Trust, not price the concern of central banks - Ash

When it comes to gold and silver, argues Adrian Ash, trust and independence were the issues most on the tongues of those that gathered in Rome for the latest LBMA conference.
Author: Adrian Ash
Posted: Thursday , 10 Oct 2013 

Price action isn't the big players' big concern in gold and silver right now... 
"FAITH and RELIGION," said Edel Tully of UBS, the Swiss investment and bullion bank. 
"Those were key themes," she said, summing up this year's LBMA conference last Tuesday evening. 
We could hardly ignore those topics, meeting in the hills just west of Rome with 700 other delegates for the London 
Bullion Market Association's annual jolly. From Monday night's dinner on top of Monte Mario, the dome of St. Peter's dominated the view. And any asset which doesn't pay an income, and which has fallen in price for more than two years, must look like a "hold-n-hope" investment based more on prayer than cold logic.
Instead of "faith and religion" however, we had already scribbled down "trust and independence" as the LBMA conference's key themes. Because where Dr. Tully heard whispers of eternal beliefs – here in God (or gods), there in gold – we nearly had to cover our ears from all-too worldly shouting over safety and sovereignty, confidence and freedom.
Gold forms a triangle with these ideas throughout history. Trust and independence met gold again last week in Rome. Because today's oh-so-modern mob of taxpayers, government officials, lenders, traders, high priests and the rest still need to trust each other but also demand independence as they skip through the forum. And as the oh-so-sociable LBMA conference showed, the way that gold and silver are treated speaks to people's trust in each other, and their freedom to act as they choose.
Take central bankers. They tend to sell gold when it's cheap, and buy or hold when it's not. "This," as Blackrock's Terence Keeley rightly noted to the LBMA conference, "is no way to diversify your portfolio."
But for central banks, gold investment is about much more than smoothing returns or improving your efficient frontier. It's about independence, even if that independence puts the central bank's trust in other institutions in doubt. Institutions such as, say, the monetary union you're publicly working to deepen and develop. 
Not that any of the six current or former central bankers addressing the LBMA conference last week dared say any such thing. Nothing too blatant was given away. But you didn't need rolling translation to hear what was said.
"Trust is a central bank's most valuable asset," announced keynote speaker Salvatore Rossi of the Banca d'Italia. Only just behind that, he seemed to suggest, gold came a close second. And given Italy's recent history with gold, it certainly seems to support the central bank's trust amongst the general public. Because as Rossi said, gold so plainly supports the bank's independence from government. 
"I don't need to remind you of gold's unique role in central bank reserves," said Rossi, nevertheless reminding the 700-odd delegates to the LBMA's two-day meeting in Rome that gold is "unique amongst risk assets" because it is not "issued" by anyone. So it carries no liability and needs no counterparty for its inherent value. 
Just as importantly, the central bank of Italy's director general also pointed to "psychological reasons" for gold's key role. So did Clemens Werner of the Bundesbank, the world's second-heaviest gold owner behind the United States. More than 40 years after the final gasp of the Gold Standard and eight decades after that monetary system really hit the skids, he named "confidence" and "precaution" as the big reasons for continuing to hold gold. 
Because as Italy's Rossi went on in his speech, gold "enhances resilience" in the central bank's reserves overall, typically rising when other risk assets plunge. More notably, gold "underpins the independence of the central bank" from government. Quite how, Rossi didn't say. But with Silvio Berlusconi trying to destroy Italy's government just a few minutes cab-ride away, the point was plain enough if you knew the history.
Il Cavaliere came after the Banca d'Italia's gold in 2009. He was told where to go. The central bank's big friends at the European Central Bank then told Berlusconi where to go, too. Trying to tax the central bank's unrealized profits on gold was illegal under the Euro treaty, breaching line after line of the critical "independence" from government which national central banks must retain. Italian central-bank governor Mario Draghi has since moved into the job of ECB chief. So his stand against Berlusconi's failed gold bullion tax grab looks a good template for how the ECB, and the biggest gold-owning central banks of the Eurosystem, might view their gold reserves today. 
Most definitely, none of Germany or Italy's gold is up for sale this year. Alexandre Gautier said the same of France's hoard. But then again, the Banque de France said that in the late 1990s, only to break ranks and take advantage of rising prices in the early Noughties. Gautier also spoke last week about trading and lending (this was a business conference, after all), but only to say the former is now very limited, while the latter is off the table. Not until gold borrowers come up with collateral. Which is unlikely but necessary now that – compared with 10 or 15 years ago, when lending European central-bank gold was all the rage (as was selling it, at least outside Rome and Frankfurt) – "the environment is totally different. I'm not sure it could be acceptable for a 1-year loan without collateral."
Which brings us back to be continued in Part II...
Adrian Ash
Adrian Ash is head of research at BullionVault, the secure, low-cost gold and silver market for private investors online, where you can fully allocated bullion already vaulted in your choice of London, New York, Singapore, Toronto or Zurich for just 0.5% commission.

Barron's Cover 


What, Me Worry?

Stop all the dithering, D.C. The baby-boom budget bomb could destroy the economy within 25 years. The time to act is now.

As President Barack Obama and Congress continue to bicker over passing the federal budget and raising the government's debt ceiling, a report published by one of the nation's most credible agencies warns that the U.S. could face economic disaster within 25 years due to excessive government spending.
Obamacare is part of the problem, but so are Medicaid, Medicare, and Social Security. The cost of these programs will mushroom as tens of millions of baby boomers reach retirement age.
[image]Scott Pollack for Barron's
The report was published on Sept. 17 by the nonpartisan Congressional Budget Office. Its most optimistic forecast shows the federal debt growing to 100% of annual economic output by 2038, from an "already quite high 73%" today. That would make the U.S. like France, which in terms of fiscal strength is none too good.
But the CBO implicitly concedes that the outcome is likely to be a lot worse than that, and so it included its "alternative fiscal scenario," which is far more realistic. It projects the federal debt will grow to 190% of the nation's annual economic output by 2038. That would make us worse than Greece today, which has a 27% unemployment rate and periodic bloody riots over its dreadful economic conditions.
Barron's cover story on the federal debt compared the potential fiscal crisis in the U.S. to that of Greece ("Debt Crisis: Next Stop, Greece," Feb. 18). Some critics of that shocking analogy failed to notice that it did not originate with Barron's, but with the CBO itself. In its September 2013 report, the CBO stood by that analogy.
It is a truism of American democracy that politicians' time horizons rarely extend beyond the next election. That's why you have to go back nearly 15 years to find a president squarely addressing the baby-boom budget bomb. In his State of the Union address in January 1999, Bill Clinton urged Congress to seize "an unsurpassed opportunity to address a remarkable new challenge, the aging of America." With the winds of a budget surplus at his back, Clinton declared that "now is the moment for this generation to meet our historic responsibility to the 21st century."
So much for responsibility. The big opportunity slipped away, and fiscal planning has since devolved into a series of standoffs verging on defaults and shutdowns. The latest one has Washington paralyzed right now.
DEMOGRAPHICS ARE A KEY DRIVER of future spending. By 2038, there will be 79.1 million U.S. residents 65 and over, up from 44.7 million today. The working-age population, 18 to 64, will grow at a much slower rate, to 214.7 million from 197.8 million. As a result, this "dependency ratio" will plummet to 2.7 working-age people to support each senior in 2038, from 4.4 today, as illustrated by the above chart.

But since the elderly population won't begin to reach critical mass until the mid-2020s, the rising tide of red ink will be relatively contained for the next decade. Under the alternative fiscal scenario, the increase in the debt-to-economic-output ratio will be relatively modest over the next 10 years, rising just eight percentage points, to 81%, before exploding to 138% by 2033 and 190% in 2038.

The math is pretty straightforward. Retiring baby boomers are pushing up the cost of elder-care entitlements. Mainly as a result, spending will rise much faster than revenues. Deficits will therefore be incurred every year, adding to the debt. That the federal government can no longer be expected to balance its budget, however, is not in itself the reason the CBO calls the trend unsustainable. The trend cannot be sustained because yearly deficits will be so large that the debt will grow faster than the economy's ability to pay for it.
Because most standard projections extend just 10 years, however, the media has helped stoke complacency about the budget, ignoring repeated warnings from the CBO about the misleading nature of the 10-year outlook.

The CBO's new 25-year projections should again make the message clear: The next decade is the relative calm before the coming storm. Any short-term improvement in the budget during the recent upswing in the business cycle is negligible when measured against looming long-term shocks.
The next 10 years, in other words, should be treated as an opportunity to avert the fiscal iceberg before solutions must be so Draconian that they do damage to people involved. It is difficult enough to put 50-year-olds on notice that entitlements they expect at 70 will probably not be available. To give them this bad news when they're 60 or 65 is inhumane.

Obama seems wedded to a time frame that does not even exceed his years left in office. Three days after the release of the CBO projections, the president in a speech returned to his often-repeated point that "our deficits are now coming down so quickly that by the end of this year we'll have cut them by more than half since I took office."
[image]Andrew Harrer/Bloomberg News
President Obama, during last week's debate, said he won't consider any spending cuts.
That boast is hollow at best, given that those deficits were all-time records. In any case, the CBO has taken all that progress into account and still deems the budget to be on an unsustainable course. If the president's Office of Management and Budget disagrees, it should explain why.

The nation might thus be likened to a family with about 10 good working years left that needs to cut spending in order to save for a rapidly approaching old age. But alas, it's a dysfunctional family incapable of rational planning. That may be one reason that rabble-rousing Republicans seek to exploit the debt-ceiling crisis as a way to reduce the debt. As Rahm Emanuel, the president's former chief of staff, once famously said, "You never want a serious crisis to go to waste. And what I mean by that is an opportunity to do things you think you could not do before."
Such as curbing the government's addiction to debt and deficits.

IN PRESENTING THE CBO REPORT at a news conference, the agency's director, Douglas Elmendorf, said the "bottom line remains the same as it was last year," clearly referring to his agency's last long-term budget projections, released in June 2012. Three things have changed since then, altering that bottom line for the better. To begin with, a tax bill was passed in January, hiking the top marginal rate to 39.6% on earnings of more than $450,000 for married couples and more than $400,000 for individuals. In addition, the CBO assumed lower spending, based mainly on slowed growth in spending on medical care. Also, gross domestic product, the denominator of the debt/GDP ratio, has been upwardly revised going back to 1929, reflecting a broader definition of GDP.
But these changes for the better have achieved very little. The CBO's alternative fiscal scenario now puts the debt/GDP ratio at 190% by 2038, as the chart on the facing page indicates, while the June 2012 version of the same scenario put the debt/GDP ratio at 190% by 2036 -- a two-year improvement.
The alternative fiscal scenario is the most realistic of those put forward by the CBO. As the agency explains, it "incorporates the assumptions that certain policies that have been in place for a number of years will be continued and that some provisions of law that might be difficult to sustain for a long period will be modified." For example, the CBO's "baseline" scenario assumes that the law requiring cuts in physicians' fees paid by Medicare will be implemented, even though Congress has rescinded these cuts every year for the past 10 years, a maneuver famously dubbed the "doc fix." The alternative fiscal scenario more realistically assumes that the doc fix is permanent.
[image]Daniel Acker/Bloomberg News
In May, former President Clinton reiterated his concerns about the long-term budget outlook.

Similarly, the alternative fiscal scenario assumes that the automatic spending cuts under the sequester, which are unpopular with Democrats and some Republicans, will be ended, although less Draconian spending caps under the Budget Control Act will continue. As Cato Institute fellow Chris Edwards, editor of, says, "The CBO's alternative fiscal scenario more realistically reflects the budget culture currently prevailing in Washington."
The CBO stipulates that its "budget projections are inherently uncertain," and of course they are. They are also too plausible for a responsible government to ignore. For starters, they are driven by demographics -- the plunge in the dependency ratio -- and if demographics is not always destiny, in this case, it should be approximately right. In fact, the fiscal accident-waiting-to-happen could also occur much sooner than the CBO expects.

For example, the agency's baseline projection for real GDP growth, which determines the denominator of the debt/GDP ratio, is 2.3% per year over the next 25 years. Since annual growth has been just 1.7% since 2000, that could be far too optimistic. Also, interest costs on the debt, projected under the alternative fiscal scenario at 6% by 2038 versus 1.3% today, might be far too low. As Director Elmendorf stressed, the projected costs of debt servicing are based on past patterns, in which the debt-to-GDP ratio rose and fell.
The future debt trajectory, however, will be unprecedented, with the debt inexorably rising faster than GDP. As the market becomes aware of this dire prospect, there is no telling how high interest rates might go.
In line with the scary projections for the debt, the CBO report reiterated its previous warnings about the "risk of a fiscal crisis -- in which investors demand very high interest rates to finance the government's borrowing needs." If interest on Treasury debt reaches levels normally associated with junk bonds, interest on private-sector debt could reach levels that impair the private sector's ability to function.

Those who deny that the debt can ever be a worry for the U.S. often point out that the debt is denominated in the same U.S. dollars the Federal Reserve has the ability to print. Ergo, there needn't be defaults on that debt. But funding the debt by running the printing press could be like pouring gasoline on a fire. In fact, in his 2007 memoir, The Age of Turbulence, Alan Greenspan warned about the dangers of monetary expansion in response to the fiscal "tsunami" brought on by retiring baby boomers, and expressed the hope that the future Fed chairman would resist pressures to expand.

As Greenspan pointed out, rapid monetary expansion not only could bring price inflation, but also could cause a decline in the dollar's exchange value against other currencies. Price inflation and exchange-rate devaluation would in turn bring a plunge in the value of the dollar in which the debt is denominated, both for domestic and foreign holders of that debt. The full faith and credit backing U.S. debt would therefore be less than full, since the debt would be paid in depreciating dollars. Result: a selloff in these bonds, bringing the surge in interest rates that the CBO warned about.
While defaults on the debt would take the form of payments in depreciating dollars, defaults on entitlement programs for the elderly will probably be in terms of actual dollar cuts. But the cuts would take the form of, say, a diminished number of drugs and treatments approved for reimbursement by Medicare, or a cap on the cost-of-living escalator governing Social Security payments, especially painful as price inflation accelerates. When government tightens our belts, it rarely does so in explicit terms.

THE CHART "Soaring Debt" tells a grim story. From 1850 to 1980, the debt/GDP ratio rose with major wars -- the Civil War, World War I, and World War II -- and then in each case rapidly fell. The Korean War of the early 1950s, and the Vietnam War of the late 1960s and early 1970s, were not accompanied by increases in the ratio. Within this 130-year interval, there was only one other time the debt-to-GDP ratio rose: with the onset of the Great Depression of the 1930s.
By 1980, however, the ratio began to show a noticeable tendency to rise in the absence of a major war or major downturn. It rose in the 1980s when the tax cuts pushed through by President Ronald Reagan were unaccompanied by commensurate spending cuts. As David Stockman, budget director during Reagan's first term, has written in his recent book, The Great Deformation, "Notwithstanding decades of Republican speech-making about Ronald Reagan's rebuke to 'big government,' it never happened."
Getty Images
Stockman's rogues' gallery of profligate presidents also includes George W. Bush. But he exempts Bill Clinton, whose "courageously balanced budgets were the last hurrah of the old fiscal orthodoxy."
If a sitting president in 1999 could be concerned about "our historic responsibility to the 21st century," the president in 2013 should be doubly concerned. We are 14 years closer to the "senior boom" of the year 2030. In the interim, Obama's Republican predecessor, George W. Bush, increased the burden of senior entitlements by adopting the Medicare prescription-drug benefit; and let's not forget the cost of Obama's own Affordable Care Act. In 1999, the debt-to-GDP ratio stood at 38%, about half of today's level. Spending as a share of GDP ran 18% against today's 21%.

Despite obvious political constraints on Clinton's ability to raise issues that might stand as a rebuke to a sitting Democratic president, the very fact that he appeared at the Fiscal Summit in May, hosted by deficit hawk Peter Peterson, indicates he hasn't quite forgotten his 1999 State of the Union address.
In his remarks, Clinton judiciously allowed that deficit dove Paul Krugman of the New York Times is "right in the short run" when he states that deficits don't matter. But the hawks, including Peterson, Clinton asserted, are "right in the long run." He even echoed the CBO's warning about a fiscal crisis resulting from soaring debt, noting that it would make the slowdown in the economy due to the budget cuts from the sequester "look like a Sunday afternoon walk in the park."
Krugman is clearly wrong about the short run, as well, since the short run and the long are both part of the same animal. The longer the federal government waits to address the problem of the soaring debt, the more painful the adjustment will be. Trillions of dollars, over time, must be cut from the deficits, through a combination of spending cuts and tax increases.
Speaking of entitlement programs at his Sept. 17 news conference, CBO Director Elmendorf commented, "We as a society have a fundamental choice of whether to cut back on those programs or to raise taxes to pay for them. So far, we've chosen to do very little of either." 
Copyright 2013 Dow Jones & Company, Inc. All Rights Reserved

Mohamed A. El-Erian

Mohamed A. El-Erian is CEO and co-Chief Investment Officer of the global investment company PIMCO, with approximately $2 trillion in assets under management. He previously worked at the International Monetary Fund and the Harvard Management Company, the entity that manages Harvard University's endowment. He was named one of Foreign Policy's Top 100 Global Thinkers in 2009, 2010, 2011, and 2012. His book When Markets Collidewas the Financial Times/Goldman Sachs Book of the Year and was named a best book of 2008 by The Economist.

The Fed’s Surprise and Yellen’s Challenge

10 October 2013
NEWPORT BEACH – The US Federal Reserve sparked a global – and now month-long – guessing game with its decision on September 18 not to “taper” its monthly purchases of long-term securities. The Fed does not surprise markets often, and this has been especially true of the Ben Bernanke-led Fed, which has devoted enormous time and effort to better communication, greater transparency, and timely management of expectations. Now that President Barack Obama has nominated Fed Vice Chair Janet L. Yellen to succeed Bernanke in January, there is even greater interest in what lies ahead for the world’s most important central bank.
To be sure, Fed officials did not do a great job of managing expectations in the weeks preceding their September policy meeting. Having also struggled to reclaim the narrative thereafter, there is great interest in understanding what led the Fed to act in such an uncharacteristic manner. Nonetheless, the real issue is that the Fed’s last-minute change of heart does not significantly alter the main challenge that the highly qualified Yellen will face: persistently weak economic fundamentals and doubts about the continued effectiveness of the Fed’s policy tools.
Five main arguments for the Fed’s decision to postpone the taper have frequently been proposed. One view is that the Fed recognized that its specification of policy thresholds (based on the unemployment rate) understated the vulnerability of the US labor market. Another is that officials worried about excessive financial tightening after Bernanke’s mention in May of a possible taper, jeopardizing the economy’s gradual recovery.
Moreover, some believe that the Fed considered the possibility of adverse feedback loops associated with the financial dislocations in emerging economies. Others see in the decision to postpone the taper an effort to pre-empt the negative effects on the economy of a possible congressional debacle over government funding and the debt limit. Indeed, the final argument – in a sense underpinning the others – is that the Fed became less worried about the potential for collateral economic damage from prolonged reliance on unconventional monetary policy.
The first three arguments speak to the Fed’s heightened concerns about the economy in general, and about the labor and housing markets in particular. The fourth reflects a desire to insure the economy against congressional dysfunction. And if the Fed feels that the costs and risks of hyper-activism have indeed diminished (the fifth argument), it becomes more comfortable maintaining intense policy experimentation.
Most of these arguments – though not all of them – have merit. That is the good news. The bad news is that the decision not to taper is unlikely to put either the Fed or the economy in a better place, confronting Yellen with a difficult task when she begins her historic tenure.
True, the Fed’s use of the classic measure of the unemployment rate as a key policy threshold underestimates the US economy’s fragility. Rather than reflecting buoyant job creation, too much of the recent decline in the unemployment rate has been associated with a fall in labor-force participation to a level last seen 35 years ago. Long-term joblessness and youth unemployment remain far too high, with skills erosion, reduced mobility, and a growing opportunity gap relative to formal educational attainment risking lasting damage in the aftermath of the Great Recession.
The debate about financial conditions is both more heated and more nuanced. While equity and credit markets did rebound from their May-June dislocation, higher interest rates have hit the housing market quite hard, reflected in a sharp fall in the mortgage-refinance index, lower home affordability, and declining purchases.
This attests to the extent to which parts of the financial intermediation process remain over-reliant on Fed experimentation, even as small and medium-size companies still find it difficult to obtain adequate credit at reasonable cost. The less confident the Fed is about the robustness of economic recovery at home, the greater is its interest in minimizing external headwinds.
Thus, it would be natural for the Fed to worry about slowing economic growth in emerging countries (accentuated in countries like Brazil and India by the financial volatility that followed the Fed’s taper talk in May). Moreover, with extreme political partisanship causing a government shutdown and threatening a debt-ceiling debacle, it would be understandable for the Fed to try to limit the impact of a dysfunctional Congress on consumer demand and business confidence.
So what does all this say about the future, including the key issues facing Yellen?
In assessing how far it is from meeting its mandate, the Fed may be better served by shifting from unemployment to employment thresholds (for example, the employment/population ratio). It could even start moving to a more holistic operational measure (say, nominal GDP), together with indicators of the economy’s structural fragility.
The Fed would have an opportunity to discuss this in its upcoming policy meetings in the context of evolutionary steps to strengthen its forward policy guidance, an initiative that Yellen has spearheaded. It may also need to think more about support for small and medium-size firms that continue to face structurally clogged credit pipes.
Unfortunately, with what is happening in Washington, none of this would significantly heighten the durable impact of Fed policy on economic growth and employment. Other policymaking entities – particularly those with potentially more effective tools to help the economy reach escape velocity – need to act but are hampered by legislative impasse. Meanwhile, continued and prolonged reliance on unconventional policies does involve unusual uncertainty and potential costs.
With Yellen’s nomination to succeed Bernanke, one Fed guessing game has ended. But, as speculation over the direction of monetary policy continues – indeed, intensifies ahead of the Fed’s next policy meetings – we should not lose sight of an uncomfortable reality: No matter how hard it tries – and it is trying very hard – the Fed is still stuck with tools that are too blunt, and whose effects are too indirect, for the challenging tasks at hand.

viernes, octubre 11, 2013



Wall Street's Best Minds


Don't Give Up on Gold

Prices will be helped by declining supply and strong Asian demand, argues a leading gold-fund manager.

(Editor's Note: Hathaway is manager of the Tocqueville Gold Fund (TGLDX), which invests primarily in mining stocks. The fund has lost 40% of its value this year, though it's averaged a yearly gain of 6.4% over the past 10 years. A version of this article with charts is available on the Tocqueville Website.)
Gold and gold mining shares spent most of the third quarter backing and filling without establishing any clear direction. Gold increased 7.6% during the quarter, closing at $1328.6 an ounce, but down 20.7% year-to-date. The XAU Index of gold and silver stocks rose 4.1% during the quarter, and was down 42.5% on a year-to-date basis.
The rationale for investing in the precious metals sector remains compelling, in our opinion. That rationale rests on two fundamental pillars. Firstly, world-wide fiscal and monetary policies have been directly and indirectly subsidizing asset values, which make financial assets especially vulnerable to permanent impairment when supports inevitably end. Secondly, continuous and unconstrained monetary emissions are fraught with unintended consequences, which have historically included debasement of paper currencies via inflation or devaluation and sovereign debt crises.
These risks can imperil all financial assets both in terms of their market prices and solvency.
It is astonishing to us that the Federal Reserve and its radical monetary policy retain even a sliver of credibility and trust within the financial markets. Third-quarter commentary by various prominent Fed officials conveyed no consensus for attaining their prime objective of slowing the rate of asset purchases and thereafter reducing the size of the Fed balance sheet.
The Fed decision not to taper following the FOMC meeting in September momentarily surprised the markets, leading to a brief but sharp rally in gold and related equities. It is our view that the Fed will be unable to taper because economic activity will remain lethargic indefinitely.
We also believe that the robust level of activity required to execute the Fed's fabled "exit strategy" will remain elusive because the Fed's strategy of asset purchases suppresses interest rates. Artificial interest rates impede productive economic activity by distorting price signals and misdirecting capital flows. The longer current Fed policies remain in force, the greater the potential disruption to financial markets when it changes, most likely due to events yet unforeseen.
Still, conventional economic commentary remains confident of Fed competence to unwind its balance sheet. When this confidence dissipates, as we expect, investment demand for gold will resurface in the most forceful manner.
Other constructive factors we find supportive of future gold demand include:
• The mining industry is in the midst of a major retrenchment. Current gold prices are insufficient to justify new mine construction. Future mine supply seems likely to decline, perhaps significantly.
• The spread of onerous banking and securities industry regulation will, in our opinion, drive investment demand for gold, which, if owned in the correct manner, has little or no counterparty risk and is not subject to financial market and banking industry control.
• A gathering loss of investor credibility in traditional intermediaries between financial markets and bullion, such as Comex and London Buillion Market Assocation. These intermediaries in reality offer only a very indirect connection to physical metal and depend on a highly levered structure of collateral rehypothecation, and in our opinion, market ignorance, in order to operate. Because the paper market in gold is deep and liquid in comparison to other futures markets such as, for example, pork bellies, it attracts speculative capital. However, unlike other deep and liquid commodity markets such as oil, copper, or wheat, the commercial interests, i.e., gold mining companies, jewelry trade etc. have a comparatively small impact on day-to-day and year-to-year flows. Therefore, the paper market for gold is ideal for speculative capital inclined to manipulate for purposes of maximizing year-end bonuses.
• Robust Asian demand for physical gold continues in complete contrast to liquidation by Western investors over the past two years. Shanghai premiums vs. London spot were up to 7% this year.
Despite a modest rally over the summer months, market sentiment remains at very low levels. In addition, the chart below shows a muted level of interest by speculative longs on the Comex,
In summary, we believe the gold market is set up for a major advance, but recognize that the timing of a turn has been elusive and frustrating. Identifying the catalyst for a new advance is a speculative exercise at best. The current government shutdown is on the one hand an unfortunate headline-grabbing side show, which drives aimless short-term speculative trading activity.
On the other hand, regardless of how it plays out, we regard this very divisive process as a fissure in U.S. credit. We also believe persistent questions about economic recovery in the U.S. and Europe could provide a catalyst in the form of a draw-down of equity market valuations or as a further undermining of Fed credibility. What is certain to us is that market reversals of the kind we anticipate require a tolerance for the pain that it takes to be invested at the low, and that money on the sideline will be paralyzed and unable to act until metals and share prices have advanced strongly.


    The GOP's Flirtation With Disaster

    Despite a glimmer of progress on Thursday, the doomsday scenario is all too plausible.


While I get more cynical about politics every year, I keep concluding that I'm not cynical enough. It's happened again.
Congress could long see two deadlines looming ahead: a partial government shutdown on Oct. 1 if no budget was passed, and a potentially cataclysmic collision with the national debt ceiling if that limit wasn't raised in time. I'll get to the economics shortly, but first let's compare the political degrees of difficulty. The budget deadline looked easy; the debt ceiling looked hard.
Passing what Washington calls a "clean CR" (continuing resolution) just kicks the proverbial can down the road—an activity at which Congress excels. It takes no imagination, no complex negotiations, no concessions to the other side, and CRs come in any size you like: a week, a month, a quarter. You just continue arguing over the budget and live to fight another day. Furthermore, in this case, a CR would have held federal spending at low postsequester levels—a win for Republicans. And it would have kept House Republicans out of the political box from which they are now desperately seeking to escape.
Instead of refusing a clean CR and forcing the partial government shutdown on Oct. 1, Republicans could have put all their chips on the table for an epic poker game over the national debt ceiling—where they had a stronger hand to play. Would President Obama really be willing to become the first U.S. president to preside over a federal default? Or would he cave instead? Remember, Republicans won such a battle in August 2011. And public opinion, which abhors the national debt, might even have put some wind at their backs—until the stock market crashed.
So, in my naïveté, I thought House Republicans would choose the path that was better for themselves: avoiding the shutdown and girding for battle over the debt ceiling. Wrong! My poor political forecast wasn't based on a naïve belief that members of Congress would pursue the public interest. Rather, it was based on what I thought was the first rule of congressional behavior: avoid blame. Where I went wrong is in failing to believe that a determined minority of zealots—probably no more than a quarter of the House Republican caucus—could bend Speaker John Boehner to their will so easily.
That is why I'm now much more worried about the debt ceiling. A glimmer of hope arose Thursday when Mr. Boehner announced that the GOP might accept a short-term debt-ceiling increase in return for budget negotiations—while keeping the shutdown in place. The White House reportedly rejected that opening offer, and as of press time it wasn't clear whether a deal could or would be struck.
Which brings me to the economics.
What damage have we endured already from the partial government shutdown? Several private firms estimate that each week of shutdown trims the GDP growth rate for the fourth quarter of 2013 by something around 0.15 to 0.2 of a percentage point—with virtually all of that made up in the first quarter of 2014. If you don't care about messing up the lives of about 800,000 government employees, plus tens of millions of Americans who depend on their services, that may not seem like much. But there is also a less tangible, though perhaps more durable, cost of making the United States of America look clownish in the eyes of the world.
jewel samad/Agence France-Presse/Getty Images
Failing to raise the national debt limit on time would be vastly more costly. Start with the most obvious, tangible, and easily measurable cost: the near-term damage to our economy. The federal budget deficit is now running around $750 billion a year, roughly 4.5% of GDP. If the Treasury loses the ability to borrow more, the budget must be balanced immediately, meaning that federal spending must fall immediately by about $750 billion (at annual rates), or about 20%. Both the amount and the suddenness are stunning. Cutting federal spending that much would likely reduce GDP by more than 4.5%—in an economy that is barely managing 2% growth rates. That spells recession.
Most of the negative impact on GDP would cease once the impasse ended, though strong downward momentum is hard to arrest. Other costs, however, would last for years, if not decades. Once international investors come to see threats to default as a standard weapon of American political combat—something they may now be starting to believe—U.S. Treasury debt would cease being the world's safest asset. And that would have two serious implications.
First, the Treasury would have to pay somewhat higher interest rates on all future borrowing, perhaps for decades, maybe forever. By the way, that might happen even if we meet all our interest and principal payments and default—yes, that is the right word—on some other obligations.
Second, the global financial system would begin a frantic search for a new international currency. U.S. Treasurys have long served that purpose. But if international investors see Treasurys as potential political pawns, they will seek something safer. Since there is no obvious replacement, a world-wide financial panic along 2008 lines is possible.
And did I mention that Washington would look like a bunch of knaves and fools? It is hard for a nation that has taken leave of its senses to remain the undisputed leader of the Free World. Hopefully, Mr. Boehner's offer will take this doomsday scenario off the table. However, the level of partisan acrimony has ratcheted up several notches in the past month. Furthermore, the tea-party faction has intimidated Mr. Boehner before, and might do so again. And since the partial government shutdown hasn't ended civilization as we know it, some Republicans may now see the risk of a debt calamity as acceptable. A few are already talking that way.
Back to political cynicism. Where reason fails, polls might succeed. Our best hope of avoiding Armageddon now may be lopsided polling results showing that Republicans will be blamed for the debacle. But so far, while polls do show Republicans getting more blame than Democrats, the margins aren't overwhelming. They do, however, look to be moving in that direction. C'mon Gallup, CNN and The Wall Street Journal. The country is at your mercy.
Mr. Blinder, a professor of economics and public affairs at Princeton University and former vice chairman of the Federal Reserve, is the author of "After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead" (Penguin, 2013).

October 10, 2013

Dealing With Default

So Republicans may have decided to raise the debt ceiling without conditions attached — the details still aren’t clear. Maybe that’s the end of that particular extortion tactic, but maybe not, because, at best, we’re only looking at a very short-term extension. The threat of hitting the ceiling remains, especially if the politics of the shutdown continue to go against the G.O.P.
So what are the choices if we do hit the ceiling? As you might guess, they’re all bad, so the question is which bad choice would do the least harm.
Now, the administration insists that there are no choices, that if we hit the debt limit the U.S. government will go into general default. Many people, even those sympathetic to the administration, suspect that this is simply what officials have to say at this point, that they can’t give Republicans any excuse to downplay the seriousness of what they’re doing. But suppose that it’s true. What would a general default look like?
A report last year from the Treasury Department suggested that hitting the debt ceiling would lead to a “delayed payment regime”: bills, including bills for interest due on federal debt, would be paid in the order received, as cash became available. Since the bills coming in each day would exceed cash receipts, this would mean falling further and further behind. And this could create an immediate financial crisis, because U.S. debt — heretofore considered the ultimate safe asset — would be reclassified as an asset in default, possibly forcing financial institutions to sell off their U.S. bonds and seek other forms of collateral.
That’s a scary prospect. So many people — especially, but not only, Republican-leaning economists — have suggested that the Treasury Department could instead “prioritize”: It could pay off bonds in full, so that the whole burden of the cash shortage fell on other things. And by “other things,” we largely mean Social Security, Medicare, and Medicaid, which account for the majority of federal spending other than defense and interest.
Some advocates of prioritization seem to believe that everything will be O.K. as long as we keep making our interest payments. Let me give four reasons they’re wrong.
First, the U.S. government would still be going into default, failing to meet its legal obligations to pay. You may say that things like Social Security checks aren’t the same as interest due on bonds because Congress can’t repudiate debt, but it can, if it chooses, pass a law reducing benefits. But Congress hasn’t passed such a law, and until or unless it does, Social Security benefits have the same inviolable legal status as payments to investors.
Second, prioritizing interest payments would reinforce the terrible precedent we set after the 2008 crisis, when Wall Street was bailed out but distressed workers and homeowners got little or nothing. We would, once again, be signaling that the financial industry gets special treatment because it can threaten to shut down the economy if it doesn’t.
Third, the spending cuts would create great hardship if they go on for any length of time. Think Medicare recipients turned away from hospitals because the government isn’t paying claims.
Finally, while prioritizing might avoid an immediate financial crisis, it would still have devastating economic effects. We’d be looking at an immediate spending cut roughly comparable to the plunge in housing investment after the bubble burst, a plunge that was the most important cause of the Great Recession of 2007-9. That by itself would surely be enough to push us into recession.
And it wouldn’t end there. As the U.S. economy went into recession, tax receipts would fall sharply, and the government, unable to borrow, would be forced into a second round of spending cuts, worsening the economic downturn, reducing receipts even more, and so on. So even if we avoid a Lehman Brothers-style financial meltdown, we could still be looking at a slump worse than the Great Recession.
So are there any other choicesMany legal experts think there is another option: One way or another, the president could simply choose to defy Congress and ignore the debt ceiling.
Wouldn’t this be breaking the law? Maybe, maybe not — opinions differ. But not making good on federal obligations is also breaking the law. And if House Republicans are pushing the president into a situation where he must break the law no matter what he does, why not choose the version that hurts America least?
There would, of course, be an uproar, and probably many legal challenges — although if I were a Republican, I’d worry about, in effect, filing suit to stop the government from paying seniors’ hospital bills. Still, as I said, there are no good choices here.
So what will happen if and when we hit the debt ceiling? Let’s hope we don’t find out.