Casino Royale

January 20, 2008

Let there be no misunderstanding. The "investment" markets across the globe have become like casinos and, in trying to make a buck in any of these markets, you are betting against the house. If you want commodity prices in general to rise, and the gold price in particular to rise, you can be sure that the house wants these prices to fall. If you want the price of industrial equities to fall, you can be sure that the house wants them to rise. Who will pocket the most winnings in this monstrous game of roulette?

Well, let's put it this way: If we "investors" break the bank, do we seriously believe we are just going to go back to the comfort and safety of our homes to enjoy the fruits of our winnings? Today we are playing roulette. But, for six years now, this analyst has been trying to warn that, if we carry on in this way, the game will eventually morph to become a game of Russian roulette. The flip side of a booming gold price will be a dysfunctional world economy; and there is no question now that "the markets" are expecting the gold price to boom.

The following statement was made in an Associated Press news release on January 16th 2008: "Consumer prices rose by 4.1 percent for all of 2007, up sharply from a 2.5 percent increase in 2006, the Labor Department said Wednesday. Consumers felt the pain when they filled up their gas tanks or shopped for groceries. Prices for both energy and food shot up by the largest amount since 1990."

Dear reader, if you believe the 4.1 percent number then, I guess, the tooth fairy is real for you too. From January 2007 to December 2007 the US$ Index fell, roughly, from 85 to 75. Thus, the price of an imported article - if it was priced in a foreign currency - would have risen from 100 to 113 or by 13%. Of course, the "poor" Chinese manufacturers would have absorbed some of the impact because they price in US Dollars. Their own input costs rose far faster than their Yuan rose relative to the US Dollar. It follows that they must have shared some of the US's inflationary pain, but not enough to have put a 4.1% cap on US inflation.

The chart below shows that the US Dollar fell relative to the Chinese Yuan from roughly 7.8 to 7.3 or by 6.4% (source: http://au.finance.yahoo.com/currency/convert?amt=1&from=CNY&to=USD&submit=Convert)

Now, from the perspective of the Chinese, their raw material costs skyrocketed in 2007 - as can be seen from the following Commodities Index Chart, courtesy DecisionPoint.com. It rose from roughly 380 to 460 during the year, or by 21%.

And yet, the Shanghai Index chart below (source: http://au.finance.yahoo.com/q/bc?s=000001.SS&t=1y ) rose from roughly 3,000 to 6,000

Let's just stop and think about that for a moment: Raw material cost inputs in China rose 21% and, on average, its currency strengthened by only 6.4%. The net difference, assuming commodities are priced in Dollars, was around 13.6% rise in commodity prices; and its wage costs undoubtedly also rose. And the Shanghai Index doubled?

Well, there are two extreme possibilities along a spectrum of possibilities that could explain this. Either:

  1. Chinese manufacturers absorbed no cost increases and raised prices to compensate for their own cost inflation; and they made embarrassingly large profits (thereby causing the US inflation rate to soar way beyond the stated 4.1% - which includes gasoline and food prices which undoubtedly rose by far more than 4.1%), or
  2. Chinese manufacturers absorbed all their cost increases, which implies:
    1. Chinese manufacturing profits were under serious pressure (which will undoubtedly cost Chinese equity investors an arm and a leg when reality finally hits and the Shanghai Index takes a nosedive), and/or
    2. US imported inflation rose by around a net 6.6% on Chinese goods, apart from the more than 50% increase in oil prices during the year (see chart below, courtesy stockcharts.com)

Of course, their own economy might have boomed internally, but the Chinese Consumer would have also been experiencing inflationary pain under those circumstances. They would have been pushing for wage increases which, in turn, would have put enormous upward pressure on export prices. Whichever way you look at it, the stated 4.1% inflation rate in the USA is a crock. The "pain" that the US consumer has been experiencing at the gas station can be clearly seen in this chart.

But let's not get carried away. Let's make sure we are at least on the same page: The hypothesis of this particular analyst is as follows:

If the gold price soars to the heavens, this will be a sign that 'the bank' (in this game of roulette) has been broken. Logically, if the bank does break, one implication will be that the world economy will become dysfunctional because all fiat currencies will become worthless.

Let's examine this hypothesis in context of inflation that is undoubtedly running out of control in the USA.

First: Why "all"? Why wouldn't the breaking of the bank be confined to the US Federal Reserve Bank? (Notice how easily you fell for that? The name of the organization is the Federal Reserve "System". It was never supposed to be a Central Bank.)

As an aside, the "system" is comprised of twelve regional banks. The Federal Reserve Board of Governors is supposed to have seven members, all of whom are members of the Federal Open Market Committee (which is the committee that manages the money and credit of the USA) and the other five of the FOMC's 12 members are drawn from the Presidents of the regional banks - one of whom is the president of the Federal Reserve bank of New York who has a permanent seat. There is supposed to be a 7/5 split between duly appointed Federal Reserve Board Governors and representatives of Private Enterprise (The Federal Reserve Banks are not-for-profit enterprises which are owned by Private Enterprise)

Except that, right now, the split is 50/50. There are only five sitting governors. Two seats are vacant and have been vacant since May 2007. Right now, the decision making process of the FOMC is dysfunctional - and it has been for several months. Whose interests are being served when a committee of 10 has four academics, one Investment Banker and five presidents of privately owned central banks taking decisions? (Smells to me like 6:4 in favour of the bankers interests).

Getting back to the main point at hand, to answer that particular question (why "all?"), one has to understand what happened at the Bretton Woods Conference in 1944 - arranged by the UK and the USA when the Allies were unsure of the outcome of World War II.

The 44 representatives of the Allied Nations agreed to switch from a Gold Standard to a system of fixed currency exchange rates with the US Dollar being the axle of the wheel from which all spokes radiated. The US$ was to be the currency in which payment for all international transactions would be settled and, in turn, the US$ was supposed to be backed 100% by gold. At that time, the USA owned $26 billion of the world's $33 billion inventory of gold.

That was the "bill of goods" that everyone bought. Here is the reality, in a nutshell:

  • To finance World War II reparations, the US made available (?) $17 billion. The gold backing fell to 26/(26+17) = 60%.
  • Then came the Korean war and the Vietnam war. By 1971, the gold backing had fallen to 22%.
  • Then, in 1971, came that pillar of ethical rectumtude, Richard Nixon who said, effectively, "sorry to break this to you guys, but I decided over my corn flakes this morning that the USA won't honour its debts in gold anymore".

Where did this lead to?

At end November 2007, the amount of US$ denominated "currency" in circulation, world-wide, including dollars held in reserves by all countries of the world, was around 2.4% backed by the gold that was supposedly in deep storage at Fort Knox. The reason the word "supposedly" is used is that the last time this inventory was audited was in 1959. Also at end November 2007, the gold price was $850. Coincidentally, the numbers as at November 1913 - the month before the US Federal Reserve Act was passed into law, thereby creating "the house" - the price of gold stood at around 2.2% of $850 per ounce, and money in circulation was effectively backed fully by gold.

For the record, in 1900, the total of all world currency reserves was $11.6 billion (source: http://query.nytimes.com/mem/archive-free/pdf?_r=1&res=9C01EFD6133DEE32A25757C0A9679C946097D6CF&oref=slogin). In November 2007, the total of all world currencies was $6 trillion (source:www.imf.org/external/np/sta/cofer/eng/cofer.pdf)

So, you want to know why "all" currencies will become worthless? Simple: Because the most recent available information shows world currency reserves to be comprised roughly 65% of US dollars. If the dollar becomes worthless, then 65% of the entire world's currency reserves will become worthless. Under such circumstances, what would be the basis for valuing the Euro or the Yen or the Yuan if they were to take over from the Dollar?

"Trust me"?

As a matter of pure pragmatism, we probably would land up "trusting" our governments because there would be no choice. But you and I would have to be intellectually discombobulated and neurologically short-circuited in our thought processes to believe that people will just carry on doing business in the same manner that they did right up to the point that the US Federal Reserve System "broke". Going forward, we would be facing a brand new game where the rules would not yet be understood. Caution would be the watchword. Volumes of transaction would implode. Velocity of money would implode. Economic activity would implode. The mountain of debt would implode. Confidence would be shattered. And the central bankers strategy for avoiding all this? "Print more money!" Hands up all those who think that strategy will work?

So, as a matter of pragmatism, what do we do? Will it be every man for himself? Does self-centredness really prevail over co-operative behaviour? Do you really think you will survive by your wits alone?

Over the past few years I have had debates with people who flippantly argue that "The core problem is overpopulation. All our problems will be solved by human culling. This culling will either happen naturally or artificially, but it is inevitable." Oh really? And what makes you think that you will somehow miraculously escape the culling process?

In the real world, we are all in this together. We will either close ranks and solve our problems together, or we will expire - all of us.

I will never forget the sage advice given me by my 90 year old Professor of psychology. His name was Professor Solem. "Brian, if you ever want to ask your boss for a raise, do it while you are both standing at the urinal. In that particular place, all men are equal." When all is said and done, no matter what we may think, we are, as humans, all equal in power relative to each other when pitted against the forces of Nature. Mr Rothschild and Mr Ahmadinejad and Mrs Windsor and even The Pope all need to breathe the same air and drink the same water and have access to the same energy source as you and me.

Dear reader, I have devoted over twenty years of my life trying to work out what we will do, practically, if the world economy ever became dysfunctional. The answers lie in two words, neither of which has the word "money" in it.

The two words are: "Energy" and "Reconciliation".

We have to stop behaving like Neanderthals grabbing for personal power and aggrandisement. I was born and brought up in Africa. I know for a coal-face certainty that, regardless of the size and cost of your mansion, it is inexorably reduced to weed infested rubble when society breaks down. There is only one way out of this: Humanity has to bury its differences and start working together like a unified team. We are running out of time.

How can this be achieved? Read the book, Beyond Neanderthal. It is targeted for publication at end March 2008. It took me 45 years to put the jigsaw puzzle together. It may offer a point of departure.

Brian Bloom
www.beyondneanderthal.com

Since 1987, when Brian Bloom became involved in the Venture Capital Industry, he has been constantly on the lookout for alternative energy technologies to replace fossil fuels. He has recently completed the manuscript of a novel entitled Beyond Neanderthal which he is targeting to publish by end March 2008.

The novel has been drafted on three levels: As a vehicle for communication it tells the light hearted, romantic story of four heroes in search of alternative energy technologies which can fully replace Neanderthal Fire. On that level, its storyline and language have been crafted to be understood and enjoyed by everyone with a high school education. The second level of the novel explores the intricacies of the processes involved and stimulates thinking about their development. None of the three new energy technologies which it introduces is yet on commercial radar. Gold, the element, (Au) will power one of them. On the third level, it examines why these technologies have not yet been commercialised. The answer: We've got our priorities wrong.

Beyond Neanderthal also provides a roughly quantified strategic plan to commercialise at least two of these technologies within a decade - across the planet. In context of our incorrect priorities, this cannot be achieved by Private Enterprise. Tragically, Governments will not act unless there is pressure from voters. It is therefore necessary to generate a juggernaut tidal wave of that pressure. The cost will be 'peppercorn' relative to what is being currently considered by some Governments. Together, these three technologies have the power to lift humanity to a new level of evolution. Within a decade, Carbon emissions will plummet but, as you will discover, they are an irrelevancy. Please register your interest to acquire a copy of this novel at www.beyondneanderthal.com . Please also inform all your friends and associates. The more people who read the novel, the greater will be the pressure for Governments to act.

The King James Bible mentions gold 417 times. Not once does it mention a paper currency.

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