The Room – 04/03/2009
Dear Readers,

In the March 6, 2009 edition of this missive/blog/column/whatever you want to call it, I listed three "Desperate Measures" the U.S. government might turn to next in its futile attempt to rearrange the ruined economy into something more resembling a perfect world.

  • Suspend "mark to market" rules. At the time of my initial write-up (which you can read here), highly placed sources within the financial services industry that I spoke to were of the opinion that no significant changes would be made, for the simple reason that to do otherwise would risk destroying what little credibility was left for the financial sector.

    As you now know, the government has strong-armed the FASB into modifying the rules, essentially allowing companies to "mark to model." Which simply means that the same financial wizards who helped create the models so pivotal to causing the mess in the first place are now free to dust those models off, give them a little tweak, and use them to fabricate more attractive values for the toxic waste than the market was willing to assign. Some might term these rule changes outrageous, fraud even... I call it business as usual.

  • Bad bank. The government has moved forward with this initiative as well, essentially rigging up a system that literally guarantees that a very small handful of firms -- likely just four or five -- will receive the sweetheart deal of the century, at the same time that the U.S. taxpayer gets the short end of the stick… right up the side of the head.

  • Fed buys long-term Treasuries. This, too, has now come to pass and is likely to accelerate. While there are many ways that one could describe this latest initiative, I find it best to keep these things simple... it's called inflation.

Maybe next week, I'll try to come up with some new candidates for desperate measures, but for now I would like to turn my attention to the much-anticipated and widely watched G20 meeting that has just wrapped up in London.

I imagine, because it is such a headliner event, many of you expect me to wax with some vitriol about it, but I fear I must let you down.

Sure, it bothers me that our president traveled to the event with an entourage of 500, including secret service agents, paper carriers, and other lucky sycophants -- all of whom were put up in grand style at taxpayer expense. (By way of comparison, my Portugal-based correspondent General Watson reminded me that when Maggie Thatcher was prime minister, for state visits, she used to travel commercial with a small group of aides. Often times, the other passengers were unaware she was even on the plane. )

This sort of excess is somewhat ironic and maybe even a little hypocritical, given Mr. Obama's derogatory comments about companies flying executives to corporate meetings in places such as Las Vegas, a topic I briefly touched upon last week.

I cannot begin to imagine what sort of costs are involved in transporting all those people -- along with three presidential helicopters and any number of stretch armored limousines -- to Europe, then keeping them in clover for a week... but I suspect it would be more than enough to keep the occupants of a moderately sized city in some third-world country in food for a decade or so.

G20 Meeting, Who Cares?

While I often don't succeed, I try to focus these weekly comments on matters that are actually of some importance -- on a broader scale, and to me personally. With that filter in place, the G20 meeting barely registers a blip.

Sure, there were a lot of fine-sounding speeches by politicians, but since when are those worth the paper they are written on? And yes, they managed to agree in principle to give over $1 trillion to the IMF – a topic I’ll have more to say about in a minute. In addition, they promised to collectively put the shoulder to the wheel in an effort to create a massive, new, global regulatory regime.

Run for cover? Hardly.

On the radio yesterday, I heard an African intellectual bemoaning the fact that the G20, by its numerically limited scope, excluded the representatives -- and therefore bypassed the inputs and opinions -- of over 180 other, lesser nations whose names did not make it onto the invite list.

Now, let me ask you, when it comes to implementing the high-sounding pronouncements that emanated from the G20 meeting, what are the odds that this collection of talk-a-crats will actually be able to come together to the extent required to create a functioning bureaucracy that delivers on its promises at any time in, say, the next 1,000 years?

Which makes the laments of the above-mentioned African intellectual all that more laughable. Can you imagine political junket-goers from 200 countries getting together and accomplishing anything other than drinking the hotel bar dry?

For the source of my skepticism, look no further than the United Nations.

(One thing I do find mildly amusing at gatherings such as the G20 is a circus of professional protesters who flail their thin arms at the rather better-equipped, truncheon-wielding security forces. The source of my humor is that the vast majority of these individuals are there to encourage the representatives of the world's governments -- the very same governments whose names should appropriately be entered into the blank following the question "Who is most responsible for the mess the world is in?" -- to further expand and extend their powers. Memo to protesters: the solution to bad government is not more government.)


It seems somewhat ironic that the IMF, which was founded in 1944 as part of the Bretton Woods arrangement, should now be viewed as a possible source of the world's salvation.

In the way of history, its original purpose was to "promote international monetary cooperation," specifically by attempting to maintain fixed exchange rates for the world's many currencies. The idea was that the IMF would step in whenever a country suffered from a temporary deficit in its balance of payments. To help the country avoid having to debase its currency to meet its external obligations, the IMF will provide a short-term loan. These loans came with "strings" attached, in the form of various demands for monetary reform following the Keynesian principles favored by the functionaries of the organization.

According to a briefing paper prepared by the CATO organization for Congress (which they'll never read anyway)...

    Although the IMF in theory makes short-term loans in exchange for policy changes in recipient countries, it has not helped countries move to the free market. Instead, the fund has created loan addicts. More than 70 nations have depended on IMF aid for 20 or more years; 24 countries have received IMF credit for 30 or more years. Once a country receives IMF credit, it is likely to depend on IMF aid for most, if not all, of the following years. That is not evidence of either the success of the fund’s so-called conditionality or the temporary nature of the fund’s short-term loans.” (Read the complete paper here)

In addition to spawning a coterie of kleptocrats around the world, the IMF has also failed miserably in its role of managing the global monetary system, witnessed by the persistent inflation the world has suffered since its founding.

(As for the fixed rate system it was supposed to be managing, that came to a sudden halt when the U.S. government closed the window on gold convertibility, a central tenet of the same Bretton Woods agreement that birthed the IMF.)
So what function does the IMF currently serve? Shedding light on that topic is Ken Ewert, writing in The Freemen...

    Why then, the widespread support for the IMF? The reason is more straightforward than many of us would like to believe. When governments speak of the need for "increased economic coordination," what they mean is that governments around the world want to better synchronize their inflationary monetary policies. Inflation is politically expedient for every government in our age. It temporarily stimulates economic activity and in so doing buys considerable political favor. Only later when the unpleasant effects appear -- rising prices, economic dis-coordination, consumed capital, and unemployment -- does the inflation become a political liability. The illusive goal pursued by governments around the world is to reap the political benefits of inflation without paying its subsequent costs.

Even so, perhaps out of sheer frustration or even spite, the Chinese, Russians, and any number of other nations are now openly discussing the idea that the IMF should be given both the resources and the responsibilities to create a new international monetary regime that would serve to demote the U.S. dollar to just another currency, albeit a still very important one.

    [Ed. Note: Ambrose Evans-Pritchard, whose views often makes sense to us, wrote an essay on this topic titled "The G20 moves the world a step closer to a global currency" that you might find interesting. Read it here. )

Many observers assume the Chinese are bluffing when they raise the topic of pushing the U.S. dollar aside as the world's reserve currency... or that these comments were otherwise cooked up in a Beijing political meeting to give the Obama administration pause in its headlong rush to debase of the U.S. dollar.

Those assumptions could prove wrong -- the Chinese may be sincere in their calls for a new monetary regime. I say that after reading a paper written by Zhou Xiaochuan, governor of the People's Bank of China, titled "Reform International Monetary System.

I highly recommend that you at least give the article a quick scan, because it shows that Zhou has a clear understanding of the various monetary systems and a clear preference for currency that is "anchored to a stable benchmark and issued according to a clear set of rules." He goes on to take a direct shot at the world’s fiat monetary system, saying, correctly, "The acceptance of credit-based national currencies as a major international reserve currencies, as is the case in the current system, is a rare special case in history."

Read his essay by clicking the link here.

As per above, I am completely confident that despite China's wishes, the world's leading governments won't be able to get out of their own way long enough to produce a new monetary system -- let alone one that is based on something other than political hot air. That leaves the door open for a single country to decide to break the mould by backing its currency with gold or some other basket of tangibles. That, of course, we shall watch for with some anticipation.

Before leaving this subject, I thought I'd share the contents of a message that our own Bud Conrad sent across this morning on the topic of China and the beefed-up IMF Special Drawing Rights...

    China has woken up to the fact that they are holding a stack of worthless U.S. dollar paper. They want a way out. So they are proposing that a new world currency be developed, based on the Special Drawing Rights of the International Monetary Fund.

    Perhaps we should be laughing at them for taking our silly paper money and giving us real goods. Perhaps we should be scared stiff at the fact that all our paper money could fall to its intrinsic net worth. Perhaps this is just high-level bureaucrat posturing.

    These are truly crazy times, when central bankers look to creating paper on top of paper to bail out the problems of too much paper. This whole thing is seriously out of whack, and no one has a clue of how to right the ship of unbridled paper money creation. Our great Timmy G. at first said we didn't need a new currency, but when he realized he might be offending our biggest patsy in buying our egregious international debt, he changed his tune to say something like the smart contributions of our great Chinese friends should be considered.

The IMF's Gold

Those among you who find gold to be an attractive asset, which I suspect is most, are well aware that this week the IMF announced that it was likely to sell off 400 or so tons of gold in order to continue supporting the borrowing habits of its regular clientele.

While these special sales have been threatened in the past, this time around it looks like it might actually happen. While the idea of the sale might spook the gold markets for a bit, the actual event is likely to have little if any lasting effect… other than continuing to hollow out the IMF.

That's because the odds are very high that the gold will never actually make it onto the market, but instead will trade hands in an off-market transaction between the IMF and the Chinese or some other nation looking for the earliest opportunity to trade its much abused paper dollars for something of tangible value.

At this writing, of China's $2 trillion in reserves, only about 1% is held in gold. There has been credible talk of them boosting that percentage to as much as 10%.

At $900 per ounce, the math looks something like this…

At 32,000 ounces per ton, 400 tons equals 12,800,000 ounces. Multiplied by $900, we arrive at a total value of the intended IMF sale of $11.5 billion.

Ready to be deployed against that amount is as much as another 9% of China's $2 trillion reserves -- which adds up to $180 billion. And that's just China. Of course, there are any number of other countries sitting on piles of U.S. dollars and viewing the outlook for those dollars in fairly negative terms.

So, sure, the notion of a big IMF gold sale might spook the gold market a bit… but in the final analysis, it will amount to less than a hill of beans.

The Closing Door

Speaking selfishly, a human trait I won't apologize for, the headlong rush of global governments to debase their currencies might be viewed as something of a positive. That's because, being aware of it, we can take steps to arrange our investments in such a way that we should be able to profit from it.

Unfortunately, the currency debasement is only one of many actions we can anticipate that governments will take going forward. Because as they set about destroying their currencies, they’ll simultaneously be looking to raise revenue elsewhere -- specifically by squeezing the productive segments of society out of whatever money they can. But of course, until they actually put up The Wall, most people of means, in most countries, are still free to pick up their bags and move to climes where their capital is better treated.

Understanding that, one of the major initiatives that came out of the G20 soirée just ended was a rededication by the world's bureaucrats to tighten the vise on any country deemed to be overly capital-friendly. Doug Casey, who has long anticipated these developments, has warned that time is running short for U.S. citizens in particular to diversify globally.

Specifically, the gang of 20 announced they were going to use a list just published by the Organization for Economic Cooperation and Development to aggressively go after "tax havens." Regrettably, that list includes names such as Costa Rica and Uruguay, places that we know many of our subscribers have an interest in.

The implications of these moves on personal freedom are not to be sniffed at. While the G20 countries may lack the organizational skills to create a functional new monetary system or widespread regulatory regime, it is a fairly easy matter to apply financial pressures on “errant” countries. They have a lot of experience in that regard. And so, to quote the G20 communiqué on the subject, "We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over."

Few nations can stand up to the pressure of global sanctions, and so many if not most of those nations are likely to roll over. The only way to stave off this latest assault on the free flow of money would be if there were an eruption of a widespread public outcry, complete with rampaging mobs and a liberal throwing of rocks. But as you and I both know, that’s not going to happen.

Some of you may think that I am making much ado about nothing, but I believe it's important to view these sorts of developments not based upon the world as it now is… but rather as it could be.

That exercise is usually helped by taking a quick glimpse in the rearview mirror. And, looking back over history, you can find any number of examples where despots have taken control of governments and engaged in the wholesale confiscation of private property, either overtly or through determined inflation.

Up to this point in time, with some limitations, a person could always take some comfort in the idea that -- should push come to shove -- they will be able to escape to another jurisdiction with enough wealth to start over again.

In the brave new world we are headed for, that simply may not be possible.

As something of an experiment, I recently walked into a bank in Uruguay and asked for the papers required to open an account (one, I can assure you, that I would have fully disclosed), but was told in an apologetic tone by the bank manager that they would not accept accounts from Americans.

The door is closing, the noose tightening.

Letters from You

    As an employee of an international investment advisory service with a clientele made up mostly of endowments and non-profits, I thought it relevant to let you know the results of an informal survey a member of our research group conducted concerning gold. Specifically, the questions posed to consultants were: Do you have an allocation to gold? If so, what % allocation? How is this expressed: bullion in a bank, gold ETF, or precious metals equities?

    Granted that only a small percentage of our nearly 800+ client base was represented with responses (which may also be telling), but in summary 10 clients have a current allocation to gold, while 10 are actively considering. The average allocation is about 5% of the total portfolio with most of the exposure through GLD. Only four clients represented in the responses hold bullion, while even fewer hold a combination of paper gold and bullion.

    As many have stated that the next phase ("mania") of the long-term gold bull market will be driven by the masses finally realizing gold's benefits, it seems that that time is still some time off. Although many of our investment managers and individual clients seem to be bringing up the issue of gold (and indeed buying it) more than in the past, there is still some misunderstanding to gold's real purpose in a portfolio. I will be keen to the point when consultants are actively building their client's gold positions and clients are demanding the action be done. As our client base is largely institutional, that shift may be a sign that the next phase is really underway. JK.

David again... as JK's email confirms, while there has been a huge pick-up in the interest in gold compared to even a couple of years ago, we are nowhere near the mania phase. In fact, if you step back and look at the situation dispassionately, you’ll note that gold has remained strong not because of but in spite of the current economic environment. An environment that includes, of late, a clear deflationary trend pretty much across the board in the commodity sector.

All of which is to say that once the environment for gold begins to change for the better and the consequences of today’s inflation begin to be widely felt, then and only then will gold really begin to move. In the interim, we can expect gold to fluctuate, which – for those of us who are comfortable getting positioned now, ahead of the crowd – simply means additional buying opportunities.


  • I'm sure the orphan will thank them later. It’s good to know that the poor orphans are safe from the horror of being adopted by zillionaire rock stars. Thanks in no small part to human rights groups, led by the Human Rights Consultative Committee, a coalition of 85 groups that apparently have nothing else to do with their time and their donors’ money, the Malawian government turned down Madonna’s request to adopt a second orphan from that country. Why should they oppose this adoption? Easy, it was out of heartfelt concern that the impoverished orphan might enjoy a better life than they. (Click here for more)
  • Kick them when they're down. This item also got my attention this week... “March 31 (Bloomberg) -- A Senate panel approved new restrictions on credit-card interest rates that are broader than those adopted by the Federal Reserve in December, brushing aside objections from Republicans and the banking industry.

    “…The bill, known as the ‘credit card bill of rights,’ also would require the signature of a parent for a borrower under age 21, unless there’s proof of independent income or completion of a financial education course.”

    So, let me get this straight. First the government bails out the banks, then promptly handcuffs them in their ability to price for the elevated risk of credit card loan losses, assuring that the money provided them will soon get flushed down a rat hole. Or, more likely, they’ll just stop offering credit. But wait -- isn’t that the very problem the government is trying to fix?

    Now, I'm no fan of many of the practices of credit card companies, but I'm even less of a fan of the government establishing what is essentially price controls on the credit industry, with an added dose of nanny state thrown in via the requirement that adults – and anyone over the age of 18 is certainly an adult – must first take a course in finance prior to being allowed to get a credit card.

    Do I think that adults will benefit from taking courses in finance? Of course. Do I think that they should be forced to it? Absolutely not. What's next, mandatory courses in parenting before being allowed to have a child?

  • Soup lines. Many commentators have observed that all that the current financial crisis is missing now is the sight of soup lines around the blocks of our cities. Actually, there's a reason these haven’t yet appeared. Namely that, thanks to the innovation of food stamps, the inconvenience of a soup line is no longer necessary. And at this point, according to a report just released by the Agriculture Department, fully 10% of Americans are now relying on food stamps for some portion of their daily bread. That is roughly 32,000,000 people – a very long line, indeed.

And on that unhappy note, I must sign off. As I do, a quick glance at the screens tells me that the S&P 500 is flat, taking a breather after the strong gains of last couple days. Given the onslaught of continued bad news, including the latest, poor unemployment numbers, the stock market should be in a freefall at this point.

And it probably would be if it hadn’t been buoyed up by the change in the "mark to market" rules that will soon usher in a new era of obfuscation and outright deceit. Those changes will also serve to extend the current downturn, for the simple reason that they postpone the value discovery process that ultimately must occur in order for some semblance of confidence to return to investment markets.

In the history books, I suspect that the best they'll be able to say about these rule changes will be "it seemed like a good idea at the time."

Meanwhile, I note that gold is below the $900 level for the first time in a while. I'd be very surprised to see a drop to below $850 anytime soon, and maybe never. If it were to happen, however, I’d be just one of many on the phone to the bullion dealer.

Until next week, thank you for reading and for subscribing to a Casey Research publication.


David Galland
Managing Director
Casey Research

Posted 04-03-2009 10:00 AM by David Galland