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Posts Tagged ‘Financial Disaster

Gold, Eurodollars, and the Black Swan that will devour the US Futures and Derivatives Markets

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by Jesse at CaféAméricain
Posted December 3, 2011

THE EURODOLLARS ESTIMATE IN THE CHART BELOW IS BASED ON THE BIS BANKING ESTIMATES from Commercial Banks and may not include official reserves held by Central Banks. As you know the Federal Reserve stopped reporting Eurodollars some years ago, with the consequence that it also stopped reporting M3 money supply. I like to think of Eurodollars and banking system derivatives as the Fed’s off-balance-sheet method of monetization and policy implementation, with plausible deniability.

Swap lines are provided to other Central Banks, and they in turn make the loans to their member banks, and from there to their customers. So this eurodollar creation is made outside the real domestic economy, and therefore has no immediate effect on domestic money supply and prices at the end of the money chain. But the effect is there, and the smart money closer to the financial system sees it coming. I do not know if the Fed’s swap line activity actually shows up immediately in their Balance Sheet and therefore the Adjusted Monetary Base. But I think it is fairly obvious that if swaps are used to create dollars by foreign central banks, who in turn loan those dollars to their own members, the impact of that broader dollar creation will only be felt with a significant lag in the domestic US economy. But it will be felt at some point.

When the Fed was tracking Eurodollars, I believe that they were not counting certain assets, or liabilities from the banks point of view, as money.  What exactly those assets might be and how liquid they are is a open question.  How much of them were held in Agency debt, and how much in Treasury debt?  Is a liquid obligation held by a foreign source part of the broad money supply, or not?  Since it can be quickly converted into dollars, and then into another currency, leaves little question that it is potential money at least.

At least part of the problem being faced by Europe in this crisis is the sharp point of the deleveraging of US assets underlying dollar denominated debt.   And if foreign confidence in the US dollar debt breaks, the losses would be daunting for the holders of that debt, so there will first be a rush into Treasuries and away from Agency debt and CDOs.  This will be like the ocean retracting, causing people to flock to the shore in wonder at the cheapness of the debt.  But eventually the returning tsunami of US dollars may very well swamp the Fed’s Balance Sheet and the domestic US economy and the savings of many. The hyper-inflation of financial paper is happening quietly and  off the books. The growth rate in derivatives held by the Banks is mind boggling. And how this will manifest in the real world economy is not fully known. A good sized chunk of the financial system may simply vaporise.  And I suspect that the policy makers will heavily allocate the damage to the least powerful members of the private sector.

Ownership of the real economy will continue to be concentrated in fewer and fewer hands. Stagflation is the most likely outcome because of this lack of reform and the rise of a self-serving oligarchy. As for the US Dollar, as I have said on numerous occasions, inflation and deflation are at the end of the day a policy decision. Period. Those who see a hyper-deflation or a hyper-inflation as inevitable elude my knowledge of the facts as they are. The Fed owns a printing press, and it uses it selectively.

Speaking of lags, I think the unusually long lag between the growth in Eurodollars and the price of Gold can be attributed to the gold sales programs by the Western Central Banks. Once those programs were suspended, and the Banks turned again into net buyers, the gold price rose dramatically. The most recent Eurodollar operation of the Central Banks in relieving the Dollar short squeeze in euro is not yet in the totals.

It should also be noted that there are other correlations one can use in determining the gold price, most notable ‘real interest rates.’ However, there are linkages amongst all the variables, given a non-organic increase in the money supply and artificially low interest rates for example being among them. So, when will the price of gold stop rising? Most likely when the Central Banks stop printing money, and return to transparently set market based interest rates and a productively reformed financial system. ‘Not on the horizon’ does come to mind.

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German Pope, Italian Central Banker

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by Gary North
Posted November 24, 2011 

CONCLUSION: EUROPE IS IN BAD SHAPE. This is hedge fund manager Kyle Bass’s assessment of the situation in Europe. He stated this in a rousing interview on the BBC’s TV network. Here is the segment:

He made two crucial points – points that stock market investors are ignoring. First, over the last nine years, there has been an increase of world debt from $80 trillion to $210 trillion. These numbers are staggering. Global debt over the last nine years has grown at 12% per year, while GDP has grown at 4% per year.

While he did not verbally spell out the conclusion for the interviewer, it is this: when credit must grow by 12% per year in order to produce 4% GDP growth, at some point there will not be enough GDP to supply sufficient credit. It is time once again to quote economist Herb Stein: “When something cannot go on forever, it has a tendency to stop.”

Bass had a great metaphor: the PIIGS have “sailed into a zone of insolvency.” Second, he explained, the sovereign debts in Europe will be written down. There is no other solution. The airhead interviewer with the Oxbridge accent seemed to be doing a college-skit imitation of Emma Thompson. She challenged him. What about Germany? Can’t Germany continue to fund Europe’s “southern neighbors”? Germany has “the earning power.” (Note: this means German taxpayers.)

Bass responded instantly. First, the German court has determined that any further bailouts are unconstitutional. Second, Greece – and, by implication, the other “southern neighbors” – will spend every euro it borrows from Germany and then come back for more, threatening a default if its demands are not met – exactly what it has done so far. This goes on until the write-down takes place, which it will.

There are two ways of looking at this: the Bass way and the Bass-ackwards way. The airhead chose the latter.

He draws conclusions from the numbers. No one in the mainstream media and mainstream investment fund world seems to be willing to do this. They talk and invest as if the process can go on forever. Debts need not be repaid. This is ancient Keynesian dogma that goes back to the New Deal. “We owe it to ourselves.” On the contrary, specific borrowers owe it to specific creditors. At some point, the specific borrowers are going to default, leaving specific creditors with huge losses. How huge?

THREE TRILLION EUROS!

Charles Hugh Smith agrees with Bass. He says that there will have to be a write-down. By “write-down” he means write-off. He estimates the losses at three trillion euros. Someone will have to take the hit. The great political debate in Europe today is over who will take this hit, and how soon.

It will be investors. But, to forestall the day of reckoning, Europe’s politicians pretend that taxpayers’ credit lines can be used by superficially solvent Northern European governments in order to borrow more money from creditors in order to lend to the PIIGS’s governments, so that the PIIGS’s governments can continue to (1) delay real austerity measures, i.e., massive layoffs of government workers and massive cuts in welfare payments, and (2) make payments on what they owe to investors, mainly banks.

Smith admits that three trillion euros is a guess. Nobody knows how much bad sovereign debt there is, so we must start somewhere. In a world of $210 trillion worth of debt, his estimate seems reasonable to me.

Let’s start with the most basic fact about all this uncollectible, impaired, bad debt: every euro of debt is somebody else’s asset. Wipe out the debt and you wipe out the asset. That’s why there’s no willingness to accept the writedown of debt: somebody somewhere has to suck up 3 trillion euros of loss.

This is the source of Europe’s present policy of “kick the can,” or more accurately, “kick the can with press releases and summits.” If there were a pain-free solution, it would have been implemented long ago. There is no way Europe is going to “grow its way out of this debt.” How much of the eurozone’s “growth” was the result of rampant malinvestment and risky borrowing? More than anyone dares admit. It won’t take austerity to crash the euroland economy, all it will take is turning off the debt spigot.

Europe is facing the problem that Bass raised when he spoke of 12% per year increases of credit and 4% increases per year of GDP. There is no way to grow your way out of this. This is not just Europe’s problem. It is the world’s problem. But Europe is facing it now because the debts are coming due now. They must be rolled over. Creditors must agree to re-lend. But why should they?

The Establishment world of crony capitalism speaks of “re-structuring” the debt. What does this mean? Smith does not pull any punches.

“Restructuring” is a code word for writeoffs. Here, let me “restructure” the euro bond you bought at a 4% coupon yield. Now you’re going to get 2%, and you’re going to like it. Bang, your bond just lost half its market value, but everyone gets to keep it on the books at full value. Nice, until you have to sell it to raise cash. Oops, the euro has slipped in value so you lost more than 50%.

The banks keep the assets on the books at face value. The underlying value is down by at least 50% for Greek bonds. The European experts admit this. (Why the debt is worth that high a percentage is beyond me.) The Greeks are going to default, one way or another.

Who will take the hit? Smith writes: “There’s a fundamental truth that everyone has to understand: what the government spends, the public will pay for sooner or later, whether in taxes or inflation or having their debt defaulted on.” This is reality. But it’s not precise enough.

WHO IS THE PUBLIC?

If there is hyperinflation – price inflation above 30% per year for a decade or more – the public that takes the hit will be almost everyone inside the eurocurrency zone. There will be almost universal hardship.

On the other hand, if monetary inflation ceases for more than a few months, there will be a depression. Big banks will fail. Their depositors will lose everything. The money supply will shrink. It will be 1930-38 all over again.

Central bankers do not allow such things. The European Central Bank will try to walk the tightrope, just as the national central banks in Europe did after World War II. The ECB will pursue boom-bust policies, refusing to capitulate either to a Great Depression or hyperinflation.

But how can it walk this tightrope? The losses will be huge for large banks. The politicians will try to transfer the cost of bailing out Europe’s banks to Germany. But the debts are too large.

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The moral unraveling of the EU, bailouts and central banking

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by Anthony Wile
from The Daily Bell
Saturday, October 15, 2011

SLOVAKIA HAS NOW APPROVED THE EUROPEAN DEBT-CRISIS bailout fund, but the problems Europe is experiencing are similar to those faced by America in the grip of the Fed’s immense bailouts of the past two years. Increasingly, these are seen as morally repugnant by citizens throughout the West. And this has significant consequences that the mainstream press declines to report.

Dominant social themes work by omission as well as commission; in this column, I want to re-examine potential ramifications. I’ve done it before, but I think it’s worth repeating. Not enough commentators, even in the alternative media, point them out in my humble opinion.

Money continues to flood Western regimes and financial institutions with billions and billions that they don’t deserve and cannot properly apply. Perhaps there is no alternative but to “kick the can down the road.” On the other hand, perhaps the bailouts are part of a wider elite destabilization effort, one intended to generate chaos and misery that will pave the way for global governance and maybe a new world currency. This is the view of the more conspiratorially-minded among the alternative media.

For whatever reasons, the bailouts, against all logic, continue apace and are being increasingly resisted … not merely for their Draconian impacts but because people are using technology to become more informed. This bailout saga, therefore, has been unusual, not only for the incalculable wealth that’s been extended but also because it’s played out in front of millions.

The ramifications continue to be felt in my view. The push-back began in the US with TARP and then continued with revelation of US$16 trillion-plus (probably more) in short-term loans extended by the US Federal Reserve to financial institutions – not just in America but around the world.

Now US Congressman Ron Paul is conducting the Federal Reserve’s first “audit.” Ben Bernanke speaks, but his pronouncements have nowhere near the power or authority of his predecessor Alan Greenspan. Occupy Wall Street and alternative journo Alex Jones are both holding organized protests outside Fed buildings. In Southern Europe, protests and riots (Greece) rise wherever the EU and its bankers attempt to impose “austerity.”

The Internet has allowed people to see – finally – exactly what’s going on. Prior to the Internet, the controlled mainstream news would have explained in unison that the Fed “made massive adjustments to the global financial fabric to ensure that systemic collapse was mitigated …” or employed other nonsensical euphemisms. These sorts of non-explanations would have been repeated ad nauseum.

But in the era of the Internet, such gobbledygook has been effectively negated by literally millions of articles (and thousands of videos) explaining what central banking really is – monetary price fixing – and how central bankers “print money from nothing” to advantage their cronies at the expense of everyone else.

The system survived because it appeared so incomprehensible that it was beyond criticism. Not anymore. People around the world “get it” and the anger is breaching even the indolence of the political class. Eventually, if certain fundamental knowledge becomes widespread enough, the elites may have to take a “step back” as we have predicted they might. Resistance is spreading.

We can see this in Slovakia, where that Eastern European nation was the last holdout among euro-zone nations to approve the EU’s most recent sovereign bailout fund. On Tuesday, the parliament rejected the fund and brought down the government of Prime Minister Iveta Radicova. On Thursday, the parliament voted FOR it, but the point had been made.

Even parliamentary representatives, notoriously resistant to the public sentiment they are supposed to be accommodating, are now beginning to reflect the animosity of their constituents. The Telegraph‘s Ambrose Evans-Pritchard recently captured this sentiment in a column entitled, “EU bailout is racket for financial elites.”

Twenty years ago, no mainstream paper in the world would have run such an article – even given today’s extreme stress and provocation. But times have changed. The financial system has come in for criticism the likes of which has not been seen (or heard) for decades. Here’s an excerpt from Evans-Pritchard’s article:

What the Slovak debate has shown us yet again – as if the political storm in Germany over the past two months has not been enough – is that escalating bailouts are nearing their political limits. The traumatic affair almost brought down the German government. It has in fact brought down the Slovak government. You can’t keep doing this. Democracies are not to be toyed with …

Slovakia’s cry of defiance has not been entirely pointless. Richard Sulik – the speaker of parliament – has caught a mood of popular disgust that goes far beyond his own country. His objections are unanswerable.

How can there be any justification for a state of affairs where a poor but rule-abiding EMU state must bail out a serial violator with twice the per capita income, and triple the level of the pensions – a country which is in any case irretrievably bankrupt? How can it be that the no-bail clause of the Lisbon Treaty has been ripped up?

But he also touched on the most neuralgic issue, reminding everybody that the EFSF is ‘mainly for saving foreign banks’. These are French, German, British, Dutch, and Belgian banks, of course … ‘I’d rather be a pariah in Brussels than have to feel ashamed before my children,’ Sulik said … Bravo.

“Bravo,” writes Evans-Pritchard, summing up the New Age’s defiance to establishment ways. We began to write about this back in August of 2009 when The Market Oracle’s Stewart Dougherty – a financial consultant – sent us a column entitled “The Metastasis of Moral Hazard and its Effect on Gold.” He wanted us to see what he’d written. Here’s an excerpt:

The colossal miscalculation made by Washington and Wall Street is that they could control the moral hazard genie once they removed it from the bottle. They believed they could use the genie to enrich themselves with trillions of dollars’ worth of taxpayer money, and then replace it in the bottle before its magic spell of immorality metastasized throughout society at large. They assumed that the people would be too stupid to see what was going on. And that even if the people did figure things out, they would willingly wear the thick, choking chains of debt being welded to their necks by the financial elite and its Washington enablers.

Instead, thanks to the Internet and the democracy of information and insight it affords, the people were instantly wise to what was happening, and it stirred them. The concept of “an eye for an eye, a tooth for a tooth,” harkens to the Bible. And perhaps Shylock was speaking for all of humanity when he said, “If you prick us, do we not bleed? If you tickle us, do we not laugh? If you poison us, do we not die? If you wrong us, shall we not revenge?”

We thought then, and believe now, that Dougherty wrote one of the decade’s most profound columns, capturing the MORAL dimension of the fraud of “bailouts” and the impact of their fundamental – even obscene – unfairness. We wrote about his column (you can see it here: Have the Immoral Actions of Central Bankers Precipitated the Decline of the West?) and commented:

Dougherty has written a REAL article of REAL observations about the end of Western civilization. Sheesh, … Spengler’s Decline of the West in three darn pages … He’s right, he has gotten the morality right. It’s not just the culture of the West, or its promotions, or even its social organization that is finished.

You CANNOT, as a society, witness a couple of guys pull a trillion out of their back pockets without feeling, well … snookered. And after feeling snookered, something else begins to percolate. “Hey,” you say, “wait a minute. I sit here with my debts and my job and my house in foreclosure and this guy – THIS GUY – throws around trillions? Wait a minute. WHEN DO I GET MINE!”

Now the rage spreads.

The Internet Reformation is a process, not an episode.

Germany and Greece flirt with mutual assured destruction

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by Ambrose Evans-Pritchard
The Telegraph
Posted 11 September 2011

BILD ZETUNG POPULISM HAS PREVAILED. Germany is pushing Greece towards a hard default, risking the uncontrollable chain reaction so long feared by markets. Greece can, if provoked, pull the pin on the European banking system and inflict huge damage on Germany itself. Photo: AP

First we learn from planted leaks that Germany is activating “Plan B”, telling banks and insurance companies to prepare for 50pc haircuts on Greek debt; then that Germany is “studying” options that include Greece’s return to the drachma. German finance minister Wolfgang Schauble has chosen to do this at a moment when the global economy is already flirting with double-dip recession, bank shares are crashing, and global credit strains are testing Lehman levels. The recklessness is breath-taking.

If it is a pressure tactic to force Greece to submit to EU-IMF demands of yet further austerity, it may instead bring mutual assured destruction.

“Whoever thinks that Greece is an easy scapegoat, will find that this eventually turns against them, against the hard core of the eurozone,” said Greek finance minister Evangelos Venizelos. Greece can, if provoked, pull the pin on the European banking system and inflict huge damage on Germany itself, and Greece has certainly been provoked.

Germany’s EU commissioner Günther Oettinger said Europe should send blue helmets to take control of Greek tax collection and liquidate state assets. They had better be well armed. The headlines in the Greek press have been “Unconditional Capitulation”, and “Terrorization of Greeks”, and even “Fourth Reich”.

Mr Schauble said there would be no more money for Athens under the EU-IMF rescue package until the Greeks “do what they agreed to do” and comply with every demand of ‘Troika’ inspectors.

Yet to push Greece over the edge risks instant contagion to Portugal, which has higher levels of total debt, and an equally bad current account deficit near 9pc of GDP, and is just as unable to comply with Germany’s austerity dictates in the long run. From there the chain-reaction into EMU’s soft-core would be fast and furious.

Let us be clear, the chief reason why Greece cannot meet its deficit targets is because the EU has imposed the most violent fiscal deflation ever inflicted on a modern developed economy – 16pc of GDP of net tightening in three years – without offsetting monetary stimulus, debt relief, or devaluation.

This has sent the economy into a self-feeding downward spiral, crushing tax revenues. The policy is obscurantist, a replay of the Gold Standard in 1931. It has self-evidently failed. As the Greek parliament said, the debt dynamic is “out of control”. We all know that Greece behaved badly for a decade. The time for tough love was long ago, when the mistakes were made and all sides were seduced by the allure of EMU.

Even if the Papandreou government met every Troika demand at this point, it would not make any material difference. Greek citizens already understand this, and they understand that EU loan packages are merely being recycled to northern banks. Instead of recognizing the collective EU failure at every stage of this debacle, the creditor powers are taking out their fury on what is now a victim.

We have never been so close to EMU rupture. Friday’s resignation of Jurgen Stark at the European Central Bank is literally a kataklysmos, a German vote of no confidence in EMU management. Dr Stark is not just an ECB board member. He is the keeper of the Bundesbank’s monetary flame.

The vehemence of his protest against ECB bond purchases confirm what markets suspect: that the ECB cannot shore up Italian and Spanish debt markets for long without losing Germany. “I look at what is happening in EMU and the words that spring to mind are total and utter disaster”, said Andrew Roberts, credit chief at RBS. He thinks German Bund yields could break below 1pc in the flight to safety.

Citigroup and UBS both issued reports last week on the mechanics of EMU break-up, both concluding with touching faith that EU leaders cannot and will not allow it to happen.

“The euro should not exist,” said Stephane Deo from UBS. It creates more costs than benefits for the weak. Its “dysfunctional nature” was disguised by a credit bubble. The error is now “painfully obvious”. Yet Mr Deo warns that EMU exit would not be as painless as departing the ERM in 1992. Monetary unions do not break up lightly. The denouement usually entails civil disorder, even war.

If a debtor such as Greece left, the new drachma would crash by 60pc. Its banks would collapse. Switching sovereign debt into drachma would be a default, shutting the country out of capital markets. Exit would cost 50pc of GDP in the first year. If creditors such as Germany left, the new mark would jump 40pc to 50pc against the rump euro. Banks would face big haircuts on euro debt, and would need recapitalization. Trade would shrink by a fifth. Exit would cost 20pc to 25pc of GDP. UBS concludes that the only course is a “fiscal confederation”, a la Suisse.

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Wikileaks discloses the reason(s) behind China’s shadow gold buying spree

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by Tyler Durden
Posted Zero Hedge, September 3, 2011

WONDERING WHY GOLD AT £1850 IS CHEAP, OR WHY GOLD AT DOUBLE THAT PRICE will also be cheap, or frankly at any price? Because, as the following leaked cable explains, gold is, to China at least, nothing but the opportunity cost of destroying the dollar’s reserve status. Putting that into dollar terms is, therefore, impractical at best, and illogical at worst.

We have a suspicion that the following cable from the US embassy in China is about to go not viral but very much global, and prompt all those mutual fund managers who are on the golden sidelines to dip a toe in the 24 karat pool. The only thing that matters from China’s perspective is that “suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar’s role as the international reserve currency. China’s increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.” Now, what would happen if mutual and pension funds finally comprehend they are massively underinvested in the one asset which China is without a trace of doubt massively accumulating behind the scenes is nothing short of a worldwide scramble, not so much for paper, but every last ounce of physical gold…

From Wikileaks:

“China increases its gold reserves in order to kill two birds with one stone”

“The China Radio International sponsored newspaper World News Journal (Shijie Xinwenbao)(04/28): “According to China’s National Foreign Exchanges Administration China ‘s gold reserves have recently increased. Currently, the majority of its gold reserves have been located in the U.S. and European countries. The U.S. and Europe have always suppressed the rising price of gold. They intend to weaken gold’s function as an international reserve currency. They don’t want to see other countries turning to gold reserves instead of the U.S. dollar or Euro. Therefore, suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar’s role as the international reserve currency. China’s increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.”

Perhaps now is a good time to remind readers what will happen if and when America’s always behind the curve mutual and pension fund managers finally comprehend that they are massively underinvested in the one best performing asset class.

From The Driver for Gold You’re Not Watching (via Casey Research):

You already know the basic reasons for owning gold – currency protection, inflation hedge, store of value, calamity insurance – many of which are becoming clichés even in mainstream articles. Throw in the supply and demand imbalance, and you’ve got the basic arguments for why one should hold gold for the foreseeable future.

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Keynesian solutions: after total failure, try, try again

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by Jim Quinn
The Burning Platform
Posted August 23, 2011

“LENIN IS SAID TO HAVE DECLARED THAT THE BEST WAY TO DESTROY THE CAPITALIST SYSTEM was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth.” – John Maynard Keynes – The Economic Consequences of the Peace

While Barack Obama vacations on Martha’s Vineyard this week he’ll be thinking about his grand vision to save America – again. There is one thing you can say about Obama – he’s predictable. He promises to unveil his “new” plan for America in early September. The White House said Obama will give a speech after the September 5 Labor Day holiday to outline measures to boost hiring and find budget savings that surpass the $1.5 trillion goal of a new congressional deficit-cutting committee. It is heartening to see that Barack has turned into a cost cutter extraordinaire. He should be an inspiration to the Tea Party, except for one little problem. The plan he unveils in a few weeks will increase spending now and fret about spending cuts at some future unspecified date.

I can reveal his plan today because the White House has already leaked the major aspects of his plan. He will call for an extension of the Social Security payroll tax cut of 2% for all working Americans. This was supposed to give a dramatic boost to GDP in 2011. Maybe it will work next time. He will demand that extended unemployment benefits be renewed. Somehow providing 99 weeks of unemployment benefits is supposed to create jobs. It’s done wonders thus far. He will propose some semblance of an infrastructure bank or tax cuts to spur infrastructure spending. It will include a proposal for training and education to help unemployed people switch careers. He will attempt to steal the thunder from the SUPER COMMITTEE of twelve by coming up with $2 trillion of budget savings by insisting the Lear jet flying rich fork over an extra $500 billion.

You may have noticed that followers of Keynesian dogma like Paul Krugman, Larry Summers, Brad Delong, Richard Koo, John Galbraith, every Democrat in Congress, and every liberal pundit and columnist have been shrieking about the Tea Party terrorists and their ghastly budget cuts that are destroying our economy. They contend the stock market is tanking and the economy is heading into recession due to the brutal austerity measures being imposed by the extremists in the Republican Party. There is just one small issue with their argument. It is completely false. It is a bold faced lie. This is 2011. The economy has been in freefall since January 1. No spending cuts have occurred. Nada!!! As the CBO chart below reveals, the horrendous slashing of government will amount to $21 billion in 2012 and $42 billion in 2013. Of course, those aren’t even cuts in spending. They are reductions in the projected increases in spending. Politicians must be very secure in the knowledge that Americans are completely ignorant when it comes to anything other than the details of Kim Kardashian’s wedding and who Snooki is banging on Jersey Shore.

I’d like to remind the Harvard educated Keynesian economists that Federal government spending is currently chiming in at $3.8 trillion per year. Federal spending was $2.7 trillion in 2007 and $3.0 trillion in 2008. Keynesians believe government spending fills the gap when private companies are contracting. Obama has taken Keynesianism to a new level. Federal spending will total $10.8 trillion in Obama’s first three years, versus $8.4 trillion in the previous three years. Even a Harvard economist can figure out this is a 29% increase in Federal spending. What has it accomplished? We are back in recession, unemployment is rising, forty six million Americans are on food stamps, food and energy prices are soaring, and the middle class is being annihilated. The standard Keynesian response is we would have lost 3 million more jobs, we were saved from a 2nd Great Depression and the stimulus was too little. It would have worked if it had just been twice as large.

The 2nd Great Depression was not avoided, it was delayed. Our two decade long delusional credit boom could have been voluntarily abandoned in 2008. The banks at fault could have been liquidated in an orderly bankruptcy with stockholders and bondholders accepting the consequences of their foolishness. Unemployment would have soared to 12%, GDP would have collapsed, and the stock market would have fallen to 5,000. The bad debt would have been flushed from the system. Instead our Wall Street beholden leaders chose to save their banker friends, cover-up the bad debt, shift private debt to taxpayer debt, print trillions of new dollars in an effort to inflate away the debt, and implemented every wacky Keynesian stimulus idea Larry Summers could dream up.  These strokes of genius have failed miserably. Bernanke, Paulson, Geithner and Obama have set in motion a series of events that will ultimately lead to a catastrophic currency collapse. We have entered the second phase of the Greater Depression and there are no monetary or fiscal bullets left in the gun. Further expansion of debt will lead to a hyperinflationary collapse as the remaining confidence in the U.S. dollar is exhausted. We are one failed Treasury auction away from a currency crisis.

John Maynard Keynes argued the solution to the Great Depression was to stimulate the economy through some combination of two approaches: a reduction in interest rates and government investment in infrastructure. Investment by government injects income, which results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment.

It sounds so good in theory, but it didn’t work in the Depression and it hasn’t worked today. It is a doctrine taught in every business school in America with no actual results to support it. Who needs facts and actual results when a good story believed and perpetuated by non-thinking pundits will do? Every Keynesian play in the playbook has been used since 2008. The American people were told by Obama and his Keynesian trained advisors that if we implemented his $862 billion shovel ready stimulus package, unemployment would peak at 7.9% and would decline to 6.5% by today. The cascade of recovery was going to be jump started by a stimulus package that equaled 27% of the previous year’s entire spending. Obama’s complete package was implemented. The outcome was an eye opener.

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Too much of a good thing is not a good thing

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by David Galland of Casey Research
Posted August 12, 2011

I AM BEGINNING TO FEEL A BIT LIKE ONE OF THE FRENCH unfortunates stumbling through the fog in the Ardennes, circa 1914. Except that, instead of Germans full of deadly intent coming at me in the gloomy forest, it is a flock of black swans. As it was for the French in the Ardennes, the number of problems – then Germans, now black swans – is becoming overwhelming.

Consider just a little of what we as investors, and as individuals looking forward to retirement in accommodations more commodious than a shipping box, must contend with:

  • The Euro-Stone. Despite all the bailouts and bluster flying about Europe, the yields in the wounded “piiglets” of Greece, Portugal, etc. have failed to soften to more tolerable levels. Worse, yields in the fatter PIIGS of Spain and Italy are hardening. This is of no small import to the German and French banks, which together are owed something like US$2 trillion by the porkers. At this point, it is becoming clear that the eurozone’s systematic flaws doom the euro to continue trending down until it ultimately takes its place in the pantheon of failed monies.
  • The Yen Has Lost Its Zen. This week the Japanese government again began intervening in currency markets because, remarkably, the yen has been pushed to highs against the dollar. This in a nation with a government debt-to-GDP ratio that is better than twice the also horrible ratio sported by these United States.

That ratio ensures that Japan’s long struggles will continue, burdened as it also is with the aftermath of the deadly tsunamis and the ongoing drama at Fukushima. Adding to its woes are the commercial challenges it faces from aggressive neighbors, and maybe worst of all, the demographic glue trap it is stuck in, with fewer and fewer young to pick up the social costs of the old. Toss in the waterfall plunge in Japan’s much-vaunted savings rate – formerly a big prop keeping Japanese interest rates down – and the picture for Japan is anything but tranquil.

  • China’s Crucible. There are many reasons for being optimistic about the outlook for China, including a large and hard-working populace. But there is one overriding reason to expect a big bump in the path to China’s emergence as the world’s reigning economic powerhouse.

Simply, it’s a capitalistic country with a communist problem.

Now, in the same way that some people believe in leprechauns or any of dozens of other magical beings, some people believe that an economy can be successfully commanded just as a captain commands the crew of a Chinese junk cruising along the coast. It’s a fantasy.

While the comrades in charge have done quite well – largely by getting out of the way of natural human actions – they are fast reaching the limits of their ability to navigate the shoals. As I don’t need to tell you, China is a massive country, with hundreds of millions of people capable of every manner of human strengths and frailties. But if they share one interest, it is in a job that allows them to keep their rice bowls full and a roof over their heads. Said jobs don’t come from government dictate – at least not on a sustainable basis – but rather by the messy process of free-wheeling commerce… and the more free-wheeling, the better.

In the July edition of The Casey Report, guest contributor James Quinn discusses the very real challenges facing China, not the least of which is that in the latest reporting period, official Chinese inflation popped up to 6.4%. Even more concerning was a 14% rise in the price of food.

Scrambling to keep employment high while also keeping inflation low, the Chinese government is throwing all sorts of ingredients into the mix – building ghost cities, raising interest rates, stockpiling commodities, clamping down on dissent, hacking everyone – but in the end, the irrefutable laws of economics must prevail. And so the Chinese government will have to atone for the massive inflation it unleashed in 2008, and for the equally disruptive misallocations of capital that are the hallmark of command economies.

While the blowup in China will wreak havoc in world markets, including many commodities, a bright side for gold investors is that the country’s rising inflation should help keep the wind in the sails of monetary metal. It’s no coincidence that the World Gold Council’s latest data show investment demand for gold in China more than doubling in the first quarter of this year.

  • Uncle Scam. Then there is the United States. Casey Research readers of any duration know the fundamental setup… The political avarice that dominates both parties… The fear and greed of John Q. Public and his steady demands that the government do more… The scam being run by the Treasury and the Fed to provide the funny money to keep the government running… The cynical attempts by certain politicians to stoke a class war… The cellars full of toxic paper at the nation’s financial institutions… The outright corruption and deceit of the various government agencies as they twist and torture the data to fool the people into supporting them in their scams.

But there’s a growing problem: An increasing number of people and institutions are coming to understand just how intractable the problems are. This has resulted in a steady move into tangible assets – gold, especially – that are not the obligation of any government. And it’s not just individuals and money managers moving into gold, but central banks as well. That is an absolute sea change from the situation even a few years ago.

Meanwhile, with the Treasury unable to borrow since May, a backlog in government financing needs has built up. Which begs the question: With the Fed standing aside (for the moment), where is the government going to find all the buyers for the many billions of dollars worth of Treasuries it needs to flog in order to keep the scam going?

If I were a conspiracy theorist, I might look at the sell-off in equities this week, triggered as it was by nothing specific, and see a gloved hand operating behind the curtain. After all, nothing like a good old-fashioned stampede out of equities to send billions chasing after “safe” Treasuries… which has been exactly the case this week.

Regardless, with the crossroads for hard choices now behind us, the global economy finds itself at the top of a long hill… with no brakes. From here on, it will increasingly be every nation for itself – meaning a return to competitive currency devaluations and, in time, exchange and even trade controls. And we will see a return of the Fed to the markets. On that topic, I will once again trot out a chart from an article by Bud Conrad that ran in The Casey Report a couple of years back.

I do so because it shows what I think is a very strong corollary between what occurred in Japan after its financial bubble burst and what is now going on here in the U.S. (and elsewhere). As you can see, as a direct result of the Japanese central bank engaging in quantitative easing, the Japanese stock market bounced back strongly. But then, when the quantitative easing stopped, the market quickly gave back all its gains.

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