Keith Weiner at Monetary Metals asks Who Would Invest in a Gold Bond?
Berkshire Hathaway CEO Warren Buffet famously dismissed gold. “Gold has two significant shortcomings, being neither of much use nor procreative.”
Nevada now has legislation pending, to enable the state to issue gold bonds. Not gold-backed bonds, which are a way to sink deeper into debt, to borrow more dollars using gold as collateral. True gold bonds, which are denominated in gold, pay interest in gold, and return investors’ principal in gold.
Interest. That is what Warren Buffet declared that gold has not got. And now an AA-rated state government is close to paying interest on gold. That is an interesting development (permit me my little pun). But there is a challenge.
Although there is no downside, and no special interest groups are harmed, the bill might not pass. The Democrat majority who controls the state legislature could perceive the gold bond as a Republican partisan measure. I can say that this assumption is totally wrong. Most mainstream Republicans are not especially fond of gold. For example, it took Arizona five years to pass its gold legislation, with three vetoes by two Republican governors.
Unfortunately, politics has become hyper-partisan. If Nevada Democrats perceive this as a Republican bill, they will vote it down. Since they are in the majority, they will kill the bill. That must not happen! The decay in our monetary system is at an advanced stage. No one can predict how much time remains, but I can say one thing with absolute certainty. We need to begin developing an alternative. We need to begin remonetizing gold, and that means gold bonds.
So I am going to ask for something, which I have never done before. If you would consider buying a gold-bond, please sign my Nevada Gold Bond Petition. If you are not interested in buying but think the state of Nevada should try this out, please sign or promote the Gold Bond Petition at Change.Org.
Missing Pieces
I ask Weiner to explain why this was such a good deal for Nevada. Here are some of the things we discussed on the phone yesterday evening and via email today.
Why Nevada?
Over 160 tons of gold are produced annually in Nevada. The state tax on this is 5%, or about 8 tons (a bit less due to smelting and other costs taken off the top). That was worth over $320 million at recent prices. Nevada counts on this revenue to cover expenses. But if the gold price drops 10%, then revenues would drop $32 million. Since expenses don’t go down, there is a budget deficit.
Gold bonds eliminate Nevada’s gold price risk. Gold bonds are like regular bonds, except they pay gold. Because the payments are gold, the debt service expense falls with the gold price. If tax revenue drops and bond payments also drop the same, then there is no impact to Nevada finances.
And there’s a bigger benefit. Nevada can reduce its debt at a discount.
To do this, swap the gold bond for outstanding dollar bonds. Direct gold bond buyers to bid not in dollars, but in outstanding Nevada paper. The auctions set the exchange rate, how many old dollar bonds are retired to get the new gold bond. For example, the state issues a 1,000 ounce gold bond. The current gold price is $1,250 per ounce. Buyers might offer $1,250,000 of bonds.
However due to inflation, a dollar to be paid in the year 2028 is worth less today. Many investors will prefer gold bonds to dollar bonds (it only takes a few). They will happily trade more than $1.25 million of dollar bonds for a 1,000 ounce gold bond. This discounts the dollar bond, retiring more dollar bonds than the value of the gold backing the gold bond.
If the market sets a rate of $1.5 million per 1,000 ounces, it’s a 20% discount. Nevada cuts $250,000 of debt with one 1,000 oz gold bond. Even at 10%, the total benefit to the state could be $1 billion.
Best Regards,
Keith
In addition to the state of Nevada, miners would also benefit by raising funds via gold bonds instead of dollar-denominated bonds.
Here’s a longer Monetary Metals article on the Benefits of Issuing Gold Bonds.
Please Sign the Petition
If you are a potential buyer, please sign Keith’s Nevada Gold Bond Petition. If you are not interested in buying but think the state of Nevada should try this out, please sign or promote the Gold Bond Petition at Change.Org.
Mike “Mish” Shedlock
With future zero interest rates cometh, (c’mon we know it’s coming eventually), this is a forward looking concept. They just have to make it work somehow. I think it’s difficult with gold, it’s a hoarded relic that never did circulate very well either.
It may look like a decent proposal and both Nevada and Bond holders win , but in reality both cannot win at the same time, one must lose. Loser will be Nevada here. 1- Assume gold price went up in future, Nevada loses future revenue, gold price is lowest in last few years and most likely it will go up from here in next 10 years so Nevada will be losing big revenue here. 2- Like Kinuachdrach highlighted earlier, what will happen if gold output drops, all mines have a drop in production over the years, most likely there will be a drop in output in the next 10 years, Nevada will give to bondholders more gold than it collects, so again Nevada will be losing a revenue here.
Only Nevada wins if gold price drops in future and if this does not offsett the drop in gold production. For me it looks like a big losing proposal for Nevada, if I were a legistator in Nevada i would reject this proposal.
If you are a corn farmer, you are generally better off paying interest and principal in corn, than in some random other commodity. Despite the fact you can trade the corn you produce for said other commodity, and then use the proceeds to pay off the the loan.
Nevada can “print” it’s own money, within reason, as long as that money is Gold. So they benefit similar to countries being able to borrow in their own currency, rather than a foreign one.
The above holds universally. In theory. In practice, it could well be that financial markets in dollars, are so much bigger, deeper and more efficient than Gold ones, that the friction drag from doing something so novel and one-off, more than makes up for what gains Nevada can expect to see.
Were I Nevada, I’d most certainly go through with the Gold issue. If for no other reason than possible future gains from being a forerunner in Gold finance. There’s got to be a whole hornet’s nest’s worth of special considerations that props up in Gold deals, that are nonexistent, or at least very different, in Fiat deals. By taking the lead, Nevada law and customs stand an increased chance of being standard setting. With all the benefits that may confer on Nevada legal, professional and financial services actors in the future, should Gold deals again become more widespread.
Doesn’t this amount to just a fancy way for Nevada to borrow against future gold revenues?
With oil & gas, in some jurisdictions governments (more generally, royalty owners) have a right to take the royalty payment in kind instead of in cash. If that is how Nevada gets the gold to pay “interest”, then they would really be borrowing today against expected future gold royalties in kind. What happens when future gold production declines — for any of a number of reasons?
Nevada likely feels more exposed to future moves in the price of gold, than in the amount of it they reckon they’ll be able to produce.
Buffet’s comment echoes sentiments in ancient times, when metal money was often dubbed “barren” since it cannot reproduce. It is important to know that interest on loans was often seen in terms of reproduction. Loans were often agricultural, and repayment of the loan with interest occurred after harvest. At that time the loan would be said to have “calved”. Since the interest on loans could only be paid by investing it productively, purely monetary gain (from money changers or speculative loans) was viewed as a zero-sum game with losers and winners, in distinction to productive investment, where there was actual economic gain. The distinction between productive investments and returns on purely speculative endeavours remains very important, and obfuscating the difference for tax and other purposes is one of the main tasks of economic apologists.
As I understand this, Nevada borrows dollars, which they spend for things like roads, schools, etc. Then, instead of paying the interest in USD, they pay the interest in gold, and at the end of the term, they pay the principle in gold. This would be a way for someone to buy gold without having to actually take delivery for, say, 30 yeas. For Nevada, it might or might not be cheaper than issuing dollar denominated bonds, but as mentioned in the article, it would make it’s expenses vary with the price of gold.
For Nevada, it reduces their exposure if the Gold price should fall. For buyers, it allows them to partake in a rising Gold price, while still earning interest on their investment.
Assuming no friction, and no counterparty risk, both parties can achieve the same with hedges and other currently fashionable hocus pocus. But those assumptions become less and less realistic, the more leveraged participants are.
OTOH, since the hocus pocus’ers are the ones with the Junta’s ear; any participant to non-traditional deals, run increased risk of being thrown under the bus, in order to keep the illusion that hocus pocus is somehow useful economic activity, alive. In general, it pays to be positioned such that robbing you, is hard to do without simultaneously robbing Goldman. Being “clever” enough to not suffer when Chavez’, or Paulson’s buddies did, just mean you “need” to pitch in to prevent “The System” from Collapsing.”
I admit I couldn’t wrap my head around this scheme on the first read. The gold tax is paid in gold, rather than in $ based on the $ value of the gold? They could eliminate the gold price risk like everyone else does: the commodities futures exchange. I still can’t figure out why someone would pay more for a gold bond than the actual gold is worth. Oh well, as Warren Buffet also says, if you don’t understand it, don’t buy it.
To paraphrase John Hussman, fair value for an ounce of gold has 3 digest. Miners will be massacred.