Peter Schiff on the Pernicious Effects of the Fed’s Proposed Exit Fee on US bonds

The US Federal Reserve proposes to avert a bond market meltdown by implementing an “exit fee”

The question is why the need for an exit fee? Apparently US officials seem to sense something unfavorable ahead.

Peter Schiff at his Euro Pacific website explains why such "exit fee" could translate to an impending black swan (bold mine)

The American financial establishment has an incredible ability to celebrate the inconsequential while ignoring the vital. Last week, while the Wall Street Journal pondered how the Fed may set interest rates three to four years in the future (an exercise that David Stockman rightly compared to debating how many angels could dance on the head of a pin), the media almost completely ignored one of the most chilling pieces of financial news that I have ever seen. According to a small story in the Financial Times, some Fed officials would like to require retail owners of bond mutual funds to pay an "exit fee" to liquidate their positions. Come again? That such a policy would even be considered tells us much about the current fragility of our bond market and the collective insanity of layers of unnecessary regulation.

Recently Federal Reserve Governor Jeremy Stein commented on what has become obvious to many investors: the bond market has become too large and too illiquid, exposing the market to crisis and seizure if a large portion of investors decide to sell at the same time. Such an event occurred back in 2008 when the money market funds briefly fell below par and "broke the buck." To prevent such a possibility in the larger bond market, the Fed wants to slow any potential panic selling by constructing a barrier to exit. Since it would be outrageous and unconstitutional to pass a law banning sales (although in this day and age anything may be possible) an exit fee could provide the brakes the Fed is looking for. Fortunately, the rules governing securities transactions are not imposed by the Fed, but are the prerogative of the SEC. (But if you are like me, that fact offers little in the way of relief.) How did it come to this?

For the past six years it has been the policy of the Federal Reserve to push down interest rates to record low levels. In has done so effectively on the "short end of the curve" by setting the Fed Funds rate at zero since 2008. The resulting lack of yield in short term debt has encouraged more investors to buy riskier long-term debt. This has created a bull market in long bonds. The Fed's QE purchases have extended the run beyond what even most bond bulls had anticipated, making "risk-free" long-term debt far too attractive for far too long. As a result, mutual fund holdings of long term government and corporate debt have swelled to more $7 trillion as of the end of 2013, a whopping 109% increase from 2008 levels.  

Compounding the problem is that many of these funds are leveraged, meaning they have borrowed on the short-end to buy on the long end. This has artificially goosed yields in an otherwise low-rate environment. But that means when liquidations occur, leveraged funds will have to sell even more long-term bonds to raise cash than the dollar amount of the liquidations being requested.

But now that Fed policies have herded investors out on the long end of the curve, they want to take steps to make sure they don't come scurrying back to safety. They hope to construct the bond equivalent of a roach motel, where investors check in but they don't check out. How high the exit fee would need to be is open to speculation. But clearly, it would have to be high enough to be effective, and would have to increase with the desire of the owners to sell. If everyone panicked at once, it's possible that the fee would have to be utterly prohibitive.

Read the rest here 

Peter Schiff on Dark Gold

Why has the US Federal Reserve been slow to deliver physical gold owned by Germany’s central bank? Why has China’s government been quietly accumulating physical gold? 

Author and businessman Peter Schiff explains Dark Gold at his company’s website:

Gold is the simplest of financial assets - you either own it or you don't. Yet, at the same time, gold is also among the most private of assets. Once an individual locks his or her safe, that gold effectively disappears from the market at large. Unlike bank deposits or stocks, there is no way to tally the total amount of gold held by individual investors.

I like to call this concept "dark gold." This is the real, broader gold market that exists below the surface-level transactions on the major exchanges. It's impossible to know precisely how much dark gold exists around the world, but we do know that it is enough to render "official" gold holdings insignificant. That's why I don't buy and sell gold based on the decisions of John Paulson, or even J.P. Morgan Chase. It is a long-term investment that requires a deep understanding of the nature of money - and how little Wall Street's media circus really matters.

Observing Dark Gold

Think of dark gold like dark matter. Dark matter is a mysterious substance that scientists hypothesize is an essential building block of our universe. All we know is that the universe is a certain size and that a huge amount of its mass is unobservable - this is what we've come to call dark matter.

We haven't yet looked directly at dark matter. We can only observe phenomena that suggest there is a substance we aren't seeing and can't quite measure.

Likewise, dark gold is an essential building block of global financial stability. But the extremely private nature that makes it so valuable also makes it nearly impossible to directly observe.

But every now and then, we get a glimpse into the hidden undercurrents of dark gold. In the past year, the Federal Reserve slipped up in a big way and momentarily poked a hole that we can peek through to see what's happening with some of the largest stores of dark gold in the world.

Gib Mir Mein Gold!

A year ago, the big news was that the Bundesbank, Germany's central bank, would begin the process of repatriating a portion of its foreign gold reserves, including 300 metric tons stored at the New York Federal Reserve Bank.

The controversy really started in late 2012, when Germany simply wanted to audit its gold reserves at the Fed. They were denied this access, so the Germans switched their approach. If they weren't allowed visitation with their holdings, they would instead demand full custody. In response, the Fed said it would oblige - within seven years!

As of the end of 2013, a Bundesbank spokesman reported that only 5 tons had been transported from New York to Germany so far, leaving the repatriation far behind schedule.

"But wait," some might argue, "the repatriation process might be delayed, but we know the gold is there. Central bank holdings constitute the most visible gold in the world. These institutions report their holdings to the world regularly. The gold at the Fed isn't dark gold at all!"

If this is a true and certain fact, then why was the Bundesbank denied a third-party audit of its gold in the Fed's vaults? The closest we've seen was an internal audit by the US Treasury last year. Of course, the US government holds the sovereign privilege of answering to no one but itself, but that hardly makes for reassuring statistics on which to base one's investments.

Read the rest here

Peter Schiff: The Website is Fixable, Obamacare Isn’t

Peter Schiff explains on why Obamacare virtually digs itself into an abyss.

Here is slice from LewRockwell.com

Since Obamacare made its debut, discussions have focused on Ted Cruz’ efforts to defund the law and the shockingly bad functionality of the Website itself. Fortunately for Obama, polling indicates that Senator Cruz has lost, at least for now, the battle for hearts and minds. The President has not been nearly so lucky on the technological front. If current trends continue, the rollout may go down as the worst major product launch in history. But given the government’s enormous resources, it’s safe to say that the site itself will ultimately be fixed. But when it is finally up and running, the plan’s many deeper, and more intractable, flaws will come into focus. That’s when the fun will really begin.

Put simply the program is built on a mountain of false assumptions and is covered by a terrain of unanticipated incentives. Any cleared-eyed observer should conclude that it is perfectly designed to raise the costs of care and wreck the federal budget. However, like just about every other complicated problem that bedevils the nation, the public has become far too caught up in the politics and has ignored the horrific details.

Most people agree that the plan can only remain solvent if enough young and healthy people (“the invincibles”) agree to sign up. They are the ones who are likely to pay more into the system than they take out. But now that insurance coverage is guaranteed to anyone at any time (at the same price — even after they have gotten sick or injured), the only incentive for the invincibles to sign up will be to avoid the penalty (I think we can dismiss “civic duty” as an effective motivator). But as I detailed in a column last year, Justice John Roberts declared the law to be constitutional only because the penalties are far too low to actually compel behavior. Once young healthy people understand that they can save money by dropping insurance, they will. No amount of slick, cheerful TV ads will change that.

The good news for Obama is that the plan will get a large percentage of young people covered. The bad news is that many of those that do sign up will not help the bottom line. The youngest and healthiest of the group are under 26 and will now be able to stay on their parents’ plans. This group will add nothing to the pool of premiums (but will use services). Among those older than 26, the ones who qualify for the largest subsidies will be more inclined to sign up. The way the plan is structured, individuals and families earning between 1.38 and 4 times the Federal poverty level will qualify for a subsidy. The government subsidy covers almost the entire premium for those near the bottom of that spectrum. These individuals will definitely sign up. But just like those under 26, they will be a net drain on the system.

From my estimations, private premium contributions don’t surpass the government contributions until an individual or a family makes about 2.5 times the poverty level (which equates to about $28,000 for an individual and $55,000 for a family of 4). Since a very large percentage of young people earn less than that, many will sign up to get the benefit. But these people will likely be net drains to the system as well. Their total premiums paid may be more than the services they receive, but that may not be true when you look only at what they actually pay in.

Read the rest here

Video: Peter Schiff on The Myth Surrounding Janet Yellen's Forecasting Record

Mainstream media glorifies incoming Fed Chairwoman Janet Yellen's forecasting track record for supposedly having warned against the 2008 crisis. 

Using Ms. Yellen's speeches and public pronouncements as basis, financial analyst Peter Schiff, in the following video, debunks such claims as inaccurate and an exaggeration.

This is important because the consensus seems to have massively build their hopes and optimism around Ms. Yellen's leadership. In reality, what the mainstream  has been cheering about has been the prospects of bigger inflationist policies, which signify as subsidies to Wall Street and politicians at the expense of main street. This also means that the mainstream expects Ms. Yellen to accommodate bigger and bigger systemic debt.

Worst, should Ms. Yellen's administration oblige to Wall Street's desires, then we should expect a bubble bust under her watch. 

Again as pointed out in the past, outgoing Fed chief Ben Bernanke must have been cunning enough to have bailed out and passed the burden of bubbles to his successor.

(hat tip Zero Hedge)

Video: Peter Schiff Was Right (Again) - 'Taper' Edition

hat tip EPJ

Quote of the Day: FED Policies: Hope is not a strategy

But the reality is that the economy will never regain true health as long as the stimulus is being delivered. Despite trillions already administered, the workforce is shrinking, energy usage is down, the trade balance is weakening, savings are down, inflation is showing up in inconvenient places, debt is up, and wages are flat. So while QE has succeeded in hiding the truth, it hasn't accomplished anything of substance. Unfortunately, the Fed is only interested in the headlines.

We also must understand that even if the Fed were to deliver a small reduction in bond purchases, such a move would change nothing. The Fed would still be adding continuously to its enormous balance sheet while presenting no credible plans to actually withdraw the liquidity. As I have pointed out many times, it simply can't do so without pushing the economy back into recession. Although this would be the right thing to do, you can rest assured that it won't happen.

We should also recall where this all began. When QE1 was first launched Bernanke talked about an exit strategy. At the time I maintained the Fed had no exit strategy as it had checked into a monetary Roach Motel. But now questions about an exit strategy have been replaced by much more delicate taper talk. But easing up on the accelerator without ever hitting the brakes will not stop the car or turn it around.

Bernanke has maintained that his purchases of government bonds should not be considered "debt monetization" because the Fed intends to only hold the bonds temporarily. In recent years however talk of actively selling bonds in the portfolio have given way to more passive plans to simply hold the bonds to maturity. But this is a convenient fiction. When the bonds mature, the Fed will have little choice but to roll the principal back into Treasury debt, as private bond buyers could not easily absorb the added selling that would be required to repay the Fed in cash. Judged by his own criteria then, Bernanke is now an admitted debt monetizer.

Following this playbook, the Fed will likely maintain the pretense that tapering is a near term possibility and that it has a credible plan on the shelf to bring an end to QE. In reality the Fed is stalling for time and hoping that the economy will inexplicably roar back to life. Unfortunately, hope is not a strategy.

This is from financial analyst and investment broker Peter Schiff at his company’s (Euro Pacific) blog

Why Bernanke’s Taper Talk is another Poker Bluff

Since 2010, I have been saying that FED “exit strategies” or the du jour “taper talk” represents no more than “poker bluffs”.  Each time the FED signaled about “exit”, the eventual consequence has been to expand easing policies.

Today’s “taper talk” by the Bernake-led US Federal Reserve essentially signifies as the same dynamic.

Bernanke’s “Taper talk” is really a tactical communication maneuver to REALIGN their actions with that of the current developments in the US bond markets. The FED wants the public to believe that they are in control of the markets when they are not.

As one would note, yields of the 10 year note has been ascendant since July 2012.

The Fed expanded unlimited QE 3.0 which only had a 3 month effect of bringing down rates.

Last May, yields began to move sharply upward a month after Kuroda’s announced one of the three arrows of Abenomics. Even the interest rate cut by the ECB had no effect on the global trend of rising yields

The impact from such polices has been one of narrowing durations, and this has been expressed by rising yields amidst unlimited and boldest monetary experiments which are indications of diminishing returns. 

Global central banks, led by the FED, will need another “shock and awe”, but effects of which may also be short-term.

The "Taper talk" as aggravating factor has only intensified the ascent of the treasury yields.

All these only reveals of the growing contradictions between monetary policies aimed at  maintaining “downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative” and rising rates as indicated by the bond markets. 

So in order to maintain credibility, the exigency by the FED has been to recalibrate policies to reflect on market’s actions, thus the taper talk.

In short, Bernanke’s taper talk really is a “face saving” act for the US Federal Reserve. Unfortunately face saving has been met by a dramatic revulsion in the marketplace.

Peter Schiff at the Euro Pacific Capital articulates why Bernanke’s Taper Talk is another Poker Bluff (bold mine)

As usual the Federal Reserve media reaction machine has fallen for a poorly executed head fake. It has fallen for this move many times in the past, and for its efforts, it has tackled nothing but air. Yet right on cue, it took the bait once more. Somehow the takeaway from Wednesday's release of the June Fed statement and Chairman Ben Bernanke's press conference was that the central bank is likely to begin scaling back, or "tapering," its $85 billion per month quantitative easing program sometime later this year, and that the program may be completely wound down by the middle of next year.

Although this scenario is about as likely as an NSA-sponsored ticker tape parade for whistle blower Edward Snowden, all of the market segments reacted as if it were a fait accompli. The stock market - convinced that it will lose the support of ultra-low, long-term interest rates and the added consumer spending that results from a nascent housing bubble - sold off in triple digits. The bond market, sensing that its biggest and busiest customer will be exiting the market, followed a similarly negative trajectory. The sell-off in government and corporate debt pushed yields up to 21 month highs. In foreign exchange markets, the dollar rallied off its four-month lows based on the belief that Fed tightening will support the currency. And lastly, the gold market, sensing that an end of quantitative easing would eliminate the inflationary fears that have partially fueled gold's spectacular rise, sold off nearly five percent to a new two-and-a-half year low.

All of this came as a result of Bernanke's mild commitments to begin easing back on permanent QE sometime later this year if the economy continued to improve the way he expected. The chairman did not really elaborate on what types of improvements he had seen, or how much farther those unidentified trends would need to go before he would finally pull the trigger. He was however careful to point out that any policy shift, be it for less or more quantitative easing, would not be dependent on incoming data, but on the Fed's interpretation of that data. By stressing repeatedly that its data goalposts were "thresholds rather than triggers," the chairman gained further latitude to pursue any stance the Fed chooses regardless of the data.

Yet the mere and obvious mention that tapering was even possible, combined with the chairman's fairly sunny disposition (perhaps caused by the realization that the real mess will likely be his successor's problem to clean up), was enough to convince the market that the post-QE world was at hand. This conclusion is wrong.  

Although many haven't yet realized it, the financial markets are stuck in a "Waiting for Godot" era in which the change in policy that all are straining to see will never in fact arrive. Most fail to grasp the degree to which the "recovery" will stall without the $85 billion per month that the Fed is currently pumping into the economy.

What exactly has convinced the Fed that the economy is improving? From what I can tell, the evidence centered on the rise in stock and real estate prices, and the confidence and spending that follow as a result of the wealth effect. But inflated asset prices are completely dependent on QE and are likely to reverse course even before it is removed. And while it is painfully clear that expectations about QE continuance have made a far bigger impact on the stock, bond, and real estate markets than any other economic data points, many must be assuming that this dependency will soon end.

Those who hold this belief have naively described QE as the economy's "training wheels." (In reality the program is currently our only wheels.) They are convinced that the kindling of QE will inevitably ignite a fire in the larger economy. But the big lumber is still too dampened by debt, government spending, regulation, and high asset prices to catch fire - all we have gotten is smoke instead. A few mirrors supplied by the Fed merely completed the illusion. The larger problem of course is that even though the stimulus is the only wheels, the Fed must remove them anyways as we are cycling toward the edge of a cliff.

Although Bernanke dodged the question in his press conference, the Fed has broken the normal market for mortgage backed securities. While it's true that the Fed only owns 14% of all outstanding MBS (the "small fraction" he referred to in the press conference), it is by far the largest purchaser of newly issued mortgage debt. What would happen to the market if the Fed were no longer buying? There are no longer enough private buyers to soak up the issuance. Those who do remain would certainly expect higher yields if the option of selling to the Fed was no longer on the table. Put bluntly, the Fed is the market right now and has been for years.

A clear-eyed look at the likely consequences of a pull-back in QE should cause an abandonment of the optimistic assumptions behind the Fed's forecast. Interest rates are already rising rapidly based simply on the expectation of tapering. Imagine how high rates would go if the Fed actually tried to sell some of the mortgages it already owns. But the fact is the mere anticipation of such an event has already sent mortgage rates north of 4%, and without a lifeline from the Fed in the form of more QE, those rates will soon exceed 5%. This increase will greatly impact the housing market. Speculative buyers who have lifted the market will become sellers. More foreclosure will hit the market, just as higher home prices and mortgage rates price any remaining legitimate buyers out of the market. Housing prices will fall to new post bubble lows, sinking the phony recovery in the process. The wealth effect will work in reverse: spending and confidence will fall, unemployment will rise, and we will be back in recession even before the Fed begins to taper.

In fact, the rise in mortgage rates seen over the last month has already produced pain in the financial world, with banks reporting a rapid decline in refinancing applications. By the time rates hit 5%, the current rally in real estate will have screeched to a halt. With personal income and wage growth essentially stagnant, individual buyers are extremely dependent on the affordability allowed by ultra-low rates. A near 50% increase in mortgage rates, which would result from an increase in rates from 3.25% to 5.0%, would price a great many buyers out of the market. Higher rates would also cool much of the housing demand that has been coming from the private equity funds that have been a factor in pushing up real estate prices in recent years. Falling home prices would likely trigger a new wave of defaults and housing related bankruptcies that plunged the economy into recession five years ago.

A similar dynamic would occur in the market for U.S. Treasury debt. Despite Bernanke's assurances that the Fed is not monetizing the government's debt, the central bank has been buying nearly 70% of the new issuance in recent years. Already, rates on 10-year treasury debt have creeped up by more than 50% in less than two months to over 2.5%. Any actual decrease or cessation in buying - let alone the selling that would be needed to unwind the Fed's multi-trillion dollar balance sheet - would place the Treasury market under extreme pressure. Since low rates are the life blood of our borrow and spend economy, it is highly likely that higher rates will lead directly to lower stock prices, lower GDP growth, and higher unemployment. Since rising asset prices and the confidence and spending they produce is the basis for Bernanke's rosy forecast, new lows in house prices and a bear market in stocks will likely reverse those forecasts on a dime.

Lost on almost everyone is the effect higher interest rates and a slowing economy will have on federal budget deficits. As unemployment rises, tax revenues will fall and expenditures will rise. In addition, rising rates will not only make it more expensive for the Fed to finance larger deficits, it will also make it more expensive to refinance maturing debts. Furthermore, the profit checks Fannie and Freddie have been paying the Treasury will turn into bills for losses, as a new wave of foreclosures comes tumbling in.

It's fascinating how the goal posts have moved quickly on the Fed's playing field. Months ago the conversation focused on the "exit strategy" it would use to unwind the trillions in bonds and mortgages that it had accumulated over the last few years. Despite apparent improvements in the economy, those discussions have given way to the more modest expectations for the "tapering" of QE. I believe that we should really be expecting a "tapering" of the tapering conversations.

As a result, I expect that the Fed will continue to pantomime that an eventual Exit Strategy is preparing for a grand entrance, even as their timeline and decision criteria become ever more ambiguous. In truth, I believe that the Fed's next big announcement will be to increase, not diminish QE. After all, Bernanke made clear in his press conference that if the economy does not perform up to his expectations, he will simply do more of what has already failed.

Of course, when the Fed is forced to make this concession, it should be obvious to a critical mass that the recovery is a sham. Investors will realize that years of QE have only exacerbated the problems it was meant to solve. When the grim reality of QE infinity sets in, the dollar will drop, gold will climb, and the real crash will finally be upon us. Buckle up.

Bottom line: High interest rate amidst a greatly leveraged system will sink asset prices heavily dependent on Fed steroids. This will impair the balance sheets of 1) politically privileged banking industry, main financing intermediaries of the US government, and 2) most importantly the heavily indebted US government.

The FED is trapped. Fed policies can now be said as “damned if you “taper”, damned if you “ease”.  

Yet like Mr. Schiff, since 2010 my bet has been on the latter. Crashing markets will only give the FED the eventual justification to ease. But again the potential outcome will hardly be a risk ON environment.

Video: Peter Schiff on the Solid Gold 'Chocolate Bar'

The Valcambi Suisse refinery introduces the Valcambi CombiBar 50-gram “chocolate bar” which can be broken into individual 1-gram gold bars. 

In short, pocket sized gold bars. 

Peter Schiff claims that its all the rage in Europe, in the following video (hat tip Lew Rockwell.com) 

Important disclosure: I have no business relationship with Peter Schiff as of this writing. 

I share this video with the purpose of informing my readers of the innovative trends in gold products. 

If pocket size gold bars become widespread or become available in Asia, I may be one of their buyer.

Video: Peter Schiff: This time it is different, it will be a lot worse

This time is different, it will be a lot worse, says Peter Schiff speaking at the 2013 Las Vegas MoneyShow. 

Mr Schiff's talk covers a wide range of interrelated topics from today's deja vu of 2006 in terms of steroid induced market euphoria, the bond market ponzi scheme, the Fed exit's bluff, manipulation of price inflation and growth statistics, runaway inflation and hyperinflation and the gold bubble (a bubble which ironically hardly anybody from Wall Street owns). (hat tip Lewrockwell.com)

Peter Schiff on US GDP Accounting Hocus Focus

Slow economic growth? No problem. All what is needed is for the government to change the methodology of computation. 

Explains Peter Schiff  at the lewrockwell.com (bold mine) [italics-my comment]

In the simplest terms, GDP is calculated by combining a nation's private spending, government spending, and investments (while adding trade surplus or subtracting trade deficits). Business spending on R&D, a portion of which comes in the form of salaries, has traditionally been considered an expense that does not explicitly add to GDP. But now, the United States will lead the rest of the world in redefining GDP. Washington has now declared that the $400 billion spent annually by U.S. businesses on R&D will count towards GDP. This equates to about 2.7% of our nearly $16 Trillion GDP. The argument goes that, for example, the GDP generated by iPhones has far exceeded the cost spent by Apple to develop the product. Therefore, Apple's R&D is not an expense but an investment.

The BEA also argues that the cost of producing television shows, movies, and music should count as investments that add to GDP. Supporters of the change often hold up the blockbuster television comedy Seinfeld as an example. Given that the show's billions in earnings far exceeded its initial costs, they argue that the production expenses should be considered "investments" (like R&D) and be added into GDP.

Economists who have staked their reputations on the efficacy of Keynesian growth strategies have argued that such changes will more accurately reflect the realities of our 21st century information economy. But their analysis ignores the failures so often associated with R&D and artistic productions. For every breakthrough iPhone there are dozens of ill-conceived gizmos that never get off the drawing board. For every Seinfeld, there are countless failures and bombs that leave nothing but losses. (Such is called survivorship bias-Benson)

In essence, the new methodology is an exercise in double accounting. For instance, suppose a company employs an accountant who works in the sales department, who is then transferred to the R&D department at the same salary. He still counts beans but now his salary will be billed to the R&D budget rather than sales. In the old methodology, the accountant's impact on GDP would come only from the personal consumption that his salary allows. Going forward, he will add to GDP in two ways: from his personal consumption and his salary's addition to his company's R&D budget. The same formula would apply to a trucker who switches from a freight company to a movie production company (for the same salary). If he moves refrigerators, he only adds to GDP through his personal spending, but if he hauls movie lights, his contribution to GDP is doubled. It makes no difference if the movie bombs.

These double shots are different from traditional investments, which inject savings (or idle cash) back into the marketplace. Until money from personal or corporate savings is invested, it is not adding to GDP. (This is why statistical GDP is an unreliable gauge for real growth-Benson)

Another change that will artificially boost GDP concerns how government salaries will be counted. Unlike most private sector compensation, wages, salaries, and pension contributions paid to government workers are added directly to GDP. This distinction makes sense and eliminates potentially double accounting. Profits generated by private companies add to GDP when they are ultimately spent or invested by the company. Wages reduce profits, and therefore reduce GDP. But that reduction is cancelled out by the consumption of the employee receiving the wages. Governments do not generate profits, so salaries are the only way that public spending adds back to GDP.

The new system magnifies the GDP impact of government pensions, which are a principal component of public sector compensation. Going forward, the pensions will be calculated not from actual contributions, but from what governments have promised. Under the old system, if a state had a $10,000 pension obligation but only contributed $1,000, only the $1,000 would be added to GDP. Under the new system the entire $10,000 would be counted. So now governments can magically grow the economy simply by making promises they can't keep.

The bottom line is that now certain private sector salaries (in R&D and entertainment) will be counted twice and public pension contributions will be counted even if they aren't made. The economy will not actually be any larger or grow any faster, but the statistics will claim otherwise. With the stroke of a pen, our debt to GDP ratio will come down. Will this soothe the fears of our creditors? Will critics of big government take comfort that spending as a share of GDP may be lower? My guess is that the government is confident that its trick will work, and that distracting attention with a statistical illusion is the sole motivation for the change.

Pls read more of the accounting chicanery here.

So by changing the accounting method, the US government hopes that the risks will be simply wished away from her profligate spending ways which also justifies more of the same. 

Yet another proof that governments have been engaged in wholesale manipulation markets directly and indirectly.

Are Central Bankers Poker Bluffing the Gold Markets?

Dr. Ed Yardeni at his blog writes

Other than profit-taking, what might be the fundamental reasons behind gold’s weakness? Perhaps the most important reason for the weakness in gold is that after three years of “living dangerously”--with lots of panics about apocalyptic endgame scenarios--the global economic and financial outlook is improving. That means that central banks may start to ease off on easing.

Earlier he wrote of the important role played by the FED in influencing stock market prices, (chart from Dr. Yardeni)

The Fed has contributed greatly to the bull market with its NZIRP and QE ultra-easy monetary policies, as evidenced by the close correlation of the S&P 500 and the securities holdings of the Fed. Bond yields fell to historic lows as the Fed purchased more fixed-income securities, increasing the attractiveness of stocks.

If gold prices indeed has been anticipating a forthcoming squeeze in the monetary environment due to an alleged "improving" fundamentals, which has bolstered the stock market, then we can easily deduce that tightening policies may similarly lead to falling stock markets.

This means that gold prices could be a leading indicator of the stock markets.

One can easily correlate the substantial contraction of the ECB’s balance sheet (left window), with the recent collapse in gold prices (right window).

The ECB’s balance, which has shrank to its lowest level since March of last year, began its accelerated descent since October almost simultaneously with peak gold prices.

Also, China’s government has announced pulling back on her easing policies through “a net 910 billion yuan ($145.89 billion) drain from the interbank market this week” (Reuters) which has coincided with a slump in her stock markets.

Of course, today’s booming US stock markets, as well as property markets, has prompted for the increasing hawkish statements from FED officials.

As Bloomberg’s Caroline Baum rightly points out,

Market participants forget that the Fed is neither omniscient nor a very good forecaster. What it is is the sole proprietor of the printing press. If the hint of cutting back on its hours of operation is enough to frighten the stock market, then the Fed really has to be concerned by what it hath wrought. 

This only means the Fed has been caught in a box. Once the stock markets gets freaked out by the prospect of a money squeeze, two question arises: 

-Will the central bankers stand firm and let the market clear (bubble bust)?  

-Or will they come rushing back to reflate the markets?

At the end of the day, my bet is that all these hawkish talks will pave way for future easing, thus a resurgent gold.

Euro Pacific Peter Schiff, in the following video, expounds on this matter:

Quote of the Day: Fiscal Cliff: The Dangerous Idea of the Permanence of Low Interest Rates

The current national debt is about $16 trillion. This is just the funded portion — the unfunded liabilities of the Treasury, such as Social Security and Medicare, and off-budget items, such as guaranteed mortgages and student loans, loom much larger. Our recent era of unprecedented fiscal irresponsibility means we are throwing an additional $1 trillion or more on the pile every year. The only reason this staggering debt load hasn’t crushed us already is that the Treasury has been able to service it through historically low interest rates (now below 2 percent). These easy terms keep debt-service payments to a relatively manageable $300 billion per year.

On the current trajectory, the national debt likely will hit $20 trillion in a few years. If, by that time, interest rates were to return to 5 percent (a low rate by postwar standards) interest payments on the debt could run around $1 trillion per year. Such a sum would represent almost 40 percent of total current federal revenues and likely would constitute the single largest line item in the federal budget. A balance sheet so constructed would create an immediate fiscal crisis in the United States.

In addition to making the debt service unmanageable, a return to normal rates of interest would depress the kind of low-rate-dependent economic activity that characterizes our current economy. A slowing economy would cut down on tax revenue and trigger increased government spending to beleaguered public sectors. Higher rates on government debt also would push up mortgage rates, thereby putting renewed downward pressure on home prices and perhaps leading to another large wave of foreclosures. (My guess is that losses on government-insured mortgages alone could add several hundred billion dollars more to annual budget deficits.) When all of these factors are taken into account, I think annual deficits could quickly approach, and then exceed, $3 trillion. This would double the amount of debt we need to sell annually.

Currently, foreign creditors buy more than half of all U.S. debt issuance. Most of these purchases are motivated by political reasons that are subject to change. The buyers, who legitimately can be described as “investors,” extend credit to the United States at such generous terms largely because of America’s size, power and perceived economic unassailability. If those perceptions change, 5 percent could quickly become a floor, not a ceiling, for interest rates. Given that America’s balance sheet bears more than a casual resemblance to those of both Spain and Italy, it should not be radical to assume that one day we will be asked to pay the same amount as they do for the money we borrow. The brutal truth is that 6 percent or 7 percent interest rates will force the government to either slash federal spending across the board (including cuts to politically sensitive entitlements), raise middle-class taxes significantly, default on the debt, or hit everyone with the sustained impact of high inflation. Now that’s a real fiscal cliff.

By foolishly borrowing so heavily when interest rates are low, our government is driving us toward this cliff with its eyes firmly glued to the rearview mirror. Most economists downplay debt-servicing concerns with assertions that we have entered a new era of permanently low interest rates. This is a dangerously naive idea.

This is from Peter Schiff at the Washington Times.

My impression is that once a recession becomes a reality, the likely actions by the US government will be to undertake bailouts of the politically favored institutions similar to 2008.

Such rescue efforts will easily bring to fulfillment Mr. Schiff’s $20 trillion debt target in no time.

Eventually the US will default directly (most likely path; read Gary North and Jeffrey Hummel) or attempt to default first indirectly through monetary inflation.

Keynesians, who look to the Great Depression and the Japan lost decade as model, fails to see or are blinded to the fact that today’s problem has not only been a banking based financial crisis but compounded by sovereign debt crisis which has been unprecedented.

The root of the problem hasn't been the lack of aggregate demand but from the sustained consumption of capital which mostly has been burned through serial political rescues, malinvestments from easy money policies and worsened by unsustainable welfare warfare systems.

Video: Peter Schiff takes on Gold Bear Chartist

The following video shows of the typical differences of how market participants operate.

Peter Schiff here staunchly defends the bullish case of gold based on fundamental long term perspective against a gold (short term) bear chartist. (hat tip: Bob Wenzel)

Charts or trend patterns are usually interpreted based on the underlying bias of the technician.

Moreover, the video wonderfully exhibits the stakeholder's dilemma at work-where the incentives to secure knowledge are driven by the degree of stakeholdings.

Such conspicuous nuances can be seen from the perspective of the institutional "analyst" who lack the meticulousness in her analysis of the gold market (because she don't have exposures on them) and of "equity holders" (as represented by Peter Schiff) who has direct stakeholding on gold.

The contrast of incentives frequently leads to the principal-agent problem or ethical dilemma. It is just in this case, the equity holder has been in command of the situation and is aware of the weakness of the analyst. In usual cases, it is the latter that influences the former.

Quote of the Day: Global Monetary Order is on the Verge of a Reset

The return to gold is unmistakably the product of a strategic, not merely a tactical, shift in global central banking policy. Central banks in the developed world have now altogether stopped selling bullion. This was foreshadowed by their behavior over the past decade, when they sold even less gold than they were permitted to under the anti-dumping Central Bank Gold Agreements. Clearly the concern about dumping gold was out of step with the trend. But more importantly, central banks in the emerging markets have been buying gold by the truckload.

Since the financial crisis of '08, nations as diverse as Mexico, the Philippines, Thailand, Kazakhstan, Turkey, Ukraine, Russia, Saudi Arabia, and India have led the way back to gold as a primary reserve asset. Russia alone has added an impressive 400 tonnes of bullion to its reserves, most of it coming from domestic purchases. Mexico has added over 120 tonnes, including 78 tonnes from one mega-purchase in March 2011. The Philippines have bought over 60 tonnes, with 32 tonnes coming in as recently as March 2012. Thailand has added approximately 60 tonnes, and Kazakhstan just shy of 30 tonnes. Turkey amended its regulatory policy late last year to allow commercial banks to count gold towards their reserve requirements, adding over 120 tonnes to its official reserves. And bullion imports into mainland China through Hong Kong have been reaching all-time highs.

Finally, loyal US allies Saudi Arabia and India, in what is sure to leave particularly bitter taste in Washington's mouth, have been adding gold to their reserves by the hundreds of tonnes.

In short, the governments of emerging markets recognize that the global monetary order is on the verge of a reset. These emerging markets are the economic engines of the 21st century, and they're determined not to be undermined by Western fiat paper.

This is from Peter Schiff at the lewrockwell.com talking about the return to the gold standard

Peter Schiff Interviews James Rickards on the Currency Wars

Peter Schiff recently had an interesting interview with author James Rickards author of the sensational Currency Wars: The Making of the Next Global Crisis.

Find below the interview along with my comments [bold italics]

Peter Schiff: You portray recent monetary history as a series of currency wars - the first being 1921-1936, the second being 1967-1987, and the third going on right now. This seems accurate to me. In fact, my father got involved in economics because he saw the fallout of what you would call Currency War II, back in the '60s. What differentiates each of these wars, and what is most significant about the current one?

James Rickards: Currency wars are characterized by successive competitive devaluations by major economies of their currencies against the currencies of their trading partners in an effort to steal growth from those trading partners.

While all currency wars have this much in common, they can occur in dissimilar economic climates and can take different paths. Currency War I (1921-1936) was dominated by a deflationary dynamic, while Currency War II (1967-1987) was dominated by inflation. Also, CWI ended in the disaster of World War II, while CWII was brought in for a soft landing, after a very bumpy ride, with the Plaza Accords of 1985 and the Louvre Accords of 1987.

What the first two currency wars had in common, apart from the devaluations, was the destruction of wealth resulting from an absence of price stability or an economic anchor.

Interestingly, Currency War III, which began in 2010, is really a tug-of-war between the natural deflation coming from the depression that began in 2007 and policy-induced inflation coming from Fed easing. The deflationary and inflationary vectors are fighting each other to a standstill for the time being, but the situation is highly unstable and will "tip" into one or the other sooner rather than later. Inflation bordering on hyperinflation seems like the more likely outcome at the moment because of the Fed's attitude of "whatever it takes" in terms of money-printing; however, deflation cannot be ruled out if the Fed throws in the towel in the face of political opposition.

[My comment:

At this point policy actions by global authorities do not seem to indicate of a currency war or competitive devaluation as the olden days (as per Mr. Rickards scenarios].

While major central banks have indeed been inflating massively, they seem to be coordinating their actions to devalue. For instance, the US Federal Reserve has opened swap lines to major central banks and to emerging market central banks as well. Japan’s triple calamity a year ago prompted a joint intervention in the currency markets, which included the US Federal Reserve.

Current actions partly resembles a modern day concoction of Plaza Accord and Louvre Accord]

Peter: You and I agree that the dollar is on the road to ruin, and we both have made some drastic forecasts about what the government might do in the face of the dollar collapse. How might this scenario play out in your view?

James: The dollar is not necessarily on the road to ruin, but that outcome does seem highly likely at the moment. There is still time to pull back from the brink, but it requires a specific set of policies: breaking up big banks, banning derivatives, raising interest rates to make the US a magnet for capital, cutting government spending, eliminating capital gains and corporate income taxes, going to a personal flat tax, and reducing regulation on job-creating businesses. However, the likelihood of these policies being put in place seems remote - so the dollar collapse scenario must be considered.

Few Americans are aware of the International Economic Emergency Powers Act (IEEPA)... it gives any US president dictatorial powers to freeze accounts, seize assets, nationalize banks, and take other radical steps to fight economic collapse in the name of national security. Given these powers, one could see a set of actions including seizure of the 6,000 tons of foreign gold stored at the Federal Reserve Bank of New York which, when combined with Washington's existing hoard of 8,000 tons, would leave the US as a gold superpower in a position to dictate the shape of the international monetary system going forward, as it did at Bretton Woods in 1944.

[my comment: the direction of current trends in policymaking is the destruction of the US dollar standard. The alternative would be the collapse of the banking system along with the welfare-warfare state. Policymakers are caught between the proverbial devil and the deep blue sea.]

Peter: You write in your book that it's possible that President Obama may call for a return to a pseudo-gold standard. That seems far-fetched to me. Why would a bunch of pro-inflation Keynesians in Washington voluntarily restrict their ability to print new money? Wouldn't such a program require the government to default on its bonds?

James: My forecast does not pertain specifically to President Obama, but to any president faced with economic catastrophe. I agree that a typically Keynesian administration will not go to the gold standard easily or willingly. I only suggest that they may have no choice but to go to a gold standard in the face of a complete collapse of confidence in the dollar. It would be a gold standard of last resort, at a much higher price - perhaps $7,000 per ounce or higher.

This is similar to what President Roosevelt did in 1933 when he outlawed private gold ownership but then proceeded to increase the price 75% in the middle of the worst sustained period of deflation in U.S. history.

[my comment: I don’t think current policymaking trends has entirely been about ideology, a substantial influence has been the preservation of the incumbent political institutions comprising of the welfare-warfare state, the politically privileged banking and the central banking system. True, the markets will eventually prevail over unsustainable systems]

Peter: You also write that you were asked by the Department of Defense to teach them to attack other countries using monetary policy. Do you believe there has a been an deliberate attempt to rack up as much public debt as possible - from the Chinese, in particular - and then strategically default through inflation?

James: I do not believe there has been a deliberate plot to rack up debt for the strategic purpose of default; however, something like that has resulted anyway.

Conventional wisdom is that China has the US over a barrel because it holds more than $2 trillion of US dollar-denominated debt, which it could dump at any time. In fact, the US has China over a barrel because it can freeze Chinese accounts in the face of any attempted dumping and substantially devalue the worth of the money we owe the Chinese. The Chinese themselves have been slow to realize this. In hindsight, their greatest blunder will turn out to be trusting the US to maintain the value of its currency.

[my comment: There are always two parties to a trade, if China would be “dumping” then there has to be a buyer. Question is who would be the buyer? If the world will join China in the US treasury dumping binge, then obviously the buyer of last resort would be the US Federal Reserve. If the US Federal Reserve does not assume such role, then there would be a freeze in the global banking system similar to 2008 or worst.

As to freezing of China’s account; that may happen after the US Federal Reserve consummates the transaction. This stage may not even be reached, unless the US will declare economic sanctions against China which would signify an indirect declaration of war.]

Peter: In your book, you lay out four possible results from the present currency war. Please briefly describe these and which one do you feel is most likely and why.

James: Yes, I lay out four scenarios, which I call "The Four Horsemen of the Dollar Apocalypse."

The first case is a world of multiple reserve currencies with the dollar being just one among several. This is the preferred solution of academics. I call it the "Kumbaya Solution" because it assumes all of the currencies will get along fine with each other. In fact, however, instead of one central bank behaving badly, we will have many.

The second case is world money in the form of Special Drawing Rights (SDRs). This is the preferred solution of global elites. The foundation for this has already been laid and the plumbing is already in place. The International Monetary Fund (IMF) would have its own printing press under the unaccountable control of the G20. This would reduce the dollar to the role of a local currency, as all important international transfers would be denominated in SDRs.

The third case is a return to the gold standard. This would have to be done at a much higher price to avoid the deflationary blunder of the 1920s, when nations returned to gold at an old parity that could not be sustained without massive deflation due to all of the money-printing in the meantime. I suggest a price of $7,000 per ounce for the new parity.

My final case is chaos and a resort to emergency economic powers. I consider this the most likely because of a combination of denial, delay, and wishful thinking on the part of the monetary elites.

[my comment:

I am less inclined to think of a global money (or second) scenario.

I think that the incumbent currency system may transform or morph into a regime of multipolar currencies and or with possible gold/silver participation.

Since I don’t believe that the world operates in a vacuum, even if a global hyperinflation does become a reality, people, communities, states or even governments will act to substitute a collapsing currency incredibly fast.

The currency crisis hasn’t happened, yet we seem to see signs of nations already taking steps towards self-insurance, partly by engaging in bilateral trade financed by the use of local currencies (Brazil-Argentina, China-Japan), and partly by increasing gold’s role in trade: Some US states have begun to promote the use of gold and silver coins also as insurance.

So the seeds to a transition of monetary standards are being sown]

Peter: What do you see as Washington's end-game for the present currency war? What is their best-case scenario?

James: Washington's best-case scenario is that banks gradually heal by making leveraged profits on the spreads between low-cost deposits and safe government bonds. These profits are then a cushion to absorb losses on bad assets and, eventually, the system becomes healthy again and can start the lending-and-spending game over again.

I view this as unlikely because the debts are so great, the time needed so long, and the deflationary forces so strong that the banks will not recover before the needed money-printing drives the system over a cliff - through a loss of confidence in the dollar and other paper currencies.

[my comment: debts are symptoms of prior government spending both from welfare-warfare state and rescues/bailouts of crisis affected institutions including governments]

Peter: I don't think this scenario is likely either, but say it were... would it be healthy for the American economy to have to carry all these zombie banks that depend on subsidies for survival? Wouldn't it be better to just let the toxic assets and toxic banks flush out of the system?

James: I agree completely. There's a model for this in the 1919-1920 depression, when the US government actually ran a balanced budget and the private sector was left to clean up the mess. The depression was over in 18 months and the US then set out on one of its strongest decades of growth ever. Today, in contrast, we have the government intervening everywhere, with the result that we should expect the current depression to last for years - possibly a decade.

[my comment: indeed]

Peter: How long do you think Currency War III will last?

James: History shows that Currency War I lasted 15 years and Currency War II lasted 20 years. There is no reason to believe that Currency War III will be brief. It's difficult to say, but it should last 5 years at least, possibly much longer.

[my comment: past performance may not guarantee future outcomes]

Peter: From my perspective, what is unique about a currency war is that the object is to inflict damage on yourself, and the country often described as the winner is actually the biggest loser, because they've devalued their currency the most. Which currency do you think will come out of this war the strongest?

James: I expect Europe and the euro will emerge the strongest after this currency war by doing the most to maintain the value of its currency while focusing on economic fundamentals, rather than quick fixes through devaluation. This is because the US and China are both currency manipulators out to reduce the value of their currencies. In the zero-sum world of currency wars, if the dollar and yuan are both down or flat, the euro must be going up. This is why the euro has not acted in accord with market expectations of its collapse.

The other reason the euro is strong and getting stronger is because it is backed by 10,000 tons of gold - even more than the US This is a source of strength for the euro.

[my comment:

I don’t think the ex post gold holding under current monetary system will significantly matter.

Some countries (like crisis affected Europe) may sell gold while others (such as emerging markets) may buy gold. So gold ownership will be in a state of continued flux.

The crux would revolve around the following issues

-control of debt build up from government spending

-allowing markets to clear

-what governments does with their gold holdings or will governments reform their currency system by eliminating policy induced bubble cycles? How?]

Peter: You and I both connect the Fed's dollar-printing with the recent revolutions in the Middle East. This is because our inflation is being exported overseas and driving up prices for food and fuel in third-world countries. What do you think will happen domestically when all this inflation comes home to roost?

James: The Fed will allow the inflation to grow in the US because it is the only way out of the non-payable debt.

Initially, American investors will be happy because the inflation will be accompanied by rising stock prices. However, over time, the capital-destroying nature of inflation will become apparent - and markets will collapse. This will look like a replay of the 1970s.

[my comment: the $64 trillion question is inflate against who? Every major central banks seem to be engaged in synchronous-coordinated inflation.]

Peter: How long do you think China's elites will put up with the Fed's inflationary agenda before they start dumping their US dollar assets?

James: The Chinese will never "dump" assets because this could cause the US to freeze their accounts. However, the Chinese will shorten the maturity structure of those assets to reduce volatility, diversify assets by reallocating new reserves towards euro and yen, increase their gold holdings, and engage in direct investment in hard assets such as mines, farmland, railroads, etc. All of these developments are happening now and the tempo will increase in future.

[my comment: Dumping isn’t going to happen unless there would be a buyer. See my earlier comment above]

Peter: In your view, what is the best way for investors to protect themselves from this crisis?

James: My recommended portfolio is 20% gold, 5% silver, 20% undeveloped land in prime locations with development potential, 15% fine art, and 40% cash. The cash is not a long-term position but does give an investor short-term wealth preservation and optionality to pivot into other asset classes when there is greater visibility.

[my comment:

I would adjust portfolio according to the evolving circumstances.

Taking a rigid stance under current heavily politicized conditions could bring about huge market risks. For example, if hyperinflation occurs which Mr. Rickards sees as a “more likely outcome at the moment”, then cash and bond holdings will evaporate]

Video: Predictive Value of Austrian Economics versus Keynesian Economics

To kick off my vacation blogging, the following video shows of the predictive value of Austrian Economics versus mainstream mostly Keynesian economics (hat tip Bob Wenzel).

Notice the intense pressures Austrians face when confronted by usually hostile mainstream crowd. I know how this feels.

And this is where Mahatma Ganhi's rule applies

First they ignore you, then they laugh at you, then they fight you, then you win

Video: How to silence a Nobel Prize winning economist: Ask him about the economy.

This video from Peter Schiff is a must watch. (hat tip Justin Ptak Mises Blog)

The current Nobel Prize winners, whom are economic modelers or supposed technical experts on the economy, can't seem to defend their work, or much less explain their perspective of the US or European economy, in public.

Incredibly or even embarrassingly, both opted to take a silent stance in a news conference.

Watch the Princeton news conference video through this link

Another vindication of the great Ludwig von Mises who once wrote,

There is no such thing as quantitative economics. All economic quantities we know about are data of economic history. No reasonable man can contend that the relations between price and supply is, in general or in respect of certain commodities, constant. We know, on the contrary, that external phenomena affect different people in different ways, that the reactions of the same people to the same external events vary, and that it is not possible to assign individuals to classes of men reacting in the same way. This insight is a product of our aprioristic theory.

Peter Schiff Schools US Congress: Government Spending Represents Shot of Monetary and Fiscal Heroin

Peter Schiff does a magnificent job lecturing Congress and their private sector ally in this testimony...

Part 1 On burdensome regulations

Part 2 On baneful impacts of government spending

Peter Schiff Takes Down Paul Krugman & Co.: They're In For A Rude Awakening

Peter Schiff debunks Paul Krugman's protectionist overtures. (hat tip: William Anderson)