EIGHT years in a row

Why our fancy with gold?

Why our fancy with gold?

While we can cite growing demand supply imbalances amidst the present turmoil, our focus is on how global central bankers have been dealing with the present crisis.

Again while major global central banks have been force feeding the banking system with record amounts of money which is basically being eaten up by the losses of the highly financial leveraged system, eventually the seemingly endless tsunami of money being fed will overwhelm such losses. Of course, all this could take time but that would be in the assumption that we can time the markets. Nonetheless, the obvious effect will be risks of HIGHER inflation if not HYPERINFLATION. And inflation’s reappearance could be dramatic.

In addition, not all of the global economy has been ravaged by debt deflation. Economies in Asia for instance have been less leveraged or less affected, yet global governments including Asia and Emerging Markets have been adopting the same policies of currency debauchment. Stimulus programs that can’t be paid for by taxes or borrowed from taxpayers domestically or internationally will have to be met by the central banks’ printing or digital presses. Basically this implies inflation.

Again in the US, government fiscal deficits won’t only be about recapitalization and support of the financial industry but also about plugging of the shortfalls in tax revenues.

Figure 4: Nelson Rockefeller Institute: Deteriorating Tax Environment

The Nelson Rockefeller Institute projects tax collections “likely heading into negative territory for the first time since the last recession in 2002”.

So the amount exposed yet by the US government is likely to be a downpayment among other possible future installments.

Again all these sums up to a potential massive spillage of unsterilized money being churned out by global central banks and governments which the entire economic system will have to absorb.

Moneyness of Paper Money

Moreover, in a world where central banks are working to devalue their currencies overtime, any other currencies aren’t likely to assume the role of safehaven again because of implicit political interests.

Remember, paper currencies are basically IOUs issued and stamped by governments as “legal tender” and backed by nothing but FAITH in the issuer. Because paper money is an IOU, it bears counterparty risks.

Where money as a medium of exchange requires these characteristics: durability, divisibility, scarcity, portability, uniformity and acceptability, unlimited issuance of paper money essentially diminishes the moneyness quality of paper currencies. As we cited earlier given the massive and full scale deployment of the printing press globally, such the raises the risk of a potential of disintegration of the present financial architecture.

The chafing the characteristics of the moneyness of paper money, the gradual erosion faith over its LEGAL TENDER status, global currencies in a race to the bottom, potential upheaval of the monetary structure or the plain universality of economic law where the growth of supply of money is greater than economic output simply collectively means a loss of purchasing power of paper money against gold (and other real assets).

At best, gold, which bears no counterparty risks and functions as no one else’s liability, will be your insurance against the vast stealth tax employed by global governments. At worst, gold will regain its monetary luster or play a renewed role in reshaping the next global monetary regime (worst because of the unfathomable distress that the world will possibly undergo first before rediscovering gold’s importance).

This is why signs of shortages in physical gold has been offsetting the huge short positions taken by a few government controlled big banks (see Influencing Gold and Silver Markets, Backwardations Imply Higher Gold and Silver Prices), which is in my suspicion have been attempts to manipulate gold prices as to refrain from exposing the inflationary effects of their actions. Unfortunately, markets are larger than government can permanently control where manipulation can only influence price signals over a limited period.

Debt Over Issuance Over Limited Capital Equals Treasury Bubble

Finally, it is obvious that in a world where losses have been mounting and where institutions have been seeking refuge in governments, that capital is in an apparent shortage. Yet, expected material slowdown of world trade and a projected global economic deterioration implies an erosion of economic output, and perhaps a reduction of real savings, especially as governments work to redistribute residual capital.

Nonetheless as global governments attempt to reinflate the global economy, this translates to an ocean of issuance of debt instruments which would effectively compete with the diminishing supply of “savings-based” capital. This means that the panic driven boom in US treasuries seems more and more like time bomb waiting to implode that could bring about the next crisis to US treasuries holders.

As an aside, the plan of the US Federal Reserve to buy long dated bonds in an effort to close the arbitrage windows for banks could bring opportunities for foreign owners of US treasuries, where about 55% of privately held US treasury securities are foreigners (CRS Report for US Congress), to gracefully exit the bubble. It’s a wonder if China and Japan will do so. And it is amazing how complex the world is and full of unforeseen possibilities.

Eventually capital will be seeking a premium over the sea of debts which means higher interest rates for the world.