Update: Is There Danger?
My question about danger last Friday wasn’t with respect to the economy or financial system. The answer to economic and financial danger is more than obvious and we didn’t even need today’s defeat of the $700 billion bailout package or the market reaction to it in order to figure that out.
Instead, my question was with respect to gold and silver: Is there danger that the monetary metals will get taken down once again by the market turmoil? So far, the answer in the case of gold is ‘no’ whereas for silver it is ‘not sure’. Of course, silver was under pressure today as just about every commodity and industrial metal was clobbered. Meanwhile, gold behaved like the classic safe haven that it is, along with U.S. Treasury Bills. The result was a price disconnect of gold from the U.S. Dollar, and it could last for a while. At the same time, should U.S. Treasuries begin to lose their own safe haven cachet (there was recently a rise in the cost of credit default swaps on Treasuries), we could very quickly see the dollar start to fall again while gold continues to soar.
This is the perfect scenario that I’ve been looking for: rising gold, falling dollar and falling energy/commodities. Initially, silver might not seem like a winner under such circumstances, but patience will reward the silver investor. For one, as several readers have already pointed out, low zinc, lead and copper prices will reduce base metal mining. Since over 50% of worldwide mine output of silver is a by-product of zinc, lead and copper mining (the rest is a by-product of gold, or is primary silver), there would be a reduction (at least in theory) in silver mine supply. This reduction would not occur immediately but if base metal prices remain depressed for a substantial period of time, then we might start seeing the effects by late 2009.
At the same time, here is something that might be worthwhile to look into (and we will be doing just that as part of The Metal Augmentor service): how vulnerable are companies like Silver Wheaton and Silverstone Resources to a downturn in base metal prices considering many of the mines from which they receive their ’silver streams’ are not receiving full credit for their silver by-product while at the same time their revenues from base metals are declining? In other words, is it possible that the mines themselves might be shut down and therefore Silver Wheaton would be deprived of the ’silver stream’ itself? I don’t have the answer and it will require a very detailed analysis, but if you have a large position in one of these companies it would be worthwhile for you to look into it. The way you would do so is to run a price sensitivity analysis on the mines themselves using an assumption of lower long-term base metal prices. Or, you could wait until we address this issue in The Metal Augmentor once it is launched.
Getting back to the U.S. dollar, no other currency appears immune to the financial mess so perhaps we shouldn’t necessarily expect the dollar to fall off a cliff immediately. In the long term, however, the dollar has a long way down given the amount of dollar-denominated debt that must be paid back, defaulted or inflated away.
Speaking of ‘inflated away’, I know that we are still looking at a bunch of Alices in Wonderland when we hear legislators, bankers, economists and other ‘experts’ still questioning whether or not the $700 billion bailout package or an alternate government-sponsored ’solution’ will be inflationary. HELLO!!! The U.S. government has debt on the books of $10 trillion with another $30-40 trillion in obligations, while the private sector has close to $20 trillion in debts. At the same time: (1) demographics will start to drag on gross domestic product in the U.S. starting 2011 (when the Baby Boomers begin to retire in earnest); (2) there is more and more competition from emerging economies (reducing developed economies’ share of worldwide economic growth); (3) natural resources are being constrained by production peaks and depletion; and (4) interest rates cannot continue to go down forever.
Without some type of transition to a gold-based monetary system (and even with it), there are only two outcomes here: (1) Inflate the debts away (which will cause substantial financial harm to all ’savers’ including China and other countries holding U.S. denominated debt) or (2) Die (a total collapse of the financial system with a restart likely from a ‘caveman’ scenario). Anybody who thinks there is the possibility of ‘muddling through’ or ’steering a course’ for long term prosperity while this debt-laden monster continues to roam is crazy. There is always a chance something could work for a while, even a few years. Throw in a world war or other catastrophe that boosts economic output out of sheer necessity (bullets and war machinery need to be constantly replaced during a major war, infrastructure needs to be rebuilt, etc.) and perhaps the status quo of massive debt overhang could be stretched for a decade or longer. But when the fat lady finally sings, it will still come down to inflate or die. And while I sure as heck don’t want to experience hyperinflation, I want to see my neighbors turn into cavemen even less. Of course if you are a saver, the answer to all this is relatively easy: ’save’ in gold (and silver).
There is a third option — default.
That is the same as “die”.
When Nixon defaulted in 1971, did we die? Did the public even realize we defaulted? Let’s see what creative defaulting in the 21st century looks like.
I favor the caveman scenario. We could be only weeks away from such. So, hold 6 months worth of food and cash at home as a buffer.
tzo: The U.S. defaulted on its gold-backing for international currency settlement. Anybody could still have used U.S. dollars to buy gold even if it wasn’t from the U.S. Treasury. That was a default with a small ‘d’. To default now would be a real ‘Default’ in that the government would essentially walk away from all of its obligations. This is the same thing as die since the U.S. dollar and everything based on it would be dead.
Joe M: I would too if I didn’t have family or friends to care about. The caveman scenario would probably be “better” but it would also be more dangerous in a literal sense. Wealth is nothing compared to friends and family. That is where greed stops in my case.
Inflate or die isn’t even a valid option. Reckoning day may be delayed by such a tactic, but it can never be completely avoided.
Restating the options, you can not inflate and die today, or you can inflate and die tomorrow.
Did I mention that every day delay only adds to the number of deaths as the problem grows larger?
There is no avoiding the consequences, Tom, nor the painful adjustment that will occur. You can only hope to still be alive when it happens, so that you might help as many people as you can. Hoping that we can be protected from reality until after we die is no solution, but a condemnation of our heirs that we allegedly love.
If not here, where? If not now, when?
silverax:
Gold is money and currency is credit. Currency is a receipt for “gold in the vault.” If the vault owner cannot redeem his outstanding credit receipts for gold, he has defaulted with a capital, bold-faced “D.”
The fact that others are willing to accept those dead receipts at a discount (it wasn’t too long after 1971 that the gold market accepted dollars at a 350 to ration, or a 90% discounting of the junk paper) is irrelevant. The U.S. Treasury, by not redeeming its own debt notes, declared bankruptcy. Period. This junk paper is now trading at a greater than 96% discount on the gold market from its 1971 value.
The paper dollar was never money, it was currency. It was never “as good as gold” due to its counterparty risk?just like paper and electronic PM contracts today. The outrage and scandal that surrounds today’s PM futures markets is due to more paper than actual metal. It’s a farce. But that’s exactly what the U.S. did with its fiat “futures contracts,” the paper dollar. They defaulted the same way the PM futures market must soon. When promises far exceed delivery possibility, then default is inevitable.
Our economy died in 1971. That it still lurches about like something from Pet Sematary is testimony to our misplaced faith and general ignorance.
Capitalism is based on capital?stored wealth in the form of commodities. We have been living in a system of creditism for the past 3-plus decades. Big difference.
So is our economy going to die? Yes, because fiat credit economies always die, and deservedly so. Will we reestablish a capitalist economy with real money to replace the failed creditist model? Hard to see that as a possibility yet. Could happen, though.
More likely: Misplaced faith and general ignorance leads to the 21st century version of the stealth default. Forget the dollar?here’s the Amero! Worth ten dollars each! Trade in your dollars while you still can! The Amero is strong! Speculators will not be able to attack it! Take your faith out of that old, worn out, outdated currency and put it right here!
Everyone loses 90%, but all debts are reduced 90% as well.
What default?