Solving a Debt Crisis with More Debt?
April 9, 2012
What most people don’t think about is that “debt is the raw material from which Ben Bernanke creates money in this fiat system.” If we were in some kind of asset-based money system, as the markets have chosen throughout history, you would need to mine more gold or silver or find some other commodity to increase the money supply. But the most favorable characteristic of asset-based money is that it contains intrinsic value, unlike fiat money, which is good only to the extent debts can be and are paid. By law (fiat) not by natural market choice, we are forced to use debt money! And now when the levels of debt cannot be paid, the monetary system itself is breaking down and will ultimately be replaced with gold or silver.
Actually, it’s not just been Bernanke. It’s Greenspan before him and various FED Chairmen before him, including G. William Miller and Arthur Burns, who pumped debt money into our system at an ever accelerating pace since Nixon took us off the international gold standard in 1971. But the policies are insane and so logically flawed that it demonstrates just how powerful and effective our national propaganda machinery is. Major uni-versities and media profit from the lies that printing money can “fix” the economy, because this practice con-tinues to allow them to reallocate wealth from those who produce it-the miners, manufacturers, farmers, and inventors-to those who control the system, namely, bankers and politicians and large corporate interests, espe-cially those joined at the hip of the financial system. But what could be clearer about the inevitability of our systemic breakdown than the picture shown in the chart above? Debt, which is measured by the red line, is growing exponentially while the blue line, which is GDP, is growing at a low-level linear pace.
The tiny curl over in the debt (red line) is all we achieved from the pain of the post-Lehman Brothers Trauma. Had the FED and the U.S. Treasury not stimulated the economy, debt would have collapsed and we would now be getting ready for sustained growth, because excessive debt would have been wiped off the books and those who acted irresponsibly would have been punished instead of asking the general population to pay for the sins of our banking system. How long will it take for us to climb out of our current economic malaise so we can resume a more “normal” level of growth and economic prosperity? Tell me when our total U.S. debt to GDP ratio falls back into the normal range of 125% to 175% from its current 360%, and I can answer that question. That would happen very, very quickly if policymakers stopped keeping the market from doing its job of allo-cating scarce resources as efficiently as is possible within the four dimensions of time and space.
Please note the chart above and to your right, which shows just how far out of line we have risen with historical precedent. We have exceeded even the ridiculously high 1932 levels, when the debt/GDP ratio climbed to the enormous and, until then, unheard-of heights of approxi-mately 280%. And that took place, not because of such an enormous growth of debt (although debt was increased then too, despite the gold standard), but because of a massive decline in GDP. Now the ratio is north of 360%. So we have a long, long way to go before we get back into a healthier debt/GDP range of 125% to 175%.
There are many other reasons to be very cautious about the equity markets at this point in time, not the least of which is optimism among market professionals and the non confirmation of financial stocks. The financials have recovered and all manner of happy talk from the main-stream media have proclaimed the banking crisis in the U.S. is over. But Europe’s problems loom bigger than ever which is no doubt why Bernanke entered into a swap with (provided a loan to) the Euro Zone. An unraveling of the European banking system will domino over into our markets as well. There is no way on God’s little green earth that the European crisis is anywhere nearly over.
And then there is the housing industry. One of the reasons for the protracted depression in the payroll accounts is that new home construction can’t get started. The reason for that can be blamed entirely on Alan Greenspan’s excessive money creation, which led to this massive mal investment and indebtedness. So many homes remain on the market that, unlike other reces-sions now, housing starts remain at extremely depressed levels. (See chart above right.) So with the housing sector still set for another 20% decline, according to A. Gary Shilling, there is more pain in the U.S. yet to come from Alan Greenspan’s mismanagement of monetary policy throughout his career at the FED but especially during has later years.
The Elliott Wave Financial Forecast outlined a host of contrary indicators that suggest a market top is either in or very nearly in. The stock market is a leading indicator. If we are right and another decline is in the cards, it will foretell of another decline in the economy. The rise in stocks has corresponded with a small rise in a lead-ing economic statistic, namely, nonfarm payrolls. But note how sick this statistic remains as it stays incredibly below the trend line.
With regard to gold, Paul van Eeden said on my show last week that gold’s real value now is about $900. I’m not sure I buy Paul’s number without reviewing his methodology once again. Click here to listen to his com-ments and those of Adrian Day as well, who was also on my show last week.
I hope to have Paul back on my show again in the near future to explain why he has picked such a low number for gold. I’m certainly not dismissing his view by any means. In a deflationary world like the one we are living in, prices can collapse beyond belief. We began to witness that after the bubble burst with the Lehman Brothers decline in 2008. But at that time, the real price of gold rose dramatically and has remained very high, which is a major reason gold producers are continuing to experience net profits far and above those generated in 2008, before the Lehman Brothers decline. In other words, what I am saying is that, contrary to popular opinion, an environment where credit markets are deflating is very positive for gold mining even if the price of gold does not rise or even declines.
The chart on your left helps to make the point with respect to how well gold has performed, relative to a basket of commodi-ties measured in the Rogers Raw Material Fund. The gold price rose from a low of $842 on Jan. 16, 2009, to $1,631 as of this week. That’s a 93.7% increase. By contrast, the Rogers Fund rose by “only” 68% from its post-Lehman Brothers low, from 2,256 on Feb. 20, 2009, to 3,797 this week.
So, the “real” price of gold-what an ounce of gold will buy-has risen dramatically during the credit contraction, as you can see from the chart on your left. This has happened even though the amount of debt that has been rung out of the system is miniscule, compared to what ultimately needs to be decreased. My own belief is that no matter what the nominal price of gold is, as long as the world is in a credit deleveraging phase-and I think it has many more trillions of dollars to go-the real price of gold will rise, and those companies that are producing gold economically will do exceptionally well in building value for shareholders. How soon the share prices of these companies reflect the growing profitability of the senior mining companies is less problematic to me than being sure I own solid companies that build the net intrinsic value of the shares I own.
On the other hand, companies that are not in production and that have to issue shares to stay alive will have a huge problem if my deflationary views prove to be correct. In that event, you will see a massive consolidation of exploration companies, as indeed started to occur in 2008 and 2009. It is the huge potential loss of capital that prompted me on March 9 to suggest liquidating 75% of your equity holdings to build cash.
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