Why rising debt will lead to $10,000 gold
http://www.stockhouse.com/Columnists/2012/Jan/11/Why-rising-debt-will-lead-to-$10,000-gold
Nick Barisheff
11th Jan 2012
Today, Id like to focus on one important idea: the direct relationship
between the rising price of gold and the rising levels of government
debt that result in currency debasement. Since we measure investment
performance in currencies a clear understanding of the outlook for
currencies is critical.
In order to understand golds relationship, its important to understand
that gold is money. It is not simply an industrial commodity like copper,
or zinc. It trades on the currency desks of most major banksnot on their
commodities desks. The turnover at the London Bullion Market Association
is over $37 billion per day, and volume is estimated at five to seven
times that amount clearly, this is not jewellery demand.
The worlds central banks know gold is money: after decades of modest sales
they have become net buyers since 2009. This trend strengthened in 2010
and gained momentum in 2011. They are buying gold as a counterbalance
to their devaluing currencies.
As money, gold has provided the most stable form of wealth preservation
for over three thousand years it still does today. Gold has outperformed
all other asset classes since 2002.
This chart clearly shows that U.S. federal debt (purple) and the
price of gold (gold) are now moving in lockstep. This correlation will
likely continue for the foreseeable future. The red line represents the
repeatedly violated government debt ceilings.
(Chart US Government Debt deleted)
Based on official estimates, Americas debt is projected to reach $23
trillion in 2015 and, if the correlation remains the same, the indicated
gold price would be $2,600 per ounce. However, if history is any example,
its a safe bet that government expenditure estimates will be greatly
exceeded, and the gold price will therefore be much higher.
And its not just the U.S. Most Western economies have reached
unsustainable levels of debt that will be impossible to pay off. Its worth
noting that the U.S. Federal Reserve, unlike the European Central Bank,
can create currency without restriction. The U.S. dollar has been the de
facto world reserve currency for over half a century; the rest of the
worlds currencies are essentially its derivatives. Whether global debt
is in euros or Special Drawing Rights issued by the IMF, the Fed, and
thus indirectly the U.S. taxpayer, may become the lender of last resort.
There are four possible ways to reduce government debt:
One: Grow out of it through increased productivity and increased
exports. This is highly unlikely, as Western economies, and even China,
are poised for recession.
Two: Introduce strict austerity measures to reduce spending. This has the
unwanted short-term effect of increasing unemployment and reducing GDP,
resulting in even higher deficits.
Three: Default on the debt. This will make it difficult to raise future
bond issues.
Four: Issue even more debt, and have the central bank in question simply
create whatever amount of currency is needed.
Most politicians will select option four, since few have the political
will to choose austerity, cutbacks and full economic accountability
over simply creating more and more currency. Almost inevitably, they
will choose to postpone the problem and leave it for someone else to
deal with in the future.
Last August, the world watched as the U.S. government struggled to come to
an agreement on raising the debt ceiling, and was forced to compromise and
delegate the final solution to a super committee. Its lack of political
will earned the country an immediate downgrade from the S&P. Then,
the hastily convened super-committee failed to reach a solution.
In Europe, matters were even worse. Greece did try to write off half
its debt, but Germany and France reminded the Greeks that, if they
did, no one would buy their bonds. The British and Irish implemented
austerity measures that raised unemployment and reduced GDP, resulting
in even higher deficits. The Italians watched their bond yields rise to
seven percent. While the tsunami and related nuclear incident deflected
attention from Japans financial problems, it is a temporary lull, because
Japan has the highest debt to GDP ratio of any of the developed countries.
In order to compensate for slowing growth, governments attempt to devalue
their currencies and thus improve export competitiveness. This can lead
to a global currency war that author and Wall Street/Washington insider
James Rickards discusses in his bestselling new book, Currency Wars. This
process is now well underway.
A recent Congressional Budget Office report predicted the U.S. federal
governments publicly-held debt would top an unsustainable 101 percent
of GDP by 2021. Currently, the official U.S. debt is an astronomical
$15 trillion. Yet this is only the current debt. If the U.S. government
used the same accrual accounting principles that public companies must
use, unfunded liabilities like Social Security and Medicare make the
real debt more than $120 trillion. This represents over $1 million per
taxpayer. Obviously, this amount is impossible to repay.
Its interesting to note that in almost every recorded case of
hyperinflation, the point where inflation exceeds 50 percent a month was
caused by governments trying to compensate for slowing growth through
full-throttle currency creation. This is exactly what we are seeing today.
These events gave me the confidence to title my new book $10,000
Gold. The book connects the many trends that will be directly and
indirectly responsible for both the rising debt and the rising gold
price over the next five years. It will be published this year.
To make matters worse, the irreversible macro trends I discussed in last
years Empire Club speech are still very much in place today. These include
the added costs of retiring baby boomers, systemic unemployment due to
outsourcing of Western jobs through globalization and rising oil prices
due to peak oil. These irreversible trends will increase unemployment,
lower GDP, reduce tax revenues, increase deficits further and force
governments to borrow even greater amounts.
Governments find themselves between the proverbial rock and a hard place,
as even austerity measures tend to negatively impact GDP. As GDP falls
and debt increases, credit downgrades are likely to follow, resulting
in higher bond yields followed by even greater deficits. This becomes
an unstoppable descending spiral.
Loss of purchasing power against gold continued unabated last year. The
U.S. dollar and the British pound have lost over 80 percent of their
purchasing power against gold over the past decade, and the yen, the
euro and the Canadian dollar have lost over 70 percent.
As we remind our clients this is not a typical bull market. Gold is
not rising in value, currencies are losing purchasing power against
gold, and therefore gold can rise as high as currencies can fall. Since
currencies are falling because of increasing debt, gold can rise as high
as government debt can grow.
(Chart Currency Decline deleted)
The sovereign wealth funds as well as the more conservative central banks
will have little choice but to re-allocate to gold in order to outpace
currency depreciation. This is why some central banks, particularly
those of China and India, accelerated their gold buying in 2011, for
a third year in a row, to nearly 500 tonnesabout one-fifth of annual
mine production.
While central banks have been net purchasers of gold since 2009,
the real game changers will be the pension funds and insurance funds,
which at this point hold only 0.3 percent of their vast assets in gold
and mining shares. Continuing losses and growing pension deficits will
make it mandatory for them to eventually include goldthe one asset
class that is negatively correlated to financial assets such as stocks
and bonds. When this happens, there will be a massive shift from over
$200-trillion of global financial assets to the less than $2 trillion
of privately-held bullion.
In considering where gold will be at the end of 2012, I looked back
to my first Empire Club talk of 2005. I said then that it didnt really
matter whether gold closed the year at $400 or $500 an ouncethe trends
were in place to ensure it had much further to rise. Seven years later,
we can say the same thing. It doesnt matter whether gold ends 2012 at
$2,000 or $2,500, because golds final destination will make todays price
seem insignificant.
These can be frightening times, but gold always offers hope. We may
not be able to heal the global economic problems of government debt,
but individuals can protect and even increase their wealth through gold
ownership. Gold bullion ownership, not mining shares, ETFs or other paper
proxy forms of ownership, is an insurance policy against accelerating
currency debasement. We use the analogy that - In the case of fire,
would you rather have a real fire extinguisher or a picture of one?
A number of people have approached me recently and said they wished
they had listened five years ago. They feel they have missed the boat,
that its too late to buy gold. For those who feel that way, let me close
with a Chinese proverb I discovered last year:
The best time to plant a tree is 20 years ago. The second best time
is today.