The Gold Top & The Housing Bottom

In April, I noted that I thought the gold bull market is over. Since then, gold has fallen over 10% down to below $1400 today. That’s quite a severe correction.

Today, I found an interesting graphic showing that the gold price peaked out while housing bottomed out, and since then, the two have gone in opposite directions:


Correlation, of course, is not causation, but this is an interesting association. Gold flourished on the back of a deep and severe correction in the housing market. Demand for gold as a countercyclical alternative asset proved very strong in the years when very few other assets and asset classes were performing, and prices soared.

So it stands to reason that a large number of individuals putting their money into gold in the boom years were putting their money there because of risks and losses in other markets and areas, and because of the belief that gold was a safe, antifragile asset for troubled times. In 2011, according to Gallup, a plurality of Americans considered gold to be the best asset class to own — something of a psychological bubble that has been burst as prices have fallen.

Indeed, in 2013, gold has been knocked off its perch by real estate — a sensational comeback given the depth of the real estate slump. Real estate, of course, was also ranked the safest in 2006 before the bubble burst. What this signifies is that money, credit and sentiment that once upon a time was flowing into gold and alternative investments is now flowing back into more traditional investments like real estate now that prices are rising again.

So long as investments like stocks and housing that produce a yield continue rising in price, the incentive driving this trend will continue to exist. Investments  once thought antifragile — gold, but also AAPL, guns and ammunition,  etc — may prove fragile to a different (and less apocalyptic) economic climate.

The last time a gold bull market ended (1980) the dollar-denominated price remained depressed for over 20 years! Perhaps this time is different, but maybe not…


Currency Competition

The greatest trouble with monopolies is what they take away — competition. Competition is a beautiful mechanism; in exercising their purchasing power and demand preferences, individuals run the economy — it is their spending that allocates, labour, capital, resources and brainpower. It’s their spending that transmits the information that determines what gets made, what doesn’t, which businesses succeed and which don’t. Individuals exercise a far greater political and economic power in a free economy when they spend, and when they work than when they vote. So without competition, the power of choice suffers, and businesses, markets and societies can become economically stagnant and rampantly corrupt; look at North Korea and the myriad other examples of once-prosperous societies impoverished within the context of a lack of competition.

In a free market, monopolies are potentially less problematic because without competition a monopolist can become complacent and inefficient, allowing competitors a foothold to grab market share; consider the near-monopoly of Microsoft Windows and Internet Explorer in the 1990s, which began to melt away via the rise of Apple, Google, Firefox and the poorly-received Windows Vista in the 2000s. While a free market is not a foolproof guarantee of a competitive market — and sometimes regulation is necessary to prevent the formation of cartels — it is the closest thing to such a thing.

Monopolies can become much more problematic when a monopoly develops and the holders of that monopoly utilise the power of the state to protect their dominance. Whether their business is food, or clothes, or computers, or money, a state-protected monopoly limits competition and distorts the process of allocating of resources, capital and labour.

If we are for competition in goods and services, why should we disclude competition in the money industry? Would choice in the money industry not benefit the consumer in the manner that choice in other industries does? Why should the form and nature of the medium of exchange be monopolised? Shouldn’t the people — as individuals — be able to make up their own mind about the kind of money that they want to use to engage in transactions?

Earlier, this year Ben Bernake and Ron Paul had an exchange on this subject:

Bernanke contends that it is possible to transact in a competing currency like Yen, or pesos or bitcoin. This is technically correct. But, as Ron Paul points out, there are still a number of laws which are arguably preventing a level playing field:

The first step [to real currency competition] consists of eliminating legal tender laws. Article I, Section 10 of the Constitution forbids the States from making anything but gold and silver a legal tender in payment of debts. States are not required to enact legal tender laws, but should they choose to, the only acceptable legal tender is gold and silver, the two precious metals that individuals throughout history and across cultures have used as currency. There is nothing in the Constitution that grants Congress the power to enact legal tender laws. Congress has the power to coin money, regulate the value thereof, and of foreign coin, but not to declare a legal tender. Yet, there is a section of US Code, 31 USC 5103, that purports to establish US coins and currency, including Federal Reserve notes, as legal tender.

The second step to legalizing currency competition is to eliminate laws that prohibit the operation of private mints. One private enterprise which attempted to popularize the use of precious metal coins was Liberty Services, the creators of the Liberty Dollar. The government felt threatened by the Liberty Dollar, as Liberty Services had all their precious metal coins seized by the FBI and Secret Service in November of 2007.

The final step to reestablishing competition in currency is to eliminate capital gains and sales taxes on gold and silver coins. Under current federal law, coins are considered collectibles, and are liable for capital gains taxes. Coins held for less than one year are taxed at the short-term capital gains rate, which is the normal income tax rate, while coins held for more than a year are taxed at the collectibles rate of 28 percent.

This is not a radical change. In this age of cashless payment people can simply load their alternative currency onto a debit card and spend it — similar to the gold-denominated debit card currently available to non-Americans from Peter Schiff’s EuroPacific Bank. In this age of Google and ubiquitous computing, exchange rates can be calculated instantaneously.

If people and businesses choose to stick to government-backed fiat money and refuse other currencies, that is their prerogative. It is possible that other media of exchange would not become popular; but at least there would be a more level playing field. Under the status quo, there is no level playing field.

It is often said in interventionist circles that Bernanke is too tame a central banker, and that right now the people need a greater money supply. Well, set the society free to determine their own money supply based on the demand for money; let the people decide.

We’re All Doomers Now

How bad are things getting in the Eurozone?

Paul Krugman is getting apocalyptic:

The big story: German bonds are now being priced as a risky asset — what the FT calls the “apocalypse trade“. The interest rate on bunds, at 2.21% as I write this, is still very low by historical standards. But it’s above the rate on UK bonds (2.17%) and way above the rate on US bonds (1.88%).

The way to see this is that the market is in effect pricing in a real possibility of eurozone collapse.

In particular, market expectations seem to assume that the ECB will remain utterly indifferent to its responsibilities. The German breakeven rate, an implicit forecast of inflation over the next 5 years, is just 1 percent. That’s a disaster level, implying severe deflation in the debtor nations — or, more likely, a euro breakup.

There is a cruel and almost Shakespearean irony to all of this: the Teutonic monetarists at the ECB, with their sole mandate of price stability, and deep hostility to inflation have had the horrors of the hyperinflation of the 1920s imprinted on their memories. Really, they should have been worried about the credit contraction and austerity of the Brüning years in the early 1930s. Unemplyment shot up, industrial production slouched, hunger was rife, and Germans were willing to vote for a charismatic Austrian anti-semite bent on consolidating Europe into one.

While I do not agree with much from Keynes, he did understand that monetary contractions in a system of fractional banking can totally destroy the productive economy. His response to that was that the answer was government-driven stabilisation. My response to that is interventionism and preservation eventually turns to zombification, and that the true answer to the problem of credit contractions is noticing that fractional banking is a fundamentally unstable and dangerous system, and abolishing or significantly reforming it. But that’s an argument for another day.

From Zero Hedge:

The only quote worth noting from the just delivered speech by ECB executive board member José Manuel González-Páramo is the following: “We cannot completely delegate governance to financial markets. The euro area is the world’s second largest monetary area. It cannot depend solely on the opinions of ratings agencies and markets. It needs economic governance arrangements that are preventive and linear. This underscores my central point that a much more comprehensive approach to economic governance is now the priority for the euro area. And this means more economic and financial integration for the euro area, with a significant transfer of sovereignty to the EMU level over fiscal, structural and financial policies.”

So the ECB has lost faith in markets and now believes that a form of central planning is a better economic model.

It’s a shame they haven’t lost faith in austerity — because it is those disastrous, divisive, technocratic and wrong-headed policies that will drive Europe to the stage of bank runs and systemic collapse far quicker than anything else.

Anyway, despite the technocratic coups d’état in Italy and Greece, a federalised Europe still seems politically and socially impossible. Bureaucrats will be punished for this folly. History always sees to that.

The Only Chinese Hard Landing Will Be On America’s Head

A lot has been made of the so-called Chinese property bubble. And after 2008, when America’s subprime bubble was the straw that broke the camel’s back, who can blame those who see China as low-hanging fruit? In the hedge fund world, both Hugh Hendry and  Jim Chanos (among others) are significantly outperforming the market by shorting Chinese companies.

But the naysayers will be proven sorely wrong.

There are many differences between the Chinese situation and the American one but there is one that outsizes all the others. Over-inflated American (and by-extension, Western) property was being used as a spring-board to fund consumption. Growing home equity allowed real-estate owners to remortgage, and use their surpluses to buy boats, cars and trips around the world; i.e., living beyond their productive means. Once the property bubble burst, not only were many home-owners left underwater, but all of that excessive consumption came to a halt, with a significant negative effect on GDP. China simply doesn’t have that problem. The Chinese nation and its government are not net-borrowers but net-savers.

In addition, there is no evidence that China has the same problem with widespread securitisation that America had in 2008. The subprime bubble created huge systemic risk in the financial sector by bundling up subprime debt in mortgage-backed securities and collateralised debt obligations, and spreading it around American and European balance sheets. This made the system very fragile — as a few defaults, could lead to a global cascade of margin calls and defaults.

In fact, Chinese leverage levels are dropping.

From RBS:

Chinese firms are generally in good financial conditions. The latest data suggests that Chinese companies actually have seen their leverage ratios decline in the past three years, on the back of strong profitability and retained earnings. Most sectors have seen a decline in leverage. Property development was the only main sector that shows the opposite trend of rising leverage but it accounts for only about 6% of total loans. In fact, the average leverage ratio of Chinese companies is one of the lowest among key economies and emerging markets. At the same time, they have maintained one of the strongest profitability.

Chinese GDP (and profitability) is ballooning (and will continue to do so) because of global demand, even on the back of the recessions in Europe and America. That’s because China does everything much more cheaply, and so now controls crucial supply chains in components and products. Now that the world is flat, manufacturing such components in other places is not economically viable, so the supply chains no longer exist, and manufacturing-oriented labour markets are stagnating.

China’s good fortune is its high population levels and high population density.

From Noahpinion:

It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other (“agglomeration”). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial “Core” and a much poorer agricultural “Periphery” that produces food, energy, and minerals for the Core.

Now when you have different countries, the situation gets more interesting. Capital can flow relatively easily across borders (i.e. you can put your factory anywhere you like), but labor cannot. If you start with a world where everyone’s a farmer, agglomeration starts in one country, but that country gets maxed out when the costs of density (high land prices) start to cancel out the effect of agglomeration. As transport costs fall and the economy grows, the industrial Core spreads from country to country. Often this spread is quite abrupt, resulting in successive “growth miracles” that get faster and faster (as each new industrial region starts out with a bigger global customer base). The evidence strongly indicates that agglomeration is the driver behind developing-world growth.

Looking at global population density — with American taxpayers subsidising the cost of a flat global marketplace — where can we expect productivity to agglomerate?

Of course, China does have a property bubble and a scary-sounding $1.6 trillion in local government debt. But $1.6 trillion of local government debt is still significantly less than China’s dollar and treasury hoard. The bottom line is if that China’s real estate market collapses, China can bail itself out with money it has saved from the prosperity years, not through new debt acquisition. This was the lesson of John Maynard Keynes — governments should save in the boom years, to spend in the bust years and even-out the business cycle — a lesson which seems lost on Western policy-makers, who seem to believe that you should borrow massive amounts every year.

So taking the absolute worst-case-scenario, China has plenty of leeway to bail itself out. Of course, this would mean China might decide to liquidate a significant amount of its treasury holdings — especially seeing as bonds are at all-time highs.

Could such a liquidation be the event that finally bursts the Treasury bubble, sending yields soaring and making it much more difficult for America to acquire new debt?

With 10-year yields now well below 2%, that sure looks like a bubble to me.

Is China a Bubble?

Hedge fund manager Jim Chanos (among others, including Nouriel Roubini) says that China is a giant wreck due a hard landing.

From Zero Hedge:

On the Chinese government’s balance sheet:

“The Chinese government’s balance sheet directly does not have a lot of debt. The state-owned enterprises of the local governments and all the other ancillary borrowing vehicles have lots of debt and its growing at a very fast rate. The assumption is that the state stands behind all this debt. We see that the debt in China, implicitly backed by the Chinese government, probably has gone from about 100% of GDP to about 200% of GDP recently. Those are numbers that are staggering. Those are European kind of numbers if not worse.”

On how a Chinese property bubble will play out:

“I think that will be the surprise going into this year, and into 2012 – that it is not so strong. The property market is hitting the wall right now and things are decelerating. The CEO of Komatsu said last week that he is having trouble getting paid for his excavator sales in China. Developers are being squeezed. They’re turning to the black market for lending, this shadow banking system that is growing by leaps and bounds like everything in China.

“Regulators over there are really trying to get their hands around the problem. In the meantime, local governments have every incentive to just keep the game going. So they will continue with these projects, continuing to borrow as the central government tries to rein it in.”

Chanos on his long and short positions:

“We are short Chinese banks, the property developers, commodity companies that sell into China, anything related to property there is still a short.”

“We are long the Macau casinos. It’s our long corruption, short property play. We feel that there’s American management and American accounting. They are growing at a faster rate even than the property developers.”

On the IMF lowering growth estimates for China:

“A lot of people are assuming that half of all new loans in China are going to go bad. In fact, the Chinese government even said that last year relating to the local governments. If we assume that China will grow total credit this year between 30% to 40% of GDP, and half of that debt will go bad, that is 15% to 20%. Say the recoveries on that are 50%. That means that China, on an after write off basis, may not be growing at all. It may be having to simply write off some of this stuff in the future so its 9% growth may be zero.”

Is he right?

Absolutely not.

China has a property bubble, resulting from excess supply. It is also the world’s greatest industrial behemoth, controlling the world’s supply chains in many key components, and is becoming an increasingly powerful player in energy markets thanks to its buy-out of Venezuela and its close ties to authoritarian Eurasian energy powers like Russia, Iran and Pakistan. This means that it’s probably not the best place for Westerners to park capital in the short term. But it has no bearing on China’s strategic standing in the medium to long term.

A comparison with America is inevitable. The United States destroyed its industrial productive capacity, has a zombified financial system , a stagnating labour market, stagnating infrastructure, a clueless establishment, and its currency is about to lose global reserve currency status.

Every day, America becomes more dependent on foreign oil and resources.

America needs the global resource and trade infrastructureThat’s why America is in Iraq, Afghanistan, Yemen, Pakistan. That’s why there are hundreds of bases around the world and why America spends trillions policing the world.

The counter-argument I often hear is “but America has nukes, America can order other countries to do things and they will do it”. But ever since mutually-assured destruction that hasn’t been true.

If you don’t control your supply chains, you have a geostrategic problem. China grasped the importance of supply chains, and through cunning use of long-term planning has made itself the spider at the centre of the web of global trade. America grasped they could get a free lunch with US treasuries and that free lunch destroyed their productive capacity.

China has a cold. America has congential haemerrhoids, restless legs syndrome, diabetes, and autism.

Understanding Biflation

If I were to rewrite the economics textbooks the first idea that I would throw into the dustbin is the idea of a standardised rate of inflation. Why? Because in every economy, different money, coming from different individuals and different strata of society chase different products, causing every price over time to inflate or deflate at a unique level, and every consumer and producer — depending on their wants and needs — to experience a separate and unique rate of inflation of deflation.

When an economist like Paul Krugman suggests that the Fed needs to print more money to raise inflation because inflation has fallen to “historic lows” — he is referring to the totalised rate of inflation for urban consumers, or CPI-U:

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