gold

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Bernanke vs Greenspan?

Submitted by Andrew Fruth of AcceptanceTake

Bernanke and Greenspan appear to have differing opinions on whether the Fed will monetize the debt.

Bernanke, on behalf of the Federal Reserve, said in 2009 at a House Financial Services Committee that “we’re not going to monetize the debt.”

Greenspan, meanwhile, on Meet the Press in 2011 that “there is zero probability of default” because the U.S. can always print more money.

But they can’t both be true…

There is only 0% probability of formal default if the Fed monetizes the debt. If they refuse, and creditors refuse to buy bonds when current bonds rollover, then the U.S. would default. But Ben said the Fed will never monetize the debt back on June 3, 2009. That’s curious, because in November 2010 in what has been termed “QE2” the Fed announced it would buy $600 billion in long-term Treasuries and buy an additional $250-$300 of Treasuries in which the $250-$300 billion was from previous investments.

Is that monetization? I would say yes, but it’s sort of tricky to define. For example, when the Fed conducts its open market operations it buys Treasuries to influence interest rates which has been going on for a long time — way before the current U.S. debt crisis.

So then what determines whether the Fed has conducted this egregious form of Treasury buying we call “monetization of the debt?”

The only two factors that can possibly differentiate monetization from open market operations is 1) the size of the purchase and 2) the intent behind the purchase.

This is how the size of Treasury purchases have changed since 2009:

Since new data has come out, the whole year of 2011 monetary authority purchases is $642 billion – not quite as high as in the graph, but still very high.

Clearly you can see the difference in the size of the purchases even though determining what size is considered monetization is rather arbitrary.

Then there’s the intent behind the purchase. That’s what I think Bernanke is talking about when he says he will not monetize the debt. In Bernanke’s mind the intent (at least the public lip service intent) is to avoid deflation and to boost the economy – not to bail the United States out of its debt crisis by printing money. Bernanke still contends that he has an exit policy and that he will wind down the monetary base when the time is appropriate.

So In Bernanke’s mind, he may not consider buying Treasuries — even at QE2 levels — “monetizing the debt.”

The most likely stealth monetization tactics Bernanke can use — while still keeping a straight face — while saying he will not monetize the debt, will be an extreme difference between the Fed Funds Rate and the theoretical rate it would be without money printing, and loosening loan requirements/adopting policies that will get the banks to multiply out their massive amounts of excess reserves.

If, for example, the natural Fed Funds rate — the rate without Fed intervention — is 19% and the Fed is keeping the rate at 0%, then the amount of Treasuries the Fed would have to buy to keep that rate down would be huge — yet Bernanke could say he’s just conducting normal open market operations.

On the other hand, if the banks create money out of nothing via the fractional reserve lending system and a certain percentage of that new money goes into Treasuries, Bernanke can just say there is strong private demand for Treasuries even if his policies were the reason behind excessive credit growth that allowed for the increased purchase of Treasuries.

Maybe Bernanke means he will not monetize a particular part of the debt that was being referred to in the video. Again, though, he could simply hide it under an open market operations 0% policy or encourage the banking system to expand the money supply.

Whatever the case, if you ever hear Bernanke say “the Federal Reserve will not monetize the debt” again, feel free to ignore him. When he says that, it doesn’t necessarily mean he won’t buy a large quantity of Treasuries with new money created out of nothing.

Remember, Greenspan says there’s “zero probability of default” because the U.S. can always print more money. Does Greenspan know something here? There’s only zero probability if the Fed commits to monetizing the debt as needed. If Greenspan knows something there will be monetization of the debt, even if Bernanke wants to call it something else.

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Warren Buffett Priced in Gold

Can you say bubble? Or, more to the point, can you say bursting?


Warren Buffett loves to bash gold — claiming that stocks are inherently superior, because they produce a return, whereas gold just sits.  Trouble is, stocks (and all paper assets) are subject to counter-party risk, whereas physical gold isn’t. Gold doesn’t overcompensate its CEOs, it doesn’t leverage its productive capital in toxic derivatives, it doesn’t cause industrial disasters like Deepwater Horizon, its value isn’t dependent on central banking, or securitisation, or American imperialism, or the machinations of the military-industrial complex. It just sits, retaining its purchasing power.

Warren Buffett had a great ride: he grew his wealth and businesses in an era of unprecedented growth powered by OPEC oil, and later by Chinese industrialism. That era — the era of the American free lunch — is coming to an end.  His insights are applicable to that era. Today is a different world.

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Price Stability?

Yeah.

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Where Gold is Going

Many will argue that — more or less — this reflects the U.S. government’s attempts to deal with broad and deep social and financial problems through monetary policy. The higher the price of gold goes, the more the market believes that monetary policy just isn’t working, and that the big problems in American and Western society — oil dependency, deindustrialisation, unemployment, regulatory capture and debt saturation — are just not being effectively addressed.

As I wrote last month:

Getting out of a depression requires debt erasure, and new organic activity, and there is absolutely no guarantee that monetary easing will do the trick on either count. Most often, depressions and liquidity traps are a reflection of underlying structural and sociological problems, and broken economic and trade systems. Easing kicks the can down the road a little, and gives some time and breathing room for those problems to be fixed, but very often that just doesn’t happen. Ultimately, societies only take the steps necessary (e.g. a debt jubilee) when their very existence seems threatened.

The simple expansionary recipe for getting out of depressions is a sad smile, a false promise of an easy route out of complex and multi-dimensional problems.

If these problems are fixed, then the correlation between the debt ceiling and the price of gold will go away. Gold is not necessarily going to the moon, and the gold speculators will be forced to give up the ghost as real broad-based economic growth returns. The trouble is, I don’t see any evidence that these problems are going away. Japan is still — more or less — in the same place it was twenty years ago. Now the whole world may be moving to the Japanese model. Readers are welcome to try and convince me otherwise.

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Zombification & Gold

From Bloomberg:

Japanese Finance Minister Jun Azumi will be rewarding investors who buy more than 10 million yen ($129,000) in reconstruction bonds with gold in the government’s latest attempt to bolster demand for the debt.

Individual investors who hold the bonds for three years will be eligible for a gold commemorative coin valued at 10,000 yen, the Finance Ministry said in Tokyo today. At 15.6 grams, (0.55 ounces), it would be worth about $948 based on prices for the precious metal. Only a limited number of coins will be issued, the Finance Ministry said in a statement.

Azumi, whose hometown was devastated by the March 11 disaster, said today he bought 1 million yen of the debt to support rebuilding efforts from the March 11 earthquake and tsunami. Offering gold bolsters the value of the return on the debt, which will be at 0.05 percent for the first three years.

Japan — the prototypical case of zombification — has kicked the can all the way to the end of the road. How easy is it for an investor or an institution to accept a near-zero bond yield when they could buy a piece of gold that has averaged a 17% yield this decade? Not easy at all. That is why — if governments want to kick the can and avoid liquidation at all costs  — governments will have to find a way to limit gold yields. I outlined a fairly outlandish (but undoubtedly Keynesian) method a couple of months ago — a new stimulus package to mine gold. Of course, there is a more devastating alternative with a historical precedent, which is confiscation, but whatever they do they need to address the fact that a form of economic activity that produces nothing — buying gold —  is far more attractive than investing in stocks or bonds or (any fiat-denominated instruments).

Now I don’t expect America to get to the stage Japan is at — America is at its core a free-spirited, libertarian nation, and years of austerity, unemployment and zero growth will foment revolution. Japan, by contrast, is a very conservative, and conformistic nation. Jobless Japanese kids — unlike their British and American contemporaries — do not seem to riot. So I never expect the American or British Treasuries to get to the stage where they sweeten the deal on their crummy debt by throwing in gold coins.

But the lesson here is all the same — without some kind of miracle, bailing out zombie institutions and financial systems kills creative destruction (the heart of capitalism), which kills growth, and makes gold an extremely attractive investment. That’s because it doesn’t lose any intrinsic value, while stocks and bonds are blighted by systemic dereliction, monetary mismanagement, and weak demand.

Frankly, I’d rather live in an economy where gold is not such an attractive investment, where stocks and bonds trade on fundamentals rather than the latest interventionist hyperbole from Benny at the Fed, where products and firms succeed and fail based on their inherent characteristics, rather than on whether the Euro will fail or not. But until capitalism is restored, until firms are free to succeed and fail on their own merits, gold — the true symbol of capitalism in a perverted system of corporatism — will keep going up and up.

Zombie Economics

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Italian Gold Heading to China?

James Rickards and Max Keiser suggest one of the logical conclusions of the Italian-debt blowup is that Italian gold will be auctioned off, perhaps to China:

With Italian external debt standing at $2.2 trillion, and Italy’s 2,400 tonne gold holdings worth only $137 billion, gold would have to rise pretty significantly for that option to come into play.

Of course, these figures ram home the idea that gold is significantly undervalued relative to current credit/debt levels. America’s external debt stands at $14.3 trillion, yet its gold reserves are worth just less than $500 billion.

Officially, gold is not money. Officially, levels of debt should have no tie to gold reserves (i.e., the ability to pay in the 6,000-year old store of value).

But with the current malfunction in the global economic system, which soon may have to deal with the consequences of Euro breakdown, or an oil shock, or a new middle eastern war, it is perfectly plausible (or even likely) that the newer fiat monetary systems — all of which are subject to counter-party risk — will crumple, and bring the old currency — gold — back into play.

While a chance of systemic collapse remains, nobody will be keen to see their gold reserves sold off. Nations with less gold than their rivals — particularly China who have recently shown particular interest in converting their FX hoard into gold — will be keen to see the system live on for as long as possible (to cash out into physical assets and gold).

And that is the fundamental contention — the Eurozone wants to keep its gold, but fear the catastrophic impact of Euro-breakdown — and the Chinese want to keep the system going while slowly accumulating gold.

I can see that there is quite a lot of scope for a middle ground. The real question is how much would a Sino-European bailout-for-gold deal cause gold to spike…

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Israel, Iran & War

Forget the Eurozone — this is surely the scariest news of the year.

From the Daily Mail:

  • Fears mount that Iran could be ‘nuclear ready’ in a matter of months
  • UN intelligence suggests Iran was helped by foreign experts – including rogue Russian scientist
  • Russia foreign minister says any military action would be a ‘serious mistake’
  • Condoleezza Rice: ‘We must do everything we can to bring Iran down’
  • Mahmoud Ahmadinejad remains defiant
Russia and China have expressed growing concern about a mooted American military strike against Iran over its alleged nuclear programme.The UN last week warned it had ‘compelling evidence’ to suggest Iran is secretly building an arsenal of nuclear warheads.

The UN’s International Atomic Energy Agency (IAEA) is this week due to publish a damning report on the findings fuelling fears Iran could be ‘nuclear ready’ within months.


Sticking my neck out a little, if a rampant communist dictatorship like the Soviet Union can have nuclear weapons for over forty years without nuclear apocalypse (not to mention ethnocracies like Pakistan and Israel) then I can’t see what the problem is with Iran having them. Surely a last ditch strike on a pre-nuclear Iran would confirm the scary post-Qaddafi reality that dictatorships, autocracies and theocracies are not safe from Western liberal interventionism until they have gained a nuclear arsenal?

More concerningly, a Western attack on a nation at the heart of Eurasia — and a friend to the other Eurasian autocracies, particularly Russia and China — is surely a message that America and Israel will do everything in their power to maintain the petrodollar status quo, something that rising powers like Russia and China find distasteful and disrespectful.

But the emerging reality of a multi-polar world will do nothing to stop the hawks from clawing and shrieking against the reality of change.

From Haaretz:

Former Secretary of State Condoleezza Rice has said she is sure the Israelis will defend themselves against the Iranians if they were to reach nuclear capabilities.

“I don’t have any doubt that the Israelis will defend themselves if the Iranians look as if they really are about to cross that nuclear threshold,” Rice told Newsmax in a TV interview.

I — on the other hand — have no doubt that the era of American-Israeli-British primacy is drawing to an end. The global system of floating fiat currencies is being gutted by years of competitive debasement. The international financial system is a house of cards, swaying in the breeze. Western industry has been gutted, and shipped to the East. Western capital is exported away to the East via humungous Western trade deficits. Western labour markets rot, beleaguered by high unemployment, evaporating skills, and huge inequality between the rich and poor. Western discontent is rising. Most dangerously, the West remains highly dependent on foreign oil — a supply that a new war, or some other black swan might disrupt — wreaking havoc.

So, as I wrote last month:

Sadly, we know how that aphorism from Winston Churchill goes: that Americans will do the right thing — after they’ve tried everything else.

Which is why I’m coming to believe that the military-Keynesian establishment might try and kill every bird with one stone — a new regional war in Eurasia, probably involving Syria, Iran and Israel. Let’s look at what that might accomplish:

  1. Create a new post-9/11-style hard-to-question patriotism — “There’s a war on — we all need to rally together around the flag — the complainers and protestors must hate America”
  2. Put America back to work — in weapons factories, and on the front lines.
  3. Give the economy a large Keynesian injection — through war spending.
  4. Take out Iran, a powerful enemy of America — and send a threatening message to other uppity Eurasian autocracies like Russia and China.
  5. Curtail civil liberties & censor the internet — “There’s a war on — we all need to rally together around the flag — and those who don’t must be working to undermine America”
John Maynard Keynes noted that in the long run, we’re all dead. I hope that in the short run, we’ll all still be alive.
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Paper vs Gold

Last month I explained why gold is not an asset to hold in every kind of market. But here’s an even more extreme piece of evidence.

During the last 200 years — an era of unprecedented growth and development — paper investments have trounced gold:

Now there are two perspectives on this:

  1. Gold is so far behind because it has no inherent value, it creates no product or new income, or innovation. It just sits.
  2. Gold is so far behind because stocks, bonds and dollars in a humungous, history-shattering bubble.

We shall see which case is correct.

Investors need to remember that the reasons for gold’s present strength — above all else mismanagement of the global economy and international financial system by governments and large financial corporations which has resulted in a low-growth, high unemployment, negative real rate environment — although historically abnormal, will eventually subside, and we will return to the historical norm where gold significantly under-performs paper. That’s because gold just sits, whereas other assets either produce a net return, or are a net liability.

As I explained last month:

I believe that in order to restore growth, what the system needs, and what it is driving toward is restructuring. This can either be accomplished intentionally through explicit haircuts or defaults, through high inflation, through a slow painful private deleveraging process or through strong organic growth.

I don’t know how debt reduction will take place. It could be three months or years away, or it could be another grinding, unemployed and depressed ten years, full of false dawns. Certainly that is what has happened to Japan since its stock market and real estate bubbles burst twenty years ago. Maybe the West will perform better than Japan in the deleveraging trap — maybe new technological innovations like cheap decentralised solar energy will provide the necessary organic growth to overcome the debt problem. Or maybe not.

Until the private debt load is significantly reduced, it will act as a huge weight tying down economic growth, tying down employment, and structurally weakening both the financial system and society. High debt loads require low interest rates to sustain — which with a little inflation means negative real interest rates. Gold has traditionally done very well in low real rate environments.

Once the deleveraging trap has been left behind, it will be the time to ditch gold and plough all of that purchasing power into productive assets: industrial stocks, real estate, farm land, inventory, and labour force.

And gold will once again settle into significantly under-performing stocks.

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Gold in 2012 & the Coming Bond Crash?

Since that spurt up to $1917, and the slump down to $1528 gold has been on ice below $1700. The technical analysis suggests that there is little to get excited about until gold breaks out of the $1600 to $1700 range, and I tend to agree. This is a slow-motion degeneration: triggers for a breakout seem limited to a deeper Euro meltdown (coming — and ultimately leading to a default cascade, and a derivatives meltdown), more American money printing (coming), or (most importantly) a large scale and visible dumping of dollars or treasuries by foreign creditors. Black swans like another Fukushima, incidences of terrorism, or broader social unrest might be bullish for gold in the long term, but gold right now (at least in the West) is up against a wall of perceptions: namely, that haven assets are limited to dollars, and to US treasury bonds. In the mainstream lexicon, gold is used to hedge tail risk and to make jewellery, and until that perception is shattered then I don’t think the funds will begin to significantly increase gold allocations.

There are two very strong pieces of evidence here for dollar and treasury weakness and instability: firstly, the very real phenomenon of negative real interest rates (i.e. interest rates minus inflation) making treasury bonds a losing investment in terms of purchasing power, and secondly the fact that China (the largest real holder of Treasuries) claims to be committed to dumping them and acquiring harder assets (and bailing out their real estate bubble). So when these perceptions will be shattered? Here are bond yields since 2007:


The bond market is a market, and like any other it is determined by supply and demand (Zero Hedge readers — algorithmic trading is still a form of supply and demand, albeit a fucked-up one). Low yields mean high prices, which mean that demand is still high — pretty close to all-time highs — which means that in the market the belief that treasuries are a haven still mostly holds.

A large sovereign treasury dumper like China with its $1+ trillion of treasury holdings throwing a significant portion of these onto the open market could very quickly outpace the institutional buyers, and force a small spike in rates (i.e. a drop in price). The small recent spike corresponds to this kind of activity. The difference between a small spike in yields and one large enough to make the market panic enough to cause a treasury crash is the pace and scope of liquidation.

Now, no sovereign seller in their right mind would fail to pace their liquidation just slowly enough to keep the market warm. After all, they want to get the most for their assets as they can, and panicking the market would mean a lower price.

But there are two (or three) foreseeable scenarios that would raise the pace to a level sufficient to panic the markets:

  1. China desperately needs to raise dollars to bail out its real estate market and paper over the cracks of its credit bubbles, and so rashly goes into full-on liquidation mode.
  2. China retaliates to an increasingly-hostile American trade policy and — alongside other hostile foreign creditors (Russia in particular) — organise a mass bond liquidation to “teach America a lesson”.
  3. Both of the above.

Now the pace and scope of any coming treasury liquidation is still uncertain and I expect it to very much be dictated by how the Chinese real estate picture plays out — the worse the real estate crash, the more likely a Chinese liquidation.

The pace of events might also be significantly accelerated in the light of a full-blown Eurozone default.

So in conclusion — give or take the inevitable QE3 spike — I expect gold prices to be stable or lower — even in the context of low real interest rates — up ’til a significant treasury liquidation. I don’t know when or if this will occur, but if it does, I would expect gold prices to soar in the following months. If it doesn’t occur and markets return to stronger organic growth, the gold bull market will probably end.

It must also be noted that a stock market crash will probably send gold lower in the short term, as with 2008. Ironically, the subsequent flight into treasuries (driving rates lower still) might be a NASDAQ-esque “blow-out top” that signifies the end.

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Is it Always a Good Time to Own Gold?

Is it always a good time to own gold?

Absolutely not. A portfolio in the S&P 500 or Treasuries in 1973 has returned a much higher rate than gold bought that year — even if gold raced ahead up ’til 1980, and is racing ahead again now. We know that throughout history gold has sustained its purchasing power, and fiat currency has lost its purchasing power. But we also know that stocks have grown their purchasing power.

But gold continues to rise — so what makes gold different right now? Well, from a technical perspective, America and the West are in a secular bear market:

But a technical perspective doesn’t really give enough political and economic background to explain why we are where we are.

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