The Fed and the ECB: Two Paths, One Goal

by Philipp Bagus

 Both the Federal Reserve (Fed) and the European Central Bank (ECB) are owners of the printing press. They produce base money. On top of the base-money production, the fractional-reserve-banking system can produce money out of thin air. Both central banks produce money in order to finance their respective governments. As a result of their money production, prices will be higher than they would have been otherwise. All money users indirectly pay for the government deficits through a reduction in purchasing power and the reduced quality of their money.
While the ECB's and Fed's functions (to provide liquidity to the banking system in times of crisis and to finance the government together with the banking system) are the same, there exist small differences between them. In the so-called open-market operations (another term for active manipulation of the money supply) the central banks produce or destroy base money.
There are two ways central banks produce base money. By tradition, the Fed uses the produce-money-and-purchase approach (PMP). Normally, the Fed produces money in their computers and uses it to buy US Treasuries from the banking system. In exchange for the US Treasuries, the Fed creates money on the account that the selling bank holds at the Fed.
The ECB, in contrast, uses the produce-money-and-lend (PML) approach. It produces money and lends it to the banking system for one week or three months. The preferred collateral for these loans to banks is government bonds.[1] As a result of PMP and PML, banks receive new base money. They hold more reserves at their account at the central bank. The additional reserves mean that they can now expand credit and create even more money.
For governments, the mechanism works out pretty well. They usually spend more than they receive in taxes, i.e., they run a deficit. No one likes taxes. Yet, most voters like to receive gifts from their governments. The solution for politicians is simple. They promise gifts to voters and finance them by deficits rather than with taxes. To pay for the deficit, governments issue paper tickets called government bonds such as US Treasuries.
An huge portion of the Treasuries are bought by the banking system, not only because the US government is conceived as a solvent debtor, thanks to its capacity to use violence to appropriate resources, but also because the Fed buys Treasuries in its open-market operations. The Fed, thereby, monetizes the deficit in a way that does not hurt politicians.
But what about the interest paid on the Treasuries? The US government has to pay interest on the bonds to their new owner, the Fed. The Fed receives the interest, which increases the Fed's profit. Who receives the Fed's profit? The bulk of the Fed's profit is remitted back to the US government at the end of the year.
But what about the principal on the bonds? What happens when the bond must be paid back? At the end of the term of the bonds, the government would have to pay its holders. The trick here is just to issue a new bond to pay for the maturing one. Thus, the debts must never be paid but keep getting monetized. Figure 1 shows how the Fed finances the US deficit:

Figure 1: How the Fed finances the US government

The ECB finances deficits in a more subtle way. Only in the sovereign-debt crisis did it start to buy government bonds outright. Normally, the ECB lends to banks against collateral. Banks buy government bonds because they know it is preferred collateral at the ECB. By pledging the bonds as collateral at the ECB, banks receive new reserves and can expand credit. As the government bonds are still owned by banks, governments have to pay interest to banks. Banks, in turn, pay interest on the loans they receive from the ECB, which remits its profits back to governments.
Thus, the system is similar to the Fed, with the difference that normally some of the interest payments leak out to the banking system that pays lower interest rates on its loans than it receives on the bonds. Another important difference is that there may be a redistribution between governments if eurozone governments run deficits of different sizes. In my book The Tragedy of the Euro I explain that the Eurosystem resembles a tragedy of the commons. Several independent governments can use one central-banking system to finance their deficits and externalize the costs in the form of a loss of purchasing power of the Euro onto all users of the currency. The incentive is to have higher deficits than other eurozone governments in order to profit from the monetary redistribution. The flow of the new money is shown in figure 2.

Figure 2: How the ECB finances Euro area governments

Is the difference between the Fed's and the ECB's manipulation of the money supply essential? The Fed buys government bonds outright, while the ECB accepts them as collateral for new loans to the banking system. Economically, the effects are identical. The money supply increases when the Fed buys government bonds. When the ECB grants a loan with government bonds pledged as collateral, the money supply increases as well. In the case of the Fed, the money supply increases until the Fed sells the bond. In the case of the ECB, the money supply increases until the ECB fails to roll over (renew) its loan to the banking system.
There exists a legal difference. The Fed integrates the government bonds on its balance sheet. The ECB does not do so as bonds remain legally the ownership of the banks. Because the ECB does not publish the collateral provided for its loans, we do not know how many Greek government bonds, for example, are provided as collateral for ECB loans. The Fed is more transparent in this respect.
In both cases, government deficits are effectively monetized. That means that the ECB was bailing out Greece even before May 2010. It did not have to buy the Greek bonds outright; it only had to accept them as collateral. If the ECB had not accepted Greek bonds, Greek debts could not have mounted to such an extent. The Greek government would have had to default much earlier.
Aside from this more direct monetization, there is also a monetization going on that is often neglected. Market participants know that central banks buy government bonds and accept them as the preferred collateral. Banks buy the bonds due to their privileged treatment ensuring a liquid market and pushing down yields.
Knowing that there is a very liquid market in government bonds and a high demand by banks, investment funds, pension funds, insurers, and private investors buy government bonds. Government bonds become very liquid and almost as good as base money. In many cases, they serve to create additional base money. In other cases they stand as a reserve to be converted into base money if necessary. As a consequence, new money created through credit expansion often ends up buying liquid government bonds, indirectly monetizing the debt. (Another main holder of government debts is other foreign central banks.)
Imagine that the government has a deficit and issues government bonds. Part is bought by the banking system and used to get additional reserves from the central bank, which buys the bonds or grants new loans, accepting them as collateral. The banking system uses the new reserves to expand credit and grant loans to, for example, the construction industry. With the new loans, the construction industry buys factors of production and pays its workers. The workers use part of the new money to invest in funds. The investment funds then use the new money to acquire government bonds. Thus, there is an indirect monetization. Part of the money created by the fractional-reserve-banking system ends up buying government bonds because of their preferential treatment by the central bank, i.e., its direct monetization.
The process is shown in figure 3:

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

Notes

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

The Fed Plays All Its Cards

by Peter Schiff - Europac

There never really could be much doubt that the current experiment in competitive global currency debasement would end in anything less than a total war. There was always a chance that one or more of the principal players would snap out of it, change course and save their citizenry from a never ending cycle of devaluation. But developments since September 13, when the U.S. Federal Reserve finally laid all its cards on the table and went "all in" on permanent quantitative easing, indicate that the brainwashing is widely established and will be difficult to break. The vast majority of the world's leading central bankers seem content to walk in lock step down the path of money creation as a means to economic salvation. Never mind that the path will prevent real growth and may ultimately lead off a cliff. The herd is moving. And if it can't be turned, the only thing that one can do is attempt to get out of its way.

The details of the Fed's new plan (which I christened Operation Screw in last week's commentary) are not nearly as important as the philosophy it reveals. The Federal Reserve has already unleashed two huge waves of quantitative easing (purchases of either government securities or mortgage-backed securities) in order to stimulate consumer spending and ignite business activity. But the economy has not responded as hoped. GDP growth has languished below trend, the unemployment rate has stayed north of 8%, and the labor participation rate has fallen to all-time lows. In the meantime, America's fiscal position has grown significantly worse with government debt climbing to unimaginable territory. Despite the lack of results, the conclusion at the Federal Reserve is that the programs were too small and too incremental to be effective. They have determined that something larger, and potentially permanent, would be more likely to do the trick.

However, in making its new plan public, the Fed made a startling admission. At his press conference, Ben Bernanke backed away from previous assertions that printed money would be effective in directly pushing up business activity. Instead he explained how the new stimulus would be focused directly at the housing market through purchases of mortgage backed securities. He made clear that this strategy is intended to spark a surge in home prices that will in turn pull up the broader economy. Such a belief requires a dangerous amnesia to the events of the last decade. Despite x²the calamity that followed the bursting of our last housing bubble, economists feel this to be a wise strategy, proving that a poor memory is a prerequisite for the profession.

But now that the Fed is thus committed, the focus has shifted to foreign capitals. Not surprisingly, the dollar came under immediate pressure as soon as the plan was announced. In the 24 hours following the announcement, the Greenback was down 2.2% against the euro, 1.6% against the Australian Dollar, and 1.1% against the Canadian Dollar. A week after the Fed's move, the Mexican Peso had appreciated 2.7% against the US dollar. Many currency watchers noted that more dollar declines would be likely if foreign central banks failed to match the Fed in their commitments to print money. On cue, the foreign bankers responded.

It is seen as gospel in our current "through the looking glass" economic world that a weak currency is something to be desired and a strong currency is something to be disdained. Weak currencies are supposed to offer advantages to exporters and are seen as an easy way to boost GDP. In reality, weak currencies simply create the illusion of growth while eroding real purchasing power. Strong currencies confer greater wealth and potency to an economy. But in today's world,no central banker is prepared to stand idly by while their currency appreciates. As a result, foreign central banks are rolling out their own heavy artillery to combat the Fed.

Perhaps anticipating the Fed's actions, on September 6th the European Central Bank announced its own plan of unlimited buying of debt of troubled EU nations (however, the plan did come with important concessions to the German point of view - see John Browne's commentary). On September 17th, the Brazilian central bank auctioned $2.17 billion of reverse swap contracts to help push down the Brazilian Real. The next day, Peru and Turkey cut rates more than expected. On September 19th, the Bank of Japan increased its asset purchase program from 70 trillion yen to 80 trillion and extended the program by six months. It's clear we are seeing a central banking domino effect that is not likely to end in the foreseeable future.

Although the Fed is directing its fire towards the housing market, the needle they are actually hoping to move is not home prices, but the unemployment rate. Until that rate falls to the desired levels (some at the Fed have suggested 5.5%), then we can be fairly certain that these injections will continue. This will place permanent pressure on banks around the world to follow suit.

All of this simultaneous money creation will likely be a boon for nominal stock and real estate prices. But in real terms such gains will likely not keep pace with dollar depreciation. Inflation pushes up prices for just about everything, so stocks and real estate are not likely to prove to be exceptions. Even bond prices can rise in the short term, but their real values are the most vulnerable to decline. In fact, even nominal bond prices will ultimately fall, as inflation eventually sends interest rates climbing. But prices for hard assets, precious metals, commodities, and even those few remaining relatively hard currencies should be on the leading edge of the upward trend in prices.

While I believe the Fed's plan will be a disaster for the economy, the silver lining is that it provides investors with a road map. As the policy of the Fed is to debase the currency, those holding dollar based assets may seek alternatives in hard assets and in the currencies of the few remaining countries whose bankers have not drunken so freely from the Keynesian Kool-Aid. We believe that such opportunities do exist. Some broad ideas are outlined in the latest edition of my Global Investor Newsletter, which became available for download this week. I encourage those looking for ways to distance their wealth from the policies of Ben Bernanke to start their search today.

Peter Schiff is CEO of Euro Pacific Precious Metals, a gold and silver dealer selling reputable, well-known bullion coins and bars at competitive prices.

Damages

William H. Gross

  

• The U.S. has federal debt/GDP less than 100%, Aaa/AA+ credit ratings, and the benefit of being the world’s reserve currency.
• Studies by the CBO, IMF and BIS (when averaged) suggest that we need to cut spending or raise taxes by 11% of GDP and rather quickly over the next five to 10 years. 
• Unless we begin to close this gap, then the inevitable result will be that our debt/GDP ratio will continue to rise, the Fed would print money to pay for the deficiency, inflation would follow, and the dollar would inevitably decline.

I have an amnesia of sorts. I remember almost nothing of my distant past – a condition which at the brink of my 69th year is neither fatal nor debilitating, but which leaves me anchorless without a direction home. Actually, I do recall some things, but they are hazy almost fairytale fantasies, filled with a lack of detail and usually bereft of emotional connections. I recall nothing specific of what parents, teachers or mentors said; no piece of advice; no life’s lessons. I’m sure there must have been some – I just can’t remember them. My life, therefore, reads like a storybook filled with innumerable déjà vu chapters, but ones which I can’t recall having read.

I had a family reunion of sorts a few weeks ago when my sister and I traveled to Sacramento to visit my failing brother – merely 18 months my senior. After his health issues had been discussed we drifted onto memory lane – talking about old times. Hadn’t I known that Dad had never been home, that he had spent months at a time overseas on business in Africa and South America? “Sort of, but not really,” I answered – a strange retort for a near adolescent child who should have remembered missing an absent father. Didn’t I know that our parents were drinkers; that Mom’s “gin-fizzes” usually began in the early afternoon and ended as our high school homework was being put to bed? “I guess not,” I replied, “but perhaps after the Depression and WWII, they had a reason to have a highball or two, or three.”

My lack of personal memory, I’ve decided, may reflect minor damage, much like a series of concussions suffered by a football athlete to his brain. Somewhere inside of my still intact protective helmet or skull, a physical or emotional collision may have occurred rendering a scar which prohibited proper healing. Too bad. And yet we all suffer damage in one way or another, do we not? How could it be otherwise in an imperfect world filled with parents, siblings and friends with concerns of their own for a majority of the day’s 24 hours? Sometimes the damage manifests itself in memory “loss” or repression, sometimes in self-flagellation or destructive behavior towards others. Sometimes it can be constructive as when those with damaged goods try to help others even more damaged. Whatever the reason, there are seven billion damaged human beings walking this earth.

For me, though, instead of losing my mind, I’ve simply lost my long-term memory. It’s a damnable state of affairs for sure – losing a chance to write your autobiography and any semblance of recalling what seems to have been a rather productive life. But I must tell you – it has its benefits. Each and every day starts with a relatively clean page, a “magic slate” of sorts where you can just lift the cellophane cover and completely erase minor transgressions, slights or perceived sins of others upon a somewhat fragile humanity. I get over most things and move on rather quickly. The French writer Jules Renard once speculated that “perhaps people with a detailed memory cannot have general ideas.” If so, I may be fortunate. So there are pluses and minuses to this memory thing, and like most of us, I add them up and move on. If that be the only disadvantage on my life’s scorecard – and there cannot be many – I am a lucky man indeed.

The ring of fire
In last month’s Investment Outlook I promised to write about damage of a financial kind – the potential debt peril – the long-term fiscal cliff that waits in the shadows of a New Normal U.S. economy which many claim is not doing that badly. After all, despite approaching the edge of 2012’s fiscal cliff with our 8% of GDP deficit, the U.S. is still considered the world’s “cleanest dirty shirt.” It has federal debt/GDP less than 100%, Aaa/AA+ credit ratings, and the benefit of being the world’s reserve currency – which means that most global financial transactions are denominated in dollars and that our interest rates are structurally lower than other Aaa countries because of it. We have world-class universities, a still relatively mobile labor force and apparently remain the beacon of technology – just witness the never-ending saga of Microsoft, Google and now Apple. Obviously there are concerns, especially during election years, but are we still not sitting in the global economy’s catbird seat? How could the U.S. still not be the first destination of global capital in search of safe (although historically low) prospective returns?

Well, Armageddon is not around the corner. I don’t believe in the imminent demise of the U.S. economy and its financial markets. But I’m afraid for them. Apparently so are many others, among them the IMF (International Monetary Fund), the CBO (Congressional Budget Office) and the BIS (Bank of International Settlements). I hold on my lap as I write this September afternoon the recently published annual reports for each of these authoritative and mainly non-political organizations which describe the financial balance sheets and prospective budgets of a plethora of developed and developing nations. The CBO of course is perhaps closest to our domestic ground in heralding the possibility of a fiscal train wreck over the next decade, but the IMF and BIS are no amateur oracles – they lend money and monitor financial transactions in the trillions. When all of them speak, we should listen and in the latest year they’re all speaking in unison. What they’re saying is that when it comes to debt and to the prospects for future debt, the U.S. is no “clean dirty shirt.” The U.S., in fact, is a serial offender, an addict whose habit extends beyond weed or cocaine and who frequently pleasures itself with budgetary crystal meth. Uncle Sam’s habit, say these respected agencies, will be a hard (and dangerous) one to break.

What standards or guidelines do their reports use and how best to explain them? Well, the three of them all try to compute what is called a “fiscal gap,” a deficit that must be closed either with spending cuts, tax hikes or a combination of both which keeps a country’s debt/GDP ratio under control. The fiscal gap differs from the “deficit” in that it includes future estimated entitlements such as Social Security, Medicare and Medicaid which may not show up in current expenditures. Each of the three reports target different debt/GDP ratios over varying periods of time and each has different assumptions as to a country’s real growth rate and real interest rate in future years. A reader can get confused trying to conflate the three of them into a homogeneous “fiscal gap” number. The important thing, though, from the standpoint of assessing the fiscal “damage” and a country’s relative addiction, is to view the U.S. in comparison to other countries, to view its apparently clean dirty shirt in the absence of its reserve currency status and its current financial advantages, and to point to a more distant future 10-20 years down the road at which time its debt addiction may be life, or certainly debt, threatening.

I’ve compiled all three studies into a picture chart perhaps familiar to many Investment Outlook readers. Several years ago I compared and contrasted countries from the standpoint of PIMCO’s “Ring of Fire.” It was a well-received Outlook if only because of the red flames and a reference to an old Johnny Cash song – “I fell into a burning ring of fire –I went down, down, down and the flames went higher.” Melodramatic, of course, but instructive nonetheless – perhaps prophetic. What the updated IMF, CBO and BIS “Ring” concludes is that the U.S. balance sheet, its deficit (y-axis) and its “fiscal gap” (x-axis), is in flames and that its fire department is apparently asleep at the station house.

To keep our debt/GDP ratio below the metaphorical combustion point of 212 degrees Fahrenheit, these studies (when averaged) suggest that we need to cut spending or raise taxes by 11% of GDP and rather quickly over the next five to 10 years. An 11% “fiscal gap” in terms of today’s economy speaks to a combination of spending cuts and taxes of $1.6 trillion per year! To put that into perspective, CBO has calculated that the expiration of the Bush tax cuts and other provisions would only reduce the deficit by a little more than $200 billion. As well, the failed attempt at a budget compromise by Congress and the President – the so-called Super Committee “Grand Bargain”– was a $4 trillion battle plan over 10 years worth $400 billion a year. These studies, and the updated chart “Ring of Fire – Part 2!” suggests close to four times that amount in order to douse the inferno.

And to draw, dear reader, what I think are critical relative comparisons, look at who’s in that ring of fire alongside the U.S. There’s Japan, Greece, the U.K., Spain and France, sort of a rogues’ gallery of debtors. Look as well at which countries have their budgets and fiscal gaps under relative control – Canada, Italy, Brazil, Mexico, China and a host of other developing (many not shown) as opposed to developed countries. As a rule of thumb, developing countries have less debt and more underdeveloped financial systems. The U.S. and its fellow serial abusers have been inhaling debt’s methamphetamine crystals for some time now, and kicking the habit looks incredibly difficult.


As one of the “Ring” leaders, America’s abusive tendencies can be described in more ways than an 11% fiscal gap and a $1.6 trillion current dollar hole which needs to be filled. It’s well publicized that the U.S. has $16 trillion of outstanding debt, but its future liabilities in terms of Social Security, Medicare, and Medicaid are less tangible and therefore more difficult to comprehend. Suppose, though, that when paying payroll or income taxes for any of the above benefits, American citizens were issued a bond that they could cash in when required to pay those future bills. The bond would be worth more than the taxes paid because the benefits are increasing faster than inflation. The fact is that those bonds today would total nearly $60 trillion, a disparity that is four times our publicized number of outstanding debt. We owe, in other words, not only $16 trillion in outstanding, Treasury bonds and bills, but $60 trillion more. In my example, it just so happens that the $60 trillion comes not in the form of promises to pay bonds or bills at maturity, but the present value of future Social Security benefits, Medicaid expenses and expected costs for Medicare. Altogether, that’s a whopping total of 500% of GDP, dear reader, and I’m not making it up. Kindly consult the IMF and the CBO for verification. Kindly wonder, as well, how we’re going to get out of this mess.

Investment conclusions
So I posed the question earlier: How can the U.S. not be considered the first destination of global capital in search of safe (although historically low) returns? Easy answer: It will not be if we continue down the current road and don’t address our “fiscal gap.” IF we continue to close our eyes to existing 8% of GDP deficits, which when including Social Security, Medicaid and Medicare liabilities compose an average estimated 11% annual “fiscal gap,” then we will begin to resemble Greece before the turn of the next decade. Unless we begin to close this gap, then the inevitable result will be that our debt/GDP ratio will continue to rise, the Fed would print money to pay for the deficiency, inflation would follow and the dollar would inevitably decline. Bonds would be burned to a crisp and stocks would certainly be singed; only gold and real assets would thrive within the “Ring of Fire.”

If that be the case, the U.S. would no longer be in the catbird’s seat of global finance and there would be damage aplenty, not just to the U.S. but to the global financial system itself, a system which for 40 years has depended on the U.S. economy as the world’s consummate consumer and the dollar as the global medium of exchange. If the fiscal gap isn’t closed even ever so gradually over the next few years, then rating services, dollar reserve holding nations and bond managers embarrassed into being reborn as vigilantes may together force a resolution that ends in tears. It would be a scenario for the storybooks, that’s for sure, but one which in this instance, investors would want to forget. The damage would likely be beyond repair.

William H. Gross
Managing Director 

Hyperinflation Watch - Cyclical or Structural?

by James Turk - Goldmoney

The US federal government spent $369 billion in August, but only received $179 billion in revenue. The resulting $190 billion deficit was a record for any August and the third highest monthly deficit in the current fiscal year, which ends on September 30th.

Looking at this deficit another way, the federal government borrowed 51.6% of the dollars it spent in August. Consequently, the growth of the national debt continues to accelerate, as illustrated by the green bars in the following chart.

This chart also illustrates that the deficit – the gap between expenditures (red line) and revenue (blue line) – is not narrowing to any significant extent, which is a critically important observation. A persistent gap that is barely shrinking has never happened before.

Normally economic activity revives after a recession, which in turn leads to increased revenue for the federal government, like it did from 2004-2008 when the more rapid growth in revenue almost eliminated the deficit. But not this time. Revenue is increasing, but so are expenditures at almost the same rate.

Consequently, the deficit is not shrinking, which confirms a point I have made repeatedly for two years. The US is confronting a structural problem. It is not a cyclical one that will go away with improved economic activity. Importantly, the failure to address this problem will eventually lead to hyperinflation and the destruction of the dollar.

Mr. Bernanke sees it differently. Here is what he said in his well-publicized Jackson Hole speech on August 31st.

“In light of the policy actions the FOMC has taken to date, as well as the economy's natural recovery mechanisms, we might have hoped for greater progress by now in returning to maximum employment. Some have taken the lack of progress as evidence that the financial crisis caused structural damage to the economy, rendering the current levels of unemployment impervious to additional monetary accommodation. The literature on this issue is extensive, and I cannot fully review it today. However, following every previous U.S. recession since World War II, the unemployment rate has returned close to its pre-recession level, and, although the recent recession was unusually deep, I see little evidence of substantial structural change in recent years.” [emphasis added]

Note how Mr. Bernanke relies on precedent to defend his point of view. He believes that economic activity will grow just like it has after “every previous U.S. recession since World War II” because unemployment will fall as it always has, even though unemployment remains stubbornly high. Not only does he thereby imply that so-called black-swans – which are rare events – exist, he clearly refuses to believe that we may already be in one. To see the “evidence of substantial structural change” he says is missing, all Mr. Bernanke needs to do is look at the deficit gap so clearly illustrated in the above chart.

It is not the first time Mr. Bernanke has relied on ‘what is supposed to happen’ instead of what is actually happening. The following is from a CNBC interview on July 1, 2005.

“INTERVIEWER: Tell me, what is the worst-case scenario? We have so many economists coming on our air saying ‘Oh, this is a bubble, and it’s going to burst, and this is going to be a real issue for the economy.’ Some say it could even cause a recession at some point. What is the worst-case scenario if in fact we were to see prices come down substantially across the country?

BERNANKE: Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.” [emphasis added]

Just a few months before, Doubleday published The Collapse of the Dollar and How to Profit From It, the book I co-authored with John Rubino. Here is what we said on page 164 after providing our analysis of the housing market: “To put it bluntly, by virtually every measure, today’s housing market is a classic financial bubble.” The housing bubble was apparent not only to John and me, but also the dozens of others who understand the fundamental economic principles of the Austrian School. Apparently, that does not include Mr. Bernanke.

In conclusion, don’t put your faith on the pronouncements of any central planner. Rely instead on your own common sense, which hopefully has been well grounded by insights from parents or grandparents who lived through the collapse of the German Reichsmark, Serbian dinar, Argentine austral or any of dozens of other currency collapses. If you did not have that opportunity to learn from relatives who experienced a currency collapse firsthand, then I recommend that you read Mises, Rothbard and the other Austrian School scholars published at Mises.org.

Once you do, then decide for yourself whether the problem facing the US is cyclical or structural. Common sense and experience are telling me that it is structural.

Sadly, policymakers are doing little if anything about it. So we need to prepare for the consequences. The best way to do that of course is to own physical gold and silver.

Originally published at http://www.fgmr.com/cyclical-or-structural.html

Race To Debase - 2012 Q3 - Fiat Currencies vs Gold & Silver

GoldSilver.com

Welcome back to the Worldwide Fiat Currency Race to Debase!

Gold has recently touched new all time highs in terms of euros, Swiss francs, and Brazilian real.
Below you will find a report on 75 different fiat currencies vs gold and silver from around the globe.  
Note how they have ALL lost value to gold and silver thus far in 2012.  
With recent announcements of even further central bank monetary easing policies (QE3, Japan, Brazil, etc.) we fully expect the current gold bull market and silver bull market revaluation trend to not only continue, but to quicken moving forward. 
Be sure to also click here and see how fiat currencies have performed against gold and silver over the last 12+ years.
   

Base Currency vs 1 Gold Ounce	1-Jan-12	30-Sep-12	% Gold +/- 2012 Q3
Afghanistan Afghanis	75,531	89,681	18.7%
Albania Leke	168,101	192,130	14.3%
Algeria Dinars	117,439	140,418	19.6%
Argentina Pesos	6,725	8,324	23.8%
Australia Dollars	1,531	1,708	11.6%
Bahamas Dollars	1,563	1,773	13.5%
Bahrain Dinars	589	669	13.5%
Bangladesh Taka	127,834	144,798	13.3%
Barbados Dollars	3,126	3,547	13.5%
Bermuda Dollars	1,563	1,773	13.5%
Brazil Reais	2,911	3,592	23.4%
Bulgaria Leva	2,362	2,691	13.9%
CFA BEAC Francs	791,233	904,853	14.4%
Canada Dollars	1,597	1,744	9.2%
Chile Pesos	811,978	840,821	3.6%
China Yuan Renminbi	9,839	11,147	13.3%
Colombia Pesos	3,029,385	3,192,957	5.4%
CFP Franc	143,941	164,611	14.4%
Base Currency vs 1 Gold Ounce	1-Jan-12	30-Sep-12	% Gold +/- 2012 Q3
Costa Rica Colones	788,922	873,382	10.7%
Croatia Kuna	9,094	10,259	12.8%
Czech Republic Koruna	30,882	34,666	12.3%
Denmark Kroner	8,960	10,284	14.8%
Dominican Republic Pesos	60,181	69,694	15.8%
East Caribbean Dollars	4,221	4,788	13.5%
Egypt Pounds	9,424	10,813	14.7%
Euro	1,206	1,379	14.4%
Fiji Dollars	2,846	3,141	10.4%
Hong Kong Dollars	12,143	13,751	13.2%
Hungary Forint	379,759	393,615	3.6%
IMF Special Drawing Rights	1,018	1,153	13.2%
Iceland Kronur	191,361	219,299	14.6%
India Rupees	82,941	93,721	13.0%
Indonesia Rupiahs	14,177,770	16,962,571	19.6%
Iran Rials	17,390,044	21,751,503	25.1%
Iraq Dinars	1,828,104	2,066,011	13.0%
Israel New Shekels	5,970	6,951	16.4%
Jamaica Dollars	133,727	158,395	18.4%
Base Currency vs 1 Gold Ounce	1-Jan-12	30-Sep-12	% Gold +/- 2012 Q3
Japan Yen	120,542	138,299	14.7%
Jordan Dinars	1,109	1,252	12.9%
Kenya Shillings	132,790	151,182	13.9%
Kuwait Dinars	435	498	14.4%
Lebanon Pounds	2,350,978	2,663,647	13.3%
Malaysia Ringgits	4,954	5,425	9.5%
Mauritius Rupees	45,175	54,159	19.9%
Mexico Pesos	21,802	22,813	4.6%
Morocco Dirhams	13,404	15,254	13.8%
New Zealand Dollars	2,010	2,137	6.3%
Norway Kroner	9,345	10,156	8.7%
Oman Rials	602	681	13.2%
Pakistan Rupees	140,605	168,273	19.7%
Peru Nuevos Soles	4,215	4,607	9.3%
Philippines Pesos	68,466	74,039	8.1%
Poland Zloty	5,374	5,681	5.7%
Qatar Riyals	5,692	6,457	13.4%
Romania New Lei	5,210	6,264	20.2%
Russia Rubles	50,021	55,332	10.6%
Base Currency vs 1 Gold Ounce	1-Jan-12	30-Sep-12	% Gold +/- 2012 Q3
Saudi Arabia Riyals	5,862	6,648	13.4%
Singapore Dollars	2,027	2,177	7.4%
South Africa Rand	12,630	14,739	16.7%
South Korea Won	1,810,284	1,970,780	8.9%
Sri Lanka Rupees	180,278	229,522	27.3%
Sudan Pounds	4,176	7,826	87.4%
Sweden Kronor	10,794	11,644	7.9%
Switzerland Francs	1,467	1,666	13.6%
Taiwan New Dollars	47,324	51,938	9.7%
Thailand Baht	49,310	54,674	10.9%
Trinidad and Tobago Dollars	9,926	11,390	14.8%
Tunisia Dinars	2,339	2,790	19.3%
Turkey Lira	2,957	3,187	7.8%
United Arab Emirates Dirhams	5,742	6,514	13.4%
United Kingdom Pounds	1,007	1,097	9.0%
United States Dollars	1,563	1,773	13.5%
Venezuela Bolivares Fuertes	6,722	7,626	13.5%
Vietnam Dong	32,873,044	36,999,792	12.6%
Zambia Kwacha	7,995,512	8,918,429	11.5%

Gold is Good Money - Dr. Ron Paul, U.S. Congressman

goldseek.com

Last year the Chairman of the Federal Reserve told me that gold is not money, a position which central banks, governments, and mainstream economists have claimed is the consensus for decades. But lately there have been some high-profile defections from that consensus. As Forbes recently reported, the president of the Bundesbank (Germany's central bank) and two highly-respected analysts at Deutsche Bank have praised gold as good money.

Why is gold good money? Because it possesses all the monetary properties that the market demands: it is divisible, portable, recognizable and, most importantly, scarce - making it a stable store of value. It is all things the market needs good money to be and has been recognized as such throughout history. Gold rose to nearly $1800 an ounce after the Fed's most recent round of quantitative easing because the people know that gold is money when fiat money fails.

Central bankers recognize this too, even if they officially deny it. Some analysts have speculated that the International Monetary Fund's real clout is due to its large holdings of gold. And central banks around the world have increased their gold holdings over the last year, especially in emerging market economies trying to protect themselves from the collapse of Western fiat currencies.

Fiat money is not good money because it can be issued without limit and therefore cannot act as a stable store of value. A fiat monetary system gives complete discretion to those who run the printing press, allowing governments to spend money without having to suffer the political consequences of raising taxes. Fiat money benefits those who create it and receive it first, enriching government and its cronies. And the negative effects of fiat money are disguised so that people do not realize that money the Fed creates today is the reason for the busts, rising prices and unemployment, and diminished standard of living tomorrow.

This is why it is so important to allow people the freedom to choose stable money. Earlier this Congress I introduced the Free Competition in Currency Act (H.R. 1098) to permit people to use gold as money again. By eliminating taxes on gold and other precious metals and repealing legal tender laws, people are given the option between using good money or fiat money. If the government persists in debasing the dollar – as money monopolists have always done – then the people would be able to protect themselves by using alternatives such as gold that are both sound and stable.

As the fiat money pyramid crumbles, gold retains its luster. Rather than being the barbarous relic Keynesians have tried to lead us to believe it is, gold is, as the Bundesbank president put it, "a timeless classic." The defamation of gold wrought by central banks and governments is because gold exposes the devaluation of fiat currencies and the flawed policies of government. Governments hate gold because the people cannot be fooled by it.

THE BUBBLE - A chronological re-ordering of the events and arguments of the bubble

thebubblefilm.com

Who Caused it. Who Called it. What’s Next.

Coming in Fall 2012, The Bubble asks the experts who predicted the current recession, “What happened and why?” Diving deep into the true causes of the financial crisis, renowned economists, investors and business leaders explain what America is facing if we don't learn from our past mistakes. The film poses the question: “Is the economy really improving or are we just blowing up another Bubble?”

A chronological re-ordering of the events and arguments of THE BUBBLE

PART 1: THE CAUSES

The Federal Reserve and Interest Rates


Low interest rates from the Federal Reserve enticed people to borrow savings that did not exist. Both the government and the artificially lowered interest rate diverted resources into housing, creating a bubble that would inevitably burst.
· Increased home prices encouraged home owners to borrow money based on their real estate price and accumulate more debt.
· When the market responded by forcing interest rates back up, these bubble projects failed. People realized they could not afford this lifestyle.


Government Guarantees

· Fannie Mae and Freddie Mac were Government Sponsored Enterprises that subsidize and guarantee home mortgages. Their liabilities were implicitly guaranteed by the government, who nationalized them in September of 2008.

· Banks frequently underwrote bad mortgages and sold them on secondary markets created by Fannie Mae and Freddie Mac.

· Commercial bank deposits are guaranteed by the FDIC, a highly leveraged government program that allows banks to take more risks.

· The Greenspan Put was the widespread belief in the market that Alan Greenspan would intervene to bail out the financial sector whenever threatened. This was based on his reaction to the Savings & Loan Crisis, the bailout of the Mexican Peso in the 90’s, the bailout of LTCM, the liquidity approaching Y2k, and his actions forcing the interest rate down to 1% for a full year after September 11th. This was later replaced with the even larger Bernanke Put.

Government Home Ownership Policies

· The mortgage income tax deduction artificially stimulated the real estate market and led to larger home purchases.

· The Basel regulations allowed banks to be more leveraged if they held mortgage loans and even more leveraged if they held mortgage backed securities.

· Presidents Clinton, Bush, and Obama have all attempted to decrease the down payment needed to buy homes.

Nontraditional Mortgages

· Includes both subprime loans (low credit score) and alt-a loans. (low down payment, adjustable rate, no doc)

· By 2008, half of all mortgages were nontraditional mortgages.

· Fannie Mae and Freddie Mac owned more nontraditional mortgages than the entire private sector.



Affordable Housing

· The Department of Housing & urban Development required Fannie and Freddie to allocate 50% of mortgages to individuals that were at or below the median income in their communities.

· The Community Reinvestment Act required mortgage lenders to fulfill a quota for low and moderate income home buyers in certain communities. Although it was expanded in the 1990’s, the role in the housing bubble was minor.

PART 2: PAST CRISES

Panic of 1920

· The Depression of 1920 was worse than the first year of the Great Depression. Production fell 21%, GDP dropped 24% and unemployment went from 4% to 11.7%.

· The Federal Government cut spending in half from 1920 to 1922 and did not enact a stimulus policy.

· The Depression ended in the summer of 1921 and unemployment dropped to 6.7% in 1922 and 2.4% in 1923.

The Great Depression

· Nominal GDP was down 46% during the Great Depression.

· Both Herbert Hoover and Franklin Delano Roosevelt increased government spending while implementing wage and price controls, along with tariffs.

· The Great Depression lasted a decade and the economy did not recover until World War II was over.

Inflation In The 1970s

· America rapidly increased the money supply and abandoned the gold standard in 1971.

· The economy suffered a downturn and prices increased dramatically. The cost of oil alone went from $3 to $30 a barrel.

· To fight inflation, Federal Reserve chairman Paul Volcker allowed interest rates to rise, by slowing down money creation. This lowered price inflation from 13.5% at its peak to 3.2% in 1983.

· The high unemployment and high inflation of the 1970s was predicted by the Austrians, while the Keynesian school of economics believed that combination to be impossible.

PART 3: Response To The Current Crisis

Interest Rate Cuts

· The Federal Reserve has consistently lowered interest rates throughout the crisis.

· They have now pushed interest rates down to zero.


Bailouts

· Bear Stearns creditors were bailed out on March 14th, 2008, despite their investment bank being leveraged 35.5:1.

· Fannie Mae and Freddie Mac were taken over by the government in September of 2008. This confirmed that their debt was guaranteed by the government. Treasury Secretary Paulson claimed in July 2008 that the companies were adequately capitalized despite only having $83 billion for $5 trillion in obligations.

· Although Lehman Brothers was allowed to fail, the rest of the financial sector was bailed out by the Federal Reserve, the Treasury department, and Congress.

· When Congress did not bail out the auto companies, President Bush did.

Stimulus Spending

· In February of 2008, following uncertainty in the Subprime mortgage market, George W. Bush signed a stimulus bill for over $152 billion dollars, attempting to get people to spend again.

· To support the housing market, George W. Bush signed the economic recovery act of 2008 which added $800 billion to the national debt.

· Following the bankruptcy of Washington Mutual and the bailout of AIG, George W. Bush signed the Trouble Asset Recovery Program which authorized the Treasury to buy up to $700 billion in bad assets.

· Due to the slow moving economy, newly elected President Obama continued George W. Bush’s spending spree by signing a $862 billion dollar stimulus bill.

PART 4: What America is Facing

Education Bubble

· Student loan debt’s version of Fannie Mae is called Sallie Mae.

· Student loans have spiked over a trillion dollars, more than all the car loans in the country combined.

· Graduates are finding they cannot pay back their loans with or without a job.

Coming Price Inflation

· Prices will dramatically rise due to the money created in response to the housing crash.

· Increased prices will lower the standard of living in the country.

· The devalued dollar resulting from inflation will wipe out savings for millions of Americans, particularly in the lower and middle classes.


National Debt Bubble

· The national debt approaching $16 trillion dollars is not sustainable.

· Foreign countries will stop buying Treasury bonds and interest rates will rise.

· Rising interest rates and deficits as far as the eye can see will lead to interest payments consuming the entire budget.

· America will be forced to cut spending.

Unfunded Liabilities Bubble

· The unfunded liabilities from Social Security and Medicare are as high as $119 Trillion Dollars.

· With the already high national debt, the federal government cannot absorb these added costs.

· Both Social Security and Medicare will be forced into bankruptcy. Defense will have to be cut.

Raw footage of Ron Paul interview from The Bubble film

The Bubble is a feature length documentary that ask those who predicted the greatest recession since the Great Depression, why did it happen and what are we facing? The documentary is an adaptation of Tom Woods' New York Times bestseller Meltdown. Filmmaker Jimmy Morrison is releasing each interview in full for free before the film's release.

thebubblefilm.com

Big Changes Are Coming, But The World Will Not End

by Robert Fitzwilson

source : KingWorldNews.com

40 year veteran, Robert Fitzwilson, wrote the following piece exclusively for King World News. Fitzwilson, who is founder of The Portola Group, warned, “Changes are coming, but it doesn’t mean the world will come to an end. But financial regime changes do result in a massive transfer of wealth from those who own paper assets, to those that own real assets.”
“Reflecting upon the news and the current state of affairs, it is striking how events are playing out according to script, as history and strategists have predicted. In the beginning of our journey, it was focused on discovery, historical context and understanding as to what had changed about markets, governments and people. The answer is almost everything if one looks just at our lifetimes.
On the other hand, nothing has really changed if one takes a longer view. One of our favorite sayings is, “The only thing new is the history you have not read”....
“We can vouch for that. After a review of much of the last 2,600 years, we have concluded that we are not the historic anomaly that we surmised at the beginning of the journey. In fact, we are simply repeating the same cycles and mistakes that all of our ancestors have made before us. Every culture throughout history has done exactly what we are doing now. The only difference is that this time it involves the entire planet.
As we read history, paper money was not designed to be an asset. It was an intermediary between sellers of goods and services. A seller might not have an immediate purchase in mind, so receiving a paper receipt that could be redeemed at a later time, and even at another location, was both efficient and much safer than receiving payment in gold or silver. The return trip from Rome to London was perilous under normal circumstances, let alone if one was returning with precious metals.
In our era, these receipts have taken many forms. Even the cash in our pockets is a derivative. In technical terms, it is a zero-coupon, perpetual obligation of the issuing government. In essence, the writing on the paper currency is promising “somebody owes you something, someday”.
The post-WWII monetary system began at Bretton Woods, New Hampshire. It began to unravel in the middle of the 1960s, but the mortal blow was struck by President Nixon with the suspension of dollar/gold convertibility. It has certainly been a long “suspension”.
Almost every ugly chart relating to the growth of debt and money can trace it’s roots to 1971. The evidence is incontrovertible. The value of the ancient form of receipts has been sliding ever since. The slide has not been linear over that 40-year period, but it certainly went into free-fall 12 years or so ago.
In the past, rulers created money out of something considered to hold value, often gold and silver. Seignorage was the right of kings to make a profit on that money. Unlimited seignorage was impossible as supplies of gold and silver came and went, and it was expensive to mint the coins.
With the use of paper and now electrons to create money, we now have unlimited seignorage. Money is created out of nothing, and you can see how it has been abused in the post-1971 charts. The abuse is accelerating on a massive, global scale. Cash and other derivatives have replaced our markets. Profits were to be made on creating and trading derivatives, not providing real goods and services. The real aspects of our economies continue to function, but the derivatives dwarf the size of the real global economy.
Much has been written about the historic confluence of our population growth coming together with the exponential endpoint of our resources. The same can be said for our money. Our resources are finite. The ability of our planet to sustain a population is finite.
We are now witnessing the exhaustion of our savings and real assets and our ability to sustain an exponential growth in money and derivatives. Unlimited derivates are hitting the proverbial brick wall, and their collapse will destroy everything based upon them, it is just history. This cycle has been repeated time and time again.
We also believe that we are approaching the end of a wonderful 200-year period in human history, driven by the industrial and technological revolutions. The exponential usage of resources and our population growth began almost precisely 200 years ago. If we combine this resource endgame with various groups which are desperate to maintain power or inflict it on others, it is a very toxic historical “soup”.
As to the resolution of what comes next, it is impossible to say. There are too many moving parts, or ‘Black Swans’ as people say. All we can do is to pay careful attention to events as they unfold, looking for clues as to how this mess will play out.
For our portfolios, the message is clear. Get out of paper assets that can be destroyed by the unlimited seignorage, and convert them into real assets. The end of the fiat money system will come swiftly, and perhaps overnight. It cannot be too far off at this point.
Changes are coming, but it doesn’t mean the world will come to an end. But financial regime changes do result in a massive transfer of wealth from those who own paper assets, to those that own real assets. Historically, gold and silver are traditional safe havens.
Despite what we read, the physical supply of these metals is becoming diminished for a variety of reasons. Waiting too long to purchase them could result in the inability to do so or certainly being forced to buy at much higher prices.”

Raw footage of Jim Rogers interview - The Bubble film

The Bubble is a feature length documentary that ask those who predicted the greatest recession since the Great Depression, why did it happen and what are we facing? The documentary is an adaptation of Tom Woods' New York Times bestseller Meltdown. Filmmaker Jimmy Morrison is releasing each interview in full for free before the film's release.