Fighting the Crisis, Fighting Gold

"Why won't you die, damn it!" shouts the video-gaming central banker at the crisis...

BACK WHEN I had more time, I would occasionally play Oblivion, a video game, writes David Galland, managing director of Casey Research.

That game is so addictive, it's been blamed for people flunking out of colleges and the failure of marriages. And when persevering in a sword fight, your computerized opponents were prone to angrily mutter the phrase "Why won't you die, damn it!"

That phrase pops to mind as I watch the global stock market continue to get hammered, and Gold continues to battle the headwinds with impressive tenacity.

So why won't the damn crisis just die – and with it, gold?

It's not my intention to rehash the details of the events leading so many economies to this challenging place. Instead, I'll cut right to the chase by stating my firm opinion that the reason this crisis is so persistent – why it won't die anytime soon, and not without a lot of thrashing about – has to do with the debt at its core.

Earlier today, I was trying to explain the situation in terms appropriate to my son's 13-year-old mind. I put it something like this...

Imagine if you made $12,000 a year working as a counter clerk at the local pizza parlor. Then imagine you had foolishly run up $12,000 in credit card debt, the proceeds of which you had frittered away on consumables that contribute in no substantive way to creating future wealth.

Now, imagine someone was foolish enough to continue lending you money, so that you were able to spend approximately 40% over the amount you earned – or $16,800 in total, some percentage of which was the interest you were paying on your overhanging credit card debt.

Given that set-up, I asked, how could you possibly pay off your debt?

"Get a better job?" he responded.

A good answer, I thought.

But stepping out of the metaphor to the actual players in this drama, the indebted nation-states, how do they get the equivalent of a "better job?" Which is to say, raise revenue?

Only one way, really. And that is to raise taxes. But taxes can only be raised so far before they hit a wall beyond which people simply won't, or can't, pay them. And raising taxes by a sufficient amount to count, in the teeth of an epic downturn, will only further hobble the economy.

For the time being, thanks to all sorts of machinations, the US Treasury is finding lenders willing to buy its debt and keep things afloat.

But now jump back to the pizza counter help and imagine what would happen to his or her finances if:

• the foolish lenders wised up and refused to keep trading good money in exchange for highly suspect IOUs backed by nothing...while simultaneously
• the credit card company bumped the interest rate on the debt outstanding from 3% to 10%...?

In a nutshell, this is the current set-up of things. While the specifics will vary depending on whether it is the flag of Greece, Spain, Portugal, the UK, the US, Japan, etc., which flies over the home turf, the fundamental realities of this being a debt crisis are immutable.

And, as the EU is now learning, intractable. Which is to say, the only way that this crisis will die is if the debt can be reduced to a manageable level.

Given the sheer scale of the debt problem, all the easy ways for that reduction to occur have long ago packed up and left town.

At this point, any real solution will likely involve all of the following:

1. Bond investors being wiped out, or at least suffering serious losses. Tough luck, a non-bond investor might be tempted to think. But before you do, make sure you checked the prospectuses of your money market funds and the paper being held in great piles in the financial institutions where you currently park your money.
2. Inflation. Why pay back $1.00, when you can pay back 50 cents?
3. A wholesale canceling of contracts. Okay, so you thought you were going to collect Social Security in your declining years – think again. And that nice government pension? Oops.
4. Higher taxes across the board. Congress is getting ready to quadruple the federal tax on oil. And the imposition of a VAT in the US is a near certainty, albeit with all manner of politically convenient but ineffective provisions to make it look like the Democrats aren't breaking their pledge to not raise taxes on the middle class.
5. Ultimately, defaults on sovereign paper. Like the indebted pizza jockey, once it begins to be hard to find lenders, and those that you can find are only willing to lend at much steeper rate, all that is left to you is to borrow enough gas to drive down to the nearest office of Dewey, Cheatem & Howe and start the process to declare bankruptcy.

In other words, this crisis is not going to go quietly to its dirt nap. Instead, the end will almost certainly be akin to a Viking funeral with the political equivalent of rape followed by a raging fire on a sinking ship. Riots in the street and a serious degradation in the quality of life of the majority of the citizenry are all but inevitable, followed by a sea change in the political landscape.

Then, and only then, can the world get back to the business of forgetting the lessons learned in order to repeat the cycle all over again.

As for buying gold, the fact that it has refused to die as the world's only reliable form of money over the last seven millennia should give you the confidence to include it in your portfolio at today's purportedly elevated levels.

Gold: US Tax Guide

A quick guide to US tax and Gold Investment...

PROPER FINANCIAL PLANNING remains incomplete until you consider the endgame consequences of your investment decisions, writes Jeff Clark, senior editor of Casey's Gold & Resource Report.

So just what are the tax consequences for a US citizen of selling investment gold, Gold ETFs or Gold Mining stocks?

There's lots of conflicting and inaccurate tax information on the internet about this. We know of one site, for instance, that claims the sale of silver Eagles is exempt from capital gains tax due to some obscure law. (Not true.)

So – acknowledging that the following information pertains to US taxpayers only and is not intended as nor should be considered personal tax advice. Always consult a financial planner and/or tax professional before investing – let's nail down the current tax rules for selling gold while paying taxes in the United States.

First, the IRS considers gold a "collectible" and will tax your capital gains at a 28% rate. This designation includes all forms of gold (other than jewelry), such as:

• All denominations of Gold Bullion coins and numismatic/rare coins;
• Precious metal bars, whether ounce, kilo or larger – whether held at home or via secure custody services such as GoldMoney and BullionVault – and also gold wafers;
• ETFs like GLD, PHAU and so on (closed-end funds have different rules; see below);
• Any "paper gold" or Gold Certificates, such as Perth Mint Certificates and EverBank accounts;
• All forms of pool gold, rounds, and commemorative coins;

The same designation and rules apply to silver, platinum, and palladium.

"Reporting" requirements can be confusing. It is true that precious metals dealers aren't required to report certain small sales to the IRS – but that doesn't relieve you of the obligation. If you sold one gold or silver coin to your local dealer, he is not obligated under current regulation to report the sale. But selling at a profit requires you to report it and pay 28% tax on your gain.

Keep in mind that the Patriot Act obligates a dealer to report any "suspicious customer activity". Therefore, don't expect a wink from your dealer if you proclaim you won't be reporting your sale or ask him to "book" only half the coins you sell him. There are people sitting in prison who've tried this.

Gold Mining stocks, on the other hand, are not designated as a collectible and are therefore subject to the standard capital gains tax rates like all other stocks.

Gold jewelry sales are not reportable. This makes the Heirloom Collection an attractive consideration and an excellent diversification maneuver (for both financial and romantic reasons!).

We wouldn't advise making your investment decisions based solely on tax considerations. You should own both Gold and gold stocks for different reasons – gold for wealth protection and gold stocks for profit potential.

There's a lobbying arm for our industry, the Industry Council for Tangible Assets. Their efforts are mostly for dealers, but their website contains valuable information on this topic.

For US investors, there's one more tax consideration if you own, or plan to own, a closed-end fund (whether it's precious metals or otherwise). For example, the Central Fund of Canada (which holds gold and silver bullion) is considered a Passive Foreign Investment Corporation (PFIC) for US investors. This is a complex topic, but what I learned could save you some dinero now and some hassle later if you own a foreign closed-end fund like this one.
 
Keeping it simple, if you own CEF, you can qualify for the standard capital gains tax rates, instead of the 28% collectibles rate, if you file a timely and valid Qualified Electing Form, or QEF. There are several options you can take with a PFIC, but this is the most common election.

Even if you don't sell the fund in any given year, you must file this form every year. If you don't complete an annual QEF or make one of the other elections, you could get hosed when you eventually do sell because your gain will be considered ordinary income, forcing you to pay interest and penalties on top of the regular tax.

You can hold a PFIC stock for years without paying tax, but if you haven't made a QEF or other election, you get the bad result we're describing when you sell. Further, if the PFIC company reports income in a given year, this income is reportable and taxable as regular income that year, even if no stock was sold and even if the stock ended down on the year.

The point here is obvious: don't blindly buy into a PFIC.

The QEF benefit is clear: you can cut your tax liability up to 46%, the difference between the 15% long-term capital gains rate and the 28% collectibles rate. Yes, US capital gains rates are scheduled to rise next year, but this option still reduces your tax liability.

A successful investor is an informed investor, and you should read the prospectus of any closed-end fund before buying. And if you don't want to mess with the tax hassle, use an ETF or outright Gold Dealing service instead.

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“Go 30% Gold Minimum”

Comfortable with the Euro or Dollar? Comfortable with the risk of Gold Mining stocks...?

WITH GOLD and Gold Mining stocks on a tear recently, does Casey Research still recommend holding one-third of an investment portfolio in cash? asks David Galland, managing director of Casey Research, of himself...

The answer depends, of course, on what country you are currently sitting in. Were I sitting in the Eurozone, I would have already moved much of my safe-harbor cash into the "resource" currencies such as Canada and Norway...i.e., countries that are rich in the natural resources that the world needs and will always need.

If my derrière were resting in a seat planted on US soil, as it is, and I didn't plan on doing any significant overseas spending, then I would feel relatively comfortable – for the time being, with a larger than usual allocation to the Dollar. But I would have been diversifying into the resource currencies as well.

But how can we write frequently about the demise of the Dollar and yet be "relatively comfortable" holding the stuff? Because in a nutshell, the monetary inflation, Quantitative Easing, and insane spending of the US government, emulated by countries around the globe, have set the table for a large serving of currency depreciation down the road.

Once that depreciation begins to appear in the form of price appreciation, we'll look to trade our greenbacks for more in the way of tangibles – probably more Gold Bullion...maybe real estate in a good location, location, location...maybe more silver...maybe deep-value energy stocks...maybe antiques...maybe some of all of the above.

For the time being – because price inflation is not out of control and yields are so low – there is little real carrying cost to holding a larger allocation to cash, and the flexibility and security of having cash is a big plus.

But what about gold and Gold Mining stocks in particular? Gold is sound money. Always has been, probably always will be. In the sort of crisis now underway – a crisis that to no small extent is now focused on sovereign fiscal and monetary excesses – gold has a particularly important role in protecting wealth.

If you don't own it, start accumulating it is our advice, preferably on the inevitable dips. If you do own it, hold it and consider accumulating it up to somewhere between 20% and 30% of your portfolio, though the exact amount will depend on factors such as your cash flow needs, personal debt obligations, your age and work status, and so on...factors that we can have no way of knowing.

One of the nuances in answering this question has to do with deciding what form of gold to own. While we like physical gold held in a safe place, you don't want to go overboard, because things can happen. For instance, robbery, or even a house fire that melts your wealth back into the dirt.

In addition, at some point the gold bull market will end, and when it does, the scramble to sell will likely overwhelm the coin dealers to the point where they literally take their phones off the hook. That creates the potential for big gaps down in the price between the time you decide to sell and are actually able to sell. Mind you, I don't see that being a concern anytime soon – but it's always worth keeping in the back of your mind.

There are a number of other bullion alternatives – a big positive being that many are easy to buy, hold, and sell – including Allocated Gold as well as unallocated accounts, electronic gold, Gold ETFs, and so forth. Some are better than others – and all are worth understanding before making investments. Our Casey's Gold & Resource Report is a good source for this sort of info.

Generally our recommendation is to hold your gold in a variety of investment vehicles as that will mitigate the risks of having too many eggs in one basket.

Turning to Gold Mining stocks, savvy investors will already be well positioned in the best of the best. And will own many positions risk-free, having already recaptured their original investment. If that is the situation you are in, and you really understand the companies you are invested in, then at this point either hanging in for the big upside or trading the surges and dips makes sense. If you are new to the sector, I wouldn't chase the stocks just now – but rather put in stink bids – i.e., 10% to 20% below the current market, and look to get filled on a correction.

If you are new to the gold stocks, or risk-averse, then look to build a portfolio of large-cap gold stocks. Those will attract a lot of attention from the public at large, and from institutions, as the bull market gathers steam.

If you have experience with Gold Mining stocks, and a higher tolerance for risk, then you may want to focus on the small-cap Canadian explorers and developers. Those juniors have amazing volatility and, when the news is good, the upside can be breathtaking.

Regardless of the approach you take, don't chase stocks as they move higher – but look to build your portfolio on dips over the next few months. The idea is to get positioned before the underlying price of gold reaches a level where the public starts to come into the sector in a big way – at which point, if history is any guide, the early investors will make stunning returns.

What price is that? Some years ago, we had someone spend the better part of a week in a musty storage room full of old Canadian newspapers, paging through past issues and recording the price and volumes of the gold stocks during the last big run-up, in the 1970s. We then compared that data to the Gold Price in inflation-adjusted Dollars in order to determine the price when the broader investment public began piling into the gold. The number worked out to about $1250 per ounce in today's Dollars. In other words, when gold decisively takes out $1250 an ounce and holds above that level, if history is a guide, we may start seeing the average guy on the street – and the institutions – pile into the stocks.

Of course, while interesting from an historical perspective, that analysis has no scientific basis. The key point, therefore, is that during the last big gold bull market the public wasn't involved in the gold stocks when they should have been – in the run-up phase – but rather only piled in after the price of gold bullion soared, relatively late in the bull market. So far, the average Joe and Jill are just not in this market. But they will be. It's got a good while to run yet.

Having been around and actively involved in hard assets during the last big gold bull – as the editor of Gold Newsletter and the conference director of the New Orleans Conference – I hope I can provide some useful perspective. For instance, I can well recall when, in late 1979, all of the many gurus of the day were predicting gold would keep going higher and higher still. Well, as we all know, it didn't.

What's interesting about this time around is that there is almost no scenario we can envision that is going to kick the legs out from under the gold market – at least not anytime soon. In contrast, in the late 1970s, the gold bulls coulda/shoulda seen that the Fed had a lot of room to act – i.e., by pushing up interest rates – in order to tackle the price inflation that was the key driving force in the soaring Gold Prices of the time.

Today, the situation is profoundly different. Starting with the fact that this is, at the core, a debt crisis. And the one thing you can't do in a debt crisis is to encourage interest rates to rise. Look no further than Greece for that lesson.

So, we have an unprecedented monetary inflation, truly out-of-control sovereign spending and debt, unprecedented levels of private debt, unprecedented trade deficits, a massively overbuilt and overpriced post-bubble real estate market, and, importantly, near historically low interest rates.

We have to ask ourselves – other than continuing to exercise its powers of fiat money creation – what ammunition does the government have at its disposal to address the structural problems of today's economy? And, of course, actually creating more money and more debt isn't addressing the structural problems, it is compounding them.

Of course, the government can default on their sovereign obligations – an option I think we'll see Greece and others of the PIIGS take, and probably fairly soon. They can also continue to inflate, which we expect them all to do.

And they can...no, actually, I think that about sums it up: default or inflate. In either scenario, gold is going to be seen as the ultimate safe harbor.

But won't the government see gold as a threat to its fiat currency and try to do something about it? Of course, governments might try any number of stunts that could affect gold. For example, raising margin requirements to curb playing the Gold Futures market with leverage, or even attempting outright confiscation of gold held on-shore. All we can do is to monitor the situation closely and try to anticipate their next moves in order to get out of the way. A number of people I know have opened safety deposit accounts in other countries as one way to hedge their bets against confiscation. Others have bought "numismatic" rare coins – but be careful on that front, because that can increase illiquidity.

It is not out of the question, in my view, that before this is over, we could see a revaluation of gold in order to re-link the US Dollar to it – because sooner or later, as the crisis reaches its climax, something is going to replace the fiat currencies. But at this stage it's impossible to guess what that will look like. If we did see a return to a Gold Standard, then the government could actually be responsible for sending gold up by many multiples.

Back to the present, at this point I can't see anything that is going to derail this bull market – but I do see a whole lot of things with the potential to send it into the stratosphere.

Buying Gold today...?

Why the Euro Is Falling

Why the single currency is doomed...

On APRIL 22nd, the Eurostat data agency released figures on European Union member states' government deficits and debt for 2006-2009, write Kevin Brekke and David Galland of The Casey Report.

The European Commission requires member states to report certain data every April. This year, the timing of the report's release could not be more problematic for Greece, which has been in discussions with the IMF and other EU states over possible bailout assistance. In a note to the report, Eurostat expressed reservations about Greece's accuracy in its numbers from last year, saying:

"Eurostat is expressing a reservation on the quality of the data reported by Greece, due to uncertainties on the surplus of social security funds for 2009, on the classification of some public entities and on the recording of off-market swaps. Following completion of the investigations that Eurostat is undertaking on these issues in cooperation with the Greek Statistical Authorities, this could lead to a revision for the year 2009 of the order of 0.3 to 0.5 percentage points of GDP for the deficit and 5 to 7 percentage points of GDP for the debt."

If these "reservations" prove correct, it will catapult Greece into the debt-to-GDP leader at 122.1%, leap-frogging Italy, which is currently at 115.8%.

But perhaps most telling is the report's title – "Euro area and EU27 government deficit at 6.3% and 6.8% of GDP, respectively." Recall that the EU's Stability and Growth Pact mandates a budget deficit ceiling of 3.0%, and we see that the 16 Euro area members are, in aggregate, in gross violation of the pact. Even more alarming is the rate of change in the aggregate budget deficit figure from 2008 to 2009, growing 230%.

And lastly, the aggregate Euro area debt-to-GDP ratio climbed from 66.0% in 2007 to 78.7% in 2009, a stunning rise. If this annual rate of growth continues, the Euro area debt-to-GDP ratio will zoom past 100% in two years, a level at which many think it begins to exert significant strain on fiscal budgets and spending.

The report, on the whole, paints a picture of an experiment in currency sharing and cross-border "normalization" of fiscal order that has gone terribly wrong. The old saying that a camel is a horse designed by committee seems to be underway here. It will be amusing to watch into what sort of "animal" the EU morphs in the coming years.

As one would expect on reading news that is less than cheery for the Eurozone, the US Dollar has been moving up, sending gold lower. So, perversely, you have gold and the Euro moving together.

While the current rebound in the Dollar may be discomfiting to some gold investors, especially in that gold has been facing headwinds again, in our scenario of a broad-based crisis in the global fiat currencies, the major currencies will come under pressure individually before coming under pressure collectively.

Today, safe-haven seekers reflexively run from the Euro to the US Dollar, which in turn sends a signal to the trading community to sell gold for no better reason than the historical inverse connection between the Dollar and gold. This is only temporary, as you can see in the following chart plotting the Euro against gold over the last troubled year.

This is all just part and parcel of the secular trend that will lead to the end of the fiat currency experiment as the world wakes up to the full implications of the institutionalized monetary abuse engendered by a fiat system. As is so clearly evidenced in the drama now playing out in Greece, when a government is forced to solve its debt problem by issuing more debt, the end is nigh.

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Low Rates, High Spending

How US and Chinese politicians are working together to fight the inevitable...

GIVEN HOW critical government has become in the financial markets, predicting what move the government is most likely to take next means we must first assess the probabilities, writes David Galland, managing editor of The Casey Report.

In order to do that, we start by restating the central question:

"How does the US government spend, spend, spend (a minimum of $10 trillion in red ink over the next decade) and yet maintain today's historically low interest rates?"

Not to get all Freudian here, but we begin to answer that question by understanding that, despite evidence to the contrary, government officials are actually human beings. And so it is that, just as babies reflexively learn that a return trip to mother's breast results in a reliable reward, politicians reflexively repeat actions that have previously produced the desired results.

So, how does a government spend like a drunken casino jackpot winner, without actually winning the jackpot?

And do so, while simultaneously having interest rates fall to the lowest level in 50 years?



The answer?



With artificially low rates, the US consumer was able to buy pretty much any shiny thing his or her eyes came to rest on.

But only because our foreign trading partners, most notably China, were willing to recycle the Dollars they earned selling us flat-screen televisions and disposable diapers into US Treasury debt. That allowed the government to keep rates down while simultaneously spending up a storm.

Given how well the symbiotic relationship between the US government and its trading partners worked for all parties concerned, it should be no surprise to expect the bureaucrats to sign on for the sequel. In that regard, I don't think it's a coincidence that there has been a sea change in the tenor of the diplomatic exchanges between the Obama administration and the Chinese in recent weeks.

One minute it was all bared teeth and cracking knuckles, and the next we hear that the Treasury Department's semi-annual report on global currencies, which was expected to condemn the Chinese as currency manipulators, may be toned down.

Doing their part to reduce the heat, the Chinese have said they'll adopt a more flexible currency regime and even follow the US lead on sanctions on Iran. Meanwhile Timmy Geithner has been hopping on a plane for Beijing ahead of a meeting between that country's president and The One.

It's enough to make the head spin.

Unless, of course, you take a moment to understand that, as hedge fund manager James Chanos so succinctly put it, that China is on a "treadmill to hell." (It's the treadmill right next to the one that the US is now laboring on.) Or, to quote Ben Franklin's oft-quoted remark to the continental congress, "We must, indeed, all hang together, or most assuredly we shall all hang separately."

One might imagine that the conversation now going on between Timmy and the Chinese is running along the following lines:

"Okay, what do you guys want?" Timmy asks nervously.

"We need access to US markets, because if we can't get all these empty factories humming, we're going to get strung up by our collective heels..."

"And so you want us to do what?"

"For starters, pretty boy, tell your most esteemed party members to stop yapping like diseased dogs about our currency. And stop all this talk about tariffs. We got business to do, and that business is selling your peasants cheap stuff."

"We can do that. But in exchange, you have keep showing up at our Treasury auctions. Use that big pile of foreign reserves to buy a ton of Treasuries over the next couple of years. That way we can try to buy our way out of this damn recession while keeping rates low. That works out well for you guys, too, because it will mean that our peasants will still be able to afford the stuff made by your peasants. That's what we Americans like to call a 'win-win'."

"But then we'll end up with even more Treasury paper. Already it's getting hard to find a place to stash all of it. And if you keep cranking the stuff out like a noodle shop, then in time it will be worthless."

"I hate to break it to you, but it's already pretty much worthless. We're so broke that I had to pass on the lobster last night. Your only hope is to keep the shell game going a little longer – you know, buy us some time to work this thing out."

"Can't you just invade Canada? They got lots of resources, but they don't have no nukes. Kind of like Tibet."

"Let's just say that all options are on the table. But for now, all that's required is that you just keep showing up at the Treasury auctions."

"We are going to want some special considerations, starting with losing that whole currency manipulator thing."

"Well make it go away. After all, we're all comrades now."

And it won't be only the Chinese that the US will begin rolling over for. The Russians, the oil sheikdoms, the Japanese – all are going to get calls, if they haven't already. Given that the US currently holds the title "Global Empire", we have a lot to trade with. Whereas, if your country doesn't currently hold that title, or is otherwise lacking in trading chits, then your sovereign debt problems are very likely to go "Greek" in the near future. As the leaders of Thailand and Kyrgyzstan are now finding out, it's a dog-eat-dog world; get used to it.

How will we know if this scenario is coming to pass? First and foremost, watch foreign government participation in the US Treasury auctions. If they show up in droves and keep buying at today's low rates, you know the fix is in. And watch the language as it relates to China's currency manipulation in the soon-to-be-released Treasury report.

Also, watch the level of China-bashing emanating from Democrats. Today it is high, but I suspect it will begin to moderate following Geithner's trip, as China puts its financial reserves to the task of saving the US economy while talking the talk (if not walking the walk) about letting its currency rise.

Beyond that, watch as the concessions to other important Treasury buyers start to roll out. The long-term consequences of those concessions will be of no concern to the current administration, because at this point they are in full panic mode – panicked because they know if they can't keep interest rates down, it's game over – and not just for their political fortunes.

So, what's the second move the government is most likely to make in its attempt to head off a debt-driven death spiral?

They'll have to raise some revenue. However, once the Bush tax cuts expire next year (or are repealed this year), then further raising taxes on the affluent will be difficult – especially given that the top ten percent currently pay 73% of the nation's income taxes, while the bottom 46% pay none.

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Inflation Adjusted Gold

Gold Prices reviewed with an adjustment for inflation...

The INEVITABLE QUACKING about gold being over-valued has begun as the Gold Price rises once more, writes David Galland, managing director of Casey Research.

I think a quick check-in with the historical perspective, starting with inflation adjusted Gold Prices, might prove useful.

The first of two charts that follow shows the long-term picture of Gold Prices from 1970 to the present, correctly adjusted for inflation.

In the second chart, we overlay the inflation-adjusted Gold Price from the last secular bull market of the 1970s with the secular bull market we've been in since 2001.

As you can see, if the current bull ends with the sort of grand finale we saw at the end of the last big blow-off, then prices have a long way to go from here. That said, a credible case can be made that this time around, the price could go much higher.

For starters, in the 1970s, the economy was in much better shape than it is today – though it wasn't good by any means. The chart here uses long-term unemployment as a proxy for that contention.

As you can see, at the end of the 1970s, the employment picture was quite healthy. Whereas today, in addition to wildly out-of-control debt on both the private and public levels, we have a massive problem with unemployment and the consequences of a burst housing bubble.

Thus, Paul Volcker's somewhat simplistic solution to inflation – and the trigger for the end of the last Gold Price bull market – was to seriously ratchet up interest rates. But that's now off the table. (Since we're trying to gain perspective, I'll remind you that at the beginning of the 1980s, mortgage rates topped 18%.)

But wait, I heard someone in the back shout, "There is no inflation today!" Wrong, there is unprecedented inflation – properly defined as an increase in the monetary base. What's missing, so far, is the inevitable consequence of the inflation – steadily rising prices.

That will come, and when it does, the government will find it is going into a gunfight with a (dull) knife – because raising interest rates in the Kingdom of Debt will lead to a predictable outcome.

Unfortunately, thanks to the inflation, interest rates are going up no matter what the government would prefer to happen, a contention of ours that is now gaining traction in the mainstream. And, yes, up to a point, history shows Gold Prices and interest rates moving upwards in concert.

Don't go crazy about Buying Gold, but by all means, if you don't own some, begin a monthly program of purchases. While it would be perfectly natural to see the Gold Mining stocks give back some of the big gains they have offered since last year's correction, any further corrections should be viewed as opportunities. But again, don't go overboard. If you have an investment portfolio with 20% to 30% in a combination of precious metals bullion, large-cap and small-cap stocks, you'll be well positioned – and protected – for what's coming.

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Inflation Adjusted Gold

Gold Prices reviewed with an adjustment for inflation...

The INEVITABLE QUACKING about gold being over-valued has begun as the Gold Price rises once more, writes David Galland, managing director of Casey Research.

I think a quick check-in with the historical perspective, starting with inflation adjusted Gold Prices, might prove useful.

The first of two charts that follow shows the long-term picture of Gold Prices from 1970 to the present, correctly adjusted for inflation.

In the second chart, we overlay the inflation-adjusted Gold Price from the last secular bull market of the 1970s with the secular bull market we've been in since 2001.

As you can see, if the current bull ends with the sort of grand finale we saw at the end of the last big blow-off, then prices have a long way to go from here. That said, a credible case can be made that this time around, the price could go much higher.

For starters, in the 1970s, the economy was in much better shape than it is today – though it wasn't good by any means. The chart here uses long-term unemployment as a proxy for that contention.

As you can see, at the end of the 1970s, the employment picture was quite healthy. Whereas today, in addition to wildly out-of-control debt on both the private and public levels, we have a massive problem with unemployment and the consequences of a burst housing bubble.

Thus, Paul Volcker's somewhat simplistic solution to inflation – and the trigger for the end of the last Gold Price bull market – was to seriously ratchet up interest rates. But that's now off the table. (Since we're trying to gain perspective, I'll remind you that at the beginning of the 1980s, mortgage rates topped 18%.)

But wait, I heard someone in the back shout, "There is no inflation today!" Wrong, there is unprecedented inflation – properly defined as an increase in the monetary base. What's missing, so far, is the inevitable consequence of the inflation – steadily rising prices.

That will come, and when it does, the government will find it is going into a gunfight with a (dull) knife – because raising interest rates in the Kingdom of Debt will lead to a predictable outcome.

Unfortunately, thanks to the inflation, interest rates are going up no matter what the government would prefer to happen, a contention of ours that is now gaining traction in the mainstream. And, yes, up to a point, history shows Gold Prices and interest rates moving upwards in concert.

Don't go crazy about Buying Gold, but by all means, if you don't own some, begin a monthly program of purchases. While it would be perfectly natural to see the Gold Mining stocks give back some of the big gains they have offered since last year's correction, any further corrections should be viewed as opportunities. But again, don't go overboard. If you have an investment portfolio with 20% to 30% in a combination of precious metals bullion, large-cap and small-cap stocks, you'll be well positioned – and protected – for what's coming.

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Taxes & Inflation

You plan for taxation. Best now plan for inflation as well...

LIKE MOST PEOPLE, I'd say the passage of the healthcare bill wasn't met with the popping of champagne in my house, writes Jeff Clark, senior editor of Casey's Gold & Resource Report.

I found myself chanting "Uncle Sam, Uncle Sham" as the day wore on. Higher taxes and other major changes are headed our way. And yet, I think there's something in the bill that's even more dastardly.

If you're a supporter of the bill, you'd point to its benefits: Poor adults will get Medicaid. Low-income families will get federal subsidies to buy insurance. Small businesses may get tax credits. Kids will be able to stay on the parents' policy until they turn 26. Seniors get additional prescription drug coverage. People with pre-existing medical conditions can't be denied or dropped.

While no one is really against any of those things, the elephant in the room (or boa constrictor in the bed) is how those things are going to be paid for. Here's how: the "wealthy" will pay higher taxes; businesses with 50 or more employees will have to insure them or pay a penalty; individuals will have to pay a fine if they don't buy insurance; premiums will rise for many who already have insurance; and seniors with Medicare Advantage policies could lose those plans or pay more to keep them.

Regardless of how you feel about the bill, the fact is that taxes are going up, and not necessarily just on the "wealthy." The healthcare plan will cost $940 billion over the next decade, almost $100 billion a year.

I haven't read the 2,407-page bill (almost twice as long as the Gutenberg Bible), but there are plenty who have. Here's a summary I compiled, from various sources, that outlines the tax ramifications of what is now the law of the land.

Assuming the Senate passes the package of changes, the biggest tax increases will be in Medicare payroll taxes. Those take two forms, both starting in 2013:

• Singles earning more than $200,000 and couples earning $250,000 will pay 0.9% more on wages and self-employment income.
• All investment earnings will be taxed an additional 3.8%. This includes capital gains, dividends, and interest, the first time in history the Medicare tax is applied to them.

But keep in mind that the Bush tax cuts expire at the end of this year, which will push the Medicare tax on capital gains to 23.8% in 2013 on these earners. Dividends, currently taxed at the top rate of 15%, will be taxed as ordinary income, with the top rate scheduled to rise to 39.6% (from 35%).

This means that the tax on dividends could go as high as 43.4% when the new Medicare tax goes into effect in 2013. (Obama has proposed a top dividend tax rate of 20%, so if Congress enacts his proposal, the top tax rate for dividends would "only" rise to the 23.8% level in 2013.)

You may think you'll escape this tax if you're not "rich". But it's those darn Unintended Consequences politicians never seem to think about that could still sting you. For example, the 3.8% Medicare surtax could snag you if you happen to sell some real estate for a big gain.

The other major tax increase is the one imposed on health insurance plans that are more generous, the so-called "Cadillac" health plans. And this tax increase doesn't just apply to high-income earners; those state and union workers that lobbied for better health coverage instead of big pay increases are going to find they're included with the "rich" in a new excise tax. Starting in 2018, family insurance plans valued at more than $27,500 ($10,200 for individuals) would pay a 40% tax above that level.

Ouch.

And there's other ways you'll be taxed, particularly through the magic of "passing it on to the consumer."

For example, pharmaceutical manufacturers will pay an annual fee based on their market share starting in 2011; same for health insurers, starting in 2014. A 2.3% excise tax on the sale of medical devices will start in 2013. A 10% excise tax on indoor tanning services goes into effect this July.

How will all these businesses afford the additional tax? They won't. You'll pay it, through higher prices.

Further, were you one of those who incurred medical expenses above 7.5% of your income, thus allowing you to deduct them? That ceiling will be 10% starting in 2013. (It remains 7.5% for those over 65.)

There's more, most of it in the form of greater restrictions, increased penalties, and higher fines on various entities, businesses, health plans, or individuals. But what I especially cringed at was this: the bill vastly expands the responsibilities of, and gives greater strength to, the IRS. The agency will hire as many as 16,500 additional auditors, agents, and other employees just to enforce all the new taxes and penalties.

Specifically, the bill will empower the IRS to do the following: verify citizens have "acceptable" health care coverage; impose fines up to $2,085 or 2% of income (whichever is greater) for failure to purchase "minimum essential coverage"; confiscate tax refunds; and increase audits.

The upshot is that this will force many taxpayers to be more conscientious of monitoring their income and tax withholding.

Perhaps most damaging to the government's plans is if the bill leads some to ask the Ayn Rand/Atlas Shrugged questions: What if I just stop being productive? What if I stop working once my income approaches the threshold? What if I invest less so that I stay under the limits?

And last, here's the time bomb that could trump the tax concerns: none of these taxes are indexed to inflation. Since the bill fails to index to inflation the exemption threshold for the Medicare taxes on both earned and unearned income, it's almost certain many taxpayers will get to these tax levels a whole lot quicker than they think.

What this essentially means is there is now more incentive on the part of the government that we have inflation. If inflation reaches 10% at some point, which is below the 14%+ rate it hit in 1980 and far below any hyperinflationary level that's possible, the $100,000 earner gets to the magical $200,000 level in seven-and-a-half years. From the government's perspective, it makes the printing of money a lucrative affair.

Yes, higher taxes are coming. But with the government's built-in incentive for inflation, along with the reward that comes from getting more citizens to higher tax rates, many may find the tax issue an annoying mosquito bite compared to the alligator chomp of inflation. And high inflation affects every citizen, regardless of income or tax rate. Those who think they've escaped the cold may find they've walked into a freezer. 

With this added push to inflate, our investment strategy for the foreseeable future is now clear: We must invest in assets that not just keep up with inflation but outpace it.

All wise citizens do tax planning. Have you done inflation planning? We here at Casey Research think it's imperative investors be overweight precious metals.

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The True US Deficit

Re-counting the US budget deficit forecasts, courtesy of the CBO...

RECENTLY the Congressional Budget Office (CBO) published its scoring of President Obama's budget for the next 10 years, writes Bud Conrad, editor of The Casey Report.

It shows a budget deficit of $9.8 trillion. That is just shy of $4 trillion worse than the CBO's baseline budget, a budget that includes only the laws as currently enacted, with no estimates of any new programs lawmakers may add that worsen future projections.

That our budget is out of control is no surprise, but the charts I present here should provide some perspective of just how dangerous this set of budget estimates could turn out to be. The first chart below shows the amount of red ink in each year for the two CBO estimates.

To get a visual interpretation of just how big these budget deficits have become, I plotted the long-term history, then tacked on the CBO evaluation of the president's proposal. Knowing the propensity of governments to spend more than they promise makes one question if the large improvement shown in the dotted line will actually occur.

Even if nothing changes, however, the results look like they could be very damaging for other aspects of our economy.

One aspect of the CBO projections that is difficult to defend is the expectation that inflation will stay incredibly low. In the next chart, I present the same sort of long-term history, coupled with the projection, for the Consumer Price Index (CPI).

In the next chart, I put together two of the most important measures: the three-month T-bill interest rate and the deficit expressed as a percentage of the gross domestic product (GDP). Both history and projection are shown.

The most important observation is just how disastrous the current deficit is in the historical context, even after rationalizing it by dividing it by the GDP. I overlaid the two series to show that higher deficits in the past tended to occur along with higher interest rates.

As you can see, we now have a significant anomaly, with the budget deficit at its worst in half a century, while interest rates remain near their lows for the period. A closer look at history shows many divergences, to the point that in the short term these two series tend to bounce in opposite directions. That is probably because when the economy shows weakness, the government expands its spending and collects lower taxes, so the deficit becomes worse. Thus, in the short-term cycle of a few years, these two measures often move in opposite directions.

But the situation we face now is much bigger than anything we've seen since the 1950s. The government bailouts and stimulus are at record levels, and the special actions of the Federal Reserve have driven interest rates close to 0%. It is my expectation that both inflation and interest rates will rise dramatically because of these large deficits.

I also think the projected interest rates are much lower than what I expect the deficit would require. As foreigners and others recognize how seriously indebted the US government is becoming, they will expect higher interest rates to compensate for the debasement of the currency.

The budget analysis goes further in calculating the expected growth of the economy, which ranges from 2 to 4% over the years. Those are not large numbers for real GDP, but there is no expectation of another recession during the decade. If the economy didn't grow, tax revenue would be less, and the budget deficit would be worse.

While interest rates are expected to rise as shown in the chart above, the projections expect that they roll over and stop rising at around 5%. That is contrary to my expectations that they will be much higher, and even perhaps closer to 10%, by the end of the decade. If they are, the cost of funding the outstanding government borrowing escalates rapidly because the increased interest has to be added to the debt so that the debt grows even more.

The problem from the onset of this crisis has been the debt, and that continues to be the case. Leaving aside the above two adjustments that could make the budget deficit worse, it's helpful to look at the outcome with the given assumptions and see where it leads. Perhaps the most problematic result is that the debt of the federal government held by the public grows from $7.5 trillion in 2009 to $20 trillion by 2020. Such big numbers are hard to understand, though you can get some sense of things by considering that the government is intending on almost tripling the debt in just 11 years.

The ratio of this outstanding debt to the GDP gives a flavor of how dangerous the situation has become. As Ken Rogoff and Carmen Reinhart have indicated in their new book, when we approach 90% government debt of GDP, we have serious potential for a currency crisis. As you can see, we are well on our way to those levels, even without assuming the two adjustments above.

How will the deficit be funded?

The question arises who will service the rising levels of debt. Clearly the taxpayers are on the hook for all these projections, with more to come. So the question becomes whether the tax base can grow fast enough to provide support for servicing the debt.

The CBO gave us two series for the tax base. One is Domestic Economic Profits, and the other is Wages and Salaries. The basic assumption is that these are the main revenue streams that can be taxed by the government to fund its expenses. I added these two series together and divided by the GDP to determine if the tax base is growing more rapidly than the economy. Unfortunately, but as expected, the orange line in the above graph shows that the tax base only grows about as fast as the economy itself. That's not surprising, but the contrast to the rapid growth in debt will be a serious source of problems, as the only way the debt can be sustained will be through increasing the tax rates, and probably quite dramatically.

The latest set of budget predictions will probably be wrong, and not just because the assumptions are too optimistic, but because there is a relatively high probability that something will go off track to cause a major shift before the 10 years are completed.

Unfortunately we are not preparing ourselves for such problems, and so I would interpret the CBO projections as being far too rosy.

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Ye Olde Rub

Beware the Great Debasement...

IT TAKES VERY little to set me off on yet another rant against the American political class these days, writes David Galland, managing director of Casey Research.

On occasion, I'm tempted to apologize for these rants. Not so much for the message, but for the frequency. Unfortunately, when surveying the landscape on which our hovels rest, the king's castle looms large in the foreground.

I am not an envious person by nature, and so wouldn't begrudge the king his fine trappings, provided they were honestly earned. But therein lies Ye Olde Rub.

Ever more frequently these days, the drawbridge comes down and a troop of the king's finest sallies forth to extort from me more than half of my crops, and to read new royal proclamations whose net result is to add to the daily burden of trying to provide sustenance for family and jobs for workers.

Should I protest, say, by grabbing a pitchfork and telling the soldiers to clear off my land, or refuse to fill their wagons with the best of my crops – each leaf of which represents time and investment on my part – they would grab me by the shoulders, drag me to the king's dungeon, and confiscate my property. In fact, the only thing that has changed since the days of yore is that the king's knights don't now rape as well as pillage.

Yes, to be fair, the annals of history contain rare instances of kind and intelligent monarchs, the sort who understood that overburdening the peasants ultimately reduces crop production, leading to unnecessary and unproductive hardship and, in time, even revolt. Though, by temperament, I resist authority of any description, I suppose I could live comfortably under the rule of a fair and benign monarch.

The problem with that notion, of course, is that the corruptive nature of power leads to the near certainty that Baldash the Not So Bad will be followed by Norbit the Nasty. And all of a sudden, instead of politely requesting I kick in some reasonable percentage of my crops to help maintain a constabulary, courts, and maybe the highways, Norbit's men are kicking in my doors and we're back to ox carts full of my produce being confiscated to provide a new golden dinner servicefor the crown, and to pay the cost of invading neighboring lands.

While some among you will protest, there is, I would contend, little difference between a degraded monarch and a degraded democracy. In the monarchy, a single leader directs his minions in their ruinous acts; in a democracy, the directions come from professional politicians, as well versed in gaining and keeping power as any royalty of a bygone era. (Sir Robert Byrd held high office in this nation for 57 years.)

Far from being benign, the nation's leadership, masters at appealing to the self-interest of an unprincipled voter class, have led us to a perilous situation where the fields are being left unplanted. And an increasing percentage of the citizenry is now muttering angry curses as the king's men ride by in their shiny black limo-horses.

For a clear understanding of just how poorly ruled this country has been, look no further than the latest budget projections. In his recent article, "America's Impending Master Class Dictatorship," Stewart Dougherty does just that, analyzing the government's wanton spending and penning some notable, and quotable, words on the topic.

One stark and sobering way to frame the crisis is this: if the United States government were to nationalize (in other words, steal) every penny of private wealth accumulated by America's citizens since the nation's founding 235 years ago, the government would remain totally bankrupt.

Recently our stalwart CEO Olivier Garret sent over an insider doc from the Republicans' Study Committee that provides talking points for candidates to use in the unending struggle for control of the castle. While I think the color of flag flapping over the battlements is at this point almost irrelevant, the document contains some interesting data points.

For instance...

• $13.5 Trillion of New Debt: The president's budget proposes to increase the national debt from today's level of $12.3 trillion to $25.8 trillion in FY 2020 – an increase of $13.5 trillion or 109.8%. The amount of new debt proposed by this budget is larger than the total amount of debt accumulated by the federal government from 1789 to today (even including the $3.6 trillion of new debt over the last three years).
• $2.8 Trillion Tax Increase: The president's budget submission increases taxes by $2.8 trillion over ten years. This includes allowing many of the 2001 and 2003 tax cuts to expire at the end of this year, such as allowing the top rate (which is often paid by small businesses) to increase from 35% to 39.6%, and allowing the top capital gains tax rate to return to 20%. These tax increases would take effect in an economy that, according to many economists, will still have an unemployment rate around 10%.
• Mandatory Spending: Increases from last year's level of $2.1 trillion to $3.4 trillion in 2020, an increase of $1.3 trillion or 59.4%. Within that amount: Medicare spending increases from $425 billion in 2009 to $953 billion in 2020 – an increase of $528 billion or 124.2%; Social Security spending increases from $678 billion in 2009 to $1.20 trillion in 2020 – an increase of $523 billion or 77.1%; and Medicaid spending increases from $251 billion in 2009 to $487 billion in 2020 – an increase of $236 billion or 94.0%.
• Interest Payments on the debt: Increases from $187 billion in FY 2009 to $840 billion in FY 2020 – an increase of $653 billion or 349.2%.

The projection on interest costs is far too conservative. While the government's always flawed projections don't anticipate it, both Bud Conrad and Doug Casey see strongly rising interest rates as a certainty in the foreseeable future. At that point, the debt death spiral begins in earnest, and the whole charade begins to come apart.

But it won't take soaring interest rates to bring the economy down. That's just going to accelerate things. And, of course, the worse things get, the worse the monarchy will act – demanding ever higher taxes and further debasing the currency, as they now certainly must.

How can you protect yourself? It really depends on where you are from.

One obvious solution would be to move to a different kingdom, one that treats you and your money better. Or that pretty much ignores you altogether. If you are from the US, the king's tax collectors will follow you wherever you go – but even so, there are modest tax advantages you can gain by expatriation. Ask your tax counsel for details.

If, on the other hand, you live in a kingdom that doesn't tax foreign-derived income (yet), becoming a citizen of the world can offer serious advantages and is well worth considering. The situation in most of the developed kingdoms, where easy money and quick mortgages greatly exacerbated the levels of debt, is only going to get more dire as the rulers cast a wider and stronger net in the quest for more revenue.

Even if you aren't in a position to move, however, you'll benefit from clearly understanding one key point about the king. While he may dress well and speak in dulcet and pleasing tones, he doesn't actually produce anything. What money he has to spend must first be taken off the productive elements of the peasantry.

But there are limits to how much he and his men can squeeze out of the citizenry. We are nearing those limits.

That means that all that is left to the monarchy is for it to issue IOUs. And given the levels of their debts and ongoing spending, lots and lots of IOUs. Those IOUs are called Dollars, Pounds or Pesos, Yen, Euros, Reals...

While there will be no straight line up or down for any asset class in the unsettled times we will live through, using periods of weakness to build your exposure to tangible assets – most notably Gold Bullion, whose primary and best use is as sound money – is the only way to protect yourself from the Great Debasement that's coming.

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