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Living in an age of gold rather than a Golden Age

The real size of the U.S. budget deficit

On Jan. 17, to little fanfare and even less media coverage, the Treasury reported (a month late) that the Generally Accepted Accounting Principles deficit was $6.9 trillion, or 46 percent of total U.S. economic activity for 2012. The 2011 GAAP deficit was $4.6 trillion.

GAAP accounting is required of all publicly traded companies in the U.S. The GAAP deficit includes the present value of all of the newly promised unfunded liabilities, mainly Medicare, Medicaid and Social Security. The General Accounting Office currently estimates the total sum of all past and present unfunded liabilities at $88 trillion, or nearly six times the size of the GDP.


Worse, because of materiality issues, the GAO will not offer an opinion on the Treasury’s GAAP financial statements. Imagine what would happen in the marketplace to the stock price of a publicly traded company that reports a loss, but upon audit, it is revealed that the loss is more than six times higher and that the auditor won’t opine because of material issues with the data. Think of the fury of the politicians and the reaction of the SEC. Yet, not a word has been uttered nor is the real magnitude of the United States’ fiscal issues even acknowledged.

The forecast: “Twin Shocks”

A report released on Jan. 11 and authored by Meghnad Desai, chairman of the Official Monetary and Financial Institutions Forum, a global monetary think tank and adviser to central banks, sovereign funds and financial policy makers, warns of “twin shocks” to each of the dollar and the euro. The report contends that “gold — the official asset that plays no formal part in the monetary system, yet has never really gone away — is poised, once again, to play a critical role.”

What hedging means

While the western currencies weaken due to heretofore unthinkable worldwide money creation policies, China and countries in Asia, which have “oversaved,” now sit on “massive monetary reserves.” The level of such reserves has “become the most potent factor behind reserve diversification into other assets including gold,” Desai said. That is, the holders of these reserves are beginning to shun the dollar and the euro and are looking for safe havens. No doubt, gold will be a major player.

First, Venezuela – now Germany

In mid-2011, Hugo Chavez’s Venezuela demanded that 160 tons of its gold bullion that was safekept at the Bank of England, JPMorganChase, Barclays and Standard Charter be shipped back to Caracas, the last shipment arriving in Caracas on Jan. 31, 2012.

Soon thereafter, the Bundesbank’s governing body demanded an audit of the gold reserves it had stored at the Federal Reserve Bank of New York.

The Fed denied the German request for an audit, and after much political pressure succumbed somewhat and allowed a German official to inspect one vault — but still no audit of the 1,536 tonnes of German gold that is supposed to be there.

While all the Germans originally wanted was a basic audit, the lack of cooperation on the part of the Fed has now caused the Bundesbank to demand that half of its reserves (768 tonnes) be transported back to Frankfurt.

And who could blame them? In an era in which we have seen the collateral of unsuspecting clients simply disappear (M.F. Global, Bernie Madoff), and, in an era where gold is pledged to cover loans to large institutions and such loans are handed out willy-nilly, there should be cause for concern on the part of large central banks that hold gold in foreign vaults.

The signs are clear. The world’s major reserve currency country is running a GAAP deficit six times larger than their “official” numbers, and that deficit represents nearly half of its economic output. That reserve currency country is making payment promises it can’t ever hope to fulfill without either default or significant inflation.

The monetary authority, the Fed, enables such policies by running the money printing presses and using the newly minted stuff to purchase much of the deficit. Because there are no real assets behind the unfunded liabilities, the cash deficit is destined to become larger and larger as the promises made turn into demands for payments. Unfortunately, the U.S. is not the only bad actor on this stage. The central banks of the other industrial countries have followed the Fed’s lead.

The writing on the wall

International observers are warning of the implications of such policies, yet their warnings are ignored and the policies persist. Because there is no other country with a sound financial system that is capable of stepping up to reserve currency status, countries with significant monetary reserves are starting to look to hedge the value of those reserves against what is sure to be devaluing major currencies. Japan has now, under the new Abe government, openly espoused such devaluation.

Central banks around the world with currency reserves are scrambling to hedge their hard-earned reserve stash. The actions of Venezuela and now the Bundesbank are just the beginning. The warning signs are as clear as the words on these pages.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.


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