The World Won't Flock to Paper

.August 18, 2010

On July 28th, NIA released an article entitled, "Gold and Silver Capitulation is Near". In this article NIA said, "The sentiment on gold and silver has abruptly changed to the negative like nothing we have ever seen before and to us this means the big move to the upside is right around the corner." It turns out that July 28th was the exact bottom for gold and silver prices. Since then, gold prices have risen 12 out of 15 days for a gain of 5.8% and silver prices have risen 11 out of 15 days for a gain of 5.2%.

It was just announced that China cut their long-term U.S. treasury holdings by $21.2 billion in June to $839.7 billion, their largest cut in U.S. treasury holdings in history. China's holdings of U.S. debt are now at their lowest level in a year. Meanwhile, China has more than doubled their holdings of South Korean debt. It speaks volumes that things have gotten so bad in the U.S. that China sees the need to diversify out of U.S. debt to buy the debt of a third-world nation.

China just surpassed Japan as the second biggest economy in the world and is now stepping up its efforts to internationalize the yuan by allowing foreign financial institutions to participate in their interbank bond market. This is being done as the Federal Reserve begins to once again monetize our debt with the purchasing of $2.551 billion in U.S. treasuries. At this time last year, mainstream economists thought that the Federal Reserve would be exiting its low interest rate policy by now. The truth is, it will be impossible for the Federal Reserve to ever raise interest rates to a level that is higher than the real rate of price inflation.

It is unbelievable to us that most mainstream economists believe that deflation is the biggest threat facing the U.S. economy. In order to believe that U.S. deflation is possible, you need to believe that the U.S. government will default on its national debt and Social Security obligations and that the U.S. dollar will rally in the process. In our opinion, there is zero chance of the U.S. government formally defaulting on its debts and Social Security obligations when it has a printing press. But for conversation's sake let's say the U.S. outright defaults and refuses to pay its debt. Why on earth would the U.S. dollar rally in the process? Why do deflationists believe the world will flock to the safety of paper? Look outside, unless you live in a desert, you will see plenty of trees.

During the Great Depression, the U.S. experienced deflation because the U.S. dollar was backed by gold. As the rest of the world defaulted on their debts, they flocked to the dollar as a safe haven because the dollar was gold, not paper. The deflationists like to point to the financial crisis of 2008 when the U.S. dollar rallied as asset prices collapsed, as an indication that the world believes paper is a safer asset than gold. Clearly in 2008, the markets acted irrationally. There is very little chance of the markets acting irrationally in this same way again, especially when the financial crisis of 2008 is still fresh in investors' minds and most people on Wall Street mistakenly believe the dollar will rally.

The markets usually act in the exact opposite of the way most people think. Just like we knew gold and silver were at or near a bottom on July 28th because everybody had become negative, we know that precious metals will be the safe haven during the upcoming fiscal crisis, because most people today feel that U.S. treasuries are the safest asset. The U.S. is currently experiencing the greatest bubble in world history, the U.S. bond/dollar bubble. When this bubble bursts, real unemployment will rise back to Great Depression levels of 35% because our nation's number one employer, the U.S. government, will no longer have the resources to pay its employees.