Quote of the Day: The goal of Nixon Shock is to get foreign governments to hold US debts

Nixon unilaterally abolished the monetary agreement established in 1944 at Bretton Woods, New Hampshire. At that meeting, the United States, Great Britain, and other Western nations established a new monetary order. It would be supported by the United States Treasury. The United States Treasury would guarantee that any central bank or foreign government could buy gold from the Treasury at a price of $35 per ounce.

The goal of the Treasury was simple: to get foreign governments to hold Treasury debt instead of gold. Because Treasury debt was supposedly as good as gold, foreign governments and central banks could hold Treasury debt instead of holding gold. This enabled the United States government to run fiscal deficits, and foreign governments and central banks financed a portion of this debt. They did so by creating their own domestic currencies out of nothing, and then using these currencies to buy U.S. dollar-denominated debt, meaning U.S. Treasury debt. It was a nice arrangement. Foreign governments and foreign central banks gained an interest rate return on holding treasury debt, which they could not get by holding gold. Yet the dollars that they were being promised by the Treasury were supposedly as good as gold.

This is an extract from Austrian economist Gary North’s article in remembrance of the Nixon Shock or the closing of the Bretton Woods Gold Exchange Standard 42 years ago today.  

This shift towards the fiat money US dollar standard regime magnifies the Triffin Dilemma, where recent improvements in US trade and budget deficits could mean trouble ahead for global markets and economies.

The Four Horsemen of the Financial Apocalypse

In the Book of Revelation in the Christian Bible, the end of the world or the ‘Last Judgment’ will be presided by the four horseman of the apocalypse. These figurative horsemen embodies conquest, war, famine and death.

While not exactly according to biblical prophesy, such allegorical omen may be seen as applicable to today’s modern day financial and monetary central bank based fractional reserve money system.

From the Sovereign Man’s prolific Simon Black (bold mine)

Today’s financial system is dominated by central bankers who have been awarded nearly dictatorial control of global money supply.

In allowing them to set interest rates, they are able to control the ‘price’ of money, thus controlling the price of… everything.

This power rests primarily in the hands of four men who control roughly 75% of the entire world money supply:

-Zhou Xiaochuan, People’s Bank of China

-Mario Draghi, European Central Bank

-Haruhiko Kuroda, Bank of Japan

-Ben Bernanke, US Federal Reserve

Four guys. And they control the livelihoods of billions of people around the world.

So, how are they doing?

We could wax philosophically about the dangers of fiat currency. Or the dangers of the rapid expansion of their balance sheets. Or the profligacy of wanton debasement through quantitative easing.

But let’s just look at the numbers.

In theory, a central bank is like any other bank. It has income and expenses, assets and liabilities.

For a central bank, assets are typically securities or commodities which have value in the international marketplace, such as gold or US Treasuries.

Central bank liabilities are all the trillions of currency units floating around… dollars, euros, yen, etc.

The difference between assets and liabilities is the bank’s equity (or capital). And this is an important figure, because the higher the capital, the healthier the bank.

Lehman Brothers famously went under in 2008 because they had insufficient capital. They had assets of $691 billion, and equity of just $22 billion… about 3%.

This meant that if Lehman’s assets lost more than 3% of their value, the company wouldn’t have sufficient cushion, and they would go under.

This is exactly what happened. Their assets tanked and the company failed.

So let’s apply the same yardstick to central banks and see how ‘safe’ they really are:

US Federal Reserve: $54 billion in capital on $3.57 trillion in assets, roughly 1.53%. This is actually less than the 1.875% capital they had in December. So the trend is getting worse.

European Central Bank: 3.69%

Bank of Japan: 1.92%

Bank of England: 0.843%

Bank of Canada: 0.532%

Each of these major central banks in ‘rich’ Western countries is essentially at, or below, the level of capital that Lehman Brothers had when they went under.

What does this mean?

Think about Lehman again. When Lehman’s equity was wiped out, it caused a huge crisis. The company’s liabilities instantly lost value, and almost everyone who was a counterparty to Lehman Brothers lost a lot of money because the company could no longer pay its debts.

Accordingly, if the US Federal Reserve’s assets unexpectedly lose more than 1.5% of their value, the Fed’s equity would be wiped out. This means that any counterparty holding the Fed’s liabilities (i.e. Federal reserve notes) would lose.

More specifically, that means everyone holding dollars.

Theoretically if a central bank becomes insolvent, it can be bailed out. It happened in Iceland a few years ago.

There’s just one problem with that thinking.

Iceland’s government wasn’t in debt at the time. So they were able to borrow money in order to bail out their central bank. Today the government is in debt over 100% of GDP, but the central bank is solvent.

But governments in the US, Europe, Japan, England, etc. are all too broke to bail out their central banks. These governments are already insolvent. So if the central bank becomes insolvent, there won’t be anyone to bail them out.

This is one of the strongest indicators of all that the financial system as we know it is finished. When central banks can no longer credibly issue liabilities, and their home government are too broke to bail them out, this paper currency standard can no longer function.

Such data really underscores the importance of owning real assets such as productive land and precious metals.

Given its nominal roller coaster ride lately, there has certainly been a lot of scrutiny and skepticism about gold.

But to paraphrase Tony Deden of Edelweiss Holdings, if you dispute the validity of gold as a hedge against declining fiat currency, that makes you, by default, a paper bug. Can you really afford to be confident in this system?

As been repeatedly noted here, QEs by major central banks have been meant to shore up asset markets which underpins the assets on the balance sheets of crony banks, and their guardians, the central banks. 

Of course QEs has fostered a low interest rate environment, which in effect, subsidizes debt financed government spending and the welfare warfare bureaucracy that the banking system, by virtue of Basel regulations, holds mainly as 'risk free' collateral.

And the same set of collateral have been used by crony banks to get loans from discount windows of central banks, and likewise, these collateral constitutes one of the major instruments used by central banks to conduct QE.

So all these ‘merry-go-around” or 'cul-de-sac' or 'loop-a-loop' arrangement has been designed to eliminate the threat of insolvencies of the cartelized unsustainable centralized debt-based political economic system

But there’s more. For the major economies, central banks can use changes in accounting methodologies to elude insolvencies, similar to the US Federal Reserve in January 2011.

As Austrian economist Robert Murphy noted, “It is now mathematically impossible for the Fed to become insolvent, through the magic of "negative liabilities."”

Ultimately central banks will tap the printing press should "bank runs” occur. 

Again Professor Murphy: 

But for the case of the Federal Reserve — with dollar-denominated liabilities — it is hard to see what actual constraints it would face, should its accountants suddenly announce its insolvency. Even if there is a "run on the Fed," where all of the commercial banks want to withdraw their electronic reserves on the same day, the central bankers need not panic: they can order the Treasury to run the printing press in order to swap paper currency for electronic checkbook entries. (This is a neat trick unavailable to the mere commercial bankers.)

The smaller central banks will not have the same privileges. Nonetheless, their assets are also anchored on assets of their major contemporaries.

I would like to further point out that aside from Iceland, another example of a bailed out insolvent central bank has been the defunct Central Bank of the Philippines (CBP)

As I wrote in June 2012

Central Bank of the Philippines, the predecessor of the BSP, suffered massive losses to the tune of an estimated Php 300 billion as consequence of the series of bailouts provided by then President Cory Aquino to her favorites.

The losses were eventually transferred to the central bank board of liquidators.

Don’t take just take it from me. Canadian monetary analyst JP Koning recently noted (bold mine) 

Consider the case of the Central Bank of Philippines (CBP), for instance. According to Lamberte (2002), the CBP was harnessed by the government in the 1980s to engage in off-balance sheet lending and to assume the liabilities of various government-controlled and private companies. All of this was to the benefit of the government as it lowered the deficit and kept spending off-budget. Later on these loans proved to be worthless, leaving the central bank holding the refuse. This has shades of Enron, which used various conduits and SPVs to hide its mounting losses.

The CBP was replaced in 1993 by the newly chartered Bangko Sentral ng Pilipinas (BSP). The BSP took over the CPB's note and deposit liabilities, as well as its foreign reserves and other valuable assets (the bad assets were allocated elsewhere).

A non-partisan observation on the populist perception which sees political leadership then as a 'virtuous' regime.

Bottom line: Small central banks will be bailed out. But if troubles of the four biggest and the most important central banks aggravates, then as Mr. Black notes “the financial system as we know it is finished” or financial apocalypse from the biblical equivalent of the four horsemen.

Quote of the Day: Financial markets do not work like real markets

The first thing we need to keep in mind is that the euro and the US dollar are currencies subject to monetary central planning. They are monopoly monies controlled and issued by central banks. Their quantity is determined by the decisions of the monetary central planners who oversee them; they influence the amount of "reserves" banks have for lending purposes, and through this control over the supply of money in the banking system can manipulate a variety of interest rates, especially in the short run.

As a consequence, financial markets do not work like real markets. We cannot be sure what the amount of real savings may be in the society to support real and sustainable investment and capital formation. We cannot know what the "real cost" of borrowing should be, since interest rates are not determined by actual, private sector savings and investment decisions. And, therefore, there is no guarantee that the amount of investments undertaken and their time horizons are compatible with the available resources not also being demanded and used for more immediate consumer goods production in the society.

This is why countries around the world periodically experience booms and busts, inflations and recessions − not because of some inherent instabilities or "irrationalities" in financial markets, but because of monetary central planning through central banking that does not allow market-based financial intermediation to develop and work as it could and would in a real free-market setting.

This is from former FEE President, author and professor Richard Ebeling in an interview with Anthony Wile at the Daily Bell

When the crisis comes don't blame the markets for what is truly a product of monetary central planning

How Tax Distortions Contribute to the Boom Bust Cycles

I recently posted about the glaring disconnect between stock market pricing and earnings expectations in the US. 

Aside from the US Federal Reserve’s easing policies and from the implicit guarantees also from the same agency, there is another very significant factor that adds to the serial blowing of asset bubbles: massive distortions from a tax regime which promotes share buybacks financed by leverage.

Philip Coggan under the pen name Buttonwood at the Economist articulates Apple as an example

WHAT a crazy world. Apple, a company with $145 billion of cash, is issuing some $17 billion of debt to buy back its own shares. Why doesn't it just use its cash to do the same thing? First, because a lot of that cash is overseas, and bringing it back to America would incur a tax charge. Second, because interest rates are low and debt interest is tax-deductible, making this look a great arbitrage.

But think of it from the point of view of the hard-working American taxpayer. Apple's money will still sit overseas and not be invested at home to create jobs. Apple's tax bill will fall, as it offsets the interest payments against its profits. The buy-back will probably push up the share price in the short term*, boosting the value of executive options; profits from those options will probably be taxed at the long-term capital gains tax rate of 15%, lower than the rate many workers pay. Organising a bond issue, rather than using a company's own cash, incurs costs in the form of fees to bankers on Wall Street; the same bankers taxpayers helped support five years ago

In short, the incumbent complex tax structure basically rewards debt accumulation and the principal-agent problem.

The latter or conflict of interest dilemma means that the same tax policies induces a fissure between the economic interests of the shareholders and of the option holders, held mostly by corporate officers.  Such has mostly been channeled through the tilting of the balance of incentives that encourages short term outlook and actions at the expense of the long term.

Buybacks and dividend issuance has accounted for a substantial share of the gains in the S&P.

Dr. Ed Yardeni notes that both has totaled “$2.1 trillion for the S&P 500 since stock prices bottomed during Q1-2009 through Q4-2012--has been driving the bull market since it began”.

Yet the distortions from tax incentives that promotes debt funded buybacks has not only been a bane via a conflict interest in corporate relationships particularly between between shareholders and corporate managers, but has also been materially affecting the real economy through the diversion of resources to speculation rather than to investments.

Notes analyst Martin Spring in his latest outlook (no link)

One reason why prices continue to rise despite sluggish growth in corporate profits is the contractionary impact on supply from share buybacks, which are rising towards to levels last seen in 2007.

“The motivation,” reports CLSA Asia-Pacific’s Christopher Wood, “appears to be primarily to boost earnings per share – a formula on which so many corporate executives’ remuneration is based.”

He adds: “The pick-up in commercial and industrial lending in America over the past two years has been primarily driven by the desire to finance financial engineering exercises such as share buybacks, rather than to fund new investment.”

Essentially, the money bubble is being used primarily for speculation rather than stimulating economic activity, its supposed intention.

Government policies whether via taxes or central bank policies or administrative policies (e.g. homeownership) have all been synched or engineered to promote leveraging and debt accumulation.  

Debt is the essence of the paper money system.

Since the world’s monetary system shifted away from the gold standard, debt has increasingly been a tool to promote statistical “growth”.

Thus the increasing recourse to debt also means the increasing frequency of financial-banking crises.

Going back on how tax distortions promote systemic fragility, again Mr. Coggan

In short, the whole deal is linked to tax distortions; the treatment of repatriated cash, debt versus equity and capital gains versus income. The ideal tax system, as we have argued many times, is neutral between sources of income. The tax deductibility of interest played its part in creating this mess, both in the corporate and mortgage markets. Why should the taxpayer want to encourage higher leverage, when high leverage is the root of financial crises?

Well, the answer to that is that debt or leverage mainly works to the interest of the banking-welfare warfare state-central banking cartel, who use debt to finance their intertwined interests. The incumbent political architecture in turn gives voters and taxpayers access to debt, via the above policies. Thus, the boom bust cycles.

That which is unsustainable, won’t last.

Matthew Ridley: Bitcoin as Synthetic Money

The impressive and articulate Matthew Ridley on his blog explains that Bitcoin is a form of synthetic money: 

Bitcoins resemble “commodity money”, like gold or cowrie shells, which rely on scarcity and indestructibility to be a good store of value. Real commodity money is vulnerable to inflation if there is suddenly a new discovery of gold — or deflation if there is suddenly a demand to use the commodity differently. In theory “fiat money”, such as we use today, avoids these problems — but governments have always removed the check on supply by printing money at whim to reduce debts.

There might be a way to cross fiat with commodity money and capture the benefits of both. Selgin calls this “synthetic commodity” money. Unlike fiat money it would have absolute scarcity; unlike commodity money it would have no non-monetary use. For example, a government could print paper money and then ostentatiously destroy the lithograph plates to show that it would never print any more.

In effect, this happened to the Swiss Iraqi dinar in the 1990s. Saddam’s regime used high-quality money engraved in Switzerland and printed in Britain. But during the first Gulf war in 1990 the supply dried up because of sanctions. Saddam began to print dinars at home, but these were easily faked, so they fell in value. The Swiss dinars remained in circulation for many years (though growing tatty) and held their value against the dollar.

Metaphorically, Bitcoin’s creators have destroyed the plates by making it impossible for anybody to change the programmed supply. So far that part of the experiment is succeeding, but Bitcoins are not yet ready for prime time. A friend who acquired some is sitting on a handsome profit, but finds the only thing he can exchange them for in his nearest city is chocolate.

Selgin points out that to get an exchange network going from scratch is hard enough when a new currency is fully compatible with established money, as in Birmingham; or when it consists of a commodity with other uses. But to do so using something with no non-monetary uses, so no one ought to want it at all except as a means of trade, should be almost impossible.

This only makes Bitcoin’s modest foothold even more impressive. An appetite for new kinds of money is there. The use of mobile phone credits as a currency in Africa, pioneered by M-pesa, is another example, and has had as jealous a reaction from central banks as Birmingham’s private coins did from the Royal Mint.

Read the rest here.

I would add that bitcoin’s evolution has also been a function, not only of as a cross between fiat money and commodity money, but also of the technology adaption lifecycle or technology diffusion via the S-curve.

Parallel Universe in Gold: More US States Push for Gold as Money

Even amidst aggressive inflationism from central bankers and from predatory confiscation of people’s savings, prices of gold has staggered.

Priced in major currencies (USD, EUR, GBP) except Japan’s yen, gold has substantially softened since mid 2011 (Gold.org)

Technically speaking, languid gold prices has been mostly due to a selloff in paper gold and through short sales. (chart from Danske Research)

In an interview with the South China Post, George Soros attributes falling gold prices to deleveraging in the Eurozone:

But when the euro was close to collapsing in the last year, actually gold went down, because if people needed to sell something, they could sell gold. Therefore they sold gold. So gold went down together with everything else

This implies that gold has not been deflationary hedge.

Nonetheless Mr. Soros partly acknowledges of the parallel universe that exists in the pricing of gold:

Gold was destroyed as a safe haven, proved to be unsafe. Because of the disappointment, most people are reducing their holdings of gold. But the central banks will continue to buy them, so I don’t expect gold to go down. If you have the prospect of a crisis, you will have occasional flurries or jumps. So gold is very volatile on a day-to-day basis, no trend on a longer-term basis.

Gold really has not lost its safe haven status, the role of currency safe haven may have partly been assumed by bitcoin.

But the bear raid on paper gold could have been orchestrated to influence “inflation expectations”. Gold plays a vital role in the commodity sphere, signifying a key benchmark on commodity ETFs, from the Mineweb last March:

The exodus from gold pulled down the entire commodities ETP complex, global data from BlackRock showed, as the gold segment accounts for some 70 percent of total commodity ETP investments.

Some $5.1 billion left commodities ETPs as inflows to industrial metals and broad basket commodity ETPs failed to offset the gold meltdown.

In other words, by suppressing gold prices, the general commodity sphere will likewise follow.

 

Also my personal view that gold’s has been undergoing a normal reprieve (profit taking-shake out phase) considering TWELVE consecutive years of advances.Markets hardly ever move in a straight line.

Yet aside from record central bank buying buying of physical gold as noted by Mr. Soros, gold coin sales has just been slightly off the record highs, while silver coins remains on record breaking path,

The more significant part of the growing parallel universe in gold dynamics is that about a dozen US states appear to be in the process of legislating gold as money.

From Bloomberg

Distrust of the Federal Reserve and concern that U.S. dollars may become worthless are fueling a push in more than a dozen states to recognize gold and silver coins as legal tender.

Arizona is poised to follow Utah, which authorized bullion for currency in 2011. Similar bills are advancing in Kansas, South Carolina and other states.

The measures backed by the limited-government Tea Party movement are mostly symbolic -- you still can’t pay for groceries with gold in Utah. They reflect lingering dollar concerns, amplified by the Fed’s unconventional moves in recent years to stabilize the economy, said Loren Gatch, who teaches politics at the University of Central Oklahoma.

If gold’s role as money will continue to get political recognition, then eventually this will reflect on prices, in spite of Central bank-Wall Street’s stealth suppression schemes.

Quote of the Day: The Roots of the Too Big To Fail Doctrine

For fractional reserve banking can only exist for as long as the depositors have complete confidence that regardless of the financial woes that befall the bank entrusted with their “deposits,” they will always be able to withdraw them on demand at par in currency, the ultimate cash of any banking system. Ever since World War Two governmental deposit insurance, backed up by the money-creating powers of the central bank, was seen as the unshakable guarantee that warranted such confidence. In effect, fractional-reserve banking was perceived as 100-percent banking by depositors, who acted as if their money was always “in the bank” thanks to the ability of central banks to conjure up money out of thin air (or in cyberspace). Perversely the various crises involving fractional-reserve banking that struck time and again since the late 1980s only reinforced this belief among depositors, because troubled banks and thrift institutions were always bailed out with alacrity–especially the largest and least stable. Thus arose the “too-big-to-fail doctrine.” Under this doctrine, uninsured bank depositors and bondholders were generally made whole when large banks failed, because it was widely understood that the confidence in the entire banking system was a frail and evanescent thing that would break and completely dissipate as a result of the failure of even a single large institution.

(italics original) 

This is from Austrian economics professor Joseph Salerno at the Mises blog

Example of the Mania Phase: Awards Received by the Bank of Cyprus

Euphoric sentiment is one principal trait of the manic phase; particularly the feeling of overconfidence, grandeur,invincibility and or infallibility. 

As I previously pointed out it had been no different in Cyprus whose banking system thought they were “immune” or "decoupled" to the euro crisis such that they even passed the “stress test” conducted by the European Banking Authority in 2011.

Chris Rossini at the Economic Policy Journal enumerates the string of awards that Bank of Cyprus received during their heyday or the pinnacle/climax of the bubble cycle.

The Bank of Cyprus, which is stealing up to 40% of deposits from those with more than 100k Euros, had quite a veil of legitimacy. 

Check out the prestigious awards that the bank recently earned:

Feb 25 2011 - The Banker magazine ranked the Bank of Cyprus amongst the leading banks of the world.

Apr 4 2011 - The prestigious Global Finance financial magazine honours the Bank of Cyprus with the title of Best Bank in Cyprus.

Jun 15 2011 - The Bank of Cyprus has succeeded in being included in the category of «Best Banking Organizations» worldwide at the annual World Finance Banking Awards of the internationally acclaimed financial magazine World Finance.

Sept 13 2011 - In the framework of its annual “Awards for Excellence 2011”, the Bank of Cyprus was named Best Bank in Cyprus by the international financial magazine EUROMONEY.

Nov 1 2011 - The Bank of Cyprus was awarded the ‘JP Morgan Chase Quality Recognition Award’ for its funds transfer operations for the eleventh consecutive year.

Dec 1 2011 - The Bank of Cyprus was named “Bank of the year 2011” in Cyprus by the prestigious international financial affairs publication The Banker, during its annual “Bank of the Year Awards 2011.”

Feb 9 2012 - Bank of Cyprus has been named as the Best Bank for Private Banking in Cyprus, by the internationally acclaimed magazine EUROMONEY.

Mar 23 2012 - The international financial magazine ‘Global Finance’ has named the Bank of Cyprus the best banking institution in Cyprus in the Developed Markets category of “World’s Best Banks Awards”.

Sep 26 2012 - Bank of Cyprus has been awarded the ‘2011 Citi Performance Excellence Award’ by the world-renowned financial organization Citibank, for global electronic payments leadership and excellence.

Notice that the accolades flowed from 2011 until September of 2012, which was only a few months back.

Then events unhinged or unglued pretty fast.

It has been part of the mainstream’s propaganda to say that current system based on fiat money has been hunky dory and functioning well. The reality is that it hasn’t.

Yet when aura of superiority, augustness and opulence have been propped up by a credit bubble, watch out. 

This applies to any country or region, Asia and the Philippines notwithstanding.

BRICs Mull Bank to Bypass World Bank and IMF

Developing economies represented by the BRICs or Brazil Russia India and China, a popular acronym coined by Goldman Sach analyst Jim O’Neill, have been reported as intending to establish their own multilateral bank to bypass or breakout from the clutches of the influences of the US and the World Bank-IMF cabal. 

From Bloomberg:

The biggest emerging markets are uniting to tackle under-development and currency volatility with plans to set up institutions that encroach on the roles of the World Bank and International Monetary Fund.

The leaders of the so-called BRICS nations -- Brazil, Russia, India, China and South Africa -- are set to approve the establishment of a new development bank during an annual summit that starts today in the eastern South African city of Durban, officials from all five nations say. They will also discuss pooling foreign-currency reserves to ward off balance of payments or currency crises.

“The deepest rationale for the BRICS is almost certainly the creation of new Bretton Woods-type institutions that are inclined toward the developing world,” Martyn Davies, chief executive officer of Johannesburg-based Frontier Advisory, which provides research on emerging markets, said in a phone interview. “There’s a shift in power from the traditional to the emerging world. There is a lot of geo-political concern about this shift in the western world.”

The growing role of emerging markets suggests of a commensurate expansion in geopolitical clout. From the same article:

The BRICS nations, which have combined foreign-currency reserves of $4.4 trillion and account for 43 percent of the world’s population, are seeking greater sway in global finance to match their rising economic power. They have called for an overhaul of management of the World Bank and IMF, which were created in Bretton Woods, New Hampshire, in 1944, and oppose the practice of their respective presidents being drawn from the U.S. and Europe…

Trade within the group surged to $282 billion last year from $27 billion in 2002 and may reach $500 billion by 2015, according to data from Brazil’s government. 

But such plans are still on the drawing board…

While BRICS leaders may approve the creation of a development bank in principle at the summit, there’s still disagreement on how it should be funded and operated.

There is more than meets the eye from this development.

 

The BRICs has been expressing apprehension over central bank 'credit easing policies' adapted or imbued by developed economies led by the US Federal Reserve. 

Russia’s Putin calls Bernanke’s QEs as “hooliganism”. Brazil has blamed the Fed for inciting a currency war, and so with China’s censure of QE. 

And partly in response and also in part to promote advancing her geopolitical role, China has been promoting the yuan, via bilateral trade arrangements to the BRICs and the ASEAN.

BRICs along with other emerging markets have been major buyers of gold

Emerging markets led by the BRICs dominated buying in 2012 according to the Bullion Street:

Central bank buying lifted gold last year and is likely to do so this year as more and more emerging market central banks have become first time buyers in recent years.

Observers said central banks across the globe collectively bought more gold than they had previously over 40 years. The buyers were not the usual central bank suspects among the old world European nations, but emerging economies.

And also in 2011 (chart from Reuters)

And recent events in Cyprus only exhibits of the rapidly deteriorating state of the current central bank based fiat money system. 

As Tim Price at the Sovereign Man aptly commented

It matters because the inept handling of its crisis last week threw one facet of modern banking into sharp relief: if a deposit guarantee is seen to be fraudulent or sufficiently fragile to be easily smashed by politicians, then confidence in banks, and in unbacked paper currency itself, will be vulnerable to an unpredictable run.

So the BRICs dissension over the current system has been prompting them to "diversify" (euphemism for acquiring insurance through gold purchases), as well as, to work on creating an alternative system that would circumvent the US dollar standard, possibly with their own bank. 

Perhaps BRICs officials are becoming more aware of the warning given by the French historian and philosopher François-Marie Arouet, popularly known by his nom de plume Voltaire: Paper money eventually returns to its intrinsic value--zero.

Bitcoins: Safehaven from Cyprus Debacle and Officially Recognized by the US Treasury

I questioned yesterday the wisdom of mainstream’s assault on bitcoins, where the Economist calls bitcoins a “bubble”.

Well it figures that the recent spike in the public's interests on bitcoins has partly been a ramification or an offshoot to the Cyprus savings grab debacle

Here is Businessweek/Bloomberg,

Since Sunday, a trio of Bitcoin apps have soared up Spain’s download charts, coinciding with news that cash-strapped Cyprus was planning to raid domestic savings accounts to pay off a $13 billion bailout tab. Fearing contagion on the other end of the Mediterranean, some Spaniards are apparently looking for cover in an experimental digital currency.

“This is an entirely predictable and rational outcome for what’s happening in Cyprus,” says Nick Colas, chief market strategist at ConvergEx Group. “If you want to get a good sense of the stress European savers are feeling, just watch Bitcoin prices.”

The value of the virtual currency has soared nearly 15 percent in the last two days, according to the most-recent pricing data. “One hundred percent of that is due to Cyprus,” says Colas. “It means the Europeans are getting involved.”

So aside from gold, bitcoins appear to be a major beneficiary from the Euro crisis. So which shows more signs of a bubble: bitcoin or fiat money?

Yet for those who claim bitcoin lacks the widespread acceptance, well, they fail to take account that even the US Treasury now officially recognizes bitcoins.

From Bradley Janzen of Freebanking.org

Financial Crimes Enforcement Network (FinCEN) is the bureau of Treasury that enforces the Bank Secrecy Act (which requires banks to spy on their customers for the government).

FinCEN Issues Guidance on Virtual Currencies and Regulatory Responsibilities

To provide clarity and regulatory certainty for businesses and individuals engaged in an expanding field of financial activity, the Financial Crimes Enforcement Network (FinCEN) today issued the following guidance: Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies. The guidance is in response to questions raised by financial institutions, law enforcement, and regulators concerning the regulatory treatment of persons who use convertible virtual currencies or make a business of exchanging, accepting, and transmitting them. Convertible virtual currencies either have an equivalent value in real currency or act as a substitute for real currency. The guidance considers the use of virtual currencies from the perspective of several categories within FinCEN's definition of MSBs.

News Release: http://www.fincen.gov/news_room/nr/pdf/20130318.pdf

Guidance: http://www.fincen.gov/statutes_regs/guidance/pdf/FIN-2013-G001.pdf

Welcome to the mainstream bitcoin.

Well, my favorite iconoclast Nassim Taleb has great words to say about bitcoins at the reddit.com: (hat tip Zero hedge)

Bitcoin is the beginning of something great: a currency without a government, something necessary and imperative.

A sentiment I share. 

Bitcoins could herald the epoch of decentralization or the information age and importantly perhaps a transition to F. A. Hayek's denationalization of money

Quote of the Day: Trust me, this time is different…

History shows there are always consequences to entrusting a paper money supply to a tiny handful of men. The French experiment is but one example. Our modern fiat experiment will be another.

 

Like the French, our politicians think this time is different. Our central bankers think they’re smarter. And they want us to trust them. After all, what could go wrong?

Ben Bernanke, a man who has expanded the Federal Reserve balance sheet by nearly 300% during his tenure as central banker, just wrapped up Congressional testimony downplaying the risks of his own money printing:

“We do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery…”

It’s also quite interesting that the Federal Reserve Chairman is discussing the ‘stronger’ economy, especially when by the government’s own numbers, US GDP contracted in the 4th quarter of 2012. Meanwhile the price of everything from food to fuel keeps getting higher.

Simultaneously, politicians in the US are racing to avoid imminent ‘sequestration’ budget cuts. They’ve created a problem caused by excess spending, and their solution is to ensure they can keep spending.

The French were in the same boat in the 18th century. During the time of Louis XV, no one could imagine how French society could possibly function if they cut the welfare system or defense budget. So they kept spending… kept going into debt… and kept debasing the currency.

We know what happened next.

The US already must borrow money just to pay interest on the money they’ve already borrowed. The political elite is dangerously out of touch. This time is not different. Assuming otherwise is really dangerous.

(bold original)

This is from Sovereign Man’s Simon Black

Hong Kong’s Parking Lot Bubble

I previously pointed out how Hong Kong’s recently imposed property curbs, which essentially are capital controls, would compound or intensify on the distortions and nasty side-effects from its currency peg on the US dollar.

We seem to be getting more evidence on this

Sovereign Man Chief Investment Strategist Tim Staermose notes of how Hong Kong’s currency peg and property curbs (capital controls) have found a new, if not an additional object of policy induced bubbles: Parking Lots.

In another absurd example of what happens when unrestrained money printing meets idiotic government taxes, the price of parking spaces at a suburban apartment complex some 40 minutes from central Hong Kong is now HK$1.3 million, or approximately US$168,000.

There are two key factors driving this lunacy–

1) the tidal wave of money from across the Pacific as a result of the Federal Reserve’s QE infinity policy; and,

2) the Hong Kong government’s misguided attempts to control the property bubble here.

A few weeks ago, as we reported, the government snuck in 15% stamp duty tax affecting foreign buyers, plus a property tax increase, in hopes of snuffing out property speculation. Yet all they did was send the speculative money flows into things such as parking spaces instead, which are not affected by the tax hikes.

Hong Kong is flush with liquidity. The Hong Kong dollar is pegged to the US dollar at the rate of 7.80 +/- a very narrow band, which means that whenever the US Federal Reserve prints money, the Hong Kong Monetary Authority must also print money in order to keep up.

Interest rates here are effectively zero. And there are consequences to making money available for nothing.

All of the hundreds of billions of new Hong Kong dollars floating around in the system has to end up somewhere, and in recent years, much of it has ended up in Hong Kong’s property market.

Property prices in Hong Kong are the most expensive in the world. Recently a 6,200 square foot apartment sold for $62 million (USD), a mind boggling $10,000 per square foot.

Both the US dollar peg and capital controls through property curbs signify as a fatal cocktail mix to Hong Kong's free market economy. As I previously wrote, 

Inflationism essentially sow the seeds for protectionism through various forms of interventionism as capital controls. On the other hand, protectionism fosters antagonism. Central banking policies, thus, promotes social instability even in what used to be economically free nations.

Now if for every action there is an equal and opposite reaction according to Sir Isaac Newton's third law of motion, then expect that for every (artificially induced) boom, a bust will be the natural reaction. 

That's the nature of the fiat paper money system, promoted and operated by central banks.

Graphic of the Day: EUSSR

British author, journalist and politician Daniel Hannan at the Telegraph writes,

Take a close look at this promotional poster. Notice anything? Alongside the symbols of Christianity, Judaism, Jainism and so on is one of the wickedest emblems humanity has conceived: the hammer and sickle.

For three generations, the badge of the Soviet revolution meant poverty, slavery, torture and death. It adorned the caps of the chekas who came in the night. It opened and closed the propaganda films which hid the famines. It advertised the people's courts where victims of purges and show-trials were condemned. It fluttered over the re-education camps and the gulags. For hundreds of millions of Europeans, it was a symbol of foreign occupation. Hungary, Lithuania and Moldova have banned its use, and various  former communist countries want it to be treated in the same way as Nazi insignia.

Wonder why the euro, with its current thrust towards centralization (fiscal union, banking union, bank supervision), seems headed for perdition?

Swiss National Bank’s Currency Interventions Spawns Property Bubble

The unintended consequences from massive currency interventions conducted by the Swiss National bank, designed to curb huge inflows from a capital diaspora in the Eurozone by putting a ceiling on the euro, has apparently spawned a monster property bubble.

From Bloomberg,

Thomas Jordan’s fight to protect the Swiss economy is set to widen beyond currency markets and too- big-to fail risks as the central bank chairman considers how to curb the biggest real-estate boom in two decades.

The Swiss National Bank may act to stem what it called risks from “excessive credit growth,” economists from Bank Sarasin to UniCredit Group said. An option available to the central bank would be to force lenders to hold additional capital of as much as 2.5 percent of their domestic risk- weighted assets to help buffer against losses.

The SNB has already put a cap on the franc to counter the currency’s ascent and protect the economy. After leading efforts to boost capital requirements for UBS AG (UBSN) and Credit Suisse Group AG (CSGN), the country’s two largest banks, Jordan is now turning his focus to smaller lenders as the risk of a significant drop in property prices increases.

“The SNB has been warning for quite a while of a real- estate bubble and it wants to see a cooling,” said Andreas Venditti, a senior analyst at Zuercher Kantonalbank in Zurich. “It’s very possible that the buffer will be implemented before the end of the year.”

In the SNB’s June Financial Stability Report, which also called on Credit Suisse, Switzerland’s second-largest bank, to boost its capital, the central bank said the mortgage market poses a significant risk to Swiss lenders. Home loans have increased by almost 300 billion francs ($307 billion) in a decade and gained 5.2 percent last year to 797.8 billion francs. That’s about 140 percent of Swiss gross domestic product.

Surging Prices

The cost of owner-occupied apartments with as many as five rooms has risen the most over the past 10 years, with prices jumping 40 percent, SNB data shows. Prices of rental apartments have increased 29 percent.

UBS and Credit Suisse had combined outstanding mortgages of 240.6 billion francs at the end of 2011, up 2.8 percent from the previous year. Cantonal banks, which are largely owned by the regions, had a 6 percent increase, while the cooperative-based Raiffeisen banks saw mortgages surge 7.4 percent.

UBS said on July 31 that if property values fell by 20 percent, 99.7 percent of its exposure to Swiss real estate would remain covered by collateral. While prices are still climbing in some regions, “at this time, we don’t believe this could destabilize the Swiss economy or cause major losses for UBS,” Chief Financial Officer Tom Naratil said.

Chart courtesy of La Chronique de Crottaz Finance

To what extent has the SNB expanded their balance sheet?

Here’s the Financial Times,

Foreign exchange reserves rose to SFr406bn ($419.7bn) last month, up from SFr365bn in June, marking the third consecutive month that the Swiss National Bank has been forced to add tens of billions to its balance sheet in its efforts to weaken the Swiss currency.

The SNB has had a policy of keeping the franc at a ceiling against the euro of SFr1.20 since September and has vowed to buy as many euros as necessary to prevent the franc from strengthening beyond that level.

Recent interventions in the forex market have seen the SNB’s balance sheet expand to record levels. Forex reserves have risen 71 per cent since April, the latest figures show.

The credit boom seems to have percolated into the stock market too.

As of yesterday the Swiss Market Index has returned 9% and about 29% from the trough last August or about a year ago.

And considering that the growth of SNB’s balance sheet has vastly outpaced the the US Federal Reserve and other major central banks, the Swiss franc has even weakened substantially against the US dollar.

Taking cue from the Great Depression, the distinguished dean of Austrian economics Murray N. Rothbard wrote,

The trouble did not lie with particular credit on particular markets (such as stock or real estate); the boom in the stock and real estate markets reflected Mises's trade cycle: a disproportionate boom in the prices of titles to capital goods, caused by the increase in money supply attendant upon bank credit expansion

Yet if the SNB succeeds to restrain the banking system’s unsustainable credit expansion then a bust should be expected.

The boom-bust (Austrian Business) cycle as explained by the great Professor Ludwig von Mises,

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.

In a fiat money central banking standard, boom bust cycles have been the dominant landscape.