Developed World in Financial Decay – How Long Before Money Collapses?

 

by Julian D. W. Phillips - Gold Forecaster
Published : September 14th, 2012

The Current Scene

Since 2007 and the start of the “credit-crunch” the developed world’s money system has been under stress. As a consequence, there has been an economic downturn that government and bankers have not been able to stop, convincingly, in the last five years.

The developed world has decayed to the point that it can’t handle another major crisis such as an oil price well into the $100+ area.

• · Food inflation now threatening, must not be allowed to take off because consumer/voter reaction will undermine government and money still further. 

• · As it is confidence in both the euro and the dollar is at a low ebb. Yes, it is still the only means of exchange and it can be forced onto citizens, but general confidence in the economy, the monetary system and a broad range of markets is suffering as never before.

There are bright sparks of hope, such as the Dow Jones Index returning to the highs it saw in 2007; however, this is by no means in the same investment climate as before the credit-crunch. Fear and instability pervades most markets as faith declines.

Daily we see another Eurozone crisis unfold casting doubts on the continuance of the euro and the financial credibility of its weaker members. Overall, on both sides of the Atlantic, consumer confidence continues to fall after so many efforts by central bankers to resuscitate their economies.

Why is so large a burden being put onto the central bankers, who should only really support governments’ actions? Because the U.S. government is mired in political gridlock, it cannot achieve the vigorous action needed to do all it can to restore growth and confidence, and doubts now remain as to whether it’s too late for any government to do so.

[Forecasts of a dollar decline are seen daily as its debt levels mount to new unacceptable highs. With the impending ‘fiscal cliff’ on the horizon and promises of a heated political battle, consumers and companies expect a savage tax blow around year’s end, further damaging consumer confidence. Will we see a recession in the States next year? It seems likely. Its timing could not be worse.

In the Eurozone, we daily see discord between citizens of the financially stronger nations and the weaker ones. Government discord is constantly apparent. Growth is proving even more elusive in the world’s biggest trading bloc as it stands in a mild recession already.

Hope springs eternal, but today, realities keep hope on the run.

Can the Money System Collapse?

The thought seems unrealistic to people because it’s what we use every day. But the money we use is entirely reliant on government and its central bank. If their performance does not meet the criteria required by money then confidence in that money will collapse eventually. It’s clear that all currencies are not performing well at the moment as the balance sheet of most nations (except China) gets weaker and weaker. If most nations were individuals, then they would have been bankrupted by now.

A look back in history shows that not one paper currency system has lasted throughout the centuries, with the exception of those based solely on gold and silver which remain as money assets all the way.

Not today, you may well answer! We say oh, yes, today too. Despite all the rhetoric since 1971 gold remains in the bulk of the world’s leading reserves for that rainy day when something else is needed other than the currency issued by the nation’s central bank.

How Does Money Collapse?

Look back at Argentina in the 1990’s and you see it using the U.S. dollar, but the economy of Argentina could not support the use of the dollar so it reverted to the Peso after savaging its citizen’s dollar savings in exchange for that Peso. That was a ‘collapse’ of their currency. If the Greeks return to the Drachma or the Spanish the Peseta, we will see a similar scene; it will be a collapse of their currency (the euro) inside their nation.

Can the dollar collapse? Because it’s a government-controlled money system, the dollar will remain the means of exchange it is, even in a collapse.

A collapse will be expressed in several ways:

· Its exchange rate against other currencies can fall heavily. In the case of the dollar as the world’s foundation, un-backed currency, this is unlikely as it supports the un-backed currencies across the world indirectly. Its trading partners will try to pull their currencies down with it so as to protect their trading with the U.S. The same applies to a greater or lesser extent with the other main trading blocs of the world such as the Eurozone and China. You will have noted the narrow trading range of the € & the $ between $1.21 and $1.45 over the last few years. This is because of the mutual support between the Fed and the ECB by way of currency swaps.

• It can collapse inside the country, as its buying power declines rapidly. This is monetary inflation usually caused by the over-issuance of a currency.
  
• Another form of collapse could include a bond market collapse where the markets push interest rates up so high as to make it impossible for governments to repay debt. This level is generally set at 7% and we have seen it in the P.I.G.S. nations of the Eurozone over the last three years. If these countries had separate currencies, they would have collapsed, but inside the euro we see that that final collapse will be expressed by exiting the Eurozone and returning to past currencies.
  
• In a nation where there is still a working economy, a collapse can also be expressed by the imposition of Capital and Exchange Controls, restricting the flows of money in and out of a country to protect the capital inside its borders. Its citizens usually bear the brunt.

Can the Global Monetary System Collapse?

We’re of the opinion that even if the system is hobbling along, it will continue until global economies collapse. This was the case in Zimbabwe in the last decade. The Zimbabwe dollar continued in use because the government enforced its use inside its borders. But to all intents and purposes, it has collapsed long before then. In the case of Zimbabwe, the U.S. dollar became the currency in use in the country and in what’s left of its economy. This is still the case today.

Before any such collapse occurs, we are certain that each individual developed world economy would cooperate with each other to take whatever measures are available to them to shore up the monetary system. These measures will prevent the system from a total collapse, keeping it staggering on all the way. We believe that they will fully harness gold then.

The questions remaining are how and when?

source :  http://www.24hgold.com/

The Fed's Balance At The End Of 2013: $4 Trillion

What happens next:

• Imminently, the Fed's Open Markets Operations desk will commence buying $40 billion in MBS per month, or about $10 billion each week. Concurrently, the Fed which is continuing Operation Twist, will still purchase $45 billion in "longer-term" Treasurys, sterilized by the $45 billion or so in 1-3 years Bonds it will sell until the end of the year at which point it runs out of short-term paper to sell.

End result: every month through the end of 2012, the Fed's balance sheet expands by $40 billion in MBS.

• Beginning January 1, 2013 the Fed will continue monetizing $40 billion in MBS each month, and will continue Operation Twist, however it will adjust the program so that it continues to increase its long-term holdings at $85 billion per month, without sterilization as it will no longer have short-term bonds to sell. It will also need to extend its ZIRP language "through the end of 2016" so all bonds 1-3 years are essentially risk free, as they are now, in effect eliminating the need to sell them.

End result: every month in 2013 the Fed will increase its balance sheet by $85 billion, consisting of $40 billion in MBS, and $45 billion in 10-30 year Treasurys, or the natural monthly supply of longer-dated issuance. The Fed will therefore monetize roughly half of the US budget deficit in 2013.

Putting it all together, the Fed's balance sheet will increase from just over $2.8 trillion currently, to $4 trillion on December 25, 2013. A total increase of $1.17 trillion.

This is what the Fed's balance sheet will looks like:

Another way of visualizing this is how many assets as a percentage of US GDP the Fed will hold on its books. Currently, this number is 18%. By the end of 2013, the Fed's historical flow operations will be accountable for 24% of US GDP.

Why is this important? Simple: when the time comes for the Fed to unwind its balance sheet, if ever, the reverse Flow process will be responsible for deducting at least 24% of US GDP at the time when said tightening happens. If ever.

What is scariest, is that as of this moment, all of this is priced in. Any incremental gains in the stock market will have to come from additional easing over and above what Bernanke just announced.

And finally: Fed's DV01 at December 31, 2013: ~$4 billion

Submitted by Tyler Durden on 09/13/2012 17:39 -0400

source from : http://www.zerohedge.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

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".

Jim Rogers on the EU, the U S election, and the next big investment opportunity

Jim Rogers is an author, financial commentator and successful international investor. He has been frequently featured in Time, The New York Times, Barron’s, Forbes, Fortune, The Wall Street Journal, The Financial Times and is a regular guest on Bloomberg and CNBC

Jim Rogers, a native of Demopolis, Alabama, is an author, financial commentator and successful international investor. He has been frequently featured in Time, The Washington Post, The New York Times, Barron’s, Forbes, Fortune, The Wall Street Journal, The Financial Times, and most publications dealing with the economy or finance.

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.

Agnico CEO Warns Gold To Hit $3,000 On Supply Concerns

Today one of the top CEO’s in the world told King World News that going forward, “... we will see increasing central bank demand for gold.”  He also warned, “We will (also) see reduced supply.”  Sean Boyd, who is CEO of $8 billion Agnico Eagle, also discussed why the gold price is set up to frustrate the bears by nearly doubling from current levels.

Here is what Boyd had to say:  “We are just looking at further stimulus, this time coming out of China, where they are looking to spend over one trillion dollars on stimulus projects to try to boost the economy.  This takes us back to late 2008, when the powers that be were trying to sort out the financial crisis.”

Sean Boyd continues:

“The answer was more stimulus, and at the time gold was $700.  Gold went from $700, on the back of that stimulus (in 2008), to $1,900.  I think we are about to repeat that same pattern.  Here we are, gold is at (roughly) $1,600, and there are a lot of question about the weakness in the global economy.  There are certainly expectations that we are going to see a renewed round of stimulus coming out of Europe and the US....

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