Five Years Since The Great Financial Crisis: "No Growth, No Deleveraging"

Submitted by Tyler Durden

One of the populist buzzwords of the past 5 years, particularly in Europe, has been "austerity", which as we have said for the roughly the same past 5 years, is simply a synonym for "deleveraging" but one which carries just the right amount of negative connotations, and is used by crafty politicians to shift blame from their own failure to enact proper policy (which over the past 30 years has merely meant to borrow growth from future political cycles, aka, issue debt) onto a "technical" word conceived by Ph.D.-clad economists, who too, are looking for a passive victim on which to project their failure of enacting a voodoo economic theory. There is one problem with all of the above. As we have also been saying for the past five years, the austerity deleveraging myth is one big lie. We are setting the record straight below with facts and figures. We would be delighted if some politician, somewhere, could disprove these facts, which essentially imply that the world is now in a global recession, having experienced no growth as the recent 100% contractionary PMI print of all major economies confirms, yet without any country actually having implemented austerity, pardon deleveraging to have at least a modest justification for this failure of growth.

Finally, this article proves that the European chorus screaming for "growth" when everyone knows it demands merely more of the same drug - debt - is 100% wrong, and that while the underlying causes of "growth" are there, the only thing missing are the symptoms. DB's Jim Reid provides the charts and facts:

Figure 37 shows the combined Debt to GDP of the EU-12 (excluding Luxembourg), the US, UK, Japan and Australia. This debt includes Governments, Financials, Corporates and Households. Ireland’s small economy and large financial system (domestic and foreign), ensures an outsized reading which we cut off in the chart.

Figure 38 then shows; 1) how this ratio has changed from the end of 2007 to the end of 2011; 2) what the trend was in the 1-year to the end of 2011 to see momentum; and 3) where the ratio is from the peak point. The data is represented in percentage point moves.

As can be seen, only the US and Australia have seen their overall economy Debt to GDP fall since the end of 2007 and for both these the fall is negligible. The US has gone from around 348% to 345% on this measure. From the peak the US has fallen from the 366% seen in 2009 and the 353% seen in 2010 but few other countries are seeing their debt/gdp ratio move in the right direction. Many are currently at their peak overall economy wide leverage number and as already discussed when looked at from the start of the crisis all but the US and Australia have seen this ratio rise. Interestingly as we’ll see below Australia and the US have still seen debt rise but Nominal GDP has risen by a higher amount, thus helping them see leverage ratios decline slightly. It shows how important growth and inflation are if you want to delever.

Deleveraging problems from both the debt and growth side

The deleveraging problem comes from both sides. As we saw in Figure 36 in the previous section, growth has struggled to eclipse its peak levels across a number of countries with only inflation allowing many to surpass their peak activity levels. In terms of debt, Figure 39 shows the growth of an index of economy wide liabilities from our DW sample rebased at 100 at the end of 2007. We have gone back as far as the full data starts for each country.

Figure 40 then shows a simple un-weighted average and median of this basket and shows that debt is still increasing in the developed world.

Figure 41 then looks at the numbers for each country again from the end of 2007 to Q1 2012, since the end of 2010 and also from the peak. Debt hasn't started to turn down anywhere in the Developed World since the end of 2007. As already discussed, those that have seen their debt/GDP ratios stabilise (e.g. US and Australia) have required some nominal GDP growth.

So debt is still climbing in most countries. Clearly the splits are changing with more emphasis on public over private debt but there's little evidence that the DM deleveraging trend has started yet.

Given such an unparalleled run up in debt over the last few years and decades, will we be able to de-lever naturally and without defaults? If we can find a higher pace of growth and inflation than debt accumulation then we can. But can every country succeed? The reality is that we would make a strong argument suggesting that the high debt burdens are actually holding growth back thus ensuring a problem of circularity. As a minimum it likely ensures that these economies remain fragile and vulnerable to shocks for many years to come.

So in aggregate the DM post-GFC world can be characterised by a “No Growth, No Deleveraging” mantra and one where we are still in a similar situation to where we were five years ago.

source : www.zerohedge.com

BofA Makes The Case For $3,000 Gold

Everyone loves gold these days. Deutsche Bank sees $2000 gold soon. And Citi says it could go to $2500 in six months.

BofA, too: the firm recently initiated a $2,400 target price for the shiny yellow metal since the Fed's announcement of open-ended bond buying.

However, BofA analyst Stephen Suttmeier thinks there's a case to be made that gold goes even higher than the bank's official call.

In a note to clients today, Suttmeier writes:

The secular bull case for Gold $3000

We remain secular bulls on gold. Key chart and uptrend supports between $1600 and $1400 have held and we have viewed $1550-1500 as a good area to buy gold. The breakout above the year-long downtrend line completes the correction within the longer-term uptrend and targets resistances at $1800 and $1925. But, the secular bull market for gold points to a stronger rally to $2050-2300 and up to $3000 longer-term. The top of the rising channel from mid 2005 is near $2375 and reaches the $3000 area by early 2014. Key channel supports are in the $1600 and $1400 areas and rise ~$25/month. The chart below shows the secular bull market for gold.

Here is the chart Suttmeier is looking at:

BofA Merrill Lynch

source : www.businessinsider.com

Interest Rates and the Business Cycle

by Glen Tenney 

The cause of the business cycle has long been debated by professional economists. Recurring successions of boom and bust have also mystified the lay person. Many questions persist. Are recessions caused by underconsumption as the Keynesians would have us believe? If so, what causes masses of people to quit spending all at the same time? Or are recessions caused by too little money in the economy, as the monetarists teach? And how do we know how much money is too much or too little? Perhaps more importantly, are periodic recessions an inevitable consequence of a capitalist economy? Must we accept the horrors associated with recessions and depressions as a necessary part of living in a highly industrialized society?

Concerns about aggregate money supply levels and aggregate spending might make for interesting conversation, and a discussion of these matters might even reveal certain threads of truth, but they are inadequate in arriving at the cause of the boom and bust cycle that seems to pervade the economy in modern times. Economists in the Austrian school of thought have provided an explanation that bases economic fluctuations on microeconomic theory that is firmly grounded in principles of human action. These economists have pointed out that macroeconomic fluctuations, or what have come to be known as business cycles, are caused by extraneous manipulations of interest rates in the economy.1 This manipulation of interest rates might entail conscious actions by governmental authorities or merely the result of governmental actions taken with other goals in mind.

Interest Rates Reflect Time Preferences

The rate of interest in an economy is an important reflection of the time preferences of individuals. People are willing to forgo some amount of current consumption in order to invest in production processes which promise finished goods that are valued higher than the sum of the inputs to the production process. The spread between the amounts paid to the owners of the productive inputs and amounts obtained from the sale of the completed product is interest income to the businessman who advances money incomes to the resource owners in terms of wages and rents. The capitalist/ businessman then provides current buying power to workers and owners of other productive inputs in exchange for an amount we call interest. And looking from the opposite perspective, workers and other resource owners are willing to take a discounted amount in payment for their productive inputs in order to have current incomes rather than waiting for the completion of the product.

Of course in the market for loans, the interest rate also contains an entrepreneurial component which accounts for certain areas of uncertainty which are always present in borrowing and lending money. An inflation premium is included if the dollars to be repaid on the loan are expected to have less purchasing-power than the dollars that are lent. And a default-risk premium is included based upon the ability and/or willingness of the borrower to repay the loan as agreed. Thus the interest rate that is agreed upon in the loan market includes these entrepreneurial factors in addition to an amount sufficient to induce people to forgo current consumption in favor of consumption in the future.

The interest rate serves a coordinating function in the economy by providing useful information about the availability of credit and the profitability of investments to both lenders and borrowers, if, for example, people’s rates of time preference increase, this change is reflected as higher interest rates, which encourages more saving and discourages borrowing at the margin. This means that individuals in general are requiring more of an incentive to forgo current consumption than they did previously. There are two ways in which this coordinating function is hindered by governmental action in the economy.

New Money Gives a False Signal

Money is primarily a medium of exchange in the economy; and as such, its quantity does not have anything to do with the real quantity of employment and output in the economy. Of course, with more money in the economy, the prices of goods, services, and wages, will be higher; but the real quantities of the goods and services, and the real value of the wages will not necessarily change with an increase of money in the overall economy. But it is a mistake to think that a sudden increase in the supply of money would have no effect at all on economic activity. As Nobel Laureate Friedrich A. Hayek explained:


Everything depends on the point where the additional money is injected into circulation (or where the money is withdrawn from circulation), and the effects may be quite opposite according as the additional money comes first into the hands of traders and manufacturers or directly into the hands of salaried people employed by the state.

Because the new money enters the market in a manner which is less than exactly proportional to existing money holdings and consumption/savings ratios, a monetary expansion in the economy does not affect all sectors of the economy at the same time or to the same degree. If the new money enters the market through the banking system or through the credit markets, interest rates will decline below the level that coordinates with the savings of individuals in the economy. Businessmen, who use the interest rate in determining the profitability of various investments, will anxiously take advantage of the lower interest rate by increasing investments in projects that were perceived as unprofitable using higher rates of interest.

The great Austrian economist Ludwig von Mises describes the increase in business activity as follows:


The lowering of the rate of interest stimulates economic activity. Projects which would not have been thought “profitable” if the rate of interest had not been influenced by the manipulation of the banks, and which, therefore, would not have been undertaken, are nevertheless found “profitable” and can be initiated.

The word “profitable” was undoubtedly put in quotes by Mises because it is a mistake to think that government actions can actually increase overall profitability in the economy in such a manner. The folly of this situation is apparent when we realize that the lower interest rate was not the result of increased savings in the economy. The lower interest rate was a false signal. The consumption/ saving ratios of individuals and families in the economy have not necessarily changed, and so the total mount of total savings available for investment purposes has not necessarily increased, although it appears to businessmen that they have. Because the lower interest rate is a false indicator of more available capital, investments will be made in projects that are doomed to failure as the new money works its way through the economy.

Eventually, prices in general will rise in response to the new money. Firms that made investments in capital projects by relying on the bad information provided by the artificially low interest rate will find that they cannot complete their projects because of a lack of capital. As Murray Rothbard states:


The banks’ credit expansion had tampered with that indispensable “signal”-the interest rate—that tells businessmen how much savings are available and what length of projects will be profitable . . . . The situation is analogous to that of a contractor misled into believing that he has more building material than he really has and then awakening to find that he has used up all his material on a capacious foundation, with no material left to complete the house. Clearly, bank credit expansion cannot increase capital investment by one iota. Investment can still come only from savings.

Capital-intensive industries are hurt the most under such a scenario, because small changes in interest rates make a big difference in profitability calculations due to the extended time element involved.

It is important to note that it is neither the amount of money in the economy, nor the general price level in the economy, that causes the problem. Professor Richard Ebeling describes the real problem as follows:


Now in fact, the relevant decisions market participants must make pertain not to changes in the “price level” but, instead, relate to the various relative prices that enter into production and consumption choices. But monetary increases have their peculiar effects precisely because they do not affect all prices simultaneously and proportionally.

The fact that it takes time for the increase in the money supply to affect the various sectors of the economy causes the malinvestments which result in what is known as the business cycle.

Government Externalizes Uncertainty

Professor Roger Garrison has noted another way that government policy causes distortions in the economy by falsifying the interest rate. In a situation where excessive government spending creates budget deficits, uncertainty in the economy is increased due to the fact that it is impossible for market participants to know how the budget shortfall will be financed. The government can either issue more debt, create more money by monetizing the debt, or raise taxes in some manner. Each of these approaches will redistribute wealth in society in different ways, but there is no way to know in advance which of these methods will be chosen.

One would think that this kind of increase in uncertainty in the market would increase the risk premium built into loan rates. But these additional risks, in the form of either price inflation or increased taxation are borne by all members of society rather than by just the holders of government securities. Because both the government’s ability to monetize the debt and its ability to tax generate burdens to all market participants in general rather than government bond holders alone, the yields on government securities do not accurately reflect these additional risks. These risks are effectively passed on or externalized to those who are not a part of the borrowing/lending transactions in which the government deals. The FDIC, which guarantees deposit accounts at taxpayer expense, further exacerbates the situation by leading savers to believe their savings are risk-free.

For our purposes here, the key concept to realize is the important function of interest rates in this whole scenario. Interest rates serve as a regulator in the economy in the sense that the height of the rates helps businessmen determine the proper level of investment to undertake. Anything in the economy that tends to lower the interest rate artificially will promote investments in projects that are not really profitable based upon the amount of capital being provided by savers who are the ones that forgo consumption because they deem it in their best interest to do so. This wedge that is driven between the natural rate of interest and the market rate of interest as reflected in loan rates can be the result of increases in the supply of fiat money or increases in uncertainty in the market which is not accurately reflected in loan rates. The manipulation of the interest rate is significant in both cases, and an artificial boom and subsequent bust is inevitably the result.

Conclusion

Changes in the supply of money in the economy do have an effect on real economic activity. This effect works through the medium of interest rates in causing fluctuations in business activity. When fiat money is provided to the market in the form of credit expansion through the banking system, business firms erroneously view this as an increase in the supply of capital. Due to the decreased interest rate in the loan market brought about by the fictitious “increase” in capital, businesses increase their investments in long-range projects that appear profitable. In addition, other factors as well can cause a discrepancy between the natural rate of interest and the rate which is paid in the loan market. Government policies with regard to debt creation, monetization, bank deposit guarantees, and taxation, can effectively externalize the risk associated with running budget deficits, thus artificially lowering loan rates in the market. Either of these two influences on interest rates, or a combination of the two, can and do influence economic activity by inducing businesses to make investments that would otherwise not be made. Since real savings in the economy, however, do not increase due to these interventionist measures, the production structure is weakened and the business boom must ultimately give way to a bust.

Source www.thefreemanonline.org

All Signs Pointing to Gold

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

With another syringe of quantitative easing being injected into the U.S. economy’s bloodstream, Ben Bernanke is giving the markets their liquidity fix. The Federal Reserve’s action reaffirmed my stance I’ve reiterated on several occasions that the governments across developed markets have no fiscal discipline, opting for ultra-easy monetary policies to stimulate growth instead.

The government’s liquidity shot promptly boosted gold and gold stocks, as investors sought the protection of the precious metal as a real store of value. You can see below the strong correlation between the rising U.S. monetary base and growing gold value. Since the beginning of 1984, as money supply has risen, so has the price of gold.



The dollar declined due to the Fed’s easing, which isn’t surprising, given the fact that gold and the greenback are often inversely correlated, and increasing money supply generally causes the currency to fall in value.

What’s interesting is that currency decline was what Richard Nixon sought to avoid when he ended the gold standard in 1971 and announced that the country would no longer redeem its currency in gold. During his televised speech to the American public, Nixon translated in simple terms the “bugaboo” of devaluation, saying, “if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.”

As you can see below, more than 40 years later, a dollar is worth only 17 cents. This significant decline in purchasing power only strengthens the case of gold as a store of value, likely prompting Global Portfolio Strategist Don Coxe to propose making Nixon the “patron saint of gold investors,” during this year’s Denver Gold Forum.



As Milton Friedman once said, “Only government can take perfectly good paper, cover it with perfectly good ink and make the combination worthless.”

In its long-term asset return research charting economic history in comparison to current markets, Deutsche Bank illustrates multiple ways how “the world dramatically changed post-1971 relative to prior history.” While the research firm makes it clear that returning to the gold standard would be “disastrous,” DB finds that the “lethal cocktail of unparalleled levels of global debt and unparalleled global money printing” are relatively new governmental developments.

Prior to the last four decades, deficits only occurred in extreme situations of war or severe economic setbacks, such as the Great Depression. Balanced budgets were a “routine peace time phenomena in sound economies.” Since 1971, surpluses have been rare. The U.K. has had an annual budget deficit 51 out of the past 60 years and Spain has had 45 years of deficit spending over the past 49 years, according to DB.



Many developed countries are in a predicament, as fiscal austerity attempts have led to weaker-than-expected growth in Greece, Ireland, Portugal, Spain and Italy. DB asks, “Can we really be confident that the developed economies that we have created over the last 40 years have the ability to withstand the effects of austerity and cut backs? Do our modern day econometric models have the ability to understand the impacts of fiscal retrenchment after a financial crisis having been calibrated in a period of excessive leverage?”

Countless discussions over fiscal and monetary policies will carry on, but time will tell. Ian McAvity, editor of Deliberations on World Markets, says, “Excessive debt creates deflationary drag that they repeatedly fight by throwing fresh ‘liquidity’ or ‘stimulus’ at, to debauch the currency of that debt… For private investors, gold is the best medium for self-protection and preservation of purchasing power in my view.” I agree. Rising money supply, declining purchasing power and annual deficits are giving the all-clear to include gold in your portfolio.

Many others appear to agree with us, as sentiment has shifted in favor of the metal in recent days: According to Morgan Stanley’s survey of 140 institutional investors in the U.S., gold sentiment was at its highest bullish reading since July 2011 and the largest month-over-month increase during the survey’s three-year history!

So, gold investors, if you haven’t put in your orders, consider getting them in quickly, because the bulls are buying. Credit Suisse saw “massive inflows” into gold exchange-traded products in August after experiencing significant outflows compared to crude oil and the broader market in March, April, May and July. August shows a clear preference toward gold.



We generated lots of interest when we showed our standard deviation chart a few weeks ago, so I updated it through September 13. Although gold has been on a tear recently, breaking through the stumbling block of $1,600 and climbing to $1,770 by Friday, bullion still looks attractive, with a low sigma reading of -1.7.



A look at a histogram shows how many times gold bullion historically fell in this sigma range. Today’s sigma of -1.7 has occurred only about 2 percent of the time. Bernanke and Draghi only made the decision more obvious for gold and gold stock buyers.



The Fed and ECB also make my job presenting at the Hard Assets conference in Chicago very exciting. Don’t miss my presentation on September 21. I invite you to be there in person if you live in close proximity to Chicago, or you can download a pdf at www.usfunds.com following the meeting.

You might also learn something you didn’t know with our newest interactive slideshow, the 10 Surprising Uses of Commodities. Check it out and share with a friend.

souce : www.321gold.com/

The Dark Side Of QE: The Next Chapter In Our Stor...

I am about to tell a story with a very happy beginning and a very sad end. Unfortunately, it happens to be the story we are living in today, but because we are still in the happy part of the story most people cannot see what is coming ahead. I will provide that for you here.

The immediate knee jerk reaction to the Fed's announcement today is that the Fed printing $40 billion per month and pumping it into the banking system is fundamentally strong for every type of asset in the world. Those that graduated from college in 2009 and have only been watching the market for a few years would believe this is a fact.

In essence: buy everything and just keep on buying.

Now that we know we are on the path of QE to infinity it is very important to understand how an endless running stream of new money fundamentally impacts assets differently. You'll notice a repetition of the word fundamentally because for long periods of time assets can move in the opposite direction of their fundamentals. Think of the 100% par value of subprime mortgage tranches in early 2006 or the multi-billion dollar valuation of Pets.com in 1999. Over time assets have a tendency, like gravity, to revert back to their fundamental value. This is what causes booms, busts, opportunity, and disaster.

Before we go any further, let's quickly review how QE actually works. The Fed shows up at the doorstep of primary dealer (the largest) banks with a printed bag full of money and asks them if they can come in and buy some mortgage bonds. The banks agree, hand them the bonds, and take the bag full of cash. The banks now have a new lump sum of money to spend or do with what they like. This is also new money that did not exist in the economy before which is how the money supply is increased. In reality, there are no knocking on doors with bags of money, this process takes place electronically with a few key strokes from either side. The outcome, however, is the same.

Part 1: The Positive Benefits Of QE (March 2009 - September 2012)

We'll start with mortgage bonds as a completely separate conversation because the Fed has targeted this one asset as their choice of purchase. Mortgage bonds and mortgage rates will have an obvious fundamental advantage to the Fed purchasing them every single month. If the Fed decided they were only going to purchase blue Honda Accord cars every month, it would have a positive fundamental impact on the price of those cars.

The QE process of mortgage bond purchases has the immediate impact of lowering mortgage rates (a new larger buyer of mortgages in the market - higher demand equals lower rates). It also has an alternative impact due to the bag of money left at the doorstep of the banks. The banks can now take this money and spend it. They can purchase treasury bonds, corporate bonds, and municipal bonds (plus a few other assets we'll get to in a moment).

This bond purchasing lowers the cost of borrowing for everyone as lower interest rates allow corporations, local governments, and the federal government to borrow more. This is the Fed's second goal: to lower the cost of borrowing to stimulate the economy.

Stocks rise with the Fed easing in part for the very reason just discussed. If it costs corporations less to borrow money it increases their profits and allows them more opportunity to grow. QE also has the ability to push up stock prices because banks now have more fresh cash that they can put to work in the stock market.

The positive benefit of QE, the happy part of the story, is essentially what we have experienced since the first QE program began in March of 2009. Interest rates on every type of bond in America: treasury, corporate, municipal, mortgage, auto, credit card, and junk bonds have fallen significantly.

Stocks have soared, rising over 100% in the S&P 500 since the first QE began that March. This creates an immediate wealth effect for those holding stocks (their portfolio says $400,000 instead of $200,000 making them more likely to spend and boost the economy).

Corporate profits have surged with the lower cost of borrowing, the massive reduction in expenses (mostly through employee layoffs), and an increase in productivity.

Over the past 3.5 years when rolling out QE 1 & 2 the dollar index has moved sideways and even appreciated (due mainly to the over weighting of the index to the euro).

So far we have only experienced the good part of inflation. We have only experienced the high of the drug, and the buzz of the alcohol. If the story ended here today it would appear that QE was the correct decision all along and that the unlimited QE program announced today has no reason to be anything but positive.

But the story will not end here today. We will look now look at what comes next.

Part 2: The Dark Side Of QE (2013 - 2016)

This is where we move away from the fairy tale and back into reality.

When the Fed shows up at the bank with the bag of cash there is another asset class the bank can purchase with the money: commodities.

Commodities include agriculture (food), energy (oil and natural gas), metals (copper, steel, aluminum), lumber, water, precious metals, and every other tangible good in the world. Many of these items are either directly purchased by consumers (food and energy) or they are purchased as a byproduct of other items they use such as a car, shirt, or washer and dryer. This directly raises the cost of living for consumers. A higher cost of living means less disposable income and less money available to buy goods such as iPads, furniture, vacations, or cars. A slow down in spending in these areas not only impacts the stock prices of these companies, it spurs lay offs at them as well.

This is looking directly at the consumer side, but what about the corporate side? At the end of the day a company is judged (with its stock price) based on its ability to generate profits. If the cost of goods to produce rises (with rising commodity prices) and companies are not able to raise prices enough to offset those costs (which would occur if wages were not rising at an equal or greater pace) then profit margins fall.

Do you see, based on the fundamentals of economics, how inflation does not help the price of stocks. This is, in part, why stocks were crushed during the stagflationary period of the 1970's.

What about bonds?

Bonds face a similar dilemma, only magnified. Why? Because bonds do not have the ability to raise prices the way a company can to offset inflation (even though we just saw how companies can only raise prices so far without choking off all demand). Bonds are set at a fixed interest rate. If the underlying value of the currency the bond is held in depreciates in value then the investor is trapped.

Many bonds today actually have a negative yield. This means that the cost of living is rising more rapidly every year than what is paid out in interest. Investors buying these bonds know going in that they are losing purchasing power. Why would anyone ever do this? I have no idea. Why would they purchase Internet stocks in the year 2000 at sky high valuations when the companies had no profits? Bonds today, like stocks then, are in a bubble. The madness of crowds has set in.

At some point, as new QE money enters the money supply and continues to depreciate the value of the currency there will be an awakening moment for bond holders. What will trigger this "moment?" I have no idea. But I know that it is coming. Those trapped inside the long term bonds that have been front running the Fed's QE programs will suddenly realize that they are running in quicksand.

How about the currency itself? Paper bills. They have no interest rate risk right? They have no corporate margins to worry about right? Holding cash at the bank seems like the best available option.

In reality it will be ultimately be the worst. The only thing worse than a low interest rate during a period of high inflation is no interest rate. We live in a borderless world today where investors do not have to hold their money in a domestic bank (just watch what is taking place right now in Spain). Money can be moved to a bank in Switzerland, Hong Kong, Brazil, or Canada. It can also be held in those currencies at those banks.

This is what will take place at first slowly in America and then in a rush at the end. Most will likely not be allowed to escape as the borders are shut when the politicians realize what is taking place. Their money will be trapped inside the closed room being filled with water by Bernanke. Their purchasing power will drown.

How about real estate? This is one of the favorites for those arguing for an inflation investment. The problem is that real estate is purchased with debt. If the cost of the debt rises significantly (interest rates rise) then the price of the asset is going to fall, even if the cost of building a new home is rising as well. This will only occur over the short term because we still have an enormous amount of untapped supply to mop up. It is only in a hyperinflationary environment, not a very high inflationary environment, that real estate will be a strong investment.

So after understanding why stocks, bonds, cash, and real estate fundamentally should go down in a high inflationary environment, what is the best investment option?

Commodities

I have explained numerous times using historical examples and charts how we are in a long term secular bull market for commodities which began in the year 2000. Energy, agriculture, water, rare earths, and precious metals have been and still are my personal favorites.

If the Fed prints more money tomorrow there is no fundamental downside for the price of gold. There are no corporate margins squeezed. There are no interest rate risks. There is no dilution of the money. It is just a larger amount of paper money chasing a stable amount of physical gold. Throughout history that has only led to one thing: a price adjustment in the price of gold to account for the paper money that has been created.

Usually this happens very slowly over a long period of time and then very suddenly and violently at the end. Almost all of the entire bull market run in gold during the 1970's happened in the last 90 days leading into January 1980. I think it will be the same this time as well.

Thursday, September 13, 2012

source from : http://www.ftense.com

Dollar-Priced Gold

by Ranting Andy - Miles Franklin
 

  

I have long emphasized a point that few – if any – discuss regularly. To me, it’s not just the MOST IMPORTANT VARIABLE in understanding REAL MONEY; but ultimately, the key to the Cartel’s demise, and with it, the GLOBAL FIAT CURRENCY REGIME. And that point, of course, is that the world DOES NOT revolve around the United States!

Twelve years into the world’s most powerful bull market – or should I say, the most powerful fiat bear market – I cannot recall a SINGLE DAY when the U.S. MSM, or newsletter/analyst community – discussed the movement of PM prices in anything other than dollars.

Remember, for a substance to truly act as MONEY – as opposed to just currency – it must meet ALL the parameters below. Dollars, Euros, and Yen only meet the two black-highlighted points – the LEAST IMPORTANT, I might add – as countless substances are both divisible and fungible…

Conversely, only GOLD and SILVER are accepted mediums of exchange EVERYWHERE – which the dollar, Euro and Yen are decidedly NOT – and serve as reliable stores of value, exactly the OPPOSITE of the dollar’s performance during the Fed’s 99-year “reign of terror”…

Sadly, the secular, sheltered MSM – and much of the “PM community” – refuses to acknowledge, or even understand, that these issues are not just American, but GLOBAL. And equally important, that PMs are not only priced in dollars. The fact is, essentially EVERY country has its own fiat currency; most of which have been anchored to the failing dollar since the gold standard was abandoned 41 years ago – and thus, will soon be DEAD…

 read more from source http://www.24hgold.com

No CB Solutions: Liquidity vs Insolvency

 by Jim Willie CB - Hat Trick Letter

 

The Hippocratic Oath dictates never to do harm to the patient. The central bankers instead take the Hypocritical Oath that dictates to cripple the patient, to drain the blood, to preserve power by tightening the straps, to erode buying power from hard work, and to render life savings a weak shell, while whispering lies in the ears on blame for what went badly wrong, against the background din of endorsed war themes. The effectiveness of the latter oath is seen in the systemic failure of the USEconomy, whose financial and economic structure has been destroyed by bad economic policy, the poor paper financial foundation from the monetary system, corrupt bond market practices marred by $trillion frauds, and a marriage between the state and sanctioned large corporations whose only efficiency is seen in dark corners protected by criminal impunity. The Fascist Business Model showed itself in bold terms in the 1990 decade, in the strengthened links between state and major corporations, where inefficiency, favoritism, and corruption produce the bitter fruit of a sclerotic financial structure and weakened body economic. The Gold price responds to the systemic failure of the ruinous financial and economic policy, aggravated by the devoted ghoulish doctors and their perverse solutions that neither fix anything nor attempt to apply remedy. The Jackson Hole conference was another gathering of losers, stuck in apologist mode to explain their vast ongoing enduring failure. It has become an empty echo to the Davos Forum. This year, after two years of the drastic treatment reliant upon bond monetization (Quantitative Easing), the display revealed more vividly than in the past the gaggle of losers gone fishing. The Bernanke speech said nothing of substance, nothing. He is out of ideas, out of tools, out of credibility, holding a ruined balance sheet which will not be restored. The latest Bernanke stupidism is the continued bond monetization until a certain threshold of economic growth (GDP) is reached. These loser bankers do not even attempt legitimate solutions, choosing instead their usual fare to work toward power preservation whose schemes are marred by yet more paper mache covering of toxic sores. The financial markets look to clues on QE when it never ended, and thus its participants appear truly clueless. They appeal beseechingly like emaciated hound dogs seeking small food scraps from the fat bankers who never miss a $200 lunch, the tab always paid by the starving serfs and vassals that peer through the windows. In past years the Jackass was eager to hear the buzz from the conference, looking for choice morsels to indicate future direction. This year, a walk around the block to look at blossoms from the vibrant flora has been brought more satisfaction. Even EuroCB chief witch doctor Draghi decided not to attend the conference, perhaps unwilling to be tarnished by a broad inept banker brush, or to find himself impaled by a fishing hook. The banker losers will continue to ply their trade, to print more money and avoid the Gold Standard. They will find ways to justify more propping of the giant insolvent banks, whose business model has been wrecked, whose balance sheets have been wrecked, whose executives live large despite the wreckage. The dangerous dastardly desperate concoctions with hidden derivative platforms and cables erected by the big banks in the 1990 and 2000 decades bought them more time, but did not avert the mutually assured destruction. The central bankers have no solutions. The Gold price responds to the systemic failure of the ruinous financial and economic policy, aggravated by the devoted ghoulish doctors and their perverse solutions that neither fix anything nor attempt to apply remedy. 

 

 

read more from source : http://www.24hgold.com/

Bill Gross Gold a Better Investment Than Bonds, Stocks

Bill Gross managing director at Pimco talks with Bloomberg's Stephanie Ruhle Alix Steel and Adam Johnson about the outlook for gold prices. "Gold is a fixed commodity and a store of value...when Central Banks start writing checks and printing money in the trillions of dollars, it is best to have something tangible that can't be reproduced," said Gross. Gross said gold is going higher and will provide a better return than stocks or bonds in the 3-4% range.

from : www.swissamerica.com

What Bill Gross Is Really Doing With Treasuries

 

The PIMCO Total Return manager offers more definition on the fund's current Treasury positioning and the motivation behind it.

More Videos: http://www.morningstar.com/cover/videoCenter.aspx

Jim Rogers Blog: The Solution Is Not Papering It Over

Jim Rogers Blog: The Solution Is Not Papering It Over: A recent video interview with Reuters. Jim Rogers is an author, financial commentator and successful international investor. He has bee...

International investor Jim Rogers says all that the Fed has done with QE is to artificially inflate stock and bond markets. He argues the Fed could push the U.S. into another recession in 2013. (September 12, 2012)

Debt and Hyperinflation

by Ranting Andy www.milesfranklin.com

The inevitable COLLAPSE of the U.S. dollar is a mathematical certainty, but the timing of its occurrence is impossible to predict. Assuming no “black swan” events – like nuclear war or catastrophic market crashes – I believe the dollar will have lost the last vestiges of its “reserve currency status” within two to three years; and likely, within five years be replaced by a new, gold-backed currency. However, such numbers are pure speculation, as no one truly knows what will happen, or – more importantly – when, and why.

That is why I repeatedly recommend ownership of PHYSICAL gold and silver; as regardless of this time frame, the likelihood of prematurely selling your bullion is extremely low – barring personal financial emergencies, of course. And the same goes for “betting” on the timing of Hyperinflation – as if you hold too much debt before it occurs, you could lose the underlying assets – such as your home – or even your PHYSICAL PMs if you need to sell them to pay off your debts.

Moreover, think long and hard about the wisdom of purposefully holding large amounts of debt into what could be a cataclysmic financial event. Ann Barnhardt says to pay off as much debt as possible beforehand, with the aim of distancing oneself as much as possible from “the system” when “the Big One” hits. And frankly, I agree with her, 100%. Sure, if your bank fails, your mortgage obligation may go with it. But who’s to say the bank won’t be acquired by a more evil entity, such as the U.S. GOVERNMENT? For all we know, a new, totalitarian dictator will declare all mortgaged homes state property – or some other, equally draconian decree.

As for what happens to debt during Hyperinflation, it is absolutely devalued – benefitting the borrower, at the expense of the lender. Out of control MONEY PRINTING may cause a loaf of bread to cost $500,000, but your $500,000 mortgage will still be the same; in other words, worth the same as the bread. If you have limited savings, you still won’t be able to pay off your mortgage – especially if you lose your job, a highly likely scenario. However, you could sell ITEMS OF REAL VALUE – like a loaf of bread, or a gold coin – to obtain the funds to pay off your mortgage. Moreover, a handful of companies might even institute inflation-adjusted pay – though I wouldn’t count on it.

Hyperinflation could break out at any time – as in the case of the aforementioned “black swan” events. However, more likely a 1930s-like scenario of unemployment, poverty, social unrest, and war will precede it. PHYSICAL Precious Metals will protect you under all scenarios, but DEBT could prove just as much an albatross as a boon. It’s VERY rare for anything positive to ever come of debt, so I strongly advise you do not consider it an “asset.”

Author : Ranting Andy Andrew Hoffman was a buy-side and sell-side analyst in the United States (including six years as an II-ranked oilfield service analyst at Salomon Smith Barney), but since 2002 his focus has been entirely in the metals markets, principally gold and silver. He recently worked as a consultant to junior mining companies, head of Corporate Development, and VP of Investor Relations for different mining ventures, and is now the Director of Marketing for Miles Franklin, a U.S.-based bullion dealer.

Steve Forbes: Get Ready, Gold Standard is Coming Read more: Steve Forbes: Get Ready, Gold Standard is Coming

By Forrest Jones from : www.moneynews.com

Low interest rates and extremely accommodative monetary policies will leave the country with no choice but to return to a modern version of the gold standard, said publisher and one-time GOP presidential hopeful Steve Forbes.

The GOP platform has called for a commission to study the feasibility of the gold standard, which attaches the value of the dollar to a fixed weight of gold.

President Richard Nixon dropped the gold standard in 1971 and opened the era of a fiat dollar. Supporters of the gold standard’s revival say the plan would prevent the government from living outside of its means like it does today.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did Gold will likely take a back seat to jobs, Middle East tensions and entitlement and other economic reforms in the upcoming elections.

“But the yellow metal will be a hot topic in the next 24 months. The commission is going to take on an importance that will astound today’s political punditry, besotted as they are with stale Keynesian quackeries about money, taxes and spending,” Forbes wrote in his publication.

“Why? Events economic and political. The ever deepening financial crisis around the world will force the new Romney-Ryan administration to consider — and quickly, too — dramatic measures to deal with the disaster,” Forbes added.

“The Obama/Bernanke Federal Reserve has been an abysmal failure. No major country’s central bank has been so destructive since the Fed in the 1970s; prior to that, nearly a century ago, it was Germany’s central bank, which created a hyperinflation that helped set up an environment for the Nazi revolution.”

Since the downturn, the Fed under Chairman Ben Bernanke has slashed interest rates to near zero and has injected some $2.3 trillion into the economy by purchasing assets such as Treasury holdings or mortgage-backed securities from banks, a monetary policy tool known as quantitative easing that floods the economy with liquidity in way to encourage investing and hiring.

Critics say the move consists merely of printing money out of thin air and has planted the seeds for inflation down the road.

Such policy would be undoable under a gold standard, since the amount of money in circulation is tied to a fixed amount of gold.

“In order to work properly and productively, markets need a reliable pricing mechanism,” Forbes wrote.

“By manipulating interest rates on such an unprecedented scale the Federal Reserve has effectively destroyed the ability of our credit markets to genuinely price the borrowing and lending of money. Does anyone really believe a 10-year Treasury should yield little more than 1.5 percent or a 30-year government bond just under 3 percent?”

Some analysts say calls for a gold standard serve a message the country needs to address much-needed fiscal and monetary reforms.

“Examining a return to the gold standard is one avenue to show the public and markets a level of seriousness about the U.S dollar, monetary policy and the budget deficit,” said Jeffrey Wright, managing director of Global Hunter Securities, according to Reuters.

Is Central Bank Buying Just a Driving Force Behind Gold or Much More?! – Part II

by Julian D. W. Phillips - Gold Forecaster 

Basel III Discussing Lifting the Accepted Value of Gold on Commercial Banks Balance Sheets from 50% to 100%Part of the side-lining of gold from the monetary system was through either taxation on its sale (in some countries) or by undervaluing it as an asset.

When the 2007 credit crunch hit hard, the loss in value of so many paper assets forced the sale even of those assets that did manage to retain both value and liquidity. Individual investors often sold gold, silver, and the like to cover margin requirements that screamed to be topped up in the hope of retaining assets that were losing value. That’s why asset values on so many fronts declined so markedly. Even assets whose market fundamentals remained solid were sold down only to recover when the storm passed. Gold and silver were among those.

At banking level, the pressure to go against investor logic was due to the regulations of the system. With gold a Tier II asset in bank’s balance sheets, only 50% of its value could be credited as an asset to that balance sheet. So its real market value could only be given meaning when it was sold. By selling gold and using the proceeds to buy Tier I assets, such as Treasuries, the bank ensured that their balance sheets benefitted fully from its value. Even when the gold price fell 20% it was worth selling, so that at least 80% of its former [$1,200] value could be credited to the bank’s balance sheet instead of just 50% [or 40% at the value after a fall in the price of 20%].

As the value of assets of various governments and potentially U.S. bonds are threatened by over-indebtedness, commercial banks are left little recourse except changing the situation by changing the rules for the banks. Hence, the current discussions on its definition in the bank’s balance sheets. If gold is redefined as a Tier I asset, then when any future loss of asset value of paper assets occurs, there will be no need for banks to sell gold to compensate for such falls. And, as gold has amply demonstrated, the gold price is more than likely to rise in such situations, proving to be a ‘counter to all paper assets’ on the bank’s balance sheets.

Such a change will do a great deal to remove the shock to the solvency of so many commercial banks in credit crunches and the like.Will the change happen? We believe so and expect this to take effect on January 1st 2013.

Why Clearing Entities Are Accepting Gold as Collateral

LCH.Clearnet is a clearing house for major international exchanges and platforms, as well as a range of OTC markets. As recently as 9 months ago, figures showed that they clear approximately 50% of the $348 trillion global interest rate swap market and are the second largest clearer of bonds and repos in the world. In addition, they clear a broad range of asset classes including commodities, securities, exchangetraded derivatives, CDS, energy and freight. The development follows the same significant policy change from CME Clearing Europe, the London-based clearinghouse of CME Group Inc., announced recently that it planned to accept gold bullion as collateral for margin requirements on over-the-counter commodities derivatives. Both C.M.E. and now LCH.Clearnet Group have decided to allow use of gold as collateral from 28th August. It is likely that they too have the same concerns about the possibility of another ‘credit crunch’ and the danger forced asset sales can have on liquidity. They too see the benefits of treating gold as money and collateral.

LCH.Clearnet Group Ltd. said it will accept ‘loco London’ gold [0.999 or 0.995 quality gold] as collateral for margin-cover requirements on OTC precious-metals forward contracts and on Hong Kong Mercantile Exchange precious-metals contracts starting Aug. 28. ‘Loco London’ gold is London ‘Good Delivery’ Bars (roughly 400-ounce or 12.5 kilograms gold bar) held with LBMA members within the London bullion clearing system. The clearing house has already been using gold bullion as collateral since 2011 but now will accept ‘loco London’ gold as collateral.


Additionally, Intercontinental Exchange Inc. too has allowed the use of gold as collateral. LCH.Clearnet limited the amount of gold that could be used as collateral to no more than 40% of the total margin cover requirement for a member across all products and at a maximum of $200 million, or roughly 130,000 troy ounces, per member group. David Farrar, Director, LCH.Clearnet said at the time that “market participants want greater choice when it comes to assets that can be used as collateral. Gold is ideal; as an asset it typically performs well in times of financial stress, remains liquid and has a well-established pricing mechanism.”

Thus the commercial banking system is and has prepared to treat gold as full-bloodied money because of its invaluable liquidity virtues and its acceptability even under pressure.

We believe that the markets have yet to catch up to what’s going to happen. But the current gold price breakout is not because of this aspect of gold; it’s because of both Technical and seasonal factors. When gold is a Tier I asset and commercial banks appear in the market place, then the gold market will also see a new driving force behind the gold price. There is still a considerable distance to go before the gold price really does discount these potential changes.

In summary, the banking system, overall, is moving toward where gold will be an active, confidence-building monetary asset.

Will ‘Powers that Be’ Continue to Allow Citizens to Own Gold?

With gold moving back to such a pivotal position in the monetary system, won’t the private sector interfere with the ‘stability’ of the gold market, chasing its price up just as the Hunt Brothers tried to do in the days of yesteryear? This is possible, but this time the gold price will not be at a fixed price as it was under the gold standard. By ‘floating’ the gold price, every time it rises in price, it will benefit bank’s balance sheets and liquidity levels, countering volatile markets. The reverse is true if the gold price falls and other assets rise in value as the markets seems to believe will be the case.

Overall there will be a ‘value anchor’ as Mr. Zoellick, the last head of the World Bank, advocated last year.

If these changes are instituted, there is a danger of interference in the gold market price by the public, but on the upside not the downside. After all, it will be in the interests of the monetary system to see higher gold prices rather than lower prices that the powers-that-be appeared to want between 1985 and 2005. But they will want to see a level of stability consistent with that of currencies and other monetary assets in that situation. Their desire for this can be overwhelming, as we saw in 1933 when U.S. citizens were banned from holding most forms of gold in the interest of the nation’s monetary system. It was not until 1974 that they were again permitted to do so; however, this permission came with the proviso that owning gold from then on was a “privilege, not a right” as though to warn us all that things could change again. Even though governments attempted to write gold out of the system, they made it clear that they considered gold as part of their domain.

This is a real danger and one that should not be overlooked by us all in all the nations of the world. Any government that feels it is in their interests to take their citizen’s gold will do so even if it means changing their laws.

Julian Philips' history in the financial world goes back to 1970, after leaving the British Army having been an Officer in the Light Infantry, serving in Malaya, Mauritius, and Belfast. After a brief period in Timber Management, Julian joined the London Stock Exchange, qualifying as a member. He specialised from the beginning in currencies, gold and the "Dollar Premium". At the time, the gold / currency world exploded into action after the floating of the $ and the Pound Sterling. He wrote on gold and the $ premium in magazines, Accountancy and The International Currency Review. Julian moved to South Africa, where he was appointed a Macro economist for the Electricity Supply Commission, guiding currency decisions on the multi-Billion foreign Loan Portfolio, before joining Chase Manhattan the the U.K. Merchant Bank, Hill Samuel, in Johannesburg, specialising in gold. He moved to Capetown, where establishing the Fund Management department of the Board of Executors. Julian returned to the 'Gold World' over two years ago and established "Gold - Authentic Money" and now contributing to "Global Watch - The Gold Forecaster".

The Faustian Bargain

The Faustian Bargain by guggenheimpartners.com

Since 2008, governments that have relied upon quantitative easing instead of undertaking structural reforms have arguably entered into a Faustian bargain of epic proportions. What are the potential consequences of global central banks printing trillions of dollars, euros, pounds, francs, and yen in an attempt to provide short-term fixes for their nations’ long-term economic problems?

In Goethe’s 1831 drama Faust, the devil persuades a bankrupt emperor to print and spend vast quantities of paper money as a short-term fix for his country’s fiscal problems. As a consequence, the empire ultimately unravels and descends into chaos. Today, governments that have relied upon quantitative easing (QE) instead of undertaking necessary structural reforms have arguably entered into the grandest Faustian bargain in financial history.

As a result of multi-trillion dollar quantitative easing programs, central banks around the world have compromised their ability to control the money supply, making them vulnerable to runaway inflation. When interest rates rise, the market value of central bank assets could fall below the face value of their liabilities, potentially rendering the banks incapable of protecting the stability and purchasing power of their currencies.

In the Beginning, There Was Gold

To better understand the potential consequences of quantitative easing, it is useful to review the historical evolution of central banking. Early central banks acted as clearing houses for gold. Individuals and trading companies placed their bullion on deposit at a central bank and received a claim that could be redeemed upon demand. The system’s strength was largely derived from its simplicity. This innovation had a profound effect on global trade. In the British Empire, for example, it meant a gold-backed pound note from London could be used for commercial purposes in Bombay.

Today, the gold standard no longer exists and for the first time the entire global monetary system is built on a foundation of fiat currencies. This monetary paradigm works because of an abiding faith that paper money will be accepted as a medium of exchange and remain a store of value. At the core of this system is the presumption that central banks, as the issuers of paper money, have enough assets that can be readily sold in the event that their currencies’ value begins to fall and the money supply needs to be reduced. When confidence in a central bank’s ability to reduce its money supply in a sufficient amount to maintain its currency’s purchasing power is drawn into question, there is a risk of a currency crisis or even hyperinflation.

While Europe has had central banking since the 17th century, the United States did not have a central bank until the beginning of the 20th century. As a direct result of the panic of 1907, the Progressive political movement created the Federal Reserve System in 1913. Under the newly created Federal Reserve, the definition of eligible central bank reserve assets was extended beyond gold to include short-term bills of trade such as bankers’ acceptances. By expanding the definition of reserve assets the Federal Reserve had the ability to temporarily increase the money supply in excess of the amount of its gold reserves, to provide elasticity to credit markets. This incremental flexibility in money creation was designed to reduce the risk of panics which had plagued the U.S. through most of the 19th century under the gold standard.

During the Great Depression of the 1930s the Federal Reserve sought greater flexibility and leverage. In 1934, the Federal Reserve noteholders’ right to convert paper to gold on demand was unexpectedly revoked and the U.S. government seized all of the citizenry’s gold holdings. Subsequently, the Treasury arbitrarily re-valued the price of gold from $20.70 to $35 per ounce. Nevertheless, the presumption remained that every U.S. dollar was “as good as gold” because the Federal Reserve continued to hold bullion as its primary reserve asset. 

A Dangerous Game

In 1935, the Federal Reserve was also granted “temporary” emergency powers allowing it to begin using Treasury securities, or government debt, as a reserve asset. The problem with Treasury securities as a reserve asset is that, unlike gold, they are affected by changes in the level of interest rates. The impact of interest rates on the value of these securities is commonly measured in units of time and price sensitivity referred to as duration.

The higher the duration of an asset, the more sensitive its price is to changes in interest rates. For example, an upward move in interest rates will cause the value of a bond with a duration of 10 years to fall by 10 times the value of a bond with a duration of one year.

DURATION: A way of measuring the sensitivity of a bond’s value to changes in interest rates. A bond’s duration is the number of years it takes for its cash flows to equal the price for which the lender (investor) bought the bond. A bond without periodic payments (zero-coupon bonds) has a duration equal to its term to maturity.

As the Federal Reserve’s holdings of Treasury securities increased relative to its gold holdings, its portfolio took on greater duration risk. For the first time, the potential existed that rising interest rates could cause the market value of the Federal Reserve’s assets to fall below the face value of its liabilities (Federal Reserve notes). This was not a concern under the tautological gold-backed system because the value of a central bank’s outstanding notes was directly tied to the amount of gold in its vaults.

The way to minimize the risk of a meaningful decline in the value of balance sheet capital resulting from a rise in interest rates was for central banks to maintain a relatively low debt-to-equity ratio while keeping a relatively short interest rate duration on its assets. By maintaining this discipline the Federal Reserve was virtually assured of having enough liquid assets at market levels to repurchase dollars without incurring large losses on its portfolio.

A Quantitative Quagmire

From the 1930s until the early part of the current century, the Federal Reserve was able to engage in relatively effective monetary policy. In 2008, just prior to the first of two rounds of quantitative easing, the Federal Reserve had $41 billion in capital and roughly $872 billion in liabilities, resulting in a debt-to-equity ratio of roughly 21-to-1. The Federal Reserve’s asset portfolio included $480 billion in Treasury securities with an average duration of about 2.5 years. Therefore, a 100 basis point increase in interest rates would have caused the value of its portfolio to fall by 2.5%, or $12 billion. A loss of that magnitude would have been severe but not devastating.

Beginning in 2008, the monetary orthodoxy of the previous 95 years quickly disappeared. By 2011, the Federal Reserve’s portfolio consisted of more than $2.6 trillion in Treasury and agency securities, mortgage bonds, and other obligations. This resulted in an increase in the central bank’s debt-to-equity ratio to roughly 51-to-1. Under Operation Twist the Federal Reserve swapped its short-term Treasury securities holdings for longer-term ones in an attempt to induce borrowing and growth in the economy. This caused an extension of the duration of the Federal Reserve’s portfolio to more than eight years.

Now, a 100 basis-point increase in interest rates would cause the market value of the Federal Reserve’s assets to fall by about 8% or approximately $200 billion which would leave the Federal Reserve with a capital deficit of $150 billion, rendering it insolvent under Generally Accepted Accounting Principles (GAAP). Although this may not happen in the immediate future, if interest rates rose five percentage points the Federal Reserve could lose more than a trillion dollars from its fixed income portfolio.

Staring Into a Monetary Abyss

Unlikely as it seems in a world of zero-bound interest rates, someday, as the economy continues to expand, the demand for credit will increase to the point that interest rates will begin to rise. In time, significantly stronger growth will create economic bottlenecks, placing upward pressure on prices. At that time the Federal Reserve would be expected to restrain credit growth by selling securities, resulting in a further increase in interest rates.

As interest rates rise, the market value of the Federal Reserve’s assets will fall. It could then become apparent that the face value of the Federal Reserve’s obligations had become greater than the market value of its assets. This could leave the Federal Reserve without enough liquid assets to sell to protect the purchasing power of the dollar, resulting in a downward spiral in its value.

If the dollar weakens relative to other currencies, its use as a reserve currency, and the safety of U.S. Treasuries, could falter. Given the United States’ dependence on foreign capital to finance its large fiscal deficits, a reduction in foreign flows could cause Treasury securities to lose a significant amount of value. The Federal Reserve could then find itself having to support the price of the country’s debt by becoming the buyer of last resort for Treasury securities. This scenario would closely resemble events unfolding in the periphery of Europe today. By printing increasing amounts of money to finance the national debt, the Federal Reserve would lose control of its ability to manage the money supply, leaving the government hostage to its printing press.

Investment Implications

To hedge against deterioration in the dollar’s purchasing power, investors have already begun migrating toward hard assets such as gold, commercial real estate, artwork, collectibles, and rare consumer products like fine wines. Such diversification may have significant barriers to entry, however, considering the risks built into financial assets, long-term investment portfolios should be at least partially composed of tangible assets.

Other areas that are likely to perform well in the immediate term due to effects of quantitative easing are credit-related instruments including bank-loans and asset-backed securities. High yield debt should perform well because abundant liquidity means default rates will remain low. Additionally, the ongoing balance sheet expansion by the European Central Bank means European equity prices are likely to outperform U.S. equities over the coming years.

Long-duration, fixed-rate assets such as government bonds are likely to underperform. Given the primacy of Treasury securities in the Federal Reserve’s current yield curve management program, Treasury bonds will come under the greatest pressure once the Federal Reserve ends QE. This asset class’ yields have fallen by over 1100 basis points in the past three decades. While no one knows if we have reached the bottom for Treasury rates, staying in the market for the final 50 or 60 basis points appears imprudent. As Jim Grant has noted, investors’ perception of U.S. Treasuries – and most sovereign debt – is shifting from representing risk-free return to “return-free risk.” Now is a better time to sell Treasury securities than to buy them, and for the stout of heart this is an opportunity to set short positions in the asset class.

An Uncertain Future

Half a year before the centennial of central banking in the U.S., neither policymakers nor investors have much to celebrate. By abandoning monetary orthodoxy and pursuing large-scale asset purchases, global central banks have increased the risk of inflation and compromised their ability to stamp it out. Inordinately higher leverage ratios and the extension of central bank portfolio duration means governments now face the potential for central bank solvency crises. It is too early to predict exactly how this Faustian bargain will play out; but, with each additional paper note that rolls off the printing press or gets conjured up in the ether, the likelihood of a happy ending becomes increasingly evanescent.

Source : http://guggenheimpartners.com/

How Long Will the Dollar Remain the World's Reserve Currency?

We frequently hear the financial press refer to the U.S. dollar as the "world's reserve currency," implying that our dollar will always retain its value in an ever shifting world economy. But this is a dangerous and mistaken assumption.

Since August 15, 1971, when President Nixon closed the gold window and refused to pay out any of our remaining 280 million ounces of gold, the U.S. dollar has operated as a pure fiat currency. This means the dollar became an article of faith in the continued stability and might of the U.S. government.

In essence, we declared our insolvency in 1971. Everyone recognized some other monetary system had to be devised in order to bring stability to the markets.

Amazingly, a new system was devised which allowed the U.S. to operate the printing presses for the world reserve currency with no restraints placed on it-- not even a pretense of gold convertibility! Realizing the world was embarking on something new and mind-boggling, elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC in the 1970s to price oil in U.S. dollars exclusively for all worldwide transactions. This gave the dollar a special place among world currencies and in essence backed the dollar with oil.

In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup. This arrangement helped ignite radical Islamic movements among those who resented our influence in the region. The arrangement also gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as the dollar flourished.

In 2003, however, Iran began pricing its oil exports in Euro for Asian and European buyers. The Iranian government also opened an oil bourse in 2008 on the island of Kish in the Persian Gulf for the express purpose of trading oil in Euro and other currencies. In 2009 Iran completely ceased any oil transactions in U.S. dollars. These actions by the second largest OPEC oil producer pose a direct threat to the continued status of our dollar as the world's reserve currency, a threat which partially explains our ongoing hostility toward Tehran.

While the erosion of our petrodollar agreement with OPEC certainly threatens the dollar's status in the Middle East, an even larger threat resides in the Far East. Our greatest benefactors for the last twenty years-- Asian central banks-- have lost their appetite for holding U.S. dollars. China, Japan, and Asia in general have been happy to hold U.S. debt instruments in recent decades, but they will not prop up our spending habits forever. Foreign central banks understand that American leaders do not have the discipline to maintain a stable currency.

If we act now to replace the fiat system with a stable dollar backed by precious metals or commodities, the dollar can regain its status as the safest store of value among all government currencies. If not, the rest of the world will abandon the dollar as the global reserve currency.

Both Congress and American consumers will then find borrowing a dramatically more expensive proposition. Remember, our entire consumption economy is based on the willingness of foreigners to hold U.S. debt. We face a reordering of the entire world economy if the federal government cannot print, borrow, and spend money at a rate that satisfies its endless appetite for deficit spending.

Author: Ron Paul

Congressman Ron Paul of Texas enjoys a national reputation as the premier advocate for liberty in politics today. Dr. Paul is the leading spokesman in Washington for limited constitutional government, low taxes, free markets, and a return to sound monetary policies based on commodity-backed currency. He is known among both his colleagues in Congress and his constituents for his consistent voting record in the House of Representatives: Dr. Paul never votes for legislation unless the proposed measure is expressly authorized by the Constitution. In the words of former Treasury Secretary William Simon, Dr. Paul is the "one exception to the Gang of 535" on Capitol Hill.