Scoops Lane
Wednesday, 9th October 2013
Melbourne, Australia
By Dan Denning

  • 216 hours to default?
  • Gold’s next move
  • 4G warfare pioneer dies
  • Death spiral and dirty power, by Nick Hubble

‘The U.S. must avoid a situation where it cannot pay and its triple-A ranking plunges all of a sudden…The U.S. must be fully aware that if that happens, the U.S. would fall into fiscal crisis.’Taro Aso, Japanese Finance Minister

‘What frightens us the most is what happens to the plumbing system of the global-financial system. You will have cascading failure, multiple defaults, and Treasurys that act as collateral would be very difficult to exchange and people will simply step back. It will be like Lehman, but more unpredictable.’Mohamed el-Arian, PIMCO

‘It’s fair to say that banks don’t want to take Treasury bills as collateral if in fact they are not going to be paid.’ John Brady, RJ Obrien

NB: There are 38 seats available for a special event I’m hosting on Tuesday, October 29th, from 3:00-4:30 pm at the State Library of Victory. My old friend Rick Rule will be talking gold, commodities, and how to be a contrarian resource investor, not a victim. The event is free. But only RSVP if you intend on coming. Rick took time out of his schedule to make himself available exclusively for US. He’ll deliver about 45 minutes worth of remarks, and then take questions. To RSVP for one of the last spots, send an email to If there are seats left, you’ll be sent an email confirming the details of the event.

216 hours to default?

If you believe the media and the White House, the US is on the countdown clock to default. If the ‘debt ceiling’ isn’t raised by October 17th, all hell will break loose. What’s more true, at least for financial markets, is that the actions of the Federal Reserve matter a lot more to stock prices than whatever the Congress or the President do. Fiscal policy is dead. Long live monetary policy!

Warnings of a default are political scare mongering. It’s designed to get the public worried about an imminent crisis so that the ceiling will be raised and the US can stack on more debts it will never repay. In point of fact, even if the Congress doesn’t raise the debt ceiling, there is plenty of cash for the US Treasury to pay interest on its bonds. There’s just enough cash to pay bondholders and everything else, including new spending.

The US will collect nearly $200 billion in tax revenues in October, according to economist Brian Wesbury at First Trust Advisors. He reckons the Treasury will have to pay about $25 billion in interest payments for the month. On a cash flow basis, then, there is plenty of money to pay bond-holders without having to miss a payment (default). So what’s the problem?

The real problem is that the US has a spending habit financed with short-term borrowing. That borrowing has to be refinanced as debt matures. You issue new debt to pay off the old debt and you keep spending like there’s no tomorrow. But tomorrow has come early!

Over 80% of the marketable US government debt held by the public – or $9.2 out of $11.5 trillion – is in notes and bills. The notes can be three, five, or seven years. That’s about $7.7 trillion in debt held by the public. About $1.5 trillion is in short-term bills (usually less than a year in maturity).

All of that means US debt is HUGELY interest rate sensitive. If you have to refinance it at higher rates, your interest payments go up too. And that’s the real problem for America. In 2012, the Treasury redeemed $6.8 trillion in notes, bills, and bonds and sold $7.9 trillion. The $1.1 trillion difference represented the total expansion in the debt level.

The Treasury sold $8.3 trillion in securities in the 2013 fiscal year and redeemed $7.5 trillion. The difference financed a $777 billion expansion in the debt. That was smaller than the previous year. But you can see the problem. The US government is systematically stacking on debts. It’s now reached the political limits of that debt expansion.

These are all the financial and political signs of an Empire in decline. The short-term shenanigans are theatre. But the long-term fiscal picture in America is quite serious. As the foundation of the global financial system – a Tier 1 asset on the balance sheet and the premier collateral for borrowing – the US Treasury market is in trouble.

That’s the real story of this whole mess. The trouble is, you don’t swap out the heart of the global financial system overnight. It simply can’t be done. Even if a stop-gap solution is found in the next 10 days, the next 10 years are when the real demographic problem will begin for America. Entitlement payments and net interest on the debt will begin consuming more than half of US tax revenues. The clock is ticking.

Gold’s next move

With the dire US fiscal situation front and centre in global markets, you’d expect the gold price to get a boost. Yet it hasn’t. That prompts an important question: if gold can’t move higher with mounting anxiety over a US default, what happens when the debt ceiling is eventually raised? Will gold head lower?

The technical chart doesn’t yield a clear answer. The gold price is up off the June lows. But since the short-covering rebound it seems to have rolled over again. It’s trading below both the 35-day and 50-day moving averages. And if the 35-day crosses below the 50-day, it’s possible we could retest the June lows.

A retest of those lows would be a killer blow for junior gold stocks. That makes this gold discussion critically important if you’re in Aussie junior gold stocks. You would want to avoid bigger losses on a resolution to the debt ceiling. At the very least, obey your trailing stops.

As I mentioned in last week’s Denning Report, the reasons for owning physical gold have never been more obvious or stronger. But in the paper gold market – for gold shares and ETFs – a credit crunch in the US triggered by Treasury anxiety is likely to be extremely bearish. That’s what you have to prepare for. A re-test of the June lows will see even more selling in gold stocks.

The crisis in the Western welfare state model – and that’s what you’re seeing in America – is part of the shift of economic power from West to East. That shift includes the transfer of physical gold. For the fourth month in a row, China was a net importer of more than 100 tonnes of gold from Hong Kong. The August figure was down 5% from July. But it shows the demand for gold in China is strong – even if ETF and investment demand in the West is not.

Meanwhile, in India, investigators from the Directorate of Revenue Intelligence discovered 32kgs of gold hidden in the bathroom of a plane landing at Chennai. The plane originated in Dubai. This follows the intercept of another 35kgs of gold moving across the mountainous border between Nepal and China last month. The smugglers are trying to get around the import duties India’s government has slapped on official gold purchases.

It’s been said by some pundits that the Indians ought to be buying Treasury bonds and notes for the future, not gold. But let’s not forget, India and China are both 5,000 year old civilisations with a tradition of using precious metals as a store of value. The Welfare State model of borrowing from tomorrow to pay today’s bills is a few hundred years old and appears to have already reached its limit.

4G warfare pioneer dies

Speaking of the decline and failure of the Welfare State model, one man who could argue he sped that decline was Vietnamese General Vo Nguyen Giap. Giap died in Hanoi last Friday at the age of 102. He became prominent as the architect of the defeat of French forces after a 57-day siege at Dien Bien Phu in 1954.

Giap said Dien Bien Phu was, ‘The first great victory for a weak, colonized people struggling against the full strength of modern Western forces. This is why it was the first great defeat for the West. It shook the foundations of colonialism and called on people to fight for their freedom.‘ He may not have known it at the time, but Giap was a pioneer of fourth generation warfare (4G), where a smaller guerrilla army can defeat a technologically superior opponent with asymmetric warfare.

I put another Giap quotation at the start of the eighth chapter of my 2004 book, The Bull Hunter. Giap said, ‘Our strategic directives were dynamism, initiative, mobility, and rapidity of decision in the face of new situations.’ In my book, I made the point that investors have to think more like traders, in light of the sweeping changes to the global system. There are exchange traded funds (ETFs), for example, that allow you to have a punt on nearly any macroeconomic trend or forecast you’re making.

That’s still true, although you could argue the market has become more speculative than ever since 2009. What’s more, the entire financial system has become unstable with doubt cast on the long-term value of US Treasuries. The return of capital may become a lot more important to investors than the return on capital.

The Coming Shocks-‘Death Spiral and ‘Dirty Power’
By Nick Hubble, The Money for Life Letter

Australians already pay a higher price for electricity. Renewable energy powerhouses like Denmark and Germany are the only two countries in world, which pays a similarly higher price.

In the last four years power prices has risen 70% on average and power companies blame ‘Network Costs’ for this. Half of our power bills go out to pay for this ‘Network Costs’. The electricity network or the power grid in Australia is more than 50 old and requires a major upgrade.

According to an estimate done by the Department of Resources, Energy and Tourism, Australia will need an investment of $100 billion for electricity generation and network infrastructure in the next 10 years, including for renewables. It’s a monumental task as the country’s total existing asset base for generation, transmission and distribution infrastructure is $120 billion.

This is a bold ambition by the government, which talks about almost doubling the infrastructure that we currently have. One might think for a country like Australia, which enjoyed a massive growth in the resources sector, it’s a piece of cake, we might have to think again. Thanks to the mismanagement of the state governments, our abundant resources and electricity industry is in such a bad state, that we turned an advantageous position into a disadvantageous one.

What you might not realise is how disastrous this will prove to be for the country. To get an idea of where we are heading, take a look at Europe.

We face a systemic industrial massacre,‘ Antonio Tajani, the European industry commissioner, told The Daily Telegraph at a recent meeting of policy makers from around the world in Lake Como. ‘The loss of competitiveness is frightening. When people choose whether to invest in Europe or the US, what they think about most is the cost of energy’ explained Paulo Savona, head of Italy’s de­posit insurance fund.

European President Herman Van Rompuy connected the dots: ‘Compared to US competitors, European industry pays today twice as much for electricity, and four times as much for gas.‘ With Europe going on a very expensive green energy crusade to save the world from global warming while America’s scientists point to the 60% growth in polar ice caps as a sign of global cooling, Europe’s industry looks doomed. Power will simply be too expensive.

But what do European electricity prices have to do with you? Well, if Europe faces an industrial massacre from high power costs, Australia faces an industrial Armageddon. These charts from CME, ad energy consultancy, show Australia’s power prices are already outrageous:

I recently caught up with Len McKelvey to discuss about the future of Australia’s energy state. Len McKelvey is a pioneer and a leading guru when it comes to power. Through his company OzGreen Energy, he provides tailor made energy, water and resource management solutions to their clients’ individual needs.

Len saved a Gold Coast theme park so much money on their power bills that the utility company sent out engineers to check their equipment. They even asked the park engineer whether he had ‘turned the power off‘. In other words, he’s just the man to explain what’s going on, and what you should do about it.

In my interview with Len, he highlight’s two key developments that are going to put even more pressure on costs, and thereby the prices you pay. 

The first problem is called the Death Spiral by those in the industry. Network costs have been rising steadily over the years in order to support the power infrastructure that we need throughout Australia. It keeps going up. More and more people are using solar panels on their roofs and generate more power into the system and using less power themselves.

As a result of this we now have a steadily decreasing use of power but still requiring the same infrastructure to be maintained. The government was banking on a surge of power demand from users, to curb any price rises, but instead has not been able to realize it, due to so many people generating their own power.

According to Len, over the last 50 years the utilities could price in the fact that market would require an increase in demand each and every year. But during the last two years, all of that planning and forward projected growth has just disappeared completely.  Therefore, the infrastructure that’s in place is vastly more expensive to maintain than what is currently required. As a result of this power prices must go up.

The second problem is called the Dirty Power. Ironically this derives from one government policy which has been successful in the past few years, which is solar panels, has turned out to be a failure. Traditionally, the network delivers power to the consumer from the power stations.  The advent of solar panels being installed in many households and factory rooftops forces the excess power back into the grid.

This push back into the grid creates instability in the grid and causes ‘sags and swells’, where voltage drops away and where voltage increases over what it should be. Conventionally, when such an event occurred, the factory was able to compensate for that. But now as more manufacturing companies are using sophisticated electronic/computerized equipment, which are very sensitive to power issues, such saga and swells creates production process dropouts. It adds up to being a major cost to the company and intern it is transferred to the end user/consumer. All of those sorts of costs are what we might call the hidden costs of dirty power.

Len also points out that despite the introduction and incentives given towards solar energy initiative, the government got the whole forward planning wrong, by privatising the most profitable parts of the grid (retailing of power), which could have been used to upgrade the ailing energy infrastructure and holding the responsibilities of generating power and maintaining the network (which is the expensive part).

Despite this dire news predicted for Australians, Len believes that there is a silver lining behind all of this. He based his hopes on the Energy Revolution, where new and emerging technologies are geared at the consumers and end users. ‘It will be possible for you to operate your own home completely off the grid, isolated from the grid at your choice within a relatively few short period of years.’

That’s a libertarian’s dream because it’s complete independence.