from Le Metropole Cafe

What a complete farce we are living through now. President Obama submitted his budget with a $1.75 Trillion projected deficit, yeah this one's manageable, it is only about 12-13% of GDP. Can you say banana republic? Only a day after his "fiscal responsibility" speech we get the details of this porked out, bloated, nation destroying farce of a budget proposal. Did I mention the $643 billion for health care? Actually, I believe this amount was the "down payment" over 10 years, I can't wait until the final tax bill comes. We will probably witness more heart attacks, more inductions into insane asylums, and more ulcers as a reaction than they will cover the previously uninsured.

This is truly banana land and the market is sniffing it out. Yields on Treasuries are rising and the default insurance on a 5 year note now exceeds that of Germany, France, and Japan. But here is the funniest part of all, if the US were to default, who would be left standing to make good on the default insurance? Aren't the insurers the likes of AIG, GE, and JP Morgan? If the government defaults, would any public finance company be left standing to pay up in Dollars? Wouldn't these Dollars presumably have no value because the "full faith and credit" just went broke? Wouldn't it be a better idea to just take the insurance premiums and buy Gold bullion over the 5 years? Hey, at least at the end you would still have bullion even if there was no default. But the best part, you would have bullion if they did default! I am confused as to what board of directors, money managers, etc. would pay Dollars today [that could be converted into something real] to insure against default of the US, only to receive more currency of the bankrupt entity ? Buying credit insurance on US debt is the equivalent of buying a BIC lighter for fire insurance.

The whole show has gotten stupid, the autos, banks, insurers, home builders and lenders are all crippled because we went off a deflationary cliff and this in turn has dragged the balance sheet of the Fed and Treasury into a black hole. And what do we hear on CNBC? Now is the time to BUY BUY BUY, especially the banks! They will lead us out! I am no rocket scientist but I can do simple math on a scratch pad, the SYSTEM is broke and no amount of freshly created worthless monopoly money is going to change this. It is over the edge and the only thing we hear from Washington is "we will borrow more money to make the already over levered system right again"! I don't think so Tim.

This thing is busted, if it wasn't, then 0% rates, $ Trillions in bailouts and stimulus, plans A-Z surely would have turned us around. They haven't worked and in fact things are much worse now than 6-12-18 months ago. The history books will be read 100 years from now and I can already hear an astute 3rd grader asking, "who WERE these people"?

from Dow Jones news wires

Veteran U.S. bullion dealers say the demand for gold and silver coins and investment bars so far during 2009 is perhaps the strongest they have ever seen.

Investors are snapping up physical metal amid ongoing worries about other financial investments, the health of the global banking system and fears about inflation down the road due to fiscal-stimulus efforts.

Buying gold in times of economic uncertainty isn’t new, but bullion dealers have noticed some differences in this investment surge. Dealers have reported growing institutional demand, rather than demand from just small retail investors, and a lack of backdated coins that historically could be bought at lower prices.

Bullion dealers said supply continues to be tight, although conditions have improved somewhat from 2008 when many of the mints around the world at times had to suspend sales due to a lack of blanks.

"We’re having some of our strongest months ever," said Scott Thomas, president and chief executive of American Precious Metals Exchange in Edmond, Okla. "The bottom line is our numbers are probably double what they were last year, and last year was very busy. The demand is incredible. And even the strong prices for metals are not slowing it down."

Most-active April gold futures on the Comex division of the New York Mercantile Exchange on Friday hit the $1,000-an-ounce level for the first time since July.

Through Sunday, Thomas said, his company had made nearly 10,000 trades so far in February, compared to 4,379 in the same year-ago period.

Officials at New Orleans-based Blanchard & Co. said the dollar value of their sales during the first 1 1/2 months of 2009 was more than all 12 months of 2007. This occurred as more investors read that gold and Treasury securities were about the only assets that survived the market "carnage" last year, said Donald W. Doyle Jr., chairman and CEO of Blanchard.

"People are moving out of stocks and bonds and CDs [certificates of deposit] in a large fashion," said George Cooper, senior account executive with Denver-based Centennial Precious Metals, who often works 12-hour days and describes business lately as "gangbusters." Many of the calls are from investors who lament losing half of their life savings to the tumble in stocks, he said.

James Cook, president of Investment Rarities in Minneapolis, said last week may have been the busiest for retail sales since he started his company in 1973.

"When they [Obama administration officials] came out with the new bailout plan, people were alarmed at what could happen to the purchasing power of the dollar," Cook said.

His company’s sales are roughly 75% silver and 25% gold. Physical sales of bars and coins last week totaled $5 million.

"Silver Eagles are still rationed," Cook said of the silver bullion coins available from the U.S. Mint. "We get 20,000 a week and they fly out the door. We can get 10,000 Silver Eagles on a Monday and basically they’re gone in 15 minutes. I have 55 guys on the phone calling out."

The industry veteran said the current demand has been more consistent and probably exceeds that from the bull run that carried silver to its all-time high above $50 an ounce in 1980 while also lifting gold to a then-record high that stood for 28 years.

Andrew Schectman, owner of Miles Franklin, based in Wayzata, Minn., described recent demand as "parabolically stronger" than in the past.

As an example of the interest in gold, he reported that a recent presentation he gave at the World Money Show in Orlando drew an audience of some 700 people, with more turned away due to a lack of space. By contrast, the audience at the same program a year ago was 75, he said.

Institutions, High-Net-Worth Investors Seek Coins, Bars

Several dealers said much of the current demand is coming from large investors and even institutional clients.

Most of Blanchard’s customers in years past were individual retail investors, Doyle said.

"More and more now, we’re finding we not only have individual investors but institutional buyers," he said. "That is a significant change even just in the past year or so."

And, Doyle added, institutional clients are buying in "significant quantities."

Cooper said more high-net-worth individual investors also are looking for coins and bars.

"Last year, it was the little guys, people with $10,000 to $20,000, up to $100,000," he said. "Now, we’re getting calls for $100,000, $500,000 to $1 million."

Yet another noticeable change is the absence of less-expensive backdated coins from past years, said Schectman, who has been in the business for 19 years.

During the last 15 years, if a client called wanting to place a large order for coins from any of the major mints around the world, Schectman would try to get coins from a past year. That’s because "an ounce [of gold] is an ounce is an ounce; it doesn’t matter," Schectman said. However, by purchasing an older coin, the investor could avoid a premium for a new-year coin caused by factors such as demand from collectors.

"What is unique about this time is that, since last year, roughly June, all of the backdated coins are gone," he said.

Thus, with no backdated coins, he anticipates there will be further back orders and delays from the world’s major mints.

"The secondary market for so many years made the industry, with people like yourself buying gold, holding it a few years and selling it back," Schectman said. "Nobody is selling. In $92 million of business done last year, if $5 million were related to buybacks, I would be shocked.

"If you are a small coin shop relying on the secondary market to give you supply, you’re going out of business."

In fact, with so many large orders from high-net-worth investors and the lack of metal on the secondary market, the "average person trying to buy gold and silver is going to have a very, very challenging time," Schectman said.

by Axel Merk

With gold reaching $1,000 an ounce and posting new highs versus all currencies, are there any hard currencies left? Over the past 100 years, we have moved further and further away from the gold standard. We see no indication for that trend to reverse; if anything, it may accelerate. As a result, we have cautioned long before this credit crisis erupted that there is no such thing as a safe asset anymore; investors may want to take a diversified approach to something as mundane as cash. This lack of confidence in cash goes beyond “cash equivalents” such as money market funds, commercial paper, auction rate securities, to currencies themselves. We all rely on cash for liquidity, but are concerned about purchasing power. While we are told that equities outperform in the long run, the deflationary forces in the equity markets, and the threat of a depression, has many looking for ways to avoid systemic risk affecting equity markets. While there are deflationary forces, there is also the threat of inflation because of the governments’ efforts to restart the economy; as a result, investors do not want interest and credit risk, either. Is physical gold the only answer? Possibly, but even the staunchest gold bugs rarely ever invest all their net worth in gold, if for no other reason than it is impractical. The principal motivation to invest in other currencies is to diversify based on concerns that the U.S. dollar’s purchasing power may not hold up and that – on a relative basis – it may hold up better in other currencies. We have long promoted baskets of currencies to mitigate the risks associated with the policies of any one country’s monetary policies. This analysis is intended as an overview of where we believe currencies stand.



This analysis is one in a series; today, we focus on the U.S. dollar and the euro.



The U.S. dollar



We are rather concerned about the U.S. dollar. Because it has been in the interest of other countries to have a strong dollar to export to U.S. consumers, the U.S. has gotten away with policies that – in our assessment – would have been detrimental had the U.S. not enjoyed its safe haven status. But the status as a reserve currency has to be earned on an ongoing basis – at some point, the abuse may come back to haunt the U.S.; some say that they will take action only if and when the dollar falls sharply. We would like to remind everyone that gold has quadrupled from a low of $250 to now around $1000. Further, the dollar nearly halved between October 2000 and the spring of 2007 versus the euro; it has since rebounded a bit, but make no mistake about it: the U.S. dollar has been in a long-term downward trend.



In making investment decisions, we take into account risk based scenarios. We do not know whether policy makers will come to their senses or whether they will continue to pursue policies to the potential detriment of the U.S. dollar. But if investors believe that there is a risk that policy makers will continue to make bad decisions, then investors may want to take that into account in their portfolio allocation.



A key concern we have is that inflation may become embedded long-term into the U.S. dollar. For now long-term inflation expectations influence the way the Federal Reserve (Fed) monitors them – the spread between 10-year inflation protected securities (TIPS) and 10-year government bonds – are low. In our humble opinion, that’s not good enough. Specifically, look ahead at the exit-strategy for the current monetary and fiscal stimuli. Fed Chairman Bernanke, in a speech on February 18, 2009, tried to persuade the public that the Fed can mop up all the liquidity fairly easily: the Fed would simply let many short-term programs expire. That may well be the case with short-term funding facilities. But that is not the case, for example, with the $500 billion program to buy mortgage-backed securities (MBS) before the middle of the year, a program that may be expanded. In our view, it will simply be impossible to sell these securities back to the market. The Fed’s balance sheet before the credit crisis hovered around $800 billion. Adding $500 billion permanently is inflationary unless the Fed somehow “sterilizes” it; quite possibly, the Fed’s recent interest to issue its own debt may serve this purpose (the Fed would be competing with the Treasury if it were to issue its own debt). More importantly, however, the policies we have seen encourage maintaining high levels of consumer debt. Unless we have a surge in real wages, consumers will remain extremely fragile even as the economy shows signs of improving. While we believe that both fiscal and monetary stimuli are rather ineffective, at some point, some of the money will stick. The Fed says it knows how to fight inflation. We don’t believe so: in our view, there is no way that policy makers will be willing to raise interest rates like Volcker did in the early 80’s to weed out inflation – it would cause a collapse of economic activity, if not a revolution. At “best”, the Fed will start to tighten when inflation starts to show in the statistics they follow, but may have to revert course right away as economic activity falters as a result.



In the same speech, Bernanke also said that the Fed’s activities do not add to the budget deficit. That’s why Congress loves the Fed – the Fed can print money that is off balance sheet. However, as the Fed veers closer into fiscal policy by providing not just money to the banking system as a whole, but to specific industries and companies, the love affair with Congress may end. We believe the Fed underestimates the political fallout that will result from all the policies pursued; ultimately, the credibility and with it the effectiveness of the Fed may suffer. This credibility is not bolstered by Bernanke’s comment that Congress will benefit from the Fed’s activities as the Fed starts to pay taxable interest on deposits held by banks with the Fed. This sort of comment shows the audacity of the Fed – John Law could not have made a better sales pitch as the interest the Fed is referring to is printed by the Fed at will. The “benefit” to Congress will be dubious at best.



The Fed has been actively engaged in the purchase of agency securities, those of Fannie and Freddie. In doing so, many have praised how the cost of mortgages has come down. However, the flip side is what has us concerned: in buying agency securities, the Fed drives up their prices (lowers the yields). What rational market participant would want to buy securities that are intentionally overpriced? This is relevant to the dollar as foreigners, in particular the Chinese, are the traditional buyers of these securities. As these securities are now labeled “overpriced”, we fear that foreign buyers may abstain. Last summer the Treasury had to provide an explicit government guarantee to Fannie and Freddie as foreign buying of these securities vanished. Zooming in on China: the Chinese may now be discouraged from buying U.S. agency securities; they may need to deploy their reserves at home for their domestic stimulus package; on top of that, they get insulted by the new administration. It seems like a real possibility to us that at least on the margin, the Chinese may buy less U.S. debt, just as the need to raise money for the U.S. government explodes. We don’t need foreigners to sell the dollar for the dollar to be under pressure: because of the current account deficit, foreigners need to buy over $2 billion dollars every single day, just to keep the dollar from falling. By the way, contrast that with the comments by Wen Jiabao, the Chinese premier, who says he wants to use his country’s reserves to buy U.S. and European technology while downplaying efforts to convert some of their reserves to U.S. dollars. The Chinese have no interest in a plunging dollar and work hard to be constructive in the public policy debate; as we elaborate more below, the Chinese may be the most prudent in the world right now – that in itself should give everyone pause to think .



Should protectionist sentiment flare up further, countries with current account deficits are most vulnerable. Trade barriers punish those who have adjusted to the world we live in. In recent years, when trade barriers have been discussed, the dollar has generally suffered; that’s because we are dependent on foreigners buying U.S. dollar. If there is less trade, there are fewer dollars to be reinvested in the U.S.



So far, the types of protectionist activities we have seen are unconventional, let’s call them “stealth protectionism”, and have actually favored the dollar. Specifically, the expanded guarantees on bank deposits have drawn money away from weaker countries, specifically from Eastern Europe and some Latin American and Asian countries, to the U.S. and the eurozone. Separately, the enormous amount of debt the U.S. government needs to raise this year is a form of protectionism: as over $2 trillion is likely to be raised, this is money not available to the corporate sector or weaker sovereign countries. At home, even if there were a magic wand to cure the ills of the banking system, the clients of financial institutions – corporations and sovereign countries – will continue to pay a high price to access the credit markets; in this environment, economic growth is likely to continue to lag behind expectations. Internationally, however, weaker countries will see the pain in their reduced ability to raise money; we see this already in the downgrades of sovereign debt of Spain and Greece; we see it in Eastern Europe; it is also possible to see both higher borrowing costs and a weaker currency as foreign appetite to provide funding is lackluster – one need to look no further than the U.K. In this environment, protectionist measures will be called upon to counter the stealth-protectionism pursued.

The potentially most serious threat to the dollar: the Fed. In our view, the Fed wants to have a substantially weaker dollar. Bernanke has repeatedly praised Roosevelt for devaluing the dollar during the Great Depression by taking the U.S. off the gold standard. Bernanke argues that the countries that came off the gold standard had more rapid growth recovery. Bernanke is right, naturally so: when your savings lose their purchasing power, you have a greater incentive to work. There are those, however, that don’t love work so much that they would be willing to give up a good portion of their purchasing power for the incentive to work harder. A Fed that doesn’t like home prices to fall because of the fallout of having too many homeowners “upside down” in their mortgages, prefers to have the overall price level rise so that the relative prices of homes aren’t as overvalued anymore. In our view, the Fed wants to have inflation. The purchase of agency securities and the potential increase in purchases of Treasury Bonds speaks for itself. We are concerned that the Fed may be getting more than it is bargaining for, especially since we believe the exit strategy for this risqué approach is doubtful.



The rally in the dollar we saw in the second half of 2008 was reflected in a surge of buying interest in U.S. Treasury Bills. Typically when a currency rises, inflows from abroad are deployed throughout the economy, not just short-term Treasury securities. As the panic abates, we fear that some of this money will flow out of the country again, putting renewed downward pressure on the dollar.



The Euro



Everyone loves to hate the euro these days. We are not as negative about the euro, mostly because the European Central Bank (ECB) for years has shown more restraint. As a result, the bulk of European consumers are in far better shape than their American counterparts. When European consumers were told there would not be money for their retirement, they stopped spending earlier this decade; in contrast, American consumers racked up their credit cards.



Conventional wisdom says one needs growth to have a flourishing currency. True, growth helps, but it is countries with significant current account deficits that require growth to sustain their currencies. The eurozone has a rather small current account deficit – the area’s “worst” deficit of 2008 was still smaller than a single month’s deficit in the U.S. Think about what Bernanke says about countries that went off the gold standard during the Great Depression and devalued their currencies: those who did not devalue recovered more slowly, but had stronger currencies. Indeed, we believe the eurozone is likely to have a rather painful recession; if the U.S. and Asia manage to reflate the world economy, the eurozone may experience a bout of stagflation. However, we believe the euro will be surprisingly strong in this context.



There are both fiscal and monetary reasons why we like the euro more than others. At the peak of the financial crisis in the fall of 2007, Europe (first the UK, then the eurozone) was faster than the U.S. in guaranteeing the banking system. In the meantime, the world has shown that a disorderly collapse of the financial system will be avoided at just about any cost. The next phase should be to allow an orderly adjustment to weed out the excesses of the boom. However, most policy makers around the world are not willing to let the markets adjust; instead, there is a drive to re-inflate the system. In our view, the U.S. will be far more “efficient” at this process than the eurozone. In 2009, the debt to GDP ratio may go as high as 18 percent in the U.S. In contrast, the eurozone growth and stability pact requires that this ratio not exceed 3 percent of GDP. Granted, that pact has more holes than Swiss cheese and member states may deviate from this goal for just about any “emergency” as long as they pledge to revert to the 3 percent ceiling in reasonable time; however, we believe the bureaucratic structures of Europe will prevent the eurozone from being as forceful with its stimulus as the U.S. As a result, growth may lag in the eurozone, but the currency may be stronger as fewer long-term inflationary seeds are planted.



On the monetary side, we also see far more restraint. Trichet, the head of the ECB, has repeatedly expressed his dislike for a zero percent interest rate policy. He seems more concerned about the downside risks of such a policy than its advantages. Instead, the ECB has opted to provide almost unlimited liquidity to financial institutions. Eventually, this may allow zombie (technically insolvent) banks to survive, but it will avoid the inflationary or even hyperinflationary risks that the U.S. approach may be risking.



The ECB has for years been reluctant to join the U.S. and Asian growth frenzy; one can of course argue that this hasn’t helped the eurozone much as they now also suffer in the downturn. However, the ECB policies make European consumers in particular more shock resistant; there will be suffering, but that is nothing new to European consumers. Retail stores in Germany, for example, had an extremely tough couple of years before the credit bubble burst. Even Wal-Mart withdrew from Germany as margins were too thin to compete with domestic discounters.



ECB president Trichet is the only central banker governing a major currency we are aware of that believes money supply plays a role – all other central bankers have joined the academic bandwagon that money supply is irrelevant as long as “inflation expectations are firmly anchored”.



All the prudence at the ECB hasn’t stopped European financial institutions from leveraging up their balance sheets with toxic assets. The motto in Europe has been to copy any idea Goldman Sachs has, but being late to the party, they engaged in greater leverage when pursuing them. A lack of understanding of the instruments purchased was, and in some cases still is, prevailing at many institutions. Whereas in the U.S., money to support the banks can simply be printed, the structure in the eurozone requires that member states – or in some cases regional governments – must finance any bailouts. As a result, the fear that some institutions may be “too big to bail” has spread. Rather than injecting capital, European governments have favored to a “ring fence” approach where the debt of institutions is guaranteed, thereby avoiding the deployment of cash until it is called upon.



While European financial institutions loved all that are now considered toxic securities, they have been suspicious of the U.S. dollar for some time. As a result, many institutions hedged their dollar exposure. Ironically as the value of the toxic securities plunged, the hedging position was still based on the full value of the securities. That meant that those institutions had to buy dollars in 2008 to bring the value of their hedging positions in line with the value of the securities. A good portion of the dollar rally in 2008 may have been attributed to this alignment.



There have been calls to create European bonds, i.e. bonds issued by the European Union rather than member states to address this issue. Currently, when we, or anyone, buy European sovereign debt, one buys, say, German or French government bonds. If the euro were really to break up, one would still be left with the bonds issued by the respective governments and they would revert to, for example, Deutsche mark or French franc bonds. However, the current proposals provide for bonds guaranteed by the member states. Unfortunately that seems too much like a structured product to help the weaker member states Greece and Spain; we don’t think there is a market for such a product at this stage. If one wants to pursue this route, a true European bond issued by an EU Treasury with independent taxing authority would be needed; then, if a member state were to break away or default, the debt would truly be EU debt and not shaken by turmoil in any one country. Having said that, adding another layer of taxation in Europe is the last most want to see. While the idea may work on paper, it may easily create another runaway bureaucracy in the long run. Europeans are also deeply suspicious of whether providing such power could lead to excessive spending.



We don’t think the euro is at the risk of a breakup because a breakup would be far too expensive for all involved; the pain of staying together is the lesser evil. This doesn’t mean that a member state couldn't break out of the eurozone in a bad case scenario, but the euro itself, in our view, is here to stay. In our view, widening risk spreads in different eurozone countries should be embraced, not fought. Member states with fiscally sustainable policies should be rewarded by the markets through lower interest rates; those who promise too much to their pensioners or make too many concessions to unions should pay the price through a higher cost of financing. In the U.S., different states also have varying costs of financing, something to be embraced rather than shunned.



Earlier, we mentioned the stealth protectionism the U.S. and Europe has engaged in by guaranteeing their banking systems. These guarantees have now come back to haunt those institutions that have heavily invested in Eastern Europe. Austrian banks in particular, but also banks in other European states, have bought many Eastern European banks or extended loans to Eastern Europe. The trouble is that Eastern European homeowners and many businesses have been lured by low interest rates available in Europe, particularly Switzerland, taking out loans denominated in Swiss francs or euro. The banking guarantees provided in the eurozone exacerbated a flight of money from Eastern Europe to the eurozone, thereby placing downward pressure on Eastern European currencies. That is a major problem for those who borrowed heavily in euro or Swiss franc as the value of the collateral in local currency has diminished.



In our view, European governments will ultimately provide support to their financial institutions exposed to Eastern Europe. Moreover, after the typical grudging discussions taking place in Europe, support may likely also be provided to Eastern Europe itself. Much of the industry in the European Union has focused on building the infrastructure in Eastern Europe. It may be cheaper for the European Union to subsidize its customer, Eastern Europe, than to allow market forces to cause massive failures. This is not a judgment of whether this is desirable or not from a free market perspective, but our assessment of how the politics will play out.



Note that while it may be cheaper for the European Union to bail out Eastern Europe, the same cannot be said for China; for China, it will be cheaper to stimulate its domestic economy than to prop up U.S. consumer spending through cheap exports.

by John Browne

When the US Congress passed its US$787 billion stimulus package last week, the size of the plan caused many observers to forget the water that has already passed under the bridge. Fewer still are wondering what havoc will erupt when all this liquidity eventually washes ashore.

The latest spending, signed into law this week by President Barack Obama, came on top of $300 billion committed to Citigroup, $700 billion for Troubled Assets Relief Program 1, $300 billion for the Federal Housing Administration, $200 billion for the Term Auction Facility and some $300 billion for mortgage guarantors Fannie Mae and Freddie Mac. Just over the past six months, which excludes the initial George W Bush administration

stimulus and several massive, unfunded Federal guarantees, nearly $5 trillion has been committed by the government to the financial industry. Rational observers cannot be faulted for concluding, despite administration claims to the contrary, that the government is merely throwing money at the problem.

Although the rhetoric has managed to convince many observers of the possibility of success, the gold market appears to clearly understand the implications of this unprecedented spending.

The feeling that the government has no idea how to proceed has created palpable panic. In response, pragmatic investors are seeking the ultimate store of wealth. In 2009, as has occurred countless times throughout history, that store will be stocked with gold. Thus, whether the Federal government's interventions will succeed or fail will be anticipated by the price of gold. Right now, the market is screaming failure.

Prior to the latest round of Federal spending, the Federal government had committed $4 trillion to postpone bank collapses and to lay the groundwork for subsequent restructuring. But has any of this activity actually rescued the banking system? In light of the evidence of deepening recession, is it likely that the additional $787 billion in the latest stimulus will instill enough confidence to restore economic growth? If not, what damage will it do to the eventual recovery?

Congressional rescue packages rarely work. Nevertheless, Congress is turning up the heat with previously unimaginable increases of government debt to fund stimulus and rescue packages. Senator John McCain rightly describes the scheme as "generational theft". Each package of debt will encumber many future generations, halt restructuring and also threaten latent hyperinflation.

While Congress claims that the seriously over-leveraged economy is in desperate need of restructuring, it appears blind to the fact that deleveraging will encourage such restructuring. Instead, Congressional leaders actively seek to increase leverage and add debt. They warn of fire, while pouring petrol on the flames.

The seriousness of the situation is magnified by the rapidly increasing scale of the problem. Just this week, the release of the latest minutes of the Federal Reserve confirmed that even that bastion of eternal optimism is sobering. The American economy, which shrank by 3.8% in the last quarter of 2008, is forecast to decline by some 5.5% in the first quarter of this year. In some pockets, the unemployment rate is already in double figures. Despite massive government spending on rescue and stimulus, the American consumer clearly is becoming increasingly nervous, and the credit markets show few signs of recovery.

With bad news only getting worse, investment markets are turning into quagmires. The Dow Jones Average is testing new lows, and the commodities markets show few signs of life. In such times, the price of gold should fall along with the prices of other assets and commodities. But, the reverse has occurred. In the past two months, gold has staged a remarkable rally. This is despite the activity of price-depressants such as official gold sales by the International Monetary Fun and official "approval" for massive naked short positions to be opened by new "bullion" banks.

Not only have gold spot prices risen in the face of such selling pressure, but the price of physical gold is now some $20 to $40 per ounce above spot. This would indicate that investors are now so nervous that they are insisting on taking physical delivery.

Make no mistake, the economy will not turn around soon. When the recovery fails to materialize, look for governments around the world, and especially in the US, to send another massive wave of liquidity downriver. When it does, the value of nearly everything, except for gold, will diminish. Don't be intimidated by the recent spike in gold. Buy now while you still can.

Frightening to think we might only be halfway through this mess.....

Click on the chart for larger view:

by Dave Kranzler

Given that the stated amount of gold in the GLD Trust has grown to over 850 tonnes, it appears that a lot of investors believe that investing in GLD is the same thing as buying physical gold bullion."

There may be many things to hope for in the oncoming Obama administration. Investing in the bullion ETF, GLD, is not one of them.

1. I'll start with the opening sentence of the gold ETF itself and work outwards to you. The opening sentence of the November 2004 gold ETF prospectus said, "This ETF is intended to track the performance of the price of gold." Note that it doesn't say it will own gold, or anything so prosaic. This Exchange Traded Fund that promises easy gold ownership for America is only going to track it. You know, like your cat tracking a crow in the back yard. And if GLD or your cat never quite gets there, well, it was an interesting exercise.

A careful reading of the first sentence should tell you that this is a document written by lawyers, and it is intended to be read by other lawyers who might be thinking of suing the guys represented by the first group of lawyers. The opening sentence is nothing if not defensible.

2. GLD Share Price: The current price of the ETF is said to be 1/10 of the price of gold. Yet, GLD's price is usually below the actual price of gold even as priced on the COMEX. Well, when GLD sells new shares that's the amount of money they get to buy gold. And they buy ounces of gold with it. This means that somehow, by some secret method, the guys managing a gold bullion ETF, while always behind the market, manage to pick up tonnes of gold at a discount to the COMEX price. This is not possible. The gold market is global and operates 24/7 all over the planet. If gold is under priced somewhere, it will be arbitraged like a Tonya Harding knee chop.

Think about it. Gold is currently very difficult to find under the earth. It's tough to mine profitably, much less mill and smelt, and insure, transport and store. Why would anybody be selling a bar of gold even near or below the price of an historically suspect pricing mechanism like the NY COMEX? Why is there no premium on these shares? The Central Fund of Canada (CEF) trades at a premium, but then, it goes to some lengths to actually buy and own gold bullion.

Only if there's some other "form" of gold being purchased, such as a derivative "promising" to deliver gold, can the pricing mismatch begin to be explained. (See #9 below, Jim Turk says there are only gold "deposits" involved here. And Jim Sinclair says gold derivatives are being used.)

Or perhaps the disparity of price could have to do with the shorting of GLD shares by those nefarious short sellers. With shorted shares, at the very least, you have two potential claims to ownership to a GLD share. If the shares were shorted naked, who knows how many claimants there could be. Want to go there?

3. Gold Acquisition: Then there's the amount of alleged gold acquired for GLD per se. Many sources, including the World Gold Council, the Sponsor of the ETF, have noted that the quantity of gold mined the past four years has plateaued somewhere below 2500 tonnes a year. Divide even that optimistic 2500 tonne number by 52 weeks a year, and you get about 48 tonnes of global gold production per week.

Yet, somehow, during the first two weeks of February, 2009, for instance, GLD said it acquired almost 103 tonnes of gold, more gold than was mined in the entire world during that two week period. (Don't ask about getting gold from above ground stocks. Do you think that owners of large piles of gold are selling these days?) GLD's purchases apparently left zilch gold for all those other gold bullion ETFs - the IAU in the U.S., and the British, Swiss, Indian and Australian gold ETFs in their respective countries.

These plentiful purchases of GLD occurred smoothly and instantly despite London Metal Exchange buyers, mining shortfalls, South African power failures, the dental profession, manufacturing, and even Central Bank buying. And GLD did all this buying without kicking up the price unduly?

India, which has been buying more than 25% of the gold coming out of the ground for years (said to be some 15 tonnes a week) apparently got none.

The OPEC countries, that have been buying a lot of gold through Istanbul, apparently didn't get any gold those weeks either.

And the jewelry industry, which supposedly absorbs over 70% of the gold mined each year, apparently surrendered its purchasing for the first two weeks in February so that ONE American bullion ETF could buy all the gold available.

Ever heard of a guy named Tino DeAngelis? Back in the 1960s, he said he had a lot of salad oil...and didn't. If you believed in Tino, and you believe in the GLD purchasing prowess, then you probably also believe in financial tooth fairies.

4. The Legal Structure of GLD. Who are these guys?

A. There is a Sponsor of the ETF - the World Gold Trust Services, a subsidiary of the World Gold Council in London.

B. There is a Trustee subsidiary that holds title to the bullion and issues shares - The Bank of New York (BK).

C. There is one listed Custodian - HSBC (HBC), and provision for one or dozens of "sub" custodians, Great, if something goes wrong, first you've got to find where which custodian allegedly had it. And while the custodian is charged with a duty of due care in hiring the subs, there's no assurance the subs won't screw up afterwards and there's no real recourse if a sub does. Which brings up...

D. There is a marketing agent, for the shares - State Street Global Agents, a separate creation of State Street Bank (STT) in Boston, but they really don't answer anybody's questions. GLD is considered a "permanent offering" and the aforementioned marketing team can say nothing about anything during a permanent "quiet period." This ETF took two years to get through the SEC...And I'm not sure it didn't get the benefit of grade inflation on the SEC view of crookedness as it went along. "Hey," the SEC said, "This ETF isn't absolutely, totally rotten on its face, let it go through. At least it's not a CDO. Hah, hah."

Each of these outfits have created separate subsidiary corporations to provide more limitation of liability for the parent. There were marvelous waffle words, and exemptions from legal liability for even these subsidiary players in the original S1 prospectus, filed on November 15, 2004. These have been carried forward and even improved upon. See the prospectus.

5. Sub Custodian Shenanigans: Assuming GLD managed to find some gold and buy it, and some sub custodian somewhere got possession of it, there's nothing in the legal structure that prohibits the sub from leasing or even selling that gold and putting an IOU in the vault claiming it still owns it. Central Banks and the IMF have been shuffling these cards for decades.

The Bank of England is listed as a sub custodian. Other sub custodians are the Bank of Nova Scotia (BNS) (ScotiaMocatta), Deutsche Bank AG (DB), JPMorgan Chase Bank (JPM), and UBS AG (UBS) (Page 47). All are known to actively lease or otherwise trade in the gold markets. I.e., I believe that investors should assume that there will be trading or leasing of GLD assets,

When the gold bull market ran out of gas back the early 1980s a lot of allegedly respectable gold dealers who claimed to be storing gold for their customers, fessed up and said they didn't have it, and went broke.

On June 12, 2007, Morgan Stanley announced it had settled a case wherein a Mr. Silberblatt was charged for storage and insurance on silver that Morgan had never bought. And Morgan claimed in its defense that its "practices" were the "industry standard."

Such disreputable practices occur in most precious metals areas with great regularity. You really ought to consider deep therapy if you believe the promises of a financial institution these days if it's talking about gold. Hell, if it's stonewalled and fibbed to Congress, regulators, auditors and the media about almost everything, why wouldn't it lie about gold? (That's a rhetorical question.)

6. "Regulation" of the ETF: After the Fed's failure to regulate much of anything, the SEC's treatment of Bernie Madoff, and its elimination of leverage maximums for brokers, the NYSE killing of the NYSE Uptick Rule and circuit breakers, and bank regulators' encouragement of cheating at Countrywide, I barely see the point of mentioning regulation. There is NO adult supervision of financial guys. Customers are absolutely on their own.

Oh, ok, the Trustee can monitor the custodian "up to twice" a year (Page 37 of the prospectus). Oh, the ignominy of a visit from an official every six months. And there's no mention of what will happen if an inspecting official finds some wrongdoing. Probably just drop a note in a file. The Trustee apparently does not have the right to visit the premises of any sub custodian for the purposes of examining the actual gold, but only to visit to look at records maintained by the sub custodian. And no sub custodian is obligated to cooperate in any such review.

Finally, the prospectus clearly states that the auditor's “responsibility is to express an opinion on the Trust’s internal control over financial reporting.” Boy, that makes me feel better. Their processes are good.

7. If Things Do Go Wrong: If the Sponsor, Trustee, Custodian, Sub custodian, or Marketing Agent folks fall over, they'll have high priced lawyers defending them everywhere. (Bankruptcy is not a totally unlikely scenario, considering the recent performance of Bear Stearns, AIG, Lehman Brothers, CitiGroup, Fannie Mae, etc.) Well, since the prospectus excuses all sorts of GLD malfeasance, non-feasance, negligence, and probably even manslaughter, customers would - at best - wind up as general creditors of a GLD party. And investors will be far down the list of creditors behind bank lenders, bondholders, preferred shareholders, and common stockholders. Have you considered Lottery tickets for your retirement?

Oh, and there may be a few delays and costs involved...in the bankruptcy filing of a giant financial institution with claimants from all over the planet. And I doubt if specific performance is available to claimants in a bankruptcy proceeding to help people get the actual gold they thought they'd bought. Wasn't gold ownership supposed to be for safety without counter party risk?

And this is an American ETF, yet most of the custodians are British, European, or Canadian. Eh? It will be difficult to sue them in U.S. Courts, and it will be expensive to sue overseas. What, there weren't any suitable sub custodians available in the U.S.? I hear Fort Knox is mostly empty, maybe the ETF could store its alleged gold there.

Also, there is no requirement that the Trustee, Custodian or sub custodians carry insurance or even a surety bond with respect to gold. (Page 11). So even if a liability is found...there probably won't be any deep insurance pocket money.

In summary, the GLD prospectus is a steaming pile of legal loopholes. Only a lazy mutual fund manager or a brain-dead pension fund manager would touch this turkey. It's also likely that retail investors, and their highly compensated advisors, are even remotely aware of the astounding risks declared in the ignored GLD trust documents.

8. There are other GLD critics, besides the Financial Foghorn here, who think that the gold ETF is untrustworthy. Dave Kranzler, from whom much of this dissertation has been respectfully purloined, has obviously analyzed the prospectus carefully and found it wanting.

James Turk, a former money manager for the Saudi Arabian Central Bank, long time precious metals market analyst, and the founder of www.goldMoney.com, has been critical of GLD since it was proposed in 2004. And he recently noted that the August, 2008 GLD updated prospectus, on page 3, says: "Proceeds received by the Trust from the issuance and sale of Baskets consist of gold deposits and, possibly from time to time, cash." A "gold deposit" is a word that has a precise meaning in the law, and is the exact opposite of "bailment".

A bailment is what happens when you give your car to valet parking. When you present the ticket, you get your very own car back. With a "deposit," a bank gives you a certificate of deposit, a checking account statement, a savings book or some other evidence of its debt to you. You are no longer entitled to get your very own dollars back, but have become a depositor and general creditor of the bank. Title/ownership has transferred from you to the bank, and the bank can do whatever it wants with your former dollars.

It is extremely unlikely that a highly paid passel of lawyers that worked over the GLD prospectus would offhandedly put in a word like "deposit" unless there was a good avoidance-of-liability reason to do so. If physical gold were actually in the ETF, the above statement would have read: "Proceeds received by the Trust from the issuance and sale of share baskets consist of gold (or gold bailments) and, possibly from time to time, cash."

Turk's point, and Kranzler's reference, is that "gold" is one thing and a "gold deposit" is something entirely different. "Gold" is physical metal stored/bailed in a secure vault. A "gold deposit" is a liability of a financial institution, and it's just another lousy paper gold IOU. Whoops.

Jim Sinclair has chimed in with his opinion on these issues at www.jsmineset.com. He says that the only thing GLD owns is derivatives on gold, and that allows for much game playing to fool the rubes.

9. But can you actually get real gold from GLD? Yes, Virginia, there is a provision in the prospectus for obtaining possession of the gold bullion your shares represent. Unfortunately, it's a cruel hoax. You must own a minimum of 100,000 shares (I believe it used to be 50,000 shares under the 2004 prospectus) to claim your bullion. Hmmm, 100,000 times $90 or so a share would be $9 million. Think the little guy is gonna put in for any actual gold? Think the mutual fund guy is gonna go to his boss and say he wants to take delivery of 10,000 ounces of gold? That's 833 pounds of gold. "Delivered here?" "Gonna put that in the conference room, Tom?"

10. So why do these gold and silver ETFs even exist?

My belief is that the real purpose of a bullion ETF is to be a sacrificial lamb. The growing number of gold and silver ETFs around the world will indeed accumulate some gold and silver, and under some Executive Order down the road, Da Boyz will swoop down and take it, just like 1933. They'll need the gold to back their spanking new, Global, Electronic, All-Beef currency. An ETF seizure will be much easier than going bank box to bank box to get citizens' gold.

Given the citizens' restiveness these days, it isn't hard to predict that it will be slightly more difficult in the 21st century to convince citizens to turn in gold than it was back in 1933. Our current politicos appear to have dissipated some of the trust people have traditionally had for their elected Representatives. (Insert your favorite, dastardly Congress-person examples here...)

And as far as legalities are concerned, the government will indeed comply with the 5th Amendment Taking-with-Due-Process issue by paying the investors for the value of gold on the day they seized it.

But that will be a far cry from the price of gold the day AFTER they seize it. The day after an ETF seizure, the world will realize that the paper jig is up, and everybody will want to own physical gold, or a real gold mining company. Why not do that now?

NEW YORK, Feb 18 (Reuters) - The cost to insure U.S. Treasury debt with credit default swaps jumped to a record high on Wednesday as President Barack Obama unveiled another round of spending designed to stem home foreclosures.

Credit default swaps on U.S. government debt widened 8.5 basis points to 90 basis points, or $90,000 per year for five years to insure $10 million in debt, according to Markit. The swaps had traded at less than 10 basis points a year ago.

President Barack Obama on Wednesday pledged up to $275 billion to help stem a wave of home foreclosures that sparked the U.S. financial meltdown.

Swaps protecting the sovereign debt of Germany also rose 12 basis points to 85 basis points on Wednesday, while swaps on Britain fell 4.5 basis points to 164.5 basis points, Markit data shows.

from the UK Telegraph

Gold hits record against euro on fear of Zimbabwean-style response to bank crisis
Gold has surged to an all-time high against the euro, sterling, and a string of Asian currencies on mounting concerns that global authorities are embarking on a "Zimbabwe-style" debasement of the international monetary system.

"This gold rally is driven by safe-haven fears and has a very different feel from the bull market we've had for the last eight years," said John Reade, chief metals strategist at UBS. "Investors are seeing articles in the press saying governments should deliberately stoke inflation, and they are reacting to it."

Gold jumped to multiple records on Tuesday, triggered by fears that East Europe's banking crisis could set off debt defaults and lead to contagion within the eurozone. It touched €762 an ounce against the euro, £675 against sterling, and 47,783 against India's rupee.

Jewellery demand – usually the mainstay of the industry – has almost entirely dried up and the price is now being driven by investors. They range from the billionaires stashing boxes of krugerrands under the floors of their Swiss chalets (as an emergency fund for total disorder) to the small savers buying the exchange traded funds (ETFs). SPDR Gold Trust has added 200 metric tonnes in the last six weeks. ETF Securities added 62,000 ounces last week alone.

In dollar terms, gold is at a seven-month high of $964. This is below last spring's peak of $1,030 but the circumstances today are radically different. The dollar itself has become a safe haven as the crisis goes from bad to worse – if only because it is the currency of a unified and powerful nation with institutions that have been tested over time. It is not yet clear how well the eurozone's 16-strong bloc of disparate states will respond to extreme stress. The euro dived two cents to $1.26 against the dollar, threatening to break below a 24-year upward trend line.

Crucially, gold has decoupled from oil and base metals, finding once again its ancient role as a store of wealth in dangerous times.

"People can see that the only solution to the credit crisis is to devalue all fiat currencies," said Peter Hambro, chairman of the Anglo-Russian mining group Peter Hambro Gold. "The job of central bankers is to allow this to happen in an orderly fashion through inflation. I'm afraid it is the only way to avoid disaster, but naturally investors are turning to gold as a form of wealth insurance."

One analyst said the spectacle of central banks slashing rates to zero across the world and buying government debt as if there was no tomorrow feels like the "beginning of the 'Zimbabwe-isation' of the global economy".

Gold bugs have been emboldened by news that Russia has accumulated 90 tonnes over the last 15 months.

"We are buying gold," said Alexei Ulyukayev, deputy head of Russia's central bank. The bank is under orders from the Kremlin to raise the gold share of foreign reserves to 10pc.

The trend by central banks and global wealth funds to shift reserves into euro bonds may have peaked as it becomes clear that the European region is tipping into a slump that is as deep – if not deeper – than the US downturn. Germany contracted at an 8.4pc annual rate in the fourth quarter. The severity of the crash in Britain, Ireland, Spain, the Baltics, Hungary, Ukraine and Russia has shifted the epicentre of this crisis across the Atlantic. The latest shock news is the 20pc fall in Russia's industrial production in January. The country is losing half a million jobs a month.

Markets have been rattled this week by warnings from rating agency Moody's that Austrian, Swedish and Italian banks may face downgrades over their heavy exposure to the ex-Soviet bloc. The region has borrowed $1.7 trillion (£1.2 trillion) – mostly from European banks – and must roll over $400bn this year.

Austria's central bank governor, Ewald Nowotny, said the regional crisis had become "dangerous" and called for a pan-EU rescue strategy to prevent contagion.

Bartosz Pawlowski, from TD Securities, said the recent plunge in currencies across Eastern Europe had come as a brutal shock. "The rout could potentially lead to substantial problems, if not an outright collapse of the financial system," he said, citing the rising real burden of debt taken out in euros and Swiss francs.

Even Poland – a pillar of stability in the region – may ultimately need a bail-out by the International Monetary Fund. Latvia, Hungary, Ukraine and Belarus have already been rescued. Romania's premier, Emil Boc said his country would decide over the next two weeks whether to seek an IMF loan. Turkey is next

Russian Prime Minister Vladamir Putin has said the US should take a lesson from the pages of Russian history and not exercise “excessive intervention in economic activity and blind faith in the state’s omnipotence”.

“In the 20th century, the Soviet Union made the state’s role absolute,” Putin said during a speech at the opening ceremony of the World Economic Forum in Davos, Switzerland. “In the long run, this made the Soviet economy totally uncompetitive. This lesson cost us dearly. I am sure nobody wants to see it repeated.”

Sounding more like Barry Goldwater than the former head of the KGB, Putin said, “Nor should we turn a blind eye to the fact that the spirit of free enterprise, including the principle of personal responsibility of businesspeople, investors, and shareholders for their decisions, is being eroded in the last few months. There is no reason to believe that we can achieve better results by shifting responsibility onto the state.”

Putin also cautioned the US against using military Keynesianism to lift its economy out of recession, saying, “in the longer run, militarization won’t solve the problem but will rather quell it temporarily. What it will do is squeeze huge financial and other resources from the economy instead of finding better and wiser uses for them.” Putin’s comments come in sharp contrast to Russia’s own military buildup and expansion.

Putin also echoed the words of conservative maverick Ron Paul when he said, “we must assess the real situation and write off all hopeless debts and ‘bad’ assets. True, this will be an extremely painful and unpleasant process. Far from everyone can accept such measures, fearing for their capitalization, bonuses, or reputation. However, we would ‘conserve’ and prolong the crisis, unless we clean up our balance sheets.”

“The time for enlightenment has come. We must calmly, and without gloating, assess the root causes of this situation and try to peek into the future.”

From UK Times

The dollar is simply a piece of paper. Gold is a much better store of value and is the best insurance against future shocks
Last week was a bad one for bank shares; after the HBOS £8.5 billion loss, Lloyds shares fell by a third and other bank shares fell as well. Yet it was a very good week for the gold price, which closed on Friday at $935 an ounce, after reaching what was nearly a seven-month high of $953.30 on Wednesday.

Barclays Capital commented that gold prices were resuming their long-run bull trend after eight consecutive years of gains. For longer than the past eight years I have been arguing that investment in gold is an essential insurance against financial shocks. Last week was a classic example. Respectable British bank shares have now fallen by up to 90 per cent, while the gold price has risen by more than 200 per cent since Gordon Brown began selling the Bank of England's gold reserve.

I have been following the gold price since I published The Reigning Error, a short book on inflation, in 1974. I have not consistently advised people to buy gold - like all other assets, gold can become significantly overvalued, as it did in 1980. However, I have found that the movements of the gold price are one of the most useful pieces of evidence about the health of the world economy. Mr Brown's sale of gold was an avoidable error. My friend the MP Peter Tapsell repeatedly warned him in Parliament not to do it.

People buy gold when they are nervous about the economy, and they are right to do so because gold is a unique commodity. It has to a high degree two qualities that are seldom found together: liquidity and reality. It has strong liquidity; it can almost always be bought, sold or exchanged. There are other liquid assets, of which the US dollar is probably supreme, but they lack gold's quality of real value.

Dollars do not constitute a real asset, such as property or “real estate”. The dollar is simply a piece of paper. Gold has been a much better store of value than the dollar.

In 1873 one of the leading British economists, William Stanley Jevons, published a short book, Money and the Mechanism of Exchange. By 1887 it had reached its eighth edition. Unfortunately, there are few modern economists who do not suffer from the delusion that new truths make old ones obsolete.

Great mistakes could have been avoided in 2008 if bankers and politicians had studied Jevons, even though his little book was written 136 years ago. Jevons quotes Herbert Spencer as observing that “it is the grave misfortune of the moral and political sciences that they are continually discussed by those who have never laboured at the elementary grammar or the simple arithmetic of the subject”. That was true then, and it is true now. Indeed, there are still some people who believe that poverty can be abolished by the issue of printed bits of paper.

Nowadays such people usually call themselves Keynesians, though their doctrine is not to be found in the works of Maynard Keynes, a much less simplistic economist than some of his modern followers. These so-called neo-Keynesians are hostile to gold, usually for two reasons. They see gold as the natural enemy of the paper money in which they put their trust; they see gold-related systems as imposing a discipline on the unlimited issue of paper money, and they reject that.

World trade depends on the existing global system, which is one of paper currencies, separately managed and largely unconvertible. These currencies float in terms of each other, sometimes with a fixed rate in relation to a larger currency. Since President Nixon closed the gold window in 1971, there has been no fixed-rate convertibility between any of these paper currencies and gold. In the past 40 years the world exchange system has suffered from two periods of high inflation and is now suffering from the worst depression since the 1930s.

In 1873 Jevons could already write: “It is hardly requisite to tell again the well-worn tale of the over-issue of paper money which has almost always followed the removal of the legal necessity of convertibility. Hardly any civilised nation exists, which has not suffered from the scourge of paper money at one time or another... Time after time in the earlier history of New England and some of the other states now forming part of the American Union, paper money had been issued and had brought ruin.”

Daniel Webster's opinion should never be forgotten. Of paper money he says: “We have suffered more from this cause than from every other cause or calamity. It has killed more men, pervaded and corrupted the choicest interests of our country more, and done more injustice than even the arms and artifices of our enemy.”

In the 1930s some nations tried to beat the slump by competitive devaluations. In the present crisis, Britain has already experienced a very big devaluation of the pound, taking it down by a quarter against the dollar. Every country, led by the United States, has been issuing money, often in very large amounts, in order to bail out its banks. No one knows the total value of these national injections of cash into the banking systems. As the earlier injections have not restored stability to national economies, further injections inevitably will be made. All will be made in unconvertible currency, and overissue will occur.

Sooner or later the world's governments will have to reconsider Keynes's two real achievements, Britain's low inflation finance of the Second World War, and the world currency system that he negotiated at Bretton Woods.

Both Jevons and Keynes believed in the need for what Jevons called “a worldwide system of international money”. Without it, recurrent crises, such as the present one, will be inevitable. Governments need to create a new world system, in which gold, as a stabiliser, should play its part. For individuals, gold remains the best insurance against future shocks and the best store of value.

by Gary Gibson

Credit isn’t wealth.......A lot of people are discovering that the hard way. Welcome to the credit deflation prelude to hyperinflation:

During a credit deflation, things get cheaper. Without lines of credit, people can’t bid things up and prices fall to their “cash on hand” level. Given a long enough time, things settle out and prices relative to wages actually become attractive. But it’s a long and bumpy ride from here to there. The trick is to maintain roughly the same level of income as others take wage cuts or lose their jobs entirely. Add this to the general lack of credit and you find that the cost of living drops dramatically. You might have felt poor a couple of years ago when you earned $50,000 per year, but if you can hold onto that income, why, in the next couple of years you could feel positively wealthy!

The holding on part is where it gets a little tricky.

It’s tricky because when credit evaporates, less goods and services can be bought. A lot of jobs providing those goods and services become unnecessary. Layoffs become all the rage. You wind up with a lot of formerly employed people with no jobs and no money and no attractive prospects. Doesn’t seem fair, but that’s what happens when hopes and livelihoods get propped up on the shifting sand of credit expansion. When credit vanishes, actual cash becomes king. Promises to pay take a back seat to actual ability to pay. Exactly what are we calling “cash,” though? God and the free markets like gold and silver because they’re relatively rare, easily divisible, and it’s very difficult to control their supply, and hence innately honest. Governments prefer colorful bits of paper that they issue precisely because they can print up as many as they need. While credit isn’t wealth, neither is money. Money is just a commodity we use to represent and exchange wealth. It’s rather vital to have a measuring tool that resists stretching and deformation or else you get into all sorts of trouble. Gold and silver tend to resist stretching; paper money begs for it. During the last really big credit bust in this country cash was very strictly tied to gold and silver. The exchange rates were fixed; you got one ounce of gold for a twenty-dollar bill (plus 67 pennies). Fifty-four cents got you an ounce of silver. So when the credit bubble popped and prices slumped, they did so in terms of a dollar that was a reliable proxy for gold and silver. How things have changed!

First FDR devalued the dollar and a little later Nixon killed it. The currency we have today is a hoax wrapped in a lie. It isn’t tied to anything. The old dollar was a certificate that could be exchanged for a very specific amount of gold. The one we’ve had since 1971 is a promise from the U.S. government…and little paper promises from governments have a dismal history. You may have noticed that during our recent gargantuan credit bust people again ran to the dollar. They expressed a very strong preference for greenbacks over…well, just about everything else in the wide world. But running to the dollar for shelter these days is like seeking protection from the man who is shooting at you…or running from the doorway of a burning building to the second floor.

During the last depression, the dollar’s tie to gold limited the ability of our communist dictator to goose the money supply. Roosevelt had to coerce the citizenry to give him their gold under pain of imprisonment so he could allow for some easing of the dollar’s value. This time around, FDR II can just have central banks conjure more up as much cash as deemed necessary out of nothingness because the dollar isn’t tied to gold anymore. Inflation is a slow burn on its default setting, which governments enjoy so much. It’s why they insist on monopolizing currency in the first place. But let inflation go on long enough and the currency becomes worthless. Sometimes events conspire to accelerate the race to worthlessness. Wars, laughably unpayable national debt, financial panics…that sort of thing. The government would prefer an endless boom, even though such a thing — like individual biological immortality or perpetual motion — just isn’t possible. The central bank gets things started by expanding credit. Good times ensue. Everyone is employed and everyone lives beyond their means and bids up the prices of assets with money they don’t really have. This can’t go on forever (and never does!), but governments hate to see the ravages of the inevitable contraction after their artificially-induced boom. States love for their citizens to be blissfully distracted with fantasy, especially the really unsustainable sort.

So what is a government to do when it wants people to spend and they just refuse? When the rubes refuse to play ball and insist on hanging on to their savings, all you have to do is make saving less attractive than spending. Increase the money supply…make the money people hold less valuable…encourage them to get rid of it. Set the currency ablaze and ferret the consumers out. Around these parts, we subscribe to the view that savings are essential for capital investment, but politicians side with Keynes on this and believe savings are for suckers; debt is where it’s at. And if private debt has brought the population to its knees, then the obvious answer is a dollop of public debt to kill their currency and finish them off! It’s not just the amount of dollars that the central bank produces, however; it’s the amount that actually gets circulated and the speed at which it moves through the economy. When the general populace senses that the dollars they’re holding are losing value (because the central bank is accelerating the increase in supply), they try very hard to get rid of them as quickly as possible. They trade them for things that will hold their value.

The real trouble with hyperinflation isn’t that it devalues the currency, however; it’s that it devalues souls. It leads people astray. It removes the moral stops. It changes all sense of proportion. Like a sadistic, juvenile prankster, government spikes the punch with a little quantitative easing and before you know it all bets are off. People drunkenly succumb to the baser instincts they normally keep in check. The thin layer of restraint provided by the neo-cortex is broken and all sorts of reptilian longings are indulged…and consequences be damned. Trying to invest and plan for the future under a fiat currency regime is like trying to be witty and convincing while drunk. Inevitably the wrong things are said and done because perception and judgment are hopelessly warped.

During a hyperinflation, the majority of the population who counted on the scrip they were forced to deal with and save can only feel angry desperation as all their savings turn to ashes practically overnight. The reward for personal thrift coupled with trust in the largest institution around — the state — is loss and future uncertainty. Under such conditions, societies tend to come apart fairly rapidly. Crime rises as savings and incomes disappear. Ethnic tensions may mount. There is a bull market in internal strife and personal misery.

People generally rather consume than produce or delay gratification. This is why the masses can be lied to with paper. But the universe is a weighing machine, not a voting booth. Wishes don’t trump reality. And disaster must befall those who expect something for nothing. We here in the Whiskey Room like to point the finger at governments, but we also have to acknowledge that thing in human nature that allows governments to exist in the first place and to flourish. For the past decade in the U.S. easy credit — pretend money — led people to put their houses up as collateral on debts that could only be paid back if real estate prices kept getting propped up by more easy credit. Then they used this debt to finance vacations and trips to big retails chains to buy things that would not be used to produce or store wealth. And this was just an expansion of credit!

When the actual money supply expands in order to ease debt repayments…well, all sorts of screwy things happen. That’s what generally spurs the vulgar expansion of the money supply: the political desire to ease massive debt repayment, both public and private…that and war. When you see a nation living beyond its means, watch out; its currency will be thrown under the bus when the bill comes due.

Destroying the currency, however, means that the debts really weren’t repaid…because they were paid back with dollars that aren’t worth the value of those that were initially borrowed. It’s a big swindle and everyone involved knows it. But it goes on anyway with all the nasty consequences you’d expect from such massive debauchery, delusion and theft. The list of countries that have suffered the ravages of paper money hyperinflation is pretty darned long…and ironically it starts with the very first country to give paper money a try, long, long ago. China’s Yuan Dynasty’s little experiment with paper money ended badly. In fact, it helped end the Yuan Dynasty.

For the first time in history, currencies everywhere are merely paper…including the world’s reserve currency. The potential…the inevitability…of a worldwide bonfire of these little paper vanities staggers the imagination. The conflagration will be mesmerizing in its size and intensity. You may even find yourself enjoying the view…if you make it a point to be standing far enough away not to be consumed.

by Frank Shostak

We live in an age of grave economic ignorance, if central-bank policy is an indication of prevailing economic theory. It is apparent that we've learned nothing from several millennia of monetary destruction. The persistent demonstration that capital, not paper, is the basis for prosperity has fallen on deaf ears. Daily, we face the sad spectacle of government officials, pundits, and even Nobel laureates telling us that printing money is the answer to an economic downturn.

Consider that since the eruption of the financial credit crisis in the second half of 2007, all major central banks have embraced an irresponsibly loose-interest-rate stance.

For instance, the policy rate of the Bank of England (BOE) was lowered from 5.75% in November 2007 to the current level of 1%. The sharp decline in the BOE policy interest rate is in line with policies of other central banks.

The US central bank (the Fed) has lowered its policy rate (the federal-funds rate target) from 5.25% in August 2007 to around zero at present.

Also, the relatively "conservative" European Central Bank (ECB) has been aggressively lowering its policy interest rate. The rate was lowered from 4.25% in September last year to the present target of 2%.

Similarly, the Bank of Japan (BOJ) has visibly eased its interest rate stance. The policy rate was reduced from 0.5% in September 2008 to the current level of 0.1%.

Given that, so far, already extremely low interest rates have failed to revive economic activity, central bankers are now considering another approach.

Last Wednesday, February 11, the governor of the Bank of England said that the UK central bank is going to embrace a quantitative easing policy to revive the economy. The idea here is to flood the economy with money by buying government bonds. US central-bank policy makers are currently contemplating a simliar idea.

We shouldn't overlook the fact that, since embracing the aggressive lowering of rates, central banks have been aggressively pushing money into the banking system without succeeding in reviving economic activity. So why should aggressive money pumping work now?

The yearly rate of growth of the US central-bank balance sheet (money pumping) jumped from 3.9% in August last year to 152.8% in December 2008 before falling to 127.5% in January. The yearly rate of growth of the balance sheet of the Bank of England jumped from negative 7.2% in May 2007 to positive 179.4% by October 2008 before easing to 157.6% in November last year and 129% in January.

The growth momentum of the European Central Bank balance sheet has accelerated in January. Year on year, the rate of growth jumped from 7% in July 2007 to 45.5% in December and to 56.5% in January.

Also, the yearly rate of growth of the BOJ balance sheet follows a visible uptrend. The rate of growth climbed from negative 0.8% in August last year to 10.3% in December before easing to 5.7% in January.

What permits real economic growth is an improvement in the investment infrastructure of the production process. What makes the improvement possible is real savings. It is real savings that fund the enhancement of infrastructure through various tools and machinery, i.e., capital goods. With better tools and machinery, a better quality and a greater quantity of goods and services can be produced.

In a free, unhampered market economy the established infrastructure is in accordance with the tendency toward harmony between various activities. This means that the flow of real savings is sufficient to fund various lines of production without any disruption.

On this Murray Rothbard, paraphrasing Ludwig Lachmann, wrote,

Capital is an intricate, delicate, interweaving structure of capital goods. All of the delicate strands of this structure have to fit, and fit precisely, or else malinvestment occurs. The free market is almost an automatic mechanism for such fitting; … with its price system and profit-and-loss criteria, [it] adjusts the output and variety of the different strands of production, preventing any one from getting long out of alignment.[1]

As a result of the artificial lowering of interest rates and massive money pumping, an additional demand for various goods and services emerges. This leads to an attempt to expand the infrastructure.

This attempt is bound to fail since the flow of real savings is not large enough to support the expansion of the capital structure. Consequently, the attempt to expand the infrastructure leads to the diversion of real funding from various activities that make the present flow of real savings possible. Thus, the flow of real savings comes under pressure and the rate of real economic growth follows suit.

Neither an artificial lowering of interest rates nor monetary pumping by central banks has direct input in the production of capital goods and the production of goods and services that are required to promote and maintain human life and well-being.

The artificial lowering of interest rates and monetary pumping only give rise to various false activities by diverting a portion of the flow of real savings to these activities. The more false activities that emerge on the back of the artificial lowering of interest rates and monetary pumping, the less real savings will be available for wealth-generating activities.

The fact that economic conditions have continued to deteriorate despite the aggressive lowering of interest rates and massive money pumping by central banks raises the likelihood that the flow of real savings is in trouble.

Note again that monetary pumping and the artificial lowering of interest rates can't replace nonexistent real savings. Without additional real savings, it is not possible to undertake various new projects without weakening the existent structure of production.

Remember that the interest rate is just an indicator of the state of demand and supply for real savings. The falsification of this indicator cannot expand the flow of real savings.

Likewise money is just a medium of exchange. Its function is to permit the exchange of the products of one specialist for the products of another specialist. More money cannot generate more real savings or real economic growth.

On the contrary, a further planned expansion in monetary pumping by central banks can only weaken the flow of real savings and undermine prospects for a sustained economic revival.

by Ludwig von Mises

This essay originally appeared March 4, 1958.

Our economic system — the market economy or capitalism — is a system of consumers' supremacy. The customer is sovereign; he is, says a popular slogan, "always right." Businessmen are under the necessity of turning out what the consumers ask for and they must sell their wares at prices which the consumers can afford and are prepared to pay. A business operation is a manifest failure if the proceeds from the sales do not reimburse the businessman for all he has expended in producing the article. Thus the consumers in buying at a definite price determine also the height of the wages that are paid to all those engaged in the industries.

1. Wages Ultimately Paid By the Consumers

It follows that an employer cannot pay more to an employee than the equivalent of the value the latter's work, according to the judgment of the buying public, adds to the merchandise. (This is the reason why the movie star gets much more than the charwoman.) If he were to pay more, he would not recover his outlays from the purchasers, he would suffer losses and would finally go bankrupt. In paying wages, the employer acts as a mandatory of the consumers as it were. It is upon the consumers that the incidence of the wage payments falls. As the immense majority of the goods produced are bought and consumed by people who are themselves receiving wages and salaries, it is obvious that in spending their earnings the wage earners and employees themselves are foremost in determining the height of the compensation they and those like them will get.

2. What Makes Wages Rise

The buyers do not pay for the toil and trouble the worker took nor for the length of time he spent in working. They pay for the products. The better the tools are which the worker uses in his job, the more he can perform in an hour, the higher is, consequently, his remuneration. What makes wages rise and renders the material conditions of the wage earners more satisfactory is improvement in the technological equipment. American wages are higher than wages in other countries because the capital invested per head of the worker is greater and the plants are thereby in the position to use the most efficient tools and machines. What is called the American way of life is the result of the fact that the United States has put fewer obstacles in the way of saving and capital accumulation than other nations. The economic backwardness of such countries as India consists precisely in the fact that their policies hinder both the accumulation of domestic capital and the investment of foreign capital. As the capital required is lacking, the Indian enterprises are prevented from employing sufficient quantities of modern equipment, are therefore producing much less per man-hour and can only afford to pay wage rates which, compared with American wage rates, appear as shockingly low.

There is only one way that leads to an improvement of the standard of living for the wage-earning masses, viz., the increase in the amount of capital invested. All other methods, however popular they may be, are not only futile, but are actually detrimental to the well-being of those they allegedly want to benefit.

3. What Causes Unemployment

The fundamental question is: is it possible to raise wage rates for all those eager to find jobs above the height they would have attained on an unhampered labor market?

Public opinion believes that the improvement in the conditions of the wage earners is an achievement of the unions and of various legislative measures. It gives to unionism and to legislation credit for the rise in wage rates, the shortening of hours of work, the disappearance of child labor and many other changes. The prevalence of this belief made unionism popular and is responsible for the trend in labor legislation of the last two decades. As people think that they owe to unionism their high standard of living, they condone violence, coercion, and intimidation on the part of unionized labor and are indifferent to the curtailment of personal freedom inherent in the union-shop and closed-shop clauses. As long as these fallacies prevail upon the minds of the voters, it is vain to expect a resolute departure from the policies that are mistakenly called progressive.

Yet this popular doctrine misconstrues every aspect of economic reality. The height of wage rates at which all those eager to get jobs can be employed depends on the marginal productivity of labor. The more capital — other things being equal — is invested, the higher wages climb on the free labor market, i.e., on the labor market not manipulated by the government and the unions. At these market wage rates all those eager to employ workers can hire as many as they want. At these market wage rates all those who want to be employed can get a job. There prevails on a free labor market a tendency toward full employment. In fact, the policy of letting the free market determine the height of wage rates is the only reasonable and successful full-employment policy. If wage rates, either by union pressure and compulsion or by government decree, are raised above this height, lasting unemployment of a part of the potential labor force develops.

4. Credit Expansion No Substitute for Capital

These opinions are passionately rejected by the union bosses and their followers among politicians and the self-styled intellectuals. The panacea they recommend to fight unemployment is credit expansion and inflation, euphemistically called "an easy money policy."

As has been pointed out above, an addition to the available stock of capital previously accumulated makes a further improvement of the industries' technological equipment possible, thus raises the marginal productivity of labor and consequently also wage rates. But credit expansion, whether it is effected by issuing additional banknotes or by granting additional credits on bank accounts subject to check, does not add anything to the nation's wealth of capital goods. It merely creates the illusion of an increase in the amount of funds available for an expansion of production. Because they can obtain cheaper credit, people erroneously believe that the country's wealth has thereby been increased and that therefore certain projects that could not be executed before are now feasible. The inauguration of these projects enhances the demand for labor and for raw materials and makes wage rates and commodity prices rise. An artificial boom is kindled.

Under the conditions of this boom, nominal wage rates which before the credit expansion were too high for the state of the market and therefore created unemployment of a part of the potential labor force are no longer too high and the unemployed can get jobs again. However, this happens only because under the changed monetary and credit conditions prices are rising or, what is the same expressed in other words, the purchasing power of the monetary unit drops. Then the same amount of nominal wages, i.e., wage rates expressed in terms of money, means less in real wages, i.e., in terms of commodities that can be bought by the monetary unit. Inflation can cure unemployment only by curtailing the wage earner's real wages. But then the unions ask for a new increase in wages in order to keep pace with the rising cost of living and we are back where we were before, i.e., in a situation in which large scale unemployment can only be prevented by a further expansion of credit.

This is what happened in this country as well as in many other countries in the last years. The unions, supported by the government, forced the enterprises to agree to wage rates that went beyond the potential market rates, i.e., the rates which the public was prepared to refund to the employers in purchasing their products. This would have inevitably resulted in rising unemployment figures. But the government policies tried to prevent the emergence of serious unemployment by credit expansion, i.e., inflation. The outcome was rising prices, renewed demands for higher wages and reiterated credit expansion, in short, protracted inflation.

5. Inflation Cannot Go On Endlessly

But finally the authorities become frightened. They know that inflation cannot go on endlessly. If one does not stop in time the pernicious policy of increasing the quantity of money and fiduciary media, the nation's currency system collapses entirely. The monetary unit's purchasing power sinks to a point which for all practical purposes is not better than zero. This happened again and again, in this country with the Continental Currency in 1781, in France in 1796, in Germany in 1923. It is never too early for a nation to realize that inflation cannot be considered as a way of life and that it is imperative to return to sound monetary policies. In recognition of these facts the administration and the Federal Reserve authorities some time ago discontinued the policy of progressive credit expansion.

It is not the task of this short article to deal with all the consequences which the termination of inflationary measures brings about. We have only to establish the fact that the return to monetary stability does not generate a crisis. It only brings to light the malinvestments and other mistakes that were made under the hallucination of the illusory prosperity created by the easy money. People become aware of the faults committed and, no longer blinded by the phantom of cheap credit, begin to readjust their activities to the real state of the supply of material factors of production. It is this — certainly painful, but unavoidable — adjustment that constitutes the depression.

6. The Policy Of The Unions

One of the unpleasant features of this process of discarding chimeras and returning to a sober estimate of reality concerns the height of wage rates. Under the impact of the progressive inflationary policy the union bureaucracy acquired the habit of asking at regular intervals for wage raises, and business, after some sham resistance, yielded. As a result these rates were at the moment too high for the state of the market and would have brought about a conspicuous amount of unemployment. But the ceaselessly progressive inflation very soon caught up with them. Then the unions asked again for new raises and so on.

7. The Purchasing Power Argument

It does not matter what kind of justification the unions and their henchmen advance in favor of their claims. The unavoidable effects of forcing the employers to remunerate work done at higher rates than those the consumers are willing to restore to them in buying the products are always the same: rising unemployment figures.

At the present juncture the unions try to take up the old, a-hundred-times-refuted purchasing-power fable. They declare that putting more money into the hands of the wage earners — by raising wage rates, by increasing the benefits to the unemployed and by embarking upon new public works — would enable the workers to spend more and thereby stimulate business and lead the economy out of the recession into prosperity. This is the spurious pro-inflation argument to make all people happy through printing paper bills. Of course, if the quantity of the circulating media is increased, those into whose pockets the new fictitious wealth comes — whether they are workers or farmers or any other kind of people — will increase their spending. But it is precisely this increase in spending that inevitably brings about a general tendency of all prices to rise or, what is the same expressed in a different way, a drop in the monetary unit's purchasing power. Thus the help that an inflationary action could give to the wage earners is only of a short duration. To perpetuate it, one would have to resort again and again to new inflationary measures. It is clear that this leads to disaster.

8. Wage Raises As Such Not Inflationary

There is a lot of nonsense said about these things. Some people assert that wage raises are "inflationary." But they are not in themselves inflationary. Nothing is inflationary except inflation, i.e., an increase in the quantity of money in circulation and credit subject to check (checkbook money). And under present conditions nobody but the government can bring an inflation into being. What the unions can generate by forcing the employers to accept wage rates higher than the potential market rates is not inflation and not higher commodity prices, but unemployment of a part of the people anxious to get a job. Inflation is a policy to which the government resorts in order to prevent the large-scale unemployment the unions' wage raising would otherwise bring about.

9. The Dilemma of Present-Day Policies

The dilemma that this country — and no less many other countries — has to face is very serious. The extremely popular method of raising wage rates above the height the unhampered labor market would have established would produce catastrophic mass unemployment if inflationary credit expansion were not to rescue it. But inflation has not only very pernicious social effects. It cannot go on endlessly without resulting in the complete breakdown of the whole monetary system.

Public opinion, entirely under the sway of the fallacious labor-union doctrines, sympathizes more or less with the union bosses' demand for a considerable rise in wage rates. As conditions are today, the unions have the power to make the employers submit to their dictates. They can call strikes and, without being restrained by the authorities, resort with impunity to violence against those willing to work. They are aware of the fact that the enhancement of wage rates will increase the number of jobless. The only remedy they suggest is more ample funds for unemployment compensation and a more ample supply of credit, i.e., inflation. The government, meekly yielding to a misguided public opinion and worried about the outcome of the impending election campaign, has unfortunately already begun to reverse its attempts to return to a sound monetary policy. Thus we are again committed to the pernicious methods of meddling with the supply of money. We are going on with the inflation that with accelerated speed makes the purchasing power of the dollar shrink. Where will it end? This is the question which Mr. Reuther and all the rest never ask.

Only stupendous ignorance can call the policies adopted by the self-styled progressives "pro-labor" policies. The wage earner like every other citizen is firmly interested in the preservation of the dollar's purchasing power. If, thanks to his union, his weekly earnings are raised above the market rate, he must very soon discover that the upward movement in prices not only deprives him of the advantages he expected, but besides makes the value of his savings, of his insurance policy, and of his pension rights dwindle. And, still worse, he may lose his job and will not find another.

10. Insincerity In The Fight Against Inflation

All political parties and pressure groups protest that they are opposed to inflation. But what they really mean is that they do not like the unavoidable consequences of inflation, viz., the rise in living costs. Actually they favor all policies that necessarily bring about an increase in the quantity of the circulating media. They ask not only for an easy money policy to make the unions' endless wage boosting possible but also for more government spending and — at the same time — for tax abatement through raising the exemptions.

Duped by the spurious Marxian concept of irreconcilable conflicts between the interests of the social classes, people assume that the interests of the propertied classes alone are opposed to the unions' demand for higher wage rates. In fact, the wage earners are no less interested in a return to sound money than any other groups or classes. A lot has been said in the last months about the harm fraudulent officers have inflicted upon the union membership. But the havoc done to the workers by the unions' excessive wage boosting is much more detrimental.

It would be an exaggeration to contend that the tactics of the unions are the sole threat to monetary stability and to a reasonable economic policy. Organized wage earners are not the only pressure group whose claims menace today the stability of our monetary system. But they are the most powerful and most influential of these groups and the primary responsibility rests with them.

11. The Importance of Sound Monetary Policies

Capitalism has improved the standard of living of the wage earners to an unprecedented extent. The average American family enjoys today amenities of which, only a hundred years ago, not even the richest nabobs dreamed. All this well-being is conditioned by the increase in savings and capital accumulated; without these funds that enable business to make practical use of scientific and technological progress the American worker would not produce more and better things per hour of work than the Asiatic coolies, would not earn more and would, like them, wretchedly live on the verge of starvation. All measures which — like our income and corporation tax system — aim at preventing further capital accumulation or even at capital decumulation are therefore virtually antilabor and antisocial.

One further observation must still be made about this matter of saving and capital formation. The improvement of well-being brought about by capitalism made it possible for the common man to save and thus to become in a modest way himself a capitalist. A considerable part of the capital working in American business is the counterpart of the savings of the masses. Millions of wage earners own saving deposits, bonds, and insurance policies. All these claims are payable in dollars and their worth depends on the soundness of the nation's money. To preserve the dollar's purchasing power is also from this point of view a vital interest of the masses. In order to attain this end, it is not enough to print upon the bank notes the noble maxim In God We Trust. One must adopt an appropriate policy