Six Situations to Monitor for the Rest of 2008

Six Situations to Monitor for the Rest of 2008

analysis by USAGOLD-Centennial Precious Metals
Michael J. Kosares
September 8, 2008

"The next Fourth Turning is due to begin shortly after the new millennium, midway through the Oh-Oh decade. Around the year 2005, a sudden spark will catalyze a Crisis mood. Remnants of the old social order will disintegrate. Political and economic trust will implode. Real hardship will beset the land, with severe distress that could involve questions of class, race, nation, and empire."

-- William Strauss and Neil Howe, The Fourth Turning, 1997
1. The bullion gold coin shortage

When IndyMac Bank collapsed in early July, USAGOLD-Centennial Precious Metals logged the largest single week volume in its 35 year history. And that was just the beginning. By mid-August gold coin demand had become so strong globally that U.S. Mint and South Africa's Rand Refinery announced they could no longer keep up with their orders and promptly shut down operations. Soon thereafter, the U.S. mint resumed gold coin production, but explained that they would now be forced to ration output. Much of the demand that spawned the mints' problems came from individuals around the globe concerned about the safety of their banks and financial institutions -- a worry not likely to dissipate anytime soon.

Conclusion: Thus far the gold industry has done a good job addressing the gold coin shortage problem. Adjustments have been made, and the flow at this writing has returned to some semblance of normal. Though there is no guarantee that we won't revisit the problem of shortages later in the year, the most likely outcome will be higher gold prices and higher premiums on coins and bullion until market equilibrium is regained. As a matter of fact, premiums have already risen on most gold coins.

Recommendation: Please keep in mind that the word "shortage" is not defined as a complete absence. Shortages are not cause for undue alarm, but do warrant decisive action. We expect demand to continue at a steady pace no matter what the price does, particularly if systemic risk remains in the headlines.
2. The election

The economy has replaced the Iraq war and gasoline prices as the centerpiece issue for this election, yet neither candidate comes off as economically astute enough to deal with its complexities. There was some talk about oil at the party conventions, but the trade deficit was skipped over, and neither party talked very convincingly about smaller government, or balanced budgets, or the future value of the dollar. The Fannie Mae and Freddie Mac debacle wasn't even mentioned, nor was the Misery Index -- the combination of inflation and deflation -- which over the past year has gone into double digits and remains a primary concern for all Americans.

Conclusion: If you count yourself among the growing list of those who feel that neither party can deal effectively with the growing credit crisis, you are not alone. It's one thing to make promises about the economy and taxes. It's quite another to deliver, especially when those promises involve increased military commitments overseas and bigger and better social programs at home. Let's not forget that the same president who promised to retire $1 trillion of the national debt in his first four years (GW Bush), managed instead to add $4 trillion over his term in office.

Recommendation: Looking back, the conventions did as good a job selling gold to the American public as they did selling their respective presidential candidates. Rather than waiting for Washington to deliver on the economy, you might be better served by taking matters into your own hands. Take to heart this issue's masthead quote from Strauss and Howe's The Fourth Turning.

3. The Fed's magic money machine

A well-oiled and functioning market for paper instruments depends in the end on faith and trust. Value in one financial house depends upon performance from another financial house which depends upon performance from still another -- a seemingly infinite web of interlocking counterparties fully dependent upon each other for their existence. A breakdown in one major institution, we are told, could lead to a domino effect and collapse the entire system. As a result, the Federal Reserve and U.S. government have no other choice, the logic continues, than to bail out the institution in trouble and shift that loss to the taxpayer. Fannie Mae and Freddie Mac, the mortgage-backing behemoths, have rewritten the book on bailouts, and who's to say that it ends there. It is important to keep in mind, though, that Fannie and Freddie are only part of the problem. There are other credit land mines buried about this economy that could be tripped at any moment.

Conclusion: The good news (if you happen to go to work every day on Wall Street like the fellow in the Stein cartoon above) is that you are likely to get bailed out if your balance sheet is reduced to a puddle. Fed chairman Ben Bernanke was serious about those money-dropping helicopters after all. The bad news is that there is a significant downside to the Fed's Magic Money Machine. Runaway stagflation becomes a distinct possibility. Already the Misery Index (the combination of inflation and unemployment) is in double digit territory at roughly 12%. And that's the misery level utilizing the government's numbers. It could be even worse if you use Shadow Government Statistics. (Please see #5 "Lies, damn lies and statistics" below.)

Recommendation: Systemic failure meets the printing press and for those who keep their savings in dollars, and dollars only, the risks are evident. Closely monitor the credit crisis and how it is handled by the Washington authorities. Commenting on the Fannie/Freddie government bailout, Robert Bruner of the Darden School of Business at the University of Virginia said, "If anybody thought we had a pure free-market financial system, they should think again."

**Ed Stein cartoon published with permission.
4. China's central bank capital shortage

When the New York Times reported that China's central bank was running out of capital, some took the report as preposterous. How could a country have so much money and be broke at the same time? To answer that question all one has to do is to hold in his or her hand a stack of the multi-million mark notes issued by Germany in 1923. Technically, what you have in your hand qualifies you as a multi-millionaire, possibly even a billionaire. There's one problem: That stack of notes wouldn't have bought a cart full of groceries.

For China ultimately it will get down to the value of the money it takes in after it ships something out. As the Times reported, "Victor Shih, a specialist in Chinese central banking at Northwestern University, said that when he visited the People's Bank of China for a series of meetings this summer, he was surprised by how many officials resented the institutional losses. He said the officials blamed the United States and believed the controversial assertions set forth in the book Currency War, a Chinese best seller published a year ago. The book suggests that the United States deliberately lured China into buying its securities knowing that they would later plunge in value."

Conclusion: Doesn't that sort of thinking qualify China's central bank as a potential gold owner? There were reports earlier this year that Robert Mundell, the Nobel Laureate in economics, was advising China's central bank. Mundell has always believed that gold should play a strong role in central bank reserves because currencies issued by nation states are always subject to depreciation and even the prospect of total collapse. Any significant sale of gold by the central banks will likely be met by significant purchases from other central banks. And The Peoples' Bank of China likely sits at the top of the buyers' list.

Recommendation: Keep a close eye on China because it now holds the key to the U.S. Treasuries market. Its decisions could become a major influence on U.S. interest rates, as well as to what degree the U.S. budget deficits will need to be financed with printing-press money.

5. Lies, damn lies and statistics

More and more, I find myself relying on the economic numbers posted by Shadow Government Statistics (SGS) over those by the U.S. federal government. For my money, and I mean that quite literally, I rely on SGS numbers for the real story on the economy. Here are some examples of the differences. Let's start with the inflation and unemployment rates -- two figures near and dear to the hearts of all Americans. SGS, going by the same Consumer Price Index used in 1980, pegs the inflation rate at roughly 9% -- dangerously close to the double digits. The Labor Department has consumer prices up 6.2% over the same period. The official unemployment number is running around 6%. SGS' number is closer to 15% -- a 9% difference! If you combine the two to get the old Misery Index, it is a little over 12% by the government's calculations, and 24% by SGS'!! (Please see graphs below.)

Conclusion: Which numbers, in your opinion, are closer to fact and which are closer to fiction? Decisions cannot be made in a vacuum. Nor can they be made using bad numbers. If a 24% Misery Index doesn't elevate your level of concern, nothing will.

Recommendation: A visit to Shadow Government Statistics web site.

6. The supply of gold from central banks

Recently the Bundesbank, Germany's central bank, delivered a lecture on the role of gold as a central bank reserve item. "National gold reserves," instructed Bundesbank, "have a confidence and stability-building function for the single currency in a monetary union. This function has become even more important given the geopolitical situation and the risks present in financial market developments." France and the European Central Bank, both primary sellers of gold over the past several months, might take note. I cannot remember a more direct statement from a central bank on the role of gold in the modern era, and a more direct assault on the "barbarous relic" description made famous by John Maynard Keynes.

Conclusion: Germany holds the world's second largest gold reserve next to the United States and plays a special role in the European Union as its largest single economy. The Bundesbank's caution will raise a few eyebrows across Europe not just in the official sector but the private sector as well.

Recommendation: Like millions of private investors across the globe, Germany holds gold as a form of savings impervious to currency depreciation, systemic failure and geopolitical instability. By its example, it has delivered an important message.
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Michael Kosares has over 35 years experience in the gold business and is the founder/owner of USAGOLD-Centennial Precious Metals. He is the author of The ABCs of Gold Investing: How to Protect and Build Your Wealth With Gold as well as numerous magazine and internet articles. He is frequently interviewed in the financial press and is well-known for his ongoing commentary on the gold market and its economic, political and financial underpinnings.