The Automatic Earth

After Jared Loughner opened fire on group of people in an Arizona grocery store early last year, apparently targeting Congreswoman Gabrielle Giffords, I wrote a post called "The Lunatic is in my Head". It questioned the mainstream narrative that we were fed about Loughner being a paranoid schizophrenic who had simply gone untreated for too long, and suddenly snapped. Let me be clear – in my opinion, whether Loughner was a "lunatic" or not is irrelevant to whether he should be held accountable for his despicable actions. There is absolutely NO excuse for such actions, and people like him should (and will) be punished to account for justice.

Fast forward to July 20, 2012, and we find ourselves confronted with a very similar tragedy. Police have identified James Holmes, a 24 year old studying for a P.h.D. in neuroscience at the University of Colorado, as the gunman who killed 12 people and injured 40 others at a Dark Knight movie premier in Denver. Should we chalk this horrendous incident up to the homicidal delusions of an abnormal person in an otherwise "normal" society as well, and then forget about it next week? Is there any connection at all between the actions of Holmes and the societal institutions and ingrained culture that surrounds us?

Perhaps it is time we, as individuals living in such a society, really start to ask ourselves why these incidents are apparently becoming more common throughout the developed world, mainly in the West but also in the East. What's happening in our economies, our corporate sectors, our banking systems and our socipolitical environments is not independent of what's happening in our movie theatres and our schools and our workplaces. Something deeper is happening than just chemical imbalances and misfiring neurons here; something more sinister, and something more widespread. I dare say we owe it to the victims and their families to not only offer them our thoughts and prayers, but to offer them our deeply considered reflection on what just happened.

In that spirit, I would ask readers to consider the following summary and review of the book "Going Postal: Rage, Murder and Rebellion " by Mark Ames, written in 2007 by Ed Vulliamy for the Guardian. In the book, Ames compares modern shooting sprees to the murderous outbursts of slaves against those around them, including but not limited to their masters – acute episodes of backlash against a culture of severe oppression and alienation. In the review, however, Vulliamy takes it a step further to suggest that perhaps what we are experiencing through these acts IS our culture, and what it has been for many years now. People like Holmes are not victims, rebels or exceptions – they are the metastasized cells of a cancerous culture.

Once again, I don't want to use this incident as a platform to convince anyone of anything, but simply to present ideas that deserve our consideration in these trying times.

Rage against the American Dream

 

It came as a shock, but then seemed suddenly inevitable: another news bulletin, another school massacre. Almost exactly a year before, I had been in Jonesboro, Arkansas, to report the gunning down of four girls at Westside Middle School. Now, in April 1999, it was a town called Littleton, Colorado, and a school called Columbine High: hardened SWAT officers wiping away tears; bereaved parents, their faces crippled with sorrow; another little town with its soul torn out by yet another 'rage killing'. 'Where's your God now?' the teenaged killer Eric Harris had jibed – with what one girl I spoke to called a 'dumb giggle' – before opening fire and killing her friend Cassie Bernall.

 

Then came the excavation into the world of Columbine's 'Trenchcoat Mafia', its immersion in guns, rap music, Marilyn Manson and violent computer games, and the acclaimed film Bowling for Columbine (2002) by Michael Moore. Now comes a book about the history of 'rage killing' in America that takes its title not from the school massacres that inspired it, but from an expression every American knows. 'Going postal' entered the language after a spate of shootings in the US Postal Service facilities that began in 1986 with a murderous spree by Patrick Sherrill in Edmond, Oklahoma. Ames explains how the shootings coincided with 'semi-privatisation' under Ronald Reagan that turned working for the USPS into a corporate experience like many others in postmodern, post-industrial America. But Ames goes further.

 

There followed many more workplace massacres, the histories of which he traces meticulously, and which he posits as acts of enraged rebellion against a new system of stress, layoffs and impossible expectations which are 'making the world a crueller place' in the new American factory – the office – and at places of supposed study. It is an apolitical insurgency by people who are, he insists, 'sane'.

 

In the education system, the stress endured by pupils' parents 'doesn't so much trickle down, it rains down from parent to child, like acid rain'. Ames draws a direct line between slave rebellions and rage killing, arguing that 'the modern American work culture derives from the same sources that defined slavery's official work culture'.

 

But the idea that developing forms of modernity and postmodernity devour, reduce and alienate their pawns to the point of violence is as old as modern social analysis. And other problems arise in Ames's argument, among them the fact that there have not, so far as I know, been many, if any, cases of 'rage massacre' in the sweatshops of Asia or indeed along the chain of Mexican export assembly plants, or maquiladoras, on the United States's southern frontier, where conditions are far worse than those in the US itself.

 

What Ames is writing about is a largely American phenomenon, and mostly a white one – with black ghetto gun killing another, though related, matter. Ames scorns the way 'Americans wanted to blame everything but Columbine High for the massacre' – citing 'a violent culture, Marilyn Manson, the internet' and the gun lobby. He wants the mainstream to be responsible, not its bogeymen.

 

Of course he has a point when it comes to the alienation, stress, pressure, bullying and loneliness endemic in modern America – imitated all over the world, markedly in Britain and Asia – and the violence they detonate. But what could be more quintessential to establishment America's perversion of its own culture than the factors Ames dismisses: violence in the media, on the internet, in mass music, all of it highly lucrative?

 

Is there really such a distance between the hardcore rap lyrics that incite violence and the entertainment industry that nurtures them? Or between Hollywood violence and extreme violence on the web and in computer games designed along Silicon Valley? What if rage killing were actually an affirmation of – not a 'rebellion' against – American culture?

 

The mediocre genius of postmodern mass culture is that it creates what appears to be dissent, in order to absorb it at a profit. A more interesting volume would collate these outrages, as Ames has done, and demonstrate how they were actually inspired by creatures of that same, highly established, mass and new digital media, that same postmodern, post-industrial culture against which Ames thinks they were directed.

 

This was pointed out to me, a year before Going Postal was conceived, by David Grossman, a former army psychologist who had tutored soldiers in the psychological art of killing in Vietnam, and had come to live in Jonesboro. By the time of the massacre there, he was a college tutor in 'killology', and he told me how what he called the 'continued stimulus and conditioned response' to ensure that a soldier would kill were 'manifest all over mainstream American civilian society, on television, in the rap music, in computer games'. During his experiments, children accomplished at cyber-killing became eager and skilful marksmen on a clay-pigeon shoot.

 

But how far do we want to go in 'understanding' rage killers, and defining their rampages in terms of 'rebellion'? We in Britain tend to regard American rage killing as something of a video game in itself – a passage in that fantasy mental screen narrative we call 'Americana'. But what if we bring it home? Covering Jonesboro and Columbine were coloured for me by the unforgettable honour of having previously met an extraordinary man called Mick North, whose daughter was killed, along with 15 other children, at Dunblane primary school in 1996 by Thomas Hamilton, who had a grudge against the local scouts, against parents of children at the school and against the local police, all two of them. Do we really want to 'understand' what Hamilton did in terms of 'alienation' from our admittedly rotten and 'postal' society? And if we don't, does that make us 'Outraged of Tunbridge Wells?' No, it doesn't. Closing Ames's book and trying to think of Hamilton as any kind of revolutionary or victim … sorry, it just doesn't work.

I’m always surprised by the common argument that central authorities will “not allow defaults to occur”, as if a) they have a clear-cut choice in the matter and b) those defaults haven’t ALREADY occurred. Obviously, this threat is the most acute at the so-called “sovereign” level in the Eurozone, in which countries are inextricably wedded to each other in unholy monetary matrimony. Greece has already defaulted on its obligations to private creditors, while the so-called “autonomous” regions of Spain are following quickly in pursuit, and the regions of Italy are in a close second (the Sicilian governor is being forced to resign due to the region’s proximity to default).

Yet, the dreaded “D” word is by no means limited to that side of the Atlantic. People tend to forget that the states and cities of America borrow vast sums of money and provide a whole range of services and benefits to their citizens, including education, police, firefighters, transportation, utilities, etc. These are governmental authorities that are now being forced to file for bankruptcy in increasing numbers and renege on many of the promises they have made to institutions and people in the past. It may not seem like much when considered individually, but when you add them up in the context of an already struggling private economy, they can certainly rival the effects of defaults in Europe.

Some of the more notorious bankruptcy filings by cities/counties in recent times have been San Bernardino and Stockton in California over the past few weeks, which were the second and first largest bankruptcies in U.S. history respectively, as well as Jefferson County, Alabama and Harrisburg, PA late last year. Leading the way in bankrupted government entities, though, is the state of Nebraska, as reported by Steven Church of Bloomberg:

Nebraska, Not California, is King of Municipal Collapse

 

Busted land deals and empty subdivisions bankrupted more governmental entities in Brian C. Doyle’s home state than anywhere in America. With the recent financial collapse of three of its cities, it might be easy to assume he’s from California.

 

Doyle, however, lives in Nebraska.

 

Quirks in local, state and federal law have made Nebraska home to almost one-fifth of the more than 220 Chapter 9 bankruptcies filed in the U.S. since 1981, according to a nationwide review of federal court records. California, with more than 20 times Nebraska’s population, is second, followed by Texas and Alabama. California may soon add to its total, as San Bernardino decides whether to seek court protection this week.

 

The main difference between Nebraska and its larger brethren is the kind of governmental bodies that file for bankruptcy. No town, city or county has sought court protection in the state. All 45 of Nebraska’s Chapter 9 cases were by special tax districts, most of them owned by residential subdivision developers who used property-tax revenue to pay for streets, sewers and other infrastructure.

 

“Chapter 9 is an effective tool that can be used to protect taxpayers and treat creditors fairly,” said Doyle, a land-use attorney in Omaha who represents bankrupt subdivisions. Those special tax districts become vulnerable to bankruptcy when housing sales slow, he said.

What’s key to remember, though, is that the filing of bankruptcy is simply the culmination of a process in which an increasing number of obligations are not met by the entity involved. San Bernandino and Stockton had been cutting services and payments to various public institutions and creditors for quite some time before they finally had no choice but to file Chapter 9. Bankruptcy is truly the last option for a desperate government that can no longer find ways to squeeze and manipulate their obligations to creditors, public officials and citizens without creating a massive political and public relations disaster.

For example, Ben Duronio of Business Insider explains that the city of Stockton, CA had imposed massive austerity on its police department over the past few years, and that had led to a “surge in murders” and an “emboldened criminal element”, all before they were forced to file for bankruptcy:

STOCKTON GOES BANKRUPT And Already The Murder Rate Is Soaring

 

Stockton, California is filing for the largest bankruptcy of any U.S. city in history due to the decline in the once hot housing market and an intake of debt during its boom years.

 

The city has cut more than $90 million in spending over the past few years, specifically in its police department. The city has cut over one quarter of its police jobs, which has led to a “surge in murders”, and has created an”emboldened criminal element” in the city. According to police spokesman Joe Silva, the city has had 87 murders since the start of 2011, 29 of which have already occurred this year. In contrast, there were 35 murders in 2009 and 48 in 2010. With six months left in the year, there have already been more murders in the city since the start of 2011 than the two-year stretch of 2009-2010.

 

Further cuts to the police department would likely only worsen the issue, so filing for bankruptcy after already having cut 40 percent of its city’s employees was the only option, according to Mayor Ann Johnston.

So how many more counties/cities in the U.S. are being forced to systematically gut their institutional services to citizens on the road that inevitably leads to bankruptcy? Ben Duronio also profiles twelve other large cities/counties that find themselves in dire financial straits –  OH CRAP: A Whole Bunch Of Cities And Counties Are Now Seeing Their Finances Collapse. And those are only the ones that are worst off right now. I suspect many readers living in the U.S. can attest to various ways in which their cities are gradually imposing austerity on the public to continue rolling over their debts and meeting their obligations to private creditors. 

It won’t be enough, though, just like it was never enough for Greece. And for those who are expecting Ben Bernanke to ride in and save the day with a QE3 program that targets municipal bonds, they need to first explain why he just gave the following response to a question about how much QE the Fed can realistically do – “I assume there is a theoretical limit on QE as the Fed can only buy Treasuries and Agencies“. Personally, I don’t think Bernanke is stupid enough to place an arbitrary constraint on the Fed unless he already knows for certain that the option will not be pursued.

May 1936. “Bank that failed. Kansas.” Medium-format nitrate negative by Arthur Rothstein for the Resettlement Administration.

It seems to have been at least a month or two since the last time TAE ticked off more than a few gold bugs with an article, and that’s much too long if you ask me! My aim here, of course, is not really to tick anyone off, although that may very well be the result, but to present some balanced information about where the price of gold may be headed in the near-term. Claude B. Erb and Campbell R. Harvey from the National Bureau of Economic Research published a report last month entitled, “The Golden Dilemma”, in which they addressed many of the common arguments in favor of gold as an investment.

Given the length of the report, I am just going to present you with the excerpts and graphs that I feel are most relevant, as well as some very limited commentary of my own. There is a lot of data/information to process here, but the authors do a pretty good job of distilling it down to its most simple form. I am mostly interested in hearing what our readers think about the arguments made. There is a lot more data and analysis from the report than what will be presented here, and you can find it all by following the PDF link above.

#1 – Gold Provides an Inflation Hedge

Report: Exhibit 1 illustrates one literal version of the “gold as an inflation hedge” argument. Our initial sample starts in 1975 because for most of the history of the U.S., the price of gold was fixed by the government.8 Exhibit 1 shows the month-end value of the nearby gold futures contract versus the monthly reading for the U.S. Consumer Price Index (CPI), over the period January 1975 to March 2012. The red regression line shows that on average the higher the level of the CPI the higher the price of gold. This line roughly portrays the implied price of gold — if gold was driven by CPI. However, in Exhibit 1, the price of gold swings widely around the CPI. The inflation derived price of gold and the actual price of gold have rarely been equal. Given the most recent value for the CPI index, this version of the “gold as an inflation hedge” argument suggests that the price of gold should currently be around $780 an ounce.

 

 

Ashvin: One obvious criticism to this approach is that the official CPI numbers are under-estimated, and therefore gold has risen more commensuaretly with real inflation. However, I think this flaw is partially mitigated by their comparison of gold prices to CPI over the last 40 years, which includes periods before many CPI adjustment mechanisms were put in place. In addition, they compare gold prices to “unexpected inflation”, i.e. the change in the annual inflation rate. If the CPI is under-reporting inflation through various adjustments, then we would at least expect the magnitude of under-reporting to remain relatively constant over time.

 

 

Report: In “normal” times, gold does not seem to be a good hedge of realized or unexpected short-run inflation. Gold may very well be a long-run inflation hedge. However, the long-run may be longer than an investor’s investment time horizon or life span. In the short-run the real price of gold has been the dominant driver of the price of gold and the returns from gold. We will return to the inflation argument when we explore the “safe haven” argument where we explore hyperinflation.

#2 – Gold Serves as a Currency Hedge

Report: There are at least two ways to interpret the “gold as a currency hedge” argument. The first interpretation suggests that “gold is a foreign exchange currency hedge”. In this case, the expected return of gold should offset the expected decline in the value of one’s own currency. If, for instance, the U.S. dollar declines 10% against the Japanese yen then the “gold as a currency hedge” argument would suggest that the price of gold should rise by 10%. The net result of this hedge should be a return of zero (gold return + currency return = 0).

This perspective has the following problem. If the price of gold in a country is driven by its own inflation rate and if the exchange rate between two countries is driven by the difference in their inflation rates, then gold will only reliably be a hedge of the foreign exchange rate if one of the two countries always has an inflation rate equal to zero.

Exhibit 12 shows how the local currency real price of gold has fluctuated in a number of countries: Australia, Canada, Germany, Japan, New Zealand, Switzerland, the U.K. and the U.S. In each case the local currency price of gold is divided by a local inflation index19 and the resulting ratio is normalized to an initial value of 1.0. The message of Exhibit 12 is that since 1975 the real price of gold in these eight countries seems to have moved largely in tandem. The real price of gold reached a high level in 1980 amongst all eight countries. The real price of gold fell to a low level in each of the eight countries in the 1990s, and more recently the real price of gold has risen to very high levels in all eight countries. The historical evidence of a seemingly common local currency movement in the real price of gold does not lend itself to a convenient “gold as a currency hedge” explanation. In fact, the change in the real price of gold seems to be largely independent of the change in currency values. Furthermore, since the real price of gold seems to move in unison across currency perspectives, it is unlikely that currency movements help in explaining why the real price of gold fluctuates.

 

 

#3 – Gold is an Attractive Alternative to Assets with Low Real Returns

Report: The “gold as an alternative to other assets with low real returns” is a competing assets argument. The most frequent manifestation of this story is “the price of gold rose because nominal, or real, interest rates fell” argument.20

Exhibit 13 illustrates the historical relationship between the real price of gold in U.S. dollars (using the observations from Exhibit 2) and the real yield of a generic 10-year Treasury Inflation Protected Security (TIPS). Month-end observations from the inception of TIPS trading in 1997 to the present are used. The message of Exhibit 13 seems to be fairly obvious. When real interest rates are high, as they were during the late 1990s introduction of TIPS in the U.S., the real price of gold was low. Now that the real yield on a 10-year TIPS is low (close to zero) the real gold price is high. The correlation between ten year TIPS real yields and the real price of gold is -0.74. Is it possible to disagree with the view that low real yields caused the real price of gold to be high? Yes.

 

 

It is important to avoid the “correlation implies causation” trap. The negative TIPS real yield-gold real price correlation of -0.74 is a measure of the linear correlation of real yields with real gold prices. While it is possible to argue that low real yields “cause” high real gold prices, it is equally possible to argue that high real gold prices “cause” low real yields. Alternatively, it is possible that both low real yields and high real gold prices are driven by some other influence, such as an immeasurable fear of hyperinflation. This is a classic example of spurious correlation.

Does the competing assets argument “explain” the nominal price of gold? No. Does the competing assets argument “explain” the real price of gold? No.

#4 – Gold is a Safe Have in Times of Stress

Report: The safe haven/tail protect argument has already appeared three times. First, it is possible that gold does not hedge day-to-day inflation surprises but provides some protection in a hyperinflationary environment. Second, gold may not provide very effective hedging for currencies in usual circumstances but might provide some protection in situations of significant debasement – such as one associated with hyperinflations. Third, the negative correlation between real gold prices and real interest rates may be driven by the fear of a large negative macro event – such as hyperinflation.

First, let’s examine the safe haven with respect to financial stress. Exhibit 14 shows the joint distribution of U.S. stock and gold returns. How does gold hold up in Quadrant 3 (negative equity returns matched with negative gold returns)? The simple safe haven test states that there should be very few observations in Quadrant 3. In fact, 17% of the monthly stock and gold return observations fall in Quadrant 3. This suggests that gold may not be a reliable safe haven asset during periods of financial market stress.

 

 

For some proponents of gold investment, the hyperinflation of the Weimar Republic stands as an electrifying example of the risks of a fiat currency regime. The hyperinflation of the Weimar Republic during the years 1922 and 1923 is an example of a possible endgame for a country that spends much more than it earns. The German mark-U.S. (gold) dollar exchange rate rose from 430 in 1922 to about 433,000,000,000 by 1924. If such a hyperinflation unfolded in the U.S. today and if gold moved with the inflation rate, then the price of gold would exceed $163 trillion U.S. dollars

Largely unpredictable events with impossible to caluculate probabilities and far reaching and inestimable consequences live in Extremistan. Hyperinflation lives in Extremistan. Extremistan is populated with “I don’t know” events. For instance, if hyperinflation occurs it is likely that no one knows ahead of time how long the hyperinflation will last and how significant the magnitude of the hyperinflation will be. In Extremistan, it is impossible to tell how bad things might be so any example, such as how bad things were during the German inflation, is as good, and arbitrary, as any other possibility. In Extremistan the price of gold ten years in the future might be $72,092,964,539,007.

Exhibit 16 illustrates a simple “mixture model”, a way of thinking about financial market outcomes by looking at a combination of models that describe outcomes during “normal” times (Mediocristan) and during stressful times (Extremistan). Given the assumptions, a one-in-a-billion chance of ending up in Extremistan yields a 10 year in the future expected value for gold in excess of $72,000. A one-in-a-hundred chance of ending up in Extremistan yields an expected gold price in excess of $720 billion. The Mediocristan-Extremistan framework does not provide any insight into the probability of hyperinflation. In addition, the Mediocristan-Extemistan framework does not provide an explanation for the currently high real price of gold. Its main value is that it highlights the dilemma faced by investors: how even extraordinarily remote probabilities of hyperinflation could have a large impact on the possible future price of gold.

 

 

Ashvin: I suspect the probability that major fiat regimes will enter Taleb’s “Extremistan” in the future will easily exceed 4% as debt deflation progresses and central authorities respond. In fact, we could be well over a 50% probability another ten years from now. However, as the author’s of the report point out, it is called “Extremistan” for a reason – there is really no telling what the sociopolitical environment will look like once we get to that stage of the collapse. It is quite possible that gold technically valued at obscene amounts will actually not be that valuable to the person who possesses it, since they must protect it from central authorities and street-level thugs alike, and they must trade it for basic necessities in what could very well be a war-torn landscape.

#5 – We are Returning to a De Facto Gold Standard

Report: Why is no country on the gold standard? Some of the supposed possible benefits of a gold standard are: “life without inflation, an end to the business cycle, rational economic calculation in accounting and international trade, an encouragement to savings, and a dethroning of the government-connected financial elite” (see Rockwell, 2002). Others such as Delong (1996) highlight a belief that a gold standard would result in loss of “normal” monetary policy options (such as the possible Phillips curve trade-off between inflation and employment and impart a recessionary and deflationary bias to countries with balance of payments deficits). This line of thought focuses on the work of Eichengreen and Peter Temin (2010) who note that during the Great Depression those countries that abandoned the gold standard earliest suffered the least economic harm. One view of the “de facto gold standard” argument is that the gold standard is the worst form of currency except for all those other forms that have been tried from time to time.

If a gold standard exists then gold is money, but the “gold is money” argument does not require the existence of a gold standard. The “gold is money” argument is essentially another way of stating the “constant price when measured in gold” argument. For instance, investors Brodsky and Quaintance (2009) and hedge fund manager Dalio (2012) have argued that “gold is money” without arguing that the world is on a de facto gold standard. For Brodsky and Quaintance (2011), the “shadow price of gold”, the price they believe gold should trade for, is equal to the amount of the U.S. monetary base divided by the official gold holdings of the U.S. Given a monetary base of $2.7 trillion and official U.S. gold holdings of 8,300 metric tons this yields a “shadow gold price” of about $10,000 an ounce. Similarly, Dalio28 thinks that “the price of gold approximates the total amount of money in circulation divided by the size of the gold stock”.

The “shadow price of gold”, “gold is money”, argument is an intriguing concept. The “gold is money” argument is influenced by Friedman’s assertion that “inflation is always and everywhere a monetary phenomenon”. As a result the “gold is money” argument is essentially a restatement of the “gold as an inflation hedge” argument, and it should not be expected to more successfully explain the variation in the real price of gold. However, the “gold is money”, “shadow price of gold” argument yields a fairly specific prediction: a view of where the price of gold should be if the world actually accepted this specific view. From a U.S. standpoint, all that is needed to know where the price of gold is headed is a sense of the size of official U.S. gold holdings and the size of the U.S. “money supply”.

Exhibit 17 shows a time series of official U.S. gold holdings since 1870. Official gold holdings peaked at about 20,000 metric tons following implementation of President Roosevelt’s Executive Order 6102, which outlawed the private ownership of gold in the U.S. Official gold holdings entered a period of decline during the Eisenhower administration that continued until 1971, when President Nixon officially took the U.S. off the gold standard. Since that time, the official gold holdings of the U.S. have been slightly greater than 8,000 metric tons.

 

 

The “shadow price of gold” is simply the “money supply” divided by the official gold holdings of the U.S. There is, of course, some ambiguity as to which definition of the money supply to use. The Federal Reserve currently publishes three versions of the “money supply”: the monetary base, M1 and M2. Furthermore, the Federal Reserve once published an M3 money supply number, but M3 was discontinued in 2006. Using the monetary base as the money supply value with which to calculate the “shadow price of gold” yields a current gold price target of about $10,000 an ounce. Using M1 as the money supply value with which to calculate the “shadow price of gold” yields a current gold price target of about $8,000 an ounce. Using M2 as the money supply value with which to calculate the “shadow price of gold” yields a current gold price target of about $37,000 an ounce.

These “shadow prices of gold” may seem alarming since each of the “shadow prices” is much higher than the current price of gold. Additionally, part of the “shadow price of gold” argument is that the higher the “shadow price of gold” is relative to the market price of gold the greater the latent inflationary pressures faced by the U.S.

There are a few obvious challenges with this line of reasoning. First, in the U.S. there has been an abundance of research that finds little evidence of a link between money supply growth rates and inflation rates.29 Second, why just focus on the U.S.? The U.S. official holdings are only about 5% of the world gold supply. In summary, the shadow price of gold is an engaging concept but, because it relies upon a vague model (the theory of exchange) and poorly defined monetary aggregates, it does not help us understand the underlying dynamics of the gold price.

#6 – Gold is “underowned”

Report: Of the six arguments to own gold, the “gold is underowned” argument offers probably the best way to understand why the real price of gold might vary. In order to explore the nuances of the “gold is underowned” argument, it is important to address a number of subsidiary issues: how much gold exists, who owns the gold, and have demand trends changed over time. Of course the “gold is underowned” argument is somewhat ambiguous since all of the gold in the world is currently owned by someone. 30 In its simplest version, the “gold is underowned” argument asserts that not enough people own gold, that maybe everyone should own some gold and the move towards universal gold ownership should cause the nominal and real prices of gold to skyrocket.

How much gold is there? Gold exists both above and below the ground. Above ground gold is gold that has already been mined. Below ground gold is gold ore that has yet to be mined. No one knows exactly how much above ground gold exists. The World Gold Council (2012) estimates that 171,300 metric ton of gold have been mined since the beginning of civilization. The World Gold Council estimate provides a convenient anchor for measuring the number of tons of gold but given the Herculean task of enumerating gold holdings “since the beginning of civilization” the actual, unknown, number could be much lower or higher. Buffett (2011) points out that 171,300 metric tons of gold would create a cube measuring 67 feet on each side. The U.S. Geological Survey (USGS, 2011) suggests that there might be 51,000 metric tons of “below ground” gold reserves that could be mined in the future. If the USGS estimate is correct then over 76% of the world’s actual and potential gold has already been mined. This balance of already-mined-gold relative to yet-to-be-mined-gold once prompted the CEO of Barrick Gold to speculate about the possibility of entering a period of “peak gold”.

Exhibit 20 plots investment demand, jewelry demand and technology demand relative to the U.S. dollar price of gold over the time period 2001 to 2011. The investment demand for gold seems to rise with the price of gold. This upward sloping investment demand is striking. While it is possible that the upward sloping investment demand for gold is an example of a Giffen good or a Veblen good, there are two other explanations that might be more plausible: the impact of momentum-based investors and “too much” demand, totally divorced from a momentum motive, chasing “too little” supply.

 

 

Exhibit 21 displays the trajectory of the real price of gold and the physical gold holdings of the world’s largest gold exchange traded fund, the SPDR Gold Trust. The SPDR Gold Trust, ticker symbol GLD, was launched in 2004. Since then its holdings of physical gold (stored in vaults in London) have grown from nothing to over 1,000 metric tons. GLD currently holds a little less than 1% of the world’s known supply of above ground gold. GLD’s purchases of gold represent about 15% of the total investment demand for gold since 2004. As we will soon see, this ETF has more gold that the official holdings of China. Exhibit 21 illustrates a rising amount of gold investment as the price of gold rises, which is consistent with an upward sloping demand curve for gold. While momentum investing is consistent with an upward sloping demand curve from traditional financial investors, in which a rising price leads to rising demand, it is also possible that there has been too much “non-traditional momentum” gold demand, relative to supply, and that excess demand has driven the real price of gold to historical high levels.

 

 

Have the Chinese been buying gold? Exhibit 23 shows World Gold Council estimates of the central bank gold holdings for Brazil, Russia, India and China, the BRIC countries. China’s estimated central bank gold holdings are currently over 1,000 metric tons. There is no reason to believe that Chinese central bank gold holdings are more accurately reported than any other Chinese government statistic. Even though China’s gold holdings have risen sharply over the last few years, as just noted, China holds less gold than the SPDR ETF. China’s gold holdings may still be rising.

Exhibit 25 profiles the entities that have either purchased or disposed of the largest gold holdings since 2000. China, Russia and Saudi Arabia have been enthusiastic purchasers of gold and the Netherlands, France and Switzerland lightened up on their gold holdings. For many years the central banks of the Western countries viewed gold as a “barbarous relic” that cluttered up their balance sheets. Some Western central banks sought to lighten up on their gold holdings but the lack of liquidity in the gold market forced them into a series of Central Bank Gold Agreements (CBGA). The essence of the CBGAs was that the central banks that wished to sell gold collectively agreed that they would not sell more than some set amount of gold in any one year. Depending upon the terms of the specific CBGA, the typical amount of sales was limited to 400 or 500 metric tons per year. The motive for limiting the number of tons of gold sold in any one year was a belief that the gold market could not absorb more gold sales without the price of gold falling significantly.

 

 

The “gold is underowned” argument has probably been an important driver of the increase in the real price of gold. A rising level of gold investment by emerging market central banks in an illiquid gold market could lead to a rising real price of gold. The rising real price of gold could act as a signal to momentum based investors to allocate capital to gold. As long as some central banks are insensitive to the price they pay for gold the possible move into gold could drive the real price of gold much higher.

Ashvin: And so the report ends on a much more positive note for all the gold bugs out there, but many questions remain. Can we really expect “investment demand” to continue its upward sloping trajectory of the last decade? Do we really think the emerging market countries will continue to emerge and diversify into more and more gold holdings? I suspect that these trends are unlikely to persist in the near-term. And I also suspect that too much gold demand has come from momentum investment in the paper products offered by vehicles such as GLD, and things could get ugly when people lose confidence in the ability of such vehicles to actually produce the gold they claim to have allocated. As always, time will tell the tale.

I think the one recurring question that has been on everyone’s minds since at least 2008-09 is – what will the government do? We all know what the large private corporations and high-level bankers are going to do – they are going to lie, cheat, scheme and steal their way into whatever forms of wealth and control they can get their grubby little hands on (see the Libor scandal for the most recent example). But then we must ask whether the government is going to help them do those things and how exactly they are going to help. After four painful years of betrayal, the answer to the first part of that question seems to be a resounding YES.

And with political partisanship propaganda filtering through the Western populace in time for various elections, a lot of people will look at these government policies and scream “SOCIALISM” or “COMMUNISM” with a growing sense of frustration and anger. Indeed, there has been no other time in recent history in which central authorities have been so actively involved in the affairs of the private sector. But, if I remember correctly, the foundational tenet of central planning in a Communist system is, “from each according to his ability, to each according to his need” – the economic version of the Golden Rule. Is that what we see happening here?

That’s not what I see happening… I see the central authorities bending over backwards to take what people can no longer afford to give and giving it to those who are never satisfied with what they have. That’s the entire point of low interest rate policy, quantitative easing, central bank currency swaps, discount loans to banks, public loan guarantees, etc. They either directly hand out taxpayer money to the banks (and their large corporate beneficiaries) in exchange for worthless collateral, or they coerce workers and savers to put their wealth into the private sector in the form of consumer spending and investments. They also coerce debtors to remain in debt and continue running on the treadmill for fear that it slows down and they fall off the back, as Nicole would say.

This dynamic is the most potent in the Eurozone right now, where banks are starting to get bailed out by their governments en masse, AGAIN, and the struggling masses are forced to forgo public salaries/pensions, health benefits, etc. and also pay higher taxes. We see it all to clearly in Spain, where the Spanish government is currently at the forefront of bailing out reckless bankers and implementing austerity, while the Spanish population is already suffering upwards of 25% unemployment. However, don’t be fooled for a second into thinking that the same dynamic isn’t happening right here and right now in the U.S.

In fact, a headline from Reuters today, which probably comes off to most people as a “positive” economic development, actually confirms that the wealth extraction process in America continues on even in the absence of QE3, and is beginning to reach extreme levels.

U.S. Bankruptcies On Pace To Fall To Pre-Crisis Levels

 

July 5 (Reuters) – The number of U.S. businesses and consumers filing for bankruptcy fell 14 percent in the first half of 2012 and could end the year at the lowest level since before the 2008 financial crisis, according to data released on Thursday.

 

New bankruptcy filings fell to 632,130 in the first six months of the year compared to the same period last year, according to Epiq Systems Inc, which manages documents and claims for companies in bankruptcy.

 

The number of businesses filing for bankruptcy dropped 22 percent to 30,946 and the number of consumers seeking court protection from creditors fell 13 percent to 601,184.

 

“We are on pace for perhaps the lowest total new bankruptcies since before the financial crisis in 2008,” said Samuel Gerdano, executive director of the American Bankruptcy Institute, which jointly released the report with Epiq.

 

Gerdano attributed the decline to low interest rates, which have been kept at rock-bottom levels since the financial crisis by the U.S. Federal Reserve.

 

Despite the drop in filings, there have been several large bankruptcies this year, including photography icon Eastman Kodak Co, textbook publisher Houghton Mifflin Harcourt Publishers Inc, and Hostess Brands Inc, the maker of Wonder Bread and Twinkies.

The first question we should be asking here is who benefits from low interest rates that prevent businesses and consumers from filing for bankruptcy and discharging their debts? Yep, you guessed it – the same people who benefit from every other policy enacted by central authorities. As long as there remains wealth to be extracted from people who have mortgages, car loans, business loans, student loans, credit card debt, etc., the government will help the private banks do just that. The bankruptcy process is really the closest Americans will ever come to having a “debt jubilee” over the next decade, and that’s the one thing that is progressively slowing down, becoming sclerotic and growing much too expensive for the little guys.

A friend of mine works for a law firm that handles corporate and individual bankruptcies in Northern Virginia, and he also confirmed that business had slowed down for the firm lately. He made it clear that a primary reason was the fact that it simply wasn’t worth it for potential clients to file anymore – they didn’t have nearly enough equity left in their assets or dischargeable debt to justify paying the lawyers’ fees and court costs associated with a bankruptcy filing. Basically, they have already been squeezed out of so much wealth that they have been priced out of the bankruptcy process. It is really a sad state of affairs…

 

“From each according to his inability, to each according to his greed”

 

Make no mistake, that is the golden rule of our age. And when central governments around the world decide to nationalize their private industries through legislative dictate, it will STILL be the motto we are forced to live by, because only a select group of elites will benefit from the decisions of those central planners. No, such a paradigm cannot described as Socialism or Communism. What is happening is so unprecedented and radical that our current language barely has the words to describe it. Perhaps we can call it Fascism on Steroids and in Hyperdrive… or something like that.

But regardless of what we choose to call it, we must remember that 99%+ of humanity occupies the same boat here – there is no use trying to scapegoat one segment over another through the political process. Those types of populist calls will start coming in strong and fast, but we must resist the urge to validate them ourselves. The political machinations of nation-states are all but dead now; only the natural sovereignty of individuals and their local communities remain.

Flipping through the channels and browsing through the Internet, watching/reading the pundits on CNBC and Bloomberg and Fox and CNN and [insert your channel or website here]… I can’t help but think about how badly the mainstream media has failed us over the last 51 years. And not just because of the fact that 90%+ of it is owned and managed by a few megalithic corporations, but also because the journalists, reporters, analysts, columnists, editors, publishers, blog writers, etc. etc. have failed to venture outside of their comfort zone – to buck the Owners – in order to expose uncomfortable truths.

Granted, there have been a few courageous souls over these years that have stepped up to the plate and gone to bat for the American public and the world at large, but none of them have really managed to live up to the standards set forth by that one courageous soul of 1961; the President of the United States, John F. Kennedy, who addressed the American Newspaper Publishers Association and made it clear that the Press was the ONLY institution that could keep the country and the world from running off the rails.

Yet the Press as an institution has clearly failed, and we have run off the rails in a major way. We see the evidence of this every day now as multinational corporations and governments across the world engage in accounting fraud, taxpayer fraud, embezzlement of client funds, insider trading, political subversion of “democratic” elections, undocumented expenditures, oppressive regulation, unauthorized wars and countless other injustices against the very idea of free and independent peoples, without any meaningful discussion of these injustices in the media.

When JFK was assassinated in 1963, the Western world lost whatever remaining shreds of transparent leadership it had managed to hold onto, and we wholly succumbed to a system run by shameless guerrillas launching attacks against everything free and fair and righteous in this world under the cover of night. In fact, there are not much more than one or two political or corporate or academic leaders in the world that I can think of who fail to fit that description like it was custom-made for them, and the most influential media outlets and journalists are no longer exceptions either.

Here is the text and the audio of a Speech that truly speaks for itself:

Address, “The President and the Press,” before the American Newspaper Publishers Association, 27 April 1961

 

“Ladies and gentlemen,

 

the very word secrecy is repugnant, in a free and open society, and we are as a people, inherently and historically, opposed to secret societies, to secret oaths and secret proceedings.

 

We decided long ago that the dangers of excessive and unwarranted concealment of pertinent facts far outweigh the dangers which are cited to justify it.

 

Even today there is little value in opposing the threat of a closed society by imitating it’s arbitrary restrictions.

 

Even today there is little value in ensuring the survival of our nation, if our traditions do not survive with it.

 

And there is very grave danger that an announced need for increased security will be seized upon by those anxious who wish to expand it’s meaning to the very limits of official censorship and concealment.

 

That I do not intend to permit, to the extent that it is in my control.

 

And no official of my administration whether his rank as high or low, civilian or military, should interpret my words here tonight, as an excuse to censor the news, to stifle dissent, to cover up our mistakes, or to withhold from the press and the public the facts they deserve to know.

 

For we are opposed, around the world, by a monolithic and ruthless conspiracy, that relies primarily on covet means for expanding it’s fear of influence,

 

on infiltration instead of invasion,

 

on subversion instead of elections,

 

on intimidation, instead of free choice,

 

on guerrillas by night, instead of armies by day,

 

It is a system which has conscripted, vast material and human resources into the building of a tightly knit, highly efficient machine that combines military, diplomatic, intelligence, economic, scientific, and political operations.

 

Its preparations are concealed, not published.

 

It’s mistakes are buried, not headlined.

 

Its dissenters silenced, not praised.

 

No expenditure is questioned. No rumor is printed. No secret is revealed.

 

No president should fear public scrutiny of his program.

 

Because from that scrutiny comes understanding. And from that understanding comes support or opposition, and both are necessary.

 

I am not asking your newspaper to support an administration.. But I am asking your help in the tremendous task of informing and alerting the American people..

 

For I have complete confidence in the response and the dedication of our citizens when they are fully informed.

 

I not only could not stifle controversy from your readers I welcome it. This administration intends to be candid about its errors. For as a wise man once said, “an error doesn’t become a mistake until you refuse to correct it”.

 

We intend to accept full responsibility for our errors and we expect you to point them out when we miss them. Without debate without criticism, no administration and no country can succeed. And no republic can survive.

 

That is why the Athenian law decreed it a crime for any citizen to shrink from controversy. And that is why our press was protected by the first amendment, the only business in America specifically protected by the constitution,

 

not primarily to amuse or entertain,

 

not to emphasize the trivial and sentimental,

 

not to simply give the public what it wants,

 

but to inform, to arouse, and to reflect

 

to state our dangers and our opportunities,

 

to indicate our crises and our choices,

 

to lead, mould, and educate and sometimes even anger public opinion.

 

This means greater coverage and analysis of international news, for it is no longer far away and foreign, but close at hand and local.. it means greater attention to improved attention to greater understanding of the news, as well as improved transmission, and it means finally, the government at all levels, must meet its obligation, to provide you with it’s possible information, outside the narrowest limits of national security.

 

And so it is to the printing press, to the recorder of man’s deeds, the keeper of his conscience, the carrier of his news, that we look for strength, and his assistance, confident that with your help, Man will be what he was born to be..

 

Free and independent.”

 

 

Those are my ruminations on JFK’s “Guerrillas by Night” – what are yours?