The Crisis That Almost Wasn't

It is the last hope of the $14 trillion national deficit.

It is a crisis the 2012 Election must address.

It is a crisis

– hopefully –

The crisis that almost wasn’t.
 

What will happen to all the corporations who successfully issue Gold-Indexed Dividend Bonds?

If the price of gold goes up, the bonds become more and more attractive. If the company obtains money via gold-indexed bonds at a time when most companies cannot raise money, their stock is likely to go up.

Why do we trust gold?

Well, after the war when I was a seven-year-old child in Hungary, we first had no money, then the government created inflation by printing money, and then the system created hyperinflation, and then a new currency came into being.

Hyperinflation was not only the creation of the Weimer Republic of Germany of 1932. Hungary also created such hyperinflation because they simply printed a new currency.

The result in Hungary was that everybody was wiped out. Everything was wiped out except what they held in gold.

President Obama recommends a $3.5 trillion budget deficit. We reflect on the good old times until the twenty-first century brought in President George W. Bush. We should reflect on the good times. The decades which led to a $14 trillion deficit, those days before the year 2000 . This was "The Crisis That Almost Wasn't."

Gold Index Bonds

The price of gold is inversely related to the size of the budget deficit. When politicians talk about a trillion dollar deficit, the only reason gold declines is to liquidate for paying the grocery bills.

The United States can always float a dollar denominated convertible bond against its 8,400 tons of gold reserves. In gold we still are the biggest. The Germans only have 3,400 tons and the Chinese just reached 1,000 tons.

The simplest of a gold index bond is a bond at $1,000 denomination and it is convertible into gold at a set quantity usually for a period of time and issued at a time when gold is below the conversion value.

The "Golden Picture"

Let us now analyze various events:

• A $1000 5% non-convertible bond is simply a loan.
• A $1000 5% convertible bond is banking on the future of a company. If the stock goes up, so does the bond.
• Gold indexed bond is tied to future gold prices.

 If a $2,000 indexed bond is convertible to 1 ounce of gold — when gold is selling at $1,750, it will reach $4,000 when gold is $3,500.

The ultimate bet against the dollar.

In this example, we have pointed out that we can raise money above the market value of gold simply because of the confidence investors have in gold. In a different language, the market accepts the fact that gold is going up, that there is a budget deficit and of course the value of the dollar in terms of gold is going down. Since the dollar is the leading reserve currency of the world, the decline in the value of the dollar is a major determinant to a premium somebody can market gold-related securities.

In 1971, the late secretary of treasure, John B. Connolly, of Texas, stated to the world, "Gentlemen, the dollar is our currency but your headache."

The Signs of Uncertainty

An idea came back to my mind. By 2001 and 2002 the US dollar, which was the cornerstone of international trade, had begun to decline. Budget deficits, the Afghanistan and Iraq wars led to a position where America had to borrow every day $2 billion worth of foreign currency to pay for its deficits. By the time the Chinese had over a trillion dollars in US dollars, the dollar decline became a daily phenomenon. Correspondingly, the Euro began to climb in the current decade from $0.90 to $1.50. The issue created another problem. Frankly, we are putting Europe out of business.

Actually Spain and Italy, but particularly France and Germany, found it very difficult to cope with a $1.50 Euro. It increases their unemployment, stops some of their factories from working, puts some of their manufactured goods out of the reach of the world market. It creates unemployment and further pension liabilities.

Living in the world of European Union, we kept the old habit of having every commodity in the world – gold, silver, aluminum, copper, wheat, uranium – everything measured in US dollars. What it amounts to is that when the dollar declines, the purchase of the commodity is getting more expensive. At the same time, the deficit is growing.

We call the current age The Age of Commodities. Commodity prices have increased from $1 copper to almost $4 copper, $6,000 a ton nickel to $35,000, oil from $20 a few years ago to $80. The sale of this vast amount of commodities and the proceeds of trillions of dollars from the commodity markets, for the commodity producers, have been dropping in real value when it is converted back to their own currency. The cheap dollars become the Currency of Man's Destruction.

The value of gold and indexed gold has reached the highest level in American history.

In a private conversation in the summer of 1982, President Nixon, after studying my theories said, "I would have used the power of American gold Reserves to confront Brezhnev and win a strong point about Russia's financial weakness."

In 1982 Nixon wasn't President and the Cold War lasted almost another decade.

Actually, I wrote an article, "Russia in Bankruptcy," in which I stated that capitalism may not be able to pay for the Cold War, but Communism simply cannot afford it. The Cold War was getting more and more expensive for the Soviet Union. The story I was telling President Nixon was very simple. America had gold reserves. Float gold-backed bonds for about $1 trillion. This money would be segregated like Social Security money. Then, American agents would go all over the world and visit in London, Barclays, the Westminster Bank and ask the bank how much is the floating credit of the Soviet Union. If the answer was $100 million, rolled over every month, the American agent would simply hand over a bill for $100 million and extinguish the Russian credit. Now, if the Russians want to get money not over the $100M credit line at the end of the month, they have to come to the United States, their new creditor.

If it's done quietly, with $800 billion spent, the United States could simply buy up the worldwide Russian credit and when it comes to the first of the month, Russia would be in a dilemma. We could simply say that they should go and try to get credit from their friends. The US Treasury wants cash.

The idea appealed to the President. He went through various angles and subsequently stated that if he were President now, he would use this. After all, what is easier, to fight with a checkbook or missiles? It was then in 1980 that gold-backed bonds became a fixation in my mind. In Gold People Trust. If a nation, instead of printing money, would float in London or in New York a $100 million gold-backed bond, it would have to pay only perhaps a two or three percent interest rate instead of the prevailing rate, which certainly in the early '80s was in the vicinity of 7 to 10 percent.

Let us now return to the utility and practicality of gold-backed bonds.

If you take a sizeable and function gold mining company, we of course assume that there is a stream of production that can hit the market as the gold is delivered.

Below is an illustration of my ideas:

American Bonanza
American Bonanza has 200 million shares and the stock is selling at 60 cents.

The company expects to start producing gold in December 2011, starting with the modest sum of 2,500 ounces of gold with a production cost of $500/ounce.

In the year 2012 and 13 and 14 and 15, however, the company expects in each year to deliver 50,000 ounces per year.

4 x 50,000 x 2,000 = $400M

At a price of $2,000 per ounce, in 4 consecutive years American Bonanza would obtain a revenue stream of 100 million per annum, or a total of $400M.

American Bonanza today has only about $15M in cash.

Let us assume that through an underwriting firm, the company will register $100 million gold index bonds.

The company can specify that the owner of the gold index bonds can convert into ½ ounce of gold for every $1000 indexed bond. However, the delivery can take place in 5 years.

IF

If the price is $2,000, the owner of a $1000 Gold indexed bond gets 1 ounce of gold.

IF

If the price is $3,000, the owner of the $1000 gold indexed bond has a 50% profit.

In each case, the company which raises the $100 million of gold index bonds makes life easier for itself but still remains profitable for the buyer.

There is no reason not to register to $200 million worth of index bonds. What is happening here is that the confidence in gold converts a company from a modest ownership of money into a financially rich mining company. The mining and delivery of gold which is discounted by the bond enables American Bonanza to extend its reserve, to accelerate its mining, and convert itself into a more creative company.

And this is where gold comes into the picture. For the beginner, we have to appreciate that 90 percent of the gold that has ever been mined in history, is still in gold bars and available for trade.

I never thought that we'd go back to the barter business that prevailed in Hungary in 1945-1947. Frankly, I do not wish to go back to that system. However, the seven-year-old boy in 1945 saw his parents' daily work converted into Napoleon gold which bought the food which was necessary for living.

Sixty years later, the situation is the same. The commodity-producing country, the oil-producing country, have to buy food, have to build cities, have to modernize their life, and they may come to the same conclusion as the lucky middle class came to in Hungary who made the decision to base their daily existence on gold .

Of course, the world has advanced in the last 60 years. It is inconceivable that any government, let's say the Nigerian government, receiving its income from oil would not only buy gold, but settle its food bill with Ghana, coffee and cocoa, paying with the same gold.

Gold-backed Bonds
We have an international monetary system. We have an international bond market of various currencies, in various categories, government bonds, corporate bonds, secured bonds, and of course, real estate backed bonds.

If Ghana would like to be paid for cocoa and coffee in a solid currency, they would welcome the idea if the financiers of London or Dubai or America would create gold-backed bonds which act just as frequently as ordinary treasury bonds.

Gold-backed bonds can be created by governments. However, it is more likely that they would be created by corporations.

First of all, what is a gold-backed bond? It is a bond with an interest rate with a denomination, with an expiration date and any other characteristics like any other legal tender. If a company realized that it could create a bond with full or partial gold backing, and pay less interest and that it would be welcomed by the international purchasing community, by hedge funds, by private equities, they would quickly make the decision to create such paper.

What if KKR had access to sufficient gold that it could issue 100 percent or 50 percent or 25 percent of gold-backed bonds, wouldn't the buyer appreciate such a potential upside? And probably the takeover would have happened much faster.

Take the large or not so large gold companies that are listed on the New York Stock Exchange. Barick has been known to be an acquisition-oriented company, issuing shares on each occasion. If Barick raised $500 million in gold-backed bonds, maybe the acquisitions would have been much cheaper on a per share basis, and raised the price of their stock.

Let us not forget that the twenty-first century created other new phenomena in the market. We have not $1.5 trillion in the hedge funds industry. The hedge funds move very fast. The hedge funds have money available. The hedge funds make acquisitions. Major investment banks buy into hedge funds. The pool of capital very soon may be $3-$4 trillion. If you add the private equity companies, we are talking $5 trillion if not $10 trillion.

Eventually, even the $10 trillion hedge-fund money can be duplicated with gold-backed bonds.

Governments can fail!

If the budget deficit is measured in gold – Mr. Cain’s 9-9-9 plan would disappear in significance.