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Monday, October 29, 2012

Friday, October 26, 2012

The Tragedy of the European Union and How to Resolve It

 by George Soros New York Review of Books

Preface: In a fast-moving situation, significant changes have occurred since this article went to press. On August 1, as I write below, Bundesbank President Jens Weidmann objected to the assertion by Mario Draghi, the president of the European Central Bank, that the ECB will “do whatever it takes to preserve the euro as a stable currency.” Weidmann emphasized the statutory limitation on the powers of the ECB. Since this article was published, however, it has become clear that Chancellor Merkel has sided with Draghi, leaving Weidmann isolated on the board of the ECB.
This was a game-changing event. It committed Germany to the preservation of the euro. President Draghi has taken full advantage of this opportunity. He promised unlimited purchases of the government bonds of debtor countries up to three years in maturity provided they reached an agreement with the European Financial Stability Facility and put themselves under the supervision of the Troika—the executive committee of the European Union, the European Central Bank, and the International Monetary Fund.
The euro crisis has entered a new phase. The continued survival of the euro is assured but the future shape of the European Union will be determined by the political decisions the member states will have to take during the next year or so. The alternatives are extensively analyzed in the article that follows.

I have been a fervent supporter of the European Union as the embodiment of an open society – a voluntary association of equal states that surrendered part of their sovereignty for the common good. The euro crisis is now turning the European Union into something fundamentally different. The member countries are divided into two classes – creditors and debtors – with the creditors in charge, Germany foremost among them. Under current policies debtor countries pay substantial risk premiums for financing their government debt and this is reflected in their cost of financing in general. This has pushed the debtor countries into depression and put them at a substantial competitive disadvantage that threatens to become permanent.

Thursday, October 25, 2012

Extraordinary Popular Delusions And The Madness Of Markets

Whether its new-fangled Japanese stocks, hi-tech internet company valuations, multi-colored flowers, or mansions made affordable by criminally lax lending standards, Grant Williams notes that a bubble is a bubble is a bubble; and citing Stein's Law: "If something cannot go on forever; it will stop." In this excellent summary of all things currently (and historically) bubblicious - whether greed-driven or fear-driven - Williams concludes it is never different this time as he addresses the four phases of the classic bubble-wave: smart-money, awareness, mania, blow-off (or crash) and explains how government bonds are set to burst and gold is only just about to enter its mania phase. This far-reaching and entirely accessible presentation is stunning in its clarity and as he notes, while bubbles are always easy to spot ex-ante, understanding how they come about and why they are popped gives the few an opportunity to profit at the expense of the madness of crowds. From tulips to tech-wrecks, and from inflation to insatiable stimulus, the bubble in 'safe-haven flows' that currently exists has all the characteristics of a popular delusion.

Wednesday, October 24, 2012

Currency Wars Simulation

This short video presents a variety of hypothetical scenarios which would have significant effects on currencies and commodities. See how a geopolitical or black-swan event could give real asset investors a tremendous advantage

Is Financial Crime A Systemic Risk?

By Ron Hera - Hera Research

Famed Austrian economist Ludwig von Mises wrote in his seminal work, Human Action (originally published by the Yale University Press in 1949), that “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” The collapse of a historic credit bubble occurred in 2008. However, despite years of further credit expansion, “a final and total catastrophe” of the U.S. dollar system has yet to occur.

While an inflationary U.S. monetary policy has serious consequences, Hyperinflation is not an immediate result. There are three general ways in which the U.S. dollar system could break down: (1) rejection of the U.S. dollar as the world reserve currency, or (2) as an eventual consequence of U.S. federal government insolvency and (3) a domestic failure of confidence. Of the three, U.S. federal government insolvency is the most serious because it would result in both the loss of the U.S. dollar’s world reserve currency status and also in a failure of domestic confidence. However, a new threat to the U.S. dollar has emerged which could trigger a hyperinflationary collapse before the U.S. federal government’s finances become unworkable, e.g., when debt service begins to crowd out military and Social Security spending. Specifically, the perceived legitimacy of the U.S. financial system has not merely been tarnished by recent scandals but is in danger of collapsing. The consequences of a domestic breakdown of confidence and trust in the U.S. financial system cannot be overstated.

World Reserve Currency Status

The most commonly cited challenge to the U.S. dollar system relates to its waning status as the world reserve currency. The BRIC countries (Brazil, Russia, India and China), along with South Africa, no longer use the U.S. dollar for trade settlement amongst one another. The Chinese have internationalized the renminbi (RMB), which is now used in trade settlement with the other BRIC countries, as well as with Australia, Japan, the United Arab Emirates (UAE), Iran and various South American and African countries under bilateral agreements. Iran, which is the world’s 4th largest oil exporter, has refused to accept U.S. dollars in exchange for crude oil since 2009.

Tuesday, October 23, 2012

Japanese Government Demands BOJ Do QE 9 One Month After Failed QE 8

Tyler Durden

 Almost exactly a month ago, the BOJ surprised most analysts with an unexpected increase in its asset purchase agreement by JPY10 trillion bringing the total to JPY80 trillion. There was one small problem though: the entire impact of the additional easing fizzled in under half a day, or 9 hours to be precise. This was, as Art Cashin summarized the following day, Japan's failed QE 8. It is now a month later, and with nothing changed in the global race to debase status quo, the time has come for the BOJ to attempt QE 9. Or that's the case at least according to the toothless Japanese government, which has formally demanded that Shirakawa do a nine-peat of what has been a flawed policy response for over 30 years now, this time with another JPY 20 trillion, or double the last month's intervention. Because according to Japanese Senkei, it is now Japan's turn to pull a Chuck Schumer and demand even mor-er eternity-er QE out of monetary authority of the endlessly deflating country. In reverting to the Moore's law of failed monetarism, we expect that a QE 9 out of Japan will have the same halflife as QE 8, if indeed the program size is double the last. At which point it will again fizzle.
From Senkei via Bloomberg:
  • Govt. is asking Bank of Japan to increase its asset-purchase program by 20t yen, Sankei reports, citing an unnamed government official.
  • Program would be increased to 100t yen from current 80t yen: Sankei
  • Increased fund likely to be used to purchase long-term JGBs, ETFs and J-Reits: Sankei
  • BOJ is expected to lower economic growth, inflation forecasts in an economic report due Oct. 30: Sankei
In other words, "Get to work, Shirakawa-san." One of these days the trillions and trillions in new fiat injected will actually "work"- at that point Japan will look back at its days of deflation as a fond memory when living through the alternative.
But at least nobody pretends anywhere, anymore that the central bank of a country is apolitical: neither the ECB, which is openly using its various monetary programs to finance insolvent countries, nor the Fed, which is buying up all gross Treasury issuance longer than 10 Years, and now the BOJ, which is openly taking requests from politicians who are totally helpless to do anything to the Japanese economy on their own.
The good news is that the Keynesian singularity, where QE XYZ+1 has to take place every nanosecond just to keep the world in one place (courtesy of the magic of a closed fiat loop in which devaluation is always relative to everyone else, and is limited only by the speed of the central printer and toner inventory), is getting ever closer and closer...

Monday, October 22, 2012

U.S. to Get Downgraded Amid Fiscal ‘Theater,’ Pimco Says


The sovereign credit rating of the U.S. will be cut as “fiscal theater” plays out in the world’s biggest economy, according to Pacific Investment Management Co., which runs the world’s largest bond fund. 

“The U.S. will get downgraded, it’s a question of when,” Scott Mather, Pimco’s head of global portfolio management, said today in Wellington. “It depends on what the end of the year looks like, but it could be fairly soon after that.”
The Congressional Budget Office has warned the U.S. economy will fall into recession if $600 billion of government spending cuts and tax increases take place at the start of 2013. Financial markets are complacent about whether the White House and Congress will reach agreement on deferring the so-called fiscal drag on the economy until later next year, Mather said.
In a “base case” of President Barack Obama being re- elected and Congress becoming more Republican, there is a high likelihood an agreement “doesn’t happen in a nice way, and we have disruption in the marketplace,” he said.
Policy makers probably will agree on cutbacks that would lower economic growth by about 1.5 percentage points next year, Mather said. They may roil markets by discussing scenarios that would lead to a 4.5 percentage-point fiscal drag, he said.

‘Budgetary Meth’

Bill Gross, manager of Pimco’s $278 billion Total Return Fund, this month said that the U.S. will no longer be the first destination of global capital in search of safe returns unless fiscal spending and debt growth slows, saying the nation “frequently pleasures itself with budgetary crystal meth.” He reduced his holdings of Treasuries for a third consecutive month to the lowest level since last October.
S&P last week cut Spain’s debt rating to BBB-, the lowest investment grade, and placed it on negative outlook.
“Almost all sovereigns with poor debt dynamics are going to get downgraded, we’re just talking about the pace,” Mather said. Credit rating companies “have been slow in downgrading some sovereigns, but we think the pace probably picks up in the year ahead.”
Bond investors needn’t worry that a rating cut will hurt returns. About half the time, government bond yields move in the opposite direction suggested by new ratings, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back to 1974.

Sunday, October 21, 2012

Can Government Create Opportunity?

by James E. Miller

 Last year, the Boston branch of the Federal Reserve put out a working paper which contained detailed data on the declining trend of economic mobility in the United States.  According to the paper, the percentage of Americans who reside in the lowest income quintile and move up either to the middle quintile or higher has been in decline over the past three decades.  This statistic should be alarming as it is indicative of stagnation within an economy that supposedly fosters the entrepreneurial spirit.  Without the opportunity to create and deliver things which enhance the lives of others, society as a whole ends up being denied the work of the most constructive members. To some, it has meant that government at all levels is doing an inadequate job in addressing what appears to be a growing divide between the haves and have-nots.  Calls for higher taxes to pay for programs and schemes of redistribution which would enable the less-fortunate in following their ambitions usually follow.
It is standard fare for pro-government advocates to defend the notion that the state exists to create opportunities for the people.  In first presidential debate between U.S. President Barack Obama and challenger Mitt Romney, Obama articulated his belief that the federal government should “create ladders of opportunity” as well as “create frameworks where the American people can succeed.”  The president is not alone as economist and leading voice of progressivism Paul Krugman expressed his dismay in his New York Times column over Washington’s failure to create “equal opportunity.”
Conventional examples of government-created opportunities include cheap college loans, public education, small business loans, land grants for universities, housing for those on low-income, and an array of infrastructure projects meant to facilitate transportation.  Proponents of these measures see them as a necessary springboard for social mobility; that without these resources, the downtrodden would forever remain in a state of destitution.

Gold to $10,000 - Never say never

 by  Lawrence Williams
source :
A remark on another website by Mark O'Byrne caught my eye - "Longer term, respected analysts are calling for gold prices above $5,000/oz and much higher forecasted prices such as between $5,000 and $10,000 per ounce are not raising eyebrows as much as they have in the past." Indeed with even many of the ultra-conservative bank and fund analysts suggesting that gold will reach $2,000 or even higher within the next year, or even the next few months, certainly $5,000 or even $10,000 should not seem out of sight in some unspecified timeframe."
If one tracks the price of gold during its current bull run it has risen around 600 percent in 13 years - at the same pace of increase it could thus reach $12,250 in another 13 years - or by some time in 2025! Thus is it ridiculous to suggest that this huge valuation on an ounce of gold is achievable? Never say never! When I started managing and writing for Mineweb back in 2006 even $1,000 looked completely out of sight and people like Rob McEwen who then were predicting that level were perhaps considered at the extreme end of the spectrum. Yet within 3 years the $1,000 level was achieved and now it is a further 75% higher than that a further three years on. Nowadays, McEwen is predicting $5,000 gold - should that still be considered over extreme?

Is deflation a major threat to the eurozone?

By Dr Frank Shostak

In its October 2012 World Economic Outlook report the International Monetary Fund (IMF) said that the European Central Bank (ECB) should keep interest rates low for the foreseeable future and may need to cut them further given the risk of deflation.
Now, even if the IMF is correct and prices in the Euro-zone will start falling, why this is so bad?
The conventional wisdom holds that price deflation causes people to postpone their buying of goods and services at present on the belief that the prices of these goods and services will be much lower in the future.
Hence why buy today if one can buy the same good at a bargain price in the future? As a result a fall in consumer outlays via the famous multiplier will lead to a large decline in the economy’s rate of growth.
In fact deflation could set in motion a vicious downward spiral, which could plunge the economy in a severe economic slump similar to the one that took place during the Great Depression of the 1930’s, or so it is held by most experts.
It is for this reason that the IMF is of the view that the ECB should push the policy interest rate further down.
Now, if deflation leads to an economic slump then policies that reverse deflation should be good for the economy.

We're Headed For An Economic Black Hole

by Jhon Mauldin

"Concern about politics and the processes of international co-operation is warranted but the best one can hope for from politics in any country is that it will drive rational responses to serious problems. If there is no consensus on the causes or solutions to serious problems, it is unreasonable to ask a political system to implement forceful actions in a sustained way. Unfortunately, this is to an important extent the case with respect to current economic difficulties, especially in the industrial world.

"While there is agreement on the need for more growth and job creation in the short run and on containing the accumulation of debt in the long run, there are deep differences of opinion both within and across countries as to how this can be accomplished.

What might be labelled the 'orthodox view' attributes much of our current difficulty to excess borrowing by the public and private sectors, emphasises the need to contain debt, puts a premium on credibly austere fiscal and monetary policies, and stresses the need for long-term structural measures rather than short-term demand-oriented steps to promote growth.
"The alternative 'demand support view' also recognises the need to contain debt accumulation and avoid high inflation, but it pushes for steps to increase demand in the short run as a means of jump-starting economic growth and setting off a virtuous circle in which income growth, job creation and financial strengthening are mutually reinforcing. International economic dialogue has vacillated between these two viewpoints in recent years."

– Lawrence Summers, The Financial Times, October 14, 2012

Two Reasons Why the Gold Market is Under Pressure


There are two reasons why the price of gold has been under pressure in the last few days. One of them is legitimate; while the other is completely without grounds.

  1. The U.S. Labor Department announced on Thursday that Initial Jobless Claims fell 30k for the week ending October 6th. The plunge took first-time claims for unemployment insurance to a four-year low. Despite the fact that this drop was mainly produced by one large state not properly reporting additional quarterly claims, the gold market took the data as a sign interest rates may soon have to rise. So I thought it would be a good time to explain that rising interest rates would not negatively affect the price of gold, as long as it is a market-based reaction to inflation; rather than the work of the central bank pushing rates positive in real terms.
The price of gold increased from $100 an ounce in 1976, to $850 an ounce by 1980. During that same time period the Ten year note yield increased from 7% to 12.5%. The reason why gold increased, despite the fact that nominal interest rates were rising, is because real interest rates were falling throughout that time frame. Bureau of Labor statistics shows that inflation as measured by the Consumer Price Index jumped from 6% in 1976 to 14% by early 1980. In addition, the Fed, under Arthur Burns and G. William Miller, kept the Funds rate far below inflation throughout their tenure; increasing the interbank lending rate from 5% in 1976, to just 10.5% by late '79--just before Chairman Volcker took the helm.

If Romney Wins, Expect the End of Quantitative Easing

by Gary Dorsch - Sir Chart a lot

It’s been nearly eight years, since Fed chief Ben Bernanke told the Senate Banking Committee at his confirmation hearing, that “with respect to monetary policy, I will make continuity with the policies and policy strategies of the Greenspan Fed a top priority.” The former Princeton University professor who served as a Fed governor from August 2002 to June 2005 before accepting the post as President George W. Bush’s top economic adviser, also pledged, “I will be strictly independent of all political influences,” Bernanke said.

History will show that Bernanke did follow in the footsteps of his mentor for the first 3-½ years of his tenure. The infamous “Greenspan Put,” or the knee-jerk reaction by the Fed to rescue the stock market whenever risky bets went sour, - through massive injections of liquidity and reductions in interest rates, - was seamlessly replaced by the “Bernanke Put.” Since Bernanke gained control over the money spigots, the Fed continued to expand the MZM money supply by +65% to a record $11.3-trillion today. That’s an increase of about +9.4% per year, on average. The yellow metal never traded a nickel lower since Mr Bush tapped Bernanke to become the next Fed chief in Nov 2005, when the price of Gold was $468 /oz. Today, Gold is hovering around $1,735 /oz, up +370% for an annualized gain of +57%, - highlighting the most devastating blow to the purchasing power of the US-dollar of all-time.

Extreme Symptoms & Hidden Menace

by Jim Willie CB - Hat Trick Letter

Some competent analysts claim the United States and Western nations are stuck in the eye of the hurricane. Maybe so, but the internal stresses are so great that they will move beyond the eye into a zone of clearly apparent destruction soon. Some aware analysts believe the bond monetization plans will lift the financial markets. Maybe so, but the ensuing and continuing damage to the economies is profound from rising cost structures. Some awakening analysts no longer look to the USFed as a source of solutions. They see the central bank as increasingly desperate, pushing the same levers that accomplished nothing in the past. In fact, the failing central bank franchise system is visible in the open for all to see, with the embarrassment noticeable when the good chairman speaks as high priest of hollow dogma. New money backed by nothing swims around, financing the USGovt deficits, redeeming toxic bonds, adding nothing to the capital base. In the background is a pernicious effect, having come full circle. The Chinese industrial expansion since year 2000 came largely at the expense of the Western economies. They forfeited thousands of factories in the mindless pursuit of lower costs, while overlooking the abandoned wealth engines that produced legitimate income. In the last couple years, the Western economies have served as weakened customers for the Chinese production. The effect finally has slammed China, which complains of weaker US and European demand. Any trip through Spain will demonstrate that smaller Spanish factories and mills are shut down, with Chinese imports in replacement, as local shops stock mainly Chinese products.

We are on the road to serfdom

By Detlev Schlichter

We are now five years into the Great Fiat Money Endgame and our freedom is increasingly under attack from the state, liberty’s eternal enemy. It is true that by any realistic measure most states today are heading for bankruptcy. But it would be wrong to assume that ‘austerity’ policies must now lead to a diminishing of government influence and a shrinking of state power. The opposite is true: The state asserts itself more forcefully in the economy, and the political class feels licensed by the crisis to abandon whatever restraint it may have adhered to in the past. Ever more prices in financial markets are manipulated by the central banks, either directly or indirectly; and through legislation, regulation, and taxation the state takes more control of the employment of scarce means. An anti-wealth rhetoric is seeping back into political discourse everywhere and is setting the stage for more confiscation of wealth and income in the future.

War is the health of the state, and so is financial crisis, ironically even a crisis in government finances. As the democratic masses sense that their living standards are threatened, they authorize their governments to do “whatever it takes” to arrest the collapse, prop up asset prices, and to enforce some form of stability. The state is a gigantic hammer, and at times of uncertainty the public wants nothing more than seeing everything nailed to the floor. Saving the status quo and spreading the pain are the dominant political postulates today, and they will shape policy for years to come.

Unlimited fiat money is a political tool

A free society requires hard and apolitical money. But the reality today is that money is merely a political tool. Central banks around the world are getting ever bolder in using it to rig markets and manipulate asset prices. The results are evident: Equities are trading not far from historic highs, the bonds of reckless and clueless governments are trading at record low interest rates, and corporate debt is priced for perfection. While in the real economy the risks remain palpable and the financial sector on life support from the central banks, my friends in money management tell me that the biggest risk they have faced of late was the risk of not being bullish enough and missing the rallies. Welcome to Planet QE.

Gold vs Paper

by Ludwig von Mises

Most people take it for granted that the world will never return to the gold standard. The gold standard, they say, is as obsolete as the horse and buggy. The system of government-issued fiat money provides the treasury with the funds required for an open-handed spending policy that benefits everybody; it forces prices and wages up and the rate of interest down and thereby creates prosperity. It is a system that is here to stay.

Now whatever virtues one may ascribe — undeservedly — to the modern variety of the greenback standard, there is one thing that it certainly cannot achieve. It can never become a permanent, lasting system of monetary management. It can work only as long as people are not aware of the fact that the government plans to keep it.

The Alleged Blessings of Inflation

The alleged advantages that the champions of fiat money expect from the operation of the system they advocate are temporary only. An injection of a definite quantity of new money into the nation's economy starts a boom as it enhances prices. But once this new money has exhausted all its price-raising potentialities and all prices and wages are adjusted to the increased quantity of money in circulation, the stimulation it provided to business ceases.

Monday, October 15, 2012

Jim Rogers : Finance has failed several times in history

Jim Rogers : when i went to Wall Street in the sixties mostly it was backward nobody went to Wall Street , in the fifties sixties and seventies Wall Street was not important then we had a long bull market for thirty years it became extremely important , everybody got an MBA and everybody wanted top go to finance but that happens anytime in history for the first years of the twentieth century finance they were kings then we had the collapse of the thirties it became disastrous again until the eighties but it always worked this way , finance has failed several times in history , many times in history but everything has failed , everything goes to excess and collapses has a long period of bad period then it starts over , like agriculture ......

Sunday, October 14, 2012

Gold And Silver Capped Until After U.S. Election?

by Mark O'Byrne - Goldcore
source : 

Today’s AM fix was USD 1,767.00, EUR 1,362.80, and GBP 1,101.35 per ounce.
Yesterday’s AM fix was USD 1,767.25, EUR 1,371.45 and GBP 1,103.29 per ounce.
Silver is trading at $33.96/oz, €26.27/oz and £21.21/oz. Platinum is trading at $1,679.50/oz, palladium at $648.80/oz and rhodium at $1,205/oz.
Gold edged up $4.60 or 0.26% in New York yesterday which saw gold close at $1,767.50. Silver climbed to a high of $34.33 and then fell off and finished with a marginal loss of 0.12%.
Gold has seen volatile and choppy trading overnight in Asia and in Europe this morning with the price being capped at $1,772/oz and in a tight range between $1,767 and $1,772/oz.

Cross Currency Table – (Bloomberg)

Unthinkable Iceberg for Europe's Unsinkable Ship

by Adrian Ash
source :

BACK in 2009 when Barack Obama received the Nobel Peace Prize just nine months after becoming US president, he said he felt "surprised" and "deeply humbled".

No such shock and awe today for the European Union's unelected leaders, of course. Self-assurance and pride are now the EU's hallmarks, at least at the executive level. But its shiny new Nobel Peace Prize risks just the same historical irony.

"Mr. Obama decimated Al Qaeda's leadership," as Peter L.Bergen noted in the New York Times this spring. "He overthrew the Libyan dictator. He ramped up drone attacks in Pakistan, waged effective covert wars in Yemen and Somalia and authorized a threefold increase in the number of American troops in Afghanistan. He became the first president to authorize the assassination of a United States citizen, Anwar al-Awlaki...And, of course, Mr. Obama ordered and oversaw the Navy SEAL raid that killed Osama bin Laden."

QE Unlimited, China, and Depression 2.0

by Andy Sutton - Sutton & Associates
source : 

With the pop from the USFed’s latest attempt at financial shock and awe already seeping from lackluster markets, and the teleprompter news networks losing steam over their promotion of the same, it is time to take a look back at the decisions made on 9/13/2012 and set the record straight on some things.

QEunlimited is not going to save the US Economy.

Perhaps one of the biggest misconceptions about all this easing is that it is somehow going to help the economy. To stimulate it. To bring it out of recession (yes, we’re still in recession). None of these things happened with the first two, but there are some very good reasons it won’t happen with the third. And the truth is there is a much more gruesome component to this latest scam.

As I’ve outlined many times before in these pages, what happens when the USGovt or banks buy up toxic mortgage securities is that they’re buying the note on your house – along with thousands of other notes since they’ve all been bundled up. You signed on the dotted line with Bank of America for example, but now maybe the Chinese own your house. Or the Japanese. Or European bankers. Or the USGovt. So the fed creating another $40 billion (that they’re willing to admit) each month to buy more mortgages ought to be a pretty scary thing. Will they foreclose on you if you can’t make your payments?

China, Russia, and the End of the Petrodollar

by John Rubino - Dollar Collapse
source : 

Say you're an up-and-coming superpower wannabe with dreams of dominating your neighbors and intimidating everyone else. Your ambition is understandable; rising nations always join the "great game", both for their own enrichment and in defense against other big players.

But if you're Russia or China, there's something in your way: The old superpower, the US, has the world's reserve currency, which allows it to run an untouchable military empire basically for free, simply by creating otherwise-worthless pieces of paper and/or their electronic equivalent. Russia and China can't do that, and would see their currencies and by extension their economies collapse if they tried.

So before they can boot the US military out of Asia and Eastern Europe, they have to strip the dollar of its dominant role in world trade, especially of Middle Eastern oil. And that's exactly what they're trying to do. See this excerpt from an excellent longer piece by Economic Collapse Blog's Michael Snyder:

Can The Fed Ever Exit?

 by Tyler Durden
source :

We have extensively discussed the size (here - must read!) and growth (here) of the Fed's largesse in soaking up massive amounts of the primary and second Treasury (and now MBS) markets with the ongoing theme of 'what about the exit strategy?' among other things. The onset of QEternity likely means the Fed's balance sheet will grow to over $4 trillion within the next year and, as UBS notes, although the Fed has suggested that it will not begin an exit strategy until 2015, the magnitude of the excess balance sheet argues for considering whether the Fed has the ability to unwind their balance sheet. We, like UBS, believe that the Fed will find it far more difficult to exit than they have found it to enter given the limitations of the exit tools frequently cited. There are three main tools for reducing the Fed’s balance sheet: asset sales/maturation (bad signaling), reverse repurchase agreements (size constraints), and interest on reserves (inflationary).

Via UBS:
  • Asset sales/maturation. The portfolio shift to a longer average maturity means that the Fed is unable to reduce its balance sheet only by letting securities mature. There would be no material reduction until at least 2016 and even then the reduction would likely be under $250bn. Outright sales face a different problem – expectations. Unlike purchases where announcing a certain amount of purchases reinforces the Fed’s goal of lowering rates via expectations, any sales would likely result in the market pricing in a fully normalized balance sheet. As such, an initial sale program of just $200bn would not be credible as the expectation would be that the sale announcement signals a desire to return to normality requiring an addition $2.5tn in sales at some point.
  • Reverse repurchase agreements. This tool is swamped by the magnitude of the drain required. At present money fund assets are roughly $2.5 trillion, $200 billion less than the excess balance sheet we anticipate by the end of 2013. However, this statistic does not tell the full story as reverse repurchase agreements only make up just over 20% of money fund assets, or just $500 billion. The other primary counterparty the Fed would rely on, the Primary Dealer community, are unlikely to be able to participate in anything close to that size. While these figures do not prevent the Fed from using this tool, they do suggest it can only be a part of the overall solution.
  • Interest on reserves. Although interest on reserves theoretically creates a floor on rates in the interbank market, it does not prevent banks from using funds to make loans. Loans eventually end up as deposits somewhere and, as such, the overall level of deposits at the Fed provide little guidance as to whether the funds are circulating in the economy. The only way to prevent lending would be for the Fed to raise this rate sufficiently to make banks prefer depositing the money at the Fed to lending to their client base.
QE3 and QE4, if enacted and continued until the end of 2013, will leave the Fed with excess balance sheet of roughly $2.7 trillion.

The ECB-Driven Toxic Debt Loop At The Heart Of Europe's Misery


Just as we will not tire of pointing out the unintended consequence of the Fed's central-planning efforts, so it is time, courtesy of the IMF's latest missive, to point out the vicious circle that the ECB has created and encouraged in Europe. The unintended consequence of the ECB's intervention - as both perpetual backstop and lender of last resort - has created an ever-increasing fragmentation between the core and the periphery (exactly the supposed 'issue' Draghi is attempting to fix with his OMT). The toxic-debt-loop as capital leaves the periphery for the core, pressuring peripheral bond yields/spreads, and forcing private sector borrowing to be replaced by public-sector not only clouds the true picture for real-money investors or depositors (risk-based pricing has been destroyed) but encourages front-running fast-money flows which do nothing but provide short-term cover for banks/sovereigns to delay the inevitable (and potential market-clearing) deleveraging/restructuring that is required. Because the fundamental issue is one of solvency - not liquidity - the ECB's continued artifice of plugging liquidity shortfalls does nothing but lessen the confidence in the system and reduce any faith in price levels as without addressing the real insolvency, trust will never return.

Europe's ECB-Driven Toxic Debt Loop...

The Inflation Monster

by By Ferdinand Dyck, Martin Hesse and Alexander Jung
source :

Part 1 : How Monetary Policy Threatens Savings

Germany's central bank, the Bundesbank, has established a museum devoted to money next to its headquarters in Frankfurt. It includes displays of Brutus coins from the Roman era to commemorate the murder of Julius Caesar, as well as a 14th-century Chinese kuan banknote. There is one central message that the country's monetary watchdogs seek to convey with the exhibit: Only stable money is good money. And confidence is needed in order to create that good money.

The confidence of visitors, however, is seriously shaken in the museum shop, just before the exit, where, for €8.95 ($11.65) they can buy a quarter of a million euros, shredded into tiny pieces and sealed into plastic. It's meant as a gag gift, but the sight of this stack of colorful bits of currency could lead some to arrive at a simple and disturbing conclusion: A banknote is essentially nothing more than a piece of printed paper.

It has been years since Germans harbored the kind of substantial doubts about the value of their currency that they have today in the midst of the debt crisis. A poll conducted in September by Faktenkontor, a consulting company, and the market research firm Toluna, found that one in four Germans is already trying to protect his or her assets from the threat of inflation by investing in material assets, for example. 

No Currencies Will Survive What Lies Ahead, But That’s OK

by Robert Fitzwilson
source : 

October 19, 1987 was a shocking day as the U.S. stock market declined by a stomach churning 23 percent in that one session. It is impossible to convey the sense of desperation, on that day, felt by anyone whose savings or livelihood was dependent upon the equity markets.

Most of the financial disasters since the early 1980s were caused by well meaning professors espousing new insights derived from their research. In the case of ’87, institutions were convinced to take a much higher allocation to equities. The research showed that if a problem ensued, the institutions could simply sell a futures contract, thereby immunizing their portfolio’s exposure to the effects of any subsequent decline. It worked great in their computer simulations.

 The markets began to roll over on the preceding Friday....

“It started with Hong Kong. In those days, Hong Kong was seen as a source of emergency liquidity by institutions, and their stock market was hit very hard. As the declines reverberated around the world, the losses arrived in New York on Monday.

Unfortunately, futures traders are a smart lot. When the institutions implemented the protection phase of the professor’s plan and went to sell the futures contract, the traders on those exchanges balked. This was the fatal flaw in the hedging plan put forward by the academics. A computer would always buy the futures contract. The brokers would not.

What ensued was full-scale panic. Prices for the bluest of blue chip stocks plummeted. Orders could not be filled as the exchanges were swamped.

Being a specialist at the NYSE was a very good thing. Seats on the Exchange were often passed down from generation to generation. One of the obligations, however, was to provide temporary liquidity to the issues for which you were responsible if you could not immediately match a trade with a specific buyer and seller. That was the safety valve at the Exchange.

Ultimately, the specialist’s ability to buffer significant declines was backed up by bank loans. As the panic unfolded, the banks pulled the loans. What saved the day was Alan Greenspan telling the banks that they would make whatever loans were necessary to maintain the solvency of the specialists, and therefore the Exchange itself. It worked.

Was the government engaged in intervention and manipulation? Absolutely. Was there anyone who was not thrilled at having our money, savings and careers bailed out? Not a one.

For the next 13 years, the government stepped in time and time again to bail out markets which were once again corrupted with the professor’s well intended, but completely devoid of reality, schemes. The last one of the 1990’s was the Long-Term Capital debacle that probably could have brought down the global financial system a decade before the sub-prime mess.

Central bankers had become the financial fire department. Up until the early 2000’s, it was seen as a good thing. Alan Greenspan became a personality, not the head of the Federal Reserve. Investors and the government officials celebrated each and every word he spoke at his periodic testimonies. Taking excessive risk was not a problem. The Fed would make everything right.

The chart below juxtaposes the various forms of quantitative easing, known as QE, since the current crisis became out of control in late 2008.

As you can see, QE1 was more of the 1987 type. Wall Street, the politicians and the professors had once again gotten us into a monumental mess. While few were happy with the implication for deficits due the printing of fiat money, the $20+ trillion in global spending was seen as being rescued, akin to the 1987 experience. Cash came out of Treasuries and markets correctly anticipated the inflationary effects of spending and printing such sums and interest rates rose.

At the end of QE1, fear returned that we were headed to a severe recession. Interest rates declined as expected. People were looking for what traditionally was a safe haven, Treasury bonds. When QE2 was announced, a side effect was rising rates, as markets anticipated higher inflation and money was shifted out of Treasuries and into equities.

Europe then imploded. China began to weaken. More ‘stimulus’ and printing was needed we were told. However, a curious thing happened, interest rates have since plummeted. To an extent, it was a flight to perceived safety. Operation Twist and now QE3 are about wrestling interest rates to the ground. This is what has happened. The key function of price discovery through free markets no longer exists. Government policy now chooses winners and losers, at least for the time being.

Somewhere along the line, central banks transitioned from being safety nets to market manipulation. The central banks are taking us into waters that are unchartered in our lifetimes. But I would remind KWN readers that others have done this in the past with unpleasant endings.

We can only hope for the best. At the same time, it is imperative to switch out of paper-based assets into real assets such as gold, silver and well-located real estate. Along the way, various currencies will become the safe haven of the day, but none will survive what lies ahead. We are living in an Entitlement Bubble along the lines of the Dutch Tulip Bubble in the 1600s. No amount of printing or economic growth can prevent our destiny of currency destruction and entitlement collapse.”

Global Debt Over $200 Trillion, Gold Demand Surges

 by Today Egon von Greyerz 
 source :

 US deficits are set to continue to rise, no matter who wins the election. This means a great deal more money printing. Right now the US has $40 billion per month of QE in the form of buying mortgage-backed securities, and with ‘Twist’ another $45 billion. But you have to also add the $145 billion monthly budget deficit.”
“Right now the US deficit is running at roughly $1.5 trillion per year. So in total, the US is already printing $200 billion each month, and that will of course increase. The US debt is up $10 trillion in ten years. As revenues decline and expenditures increase, the pressures on the US economy will be enormous, and the deficit will increase substantially.
In a couple of years time, we will have $20 trillion, at least, of US debt....
“$20 trillion of US debt, think about that for a moment. US tax revenue is now around $2.3 trillion. If you examine $20 trillion of debt, and factor in a dramatic increase in interest rates in coming years, as money is printed and inflation enters the picture, an interest rate of 12% is very likely.
Take 12% of $20 trillion and you get $2.4 trillion per year just in interest. That figure is more than the current tax revenue of $2.3 trillion. So the US will reach a point, in the not too distant future, where the total debt servicing will be equal to the total tax revenue. That is of course unsustainable.
If you look at global debt, in the last ten years it is up from $80 trillion, to $200 trillion. These are figures which are hard to comprehend. Global debt has increased $120 trillion in just ten years. So when you look at the so-called prosperity of the world, it is all based on debt. So it is all an illusion.
Central bank balance sheets are also exploding. They have increased 16%, compounded, per annum. What are the central banks doing? Just like the Fed, they are buying toxic debt which has zero value. What are they doing to buy that? They are printing worthless pieces of paper, they call it ‘money,’ and with that ‘money’ they are buying another worthless piece of paper which they call an ‘asset.’
So it is the most massive Ponzi scheme the world has ever seen, and this will clearly end in total disaster. It will end with the implosion of debt and the implosion of assets. But before that, we will have hyperinflation. As governments continue to print, we will have hyperinflation.
Hyperinflation comes from a collapsing currency. Take Iran, that is a good example. Iran’s currency is now down 70%, and inflation is now estimated to be running at 50% per month. This is what we will see all over the Western world in coming years. I’m absolutely certain about that.”
Greyerz had this to say regarding gold: “So we are holding gold to preserve wealth because gold is the ultimate way of protecting your assets from total destruction as a result of the money printing. Because the financial system is bankrupt and governments are bankrupt, any asset that you hold within that system is at risk.
This is why you have to have physical gold and you must store it outside of the banking system. Eric Sprott came out with a superb report detailing the official figures we are seeing regarding production and purchases of gold. His conclusion, quite correctly, was that they are not telling the truth in those official reports being published.
He (Sprott) is looking at an annual deficit of 2,500 to 2,600 tons of gold. I have talked about this many times, and Eric puts it superbly in his report, that the 30,000 tons which central banks are holding in gold reserves, with the Western central banks holding about 23,000 tons of that gold, are probably not there.
When that becomes apparent, there will be panic in the gold market because nobody will hold paper gold anymore. It means that Western governments do not have adequate amounts of gold to back their money.”
Greyerz also added: “I would also note, Eric, that some of the refiners we are talking to, they are seeing business strongly increasing now, and in this environment they are actually increasing their margins and prices. So there is clearly an increase in short-term demand. This is why, up to now, the paper shorts in the gold market have been struggling to bring the price down.”

Tuesday, October 9, 2012

The Austrian Theory of the Trade Cycle

Compiled by Richard M. Ebeling
The Austrian Theory of the Trade Cycle
Ludwig von Mises source :

Nowadays it is usual in economics to talk about the Austrian theory of the trade cycle. This description is extremely flattering for us Austrian economists, and we greatly appreciate the honor thereby given us. Like all other scientific contributions, however, the modern theory of economic crises is not the work of one nation. As with the other elements of our present economic knowledge, this approach is the result of the mutual collaboration of the economists of all countries.
The monetary explanation of the trade cycle is not entirely new. The English "Currency School" has already tried to explain the boom by the extension of credit resulting from the issue of bank notes without metallic backing. Nevertheless, this school did not see that bank accounts which could be drawn upon at any time by means of checks, that is to say, current accounts, play exactly the same role in the extension of credit as bank notes. Consequently the expansion of credit can result not only from the excessive issue of bank notes but also from the opening of excessive current accounts.

The Destruction Of Currency And Rise Of Gold

by Nick Barisheff 
source :

Today’s discussion is based on the primary trend that started at the beginning of this millennium. The fundamental shift that has been taking place since then was the creation of value through paper assets shifting in a gradual way to hard assets, primarily (but not only) gold and silver. Part of the current ongoing dollar devaluation is caused by this disparity between financial assets and gold. Nick Barisheff gave with these rounded numbers to create a high level picture of the scale of the paper asset market versus gold. The market for financial assets should be worth approximately $250 trillion. It includes mortgage bonds, equities, treasury bills and related financial instruments. It contains pure paper assets and does not include real estate or derivatives. Against that $250 trillion stands a nominal value of the gold market of around $4 trillion.

Monday, October 8, 2012

Fraud, Why The Great Recession Happened

"Fraud. Why The Great Recession Happened" is a crowdfunded documentary.

The Great Recession has not been fault of the free market. On the contrary, it´s origin should be sought for in the State´s and central bank´s deep intervention in the economy, causing in a fraudulent way, recurrent cycles of artificial expansion, the" bubble effect" and economic recession that all citizens end up paying for.The great depression is what happens when the government sticks their hands in everyone's business. How come we still haven't learned? America was created to have less government control. and it worked amazingly. Then Roosevelt stuck his hands into everything and we spent twelve years with 25% unemployment. But we continue to try it that way.So many people are dependent on the government giving them money. What is going to happen when they run out of other peoples money to give?

Finally, the root of the Great Recession is found at the end of WW2 when were created World Bank, and first and foremost IMF. Illuminati, the majority of them being bankers, have planned since more than two hundred years ago these events (1773), and mainly IMF, next with the Hebrew Banks, had and have a vital role in today's global depression and into the enslavement of the populations of the world in these huge debts. Their final goal is a new economic, social, politic, cultural order obtained through a war: WW3 or "The Final Social Cataclism".

Determining the value of gold


When considering whether gold is a value investment, one needs to first recognise that gold does not have a balance sheet, management team, price-earnings ratio or any of the other things one needs to analyse before making an investment. Also, gold does not generate any cash flow, so it does not pay a dividend. We can therefore conclude from these observations that gold is not an investment. Indeed, it is something different, which means that normal investment analytical techniques cannot be used to determine gold’s value.

Value of course arises from an item’s usefulness, and gold is useful because it is money. Though only used as currency these days in a few places like Turkey and Vietnam, gold is still useful in economic calculation, or in other words, measuring the price of goods and services.

For example, when the Maastricht Treaty was signed in February 1992, one barrel of crude oil cost $19.00, €15.95 (Dm 31.30) or 1.67 goldgrams. Now it costs $91.79, €71.27 or 1.61 goldgrams, which makes clear that not only is gold useful in communicating prices, it preserves purchasing power. Gold has been useful in these ways for over 5,000 years, so it is logical to assume that gold will remain useful for the foreseeable future.

Have you seen Robert Triffin?

 By Joe Yasinski and Dan Flynn 
source : bullioninternational

"It was the outcome of an unbelievable collective mistake, which, when people become aware of it, will be viewed by history as an object of astonishment and scandal"  - Jaques Reuff 1972 .

The obscure Belgian economist Robert Triffin is not only very dead he also isn't exactly a household name, yet. Triffin, who died in 1993 studied at Harvard, taught at Yale, worked at the Federal Reserve, the IMF, and was a key contributor to the formation of the European monetary system. Triffin exposed serious flaws in the Bretton Woods monetary system and perfectly predicted it's inevitable demise yet his work remains largely ignored and unstudied by today's mainstream economists. This "flaw" became known as the Triffin dilemma, and many believe Triffin's dilemma has as serious implications today as it did 50 years ago. In short, Triffin proposed that when one nations currency also becomes the worlds reserve asset, eventually domestic and international monetary objectives diverge. Have you ever wondered how it's possible that the USA has run a trade deficit for 37 consecutive years? Have you ever considered the consequences on the value of your Dollar denominated assets if it eventually becomes an unacceptable form of payment to our trading partners? Thankfully for those of us trying to navigate the current financial morass, Robert Triffin did. Prior to the 1944 Bretton Woods agreement, central banks used gold as the asset to back their currencies. By the end of World War II, the United States had established itself as the world's creditor and largest holders of gold. Under the 1944 Bretton Woods agreement, the US Dollar was fully backed by gold at a fixed value of 1/35th an ounce per dollar, and foreign Central Banks could use US Dollar assets as reserves backing their currency, in lieu of gold. This agreement avoided the inevitable deflationary pressure a return to pre-war gold/currency ratios would have forced just as Europe was beginning to rebuild, and allowed US debt held abroad to be used as an asset by central banks against their local currencies.

Sunday, October 7, 2012

The three Big Central Banks, the Japanese, the European and the Americans are all in the game and printing

Jim Rogers : "The central bank in Europe is getting in the party — everybody is in the party. The Chinese are not quite so much in the party as they were before but the three big central banks, the Japanese, the European and the Americans are all in the game and printing."
"Either the world economy is going to get better and commodities are going to go up because of shortages, or they are going to print more money, and throughout history when they printed a lot of money, you protect yourself by owning real assets."

- in NewsMax TV

Click Here to watch the full interview>>>>>

Jim Rogers started trading the stock market with $600 in 1968.In 1973 he formed the Quantum Fund with the legendary investor George Soros before retiring, a multi millionaire at the age of 37. Rogers and Soros helped steer the fund to a miraculous 4,200% return over the 10 year span of the fund while the S&P 500 returned just 47%.

To Tax Is to Destroy

The landmark Supreme Court decision McCulloch v. Maryland (1819) has had wide impact on the powers of the federal government. In fact, this decision, more than any other, is responsible for the incredible growth of federal authority throughout the years. Today, Washington has a tight grip on every aspect of our lives, and much of this federal intrusion is due to the "implied powers" doctrine that emanated from this court decision.
In the case, the clerk of the Bank of the United States, James McCulloch, brought action against the state of Maryland. In opposition to the national bank, Maryland had imposed a tax on the Bank of the United States — hoping to tax it out of existence. McCulloch took the position that such a tax was an unconstitutional interference with the activities of the federal government by a state — in this case Maryland. Therefore, McCulloch brought action to stop Maryland from taxing the national bank out of existence.
Pleading the case on behalf of McCulloch, the eminent jurist Daniel Webster argued that Maryland had no authority to tax the bank. The essence of his argument was quite simple: "An unlimited power to tax involves, necessarily, a power to destroy."
The court agreed. Speaking for a unanimous court, Chief Justice John Marshall echoed Webster's words. He wrote, "The power to tax implies the power to destroy. If the States may tax one instrument, may they not tax every other instrument…? This was not intended by the American people."
Consequently, with the help of these two highly esteemed jurists, we have conclusively settled a point of contention among many scholars — that the unlimited power to tax is the power to destroy, clear and simple. And without question, the government has an unlimited power in this respect.
Let us now examine some of the many ways in which the power to tax destroys.

The Fed and the ECB: Two Paths, One Goal

by Philipp Bagus
 Both the Federal Reserve (Fed) and the European Central Bank (ECB) are owners of the printing press. They produce base money. On top of the base-money production, the fractional-reserve-banking system can produce money out of thin air. Both central banks produce money in order to finance their respective governments. As a result of their money production, prices will be higher than they would have been otherwise. All money users indirectly pay for the government deficits through a reduction in purchasing power and the reduced quality of their money.Download PDF
While the ECB's and Fed's functions (to provide liquidity to the banking system in times of crisis and to finance the government together with the banking system) are the same, there exist small differences between them. In the so-called open-market operations (another term for active manipulation of the money supply) the central banks produce or destroy base money.
There are two ways central banks produce base money. By tradition, the Fed uses the produce-money-and-purchase approach (PMP). Normally, the Fed produces money in their computers and uses it to buy US Treasuries from the banking system. In exchange for the US Treasuries, the Fed creates money on the account that the selling bank holds at the Fed.
The ECB, in contrast, uses the produce-money-and-lend (PML) approach. It produces money and lends it to the banking system for one week or three months. The preferred collateral for these loans to banks is government bonds.[1] As a result of PMP and PML, banks receive new base money. They hold more reserves at their account at the central bank. The additional reserves mean that they can now expand credit and create even more money.
For governments, the mechanism works out pretty well. They usually spend more than they receive in taxes, i.e., they run a deficit. No one likes taxes. Yet, most voters like to receive gifts from their governments. The solution for politicians is simple. They promise gifts to voters and finance them by deficits rather than with taxes. To pay for the deficit, governments issue paper tickets called government bonds such as US Treasuries.
An huge portion of the Treasuries are bought by the banking system, not only because the US government is conceived as a solvent debtor, thanks to its capacity to use violence to appropriate resources, but also because the Fed buys Treasuries in its open-market operations. The Fed, thereby, monetizes the deficit in a way that does not hurt politicians.
But what about the interest paid on the Treasuries? The US government has to pay interest on the bonds to their new owner, the Fed. The Fed receives the interest, which increases the Fed's profit. Who receives the Fed's profit? The bulk of the Fed's profit is remitted back to the US government at the end of the year.
But what about the principal on the bonds? What happens when the bond must be paid back? At the end of the term of the bonds, the government would have to pay its holders. The trick here is just to issue a new bond to pay for the maturing one. Thus, the debts must never be paid but keep getting monetized. Figure 1 shows how the Fed finances the US deficit:
Figure 1
Figure 1: How the Fed finances the US government
The ECB finances deficits in a more subtle way. Only in the sovereign-debt crisis did it start to buy government bonds outright. Normally, the ECB lends to banks against collateral. Banks buy government bonds because they know it is preferred collateral at the ECB. By pledging the bonds as collateral at the ECB, banks receive new reserves and can expand credit. As the government bonds are still owned by banks, governments have to pay interest to banks. Banks, in turn, pay interest on the loans they receive from the ECB, which remits its profits back to governments.
Thus, the system is similar to the Fed, with the difference that normally some of the interest payments leak out to the banking system that pays lower interest rates on its loans than it receives on the bonds. Another important difference is that there may be a redistribution between governments if eurozone governments run deficits of different sizes. In my book The Tragedy of the Euro I explain that the Eurosystem resembles a tragedy of the commons. Several independent governments can use one central-banking system to finance their deficits and externalize the costs in the form of a loss of purchasing power of the Euro onto all users of the currency. The incentive is to have higher deficits than other eurozone governments in order to profit from the monetary redistribution. The flow of the new money is shown in figure 2.
Figure 2
Figure 2: How the ECB finances Euro area governments
Is the difference between the Fed's and the ECB's manipulation of the money supply essential? The Fed buys government bonds outright, while the ECB accepts them as collateral for new loans to the banking system. Economically, the effects are identical. The money supply increases when the Fed buys government bonds. When the ECB grants a loan with government bonds pledged as collateral, the money supply increases as well. In the case of the Fed, the money supply increases until the Fed sells the bond. In the case of the ECB, the money supply increases until the ECB fails to roll over (renew) its loan to the banking system.
There exists a legal difference. The Fed integrates the government bonds on its balance sheet. The ECB does not do so as bonds remain legally the ownership of the banks. Because the ECB does not publish the collateral provided for its loans, we do not know how many Greek government bonds, for example, are provided as collateral for ECB loans. The Fed is more transparent in this respect.
In both cases, government deficits are effectively monetized. That means that the ECB was bailing out Greece even before May 2010. It did not have to buy the Greek bonds outright; it only had to accept them as collateral. If the ECB had not accepted Greek bonds, Greek debts could not have mounted to such an extent. The Greek government would have had to default much earlier.
Aside from this more direct monetization, there is also a monetization going on that is often neglected. Market participants know that central banks buy government bonds and accept them as the preferred collateral. Banks buy the bonds due to their privileged treatment ensuring a liquid market and pushing down yields.
Knowing that there is a very liquid market in government bonds and a high demand by banks, investment funds, pension funds, insurers, and private investors buy government bonds. Government bonds become very liquid and almost as good as base money. In many cases, they serve to create additional base money. In other cases they stand as a reserve to be converted into base money if necessary. As a consequence, new money created through credit expansion often ends up buying liquid government bonds, indirectly monetizing the debt. (Another main holder of government debts is other foreign central banks.)
Imagine that the government has a deficit and issues government bonds. Part is bought by the banking system and used to get additional reserves from the central bank, which buys the bonds or grants new loans, accepting them as collateral. The banking system uses the new reserves to expand credit and grant loans to, for example, the construction industry. With the new loans, the construction industry buys factors of production and pays its workers. The workers use part of the new money to invest in funds. The investment funds then use the new money to acquire government bonds. Thus, there is an indirect monetization. Part of the money created by the fractional-reserve-banking system ends up buying government bonds because of their preferential treatment by the central bank, i.e., its direct monetization.
The process is shown in figure 3:
Figure 3

While it is an intricate system at the first sight, one that many common citizens fail to understand, the system boils down to the following: The government spends more than it receives in taxes. The difference is financed by its friends from the financial system, accommodated by central banks. Money production sponsors politicians' dreams, thereby destroying our currencies. The population pays in the form of a lower purchasing power of money.
For governments it is the perfect scheme. The costs of their deficits are externalized to the users of the currency. The debt is never paid through unpopular taxes but simply by issuing paper that says, "government bond."

[1]  Traditionally central banks have used both ways to finance government debt. America's Federal Reserve System places emphasis on the purchase of government bonds in its open-market operations. It also accepts government bonds as collateral in repurchase agreements. Repurchase agreements and other loans in which government bonds were accepted as collateral rose in importance during the financial crisis of 2008. The European Central Bank, on the contrary, has put more emphasis on accepting government bonds in collateralized loans in its lending operations to the banking system. Only during the sovereign-debt crisis of 2010 did the ECB started buying government bonds outright. On these central-bank policies in the wake of the financial crisis, see Bagus and Howden (2009)Download PDF and Bagus and Schiml (2010).Download PDF