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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 in the months ahead, 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.
Gary Dorsch
Editor, Global Money Trends
www.sirchartsalot.com
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