Gold - The Cash That No Central Bank Manages

Ouzilly, France

After the biggest spending and borrowing binge in history, Americans need time and money. They need to pay their debts. They need to build savings for their retirements. They need time and money to recover from their mistakes.

What kind of mistakes?

Well, down near the bottom of the ladder, people bought houses they couldn’t really afford to own in places they couldn’t afford to live. And cars they couldn’t afford to run. Those mistakes need to be undone. Which is why there are so many foreclosed houses on the market... and why house prices generally are falling.

S&P/Case-Shiller reports that house prices took their biggest hit ever in the second quarter of this year. They were down 15.4% from the year before. Further up on the ladder, the rich are now embarrassed by their own housing mistakes. New Yorker magazine reports that it is the ‘season of white elephants’ in Greenwich, Connecticut. Speculators began huge mansions — in the "Georgian Stockbroker" style, for example, complete with indoor swimming pools, wine cellars, movie theatres, dozens of bathrooms, even ice-skating rinks — and now find the buyers have disappeared. Want to buy a $28 million spec house? Go to Greenwich.

At the investment level there were plenty of mistakes too. Sub-prime mortgage lending dominated the headlines for the last 12 months, but the same reckless spirit found its way into transactions all over the economy. Private equity, IPOs, student loans, shopping malls, fast-food joints — while the going was good, everyone wanted to go along.

And now they all need time and money to pay for their errors.

The baby boomers say they are postponing retirement. Some are going back to the office.

A county in Alabama says it will have to declare bankruptcy.

The FDIC says its "problem list" of banks lengthened by 30% during the second quarter.

Bank earnings fell to their second lowest level in 19 years, says Bloomberg.

In London, tens of thousands of jobs have already been lost in the financial sector, says the Financial Times. IPOs, where the City made much of its money, have "fallen off a cliff."

We have lived through the biggest credit expansion ever. Ahead is perhaps the biggest credit contraction ever. Why? Because it takes time and money to correct mistakes. The bigger the mistakes, the longer and more expensive the correction.

When money and credit flow, they tend to raise prices. You get inflation — first of asset prices... later, of consumer prices. When money stops flowing, prices come down. As George Soros puts it, the willingness to lend is directly related to the value of the collateral. Both tend to rise and fall together.

Currently, lenders are wary and the value of the collateral is falling. Everyone knows house prices are going down. But US stock prices are going down too. Adjusted for consumer price inflation, they’ve been going down since the end of 1999. That is, a $50 stock is still worth about $50... but the 50 bucks ain’t what it used to be. It buys only 1/5th as much oil, for example.

This trend, towards lower asset prices, is likely to last a long time. To protect ourselves, we began buying gold in 2000. So far... so good.

And more thoughts... more rambles... more late-summer perambulations...

*** "Gold hasn’t done too well lately, maybe it’s time to get out..." The thought comes up from time to time, most recently from a visitor from Maryland.

"If the world economy is slowing down, commodities aren’t the place to be..." he went on. "Gold either. People buy gold to protect themselves from inflation. But inflation isn’t going to increase in a recession. You’d be better off in cash until this thing turns around."

Our guest voiced what is probably the dominant opinion of the summer — that a worldwide slowdown means price increases will slow down too. Without the hot breath of the inflation hounds chasing it, gold will go back to sleep and the Fed can continue to rescue speculators from their mistakes.

That’s why the US 10-year Treasury note yields all of 3.78%. Yes, investors know they will lose money if inflation remains above 4%. But that risk — they believe — is worth taking for the safety of the dollar and the full faith and credit of the US Federal Government. Besides, inflation is almost sure to go down.

This view may turn out to be right. But when we think of moving to cash we pose the question: what cash? And there’s the problem. The planet’s alpha cash is the dollar. And while the dollar may have some limited upside in a punk market (it’s already gone up about 7% against the euro), the potential downside is enormous.

What if the bond market is wrong about inflation? What if the increase in Producer Prices — now running at nearly 10% — works its way into consumer prices? What if demand from the developing world doesn’t slack off as expected? What if there is war? What if the US economy worsens... and the feds need to cut rates and offer further $100 billion bailouts? What if Asian, Arab and Russian creditors lose faith in the dollar and switch to euros?

Any of these things could be catastrophic for holders of US Treasury bonds. At 3.78% yields — it hardly seems worth the risk. Shorter-term Treasury bills barely pay anything at all.

So what cash do you hold? We choose gold because it is cash that no central bank manages. No one prints. No government backs. And no one ever threw away a gold coin.

*** Colleague Joel Bowman lives in Dubai. We wondered whether the place was the bubble we had heard, so we posed the question to him. His reply:

"My short stay here in Dubai has led me to believe that Dubai & Co. is a largely unsustainable enterprise. "Dubai’s lifestyle makes the average American look like a prudent, energy-conscious, environmentally-friendly health nut! I read the other day that 60% of the average Emirates’ total income is spent on consumer goods — Gucci totes, designer abayas and million-dollar number plates.

"The big difference I can see is that, save for the last few years, the vast majority of America’s wealth accumulated over time and from the productive, honest toil of citizens who forged metal, cracked bullwhips and invented light bulbs. Dubai’s wealth has come on fast and strong... and is not really the product of its own honest toil. Were it not for American, British and French companies — among others — who told them what all that black stuff underfoot was and what the rest of the world was prepared to pay for it, Dubai might still be a pearl diving port of a few thousand itinerant workers.

"If the American economy is drunk on its own home brew of "irrational exuberance," Dubai is sucking down straight tequila shots and desperately trying to catch up. We see it here everyday as the government squanders its unearned wealth on extravagant welfare programs and "National Identify Preservation" boards and committees dedicated to "cultural heritage association this" and "watchdog for immoral behaviour that."

Then there’s the over-reaching controls on the economy — price fixing, wage manipulation, rent caps...the list goes on.

"I read with interest the "Frapp On Ice" story just the other day — about how Starbucks will close 600 stores over the next year as discretionary consumer spending shrinks. That story was all the more amusing for me as I actually read it on my laptop... in the Starbucks that just opened in the lobby of my building last week. There are now six Starbucks within walking distance from my front door (and I don’t walk far — it was 125 degrees on Monday). We also have numerous Seattle’s Best, Krispy Kreme’s and the rest of the strip mall junk to go along with them. It’s like anytown USA... super-supersized. Which brings me to my next point...

"Jumeirah Beach Residence (or JBR for the cool kids) is a 36-building project that opened a year or so ago. Each building is around 40 stories and there is said to be space for 25,000 people to live here. But where are the people, I ask myself? So few apartments are occupied that I still notice when a conspicuous new light comes on at night in the surrounding buildings... yet, apparently, most are sold. I can’t see the newbies rushing to cut more keys as rent prices have, get this, risen by over 50% since we moved in in December. We took a relatively comfortable two-bedroom with a decent view, but if I walked in off the street today I couldn’t get a studio on the first floor for the same price.

"The story is similar elsewhere in the city too. Projects are developed, pumped through the massive Dubai & Co. media arm and, voila! the joint is 50, 60, or 70% taken! "It’s another success story," ring the papers. "Dubai’s world-beating ingenuity triumphs again!" chorus the king and his merry band of sycophants.

But, best as I can make out, the biggest developments — including JBR, touted as the "largest single-phase residential project in the world" — are still ghost towns.

"A friend of mine was out the other day to inspect a house he saw for sale in one of these new developments (Arabian Ranches, in this case). The price was at the top-end of his budget and he was "umming and ahhing" about it until the estate agent casually threw in, "now, this property is only available in lots of 10." In other words, the development is being sold off in 10-house chunks to middle-men who then flip ‘em and burn onto the next "world beating" development. "So who’s buying all these vacant houses, streets and islands? Some — and not just the conspiracy theorists either — say Dubai is a massive funnel for dirty Russian money. Others, including myself, reckon speculators buy into the hype... hoping a bigger idiot will buy into it a year later and hand them a handsome return.

"The trouble is, sooner or later you’re going to run out of idiots. Even here in Dububble the supply of them is not without limit."

*** "What a project!"

Yesterday, we drove down oak-lined lanes to a tiny village on the side of a hill. A friend, Guillaume, inherited a castle and was showing it to the "Friends of Old Houses" group. We thought we’d have a look.

The place was built of granite over many centuries. Guillaume’s grandmother lived there until she died in 2000. Her bedroom is about the only room in the house that is still liveable. Otherwise, it is a ruin. Leaks in the roof destroyed beams and rafters. Thieves stole furniture and paintings. Walls — even ancient stone walls — cracked and crumbled. We stepped carefully — watching out for the holes in the floor.

"This house has been in my family since 1217, when the Count de Cordon built it or bought it. He was my great-great etc grandfather. Of course, I can’t let it fall into ruins. It’s the family chateau."

Guillaume is a gendarme during the workweek. On weekends, he is a mason, a painter, or a carpenter. He has about 100 years’ worth of repairs to make — including installing electricity and plumbing.

Recently, Guillaume has been sent on 6-week tours to French Guiana, in South America, where his mission is to stop illegal gold mining.

"It’s all jungle. A miserable place. I can see why we used to send prisoners there. Who else would want to go?

"These miners sneak across the border with Brazil. They’re almost all Brazilian. But they’re very industrious. They will carry pieces of a bulldozer with them — on their backs, because there are no roads. And they’ll but them together. Then, by hand... or with these smuggled machines... they just dig up the earth, looking for gold.

"We’re sent out in teams of 5 to 10... we parachute down to the jungle clearings... then we run them off. Usually, they take off when they see us. Then, we set fire to everything. We destroy their shacks and their machines.

"You wouldn’t believe the kind of mess they make. Hundreds of acres can be torn up in a few weeks... and then, they wash all dirt down the river.

"Our problem is that once we get on the ground, we have to travel by foot... and sleep in hammocks, just like the local Indians. And the mosquitoes bite the hell out of us. But you get used to it..."

Back in France, Guillaume returns to the family chateau and gets back to work. P.S. If you enjoyed this article then we encourage you to sign up for the free Fleet Street Daily eletter. Learn what you can expect from today's markets -- and how to prosper in the face of uncertainty. You won't find more thought provoking writing anywhere on the Internet.

^ Back to top

BlinkList
Del.icio.us
Digg
Facebook
Google Bookmarks
Livejournal
Newsvine
Reddit
StumbleUpon
Yahoo! My Web

Gold - The Cash That No Central Bank Manages

RELATED ARTICLES

FLEET STREET LETTER

SMART COMMODITIES UK

PROFIT HUNTER

ZURICH CLUB

Gold - The Cash That No Central Bank Manages