Saturday, January 28, 2012

Open Forum

A few people have reported problems accessing the second page of comments, so here's a new thread for new comments. This link should get you to the 2nd page of the last thread:

Some of you only read comments in the popup window, but you can also read them right under the post. If you click on the name of the post at the top, here's where that page 2 link appears at the bottom once the number of comments reaches 201:


PS. Here is the link to the second page of comments on this thread:

I see we're on page 3 now. To get there, just change the two to a three in your browser bar if you still can't see the links at the bottom. Or try a different browser.

Monday, January 23, 2012

Yonder ...thur be DRAGONS!!


Below is a fun little Chinese New Year guest post by Sir Topaz, aka One Bad Adder (although he seems to be pretty good at math to me). Just a little "food for thought" as he says...

9 月 8 evening Yan’an Road, Shanxi Road intersection, north-south and east-west traffic to each other and lack of traffic police to ease, crossing continued congestion. Post intern reporter Wang Ju Liang Yang deep to figure

The Shanghai Transportation System – an analogy
by OBA

In China there generally exists a feeling of the presence of “authority”. In almost all cases this is reassuring for the visitor …not so however on the streets of the cities.
There, chaos seems to rule …and it would be a brave, nay foolish “westerner” who would even contemplate getting behind the wheel without spending a lot of time to first study and absorb the “local” way.

After the initial shock, the traffic chaos begins to take on a semblance of order as one realises there are very few accidents evident and largely the only obstruction to the (albeit slow) traffic flow, is the occasional breakdown.

Seemingly, the “secret” to navigating your way in Shanghai traffic is to quickly develop an understanding of (a) the user, (b) the signalling …and lastly (c) the law.

The Chinese motorist, bike-rider and pedestrian all appear to have what I regard as a highly developed “respect” for one-another. This, above all else is the key to maintaining a smooth flow of traffic and getting to where you need to be.

Wherever they’re installed, the ubiquitous Traffic Lights are essentially used to complement this level of individual respect where: - GREEN means GO (cautiously) …and RED means STOP …and GO (slightly more cautiously)
There are few (if ANY) Walk – Don’t Walks …and I’m yet to figure out what AMBER means ;-)

The ever-present “authority”, when applied to traffic management, appears to be treated with a certain level of disrespect …not necessarily contempt, apparently something more akin to “I’m alright Jack! – we’ll manage it amongst ourselves”.

“Management” approach to the Shanghai Traffic System du-jour and I might add to life in general in China …to all intents, appears to be a case of “let-it-be”.

My apprehension in Chinese traffic is also compounded by the fact that I’m used to driving on the Right-(correct ;-) hand side of a vehicle!

It is worth also mentioning here that trying to grasp the exponential increase of motor vehicle uptake in Shanghai …and China in general, now and into the future, completely boggles this layman’s mind.

So …on arrival at Shanghai airport you get a Cab and experience all this with trepidation from the passenger seat as you meander into town 1 or 2 hours away (on a good day)

Shanghai taxi driver ID includes a registration number 111,892 where the lower the number the more earlier the driver was registered. One colleagues opined that he would get out of taxi where the registration was recent – currently around 3xx,xxx, simply because the driver would need help understanding directions. The higher number of stars denote better quality of service, and to some extent whether or not the driver is likely to understand some English.

At the other end of the Shanghai Transportation spectrum …albeit separate to it, is the Mag-Lev Train.

Going from the outskirts of the City to the Airport, this state-of-the-art service delivers you in comfort and on-time at speeds never before attained for mass-transit travel “on” Earth.

A truly unique experience - as you hurtle at 431kph to or from the Airport. The thing actually backs off to 380k’s to pass the one coming the other way …wwwoosh …they pass each other in 0.7secs …exhilarating stuff!

It was so enthralling at the time we experienced it, we ended up having several “goes”.

What a contrast …City – Airport …2 odd hours in traffic …or several minutes via Mag-Lev.
They built it …and the people came – well not quite in numbers to guarantee the sustainability of the thing economically, but come they did.
It goes nowhere, it’s too costly to build, tickets are too expensive, were common complaints but, believe you me, it serves its purpose admirably. Accordingly, they plan to extend this service to the city-centre …and I understand they’re installing a similar longer one from Shanghai to a neighbouring City as I type. (Probably be finished and have it operational by the time I get this posted ;-)

We can look at the STS as described above as an analogy for what might end up developing as a Global Financial System courtesy of our Oriental cousins-in-trade.

In Shanghai / China, if they were to adopt and enforce similar draconian rules and regulations that govern western traffic flow, the System would grind to a halt in a heartbeat, so to maintain the integrity of our analogy, we can assume China en-masse follows “let-it-be” principles in all facets of their activities …and essentially I believe they DO.

In this Laissez-faire Society / System, “respect” both for the individual …and transactions between parties, is sacrosanct.

Management essentially is kept to a minimum …a-la the STS.

We can also consider the Mag-Lev as representative of a functioning Free-gold option - included in the System but not necessarily part of it - where participants can opt out of the System if they so desire …be none the worst for it …and in fact gain by the experience.

Free-Gold then acts as an arbiter of the System whereby IF participants begin to stray too far from courteous interaction and behaviour, those potentially disenfranchised simply move to Gold.

Of course the Cab drivers are represented in this analogy by the various Financial Advisers, Accountants etc. who would not necessarily benefit financially by pointing you to the Mag-Lev …and ultimately perhaps would do so quite reluctantly.

Opting out (of the traffic) and onto the Mag-Lev does also have its limitations and suitable only for the few – as per Free-Gold ….but there is (and will be) absolutely NO RISK in doing so as the Human condition ultimately guarantees an upward new-currency evaluation of REAL Gold.

Can a similar “Laissez-faire” Financial System exist WITHOUT an escape option a-la Free-Gold? I really don’t think so.

(Pictures and music added by FOFOA)

Tuesday, January 17, 2012

The Gold Must Flow

In the last thread of comments, Jaqship asked about the possibility of a future Freegold tax, a punitive tax on gold meant to intimidate regular folks and steer them away from gold, and also to capture for the collective any windfall profit coming from a gold revaluation. Jaqship, who gave me permission to use his real name, is a long-time reader and supporter named Jeffrey Schramek. Jeff has an interest in these questions because he deals in rare and valuable historic treasures including a 1935 Nobel Prize made from 23K gold. Here is his website.

Jeff is certainly not a paper bug because his savings are tied up in these rare artifacts, not in a 401(k). And it turns out that moving from hard assets into bullion is a tougher calculation than moving from paper into gold. Really big money loves hard assets with numismatic and rare value because you can transport a lot of value through time and space in a much smaller package than you can with plain bullion. Also, billionaires aren’t as concerned with profiting from revaluation as they are with simply preserving what they already have.

The coin above is a Brasher Doubloon which was recently sold by a dealer in Irvine, California for $7.4 million, the most expensive private coin sale on record. The gold content of the coin is worth around $1,300 today, so that's a numismatic premium of about 570,000%. And while premiums won't enjoy the windfall revaluation of the metal, they will likely hold their present value quite well, preserving and shuttling purchasing power in a very small package. Imagine, you could fly anywhere with that coin mixed in with the spare change in your pocket.

The point is that the questions of taxes and confiscation on plain bullion are important to someone who is already holding hard assets and considering his options. And part of Jeff's reasoning was that gold bullion would be the most likely metal to be taxed "precisely because gold is useless" to the economy. So I thought this was an important enough topic that I'd take a stab at answering his questions in a post, so that everyone can benefit and discuss these issues. Here are a few excerpts from his questions in the previous thread:

Jaqship said…

My fear is that they will at some point mess with what is left of the middle class, e.g. by imposing a punitive tax on gold sales -- to intimidate regular folk from using gold to protect themselves from HI. Maybe likewise on sales of silver and platinum, although to attack those largely- industrial metals may bring unacceptable immediate harm to real production in the economy.

Given that "the Right People" control policy, what's to stop them from the proxy confiscation
of draconian tax rates in the US (enforced upon all but themselves and their friends)?

Precisely because gold is "useless", such taxation of it wouldn't put what's left of the economy at the sort of risk that such taxation of industrial metals like silver (and maybe platinum) could cause.

If so, moving much capital immediately post-Freegold into silver might be the wise course for Americans.
Am I missing something?

"Once the USA sees capital escape..." assumes that such escape will not be blocked for all but "the Right People" (who would be allowed to duck the harsh taxes anyway).
Italy has already introduced draconian capital controls.
The IRS and DHS may enjoy working together to crush any gold etc. Black Market that tries to emerge.

My guess is that much of US policy in recent years is driven by the aim of the Elites to stealthily reduce the masses to peonage, preferably without crashing the whole economy.
If this is right, silver (because it is so used in industry) may be the only safe haven which the Elites may hesitate to harshly tax.

"the large gold holders will run the country. They won't make rules that hinder themselves."

I fear they will indeed make such rules, but they'll arrange that the rules are only enforced against shrimps; just as they have been doing for the last 10+ years, e.g. against small brokerage houses (most of whom have had to fold).
(This collapse of the US system's rep for fair treatment has much to do with gold's recent rise, according to folks like Janszen.)

"... they'll be more than happy to tax silver into oblivion -- exactly *because* it is necessary for industry."

Only if they'll be OK risking the utter collapse of an already dying economy. I must admit that they may be just fine with that, but they may flinch at that extreme; they may be OK with what their handiwork will already have done to enserf the middle class.


Hi Jaqship,

This is a common concern, that the higher the nominal gain, the higher the tax that will be levied on that particular asset. It is sometimes called a Windfall Profit's Tax. The last time we had such a tax levied in the US was in 1980 on the oil companies. That tax was repealed in 1988 and we haven't had one since. The tax was on producers of oil since the second oil crisis of the 1970s, the Iranian Revolution, reset the price of oil from $15 in early 1979 to $37 in 1980. President Carter decided to deregulate domestic oil prices allowing the oil companies to increase production and ease the shortage. But in return for the deregulation, the government decided that the majority of the difference between production cost and price should be captured by the hungry collective.

But there are a couple of things to note here. First of all it was actually an excise tax on domestic oil and not really a profits tax. And most importantly, it was a tax on producers. I fully expect such a tax on gold producers once we see the way the Superorganism resets the price of gold far above the cost of production. But to see why this will NOT be the case for private gold—gold which has already been mined and is now held in private ownership—you must try to understand why and for what purpose the human Superorganism is revaluing physical gold.

There is a purpose for highly valued gold in Freegold. It has everything to do with the savers (net-producers) in the economy, and little to do with mining companies. Miners will become tools for the state, much like the printing press is a tool today. Only the gold already in the hands of savers will be revalued to the benefit of private parties. Gold in the ground will be viewed much like oil in the ground in 1980. As it comes out of the ground most of the substantial difference between production cost and price will be captured by the hungry collective. But before we talk about windfall taxes on gold savings, there's something you really need to understand.

The Gold Must Flow

The bottom line is that private gold needs to flow as a fertile member of the balance of trade. There will be no advantage for the USG to confiscate or tax above-ground gold this time. Gold may be utterly "useless" to the present debt-based economy, but it will be absolutely vital in the Freegold economy. (Here's a comment I wrote last April about the importance of privately held gold.) This seems incomprehensible when viewed from within the current paradigm which is why you must try to put yourself in the next one to see what I'm talking about. I can try to help you see what I see. It's not easy to explain, but I'll certainly give it a valiant effort once again.

Here's the way to look at it. Today the US is running a trade deficit of 21%. We import $2.34T worth of goods and services but we only export $1.84T for a deficit of $500B or 21%. What this means is that we pay for only 79% of our imports with goods and services in return. The other 21% we borrow and then consume. Every day, every month, every year, we are borrowing and then consuming 21% of our imports. And even though the private sector has cut back on its consumption since 2008, government sponsored consumption has increased so the total hasn't changed much. And 21% is about the average for the last 30 years.

All those goods and services that we borrowed and consumed for decades on end can never be paid back. And they never will be paid back. This is a certainty. But that doesn't mean it will continue. And that's what this paradigm shift is all about. That's why the Superorganism is revaluing physical gold. So that the gold can flow along with all the other goods and services in payment for imports.

We do export gold even today. US gold exports flow primarily to London, Switzerland and India for reasons that should be apparent. But the way gold is traded on the markets today sterilizes it in terms of globally moderating and regulating the delicate balance of trade. Gold is still traded in terms of debt, or paper promises of future gold. Gold debt. This is what goes out most of the time, and any kind of international debt only increases imbalances while actually reversing the spur and brake forces a physical-only gold market would otherwise exert.

It's kind of like if you built a car where the accelerator and brake pedal functions were reversed. It would be really hard to drive that car without eventually wrecking it if every time you needed to brake you accelerated, and when you needed to accelerate you came to a stop.

Imagine that Germany is shipping more goods to London than it is getting in return. So Germany is supporting London's trade deficit in the same way that China is supporting ours. Germany is letting London "borrow" extra goods and then consume them. In exchange, let's imagine that London pays for its trade deficit with paper gold, just like the US pays China with US Treasury debt. Germany will start stacking the paper gold in the same way that China stacks Treasuries. The debt will grow. The imbalance will grow. Nothing has actually flowed opposite Germany's goods and services except debt.

If, on the other hand, physical gold flowed from London into Germany and the price was high enough that it offset the trade deficit, then there would be no trade imbalance. There would be no accumulation of debt. Everything would essentially be settled on a cash basis with no international debt. But in order for this to work in reality, the price of gold will have to be much higher than it is today because there's simply not enough gold to flow at today's prices in order to fill the trade gaps that already exist.

And here's another interesting note. It won't matter if London is still using the pound or if they switch to the euro. The gold still balances trade as it flows. So no, it's not a flaw of sharing the same currency that the PIIGS can't balance trade with others in the euro's core. It's a flaw of the current system which existed long before the euro was even born. Within the current system, the euro does remove the possibility of local currency collapse as an alternative adjustment mechanism, but honestly, that's part of what they wanted with the euro. The current system is one of irreversible debt-buildup and gold-debt which sterilizes the flow and price of gold.

Spur and Brake

Once gold is flowing at a high enough price to balance international trade, it will start accumulating in countries that run a trade surplus excluding gold (including gold, trade will balance). Likewise, it will start disappearing from those countries running a trade deficit ex-gold (excluding gold). This is how the spur and brake forces work on an economy in Freegold.

As the gold supply within a "deficit ex-gold" nation dwindles (think: USA), each piece remaining will become more and more dear in terms of other goods and services within that zone. In other words, the purchasing power of gold will rise in the "deficit ex-gold" zone vis-à-vis goods and services in that zone. Likewise, the purchasing power of gold will begin to fall in the "surplus ex-gold" zone (think Germany or China) versus goods and services in that zone because of the large and growing accumulation of gold.

At this point the large quantity of gold in the "surplus zone" will have a lower purchasing power against goods in its own zone, but a higher purchasing power abroad in the "deficit zone" and demand for imported goods will grow while exports will start to fall. This growing demand from abroad will be felt in the "deficit zone" and will be met with new supply. Likewise, the falling demand for imports from the zone with a declining volume of gold will be felt in the "surplus zone" and be met with decreasing supply. Incrementally, the "surplus zone" will slow production and increase consumption while the "deficit zone" experiences the opposite effect. Excluding gold, the balance of trade will shift back and gold will start to flow in the other direction.

Notice, please, that I'm not even talking about the flow of currency or price inflation/deflation in currency terms. Inflation or deflation in currency terms can be happening in either zone depending on how the monetary authority is managing the currency. But what matters in terms of the real trade flow will be the purchasing power of Freegold (not in currency terms, but) vis-à-vis the rest of the trade flow of goods and services.

If you have high currency inflation in the "deficit zone" because the government is printing like crazy, the price of gold will be rising even faster than the price of goods and services. On the contrary, if you have high inflation in the "surplus zone", the price of gold will be rising more slowly than the CPI, exerting its brake force on the economy because gold will still be found to have increasing purchasing power abroad and decreasing purchasing power on goods from its own zone. In other words, gold will be exported to other zones where its purchasing power is higher, spurring those other zones to produce more and putting the brakes on the overheated economy in the "surplus zone".

This flow will continue reversing back and forth forever, as it should be, because there is no such thing as a perfect equilibrium. And again, I want to draw your attention to the fact that I'm dealing only in the physical plane, ignoring the monetary plane. This is what Freegold does. And it doesn't matter if the "surplus ex-gold" and "deficit ex-gold" zones each have their own currencies or if they share a single currency. It still works the same way. Savers run the economy. Savers are the marginal surplus-producers and consumers. When the savers start saving more, it means the economy is producing more. When the savers start dishoarding and consuming, the economy is producing less vis-à-vis its balance of trade. This is the spur and brake force of Freegold, the international demand driven by the fluctuating purchasing power of gold as felt by the savers, regardless of any transactional currency effects with which the debtors may be tinkering.

Now that I've given you a brief description of how Freegold will work in the physical plane (it will also exert forces on the monetary plane, but that's a big subject for another post), let's take a quick look at how the present debt-based system, the $IMFS, differs in that it exerts the exact opposite spur and brake forces. In the present system it is debt that flows to fill in the same trade gap that will be filled by physical gold in Freegold.

As I said above, the US pays for 79% of its imports with goods and services exports. But the remaining 21% it pays for with debt that accumulates year after year. The US is the "deficit zone" and its trading partners who are accumulating US debt are the "surplus zone". Our trading partners send us 100% goods and services and we send them back 79% goods and services plus 21% US dollars. They then have to do something with those dollars. But they already have more than $4 Trillion in accumulated US debt. So what to do with those new dollars that keep coming?

If they were to insist on spending those extra dollars on more goods and services in order to balance trade, they'd simply drive up the dollar prices of goods and services relative to their own domestic goods and services. In the physical plane final analysis, they'd still receive less back from us than they sent us, and they'd simultaneously collapse the value of their $4 Trillion accumulated debt. So instead, they loan those extra dollars back to us at a nominal (not real) rate of interest and then we use them (again) to buy more of their goods.

So the more debt that flows as payment into the "surplus zone" economy, the more it is spurred to produce even more goods for the "deficit zone" to borrow. And the more "deficit goods" that flow into the deficit zone, the more dollars that must be recycled and the more the "deficit zone" must consume, which is, in effect, a brake force on the consumption-based economy. The brake force is being applied to the "deficit zone" and the spur force to the "surplus zone". The opposite of Freegold.

When debt flows, deficits accumulate and grow requiring more accumulation and more debt. The net-consumers are incentivized to net-consume more and more and the net-producers to produce ever more. There is no adjustment mechanism, no natural governor. This simply continues until the whole thing collapses. That's the only adjustment mechanism: periodic collapse. That's the $IMFS.

(For more on the Freegold adjustment mechanism, search for the word "Greece" in these two posts and start there.)

Strong Hands

So that's where the Superorganism is taking us. But before I get into the issues of a windfall profits tax and confiscation under Freegold, I want to discuss one more concept, the concept of strong hands going into Freegold.

When anyone talks about "gold" today, that word identifies a whole panoply of gold-related investment options. They include unallocated gold credits, forward contracts for future gold, futures contracts for trading, ETF shares, gram-denominated savings accounts and e-money platforms, mining company shares, exploration company shares, certificates, options, derivatives and more. There are many ways to invest in this thing called "gold" through various counterparties today. And it is the market interplay of all these various options, much more so than transactions in and movement of physical, that determines "the price of gold" as it is widely referenced today.

This is what we mean when we say that today's "price of gold" is not the price of physical. Yes, you can still buy physical at that price, but it is the price of a wide range of products claiming the name "gold" more so than it is the price of a specific metal element.

This conglomeration of many tradable, counterparty options that purports to be part of something called "gold" is struggling to stay together as "the price of gold" rises. Market mavens like Jim Sinclair have long predicted the arrival of violent swings of magnitude as "the price of gold" battles its way higher. And it seems this breathtaking volatility may be just around the corner today.

In just the last 12 months we've seen "the price of gold" run from $1,350 up to $1,900 and then back down to $1,530. Not only that, but "gold" shot up $400 in just 7 weeks during July and August, and then it plunged $300 in three weeks. I wonder what the next run will look like. If it follows the same percentages as last year, we'll hit a very special number this year.

Each time the price swings up and down like this the "gold" traders trade their way in and out of their favorite paper gold positions. But the physical side is slowly working its way into stronger and stronger hands with each swing. Strong hands buy the dips while weak hands are selling in a panic.

I heard a story from a dealer recently about a poor sap who'd bought a bunch of Eagles from a company that advertises on TV, paid too high of a premium to cover all that expensive advertising, and he had also taken physical delivery which is why I heard the story. On the last big plunge into the $1,500s he walked into this dealer with his box of gold coins, head hung low, ready to cut his "losses". That's a weak hand. Someone who doesn't understand what he's doing when he buys gold coins.

As I've noted before, when I started this blog back in 2008, the highest "gold price" predictions I had ever encountered (other than A/FOA) were in the range of $1,650 to $2,000 per ounce. That has obviously changed. Today we read a variety of future price predictions ranging from $5,000 on up to $50,000 per ounce. But the problem I see with my fellow high price prognosticators is that they don't support those prices with an explanation as fundamental as Freegold. This is a problem.

That special number I said we could hit this year, if the trend doesn't accelerate and simply repeats, is $2,333. The low to high in the last 12 months matches a rise from today's price to about $2,333 in the next 7 or 8 months, if we were to have an exact replay. And the problem is that $2,333 is the inflation-adjusted (based on official inflation) peak from 1980.

Fair warning to all gold bugs who don't understand Freegold

I'll make a prediction right now. As we approach and surpass $2,333, other high price predictions notwithstanding, you'll read articles from all of your favorite gold bug writers making the comparison with the 1980 peak. And if the ascent is anywhere as vertical as it was back in July and August, that comparison won't be lost on a single gold bug. No one wants to miss the top like so many did back then.

So when it starts to fall after a vertical rise, and it will fall, no one will be thinking about those other high price predictions. Instead, they'll be thinking "get out now, just in case. I can buy back in later and make a profit." This group will include all paper gold traders as well as a good portion of the "physical" gold bug community. And because of the "specialness" of that number, $2,333, there won't be any paper gold buyers trying to catch the knife, so it will fall hard. Possibly too hard. No one wants to be that guy who bought on the way down in 1980.

This could potentially be the final shakeout of weak physical hands, because there will be plenty of strong hands catching that physical even though physical buying won't stop the price from falling. Unfortunately for a few long-time gold bugs, the lack of a fundamental and foundational understanding of a much higher value could see them liquidating at the worst possible time in all of history. And that would truly be a shame. At least I have given fair warning. I'm not predicting that this is the way it will play out. Only that it could. And being aware of this possibility has value if it gives you strong hands at a key point in time.

Tax That Gold!

Now we can talk about windfall taxes and confiscation (related topics). Hopefully you were able to absorb the above concepts. The human Superorganism is revaluing gold vis-à-vis not currency, but everything else, for a purpose: the gold must flow. Again, the Superorganism is revaluing gold in real, not nominal, terms. (It is also devaluing the US dollar in real terms, but that's a separate subject for a vastly different post.) And going into Freegold, physical will start out in the strongest of hands, meaning people like you and me who know what it's worth in international terms and Giants who don't need to sell during suboptimal conditions.

But before I get into taxation, I'd like to discharge the confiscation meme once and for all. Physical confiscation only makes sense if you are going to confiscate the gold and then, and only then, nominally revalue it yourself hoping that your currency is strong enough that a nominal revaluation actually delivers you a real windfall (see: 1934). But as I said earlier, the human Superorganism is revaluing gold this time, not FDR or the USG. So taxation is the only option. That said, I would not leave my gold where it, or my capital gain, could easily be automatically absorbed during a short-lived government misstep, which is why I recommend personal possession or at least the closest thing to it.

The first thing you need to understand is that the IRS taxes nominal gains only. It does not tax real gains. It is as blind to real gains as it is to real losses. The tax law would have to be completely abandoned and rewritten from scratch in order to tax real gains. This is not going to happen.

So let's make an assumption and see where it leads. Let's assume that the Freegold revaluation has occurred and the USG has decided to impose a 90% windfall profits tax on its citizens who hoarded physical gold through the transition. What will be the consequences of this action and who will be hurt?

Now, because the US is blind to real gains, you'd have to sell your gold at the new Freegold price in order to make a taxable nominal gain. Until you sell, you still have the same thing you had before the revaluation, a single gold coin. For all they know you'll hang onto that gold and the price will once again fall and you'll still just have one gold coin worth much less. Or maybe you'll lose it in a boating accident, or it will be stolen, and you'll have no gain. The only gain the IRS recognizes is nominal gains. (Here's a comment I wrote back in 2010 on future gold taxes.)

Part of our premise in this exercise is that Freegold has arrived, along with everything that comes with it. So even though the USG has misstepped and put on a 90% gold tax, the rest of the world has not and is now enjoying a technically balanced trade flow along with the reappearance of Jacques Rueff's "forceful but unobtrusive master, who governs unseen and yet is never disobeyed."

Let's ignore hyperinflation for now and talk in constant dollars. Gold now has the purchasing power of $55,000 in 2012 constant dollars. Your gain per ounce is roughly $53,500 and the government wants 90% of that money, or $48,150 leaving you with only $6,850 worth of purchasing power for every coin you choose to sell. Meanwhile, those strong hands in other Freegold countries have $55,000 in purchasing power for each coin they choose to sell.

Strong hands in the USA have $6,850 in constant dollar purchasing power. Strong hands in the ROW (rest of the world) have $55,000 in purchasing power. The gold must flow, but will it flow from the USA as much as from other deficit countries under these conditions? If it does flow, it will still flow across international borders at the new Freegold value and vital goods and services will flow back into the US. But only 12.5% of the purchasing power of that gold will go to the person with the choice of "to flow or not to flow" while 87.5% goes to the USG.

Tax laws always change, and this is a fact that will also be factored into the decision "to sell or not to sell" that strong hands in the US will face. Another factor is black market arbitrage. A strong hand in the US won't have to engage in smuggling gold out of the country himself in order to gain more purchasing power than $6,850. With $48,150 per ounce in potential black market profit (that's $1.5 billion per smuggled tonne), it's not hard to imagine a vibrant black market that would gladly pay you twice your $6,850 off the books.

So if the gold in private hands in the US doesn't flow in sufficient amounts, given that US debt has been discredited through the Freegold phase transition, the government will have no choice but to continue printing money in its vain attempt to support the US trade deficit and its own status quo as Uncle Sugar to the people. And in a last-ditch effort to support its own failing currency, it will have to ship Fort Knox gold overseas. FOA mentioned something about this: "…the US will find itself shipping ever higher priced gold to defend an ever lower valuation of dollar exchange rates."

In this scenario, the need to continue printing in the face of an ongoing currency collapse will obliterate any miniscule gain that comes from the few shrimps who actually decide to sell their gold in an untimely way and pay the tax. The US has precious little gold in private hands as it is. And it will need that private gold to flow. It needs you to sell your gold to your dealer so your dealer can export it to our trading partners. That's how trade flows will resume under the new paradigm, with savers choosing to let their gold flow because of the amazing purchasing power it delivers.

And with international trade flowing again, the government will have much more economic activity to tax than it did when it tried to tax real capital in its purest form based on the silly notion that the hungry collective deserves a windfall nine times greater than the gold investors who kept gold inside the zone through a turbulent transition. The bottom line here is that I do not know if the USG will try to tax the windfall profit that comes from Freegold. What I do know is that, if they do, it won't last very long.

And once again, being aware of this possibility has value if it gives you strong hands at a key point in time.


PS. See Mortymer's comments below for info on Euro-area gold taxes.

Wednesday, January 11, 2012

The Studebaker Effect

One of my resolutions for 2012 is to spend some time finding new ways to introduce gold-resistant paperbugs to the powerful arguments for buying and holding physical gold right now. But I never want anyone to invest in anything based merely on a recommendation. I want them to understand the reasons for the purchase themselves. Peace of mind can only come from within, and that's what understanding can provide.

This is tricky ground for me because I'm not a gold activist. The purpose of this blog is stated at the top. It is a tribute to Another and FOA. I'm not here to convert the unwilling. I'm not here to project my thoughts and draw in the masses. But at the same time, I do want to share what I've learned with loved ones. And from the email I receive, so do a lot of other people. That said, you can't just approach the unwilling with stories of decade-old anonymous internet personalities.

So this is my first foray into the frustrating world of the gold-resistant paperbug. With your help, I hope to build a primer on the gold thesis explaining "why gold, and why now," to those who know nothing about The Gold Trail that brought us here. This post is my first baby step.

As most of you already know, you don't get any of the usual hard money, gold standard or gold bug arguments from me. I do not predict a return to the gold standard, I'm not opposed to fiat currency or central banking and I don't think the world is going to end. What you do get is my explanation of the changes that are unfolding right now in the international monetary and financial system, and how they could affect your savings.

That last part is important. How changes in the monetary and financial system could affect your savings. What are your savings? And why do we save the way we do today? Has it always been this way? Are there universal do's and don'ts when it comes to saving for the future or for a rainy day? Do systems ever change or implode, erasing people's savings? Is it ever fair to say "this time it's different"? These are interesting questions to think about.

And now that I'm thinking about it, does anyone even save anymore? If you've got a hundred grand sitting in a bank CD or savings account someone will likely tell you that you should invest it or else you're wasting money. So you invest it in what, mutual funds and bonds? In that case there will be people that will say you should be actively trading, because you're still leaving potentially rich profits on the table.

Have you noticed how many people think they are traders and investors these days? And with all the options to invest in and trade out there, who can blame them? But in reality they are not traders or investors. They are doctors, lawyers, businessmen… and savers. What we call investing today is more like speculating. So why do we "save" the way we do today, by speculating on things we know so little about?

I had an email exchange over the holidays with a reader who was home visiting his parents. He's frustrated because he's been trying to talk to them about gold for at least a year now. Here's what he writes:

"I had to bite my tongue last night because my parents told me of the results of their trip to a financial adviser. My dad has over a million in his retirement account. Thanks to this adviser they went to, 1/2 of that is going into low-yielding Muni-bonds, the other half is going into some mixed fund that my parents really have no idea what it is. I asked about gold and apparently the adviser said it was "too volatile", so zero goes into that. Great!"

I'm guessing this is pretty common, because I received an email from another reader, also during the holidays, that said almost the same thing about his mother's savings: mostly government bonds and no gold thanks to a financial advisor's advice. Is your life's savings so trivial that you will put it somewhere based on a mere recommendation? Do you feel no need to understand, no responsibility to personally protect the fruits of your own life? I'll tell you one thing, it wasn't always done this way.

A saver is different from an investor or a trader/speculator. A saver is one who earns his capital doing whatever it is he does, and then aims to preserve that purchasing power until he needs it later. Investors and traders aim to earn more capital by putting their already-earned capital at risk in one way or another. This takes a certain amount of specialization and focus. But this difference is a big topic for another post. And anyway, it doesn't matter so much in terms of the gold thesis for today.

Today the system is in transition, so you can throw your ideas about these differences out the window. There is no safe medium for simple preservation of purchasing power when the entire system shifts from the old normal to the new normal. When systems implode, the safest place to be pays off big time!

In hindsight, the stock market (represented by the DJIA) would have been a great investment or speculation from the 1970s until 2000. Since 2000 it has gone nowhere:

Likewise, bonds would have been a great trade from about 1981 until now. As I've noted before, you make capital gains in bonds while interest rates are falling. The real pros know all about this. And from 1981 to present, interest rates fell from 20% to 0%. Flipping the interest rate chart upside down shows how the bond king Bill Gross of PIMCO traded his way into a personal $2.2 billion fortune over the last 30 years:

But markets do change. With the stock market now flat and bond yields at zero, the market is about to change again. Those of you with financial advisors putting your money into bonds should pay attention. If you don't believe me, how about the bond king himself, Bill Gross? Here's what he wrote just last week (my emphasis):

How many ways can you say it’s different this time?” There’s “abnormal,” “subnormal,” “paranormal” and of course “new normal.”…

Interest rates were lowered and assets securitized to the point where they could go no further and in the aftermath of Lehman 2008 markets substituted sovereign for private credit until it appears that that trend can go no further either. Now we are left with zero-bound yields and creditors that trust no one and very few countries. The financial markets are slowly imploding – delevering – because there’s too much paper and too little trust. Goodbye “Old Normal,” standby to redefine “New Normal,” and welcome to 2012’s “paranormal.”

Bill is a billionaire himself. And he also manages more than a trillion dollars of other people's money, including millions of retirement savers, public and private pension plans, educational institutions, central banks, foundations and endowments, among others. So you can be pretty sure he doesn't use words like "imploding" lightly.

Remember, I'm talking about "how changes in the monetary and financial system could affect your savings." I don't want you to buy anything on my (or anyone else's) recommendation. I want you "to understand the reasons for the investment yourself." And I asked, "do systems ever change or implode," and "is it ever fair to say this time is different?" Well, you just heard a mainstream billionaire bond fund manager answer "yes" and "yes."

In fact, history is chock full of stories about financial and monetary crises and change, and there is a part of these stories that often gets only a one-line mention, buried in between the descriptions of the chaos and the subsequent resolution. That line usually reads something like this: "Many elderly investors lost their life savings." That line is from an actual American story. Here's another one: "[Group 2] got lump sum payments that roughly equated to 15% of the actuarial value of their [savings]. Group 3… got nothing."

So why buy gold? Why buy only discrete coins and unambiguous bars of physical gold? And why right now? A historical perspective is necessary for understanding the answers to these questions. Crisis resolutions always involve the sacrifice of someone. And that someone is usually the savers. But there are always winners and losers. Devaluations play out like a seesaw. There is a force (the crisis devaluation), a fulcrum (what is being devalued against), and a load (the beneficiary or the winner).

I think if we are going to try and talk about gold with gold-resistant savers, we first need to think about why they save in the way that they do today, pretending to be investors and traders, and how it wasn't always this way.

The Studebaker Effect

Most of you reading this in the U.S. probably have some sort of an individual retirement account. Maybe you have a Traditional IRA, or a Roth IRA, a SEP IRA, Simple IRA, a 401(k) plan, or even a Self-Directed IRA. Or maybe you don't have your savings tied up in a tax advantaged account but you still invest in the same way, relying on the advice of an RIA, a registered investment advisor.

If this is you, then you probably also have a diversified mix of stocks, bonds and cash or cash equivalents. Perhaps you even have some non-dollar investments, foreign stocks, commodity positions or fancy REITs. Maybe you've got a little in the tech sector, a little in the banking sector, some in the energy sector and the rest in mutual funds. But have you ever stopped to wonder why this is the way we save today? Was it always this way? No, it wasn't.

The 1970s were a pivotal decade of change in so many ways. The 70s were not only a decade of high inflation, it was also the first time the U.S. blew the lid off the idea of a "permanent" debt ceiling by introducing the concept of "temporary" increases (later made permanent) and driving U.S. debt into the $Trillions by the end of the decade. In 1979, the House of Representatives passed a rule to automatically raise the debt ceiling when passing a budget, without the need for a separate vote on the debt ceiling itself. This was just one of many big changes that came out of the 70s.

The 70s decade was also the pivot point at which the U.S. switched from a trade surplus to running a perpetual trade deficit. And it was when we changed from being the world's greatest goods producer into a service-driven economy. And in 1974 Congress passed a bill which President Ford signed into law that forever changed the way we save. A law that eventually exploded into the constellation of investment options I just enumerated.

That bill was the Employee Retirement Income Security Act of 1974, or ERISA. But like all of the systemic changes that occurred in the 1970s, the roots of ERISA can be found in the 1960s, 1963 to be exact.

Before 1974, most people's retirement savings were in the form of a "defined benefit" from their employer. If you worked for a company until a specified age, you were "guaranteed" a defined, nominal benefit for the rest of your life. This system was similar to the pension funds used mostly for union workers today, only back then pensions weren't just for unions. The bottom line was that the burden of saving for retirement was on your employer, not on you.

As a pensioner, the comfort of your future retirement was in the hands of a single counterparty, your employer. Post-ERISA, most people put their hopes for retirement in the hands of a more diversified group of counterparties. With a single counterparty, default, mismanagement or fraud was and is a big risk. Secondary risks were the systemic ones, like a currency collapse, because it was your benefit that was nominally defined. Post-ERISA most companies (and individuals) switched to plans based on employee contributions rather than defined benefits.

This was a dramatic shift of burden. By the simple addition of choice, the burden of retirement savings was shifted from your employer to you. You now had not only the choice of how much to contribute, but also where to put your savings. With the old system, the payoff was a fixed, nominal promise. Through ERISA, your retirement is no longer fixed at a certain number of dollars. It now varies based on the amount you save, how you choose to invest it, and how the market values those investments when it comes time for you to retire. This can be a good thing or a bad thing, depending on what happens between now and your retirement.

In many countries other than the U.S., countries that experienced a currency collapse during the last century, it was mostly the pensioners that were wiped out. Owing only a fixed, defined number of currency units to retirees turned out to be a blessing to pension funds in these countries. Pensioners could easily continue receiving their promised $2,500 per month forever, even well after the price of toilet paper had risen above $10,000 per roll.

But getting back to the roots of ERISA in 1963, it was mismanagement and default that destroyed the retirement hopes of many people. The collapse and ultimate liquidation of the Studebaker Automobile Company was pretty orderly on the surface. Production lines were consolidated, then closed, then sold off and renamed. But it was the loss of Studebaker's employee retirement fund that started a movement toward system-wide pension reform.

By the time Studebaker closed its South Bend plant in 1963, its pension fund was so poorly funded that the effect of its default would reverberate for the next five decades. Of 6,900 Studebaker employees that had not yet retired or at least reached retirement age, 4,000 received only 15% of what was the actuarial present value of their savings, and the other 2,900 got nothing. MF Global anyone?

So the Studebaker effect became a systemic transition shifting both the burden of saving and the responsibility of decision-making onto the people themselves. And out of this transition grew the whole financial services industry as well as the full menu of investment choices listed above. Incidentally, and speaking of MF Global, another child of the transitional 70s and the Studebaker effect was the Securities Investor Protection Corporation, or SIPC.

The SIPC promises up to $500,000 insurance for individual investors against broker-dealers that go bankrupt. That is, unless a loophole can be found. Unfortunately for MF Global's customers, the vibrant commodity futures market came later than the SIPC which was only written to cover financial securities, not futures. So while the 400 securities accounts at MF Global were covered by insurance, the other 50,000 or so commodities accounts were left hoping they'll get back more than 72¢ on the dollar. Oops. Oh, and the CME also decided not to back the accounts. It seems nothing is for sure when it comes to counterparties.

The Gold Thesis

The above is a brief description of how the 70s were a decade of many changes. And also how changes in the 70s led to the way we save today. This is important to understand because I think we are in the midst of another historic transition period right now. I think this present period will be viewed by history as far more dynamic than the 70s. And I think the lessons learned from the experience of the 1970s will ultimately prove to be a poor guide for financially navigating this transition.

The evidence is already in — physical gold is "the load," set and levered for revaluation, as in the illustration above. The fulcrum is all other hard assets. And financial securities of all types, the nominal promises of counterparties, bonds, cash and cash equivalents are all vulnerable to the devaluation force. It's a three-part dynamic with hard assets—the middle part—acting as the denominator for both a devaluation of paper promises from counterparties and a revaluation of physical gold (it should be telling that we need to qualify such an elemental word as gold) and physical gold only. And from my Euro Gold post, here's the lever in early action:

The way people save today is traceable back to the collapse of the Studebaker pension fund and the reform movement that followed. In its 50 years of making automobiles, Studebaker exploded into a large and diversified company that, by 1960, included a missile and space technology division, a home and office appliance division, a tractor division, a generator division, a refrigeration division, a chemical division, and even an airline division. But within a few years it was collapsed, condensed, consolidated, liquidated and closed. And in the process, the employee savings were erased. The savers were sacrificed.

Similarly, the investment landscape that followed has exploded in supernova fashion yielding nominal credits that number like the stars in the heavens. Today's savers have given their savings to every manner of counterparty who went on a spending spree, leaving only the illusion of a debt that is too big to even be serviced in real terms. We have spent the last 35 years exploring the Milky Way galaxy of investment options, pretending to be investors and traders, when all we really are is savers waiting, once again, to be sacrificed.

It seems to me that we are now in the consolidation phase of change, heading back down to Earth. And where you choose to land, to consolidate your savings, has never been more important than it is today. I believe we are in a new transition period that is necessary, natural and inevitable (unstoppable). And that is why I don't take the quixotic stance of an activist, fighting to change the world. The only action I advocate is personal action, like purchasing power preservation and the personal action of expanding your understanding beyond the standard dogma you hear everywhere else.

And for those of you who are also struggling through the frustrating world of the gold-resistant paperbug, I'm looking for feedback so I can continue this project. What anti-gold arguments are you running into these days? And also, what worked for you? Has anyone had success introducing a Western paperbug to gold? I thought Victor's comment here, on the permanent portfolio, was very good. Those are the kinds of solid arguments I'm looking for. Perhaps, together, we can come up with a few more!


Now that she’s back in the atmosphere
With drops of Jupiter in her hair, hey, hey, hey, hey
She acts like summer and walks like rain
Reminds me that there’s time to change, hey, hey, hey, hey
Since the return from her stay on the moon
She listens like spring and she talks like June, hey, hey, hey, hey
hey, hey, hey, hey

Tell me did you sail across the sun
Did you make it to the milky way to see the lights all faded
And that heaven is overrated

But tell me, did you fall for a shooting star
One without a permanent scar
And did you miss me while you were looking for yourself out there

Now that she’s back from that soul vacation
Tracing her way through the constellation, hey, hey, hey
She checks out Mozart while she does tae-bo
Reminds me that there’s room to grow, hey, hey, hey, hey

Now that she’s back in the atmosphere
I’m afraid that she might think of me as plain ol jane
Told a story about a man who is too afraid to fly so he never did land

Tell me did the wind sweep you off your feet
Did you finally get the chance to dance along the light of day
And head back to the milky way
And tell me, did Venus blow your mind
Was it everything you wanted to find
And did you miss me while you were looking for yourself out there

Can you imagine no love, pride, deep-fried chicken
Your best friend always sticking up for you, even when I know you’re wrong
Can you imagine no first dance, freeze dried romance five-hour phone
The best soy latte that you ever had . . . and me

Tell me did the wind sweep you off your feet
Did you finally get the chance to dance along the light of day
And head back toward the milky way

Tell me did you sail across the sun
Did you make it to the milky way to see the lights all faded
And that heaven is overrated

Tell me, did you fall for a shooting star
One without a permanent scar
And did you miss me while you were looking for yourself

nah nah nah nah nah nah nah
nah nah nah nah nah nah nah

And did you finally get the chance to dance along the light of day

nah nah nah nah nah nah
nah nah nah nah nah nah

And did you fall for a shooting star
Fall for a shooting star

nah nah nah nah nah nah
nah nah nah nah nah nah

Are you lonely looking for yourself out there

Thursday, January 5, 2012

Party Like It's MTM Time

The ECB published its "Year of the RPG" year-end quarterly revaluation ConFinStat yesterday, and the trend continues. Here are the relevant results:

In the week ending 30 December 2011 the increase of EUR 3.6 billion in gold and gold receivables (asset item 1) reflected quarterly revaluation adjustments, as well as the sale of gold coin by one Eurosystem central bank.

Quarter-end revaluation of the Eurosystem’s assets and liabilities

In line with the Eurosystem’s harmonised accounting rules, gold, foreign exchange, securities holdings and financial instruments of the Eurosystem are revalued at market rates and prices as at the end of each quarter. The net impact of the revaluation on each balance sheet item as at 31 December 2011 is shown in the additional column “Difference compared with last week due to quarter-end adjustments”. The gold price and the principal exchange rates used for the revaluation of balances were as follows:

Gold: EUR 1,216.864 per fine oz.

USD: 1.2939 per EUR

JPY: 100.20 per EUR

Special drawing rights: EUR 1.1867 per SDR


As I noted here last Friday, during the dark of Thursday night, euro gold mysteriously levitated itself up a whopping €32.89 from Thursday's London PM fix of €1,184.16, which would have been a disappointing decline since the October MTM Party which marked gold at €1,206.39. This, of course, begs the question (once again) that was implied in this post as to how important "Snapshot Day" really is to young central bankers. (Evidence from Sept. '10 and April '11 seems to suggest that year-end and mid-year might be more important than the other two quarters.)

But this is neither here nor there which is why I put it in a silly little sidebar. It is simply a curious observation.

Sidebar #2

It is funny to see how pathetically little some in the euro-skeptical media really understand about the Eurosystem. Here's the Wall Street Journal's Marketwatch headline relating to yesterday's MTM Party:

ECB balance sheet grows, gold reserves increase

The flaw in the headline is compounded in the body of the article:

"The value of the Eurosystem's gold and gold receivables holdings increased by EUR3.6 billion to reflect quarterly revaluations as well as the sale of gold to the ECB by another euro-zone central bank, the ECB said."

First of all, that's not what the ECB said. This reporter's statement that one of the NCBs (National CBs) sold gold to the ECB carries obvious implications which are not only wrong, but very misleading. Someone in Europe emailed me last night asking:
"Did you notice that one European CB sold gold to the ECB? My guess is it was Italy."
Someone else posted this comment on a forum after reading that article:
"Gold of a Eurozone CB sold to ECB ... If I am not mistaken-correct me if I'm wrong-this does not happen very often?

More gold on ECB balance sheet in exchange for buyout sovereign debt perhaps ...?"

Here are the problems with that article. The ECB is simply the core of the Eurosystem. Actually, there are two systems. The ESCB or the 'European System of Central Banks' which is comprised of all the CBs in the EU, even those not using the euro as their currency. And then there's the Eurosystem which is comprised of all the CBs using the euro, with the ECB at its operational core.

The ConFinStat, put out weekly with quarterly MTM revaluation, is the balance sheet of the whole Eurosystem which includes all of the NCBs using the euro. It is not the balance sheet of the ECB. If you'd like to see the ECB's balance sheet, you can find it in the Annual Report for the ESCB and the Eurosystem which is published every year at the end of the first quarter to be presented to the European Council, Parliament and Commission. In last year's report, which can be found here, the ECB's balance sheet appears on page 214.

The actual ECB balance sheet includes 16,122,143 ounces, or 501.5 tonnes of gold which was valued at €17B as of December 31, 2010. That gold comes from the "foreign reserve asset" capital subscription to the Eurosystem by the NCB's of which at least 15% of the subscription fee had to be in gold. And the amount of each member country's fee is based on a “capital subscription key” which reflects the respective country’s share in the total population and GDP of the EU. These two determinants (population and GDP share) have equal weighting. The ECB adjusts the shares every five years and whenever a new country joins the EU.

The ECB marks its 501.5 tonnes of gold to the market price each year, but the unrealized gain from the revaluation goes into a special "Revaluation Account" which is credited to the NCB's according to the subscription key. In other words, the NCB's own the ECB, use it as their system's operational core, and benefit directly from the revaluation of their share of the ECB's assets including its gold.

So hopefully you can see why it makes no sense whatsoever that, as the Marketwatch article says, a euro-zone central bank would sell gold to the ECB. And even if gold had been transferred from an NCB to the ECB, it wouldn't show up as a change on the consolidated balance sheet referred to in that article!

Furthermore, the amount of gold *coins* that one of the NCBs sold last week was all of €1 million. What's that, 820 coins? Most likely it was simply a net sale of gold coins to the public.

Finally, try a Google search of the first part of that Marketwatch headline, "ECB balance sheet grows", and you'll see just how many analysts are incorrectly referring to the Eurosystem's balance sheet as if it belongs to the ECB. And if you can't quite see how this seemingly-innocuous incorrect view is detrimental to the usefulness of one's analysis, just ask Texan any question you want to about the ECB. (j/k Texan ;)