Friday, August 31, 2007

What Bank of England?

Further to yesterday's piece on the licence to the European Central Bank to seize the Bank of England's assets, here are two relevant articles from the Maastricht Treaty. The Campaign for an Independent Britain was stating no more than the truth. (In the extracts, red highlighting is mine.)

ARTICLE 30

Transfer of foreign reserve assets to the ECB

30.1. Without prejudice to Article 28, the ECB shall be provided by the national central banks with foreign reserve assets, other than Member States’ currencies, ECUs, IMF reserve positions and SDRs, up to an amount equivalent to ECU 50,000 million. The Governing Council shall decide upon the proportion to be called up by the ECB
following its establishment and the amounts called up at later dates. The ECB shall have the full right to hold and manage the foreign reserves that are transferred to it and to use them for the purposes set out in this Statute.


30.2. The contributions of each national central bank shall be fixed in proportion to its share in the subscribed capital of the ECB.

30.3. Each national central bank shall be credited by the ECB with a claim equivalent to its contribution. The Governing Council shall determine the denomination and remuneration of such claims.

30.4. Further calls of foreign reserve assets beyond the limit set in Article 30.1 may be effected by the ECB, in accordance with Article 30.2, within the limits and under the conditions set by the Council in accordance with the procedure laid down in Article 42.

30.5. The ECB may hold and manage IMF reserve positions and SDRs and provide for the pooling of such assets.

30.6. The Governing Council shall take all other measures necessary for the application of this Article.


ARTICLE 42

Complementary legislation

In accordance with Article 106(6) of this Treaty, immediately after the decision on the date for the beginning of the third stage, the Council, acting by a qualified majority either on a proposal from the Commission and after consulting the European Parliament and the ECB or on a recommendation from the ECB and after consulting the European Parliament and the Commission, shall adopt the provisions referred to in Articles 4, 5.4, 19.2, 20, 28. 1, 29.2, 30.4 and 34.3 of this Statute.

(Remember that "consulting" may mean no more than finding out how much we hate their plan, before they go ahead and implement it anyway.)

On the nose?

Aubie Baltin in DollarDaze gives it out straight from the shoulder: a 50% drop in US real estate that will take 10 years to turn around; a 30-50% drop on the Dow; we should be positioned 50:50 cash and gold bullion.

This last chimes with others who say there's bubbles everywhere but can't predict whether the Federal Reserve will feel forced to hyperinflate the currency.

The Dow 9,000 prediction

In SafeHaven on 9 July 2007, Robert McHugh predicted the Dow would drop to 9,000 "over the intermediate-term, although if the PPT responds by hyperinflating the money supply, it could be 9,000 in real dollars (gold adjusted), not nominal." This would mean a drop of 33.88% from its 6 July value. Others have also forecast a fall in the Dow and/or the dollar. I plan to test this assertion from time to time.

The situation is complicated by monetary inflation in the USA, and in other countries that are trying to maintain the exchange rate of their currencies against the dollar, in order to protect their trade with America. So we'll take the Dow as it was on 6 July (the chart McHugh was using) and adjust for relative currency movements and the price of gold.

Starting points for 6 July 2007: the Dow was 13,611.69; gold (London AM fix) $647.75/oz.; using the interbank rates as given by O&A, one US dollar bought 122.7160 Japanese yen, 0.49630 British pounds, 0.73450 Euros, 7.60760 Chinese yuan/renminbi.

Situation as at c. 7 a.m. GMT 31 August 2007: Dow 13,238.73; gold $666.30; dollar buys 115.73200 Japanese yen, 0.49660 British pounds, 0.73280 Euros, 7.55580 Chinese yuan/renminbi. Adjusting for movements in currencies and the price of gold, we reinterpret the Dow today as being worth:

12,870.16 against gold
12,485.29 against the Japanese yen
13,246.73 against the British pound
13,208.09 against the Euro
13,148.59 against the Chinese yuan/renminbi

At present and in purchasing terms, the Dow since 6 July 2007 has fallen most (8.275%) against Japan, next against gold (5.45%), then China (3.40%), Europe (2.97%) and the UK (2.68%). I see this last as a measure of Britain's own weakness.

So within two months, and against the yen, the Dow has already fallen by about one-quarter of McHugh's predicted overall drop.

September 8: since August 31, the Dow has slipped further to close at 13,113.38 on Friday; gold has risen to $701 (London PM gold fix). Adjusted for the rise in the price of gold, the Dow is now the equivalent of 12,117.25. So in terms of Robert McHugh's prediction, it has lost 10.98% since July 6. Time for another quiet release of gold by central banks?

September 18: At the time of writing (6 p.m. British Summer Time), the Dow stands at 13,493 and gold at $713.70/oz. Adjusted for the change in the price of gold, the Dow has fallen by just over 10% since July 6.

September 21: Dow currently 13,839.54, gold (10.03 a.m. NY time) $736.30. Adjusted for the change in the gold price, the Dow would be worth 12,175.15, or down 10.55% since July 6.

Putting it another way, gold has risen 13.67% against the dollar in 77 days; that's getting on for 90% annualised. Is this lift-off for Doug Casey's trip to the moon?

September 29: July 6 to present: Dow up from 13,611.69 to 13,895.63; gold up from $647.75/oz. to $743.10. So the "gold-priced Dow" is down 11.01% in 84 days.

Annualised equivalent: gold increasing by c. 82% p.a., "gold-priced Dow" falling 40% over a year. Will these trends continue?

October 27: The Dow is currently at 13,806.70, up slightly from its July 6 valuation of 13,611.69. But gold has risen from $647.75 to $783.50 in the same period - up 21% in 113 days, or around 85% annualised. This means the "gold-priced Dow" is worth 11,414.54. At this rate, Robert McHugh's prediction will be fulfilled by March 8 next year.

November 2: Dow at 13,595.10, gold $806 per ounce. Since July 6, Dow has appeared to hold its ground, but the "gold-priced Dow" has dropped to 10,925.83 - a fall of over 49% annualised. And at this rate, gold will have doubled in dollar terms by July 2008.

November 7: Dow at 13,660.94, gold $833.80/oz. "Gold-priced Dow" has therefore gone down since July 6, from 13,611.69 to (effectively) 10,612.71, a drop of 22% (or 52% p.a. annualised).

To put it another way, the Dow has stood still and gold has risen 29% (or 112% p.a. annualised) over the last 123 days.

January 13, 2008: Last year, Robert McHugh predicted that the Dow would drop to 9,000, if not in nominal terms then in relation to gold. The Dow was then 13,238.73 and gold $666.30/oz, which means that it took 19.87 ounces of gold to buy the Dow. McHugh's prediction implies the Dow dropping to 13.51 gold ounces (a fall of 6.36 ounces).

The Dow is now 12,606.30 and gold $894.90, so the Dow is now worth 14.09 gold ounces. It has fallen by 5.78 ounces out of the predicted 6.36, so the prediction is 90.9% fulfilled so far.

McHugh will be fully correct if, for example, the Dow remains unchanged and gold rises to $933/oz; or if gold stalls, the Dow will need to fall to 12,090.

January 18, 2008: Dow 12,082.31, gold $880.50/oz, so the Dow is now worth 13.72 ounces of gold as against Robert McHugh's prediction of 13.51.

Nearly there, and the new announcement of a $145 billion reflation may push gold that extra yard.

January 22, 2008: As at the time of writing, the Dow is 11,820.24 and gold $875.90/oz. The Dow/gold ratio is therefore below 13.51 and has (perhaps fleetingly) fulfilled Robert McHugh's prediction.

Whether the Dow falls below 9,000 nominal in the course of a severe recession is something we shall have to see.

Thursday, August 30, 2007

More on the Euro as the dollar's replacement

From the website of the Campaign for an Independent Britain, a point about Britain's gold reserves. This strengthens the speculation that the Euro might become gold-related and take the reserve-currency mantle from the US dollar.

Is it really true that Britain's gold reserves would be transferred to Germany in the event of monetary union?

The arrangements for Economic and Monetary Union are set out in a Protocol annexed to the Maastricht Treaty signed by the British Government in 1992. Article 30 of the Protocol would require Britain, on joining EMU, to transfer around £8,000 million of our gold and dollar reserves irrevocably to the European Central Bank in Frankfurt, Germany.

Article 42 provides that more of our remaining reserves could be transferred to the European Central Bank if a majority of the other EMU countries required it.

Britain would not be able to veto this process.

If so, perhaps holders of these German gold bonds from between the two World Wars might end up with Britain's bullion!

Good luck, Tampa investors.

UPDATE

The suit for German gold was brought by a farmer called Ronnie Fulwood. Here's the (English edition) German Spiegel article from 2004. His attorneys seem to have a history of long-shot claims, as this blog from May 2007 explains.

Money safety update - American banks

"I warn you, Sir! The discourtesy of this bank is beyond all limits. One word more and I—I withdraw my overdraft." (Punch, June 27, 1917)

I recently looked at the security of deposits in British banks, but what about the USA? As with my earlier post this morning, we find concise information included in a different argument, in this case about the American liquidity crisis.

In the USA, it seems that up to $100,000 in checking and savings accounts (per depositor per "member bank") is covered by the Federal Deposit Insurance Corporation. There were two separate funds - one for banking, the other for savings (following the $150 billion losses in the savings & loan crisis a generation ago) - but they have been merged as from the end of March 2006.

There are three compensation methods used. One is direct payment to the investor, termed a "straight deposit payoff". The other two involve transfer of business to a healthy bank, with some financing from FDIC: these are known as "purchase and assumption" (P&A) and "insured deposit transfer" - full details here and here. (N.B. although FDIC prefers not to make a straight deposit payoff, as it is the most expensive solution for them, it remains an option - Sutton and Hagmahani's brief account skates over this point.)

The $100k upper limit for depositor protection is more generous than in the UK - and it seems to be 100% insured, unlike for the poor British saver. But, the authors warn, FDIC "only works when bank failures are isolated events, and will not work in a systemic crisis...or for that matter one really big bank failure."

Taking a more general view, the article explains that the subprime mess has reduced liquidity in the system, causing it to work inefficiently, which is why the Federal Reserve has pumped in more cash - accepting "toxic waste" collateral in return, and offering a discount on its loan rate to banks.

The authors have two objections to this assistance:
  • it rewards bad behaviour and encourages a repetition ("moral hazard")
  • accepting unrealizable obligations as collateral is inflationary, since it turns nothingness into money
Their prediction: a fall in the value of the dollar, and if the banks disguise their problems and fail to clean house, at worst a collapse of the financial system. The Fed has bought some time, but that time has to be used for urgent reform.

Doug Casey: business cycles and subprime loans

"The Man In The Moone" by Francis Godwin, Bishop of Hereford (1620)

I noticed years ago that you get the crispest explanations from someone who's busy trying to get to their main point - Isaac Asimov's "Extraterrestrial Civilizations" (1979) is an excellent example. Even if you disagree with the conclusion, you have learned so much on the journey, and so quickly.

Doug Casey in DollarDaze yesterday summarises the theorised relationship between the money supply and the business cycle, plus subprime mortgages and hedge fund gearing, as part of the argument for gold mining stocks. Again, you may not agree with him that gold "is going to the moon", but in the meantime he has given us a clear and concise exposition of two important economic topics.

Wednesday, August 29, 2007

2012: Olduvai Theory, sunspots and energy planning

Wm. Robert Johnston's reconstruction of the last Ice Age (at 16,000 BC)

A fascinating article by Brian Bloom in The Market Oracle on 6 August. He ties together a number of threads:
  • Regular periodic stockmarket cycles
  • Richard Duncan's Olduvai Theory (we've passed the peak of the per capita energy use that built our civilisation)
  • The possible role of sunspots in cycles of climate change (allegedly we're heading for a deep global freeze in 50 years' time)
  • The sun's movement in relation to the Milky Way, tentatively linked to a 100,000-year glaciation cycle
... and relates them to economic and political issues to suggest that we need to take urgent action to reduce debt and become more energy-efficient.

In case you are tempted to dismiss frontier thinking of this kind, it's worth remembering that many highly successful investors are intrigued by long-wave patterns. For example, Marc Faber is interested in the Kondratieff cycle, among others:

...business cycles do exist. Some economists claim that they occur, according to Juglar, every eight to twelve years. But according to Kondratieff and Schumpeter, you have these long waves that occur. You have a rising wave of about 15 to 25 years, then there is a plateau and downward again for 15 to 25 years. And then you have a drop and the entire cycle starts again. You have all kinds of cycle theory. I am not so sure you can measure the timing of the peak and the bottom, but definitely cycles do exist.

(Interview with Jim Puplava on Financial Sense, February 22, 2003)

More on Marc Faber and agricultural land

Zee News reports Dr Faber's continuing support for the agricultural sector, in which he himself has invested:

Faber... owns agricultural land and plantation stocks in Indonesia, Thailand and Malaysia.

Gold and farmland: further points

The Daily Reckoning Australia has very stimulating thoughts today.

(1) Dan Denning quotes a friend (David Evans) on the divergence between physical gold and shares in gold mining companies:

If the price of gold rises a lot, gold shares have greater leverage and will tend to go up more than gold bars (the cost of mining the gold stays constant, but the price of the mined gold goes up). When the general public gets involved and everyone just wants gold, gold bars tend to appreciate faster... The obvious strategy is to own gold shares now, and when every man and his dog is clamouring for gold, sell your gold shares and buy gold bars to enjoy the last part of the ride.

So when I looked at gold dropping with the Dow, maybe I should have also taken a peek at what gold shares were doing at the same time. For example, Newmont Mining opened yesterday at $40.30 and closed up at $41.07, whereas gold for delivery in December fell by $2.70.

(2) Chris Mayer looks at agricultural land in Brazil and Argentina, in the light of a hungry and resource-limited China:

In Brazil and Argentina, you have one of the few places left in the world where you can acquire large tracts of land in temperate climates with plenty of rainfall to support large-scale agriculture. Already, the two countries produce about one-third of the world’s agricultural commodities. As China is the world’s workshop and India its back office, so has South America become its breadbasket.

Maybe this is why Hugh Hendry and his colleagues have just launched the Eclectica Agriculture Fund.

Gold: speculative investment vs store of value

White Star Line's "Olympic", launched 20th October 1910 (big picture)

Yet again, the Dow drops (about 2%), and gold limps after the pack (down about 0.3%). Until there's a major financial disaster, or it is returned to currency status, gold will not be able to make up its mind whether it's a quality investment or an emergency provision - a liner or a lifeboat.

Tuesday, August 28, 2007

Money supply, shares and property

Here's a 22 May article by Cliff d'Arcy in The Motley Fool, comparing house prices and the FTSE 100. From mid-1984 to December last year, the FTSE has outperformed by 7.4% compound per year versus 7.2% for houses. But as he points out, houses are "geared" by mortgages, whereas most of us don't borrow to buy shares.

From September 1984 to the end of 2006, the money supply as measured by M4 showed an annualised average increase of 11.64%. Looking at the growth of M4 as against that of two classes of asset, I wonder where the difference went? Do interest charges roughly account for this?

The money supply, the stockmarket, gold and land

Here's part of an interesting interview with a hedge fund manager in 2003, reproduced in October 2005:

An old interview with Hugh Hendry (2003)

Hendry: What's happening today happened 300 years ago in the French economy when John Law, another Scotsman, was allowed to launch the first government-sanctioned bank, which replaced coins with paper money. Commerce boomed. Politicians recognized this correlation between issuing more money and people liking you. They issued more and more money, but it was a false promise. Nothing intrinsically was being added to the economy except promises, which could never be redeemed. Selling by speculators caused the stock market to correct. The correction encouraged the authorities to print more funny money. Ultimately, the continued pumping of liquidity destroyed the economy, the stock market and France's currency.


More recently, the U.S. came off the gold standard in 1971 and the Dow Jones Industrial Average bottomed in 1974. Over the next 25 years, the Dow goes up 20-fold because every period of economic anxiety brought forward an orthodoxy of generous liquidity. Money has to go somewhere. It seeks to perpetuate itself by going into a rising asset class. This time, it is financial assets. Just like the Mississippi stock scheme in 1720 and the South Sea Bubble in London at the same time.

Hugh Hendry set up Eclectica Asset Management in 2005 and like others I've mentioned before, seems to have discovered an enthusiasm for agriculture; Eclectica's new Agriculture Fund is detailed here.

Elections, inflation and the stockmarket

Here's an interesting 2005 piece from British home lender / banker HBOS/Halifax, correlating periods of government with inflation and share prices. The conclusion:

Martin Ellis, chief economist at Halifax, said:

"Although wider economic conditions clearly play a part in the rise and fall of the stock market, election campaigns do appear to have a marked impact on share prices. The three month period preceding any general election traditionally sees large fluctuations in share prices as the market tries to understand the likely outcome of the election."


I haven't yet tried to relate increases in the money supply to General Elections, but it might be an interesting avenue to explore.

Buy or sell?

FT Alphaville (20 August) summarises an interim (between scheduled GBD newsletters) report by Marc Faber. The gist is that we should be looking for the right moments to sell, not to buy.

Peter Schiff: recession "necessary and inevitable"

Writing in The Market Oracle on Friday, Peter Schiff thinks it's time we took our medicine.

Monday, August 27, 2007

Economic warfare?

Gerard Jackson, in The Market Oracle today, rehearses the economic explanation for what's going on between America and China. He lays the blame on the expansion of credit in the US monetary system, rather than sinister Chinese intentions.

That's not to say that some in China don't see the weakening of America - and the West generally - as a bonus. National pride can be underestimated.

But the real question is whether our democracies can take really tough decisions now, in order to prevent a much greater disaster later.

Friday, August 24, 2007

Enduring Power of Attorney: "October the first is too late"

...to quote the title of a Fred Hoyle novel.

There are big difficulties in handling the affairs of someone who has become mentally incapacited. Even a spouse is not automatically assumed to have the right to sell or otherwise manage property belonging to the affected person - or jointly owned with him/her.

This is where an Enduring Power of Attorney comes in. It gives advance permission for someone to look after your investments and other possessions, if you can't. (This permission can be altered or withdrawn before that event.)

Why not simply use an ordinary power of attorney? Because this power is given on the legal understanding that you can step in and reassume control whenever you wish. Obviously, if you're in a coma, you can't, so normal power of attorney ceases to have effect in such circumstances.

Does it matter? Yes: as well as physical, there can be financial abuse of the mentally disabled and other legal minors, which is why these matters come under the Court of Protection (within the Chancery division - remember Dickens' "Bleak House", which exposed legal abuses of protected persons' estates?)

Is this a rare eventuality that you can afford to ignore? No. Here's some statistics:

Although there are no precise statistics about the number of people who may lack capacity in the country, the Mental Capacity Act Implementation Programme has estimated a range of 1 – 2 million, including some of the following:

• Over 700,000 people with dementia (rising to 840,000 by 2010)
• 145,000 people with severe learning disability and 1.2 million with mild to moderate learning disability
• 1% of the population with schizophrenia, 1% with bipolar disorder and 5% with serious or clinical depression at some stage in their lives
• 120,000 people living with the long-term effects of a severe head injury


Source: MHCA Briefing Paper, 2005

At the moment, it's a short and fairly simple form, that only needs the names of your potential attorney/s and a couple of signatures. So it's easy -often part of a legal services package offered by professional will writers - and therefore cheap. 22,508 EPAs were registered with the Public Guardianship Office last year (source: PGO Annual Report 2006-2007). Should the need arise, the named responsible person/s take the form and have it registered with the PGO (see Alzheimer's Society information on EPAs and their successors).

But from October 1st, it will be replaced by "Lasting Power of Attorney". This will be over 20 pages long and much more expensive to arrange - one legal firm estimates up to £600 instead of their current fee of £75 (see Daily Mail article, 22 August).

So it looks like a good idea to do it now.

By the way...

There will be two types of Lasting Power of Attorney. The first is the new and more expensive version of an Enduring Power of Attorney; the second is a form of what is known as an Advance Directive, or "Living Will".

An Advance Directive gives permission to others to make decisions about your healthcare if you're disabled - the life-support machine question, for example. There are serious ethical and religious issues about this, and I'm a bit suspicious of these two quite different legal documents being given the same name from October - it's as though the government is keen to get you to sign away your right to life (e.g. perhaps for budgetary reasons).

And isn't is a little revealing that a Court (of Protection) has been replaced by an Office (of the Public Guardian)? Perhaps part of the airbrushing of the Monarchy out of our Constitution - more revolution by stealth.

Thursday, August 23, 2007

Wells Fargo in deep water

Wells Fargo Stage Coach by Sven Ohrvel Carlson

It seems that, encouraged by new US accounting rules, some companies are resorting to optimistic subjective estimates of their own value, in order to reassure their investors. Jonathan Weil reported on this in Bloomberg yesterday.

Let's hope the wheels don't come off! And thanks to Michael Panzner for spotting the article.

Is your money safe in the bank?

Mike Shedlock, in The Daily Reckoning Australia today, raises a point we should all consider - how far your cash deposits are protected by law. This is NOT an academic question - a hard-working and thrifty truck driver has recently lost over $300,000 of his life savings in the Metropolitan Savings Bank in Lawrenceville.

For British savers, here is the current position:

"Financial Services Compensation Scheme

The Financial Services Compensation Scheme (FSCS) was created and put into operation in December 2001. It was brought in to replace the Building Societies Investor Protection Scheme, Deposit Protection Scheme and several other schemes previously in place. The FSCS was introduced to protect customers of firms that go into liquidation or out of business.

The scheme is activated when an authorised firm goes out of business or the Financial Services Authority (FSA) considers that an authorised firm is unable or unlikely to be able to repay their customers.

Most customers are partially protected under this scheme and are entitled to the following amount of compensation:

100% of the first £2,000
90% of the next £33,000

The maximum amount of compensation each individual can receive is £31,700.

The compensation limit applies to individuals and covers the total amount of all their deposits held with that firm. Each individual in a joint account is eligible to receive compensation up to the maximum limit in respect of his or her share of the deposit. The FSCS assumes the account is equal and splits it 50:50 unless evidence shows otherwise.”

Source: http://www.moneysupermarket.com/savings/GuideToSavings.asp (accessed 17 Aug 07)

From this you can see that for your savings lodged with any one deposit taker, any excess over £35,000 for a single account holder, or £70,000 for joint (50:50) holders, is not protected.

Some may say, "It can't happen here", but it did in the Isle of Man in 1982, where the Savings & Investment Bank collapsed, losing £42 million of depositors' money. International bank BCCI collapsed in 1991 with debts of £10 billion, hitting 6,500 British depositors - and the legal case against the bank ultimately collapsed as well.

Savings schemes are not safe, either. About £41 million was lost in the Farepak Christmas hamper collapse last year.

The strategy is to know your rights, and to diversify. As Antonio says in The Merchant of Venice:

My ventures are not in one bottom [i.e. ship's keel] trusted,
Nor to one place; nor is my whole estate
Upon the fortune of this present year:
Therefore my merchandise makes me not sad.

Invisible earnings may disappear

The UK's trading balance has been substantially assisted by the money flowing through the City of London's financial community. Martin Hutchinson's 20 August essay in PrudentBear explores the possibility that the City will eventually lose its eminence, and the loss of revenue will have to be replaced by higher domestic taxation.