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Archive for July 14th, 2011

Bernanke: Gold isn’t money

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from The New York Sun
Posted July 13, 2011

The Fed Chairman and Ron Paul clash over the dollar

IF ONE WANTED TO EDIT OUR SUMMER OF QUARRELS DOWN TO ONE EXCHANGE that encapsulates our national misunderstanding, we would commend that which took place today between the chairman of the Federal Reserve governors, Ben Bernanke, and the chairman of the House Monetary Affairs subcommittee, Congressman Ron Paul. The exchange lasted five minutes, and one won’t find it flagged on the front pages of, say, the New York Times. But it was up in lights on the Drudge Report, which has mounted a picture of Mr. Bernanke under the headline “Bernanke: Gold Not Money,” and linked to a piece in Forbes.

Dr. Paul began by expressing skepticism over optimistic reports on the economy, noting our lackluster performance over the past three years despite the Congress and the Fed having injected $5.3 trilllion dollars into the economy. He noted that the national debt has grown by $5.1 trillion, while GDP has grown less than 1% and 7 million people are unemployed. The average term of unemployment, he observed, has soared to nearly 40 weeks from 17 weeks. He also expressed skepticism over claims that inflation is low, citing one definition of inflation that has prices up 34% over the three years despite the weak economy. So, he asked, why pay money to banks and corporations under a policy of too big to fail rather than giving money directly to the people?

Mr. Bernanke responded by saying that the Fed hasn’t spent any money but has, in fact, made profits that it has returned to the government. He noted that the Fed was founded to deal with financial panics. Dr. Paul interrupted, noting that his five minutes were running out, and asked about the collapse in the value of the dollar by almost 50% in the past three years to less than a 1,580th of an ounce of gold. “When you wake up in the morning, do you care about the price of gold?” he asked Mr. Bernanke.

“Well,” the chairman replied. “I pay attention to the price of gold. But I think it reflects a lot of things. It reflects global uncertainties. I think the reason people hold gold is as protection against of what we call tail risks, really, really bad outcomes. And to the extent that the last few years have made people more worried about the potential of a major crisis then they have gold as a protection.”

“Do you think gold is money?”

Here the chairman paused awkwardly, before, finally, replying.

“No, it’s not money. It’s a precious metal.”

“Even if it’s been money for the past 6,000 years, somebody reversed that, eliminated that economic law?”

“Well, it’s an asset. Would you say treasury bills are money? I don’t think they’re money, either. They’re an asset.”

“Why do central banks hold it?”

“Well, it’s a form of reserve.”

Why don’t they hold diamonds?”

“Well, it’s tradition, long term tradition.”

* * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

The exchange, which Dr. Paul ended by remarking that some people still think gold is money, throws into relief the disconnected nature of our dialog. In the narrow sense, it’s true that the Fed doesn’t spend money. In the broader sense, it’s true that the Fed has become the enabler of the Federal government’s binge of spending — all the while boasting of the profits from such lending. Now we are in a showdown between a House elected to halt the increases in taxes and spending and a president and Senate bent increasing both. Into this midst comes a central bank signaling its preparedness to mount yet another round of quantitative easing, while the definition of inflation undergoes the equivalent of a gerrymander to disguise the significance of the collapse in the value of the dollar, which — on cue — hit a record low even as the chairman was speaking and the Republican leadership in the Senate was maneuvering to grant the president authority to issue debt on his own say-so. In our 40 years on this beat we don’t think we’ve seen a more cynical performance — by a central bank or an administration — than that which has been on display these past few years.

Sovereign debt blows big holes in big banks

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by John Browne
– Euro Pacific Capital
Posted July 14th, 2011

THE PAST FEW DAYS HAVE BEEN VERY BAD FOR THE WORLD’S LARGEST BANKS. American behemoths Citigroup and Bank of America are down about 7% each. Across the Atlantic, things are far worse. BNP Paribas, Barclays, and Banco Santander are all down 13% or more… and Société Générale is down an astounding 16%! Some pundits warn of an overreaction and suggest this is a buying opportunity for the beat-up financials. I disagree. Rather, I think the financials should now be considered toxic assets. Caution is justified.

It was only a week ago that markets were preoccupied by a downgrade of Portuguese sovereign debt and renewed concerns that Greece will need about $100 billion by year’s end to remain solvent. Now, as eyes are quickly shifting towards the first tremors of financial crisis in Italy, concerns over Greece and Portugal seem rather quaint. With an economy roughly 7 times larger than that of Greece, Italy is simply too big to bail out. Its collapse, like the sinking of a great ship, could create a vortex that drowns Europe’s major banks in red ink.

In addition to exposure to sovereign debt from insolvent nations like Greece, Italy, Spain, and Portugal, major US and EU banks are also massively exposed to toxic mortgage debts, the value of which continues to be eroded by crumbling real estate markets across the West. Meanwhile, at the least opportune moment, the banks are being besieged by ill-targeted regulations devised by vindictive politicians. Finally, banks’ balance sheets are skewed by ultra-low interest rates and new rules that shield them from pricing their assets to market. Beneath a thin veneer of smoke and mirrors, serious risks remain.

Intractable budget negotiations in Washington and Rome have significantly increased the likelihood of default by the West’s two major economic blocs. It could be reasonably inferred that we are entering a new phase of sovereign decline: the US is within weeks of temporary default; Italy is teetering; and the consensus on Greece is shifting toward the ‘German fix’ of bondholder haircuts. What’s worse, there are no long-term solutions readily apparent. The EU is so rigid that it’s only option is to break into pieces, while the US is so pliant that its main political parties are allowed to waste precious time scoring political points at the expense of the greater good.

Since the EU does not have a formal mechanism for handling default, large European banks have been ‘persuaded’ for many months by the ECB and national governments to invest in the debt of financially challenged nations within the EU, most importantly that of Portugal, Ireland, Italy, Greece and Spain (PIIGS). This approach was considered more politically viable than direct investment by the ECB. Now, these European banks are left holding the bag. Since there is still no viable mechanism to deal with this debt at the sovereign level, it’s no surprise that EU banks are being hit hardest in this correction. The question remains: what were they promised in exchange for ‘walking the plank’ into the debt abyss?

American banks have a lesser exposure to sovereign debt of the European PIIGS, but many of these institutions have made massive profits by selling insurance derivatives known as credit default swaps to their European counterparts. This is the same strategy that brought down insurance behemoth AIG in the wake of the 2008 Credit Crunch. Therefore, major American banks are far more heavily exposed to PIIGS debt than first appears. It’s as if they have learned nothing. Even conservative, and supposedly bulletproof, money market funds have exposure to EU bank debt.

I do not expect all of these banks’ shares to go to zero. Powerful governments are likely to resort to almost any means to salvage their grotesque central-banking/fiat-money system. Likely, that will include eventually forcing their citizens to rescue their banks again — but this time from even larger losses. However, in the meantime, the financials’ earnings and share prices could suffer dramatically.

Moreover, Italy’s situation brings some larger questions to the forefront: what happens when the next round of bank bailouts bring major sovereigns to their knees? Where will you want to have your assets positioned if the EU comes apart at the seams, or the US stops paying its soldiers and seniors? What’s your plan if the central banks flood the market with even more cheap money?

Readers are strongly encouraged not to waste time gambling on shaky financials, but rather to build themselves an ark of hard assets and start rowing away from the sinking great ships of state. You don’t want to be caught in the vortex when they go down.