Below is the transcript for Paul Tustain: Gold Is Sending A Signal That The Monetary System Is In Grave Danger
Chris Martenson: Welcome to another PeakProsperity.com production. I am your host, Chris Martenson and today we have the pleasure of talking with Paul Tustain, founder and CEO of BullionVault, and a respected gold market analyst and commentator. Welcome Paul, it is a real pleasure to have you.
Paul Tustain: Well, it is a pleasure to be asked.
Chris Martenson: Terrific, I would love to start with a brief history of yourself and how it is that you came to create BullionVault and why you did.
Paul Tustain: Well, I was a Computer Science graduate and I spent about twenty years in systems in the city of London. I built my first business between 1990 and 2000 and I was selling that about 2000. Just as the British government was selling our national gold reserve and that sort of drew my attention to gold for the first time. Then I tried to buy some. The price then was a little under $300.00 an ounce and it was very difficult, very expensive, and perhaps, worst of all, the gold that was being sold to me was unallocated. And I fairly quickly realized that the gold market infrastructure was significantly underdeveloped and that was probably because gold had been on the slide for twenty years and nobody had been investing in it – that was up to about 2000. And, it was particularly underdeveloped for private investors.
Chris Martenson: But how did you have to buy it when you say buy it? What was the process for you?
Paul Tustain: I went to a Swiss Bank and it was amusing actually, because the private banker was very insistent that the gold was, or that everything that they did, was all custodian. And so, I dutifully bought gold from them and it turned out that gold was the one exception. It was the one thing which was done on their balance sheets through an unallocated gold program. So, we had to switch out of that, which cost still more money, and eventually ended up with some of the big gold bars.
Chris Martenson: Hmm, so all right, so you are trying to get gold in this market and first of all, there is something not quite right about it. Allocation, for people who are not familiar with it, means that when you own gold, there is a bar, it has a number on it, and that bar is fully “allocated” meaning you are attached to it. There is a legal connection between you and that bar. “Unallocated” means somebody says “hey, I have just sold you some gold, and it is mixed in with all these other people’s gold, and I may or may not be able to tell you what numbers are on the bars or anything specific”. Is that about right?
Paul Tustain: It is about right. The key difference between the two of them is that unallocated gold means you are a creditor, you are on the balance sheet of the provider, which means if the provider goes bust, you lose your gold. That is the key thing, the key difference. Allocated gold means your gold is stored in a custody relationship, which is fundamentally different in law. You own it outright, you pay for the service of having it looked after in what is called safekeeping, and if the provider were to go bust, you continue to own it outright. And so, the liquidator has to give you all your property back, not just you know, six cents of the dollar.
Chris Martenson: Excellent, now that is a very important difference. So you recently released a video presentation that was titled, Gold, Where to Now and it was detailing your outlook for gold. We will get to the specifics of that in a moment but first I want to step back here. Introduce our listeners to your thesis for why investing in precious metals is a good idea. You know, what are the important fundamentals to be aware of here?
Paul Tustain: Well to me I think the most important fundamental with gold is just how rare and stable the gold supply is. I think many people know now, all the gold in the world would form a cube of about twenty meters in edge, and that would not quite cover a tennis court. People love saying how useless gold is, and of course, it is more or less useless in industrial terms. But yet, the same people happily pay for something with a hundred dollar bill and how industrially useless is a piece of paper? So I guess the point in terms of the fundamental quality is that both money and gold are industrially useless, but they have their very good social use, which is holding value, which is essential to trade. But they only work while they are in very stable supply. And of course while currency is fairly regularly corrupted, gold cannot be, you just cannot print more of the stuff.
Chris Martenson: Right so central banks have famously, were on record during the London Gold Pool period of trying to manipulate the price of gold after Bretton Woods was sort of falling apart. And then there were notions of calling it a barbarous relic and all of this, but despite all of this rhetoric, central banks seemed to have held on to quite a bit of their gold through that process. And I am a big believer in following what people do before I follow what they say. Would you, I mean, is it fair to say that central banks are still holding gold as a monetary asset and for no other purpose?
Paul Tustain: Well, I think that is about right. I would say that perhaps ten years ago, particularly the European Banks, under the Washington agreement, had agreed to dispose of some of their gold reserves which in European currency terms had become irreverently small as a part of their currency base, so they were selling it. Now that became increasingly embarrassing for them because of course, all other currency assets and foreign exchanges were falling in value while gold was rising. So that has pretty much fallen into disuse now. The European Banks are no longer selling and of course, the Far East is buying, Russia is buying, the oil exporters are buying and so if you would take the gold used in central banks as a whole across the globe, you would find it was pretty stable at around about 30,000 tons. And there is this gradual shift, which has now slowed to a trickle from west to east and with east buying, they are really buying new supply so now what has happened is the Central Bank gold holdings has started to increase again.
Chris Martenson: Right so this is a probably a pretty important trend. I mean that is a seismic shift going from being dis-hoarders to re-accumulators of gold at the Central Bank level. You started buying below $300.00; here we are at $1,400.00, bumping into $1,450.00 today I believe at this point. So what are the other trends that were in play through that time to drive us from $300.00 to $1,400.00, what else was in there besides this shift in attitudes at the central bank level?
Paul Tustain: Well if you look at the data again, the key shift has been the change in the demand for gold from private investments. So if you wind the clock back about eight years, you will see that private investment was probably bumping along at 400 tons a year. Now, that is running around about 1,300 to 1,400 tons a year. And last year it overtook jewelry demand for the first time, so that means in the course of about eight years, there has probably been about a 10,000 ton increase in private reserves which has taken it up to more or less the same level as public reserves or central bank reserves of gold. So that has been a seismic shift, as you put it. And of course, at the same time, we are seeing monetary corruption in all the major currencies. One of the things that I tend to think of here is that this word protectionism from history, from back in the 1930’s, which is widely a dirty word. But protectionism was all about raising import tariffs or barriers to imports so that you could protect local jobs and the local economy. Essentially, devaluing your currency is exactly the same thing. You devalue your currency to raise a price tariff against imports. And that is what has been going on competitively throughout the Western World for the last, technically, for the last six or seven years. So you have got the currency, all the major currencies of the world, in a race to the bottom, all being corrupted by increasing supply. Then you have got gold just sitting there, expanding its supply through mining output at a rate of about 1 ½% per annum. So it is a much more stable monetary store than the currencies that we have had.
I think there is another point, which I quite like to mention which is what has happened over a twenty-five year period, from about 1980, which of course, is what I call the golden age of the microchip. Now the microchip was increasing productivity around the world at something like 4% per annum, which meant that all other things being equal, we would have seen the cost of goods reducing by something like 4% per annum, but during that period, the central bankers had a pretty easy mandate to control inflation. Usually, it is only between one or maybe two percent in the UK and that gave them something like six percentage points to play with, and that meant that they could expand the monetary aggregates fairly freely and yet not see inflation because computer microchips were lowering the cost of production everywhere. So that monetary expansion basically all got frozen into typically long-term bonds, which were very attractive, because interest rates were falling and inflation was low, and that has produced a ton of bonds, basically a hundred, trillion dollars worth of bonds, which are attractive only while you have got this low level of inflation and a low level of interest rates. But the golden age of the microchip is probably increasingly running out of steam now, and what you are left with is a habit of producing monetary excess at the rate of 6%. And in the meantime, you have got this great pile of money stored in bonds, which is becoming unstable.
Chris Martenson: Well the bonds in aggregate, kind of depend on getting paid back in order to have their value. And in order to pay bonds back, you have to have a future that can deliver the goods there. And so what we have baked into our giant bond portfolio, is an assumption about future growth and economic growth, which has not really born out in the past number of years and now there is an enormous set of wrinkles in that story with energy, oil particularly, etc.. But even now, if we look at what is happening in Japan, with the world’s third largest economy, basically is going to downshift I think from third into reverse, rather suddenly. The growth story gets difficult so it really does complicate the expansionary monetary policy. And coupled to that, I think the debt policies of various governments all around the world that got quite used to easy times, being able to spend beyond means year after year after year, that kind of got baked into expectations, institutional philosophies, even investment philosophies, all of that. So, all of that has to be rethought, and I have always considered gold was going to be one of the early barometers to sort of maybe call the charade for what it was. And so that is part of the message I received from gold is it is telling us something and it is telling us something about both past policy and what we are likely to experience next. How hard is it going to be for us to shift from that, from the past twenty years of how we have been expanding into whatever we have to do next? Which I assume cannot expand nearly as fast. How does that work for us?
Paul Tustain: Well I am not sure that it does work. I am not sure that it is possible which is why gold is like a beacon, it is a signal that the monetary system is in grave danger. I agree with you that you have to find a source that is going to match or exceed the rate of growth that we had in the microchips golden age, but I do not see anything that is capable of producing that. So what you end up with is a very high debt economy, which we have clearly got. And I think it is worth looking at those numbers in terms of public debt. The U.S. Public Debt, I am going to talk about the U.S. although the UK is on broadly speaking, similar terms.
Chris Martenson: Right
Paul Tustain: The U.S. Public Debt is currently somewhere around fourteen trillion, that is the government’s debt: fourteen trillion dollars. Now, the schedule is an interesting thing in itself because this is anticipating 4% per annum, GDP growth in each of 2011, 2012, 2013, and 2014. I do not see the engine of that growth, particularly not with falling house prices. But if they get that growth, and only if they get that growth, they could hold the deficit down to budget deficits of about eight hundred billion dollars a year. That means in about eight years, on schedule, we should hit a twenty trillion dollar public debt in the United States. Now, when numbers get that large, you have to start doing some transformations to make them make sense, well at least I do, to make this thing make sense to me. And the way I do that is, I assume that twenty trillion dollars that I just assume, “Okay, what would happen if we had to pay interest rates of something like 6% on that?” Now that is not an unreasonable rate, 6%. It is historically reasonably typical and 6% of twenty trillion is 1.2 trillion dollars. Well if you divide that by 120 million U.S. households, you come up with a figure of $10,000.00 per household. Now that is the tax bill just for paying the interest on a twenty trillion dollar debt. Now the 6% assumption I used in that needs to be compared against Paul Volcker’s chosen rate when he decided to get inflation under control. He took interest rates up to 18%, which was about 4% above the then level of inflation. It just shows you that 6% is a very conservative assumption, but it is completely uncollectable. And what this means is that when you have got a public debt, up to the twenty trillion dollar level, upwards to those sorts of numbers, it becomes effectively impossible to run a meaningful counter-inflation policy. So I think what you are going to see is evermore quantitative easing, and I think it will be very difficult to exit. There is nobody to buy the debt, which is being printed by the government. I think it is very difficult to exit it and steadily things get worse and worse.
Chris Martenson: So, in 1729, Voltaire said that “paper money eventually returns to its intrinsic value: zero”. And from this recent commentary here, it sounds like what we are on is, we are on a path towards basically destroying the currency because we are in a box at this point in time. You know we have to print up this amount in order to keep the game going but if we print up that much, what we are going to end up doing is ruining the currency. If we do not print up that much, we risk sliding into watching that debt go into a default scenario, a cascading default. Honestly, between the two, I think that a default is feared more in the U.S. than an inflationary outcome. Everybody fights their last battle I guess – the great depression is what we are fighting. Even though inflation is possibly the great monster; in deflation, that’s your opportunity to rinse out all the bad decisions you have made. Inflation is I guess, your opportunity to kick the can down the road. I think we are going to kick the can down the road, most likely. Is that your assessment, if I characterize that right?
Paul Tustain: I think it is very likely because I think it is almost an inevitable consequence of the modern construction of democracy. I am a huge fan of democracy but I do think that democracy needs to be strongly constituted. And the sad problem with the way it is constituted both in Europe and in the United States is that all elections are fought at the boundary of responsible debt. If you do not go up to that boundary, if you try to offer austerity to an electorate, the other guy looks far more generous and he gets elected and for all your good intentions, your monetary discipline is consigned to the dust bin. That is the problem and that is what sort of leads you inexorably towards an inflationary future. But in fact, the point that I have been trying to make is that what we will get, what we will hear from governments as they print money, is that it is a relatively modest amount of money that they are printing. And in fact, it is, that is perfectly true. But it hides the thing that is really going on. And this is the thing that really worries me. When you just print even a little bit of money, if you just print whatever it is, seven hundred billion dollars, or whatever, it sounds modest next to coins and notes of some fifteen trillion dollars in circulation, but it sends a very powerful message to savers. Now if you look at that monetary stock, it has got this time element built into it. You think of the hundred trillion dollars of bonds, they are basically spaced out over broadly about a twenty-year period. Most of that money was frozen into the bond market freely by people who owned the debts. But they basically had this signal from QE that it is no longer safe to put money out to twenty years. And indeed, you will see that the likes of PIMCO have basically withdrawn all their money from U.S. Treasuries because they think that it is so fatal.
Now what that means is that you give the markets that signal that you are going to print money whenever the going gets tough, but eighteen-year bonds or twenty-year bonds are all still eighteen and twenty-year bonds. And the clock has to wind down, allowing those bonds to get to the short end. And you see steadily, and this of course already happened in Greece, you see a mountain of money, as it gets redeemed, even a twenty-year bond which gets redeemed, is going to be re-invested in the short end. Nothing goes back out to twenty years. And so you get this hump of money at the short end and short-end money behaves very much like cash. That is why it is kept at the short end; you can sell a short dated bond for very near its cash value, its nominal value. You cannot necessarily do that with a long-term bond. So with this pile of money at the short end, you have got, instead of having twenty trillion in coins and notes and near-term money, you suddenly go up to one hundred and twenty trillion in coins and short-term notes but getting there, is going to take fifteen years. And that is the point. The switch has been flicked and it is not possible to un-flick it. So that shift to the short end is clearly happening. If you look at quantitative easing now, it is essentially making the financing of bond purchases very cheap but the bonds themselves are still, lets say in the fifteen-year end, anything from seven years up, which is basically in the quantitative easing stock. But they are only being bought by banks, because the banks can put them back to the central bank because the central bank has got a mandate now to buy illiquid long-dated quality bonds. So that is where they all end up, everyone connects it and goes back into cash which is provided by the central bank when it buys these long-term bonds and converts all the holder’s money back into cash. So it creates this mountain of short-term money. And this is why you get inflation and deflation at the same time.
What you have got now, is an increasing glut of short-term money chasing all the things that people buy with short-term money, and that seems like your shopping basket or the gasoline for your car. But you have got a shortage of long-term money and that is what you would use obviously to buy a house. So your house, there being a shortage of money, is falling in price but the things that you buy in your shopping basket, they are all increasing in price. So the inflation has switched round from where it was in 2005 but it was the other way around as all of the money was swept out to the long end to finance house purchases. It has switched round now and it now both ways, it hurts people who have savings. Their cost of living goes up, their assets go down in value, and their standard of living steadily slides as they compete on world markets for their commodities, their food, their clothes and their oil that are the compulsory purchases of life. And for which you are competing for, on international markets, with Asians who now are sitting on a stock of two trillion dollars.
Chris Martenson: This is a great idea, I had not quite thought of it this way because I get in fairly routine – arguments is perhaps too strong of a word – but debates, intellectual debates and writing contests as it were around this whole inflation or deflation. As if it is an either/or and I say it is yes, because I can point to both happening quite clearly at this point in time. And if you take the CCI, the Continuous Commodity Index, and run it back ten years, and start drawing a line under it when it takes off in 2002, today it is a pretty straight line. And it is at 14% per annum over that period of time. And so that is in periods of a recession, all kinds of things. The deflationists look at the large monetary aggregates or credits and say look, both are falling, therefore, ergo by definition we are in deflation. I say “yeah but look at all the things that are inflating” and the argument that I have been trying to introduce is that Government Bonds behave like money. But, I had not quite sectioned them into the short versus the long, I love that distinction.
Paul Tustain: You see what is happening, it is sliding, the long-term money is sliding slowly towards the short-end and it looks to me like it is an unstoppable journey. It will get there but it will not get there tomorrow. The clock has to wind down on that long-dated debt and it all piles up at the short end. I mean I do not know if you know the story from Germany when they had their hyperinflation back in 1923, they started printing. That made long-dated debt extremely unattractive. And then it got to be the extreme, so the long-dated debt starts to wind down, there is plenty of it, they have financed their First World War on long-dated debt, and it started to wind down. And it all piled up at the short end. It was the same effective combination of the Government, the central bank, and the banks. They were doing it in much the same way as we are doing it now. But as the money starts to pile up, everybody was looking for short-term wealth stores rather than long-term ones because fearing inflation, through printing; they were worried that holding their money long-term obviously would lose value. And then it got really extreme because in the final analysis, you had money in current accounts, which you would think of as cash, but it was not cash, because it took five days to pass through the banking system. So that the seller of something could use that money he just received a check for. And five days was too long. So all people who had current accounts would go in and say I need the bank note today. So you ended up with a twenty-year stock of money all held in bank notes. Everything had compacted up to the short end. And the game was ‘pass the parcel’. What you would do, you would not ever go into cash, unless you had already realized, you had already decided, where you were going to spend that money. And you would pass that cash on to the next person, who had also decided where they were going to spend that money, so, the great big piles of cash being passed from person to person, for very short periods, and that is how prices went through the roof. Effectively, the entire monetary stock was being turned over within a period of about three or four days because nobody was holding onto cash.
Chris Martenson: So, to get inflation velocity of money has to increase, I love this idea that first the money has to slosh slowly, you know, like we have just tipped up a bathtub, right? It is half-full, and we have to wait for it to slosh down to the short end where it all piles up and then the velocity is just going to be increasing as it goes. And what you have suggested here is that, it is a process, it is not an event, and that process has been initiated. That yes, the event, we flipped a switch, QE did that and the money is currently piling up, you know heading towards the shallow end of the pool here, where it will stand up into a giant wave and velocity will increase in all of that.
Paul Tustain: That is right.
Chris Martenson: So, in your mind, that process has kicked off, let us get to the heart of it then. What does this mean to gold and when? I think you are on record, you projected a price of gold for it is $3,800.00 per ounce, how did you get there? I assume we have just talked through some of the logic. But tell us how you get there and when. You can use a range if you want.
Paul Tustain: Yes, I am going to be a little bit picky because I did not really, I do not predict a target in the way that most people do. What I am interested in doing is coming up with a reference price where there seems to me to be some basis of saying that there is a fundamental value to gold at this level. And depending on where it is, with the respect of the current price, I will either buy or sell. Anyway, the calculation I used was based on risk and reward scenarios, depending on inflationary outcomes. All of which are uncertain. There has been a probability in it, there is a bit of net present value calculation in it. But they are the sort of things which insurance actuaries use when they are working out the value of risks. It is very easy for anybody who is reasonably numerate to see how the calculations work and in fact, I put this on a spreadsheet so people can download it. Anyway, I used this calculator in primarily two different scenarios. And the first thing I did was I took historic economic data, which goes back over about 200 years thanks to a very good book by Professors Reinhart and Rogoff –
Chris Martenson: Uh-huh, it is a great book.
Paul Tustain: –that you may have heard of. It is called “This Time is Different.” And it has got 200 years of data to play with. And I used that data as best I could, to evaluate the probabilities of different levels of currency devaluation over the coming fifteen years. And that was a scenario used in the raw data from Reinhart and Rogoff, which resulted in me coming up with a net present value for gold based on risk reward, of $3,844.00, which is a number that everyone is talking about. But in many ways, it was the next scenario which I did, which I thought was more interesting. Because I had just did the risk probabilities to force the calculated value down to the current price of somewhere around $1,400.00 and what jumped out then, was that to get down to about $1,400.00 you have to be incredibly generous on future inflation scenarios. And you have to discount the hyperinflation risk effectively to zero. And I think that this is the error that the markets are making. The risk of serious inflation is much, much higher than people realize. People always get probabilities wrong, it is what caused the subprime crisis, if they had never experienced something directly, they tend to think the probability is zero and that is wrong. I think the market has got our future inflation scenarios risked all wrong as well. And once you get to see that picture of what is happening to the debt mount and how it is steady shifting to the short end, the risks become very obvious and very material. So I thought that was the interesting part, the fact that the market, at this price, seems to be discounting zero risk of hyperinflation. But when I look at the history and the data, I think that risk is not zero, in fact, in my $3,800.00 valuation, I put the risk only at about 5%, and that is pretty tame next to the historical scenarios of people who started printing money and who always find it very difficult to stop that. So I think $3,800.00, if you look at the presentation and if you look at the spreadsheet, I think you will see, they are largely cautious projections of data that I have used in coming to that number. And they are based around this abuse of our currency systems by principally quantitative easing of what that has done.
Chris Martenson: Cautious? 5% hyperinflation risk over fifteen, that is not cautious, that is beyond cautious. You could make a case to make that number much higher. Maybe add a whole zero to that. Given current policies, it is phenomenal. The amount of printing that we have seen, I do not know, has historical precedent because of the nature of the fact that a reserve currency is involved in this one.
Paul Tustain: Well, I think that is right. I agree with you, I think I am being very cautious when I talk about a 5% hyperinflation risk. But if you put those, all we are doing with this number $3,800.00, all we are doing is saying, look I have got a choice: I can hold my $1,400.00 in cash, or I can hold an ounce of gold at the current price. Looking at all these risks and trying to pass things forward by ten or fifteen years, which is the better decision? And if the probability of hyperinflation, is anything like 5%, you can take it from me: the best bet, is to hold in your hand an ounce of gold than $1,400.00, because essentially, your $1,400.00 are doomed to be worthless.
Chris Martenson: Right, this is a really hard concept for people who have not directly experienced it, and I am sure, even for myself, but reading the history books and doing the best I can, having read “This Time it’s Different” and studied a few hyperinflationary periods, they just have a habit of doing what they do. They are like fires, they burn and at the end of it, everybody wakes up and they have a lot of zeros on their currency that they do not recognize. And it has happened, it has happened a lot. In fact, I would go so far as to say that it is something that you should expect to happen, not something you should be deeply surprised by if it happens. It seems to be rather the terminal fate, as Voltaire said, of almost all paper money. There is some dynamics there, which just seems to reassert itself through all generations, through all moments of economic history, whether in the middle of an industrial boom or whether we are in the middle of a depression. These things seem to just sort of raise themselves, again and again.
Paul Tustain: Interestingly, it is not just about seaming because, one of the great things about the Reinhart and Rogoff book, in fact I do know if you know Neil Servison, who is a Harvard Professor and a Scot originally, but he used to be over here. But he has done a little TV work and he did a very good summary of the Reinhart and Rogoff book. And when you look at it, it is not just this sort of thing that seems to come out of nowhere, it is very strongly likely, ones public debt, exceeds 90% of GDP. That is the sort of magic number. You get to 90%, there is no way back, and that is the number that the U.S. is going through pretty much as we speak. It is also the number, which the UK has gone through; all of the PIGS are going through it as well. They are all going past the 90% debt to GDP ratio. Obviously, Japan is miles past it already. It is up to 200 and something percent. There does not appear, in the historical analysis, to be any great likelihood of getting back from that level of debt safely. So it is not just about seeming to be something which turns up, there is this strong evidence that above 90% debt to GDP, you will experience either a cataclysmic default – which is only really going to happen if you have got a rock solid nerve backing like gold currency or something like that – either you’re going to experience default or you are going to experience some form of very serious inflation.
Chris Martenson: Right, and that