-- Posted 28 November, 2006 | |

Martin W. Hennecke

01 December 2006

Regular readers of websites like this one will already be well informed of the onrushing financial collapse and national bankruptcy of the United States, as this topic is receiving  ample coverage nowadays from an abundance of writers and economists, including unmistakable warnings from many former senior government officials and central bankers as well as from the very institutions that are presently in charge, such as the  International Monetary Fund, the Bank of International Settlements or the US Federal Reserve. So I will save myself repeating the obvious here, suffice to say that anyone who is new to the real world and would scoff at such notion may want to start educating himself/herself by reading some introductory books such as Bill Bonner’s ‘Empire of Debt’, or browse the Federal Reserve Bank of St. Louis’ report ‘Is the United States Bankrupt?’ published earlier this year.

What a large number of even the more educated US Dollar bear-and US financial crisis expectation camp however do NOT seem to be aware of is the global nature of the problem. It is completely wrong to assume, for example, that the Euro or the British Pound are inherently ‘hard’ and healthy currencies that would provide protection from a plunging US Dollar. It is not known by most, that in fact the majority of the Western ‘developed’ world and not just the United States is facing national bankruptcy shortly ahead, and that this has been officially predicted by the world’s leading rating agency, Standard & Poor’s.

US, Germany, France and UK face junk debt status

Source: Standard & Poor’s

It has also largely gone unnoticed that Germany’s capital city Berlin just went officially bankrupt, and that Standard & Poor’s has revised its rating outlook for Germany since publication of the above chart, stating that the country may loose its triple-A credit rating on sovereign bonds already in 2007, which would speed up the previous sovereign default projection as above by roughly 10 years. Weimar II is much closer than most people would imagine.

It is the same old story time and time again that repeats itself. Governments go too deep into debt, loose control of their budget deficits, and then have to hyperinflate their currencies to get out of unpayable debt. There is not a single case in history where this has NOT happened. And yet most investors who seek ‘safety’ today mostly still choose to invest in government bonds or bank deposit thinking it is safe and earns a ‘yield’. I am afraid, not only is such yield mostly an illusion, as true inflation nowadays is at least as high as the interest earned on deposit or sovereign bonds, but the entire capital invested is now at acute risk of being destroyed through either default or hyperinflation, whether it is UK guilts, German bunds or US T-bills, it really doesn’t matter, although, unlike projected in the above chart, my guess is that the US will be hit first and hardest, due to the large trade deficit on top of the debt.

Source: www.usagold.com 

What lies ahead therefore is yet another replacement of the major present currencies with new ones. Life will go on, but those holding the present (old) money or bonds are at risk of loosing everything while those holding precious metals can simply, after the crisis, use the metal to exchange it for the new currency, with no loss and very possibly actually with substantial gains.

Against this background it is very curious, if not intriguing, to note that those institutions commonly entrusted with taking care of the financial security of individuals, mainly the banks and insurance companies, busily portray gold and silver as an unpromising, high-risk speculative assets, while marketing cash deposits, or Western sovereign bonds or bond funds as meaningful and basically risk-free investment-strategies. Nothing could be further removed from reality.

Giving the rise of Asia, and China in particular, precious metals should, at worst, have a very limited downside due to increasing demand from this region, even if a financial crisis should not materialize for whatever reason. In particular silver prices are actually likely to soar in any scenario due to extremely low prices today – the metal still trades at a 90% inflation-adjusted discount over 1980s levels –, incredibly low global silver bullion stockpiles, which have been reduced from around 10 billion ounces at the end of WWII to a few hundred million ounces today, and rapidly diminishing underground reserves.

Source: Pan American Silver Corp Annual Report 2005

Furthermore there are currently more patents for new silver applications being filed each year than for all other metals combined, due to silver’s unique light-reflectivity, conductivity and anti-bacterial properties, with many promising future-oriented industries depending on use of the metal, such as space travel, the solar industry, water purification and the fastest growing sector of nanotechnology, silver nanoparticle textiles, among many others. The often cited reduction in silver demand for photography has in fact very little bearing on total silver demand.

Source: Pan American Silver Corp Annual Report 2005

But clearly, and most importantly, non-withstanding details in demand trends for various metals, it is most important of all for investors to understand that gold and silver mean safety as either a sovereign bond default wave or hyperinflation in the major Western economies approaching. Anyone with an open mind therefore is advised to educate himself/herself on the true state of the financial system, and to use his/her common sense rather than relying on the mainstream media or the banks for advise.

Owning gold and silver today is no guarantee to make a fortune, but it does increase the chances of investors to go through the coming financial crisis unharmed. One word of caution though, when purchasing precious metals, one should purchase the physical bars and coins and/or fully allocated, independently audited and un-leased/lend bullion funds which store the metals on a fully segregated basis from the custodians’ assets and/or precious metals mining assets. The ‘paper-gold’ offered by most banks on the other hand should be avoided, as it is usually not backed by any physical metals and therefore subject to the risk of default.

Martin W. Hennecke
email: question@bridge-water.com     
website: www.bridge-water.com

An investment adviser with Bridgewater Ltd. based in Hong Kong, Martin W. Hennecke is a regular guest on CNBC, Bloomberg TV, NDTV, TVB Pearl, RTHK Radio 3 and writes for several newspapers and magazines including the South China Morning Post,  Hong Kong Economic Journal, Benchmark Magazine and Hong Kong Securities Journal.

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