GOLD’S CURRENT price-tag of $1,000 an ounce suggests big doubts over the US Dollar, its domestic economy, and its status as the world’s No.1 reserve currency.

Or so we guess after 10 years of watching it quadruple from two-decade lows. But gold investors (old, new and everywhere) should note that this decade’s bull market in bullion is about much more than the greenback.

Here are three ways of judging what you might call the “real price of gold” instead.

#1. The Global Gold Index

Gold has risen against all world currencies since the start of 2001, very nearly tripling on average and hitting record highs against everything bar the Japanese Yen. (Tokyo gold buyers are still waiting for a near-double to the peak of Jan. 1980…)

Introduced in July 2008, Bullion Vault’s Global Gold Index is a stab at mapping this trend. It monitors “real gold” by plotting the daily price in terms of the world’s ten most important currencies, averaging their moves by size of the issuing economy.

Thus the Global Gold Index currently starts with the US Dollar gold price, and then takes in the gold price for Eurozone buyers, Japan, China, the UK, Russia, Brazil, Canada, Mexico and Australia – as per the latest World Bank and IMF data. (It’s rebased each year to accommodate changes in that league table of gross domestic product; India, the world’s hungriest physical gold market until the start of this year, flips in and out.)

Not quite the price of gold for everyone worldwide, this “real” value does at least cover 2.5 billion people who account for over two-thirds of world economic activity. It starts at 100 on New Year’s Day 2000, hitting a record peak for this decade in May 2006, and then all-time record peaks in March 2008 and then Feb. 2009.

Currently, the Global Gold Index is trading some 5% off that top, rising strongly into Sept. ‘09 so far.

#2. Gold vs. the Cost of Living

What about inflation; has the ultimate “inflation hedge” (as most commentators and analysts still mistake it) out-done the cost of living?

Given how suspect inflation data can be (wherever you live), let’s roll our third “real” gold price into this picture too, comparing gold against the cost of raw, productive materials as bought and paid for in the market-place…

This chart shows the Dollar gold-price adjusted for official inflation in US consumer prices (the gold line). Jan. 2000 marks the start of our indexation. You’re looking at gold priced in Y2K dollars, left-hand scale.

The chart also maps the “real” price of gold in terms of raw materials prices (dark red, right scale), indexing it against the CRB’s Continuous Commodity Index of the most-heavily traded 19 natural resources – crude oil, corn, soy beans and the rest. (Again, Jan. 2000 is our starting point for the maths, indexing the real price of gold in commodities at 100.)

But is gold cheap or dear right now? Three observations:

• Gold built a strong base against commodities during the 1980s and ’90s, holding onto far more of its 1970s’ gains than did natural resources;
• Gold has never been more expensive in terms of the raw materials it could buy than in Feb. ‘09, almost doubling in purchasing power from crude oil’s record peak of summer last year;
• Real gold prices stand at only 50% of their 1980 inflation-adjusted peak, but they’ve trebled so far this decade;
• Consumer-price inflation has thus been stronger since Y2K than you might guess…adding 27% to the cost of living and lopping a whole multiple off gold’s nominal gains since the start of this decade.

Still, the Noughties come fifth out of the last eleven decades both for “price stability” and “low inflation”. And gold’s performance in the face of rising consumer prices is varied to say the least…

Most significant perhaps for the fate of Dollars, gold and inflation, is the fact that real commodity prices have in fact halved over the last fifty years. Adjusted for US inflation, they were never cheaper than at the start of this decade.

The decline in real commodity prices between June 2008 and Feb. ‘09 was comparable only with their doubling in 1972-73. Dropping 40% inside eight months, real commodities fell faster than any time on the CRB’s five-decade record.

If this decade’s bull market in gold were only about inflation and commodity-price fears –whether priced in US Dollars or anything else – gold would not be trading four times higher above $1,000 today.

Regards,
Adrian Ash

Source: The Real Price of Gold

So speculative betting on gold going higher now equals a record-busting 752-tonne position in Comex futures and options, yet this is not a bubble according to Michael Pento of Deltaga.

Let’s say otherwise. Let’s say that gold prices, surging by almost $100-per-ounce in barely a month, are very much in a bubble…blown up by near-zero interest rates worldwide and a sharply negative cost of borrowing after inflation. Were that the case, the question before potential and existing investors would be simple:

Is this “irrational exuberance” or a “permanently high plateau”?

Alan Greenspan applied the former to US price/earnings in Dec. 1996; Irving Fisher said the latter of US equities in Oct. 1929. Both were looking at what history would decide were clearly bubbles in hindsight. But Greenspan was three years and 105% early.

Fisher spoke less than 72 hours before the Great Crash began…

Buying gold always looks “irrational” to most financial advisors and commentators, because it doesn’t pay an income or yield.

No matter that gold has beaten all other asset classes bar none since the start of the decade. People looking to buy gold (the blue line of Google searches above) have been underwhelmed with content and analysis online, despite outstripping the volume of “buy stocks” searches (in red) for nearly five years.

Gold buyers have also averaged 20% gains year-on-year since this point in 2004. That compares with -0.6% on average from shares, but so what? Check the spike in “buy stocks” stories highlighted by Google Trends’ lower chart during October last year. Just when gold turned sharply higher – and stocks still had another 40% to fall – the news-flow focused on bottom-fishing in equities.

Gold’s productive value is also judged to be nil next to foodstuffs, energy or base metals – materials that vanish in use and thus display a clear supply/demand dynamic. Whereas all the gold mined in history—being indestructible—is still with us today…some 165,000 or so tonnes. That makes a fundamental case for gold built on tight supply, rising demand absurd. Nor can TV or newspaper journalists get used to applying “exuberance” to gold, the ultimate in gloom-and-doom insurance outside your local gun-store.

But while permanent plateaus are harder to find in finance than geology, gold’s peg-legged clambering of the last nine years most certainly puts it higher than it started.

What’s powering the Stannah Stair-Lift today? In a word, leverage.

Liquidity (meaning “leverage”, as 2008 proved) has flooded back into the big investment houses, thanks to tax-funded injections, quantitative easing, and central-bank asset guarantees.

Near-zero interest rates sure help as well. And that, in turn, has enabled what we used to call investment banks to revive their prime broking services, offering to deal whatever leverage-hungry clients want most, and financing the trade with that ultra-cheap money.

The most leverage-hungry clients, outside of the banks’ own proprietary trading desks, remain hedge funds – hedge funds which doubled in number from 2003 to end-2007 (Hedge Fund Review), growing their assets under management from $600bn (Goldman Sachs’ estimate) to $2.9 trillion (HedgeFund.net) before hitting the credit crunch precisely as Bear Stearns blew up.

Just as the long-run bull market in gold threatened to keel over on this sudden withdrawal of derivatives leverage, however, the physical appeal of owning gold – or a near proxy, at least – came into its own.

Physical gold investment surged in the back-half of 2008 and early 2009, rising 150% from July-to-Dec. 2007 before adding two-thirds of that fresh record between Jan-and-March this year alone. (Data courtesy of the World Gold Council.) And now that deflation seems to be tipping ever-so-smartly into inflation – and the surge in ETF, coin and bar demand has eased off – leverage is back just in time for gold’s typical autumn move higher, a pattern seen 20 years in the last 40 and delivering some 15% gains on average this decade between Sept. and Feb. even for cautious investors buying on cash, rather than margin.

Inflation, deflation, who cares? Whether it’s exuberant hedgies or panicked private investors with something to lose, this “bubble” in gold – if that’s what you choose to call it after a decade of beating everything else, and four years after it broke sharply higher versus all currencies, not just the Dollar – just keeps expanding.

Sub-zero real rates of interest sure help. Media hype, to date, is missing. When those two factors reverse, buying gold may well become irrational – and whatever plateau it’s reached might well give way.

Regards,
Adrian Ash

Source: Gold: A Permanently Exuberant Plateau

Today’s “legacy assets” are toxic derivatives; a decade ago it was gold reserves. Both are proving hard to shrug off, but for very different reasons. Both legacies also come thanks to previous central-bank history; the fossils remain only too livid today.

And 10 years from now, if not sooner, just how welcome will the current central bank must-have become – freshly printed government debt, bought with money that doesn’t exist until the central bank wills it?

Seeking first to defend against inflation and war, the West’s central banks built up huge reserves of the ultimate hard money –gold bullion– during the early-to-mid 20th century. Long before the turn of the millennium, however, these hoards grew to look quaint and expensive. Unyielding and relatively useless to industry, gold simply sat there, down in the vaults, costing money to store but returning no interest.

Who needed crisis-proof gold when Western Europe (if not the Balkans or Mid-East) was enjoying its first generation of peace-time in history? And who needed fine gold when the Nasdaq index of tech stocks was priced for 20% annual earnings growth over the next decade and more?

In short, who needed gold when we’d got Alan Greenspan, as the New York Times asked in May 1999. “The argument against retaining gold is that its day is past,” wrote Floyd Norris with uncanny timing, just two days before Gordon Brown’s Treasury announced its ham-fisted sale of half the UK’s gold bullion hoard.

“Once it was useful as a hedge against inflation that would hold its value when paper currencies did not. Now financial markets have their own sophisticated ways, using exotic derivative securities, to hedge against inflation.”

You could butter your toast with the irony. But it wouldn’t taste sweet or provide much nutrition. Whereas a further glance back at history might.

“With huge gold stocks available for sale, [governments] may discourage excessive price increases but naturally do nothing to prevent sharp decreases,” reported an investment piece for Medical Economics published in October 1977. (Our thanks to the author for finding and faxing it to BullionVault this week.)

“The government specter [over the gold market] can’t be expected to disappear quickly,” F.D.Williams continued, some 32 years ago. “Gold will continue to be part of many national reserves for a long time. The stocks are so large, they can’t all be dumped at once.”

Compare and contrast with today’s unwanted bequest – those toxic derivatives the US Treasury chooses to call “legacy assets” as if it played no role at all in producing them. Unlike state-hoarded gold, it only encouraged their creation; it didn’t want to look after the damn things. And quite unlike the market for state-hoarded gold, a ready stock of willing mortgage-bond buyers also looks unlikely to gather.

“The PPIP, which was beset by multiple delays as regulators tried to figure out the best means of removing many of the troubled assets from banks’ books,” as CNN reports, “is still not up and fully running yet.” It’s not been for lack of incentives. The $2 trillion Public-Private Investment Partnership, announced to much fanfare in March, offers huge leverage – entirely at tax-payer expense – plus some or other hold-to-maturity value to risk-cushioned investors, albeit as yet unknown. Private investment groups can use up to $1 of non-recourse loans, plus another dollar of Treasury finance, for every $1 they spend on taking toxic housing derivatives off the banks’ busted balance-sheets. Yet as a report published this week by the Congressional Oversight Panel put it:

“Whether the PPIP will jump start the market for troubled securities remains to be seen. It is also unclear whether the change in accounting rules that permit banks to carry assets at higher valuations will inhibit banks’ willingness to sell. Similarly, it is unclear whether wariness of political risks will inhibit the willingness of potential buyers to purchase these assets.”

Funnily enough, as the US authorities struggle to sell toxic debt, Western Europe’s Central Bank Gold Agreement has also stalled in 2009. This comes, however, despite prices and private-investor demand both holding near record levels. First signed ten years ago this September, back when no one at the New York Times, Economist, Financial Times or big central banks could see a use for the metal (simply owning this secure, liquid store of value is use enough, by the way), the CBGA capped annual gold sales and made them plain in advance for the coming five years. It aimed to avoid a repeat of May 1999, when the UK Treasury’s announcement drove prices down to what then proved their floor. In contrast to Washington’s PPIP, however, central-bank gold sales weren’t arranged in the hope of achieving maximum price, but merely curbing a rush for the exits instead. And as it is, they needn’t have bothered.

Gold prices have since risen three-fold and more against all major currencies, even while the 16 signatories to date sold almost one-fifth of their hoard in aggregate. Thus gold’s weighting in their reserves portfolio has doubled regardless, rising as gold outperformed all other assets from the start of this decade.

Hence the dramatic slowdown in central bank gold sales since the financial crisis began in August ‘07. Because it’s tough selling gold when its use becomes so clear, so present. Here in the fifth and last year of 2004’s renewed CBGA, “Net central banks sales likely to be in the order of 140 tonnes this year, down from 246 tonnes in 2008,” reckons London market-maker Scotia Mocatta. Yet the annual ceiling for CBGA sales currently stands at 500 tonnes!

The new agreement – just signed and due to commence on Sept. 27th – tips its hat to the facts, reducing that limit by one fifth. But who’s left to sell any way? Just as in the gold mining sector worldwide, the “easy metal” has already gone from West Europe’s vaults, pretty much emptying Spain, the UK and those excess Swiss holdings which maintained the Franc’s 100% gold-backing until the turn of this century. The two largest holders, Germany and Italy, continue to face down political calls for “mobilization”, refusing to yield one ounce so far despite signing all three agreements. France, the third largest owner, has pretty much sold the 600 tonnes from its hoard announced when it joined the central-bankers’ Cash4Gold party in 2005. That leaves only the International Monetary Fund’s 400-tonne sale, hardly enough by itself to meet the next half-decade’s 2,000-tonne limit.

Back at the Federal Reserve, meantime, tomorrow’s central-bank legacy – of freshly printed Treasury bonds bought with magic money from nowhere – continues to swell. Yes, the Fed’s stockpile of T-bonds may be smaller today than it was back in August ‘07 before the Great Inevitable broke, thanks to record Wall Street demand for the safety of Washington’s debt. And yes, the Fed isn’t quite collecting new bonds from the Treasury door directly, waiting instead a few days or so before picking them up (as Brian Benton, Chris Martenson and others have found) from those primary dealers who do bid at auction, rather than out-and-out monetizing the debt for all to see with its newly created cash.

And sure, private-sector demand for Treasuries continues to look so strong right now – what with overnight rates at 0%, plus the ongoing collapse of house prices, world trade and jobs creation – that the Fed says it will stop financing Uncle Sam’s spending in, umm, October rather than in September as previously stated.

But hoarding gold looked rather more sensible amidst the violence and misery of the mid-20th century, and no one at the Fed or Treasury guessed two years ago that they’d be offering leverage incentives to try and revive the market in mortgage-backed derivatives. When the global economy gets off the floor…or risk assets become more attractive to private investment…or China and Japan find they really don’t have any space left for US debt in their central-bank vaults, the market into which the Fed will want to sell its Treasury hoard will look very different to the market from which it’s currently buying.

Whether a decade from now, in 2010, or perhaps this fall – when the $300 billion of quantitative easing ear-marked for Treasuries is spent – trying to quit the Fed’s newest “legacy asset” could prove tougher even than finding ready buyers for today’s toxic junk. And given the soaring interest rates and potential US bankruptcy that in turn might trigger, spurred by whatever’s added to the Treasury’s $11.7 trillion of debt between now and then, perhaps buying gold will look a smart move to the Western world’s central bankers once more.

Regards,
Adrian Ash

Source: Gold Will No Longer Be a Toxic Derivative to Central Banks

The Fed wants you to believe hyperinflation is looming. Or at least, it shouldwant that, if doubling its balance-sheet – purchasing and lending against investment junk – is going to work the wonders that modern central-bank theory says it can. And the Fed certainly wants you to believe it will stop at nothing to avoid deflation (”whatever means necessary” as the chairman put it back in 2002).

So anyone touting the hyperinflation risk in public is playing the shill, a decoy – seemingly unconnected – proclaiming the miracle powers of Dr.Ben Bernanke’s snake oil to CNBC anchors at every chance.

In fact, they’re doing the Fed’s work better than the Federal Reserve itself. Really.

“The major danger with a zero lower bound for the interest rate,” said Swedish policy-wonk Lars Svensson(also a Princeton colleague of the Fed chief and his credit-bubble associate Paul Krugman) in a speech earlier this year, “is that inflation expectations will be too low and even negative, and that the real interest rate will thus become too high.”

With it so far? Slashing interest rates to the very minimum of 0% suggests inflation has vanished, at least in the central bank’s eyes. But that, in turn, reduces the rate of inflation expected by consumers, investors and business. Central banks are credible forecasters, you see. At least in central-bank eyes. So in Svensson’s philosophy, the zero-rate solution to falling inflation proves self-fulfilling as people hoard cash and sit tight in bonds.

“It is thus necessary to…to counteract expectations of falling inflation, and preferably to create expectations of higher inflation,” Svensson went on. But “as Paul Krugman put it” says the Riksbank’s deputy governor, “How will the central bank ‘credibly promise to be irresponsible’…?

Heaven knows the Fed’s trying. (So’s Krugman, to no one’s surprise.) But while it’s embraced credible recklessness, the Fed’s stop short of French kissing it.

Why so coy…?

“We have a very serious recession, we have a 9.4% unemployment rate,” said San Fran Fed governor Janet Yellen in a speech in California on Tuesday. “If we were not at zero, we would be lowering the funds rate…We should want to do more.”

Just how much further would the Fed go – all the way to hyperinflation perhaps? Racing to first base, “The vigorous policy actions of the Fed and other central banks, combined with sizable fiscal stimulus here and abroad, have sent a clear message that deflation won’t be tolerated,” Yellen said.

“Based on measures of inflation expectations,” she went on, an apparently reading straight from Svensson, “the public appears confident that the Fed will adopt policies that will maintain a low, positive rate of inflation. Evidently, the credibility that the Fed and other central banks have built over the past few decades in bringing inflation down has spilled over into a belief that we won’t allow inflation to get too low either.”

Steady on, cheeky! Second base next, and “A glance at history shows that many countries with massive structural deficits and without an independent central bank turned to the printing press to pay off their debts,” Yellen continued.

Straight to third then, and “That’s a recipe for high inflation and, in some cases, hyperinflation.”

Gulp, almost home! But then, somewhere between third and fourth base, the Fed’s gone shy and rebuttoned its blouse. Because “I don’t believe the United States faces that threat,” Yellen said, showing the come-on to be just one big tease.

“Looking back in history, runaway fiscal deficits have often been accompanied by high inflation,” she explained in Tuesday’s speech in the bankrupt state of California. “But, since World War II, such a relationship has only held in developing countries. In countries with advanced financial systems and histories of low inflation, no such connection is found.”

Oh man, what a let down! Who’s gonna put out hyperinflation if not the Fed…?

“In order to make up for the collapse of credit, we are effectively creating money,” said George Soros, the legendary if only occasionally accurate hedge funder, at a Washington forum in March. “If and when credit is restarted, you would then have an incredibly swollen monetary base, which, if it were leveraged, you would have an explosion of inflation.”

The trouble comes, as Lars Svensson guessed back in January, with that “if and when”. Because it opens the door to the idea that a central bank might opt instead to withdraw all this new money after the deflation panic has ended. And that in itself is enough to make creating it useless. Pointing to Japan’s five-year experiment with ‘Quantitative Easing’ between March 2001 and March 2006, said Svensson, boosting the monetary base by some 70% failed to “noticeably affect expectations of inflation and the future price level.

“For example, the Yen did not depreciate as it should otherwise have done. Firms and households clearly believed that the expansion of the monetary base was temporary and not permanent, which subsequently proved to be true. The monetary base fell back to normal levels when the interest rate was later raised to above zero.”

Sure, the Bank of Japan’s trillions did triple Japanese Gold Prices. But even with gold refusing to drop back against the Dollar right now, eagle-eyed readers will note that, quite apart from the urgent debate in Europe, the US authorities are at pains to deny they need an ‘exit plan’ any time soon. White House advisor Christina Romer made that much plain in last week’s Economist magazine, blaming the double-dip depression of 1937 on “an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy.” Yellen said it again Tuesday.

So Team Bernanke have got the right idea – at least on Planet Svensson – if not the right level of irresponsibility just yet. Slip a little vodka into their juice though, and they might start talking up inflation like Alan Greenspan, Bernanke’s predecessor and the Maestro himself, writing last week in the Financial Times. He tried to spook everyone out of cash and into the stores by warning of a decade of inflation ahead!

“A pending avalanche of government debt is about to be unloaded on world financial markets,” Sir Alan of Greenspan warned sagely, almost visibly winking from behind those enormous spectacles. “The need to finance very large fiscal deficits during the coming years could lead to political pressure on central banks to print money to buy much of the newly issued debt.”

Or given enough sauce to get really loose, the Fed might even get crazy like Asia-based doomster Dr.Marc Faber. (He’s been known to enjoy the odd cocktail or two.) Stop warning on hyperinflation. Just come out and say it instead.

“I am 100% sure that the US will go into hyperinflation,” as Faber told Bloomberg in late May, and again onJune 29th. “The US central bank has structured and introduced policies without considering exponential credit growth and its consequences,” added the Gloom, Boom & Doom author in an interview with the Korea Timeson Wednesday.

See what I mean about being a shill? It’s like he’s on the payroll…

“The United States will not raise interest rates for many years to come because it needs to pay off its huge debts,” he went on, recommending inflation-friendly assets such as equities and Gold Bullion. “In turn, too much money in the economy will raise costs of everything, including healthcare and education, giving rise to hyperinflation.”

There, now that’s the way to do it! Greenspan and Faber on song, while the Bernanke Fed tip-toes around stating its aim:

Spark inflation and leave it to burn. Because putting it out worsened both the Great Depression and Japan’s “lost decade” – the one that started two decades ago and hasn’t yet ended. Everyone who’s anyone in monetary theory knows that.

And if they claim otherwise, maybe they’re the ones kidding.

Source:  Faber and Greenspan: Shills for Fed Snake Oil

The source for this claim? Besides syllogism (”The ’70s gave us inflation and a gold bull market; ergo, the opposite must be bad for gold…”) it was apparently Roy Jastram’s The Golden Constant, that dry, dusty study of gold’s enduring stability across the very, very long run by the end of which we will all be deader than disco.

First published by Wiley in 1977, The Golden Constant has just been updated by Jill Leyland, former chief economist at the World Gold Council, for Edward Elgar Publishing. I’ve not seen the re-issue yet (not at £72 a pop, some $120). But unless Jill’s scrapped Jastram’s research entirely and written a wholly new monograph, the conclusions should in fact be precisely the opposite.

Gold, like silver, gained in purchasing power during deflation but lost out to inflation. The only things to rise during commodity-price inflations were commodity prices and social unrest.

Three centuries of data are hard to ignore, but it seems they can be misread – not least when skim-reading for a quick book review. (If you care for the big picture, Jastram’s charts are available at the Golden Sextant.) Those three centuries of data can also prove a real bore to analysts without a library pass, as Jastram apparently makes for “a very dense read” says a Seeking Alpha post today. (Its summary table then misses the very same deflation of 1723-1738 we skipped by mistake and haste in our essay online, Pick a Number, last week.) And all those numbers can also mislead the unwary if the key point’s neglected:

Gold, like silver, rose in value during deflation. But back then, it was still used as money, and it lost out to inflation back when that role applied, too. Since the end of WWII, we’ve not suffered the first and only endured the second…and gold has risen sharply in purchasing power as the supply of what we’ve come to call “money” has swelled by an order of magnitude or ten.

Meantime – and not coincidentally – gold ceased being money beyond offering a store of value (and money that’s free from default risk, as well). Little wonder that inflation really took off after the gold-edged limits to money-supply growth were cut by the Nixon White House at the start of the ’70s.

And we all know where that little trick got us…

“What the press and policymakers are calling ‘disinflation’ is simply deflation, the deterioration of the monetary standard characterized by falling prices,” wrote Jude Wanniski, formerly an associate editor of the Wall Street Journal and advisor to Ronald Reagan, in 1982 – slap bang in the middle of what he’d come to call the “Volcker Deflation” in honor of the tall, cigar-wielding, inflation-fighting Fed chairman.

Paul Volcker took US rates to double-digits and left them there, wringing inflation out of the system and squashing the Gold Price – then (as now) a key marker for the stable value (or not) of money.

“There is a confusion because commodity prices [in 1982] are falling even as the cost of living continues to rise,” wrote Wanniski to his Polyconomics clients. “[But] the price of gold, the ‘commodity money par excellence’, is the surest proxy for all prices, goods and bonds…[and] the recession that threatens to become depression could also swiftly turn into a major bull market if the Fed arrests the Gold Price decline at $300, signaling an end to continued deflation and the monetarist policies that have guided the open-market desk.”

Why the call for active Gold Price intervention? Because just over 10 years after Richard Nixon tried driving a stake through the undead Gold Standard’s heart, “Legally defining the official dollar/gold price and backing it with convertibility [was] the only means by which…the markets can be assured that Volcker’s successors would not be tempted to try another monetarist experiment,” Wanniski believed.

Fast forward the best part of three decades, and here we are again, trying to heat-treat the mutant spawn of a new “monetarist experiment” that’s also broken out of the lab and started to munch bystanders on the corner of Wall Street and Main.

Wanniski’s point back then was that, to prevent the end of the world, the Gold Price should be forced higher, making Dollar devaluation explicit and pumping cash into the economy that could then be lent and spent to unwind that “deterioration of the monetary standard characterized by falling prices.”

Only an idiot would pick a fight with Wanniski’s terms of reference. So please – if you’ll hold my jacket a second…

The vicious disinflation of the early 1980s stemmed the monetary crisis but failed to morph into outright deflation. That defied history as well as economists, since all previous prolonged destructions of monetary value had been naturally righted by falling prices to follow. But by the late 20th century, as today, gold was not money, not as a means of exchange, and nor did its above-ground supply dictate the limits of paper money in issue.

Absent the money-supply limits which the Gold Standard imposed on the world, people rightly guess that double-digit inflation would prove rocket-fuel for the bull market in gold. Yet the purchasing power of gold nearly doubled during the Great Depression, and it’s risen four-fold during this decade’s low consumer-price inflation as well.

Why? Because both those periods of low price-inflation saw the money-issuing authorities devalue the currency, first with explicit reference to gold but now without daring to name it. Roosevelt in the mid-30s slashed the Dollar’s gold content by 40%; the Greenspan/Bernanke Fed devalued the Dollar again to sidestep a DotCom Depression, keeping real interest rates at less than zero between 2002-2005.

The maestro’s apprentice applied the same trick in the back-half of 2008, but so far to no avail. Not on the official CPI measure, now negative for the first time since 1955. Here in the United Kingdom, the same wheeze is being used to try and avert the first fall in retail prices in five decades, and even the “vigilant” European Central Bank is pumping out money – a near half-trillion euros in 1% loans on Wednesday – in a bid to revive bank lending, swamp the FX markets with single currency, and pull Germany out of its first flirt with deflation since the 1930s.

Just such a devaluation – and again, absent any stated reference to gold – was attempted by the Bank of Japan a little less than a decade ago.

Indeed, Japan is the only developed nation since the end of the Gold Standard to have suffered an extended deflation in prices. So far, at least. Germany and Switzerland look set to try for a re-wind, and unless the Dollar can outpace the Euro’s descent, we might yet see truly sub-zero inflation in the United States, too.

But whatever that should mean for Gold Prices, all other things being equal, just doesn’t matter. Because the Gold Price will not get chance, as all other things are not equal, and the policy solution – rank devaluation – can only make gold more appealing to investors and savers, whether the “monetarist experiment” of TARP, Quantitative Easing or a half-trillion euros in 1% loans proves successful or not.

Japan’s slump into deflation coincided with the Bank of Japan’s “zero interest rate policy” (ZIRP) at the start of this decade. It also saw the Gold Price worldwide hit rock-bottom and turn higher – a move that analysts (including us) have typically linked to US monetary moves and investment cash looking for safety as the Dotcom Bubble exploded. But zero-rate money from the world’s second-largest economy shouldn’t be ignored. And today, zero-rate money is all the developed world has to offer.

This trick might not beat deflation. But it might just spur a whole new rush into gold regardless.

Source: Does the Price of Gold Rise or Fall in a Deflation?

“FEAR, Mr. Bond, takes gold out of circulation and hoards it against the evil day,” as 007 learns from a Bank of England officer in Ian Fleming’s Goldfinger (1959).

So “in a period of history when every tomorrow may be the evil day, it is fair to say that a fat proportion of the gold dug out of one corner of the earth is at once buried again in another corner.”

Evil-day gold buying really motored since the credit collapse began in August 2007. Soaking up investment dollars worldwide, in fact, new allocations to the metal – whether trust fund or owned outright – swelled by 38% during the first quarter of 2009 compared with total demand between Jan. and March 2008, according to marketing-group the World Gold Council (WGC).

Within that figure, what the GFMS consultancy (who supply the WGC with its data) calls “identifiable investment” leapt 248% compared to Q1 ‘08. And gold ETFs made the headlines once more, sucking in “another quarterly record” as new inflows required 465 tonnes of metal to back them, thus dwarfing the previous record of 149 tonnes set in the third quarter of last year.

That doesn’t mean the world’s investors are now all in, however. According to the World Gold Council’s Marcus Grubb last month (using we-don’t-know-which data), current gold investment allocation stands at less than 0.6% of total global wealth.

It makes a nice pie chart, and it offers a useful snapshot of different asset classes vs. each other. But we also think the idea’s worth refining. Because this estimate both over-states liquid assets in toto and under-estimates the stock of gold available to investment flows – whether retail or wholesale.

First, note the scope for double-counting between pension, mutual and insurance funds. I’m not saying the WGC’s data trips up on that error, but you can see how likely it seems given the end-allocation categories applied. For instance, “hedge funds” are stripped out separately (as are REITs and private-equity), even though institutional allocations via funds-of-funds will be counted elsewhere under the broader “funds” title.

Similarly, but more pertinent, the outstanding quantity of “gold – investment stocks” underplays the true volume of metal held as a store of wealth. Simply counting the “investment” volume excludes fully 84% of the above-ground supply, as another chart from the WGC’s presentation shows.

Why not also include “official sector” gold hoards? Sovereign wealth funds and FX reserves were included on the other side of the ledger, after all.

More crucially still, why not include jewelry? Trying to split out the volume of trinkets held for aesthetics alone might feel easy enough to a Western analyst just back from window-shopping at Mappin & Webb. But across south-east Asia, and most particularly in India – typically the world’s No.1 destination for physical gold each year – large, chunky necklaces and bracelets make for “investment jewelry”, acting as a store of wealth in the absence of any formal banking network.

Still, the point is well made, we believe. Gold remains but a slither of investable wealth – albeit a fast-growing slither as the value of other assets has dropped.

“Gold [has] been deprecated and reduced as a financial asset,” as Jeffrey Christian of the CPM consultancy put it earlier this year. “In 1968 gold may have represented 4.5% to 5.0% of the world’s wealth…By the 1990s it was down to 0.2% of the world’s wealth. Not that gold was falling in value so much as the other wealth – stocks, bonds, paper assets, government bonds, corporate bonds, bank deposits – were exploding once the tie to gold was severed.

“In 2006 gold represented 0.2% of world wealth. At the end of 2007, it was about 0.4%. Depending on what you think about wealth destruction in 2008, it may have been 0.6%.”

That figure just about matches the WGC’s estimate of 0.7% (perhaps they used the same inputs and excluded the same volumes of central-bank and jewelry gold?). It also contrasts with our own Estimate of Gold as a Proportion of Investable Wealth at nearer 2.7% by the close of 2008.

Either way, gold is fast-attracting attention – both from nay-sayers, retail investors and new die-hard bulls amongst the professional institutions. Regulatory filings show legendary hedge-fund manager John Paulson took his position in the SPDR Gold ETF (NYSE:GLD) to 30% of his portfolio during the first quarter of 2009. Paulson & Co. now owns 8.7% of that paper – as well as significant chunks of the Gold Miners ETF (NYSE:GDX), Kinross Gold (NYSE:KGC), Gold Fields (NYSE:GFI) and AngloGold Ashanti (NYSE:AU) – if not any actual bullion itself.

Does that in itself make gold a buy? Of course not. But compared to the evil days of 1930s depression – or the fearful inflationary panic of the late 1970s – the world’s wealth remains very under-invested in metal right now.

Regards,
Adrian Ash

Source: The World Gold Council Wrong About Gold

Even the UK’s small, tightly packed mainland, floating off the edge of Europe, includes disparate and distinct real-estate markets. Glasgow is as different from London as Cornwall from Cheshire. But in the main (and the mania), and with a peak of 185,000 new dwellings under construction in 2006, the broad sweep of house-price inflation…followed by an inevitable slump lasting six years or so…tends to apply across the nation.

In the United States, in contrast, new housing starts at the peak of what pundits, economists and investment bankers clearly felt was a coast-to-coast boom in 2006 approached 1.63 million amid a total housing market of 128 million units spread across 3.5 million square miles.

By necessity, that makes the idea of an “average” home price more slippery. But let’s not let such quibbles clog up our spreadsheet! Not after math PhDs, applied to mortgage-backed zeroes, clicked and dragged the answer “AAA” whenever asked. And not before we contend with the data itself.

This first chart’s solid enough, thanks to the certainty with which the Census Bureau dispenses its data.

It shows the median price of new US housing, at sale, divided by the ounce-price of gold, monthly average. And as you can see, new housing has swung wildly – measured in ounces – over the last 45 years. Quite clearly, one made a better home for investment than the other over distinct periods, as the mid-way price of new homes (half the market paid less, the other half more) was rocked and rolled by booms, bubbles and busts in both bricks and bars.

Second up, existing homes bought on the secondary market – and the same picture, but only on an annualized basis (and with the National Association of Realtors thrown in as a source) for the Census Bureau’s less lengthy, less detailed data.

You can see, between the two charts, how new housing during this last real-estate boom (2000-2006 in nominal prices) began and topped out much sooner when priced in terms of gold. New units also reached further above existing-home prices too, peaking at $243,000 in 2006 – then 550 ounces of metal – or some 10% higher than the secondary market.

Perhaps that extra cash paid for new homes’ expanding foot-print. But it’s also worth noting, turning aside from Gold Investment for a moment, that new US home prices this decade also saw the mean outstripping the median as never before. The gap between average and mid-point prices, in fact, gaped from one-fifth or less (1975-1999) to as wide as 30% during the summer of 2006. Which might show, we guess, a growing number of super-priced units way up at the top-end of the market…bought and paid for, perhaps, with bonuses skimmed off mortgage-backed bonds sold against the sub-median half.

Finally, the money shot…

True long-run figures for housing, like the concept of “average” itself, are more sketchy than Mel Gibson after a night on the sauce.

We’ve used Robert Shiller’s invaluable numbers, of course, but they only come as an index, itself built from five sources stretching back to 1890. Rolling those numbers back from today’s current average ($175,000 according to the NAR) only throws up big gaps with the Census Bureau prices collated and published every 10 years starting with 1940. It also puts the price of US housing above $4,000 in 1900 – and in 1900 dollars, too – when average wages were just $2 per day.

Okay, so home-buying was yet to meet democracy through that great 20th century liberator, the securitized mortgage loan. And yes, two-thirds of US homes had yet to gain running water, let alone electricity. But as in the UK data, Gold Bullion regained its Great Depression value in housing as the Great Inflation of the 1970s peaked out, suggesting (to us, at least) that its utility as a store of value was little diminished by new bath fittings and copper wiring.

The broad sweep – smoothed out to fix those anomalies which our quick desk-bound research, a mere 5,000 miles from the Library of Congress throws up – remains as broad and as sweeping as either gold bulls or bears might hope to spy.

From here, the bottom in housing may still be to come, at least priced in gold. Broad-sweeping investors are invited to draw their own conclusions.

Regards,
Adrian Ash

Source: U.S. House Prices in Gold

“Any house bought for ‘No Money Down’ should become a no money home, a free gift to the debtor. How’s that for putting a floor under prices…?”

Remember the great hope for Hope Now…?

“Let’s not harp on about the costs, absurdities or risks of governments meddling in real-estate bubbles when they burst,” wrote BullionVault as the Bush administration pushed the initiative front-and-center in December 2007.

“This is about hope. Hope now. Let’s worry about tomorrow some other time.”

Too bad tomorrow’s turned up, but with 917,000 homes foreclosed since then regardless. A further 1.3 million foreclosures are now in progress according to Hope Now’s own data, with nearly one-in-twenty of all US mortgages standing 60 days late or more on debt service.

Some 8.3 million mortgages risk being drowned by negative equity, too. So even if the lender moves to foreclose, the asset won’t cover the debt — if they can find a buyer at all — making the net loss of wealth truly systemic for America’s banks.

Which is kinda where all this began, only the other way round.

“Mortgage performance steadily declined each month in 2008,” says Hope Now in its full-year data. “One in 10 loans was delinquent in some way by December,” despite Hope Now itself helping modify and refinance almost a quarter-million loans that month. It helped modify and refinance a quarter-million loans yet again in January. By then, however, US real estate had lost $2.4 trillion of its value year-on-year, reckons First American CoreLogic.

Puff! It was gone, just like that. Which kinda makes you wonder where it all came from in the first place.

“There is broad agreement that until we begin to stem the tide of foreclosures, you will not get an end to the current crisis,” says Barney Frank, Democrat chair of the House Financial Services Committee, pointing to the, ummm, foreclosure crisis.

Put another way, “The remedy for [today’s] deflationary delevering and mini-depression is simple and almost axiomatic,” as Bill Gross, head of the Californian bond giant, wrote last month:

“Stop the decline in asset prices.”

Such a happy truism; stop prices falling, and you’ll stop pricing falling. But how to achieve it? Maybe Gross doesn’t quite mean what he says. Not as simply as he says it, at least. Not without trimming his (occasional) moustache into a neat little paintbrush. You know, more like that highly-strung German chap who stole Charlie Chaplin’s look (minus the hat and cane) in the 1930s.

But that word “delivering” — it throws up the real problem sparked by declining asset prices: the gap between what they’re now worth, and how much money was borrowed to buy them.

“One in five US homeowners with mortgages owe more to their lenders than their properties are worth,” First American CoreLogic goes on, as quoted by Reuters, “and the rate will increase as housing values drop in states that have so far avoided the worst of the crisis.” That army of drowning, not waving debtors now threatens to swell by one-quarter if home prices slip only 5% further from here, as well.

Negative equity, of course, doesn’t in itself force default. It’s inability to pay, most often sparked by loss of income, which forces late payments. But negative equity makes the problem systemic. Because it gears up the net loss and spreads it from debtor to lender, levering the pain of foreclosure from the hurt of the home-loser to the net lending loss suffered by banks.

Lenders end up out of pocket — and so too might their lenders in turn — even if they can sell the house reclaimed to settle the mortgage. All of which, as we say, just replays the merry-go-round spiral of soaring house values and E-Z credit in reverse.

“Making Home Affordable will offer assistance to as many as 7 to 9 million homeowners,” said the Treasury on Wednesday. (Note the friendly, if all-too pessimistic, use of the singular “home.”) Yes, the new commander-in-chief is leading a fresh charge against house-price deflation and the still-surging surge in foreclosures.

Once more, with feeling!

“The Home Affordable Refinance program will be available to 4 to 5 million homeowners [who] would be unable to refinance because their homes have lost value,” the Treasury went on, “pushing their current loan-to-value ratios above 80%…

“The Home Affordable Modification program will help up to 3 to 4 million at-risk homeowners avoid foreclosure by reducing monthly mortgage payments.”

Now throw on top the one million mortgagees expected to declare themselves bankrupt when Obama’s “cram down” bill wins the day in Senate (which it will), and up to 10 million American home-buyers look set to refinance or re-modify their loans, just 15 months after Dubya Bush and Hank Paulson swore blind that refinancing and re-modifying would stem the depression in housing.

Might it work this time round instead? Given that the cram-down act will enable federal judges to extend mortgage terms, slash the interest rates agreed with lenders, and cut the outstanding debt owed by insolvent homeowners, and you might expect the flood of foreclosures to slow. Destroying 1,000 years of contract law should achieve nothing less, you might hope. And that might stop home-prices tumbling. Right?

“Throughout 2008, the re-default rate ranged between 30% and 40%,” explains Hope Now, defining such recidivist shame as “any mortgage that is 90 or more days delinquent or in foreclosure 6 months after the date it was first modified.”

One-third of bad loans turned bad once again, in other words, even after the lender cut the debtor some slack. So perhaps the new hope for housing should just cut straight past the chase and go to the credits. Y’know, the bit where the state seizes outstanding home-loans entirely, and re-modifies their terms to give houses away free to what once were called “the buyers.”

Any house first bought for “no money down” should become a no money home, a free gift to the debtor. How’s that for putting a floor under prices!

“More householders than ever own their homes,” said the Census Bureau in 2001. Way up at 66.2%, however, that record ratio wasn’t high enough either for government or the finance industry. Hence the non-stop shilling by President Bush of home-ownership as a way to defeat racism, poverty, Bin Laden, you name it.

The number of owner-occupied homes had in fact swelled by nearly one-fifth in the previous 10 years. And since the 1990s marked prosperity (and even a shrinking fiscal deficit!) as interest rates ticked lower, runaway growth in home ownership was surely been an unalloyed good. Only an anti-American fanatic would think otherwise, you’ll agree.

But smothering fresh chunks of California, Nevada and Florida in hard-top failed to concrete over the basic facts of economics, however. Because where demand finds itself sated, but supply continues to build, over-capacity follows and prices start to fall back. And even before the housing recession became a depression, excess capacity was building fast in the US housing supply. The rate of occupation slipped from 87.5% to 86.4% between 2005 and 2007, while the total number of units crept higher to 128.2 million on the Census Bureau’s latest data.

Trying to stall or reverse this cold fact will clearly take more money — and more stupidity — than even the Bush administration could throw at the task. Such as, say, via fascism or hyper-inflation. Put a floor below prices, beneath which it’s illegal to sell; or allow house prices (if not the S&P too) to slide only in real inflation-adjusted terms, printing money to inflate the cost of living while nominal realty prices hold steady.

That would allow the slide in real asset values to continue, even as nominal prices stay flat or fall. Because short of socializing all houses and so taking their value to zero — a trick tried to sad effect across Eastern Europe c.1917 to 1991 — this tinkering and tweaking is just fighting a trend that cannot be stopped.

In this credit deflation, where the nominal price of all things is shrinking, that which inflated the most should now shrink the fastest. Both its share of total economic value and its absolute pricing are working to reverse their misallocation over the last decade and more.

And double the inflationary trouble means double deflation once the bubble has burst — as the financial services industry is only just finding out as well.

Source: Hope Now: Pretending People Can Keep Their Homes

Gold’s stellar run up to $850 per ounce, rising more than 24 times over, also came in the ’70s. So gold, therefore, must deliver its strongest returns when the cost of living shoots higher. Right?

Wrong. “In the long run, stocks have thrashed gold as great long-term hedges against inflation,” says Jeremy Siegel, professor of finance at Wharton University, Pennsylvania. What’s more, the eight-year bull run in Gold Prices so far this decade has come against the lowest average consumer-price inflation since the early 1960s.

In short, the common opinion of gold as first and foremost a defense from inflation is wildly amiss. Just look at the last 30 years.

Consumer prices in the United States, even on Washington’s data, have pretty much trebled since 1980. But starting at what was then an all-time high of $850 per ounce, gold simply failed to keep pace. In fact, it dropped half of its purchasing power (monthly data) over that time.

At its lowest point, back in 2001, gold’s loss of purchasing power for US investors reached beyond 85%. The broad S&P index, on the other hand, stood more than eleven times higher, even as the Tech Crash pushed US equities into a nosedive.

Sure, things have reversed a little since then. But not enough to reverse the cold fact of gold’s losses during the long inflation of the late 20th century. How can we square it with gold’s huge returns amid the inflationary ’70s?

“Well,” you might guess, “perhaps gold only responds to rapid inflation – the nasty kind we got 30 years ago, rather than the ‘mild’ case our money has suffered ever since?”

But again, you’d be wrong – or very close to it. Between 1980 and ‘81, consumer price inflation in the US destroyed 17 cents of the Dollar’s purchasing power, a severe depreciation by any reckoning. Yet the Dollar price of gold dropped 40% during that same period. Longer term over the 1980s and ’90s – a truly horrific period of sustained inflation, then averaging 4.6% per year and vicious by any historical comparison – the real value of gold sank by more than four-fifths.

Look further back – even to when physical gold stored in government vaults underpinned the Dollar, just as it underpinned all major currencies – and you’ll find that gold almost always made a poor hedge against rising prices. In the mid-70s, Professor Roy Jastram at the University of California at Berkeley found that gold failed to keep pace with the cost of living during seven inflations in Britain across more than three centuries. In the United States, Jastram spied six inflationary periods between 1808 and 1976. On average, they saw the purchasing power of gold fall by more than one-fifth!

Only the final period in Jastram’s study – beginning in 1951 – saw the metal gain value, and it continued to gain purchasing power for the next 30 years. By the end of 1980, the average annual price of gold had risen more than 17 times over. But right from that top it was downhill for the next twenty years.

How come?

What changed at the start of the ’80s? Two things in short order, which were entirely connected.

First, Paul Volcker – the famously tall cigar-loving chairman of the US Federal Reserve – raised Dollar interest rates to nearly 20%. So secondly, and as a direct result, the rate of inflation sank from that record peace-time spike above 14%.

Volcker’s strong medicine took nearly two years to slow the rate of inflation. But it killed the Gold Price almost instantly. Before Volcker hiked rates – and before he and his successors gained ample room to cut them year after year – “There was a kind of great speculative pressure,” as Volcker since said. The Fed noted how “speculative activity” in the gold market was spilling into other commodities. One official at the US Treasury called the gold rush “a symptom of growing concern about world-wide inflation.”

So yes, people piled into gold as double-digit inflation and collapsing bond prices destroyed their savings at the end of ’70s. And yes, it took a record return paid to cash for the devaluation of money to slow down, allowing a cautious return to risk assets like corporate debt, listed equities and new private ventures – assets whose long-term appeal rests on stable costs and expenses, rather than a speculative guess at how the central bank might set its interest rates from one month to the next.

But now, in contrast, Britain stands on the brink, the United States will likely confirm it on Friday, and Japan’s pretty much there – yet again – suffering the horrors of inflation’s bleak evil twin, deflation.

How come gold just keeps hitting new record highs?

Before the 20th century, short periods of falling prices were as common as scurvy, and just as harmless for the long-term value of money and assets. Indeed, deflation is a good thing, for savers at least. Provided their savings institutions stay solvent. And provided their cost of living actually goes down faster than the value of the assets they’ve saved. Which is not what’s happening today. And that brings gold’s other key feature – the one investors should note if they buy it as a tightly supplied metal that shot higher in price when inflationary panic struck in the late ’70s.

Because fact is, gold also offers a deep, liquid market (if held in its internationally tradable form of large wholesale bars) with no risk of counter-party default (if owned outright, rather than through a trust or a fund or a similar financial structure).

In our debt-deprived world today – where the outstanding value of what retirees and savers are owed is deflating much faster than costs – it’s this attraction of gold…it’s “off risk” advantage…which is fast-gaining appeal amongst large funds and private investors alike.

Inflation and deflation – both a crisis in money – both also force business and growth to give up. What remains, paying zero and promising nothing, is the need to simply store wealth and savings for a better future, whenever it shows.

Source: Gold Amid Inflation & Deflation

“When the Treasury tells a bank to pay a penny a share versus its old dividend, you know who’s calling the shots,” says Jon Bruss, an old-hand banker and founder of Fortress Partners Capital Management in Wisconsin according to Bloomberg.

“It may not be de jure nationalization but I think it’s de facto nationalization.”

Ignore the italics; state-control by law is coming regardless – soon and everywhere.

Starting in the US, Larry Summers’ letter to law-makers last week guarantees nationalization by default, by making good on the myth that private investors control how publicly-quoted corporations behave. They therefore deserve an absolute loss of capital investment, if not a full public flogging, starting with zero return. And no return means zero risk capital.

Promising to be the very best head of Barack Obama’s National Economic Council he ever could be, Summers vowed to cap and cancel dividends to banking stock-holders if their bank requests two dollops or more of federal assistance. So as the last fortnight’s trade shows, those banks crying “Help!” will only see whatever risk-capital still remains flee…meaning the state will have to step in with more aid again…guaranteeing no return-on-investment to free-market cash…sparking a last panic out of the bank’s issued share capital…leaving the feds to step in and acquire the whole bank.

Private investment isn’t being crowded out, in short, so much as thrown out the window. But it’s not just this capital re-structuring which will surely end with outright state ownership. Standing surety for depositors’ cash makes it a dead-cert as well – or so we guess here at BullionVault – for all but the smallest, most boring (and therefore most innovative!) groups.

Deposit insurance is one thing, and a very fine thing the FDIC represents too – that post-Depression vow of well-meaning bureaucrats to abolish all day-to-day risk in money, creating untold risk instead in home loans, investment banking and consumer credit over the next 60 years. But stumping up hard cash in the event of a bank-run would now be quite another joy-ride entirely. Because one run would beget more runs elsewhere. And meeting the cash call all in one go would bankrupt the entire state at a stroke.

For example, household cash balances at UK banks now total almost £1 trillion ($1.35trn) – nearly twice the London government’s entire 2008 budget. Other financial firms are owed a further £880bn by the banks. Non-financial firms hold £375bn on deposit. So in the event of a banking collapse, full nationalization would seem the cheap option (short-term, at least) ahead of paying out on the FSCS (the UK equivalent of the FDIC). Meeting the statutory promise, with little or no cash cushion to help, the British state would need to find something like 1.8 times a full year’s GDP. A fire-sale of “assets” would only cause a further meltdown in stocks, housing and credit. Trying to raise the cash by selling new gilts would prove risible. (The UK’s going to have trouble raising £118bn for its operational deficit alone in 2009.) Whereas deferring the hit, by taking it onto the state’s balance-sheet for some indefinite settlement, at least keeps the sovereign solvent today.

And what does that world look like? Iceland is first to find out, that tiny island of 305,000 souls. Its banking sector – with risk “abolished” and thus merely transmuted, just like everywhere else – built up what looked like assets worth some €100 billion by 2007 (around $130bn, both at then and today’s exchange rates). Yet the central bank only had €2 billion in foreign currency reserves, as the Wall Street Journal noted last autumn, “meaning it was effectively unable to fill its role as lender of last resort” when foreign lenders – the true deus ex machina for any national economy – baulked at fresh loans.

Come the crunch, Iceland’s banks found themselves without a back-stop. The safety-net of government aid simply didn’t exist…the holes between the strings were too big…and in a nation of just 305,000 people, the problem all governments face became plain to see. Because the Treasury, state, government, sovereign – whatever you want to call that leviathan supposed to exist outside of the day-to-day flux, secure and securing against all possible outcomes – is only ever identical with the population. National resources can never be greater than the nation itself.

Or as Abe Lincoln almost said, “Government of the people, for the people and by the people just keeps coming back to…umm…the people!”

Defending bank savers against bank default means using bank savings as their own guarantee. Because where else will the money come from? Now the risk of default stands so plainly in front of the entire industrialized world, it sure won’t come from that rare beast known as banking-stock shareholders. Those few stock-holders still in are being chased away.

Fancy a loan, comrade?

Source: Broke: No Choice But Nationalization