Gold Is The Only Asset With No Counterparty Risk

By: Axel Merk

While the introduction of a trillion-dollar coin has been shrugged off as nonsense, there are plenty of nonsensical concepts employed in our monetary system. Here we’ll shed light on a few of them.

Governments – or their central banks – can print a $100 bill. The value of such a piece of paper is worth exactly as much as the supply and demand of a currency dictates. Dollar bills are legal tender for payment of debt, but if someone does not like that the $100 bill is not backed by anything, then anyone is free to decline a $100 bill in exchange for services, and barter instead.

The problem arises when the government decrees that something is worth a certain amount, unless it becomes the basis of the government’s entire framework of reference, as in a gold standard. In my humble opinion, no one, let alone a government can precisely value anything. The value of goods, services, even debt, is in the eye of the beholder, and varies based on supply and demand:

Consumers buy goods or services because they believe they are “good value;” in other words, they only exchange money for goods in a deal where they see themselves benefiting. Consumers should not blame companies for “over-priced” goods or services; they should blame themselves for paying such prices.The perception of what is good value varies from person to person. What may be a must-have $80 a month cable TV subscription, may be a waste to others. It also varies over time, as some may deem a vacation well worth the money during good times, but rather stay at homes when times are tough.When monopolies or governments impose prices, distortions, such as supply disruptions can occur. Or conversely, when the government keeps the price of fuel artificially low, it can significantly erode the government’s ability to provide other services, possibly even bankrupt it.

The market currently prices platinum at over $1,600 a troy ounce. If the Treasury were to decree that a specially minted coin is worth $1,000,000,000,000 instead, no rational person would want to buy it. The argument is that the Federal Reserve could be coerced into accepting it at face value, crediting the Treasury’s account at the Fed with $1 trillion for it to spend. In our view, such a move, if it were upheld in the courts, would:

Highlight the not so well known fact that the Federal Reserve (Fed) does not mark its holdings to market. The lack of mark-to-market accounting leading up to the financial crisis is a key reason why the financial system was brought to its knees in 2008. A major loss at the Federal Reserve, such as writing down a $1 trillion coin to $1,600 may not be too worrisome for those that know that even a negative net worth won’t render a central bank inoperative. However, losses at the Fed would deprive the Treasury of what has become an annual transfer of almost $90 billion in “profits” (see MerkInsight Hidden Treasury Risks?).Dilute the value of the dollar. If the Treasury whips up an additional trillion to spend through trickery, odds are that a trillion would no longer be worth what it used to be.

But wait, $1 trillion is already not worth what it used to be, and a $1 trillion coin has not even been minted. And I’m not talking about our grandparents: who had ever heard of trillion dollar deficits before the financial crisis? The Federal Reserve holds just under $3 trillion in assets, up by over $2 trillion since early 2008. When the Federal Reserve engages in “quantitative easing”, QE, QE1, QE2, QE3, QEn or however one wants to call it, the Fed buys securities (mortgage-backed securities, government bonds) from large banks, then credits such banks’ accounts at the Fed. Such credit is done through the use of a keyboard, creating money literally out of thin air. Even Fed Chair Bernanke refers to this process as printing money, even if banks have not deployed most of the money they have received to extend loans. However, the more money the Fed prints, the more debt securities it buys, the greater its income; it’s that argument that has allowed Bernanke to claim that his operations have been “profitable,” neglecting to state that such money printing may pose significant risks to the purchasing power of the dollar.

Note that we don’t need the Fed. Amongst others:

If the Treasury wants to issue debt, it can do so without the Fed.If the Treasury wants to manage the maturity of the outstanding government debt portfolio, it can do so without the Fed’sOperation Twist.

Congress and the Administration love the Fed because it is an off-balance sheet entity for the government with special features; the Fed has ‘unlimited resources’ (it can print its own money); and the Fed can have a negative net worth without defaulting.

The way a trillion dollar coin could work is if not just one, but all platinum coins of the same fine ounce content (say one troy ounce) were decreed to be worth $1 trillion. It would be the re-introduction of a gold, well, platinum standard, as it would link the value of a precious metal to the value of the currency. The government would quite likely want to punish any speculators that are front-running the idea of valuing platinum at $1 trillion, possibly even outlawing private ownership. But it would put the value into context and anyone could buy a substitute. Pricing of all goods and services would adjust to reflect the new value of $1 trillion for a troy ounce of platinum. In plain English, such a move would substantially move up the price level.

We deem the re-introduction of a precious metals standard to be rather unlikely, precisely because it takes away the power of Congress to spend: it could only spend money if it got hold of more platinum. Unless, of course, Congress realizes that it may get away with not backing all of the currency with platinum or resets the price of a platinum coin yet again. Soon enough, the “platinum window” would be closed again, just as Richard Nixon closed the gold window in 1971. Let’s call it a coincidence Nixon would have turned 100 years old this year, just as the Federal Reserve is celebrating its 100th anniversary.

While most agree that a $1 trillion platinum coin is a silly idea, few think that a $100 bill is also absurd. There are indeed key differences:

$100 bills are all one and the same. Well, almost. In some developing countries, newer bills are worth more than older ones (because of counterfeit bills in circulation).A platinum coin has intrinsic value: its fine ounce content of platinum. In contrast, the $100 bill is worth the paper it is printed on.

To be precise, a $100 bill is a Federal Reserve Note:

The holder of a $100 bill may deposit such bill into his or her account.The bank can deposit the $100 bill at the Fed. In turn, the Fed will credit the bank with $100 in checking account.The bank can withdraw the deposit of $100 from the Fed.The bank account holder can withdraw $100 from the bank yet again.

Importantly, the $100 is always an obligation: an obligation of the bank, the government (through FDIC insurance in case of default of the bank) and the Fed (currency in circulation appears on the liability side of the Fed’s balance sheet). Most currency is not issued in paper, but in electronic form. Banks receiving a $100 electronic credit can, through the rules of fractional reserve banking, lend out a multiple of such deposits. Because of this, currency always carries counter-party risk. By regulation, if the counter-party is the Federal Reserve or the Treasury, it is considered to be risk-free. But it’s still a debt security. Moreover, the rating agency Standard & Poor’s does not consider US debt risk-free, having downgraded it because of the dysfunctional political process in addressing the long-term sustainability of U.S. deficits.

In contrast, a coin in itself does not have counter-party risk. It’s a coin with intrinsic value. If a government decreed a value onto that coin, there’s a risk that such decree may change or be undermined.

Precious metals coins may be considered barbarous relics, but at least they do not carry counterparty risk. Indeed, we like the fact that gold in particular has comparatively little industrial application, making it a pure play on monetary policy.

So what is an investor to do? In our opinion, investors must gauge for themselves what something is worth, rather than rely on a government. That applies to the dollar as much as it does to a platinum coin or any security. Notably, forget about the notion that something is risk-free. Those trusting their governments to preserve the purchasing power of their savings will be the losers. Those throwing out the risk free component in their asset allocation models may well come out with fewer bruises.

And while the gold standard has some admirable features, democracies tend to favor spending over balancing books. Over the past 100 years, we have moved further and further away from the gold standard. While a collapse of the fiat monetary system might temporarily get us back on a gold standard, don’t trust a government to take care of you. In practice, this means that investors need to create their personal frame of reference as to how to deploy investments; rational investors are unlikely to mint a personal $1 trillion coin, realizing that no one would pay $1 trillion for it. It also means there is no single safe haven during times of crisis. The fact that precious metals have no counter-party risk is an attractive feature, but don’t kid yourself: if your daily expenses are in U.S. dollar, the value of your purchasing power will fluctuate. Investors must be able to sleep at night with their investments; if not, consider reducing your exposure.

Is volatility with regard to the U.S. dollar an argument against owning precious metals? No, but one needs to be keenly aware of the risks of any investment, including perceived safe havens. To manage the risk to the U.S. Dollar, investors may also want to consider actively managing dollar risk. Please join our Webinar this Tuesday, January 15, 2013, that focuses on our outlook for the dollar, gold and currencies for 2013. Please also sign up for our newsletter to be informed as we discuss global dynamics and their impact on gold and currencies.

Axel Merk

Axel Merk is President and Chief Investment Officer, Merk Investments.

Merk Investments, Manager of the Merk Funds.


Gold Will Benefit From The Coming Currency Turmoil

By:  Axel Merk, Merk Investments

Sidetracked by the discussion over the “fiscal cliff” and possibly a New Year’s hangover, it’s time to face 2013 in earnest. Is the yen doomed? Will the euro shine? What about Asian and emerging market currencies? Will gold continue its ascent? And the greenback, will it be in the red?

Before we look too far forward, let’s get some context:

“Central banks hope for the best, but plan for the worst” was our theme a year ago. With everyone afraid of the fallout from the Eurozone, printing presses in major markets were working overtime. We argued this would benefit currencies of smaller countries – be that the so-called commodity currencies or select Asian currencies – that feel less of a need to “take out insurance.”While we were positive on the euro when it approached 1.18 versus the U.S. dollar in 2010, arguing the challenges are serious, but ought to be primarily expressed in the spreads of the Eurozone bond market. Then in the fall of 2011, we grew increasingly cautious because of the lack of process: just as it is difficult to value a company if one doesn’t know what management is up to, it’s difficult to value a currency if policy makers have no plan. In the spring of 2012, when we were most negative about the euro, we lamented the lack of process in a Financial Times column. European Central Bank (ECB) chief Mario Draghi appeared to agree with our concerns, imploring policy makers to define processes, set deadlines, hold people accountable. After his “do whatever it takes” speech in July 2012, he took it upon himself to impose a process on European policy makers in early August 1. We published a piece “Draghi’s genius” where we called for a bottom in the euro. We were inundated with negative feedback in the immediate aftermath of our analysis from professional and retail investors alike, confirming that were not following the herd, nor buying something that’s too expensive.While we liked commodity currencies in the first half of the year because of printing presses in larger economies working overtime, we grew a little cautious as the year moved on, partly because of valuations. Each commodity currency has its own set of dynamics, as well as their own Achilles heel: in the case of the Australian dollar, we had some concerns about its two tier domestic economy (not all of Australia was benefiting from the commodity boom), but also about the perceived slowdown in China.We studied the Chinese leadership transition with great interest; while 2012 may have been a year in transition, more on the dynamics as we see them play out below.Back in the U.S., we squandered another year to get the house in order. The fiscal cliff was a distraction; we need entitlement reform to make deficits sustainable. Europeans have no patent on kicking the can down the road. But unlike Europe, the U.S. has a current account deficit, making it more vulnerable should investors demand more compensation to finance U.S. deficits (that is, higher interest rates).Japan: the more dysfunctional the Japanese government has been, the less it could spend, the less pressure it could exert on the Bank of Japan. Add to that a current account surplus, and all this “bad news” was good news for the yen. Countries with a current account surplus don’t need inflows from abroad to finance government deficits; as a result, the absence of economic growth that keeps foreign investors away is of no detriment to the currency. Conversely, countries with current account deficits tend to pursue policies fostering economic growth to attract capital from abroad. However, in late 2012, we published a piece “Is the Yen Doomed?” What happened? Japan was about to have a strong government. More in the outlook below.

We believe the currency markets are well suited for decision-making based on macro-analysis. Just as throughout 2012 the themes were evolving, please keep in mind that our 2013 outlook may be outdated the moment it is published, as we update our views based on new information or a new analysis of old information. Still, those who have followed us over the years are well aware that we like to shift our views within a framework. Please consider our 2013 outlook in this context:

We believe the yen is indeed doomed. We remove the question mark. Prime Minister Abe’s new government sets the stage, but key to watch are: Abe’s government will appoint the three top positions at the Bank of Japan, as the governor and both deputy governors retire. Recent appointees have already been more dovish. Japanese culture is said to prefer talk over action, but the time for dovish talk may finally be over (despite their dovish reputation, the Bank of Japan barely expanded its balance sheet since 2008; in many ways, of the major central banks, only the Reserve Bank of Australia has been more hawkish).Japan’s current account is sliding towards a deficit. That means, deficits will start to matter, eventually pushing up the cost of borrowing, making a 200%+ debt-to-GDP ratio unsustainable.Abe’s government is as determined as it is blind. Abe believes a major spending program is just what Japan needs. As far as the yen is concerned, Abe may be getting far more than he is bargaining for.But isn’t everyone negative on the yen already? Historically, it’s been most painful to short the yen; as such, many have not walked their talk. We expect some fierce rallies in the yen throughout the year. Having said that, the yen looks a lot like Nasdaq in 2000 to us. Not as far as technicals are concerned, but as far as the potential to fall without much reprieve.The euro may be the rock star of 2013. Boring is beautiful. Sure, there are plenty of problems, but the euro is morphing into yet another currency, but is still priced as if it had a contagious disease. While the Fed, the Bank of England, the Bank of Japan are all likely to engage in further balance sheet expansion (we refer to it as “printing money” as assets are purchased by central banks, paid for by entries on computer keyboards, creating money out of thin air), there’s a chance the ECB balance sheet may actually shrink. That’s because some banks have indicated they will pay back early part of the €1 trillion in 3-year loans taken from the ECB. Some suggest the ECB might print a boatload of money should the “Outright Monetary Transaction” (OMT) program be activated to buy the debt of peripheral Eurozone countries. Keep in mind that the OMT program would be sterilized, likely by offering interest on deposits at the ECB. As such, the OMT would lower spreads in the Eurozone and, through that, act as a massive stimulus. In our assessment, however, such a stimulus is far less inflationary than central bank action in other regions. It’s no longer a taboo to be positive on the euro, but most we talk to are at best “closet bulls.”The British pound sterling. The Brits are getting a new governor at the Bank of England (BoE) in the summer, the current head of the Bank of Canada (BoC), Carney. One of the first speeches Carney gave after his appointment was made public was about nominal GDP targeting. Carney will have a chance to replace many of the current BoE board members. That’s the good news, as the old men’s club is in need of a makeover. The not-so-good news is for the sterling. British 10 year borrowing costs have just crossed above those of France. We’ll monitor this closely.As the head of the BoC, Carney was particularly apt at talking down the Loonie, the Canadian dollar, whenever it appeared to strengthen. If Macklem, his current deputy, is appointed, we may get a real hawk at the helm of the BoC. We are positive on the Loonie heading into 2013, but will monitor developments closely, as there are economic cross-currents that, for now, Canada appears to be handling very well.Staying with commodity currencies, we are cautiously optimistic on the Australian dollar (China better than expected; monetary policy more hawkish than priced in) and New Zealand dollar (more hawkish monetary policy on better than expected growth). We continue to stay away from the Brazilean real and leave it for masochistic speculators looking for excitement.We are positive on Norway’s currency (joining the above mentioned rock star, with greater volatility), yet cautious on Sweden’s (priced to perfection is not ideal when things are not perfect, even in Sweden).China: the new leadership has indicated that liquidity for the Chinese yuan may be their top currency priority. That’s great news, as we believe it implies policies that attract investment, not just from the outside, but also with regard to a development of a more vibrant domestic fixed income market. We are more positive on China than many; more on that, in an upcoming newsletter (click to sign up to receive Merk Insights)Korea, Malaysia, Taiwan: all positive, benefiting from both internal forces, but also beneficiaries of actions in other large economies. If we have to pick a favorite today, it would be Korea, but keep in mind that the Korean won is the most volatile of these currencies.Singapore: we continue to like the Singapore dollar. A year ago, we started using it as a substitute for the euro (rather than using the U.S. dollar as the safe haven currency). The currency may well lag the euro’s rise, but the lower risk profile of the currency makes it a potentially valuable component in a diversified basket of currencies.Gold. We expect the volatility in gold to be elevated in 2013, but consider it good news, as it keeps the momentum players at bay. We own gold not for the crisis of 2008, not for the potential contagion from Europe, but because there is too much debt in the world. We think inflation is likely a key component of how developed countries will try to deal with their massive debt burdens, even as cultural differences will make dynamics play out rather differently in different countries. Please see for more in-depth discussion on our outlook on gold.

And what about the U.S. dollar? While much of the discussion above is relative to the U.S dollar, the greenback itself warrants its own analysis:

Investors in the U.S. should fear growth. The spring of 2012 saw the bond market sell off rather sharply as a couple of economic indicators in a row came out positively. Bernanke wants to keep the cost of borrowing low, but can only control the yield curve so much. That’s why, in our assessment, he is emphasizing employment rather than inflation, in an effort to prevent a major sell-off in the bond market before the recovery is firmly established. Growth is dollar negative because the bond market would turn into a bear market: foreigners’ love for U.S. Treasuries might wane, just as it historically often does during early and mid-phases of an economic upturn as the bond market is in a bear market.Good luck to Bernanke to raising rates in 15 minutes, as he promised he could do in a 60 Minutes interview. Sure he can, but because there’s so much leverage in the economy, any tightening would have an amplified effect. At best, we might get a rather volatile monetary policy. But we are promised by the Fed that this is not a concern for 2013.Both of these, however, suggest volatility will rise in the bond market. Remember what got the housing bubble to burst? An uptick in volatility. That’s because leveraged players, momentum players run for the hills when volatility picks up. And a lot of money has chased Treasuries, praised as the best investment for over two decades. We don’t need foreigners to sell their U.S. bonds for there to be a rude awakening in the bond market; we merely need a return to historic levels of volatility. Why is this relevant to a dollar discussion? Because a bond market selloff makes it more expensive for the U.S. to finance its deficits. Please see our recent analysis of the risks posed to the dollar by a bond market selloff for a more in-depth discussion on this topic.

Axel Merk is President and Chief Investment Officer, Merk Investments. Merk Investments, Manager of the Merk Funds.


Profit From Power Elite’s Key Sector Price Inflation With Gold

“The future price tag of printing six trillion dollars’ worth of checks comes in the form of inflation and devaluation of currencies either relative to each other, or to commodities in less limitless supply such as oil or gold.

Zero-bound interest rates, QE maneuvering, and ‘essentially costless’ check writing destroy business models and stunt investment decisions which offer increasingly lower ROIs and ROEs.”

Bill Gross, Founder & Co-CIO, PIMCO, 1/3/2013

For several years, Notable Independent Commentators, including Deepcaster, have warned that the Elite Central Banks’ Orgy of Fiat Currency Printing, a la QE etc, would result in Price Inflation.

So it is no surprise to us that The Bond King, Bill Gross of PIMCO, with about $2 Trillion under Management, would finally warn, in his January, 2013 letter to Investors, of Impending Price Inflation in Key Commodities.

Of course, General Price Inflation is already here, if one looks at the Real Numbers (e.g., U.S. CPI at 9.8% per as opposed to the Bogus Official Ones.

Going forward, this Mega Bank-generated Price Inflation provides considerable Profit Opportunities, but only in certain kinds of Commodities, and especially in one Sector Bill Gross does not specifically mention. (See Notes 1, 2, 3 and 4)

In sum, Policies actually being Implemented by the Power-Banker Elite virtually ensure a continuation of Fiat-Currency Depreciating Policies, and thus Price Inflation in Certain Commodities Sectors, as well as Increasing Risk of Systemic Destabilizing à la 2008-2009.

Yet consider also that the “Regulators” continue to accede to the Mega Banks wishes.

Basel Committee’s revised LCR prompts relief and concerns

The Basel Committee on Banking Supervision’s decision to give global banks an additional four years to meet liquidity requirements was aimed at ensuring that the change wouldn’t discourage lending to the real economy. Some banks have already benefited from the revised liquidity coverage ratio, with their share prices increasing. GFMA welcomed the Basel panel’s decision to allow mortgage-backed securities and equities to be included in banks’ liquidity buffers.

Basel panel’s allowance of MBS in buffers faces scrutiny

The Basel Committee on Banking Supervision’s decision to let banks include equities and residential mortgage-backed securities in Basel III liquidity buffers is gaining plaudits and criticism. Bankers welcome the revision, but experts say it is unlikely to significantly lift a slack securitization market. The change also presents challenges for regulators

Significantly, Many Mortgage Backed Securities are still Toxic if Mark-to-Market Standards are applied, which they are no longer required to be.

So, de facto, the Banks may “count” Toxic Securities as part of their Liquidating Buffer.

Worse yet, the Regulators have, once again, administered a mere slap on the wrist to Major Banks which engaged in unacceptable practices. For example

Banks settle mortgage-related legal disputes

Bank of America, JPMorgan Chase, Wells Fargo, Citigroup and other major banks agreed to pay a total of $20 billion to settle two legal disputes related to the mortgage crisis. BofA agreed to pay Fannie Mae $11.6 billion. In a separate dispute, 10 lenders agreed to pay more than $8.5 billion over foreclosure practices.”

sifma SmartBrief, 1/8/2013

Hardly a deterrent going forward.

In effect, this policy allows Risk to continue to Threaten Systemic Stability and its wealth of Individual Investors.

Making matters worse for Systemic Stability and Investors alike, is the Mega-Bankers’ Cartel (see Note 5) ongoing Manipulation, not just of Precious Metals but of a Wide Variety of Markets.

While Deepcaster, GATA and others have been complaining about such Manipulation for years, the Situation has become so threatening to Systemic Stability that even the Most Reputable and successful Investment Managers such as PIMCO’s CEO, Mohammed El-Erian, are complaining about the Risks inherent in such intervention as well.

“The investment recommendations made by many financial commentators are now dominated by cross-asset class relative valuation rather than the fundamentals of the investment itself….

“This is an understandable approach as unusual central bank activism has artificially elevated certain asset prices. Yet the dominance of this increasingly popular advice comes with potential risks that need to be well understood and well managed.

Several asset classes now have highly manipulated prices due to experimental central bank activities, both actual and signalled. The more this happens, the more investors come under pressure to migrate to higher risk investments in search of returns….

“Just a few weeks ago the Federal Reserve announced it is targeting a further $1 trillion in asset purchases in 2013, representing a third of its existing balance sheet. Other central banks — particularly the Bank of England, the Bank of Japan, and the European Central Bank — are also expected to expand their balance sheets again in the months ahead….

“There is a limit to how far central banks can divorce prices from fundamentals….at some point, and it is hard to tell when exactly, the private sector will increasingly refuse to engage in situations deemed excessively artificial and overly rigged….

“Have no doubt: Central banks are both referees and players in today’s markets. With 2013 starting with so many liquidity-induced deviations, investors would be well advised to take greater care when pursuing opportunities that rely mainly on the ‘central bank put.’” (emphasis added)

“Beware the ‘Central Bank Put’”, Mohamed El-Erian,, 01/07/13

Chief Executive and co-Chief Investment Officer of PIMCO

El-Erian is Spot-On correct about the Risks Associated with Investment in “Highly Manipulated Asset Classes, which is why Deepcaster’s portfolio Recommendations aim both to Minimize Risk from and to Profit from, these and others.

But it also makes certain Real Assets even more attractive going forward.

Thus the Big Smart Money is responding accordingly, moving Money into Gold and certain other commodities (See Notes 1, 2, 3 and 4).

For example, notwithstanding ongoing Cartel (Note 5) Precious Metals Price Suppression and in response to Japanese Prime Minister Abe’s pledge to spur Inflation, Japanese Pension Funds ($3.36 Trillion in Assets!) plan to double their Gold Holdings in the next two years according to Bloomberg Business Week.

A word to the wise: Go for the Gold.

Best regards,
Wealth Preservation Wealth Enhancement