Gold, Europe and the possibility of a euro break up

Investment consultant, Rick Schmull looks at the likelihood of a Eurozone break up and what that might mean for commodities

GEOFF CANDY:  Welcome to this week's edition of Mineweb.com's Gold Weekly podcast.  Joining me on the line is Rick Schmull - an independent investment consultant and speaker, he also writes a regular column for inveztor.nl Rick a lot is happening in the gold market and indeed in the macroeconomic word as well, particularly within Europe - there's a lot of concern and increasingly more and more people are concerned about whether or not we will see a euro in a few year's time.  And clearly this is going to have significant impact on the gold price and indeed the gold market as a whole.  How do you see the lay of the land at the moment?

RICK SCHMULL:  Well I think we haven't seen anything yet.  Things will get much worse and there is no soft option ahead.  Obviously gold will play an increasingly large role in the solution to our problems because the FIAT money system that we've had in the last 40 years is on its last legs because unlimited credit is impossible and eventually implodes - and that's what we've had.  We've had a system with no discipline and eventually gold will have to re-enter the monetary system at a much higher price which also means of course, a dramatic devaluation of all currencies within the current system. 

GEOFF CANDY:  How do you see the currency system changing?

RICK SCHMULL:  We will go back to some kind of standard, but not before a crisis.  We are of course in the middle of a crisis but it will get much worse - I do believe that the euro crisis is just the beginning and there is really no way to save the Eurozone because it was set up without a lender of last resort - and also it had no rules because if you accept a foreign currency and give up your power of printing money then you're not allowed to have any deficit and of course this was not done.  Now we're at a point that people say the only one who can rescue the Eurozone is the ECB, but it's too late because not only is the ECB not the official lender of last resort - so even if they tried, the market won't believe it.  The reason that the yields in the UK and the US have reached all-time lows despite their debt is because you have a lender of last resort and there is really no credit risk.  The Eurozone is full of credit risk and of course it all started to go wrong when there was talk about haircuts, etcetera - and its already too late because there's now wholesale dumping even of the AAA countries which of course are not AAA any more.

GEOFF CANDY:  If you take the scenario that you've painted, how then does gold interact with it?

RICK SCHMULL:  Well it could be that initially everything has to be sold like in 2008.  Now I believe the whole thing will come crashing down in the next few months, and everything will have to be sold, including gold, but that is a huge buying opportunity.  Where will gold go to - I think gold will go down less than silver just like in 2008.  What is my target for gold - I would say that we have to discount all the liquidity created since 1971 and that's the price where we have to fix gold.  That is much higher than $10,000 because we also have to take into account the derivatives market which is of course above $700tr and still going - and it may be much higher.  So I really have come up with a figure of $50,000 which I think is academic anyway because by $5,000 gold will become illegal again.

GEOFF CANDY:  And clearly this is the issue of gold confiscation and these issues and very much this is a dis-topic future that you're describing - it's an apocalypse of one sort or another, if you will.  Is there any way to avoid such a scenario?

RICK SCHMULL:  Oh no - the problem I have is there's a lot of complacency around - everybody still has the belief that we can inflate our way out of it.  Most economists have been educated - to the Keynesians may be the only 5% of the economists have any idea of sound money.  So as long as that is the case, this will come as a big surprise.  I predicted the collapse of the bond yields this year while most people were short, and the reason is that we are already in deflation, even though you don't see it.  All you see is the headline inflation - you don't see the asset price deflation.  Now most debt is collateralised and the value of collateral is declining rapidly and the whole debt system is unravelling and this quantitative easing hasn't been enough to stop the deleveraging because the deleveraging is much bigger.  Now the message from the bond markets is that we will have very hard times in the next few years, similar to a depression and the bond market is 10, 20 times as big as the stock market and the commodity market is tiny.  So you better listen to what the message is of the bond market.  People are still thinking there is inflation coming - hyperinflation etcetera - well people forget that we're not Zimbabwe where there's no bond market, we're not Weimar ... as soon as some people would decide to print our way out of it, but then like $10tr - $30tr everything will stop - the bond market will be destroyed - there is no way that that can happen because the bond market is the policeman of the financial markets in the west.  No, what we will have is something similar to Japan - for decades it will take - we just started the deleveraging and debt has tripled in the last 10 years in the world and of course now we have the problem of refinancing.  Liquidity is drying up and the crunch is on right now.  There is virtually nothing you can do - you cannot even delay the day of reckoning actually because look at Italy - anything could be the trigger, but Italy has 120% debt to GDP at least, but the problem is lack of growth everywhere.  We cannot grow our way out of this debt situation.  We will therefore have to cut the debt or the deficit, but that is virtually impossible in a democracy so what will happen is that it will be cut involuntarily.  Most of the deleveraging taking place at the moment, is involuntary - foreclosures for example.  But it will take a while.  In Japan it took five years before you actually realised there was deflation - now you've had deflation for 15 years and the debt in the private sector went down 50% in 20 years.  But of course the debt in the public sector doubled and the next phase in Japan is that you have to reschedule the debt and extend the maturity of public debt as the only way out you don't get hyperinflation because the old people in Japan with deflation, have a high real rate, and they're the voters.  And this is exactly what's going to happen in Europe and in America eventually.  The baby boomers are older, they are getting their pensions - they wouldn't mind having some kind of official deflation.  Now deflation again is already everywhere.  The only reason inflation goes up is when wages go up, when velocity of money goes up and that is not happening.

GEOFF CANDY:  If we unpack some of those issues now clearly the aging population is one of those things - do you then see a break-up of the Eurozone entirely or do you see it limping along as one entity, and the ECB then trying its best to kind of stave off this kind of meltdown, or do you see it breaking up?

RICK SCHMULL:  No, I see a sudden break up - it will be overnight.  I think the problems are too large - the whole thing is coming crashing down suddenly and we will have a number of years of depression in Europe.  But we will get through it.  The point is that initially the dollar will be helped - I'm very bullish on the dollar and bullish on physical gold - it's the only thing you can really have and treasuries.  But the Eurozone is toxic now and it won't be resolved - there is no soft option...

GEOFF CANDY:  Why are you bullish on the dollar then - is this purely that the US can survive a little longer with the kind of debt levels that it has?

RICK SCHMULL:  Oh yes that's right.  It's all relative of course - America has its problems long term but nothing will be done before the election.  But the US of course has a lot of debt as well but they have the reserve currency, there is no credit risk because even if the deficit is huge it always will be paid - always.  But if you have a deficit in one of the Eurozone member of countries, you have no power to deal with that.  So this was the mistake in setting up the Eurozone because of course the countries didn't want to give up their sovereignty.  But in America people underestimated the wealth of America - if you add up everything - they have $60tr.  Japan is number two with $17tr and then the rest follows - and America is nearly one third of the world economy - its only 10% exports.  They can go on for a while, and anyway I'm very confident that America will deal with its problems because the mentality in America is if America really is in danger - the giant rises up - that's what Japan experienced at the time.

GEOFF CANDY:  What about emerging markets, because clearly the other giant that people talk about quite frequently is China and increasingly India as well.

RICK SCHMULL:  I'm very negative on emerging markets because emerging markets are something that will play a role in 10 or 20 years' time.  At the moment they have an export model.  So far consumer as a percentage of GDP has only been declining.  At the same time, if you look at the debt, it has exploded.  Now China has trillions of loans that are now not paid back.  There's a huge housing bust going on already.  We have dozens of ghost towns, we have in China something similar to what we've had in the US - the big railroad boom and bust - railroads were built in the 19^th century everywhere and then without regard to return - this is very important.  In China you just expand and develop because then everybody gets bribed, but there is no return.  Then at some point the whole thing unravels.  In America, after the railroad bust, a 30-year depression followed.  I think emerging markets will have a very tough time - you can already see that in the markets by the way and that's why I'm also very concerned about commodity prices - there's a lot of inventory, a lot of expectations, and yes I'm very negative on China and emerging markets and I believe that they're fully dependent on the consumer in Europe and the US.  There is no consumer society in emerging markets yet.  There's a small tiny group which is growing and it may be hopeful - it may take 10 or 20 years but it's not there yet.  In the meantime, they could have a real bump in the road and then of course there are a lot of other issues like - it's a totally different system, these markets are dominated by a few families, there is no transparency of accounting, there's one horror story after another, and its being ignored by the west because it's a great sales story from Wall Street.

GEOFF CANDY:  I suppose the west has its own problems to deal with.  Just quickly to close off with - what is the best case scenario hereon in?

RICK SCHMULL:  I think we will have a tremendously hard landing.  We've been spoiled for the last 50 to 60 years because we were - and part of it was inflated.  Prosperity debt fuelled - we've come to the end of that road - we cannot continue like this.  Those who say we can have a soft landing because of hyperinflation forget that even if that were possibly - and I think it's impossible - then you can say goodbye to democracy and you destroy the wealth of the whole middle class and you will get a dictatorship.  So that's not a soft landing either.  But I believe it's impossible not to pay the piper, and we are now seeing the system unravelling and the only way to protect yourself is to have physical gold under your own control - not paper gold - some treasuries because they're the most liquid investment and 30 year treasuries will go to 2% yield, a 10 year will go to 1% and they will bounce along around that level, just like in Japan, for the next 10 to 20 years.  Then I would wait with stocks because stocks could go down 50% to 70% from here because a lot of companies will come and go, just like in the last 10 to 20 years, many blue chip companies have gone so the stock market is extremely vulnerable because the only reason to buy stock is when there is growth and there's no growth - there will be negative growth and the other reason for stocks - you only buy them when you have safe dividends.  Very few companies have so-called safe dividends and the dividends have to be 5% or 10%.  So stocks are only interesting when they've had a substantial correction.  Again, I've lived through the time when the Dow Jones was below a 1,000 - nobody ever believe it could go to 10,000.  Now we're here above 10,000 nobody ever believes that the Dow Jones could go back to 1,000 and I certainly think the Dow Jones could go back to 3,000.  Again, nobody believes that we're getting a time of deflation because this generation doesn't know any better.  But in the last few 100 years we've had as many deflationary periods as inflationary periods, lasting 50 to 75 years.  So the next 50 years could be a period where we have to lick our wounds, deleverage and we will have 1% to 2% deflation a year for a very long time, and if not the end of the world because we've had that many times.  There have been many periods of prosperity during deflation, but it's a totally different ball game of course.  You will not get the so called profit from asset price inflation that we've been used to - that is over...

GEOFF CANDY:  There you have it - a very sombre view of what's to come from independent commentator Rick Schmull...

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