Equities, housing, commodities and bonds viewed through the prism of what money once was…

WHAT WOULD the world look like if, as a handful of economists, investors and politicians hope, gold really was money again?

In a word, cheap…ish. Cheaper, at least, than much of it was a decade ago.

Long used (together with silver) as a means of exchange and unit of account, gold had already lost those functions by the time it ceased backing the world’s currency system in 1971. But gold retains the third function of money – as a store of value – now beating, now lagging the unbacked fiat money (i.e. created at will) which replaced it.

Since then, gold’s value has also varied more widely against other, competing stores of wealth as well as cash, amplifying the swings in its relative worth against equities, real estate, commodities and government bonds.

Perhaps you’ve seen the above chart before, for instance. Simply dividing the Dow Jones Industrial Average by the Dollar-price of gold per ounce, the Dow/Gold Ratio might sound an arbitrary yard stick. But it tracks the relative worth of US equities against an increasingly popular, if still minority store of wealth, gold bullion. Dividends are excluded, leaving just the market-price – rather than income or earnings potential – of business assets in the world’s largest economy, measured by a lump of dumb metal.

Why? Because unlike corporate equity, gold doesn’t do much. It can’t even rust, much less grow (or shrink) its return-on-capital-employed. And from the recent low (7.2 ounces per Dow unit, hit in Feb.2009), US stocks have gained 20% vs. gold. (Priced in nominal dollars, they’ve risen 73% in the last two years.) The historic low stands beneath two ounces of gold, the all-time high above forty. Today, the Dow/Gold Ratio sits just shy of nine – a little beneath its 12-decade average of ten.

Note those two lows (or rather, peaks for gold ), hit in the mid-1930s and early ’80s. Because they show up elsewhere, as well.

The average US home – a term so broad, it’s quite possibly worthless beyond the very broadest historical sweep – has averaged 202 ounces of gold over the last 120 years, at least on the data we’ve constructed from a collection of sources to cover more than a century’s worth of different housing, styles, sizes, locations and amenities.

Let’s put the methodological doubts to one side, though. Currently priced around 112 ounces, US housing hasn’t been this cheap in three decades, dropping over 75% from the 2001 high (478 ounces; the 1971 peak was 485 ounces). Returning to the very lowest prices on BullionVault’s series would see residential property lose another third. It hit 77 ounces in 1980, just above the 1934 low of 71 ounces. Whatever the national US housing stock gained in utility or comfort over that time, in short, unrusting gold priced it just as lowly amid first a deflationary and then an inflationary depression.

Commodities are a separate matter. Because they have never been cheaper in terms of gold, slumping by more than 70% since 2001, even as the much-touted “commodity super-cycle” took energy, base metal and now food prices to record highs in terms of the Dollar.

Buying commodities in the hope of growing your capital means you’re “selling human ingenuity” reckons SocGen strategist Dylan Grice, and (over the last 300-odd years) he’s got a point. Because raw materials are “generally cheaper to produce over time [as] human innovation has lowered the cost of production.” Yet ironically, Grice’s point is best made in gold, that least ingenious, least human of all pricing yard sticks. Indeed, the difference between gold-priced commodities and gold-priced stocks or housing is that raw materials failed to surge and recover their previous highs after the 1970s’ bear market. For the last six decades and more, gold has grown consistently more valuable in terms of the world economy’s natural-resource inputs.

Our chart takes the Reuters-Jefferies CRB index – a weighted basket of the 19 most heavily traded raw materials, including aluminum, crude oil, live cattle, orange juice, and gold itself – and divides it by the Dollar-price of gold. As with housing and stocks, gold’s most dramatic gains and highest valuations came during economic turmoil, outpacing the price of industrially useful natural resources even amid the severe cost-inflation of the 1970s as well as during the last four years of global financial crisis. Further back, once again, the Great Depression also saw gold’s relative worth rise sharply against raw materials, as commodity prices sank but gold was revalued higher by governments, who – then tied to its physical limits as money – were desperate to devalue currency and so reduce debt burdens in a bid to reflate the economy.

Last in our little survey of gold’s relative worth, therefore, come government bonds. There’s a problem here, because governments are constantly paying old and raising new debt, issuing bonds with a vast range of maturity dates which (unless they default) all revert in the end to par value, redeeming $100 (or £100, €100 and so forth) for every $100 originally lent by investors.

A broad price basket is hard to construct, in other words, with the various indices – such as those offered by S&P and Dow Jones – also including annual yields to give “total returns”, and only running back a few years at best.

One solution is to weigh gold’s total value against the sum total of debt outstanding – the par value of government bonds in issue. Data from the International Monetary Fund, running from 1980, at least enables us to cover the world’s “advanced” economies. And here, based on what we may as well call the “market capitalization” of gold – and in contrast to stocks, housing and industrially useful resources – government debt looks very highly priced, albeit on a mere three-decade horizon.

All the gold above-ground – swelling to some 165,000 tonnes or more today, and including central-bank reserves and that mass of jewelry used to store wealth in Asia, as well as the coins and gold bars more typically favored by Western investors – has been swamped, in terms of relative value, by advanced-economy government debt. Back in 1980, their nominal cash values were pretty much identical. Yet the doubling of gold’s Dollar-price from that year’s (then) record high, plus the two-thirds increase in above-ground gold stockpiles over the last 30 years, has still left the metal worth less than one quarter of what it was at the start of the ’80s in terms of rich-world government debt.

That debt, now 18 times larger in Dollar terms at $36 trillion, has swollen from 25% of those rich-world economies’ GDP to more than 87% of their annual output. There’s very much more of it around in 2011 than in 1980. On a relative basis – and given that the par value of debt outstanding cannot fall without default or “restructuring” – gold’s steady appreciation against equities, US housing and raw materials has barely begun to play out against government bonds.

Adrian Ash

For Money Morning Australia
Adrian Ash is head of research at www.BullionVault.com

It’s time for an apology. No, not from your editor. We’re always right, so there’s no need to apologise [wink].

Instead the apology needs to come from the Australian mainstream financial press. The same financial press that told you Australia’s banks were strong.

That Australia had the best prudential regulation in the world. That Australian banks were different to all those dirty foreign banks.

But an apology also needs to come from the banks who themselves claimed things were different here. And that Australia’s banks didn’t have the same solvency problems as US and European banks.

Why do they need to apologise? Well, two years after the global financial markets collapsed, a secret bailout of two of Australia’s biggest banks has been revealed.

This is pretty big news. Or rather, you’d think it would be pretty big news. But as you can imagine there’s almost uniform silence from the banks and the mainstream press.

Shortly after we sent you yesterday’s Money Morning we decided to do a bit of fishing around on the US Federal Reserve website. You see, earlier that morning the Fed had released some pretty hot material, and we wanted to see what it contained.

What we found shocked us. Although it really shouldn’t have, because we knew the claims about the Australian banking system being strong and robust were complete lies anyway.

In fact, so shocking is this revelation that we considered sending you a Money Morning special edition yesterday afternoon. But we didn’t. We’re fed up of giving the mainstream scoops which they then claim as their own.

Instead we thought we’d wait to see if the Australian mainstream press picked up the story first.

Surprisingly they have. But not with any enthusiasm. And hardly with what you’d call any effort. Probably because they’re a bit sheepish about the fact the banks and regulators have made fools of them. I’ll provide you with the link to the one story on it in a moment.

So excited were we to see how the mainstream had handled this story we did something we normally never do – enthusiastically open the Australian Financial Review (AFR).

The first thing we did was check the Companies Index on the back page. This was promising, the two banks in question were mentioned. We eagerly flicked through to the relevant pages… and drew a blank.

Not a single mention of it. So we started from the front and worked our way quickly through the paper… page seven… here it is… “Rescues: RBA borrowed billions from Fed” was the headline… but no, this isn’t what we’re looking for.

On we went, past the big centre-fold spread telling readers that the AFR contains, “Up-to-the-minute market information, news, commentary and expert analysis… All from just $44 per month”.

We continued… through to the end. Not peep. Not a single mention.

And the AFR is supposed to be Australia’s premium business newspaper. We wouldn’t have thought so.

About all it’s good for is lining bird cages in our opinion.

But then, we guess if the AFR exposed the banks’ duplicity it wouldn’t be able to get an interview with the likes of Commonwealth Bank of Australia [ASX: CBA] CEO Sir. Ralph Norris.

Said person is the feature item in the Boss glossy mag insert in today’s AFR.

We can’t be bothered reading it. It’s surely pap.

But anyway, what the heck are we going on about? This…

I’m talking about the near collapse of the Australian banking system in 2008. I’m talking about the likelihood of two Australian banks collapsing in 2008 if they hadn’t secured a secret loan from the US Federal Reserve.

The fact that National Australia Bank [ASX: NAB] had to borrow USD$4.5 billion from the US Federal Reserve during 2008 and 2009.

And Westpac Banking Corp [ASX: WBC] needed USD$1.09 billion in January of 2008 and 2009.

What’s that, you don’t know anything about it?

And you don’t remember reading about it?

There’s a simple reason for that. It’s been top secret information until yesterday morning.

That’s right, if it wasn’t for the passing of controversial legislation in the United States you’d never have found out about NAB and Westpac’s Federal Reserve bail outs.

And based on the lack of interest from the mainstream press – including Australia’s so-called premium business newspaper, if it wasn’t for Money Morning you’d still be none the wiser.

The one and only article we’ve found that mentions it is this one from The Age, headlined “NAB, Westpac tapped Fed”.

It appears to be an adaptation of a New York Times article based on the reference at the end, with localised bits added by Eric Johnston. But this one pathetic effort shows just how clueless the Australian mainstream press is.

Johnston makes this comment:

“The Westpac borrowings are unusual, as it barely has a North American presence, operating only a US representative office.”

Seriously, do I really need to explain it to a veteran journalist?

Talk about not being able to see the wood for the trees. Talk about not getting it.

Here’s a clue for Mr. Johnston, it wasn’t Westpac’s US office that needed the dosh, it was Westpac in Australia that needed it. It shows you that without the direct financial support of the US Federal Reserve Westpac and NAB would have been toast.

Westpac and NAB needed the loans because they were on the verge of going belly up. It’s that simple. If they hadn’t gotten secret loans from the US Fed they would undoubtedly have needed secret loans from the RBA.

Fortunately for the RBA, the Fed opened the door and this allowed Aussie central bankers and bankers to claim that the Aussie banks hadn’t received a bailout.

But not only that, what’s most extraordinary is that Westpac was one of the first institutions to borrow money from the Fed when the lending facility became available!

But more about that in a moment. Let me give you some of the background first…

You may have read about something called the Dodd-Frank Act. The full name is the Wall Street Reform and Consumer Protection Act. It’s called Dodd-Frank after the bill’s sponsors, US Senator Chris Dodd, and Representative Barney Frank.

The legislation mandates a number of things, but part of it is the requirement for the US Federal Reserve to reveal which institutions it loaned money to under the various bail out programmes.

One of those programmes was titled the Term Auction Facility (TAF). According to the Fed’s website:

“Under the program, the Federal Reserve auctioned 28-day loans, and, beginning in August 2008, 84-day loans, to depository institutions in generally sound financial condition…

“…Of those institutions, primary credit, and thus also the TAF, is available only to institutions that are financially sound.”

OK, so only “financially sound” institutions were eligible for TAF loans. That would be financially sound institutions such as LloydsTSB plc which got a USD$10.5 billion loan from the Fed and which later had to be partially nationalised by the UK government.

It would also include ABN Amro Bank which grabbed USD$1.5 billion of loans from the Fed, and which would later cause such a financial strain on Royal Bank of Scotland (RBS) after RBS bought it that the UK government had to partially nationalise it too.

Not to mention the USD$53.5 billion of loans RBS needed directly.

Then there was Allied Irish Bank, who could forget it? The Irish certainly won’t.

Between February 2009 and February 2010 Allied Irish Bank needed USD$34.7 billion of loans from the Fed. Allied Irish Bank also had all its obligations guaranteed by the Irish taxpayer and is the primary reason why Ireland now requires an International Monetary Fund and European Union bailout to the tune of $113 billion.

And what about Bayerische Landesbank which needed a USD$13.4 billion bailout from the state of Bavaria? Well, apparently it was financially sound enough to borrow USD$108.19 billion between December 2007 and October 2009.

So, we can take with a grain of salt the Fed’s claim that only “financially sound” institutions had access to the TAF programme. Financially unsound and insolvent banks were given loans too.

And in the middle of all that wheeling and dealing, when a total of nearly USD$4 trillion was loaned to and repaid by “financially sound” institutions, Australia’s very own National Australia Bank and Westpac were in on the action too.

Although it was only a relatively small amount compared to some of the other transactions, it was still USD$4.5 billion and USD$1.09 billion respectively. But it was still a lot more than the USD$1.5 billion needed by financially unsound ABN Amro.

Also don’t forget that the NAB went to the Australian stock market in late 2008 to raise $3 billion. That was a sum it needed to bolster its capital.

If $3 billion was a significant and important number for the market to know about then surely USD$4.5 billion (about AUD$7 billion at the time) was even more crucial for the market to be aware of.

But there wasn’t a peep from them.

Because as I say, you didn’t know anything about the NAB’s and Westpac’s Fed loans. It was all top secret.

And it’s obvious that $3 billion capital raising still wasn’t enough because NAB had to go begging to the Fed twice after that for $1.5 billion a time.

But as I say, you didn’t hear a word about this at the time. It was all top secret. But that didn’t stop the bankers and regulators and politicians from posturing about the stability and strength of Australian banks.

In January 2008 Westpac denied there was a problem with its US exposure. That’s despite the fact just one month before, on December 20th 2007 Westpac had gotten a USD$90 million loan from the Federal Reserve under the TAF programme.

Not only did it get the loan, but it was one of the first in the queue! As you can see from the screenshot below (click to enlarge):

Source: US Federal Reserve

You can check out the full details here by downloading the spreadsheet.

You’ll note that Westpac applied for the loan on the same day as Citibank (bailed out by US government), Lloyds TSB Bank (bailed out by UK government), Bayerische Landesbank (bailed out by Bavarian government), and Societe Generale (which was bailed out by the US government courtesy of the AIG bailout against which SocGen had a massive CDS exposure).

In other words, we’re talking about a rag-tag bag of insolvent banks. And our own insolvent bank – Westpac – was amongst the thick of it, begging for an emergency loan from the US Federal Reserve as soon as the doors were opened.

It’s something you’d think would be of interest to shareholders don’t you? But there wasn’t a word from them.

And it must now make the Reserve Bank of Australia (RBA) feel foolish, considering in September 2008, just before NAB sought the Fed’s help, the RBA wrote:

“The Australian financial system has coped better with the recent turmoil than many other financial systems. The banking system is soundly capitalised, it has only limited exposure to sub-prime related assets, and it continues to record strong profitability and has low levels or problem loans. The large Australian banks all have high credit ratings and they have been able to continue to tap both domestic and offshore capital markets on a regular basis.”

Tapping “offshore capital markets” obviously included the US Fed.

So we wonder, how much did the Reserve Bank of Australia know about this? While it was talking up the strength of the Australian banking system did it know that two of the four Australian banking pillars were desperately seeking loans from the US Fed?

Or, like you, was the RBA in the dark? And what about the Australian Prudential Regulation Authority (APRA)? We’ve been told they’ve done all manner of stress tests and the banks passed with flying colours.

How can that be possible if Westpac and NAB need emergency loans from the US Fed? Was this included in the stress tests?

Anyway, we’d like to know. So we’ve fired off emails to the RBA, APRA and the Australian Securities Exchange (ASX) asking them these simple questions.

• When did the RBA/APRA/ASX become aware of Westpac and NAB’s loans under the TAF programme?
• If RBA/APRA/ASX were not aware of the loans under the TAF programme please explain why.
• If RBA/APRA/ASX were aware of the loans please explain why this wasn’t considered to be important enough to inform the market?

We’ll let you know if or when we get a reply.

But it wasn’t just Westpac that kept quiet about it.

NAB chairman Michael Chaney must surely have realised what he was saying when he made the following comment at the December 2008 annual general meeting:

“Our traditional banking and wealth management operations are all profitable, strongly capitalised and conservatively funded. In addition, our banking businesses have sound asset quality and are well provisioned.”

So sound was the asset quality that just six weeks earlier NAB’s New York branch had to arrange a USD$1.5 billion loan at an interest rate of 0.6% with the US Federal Reserve.

All under a shroud of secrecy.

All under the belief that no-one would ever find out about it because no-one could find out about it. The Fed at that time was under no obligation to reveal which banks were taking short term loans from the Fed…

Until the Dodd-Frank Act was passed.

Look, we’ll say we told you so. We’ve claimed all along that Australia’s banking system is no different to any other. It’s inherently insolvent – as are all modern day banks.

Along the way we’ve been called a “lunatic” and a “nutter” for writing what we believed to be true. And would you believe it, once the secrecy of corrupt governments and bankers is revealed this “lunatic” and “nutter” has been proven correct.

But I understand it may not seem like that at the time. Yesterday we received this email from a Money Morning reader:

“Hello Kris

“I don’t normally send comments to publications nor do I sit there and read others comments, however, yesterday I came across a sticker on a car bumper. When I read it, I immediately thought of you and I think you will like it too.

“‘Do not steal. The government does not like competition.’

“I enjoy reading your daily newsletter. Even though some of your theories sound crazy at the beginning, it’s funny how they do in the end sound believable. We do live in a world where some people do not put other peoples’ interest first.

“Lisa”

It’s true. Government is above the law. It can legally steal private property – it’s called taxation. Nice trick huh!

But Lisa hits the nail on the head. What you read here may sound crazy, but it only sounds crazy because it’s outside the norm. It’s different to what you read anywhere else.

And that’s simply because we don’t have to worry about what our advertisers think – because we only advertise our own services. And we don’t have to worry about turning readers off with our seemingly radical ideas, because most of our readers come here because of those radical ideas.

My guess is you’re fed up with being told the same rubbish day-in and day-out by the mainstream press. A mainstream press that reports from press releases, and trusts whatever it is the guys in government or on Wall Street say.

In contrast we’ve learned to doubt everything they say.

We take the view that anything a mainstream economist or analyst says is wrong. It’s up to them to convince us they’re right. Very few of them succeed because ultimately… I hope this doesn’t sound arrogant, they are wrong.

The state of Australia’s banks is a perfect example. For the past two years you’ve had to put up with a constant drone of commentary from the mainstream telling you that Australia is different.

As I say, this bombshell from the Federal Reserve proves otherwise. And it proves we’ve been right to call the Aussie banks for what they are.

Maybe our claim about NAB’s system shutdown last week being caused by a solvency problem rather than a computer glitch still seems crazy to you. But we wonder, after reading today’s Money Morning, perhaps it now sounds just slightly less crazy than you first thought…

And furthermore, it must surely make you wonder what else it is the government and central bankers are keeping secret. Most of which will probably never be revealed.

All you and I can do is use our scepticism and questioning brain to figure out what’s really happening. Because more often than not, the story the mainstream peddles is as far from the truth as you can get.

Yesterday’s revelation from the US Federal Reserve about NAB’s and Westpac’s secret loans is a perfect example. We look forward to getting a reply from the RBA, ASX and APRA about how much they knew and when…

But we won’t hold our breath.

Cheers.

Kris Sayce
For Money Morning Australia

Some may say that Bambi’s mother dying is the saddest thing they’ve ever seen.

Others think that Travis shooting Old Yeller in the book and film of the same name is much sadder.

While the girls of the Sayce family think the movie Hachi: A Dog’s Story, starring Richard Gere is the most sadderest thing ever in the history of sadness.

But that’s not the sort of thing that makes your editor sad.

The kind of news that saddens your editor is stories such as this from 2006:

“Buffett donates $37 billion to charity”

Not that he seems to have actually donated it yet. According to the 2006 report, “Mr Buffett will hand 10 million shares in his Berkshire Hathaway firm to the Bill and Melinda Gates Foundation.”

Or maybe he has, we don’t know. But according to the Forbes list of billionaires, Mr Buffett still ranks in third place with a fortune of USD$47 billion, behind Carlos Slim and Bill Gates, both with USD$53 billion.

More recently this headline caused us to sigh in despair:

“40 billionaires sign up to Bill Gates and Warren Buffett’s charity drive”

Apparently “Forty of the world’s wealthiest entrepreneurs – including Oracle founder Larry Ellison and Star Wars creator George Lucas – have signed the ‘Giving Pledge’ charity initiative launched by Warren Buffett and Bill Gates, whereby billionaires agree to donate huge chunks of their fortunes to charity.”

The article goes on:

“Buffett and Gates, who have pledged to give away at least 50% of their fortunes, will now take their initiative to Asia, where they will try to convince billionaires in India and China to follow their lead.”

Which leads us to the next article from The Hindu:

“Bill Gates and Warren Buffett will next year approach a group of India’s richest to enlist their support for and views on setting up fund-raising initiatives in India, the billionaire duo said this week, after organising a first-of-its-kind charity dinner for China’s billionaires.”

Why are we claiming this is sad? Why does your editor disapprove of such wonderfully generous giving of wealth?

The simple reason is this. Warren Buffett and Bill Gates – like them or envy them – became two of the world’s richest men for a number of reasons.

Chief among them was their drive to succeed. It was their ambition to be the best at what they’re good at. For Buffett it was his ability to pick out good companies from the bad.

And for Gates it was his ability to recognise the huge potential in home-based personal computing and the riches that could be made from developing software to support it.

One thing is for sure, they didn’t become rich due to receiving charitable donations from wealthy benefactors.

What they did receive was something much more important. And much more useful, which I’ll get to in a moment…

We don’t know much about the Gates life story, but based on what we’ve read about Buffett, sure it seems as though he got a few leg ups along the way, but it was his ambition and his ability to prove to others that he had a magic touch with investing that got him where he is today.

But, their personal wealth is only a tiny part of the story. The bigger story is the impact their entrepreneurial activities have had on others.

Take Bill Gates and Microsoft. Microsoft started out as a tiny software company with just a handful of employees in the late 1970s. I’m sure you’ve seen the Microsoft staff photo from the early days with a geeky-looking Bill Gates.

But since then, with a combination of good fortune and a lot of business sense Microsoft grew to become one of the world’s largest companies. Over that time it has directly employed millions of people in tens of countries.

And indirectly millions of more people have been employed in the technology industry thanks to the influence of Microsoft and other technology companies.

But importantly, Microsoft has enabled the growth of new technologies and new businesses as it has been made easy and affordable to bring new computer-age technology to the home.

Computing was transformed from the age of mainframes and reel-to-reel tape, into personal computers thanks to business acumen and the pursuit of profits for the company and the selfish pursuit of wealth by Gates and the other Microsoft cohorts.

But the business acumen and selfish pursuit of wealth wouldn’t have been possible if it wasn’t for one crucial ingredient… capital.

Without capital – either yours or someone else’s – investing is impossible.

Look, today almost every home has a computer. And there would barely be a business that doesn’t use one for some purpose. Even the humble milk bar uses computers to manage inventory and do the books.

Even billionaire Buffett needed capital to get started. He convinced friends, family and strangers that he knew a good business when he saw one. So, they gave him money. But not as a charitable donation.

They gave him money because they believed Buffett would eventually give them back their capital plus more – profits. Even perhaps super profits to use the Fairy Ruddfather’s lingo.

Buffett believed he knew the secrets of identifying value in companies. His investments and his influence over the companies he invested in has created billions of dollars in wealth.

Companies became more profitable, employed more people, and shareholders in Berkshire Hathaway saw the price of their shares soar from USD$60 or so per share in the 1960s to over USD$123,000 per share today!

But now Gates and Buffett have convinced themselves that entrepreneurialism isn’t the best way to spread wealth and well-being.

It seems their egos have gotten the better of them.

You’d think that with their firsthand experience of building companies from the ground floor upwards that they’d understand the importance of capital, investment and the drive to succeed.

But no, they’ve fallen into the trap that central banks have fallen into, and that is, it’s better to just give money to people rather than letting them work for it.

I know that may seem cold hearted. But the facts speak for themselves.

Charitable organisations have been trying to save the poor in the third world for decades, and what have they achieved? A bit, perhaps. But not much if we’re honest.

Maybe someone else knows the numbers better than we do. But in a head-to-head contest we’ll bet our bottom dollar that Microsoft, Nike and Coca-Cola have created more jobs and lifted more people out of poverty in Africa and Asia than Oxfam or World Vision combined.

The simple fact is that capitalism and the selfish desire for profits and wealth by rich individuals, ordinary investors and corporations brings more wealth to more people than charitable giving.

What’s keeping poor people poor isn’t that they can’t get food or water, it’s that they don’t have access to the most important thing needed to create wealth – and that’s access to capital.

It’s no different to Western civilisation. Without access to capital we’d all still be crawling around in the mud begging for scraps from a noble Lord of the manor.

Think about it this way. You often hear the trade unions moaning about greedy bosses. And how without the workers’ labour the bosses wouldn’t be able to make the whacking great profits they make.

That’s partially true. Not entirely, but partially. After all, if the trade unions price their workers out of the market, the bosses may look towards more automation.

But again that’s not necessarily a bad thing. If a machine can perform the work more efficiently than a human, then that simply enables other industries to gain access to an increased labour force, which can see wages fall, production costs fall, prices fall, and employment increase.

Not that central banks would want that to happen, because that’s deflation. They’d rather have higher prices and higher unemployment. And there’s nothing wrong with falling wages providing production costs and consumer prices fall too.

But anyway, back to the point, you never hear the unions mention the fact that without the capital from the capitalists their members couldn’t be employed. I mean, if it was just all about the workers being exploited, what’s stopping the workers from resigning en masse and setting up their own collective business?

I’ll tell you what’s stopping them and that’s the lack of capital. But even if they did happen to have the capital to start a rival business then guess what, that would make them capitalists too!

Yet the likes of Gates and Buffett seem to have forgotten about that. They amazingly seem to have forgotten what it was that brought them untold wealth – capital. They’ve forgotten what it was that brought wealth to their shareholders and their employees – capital.

Instead Gates and Buffett seem to believe that the way to solve poverty and create wealth in the third world needs a different approach. Rather than providing the third world with what they really need to lift them out of poverty – capital – they seem to think what is needed is to spend nearly USD$14 billion on health programmes since 1994.

Which again doesn’t seem to have helped much. According to our pals at Wikipedia:

“Since then [the 1970s], African famines have become more frequent, more widespread and more severe. Many African countries are not self-sufficient in food production, relying on income from cash crops to import food. Agriculture in Africa is susceptible to climactic fluctuations, especially droughts which can reduce the amount of food produced locally.”

Many countries aren’t self-sufficient for food, not just African nations. But most nations have the ability to trade for food. If they can’t grow crops then they rely on their comparative advantage to produce something else – shoes or pillows, perhaps – which they then export. This gives them the means to import goods they can’t produce, say wheat or corn.

The trouble is, if you don’t have access to capital then you can’t produce goods or services to be exported. And if you can’t export goods then the country isn’t producing an income. And if it’s not producing an income then it can’t afford to feed itself.

And if it can’t afford to feed itself then it starves or relies on charitable donations.

While many view Gates and Buffetts as a wonderful example of corporate and individual philanthropy, we see it differently. Sure, advances in healthcare is wonderful, but are the health needs of developing nations really that so much different from those in the West?

Again, perhaps to some degree. But largely they’re the same.

Rather than getting billionaires to hand over millions of dollars and then spending it on health projects, Gates and Buffett would achieve much more if they were able to convince those same billionaires to set up factories in those countries and employ people.

That way the economy can produce goods and provide services to meet the needs of locals and to meet the needs of international markets. The natural consequence would result in an inflow of investment capital into those countries and an increase in individuals’ wealth.

This would provide the capital for more investment, more businesses, more jobs, more wealth and… an increase in the standard of living.

Instead, Gates has jumped on the Global Warming bandwagon to argue that the third world needs to reduce its carbon emissions. (Thanks to Money Morning blogger ‘earlwag’ for posting this video of Gates warning about the dangers of CO2).

Gates is obviously a very bright and smart guy. But clearly he’s got just as much (ie. none) clue about global warming as your editor.

According to Gates’ comments in the video:

“My full-time work at the Foundation is mostly about vaccines and seeds, about the things we need to invent and deliver to help the poorest two billion live better lives. But energy and climate are extremely important to these people. In fact, more important than to anyone else on the planet.”

Poor countries don’t want things invented for them. They want that magic word – capital.

While vaccines and seeds may indeed provide benefits to the poorest two billion, improvements in these areas are only achievable and sustainable if these people are able to live in comfortable surroundings.

You can have as many vaccines and seeds as you like, but if you’re still living in a ditch because you can’t afford a proper home, because you can’t get a job, because they are no firms to employ you, because there is no access to capital… well, the vaccines and seeds are only going to have a limited impact.

As I say, what’s more important to the well-being of any nation is the support and encouragement of entrepreneurial activity to achieve wealth. And for that it’s the access to capital that is the most important ingredient.

Without capital nothing happens.

Yet sadly, Bill Gates, Warren Buffett and the forty billionaires have convinced themselves that cutting carbon emissions and spending money on vaccines and seeds will cure poverty. It won’t, in fact, the odds are it’ll just make it worse.

It’s for that reason that I dislike the fad of billionaires throwing money at charities in order to boost their own egos.

Cheers.
Kris Sayce
For Money Morning Australia

The huge moves in the market at the moment are sending a big warning signal to those who are willing to listen.

The threat of a new round of quantitative easing (QEII) by Federal Reserve chairman Ben Bernanke has set off a chain reaction in world markets that can only end in tears.  Emerging market economies are being placed under extreme pressure as their currencies appreciate under the weight of hot money looking for a home.

Thailand announced on Tuesday that it will impose a 15% withholding tax on interest and capital gains made by foreign investors on Thai bonds.  Export dependent economies like China, Brazil and Japan have been trying to fight back huge flows of capital chasing yield.  Brazil last week raised a tax on foreign portfolio inflows into bonds.

Korea has been rumoured to be intervening repeatedly in the currency markets and in the Philippines, government officials are saying that the rise of the peso is a matter of concern.

Australia has even had to react to the flow of money by delaying the raising of interest rates to keep the interest rate differentials between Australia and the USA to a minimum.

Global imbalances are increasing in response to the ridiculous attempts by Bernanke to reflate the system.  All he is managing to do by threatening QEII is to force investors to search for a safe haven for their money while Bernanke tries to trash the currency.

Hard assets are of course the desired destination and the huge spike in the Australian Dollar and rally in commodity markets are seeing this race accelerate.

Bernanke’s desire is to stoke lending in America and inspire investment and job growth. I assure you that printing money is going to do no such thing.

Long term interest rates in America are at generational lows already and banks are unwilling to lend and consumers and businesses are unwilling to borrow.  Lowering the 10 year bond by another half a percentage point is not going to miraculously change this situation.

Instead of inspiring more lending at home it is going to inspire capital flight out of America and into high yielding currencies as is happening right now.

What will be the outcome of commodities going through the roof?

Input costs for businesses are going to go up and disposable income for consumers is going to go down.  There is a lack of demand anyway so why would a business invest to increase production when his input costs are going up and he has no pricing power because the end demand is so weak.

Why would a consumer go out and spend when he is paying far more at the petrol pump every week because the price of oil is going through the roof?

Greenspan created the Technology bubble and the housing bubble by keeping interest rates artificially low.  At least these bubbles made people feel rich.  Bernanke is going to create a commodity bubble.  A commodity bubble will make the resource companies feel rich, but it will impoverish everyone else.  This is not the sort of bubble that Bernanke wants to create.

Who knows when this house of cards is going to come tumbling down but many are starting to talk about QEII as the largest buy the rumour/ sell the fact trade that we have seen in years.

My own view is that we are not going to make it to early November and the announcement of QEII before the markets turn and dive.

Do you think that the rest of the world is happy to allow the Fed to ruin their economies with their policies?  Do you think Ben is sitting back in his office scratching his beard and wondering what on earth he has done.

I believe the Fed is finally arrived at catch 22.  It is damned if it does and damned if it doesn’t.

The best course of action it can take is to step back from QEII and allow the markets to deflate to where they will end up going anyway.  But we all know this is not going to happen.  Instead we are going to see cracks slowly appearing all over the world and one of those cracks is going to blow wide open and take everyone else down with it.

Will it be Japan with their 200% debt to GDP ratio (caused by years of following the same inane policies that the Fed is about to embark on) or perhaps the PIIGS will start to squeal as the Euro continues to appreciate and their economies fall in a heap.  European banks could be brought to their knees by such an outcome as they are so heavily exposed to sovereign bonds of Portugal, Ireland, Italy, Greece and Spain.

There is no doubt we are in the middle of a currency war and I fear that the end result will be the end of Bretton Woods II.

Gold is flying high because the world is finally waking up to the fact that America printing money and monetising its debt is the beginning of the end.  Physical demand for gold is going through the roof as the rich hedge their bets by buying a lazy tonne of gold at a time.

Are we going to see the crash of the Dollar that was always going to be the end game for the US.  Does China stand up to America and threaten to sell their US investments if the Fed doesn’t back off from QEII.

There are so many places where the volcano can erupt.  The smoke is billowing out and telling those who will listen to pack up shop and catch the first boat off the island.  Most are standing around and saying how pretty the volcano looks while stock prices shoot all over the place and investors convince themselves that there is some easy money to be made before the music stops.

There is an old market saying that is one of my favourites and I think it sums up the current situation perfectly.  The market is currently “picking up pennies in front of steamrollers”.

It seems easy to do because the steamrollers are moving so slowly and there are lots of pennies about.  But don’t get distracted because one day the steamroller is going to roll right over the top of you!

Regards,
Murray Dawes

Editor, Slipstream Trader

According to CEBS, the banks are only mildly tense, rather than stressed.

You’ve probably read, or at least skimmed over the details of the results already.

The upshot is that as today’s Australian Financial Review reports, “Just seven relatively minor unlisted banks of the 91 subjected to stress tests failed to pass.”

It also reports that, “regulators decided the banks needed to raise an additional €3.5 billion of capital.”

Phew! Everything must be fine then.

That’s a piddly amount. Especially so when you consider these so-called strong European banks have already raised €220 billion over the last 18 months.

As the AFR points out, “much of it from governments.”

Of course what the AFR really means is, “much of it from taxpayers.”

You can view the summary of each banks’ results under what CEBS calls the benchmark and adverse testing scenarios by clicking here.

And just in case you’re wondering what those scenarios are, here’s a link to the document that spells it out. Skip to page 3 if you’re just interested in knowing what the scenarios were. If not, enjoy the full 55 pages.

In a nutshell, the benchmark scenario is based on there being a mild economic recovery, whereas the adverse scenario is based on the much-feared double-dip recession.

But, the most interesting part of the report was perhaps footnote 19 on page 47:

“Since no sovereign defaults are considered in the exercise, there is no impact on holdings of sovereign bonds which are held to maturity in the banking book.”

Considering how close Greece came to defaulting, you’d have to be pretty confident that a sovereign default in the European Union isn’t going to happen.

And they’re probably right. As we pointed out on Friday, it’s much more likely that the Europeans will continue to take the cowards’ way out by bailing out economies and inflating their way out of one problem and into another.

Not only that, but under the adverse scenario Greek debt would receive a “haircut” of 42.2%, and Portugal 26.6%. In other words, the value of those country’s bonds would be revalued significantly less should the adverse scenario play out.

The full list is on page 52 of the link I’ve provided above.

But yet again the stress test doesn’t stress because the report notes, “these haircuts were not used in the stress test exercise and are presented only for the sake of comparison.”

Which has the effect of making the stress tests pointless.

Furthermore, we have to wonder what’s the point of testing the banks against an adverse scenario if everyone knows the European Central Bank (ECB) and European governments will just bail the banks out anyway?

And what’s the point of a stress test if you’re not going to stress it out?

You see, it just goes to show you how worthless money is, which I’ll come to in a moment.

But just one more quick note. Money Morning reader Jack has brought our attention to some interesting details of who’s holding US treasuries.

According to the latest report from the US Treasury, holders in the UK increased their holdings of US treasuries from just USD$90.8 billion in June 2009 to USD$350 billion as of May 2010.

That’s the single largest increase by holders in any particular country.

Out of interest, Australians sensibly only hold USD$14.1 billion worth.

Over the same time as the UK has more than tripled its holdings, the Chinese – who are still the biggest holders – have gradually reduced their exposure.

In other words, the Chinese are selling and the Brits are buying.

What could it all mean? We’re not sure. There are claims by one blogger that it’s simply the US government monetising its debt through offshore holdings.

Could that be right? We don’t know.

Or, could it have anything to do with the European banking stress tests? It’s possible we suppose. In anticipation of the stress testing have Europe’s banks dumped their dodgier sovereign debt holdings onto the central banks and then used the bailout money to invest in what’s deemed to be a safer asset – US treasuries.

That would make sense if it’s the case. And it could explain the massive increase over the past few months. We’ll see when the next quarterly report is released in August whether UK holdings of US treasuries have increased further.

But bringing the subject back to the points we raised last Thursday and Friday, it’s clear that the ECB will just print as much money as it needs to get the European banking system out of a hole.

After all, what’s another 3.5 billion compared to the 220 billion they’ve already put their taxpayers on the hook for?

It’s what makes the following two news stories that caught our eye over the weekend even more interesting. The best way to summarise them is that one article is about a store of value, while the other is about a store of rubbish…

A few months ago a treasure hunter in the UK county of Somerset unearthed 52,500 Roman coins. According to the report from the BBC, most of them are “made from debased silver or bronze.”

He found them on a farmer’s land while waving his metal detector around. We’re sure one or two locals have laughed at the man over the years as he’s unearthed treasures such as old bicycle frames and thirty year old empty baked bean cans.

But now he could be about to receive up to GBP1 million for the loot.

That’s not bad for 52,500 coins that are reckoned to be around 1,700 years old! That would give each coin a value of around GBP19 each.

Now take a look at this second report that we came across over the weekend. Here’s the headline as reported by News Ltd: “Old Romanian banknotes turned into bins.”

The report states, “The [Romanian] Central Bank processes roughly 4.5 million banknotes daily, of which 1.2 per cent are deteriorated and must be withdrawn from circulation.”

Ah, the coincidences. Roman versus Romanian. 52,500 coins, versus 1.2% of 4.5 million – which coincidentally is 54,000 bank notes.

If there was ever an illustration to show how valuable a hard and sound money system is compared to the worthlessness of a paper-based fiat currency system then this is it.

I mean, look at the comparison. 52,500 coins that are 1,700 years old are more valuable then paper bank notes that were probably produced no more than ten years ago.

You see, here’s the difference. The Roman coins are valuable in two ways. First of all there’s the intrinsic value. By that I mean, the actual value of the metal that the coins are made from.

And secondly there is the numismatic value, ie. The value that a collector places on the coins over the intrinsic value. Depending on how valuable these coins may be to a collector or a museum will obviously have an impact on the price.

The point is, after 1,700 years the collection of Roman coins still has real value.

Whereas the collection of paper Romanian bank notes are worthless. They contain nothing of any value. Not even as a collectable. The only worthwhile use for these notes is apparently to recycle them into things like rubbish bins!

Look, obviously if these coins were gold coins they would be even more valuable.

Although as we understand it, by the time of the fourth century the Romans were already well down the path of monetary inflation. Gradually reducing the precious metal content of coins and making them smaller while trying to retain the same face value.

Which is no different to how the modern money system works.

Except rather than changing the content of the paper notes, all the central bank has to do is just print more of them. The effect is the same, a devalued currency.

That’s why we’re in favour of a genuine money system that’s backed by gold or other precious metals. After 1,700 years, even the debased coins are still around and still have value, whereas in 1,700 years not a single paper note from today will be in existence.

The Europeans have supposedly put their banks through a rigorous test to assess their ability to withstand another financial shock.

The reality is that they’ve done no such thing. All they’ve done is provide concrete evidence of how they will save the bacon of them and their banking pals while simultaneously using the evils of inflation to destroy the wealth of its citizens.

Despite the high price it’s still clear that buying gold should be the top of everyone’s ‘To-Do’ list.

Cheers.
Kris Sayce
For Money Morning Australia