 | | The Daily Reckoning | Tuesday, May 3, 2011 |
- Osama Bin Laden is dead - time to bring home the troops! Or not...
- Who wins when bad money drives out good?
- Plus, Bill Bonner on the so-called problems with gold and that pounding rhythm to the brain...
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|  | | | A War of Diminishing Returns | | Counting the Costs of Global Occupation | |  | | Joel Bowman |
Reporting from Buenos Aires, Argentina...
"Another day, another blister," as your editor's father, a cabinetmaker by trade, likes to say.
Yesterday was a celebratory day for patriots...and an apathetic one for the rest of us. If we are to believe the various American defense and intelligence establishments, Osama bin Laden finally got the bullet that was long coming his way over the weekend. Two of them, actually. Already the Internet is abuzz with rumor, conjecture and "alternative" theories. Call them conspiracy mongers or call them skeptics. In the grand scheme of things, it probably doesn't matter either way.
As far as this editor can tell, the wars in Iraq and Afghanistan are not likely to draw to a close simply because one cave-dwelling icon of evil reached room (and then deep sea) temperature. Neither are not-so- covert operations in Yemen and along the conveniently porous Pakistani border likely to begin winding down anytime soon. Instead, we are sure to see an intensification of paranoia and consequent military adventurism as the federal government issues travel warnings and security threats as casually as it inks new dollars to help protect us from their associated "menaces."
Wrote Addison in yesterday's issue of The 5, "Al-Qaida pulled off the Sept. 11 attacks for somewhere in the vicinity of $500,000, according to the final report of the 9/11 Commission.
"By the end of fiscal 2011, the US government will have spent $1.26 trillion fighting the wars in Afghanistan and Iraq, according to the Center for Defense Information. A total equal to nearly 9% of the national debt."
Quite a lamentable "return on investment" for the now-dead Al-Qaida leader, no?
"Based on the figures above," continued Addison, who alongside Bill Bonner addressed the touchy subject of military imperialism in their 2005 book, Empire of Debt, "bin Laden pulled off a 2,514,000:1 return. And that's just versus US interests."
Indeed. It's difficult to get a good handle on the sheer size - much less real cost - of the US military machine. And that's probably not a good thing.
Official counts put the number of US military personnel serving on foreign soil somewhere around 2.5 million souls. Maybe more. According to the Department of Defense Base Structure Report for Fiscal year 2007, the Empire then boasted - unashamedly, mind you - 823 military bases around the planet. The same report from a year earlier gives some idea as to just what this means in real terms.
Worldwide, the Department of Defense occupies 32,408,262 acres, according to the report, including 712,199.5 acres for military bases alone. As a point of reference: New York City is 309 square miles (i.e. 197,760 acres). Ohio is 41,328 square miles (i.e. 26,449,920 acres).
Leaving aside the point about whether or not these folks are doing good work - or God's work, as some contend - the fact remains that installing and maintaining such an extensive network is not cheap, neither in dollars nor the various unquantifiable costs associated with camping out and firing off rounds in other folks' backyards.
This wasn't always the case, of course. Having been long oppressed themselves by a professional army, the Founding Fathers were loath to establish one of their own. This philosophy is underscored clearly in the Second Amendment, which calls for a "well regulated militia" and protects the rights of the people to "keep and bear arms" in order that they may defend themselves; a small scale, individual alternative to the common practice of maintaining a standing army.
Secretary of State William Marcy, explaining why the United States would not sign the Treaty of Paris in 1783, perhaps summed it up best when he wrote:
"The United States consider powerful navies and large standing armies as permanent establishments to be detrimental to national prosperity and dangerous to civil liberty. The expense of keeping them up is burdensome to the people; they are in some degree a menace to peace among nations. A large force ever ready to be devoted to the purposes of war is a temptation to rush into it."
During the more than two centuries that have since passed, careful to ignore Secretary Marcy's words, The United States of America has built out the most expansive military complex ever known to man. At home and abroad, this behemoth - and its associated, ironically-named federal agencies of "intelligence and security" - pose increasing threats to that same national prosperity and civil liberty Marcy and his like had hoped to protect.
It is at least worth considering, therefore, that the real enemy might not be a culturally sub-evolved, cave-dwelling fanatic running scared from the world's largest gun. As it turns out, the enemy might just be the gun itself...and the ever-present temptation to use it.
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| | The Daily Reckoning Presents | | Gold, Gresham’s Law & the Dong | |  | | Ben Traynor |
What happens when people actively shun their official currency...?
Governments are often tempted to live beyond their means. Today, that means national debts and quantitative easing. But a few hundred years ago, it meant debasing coinage.
Silver and gold coins would be 'clipped' - with a tiny quantity of their metal shaved off the edge every time they passed through government hands - or they would be minted with a lower precious metal content than their face value stated. This would enable the monetary authorities to produce more coins for the same amount of bullion, increasing the government's spending power in the marketplace.
The net result was that coins with identical face values did not necessarily hold the same commodity value. And this often led to a rather interesting phenomenon. When people knew there were both 'good' and 'bad' coins floating around, they tended to spend the bad and hang onto the good. Before long, all the good money disappeared into hoards. The only money in circulation was bad money.
This is known as Gresham's Law, named after the sixteenth century financier Sir Thomas Gresham. In its most simple form, Gresham's Law is often stated as "bad money drives out good money", and it's no mere historical curiosity. Gresham's Law is alive and kicking today in many countries all around the world.
Vietnam provides a textbook example. Vietnam's economy uses three different forms of money today. There is the official currency, the Vietnamese Dong. There is also the US Dollar, which Vietnamese people tend to trust a bit more. And then, there is gold.
Gold is a big deal in Vietnam. The average Vietnamese spends more of each unit of income on gold than anyone else on Earth. Total gold buying amounted to 3.1% of GDP last year. (By comparison, private gold purchases amounted to 2.5% of India's GDP, while China's were a mere 0.4%.)
All told, an estimated 500 tonnes of gold - over $24 billion worth - is hoarded away in Vietnam, reckons Huynh Trung Khanh, deputy chairman of the Vietnam Gold Business Council. It's hidden in mattresses and buried in the garden. But gold is not just a store of value in Vietnam. It is also used as a medium of exchange. Which is why, in the day-to-day sense, it also functions as money.
In Vietnam you can put gold in a bank and earn interest. People quote house prices in gold, and pay for them with tael gold bars - each bar weighing approximately 1.2 troy ounces. This makes sense when you consider that Vietnam is a largely cash society. A single property can cost up to 4 billion Vietnamese Dong. That's a lot of paper to count and check.
But if the Vietnamese love their gold, the same cannot be said of the country's central bank. In recent years the State Bank of Vietnam (SBV) has issued several Decrees and Circulars whose combined effect - whether by accident or design - has been to undermine gold's official monetary role:
- June 2008 - Gold imports banned (though smuggling continues);
- March 2010 - All gold trading floors closed;
- October 2010 - SBV issues Circular 22, banning banks from dealing with manufacturers and traders of gold bars;
- May 2011 - SBV bans all gold lending activity.
The latest Decree is an attempt to end the practice of banks paying interest on gold (presumably in the hope that people will substitute their gold for paper). Up to now, banks have offered interest on physical gold deposits. They sell the metal on, lend the proceeds as Dong loans and buy an equivalent amount of gold forward from an international bullion bank.
This has been a profitable activity for the banks because domestic interest rates have tended to be high enough to cover both the forward rate and the rate they were paying the depositor. Essentially it was a carry trade; borrow gold (from depositors) cheaply, lend at a higher rate.
As of May 1, however, banks will be forbidden to undertake any gold lending activities. And from May 2013 they will have to stop paying interest on gold deposits.
This latter measure may largely be moot by then. As you might expect, with the lending channel blocked, there's no money in it anymore. Gold deposit rates have already fallen sharply.
So why all the rule changes? Well, the authorities see gold as a "bad influence" - a destabilizing factor in an already messy economic picture.
Consider the following problems afflicting Vietnam:
1) A Large and Growing Trade Deficit - The trade deficit in 2010 was around 12% of GDP. Even worse, it grew wider in the first four months of the year.
2) Rising Inflation - Latest figures from Vietnam's General Statistics Office show CPI inflation at a whopping 17.5%, despite a supposedly tight monetary policy.
3) A Falling Currency - The Dong has been devalued six times since June 2008. Most recently was February 11 this year, when it fell 8.5%. Sound at all familiar? The way the central bank sees it, the propensity of the Vietnamese to buy gold also makes these problems worse. Gold imports exacerbate the trade deficit (it has no domestic mine output). Buying gold thus weakens the Dong, which puts upward pressure on inflation. Gold (and indeed Dollar) ownership also undermines the SBV's monetary policy, since its interest rates only apply to the Dong.
But you can hardly blame the Vietnamese people for buying and hoarding gold. Not when you remember that Viet inflation is running at 17.5%. In this regard, gold ownership is a direct consequence of economic conditions. The only way the SBV could provide Vietnamese with an incentive to save in Dong would be to raise the nominal interest higher than inflation, and thus provide a decent real rate of return. But this would mean rates of around 20% at least. Not only would this hit the domestic economy hard, it would almost certainly cause the Dong to appreciate, which would make the trade deficit even worse.
Unable, therefore, to directly incentivize people to hold paper money, the authorities have resorted instead to marginally disrupting gold's monetary function. But this won't work. People will still prefer to hold gold because the Dong is failing to fulfill one of the core functions of money. It is a terrible store of value.
That is why the Vietnamese continue to hoard "good" money (gold) while passing the bad stuff around. Just as Gresham's Law predicts.
Vietnam is stuck in an inflation-devaluation cycle. Ordinary people do not trust its paper currency, and sell it for something better. This reduces its value against other currencies. It also reduces its value against goods and services, which takes the form of rising consumer prices. All of which serves to make the Dong even less popular...
Could this vicious cycle ever strike the US Dollar, British Pound, or the Euro? Maybe it's already begun. Gold and silver prices have risen strongly over the last decade in all those currencies, and especially versus the Dollar so far in 2011. This tells us that many Westerners - just like the Vietnamese - are keen to swap their paper for metal.
If the Dollar and its paper cousins continue to leak value, savers will increasingly prefer "good money" like gold and silver. After all, it's Gresham's Law.
Regards,
Ben Traynor,
for The Daily Reckoning
Joel's Note: Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of The Fleet Street Letter, the UK's longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.
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| | | | Bill Bonner | | When Investing in Gold is a Good Idea | |  | | Bill Bonner |
Reckoning from Baltimore, Maryland...
Drums keep pounding rhythm to the brain
La dee da dee dee
La dee da dee da
The beat goes on! Here's the world's most successful investor talking about our favorite metal:
Warren Buffett on gold:
"You can fondle it, you can polish it, you can stare at it. But it isn't going to do anything." Except protect you from losing every dime!
"Gold really doesn't have utility," the 80-year old told shareholders at Berkshire Hathaway's annual general meeting. "I'd bet on a good producing business to outperform something that doesn't do anything." Yes, so would we. And we'd usually rather have a jacket from Ralph Lauren...or Brooks Brothers...than a Life Jacket. And we'd usually like to see a pick-up truck or a delivery truck in our driveway, rather than a fire truck. And we'd much rather spend the night with Julia Roberts stark naked than with a heart surgeon in full medical regalia.
But hey...guess what? There's a time and a place for everything.
Why did God bother to create gold, anyway? Is it just for ornamental purposes?
Historically, gold has had one other very important use. And, while most of the time it is useless, occasionally it is indispensable. Most of the time, gold is as dumb and lifeless as a joint session of Congress. Buffett is right; most of the time, it's as useless as a seat belt.
But there are times when a common lifeboat has greater utility than a luxury sailboat.
Could this be one of those times?
Well, something is going on that is turning this do-nothing metal into an investment champ. The price of gold is up 10% already this year. It's gone up every year for the last decade. You don't have to look too far to see what it is.
How about $4.5 trillion in deficits over the last 3 years? How about tripling the Fed's balance sheet holdings since the end of '08? How about TARP, TALF, QE1, QE2...and zero interest rates?
Oh, and lest you think it is all just an emergency response to the crisis of '07-'09, soon to be history...here's The Washington Post with some perspective:
WASHINGTON - The nation's unnerving descent into debt began a decade ago with a choice, not a crisis.
In January 2001, with the budget balanced and clear sailing ahead, the Congressional Budget Office forecast ever-larger annual surpluses for the foreseeable future. The outlook was so rosy, the CBO said, that Washington would have enough money by the end of the decade to pay off everything it owed.
Now, instead of tending a nest egg of more than $2 trillion, the federal government expects to owe more than $10 trillion to outside investors by the end of this year. The national debt is larger, as a percentage of the economy, than at any time in US history except for the period shortly after World War II.
Today, the CBO forecasts are unrelievedly gloomy, showing huge deficits essentially forever. As policymakers grapple with the legacy of the past decade, a demographic wave of senior citizens is crashing at their doorstep, driving up the cost of Medicare, Medicaid and Social Security. How will the feds cover this debt...and future deficits? Do you think they will put on the brakes...raise interest rates...cut spending...and raise taxes? If so, you should not own gold. Gold would go down and the dollar would go up. Of course, the bond market would crash and the economy would go into a depression too. Rehab isn't for sissies. Getting clean can be painful.
More likely in our view: the feds will keep flying...until they crash.
"There's something peculiar about an asset that will really only go up if the world is going to hell," said Charlie Munger.
Yep. Very peculiar.
But occasionally, the world does go to hell.
And more thoughts...
And here's another problem with gold. As the danger of inflation increases, so does the cost of protecting yourself. When you finally realize you need a life-vest, you're already in over your head.
Yesterday, gold changed hands at $1,557. If you bought when we first told you to, you're congratulating yourself. Your life vest has gone up more than anything, except, investment grade wine!
But if you didn't buy then, is it too late now? Now, it's not so easy. You'll be reluctant to get in now - the price is more than three times higher.
So what do you do? You wait for a correction. But the correction doesn't come when you want it to. And then, when it does come, you hesitate. You check your bearings. You read the financial press. You read about all the "poor gold bugs" who are getting killed. You hesitate more. You wonder: maybe all the run-up in gold was just a fluke. Maybe the problem has gone away. You worry that it's not a correction in a bull market, but a new bear market that will take gold back down for the next 10 or 20 years.
Then, before you know what has happened, the metal has swung up again. And soon it is more expensive than it was when you decided not to buy the last time.
*** So what should you do? We don't give advice here in The Daily Reckoning. Giving advice is for our colleagues, who know what they are doing. But we will repeat the non-advice we offered for the last 11 years:
Buy gold on dips. Sell stocks on rallies.
You have a rally in the stock market, no question about that. But a dip in gold? Not now. Not yet. Stay tuned. It will come.
Regards,
Bill Bonner
for The Daily Reckoning |
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