Friday, October 15, 2010

Keiser Report

This weeks Keiser Report looks at hard assets versus high assets, Hu Jintao bonds, political witches and more bank bailouts. Max also talks to Eric Janszen about his new book, the PostCatastrophe Economy.

Weekend Chill Out

This weekend's chill out is dedicated to the millions of gold miners over thousands of years who have gone to the river to pan for gold. Without them we would not have much of the gold that exists today, meaning civilisation and international trade may never have developed.

The Taiwanese Animators Explain Gold Mania

Uncle Sam’s Mysterious Hoard


The mainstream press still don't seem to get it, Gold is Money - the finest Money for thousands of years and will be ever so whilst humans need to store their wealth in an asset that cannot be created on Earth.

From The Atlantic, by James Picerno:

The Federal Reserve Bank of New York, a neo-Florentine fortress of sandstone and limestone in Lower Manhattan, covers a city block. A battery of structural and technological defenses makes it perhaps the world’s most secure bank; it can be sealed off in less than 25 seconds. On a recent visit to its subterranean vault, beneath 80 feet of bedrock, I walked along a narrow passageway through a 90-ton steel cylinder that can create an airtight and watertight seal. On the other side was a vault with neatly stacked walls of 27-pound yellow bricks—one of the largest collections of gold in the world.

Standing next to this mass of concentrated wealth all but paralyzes one’s sense of financial proportion. But after the initial awe of this King Midas moment, a question nagged: what’s the point?

Nearly 40 years after President Nixon suspended the dollar’s link to gold, the United States still sits on far more of it than any other nation: official holdings total 8,965 tons, or roughly 260 million troy ounces, according to the Treasury Department. (Most of it is stored in Fort Knox, Kentucky; the New York Fed holds about 11 million troy ounces, along with gold reserves from other countries and international organizations.) Gold is easily convertible into cash, and America’s mountain of metal is now worth more than ever: assuming the recent market price of $1,200 a troy ounce, the value of the federal stock exceeds $300 billion. Yet in an age of soaring deficits, our gold reserves earn no income, incur huge storage and security costs, and serve no practical purpose, short of a politically unthinkable renaissance of gold-based money (see “The Tea Party’s Brain,” page 98). Why?

Getting straight answers (or any answers at all) from Washington about our hoard of gold is weirdly difficult. Yes, the government can downsize its holdings, said Congressman Brad Sherman, a member of the Subcommittee on Domestic Monetary Policy and Technology, through a spokesman. No, it’s not a good idea, he added, offering no elaboration. When I called to interview the subcommittee’s chairman, Representative Mel Watt, his office begged off in an e-mail, advising only that he “hadn’t studied this particular issue as of yet.”

Repeated calls and e-mails to the White House press office went unanswered. The Treasury Department referred me to the section on gold in the U.S. Code. When I pressed for more information, a public-affairs official e-mailed back: “Gold? Don’t you have anything better to write about[?]”

“I don’t think that any change in the gold policy is even on the screen,” said Dale Henderson, a visiting professor of economics at Georgetown University. “It’s a bit of a mystery to me.” As a research economist at the Federal Reserve, Henderson co-authored a study in 1997 called “Can Government Gold Be Put to Better Use?” Yes, the paper concluded: selling or loaning out some or all of the reserves is preferable to doing nothing. “It’s an opportunity cost for the government,” Henderson told me. “The country has this gold and is borrowing to finance its activities. If we’re trying to maximize the return on the country’s assets, then we should borrow a little less and sell some of the gold.”

Under current law, income from the sale of gold must be used to reduce the national debt. But nothing would stop Congress from rewriting the regulation to permit other uses. By Washington’s corpulent spending standards, $300 billion may seem modest, but it’s hardly trivial: it could, for example, reduce our $1.3 trillion budget deficit by more than 20 percent; finance Social Security for nearly six months; or fund unemployment benefits for several years—in effect, create a stimulus package without pushing us further into debt.

So why hasn’t the U.S. cashed in, as several European central banks have done recently? For one thing, the Federal Reserve’s ability to print money at will—despite the risk of inflation—makes the case for selling gold less persuasive, explained Martin Murenbeeld, a veteran gold analyst and the chief economist at DundeeWealth. And some analysts worry that selling gold would be seen as a frantic effort by Washington to balance its deficit-laden budget. In turn, the market might demand higher yields on Treasury bonds, thereby minimizing if not overwhelming the revenue gains from liquidating gold.

Barry Bosworth, a senior fellow at the Brookings Institution and a former economic adviser in the Carter administration, said that the wisdom of selling would depend on what the government did with the proceeds. Reducing the nation’s gold stock to finance, say, an increase in the strategic petroleum reserve might be savvy, he said, depending on the future price of oil. But selling gold, or any other national asset, to fund consumption just looks like a “gimmick.”

That doesn’t change the fact that a handsome pile of America’s wealth lies fallow at a time of pressing need. But a few thousand years of history remind us that gold is money that’s immune to government profligacy and all the other hazards that terrorize fiat currencies like our own. Which is why the most plausible explanation for the government’s gold hoarding is political. In a world of rising debt and fears of sovereign default, gold is popular once more—an online poll by Parade magazine in February found that 87 percent of readers believed America shouldn’t sell its reserves. And a sell-off would likely trigger protests from gold investors, whose numbers have grown dramatically in recent years. Owning the commodity, on the other hand, allows the government to enjoy the aura, if not the substance, of monetary prudence—a state of grace otherwise lacking in budgetary matters these days.

As Murenbeeld said, “The best reserve-currency system is gold, because no other central bank can print the damn thing.”

U.S. Currency War is a "tomb maker"


Oct 14 (Reuters) - The United States fired the first shot in the currency war and the rest of the world must be on guard for its deliberate strategy to devalue the dollar, a Chinese economist said in an official newspaper on Thursday.

In a front-page commentary in the overseas edition of the People's Daily, Li Xiangyang described the United States as the conflict's "first maker of tomb figures", a Chinese idiom that means someone who creates a bad precedent.

Li, head of the Asia department at the Chinese Academy of Social Sciences, a top government think tank, said continued intervention in currency markets by developed economies would deal a blow to global economic recovery.

Chinese leaders have warned before that loose monetary policies in the United States pose a serious challenge for emerging markets, but rarely in such strident language, a window onto the rising anger in Beijing.

"The dollar's depreciation may appear to be market-driven. In reality, it is a depreciation coloured by very strong, deliberate actions," Li said in the paper, which serves as the chief mouthpiece of China's ruling Communist Party.

The overseas edition of the People's Daily is a smaller offshoot of the domestic edition.

Li said the Federal Reserve's announcement that it might soon launch another round of quantitative easing by buying bonds and other financial assets had been the key factor pulling down the dollar.

The motives were plain enough, he said.

Without a weaker dollar, the United States would have no hope of meeting President Barack Obama's goal to double exports in five years, Li said.

Dollar depreciation will also serve longer-term interests by generating inflation and easing the debt burden that the financial crisis dumped on the U.S. government.

"If the global financial crisis was about nationalising private debt, then in the post-crisis period the urgent need of the United States is to internationalise its national debt," he said.

Marc Faber sees interest rates going up within three months


From ArabianMoney.net:

One of the wisest and most trusted investment advisors in the world, Dr Marc Faber says that interest rates will be going up within three months after the bond market passes ‘an important inflection point’.

This is exactly the opposite of what the US Federal Reserve is promising, and is bound to turn global financial markets upside down. Higher interest rates will strengthen the dollar rather than weaken it, while the value of bond holdings all over the globe will be decimated.

Stock market impact

Stocks look to be a winner until you consider the impact of higher interest rates on an already weakened global economy, particularly the US, Japan and Europe. For one thing real estate prices will fall sharply and bank balance sheets will be once again seriously impaired. Stock markets will therefore come down. Rising interest rates are not good news for equities.

A rise in the cost of money is the last thing that the US central bank wants to achieve right now. However, interest rates can only be artificially held at record lows for so long. Eventually the weight of new money entering the system becomes too much for it to bear any longer and there is a tipping point for bonds.

Professor Niall Ferguson, the celebrity historian is another leading financial pundit to take this view, and it is no surprise that Dr Marc Faber is also an ardent student of history. For this bond market reaction is nothing new. It has happened many, many times before.

Basically money creation will always eventually overwhelm the very instrument used to create it. The pattern that follows is first a very sharp deflation of real asset prices and then later a hyperinflation of asset prices which in extreme scenarios – like Weimar Germany – requires the issuing of a new currency.

Faber’s usually right

Dr Marc Faber’s track record for calling such major market moves has been outstanding in the decade that he has been known to ArabianMoney. Sometimes he is like the boy in the parable of the emperor with no clothes, and what he says should be blinding obvious but nobody will admit it.

Today the bond market is an obvious bubble. Interest rates are perilously low and this completely distorts the investment world leaving savers with little income. But this sort of financial conjuring trick only works for so long and the saucerer’s plates eventually all come tumbling down.

Then savers get their interest again. Real estate, stocks and bonds take a big hit from higher interest rates. The dollar at first will surge in value, probably depressing precious metal prices too in the process, although they are increasingly just another currency, albeit one that pays no interest.

Fed response

But the Fed response to this crisis will be to learn nothing and print even more money, and that will finally result in runaway inflation. Only then will you want to be invested in stocks to rise with this tide.

This looks like being a very tough phase to be invested in any major asset class so the main advice seems to be to stay liquid, ironically being long the dollar seems the best defense against Fed action specifically designed to weaken the greenback.

But you would want to convert that cash back into real assets like gold, silver, houses and stocks before the great inflation. In any case that is ArabianMoney’s interpretation of how rising interest rates will play out, assuming that Marc Faber is right again.

However, for the record Dr Marc Faber has stock markets correcting in October/November in his latest newsletter and does not see stocks as a good investment now as suggested in an inaccurate Bloomberg report yesterday.

A Message to Garcia


By Jim Rickards:

One of the most famous and widely published essays of all time was A Message to Garcia by E. Hubbard. Written in 1899, it recounts the effort of the President of the United States to reach out to a foreign insurgent who was incommunicado. For this mission impossible, the President relied on U.S. Army Lieutenant Andrew S. Rowan who delivered the message against enormous odds but without hesitation and with complete loyalty and devotion to duty.

Lt. Rowan, meet Ted Truman.

Today's FT carries a column entitled "America should open its vaults and sell gold" by Edwin "Ted" Truman of the Peterson Institute. Truman's thesis, in a nutshell, is that the gold price is a bubble and the U.S. Treasury should take advantage of this by selling "high" and using the proceeds to reduce the national debt by about 2.25% of GDP. Furthermore, the interest savings on the debt reduction would amount to about $15 billion annually thus helping reduce our deficit even more. And the appeal of Truman's idea goes even further because the gold sales would give anxious citizens, "...something to hang around their necks..." How thoughtful.

The intellectual flaws in Truman's piece are too numerous to review in detail but here are a few highlights: He says that the price action in gold is driven by the "...hype of the bullion dealers (holding large inventories)..." Really? My wholesale bullion dealer constantly complains about shortages and occasionally puts his best customers on allocation because he's short of supply. Truman also says that the market is accompanied by "...the normal amount of fraud and misinformation accompanying asset price bubbles...". Apart from a few sleazy coin dealers, the only fraud and misinformation I've seen comes from the Treasury and the Fed who refuse to allow a proper audit of official holdings and who cover-up and deny their gold discussions held at BIS and other nearly impenetrable venues. More to the point, the price action does not reveal a bubble in gold, it shows the collapse of the paper dollar. The issue here is understanding the importance of the numerarie or unit of account. If you make the dollar the numerarie, and think in terms of "dollars per ounce" then the price action may look to some like a bubble. But if you make gold the numerarie and think about how many ounces your get for a single dollar (now about 0.00075; was 0.00400 in 1999) you can see that the real problem is the dollar is rapidly shrinking to a vanishing point.

Truman's idea that gold sales and debt reduction would reduce U.S. interest expense by $15 billion per year is the kind of nonsense one gets from static, linear analysis. In dynamic, nonlinear analysis, such gold sales would so undermine confidence in the dollar as to cause a skyrocketing of interest rates and an explosion of the U.S. deficit easily submerging the savings that Truman posits. Truman says that the gold standard was associated with "...unstable, prices, output and employment...". If by unstable, he means cyclical, yes that's true (and necessary) but gold was also associated with some of the longest and strongest periods of sustained real growth in U.S. history from 1865 to 1912 until gold's function was derailed by the creation of the Fed in 1913. Truman says the U.S. "...has been sitting on [gold] since the Great Depression, receiving no return..." Actually, gold went from $20.67 per ounce to $1,350 per ounce in that time period; seems like a 6,500% return to me.

Truman says that the gold standard "...has not existed for a century...". This is highly revealing. In fact, the U.S. went off domestic gold convertibility 76 years ago, within living memory to many, and only went off international gold convertibility 39 years ago. But if Truman dates the end of the gold standard not from 1971 or 1933 but from the creation of the Fed in 1913 then he's right; it has been a century. That tells you something about how establishment intellectuals like Truman view the real purpose of the Fed regardless of the existence of any formal systemic role for gold. Nevertheless, gold is not quite the musty relic Truman would like it to be although it is true that an entire generation of finance scholars have come of age since 1971 with no formal analytic training in gold.

We could go on but you get the point. No amount of analysis will reach the right conclusion if you get the paradigm wrong. Truman's paradigm is anchored in a perpetually sound fiat dollar and he is intellectually unable to see the world any other way. Sadly, he's not alone.

This leads me to Truman's most revealing remark of all. He writes, "Official discussions of the reform of the international monetary system do not include any advocates of a return to gold..." (emphasis added). The problem with this observation is that he is almost certainly right. And this is scary. I have maintained for some time that the return to gold is inevitable and the only issue is whether it would happen through a rigorous and studied process led by the United States or by a chaotic process in which the United States is caught off guard to its disadvantage. Learning from an insider like Truman that none of the power elite are thinking seriously about gold increases the odds that the dollar dénouement will be chaotic not orderly.

The reaction of the gold community and various bloggers to Truman's op-ed was swift and predictable. He was ridiculed as espousing the "dumbest idea we have ever heard" by zerohedge.com. Others were simply incredulous and assumed that Truman must have wandered onto the FT op-ed pages after decades alone on a deserted island. While I might not disagree with zerohedge, there is one problem with this response. Ted Truman is not a nobody. He's one of the most seasoned, experienced and highly respected international monetary experts in the world. His academic, government, scholarly and think-tank credentials are nonpareil. He speaks to finance ministers, sovereign wealth funds, IMF officials, and Wall Street CEO's on a daily basis. Importantly, he was a staff economist to the FOMC. I have personally worked with many of his colleagues at the Peterson Institute on matters relating to international finance and national security and they are uniformly of the highest intellectual calibre and operate with a truly warm and collegial demeanor.

And that is the point. Ted Truman is not a fringe figure or a minor intellectual; he is a giant in the field. He is not just close to the establishment. He is the establishment. An op-ed by Truman appearing one day after the IMF semi-annual meeting ended with no effective solutions on the currency wars is no coincidence. It is a metaphorical Message to Garcia, to the gold insurgents, from the President and the powers that be. It is price suppression without having to engage in actual sales. It is a warning to gold bugs that they may get crushed. It is meant to induce fear into those newly interested in gold that it's a rough game with no holds barred. It is a show of bravado by the fiat money crowd. But it is also a sign of desperation; the last gasp of the ancien régime of fiat money. If a smart guy like Ted Truman is reduced to the old canard about gold being good only for hanging around your neck, then what else is there to say? The intellectual opponents of gold are now as exhausted as the mines.

Follow Jim Rickards on Twitter at twitter.com/JamesGRickards

As long as we have the mainstream with this type of elitist attitude towards gold, there is ample room for price appreciation. This debate is far from over, stay tuned for updates and developments. The only question is, will events in the market place overtake the policy debate?

Fed's Bizarre Tactics Target Weaker Dollar


By Axel Merk, Portfolio Manager, Merk Mutual Funds

Is the Federal Reserve (Fed) experiencing a midlife crisis? Ever since Fed Chairman Bernanke gave a speech in Jackson Hole, Fed behavior can be summarized as, well, bizarre. According to Bernanke, the market's inflation expectations may be too low. He considers three possible remedies:
  • Conducting additional purchases of longer-term securities (quantitative easing);
  • Modifying the Committee's communication;
  • Reducing the interest paid on excess reserves.

Here's the problem with quantitative easing: even many on the Fed's Open Market Committee (FOMC) doubt it will necessarily boost economic growth. What types of projects promoting economic activity will be initiated when extremely low interest rates are lowered further? One might argue that the problems faced by the economy is not that interest rates are too high, but that real estate prices have still not adjusted downward sufficiently. Instead of downsizing to homes mortgage holders can afford, consumers are subsidized to stay in their homes; there's no difference between subsidizing an ailing industry or an ailing consumer: subsidies are expensive and cause a drag on economic activity. However, given that the "downsizing" implies foreclosures and bankruptcies, it's political suicide to promote what may be most prudent for the economy as a whole.

Aside from having little effectiveness, quantitative easing also brings about substantial risks. For one, should the Fed indeed buy $100 billion in government bonds each month as is rumored, the Fed would be implicitly financing new issuance of government debt by printing money ("monetizing the debt"). For those not aware, when the Fed buys $100 billion in government bonds, it literally creates money out of thin air. All that is necessary to buy the bonds is an accounting entry on the Federal Reserve's books: a credit of U.S. dollars that the institution that sold the bonds now has a claim on. This "claim" may be exchanged for other goods and services where U.S. dollars are accepted; at the Fed, however, the "claim" may only be exchanged for a piece of paper confirming the claim.

A major challenge with the Fed buying bonds is that the bond market is so enormous that the Fed is just one of many participants. $100 billion a month in purchases may not move the markets as desired, should market forces disagree with the Fed. This is why Bernanke has stated his second "remedy": communication. In our assessment, the cheapest Fed policy is one where a Fed official utters a few words and the markets move. The trouble is that since the onset of the financial crisis, with the Fed has had to employ much more than simple words: rates cuts were followed with emergency rate cuts in early 2008; these were followed with credit easing, then a mortgage backed security (MBS) purchase program in excess of $1 trillion; not to be outdone, the Fed is signaling that quantitative easing is to follow. Still, the Fed appears to be working hard to prepare the market through a blizzard of speeches by Fed officials. After all, if interest rates move based on a few well-timed speeches, a couple hundred billion dollars may not need to be printed; or so the thinking seems to be.

There's also another avenue; positioned as a joke, it is all but funny: in his Jackson Hole speech, Bernanke suggested that in an environment where inflation expectations are too low, should the public reduce its confidence in the Fed, the resulting increase in inflation expectations could become a "benefit". Since those comments, we have had a number of Fed officials make the case for quantitative easing. In the past, Fed policy was conducted at FOMC meetings; in the current environment, every avenue appears convenient to tell the public the market better price in higher inflation expectations. A secondary goal of such a communication frenzy may be to steamroll over dissenting voices at the Fed.

In our view, the Fed knows quantitative easing may not be all that effective. We happen to think that the risks of quantitative easing outweigh the benefits, but we don't think the Fed necessarily thinks the benefits are all that great. The challenges we are facing must be addressed by politics, not monetary policy. Homeowners must be allowed to downsize; we must have a tax and spending policy that is sustainable and encourages investment. Sprinkling money on the problems only encourages that the can is kicked down the road, making the problems all the more difficult to solve.

If the Fed believes quantitative easing may not be the silver bullet, why may it be pursued anyway? To just try printing another $1 trillion, hit blindly and hope that it stimulates something? Worry about the inflationary fallout later? No. In our analysis, Bernanke may have a different agenda: to intentionally weaken the U.S. dollar. When the Fed prints dollars to buy government bonds, two things happen:

  • Everything else equal, the supply of U.S. dollars increases, making the U.S. dollar less valuable versus other currencies;
  • Government bonds are intentionally over-valued as the Fed intervenes, making them less attractive to rational buyers. Rational buyers, domestic or foreign, are likely to look overseas for less manipulated returns.

Bernanke, unlike his predecessors, seeks the currency discussion. There are two dimensions he openly talks about:

  • Bernanke has testified in Congress that countries going off the gold standard during the Great Depression recovered from the Great Depression faster than those countries that held on to the gold standard longer. This is in line with discussions by economists surrounding trading purchasing power for employment. It's not the mandate of the Fed to intentionally destroy purchasing power, but currency devaluation is a tool employed by central banks to spur economic growth.
  • Bernanke has repeatedly argued that a weaker U.S. dollar is not necessarily inflationary. He points to past decades where a weaker dollar did not necessarily increase inflationary pressures.

If you combine those statements with the Fed's activities, it appears clear to us that Bernanke may not only be interested in a weaker U.S. dollar, but that he is actively working on engineering one. Unfortunately, we believe the benefits may prove elusive, while the risks are enormous:

  • A weaker dollar may not spur growth as intended. In the short-run, earnings of U.S. based exporters may benefit as foreign earnings translate to more U.S. dollars in a weak dollar environment. However, an advanced economy simply cannot compete on price; the day the U.S. exports sneakers to Vietnam may be the day I see a pig fly past my window. Instead, a strong currency is an incentive for an economy to adjust to more value added goods and services with more pricing power; that incentive is missing when a weak dollar is pursued, eroding long-term competitiveness in exchange for perceived short-term gains.
  • A weaker dollar may indeed be inflationary. Foreign exporters to the U.S. have an incentive to absorb the higher cost of doing business that results from a weak dollar through lower margins. However, there is only so much foreigners can absorb; profit margins in Asia are often razor thin. Chinese policy makers have been pointing to this challenge as a reason for taking their time in allowing the Chinese yuan to appreciate. However, when pushed, China and other Asian exporters will have to pass on the higher cost of doing business (less competitive exporters may go out of business). We saw this in the spring of 2008: at the time, it was not just the price of oil that soared to well over $100 a barrel; there were stories in New York of how dry cleaners had to pay twice as much for simple items such as coat hangers. The reason: there was no domestic producer that could jump in to keep prices lower. Asian exporters may have more pricing power than the statisticians at the Federal Reserve may recognize.

Because we believe Bernanke considers the U.S. dollar a monetary policy tool, we have also been far more optimistic on the euro than many others. Conventional wisdom has many believe that economic growth is the key to a strong currency; however, our analysis shows that this mostly applies to countries with current account deficits, such as the U.S. In the U.S., foreigners are more inclined to invest when there are prospects for economic growth, and thus help to finance the current account deficit. Conversely, a country that finances its deficits domestically does not necessarily need economic growth to have a strong currency. Japan is a good example of this. Similarly, the eurozone does not have a significant current account deficit. The eurozone may have disappointing economic growth on the backdrop of a strong currency, simply because the European Central Bank (ECB) shows more restraint, printing less money than the Fed; on the fiscal side, austerity measures may also lead to a strong currency in the absence of a significant current account deficit.