Friday, September 23, 2011

Capping Gold is The Solution

Gold cap, c. 1976
Donald Coxe has long been a favourite financial seer of mine.  He recently weighed in on the present financial crisis with a novel solution. This is a break from "always brief ... ", but so be it.  It's a long read, and well worth the effort: "Governments, Central Banks, and Gold
Perhaps the most enduring paradox in all finance is the way major governments and central banks treat their gold holdings: they ignore them. When nearly all OECD economies are running huge deficits at a time of near-zero interest rates, and nearly all governments are looking for ways to raise revenues without imposing economy-unfriendly taxes, why don't the big holders revalue their gold to, say, $2,200 an ounce and declare themselves willing sellers at that price - in bars or in bonds backed by gold - and willing buyers at, say, $2,000? Roosevelt revalued gold from $20.67 an ounce to $35 and declared that the US was a buyer and seller at that price. He also made it illegal for US citizens to own gold. By the end of the Depression, most of the world's visible gold reserves were in Fort Knox. Apart from all the jobs created in Nevada and other gold-mining states, this attempt to introduce controlled inflation at a time of surging deflation was at least mildly salutary. Having most of the world's gold also proved extremely useful in helping to finance the recoveries in war-torn Western Europe. Gold's roaring run to $1800 must be a huge embarrassment to the central bankers. Why should investors be rushing out of government bonds into bullion? Don't they believe us when we tell them that printing all this money isn't going to debauch the currency? The best way to take gold out of its new-found role as moral arbiter of governments' fiscal and monetary policies may be to cap it. Yes, captious critics would say that this is the equivalent of buying a bathroom scale whose highest reading is three pounds above the buyer's current weight. But desperate times call for desperate measures. The gold bugs have long proclaimed their own version of the Golden Rule: “He who has the gold makes the rules." By that standard, Barack Obama could become the leader of the world overnight. Proclaiming a cap on gold and making all the gold in Western central banks' vaults available for sale - or as backing for convertible bonds - would be a blow to speculators. Ironically, it would be good news for most gold mining stocks. And wonderful news for gold mine prospects that are barely more than a hole in the ground. Why? Back in the 1930s, gold mining stocks were stock market darlings. Who else could sell everything they produced to the government at a guaranteed price? Roosevelt was a hero to miners, prospectors and stock pushers. It was the golden age for penny gold stocks. Anyone could take a flutter on them. There were no lotteries, and the only legal gambling was church basement bingo games. Anybody with a dream and a drill hole was able to peddle his shares, and securities regulation ranged from lax to nonexistent... We believe a new era in which gold was back into the very centre of central banks' operations would be a great time for gold prospecting and gold mine development. As for the strong, well-financed producing gold mines with huge, politically-secure reserves - the Goldcorps, Barricks, Newmonts and their brethren - they would no longer be white chips: they'd be blue chips, paying secure dividends which, at a time of low-low interest rates, would be prized. The upward revaluation would permit some of the better-endowed PIIGS to issue gold-backed bonds at minuscule interest rates. As for the US, which has more gold than anybody else, and doesn't seem to have the faintest idea why it has it - or what to do with it - Obama could apply net sales proceeds directly to the deficits. The cap on gold would take a major bearish investment medium out of the stock market - gold bullion. For months, on the days stocks have gone down, gold has gone up. If gold were capped and governments combined their willingness to sell gold with a ban on naked short-selling of bank shares, and on naked Collateralized Debt Swaps, governments and banks might get a breathing spell. Why ban naked Collateralized Debt Swaps? Because they violate the centuries-old rule for insurance products - an insurable interest. When life insurance was first created in England, companies let anyone buy a life insurance policy on anyone else. Then they found that those lives insured by people who weren’t personally related to the life insured tended to die violently. So the concept of insurable interest developed - just as the fire insurers had never let people buy insurance on dwellings in which they had no ownership interest. AIG would never have gone down (at a cost to taxpayers of more than $100 billion), if it hadn't violated its insurance principles by going gung-ho into Collateralized Debt Swaps. As the eminent Paul Volcker has said so often, why should economies and taxpayers be at risk for banks that get deeply into newfangled financial products? Western economies grew satisfactorily in the decades before all these monstrosities were developed, and the bank failures that happened were easily managed... Why do we devote so much space to making political proposals? Because we are deeply worried that another financial crisis is coming, at a time when governments' bailut budgets are seriously constrained. President Obama's long-awaited speech about his great plans for creating jobs was greeted with reactions ranging from boredom to disdain. It was a highly-energized and well-delivered rouser. However, all he could do is promote a new batch of "shovel-ready" projects and jobs for teachers that would be financed by higher taxes on the rich. He is seen as someone who spent $800 billion on stimulus that didn't work, and he's now largely devoid of both ideas and money. Obama and his European counterparts look at the performance of shares of the big banks and must feel that ... Naught's Had, All's Spent. The government-owned gold that could provide such support to the leaders in the US and Europe is a nuisance to them, because its strong performance in the marketplace is a daily reminder of the futility of their seemingly endless crisis meetings and new acronymic rescue mechanisms backed by..........what? Bernanke has expressed a yearning for some inflation (but not in foods or fuels) to help the hapless housing market. Obama has failed to put the economy on a growth path. Most of his Republican opponents are as doctrinaire as he - while mouthing different dated dogmas of equivalent futility. As Reagan put it, when the nation faced similar crisis, "If not us, who? And if not now, when?" (He also summed up the Democrats' economic program pithily, "If it moves, tax it; if it still moves, regulate it; if it fails, subsidize it." That perfectly distills today's Demodogmatism. But the Republicans' dogmatic refusal to permit any tax increases - even on the carried interest of hedge fund managers who create few jobs - is equally unhelpful. If there were ever a time to start accessing the gold Roosevelt bought at $35 - and reducing endogenous risk in the global banking system - this is it. Gold-backed bonds and gold for sale at $2,200 to all bidders would, of course, be selling off "the family silver." But desperate times call for desperate solutions. The biggest and most obvious asset Obama has is the one asset that he supposedly can't touch. Why not? Long-duration Gold-backed Treasurys paying, say, 0.5% interest would be one way of selling off much of the Treasury's hoard without swamping the cash gold market. Those with long memories will recall when Jacques Rueff, DeGaulle's gold guru, convinced France to issue some gold-backed bonds as proof that the nation didn't face serious inflation risk. Then came stagflation and the runaway gold market and those gold-backed bonds became fabulous investments. Most central bankers know that embarrassing story, which may preclude their willingness to make any recommendations now. To be remembered as the guy who sold gold at $2,000 in a long-term bond and gold went to $5,000 would be ghastly. But the reason why Rueff lost so big was that Nixon closed the gold window in 1971 and then oil prices quadrupled and stagflation - which had never existed before - took charge. Under this tentative scenario, the US would transfer all bullion needed to back the bonds, and Congress would pass legislation guaranteeing those gold bond conversions until the bonds matured. Finally, the wise, witty folk at the Leuthold Group have published the Chart of the Year showing the cumulative total return on gold vs. the cumulative total return on the S&P since Nixon closed the gold window, repealing the cap on gold imposed by Bretton Woods. Remarkably, gold's bull market in this millennium has meant that its annualized return has caught up with the S&P - 9.9% vs. the S&P's 9.8%. If you'd put a bar of gold in a vault and left it there for 40 years, you'd have slightly outperformed most equity investors. The S&P has been long proclaimed as proof of the triumph of American capitalism with its business schools, management training, and superb collection of so many of the world's greatest companies. Buy and hold the S&P and you're going to be rewarded by the very best wealth-generators. Buy and hold gold and you're as outdated as believers in the phlogiston theory. This statistic could be used by Obama to argue that now is a good time to lock in the gold bull market by monetizing the nation's holdings through various strategies and vehicles forty years after Nixon uncapped gold and 78 years after Roosevelt boosted it 70%. The same strategy would apply to some of the more desperate European nations. They have gold; they need to sell bonds and the market doesn't want them; their deficits are scary and they're all supposed to retrench simultaneously. Issuing long-term bonds with a fixed call on gold would make their bonds marketable. Most of the gold sitting in vaults in the US and Europe was accumulated at significant cost to the taxpayers of the time. It is performing no usual function at a time when it seems as if all governments - notably Switzerland - want the value of their currencies to decline. The reason nations wanted and needed gold was to back their currencies. Pawn shops and jewellery stores report high levels of gold cashouts from middle class people who are having trouble getting by. The point of gold is that for all of history, it has been the one certain thing that can be used to buy goods and services or discharge debts. Why don't the governments bring out their gold and use it to back their bonds? Obama should, in our view, try to find one non-Keynesian economist who understands gold to advise him. We’re sure he could get an old-fashioned scholar from the University of Chicago to help him out if he made a few calls."  Congratulations, dear reader, you made it!

The Good News:  The Coxe (as opposed to "The Donald") makes eminent sense, as usual!