Podcast

Alasdair Macleod: All Roads in Europe Lead to Gold

Every horror that we discussed last time we spoke is coming
Saturday, May 19, 2012, 7:50 PM
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This week we bring back Alasdair Macleod, publisher of FinanceAndEconomics.org, because, as he puts it, "every horror that we discussed last time we spoke is coming about." This is especially scary since our previous conversation with Alasdair was less than three weeks ago...

Today's interview continues building on his excellent synopsis from last month that detailed the origins of the Eurozone crisis. The fundamental shortcomings warned of at the euro's creation in 1997, combined with the excessive sovereign debts run up since then, have finally expressed themselves at a scale too large to be contained any longer.

Today, Alasdair details in depth the huge and serious challenges facing Greece and the major Eurozone countries and the likely impacts of the fast-dwindling options left remaining.

He sees no happy ending to this story, no outcome in which serious pain and permanent behavior change can be avoided. And for those looking for shelter from the unfolding economic storm, he sees few options besides the precious metals (which he believes are severely underpriced at the moment): 

Greece

The Greek situation is entirely predictable: when you force enormous pressures on an economy and try and raise taxes from the private sector -- a private sector which isn’t used to paying taxes because usually they find away around it -- you start cutting pensions, you start cutting this, cutting that, and the people revolt. They haven’t a clue what they are doing, but we get the revolt nonetheless. It looks like nobody there can form a government; and it looks like there will be another election probably in June. That won’t resolve anything unless by some miracle, some sense gets knocked into people’s heads.

The other thing, which nobody has mentioned, is that there are about 90 billion dollars in derivative contracts involved in the Greek economy. This is not just government, but also local governments and towns and cities and all the rest of it. The counterparties to this $90 billion must be getting a bit worried about that, I would think because that looks as if it will default.

The people who have been most active in getting these derivative contracts going over time have been people like Deutsche Bank, Goldman Sachs and I suppose JP Morgan -- so you can see the problems aren’t just limited to the government and some unfortunate Greek citizens who are caught in the middle of this. 

We are looking at potentially up to ninety billion dollars worth of derivatives which one side of those transactions is going to default. One side: it is not a balanced figure is it? I don’t know that it is necessarily as bad as that, but it is a problem that needs to be dealt with, addressed and contained. I think what they have to do as much as possible, is to try to work for a sensible outcome in this, which probably will involve Greece leaving the Eurozone, but maybe obtaining help from the ECB to set up a currency board. The reason I say that is that I think for Greece to return to the drachma would be complete destruction. You would have a situation where people who owe money in Euros would still owe money in Euros. If the Greek government tried to change that by law, for starts, that could only apply to loans taken out in Euros in Greece; whereas a lot of these have been taken out in Euros elsewhere in the European Union. In any event, I think if they tried to do a law on this, it would be a retroactive, which would be open to legal challenge. 

Meanwhile, if you have deposits in a Greek bank, you can be sure the Greek government would say we are going to re-designate those into New Drachmas, which would impoverish the depositors. When it comes to trade, I think everybody would just stay well clear. To go back to a New Drachma, I think is the most destructive path Greece can have. Now, they could do that on the basis that, if the European Union wanted to make an example of Greece, then this is a way in which they could just let them go hang. The importance of that would be that the situation for Greece should be so bad that no other member of the Eurozone would contemplate leaving the Eurozone. That is a possibility. But I think that is less likely than coming to terms in such a way to give Greece an exit. But if they do get an exit, again, they’ve got to have an exit in such a way that it hurts enough and anybody else who wants to take that exit would see, well it is actually probably more painful than staying where we are. It is a very difficult balance to achieve.

The people who will do this, I don’t believe are the politicians. It would have to be the sensible people in the ECB and perhaps some of the more backroom boys who could put together some sort of face-saving mechanism without this becoming too much of a political hot potato. It is very, very tricky, it really is, and quite honestly, the way political governance has been going in Europe, the chances of them getting some sort of orderly withdraw in the interest of continuing relationships, et cetera, I think are actually probably slim. That is what we are up against: this is not easy. There is no precedence for this at all and I know that lots and lots of people are saying it has got to return to the Drachma; I just think that a New Drachma would collapse almost immediately. I think that a currency board in the Euro is actually a more sensible result given where we are.  

France

France is a mess. They have outstanding debt of 1.3 Trillion Euros, something like that. Their debt/GDP is around about 85-90% going on a hundred quite rapidly. That is a very liquid and nasty situation. Unemployment is running close to ten percent.

It is almost impossible to employ anyone in France because the taxes are so high. Do you know the total tax that you pay as an employer, more than doubles the salary that you pay an individual? This is absolute craziness, but it is been like that in France forever and a day. The result is an awful lot of the market is black market.

Spain & Italy

Spain is a worse situation. Government debt alone is just under a trillion. A trillion dollars equivalent, I should say, and that is a lot of money. That is a lot of money. Italy is over two trillion dollars. That really is a very, very big one, so this contagion must not be allowed to happen. 

Germany

Their economy is performing reasonably well, but it is not performing well because they are doing well for Europe; they are doing well because they are selling the most cars, machine tools and everything else to China, to Brazil, to Russia. Africa’s a great growth area. Europe, as far as Germany is concerned is dead. Which of course brings us on another question; that is why should Germany continue to support all these bust Europeans? There is a sort of conscience if you like about the last two world wars, but there is going to come a point where that wears pretty thin I would have thought. The trouble is that it is all very well, everyone turning around and saying, Germany has to help. Actually, what they are saying is that Germany’s citizens should give up their savings, their hard won savings to rescue a project, which is obviously dead or deceased. I think Germany really should bust out as soon as possible and I am sure that there are an increasing number of businessmen and bankers in Germany who are beginning to feel that way. 

On Gold

People who have gold or silver, I think actually had a very rough ride over the last couple of months. A lot of them are wondering what on Earth is going on because every time you get good news, gold seems to rally along with equities, but every time there’s bad news and gold actually should be giving you some protection, it goes down the swanny.

I think the problem there is that the whole system is run by people who went to college and were taught keynesian economics. In my day, when I first went into the stock market and I enjoyed that first bull market in gold when it went from thirty-five bucks to eight-fifty, the traders and investment managers were all practical people. They all cut their teeth, all learned their trade the hard way. Some of them had degrees in college, but generally it would have been something like classics or history or something like that. If they got a degree in economics, they probably would have left because they never would have understood it in those days. But now it has changed. Everybody who is employed has a degree and if they are anything to do with investment strategy, or the investment business, it is all economics degrees. So they have been brainwashed in the keynesian thing. This sort of neoclassical approach where gold is yesterday’s story, paper money is the future. They really do believe it and it is the opinions of these people who drive the markets in the short term.

The result is that gold and silver have become very, very seriously mispriced. I don’t think I have seen a stretch like this as I can remember; by stretch, the difference between perhaps where it should be. We must be careful not to tell the market what the price should be, but it is so underpriced at a time of enormous systemic stress, that I think when gold and silver snap back into a more sensible, logical valuation relationship with the markets, the move actually could be very, very sharp and quite large. If gold ran up through the $2,000 level very quickly, which I think is a very strong possibility, because it is been held down so much, that could bring other problems. The central banks, who might have sold gold and not told us about it will find that they are embarrassed. I think also the bullion banks in London who operate a fractional reserve system with gold, exactly the same way as to do with any paper currency, will be hurt very, very badly on the run. Any shorts in the futures market equally could be hurt very, very badly. We have a situation, where there is a potential for a huge run in gold and I personally wouldn’t be surprised to see it.  

Click the play button below to listen to Chris' interview with Alasdair Macleod (48m:07s):

Transcript: 

Chris Martenson:  Welcome to this PeakProsperity.com podcast. I am your host, of course, Chris Martenson. Today we are going to take a quick detour back over into Europe, because as you know, I just wrote a report talking about how this might be 2008 all over again. Of course, what I am looking at in that report is the deterioration that I am seeing across Europe, thinking of Europe as a potential trigger point for a liquidity crisis, whereas last time it was an institutional liquidity crisis centered around some dodgy debts that went bad and some derivatives thereupon that made it worse. This time, similar dynamic, of course; different players, different focus. Maybe it is happening in the sovereign debt side. Here to discuss that with us is our very own Alasdair MacLeod, who has penned a couple of nice pieces for us and is sitting over in Europe. Welcome, Alasdair.

Alasdair Macleod:  Thank you, Chris.

Chris Martenson:  Oh, so happy to have you again, and I know I described you as “our very own” with a stretch, but I like to think we have a nice relationship going.

Alasdair Macleod:  It is nice to be part of the family.

Chris Martenson:  Thank you for that. So, here’s the situation: Greece has elected a new government comprised of more powerful elements from both the left and the right, neither of which seems to have any interest, apparently, in honoring the prior bailout and/or austerity agreements. Spain seems to be under increasing fire, its banks were rudely downgraded recently by the ratings agencies, and Bankia specifically seems to be needing some help right here. Maybe it has already experienced something of a bank run of sorts, maybe if we are reading between the lines right. GDP in Spain was just announced, dropped 0.3% in the first quarter, so that confirms a return to recession there for Spain, I believe.

Let’s go to Italy. Twenty-six large and medium banks just downgraded recently. GDP, just announced, contracted by 0.8% through the first three months of the year. That would give it its fourth recession since 2001; now pretty much in the bag. What is going on over there?

Alasdair Macleod:  Well, I think you actually described it pretty well. Every horror you could imagine that we discussed last time we spoke about this is really, I am afraid, coming about. The Greek situation is entirely predictable. When you force enormous pressures on an economy and try and raise taxes from the private sector – a private sector which isn’t used to paying taxes because usually they find away around it – you start cutting pensions, you start cutting this, cutting that, and the people revolt. They haven’t a clue what they are doing, but we get the revolt nonetheless.

And it looks like nobody can form a government; it looks like there will be another election there, and that will be probably in June. That won’t resolve anything, unless by some miracle some sense gets knocked into people’s heads. I wouldn’t like to say it gets knocked into people’s heads, because it is not quite implied violence, which actually may not be too far beneath the surface in this one. No, it is not good, and the French election with Hollande getting in tells us that the pressure is going to be to not go for so much austerity, so some sort of new middle way will have to be found. Not just there, but around Europe, which implies that the Germans are going to have to give a bit. I know it is not a fashionable thing to say, but I feel quite sorry for the Germans, because it is their savings being chucked as good money after bad. That’s a mess, and I think that the Spanish situation suddenly comes upon us. The yields I don’t think quite reflect this yet. I think they are only about what, 6.5% or something.

Chris Martenson:  Yeah, that is about right.

Alasdair Macleod:  The yields should be north of ten, I think, the way this is going. So we will see higher yields, which will equate to a turn of the screw on the rack. And Italy, as you point out; things are not going so well there. The whole thing is a nightmare. I think the only thing I can say about this nightmare is that the overall debt situation is not quite as bad as America. But that is small comfort and actually causes further faults, which might make you reach for the whiskey bottle, if you like.

Really, Chris, I think all this is really coming to pass as we discussed. Bank runs, certainly the Spanish situation; we know the Greek banks have had a run on them. We know also that the Spanish banks have had a sort of run, because this has been reflected in TARGET II. The TARGET II imbalances are reflecting as much as anything is capital flight, and that is built up quite rapidly over the last two or three years, and the build up has been accelerating, as we discussed the other week. That is where we are; it is at least as bad as we said, and I think it is at least as bad as you read and probably even worse.

Chris Martenson:  Right, so let’s unpack this a little. The real question I am interested in addressing is what happens next? How does this unfold? Let’s just focus it down to Greece for a minute. So, Greece leaves the euro; I have read everything and they said that’s it; it is all over; you can just put a fork in the Greek banking system; it will be an immediate run and collapse; they will not be able to get financing; it will just be a complete horrid mess; losses for everyone. To other people, other analysts, who sort of toss their hands up and suggest, well, it will be a little rough, but maybe not all and uncertain, but they will get through it. So, what is the mechanism here? Lot of moving pieces; let’s start here.

We have heard about Greek bank withdrawals. People presumably are finally waking up and yanking their money out of their banks. I presume, if they can’t get their hands on cash, that means they are pulling it out of one bank, it is going into another. I am going to have to guess some of those banks are probably outside of Greece. Otherwise, why would you pull your money from a Greek bank, other than to avoid the potential losses that might come if Greece does decide to go with the Drachma and does some sort of a re-valuation? Which by definition, of course, will result in losses for anybody who’s in an enforced part of that conversion. So, is that part of the mechanism here?

Banks only have – first of all, they’re fractional reserve banks, like banks everywhere, so yes, they have not only a bunch of assets on the books and a bunch of liabilities and they match, roughly. But, when people are pulling money out, there can be an extraordinary mismatch developing, because of course the loans are locked into fairly longish terms and the cash has to be produced on demand. For now, the ECB (European Central Bank) has said we will help you through that process, but there are concerns now that maybe the ECB is saying we won’t even help you with that.

I don’t even remotely understand how a bank survives that, but what do you see in this mechanism? Is that about what is happening here?

Alasdair Macleod:  Well, your last point first. Let’s just address the ECB. The ECB can counteract any bank runs for banks within the euro system, but it cannot recapitalize banks. That is down to individual governments working with their own national central banks. Therefore, ensuring liquidity is available is a short-term fix while more permanent arrangements are being put in place. Unfortunately, we don’t see the more permanent arrangements being put in place. That is where the ECB is and why it has a problem. It can’t continue to chuck money at keeping these banks afloat forever. There has to be, if you like, an exit plan.

If we look at Greece, a lot of money has left Greece. The estimate I have seen is, roughly $72 billion in deposits has disappeared from the Greek banking system over the last two or three years. That must have been accelerating in the last month or two. If you look at the Bank for International Settlement’s figures, at the end of 2011, Greece’s banks had foreign assets of $195 billion and liabilities of $103 billion. That is indicative of the amount of money, if you like, that has gone out into banks, because normally you would expect those two figures to more or less balance. If you are running a bank, you do try to put that sort of discipline into your balance sheet, and the Greeks would have done that as bankers anyway. The shortfall between those two is an indication of the stress that the banking system in Greece feels.

That indicates about half the foreign position as being unwound, but it rightly makes a point. While foreigners can maybe unwind their positions as much as possible in terms of Greek exposure, it is not necessarily so easy for the Greek banks to do the same, and indeed, they won’t have quite the same motivation to do the same. The cash withdrawals that are going on at the moment are against a background of balance sheets which are already very, very badly skewed. The thing is really quite nasty there.

The other thing which nobody has mentioned is that there are about $90 billion dollars in derivative contracts involved in the Greek economy. This is not just government, but also local governments and towns and cities and all the rest of it. The counter parties to $90 billion must be getting a bit worried about that, I would think because that looks as if it will default. That is something that has to be caught worldwide. The people who have been most active in getting these derivative contracts going over time have been people like Deutsch Bank, Goldman Sachs, and I suppose JP Morgan – I don’t know, but anyway, you can see the problems aren’t just limited to the government and some unfortunate Greek citizens who are caught in the middle of this.

Chris Martenson:  Right, so let me take one point – a little diversion here. There is a lot of confusion around derivatives and how they operate, and many times I hear it and sometimes I even talk about it this way, that in large measure, a lot of derivative contracts are a zero-sum game. These are the things that JP Morgan was caught up in. You and I might decide to exchange a billion-dollar credit default swap with each other, and neither of us owns the underlying. At the end of the day, that zeros out, my loss is your gain, or vice versa. Where this doesn’t zero out is if I actually am holding the underlying.

I have Greek debt, I have a billion dollars worth of it, and what I want to do is protect that. You decide to go ahead and insure that for me, so you do a credit default swap with me. You issue it, I buy it, I pay you some rate, let’s call it 7%; 700 basis points on that. Then the underlying goes 'poof'. Those billion dollars actually go away. I want to be made whole on that, so you now owe me that billion dollars – when the underlying actually goes sour, those losses are very real, and those derivatives are the armature, the mechanism by which those losses get pushed out into the system. Is that right?

Alasdair Macleod:  That is absolutely right. We are looking at potentially up to $90 billion worth of derivatives, of which one side of those transactions is going to default. One side. It is not a balanced figure, is it? You are absolutely right in pointing that out. I don’t know that it is necessarily as bad as that, but it is a problem that needs to be dealt with, addressed, and contained. I think what they have to do as much as possible is to try to work for a sensible outcome in this, which probably will involve Greece leaving the Eurozone, but maybe obtaining help from the ECB to set up a currency board.

The reason I say that is that I think for Greece to return to the drachma would be complete destruction. You would have a situation where people who owe money in euros would still owe money in euros. If the Greek government tried to change that by law, for starts, that could only apply to loans taken out in euros in Greece, whereas a lot of these have been taken out in euros elsewhere in the European Union. In any event, I think if they tried to do a law on this, it would be a retrospective, which would be open to legal challenge.

Meanwhile, if you have deposits in a Greek bank, you can be sure the Greek government would say we are going to redesignate those into new drachmas, which would impoverish the depositors. When it comes to trade, I think everybody would just stay well clear. To go back to a new drachma, I think, is the most destructive path Greece can have.

Now, they could do that on the basis that, if the European Union wanted to make an example of Greece, then this is a way in which they could just let them go hang. The importance of that would be that the situation for Greece should be so bad that no other member of the Eurozone would contemplate leaving the Eurozone. That is a possibility, but I think that is less likely than coming to terms in such a way to give Greece an exit. But if they do get an exit, again, they’ve got to have an exit in such a way that it hurts enough that anybody else who wants to take that exit would see, well, it is actually probably more painful than staying where we are. It is a very difficult balance to achieve.

The people who will do this, I don’t believe are the politicians. It would have to be the sensible people in the ECB, and perhaps some of the more back-room boys who could put together some sort of face-saving mechanism without this becoming too much of a political hot potato. It is very, very tricky, Chris, it really is. And quite honestly, the way political governance has been going in Europe, the chances of them getting some sort of orderly withdraw in the interest of continuing relationships, et cetera, et cetera, I think are actually probably slim against.

That is what we are up against; this is not easy. There is no precedence for this at all and I know that lots and lots of people are saying it has got to return to the drachma. And you wrote, I thought, a quite well argued piece going in those lines. I just think that a new drachma would collapse almost immediately. I think that a currency board in the euro is actually a more sensible result, given where we are. In order for that to happen, Greece would have to have the euros, if you like, to back its own currency issuance. Then they would have to run it properly, so everything would have to be put in place. And this would actually work? I don’t know anyone thinking this way. This is the other trouble.

Chris Martenson:  The only other thing I can think about would be some sort of a jubilee where the ECB just pays off Greek’s debts and says let’s start over, here. As I read it right now, if Greece does fully exit the euro and then punts on all of its external liabilities, there are still three hundred and fifty billion of losses lurking out there potentially. It is quite a large number and as you say, the contagion fear is the one where if Greece gets away with it and Spain looks over and says that seems easier than trying to pay all these things off, they might do that too.

Alasdair Macleod:  Yes, that is right and in Spain, you are looking like – it is a worse situation. Government debt alone is just under a trillion. A trillion dollars equivalent, I should say, and that is a lot of money. That is a lot of money. Italy is over two trillion dollars. That really is a very, very big one, so this contagion must not be allowed to happen. I just don’t know how this is going to pan out. I can’t see where the exit is. I can’t see where the happy ending is in this. This is the problem.

Chris Martenson:  Right, so let’s talk about that for a second, because you mentioned Hollande gets elected in, and so there’s this general anti-austerity fervor in the political elections going on, if we can interpret it that way. What really could Hollande or anybody really do to say I am off the path of austerity besides engage in deficit spending at the government level? They still have to fund that in the bond markets in some way, shape, or form. They don’t have their own printing presses. They don’t have a compliant Fed over there, monetizing their sovereign debt to the tune of sixty-one percent of on the run issuance or anything lovely like that. Where and how would they even fund the opposite of austerity if it were their political desire to do so?

Alasdair Macleod:  I think this is – you have come up to the nub of it, because the answer is, they can only provide it by an easy money policy from the ECB. In order to achieve that, there has to be some very serious arguments, if you like, between the Bundesbank representing the Germans in terms of monetary policy and the ECB itself, and I see no alternative to an outcome where there is a far more expansionary policy. I don’t know, it might be quantitative easing (QE), but I think it is probably more likely that the ECB will be given a lot more firepower to try and keep the banking system going. Through the banking system, the bank is allowed to lend to the governments and to buy more debt to pay for the redemptions so the rollovers can continue.

Now, here is something which I think does become quite important, and that is, this explains a little bit of the weakness that we have seen in the euro in the last week and it would justify yet more weakness in the euro. I would see the euro going down quite a bit on this. I think that is a likely outcome.

Chris Martenson:  Interesting. Well, I am going to propose that instead of LTRO3 that the ECB promote the HMSPP – that is, the Hail Mary Speculative purchase program – and they should just issue a trillion, which can be put into Facebook stock. I think that would solve a lot right here.

Alasdair Macleod:  Yeah, well, as a speculative proposition, it is a lot less speculative than chucking it at Spain and Greece, perhaps.

Chris Martenson:  You might be right. Oops.

Alasdair Macleod:  We must not joke, actually, because it is an extremely serious situation.

Chris Martenson:  Well, it is, and the question of course is, how does this all unfold? And so I hear you describing that there are a lot of political difficulties and realities, all of which imply there is a certain pace at which the potential solutions can be proposed, vetted, and worked through the system. It is my sense that perhaps events are running a bit faster than that process can engage. Do you share that view?

Alasdair Macleod:  Yes, I would agree with you entirely. As so often happens in these things, they start slowly and the pace rather quickens. It is almost like it goes at an exponential growth rate, if you could chart events. I think that this is going to accelerate now very rapidly. There is one positive outcome and that is, if Greece leaves and they manage to work out sensible terms on the sort of lines perhaps that I suggested just now, then there may be a recovery in the markets, a sort of sigh of relief if you like. I don’t think I would put money on it. It is rather like betting on how far a dead cat might bounce. We might get a little bit of a pause in the increasing pace of events, but it would be a pause. I think it would only be a matter of a very short time before things start deteriorating again.

You cannot have the banks getting into such difficulties without really very, very adverse consequences, unless the ECB comes in very quickly and somehow manages to nip that in the bud. Ideally, as I have said before, if you can get governments perhaps to face up to the facts that they are spending more than they attract in income tax and can borrow in the markets, and actually do something about that, at least keep the banks going, then that is probably about the only way out. I have to say, the politicians are showing great reluctance to face up to reality of any sort, and they have the problem, of course, that as they do that, the people just chuck them out of office. It is a very, very difficult situation.

Chris Martenson:  I have read a number of commentators who have asked what I think is a very logical question [sic], which was, instead of feeding funds to banks and hoping that they would do the right things with it, of course, they don’t know what to do with it. Growth is not part of the equation right now, so the normal credit mechanisms are not operating quite the same. It was obvious to me that our credit markets, after a sustained forty-year bubble, were probably going to be moribund for a period of time, but Japan in the 1980s through the 1990s could have taught you the same lesson.

It is confusing that the authorities, both in the U.S. and in the U.K., following Japan’s model, I believe, gave one toss at this, let’s just make credit and liquidity very easy for the banks and cross our fingers, close our eyes and hope for the best, when there’s another strain of thought, which said, if the banks were having so much difficulty with bad loans, why didn’t you make the funds available to the people? Now, people would have gotten the funds; what would they have done with them? Well, they would have paid off their debts and put them into the banking system. It would have gone to the banking system anyway, but it would have taken a tour through the populace first, which arguably might have had a different impact on demand, if that is what you were targeting. Not that I am promoting that that would have been a good idea either; I am just saying it was perplexing what they chose to do and more perplexing now that it is provably not working. All I hear so far are strains of doing it bigger and better this time. Are you seeing different strains out there?

Alasdair Macleod:  I think you have summed it up right. There is this sort of extraordinary situation where for the amount of money they throw at the problem, you’d think if they had just distributed it around the citizens, it would be a far cheaper solution. I think there are two things that mitigate against that.

One is if you just distribute money around the citizens, then prices go up accordingly for everything very, very rapidly. In other words, it would be instantly inflationary. You distribute it through the banks, then what you are doing is you are doing something that you learned in university as you read Keynes, was the sort of thing to do to try to rescue an economy from further deterioration. They are all just actually working off the textbook. If you talk to any central banker about what his worst nightmare is, he will tell you it is the debt deflationary collapsing spiral. That is, we are so close to that, they will tell you, that is our nightmare, and we will do everything we possibly can to ensure that doesn’t happen. That is why they chuck the money at the economy through the banks, because they are worried about assets. I am sure that is a lot to do with why interest rates are where they are – to keep assets from falling over and therefore the bank’s balance sheets from falling over.

That’s the way they do it. It is a combination I think of if you just distribute it through people, rather helicoptered some money at people, then the inflationary consequences will be certain. If you go through the banks, you sort of hope that you have got a theoretical solution. Which, incidentally, as I think you are aware, I believe is no solution at all. The real problem is that we have built up such mal-investments over the years that the whole system is really falling over. It can’t take it anymore, and it is time there was a debt reconciliation. That’s the end of the Keynesian experiment; that’s the trouble.

Chris Martenson:  Right, so as we look forward – I follow a variety of things; what do you think people should be following if they are interested in getting an early read on whether something is developing or breaking or shifting in the story? Are we watching sovereign bond yields? Are we watching credit spreads? Are we parsing the language of the output from the next ECB meetings? What is it that really bears watching here?

Alasdair Macleod:  I think the clearest indication is yield spreads, because that is what the market it trying to discount. I would also say that in a bear market, which is really what rising yields are, you tend to have investors being positive and yielding to the bad news. In other words, the ability of the market to discount bad news is considerably less than a good market anticipating good news. A bear market is always open to nasty surprises. A bull market always discounts the good. If you think in bear market terms, then the yields of today that we see aren’t really discounting anything coming up. As you see those yields rise, that will give you a very, very good barometer of what is actually going on in the totality of the mess. That to me would be the thing to follow.

Chris Martenson:  Well and unfortunately that signal has been somewhat degraded in its utility by all the official intervention, the non-economic layers, the central banks stepping in and depressing the yields below what the markets would be delivering. I share with you the idea that if the markets were able to decide on their own what appropriate yields would be, they would be a lot higher than they currently are.

Alasdair Macleod:  Chris, if I could interject just a second. My comment really in this was with respect to the European yield situation.

Chris Martenson:  Well, there, too, hasn’t the ECB sort of stepped into a variety of Italian/Spanish auctions over time and through its LTRO, didn’t it (wink, wink) say we wouldn’t be too upset if you took those funds and parked them in your sovereign debt? Isn’t that a lot of what happened in Spain, for instance?

Alasdair Macleod:  Yes, that is certainly true. We saw the yields for these governments, government bonds fall very substantially on the last LTRO and there was no doubt the Italian and the Spanish banks and all the rest of it – whether they gave into pressure from their governments, or whether they did it willingly, I think is of no consequence. The fact is that they did it because yields went down. That is now no longer the situation. Those banks do have money, I guess, on deposit still at the ECB.

They are going to need them for their own debt maturities because those aren’t going to get rolled easily. They also have to have a certain amount of safety net there because the deposits are tending to walk out the door. The banks are now getting very, very limited on this, which should push yields up even more, I would have thought, for their respective governments. We should see these yields rise in Spain and Italy. Greece, I think, we treat as a special case now, but of course, there is also Portugal, and Ireland, too, which has rather gone very, very quiet. It has gone quiet there because they are out of the headlines.

Chris Martenson:  Right. Where do we go from here, do you think? Is this just the situation where we watch the yields? Is there a magic point beyond which the situation breaks for Spain? They go Greek, in essence, and we watch things unfold very rapidly?

Alasdair Macleod:  I think the markets tell us. If yields go up over 7%, then it is curtains. If that is right or not, I honestly don’t know. If the market thinks it, then this is going to be important because everybody is going to watch that. I think it is only a matter of time, probably a very short time, before we see yields reach the 7% level. My view is also that one of the more dangerous situations is France itself. I am not surprised that the socialist has been elected, a socialist who incidentally is very much part of the establishment, so the compromises that Hollande is going to obtain from Germany and all the rest of it, will be I suppose broadly acceptable in the context of where we are in Europe. I think it will probably be taken generally quite badly by the market. France is a mess. They have outstanding debt of about I suppose 1.3 trillion euros, something like that. Their debt-to-GDP is around about 85%, 90%, going on 100% quite rapidly. That is a very liquid and nasty situation. Unemployment is running close to 10%.

It is almost impossible to employ anyone in France because the taxes are so high. Do you know the total tax that you pay as an employer more than doubles the salary that you pay an individual? This is absolute craziness, but it is been like that in France forever and a day. The result is an awful lot of the market is black market. It is quite hard to find any area in Europe which is free from this mess. Germany is okay, they are all right in a sense. Their economy is performing reasonably well, but it is not performing well because they are doing well for Europe; they are doing well because they are selling the most cars, machine tools, and everything else to China, to Brazil, to Russia. Africa’s a great growth area. Europe, as far as Germany is concerned, is dead. Which, of course, brings us on another question, and that is, why should Germany continue to support all these bust Europeans?

There is a sort of conscience, if you like, about the last two world wars, but there is going to come a point where that wears pretty thin, I would have thought. The trouble is that it is all very well, everyone turning around and saying, Germany has to help. Actually, what they are saying is that Germany’s citizens should give up their savings, their hard-won savings, to rescue a project which is obviously dead or deceased. I think Germany really should bust out as soon as possible, and I am sure that there are an increasing number of businessmen and bankers in Germany who are beginning to feel that way.

Chris Martenson:  I agree, and from my view, I think that the difficulty here is that nobody quite knows how to go about doing this. Politically, obviously it is a hairball. Just from a financial system standpoint, it is quite tricky. Even if you say all right, here’s how we start to cleave these things apart, what we have learned through watching Warren Buffet attempt to unravel the derivatives positions of a single company, or noting that there are still I think somewhere in the vicinity of three hundred thousand derivative contracts still parked around, they are trying to figure out how to undo them from the Lehman collapse.

These things just take time. It is not as simple as it used to be. It is very interconnected, so the idea here is, it might be fashionable to say let’s just isolate these things. Let’s go back to some sort of Chinese firewall between these different entities, but that’s a very, very difficult prospect. Again, I see the political reality of this as requiring time, patience, care, and I see the events accelerating and going faster as you might expect on the tail end of a forty-year exponentially growing debt bubble. Those two things are just sort of in collision at this moment. That is kind of how I am interpreting it at this point, and the bottom line summary I have is, nobody knows. This is rather uncertain; we are just going to have to watch. Part of us is just going to have to be spectator on this, I think.

Alasdair Macleod:  I think that is right. Of course, the other side of the German problem is the bank indebtedness on their bank’s balance sheets. All around Europe, some of the numbers which Germany is paid – as far as I am aware, my numbers aren’t complete – you are looking at about €1.3 trillion euros, something like that, owed to the German banks from around Europe. Admittedly, that also includes a figure for the U.K., but if you look at Spain, they are owed about €178 billion. The Netherlands owe them €167 billion; now that is a quality borrower. Italy, about €165 billion; and France, about €210.

These are big numbers, and that’s just owed to Germany. Then, of course we have the TARGET II imbalances, which are rapidly moving towards €0.75 trillion euros as well. The financial impact on Germany is actually, I think likely, to make them say, well we don’t want to rock the boat unnecessarily here. That is an argument in favor of that. The only thing I feel certain is likely to come out of this from the German end is an increased demand for gold. If you think, German citizen, my savings are getting chucked out against to keep all these other countries going, how do I protect myself? I think the only protection they have is to go back to gold, and the Germans actually are quite naturally keen on gold. That’s an interesting thought.

Chris Martenson:  Right, if I was over there, a) I wouldn’t have my money in certain banks at this particular juncture, and b) I would certainly have as much out of the system as I felt I could prudently hold. That might be 100%, depending on the country I was in. I absolutely agree. If realistically, the option here is, on the one hand we are the ECB, we are going to toss our hands up; we give up, we are just going to let the chips fall where they may; and we are facing the utter dissolution of entire countries, political systems, financial institutions. It is chaos. Been down that road before within living memory, it is not pleasant, but we are going to go it. Or, we are going to try this printing thing, which will delay things, maybe pass the time on my watch of this job, or it might turn out, as far as I can tell, the plan in Europe so far, which is the plan everywhere in this exponential money system we have is, cross our fingers; as long as we can get back to growth, this whole thing will start working itself out. Not that we will get smart and say, whew! Dodged that bullet, we will actually work our debts down.

What will happen is growth will turn and everybody will go see, that’s how it is supposed to work and continue accumulating debts at the old faster than income pace until it blows up again at some point in the future. I think we are at that point in the story where enough people have looked into the future and started to ask – in all good scenario planning, you should always be asking the alternative – Where are my assumptions? Where might I have it wrong? The primary assumption that we will return to growth being potentially a flawed one is something that is seeping in, and with that comes the idea that we fundamentally have to do things very, very differently. So far, I haven’t seen that seep into the highest policy levels yet in terms of really trying something brand new.

Alasdair Macleod:  You are absolutely right on that, because ever since the 2008 financial crisis, the Keynesians in charge of the central banks have chucked out money on the basis of economic recovery will happen, budget deficits will come down, and we will all be all right. It is the Keynesian textbook response, but this is getting to be a very tired story. Here we are now, three or four years later, still no sign of a recovery, and as we discussed last time, the puffing up of GDP by just throwing money into is – it is a money total, don’t forget, and there’s no real recovery there. The result is that there are doubts creeping in, and I don’t know whether the doubts are at the intellectual level in the Federal Reserve Board, for example, but I can’t help but notice that Bernanke seems to be quite reluctant to do forced QE3. He is sitting on his hands a bit there. Whereas I am sure that two years ago, in these current circumstances, he would have printed like billy-o. But no, they’ve shot a few bullets. They know their ammunition is running a bit low, and they have achieved absolutely nothing. I think there is a level of – they are perplexed, if you like. It is the Keynesian thing; it is not working at all, and they are all very, very confused. It is almost like you can see a Picassian picture of central bankers looking at each other all asking the same question, what now?

Chris Martenson:  Sure, they have done the rain dance, they shook the rattles, and the skies are still clear. Something is broken. The magic isn’t working. It is very confusing. Totally perplexing moment here.

Alasdair Macleod:  Not to you and me though.

Chris Martenson:  No, no, it is all fairly predictable, actually.

Alasdair Macleod:  Exactly.

Chris Martenson:  As we go forward, I do believe that it is my view that the next round of QE is still all but inevitable, and because this road they see it has a bifurcation, they only see two paths. I think there are other paths, but I believe they see it as either “we win this” or “it deflates and we lose this,” and so they are not going to lose if at all possible.

Alasdair Macleod:  That is right, but I also think there are very good practical reasons for QE; that is it is the way in which government borrowing is funded.

Chris Martenson:  Yes, there you go.

Alasdair Macleod:  And in an election year in America, I think it is a no-brainer, really.

Chris Martenson:  Sure, so it brings us to my favorite topic of where to invest. I have this conversation a lot, and I still don’t see any way out of gold as being a preferred, monetary-like, or money-like asset in which you can park yourself into while we watch all of this and spectate and speculate as to what’s going to happen next. It is just a safe place to hang out until we know where the risks are, who is holding them, and what the next actions are going to be. I really don’t know what else to do at this stage.

Alasdair Macleod:  I am totally in agreement with you on that one, and people who have gold or silver actually had a very rough ride over the last couple of months. A lot of them are wondering what on Earth is going on, because every time you get good news, gold seems to rally along with equities, but every time there’s bad news and gold actually should be giving you some protection, it goes down the swanny. I think the problem there is that the whole system is run by people who went to college and were taught Keynesian economics. In my day, when I first went into the stock market and I enjoyed that first bull market in gold, when it went from thirty-five bucks to eight-fifty, the traders and investment managers were all practical people. They all cut their teeth, all learned their trade the hard way. Some of them had degrees in college, but generally it would have been something like classics or history or something like that. If they got a degree in economics, they probably would have left, because they never would have understood it in those days. But now it has changed.

Everybody who is employed has a degree, and if they are anything to do with investment strategy, or the investment business, it is all economics degrees. So they have been brainwashed in the Keynesian thing. This sort of neo-classical approach where gold is yesterday’s story and paper money is the future. They really do believe it, and it is the opinions of these people who drive the markets in the short term. The result is that gold and silver have become very, very seriously mispriced. I don’t think I have seen a stretch like this as I can remember, by stretch, the difference between perhaps where it should be. We must be careful not to tell the market what the price should be, but it is so underpriced at a time of enormous systemic stress, that I think when gold and silver snap back into a more sensible, logical valuation relationship with the markets, the move actually could be very, very sharp and quite large. If gold ran up through the $2000 level very quickly, which I think is a very strong possibility, because it is been held down so much, that could bring other problems.

The central banks, who might have sold gold and not told us about it, will find that they are embarrassed. I think also the bullion banks in London who operate a fractional reserve system with gold exactly the same way as to do with any paper currency, will be hurt very, very badly on the run. Any shorts in the futures market equally could be hurt very, very badly. We have a situation, where there is a potential for a huge run in gold, and I personally wouldn’t be surprised to see it.

Chris Martenson:  I agree with you completely on that one. It is still a subject of great inquiry, discussion, and parsing, where we have a community of people trying to figure out what truly is going on, and the gold market is fairly opaque. We know there is this stuff called “leasing” because we read about it in the footnotes of the central bank balance sheets and because there is a quoted lease rate that’s really how much and who’s got it and where it is. That is very difficult information to come by, in a way, which I find I can analyze and be comfortable that I know what’s really transpired there. Of course, that discomfort extends deep into the market, to the point that the people of Germany said, you know, about all that gold we allegedly have that the Fed’s holding for us, maybe we should just bring that home.

Alasdair Macleod:  Exactly. And in fact, I don’t know if you noticed, but the Bundesbank did actually release some statistics – they released a statement as to where their gold was being held. I have been traveling recently, so I am not totally up to date on that, but I know some of it is in the Bank of England, some is at the Fed, and there’s a third bank, I think it might have been the Bank of France.

What was not clear to me is whether this is held in what they call an “earmarked account.” In other words, held at those banks segregated out as the Bundesbank’s own assets, or whether they are held in site accounts. In other words, just part of the daily mix, the stock of bullion that they hold in the basement of the Fed or the Bank of England, which they are free to use at any time they see fit. Meanwhile there is a diary note that they owe this to the Bundesbank because that’s the way they sell gold into the market without having to account for it. It is not just the leasing, it is the operation of the site accounts, and that could mean central bank ownership amongst the central banks of the advanced economies could be as little as half of what’s stated, quite easily. We don’t know because, as you say, there are absolutely no statistics released on this and the truth is deliberately concealed from us. It could be quite a serious shortfall.

Chris Martenson:  It could be, and of course, I don’t think we will find that out until the moment of crisis, and then we will find something out and we will probably see that in rapidly rising prices.

We are at the end of our time; thank you so much for your time. Very generous, again. And how can people read you on a more regular basis?

Alasdair Macleod:  I have my own site, which is financeandeconomics.org, and I do a lot of writing for GoldMoney, and that is really the Gold Money Foundation, which you can find them through goldmoney.com. That is James Turk’s; he’s chairman of that. And what we are trying to do is educate people about the importance of sound money, not just gold and silver. There’s got to be a future after all this, and if we are going to have any valuable input as to how that future is going to transpire, I think people have got to understand the virtues of sound money, so that’s what we are trying to do, educate people about that.

Chris Martenson:  It is very worthwhile work, and of course, I do believe that we are going to need that sage counsel and advice in an historical framework sooner than later.

Alasdair Macleod:  Yes, and I agree with you entirely. It has been a great pleasure for me to talk to you, as well, and we will keep watching the situation.

Chris Martenson:  Indeed, we will. Thank you so much.

Alasdair Macleod:  Not at all; my pleasure, Chris.

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8 Comments

Erik T.'s picture
Erik T.
Status: Diamond Member (Offline)
Joined: Aug 5 2008
Posts: 1232
Outstanding

I picked SUCH a good summer to spend in Spain, France, Italy and Germany...

Erik

KennethPollinger's picture
KennethPollinger
Status: Silver Member (Offline)
Joined: Sep 22 2010
Posts: 173
John Butler and The Golden Revolution

Chris.  Please try to get an interview with Butler--fascinating book and ideas.

Doug's picture
Doug
Status: Diamond Member (Offline)
Joined: Oct 1 2008
Posts: 2736
Erik T. wrote: I picked SUCH

Erik T. wrote:

I picked SUCH a good summer to spend in Spain, France, Italy and Germany...

Erik

Boy, I'll say.  You can be our embedded reporter over there.  If you find time between visits to some of the truly great places in our world, keep us posted on what the citizens, business people and insiders are saying.

Doug

timeandtide's picture
timeandtide
Status: Bronze Member (Offline)
Joined: Apr 3 2010
Posts: 53
All roads lead to gold - really?

To summarise the interview :

liquidity crisis....Greece....dodgy debts....derivatives....bailout....austerity....horror....revolt....the Germans....savings....yields....bad as America....bank runs....mismatch....recapitalise....exit plan....balance sheets....badly skewed...."poof"....very real....sensible outcome....complete destruction....legal challenge....impoverish....the politicians....sensible people....face saving....run it properly....I don't know anyone....contagion fear....must not be allowed....can't see where the exit is....problem....printing presses....compliant Fed....political desire....nub of it....easy money....serious arguments....Euro going down....joke....extremely serious....unfold....accelerate....dead cat....face up to the facts....face up to reality....chuck them out....hope for the best....instantly inflationary....worst nightmare....debt deflationary collapsing spiral....theoretical solution....no solution at all....Keynesian experiment....credit spreads....clearest indication....bear market....nasty surprises....very limited....curtains....France....taxes....black market....uncertain....spectator....rock the boat....

Did I miss anything up to this point?

From this point the commentary appears to forget everything that has been said and returns to the popular idea of themoment. The idea that gold is a refuge and a safe store of wealth. It is certainly safer than most things but fairly useless compared to a reliable source of energy. All of the preceding argument pointed towards a deflation as being the most likely outcome. This makes complete sense. It might be very painful but writing off losses and removing debt is the only way the world can move forward. It will be far worse for the bankers and asset holders than it will be for the ordinary population who will simply operate a black market like the French.

Gold is not an investment, it is a speculation. Given that it has been rising for a decade along with equities and commodities and it is far closer to its high than its low, there is a very real element of risk in this speculation. The confusion over gold lies in the fact that gold has ended the decade much higher than it started, whereas equities are only a little higher. Nevertheless, gold and stockmarkets have been quite closely following each other or to be more accurate, they, along with the commodities, have been tracking the growth of the money supply which now appears to have peaked. The willingness of bankers and politicians to play merry with other people's money will either run out of balls or they will be removed by irate populations. The game is up.

Jim H's picture
Jim H
Status: Diamond Member (Offline)
Joined: Jun 8 2009
Posts: 1464
Time and Tide...

You make some good observations.. but your conclusion is wrong;

Gold is not an investment, it is a speculation. Given that it has been rising for a decade along with equities and commodities and it is far closer to its high than its low, there is a very real element of risk in this speculation. The confusion over gold lies in the fact that gold has ended the decade much higher than it started, whereas equities are only a little higher. Nevertheless, gold and stockmarkets have been quite closely following each other or to be more accurate, they, along with the commodities, have been tracking the growth of the money supply which now appears to have peaked. The willingness of bankers and politicians to play merry with other people's money will either run out of balls or they will be removed by irate populations. The game is up.

Gold is not a speculation.. it is simply another form of money.. a form whose scarcity integrity cannot be gamed by man, no matter how hard they (bankers) try by creating paper representations, or derivatives, thereof.  It is the form of money that will survive when paper loses it's value.   

Gold's price has indeed tracked the increasing money supply.  You think this growth has peaked?  Please explain why you think that the central bankers of the world are now going to give up the battle and allow deflation to occur?  The game is not up by any means... you must be living in some kind of bubble, because most people I know still have no idea at all how fiat money works.. and they believe all the mass media propaganda that is force fed down their throats.  The only reason populations will become irate is if the bread and circuses end.  

While investing in energy independence is great... your advice for people who have savings.. to avoid Gold because it is peaking and risky.. goes against all of the truth gathering I have done since 2008.. and I can't let your words stand without challenging them.  You seem to have bought the mass media propaganda line that Gold is a risk asset.  It is not.. it is simply money that has no counterparty risk.   

Jim H's picture
Jim H
Status: Diamond Member (Offline)
Joined: Jun 8 2009
Posts: 1464
A great quote from Atlas Shrugged...

was posted today by Dave from Denver;

What do my insights on the Facebook Ponzi scheme have to do with gold?  I'll let Ayn Rand explain, through the voice of Francisco D'Anconia in "Atlas Shrugged:"

Whenever destroyers appear among men, they start by destroying money, for money is men's protection and the base of a moral existence. Destroyers seize gold and leave to its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values. Gold was an objective value, an equivalent of wealth produced. Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims.

Read the whole piece here;

http://truthingold.blogspot.com/2012/05/is-facebook-bigger-ponzi-scheme-...

Note:  I am not saying that Gold can't go down... or that it will skyrocket tomorrow.  There will come a time though, maybe as soon as QEIII comes around, where the next phase of the bull will begin.. and it will likely be violent to the upside.  Most folks who don't have a deep understanding of what is happening - if not already invested in Gold when this next phase starts, will never get in because they won't have the "balls"... thinking that Gold has moved too much.. and they have missed the move.   

timeandtide's picture
timeandtide
Status: Bronze Member (Offline)
Joined: Apr 3 2010
Posts: 53
Buying Gold is not an investment , it is a speculation

Jim, I agree with you that Gold has more intrinsic value than a greenback or any other currency note and in that sense is a more "real" money than paper. The same could be said of copper, iron, a bag of rice etc. However, its value is just as subject to variation relative to any commodity or currency just as a currency is subject to variation against another currency. I agree that a currency has more chance of going to zero value than a raw material, a precious metal or a food commodity. But purchasing any one of these is a speculation if purchased in the hope of a capital gain rather than for immediate consumption or use. One interesting point about gold is that it rose almost 7.7 times its low value from $255 (Feb 2001) but plain old iron ore rose from a price that only varied from $11-$15 between 1982-2002 to a high of $187 or more than 12 times and is still around 9 times. Gold, on the other hand, is about 6.5 times its low. A great return certainly but if you believe that gold is going up and away from here, do you also believe that the stockmarket and commodities are headed up? I may be wrong about this but it seems to me that they have all been driven by the same money creation phenomenon. Despite an extraordinary $2 trillion+ of quantitive "easing" , very little of that money has "escaped" the confines of the Federal Reserve and the major banks. It is mostly tied up on deposit. Perhaps there will be a little more QE but I can hardly see how a little more will drive gold, the stockmarket or commodities to the stratosphere. For example, the S&P500 has had 8 up years and 4 down years but is still more than 200 points below the March 2000 high. That is why gold is not doing what so many people expect it to do. My best guess is that trillions of perceived value will be wiped out over the next few years as book values and real values are brought into line. The central bankers have already failed but hope springs eternal and perhaps Mr Bernanke or Mr Draghi will have another go. I doubt it because they too are subject to the herd instinct that is driving everyone to tighten their belts, spend less and borrow less. Until that social phenomenon has run its course there is little chance of growing our way out of trouble as the bankers and politicians hope.

rhare's picture
rhare
Status: Diamond Member (Offline)
Joined: Mar 30 2009
Posts: 1267
Gold/Iron ratio - looks good compared to the dollar

timeandtide wrote:

One interesting point about gold is that it rose almost 7.7 times its low value from $255 (Feb 2001) but plain old iron ore rose from a price that only varied from $11-$15 between 1982-2002 to a high of $187 or more than 12 times and is still around 9 times. Gold, on the other hand, is about 6.5 times its low.

Too me these seem to have tracked pretty well.  Both maintain relatively close value ratios - meaning gold held it's purchasing power pretty well over the time frame you mentioned, note I eyeballed as estimate on gold for the years - looking at a year and guessing what the average was (I'm sure it's close enough for this example, for 1980 I looked at 1979-1981 to get a less spiky guess):

  Iron Gold Ratio
1980 34.5 350 10.14
1990 30.9 390 12.62
2000 25.8 275 10.66
2010 100.9 1200 11.89
2012 147.65 1600 10.84

It looks like the ratio has stayed pretty consistent of (10-12:1). I would say gold held it's purchasing power very well over that time, whereas the dollar lost about 75% of it's purchasing power.

People don't buy gold expecting to get rich, unless you think gold is substantially underpriced, then you are speculating. People buy gold to save their wealth.  While you could buy iron, oil, or other things they are bulky and difficult to store if you have significant wealth to protect.

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