5 Record Breaking Gemstones Even Billionaires Can’t Buy

As Elizabeth Taylor once said: “I adore wearing gems, but not because they are mine. You can't possess radiance, you can only admire it.”

It’s a good philosophy, because when it comes to the world’s biggest, rarest and most extraordinary gemstone discoveries, no one—not even billionaire President Donald Trump—could afford the possession.

We’re not talking about the average diamond engagement ring that sets you back $4,000 and was probably grown in a lab. And we’re not talking about the $3,000 ruby that was probably treated.

We’re talking about the rarest gemstones in the world, like the ‘Guinness Emerald’ that came out of Fura Gems’ Coscuez emerald mine in Colombia, where excavation has only reached 10% and the next gem of the century is just waiting to be discovered.

Every year, the mining industry grows by hundreds of billions of dollars. The global economy is booming and demand for precious jewels, particularly colored gemstones, has never been higher.

That means that the greatest discoveries have yet to be made.

Here are just five examples of stones that broke all the records:

#1 “Star of Adam” Blue Star Sapphire—$100-300 Million

The world’s largest blue sapphire was discovered in Sri Lanka in early 2016. Named the “Star of Adam,” the massive stone weighs an incredible 1,404 carats.

The stone is a blue “star” sapphire, so named due to the bright six-pointed star that appears whenever light is reflected on the stone’s surface.

Estimates of the stone’s value range from the $100-$175 million range to as much as $300 million.

This single stone is worth the annual gem industry of Sri Lanka, which averages $103 million per year in exports.

Interest in blue stones increased worldwide after the royal wedding of Kate Middleton and Prince William in 2011. Middleton wore a 12-carat blue sapphire engagement ring, piquing interest in the stones and sending demand upwards.

But the royal stone has nothing on the massive Star of Adam.

#2 Guinness Emerald—$500 million

Here’s a stone so grand, it made it into the Guinness Book of World Records.

The 1759-carat emerald was discovered at the Coscuez mine, owned by Fura Gems. It was for several years the largest un-cut emerald on earth.

Only 10 percent of the Coscuez mine has been explored, which means there could be several stones like the Guinness Record emerald locked underground.

Fura Gems recently announced its total take over of the Coscuez mine. For only $10 million, the company took possession of a mine that could yield hundreds of millions of dollars’ worth of emeralds just like the Guinness Emerald.

The stone, in its un-cut form, could be worth $17 million, at a valuation of $9,800 per carat.

But once it’s been cut, it could sell for a whole lot more. An 18-carat emerald ring, for example, sold at auction in June 2017 for $5.5 million.

That means the Guinness Emerald could be worth more than $500 million to the right buyer.

Right now, the stone is resting comfortably in the Banco Nacional in Colombia.

#3 Chaiyo Ruby—$448 million

This mysterious stone has quite the back-story.

The Chaiyo Ruby is an enormous gemstone weighing 109,000 carats: that’s roughly the same weight as a seven or eight-year old child.

The stone has been valued at approximately £320 million, or about $448 million.

The ruby came out of a mine in south Asia, though where it was mined exactly is subject to considerable debate: both Myanmar and Thailand dispute ownership.

There have also been accusations that the stone is a fake, that it was manufactured in Myanmar.

In fact, the stone is so mysterious, its current whereabouts are unknown. It vanished in the early 2000s, and may be sitting in a safety-deposit box in Laos. Some rumors speculate that it was stolen from its original owners by members of the Myanmar military.

Whatever the truth is, it’s certain that this massive stone is one of the rarest and richest finds of the recent era.

#4 Bahia Emerald—$250-$925 million

The world’s largest emerald ever uncovered in a single shard, the Bahia Emerald weighs approximately 1.7 million carats, or 752 lbs. It was discovered in the Bahia region of eastern Brazil.

The huge stone, which currently sits in a vault in Los Angeles, could be worth as much as $925 million.

The incredible stone was stored for a time in New Orleans, and was nearly washed away by the flood waters of Hurricane Katrina in 2005.

Like the Chaiyo Ruby, the Bahia Emerald is shrouded in mystery. After surviving Katrina, the stone was stolen from a secure vault in South El Monte in Southern California in September 2008.

After the theft, the stone was tracked down and is now in the middle of a bitter legal battle to determine rightful ownership.

Eventually, the Bahia Emerald was awarded to FM Holdings in June 2015. But then the government of Brazil insisted it had been mined illegally, and that it rightfully belong to Brazil. That got the case started all over again.

Today, the world’s biggest emerald sits in an evidence vault at the LA sheriff’s office. Who knows when it will see the light of day.

#5 Letseng Diamond--$50-$100 million

In the tiny African country of Lesotho, a massive recent discovery was made: a 910-carat colorless, pure diamond.

The 6.4 ounce stone is about the size of two golf balls, but don’t let the size fool you: it could easily be worth tens of millions of dollars to the right buyer.

Another stone discovered by the same company sold for $20,000/carat. Analysts say the Letseng diamond could be worth as much as $40 million, and possibly much more.

Colorless diamonds, which have no visible impurities, are very rare. They are also in high demand from jewelers.

The Letseng stone has almost no nitrogen in its composition. Nitrogen can give diamonds a yellow hue, so the stone’s colorless look will make it shine much brighter once it’s been cut and polished.

And a stone of this size could easily yield a number of smaller stones, cut into various jewelry.

The largest diamond in history, for example, was the 3,106-carat Cullinan diamond discovered in 1905. It was later cut into nine large stones and more than 100 smaller ones.

This recent discovery makes it clear that huge value awaits to be unlocked by the world’s leading mining firms. Worldwide, mining firms added $141 billion to their value last year.

And with specialized companies at the forefront, there are sure to be huge, exciting discoveries. The world’s largest and most valuable diamonds and gemstones are waiting to be uncovered.

After all, records were made to be broken.

The Difference Between Xi and Mao

Chinese lawmakers are expected to rubber stamp a proposal by top Chinese Communist Party officials to abolish term limits on the presidency. It is a major break with more than 40 years of Chinese political norms, and it puts an inordinately large amount of power in the hands of a single person: President Xi Jinping, who is already a peerless figure of authority in China and who, after all, presumably initiated the abolition of term limits in the first place.

How Xi wields this power will have a profound effect on China’s future, and the early signs of his intentions have been strange, to say the least. At a gathering to celebrate what would have been the 120th birthday of Zhou Enlai, the first premier of the People’s Republic of China, Xi gave a long and effusive speech, during which he praised Zhou as a model of Chinese virtue. (When the speech was over, Premier Li Keqiang – whose power Xi has methodically curtailed in the last five years – praised Xi’s leadership of the CPC into the future.) This stands in stark contrast to the speech Xi delivered in 2013 on what would have been Mao Zedong’s 120th birthday. In so many words, Xi said Mao was a human being like any other who should be held accountable just as much for his failures as for his successes.

On the one hand, Xi is raising the possibility that he might become the first Chinese leader since Mao to govern China as dictator-for-life. On the other hand, Xi has gone out of his way to criticize Mao and praise Zhou, Mao’s closest and most loyal comrade, who, despite his service and devotion, was purged from power for trying to curb Mao’s excesses. Like I said, strange to say the least.

A Man Like Mao

Mao was a leader of world-historical importance, but it’s perfectly reasonable for Xi to point out his failures. There are many such failures to choose from, including ignoring his military commanders during the Korean War and the brutal purges of the Cultural Revolution. But none of Mao’s missteps were more destructive or more representative of his leadership style than the Great Leap Forward, Mao’s ambitious plan to vault China into the top industrial powers of the world. The Great Leap Forward failed for many reasons, but among the most important was that provincial Chinese bureaucrats were so terrified of Mao’s retribution that they falsified the data they gave the CPC. Seeing only what he was provided, Mao thought China was becoming stronger when in fact it was falling deeper into disrepair. By the time he got wise to reality, more than 45 million were dead.

The irony is that the paranoia and ambition that led to mistakes such as the Great Leap Forward were also responsible for Mao’s overall success. Mao believed that China could be free and strong only if it abandoned its past. He blamed China’s weakness in part on Chinese culture, and he sought to obliterate that culture and to replace it with a new resilient spirit of Chinese nationalism. Mao distrusted China’s vast bureaucracy because it had collaborated with foreign invaders, only to realize upon coming to power that China was too vast to rule without a bureaucracy. This led to a never-ending cycle of chaos, whereby Mao would carry out wide-ranging purges even if it meant rendering policy initiatives ineffective because China was more important than any single policy initiative. By the end of Mao’s rule, China was in chaos, but China was also independent and united.

The price China had paid for its sovereignty was extremely expensive. After Mao died, presidential term limits were instituted in 1982 in China as part of a broader effort to prevent men like Mao from coming to power ever again. The CPC still admires Mao, but the party line is that 70 percent of what he did was right and 30 percent was wrong – a remarkable party line in a country where political dissent is so carefully regulated. The CPC saw that a man like Mao, necessary as he was to unite China under the rule of one government, could not make China a world-class power. In fact, at a certain point, a man like Mao only prevented China from reaching its true potential. Mao’s successor, Deng Xiaoping, himself purged by Mao three different times, knew firsthand how destructive Mao’s leadership style was, and it was Deng who decided that the most important thing he could give China was a model for a peaceful and orderly transition of power to a younger generation. In place of these men now stands Xi, who is erasing Deng’s model as he claims the throne of the Middle Kingdom.

Xi is not Mao, and his praise of Zhou is meant to make sure the Chinese people know it. Mao ruled by chaos; Xi rules with orderliness. Mao destroyed the bureaucracy; Xi is molding it to serve his purposes. Mao purged friends and foes alike; Xi purges only his foes. Mao was a fervent communist; Xi is a communist in name only, who in the same breath speaks of Lenin and of supply-side reform. Mao was the son of a wealthy farmer. Xi is a “princeling” whose father was purged during the Cultural Revolution. Indeed, no one knows the depredations and bloodletting that Mao oversaw better than Xi, who had a front row seat for all of it.

A Different Turn

And yet, despite Xi’s intimate experience with tyranny’s discontents, he has deemed it necessary to tear down the safeguards erected to prevent a man like him from seizing power comparable to Mao’s. The fact that Xi is compelled to praise Zhou, who tried to protect the Chinese people from Mao while still paying fealty to the Chairman, shows just how nervous Xi is. Xi is not claiming the mantle of power because he is a power-hungry megalomaniac  but because he believes that China is in just as precarious a situation today as it was in 1949, when no one knew if the republic would last more than a decade.

Xi does not face the same challenges Mao did, of course. The country Mao conquered was a poor, abused, humiliated mass of people in the throes of civil war and governed by warlords. Forging the republic out of such a country required a man with Mao’s unique virtues and vices. The country Xi leads is proud and more united than China has been in centuries. Xi’s China is a major power, boasting the world’s second-largest economy and a rapidly improving military. But it is also a country rife with corruption and inequality. If Xi is to redistribute wealth to the 350 million people still living on less than five dollars a day, the government-by-consensus model that has governed China will not be enough. Xi needs to show those who stand in his way that he will crush them if they don’t bend the knee.

China is about to embark on a period of intense internal change, albeit a different kind of change than Mao wrought. Xi will aim to create the legitimacy of change not with revolution but with national pride. And nothing is more generative of national pride than powerful enemies abroad. It is not a coincidence that as Xi claims more and more power for himself, China is engaging in provocative behavior in the South and East China Seas, is attempting to upend the U.S. security alliance in Asia, and is presenting the One Belt, One Road initiative as a way to return China to its rightful place at the center of the world. China’s peaceful rise is over – its confrontation with the world is beginning. Xi will use that confrontation to justify the excesses he will have to oversee if the PRC is to survive his presidency.

In his speech about Zhou, Xi said that, were he able to speak with Zhou, he would tell him “the Chinese nation that experienced great hardships for a long time since the start of modern times has ushered in a great leap from standing up and getting prosperous to becoming strong.” Mao propped China up. Deng made China prosperous. Xi means to make China strong, and he means to do so in his own way. Mao turned on the Chinese people. Xi will turn the Chinese people on the world.

Do credit booms foretell emerging-market crises?

A commonly watched indicator of financial stability may produce too many false alarms.

ON THE morning of December 7th 1941, George Elliott Junior noticed “the largest blip” he had ever seen on a radar near America’s naval base at Pearl Harbour. His discovery was dismissed by his superiors, who were thus unprepared for the Japanese bombers that arrived shortly after. The mistake prompted urgent research into “receiver operating characteristics”, the ability of radar operators to distinguish between true and false alarms.

A similar concern motivates research at the Bank for International Settlements (BIS) in Basel, Switzerland. Its equivalent to the radar is a set of economic indicators that can potentially detect the approach of financial crises. A prominent example is the “credit gap”, which measures the divergence between the level of credit to households and non-financial firms, expressed as a percentage of GDP, and its long-term trend. A big gap may reflect the kind of unsustainable credit boom that often precedes a crisis. Anything above 9% of GDP is reason to worry, according to Iñaki Aldasoro, Claudio Borio and Mathias Drehmann of the BIS.

The biggest blips on the oscilloscope include Canada (9.6%), Singapore (11.1%) and Switzerland (16.3%), according to the latest readings, released on March 11th. But the one that has kept everyone’s eyes peeled is China, with a gap of 16.7% in the third quarter of 2017 (the latest BIS figure available).

As a crisis-detector, the credit gap has some appealing operating characteristics. It can stand alone. It can be estimated quarterly across many economies. And, according to Mr Aldasoro and his co-authors, it would have predicted 80% of the crises since 1980 in the countries and periods for which data are available.

The problem is that it has also predicted many crises that never arrived. When such early-warning indicators flash red, the chance of a crisis in the next three years is “around 50%”, says Mr Drehmann. The BIS provides over 5,200 credit-gap readings for the period since 1980. In over 850 instances, the gap exceeded 9% but skies remained clear.

The problems seem worse in emerging markets. Their data are patchier, covering just 13 crises. Of this unfortunate number, only eight were preceded by a big credit gap. (Another three struck within three years of the start of the data, which may be too early to provide a fair test of the indicator.) There have been many false alarms. The credit gap flashed red almost continuously in Chile in 1993-2002, reaching over 24%, but no crisis followed. It was also persistently large in the Czech Republic in 2007-14 and in Hungary in 2000-10 without any great trauma ensuing. The indicator successfully predicted the “Asian flu” in Indonesia, Malaysia and South Korea in the late 1990s, but only after sounding a false alarm in all three countries in the 1980s.

What about China? Paul Samuelson, a Nobel-prize winning economist, once joked that the stockmarket had predicted nine out of America’s last five recessions. Similarly, the credit gap predicted at least three out of China’s last zero crises. It rose above 9% in mid-2003, mid-2009 and mid-2012, where it has stayed since. China’s comeuppance may still arrive. But the gap is now closing rapidly. It has decreased from almost 29% in the first quarter of 2016 to less than 13% at the end of last year, according to The Economist’scalculations.

One obvious explanation for China’s resilience is that its credit is mostly home-grown, extended by domestic banks and other Chinese lenders. By contrast the crisis-struck emerging economies mostly relied on inflows of foreign capital to finance their current-account deficits with the rest of the world. Looking at both current-account gaps and credit gaps may provide better predictions, says Michael Spencer of Deutsche Bank. He calculates that China’s risk of a financial crisis this year is less than 8% (assuming a credit gap of under 13%) partly because it runs a current-account surplus of about 1.4% of GDP. If China’s government keeps credit stable as a share of GDP this year, this crisis-risk could fall to about 5%.

On that day of infamy in 1941, Mr Elliott took the radar blip far more seriously than his fellow operator did, despite being less experienced. Perhaps this should not be surprising. After less than three months of radar-watching, Mr Elliott was not yet jaded by routine. If a financial crisis eventually strikes China, many people will be caught out—not because of a lack of warnings, but because of too many.

A primer on blockchain-based versions of central-bank money

A BIS report advises: proceed with caution.

BITCOIN, Ethereum, XRP, Stellar, Cardano: the infant world of cryptocurrencies is already mind-bogglingly crowded. Amid the cacophony of blockchain-based would-be substitutes for official currencies, central banks from Singapore to Sweden have been pondering whether they should issue digital versions of their own money, too. None is about to do so, but a report prepared by central-bank officials from around the world, published by the Bank for International Settlements on March 12th—a week before finance ministers and central-bank heads from G20 countries meet in Buenos Aires—offers a guide to how to approach the task.

The answer? With care. For a start, it matters who will be using these central-bank digital currencies (CBDCs). Existing central-bank money comes in two flavours: notes and coins available to anyone; and reserve and settlement accounts open only to commercial banks, already in electronic form (though not based on blockchain) and used for interbank payments. Similarly, CBDCs could be either widely available or tightly restricted. A CBDC open to all would in effect allow anyone to have an account at the central bank.

CBDCs could be transferred either “peer to peer”, like cash, or through the banking system. They could be held anonymously, preserving the privacy of cash, or tagged, making it easier to trace suspicious transactions. Should they bear interest, that would affect demand not only for CBDCs but also for cash, bank deposits and government bonds.

The report weighs up CBDCs’ possible effects on payment systems, monetary policy and financial stability. A steep decline in the use of cash could strengthen the case for a widely available CBDC. In Sweden the Riksbank is contemplating an “e-krona” for small payments. But in most countries, despite the growing use of cards, accelerated by the advent of contactless payments, cash remains popular (see chart). Experiments with a CBDC just for interbank payments, says the report, have “not shown significant benefits”.

A widely available, interest-bearing CBDC could, in principle, tighten the link between monetary policy and the economy. An interest rate tied to the policy rate may put a floor under money-market rates. Banks may have little choice but to pass changes in the CBDC rate on to depositors. Negative rates would be easier to implement, especially if high-denomination banknotes were abolished. But all this is uncertain. Retail depositors are less sensitive than institutional investors to changes in rates. Central banks already have plenty of tools. The authors are not sure that the putative gains yet warrant creating CBDCs.

On financial stability, they are more cautious still. In times of stress, depositors flee wobbly banks for safer homes—and a CBDC would allow “digital runs” to the central bank. Even in normal conditions, banks would face higher funding costs if they had to compete with the central bank for deposits. Digital versions of currencies used internationally (eg, the dollar) could worsen these complications, if foreigners were free to use them.

Central bankers focus more on the rise of private crypto-currencies, warning that they are speculative gambles. Expect more such admonitions in Buenos Aires—and no rush to mint CBDCs.

A lose-lose trade war looms between America and China

If China cannot placate Donald Trump, it will fight him instead.

PRESIDENT DONALD TRUMP has not yet started a global trade war. But he has started a frenzy of special pleading and spluttered threats. In the week since he announced tariffs on steel and aluminium imports, countries have scrambled to win reprieves. Australia, the European Union and Japan, among others, have argued that, since they are America’s allies, their products pose no risk to America’s security. If these appeals fail, the EU has been most vocal in vowing to retaliate, in turn prompting Mr Trump to threaten levies on European cars.

In China, ostensibly the focus of Mr Trump’s actions, the public response has been more restrained. Officials have said the two countries should strive for a “win-win outcome”, a favourite bromide in their lexicon. As a rival to America, China knows that an exemption from the tariffs is not on offer. It also knows that it needs to conserve firepower. If this is the first shot in a trade war, it is, for China, small bore. Its steel and aluminium exports to America amount to roughly 0.03% of its GDP, not even a rounding error.

It is two shots to come that have China more worried. Mr Trump has asked China to slash its $375bn bilateral trade surplus by as much as $100bn, a nigh-impossible task. And an investigation into China’s intellectual-property practices is almost over. Mr Trump wants to punish China for the alleged theft of American corporate secrets. Reportedly he will seek to place tariffs on up to $60bn of Chinese imports, focused on technology and telecommunications (see Briefing).

Until recently, Chinese officials thought they had the measure of Mr Trump. During a state visit to China in November, he was treated to a lavish banquet and signing ceremonies for $250bn in cross-border deals. He still speaks fondly of the dinner, but the glow faded quickly on the deals, many of which were restatements of previous commitments. The tariffs on steel and aluminium, though negligible in their impact on China, signalled that hawkish advisers to Mr Trump were in the ascendancy. So behind their mask of calm, Chinese officials are searching for ways to fight back.

The demand that China cut its trade surplus by $100bn is, in a technical sense, risible. As Mei Xinyu, a researcher in a Chinese commerce-ministry think-tank, observes, America complains that China is not a market economy, but asks for a hard target that only a planned economy could hit. The true bilateral trade gap is smaller than reported, since Chinese exports contain many inputs from elsewhere. Add in services, including Chinese students in America, and it is smaller still.

Politically, the demand has helped focus China’s thinking. “There is a sense that they need to give Mr Trump a win, and that the win must be in the form of a big round number that he can tout,” says Eswar Prasad, an economist at Cornell University, who has spoken with Chinese trade officials. One possibility is that China might buy more of its oil and gas from America, and perhaps even make a hefty down payment on future purchases.

But if America imposes stiff penalties in the intellectual-property case—along with stinging tariffs, it might also place new restrictions on Chinese investment and travel visas—China will take a much harder line. A government adviser in Beijing says that regardless of the economic consequences, Xi Jinping, China’s president, will want to show that he is no pushover. Counter-measures will be varied, says David Dollar, America’s former treasury representative in Beijing. China will buy more soyabeans from Brazil instead of from America. It will buy more Airbus planes instead of Boeings. It will tell its students and tourists to go to other countries. It will drag its feet on approvals for American companies in China.

Worryingly, each side thinks that in a trade war of attrition, it would have the advantage. America calculates that China has the bigger surplus, and thus more to lose. But China’s exports to America are less than 3% of its GDP—large but not critically so. China, for its part, thinks Americans would object to paying higher prices for manufactured goods from toys to televisions. But much low-end production is migrating from China to other developing countries and, in a pinch, American consumers might rally round the flag. To invert China’s much-loved win-win motto, this has all the makings of a lose-lose battle.

Global Funds Are Dumping Indian Bonds at the Fastest Pace Since 2016

Global funds are dumping Indian bonds at the fastest pace since December 2016 as a bank fraud and a weakening rupee sap confidence in Asia’s highest-yielding major debt market.

Foreign holdings of government and corporate notes are set to drop for a fifth week, having fallen 146.6 billion rupees ($2.3 billion) since Feb. 9. It was around this time last month that India unearthed a $2 billion fraud at Punjab National Bank, which saw some jewelers allegedly colluding with PNB officials to obtain loans from overseas branches of other Indian lenders. The rupee is the region’s worst-performing currency this year after the Philippine peso.

“Portfolio flows have previously helped offset deteriorating fundamentals but the sentiment has weakened, with flows turning negative,” said Neeraj Seth, head of Asian credit at BlackRock Inc., the world’s largest asset manager. “The weakness in the rupee means currency gains no longer offset losses from bonds and can trigger further selling.

The selling by overseas funds threatens to exacerbate a sovereign-bond rout that’s inflicted losses worth billions of rupees on state-run banks -- the biggest holders of the securities -- prompting them to stay away from the market. The seven-month carnage has also spurred calls for intervention by the Reserve Bank of India.

As the market reeled from excessive supply of government debt, rising global yields and worries that faster inflation could prompt the central bank to start raising interest rates, the bank fraud has served as another reason for foreigners to flee Indian bonds.

The yield on benchmark 10-year sovereign notes climbed 126 basis points in the last seven months, the longest stretch in at least two decades. While the yield has fallen this month, it could face upward pressure in the coming weeks as the central government starts its 6.06-trillion rupee borrowing program in April.

The rupee has weakened 1.6 percent in 2018 amid concern over India’s deteriorating public finances and fears that U.S. President Donald Trump’s tariff plans will trigger a global trade war.

BlackRock’s Seth said India’s government may allow foreigners greater access to local debt to ease the pain. Bonds rallied Thursday after a report said policy makers may raise the investment limits for global funds.

“Looking ahead, April is an important month as this is where issuance of government bonds will resume,” said Seth. “The factors that could provide support for the market are buying from the RBI to inject liquidity, increase in the foreign limits for government bonds and clearer communication from RBI and/or the government.”

Gold Is A Giant Ouija Board

We have been promising to get back to the topic of capital destruction, which we put on hiatus for the last several weeks to make our case that the interest rate remains in a falling trend. Today, we have a different way of looking at capital destruction.

Socialism is the system of seeking out and destroying capital. Redistribution means taking someone’s capital and handing it over as income to someone else. The rightful owner would steward and compound it, not consume it. But the recipient of unearned free goodies happily and uncaringly eats it up. Socialism is not sustainable. It inherits seed corn from a prior, happier system, and it lasts only as long as the seed corn.

Totalitarian Socialism

There are different flavors of socialism. The 20^th century witnessed an aggressive totalitarian form. Both communism and Naziism feature military occupation of domestic territory and conquest of foreign lands. Few people willingly feed whatever they have into the sausage grinder of State sacrificial collectivism. And so totalitarian socialism has armed thugs all over the streets, both open military and secret police. There are frequent killings, of those suspected of disloyalty or holding back small scraps. In their constant fear of uprising, they use disappearances, interrogations, and torture to root out the names of traitors to their bloody revolution.

Thankfully, the major totalitarian socialist regimes were defeated militarily like the Nazis, collapsed after they depleted all available capital like the Soviets, or reformed like China.

Soft Socialism

Another flavor of socialism is based on so-called soft power. It taxes and regulates every private productive activity, owns and monopolizes some sectors, and promises a minimum level of subsistence to all citizens including food, shelter, and medical care. Unlike the totalitarian forms, this kinder, gentler socialism allows vigorous debate whether the government should criminalize cigarettes, allow people to hail a taxi using an app on their phone, and whether the government should include gender reassignment surgery in the list of medical services to be provided for free. However, as the citizens have mostly gone through government schools, there is almost no debate about whether or not government should take over medical care in the first place.

This kind of socialism is not stable. It is either moving towards freer markets, as for example New Zealand famously did starting in the 1980’s. Or it is moving towards government control as the United States infamously did with Obamacare.

It’s not stable, because it is rife with contradictions. For example, if I cannot afford my healthcare, and you cannot afford your healthcare, and John and Susie cannot afford their healthcare, then of course we as a collective cannot afford our collective healthcare plus a bureaucracy to manage it (not even counting the waste and corruption). No one with basic economic literacy would believe that. An 8^th grader wouldn’t believe it!

What makes it popular is the next contradiction. Most people expect to get free health care paid for by someone else. The thought of “free” is so enticing, that people overlook the obvious failings, such as the declining availability and spotty quality.

In this flavor of socialism, the destruction of capital is obvious. You can see it in the overworked staff of the National Health Service unable to care for every patient and forced to ration health care and cancel surgeries. You can observe the shabby government projects which house huge and permanent underclasses. You can witness the stagnant economies, which provide little opportunity for business owners to accumulate wealth, fewer good jobs for workers, or hope for the future.

Central Bank Socialism

There is a third flavor of socialism, which was unfortunately popularized by Milton Friedman. He did not see it as socialism, but as we shall show it certainly is.

This type of socialism lacks the totalitarian flavor’s military officers, strutting about and demanding to see your papers. It also lacks the boundless welfare programs and endless Ministries of Micromanagement of Human Life of the softer flavor.

I refer, of course, to central banking.

Friedman advocated a steady expansion of the quantity of dollars, what he called the K percent Rule. Friedman’s followers today favor other rules, for example to expand the quantity in order to grow GDP by what they feel to be the “right” amount. The man most people think to be Friedman’s diametric opposite, John Maynard Keynes, advocated expansion in response to whatever economic problem may come along. Former Fed Chair Janet Yellen, a diehard New Keynesian, wrote a paper in which she argued for printing more dollars—to enable employers to hire more workers.

Whether the central bank is to expand the quantity of dollars at a steady rate, to achieve an economic goal, or purely at the discretion of philosopher-kings, the principle is the same. We consider them to be sub-flavors of the same flavor of socialism. The central bank can nudge us for our own good, if not the good of politically connected cronies.

What is this nudging? They have found a very clever way to induce people to do as the central planners wish, without the machine guns or bloated bureaucracies. Keynes, citing Lenin, referred to “engaging all of the hidden forces of economic law”. In the same breath, he admitted that it was “on the side of destruction,” but that does not seem to have deterred anyone.

What economic law induces people to act? It’s that people act according to incentives. The central bank can change certain incentives. We will leave off the falling interest rate for now, but let’s look at something else the central bank can do.

It can make it so that credit is available to companies who don’t even produce enough revenue to cover their interest expense. Normally, such zombies (as they are called) would not be able to obtain credit. Who lends money to a company that will have to borrow more money just to cover the interest? But we are not in a normal world. We are in the third flavor of socialism.

And the Fed has made it so that the zombies, who ought not to be able to get credit at all, have gotten mass quantities of it. And this brings us back to our theme of destruction of capital.

It should be obvious that it’s destructive to feed credit to a company which cannot pay its cost of credit (and this is in a world of suppressed cost of credit, at that). Zombies wear out machinery that they cannot replace, and pay workers’ wages with borrowed funds that they cannot afford. When the end inevitably arrives, those who lent to the zombie lose their principal.

It should also be obvious that zombies add to GDP, at least while they exist. So the GDP targeting crowd sees this as a good thing. And zombies produce goods, thus increasing supply and thus pushing down prices. So the inflation targeters justify even more of the policy that feeds credit to zombies. And zombies employ people, so the unemployment optimizers see the policy as good. Stock prices are also rising, so investors see it as good, not to mention Wall Street.

By every conventional macroeconomic aggregate measure, feeding credit to zombies is a Good Thing. This is not an argument in favor of lending to zombies. It is an argument against using conventional macroeconomic aggregate measures. They are misleading.

Nudging

However, they’re used for a reason. They provide cover to this third flavor of socialism, for the central planners who nudge us down the socialist road to the destruction of capital.

So how does this nudging work? What is the form of the incentive? They make it profitable to fork over your capital to zombies. People like to make a profit. Who would have known?

Here is a chart of an ETF which owns high yield corporate bonds, presumably zombies among them.

(Click to enlarge)

If you bought in the lows after the last crisis, you could have made capital gains of over 50 percent in four years (not counting the yield). After that, well it’s not looking so good. However, there is another trade that is still making money. At least for now. Here is a graph of the spread between junk and Treasury bonds (the BofAML US High Yield Master II Option-Adjusted Spread).

(Click to enlarge)

There is currently only a 3.5 percent difference in yield between junk bonds and Treasury bonds.

The way to have played this was to buy junk and short Treasurys. The more this spread narrowed, the more you won. It performed brilliantly until mid-2014. Then you wanted to be out of it until 2016. After that, you had another good run until a month ago.

We think this trade won’t be so good going forward. Not because it’s within a point of the all-time bottom. Though it is, and one would have to be worried about that. But because zombies are time bombs waiting to go off. With each passing day, they get closer to blowing up. Don’t forget that they are destroying investor capital, and piling up more debt every day. And also, they get closer to blowing up with each uptick in the interest rate. It looks to us like junk bond yields have been in a rising trend for about half a year. LIBOR has been in a rising trend for three years, steepening considerably since September.

Lured by profits, investors are feeding capital to zombies, who destroy it. They do it because the Federal Reserve has made it profitable to do so

Keep in mind that employees of zombies buy houses, remodel kitchens, buy cars with 0 percent financing for 72 months, eat at restaurants, buy Swiss watches, etc. One could look at the major creditors of the zombies and their biggest vendors, and predict the impact to those entities. But beyond that, it is impossible to determine the full impact. The problem has grown very big.

Contrary to Milton Friedman, we argue that a central bank brings a flavor of socialism. The means may be different, but like the other flavors, the central banking flavor seeks out and destroys capital. The capital destruction is less obvious, especially if you look only at conventional macroeconomic measures such as GDP and unemployment. You must look at falling marginal productivity, or the rising number of people who are neither employed nor unemployed.

We need to evolve away from central banks, socialism, and a policy of capital destruction. We need to move forward towards the gold standard, the monetary system of a free market. The monetary system where capital is accumulated, not consumed.

Supply And Demand

The prices of the metals fell, $22 and $0.24 respectively. It’s an odd thing, isn’t it? Each group of traders knows how gold “should” react to a particular type of news. But they all want the same thing—they want gold to go up. And when it doesn’t, many hesitate to buy. Or even sell.

This is why speculation cannot set a stable price (I’m talking to you, bitcoiners).

So long as gold’s sole purpose is to bet on its price to make real money—we’re talking dollars here, baby!—then the trading action is like a giant Ouija Board, with each group having a thumb on it. You have the Indian jewelry buyers, the inscrutable central banks like China, the Wall Street firms, the gold bugs, the hedge funds, etc. When enough of those thumbs desire to push gold in the up direction, it goes up.

Of course this isn’t gold’s purpose, but that’s what is commonly believed.

It is endlessly fascinating as it is endlessly moving around, if not in the directions and for the reasons that gold analysts think. This is the dynamic we study, the interplay between buys and sellers of real metal, buyers and sellers of futures, and market makers. Many gold analysts see only the short futures position of the market makers, and conclude that they are pushing the price down. The long metal (or gold receivable, e.g. from a miner) is not reported in the Commitment of Traders report). So they misread the market. Plus, a quantity approach to position size (as with quantity of dollars or anything else) does not tell you much.

Let’s take a look at the only true picture of the supply and demand fundamentals for the metals. But first, here is the chart of the prices of gold and silver.

(Click to enlarge)

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). The ratio fell slightly.

(Click to enlarge)

Here is the gold graph showing gold basis, cobasis and the price of the dollar in terms of gold price.

(Click to enlarge)

Note that tiny rise in scarcity (i.e. cobasis, the red line) as the price of the dollar rose (inverse of the falling price of gold, in dollar terms). That is the typical pattern.

The Monetary Metals Gold Fundamental Price fell this week, to $1,387. Now let’s look at silver.

The same occurred in silver. The Monetary Metals Silver Fundamental Price fell 7 cents to $17.12.

Interestingly, the Monetary Metals Gold Silver Fundamental Ratio fell in a week when the fundamental prices of both metals fell. It is now 81.05.

Automation will drive interest rates higher, a new report concludes.

As rates rise, stress levels will, too

REAL interest rates in the developed world have been low ever since the financial crisis of 2008-09 (see chart). The global economy might have struggled to recover had that not been the case; higher rates would have caused many more companies and homeowners to default.

Central banks are now starting to push rates slightly higher. And according to a new paper* from Bain, a management consultancy, the trend towards robotics will push them higher still—at least for a decade. That could be a shock for the financial markets.

Bain estimates that by 2030 American companies will have invested as much as $8trn in automation. As companies scramble to borrow money in order to buy machinery and robots, the resulting investment boom will drive up rates.

Automation will boost productivity, which has grown sluggishly in recent years. This slowdown may have been caused by the shift from manufacturing to services, where productivity gains are harder to achieve. Between 1993 and 2014, the American car industry more than doubled its productivity, but lost 28% of its workforce. By contrast, over the same period hospitals added 28% more jobs and increased productivity by just 16%.

But automation is about to come to a wide range of service industries. Though that will be a boon for productivity, Bain estimates that 20-25% of current jobs could be eliminated by 2030. This shift will be much faster than previous labour-market transformations, such as that from agriculture to industry at the start of the 20th century. Lower-skilled workers, such as waiters, will take the biggest hit.

The result would be an even more unequal economy, because a greater share of income would go to highly paid workers. They are more likely to save and invest than lower-paid workers, who spend virtually all their income. So after the initial interest-rate surge, the increase in saving and the hit to demand could cause interest rates to plunge again, falling back to zero in real terms.

In a paper** written last year for the Bank for International Settlements, a central-bankers’ club, Charles Goodhart and Manoj Pradhan came up with similar predictions for interest rates using a different chain of reasoning. They thought demography would be the main reason interest rates would rise. Real rates adjust to balance the desired levels of savings and investment. The current low level of real rates indicates that the former has exceeded the latter as the baby boomers have made provision for their old age. But global population growth is slowing and the size of working-age cohorts in the advanced economies and China will decline.

As workers retire, they will run down their savings pots. Companies will substitute capital for labour as the workforce shrinks. A smaller pool of workers will earn higher wages, pushing up the labour share of GDP and (in a divergence from the Bain line of reasoning) thereby reducing inequality, but also driving up inflation. Keeping it under control will require higher nominal interest rates. Furthermore, desired savings will fall faster than desired investment, and real rates will rise.

What about the argument that “secular stagnation” will keep interest rates low? Andrew Smithers, an independent economist based in London, says that because there is no reason to expect world growth to be slower than average over the next decade, global interest rates could well rise to more normal levels. However, he adds, growth may be less important for rates than is the balance between fiscal and monetary policy. With fiscal policy easing in both America and Europe, monetary policy will need to be tightened, he reckons.

That would make the road to higher rates a bumpy one. The piles of debt accumulated before the financial crisis have been redistributed rather than eliminated. A sudden rise in rates might hurt economic activity, and thus be self-limiting, if central banks have to reverse policy. Financial markets have translated low rates into high valuations. Equities are priced as the discounted value of future profits; the lower the discount rate, the higher the price. But in the Goodhart/Pradhan scenario, shares might face a double whammy. As employers compete for scarce workers, the discount rate would rise and profits would be squeezed. Homeowners, and companies with lots of debt on their balance-sheets, would get a nasty shock. As rates rise, stress levels will, too.

Why low returns are inevitable

When valuations are high, the maths points to lower returns

WHEN the stockmarket is close to a record high, the chances are that recent returns will have been very strong. The terrible tendency among investors is to assume that those returns will continue. But the higher you go, the harder it is to keep rising at the same pace. 

When I visited America for a story on pensions last autumn, I was struck by how few people failed to grasp this point. Public pensions have return targets of 7-8% for their portfolios. When challenged they tend to cite their 30-year record of achieving those numbers. But that record makes it less likely, not more that they will hit their targets. 

The easiest way to think of this is via the bond market. In 1987 the yield on the ten-year Treasury bond was just under 9%. Since then it has fallen to its current level of just under 3%. So not only did bond investors get a high yield in their early years, they received capital gains as bond yields fell. Future returns are obviously limited by the low initial yield, but also by the small likelihood of future capital gains.

In their latest survey of long-term returns (the Credit Suisse global investment returns yearbook), Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School show how neatly this works for equities too. Since 1900, global investors have earned an annual 5.2% real return from equities. That reflected an average dividend yield of 4.1%, annual real dividend growth of 0.6% and a valuation improvement of 0.5% a year (see chart).

The current dividend yield on the global market is around 2.5%. It seems unwise to assume any further valuation improvement (a rise in the price/dividend ratio or fall in the dividend yield). The academics allow a fairly generous 1% for future real dividend growth to come up with a current ex ante equity risk premium of 3.5%. If that seems low, we should note that the academics made the same forecast in 2000; since then, the equity risk premium has been...3.4%.The way that academics think about returns is to say that investors get a risk-free return (from lending to the government for short periods) and then demand a “risk premium” for buying equities, which can suffer big losses in the short term. There is a difference between the ex post premium (what investors actually got) and the ex ante premium (what they expected). The LBS academics argue that investors might have hoped for real dividend growth and a valuation improvement, but they probably only counted on the dividend yield. So the ex ante equity risk premium in the past may have been 3.3%.

To estimate a total return, one must of course add the risk premium to the risk-free rate. And that is the second problem for the optimists. Real rates are negative across the world; ie short-term rates are below the rate of inflation. Even if we take a longer rate (10-year inflation-linked bonds, for example), the US has a positive real rate of just 0.5%. Adding a risk premium of 3.5% to that gets you a real return of 4%. If we assume inflation of 2%, then the nominal return from equities would be 6%. And all this assumes there is no valuation downgrade for equities, as seems quite plausible.

So even if US pension funds put their entire portfolios in equities—a highly risky strategy—they are not going to make the 7-8% they assume. This doesn’t require one to forecast a 2008-style crash, as one city finance director said to me. It is just maths.