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The
jump in the price of gold Tuesday to a record $1,083.30 per ounce, following
the announcement of the $6.7 billion sale of 200 metric tons of gold by the
International Monetary Fund (IMF) to India’s central bank, should serve
as a clear indication to U.S. investors that they are no longer the center of
the economic universe. It is evident that occupants of closed systems become
more unstable over time. This includes investors within the United States,
and potentially more important, the occupants within the Beltway in
Washington D.C.
The
danger is that as those in the bubble become detached from the realities of
their external environment, they will find themselves increasingly
jeopardizing their ability to survive on their own terms. U.S.
investors would do well to ponder yesterday’s move in the price of
gold, the direction of the global economy, and the alignment of government
policies in the U.S. An independent and thoughtful analysis of the times may
be more important than ever.
The
jump in gold on a day when the dollar rose against foreign currencies should
not suspend the case for gold as a hedge against further devaluation of the
U.S. dollar. The move relative to the U.S. dollar is not too
surprising, considering the purchase by India’s central bank was one of
the largest sales in history. Interestingly, the sale of gold by the IMF was
anticipated, but it came as a surprise that the buyer was India and not
China. India and China can be seen as competitors for hard assets as
world currencies, particularly trading currencies such as the U.S. dollar,
may become gradually less important. Both India and China cannot be
faulted for wanting to diversify out of U.S. Treasuries and into gold
considering their relatively low level of gold to foreign exchange reserves
of only about 6% and 1%, respectively.
It is
becoming increasingly apparent that central banks and foreign investors are
looking to diversify away from holding U.S. government securities and U.S.
denominated financial instruments. The U.S. economy is not showing the
requisite strength to satisfy government spending even without the looming
cost of health care reform. While businesses and households in the U.S. are
deleveraging (hoarding cash, increasing savings and reducing debt), the U.S.
government appears to be its own perpetual-motion crisis-generating cash
machine. Even countries such as Venezuela are entering currency markets to
support the U.S. dollar in order to sustain their ability to maintain their
exports. Actions by foreign central banks are temporary and ineffective
compared to stable domestic and monetary policy.
Accommodations
by foreign central banks are simply protecting their own domestic
constituents while managing a seemingly indifferent U.S. on its way to
oblivion. It would appear that the last line of resistance to the U.S.
government proceeding down that path of excess, and the brutal judgment of
global currency markets, would be an independent Federal Reserve refusing
further accommodation by absorbing new Treasury issues or allowing interest
rates to rise. At some point, domestic and foreign investors will get their
fill. Current meetings of Fed presidents may provide some indication of
direction. Certainly, gold bugs should fear real or perceived threats for
interest rate hikes as they will likely inflict even greater volatility into
gold price movements.
Reported
GDP Last Hurrah for Stimulus Program Credibility?
It is
too early to start back slapping over a confused 3.5% U.S. gross domestic
product (GDP) for the third quarter of 2009. Only a climatologist could be
capable of making the necessary adjustments for government stimulus necessary
to complete that calculation. While investors appear relieved as much as
pleased, optimism is anything but universal as government policies, actions,
and conduct insert significant uncertainty into the recovery.
A new
economic metric was produced for “jobs saved” to help the masses
understand the stimulus program. Interestingly, the complimentary
calculation of “GDP without stimulus” was conspicuously absent.
The beneficiaries of the stimulus program include an estimated 300,000
teachers and 80,000 construction workers. Actual
non-government/non-stimulus related job creation should be weighed against
the burden of paying off the debt created. There may be no clear path to
reduce this burden without inflation or transitioning to European-style
taxation. In the meanwhile, the media’s near silence about the
growing ranks of unemployed (now over 15 million) when compared to past
lamentations over homeless individuals, brings to mind a quote by Joseph
Stalin that “one death is a tragedy, a million is a statistic.”
The
U.S. economy is to be congratulated for not rolling over in the face of the
greatest economic challenge in a generation. Reductions in household
debt and efforts by small businesses to keep doors open speak volumes for
individual responsibility and the entrepreneurial spirit in the United
States. As a matter of survival, both households and S&P 500
corporations are hoarding cash at record levels. Despite the creation of
record monetary reserves, the circulation of money (Velocity) has slowed
significantly, resulting in low rates of inflation. Should non-stimulus
related GDP (Output) fail to materialize before cash starts moving through
the system, without an increase in interest rates, inflation and higher
levels for gold are more or less certain. Coincidentally, U.S. consumers
and investors may find their “hoarded” currency not going as far
overseas as before.
Questionable
Mid-term Grade on the Stimulus Program
Treasury
Secretary Timothy Geithner unflaggingly defended the stimulus program on the
Sunday morning news hour Meet the Press on November 1, 2009.
Geithner appeared sincere in his position that the downturn would have been much
worse without the stimulus program. He was generally correct that half the
money in the program had been reserved for 2010, in time for the mid-term
election, and he presented a reasonable argument that it was too early for
the administration to abandon the program. There could be no confusion that
there is no “Plan B” by the current administration to reverse
course, and that unspecified “hard choices” would need to be made
to figure out how (and who) would pay for it.
More
than 1% of the third quarter GDP came from auto sales. This is believed to be
due in part to the overly publicized “cash for clunkers” program.
Questions persist over concerns that the program cannibalized future sales
and promoted purchases of foreign automobiles. It is more difficult to
estimate the impact of the $8,000 federal tax credit for home buyers. These
credits benefited a narrow slice of the population who were in the market for
a home and in the position of making a long-term rather than a shorter term
decision such as buying a vehicle. Christina Romer, president of the White
House Council of Economic Advisors, said that without these stimulus programs
“real GDP would have risen little, if at all, this past quarter.”
While
some non-government job creation may have occurred, it is certain that the
legislation stimulated the hiring of additional Internal Revenue Service
(IRS) agents and Justice Department lawyers. As reported, over 19,000 filers
for the credit had not purchased homes and have claimed a total of $139
million. Also, an additional 74,000 claimants for $500 million had previously
owned a home and were ineligible. If this was not bad enough, the
Treasury’s inspector general reported that 53 cases included IRS
employees filing “illegal or inappropriate” claims. While the tax
credit is well-intentioned, it did stimulate graft and other unproductive
economic activities, and should stimulate additional skepticism on arbitrary
application of remaining funds and legislation for future economic
assistance.
Is
the U.S. a Champion of the Rule of Law?
Actions
by government representatives sworn to “preserve, protect and
defend” the U.S. Constitution offer plenty of reasons to question if
the nation is still on the same parchment. In retrospect, consider how
well-intentioned programs such as insuring deposits of banks (to promote
commercial stability) have led to setting CEO compensation; providing social
security and medical entitlements (to provide safety nets) have led to
redistributive progressive taxation; and the lowering of qualifications and
guaranteeing mortgage debt (to provide affordable housing) has disrupted the
availability of credit and inflicted a crisis on the financial
industry.
The
descendents of these good intentions are now fathering both the takeover of
the health care industry, reported to be one sixth of the U.S. economy, and
Cap and Trade energy legislation. Separately or in combination, the
economic gravity of these legislative initiatives raise the specter of the
Smoot-Hawley Tariff Act of 1930 by Senator Reed Smoot (R.,Utah) and
Representative (R., Oregon). This legislation, signed into law by Herbert
Hoover, initially appeared to be a success, but was eventually contributed to
the depth and extent of the Great Depression. If that is not enough,
intimidation of free speaking individuals by the government, exclusion of
potential critics in the media (Fox News) from equal access, and threatening
corporations (Humana) dependent upon government acquiescence place an inarguable
chill on the First Amendment.
It is
time to dust off The Economic Consequences of the Peace by John
Maynard Keynes, published in 1920, a classic first-hand observation of the
Allies economic treatment of Germany following WWI and its (let us hope) unintended
consequences. After great detail on the specifics of reparations, Keynes
stated that “Lenin is said to have declared that the best way to
destroy the Capitalist System was to debauch the currency. By a continuing
process of inflation, governments can confiscate, secretly and unobserved, an
important part of the wealth of their citizens. By this method they not only
confiscate, but they confiscate arbitrarily; and, while the process
impoverishes many, it actually enriches some.”
As
discussed, “inflation” could include any “arbitrary”
redistribution of wealth imposed by any economic crisis exacerbated by
legislation that increases social anxiety and reduces the order and civility
of society. Keynes adds that “those to whom the system brings
windfalls, beyond their deserts and even beyond their expectations or
desires, become… the object of the hatred.” The target of this
“popular hatred [is] the class of entrepreneurs… The terror and
personal timidity of the individuals of this class is so great, their
confidence in their place in society and in their necessity to the social
organism so diminished, that they are the easy victims of
intimidation.” Eventually, “the ultimate foundation of
capitalism, becomes so utterly disordered as to be almost meaningless; and
the process of wealth-getting degenerates into a gamble and a
lottery.” Keynes concluded that any “Bolshevist”
would have been pleased to have “designed” such a strategy.
Almost
one year ago, also on Meet the Press, Chief of Staff Rahm Emanuel quipped
“Rule one: never allow a crisis to go to waste.” In the
interim a justice has been added to the U.S. Supreme Court based on her
capacity for “empathy” as much as the law. It is not too
surprising that “Pay Czar” Kenneth Feinberg has had free reign to
mete out justice without outrage from some looking for a scapegoat.
Clearly, the appointment of a “czar” to act as an officer of the
President required “the Advice and Consent of the Senate” (U.S.
Constitution, Article II, section 2). Without following the rule of
law, the work of the czar becomes at best “a shame” (Rep.
Edolphus Towns, D., N.Y.) and at worst “a little scary” (Rep.
Mark Souder, R, Indiana). While Feinberg’s actions to reign in
risk-taking by adjusting compensation may succeed, it is clearly an end run
around Sarbanes-Oxley, another expensive legislative experiment, and
democratic shareholder governance. If successful, possibly the next
target for curtailing compensation would be Tort reform, and adjusting lawyer
compensation for unnecessary litigation, to reduce damage on risk-taking in
the pursuit of happiness.
U.S.
Investors Should Seek Information Outside Their Closed System
It is
becoming clearer that the current times are extraordinary. Since the
dinosaurs, organisms failing to adapt have met with extinction. It is logical
that incorporating information or perspective from outside an established
reality is important to increase the prospects for survivability. This may
include looking internationally or back in history. For U.S. investors, gold
is a trusted hedge against inflation and devaluation of currencies. Gold is
also a prized hedge against arbitrary and/or selective application of the
rule of law.
Mike Niehuser
Beacon Rock Research.com
Also
by Mike Niehuser
Mike Niehuser is the founder of Beacon
Rock Research, LLC which produces research for an institutional audience and
focuses on precious, base and industrial metals, and substitutes, oil and
gas, alternative energy, as well as communications and human resources. Mr.
Niehuser was nominated to BrainstormNW magazine's list of the region's top
financial professionals in 2007.
Mr. Niehuser was
previously a senior equity analyst with the Robins Group where he was a
generalist and focused on special situations. Previously he was an equity
analyst with The RedChip Review where he initially followed bank stocks but
expanded to a diverse industry range from heavy industry to Internet and
technology companies.
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