GoldCore Review of 2010 And Outlook For 2011

Tyler Durden's picture

Zero Hedge is happy to announce a new collaboration with the precious metals experts at Gold Core. We look forward to posting periodic industry updates, notes, analysis and commentary in conjunction with GC on all matters of topical significance in the PM space. As an introduction, we would like to present GoldCore's review of 2010 and Outlook for 2011.

GoldCore Review of 2010 and Outlook for 2011, via GoldCore

Review of 2010


2010 was a year that many will be glad to see the back of due to the
deepening of the global economic crisis and the ensuing financial and
economic hardship visited upon many. Worst hit were the unfortunately
named PIGS with Portugal, Spain and particularly Greece and Ireland
suffering the wrath of the bond vigilantes, austerity measures and
deepening economic crises.

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Currency Performance in US Dollars

Gold was again one of the top performing assets and currencies as seen in our currency tables in US dollars and euros.

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Currency Performance in Euros

Bond, Stock and Commodity Markets

The belief that central banks controlled interest rates is
increasingly doubted and there is a realisation that bond markets are
the ultimate arbiter of interest rates globally. Concerns of sovereign
defaults in Spain, Portugal, Ireland and Greece saw interest rates
surge in these countries. This trend has not abated and recent days
have seen interest rates in Greece rise above 12.5% and Ireland above

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US Government 10 Year - 1 Year (Daily). Performance in 2010: -11.9%

Indeed, informed speculation that the AAA rating of the US may come
under pressure due to their massive nearly $14 trillion national debt
and massive trillion-plus annual budget deficits saw US interest rates
rise sharply in the final three months of the year (see chart above).
Long term government debt has become far riskier which has important
ramifications for prudent asset allocation.

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MSCI World Index - 1 Year (Daily). Performance in 2010: +9.47%

Markets saw considerable volatility, particularly currency markets
due to concerns about the dollar, the euro, sterling and the debasement
of currencies internationally. The fragile economic recovery and
continuing cheap money policies - near 0% interest rates and the latest
quantitative easing initiative (QE2) - led to continuing risk appetite
but also to growing concerns that inflation is beginning to get a
foothold in the global economy. This led to stock markets and commodity
markets internationally having positive performances (see chart above
and below).

Commodity prices rose gradually in the second half of the year and
the Thomson Reuters/ Jeffries CRB rose by 15.4%. Copper was
particularly strong – up 28% and oil rose by 6% (NYMEX +6%; BRENT

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Thomson Reuters/ Jeffries CRB - 1 Year (Daily). Performance in 2010: +15.4%

Soft commodities and the price of basic foodstuffs such as wheat,
corn, and sugar all rose as markets reacted to extreme weather events
such as fires in Russia and floods in the US and Pakistan. Wheat prices
rose 49pc over the year, corn was up 50pc, soya beans rose 35pc and
sugar added 28pc. Cotton prices nearly doubled in the year due to high
demand and restricted supply.

While nearly all commodities rose strongly in 2010 and are near
record nominal highs – it is very important to realize that these are
record nominal highs from more than 30 years ago. This means that the
gains may well be sustainable as most commodities remain a fraction of
their inflation adjusted price of more than 30 years ago.

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The platinum group metals of platinum and palladium were strong.
Platinum rose 19.4% to $1746/oz and palladium surged 94.2% to $790/oz.
Both remain below their record highs of 2008 and 2001 respectively at
$2166.50 and $1110.50/oz.

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Gold in US Dollars - 1 Year (Daily)

Gold and Currencies

Sovereign debt, currency debasement and inflation concerns led to
continued safe haven demand for gold internationally and to gold
recording its 10th consecutive year of rising prices. Gold rose some
28% in US dollar terms, 34.5% in sterling terms and 38% in euro terms
and by similar amounts in other major currencies. The strongest
currencies in the world in the year were the Japanese yen, Australian
dollar and Swiss franc.

This shows how the price of gold is not rising per se rather fiat
currencies are losing purchasing power and being devalued
internationally. This increases the attraction of precious metals and
hard assets that are finite and cannot be debased as inflation hedges –
especially gold and more volatile silver.


As we suggested would happen, silver surged in 2010 and rose 81%.
However, it remains more than 35% below its nominal high of 1980 at
$50/oz (weekly close $49.45/oz – see chart below). The nominal high of
1980 remains a very viable long term price target and should 2011 see a
repeat of 2010 then silver will surge past the 1980 high as gold has
already done to its 1980 nominal high.

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Silver in US Dollars – 40 Years (Weekly)

Outlook for 2011

Last year we correctly indentified sovereign debt risk particularly
in the Eurozone and a real risk to the euro as a reserve currency and
to the euro itself as key themes to watch out for in 2010. These risks
remain and have actually deepened in the final weeks of 2010.

The outlook for asset class performance in 2011, as ever, depends on
what global macroeconomic conditions the world experiences. 2011 will
be guided by the fundamental US macroeconomic situation, the outlook for
the US dollar, the euro and the international monetary system and the
health of China's economy will also be important. As ever, whether
deflation or inflation prevails will be of primary importance.

Other big picture global macroeconomic factors that could become important in 2011 are:

Global Macro – Inflation or Deflation

Crystal ball gazing based on future conditions remains foolish -
particularly given the degree of uncertainty with regard to possible
deflationary or inflationary global risks.

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Gold in EUR - 1 Year (Daily)

As ever, the titanic battle between deflationary pressures and
inflationary pressures continue. The extent of deflation experienced in
most economies has been exaggerated. It is often used by uber-
Keynesian economists and governments as an excuse to print and spend
money profligately.

Deflation in most western economies has been confined to property
markets and consumer purchases such as cars and other expensive
consumer items such as electrical appliances etc. Deflation has largely
been seen in goods and assets that are debt based or have been
purchased using credit. The lack of credit or tightening of credit has
led to falling prices. These are healthy and necessary adjustments – as
many property markets remain well above their long term average and
average house prices remain unaffordable to those on average industrial

The price of essentials such as food and energy have not fallen in
recent years and many have risen this year and there are growing
inflationary pressures being seen to different degrees in economies

Should the US and the global economy experience a double dip
recession there could come another bout of deflationary pressure
particularly in vulnerable property markets. This could lead to
weakness in equity and commodity markets which would again contain
inflation for a period. However, dollar debasement and international
competitive currency devaluations should see commodities remain robust
especially given the increasing strong supply demand fundamentals of
many commodities.

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World Bank President Robert Zoellick

Global Currency Wars

The initial skirmishes of what is being called a ‘global currency
war' have been seen in 2010. These currency wars involve competitive
currency devaluation and currency debasement as governments and central
banks internationally devalue their currencies in order to maintain
job sustaining export growth and maintain fragile economic recoveries.

The importance of the currency crisis is not realized by much of the
media and the man in the street yet. But it is clearly seen in the
fact that World Bank President Robert Zoellick reaffirmed his proposal
to use gold as a "reference point" to reform the current international
monetary system. Senior policy makers are worried about the dollar's
ability to remain a stable reserve currency. Zoellick said a return to
some sort of currency link to gold would be “practical and feasible,
not radical.” Zoellick's article in FT came three days after Ben
Bernanke's announcement of QE2.

U.S. Chinese Tensions

Besides the risk of currency wars, there are also geopolitical risks
as the relative power of the US and China, lessen and increase

Yesterday, China's defense minister says his armed forces are
preparing for conflict "in every direction," and that times of peace
should not dissuade the military from readiness. Chinese defense chief
Liang Guanglie told state media that over the next five years, "our
military will push forward preparations for military conflict in every
strategic direction. "We may be living in peaceful times, but we can
never forget war, never send the horses south or put the bayonets and
guns away," he said.

His comments come ahead of a visit to China by U.S. Defense Secretary
Robert Gates, who is expected to address U.S.-China military relations
as tensions flare on the Korean peninsula and Taiwan, a U.S. ally,
remains on Beijing's radar. There is also the delicate issue of Tibet.

While there is little risk of a direct military confrontation
between the superpower and emerging superpower, there is a risk of war
being waged through proxies and of economic war involving economic
protectionism and currency wars.

China's Increasing Importance to Gold

2010 will be remembered as an important year in the process of China
becoming a dominant economic power and it was also the year that
China's growing importance to the gold market was realized.

Gold is deeply rooted in the psyche of the Chinese people. Gold is
considered a symbol of prosperity and good fortune in China and a means
to increase and preserve one's family's wealth through the
generations. This comes from a powerful mix of cultural, social and
economic associations. Gold's importance has been augmented by the
country's experience of totalitarian government.

Just this month came news that China should consider adding to its
gold reserves as a long-term strategy to pave the way for the yuan's
internationalization. So wrote central bank adviser Xia Bin in the
influential China Business News. Premier Wen Jiabao said in March he is
"worried" about holdings of assets denominated in the greenback. The
country must revise its foreign-reserves management principle, Xia

Building gold as the basis of solvency has been used through history,
PBOC adviser Xia wrote. Having a corresponding amount of solvency is a
necessary precondition and indispensible safeguard in the long-term
strategy for the internationalization of the yuan, Xia wrote. China
should raise its gold holdings and the 1,054 tons of reserves are
inadequate compared with the 8,133 tons held by the U.S. and 3,408 tons
by Germany, Meng Qingfa, a researcher at the China Chamber of
International Commerce said in October.

China is the world's largest producer and second-biggest user of
gold and has a world-record $2.65 trillion in foreign-exchange
reserves. Gold accounts for only 1.6 percent of the nation's reserves
held by the People's Bank of China, according to the World Gold
Council. The country increased gold reserves by 454 tons to 1,054 tons
since 2003, the State Administration of Foreign Exchange said last

Thirty years ago China held 95% of its foreign reserves in gold.
China's gold reserve of only 1.6% of total reserves is a figure well
below the average minimum 3%-5% adopted in many other countries. China
with an estimated gold reserve of 1,054 tonnes has a fraction of that
believed held in the U.S. and many analysts believe that China will
gradually try to increase its reserves to the levels held by the U.S.

It is often forgotten that the Chinese gold market was only reopened
in 2002. That was the first time in over 50 years (since 1949) that
Chinese individuals could buy gold in either jewellery or bullion

According to the World Gold Council China's per capita consumption
of gold remains the lowest amongst the emerging Asian economies. For
China to consume as much gold as say India, which many observers
believe likely over the long term, consumption would need to rise by
some 250%.

In China, consumer price inflation is now running at 5.5% (according
to official statistics) and yet deposits only yield some 2.5%. Until
real interest rates offer Chinese savers a real yield and are not
negative, Chinese demand will remain strong.

Increasing Sovereign Risk

Jitters abound in government debt markets about the massive issuance
of government debt in 2011 – starting in January 2011. Dubai, Greece
and more recently Ireland have been the first sovereign casualties and
there is a growing risk of contagion particularly in the Eurozone.
Besides Greece and Ireland there are many other countries in the EU
facing possible sovereign debt crisis – including Portugal, Spain,
Italy and Belgium.

Contagion remains the real concern and there is a real risk that
these periphery economies are canaries in the coalmines and herald
coming problems for larger industrial nations such as Germany, Japan,
China, the UK and the U.S. So far their markets and economies have
maintained fragile economic growth and their bond markets have not
suffered the sell offs seen in the weaker Eurozone nations.

Unfortunately, there are many more countries with poor and
deteriorating public finances – including some of the leading AAA rated
industrialized nations – with even the possibility of downgrading of
the sovereign debt of Japan, France, the UK and the U.S.

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Gold in GBP - 1 Year (Daily)

Should this happen long term interest rates would likely rise from the unsustainable record low levels seen today.

Rising Interest Rates

The prospect of a possible rise in interest rates in the second half
of 2011 is quite real. This may be necessary to protect the value of
the dollar and other fiat currencies and contain inflationary pressures
that are emerging.

The markets have become addicted to cheap money and eliminating this
dangerous narcotic may cause serious withdrawal symptoms with obvious
ramifications for already vulnerable residential and commercial property

European Economies and the Euro

The Euro looks set to experience its first major challenge as
increasing Eurozone debt and sovereign default risk (Greece etc.) could
see the single currency come under pressure. There are some who would
welcome a fall in the value of the euro so that European economies can
compete for exports with the UK, the US, Asian and economies
internationally. However, there is a risk of a disorderly adjustment
and a currency crisis. Hopes that the Euro would supplant the dollar as
the global reserve currency are gone.

Commercial Property

Falling commercial property prices and yields and the huge
liabilities in this sector (particularly in the UK and US) continue to
pose real risks. This could easily lead to the next phase 0f the global
financial crisis and could pose a risk as great, if not greater, than
that of the subprime meltdown, and poses real risks to many banks
solvency which could lead to further credit and systemic risk.

US Economy and US Consumer

As ever the strength of the US economy will be important to the
global economy and the performance of asset classes. The US economy
remains highly dependent on the buying habits of the pressured US
consumer who remains heavily indebted.

Chinese Economy

2011 could be the year when the Chinese economic miracle comes into
question. Is the massive economic growth in China real and sustainable
or based on bogus and adjusted economic statistics and cheap money and
stimulus? Some question the ability of the Chinese authorities to
manage an economic contraction similar to those faced by many western

Geopolitical Risks

Geopolitical risk from terrorism and war remains high with Taiwan,
Venezuela, Afghanistan, Pakistan, Israel and Iran and the Koreas some of
the potential flashpoints.

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Gold Inflation Adjusted Index - 40 Year (Quarterly). The 'Bloomberg
Composite Gold Inflation Adjusted Spot Price' is derived from the
monthly US Urban consumers price index

Black Swans in 2011 and 2012

War in Middle East - Global Flu Pandemic - Large Volcanic Eruption -
European Sovereign Default - Crack Up Boom and Hyperinflation

War in the Middle East

Tensions between Iran and Israel and the U.S. could lead to a
military incident (akin to the recent flare up on the Korean peninsula)
that degenerates into a regional conflict in the Middle East. 

Just this week the US imposed new sanctions against Iran, in a move
that highlights Washington's drive to keep pressure on the Islamic
Republic ahead of a new round of negotiations with Tehran in January
2011. The recent announcement by the Treasury department shows how the
US is now using sanctions to affect Iran's overall economy. 

Yesterday, the FT reported that US officials are worried Iran could
use new technology in coming months that would shorten the time needed
to reach nuclear weapon status and reduce the scope for diplomacy.
Washington says it is concerned that Tehran might deploy a new
generation of centrifuges to enrich uranium, a process that can yield
nuclear fuel and weapons-grade material.

Conflict with Iran would likely involve both Israel and the US and
could lead to a wider conflagration in the Middle East that involves
Lebanon, Syria and other countries. Oil prices would rise very sharply
due to the closure of the vital Straits of Hormuz which could lead to a
new oil crisis akin to the one seen in the 1970s.

Global Flu Pandemic

Much of the public and many investment professionals have become
somewhat cynical regarding the threat posed by a flu pandemic. After
much somewhat hysterical reporting there is an element of the "boy who
cried wolf". The risk is that at some stage a flu virus will actually
mutate and governments and pharmaceutical companies may not be able to
respond in time to a real pandemic.

Just this last week, Northern hemisphere countries were told by
health experts to brace themselves for flu outbreaks. There has been a
surge of cases in the UK during December with swine flu appearing to be
the dominant of the three strains circulating. The European Centre for
Disease Prevention and Control warned much of the rest of Europe was
also beginning to see increases too. Meanwhile, parts of the US and
Canada have reported higher levels of swine flu

A real pandemic would involve thousands of deaths and could see
travel restrictions and quarantine measures. This would likely severely
impact the already fragile global economic recovery.

Large Volcanic Eruption

The volcano in Iceland led to wide scale travel disruption in Europe
this year. But volcanologists warn that the planet is due another major
volcanic eruption. Such a volcanic eruption could lead to a longer
period of travel chaos and negatively impact the global economy. Not to
mention the risk that it could lead to a very severe and prolonged
cold spell which would lead to much higher food and energy prices.

The record-breaking cold snap that brought chaos the UK and Ireland
and much of Northern Europe this month was mild compared to the brutal
winter experienced in Northern Europe from 1739 to 1741. In Ireland, it
killed more than a third of the population. The mini "Ice Age" remains
the longest period of extreme cold in modern European history. It is
difficult to be categoric about the extremely complex science of
meteorology but some believe that the Arctic winters may have come
about after a major volcanic eruption in the Kamchatka peninsula in
Russia led to the upper atmosphere being suffocated with tens of
thousands of tonnes of volcanic dust.

It wreaked devastation across much of Europe and especially Ireland
which experienced food riots, famine and epidemics. The mini 'Ice Age'
is now seen as the last serious cold period at the end of the Little
Ice Age between 1400–1800.

Crack Up Boom and Hyperinflation

Extremely loose monetary and fiscal policies and quantitative easing
have the potential to cause what the Austrian economist Ludwig Von
Mises called a "crack up boom".

"The credit expansion boom is built on the sands of banknotes and
deposits. It must collapse. If the credit expansion is not stopped in
time, the boom turns into the crack-up boom; the flight into real
values begins, and the whole monetary system founders. Continuous
inflation (credit expansion) must finally end in the crack-up boom and
the complete breakdown of the currency system.

Should the dollar and other debt laden currencies and government
bonds fall sharply in value due to a panic and wholesale liquidation we
could experience hyperinflation. In this scenario paper assets will be
shunned and people will protect themselves by buying hard assets such
as real estate, commodities and gold and silver bullion.

In such a scenario, gold and silver surge would quickly reach their
inflation adjusted 1980 high of $2,300/oz and $130/oz before
overshooting to much higher levels as was seen in Weimar Germany and
more recently in Zimbabwe.

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It has never been more important for investors and savers
internationally to have diversified portfolios. Lack of diversification
and being overweight equities and property and the use of leverage and
speculation led to much wealth destruction in recent years.

Today, many investors and savers are overweight cash deposits and
long term government bonds and this lack of diversification may also be
seen as imprudent in the coming years.

It is important to acknowledge the risks posed to the euro due to
potential sovereign default and to the dollar, sterling and other
currencies due to currency devaluations and debasement. Loose monetary
and fiscal policies internationally mean that gold is likely to again
perform strongly in 2011 and therefore merits an allocation in the
majority of portfolios.

Many savers concerned about their savings and the risks posed by the
depreciation of fiat currencies are diversifying into gold and silver.
Gold is increasingly being seen as a currency and not as a commodity
and this is why the largest buyers of gold today are central banks in
China, India, Saudi Arabia, Russia and internationally. This trend is
not going to go away anytime soon and looks set to continue into 2011
and until at least 2012.

Given the variety of macroeconomic risks in the world today, owning a
genuinely diversified portfolio passively which includes international
equities, international bonds (high credit; short dated) cash and gold
has never been more important.

Undiversified savings and investment portfolios, unsafe
counterparties, leverage, attempting to time markets and speculation
should as ever be avoided.

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atomicwasted's picture

Oh no!  All of those eggs are in one basket!

Dr. Sandi's picture

That's okay, they're laced with dioxins anyway. They'll either be destroyed by German authorities or shipped to a Chinese baby food factory.

terryg999's picture

I am diversified.  I have both Gold and Silver.



High Plains Drifter's picture

Diversification?  We got diversification. LOL!!!

DoChenRollingBearing's picture


Consider adding Pt and/or Pd for even more diversification.  Both are PMs, and both are used in industry as catalysts.

LowProfile's picture

He already has (arguably) the best industrial PM.

I doubt LT it will do as well as gold (silver won't be monetized).

Spalding_Smailes's picture

I love ZH !!!!

Thanks T for cultivating a herd of doomers .... Viva' the short-sellers. 

Shameful's picture

Doomers perhaps.  But a real doomer would not short because they are expecting massive inflation, so that rising tide would raise all ships.  Only a fool would think "I think there will be hyperinflation, I better short a bunch of stocks/bonds!".  As a inflation "doomer" myself I would never contemplate of running shorts into the market.  Zimbabwe Ben can juice the market as much as he likes.  Likewise because the markets can be manipulated this brand of doomer is more likely to look at commodities and hard assets.

I suppose there is the deflationist breed of doomer that thinks that all the central banks will not resort to printing.  I can only assume this group has never opened a history book or suffers under the fallacies that there is no way to print the money.  Perhaps this group would short waiting for DOW 1000, which isn't coming.

Spalding_Smailes's picture



The deflation in the quadrillion dollar derivative ponzi is epic. Uncle ben injected dollars/treasuries into the system and plugged the hole. Now the game is starting all over, they continue to drink down dollars/treasuries ( the cb's ) because of the flood of dollar denominated debt in the host countries banking system.


You will not see " hyperinflation " doomer style. This dollar thang is global & the thirst continues yesterday, today, next week. Borrowing in dollars going out 5,10,30 years.



Hephasteus's picture

Well with all those customers why don't these global people just use dollars and we'll use silver. Or do you need the merican tested mother approved stamp on it or something?

Shameful's picture

Ah but there is no way to support the debt framework unless interest rates get a lower. Debt is continually added in huge amounts but the ability to repay does not significantly improve. If there is to be a continuation then this means rates will continue to fall, and eventually go negative in nominal terms, or there is a default. And I can assure you that if we see a -1.00% on the 10 year we are deep in Outer Limits territory. Look at the projected debt growth and tell me how that can be financed without basically a 0 in the interest category? Is there a trillion+ a year of capital (Not QE) that is looking to buy US Treasury paper at what will by necessity be insignificant yields?

When there is a default from the US Federal Government what do you think the dollar will be worth? After all it has the full faith and credit of the US behind it. If it has value then great, default, kick back the debt spigot and take the world for another ride. I'm less optimistic about the world being stone dead retarded, but it would be nice.

Deflation of the ponzi also assumes these bad beds and debts will be unwound as the little guy defaults, this has not happened because of gov guarantees. This shifts all risk to the govs. Deflation ends the game because it increase the cost of the debt not decreases it (both in the guarantees and real value of money increases), making it much harder to repay. So either there will be hyper inflation to purge a debt that cannot be repaid, or there will be a default on debt that cannot be repaid. In either case I do not care to be in the currency of the default or in debt based instruments.

But please by all means invest in deflation. If your right and there is deflation and somehow the system does not collapse into the black hole, great. I would really mean this time in different and infinite debt does not matter, totally rewrite all economic thinking. If I'm right then your bet helps delay the day of reckoning allowing me more time to save up for my bets. I'll keep on betting on history, and economics as known now that unpayable debts are bad. Good luck to us all.

Spalding_Smailes's picture


Ben can always service the debt he's the only one with a key ....


 The treasuries recycled by foreign central banks are being transformed from sub-inflation rate, pathetic-interest bearing notes into negative interest loans.  Uncle Ben keeps the volume of the liquidity just right and by pouring treasuries and by increasing the amount of power money supply. The Fed is blowtorching the foreign central banks and produces more negative interest loans. (With negative interest loans, the more you loan from a bank the bigger profits you get - it's the prefect investment ). The negative interest loans combined with a fresh round treasuries (released by the Fed in order to avoid a deflationary collapse over the last few years) produces bubbles and inflation on a global scale, look at China .... Lol'

This game really hurts the countries that peg ... Look at all the new debt being borrowed every single day by cb, businesses & people all across this globe. All the countries that peg , india, the opec crew, china, brazil, vietnam .... they all drink up our treasuries keeping this peg. All the commodities, global trade built upon the dollar.

The dollar has been global since the late 70's. Forex/Global Finance/Commodities all this debt floating around the globe for 40 years & since 2007 we have created how much more debt ?????

We already have a quadrillion out on the street at what point is this  " Massive Hyperinflation " going to start after all this ??? 5 more trillion ? 10 more trillion ? 


Shameful's picture

So there is a magical formula that will allow Ben to keep this act going forever? Can I see it? It's the greatest equation ever, putting the idea of Foundation to shame. Such an equation allows one to spin straw into gold.

These nations will be forever bound to the dollar and Ben flooding them with dollars? Why? What gain do these nations get?

Your investment plan is to count on foreign nations constantly wounding themselves to prop the dollar up? And when do you expect this to end? Ever? Won't there come a time when these nations finally kill themselves from the damage? It would be a great miracle, a nation that can produce nothing but accounting units and ship them to the world for goods and services, forever.

As far as massive hyperinflation, I don't have a date. But I will say the dollar will not be anywhere near it's current value in 5 years if it is still around at all, measured against commodities not other melting fiats. The world does not have limitless capital to toss at this, and unless Ben can get a control on commodity prices he'll get blown out pretty quick.

Spalding_Smailes's picture

They are keeping the peg.  Also as China raises rates this year and the drum beat of "slow down " grows louder the commodities will fall. What happens to China's subsidised ponzi manufacturing complex if they de-peg..... ? China is now heading into a shit storm, with banks,insurance,shadow banks,real estate just like we did and all the money will run for safety ( USA ).



Mike Pettis on China .... This is why they peg.


.... " One of the problems with a severely repressed financial system, especially one with rapid credit expansion, is that there tends to be a huge amount of capital misallocation supported by borrowing, and in an increasing number of cases it is only the artificially-reduced borrowing costs that allow these investments to remain viable.  I worry that even if the PBoC wanted to raise rates, it would not be able to do so without exposing how dependent borrowers are on artificially cheap capital.


Take the most obvious example, the PBoC itself.  The central bank officially has about $2.5 trillion in reserves.  This by the way almost certainly understates its true position but let’s ignore that for a moment.  The PBoC has funded this position with an equivalent amount of RMB liabilities, which makes it very vulnerable to changes in the value of the currency.


Rate addiction

In fact there were strong rumors last year that the PBoC was technically insolvent as a consequence of the 20% increase in the value of the RMB against the dollar during the 2005-08 period of currency appreciation.  Weirdly enough, although the numbers are huge, it has proven difficult to convince anyone that the PBoC is not the richest institution in the world, and that it is actually very vulnerable to big losses (although I notice that Sovereign Trends’ Terrence Keeley, in an OpEd in the Financial Times Tuesday, seems also to have done the numbers).

The problem for the PBoC occurs not just because of the currency mismatch but also because it needs repressed funding costs to keep it profitable.  How much do the PBoC foreign currency assets earn?  I would guess probably between 3% and 4%, maybe less.  The RMB funding cost, on the other hand, is roughly between 1.5% and 2.5%.  This leaves the PBoC with a net positive carry of between 1% and 2%.

If the RMB appreciates by as little as 2% a year, in other words, the PBoC runs a negative carry on its assets.  Every further 1% increase in interest rates, or additional 1% rise in the value of the RMB, then, erodes its capital by at least $25 billion (annually, if it happens through an increase in interest rates).

Let’s assume, for example, that over the next two years we see a combined appreciation and interest rate increase of 10% (let’s say a 2% increase in interest rates and a 4% annual appreciation), which is, in my opinion, the absolute minimum that China must do to slow down the worsening domestic imbalances.  Assuming no change in the rate earned on reserve assets, which in fact may decline, this means that the PBoC’s net indebtedness would rise by over $250 billion, or roughly 5% of the country’s GDP.

These kinds of number quickly add up.  And of course it is not just the PBoC that has this addiction to repressed interest rates.  Many years of very low cost borrowing has created a huge dependency on low interest rates among SOEs, local governments, and other creditors of the bond markets and the banks (not to mention the banks themselves), all of whom are directly or indirectly funded by long-suffering households." ................



Spalding_Smailes's picture

I can't wait till I can buy China stocks at rock bottom in a year or two.


Sunday, April 04, 2010 A Reply to my Critics on Local Debt

Victor Shih

Since the publication of my editorial in the Asian Wall Street Journal on local debt, there has been a wave of interest on this issue. Several investment banks have issued reports on local debt, and some of them have disputed my main finding that current local government investment vehicle debt stands at around 11.4 trillion RMB. The World Bank likewise addressed this issue and came up with a much lower estimate on local investment company (LIC) debt. In the discussion below, I outline some reasons why I still adhere to my estimate that existing local investment vehicle debt stands at around 11 trillion RMB. Furthermore, I once again reiterate that local debt is a serious problem which will require decisive actions from the Chinese government. 

Some points people have raised about my estimate of local debt:
1. The Chinese government claims that there is only 6 trillion RMB in local investment vehicle debt.
My response: A. This widely cited figure was produced by a 6/2009 CBRC survey of the situation. The exact methodology is unclear, but informants state that the CBRC extrapolated this amount on the basis of a partial study of a few provinces.
B. Other government agencies have provided conflicting and higher amounts. For example, a MOF research team uncovered "well over 4 trillion" in late 2008 (excellent Credit Swiss research even states that the 4 trillion was a YE 2007 figure).
C. The CBRC finding concerns only bank loans, but total debt should also include bond issuance and accounts payable, which constitute triangular debt.
D. if we sum the gross debt of just the top 50 or so LICs, we quickly arrive at gross debt of over 2 trillion (try adding the gross debt of Guangdong Highway, Guangdong Transportation Group, Chongqing Highway, Beijing Basic Construction, Shanghai Urban Construction and Development Company, Shanghai Pudong Development Co., Tianjin Urban Basic Infrastructure, Binhai Development...etc.), so the remaining 8000 or so entities only owe 4 trillion (on average 500 mln RMB each)?

2. The 11.4 trillion is too high when compared with total bank loans in various categories.
My response: A. First of all, total loans outstanding at the end of 2009 was well over 40 trillion RMB, and I think it is completely reasonable to believe that nearly 1/4 of it was loans to LICs. In fact, I wouldn't be surprised that a higher share of bank loans ended up in LICs. 
B. Some analysts have trouble believing that such a high share of medium and long-term loans ended up in LICs. When we consider how many LICs there are and the vital role they play in the local economic strategy, it is not surprising that likely as much as 3/4 of new medium and long term loans in 2009 ended up in LICs. 
C. Beyond medium and long term loans, many LICs are holding companies with subsidiaries engaged in a wide range of businesses. For example, the LICs run thousands of hotels across China, and loans to these hotels would be classified as loans to the service industry. Thus, in addition to medium and long term loans and loans to infrastructure, it is perfectly reasonable for a sizable share of working capital loans, trust loans, and loans in the "other" category to end up in LICs. Again, gross debt of these entities would also include bond issuance and debt owed to each other.

3. LIC debt can be calculated by subtracting government spending on basic infrastructure from the total infrastructure spending figure. In that light, LIC debt only increased by 2.8 trillion RMB in 2009.
My response:
A. First, as pointed out, LIC are diversified holding companies which do not only engage in infrastructure construction. For example, thousands of subsidiaries of local investment companies engage in real estate development and absorb some share of the real estate loans. The figure generated using the method above, however, may be meaningful one-day when the government decides how much of the existing LIC debt it will seek to take over as part of a bail out. 
B. The calculation above assumes that much of the extrabudgetary revenue from local governments derived from land sales went to infrastructure construction. According to excellent research done by Standard Chartered and UBS on land sales, much of the land sales revenue is spent on compensating original residents, leaving only a minority share for actual investment. Thus, a realistic application of this methodology would lead to something like 3.5 trillion RMB in new loans to LICs, not just 2.8 trillion. 

4. My estimate of 12.7 trillion in future LIC debt is baseless and is way too high for YE 2011.
My response:
A. To be sure, I now think most of this debt will not realize by YE 2011 also. However, it would not be far-fetched to think that most of this debt will be realize by YE 2012. This estimate is not "baseless" as it comes from the hundreds of lines of credit that banks have granted to local governments. As long as banks more or less adhere to these lines of credit, they will lend this amount to local governments at some point in the future.

Shameful's picture

Ok lets assume China is trapped and the US will vampire on them for a while. So eventually China explodes and dies, then what?

What nation will replace China for the US? What nation can replace them in allowing us to consume without producing? And when that nation is burned out what then? This game might go on for a few years, but how does it play out long term? Can the ponzi go on forever? Will endless nations rapidly rise and fall to take on our burden and never wise up?

Spalding_Smailes's picture

They will not blow-up, just a little crash and burn, we are a team. China will be fine in the long run but the transition into a consumer driven economy will be a bit bumpy'.


Its not just China, all the countries that peg have economies built upon cheap credit/debt. They must hold the peg or go boom. They will hold the peg. The house of Saud' loves the status quo-


Not sure how long it can go on but the dollar is at 81 and in the next few years China & the Euro will have some issues this is a given. The dollar is the best of the lot' & the strong bid/churn will continue for a long time.

Pettis thinks it will take until 2030 before China becomes the new reserve currency or maybe we go 50/50 with them some day ? The per capita in China is around $8,000  like the USA in the 40's.

Shameful's picture

So China will not collapse and they will forever support our wild spending? I almost feel like I should vacation over there to thank them. So the team is they produce and we consume? Have to tell you sounds like a shitty deal for them.

"Ok here is the plan. You g out and make all the money and I'll do the hard part, spending it!"

I cannot for the life of me believe that the Chinese are so dumb to follow this course forever. I would not be investing on the idea that the Chinese will forever under consume so America can over consume, but that's just me. I'm no pro.

So how is them going to infinite leverage and never crashing deflationary? Won't them getting wealthier send commodity prices to the moon?

Spalding_Smailes's picture

It all sounds crazy but its true. They de-peg they blow up the PBoC and the banks.

Confessions of an Economic Hit Man. Great book. Great insight ....


We are going to transition ( everyone ). They want to become a consumer driven economy and bring the farmers online, we need jobs back home. Not sure how its all going to play out but they will try to revalue 5% a year then maybe the banks adjust the books not sure how they get off uncle sugars cheap credit high. But they are stuck with Ben's game for now they really have no oher choice. When China does revalue over the next few years some manufacturing work will come back to the USA.

But no, we can't borrow ( joe sixer ) like we did in the past unless they get the shadow banks rolling and turbo charge the credit again.


China is now sending work into Africa, outsourcing Lol' !!!

breezer1's picture

i believe you are right ss. tomorrow i am going to dump my PMs and mining shares. the market will never go down and the dollar will always be strong. i will trust the government. i will trust the government. i will tru....................

velobabe's picture

gold finger, bitch†

goldmiddelfinger's picture

Gold. Gold will be CRUSHED, putain

fiddler_on_the_roof's picture

Can you give a time frame when Gold will be CRUSHED to less than $1000.

That is how Johnny_Bravo left the scene. you could also open another

account now, make a statement about Gold and come back in the new account

bashing Gold.

Dr. Sandi's picture

I think they caught up with JB over the weekend in Tucson. He doesn't have net access in his new digs.

Praetor's picture

Your right dickhead, gold will be crushed to form coinage.

goldmiddelfinger's picture

Somewhere in Africa a tree is missing it's monkey

latcho's picture

We aren't talking perpetual physical gold/silverholdings here. We ride the ride and get out on time (and that might be the time you consider to get on the boat)

latcho's picture

newbie... double |save| hit

Arius's picture

i just hope china backs off and realize one doesnt bite the hand that feeds her...

cranky-old-geezer's picture

When that hand is feeding dollars rapidly losing value, China's opinion may change somewhat.

Arius's picture

these dollars made tourists out of chinese peasants...they better not forget it....

yabyum's picture

Velo, is that a butterfly net you are holding?

velobabe's picture

no, my ninja sword in the right and my handmade fan in the left.

me, samurai sword fan yogi. and my belt inbetween.

goldmiddelfinger's picture

this is where the shit hits the fan

Dr. Sandi's picture

Fan, Hell. The shit's already so deep we're gonna need an auger!

DocLogo's picture

first 10 commentors get 1 free oz of gold?

High Plains Drifter's picture

Damn, how nice of TD to help us out like that.....

umop episdn's picture

More for the metalheads! Welcome, Goldcore! I hope to see more reports as well done as this one.

High Plains Drifter's picture

Its a metalhead world....

Goldenballs's picture

A Golden Opportunity.

youngman's picture

Tomorrow is going to be interesting...I bet the Portugese bonds have a 5 to 1 will be sold to the world that all is good....

DoChenRollingBearing's picture

Great move Tyler(s), your JV with  GoldCore ought to bring lots of interesting news to ZH.

belogical's picture

This stuff isn't for trading, but I found it interesting given the CFTC meeting on Thursday and the Judge getting documents in the GATA case on Friday.

mrgneiss's picture

The rant that link links to sucks.

Buzz Wired's picture

I saw that. I've been following HPH for The last 6 months or so. Should be interesting to see what might come of it all.

Silversinner's picture

Bejing put is making us gold and

silverbugs filty rich.See more than one

billion greedy fingers wanting the shiny stuff.

This demand will overwelm the market.

India likes gold and silver too,one

billion extra.Lot of them being farmers

and be able to buy some more with higher

foodprices.Banks insolvent,gouverment broke

in the west.What is not to be liked about PM.


goldmiddelfinger's picture

No targets, not even a directional call, just a call for diversification. Find some balls.

FB24601's picture

In buzzwords the "black swans" means:

- they will try to install proxy wars
- they will put out new mutated "cleaning" virus
- they will let crisis develop to a certain extent to make people believe there is deflation and no inflation
- you know HAARP

greenewave's picture

The Establishment and Mainstream Media is losing control of the PEOPLE and as a result vehemently ATTACKING ALTERNATIVE NEWS. Suddenly, anyone that does not agree with the Socialist policies of the Obama Administration is an ENEMY OF THE STATE!

Watch the video “The Establishment is Losing Control” at (


“We do not have much time left before the FREEDOM of Americans is robbed by our leaders, the Internet Censored, Guns confiscated and the PEOPLE jailed for speaking truth!”