The Federal Reserve has just
ended its $600-billion Treasury bond-buying program, known as QE-2, and
already, traders are trying to figure what new tricks the Fed might have up
its sleeve, in order counter a significant correction in the US-stock market
in the second half of 2011. Including QE-1 and QE-2, the Fed pumped
$2.35-trillion into the coffers of the Wall Street Oligarchs. Together with
near-zero interest rates, and the printing of trillions of dollars the Fed
fueled a speculative stampede into the commodity and stock markets, enabling
traders to record bumper profits, while doing little to reduce the jobless
rate.
Significantly, upon launching
QE-2 in Nov '10, the Fed said that it was deliberately seeking to raise the
inflation rate in a calculated bid to encourage a further sell-off of the
US-dollar's exchange rate. One result of the Fed's QE-2 scheme was triggering
a flood of hot money into the currencies of the Emerging economies, such as
Brazil, China, Chile, Russia, and Korea, (BRICK), where interest rates are
much higher than in the G-7 markets. Central banks in the BRICK countries are
now caught in a vicious cycle, forced to lift interest rates, to fend off the
inflationary pressures that are blown their way, by QE in England, Japan, and
the US.
The latest explosion in
commodity prices has lifted the Continuous Commodity Index to new all-time
highs. A good portion of the global surplus of cheap cash is being funneled
into crude oil, copper, cotton, Gold and Silver, and food staples such as
wheat, corn, rice and soybeans. The world's most actively traded commodity, -
crude oil, has risen to dangerously high levels that if sustained, could
derail the global economy, and knock the European, Japanese, and US economies
into recession. Despite desperate maneuvers by the US-government to cap the
rise of crude oil, such as releasing 30-million barrels of crude from the
strategic petroleum reserve in the month of July, the price of North Sea
Brent, the world's benchmark, is resilient, trading above $110 /barrel, and
could climb to $140 /barrel, if the Fed launches QE-3.
By locking the fed funds rate
near zero-percent, and vastly expanding the supply of US-dollars into the
banking network, the Fed was able to engineer a doubling of the value of the
S&P-500's Index from its March 2009 lows, and lifted the Dow Jones
Industrials, to as high as the 12,800-level, to levels that prevailed shortly
before the collapse of Lehman Brothers. Yet when seen through the prism of
Gold, and measured in "hard money" terms, the US-stock market's
rally was in essence, - a monetary illusion. In fact, 1-share of the Dow
Industrials can only fetch 7.8-ounces of Gold today, little changed since the
lows of March 2009.
The Fed was aiming for a
"wealth effect" that could lift the animal spirit of US-households,
as their brokerage portfolios increased in value, and thereby encouraging
them to spend more money in the economy. The Fed got a lot of bang for its
buck with QE-2, lifting the S&P-500 index +35% higher. Unfortunately, the
stock market gains went disproportionately to the wealthiest 10% of
Americans, who own more than 80% of outstanding stock. For the remaining 90%
of Americans there was little trickle down from QE-2. Last month, a CNN poll
found that 48% of Americans believe another Great Depression is somewhat or
very likely.
According to a recent opinion
poll of 24 bond dealers that trade directly with the Fed, only 20% though the
Fed would unleash QE-3 within the next 12-months. St. Louis Fed chief James
Bullard said on June 30th, it could take up to a year for the Fed to correctly
gauge the effects QE-2 on the US- economy. So it came as a bit of a shock,
when on July 13th, Fed chief Ben "Bubbles" Bernanke telegraphed to
the markets, that the Fed stands ready to launch QE-3 if the US-stock market
runs out of gas, and needs more high octane fuel.
"The possibility remains
that the recent economic weakness may prove more persistent than expected and
deflationary risks might reemerge, implying a need for additional policy
support," Bernanke told the House of Representatives on July 13th.
"Given the range of uncertainties about the strength of the recovery and
prospects for inflation over the medium term, the Fed remains prepared to
respond should economic developments indicate that an adjustment in the
stance of monetary policy would be appropriate," he said.
By opening the door to QE-3,
as early as the fourth quarter of 2011, the Fed chief ignited a powerful
surge in the precious metals markets, lifting gold towards $1,600 /oz, and
snapping the silver market back to life, - surging higher above $40 /oz.
Precious metal investors can hardly believe their good fortune, - the Fed
chief is QE addict. Just two weeks since the end of QE-2, the Fed chief was
already begun to feel the ill effects of QE withdrawal symptoms, and has an
itchy finger to print more money.
"Quantitative
Easing" (QE), is the nuclear option of central banking. Central banks
that experiment with the hallucinogenic QE-drug are in fact, monetizing debt,
and attempting to keep long-term bond yields locked at artificially low
interest rates, regardless if the underlying inflation rate surges sharply
higher, due to the expansion of the money supply. The Bank of Japan (BoJ) for
instance, has succeeded in driving the yield on Japan's 10-year government
bond (JGB) to as low as 1.05% this week, even though the supply of Japan's
debt, has mushroomed to 230% of Japan's GDP, - and its debt rating has been
cut to AA-.
"Even with the federal
funds rate close to zero, we have a number of ways in which we could act to
ease financial conditions further," Bernanke added. What's little
recognized by the unsuspecting public is that with QE-2, the Fed ventured
deep into new unexplored territory, by the slashing yield on the 1-year US
T-bill a stunning -250-basis points, to a record low of (negative)
3.40-percent. The "real" rate of interest fell sharply as consumer
and wholesale prices turned sharply higher, fueled by booming commodity
prices. At the same time the Fed was slashing the real rate of interest by
250-bps, it was also pumping $600-billion of "high powered" money
into the coffers of Wall Street's Oligarchic banks and hedge funds, that in
turn, pumped the ultra-cheap money into commodities, equities, and Gold and
Silver.
It's not just in the US-money
markets, where the "real rate of interest," adjusted for inflation,
is dropping sharply lower. In Shanghai, the inflation adjusted yield on
China's 1-year T-bill rate has plunged to (negative) 3%, from positive
+12-basis points, about 1-½ years ago. Five quarter-point rate hikes by the
People's Bank of China (PBoC), lifting its one year loan rate to 6.56% on
July 6th, have only acted to stem the slide in the real rate of interest on
Chinese T-bills, and short-term bank deposit rates, since the PBoC is
lingering far behind the increase in the underlying rate of inflation in
China.
China's annual inflation has
accelerated to a 3-year high of +6.4% in June, leaving inflation-adjusted
interest rates deep in negative territory. Thatencourages savers in China to
funnel their money into inflation hedges such as Gold. Worryingly, there are
signs that a weak US-dollar and expectations of QE-3, is still buoying key
global commodity prices near record high levels. Furthermore, traders
generally suspect that Beijing typically understates the true rate of
inflation in the country, while overstating the strength of its economy, when
reporting its statistics. So with a backdrop of deeply negative interest
rates, the price of Gold has risen dramatically in Shanghai, to a record
10,400-yuan /oz, up nearly +50% from a year ago.
The State Information Centre
said in a lengthy report in the official China Securities Journal on July
13th, that rising food prices are hurting consumer confidence and squeezing
their spending power, thereby undermining the economy. "China's real
deposit rate has been negative for 16-months and prices are still climbing.
We suggest the central bank increase interest rates further by one or two
percentage points, to change the negative returns on household savings,"
the centre said. Yet the PBoC is expected to limit further increases in
short-term T-bill rates to 50-basis point higher than today, in order to
prevent the appearance of an inverted yield curve, and toppling its economy
into a hard landing.
Gold is Safe haven from
Disintegration of the Euro
After slumping in the month of
January to as low as $1,300 /oz, the price of Gold in New York has been
climbing steadily higher, - and tracking the upward spiral in Greek bond
yields. While Euro-zone politicians have tried to pull every magic trick out
of the book to put worries over Greece's insolvency to rest, the bond vigilantes
have blow the lid off the Greek bond market. The upward spiral in Greece's
2-year note yield to an all-time high of 33.40% in July, is all the
information a gold trader needs to know, - where there's smoke, there is
fire. The Greek wildfire has already engulfed Ireland and Portugal, and is
now spreading to the Spanish and Italian bond markets, putting more than
$2-trillion of bond holdings at risk of devaluation.
Prospects for a disastrous,
disorderly outcome to the Greek debt crisis are beginning to show up in the
currency and precious metals markets, even though wildly bullish investors in
the stock market do not believe it will actually happen. The result is that
today's soaring bond yields in Greece, Ireland, and Portugal, may only be a
taste of what could come if Euro zone leaders fail ring-fence the weaker
peripheral bond markets. Regardless of what Euro-zone central bankers and
politicians have to say, the rapidly escalating yields for Greece's bonds, is
a clear signal that Athens is heading for default, and there's little faith
that the IMF can cobble a successful bailout. In the Euro zone, there's no
central government authority, and politicians have opposing interests. So
more often that not, very little gets resolved without a crisis.
A disorderly default in Greece
would bring steep losses to bond holders, especially for the Euro-zone's
Oligarchic banks and the ECB itself. Over the past year, the main targets of
banks and speculators have been smaller economies on the periphery of the EU,
such as Portugal, Ireland and Greece. But now, Europe's escalating debt
crisis is on the verge of engulfing by far its biggest victim: Italy, the
world's seventh-largest economy, whose sheer size could thwart any scheme to
bail it out. The addition of Italy to the so-called PIGS of Europe -
Portugal, Ireland, Greece and Spain, marks a serious escalation of the
crisis.
Italy's total debt outstanding
of nearly €1.8-trillion dwarfs that of Greece (€340-billion) and is more than
two-and-a-half times bigger than the total amount (€750-billion) available in
the EU bailout fund. Italy's bond market is the third largest in the world,
after the US and Japan. A large-scale withdrawal of funds from Italian bonds
would have enormous repercussions for the international banking system. As a
result, Italy has been described as a country that's "too big to
fail," and at the same time "too big to save."
An IMF staff report issued
July 13th, sharply criticized leading Euro zone politicians for failing to
develop unified measures to contain the debt crisis, thereby raising the
possibility of a contagion wildfire spreading to other European nations. The
main source of friction is Berlin's insistence that the banks and private
bondholders accept part of the pain of any new bailout for Greece. European
banks may have to raise as much as €80-billion ($113-billion) of additional
capital, to cover the losses in their trading books with 10-year Greek
government bonds trading at about 51-cents on the Euro.
Uncertainty over the financial
health of the Euro-zone's banking system, and lingering fears that countries
such as Greece, Ireland, and Portugal might eventually be forced to leave the
Euro currency itself, has led many depositors in the Club-Med countries to
seek safer havens in the Swiss franc and the Gold market. Foreign currency
traders have bid-up the value of the Swiss franc to a record high against the
Euro, while closely tracking the direction of weaker Euro-zone bond markets,
including Italy's bond yields. Since the start of 2011, the yield on Italy's
2-year note has jumped by roughly 2% to as high as 4.78% this week. Most of
that increase in yield occurred in the month of July, - lifting the Swiss
franc to 0.88-Euros.
The European Banking Authority
said July 15th, that only eight banks out of the 90 failed a so-called
"stress test," in the event of a severe downturn in the economy.
Yet traders thought the report was seriously flawed, because theEBA didn't
include a scenario in which Greece defaulted on its debts, even though the
credit default swap market is pricing in a 90% chance of a Greek default. The
total loss for all banks in the test on sovereign debt in their trading books
was just €10.5-billion. That compares to a total net direct sovereign exposure
to Portugal, Ireland, Italy, Greece and Spain of €687-billion.
Italian banks, which easily
passed the EBA's "stress tests" and were pronounced to be in good
health by the Bank of Italy, resumed their sharp downward slide on July 18th,
falling more than lenders elsewhere and driving Milan's main stock market
index into bear market territory. Adding to the sense of fear was that the
sharp slide of Intesa Sanpaolo SpA, Italy's largest lender, whose shares
plunged -4.2% in midday trading. Other banks, such as Unicredit, Banco
Popolare and Banca Monte dei Paschi di Siena were all tumbling lower, as
yields on Italy's 2-year note jumped to 4.70%, and its 10-year yield hit
6-percent.
Italian banks have
€164-billion in exposure to domestic government debt on their books, but a
bigger €1.26-trillion in private debts that would likely lose value in step
with a sovereign default. Regardless of sovereign default prospects, the cost
of borrowing for the private-sector is rising sharply at a time when Italy's
economic growth prospects are weak.
Another big worry is Spain
where regional and local banks could be sitting on an explosive amount of
unacknowledged losses relating to a real-estate bust. If they are, it could
require a takeover of the Spanish banking sector's bad debt by the Spanish
government, a scenario that's similar to Ireland. Official figures show that
the badloans held by Spanish banks are around €112-billion. Closer
examination reveals further losses, as loans to the stricken construction and
real estate sector stood at €440-billion at the end of 2010.
There is no guarantee that
investors will continue to buy Spanish bonds when its economy is contracting.
Spain's jobless rate has soared to 21.3%, the highest in the industrialized
world, with the jobless rate for youth under the age of 25-years reaching
43-percent. If Spanish interest rates continue to rise, it would deepen the
credit crunch. Should Spain lose its ability to borrow from global lenders at
affordable rates, it would need a loan package worth about €350-billion,
dwarfing the €275-billion total for the Greek, Irish, and Portuguese
bailouts.
Following the vicious shakeout
in the Silver market in the first week of May, several bottom fishing rallies
were turned back through the end of June. The EU's short-term bailout
maneuvers for Greece were successful in buying a few weeks of time, before
the facade blew off. However, with the latest upward explosion in Spanish and
Italian bond yields, there's been a mad rush for safety into the "poor
man's" version of gold. Measured in Euros, the price of Silver soared
+25% higher so far in the month of July, to as high as 28.95-euros /oz today,
amid fears that Europe's banking system will be badly hobbled for years to
come.
The infamous bond vigilantes
that used to wreck havoc on the G-7 bond markets in the 1980's and 1990's,
appeared to have been dead and buried, for most of the past decade. But
apparently, the bond vigilantes were tunneling their way under the Atlantic
Ocean, far beneath the radar screens of regulators in Europe and the US.
Suddenly, at the start of 2010, the bond vigilantes began to surface in the
Mediterranean Sea, and launched a surprise attack on the Greek bond market,
and moved quickly to the shores of Ireland, and Portugal. One and half years
later, the bond vigilantes are attacking Spain and Italy.
Bond markets in England,
Japan, and the US, are kept artificially afloat, by ultra-low short-term
interest rates, and in fact, deeply negative interest rates when discounting
for inflation. There is a sense of complacency in the G-7 government bond
markets that might also be misplaced. The world of finance has changed
radically since the financial crisis of 2008, but the precious metals were
the big winners over the past few years, mainly because they are increasingly
recognized as the only form of real money in the world's economy.
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