America's Credit & the New Bid for Gold
By Adrian Ash
September 1, 2007
George W.Bush is going to
nationalize US housing. Watch what happens to gold...
"THE MARKETS are in a period of
transition," said George W.Bush in his speech from the Rose
Garden on Friday.
"[But] America's overall economy remains
strong enough to weather any turbulence," he added – and
to prove it, the commander-in-chief just put the credit of the
entire US nation on the line.
Underwriting the $100 billion in subprime
real-estate losses forecast by his top monetary wonk, Ben
Bernanke at the Federal Reserve, Dubya is in effect doing what
many small-town US banks did during the early stages of the '30s
Depression.
Put all the money where passers-by will see it,
right there in the front window, just to prove that the money
exists. That way, or so the logic runs, anxious depositors will
see their money's still there...and they'll wait a while longer
before forming a queue to empty your bank in a panic.
The big difference this time – besides the sheer
size of Dubya's bail-out – is that Washington is putting
America's credit out front, rather than hard
cash. The US government doesn't have any cash to put on display;
instead, it owes the best part of $9 trillion already. Now
George W.Bush is going to add the cost of subprime debt defaults
on top, bailing out this summer's crop of late-paying home
buyers and underwriting the next two years – or more – of
refinancing.
What's an investor to do when the government
meddles so deep in the price of assets? Spot
Gold Prices rose sharply as stocks leapt and the Dollar slid
back as news of Bush's pork-barrel pledge spread early Friday.
But during the credit market turmoil of August 2007,
professional money managers had fled into the apparent
"safety" of US government debt. And US bond prices
fell sharply as the promise of fresh Treasury debt to fund
Bush's bail-out became clear.
Now those same investment-fund bondholders – and
especially those planning to stay long of US debt as the Fed
cuts US interest rates – are going to get
"shellacked" as our friend, Dan Denning of The
Daily Reckoning in Melbourne, Australia, puts it. Because
the credit put on display in the Rose Garden on Friday is merely
the credit of the US government itself. And that credit only
exists for as long as US Treasury bonds find a bid at auction.
It's a bold move to be sure, and Bush likes to be
known as "The Decider" according to Bill Gross, head
of Pimco, the world's biggest bond fund. Taunting Dubya's
man-of-action self image last week, Gross told Dubya to step
into the subprime disaster – "write some checks, bail 'em
out."
Come Monday, Larry Summers of Harvard University
joined the chorus, too. "Now is not the time for the
authorities to get religion and discourage the provision of
credit," he wrote in the Financial Times.
Add the top academic economist outside the Fed to a
guy running $692 billion, and that makes some chorus, right? We
can only guess at the phonecall that Ben Bernanke took from the
West Wing mid-week. "The government's got a role to
play" they must have agreed – a line Dubya repeated on
Friday. And in dredging up credit to bail out the US economy,
the Decider's three-pronged plan is going to spear bond holders
three times over.
FIRST, as Washington's overnight briefing to
the press explained, the Federal Housing Administration is going
to guarantee loans for delinquent US borrowers. Set up during
the Great Depression, the agency already acts to insure
mortgages for low- and middle-income borrowers. Now anyone more
than 90 days behind with their payments will get
government-supported finance at lower, more favorable lending
rates.
In other words, Washington is going to
stall foreclosures by lending money to distressed debtors.
SECOND, Bush is going to ask Congress to
suspend – but only for "a limited period" according
to the Wall Street Journal – a US tax provision that penalizes
borrowers who lose their homes to repossession or who try to
reduce the size of their loan by refinancing.
Meaning that the government's going to
cut its own tax receipts.
THIRD, the US government – through an
initiative led by the Treasury and the Housing & Urban
Development department (HUD) – will identify home-buyers at
risk of defaulting between now and 2009. For them, it will
create "more favourable" loans, working with private
lenders and insurers to reduce rates in the market and reverse
the move away from higher-risk borrowers.
Put another way, Washington is going to underwrite
the next two years of subprime re-financing, actively seeking
out defaults before they happen.
That means more new government-funded loans
still. Because if the private banking sector can't raise
funds to keep subprime US consumers in credit, then the US
Treasury will. Or so Dubya and Wall Street believe.
But the last time America's credit rating came into
crisis – during the late '70s – inflation ate both equity
and fixed-income investors alive. Gold, on the other hand, rose
by 510% for Dollar-based buyers. The metal rose five times over
against the British Pound too, and spot gold prices gained more
than 370% for German investors. Japanese gold buyers made four
times their money inside three years.
Of course, past performance is no guarantee of the
future, as the City regulators here in London force UK
investment funds to remind their clients. But Spot
Gold Prices just closed August '07 up more than 4% from the
end of last year to record only the 11th month ever to top $650
per ounce. Six of those months have come in 2007 – and the
global bid for gold only looks set to grow stronger as the panic
of August slips into September.
"The early indications are for a very, very
strong year for India's gold demand," said Philip Olden,
managing director of the World Gold Council, on Thursday.
Looking ahead to the traditionally strong gold-buying festival
and wedding season now about to begin, he forecasts Indian gold
demand in 2007 will rise by one-half from 2006, hitting record
levels.
Global demand to Buy
Physical Gold rose by 19% between April and June according
to the WGC's data. China's gold demand surged by nearly one
third, says a Reuters report, while Turkey's gold imports could
set a new record and gold buying in the Middle East is set to
rise as tourism grows.
"We are seeing a very significant restocking
process going on in the markets, primarily for India, as we are
heading to the heavy festival season," says Andy Montano, a
director at ScotiaMocatta, the bullion bank, in Toronto. "I
suspect as we move towards the latter part of the year, the
buying pressure will increase in line with the fact that we are
heading towards the Christmas period [and] the Chinese New
Year," agrees Darren Heathcote of Investec Australia.
Or perhaps foreign buyers will choose US Treasury
bonds instead of gold. Nothing is certain, not even the looming
inflation due from this week's record-high wheat prices and
resurgent crude oil.
And besides, George W.Bush just put the entire
credit of the US nation right there, out front in the shop
window, for the whole world to see.
The gambit didn't always stave off a run on the
bank in the 1930s. But you never know. It might work this time
– for a while.