Friday, November 15, 2013

Can the United States pull off a beautiful deleveraging?

As Ray Dalio points out in a recent video, "borrowers debt levels have simply gotten too big and can't be relieved by lowering interest rates", he explains that there are several ways to tackle a deleveraging which has to occur once we reach this point (cut spending, reduce debt, redistribute wealth & print money):

Dalio's video suggests that in a 'beautiful deleveraging' it takes a decade or more for debt burdens to fall and economic activity to get back to normal (2-3 years of deleveraging/depression, followed by 7-10 years of reflation).

Others believe that the deleveraging will occur over longer period of time, for example David Llewellyn-Smith of MacroBusiness recently wrote:
The GFC was and is the pivot point in a structural adjustment that has only just begun, probably has decades yet to run, and before it’s over will likely change our world to something that looks more like the nineteenth century than our super fast modern version (in the sense of slower moving capital not widespread typhous!).

Put simply, we’re in a long term deleveraging phase for the global economy following a long term leveraging phase. What this means is that pretty much for the rest of your working life, the world is going to be regularly convulsed as its debts are saved against, inflated away, defaulted upon, and even sometimes repaid! It will shake both private and public sectors repeatedly and will afflict both developed and developing economies.

This is neither good nor bad. It is neither bearish nor bullish. It just is.
My response to this post, in the comments below was:
The view that we will see decades worth of readjustment makes the assumption that we don’t see a major event (planned or unplanned) change the entire financial / monetary system as we know it. It makes the assumption that after half a century of imbalances building we will be able to rebalance slowly, but surely, with only the odd crisis to contend with (none of which will spin out of control resulting in a larger collapse or a change to the status quo). I simply don’t buy it.
I think it's very unlikely that the US (or in fact many western economies which have a high level of debt to GDP) will be able to delever so easily this time around. US total credit market debt to GDP is down from the 2009 peak, however has a long way to fall before returning to levels that could be considered sustainable if interest rates were to normalise:

In 1933 US total debt credit market GDP topped at 300% (assisted by a 46% decline in GDP starting in 1929) and took roughly 20 years to bottom:
At the beginning of the Great Depression in 1929, the bulk of US debt was corporate debt tied to the investment bubble in auto manufacturing, electric utilities, household appliances, radio and other sectors that made up the "new economy" of the Roaring Twenties. Corporate debt to GDP collapsed from over 100% in 1933 to under 30% by the mid-1940s. Household debt fell from 50% of GDP in 1933 to roughly 15% in the same time period. Much of the drop in total debt to GDP came during the 1933-1936 period, when the dollar was devalued by 50% and economic growth was very high (albeit from an extremely low base). The ratio rose again when the economy relapsed in 1937-38, but resumed its decline when the economy recovered modestly in the pre-war years. The Dynamist
Today, the US is in an even more precarious position than during The Great Depression. The level of debt to GDP is much higher and more importantly the US is not able to easily devalue the dollar as they did in 1933 when they adjusted the Gold price from $20.67 per ounce to $35 per ounce.

Many other countries left the Gold standard in the 1930's in order to devalue their currencies along with the US. It's not so easy today, the US isn't able to devalue their currency against a reserve asset like Gold as their currency is the defacto global reserve currency. They are only able to compete with other countries to devalue their currency all the while putting on the facade that they have a "strong dollar policy".

The US faces the challenge of trying to reduce their debt burden at the same time as receiving criticism from China and elsewhere over attempts to kick start economic growth & inflation to reduce their massive debt burden (the below just one example of many where they have been criticised for their actions):
A senior Chinese official said on Friday that the United States should cut back on printing money to stimulate its economy if the world is to have confidence in the dollar.

Asked whether he was worried about the dollar, the chairman of China's sovereign wealth fund, the China Investment Corporation, Jin Liqun, told the World Economic Forum in Davos: "I am a little bit worried."

Jin said he was confident that the Obama administration and Congress would ultimately solve the debate over the so-called fiscal cliff, "but of course the printing machine will have to slow down for people to have full confidence in the dollar". Jan 2013, Reuters
It seems to me that the US faces an impossible situation, as they attempt to reduce their significant debt burden, while retaining the US dollar as global reserve currency, a luxury which has allowed them to over spend as long as they have.

It seems to me what the US and the rest of the world could do with is a global reserve asset against which to devalue fiat currencies & extinguish their debt.

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Wednesday, November 6, 2013

A Bullion Company In Australia Hiding $130M Liability

This story slipped past my radar around a week ago... the Australian Tax Office, Australian Federal Police and Australian Crime Commission recently executed search warrants on premises associated with companies operating in the gold bullion and precious metals industries. The following is an excerpt from the AFP media release:
It is alleged the companies fraudulently claimed GST credits and failed to report GST correctly. They formed syndicates to conceal the true nature of their activities and to avoid detection.

As a result of the investigation the ATO has issued garnishee notices and GST amended assessments with liabilities of more than $130 million.

ATO Deputy Commissioner Greg Williams said the ATO takes GST fraud seriously.

“The majority of businesses do the right thing, however the ATO will pursue those that choose to engage in illegal behaviour.”

“Further audits of industry participants will be undertaken in the near future and we will continue to work closely with other government and law enforcement agencies to pursue those suspected of abusing the system,” Mr Williams said.
Bron Suchecki provided brief comment on his personal blog:
GST is a Australian sales tax of 10% that applies to precious metals that do not meet the definition of investment. It likely that the fraud involves scrap gold or silver where GST is payable. Note that it is being classified as "organised crime" which allows the police to invoke proceeds of crime laws so the people behind it can't hide behind the bankruptcy of the companies involved.
One thing I found interesting about the story is that the media release refers to investigating "companies". The explanation that the companies formed syndicates to conceal the nature of the activities suggests to me they are probably linked through ownership/mutual interest. So while the fraud may involve scrap metal (as Bron points out), the group of companies hiding the activities could very well include bullion dealer/s who provide services to the retail buying public.

There has been a little follow up in mainstream media, the state these companies are from has not been identified (The West), the AFP did not respond to requests for further information (ABC News).

Given that the ATO has issued garnishee notices it's possible they wish the companies to continue operating and have the money owed returned over time:
We can issue a garnishee notice to a person or business that holds money for you, or may hold money for you in the future. The garnishee notice requires them to make payments directly to us to reduce your debt. The payments may be a percentage of your wages or we may issue a notice for a lump sum amount. The notice will also specify when payments are to be made. ATO 
While this might be the best outcome for the ATO who is seeking to recover the funds (what are the chances they receive payment if the companies are publicly disclosed), it leaves bullion buying Australians in a precarious position. I know I wouldn't feel comfortable placing a large (or for that matter any sized) order with a company who has $130,000,000 in outstanding liabilities and what if these companies offer storage facilities for their clients? I'd suspect any customers holding unallocated bullion with these companies (assuming they offered such services), would be behind the ATO when lining up for a payout (in the event they were liquidated).

If the companies involved in the investigation were prepared to defraud the tax office of $65 million, then in my mind they shouldn't be allowed to continue operating, they are a risk to small time investors who are just looking for a safe asset, free of counterparty risk (ironic we often bear such risks in the purchase, delivery and storage of precious metals).

If anyone has any information that could lead to the confirmed identification of a company or companies involved in this investigation, please drop me an email (

I welcome comments on this post, but in the interest of avoiding any lawsuits please do not speculate on the identity of the companies in question. And until the identity of these companies is revealed, tread carefully when buying or storing precious metals in Australia (care you should be taking anyway!).

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