China’s Gold Investment

How can China build its gold reserves if it doesn't Buy Gold...?

"A FEW FACTORS limit our ability to increase [our] Gold Investment," said China's chief foreign exchange manager, Yi Gang, in a speech this week, notes Steve Sjuggerud in his Daily Wealth email.

Western investors have long speculated China will start Buying Gold and selling its hoard of US Dollars at some point. (China's hoard could be literally trillions of US Dollars.) It would be the first step in a "Doomsday" scenario for the greenback.

Just imagine – China trades in its Dollar reserves for Gold Bullion. The value of the Dollar crashes...and US interest rates soar, as China is no longer willing to buy US government Treasury bonds.

Some investors have said China has a perfect way to do it, available right now. The International Monetary Fund (the IMF) has a near-200-tonne hoard of gold that it wants to unload.

But if China actually used all its Dollar reserves to Buy Physical Gold, it would completely overwhelm the market. It would end up trying to buy about a third of all the gold ever mined in the history of the world. There's no way it could get all that gold without sending the price to outrageous levels.

It seems Mr. Yi recognizes that. He essentially said gold is too volatile, the historic returns aren't that great, and any gold buying by China would "certainly" increase Gold Prices.

If Mr. Yi is to be taken at his word, in short, China doesn't have plans to Buy Gold in the open market. And Mr. Yi's comments are in line with recent comments from the China Gold Association, who told the China Daily newspaper that it is "not feasible for China to buy the IMF bullion, as any purchase or even intent to do so would trigger market speculation and volatility."

So how would China acquire gold if it doesn't buy it? This is where it gets interesting...

An official from the China Gold Association told the China Daily that rather than acquiring Gold from the IMF, China would Buy Gold directly by buying gold mines "abroad". Rather than buying physical gold in the open market (where China would be the 800-pound gorilla in the room), China plans to buy future production instead.

If that's true (and there is some sense to it), then how should you play it? Dennis Gartman reported on this yesterday, in his Gartman Letter:

Perhaps we are to begin owning gold mines rather than Gold Futures or Gold ETFs. We have avoided owning mines for years, preferring the "purer" play of owning gold rather than the mines, for we fear being exposed to poor mine management, or accidents in a mine that might do damage to the equity while gold itself moves higher. But if the Chinese authorities want to own mines, perhaps we have to consider doing so also...

I've done more than consider buying Gold Mining companies. In the latest issue of True Wealth, my subscription newsletter, I recommended Buying Gold mines as the best way to have exposure to gold right now.

The reason is simple. This chart sums it up...



Gold is up 70% since the summer of 2006. Meanwhile, gold stocks (as measured by the Gold BUGS Index) have done nothing.

Usually, a 10% move in gold would mean a 20% move in gold stocks. But this relationship broke down in the financial crisis. Now, either the price of gold needs to crash... or the price of gold stocks needs to soar to correct this anomaly.

The timing might be just right. Gold mining stocks are down, and it's just coming to light that the Chinese authorities could prefer acquiring gold mines – which give the country a permanent supply – over Buying Gold in the open market.

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Gold Cycle Broken?

Yes, kind of, says one analyst. The seasonality of gold has broken down...

DON'T COUNT out the US Dollar just yet, not as the Euro waivers.

So says Louis Paquette, who launched Emerging Growth Stocks in 1995 to provide investors and speculators with a unique alternative to what he saw was a growing problem with corporate governance and conflict of interest on Wall Street.

Here he speaks to The Gold Report about the outlook for the US currency, plus the fact that the "seasonality" of Gold Prices and gold-mining stocks has broken down...

The Gold Report: In your February newsletter, you noted the negative sentiment towards the Euro driven by fears of the PIIGS's defaults. But you pointed out that states such as California are fairing far worse potentially than Greece, Italy, Spain or Portugal. So why is this boosting the Dollar and depressing Gold Prices?

Louis Paquette: For a while now, the Euro has been the currency that's weak. The attention has gone to Greece and people are thinking, well what's going to happen if this contagion spreads to Spain and other countries that are looking bad over there? We've just seen this shift after a whole year of the US Dollar falling. It got really overdone. It got to be a really crowded trade and now sentiment has shifted negative against the Euro, which has allowed the US Dollar to recover.

Interesting note on a technical basis, the US Dollar Index has now had a 50% retracement of the negative down move that took place in 2009. So who knows? Maybe we've seen enough of a rebound now of the US Dollar, and the Euro has come down enough that we're going to see a reversal now. Maybe the US Dollar will have a downturn now but, at the moment, all the attention – the negative attention – is towards the Euro.

TGR: Well factoring into the US Dollar I'm sure, California's population is well over three times the population of Greece. It's the largest US state and it's in serious trouble financially, many say much more than Greece. Are the eyes of the world investment/finance community just in the wrong place right now?

Louis Paquette: I don't know if it's the wrong place because the Euro has a really serious problem. The ratios – the debt per gross national product and the debt ratios – in many countries in Europe and England are terrible. I don't know if the investment community is looking at the wrong place. These things ebb and flow. For a while, the negative sentiment and the selling has been on the Euro; and that'll continue until it gets to be too much, and then something will happen. Some news event will take place regarding the US Dollar, and then it will have a decline. That's just the nature of markets. They move back and forth.

TGR: When the US Dollar declines, are we expecting to see a focus back onto the Euro, or would we start seeing focus on other currencies such as the Yuan or Rupee?

Louis Paquette: I think the focus will go back on the US Dollar because it will have had a pretty darn good move up and the short sellers will probably swoop down on the Dollar again. In terms of other currencies, we just keep hearing good things about the Canadian, Australian and Indian currencies. So I think the bears will circle the US Dollar again sometime later this year.

TGR: How do you think the Chinese Yuan factors into the equation right now?

Louis Paquette: Well you can't pressure the Chinese to do anything. Telling them to let their Yuan rise is almost counterproductive. They may not let it happen just because you want it to. They're going to do whatever they want no matter what.

TGR: As we move into this bear focus on the US Dollar, and we know there are issues with the Euro, are we going to see a decoupling from the Euro-goes-up-Dollar-goes-down (or vice-versa) mindset, to Euro-and-Dollar-go-down, and Canadian, Australian Dollars go up?

Louis Paquette: That's what I think is going to happen.

TGR: How does an investor play that?

Louis Paquette: It's kind of a race to the bottom with most of these currencies, even with Canada's. I hear the big, big investors saying, Canada's such a great place, and we're supposed to have a conservative government, yet they're going to have a huge massive deficit this year. Even the most favorable countries are now spending beyond their means and I guess the only way to play this is to have some gold in your portfolio. Have some raw gold, have some bullion and have some shares of good mining companies. If you're really aggressive, talented and you know how to short and play the futures markets, then you can try and time these, the bigger declines. Sooner or later the US Dollar will top out again. If you're really comfortable with doing that you could do a short sell on the Dollar with the futures markets but I'm not that comfortable doing that kind of thing. So I just hold gold.

TGR: Do you feel confident that the Canadian banking system is going to remain strong given what you've just said, or do you just see that waning a bit too?

Louis Paquette: Well the corporations themselves have run themselves fairly well. But sadly with – it seems like anytime the population figures out it can vote someone in who spends more, that's when you run into trouble. It seems like every country is doing that. Perhaps China and India aren't, but here in the West that's happening. I'm not comfortable with the government, but the Canadian banking sector is still being run fairly prudently.

TGR: There's a growing belief of a double dip recession for the second half of 2010. You refer to Dan Arnold's work, The Great Bust Ahead, predicting the bust will begin in 2013. If there is a bust ahead, how should the typical investor play a busting market? Some feel the prudent strategy is to go long in cash/gold avoiding equities whose value will fall during a bust. Is this your opinion?

Louis Paquette: I would stick with holding some gold equities of really good companies. If we do get a real meltdown in the currencies, it's going to impact the price of gold – and the companies should make terrific profits. But will they melt down, too, in a big meltdown? I really don't know, but I would just hold some. The one thing I would be confident in doing is saving a lot of cash. I would short stuff and own more cash. I would not buy luxury items and I would save cash.

TGR: In our last interview with you, we discussed the Typical Seasonality in Gold, especially gold stocks, both of which have a fall and a spring rally, followed by a typically quiet summer. At that time, you were uncertain if the climate had truly shifted for gold, and were unsure whether or not that seasonality was breaking down. A year later, do you think it has? Also, has the psyche for accumulation of the metal itself moved into the acquisition of promising junior or mid-tier Gold Mining company stocks?

Louis Paquette: Let me answer the second question first. For the last year, the emphasis has moved toward the metal. The Gold Mining shares? I'm looking at a chart right now of appreciation of gold and gold shares, and the gold shares have gone sideways for the past two years and gold has gone up. So for the moment, there's better value in the gold producers, in the shares of the companies, and people have been buying the bullion price.

The first question, has Gold Seasonality broken down? I think the answer is yes, kind of. The last buy time for seasonality was last August. That did work. The price of gold started to take off after that. But now when it comes to the high point, gold peaked on December 3rd; it hit a parabolic high at that point – and looks like a cyclical high now – and it's not strong. It's supposed to be peaking around now, and we're $100 or so below the peak. I would say the seasonality is breaking down because the price is now being driven by Gold Investment demand as opposed to physical demand for jewelry. So the answer is yes. The seasonality is breaking down and you have to revert to other methods to pick your highs and lows now.

TGR: To what extent do you believe news and the news media can make a market? And has the gold market yet to be made?

Louis Paquette: I think it has a lot to do with it. And I don't think we've seen the full extent of it yet. We haven't seen a media-driven parabolic rise yet. You don't see the average person lining up to Buy Gold coins at this point. I think that day is going to come, but I don't believe we've seen it yet.

TGR: What are you recommending for portfolio diversification with regard to gold stocks, Gold ETFs, and the physical metal?

Louis Paquette: The leveraged two-times ETFs were really popular here in Canada, and I'm completely avoiding them. They experienced time decay. So zero for the leveraged ETFs. And the main focus is on junior mining companies, exploration situations and near producers with growing reserves. I'm not Buying Gold anymore. I used to buy it years ago in the beginning first few years of the bull market, but I just sit on that. That's 5%, 10% of one's portfolio in the metal, in the Gold Bullion, and for me a lot larger than that with the gold share (but I specialize in that). So I don't know what the good number is for the average investor, but I'd say maybe 5-10% of the gold shares of selected junior mining companies.

TGR: Earlier on we were talking about a double dip recession. You said people should short stop and go long on cash. So the suggestion is to hold cash; but really early on we were talking about the devaluation of the Dollar and the Euro. How is this a good strategy?

Louis Paquette: Well, all I can tell you is what I'm also doing – taking a fair number of those Dollars and owning stocks that pay good dividends. At least I'm making an income with that money. I guess that's where you have a portion in the gold sector too, if the currencies are going to devaluate. Consumer goods are going to fall in value even faster than everything else.

TGR: Value declines as soon as you take it out of the store.

Louis Paquette: Exactly. So I'm not in a big hurry to buy brand new cars. They're going to be cheaper in the future.

TGR: So you were talking also a bit about having 5-10% of your portfolio in metals, which leaves another 90% of your portfolio in other types of things. Given that there are significant reports of green shoots and some positive economic news, at least coming out of the US, what other sectors would recommend our subscribers invest in so they have a balanced portfolio?

Louis Paquette: The areas I like are gold and energy. On weakness, I have been purchasing shares of these income trusts that pay 5-10% yields. So I'm about 50% cash and about 5-10% in the metal, say 20% in Gold Mining shares and the balance in energy shares. Also in special little situations, I've got the odd investments – biotech and even a social media company. Some very small micro cap situations are also in there, not specific to any sector, but "bottom up" selections based on the merits of the company.

TGR: In terms of energy, are there specific subsectors of energy that you're focusing in on?

Louis Paquette: Yes. I've got a love/hate relationship with natural gas right now. The production community seems to be determined to drive the price to zero. But sooner or later, this natural gas situation is going to turn around. They're going to deplete all these new reserves they've found and there's going to be a shortage of it. I'm not saying in the next month or so, but in the coming years there may be a great opportunity in natural gas.

TGR: Lou, thank you so much for joining us.

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Sell the US, Buy Germany

Low debt, tight credit, and a genuine terror of money-fed inflation...

IF YOU ARE a U.S. investor, writes Martin Hutchinson for Money Morning, you can't be happy about the prospects for your portfolio.

After all, you're mostly trapped in an economy with a gigantic and dangerous financial-services sector, a central bank that can't stop itself from printing money and a government that overspends wildly.

But there is an answer: You might consider allocating some of that "at-risk" capital to a country that has none of those problems – Germany.

Germany has a banking system, of course, but that banking system is not the overgrown financial-services monster that we have here in the United States (or, for that matter, in Great Britain). It's impossible to get a subprime mortgage in Germany: Even now – and even after mortgage levels have crept up in recent years – the average down payment for the purchase of a new home in this key Eurozone nation is 50%. As a result, the homeownership rate in Germany is only 43%, the lowest rate in the European Union.

That's actually healthy; far less of Germany's capital is tied up in unproductive housing and the savings rate is correspondingly higher. (Let's face it, most Americans don't accumulate 50% of the cost of a house in savings over their lifetimes – unless forced to do so in a company pension scheme).

What's more, this more-modest home-ownership rate reduces the impact of speculative bubbles, since the wealth of most folks isn't tied up in rapidly escalating house prices.
So while the German banking system had its own real estate problems in the late 1990s, the only parts of it that got in trouble in 2008 were those banks that had rashly ventured overseas and got caught up in the US disaster.

Up until 1999, Germany had the most admirable central bank in the world – the Bundesbank. This was a much better set up than the US Federal Reserve. It was owned by the states instead of by the national government, so political interference was much more difficult. It was a single institution, instead of a collection of regional banks, so it was much easier to manage. And it had the single objective of avoiding inflation (Germany having bad memories of the Weimar hyperinflation of the 1920s) so did not get sidetracked into attempting Keynesian management of employment. As a result, Germany's currency – the Deutsche Mark – was a beacon of stability during the inflation-ridden 1970s.

In 1999, control of Germany's monetary policy passed to the European Central Bank (ECB). The ECB is not as solid as the Bundesbank, but it still beats the Fed. The ECB expanded the money supply much less than did the Fed from 2002-07, and it has issued much less monetary stimulus since the crash. Consequently, there is far less danger of inflation in Germany and the Eurozone in general than there is in the United States.

Yes, there's the possibility that German taxpayers might have to bail out Greece, but the same possibility exists in the United States with respect to California, which is much larger.

However, the most important advantage for Germany over the United States – in fact, over all the other major industrial economies – is its superior fiscal policy. When the talk of "stimulus" first appeared in late 2008, Peer Steinbruck – a Social Democrat who was then serving as Germany's finance minister – rudely described it as "crass Keynesianism". As a result, Germany did very little stimulus, and so still has a budget deficit of less than 5% of gross domestic product (GDP), in spite of the recession.

Last September, the German electorate decided that even Steinbruck was too socialist, and so elected a coalition between Angela Merkel's Christian Democrats and the Free Democrats, a free-market party that is even more opposed to public spending than Merkel.

The effect of this has been to push Germany even more firmly into the fiscal-retrenchment camp. The German parliament lopped an extra €5.8 billion ($8 billion) off public spending before finalizing the 2010 budget. No pork barrel waste there!

The result has been a very brisk economic recovery, with no inflation and no significant risk of "crowding out" the private sector. Manufacturing orders were up a strong 4.3% in January, far more than had been expected, and are now 19.6% ahead of where they were a year ago. Unemployment is 8.2%, well below the US level, while Germany's current-account surplus is a massive 5.2% of GDP.

With competitive manufacturing, a business-friendly government and plenty of domestic capital, Germany is about as healthy an economy as there is in the world today and is thoroughly underrated by US and British analysts. Its stock market is trading at a fairly demanding 19.7 times earnings, according to The Financial Times database. But that's lower than the US market multiple of 20.0 times earnings. And Germany has better near-term prospects.

You might want to think about owning some of Germany's promise.

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The Case Against Deflation

The collapse of shadow banking adds up to massive inflation, not least for Gold...

SINCE WE have little interest in joining the speculative party going on in the stock market at the moment – other than in the best precious metals and "disruptive technologies" stocks – the task of this Daily Reckoning is to prove why the coming collapse of the shadow banking system is not deflationary but inflationary and, among other things, bullish for Gold, writes Dan Denning in Melbourne, Australia.

If that's not the sort of discussion that interests you, you might want to go take a powder or read a good book. These are murky waters we're wading through. So we'll do our best to clear them up for you, starting with the case against deflation.

All good debates begin with a proper definition of terms. Rather than defining deflation in our own way, we'll leave it up to one of its most consistent and articulate (and accurate) advocates, Robert Prechter. He's written about it for years, and in a recent video he says...

"The next big phase [in the cycle] is a credit implosion where people who are debtors are going to be scrambling for Dollars to pay off their debts and the creditors are going to be dunning the debtors to pay them back...The scramble will be for Dollars, not for things."

The investment outcome of Prechter's scenario is bullish for the US Dollar and US Treasury bills. Because, he says, "the chances of default are low."

Prechter's argument is based on the idea – which we happen to believe – that the US Federal Reserve is unable to prevent falling asset values. This would lead, by Prechter's reckoning, to falling stock, commodity, and real estate values.

All of that seems right to us here at The Daily Reckoning so far. The deflationary argument depends on the collapse of both the shadow AND the real (deposit taking) banking system. The shadow banking system is the murky world of credit, securitization, and derivatives which currently supports and/or holds some $600 trillion in assets.

Yes that's trillion with a "T".

Most of these are interest-rate and credit derivatives. As we learned in the last two years, the big risk here is to institutions which owe – and also which own – these obligations amongst one another. In our view, the degree of interconnectedness among these obligations (they still aren't unwound) makes the entire global financial system vulnerable to a systemic shock and/or total collapse.

It nearly happened last time with Lehman and frankly not much has changed since. A good old interest rate spike that's not in anyone's model might be the sort of thing that precipitates the next crisis. After all, that's the way these things generally begin.

Now, you could make the argument that it shouldn't really matter to the real economy if a bunch of global institutions find out they can't settle their obligations to one another. Why not just forget the whole mess and start other? After all, most of these derivatives are just insurance policies of some sort. Can't we just cancel the policy?

Probably not. These positions are held in conjunction with myriad leveraged bets on the direction of other asset prices. They are hedges. No one is going to walk away from them. But more importantly, the connection between the shadow banking system and the real banking system is much more substantial than you might first imagine.

So much of today's funding, financing, and lending is done by the shadow banking system through securitization and money markets and income and mortgage trusts. The real economy is tied to the shadow banking system in just the way that you are tied to your own shadow. And the real, deposit taking, depositor (taxpayer)-insured banking system is not much better off.

For example, my colleague Porter Stansberry reports that in the United States, some 7.1% of commercial real estate loans are more than 90 days overdue. The FDIC reckons that over 700 US regional and local banks are "danger" banks. The reason is that these banks own mostly commercial real estate. It's their main asset. And unlike their money-centre big brothers on Wall Street, these banks aren't going to be recapitalized or bailed out at taxpayer expense.

Students of the Great Depression will know that widespread bank failures led to a contraction in the money supply. Banks, more than the central bank, are the engine of money and credit growth in a fiat money system. Take away several hundred banks, and you get lenders not making loans. Money supply shrinks. Cash and Treasuries gain in value.

In fact, when you couple the wounded regional banks in the US, who are massively exposed to one dangerous asset class, with the potential collapse of the shadow banking system from another interest rate/liquidity/solvency shock, you begin to wonder how deflation is avoidable at all in the near future.

We have a labored three-part answer. We're going to lay it on you now. It begins with the destruction of the shadow banking system. It accelerates with the paralysis of the regular banking system. And it concludes with deliberate devaluation of the currency via monetary and fiscal policy to make up for a completely destroyed credit system.

Granted, it probably sounds absurd that you can have a $600 trillion wipe-out in the shadow banking system and somehow get inflation. But there are two points to make here.

First, it's hardly believable that an institutional panic and bank run in the shadow banking system (what happened last time) would actually boost confidence by individuals and consumers in the overall banking system.

True, it might increase people's preference for liquidity and cash. Stocks, real estate, and bonds would fall. But another swift collapse in the shadow banking system would be a hammer blow to already fragile confidence in our financial system, including the value of paper money itself.

But a more technical response is that as the shadow banking system is unable to finance economic activity and speculation, either that activity goes away (a Greater Depression) or someone else tries to fill the gap. We'll assume for the moment the regular banks won't do it. That leaves the government.

And in fact, that is what you had in the US following the last crisis. You got an alphabet soup of Fed-backed programs to provide all sorts of credit...to students, to money markets, to car companies, to corporations. This list grows longer by the day. And what it means is that the only provider of credit in a post-shadow banking world is the public sector: the Fed and the Treasury.

Whether these are loan guarantees or outright loans or the purchase of securitized mortgages (Fannie and Freddie) it amounts to the same thing: a huge transfer and burden to the public sector balance sheet. Whether it's monetization or guarantees that add to Federal liabilities, both are Dollar bearish. The transfer to the public sector then, results both in destruction of asset values and inflation in the currency.

But wait! You can't have inflation if there's no one to make loans and use the money multiplier to turn growth in the monetary base into new Federal Reserve Notes. That is, if the shadow banking system collapses, won't this lead to the same no-risk paralysis with the big banks that has led to their holding trillions of Dollars in excess reserves with Central Banks?

Why yes, it will. But this also argues for inflation. Here we're going out on a limb. But what we're arguing is that as the private sector is less able or willing to dole out credit into the economy, we're entering a world where the government is going to bypass the middleman and do the job itself.

This happens in three ways. First, the government can buy securitized assets to fund non-bank lenders. The AOFM does this in Australia to support housing prices and non-bank lending to first home buyers. It's done in the State at a much more comprehensive level. In effect, the entire American mortgage market has been nationalized with the government guaranteeing and buying trillions in mortgages.

This is the future. More nationalization of key lending institutions. If the private sector won't do it, the Feds will. But at great cost. Each new loan guarantee weakens the public balance sheet and the currency. Thus the retreat of the banks from credit creation hastens the day where fiscal and monetary policy are forced to be more transparently absurd and redistributive.

The second way in which the government becomes a lender is through extended unemployment benefits. The dole. In some States, it's possible to receive 99 weeks of unemployment benefits. This doesn't mean dole bludging has become a full time job. But because the structural changes to Western labor markets wreaked by globalization are wage deflationary, then to us (at least) this means a larger regular expenditure on the unemployed. The US is headed the way of Europe, with higher structural unemployment. Whether it can afford to pay for this while fighting two wars, spending a $1 trillion expanding health care coverage, and preparing for an increase in entitlement payments...well, you do the math.

The net result of the increased burden on the public sector in supporting private incomes is a weaker currency. It always comes back to that. And it's true for the Euro, the Yen, and the Dollar. It's true, in fact, for all paper money. This is why we believe the end of the super cycle in paper money is bullish for precious metals (not deflationary).

The third way in which the government bypasses the traditional banking sector to get money into the hot little hands of consumers has already been suggested by Ben Bernanke: via helicopter. And this really is the greatest argument against the deflationary theory.

In one sense, Bernanke was right. The Fed can create an infinite amount of digital Dollars. It can expand its balance sheet infinitely too. It can buy assets directly. It can buy gold mines. It can probably create a market that securitizes future consumer wages and pays you now for them. You literally mortgage your wage-earning future (or perhaps you get an early pay out on your social security).

The only real restrictions on the Fed's ability to create money are rising bond yields (market discipline on currency mismanagement) and political interference. On the first issue, the Fed has some covering fire. Global investors have to own something. And right now they prefer the Dollar. Unless the Fed does something radical and reckless, it can expand its role in providing credit directly to the real economy without doing huge damage to the Dollar...mostly because there are so few other good options.

Obviously we think gold is a good option. But for nations like China with trillions locked up in Dollar-denominated assets, what options are there?

You could argue that the US Congress and the President would not allow the wilful debasement of the currency via an expanded Fed role in direct lending. But we think just the opposite. Those ass-clowns will be begging for it.

When commercial real estate blows up regional banks, we predict you'll see the President declare victory in Iraq and Afghanistan within months, bring the boys home, and cut defence spending by 30%. The money will pour into new lending and "jobs" programs to support the economy. Fiscal and monetary policy will work hand in glove to pump funny government money directly into the consumer economy. The only result there can be is hyperinflation.

So, it's possible – likely even – that you're going to see across the board falls in stocks, real estate, bonds, and commodities....AND inflation. Whether we got the proper sequence right, we're not sure. But the combination of a shattered shadow banking system, a paralyzed banking system, and a terrified government certainly do add up to massive inflation.

Ready to Buy  Gold...?

Gold – a “Real Bull Market”

People really are Buying Gold, but the GDP growth story is fake...

As I was floating down impassible rivers
I no longer felt myself steered by the haulers...
- Arthur Rimbaud, The Drunken Boat

The NEWS PUSHES against us like a gentle wind, writes Bill Bonner in his Daily Reckoning.

Pending house sales are bad. Consumer spending data is good. Unemployment is bad. Manufacturing is improving.

The Dow meantime rises, but without much conviction. It can't seem to make up its mind. We thought it had headed down decisively a few weeks ago...and then, it stabilized...and wandered about. Gold has more sense of destiny about it. It's been in a bull market for the last 10 years, and shows no sign of wanting to do anything else.

Yes, it lost $11 yesterday, but still trades at $1122...not that far from its all-time high. Gold is in a real bull market. As near as we can tell it is still in the developing stages. There are a few old gold bugs around. But the public is not yet talking about Buying Gold. Investors are not yet adding major positions in gold to their portfolios. Ordinary people are not yet expecting gold to go to $5,000 or $10,000 an ounce.

Still the news keeps coming – the opinions, the rants, the data, and the theories.

This way and that...we begin to feel like a "drunken boat". That was the title to a poem written by a 17-year-old Frenchman named Arthur Rimbaud. It describes how we meander. We are driven by the winds...and pushed by the back-eddies. Turning our bow this way, and then that way...never quite sure what direction we're going...or what to think. No one is in control, and still, the current continues...and we keep heading downstream...carried by the great river...always moving along.

One day we're fascinated by what is going on in Japan. The next day it's China. Some days we think we might somehow muddle through...on others, we're sure something is going to blow up any minute. But that river just keeps rolling along...and we're on it.

Where does it lead? Well, that's the point. We're not sure. All we're sure about is that it doesn't lead where most people think. They think they see a 'recovery'. Forget it. Won't happen. We could have another speculative period...but it won't be like the Bubble Epoch of 2005-2007. Houses would have to go up 20% just to get homeowners' heads above the water. Then, maybe they could borrow and spend like it was 2005 again...but that's not going to happen. People don't have the incomes, or the credit, to bid up house prices again.

"Employment of Adult Males at Record Low," says a headline from the Wall Street Journal. here does that lead? We're not sure...but we don't think it leads to 'growth' in the US economy. Instead, it leads to bankruptcy, deflation...and maybe insurrection.

And what about the Chinese economy? Isn't that growing at breakneck speed – over 10% per year? The trouble with breakneck speeds is that you do break your neck. China should slow down...or it's going have an accident. And if it slows down, the whole world slows down with it.

And as to that 'growth' – it's counterfeit anyway. It's not real growth; it's ersatz growth, caused by greater and greater government involvement and spending. The feds (the haulers) pretend to be in control. They want us to believe they are in control. But they are out of control themselves!

Can increasing government spending really make people more prosperous? Show us an example!

Ready to Buy  Gold...?

Gold Demand Update

Down in tonnes, strong in Dollars, the gold demand story for 2009 isn't so simple...

WITH GOLD reaching new all-time highs against the Euro and holding well above $1100 an ounce for US investors, it seems one thing is certain, writes Julian Murdoch at Hard Assets Investor.

Gold demand has never been higher. Or has it?

Last month, the World Gold Council released its latest supply and demand report on the yellow metal, and it revealed more than a few surprises. Because in reality, total gold demand actually fell in 2009, down 11% year-over-year by volume. But due to the higher average price per ounce in 2009, the Dollar value of gold demand remained roughly the same from 2008.

Demand for gold comes from lots of different places: bars and coins, jewelry, dentistry, electronics, some minor industrial uses. And while some applications inherently drive demand more than others, it's interesting to see how demand has shifted from quarter to quarter.

For starters, as the World Gold Council's Gold Demand Trends report shows, investors in Gold ETFs just aren't having that big an impact on gold's overall demand. In fact, so far in 2010, investment into the big exchange-traded gold-backed trusts has been sluggish.

Gold Bullion held by the SPDR Gold Trust (NYSE Arca: GLD) has fallen to 1,115.51 tonnes – down 1.6% for the year. That's a big change from the 45% inventory increase GLD saw last year. But that 45% figure is misleading. Taken as a whole, 2009 was a great year for GLD and other Gold ETFs, but new investment demand dropped precipitously over the next three quarters, and although it still rose 87% year-over-year in 2009, ETF demand long term was definitely on the wane.

Even those folks buying physical Gold Coins and bars backed off the gas pedal after the insane demand of the 2008/2009 fall and winter. As ETF investing dropped 67% from Q4 2008 to Q4 2009, so too did so-called bar hoarding – down 55% year-over-year. Even coin sales, which remain constrained by greater supply concerns, were down 8% year-over-year.

In contrast to new Gold Investment demand – at least by weight, which fell in 2009 while holding steady in cash terms – we began to see some slight indications of recovery in jewelry demand last year.

Although the rebound remained slow, some areas such as China showed year-on-year growth; the country saw a 6% increase in gold tonnage demand, which translated to a 19% increase by value.  But we shouldn't get carried away. Most markets didn't fare nearly as well, with gold jewelry demand in tonnes dropping 20% for the year and 10% in value. In fact, electronics was the only sector that saw year-over-year gains in demand in Q4 2009.

The World Gold Council cites the economic downturn as a good thing in this case, as it led to a decline in overall electronics inventories. That, in turn, resulted in a modest uptick in semiconductor sales for 2009, which raised immediate demand for gold 25% over Q4 2008. Still, applications where gold remains optional – like dentistry – continued to suffer, given the high prices. Dentistry demand fell 5% year-over-year; other industrial applications were down 13%.

According to the World Gold Council, total gold supply was up 11 percent year-over-year in 2009, primarily due to a spike in recycled gold entering the market in the first quarter.

"Over the year as a whole, the supply of recycled gold exceeded historical norms," the World Gold Council says in its report.

That is, the flood of new cash-for-gold companies put 2009's supply near all-time highs, despite the fact that central banks once again were net buyers of Gold Bullion worldwide.

Gold Mining supply is also expected to continue rising this year, with major producing nations like Australia talking about 10-11% increases in production in 2010. The effect on prices? That's where the balance comes in.
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At this point, there's little question that ample gold supply exists to meet current demand, but most of the flexibility will come from scrap, which is hugely price sensitive. In its latest announcement, the  Australian Bureau of Agricultural and Resource Economics (ABARE) argues that gold will average $1080 an ounce across 2010, before dropping down to $900 again on oversupply. That's a far cry from HSBC's suggestion that gold could go as high as $5000 an ounce in the next five years.

So which is it? I tend to follow supply and demand, and right now, the market's coming off four straight quarters of oversupply. Given that fact, it's actually quite impressive the metal managed to rally $200 since last March. But I'm not inclined to think $5000 – or even a more modest $1500 – is anywhere in the cards until we see real demand start outstripping real supply.

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Gold: How Much is Enough?

Five per cent...? Ten per cent...? Try nearer 20% says this four decades' veteran...

The GOLD REPORT recently caught up with John Embry, chief investment strategist at Sprott Asset Management, to get his thoughts on gold and Gold Mining stocks.

An industry expert in precious metals, John Embry has worked as portfolio management specialist for  more than 45 years; he's simultaneously researched the gold sector for 30-plus of those years. He joined Sprott in 2003, after 15 years as Vice-President Equities at RBC Global Investment.

Here he tells the Gold Report about his outlook for strong Gold Price gains in 2010...

The Gold Report: John, in Investors Digest of Canada you recently said you're expecting gold to gain another 30% this year...

John Embry: I would say at least 30%. I said that I thought it would be the best year to date. We've had nine years consecutive higher year-end prices and the best year in that span for a year's return was 31%. I think this will be the year that we exceed it in this, the 10th year of the bull market.

TGR: Why is this year going to be the best year?

John Embry: I think we're getting very close to the point when a greater proportion of the public realizes the degree of difficulty that sovereign debt is in. And at that point, when you can't depend on your government paper as a safe haven, I think that fact puts gold in a much better light in more people's eyes.

TGR: You might say the first leg down were the individuals who couldn't pay their mortgages and that caused part of the '08 collapse. And now it looks like it's the government...

John Embry: It's very simple, actually. Private demand, as you know, was so weak that governments had to step in to maintain order in the economy and in so doing, they spent an enormous amount of money, at the same time that revenue streams fell because of the weakness in the private sector. Governments spent dramatically more money and the results are a budget deficit I never thought I'd see in my life. I'm shocked at the numbers in many places.

TGR: When you talk about gold, you're talking about Gold Bullion. But how do you see the gold stocks? Do you think we're going to have a pullback? Ian Gordon of Longwave Analytics and Richard Russell (Dow Theory) predict the Dow will go to 1000.

John Embry: I don't agree with them. As much as I love Richard Russell – he's probably been as big an influence in my career as anyone – I don't think that deflation is necessarily the outcome when you have a pure fiat currency system. I think the far greater risk is hyperinflation because I believe that these guys that are in control today have seen the depressionary '30s, and they will move heaven and earth to prevent that outcome. And when you've got the capacity to create unlimited money, I believe you can do it. So I hear Gordon and Russell and I respect them, but I'm in the camp that thinks we'll get hyperinflation first. We'll eventually have to clean out the debt, but I think we go hyper before that.

TGR: So hyperinflation. Would that include stocks as well?

John Embry: I think stocks will do fine. They may have a violent correction first because a lot of people don't know what the heck we're talking about here. And when they see inflation mounting and economic conditions being less than ideal, they'll sell their stocks. But the fact is that if you go back and look at any hyperinflationary environment anywhere, stocks did infinitely better than paper instruments. So precious metals first, stocks second.

TGR: When you're talking about stocks, you're not talking just about Gold Mining stocks...?

John Embry: No, I'm talking about good businesses. I'm not talking necessarily about banks and other stuff that's more dubious, based all on paper, but businesses like breweries, for example. People are always going to drink beer and a good brewing company will do exceptionally well in the debased currency of whatever country it's in.

TGR: So you think that we might have a sell-off and in that sell-off all equities, including gold stocks, would go down.

John Embry: Gold stocks, maybe. I believe the next time everything goes down, gold isn't going down. And if that were to be the case, I think gold stocks might surprise. They've been awful. Given what the Gold Price has done, gold stocks, by and large, have been awful.

Well, the well-promoted ones and the odd good one have done okay, but across the whole list, it's been pretty hard slog over the last three or four years, particularly 16 to 17 months ago when it we hit bottom. I thought they were going to zero.

So many of them are trading at less than they were back in November 2003, which was the real peak of the excitement in gold stocks, if you can imagine. Six and half years ago. The Gold Price has done nothing but go up in that time.

TGR: In this next cycle are you seeing better returns for producers or the juniors that have pounds in the ground?

John Embry: Oh, I think the juniors. The whole thing is a matter of confidence. They've got so much volatility in the Gold Price. You get a good thrust up and you got a violent correction and I think they've got so many people discouraged and going the wrong way on these gold stocks that right now the degree of confidence is very low. If I'm right and the Gold Price stages a dramatic breakout in the next 12 months – and I'm talking hundreds and hundreds of Dollars on the upside – then I think the confidence will return and people will seek an outlet in gold stocks because so many of them have been beaten up. More importantly, the overall market cap of all the gold stocks is really small in the context of all the money around.

TGR: What's the seasonality of this year?

John Embry: I think that probably we may continue to wallow around here for maybe the better part of another month. Maybe not quite that long. But, historically, mid-March to mid-May has been a really good period. When I look at the fundamentals and everything that's going on, I see no reason why it shouldn't be a very good period this time. And there's one other development. I don't know whether it will come to fruition, but on March 25th the CFTC is going to be investigating position limits in gold and silver on the Comex futures market. And if they ever put any teeth into those things and kept these bullion banks from what they're doing on the short side with their large positions, I think that could have a salutary impact on gold and silver prices.

They're finally going to have to address this because there's been so many complaints about the bizarre price action on the Comex in both gold and silver.

TGR: The International Monetary Fund is going to be selling some gold, and India stepped up earlier. What are your thoughts on that?

John Embry: The whole thing irritates me. The IMF has announced the sale of this gold 500 times and every time with the express purpose of knocking the price of gold down. It was interesting the last time when the Indians actually relieved them of over 200 tons because that was what basically vaulted the market from about $1,045, which the Indians paid, up to $1,225 in the space of less than a month. That has been followed by the third significant correction in the last three or four years.

I think we've seen the vast proportion of the correction and I think what may be one of the factors that could get this thing going again is when somebody does relieve the IMF of the gold, the 191 tonnes still to be sold.

There's speculation that India might be prepared to go to the plate again because the Chinese have been reluctant to step up. Number one, I don't think they want to be seen publicly doing it. They'd probably rather do it more clandestinely because they've got so much money to convert into hard assets. And, secondly, as somebody pointed out, the Chinese at least have a domestic supply of gold. They can buy all their domestic output to augment their reserves, where the Indians really don't have that.

So I think the Indians conceivably have a bigger vested interest here in taking that IMF gold. And there's also sort of the suggestion that the Chinese wouldn't want to be seen to be paying more than the Indians did. So they're reluctant to step up with the Gold Price some $50 higher currently than the Indians paid.

If gold really was a free market, if they were really prepared to sell it to anybody, I think I could name any number of institutions, organizations, individuals that would be more than glad to relieve them of it. It's not much money. It's $6 billion. They throw it around as if it's a big deal. Heck, given the budget deficits in some of these countries, $6 billion is literally a piss in the ocean.

TGR: What did you think when George Soros came out and said that gold was a bubble?

John Embry: I wrote about that and I got it right. I was very pleased about that because some people got all upset. The people that were negative on gold thought this was great, brilliant George Soros doesn't like gold. But if you read between the lines, if you read really what he said, he said gold is the ultimate bubble, but he didn't say gold is currently the ultimate bubble. I believe that it will be the ultimate bubble. I think the Gold Price is going to go crazy and at that point I'd be worried. And then it came out after the fact that Soros had been a major buyer of gold for his funds in the fourth quarter. So who knows what he was doing? The fact is, depending how you interpreted his remark, he was speaking at Davos, which is a very mainstream event, and he said something that can be interpreted any number of ways.

TGR: And, again, I think the financial talking heads used it as the negative.

John Embry: Absolutely. The mainstream guys were all over it. The guys who have never like gold have been wrong all the way up and said, oh, my god, George Soros doesn't like gold. But I think George Soros' remarks were misinterpreted and if you saw what he was doing, not what he was saying, he was Buying Gold...

TGR: Any last comments?

John Embry: The only comment I'd make is I really think things are sufficiently serious here in a financial or monetary debasement sense that everybody – and I have never been a table pounder – but I think every single person with a serious portfolio has got to have a reasonably significant exposure to precious metals. This isn't something that's just insurance for those who've got cold feet. This is something I think is a mainstream thing that people must have.

TGR: When you say a significant portion, what percentages are you thinking?

John Embry: I used to say 5% to 10% when it was just an insurance thing and the market was pretty sanguine. I say at least 20% now. I see the other assets as being less attractive. I wouldn't buy a bond if you gifted me with the money to do it.

TGR: John, once again, I appreciate it.

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Why is the Gold Price Rising?

What first ailed the Dollar has now sent the Gold Price in Euros soaring...

THE PIECE we wrote on gold de-coupling from the Euro/Dollar exchange rate proved correct, notes Julian Phillips at the Gold Forecaster.

The action of the last week has shown that as gold rose strongly in the Euro in the Pound and is moving up in the Dollar alongside most currencies.

More than that, market commentators are now mentioning this too. But this action involves far more than these two main currencies.

To make the point, we ask you, "Which is better, a glass cracked in the higher part of the glass or cracked in the lower part of the glass.

Now replace the glasses with the Dollar and the Euro. Both are now under question.

Above is a picture of a $50 Bill as you see it today. Below is a picture of a $50 bill from yesteryear then called a "Gold Certificate".

It was exchangeable for $50 worth of Gold Bullion when gold was fixed at $20 an ounce. Note the same President's picture there.

What would he think...?

The modern note is not exchangeable for any gold let alone 2.5 ounces. And therein lies the problem of valuing any Dollar bill. Its backing is your confidence in the government and the monetary authorities issuing it, as a reliable measure of value.

The United States is not alone, of course. The Euro is now going through a similar loss of confidence. But put in your mind's eye a situation where the currency has the backing of gold and the government overseeing the currency. The dual support gives it far more value. Whereas today, you have a currency without the backing of gold and with the backing of a government trying to control the state of the economy by printing vast quantities of money in the belief that when the time is right they will withdraw it and re-establish monetary stability.

History alone gives us due cause to be prudent, doesn't it...?

On my recent trip to London I was given a $100 trillion bill from Zimbabwe. It will not even buy one sheet of toilet paper. The currency is no more. And if currencies are to retain more than a captive set of users, they have to retain the inherent disciplines that gold brings. History has shown that both politicians and bankers cannot resist the power that comes with money, and they eventually distort it. The distance between currency management that reinforces the value of that money (not just stable prices) no matter what pain is involved and profligacy is a long one. Once travelled it is extremely difficult to go back as confidence has gone.

Take a look at both the Euro and the Dollar over the last few months and you can see how far along that road we have travelled. Greece is threatening to go to the IMF and Germany still has not announced it is willing to bail out the country. Now look from Greece westward through Italy and Spain and those countries that rely on tourist spending on second homes and holidays. They're all in the same boat. Once Greece is helped, others will come too. It's more than just Greece for sure. If the IMF bails them out the Euro will weaken.

The real issue is of course the Dollar and the Pound Sterling. As we say in our global currency slot below, we are waiting for the morning to arrive when we wake up and find one Pound for commercial transactions and one Pound for capital transactions (last time called the Dollar Premium; I started my stock exchange career as a dealer in the capital currency in 1971). As for the US Dollar, keep your eyes on those 10-year Treasury bonds to see how the Dollar is faring internationally.

If China has stopped buying T-bonds and is selling, then the yield will rise and the Dollar will fall. Or did the People's Bank merely threaten to do so?

Sadly, Gold Prices are now a thermometer to the state of global currencies and the decay of confidence. As the Dollar weakens we are seeing gold rise. As the Euro weakens the Gold Price rises and when the Pound falls gold rises. The price of gold in local currencies is being more widely quoted now, not just a US Dollar price.

The problem is systemic. All currencies operate the same way and their health springs from the US Dollar and the Euro. Only resource producing or China oriented currencies look healthy at the moment. But even there we have to realize that national power lies with people irrevocably committed to putting their national interests ahead of global interests. A global reformation is called for!

But in this scene, global national authorities, without the dominance of one single nation, have neither the will nor the competence to rectify problems.

Extrapolate this situation and you see an increase in the level of currency crises in both severity and consequence. Suddenly the musings of the IMF head, M. Strauss Kahn on a completely new global currency becomes pertinent. Unless this road is followed and quickly, the situation will darken considerably.

This is why the Gold Price is moving now. As politics will have it, unless push comes to shove and the situation becomes dire, little will be done. Smart money, institutional money is quietly moving a portion into gold as a measure of prudence.

How far will the Gold Price run in the next move up? This section is for subscribers only...

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Gold: Price Per Ounce or Ounces Owned?

Which matters more – the Gold Price you pay, or the quantity you own...?

DURING A RECENT conversation with a fellow gold analyst, he was emphatic that the price one pays for physical gold should be ignored, reports Jeff Clark of Casey's Gold & Resource Report.

"What's far more important," he insisted, "is how many ounces I own in relation to the total value of my assets."

Building a core position in Gold Bullion is a smart goal, to be sure – and a strategy Casey Research has been advising for years. However, ignoring the price you pay for gold could be seen as foolhardy.

Sure, gold can act as insurance, but isn't price part of the consideration when you shop for insurance?

The World Gold Council just released their 2009 annual report on Gold Investment, jewelry and supply trends. From the densely populated pages of interesting data, there's one compelling tidbit I gleaned that may shed some light on the buying behavior of today's gold buyers.

Overall investment in gold was 7% higher in 2009 than 2008. This is significant when you consider that demand in the fourth quarter of 2008 – during one of the worst financial meltdowns in history – was so great that shortages of physical metal abounded everywhere. And yet investors bought more gold in 2009 when investor fear about global financial uncertainty was subdued.

Further, 2009 total funds invested in all forms of gold exceeded 2008 by 20%, and the average price was 11.6% higher. In other words, investors were Buying Gold even though the price wasn't necessarily "low." To be sure, that's a broad statement. But the fact remains that year-on-year, more gold was purchased at higher prices when the markets were less scary, than when the price was lower and Hank Paulson was on CNBC every 15 minutes pontificating on how to save America's financial system.

This isn't to suggest one shouldn't pay attention to price. And the data doesn't identify how many of those who purchased gold last year were first-time buyers, as certainly there were newcomers to the sector that contributed to higher demand.

But it begs the question, who would continue to Buy Gold when the price is higher? Whoever doesn't own enough, that's who.

The gold I bought last month was certainly higher priced than what I paid in 2008. But I'm trying to position my assets for protection from eventual Dollar debasement and rising inflation. So perhaps focusing more on acquiring sufficient ounces to withstand a storm rather than stubbornly buying none, waiting for "cheaper" prices, however you define that, is a better mindset. Not owning enough gold is equivalent to holding a million-Dollar mortgage and having a $10,000 life insurance policy. It won't help much when you really need it.

Of course we should pay attention to price. But the trick is not letting that distract you from buying what you need. You're not Buying Gold bullion as a speculation (although we expect to make a bundle on our holdings), but as a sound form of cash in an environment where government has no respect for a balance sheet and sees inflation as the only way out of its black hole of debt. During periods of inflation, the government does fine; it's the citizens that suffer from the lost purchasing power of their savings. It's clear our currency is being debased. What's your plan of defense?

For those diligently accumulating gold, how do you know when you have enough? Check your anxiety quotient. If Ben continues printing money or Obama promises more goodies than he has the money to pay for, and you remain calm, then you likely have adequate gold. These are the investors who can afford to be stubborn about price as they build their holdings. In my opinion, this is where we all want to be.

What form of gold should you buy? It depends on why you're buying it. If you understand gold's role in history, owning a physical form will come naturally to you. If you see the threat of inflation on the horizon, or you worry about what is being done to the Dollar, you'll perhaps own both Gold Coins and a Gold ETF. If you're worried about possible exchange controls someday, you'll consider a Perth Mint Gold Certificate. And the more gloomy your outlook about the global economy, the greater the percentage of all forms of gold you'll buy.

That said, we maintain a bias toward physical ownership. New York's SPDR Gold Trust (GLD) and the other Gold ETFs are fine and do offer protection. But the custodian isn't going to airmail gold to you when you cash in your shares; having the "hard money" in your hand gives you the freedom an ETF cannot. In our book, owning physical gold is where your first Dollar should go.

I remember when my wife and I decided it was time to get life insurance. We just had our kids, and it was time to play grown-up. Given what 5,000 years of history has taught us about the value of gold, and given what's happening at this moment in history to our currency, are you playing grown-up with your investments?

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Zombieland

Stimulus spending is a net negative to the US economy. But in China...?

"The WORLD'S LARGEST shopping mall is almost entirely empty," says a headline now making its way around the internet, notes Bill Bonner in his Daily Reckoning.

The mall is not one of America's consumer emporia. It is not even in the UK. Instead, it is in the Middle Kingdom...and twice as large as the "Mall of the Americas"...sitting in Guangzhou, China.

The world did not end in 2009. Two things are widely reported to have saved it – stimulus in the West and China in the East.

Harvard economist Robert Barro, writing in the Wall Street Journal, considered the effect of stimulus spending on the US economy. The US government's 2009 program was originally expected to cost $787 billion. Now it is estimated to come in with a final price tag of $862 billion. What do you get for that kind of money, he wondered?

The initial spending appears to work, since the government is spending money without raising taxes to pay for it. But the money has to come from somewhere. Tax receipts inevitably have to go up. Both spending and taxing are subject to "multipliers," says Barro. He calculates that each Dollar of public stimulus spending has a net cost of $1.50 in foregone private spending. A "bad deal...there's no such thing as a free lunch," even in fiscal stimulus, he concludes.

Stimulus spending is a net negative in the US; what about in China? The China story is largely a stimulus story too. China's stimulus, compared to GDP, is the world's largest ever – four times the size of America's stimulus program.

When bank loan volume is determined by central planners you are asking for trouble. But last year, faced with a downturn in demand from their main customer, the Chinese authorities put out the word to banks – increase loans. Loan volume approximately doubled...up to $1.4 trillion...for the greatest increase, in GDP terms, ever...and equal to a quarter of the entire national output.

Investment spending has long been an oversize part of the Chinese economy. As Americans spent too much, the Chinese invested too much in factories in order to make them things they could buy – just as the Japanese had done before them. Investment spending in China increased 200% since 2001, making it the world's biggest buyer of raw materials – by a huge margin. Chinese output is less than 10% of the world's total but China consumes 30% of the world's aluminum, 40% of its copper and 47% of its steel.

Where does all this stuff go? Thanks to China's visionary central planners, it goes just where it is not needed most – into more infrastructure and output capacity. Last year, 90% of China's growth came from this fixed investment spending.

There are about five times as many rivers in the US and five times as many cars...but China now has nearly as many bridges...three quarters as much road surface. But with easy credit, the connivance of local officials, and the blessing of the central government, it builds more.

Last year, approximately one out of every four square feet of commercial office space in Beijing were empty – about 100 million square feet of zombie space. All over town are dark buildings...the Minsheng Financial Center...concrete and glass towers on Financial Street...the China Life Plaza...the Bank of Communications.

This year, the vacancy rate will go up to 30%...possibly 50%, depending on whose estimates you believe. In Eastern Beijing, officials are doubling the size of the Central Business District, even though the vacancy rate there is above 35% already. Overall, the city will add another 13 million square feet of commercial space.

Outside Beijing, the zombies are multiplying too. Whole cities are empty. And in the suburbs of Huairou, a mock alpine village...with a 200ft clock tower...rises improbably in the industrial suburbs. Called the "Spring Legend", its publicists must be the same people who write fortune cookie forecasts.

"The air is so fresh it penetrates your heart," says the sales pitch. You would normally dismiss such descriptions as puffery. But in China's industrial suburbs the air is often so acidic that it might penetrate the skull too.

National politicians determine the availability of capital. Local ones have a hand in 'investing' it. Typically, development projects involve bankers, developers, and local politicians – much like Japan's huge public works' projects of the past 20 years. Local governments are deep in debt – with total local government debt equal to about a third of GDP. But they keep spending. In Huaxi, for example, they're still planning to build the world's second tallest building, a few feet shorter than Dubai's pyrrhic monument. Huaxi is also the home of the New Sky Village...another project that is lost in the toxic clouds.

Property prices are still spiking up. People are still speculating. Ships with dirt and rocks still head for Chinese ports. The capital spending boom goes on.

It looks like growth. But it is zombie growth. People build bridges to nowhere rather than working for profit-making enterprises. Concrete is used to put up cities where no one lives. Savings that might have been used to start a new bank is instead used to prop up an old one.

Japan has been doing it for years. Encouraged by government miscues in the '80s, private industry created Japan's zombies. Then, after the bubble burst, the government kept them alive. They've been sucking blood from the living ever since.

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