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The USEconomy is
bifurcated, with price inflation advancing on the cost side while price
deflation harms on the asset side, to produce a nasty storm that is unlikely
to abate. When high pressure zones clash with low pressure zones, hurricanes
and tornadoes occur. Calling the resulting near 0% or low 2% price inflation
on a net basis a good sign completely ignores the forces pulling the national
economy apart. Economists prefer to view the landscape in aggregate, but they
miss the picture composed of two important parts enduring very different
forces. The financial sector has grotesquely grown, to an extreme. Global
financial assets have more than tripled since 1980, relative to GDP. In just
this past decade, the volume of Credit Swap Contracts (asset backed bond
insurance) increased five-fold in a span of four years. The base value of
equity derivatives (stock index contracts) increased almost five-fold in the
same four years. Leverage has also grown. Tremendous flaws exist in the
prevailing economic counsel that misguides the nation, into one phase of
disaster after another. Crisis is indeed the norm.
THE FAILED EFFECT OF NEW DEBT
The maestros believe that
new money or new debt (hard to tell the difference) can be created, and presto
change-o, the USEconomy rebounds. The new money production line is
disconnected from the tangible economy. The bankers can thus can tap federal
liquidity facilities and ignore their borrowing customers. The banking
authorities are resisting the solution, for the clear reason that many from
their sector would be destroyed and their power eradicated. The US Federal
Reserve has overseen vast money printing for years, and a continuous climax
in the past two years. A crescendo awaits. A tipping point comes, when
all the USGovt deficits, all the USTreasury Bond issuance, all the US bank
failures lead to a economic recovery, as profound change comes in
international sentiment toward the USDollar. They will exit, since
the US
markets are not permitted to clear, to liquidate, to enjoy the fresh breeze
inherent to capitalism. Financial markets throughout the entire USEconomy are
essentially frozen. A huge waiting game has emerged between the expectant
beneficiaries of USFed efforts to stimulate inflation and economic
participants. In the process, the USEconomy
deteriorates further.
Consider the shocking
graphic above. The resulting impact of new debt in the USEconomy is
actually negative. If the 0% official interest rate and the $1.5
trillion federal deficit do not convince the observer of failed policy,
failed remedy, and failed structural beams within the system, then this chart
should help. The effect of a new US$ of debt is actualy minus 45 cents in
economic activity. The engines of debt are totally broken, the saturation
levels reached. Ironically and tragically, the response from American
leadership will be to press the monetary pedal even harder, thus achieving
even worse results. Where is Paul Samuelson now, when his incorrect
quantitative theory of money has been discredited? His Nobel Prize should be
removed and replaced with a thousand foreclosure notices bound and sealed.
INFLATION VS DEFLATION AT THE TIPPING POINT
James Rickards is Director
for Market Intelligence at Omnis, a private analysis group. Rickards is a
superstar analyst in my view, quoted in the past in the Hat Trick Letter. He
has previously commented upon the justification for a 30% to 50% USDollar
devaluation, given all the extreme federal deficits and extensive future
obligations. Here he argues that the USEconomy is bifurcated, with price
inflation advancing on the cost side while price deflation renders harms on
the asset side, to produce a nasty storm that is unlikely to abate. Calling
the resulting near 0% or low 2% or climbing to 3% price inflation on a net
basis a good sign completely ignores the forces pulling the national economy
apart. Its structural defects are not being repaired. Such aggregate views
actually point out the spectacular ignorance of US economists, who fail to recommend
meaningful remedy, like job creation tax credits, like the return of all US
jobs sent to Asia, like elimination of
credit derivatives. Ours is nation of ignoramuses running the banking and
economic policy, for the benefit of the syndicate.
Rickards builds a
foundation that the financial sector has grown to the grotesque. He makes a
grand alert that in this dynamically complex system, the size of the maximum
potential catastrophe is exponentially greater than ever. He calls it
inescapable. Imagine a pendulum swing left and right, with each move farther
and higher, producing greater supposed wealth and prosperity on the positive
swing but greater recognized destruction and poverty on the negative swing. Here
are some facts to point out the extraordinary extremes that make return to
normalcy impossible. The ratio of world financial assets to world GDP
grew from 100% in 1980 to 200% in 1993 to 316% in 2005. Over the same 25 year
period, the absolute level of global financial assets increased from $12 trillion
to $140 trillion. The total notional value of all credit swap contracts (bond
insurance) increased from $106 trillion to $531 trillion between 2002 and
2006. The notional value of equity derivatives (stock index contracts)
increased from $2.5 trillion to $11.9 trillion over the same period, while
the notional value of credit default swaps increased from $2.2 trillion to
$54.6 trillion. Margin debt of US brokerage firms more than doubled from
$134.6 billion to $293.2 billion from 2002 to 2007, while the amount of total
assets per dollar of equity at major US brokerage firms increased from
approximately $20 to $26 in the same period. To say that such extensions
represent fantastic and monstrous leverage is a gross under-statement.
Resolving the current extreme situation is not possible or feasible.
In reaction to financial
crises, the emphasis has been on Wall Street taking charge with market
controls and on the US Federal Reserve handling needs with vast printed
money. Financial markets are not functioning properly, since interventions
are the norm and accounting rules are suspended. These rules are likely to be
even further suspended with the commercial loan fiasco in progress, with
fresh losses to deal with. Remedy and reform are not permitted, thus recovery
is an impossibility. Toxic assets sit on bank balance sheets, along with
foreclosed properties. The financial markets are not clearing, and that is
precisely the jam in the engine against which powerful monetary pressures are
building. The banking authorities are resisting the solution, for the clear
reason that many from their sector would be destroyed and their power
eradicated.
Rickards believes two
extreme choices are presented, and only extreme outcomes await. He said, "So while we may have temporarily
halted the slide, we have not done anything to solve our problems, which
means it is just a matter of time before one of two things happen. Either the
slide resumes and we finally arrive at the market bottom that we never hit in
2009, or they keep printing money to paper it over, eventually destroying the
dollar and undermining the entire economy. Those are the choices. What
the Fed wants is the one thing they are not going to get: Mild inflation.
They are desperately trying to get some inflation going because they are
scared to death of deflation. All of their Quantitative Easing [debt purchase
with newly printed money] and special programs with the Treasury and the
fiscal stimulus are designed to weaken the dollar. They are basically trying
to scare the markets into spending money. But right now, all Americans want
to do, naturally, is save money, de-lever, pay down debt. All very sensible
things to do on an individual basis. But when you do that, in a world where
consumption is 70% of GDP, your GDP is going to collapse. That is reflected
in the velocity of money. The whole notion that you can dial up nominal
GDP by increasing the money supply rests on another false assumption, which
is that velocity is fairly constant. Velocity has dropped through the
floor."
The perverted umbilical
cord in the Fascist Business Model directs money from the USGovt straight to
the big banks, big defense contractors, even the big pharamaceutical firms. Rickards
points out the frightening current situation that the USGovt is printing
money at unprecedented fast pace, but it cannot revive the housing market,
cannot revive business lending, cannot bring the banks back to a solvent
condition, and cannot produce price inflation. Rickards avoids mention of
other sources of inflation such as the USGovt reckless spending, the USGovt
coverage of AIG and Fannie Mae black hole losses, the USDept Treasury
constant investment in financial market interventions, the USFed vast array
of liquidity facilities, and the endless USMilitary obscene spending. His
central point should be stressed, that a TIPPING POINT comes. If the USGovt
and USFed halt their extreme financial support, then deep contraction and
reductions follow, complete with convulsions and spasms, in a melt-down. If
trouble arises and the official response is amplified financial support, then
fast rising price in key structures follows, including home prices and stock
prices, in a melt-up. The USEconomy and its overlaid financial system are
stuck in gear, the engine jammed hard. The infusion of new money will
accelerate to the point of removing the jam. The sudden jerk will be felt as
powerful price inflation that takes the nation off guard.
PARALLELS OF WEIMAR HYPER-INFLATION
Hyper-inflation
remains a threat, as parallels are strong with 1922 in the Weimar Republic of
Germany. Ben Bernanke has been set in contrast to Rudolf von Havenstein, the
central banker responsible for Germany's hyper-inflationary period. The
parallels are absolutely shocking between the US climate of 2010 and that of
the infamous Weimar Republic. Despite 1922 being such a long time ago,
the more advanced and sophisticated financial framework and government
actions bear frightening parallels to the Weimar Republic. Grasp the
parallels. They are as lengthy as they are ominous in foretelling price
problems dead ahead.
Von Havenstein monetized
debt from the German Govt after World War I, just like Bernanke
monetizes the USGovt debt after the Wall Street collapse. The debt purchase
dragged on long past the initial stop-gap of debt purchase with
printed money, but the war dragged on, just like the insolvency of banks and
housing drags on. VonH was praised as a hero, even granted a national
hero award, like BenB as Man of the Year. Actions on the monetization
path were difficult to stop since price inflation seems under control
during the early stages. The national climate was very difficult and
strained, with political factions deeply polarized, just like
Democrats and Republicans in the USCongress. War Reparations
were a huge factor in the debt to cover, just like Wall Street bank
extortions and USGovt nationalizations (Fannie Mae, AIG, General Motors) are
a huge factor. The mass unemployment and home loss tell a tale
about domestic economic and political crisis on both fronts. VonH gave blame
to external forces for their economist blunder, much like BenB blames
hedge funds for his blunders. VonH Herr missed the connection between
the continued issuance of new notes and the rise of commodity prices
amidst foreign exchange rate volatility, just like BenB fails to comprehend
the link between monetary growth and the oil price or US$ decline.
Claims of greater
sophistication are empty and ring hollow. Former USFed Chairman Volcker
uttered one of the funniest yet true insults to Wall Street last year. He
accused the US bankers of making only one worthy innovation in 20 years, the
automatic teller machine for cash dispensing. The US innovation in the
financial sector bears no fruit. The US possesses worse, even more dangerous
financial devices, and insists on revisionist history for looking at the
triggers to the Great Depression. Fractional banking, excessive credit
creation, leverage in stock market, foreign influence on US banks, these were
principal causes, not the lack of liquidity as Bernanke insists, still stuck
with hubris that he can control the inflation monster. BenB and his
predecessors know only inflation, but Mother Nature is well along in
delivering vengeance. This will end badly.
Badly bruised but
undeterred, Tyler Durden of Zero Hedge wrote, "In fact, there is one very clear difference between the hand
Von Havenstein had to play then and those today's central bankers have to
play now, namely the stability of today's political climate. Clearly this can
change, but the class warfare, nationalistic xenophobia, and revolutionary
spirit poisoning the political atmosphere of 1920s Germany is at the very
least dormant today, and certainly not meaningfully visible across the
political landscape. But let's not ignore the parallels either. As is the
case for today’s central bankers, Von Havenstein was faced with
horrible fiscal problems. As is the case for today's central bankers, the
distinction between fiscal and monetary policy had blurred. As is the case
for today's central bankers, the political difficulty of deflating was
daunting. And as is the case for today's QE-enthralled central bankers,
apparently respectable economic theory reassured him that he was doing the
right thing." The parallels are vast. See the Zero Hedge article
(CLICK HERE).
Durden minimizes the
parallel on the hostile toxic political atmosphere from 1922 Germany to US
today, steeped with class warfare, xenophobia, and revolutionary spirit, just
not as high pitched. The contrived strained story of the War on Terrorism
(used to cover vast military contractor profiteering and contraband activity)
has a strong hint of politically sanctioned nationalistic fervor that
sponsors distrust and disdain for some ethnic and religious groups. Also,
class warfare is seething under the US cultural fabric, as animosity and
distrust of New York bankers and the USCongress is at an historical peak,
ready to overflow. Also the US President cannot be seen in a press conference
of speech without at least 15 US flags, the symbol of xenophobia. The
European population well recognizes that superfluous flags as a symbol for
fascism, something not understood in the United States. As for revolutionary
spirit, see the Tea Parties and Tenth Amendment movements across several
states. They demonstrate against high taxes, banker bailouts, and oversized
government. Several states wish to exit the Union altogether, as they
recognize the federalist powers are but a syndicate, whose agenda greatly
differs from the people.
THE NEXT DREADED CHAPTER
Weimar Germany did not deal
with credit derivatives, leveraged losses, an oversized financial sector,
financial engineering gone haywire, and endless finanical firm bailouts. In
that respect, the United States avoids a certain amount of new money from
hitting the street and pushing up prices. The plan might be to starve the
Main Street and its tangible economy until the fires from Wall Street end.
That would involve a long wait. The new funds tossed into the USEconomic
cauldron essentially neutralize the Black Holes one increment of time per
treatment. They are almost entirely wasted, as the shocking negative
productivity of debt demonstrates. The treatment of Black Holes from an
imploded US leveraged financial structure, the tribute to Wall Street,
results in mammoth hidden funds to neutralize their effects. The USEconomy is
more at risk to strong price inflation from the QE2 and the next round of
money printing to manage the federal deficits, the new stimulus programs,
meaningful home loan modification aid, and urgently needed credit lines WILL
be inflationary in the sense that they do hit the street. Quantitative Easing
will not go away, only talk of it going away. Recall drastically wrong past
assessments. Remember the contained Subprimes? Remember the Green Shoots?
Remember the sound equity basis of Wall Street firms? The nation is stuck,
and new money will be urgently directed as needed. The next round of
Quantitative Easing in England is a certainty, matched by the United States.
Conditions are going to
break down. The major currencies are tied together, with no safe haven among
them, surely not the USDollar. All the fiat currencies lie in the same basket
floating at sea, part and parcel to the debt based monetary system. Threats
of sovereign default and/or prolific money printing will spawn a global
currency crisis with the USDollar at the epicenter. Debt denominated
money will be exposed as a fraud. The climax comes with a USDollar collapse,
an event written in stone, the end of the pathogenesis evolved from fiat
money. My view is that Austrian theory is prevented from producing
hyper-inflation yet, since the explosion of credit derivatives has so far
prevented it, whose notional value at one time exceeded $1.4 quadrillion. The
monetary press secretly covers such leveraged losses from Fannie Mae, AIG,
and a collection of Wall Street giants. The fires will soon be treated with
accelerant, as both the USGovt and the UKGovt succumb to pressures and
announce the second phase of Quantiative Easing, the powerful monetary
inflation they so vigorously deny as necessary.
GLOBAL GOLD BREAKOUT
Uncertainty over Greek
sovereign debt lifted demand for gold bullion across Europe as a hard asset. The
Euro currency is not fracturing, but rather consolidating as it removes
superfluous fatty portions. The European Union is not fracturing, but rather
consolidating as it removes the insolvent dead portions. In the process,
as the monetary crisis spreads across Europe, gold has been elevated into a
currency status. Great volatility in the European currencies since the latter
months of 2009 has prompted demand for gold, the true safe haven. Gold has
traditionally served as the ultimate safe haven in times of political and
financial uncertainty. A gold breakout has taken place over European soil.
Despite a stabilizing exchange rate, the underlying sentiment behind the
uncertain Euro has crept into the FOREX arena. The Gold price in Euros is
pushing out new highs in a gradual process. A very clear bullish Cup &
Handle reversal pattern indicates a sustained breakout. However, the
breakout is tentative for Gold in Euros, probably due to the queer US$
benefit. The Gold breakout in price will occur last and most powerfully in
US$ terms.
A multitude of extremely
powerful factors is aligned to push the Gold price in Pound Sterling terms to
new highs. UKGovt debt is out of control. Rescue for banks, economic
stimulus, basic outsized federal deficits, and monetization of the finances
work to produce a perfect storm. It will push up the Gold price. Reality
is soon to strike Britain that not only is another firm Quantitative Ease
round due, but the financial situation is not resolvable. Talk of UKGovt
debt default will rise to a crescendo level. What happens to Britain will
happen to the United States, but with a delayed timing. The next UK general
election is expected to result in a hung Parliament. The absence of a firm leading
coalition would have an equivalent effect of permitting blood to leak into
the waters for all FOREX trading sharks to see. The consensus is growing
for QE2, another powerful round of monetary expansion to compensate for what
Britain cannot execute, the accomplishment of a recovery or integration of
effective reform. New sterling money must be created in order to buy
UKGilt bonds, as gigantic deficits are to continue, forcing debt monetization
longer than expected. The Gold price has taken flight over British soil, also
in a gradual process. A different type of bullish Cup & Handle
reversal pattern is evident, one with an even more bullish neckline tilt
bias. It indicates a sustained breakout also. The Gold breakout in price
will occur last and most powerfully in US$ terms.
A different story is told
for Gold in Australian Dollars and for Gold in Canadian Dollars. My forecast
is for the commodity currencies (Canadian & Australian Dollars) to
outperform all major currencies in the next chapter of the Competing Currency
War. In the process, a gold breakout in those currencies is not possible. One
should remember that the Gold breakout in price will occur last and most powerfully
in US$ terms. The consolidation process appears to have come to an end.
The 1100 price level has shown solid support since December except for two
weeks, enough to permit the next upward thrust to take place. The rising
moving averages confirm the trend. Watch the 20-week moving average, which
has offered support in the latest assault on price with naked COMEX short
positions. They continue to sell gold without benefit of gold collateral,
protected by the USGovt and regulatory bodies controlled by Wall Street. When
price inflation arrives in force, hardly the tepid variety, after the Tipping
Point has been breached, the effect on the gold price will be astounding,
remarkable, and breath taking.
Gold investors have been
put to sleep. The grand wagon has seen many people fall off or jump off in
the last two or three months, typical in the gold bull market. In a world
with the USDollar sitting as global reserve currency, the main beneficiary in
the Competing Currency War, the gold bull with US$ saddle is the last to run.
Americans would do well to observe the gold price in European and British
terms, but then again, perspective beyond the US shores is not a trait of its
citizens. A small proportion own passports, and a small proportion speak a
foreign language. Many Americans cannot even identify correctly several
European capital cites. The monetary language to speak in the next chapter is
GOLD.
Jim Willie CB
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