What Do We Know?

For the past week or so, one of my cousins and I have been batting around the value of  holding gold in one’s portfolio.  He puts high value on it, I put little value on it.  He thinks I am wrong, I think he is wrong.  Chances are pretty good that we are both at least partly  wrong.

I have previously explained why I think gold is a bubble.  See “What Price Gold

In researching his well argued position, (he is a smart guy and is a retired lawyer) I found some other interesting things.  Probably unrelated to gold pricing.  Self evident on the surface but under the surface maybe not so much.  You might find them interesting.

Accepted belief -A.   The US does not “make things” anymore.  How can an economy survive if it does not make anything?

Reality 1.  The value of manufactured goods made in the US is slightly more than the value of manufactured goods produced in China.  The amount is about equal to the total GDP of Russia or India.  Hmm.  Must still make a few things.

Reality 2. In the period from 1980 to 2010, the manufacturing share in China’s GDP is down from about 43% to about 34%.  In that period, every large economy, except India,  saw manufacturing share shrink.  Some dramatically.  Like South Korea.

Reality 3.  As economies mature, people want things other than manufactured articles.  Trips, cable TV, internet access, restaurant meals and health club memberships to name a few.

All economies, as they become wealthier, move a larger share of spending and production to non-manufacturing areas. I suppose the share of GDP produced by agriculture in the 1600’s was considerably higher than it is now, but no one seems concerned.  Times change.  Old statistics must be re-contextualized to continue having meaning.

Accepted belief – B.  The US owes a huge amount to China and they could call it and bankrupt the Americans.

Reality 1.  I doubt they could call the debt or bankrupt the US if they did.  Bonds have due dates.  They would need to sell them to get their money back.  That would likely drive interest rates up for the Americans, but it would also drive down the market value of the bonds for the Chinese.  If they wanted to take a large loss I suppose they could sell.

Reality 2.  –  Most US bonds are dollar denominated.  If there is a major Chinese sell-off,  the dollar exchange rate will fall, possibly a lot.   The dollar value of the bonds will be less because the bonds fell with interest rate changes and the dollars that remain will be worth less when converted back to Chinese currency.  Double bad.

Reality 3.  What the Chinese own, while large, is less than 6% of the outstanding face value of all bonds the US government owes to bondholders.  Important, but I don’t think crucial.

Reality 4. – It is a failing business practice to bankrupt your most important customer.

While the American position is a little precarious, the others will need to find a way to get along with them.  They are still the big kid in the playground.

Accepted Belief – C.  We are running out of resources.

Reality 1. – No we are not.  For example, the known reserves of oil in 2008, were double what they were in 1968 and we have used quite a bit in that period.

Reality 2. – People don’t run out ever, because they change the way they use things beforehand.  Higher prices force that.  Plus new and better ways to do things become available.  Do you think the Chinese will use as much copper wire to provide telephones to their citizens as Americans did in the 1960’s?  Answer – No.  Because fiber optic and wireless has replaced the copper technology.

Reality 3.  – Higher prices permit exploration for and development of new resources that were not economic at the old, lower price.

People, as a group, tend not to fall off the cliff.

Moral of the story.  Do some rudimentary research before you get caught up in the noise you hear on TV.  Most of the talking heads are promoting one ideology or another.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. don.s@protectorsgroup.com

2 Comments on “What Do We Know?

  1. Another good one today. The last line reminds me of an acronym Douglas R. Boreham gave in a lecture on “Biological consequenses of Uranium and other natural radiation exposures and radiation-induced cancer and risks of low dose exposures.” at Cameco 2011 He defined FEAR as “False Evidence Appearing Real” News groups are famous for that.
    If you want some more thoughts on gold stock’s direction, I can forward you some details.

    • Thanks for the FEAR idea. It is close to the truth. You cannot kill FEAR by denying it. The only defense to bad information is good information. Sadly a simple lie is easier to believe than is a complex truth. I guess the education system needs some work to help people cope with rational thought and understanding that every decision leads to an outcome that is the basis for another decision. ad infinitum. The best question is still, “Okay, what then?”

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