Bank of Israel Buys Equities and Foreign Currencies

As I have been pointing out, inflationism has now become a central banking standard.

The Bank of Israel has reportedly bought $200 million of foreign currencies

From Ynet News.com

The Bank of Israel bought an estimated $200 million of foreign currency on Tuesday in a bid to weaken the shekel after it hit a 19-month high, although the move had little effect.

With exports comprising 40% of Israeli economic activity, the central bank has made it clear it will not allow a steep rise in the shekel.

So nearly every country have been attempting to “devalue” against another, which should provoke a competition or a race to the bottom. Some call this the currency wars.

This also shows how global central bankers will put to test the current paper money standard to the limits. Current developments have made them believe that they have attained a policymaking nirvana or where money printing bears no consequences to the real economy.

Also Bank of Israel is one example of countries supposedly diversifying into equities.

From Bloomberg:

The Bank of Israel plans to almost double equity holdings by the end of the year after falling bond yields prompted the central bank to invest in European shares for the first time.

The bank will increase its stock holdings to as much as 6 percent of foreign-exchange reserves, or about $4.5 billion, from 3 percent at the end of 2012, according to Yossi Saadon, a Bank of Israel spokesman. Investments in shares rose to about 4.5 percent of assets in the first four months of 2013 as the institution made a “small allocation” to European equities in addition to its U.S. funds, he said.

Aside from the political motive, central bank operations seem to have transitioned into hedge fund operations but underpinned by the “guns and badges” institutions.

Bank of Israel’s equity exposure on the European and US equities could be interpreted as providing support on the equity markets of the US and Eurozone.

Ironically, this comes as the shekel is deliberately being devalued by them.

Bank of Israel’s actions thus appears to be tweaking profits via foreing currency-foreign equity arbitrages through policies. 

Are these not insider trading or manipulations? At whose expense? Market players and the economy?

I am not sure whether Bank of Israel’s equity purchases has been entirely foreign.

Nonetheless Israel’s TA-25 appears to be on mends following a downdraft in 2011. (chart from tradingeconomics.com)

Bank of Israel’s recent actions are examples of implicit guarantees on asset prices that only balloons the global pandemic of asset bubbles.

The Political Pretense called Currency War

A geneticist recently claimed that human intelligence has been on a gradual decline due to the extensive use of fluorides in the water supply, pesticides, high fructose corn syrup and processed foods. 

I have a different opinion. If true, then I would say that the main culprit has been the public’s worship of state, from which untruths, as conveyed by media, politicians and their apologists, envelops its essence. Blind belief in political falsehood makes people lose their intellectual bearings.

Just recently the Japanese government has been blamed by her counterparts as Russia, South Korea and the Bundesbank for inciting, if not escalating, a “currency war” via open ended bond buying program to devalue the yen. The implication is that Japan’s “currency manipulation” polices signifies as “beggar thy neighbor” policies that have been implicitly designed to hurt other nations.

A “currency war” is another term for competitive devaluation which according to Wikipedia.org represents “a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency” where “states engaging in competitive devaluation since 2010 have used a mix of policy tools, including direct government intervention, the imposition of capital controls, and, indirectly, quantitative easing.”

Yet one would notice that the balance sheets of major central banks, all of which have been skyrocketing, and which allegedly reflects on “direct government intervention, the imposition of capital controls, and, indirectly, quantitative easing”, currency wars in the light of competitive devaluation has been an ongoing event since 2008 as shown in the chart above. 

In short, neither has this been an exclusive Japan event nor has been a fresh development.

And this has also not been limited to major central banks but extends all the way to emerging Asia and to China as well, the Philippines included. (chart from the Bank of International Settlements)

In short, global central banks have been in a state of “currency war” or “currency manipulation” since 2008.

This article is not meant to absolve Japan's policies but to expose on what seems as political canard.

In reality “currency war” or “currency manipulation” or competitive devaluation is simply nothing more than inflationism. The great Ludwig von Mises defined inflation as

if the quantity of money is increased, the purchasing power of the monetary unit decreases, and the quantity of goods that can be obtained for one unit of this money decreases also.

While there may be technical difference on what a central bank buys to expand her assets through a corresponding expansion of currency liabilities, the fact is that “quantity of money is increased”.

The assets of Swiss National Bank have mostly been in foreign currency reserves (as of November 2012) while the Bank of Japan has mostly been in JGBs (as of September 30, 2012). Table from (SNBCHF.com)

American neo-mercantilists have labeled “currency manipulation” on nations, who allegedly use of accumulation of currency reserves as exchange rate policy, from which they call their government to impose protectionist countermeasures such as China.

As I wrote previously this represents naïve thinking.

While the technical reasons why countries accumulate foreign currency reserves are mainly for self-insurance (for instance Asia reserve accumulation has partly been due to the stigma of the Asian Crisis) and from trade, financial and capital flows (NY FED), the real “behind the curtain” reason has been the US dollar standard system. Such system allows for a “deficit without tears”, or unsustainable free lunch by the use of the US dollar seingorage to acquire global goods and services that results to seemingly perpetual trade deficits. 

Deficit without tears, as the late French economist and adviser to the French government Jacques Rueff wrote in the Monetary Sin of the West (p.23), “allowed the countries in possession of a currency benefiting from international prestige to give without taking, to lend without borrowing, and to acquire without paying.” 

And this has been the main reason for America’s “financialization” and the recurring policy induced boom bust cycles around the world, which essentially has been transmitted via the Triffin dilemma or “the conflict of interest between short-term domestic and long-term international economic objectives” of an international reserve currency

Thus blaming China or even the Philippines for reserve currency accumulation seems plain preposterous and only represents political lobotomy.

Currency war or currency manipulations serves no less than to “cloak the plea for inflation and credit expansion in the sophisticated terminology of mathematical economics”, to quote anew the great professor Ludwig von Mises from which “to advance plausible arguments in favor of the policy of reckless spending; they simply could not find a case against the economic theorem concerning institutional unemployment.”

And may I add that pretentious public censures account for as ploys to divert public’s attention or serve as smokescreens from homegrown government “inflationist” policy failures.

Since major central bank represented by the G-20 knows that by labeling Japan as instigator of currency wars would be similar to the proverbial pot calling the kettle black, they went about fudging with semantics to exonerate Japan’s political authorities.

From Bloomberg,

Global finance chiefs signaled Japan has scope to keep stimulating its stagnant economy as long as policy makers cease publicly advocating a sliding yen.

The message was delivered at weekend talks of finance ministers and central bankers from the Group of 20 in Moscow. While they pledged not “to target our exchange rates for competitive purposes,” Japan wasn’t singled out for allowing the yen to drop and won backing for its push to beat deflation.

This doesn’t look like a “war”, does it?

At the end of the day, currency war, or perhaps, stealth collaborative currency devaluation (perhaps a modern day Plaza-Louvre Accord) maneuvering means that central bank shindig will go on; publicity sensationalism notwithstanding.

Brazil and China Governments Slam the FED’s QE Forever

The US Federal Reserve’s QE ‘forever’ hasn’t been welcomed by some of the major emerging market central banking peers.

Brazil’s Finance Minister Guido Mantega, according to a Nasdaq/ Dow Jones report, accuses the Fed’s third-round of quantitative easing as "stimulating currency wars”.  Mr. Mantega, thus, will “continue to take whatever action is necessary to prevent speculative flows from flooding into the country” through currency interventions that will prevent Brazil’s currency, the real, from appreciating.

Brazil’s central bank, according to Mr. Mantega, “is going to buy more reserves” through the “use of the so-called reverse swap auctions that remove U.S. dollar-hedging contracts from the futures market”

Mr. Mantega will also adopt other measures including higher taxes on investment inflows.

China’s head of the Central Bank also rebuked the Fed's quantitative easing policies.

According to Sydney Morning Herald 

THE head of China's central bank, Zhou Xiaochuan, says quantitative easing is not working and more targeted measures are required to channel credit into areas where they are needed the most.

Mr Zhou made the call in a speech delivered in April but not published on the website of the People's Bank of China until this week, as the chairman of the US Federal Reserve, Ben Bernanke, announced a new round of quantitative easing - an injection of cheap credit into the financial sector - aimed at resuscitating the sluggish US economy.

Mr Zhou criticised the flood of cheap money as an inflexible and orthodox approach, although he stopped short of naming the Fed. Chinese authorities have long expressed their displeasure at US quantitative easing policy measures, which have eroded the value of the Chinese holding of US dollar-denominated assets such as Treasury bonds. Beijing is the largest holder of US government debts.

In reality all these signify as the proverbial pot calling the kettle black.

Both Chinese Central Bank and Brazil’s central bank have engaged in the same policies of waging war against interest rates although through more subtle means.

For instance I pointed out last week of the leakage from the sterilization measures by Brazil central bank’s foreign reserve accumulation have led to a bank credit boom which a Financial Times analyst sees as credit (QE) driven economic boom.

Chart from Mao Money, Mao Problems

And given the huge foreign reserves of $3.3 trillion during the first quarter held by China, the same policy dynamic may have been implemented by the People's Bank of China (PBoC). Evidence says that the PBoC's balance sheet continues to swell.

The world of politics is like a game of the hot potato, where some entity would have to take the blame to cover for one’s malfeasance.

FED-ECB’s Nuclear Policies: Risk ON is Back!

Congratulations, Mr. Bernanke. I'm happy. My asset values go up but as a responsible citizen I have to say the monetary policies of the U.S. will destroy the world.-Dr. Marc Faber

We have practically reached a virtual denouement phase for central bank communication “inflation expectations” management strategies as well as the penultimate stage for central bank asset-purchasing programs.

“Whatever it takes” to support the incumbent political financial order has been discharged into actual policies.

Last week, the ECB launched its Quantitative Easing (QE) version of unlimited bond buying[1] program. This week, it was the US Federal Reserve’s turn to validate my predictions[2].

Political Desperation Leads to the Nuclear Option

Doing things over and over and expecting different results appears to have reached a culmination point too.

The mainstream has repeatedly argued that central bank policies have not attained the targeted goals because of the supposed insufficiency of the degree of measures undertaken to attain the desired traction. In short, for the interventionists throwing money at the problem has never been enough.

For instance, putting into the limelight the fragility or the resiliency of the current statistical economic recovery of US, the trend of non-participants in the US labor markets has been steadily increasing (upper window blue bar trend). This could mean many factors such as many people may have given up on the search for jobs or that many may have gone into the informal economy or that many could have become dependent on government welfare (lower window exhibits the recent surge in food stamps and disability participants) or a combination of the above. (chart from dshort.com[3])

In addition to this, jobs that have been created has been on a sustained decline even amidst the gamut of credit easing policies, particularly QE 1.0, QE 2.0, Operation Twist and Operation Twist Extension of the US Federal Reserve.

Thus, given the latest policies announced by the FED, as well as the ECB, the efficacies of open ended and unlimited measures will be put under the proverbial microscope.

There will hardly be any further excuses for any subsequent policy mistakes. Proponents of the inflationism appear to have been boxed into a corner.

RISK ON is Back, For Now

The reactivation of the RISK ON environment essentially comes with the German constitutional court’s clearing of the legal hurdle for the European Stability Mechanism (ESM)[4], but with some conditional[5] stipulations* and the US Federal Reserve’s announcement of the nuclear “open ended” MBS buying program.

*The ever changing rules to accommodate these bailouts, I think, will unlikely become a barrier. Central bankers have gradually been assuming the role of politicians. FT columnist Gideon Rachman captures the zeitgeist best[6]

As a result of the ECB’s actions, voters from Germany to Spain will increasingly find that crucial decisions about national economic policy can no longer be changed at the ballot box.

In the Q & A portion of the post-FOMC announcement, US Federal Reserve chief Ben Bernanke unreservedly expressed that these policies had been intended to boost prices of financial assets in order to stimulate the “wealth effect” demand-driven spending[7] or Mr. Bernanke’s financial accelerator.

The tools we have involve affecting financial asset prices. Those are the tools of monetary policy. There are a number of different channels. Mortgage rates, other rates, I mentioned corporate bond rates. Also the prices of various assets. For example, the prices of homes. To the extent that the prices of homes begin to rise, consumers will feel wealthier, they’ll begin to feel more disposed to spend. If home prices are rising they may feel more may be more willing to buy home because they think they’ll make a better return on that purchase. So house prices is one vehicle. Stock prices – many people own stocks directly or indirectly. The issue here is whether improving asset prices will make people more willing to spend. One of the main concerns that firms have is that there is not enough demand…if people feel their financial position is better they’ll be more likely to spend….

Despite the economic justification which have been premised on popular economic fallacy, from where stones can be turned into bread through inflationism, Mr. Bernanke’s decision to trigger the nuclear option which validated my prediction, has been mainly about

1) funding the US budget deficits (what I called in the past as “poker bluff” or the propaganda that FED won’t do a QE[8]),

2) the fulfillment of the perpetual promises to stimulate (where a failed expectation would have meant a violent backlash), and

I wrote[9],

Mounting expectations and deepening dependence from central banking opiate, which has been clashing with the unfolding economic reality, will prompt for more price volatility on both directions. The Bank of America posits that QE 3.0 has been substantially priced in.

Eventually stock markets will either reflect on economic reality or that central bankers will have to relent to the market’s expectations. Otherwise fat tail risks may also become a harsh reality.

3) Importantly, Mr. Bernanke’s implied support for the re-election of the President Obama, which ensures his tenure as Chairman of the US Federal Reserve[10].

Yet while it has been true that a huge amount of stimulus have been priced into the markets, the Fed’s extension of the zero bound rates through 2015 and the open ended $40 billion monthly purchases of mortgage bonds combined with the existing $267 Operation Twist have been aggressively beyond expectations of the marketplace.

So the initial impact of the FED-ECB policies to subsidize financial assets represents attained its short term goal, they succeeded to inflate asset prices first.

Steroid dependent global equity markets were in revelry as the FED-ECB programs were made public.

Most of the global markets surged. Among the major benchmarks, the BRICS (except for China) posted the biggest gains while the rest of the developed economies, along with, the ASEAN majors scored substantial weekly advances of over 1%.

In the US market breadth turned substantially positive 84% of stocks soared above the 50-day moving averages[11] while Advance Decline ratio decidely went for the bulls[12]

The unveiling of the joint central bank nuclear policies also resulted to a huge rally in the bonds of distressed nations as Spain and Italy. Yields fell hard as bond vigilantes were beaten back by the ECB’s actions (chart from Dankse Research[13])

And as expected, rallying bond prices have reduced pressures on politicians of the criss stricken nations as Spain, to underake required reforms.

Spain’s prime minister, Mariano Rajoy, according to a news report[14], said last week that “he won’t allow the European Union or the ECB to stipulate how the nation narrows its budget deficit as a condition for buying the country’s bonds”.

So the ECB’s asset purchases have only increased the moral hazard aspects in the behavior of politicians. Efforts to redress such the imbalances that caused the crisis will likely be delayed. Instead of the ECB buying time for politicians to commence on reforms, the ECB has become THE tool for EU’s politicians to do the latter’s bidding.

The risk on rally has also diffused into global corporate bond markets.

In the US, a surge in corporate bond issuance has prompted yields on speculative-grade debt to drop to an unprecedented low, which according to Bloomberg, breaks the previous record set more than 15 months ago[15].

Unintended Consequences of the FED-ECB policies

In spite of all the euphoria, the FED’s operations may likely be reaching a tipping point.

The combined monthly $40 billion MBS purchases by US Federal Reserve, as well as, the $45 billion long term (10-30 year) US treasury bond buying from Operation Twist means that the Fed’s balance sheet is likely to expand to about $4 trillion by the end of 2013 from $ 2.8 trillion or an increase of about $1.17 trillion, according to Zero Hedge[16].

Yet the sterilization measures by Operation Twist of selling $45 in short term bonds to offset the long end buying will likely end by this year as the Fed runs out of short term securities to sell.

Essentially, roughly half of the US budget deficit will be monetized by the FED. Also the FED’s buying operations will accrue to about 24% of the GDP (see chart above)

Moreover, since the FED holds about $843 billion of Agency MBS[17], the open ended MBS purchases will extrapolate to expansion of the FED’s share of ownership of the entire mortgage market to about 33%, again according to the estimates of Bank of America BofA cited by Zero Hedge[18].

In addition the bond purchasing program means that ownership share of the FED “across the 6y-30y portion Treasury curve is likely to reach about 50% by end of 2013 and an average of 65% by end of 2014”, where “in just over two years the Federal Reserve will hold two thirds of the entire bond market with a maturity over 5 years” again according to the calculation of the BofA.

The FIRST point being that FED’s buying program may end up with FED owning a very large segment, if not all, of both the Agency MBS and the US Treasuries and may run out of bonds to buy to pursue their asset purchases.

Of course they can always resort to buying equities (similar to Bank of Japan[19]) and corporate bonds. But as appropriately pointed out by the only dissenting voice at the Federal Open Market Committee (FOMC) Jeffrey Lacker of the Richmond Federal Reserve, this would be unethical[20].

Channeling the flow of credit to particular economic sectors is an inappropriate role for the Federal Reserve.

In the world of politics, moral relativism belongs to those in power.

Also the NEXT point is that these combined policies will usher in a high period of Price inflation. Aggressive expansion of money through QE will eventually filter into the economic system.

Even from the monetarist perspective, particularly the Philip Cagan model which according to Professor Garrett Jones[21] states that “Today's price level depends mostly on the future supply of money”, the communication to the public of the FED and the ECB’s combined programs should imply for higher price levels than today.

Yet the huge amount of coming infusions from the FED-ECB will likely be complimented by the Bank of England, and Bank of Japan, as well as the Swiss National Bank whom has been the quasi-pioneer implementer of the unlimited option via the Swiss-Franc Euro price cap[22]

Seminal Signs of a Crack-UP Boom?

The recent strong performance of commodities may have altered balance between the recently outperforming stock market (S&P 500) and commodity prices (CCI or the CRB Reuters Index).

Commodities could be in a major inflection point relative to the stock market.

The same dynamics seems are being channeled into the currency markets.

It would be a mistake to see a rallying euro as a sign of “progress”. The rallying euro has been a manifestation of the obvious shift to a RISK ON environment through massive central bank manipulations.

As Doug Noland of the Credit Bubble Bulletin rightly points out[23]

I’ll state what others hesitate to admit: this week our central bank took a giant leap from radical to virtual rogue central banking. If Bernanke’s plan was to leapfrog the audacious Draghi ECB, our sinking currency – even against the euro – is confirmation of his success. If his goal was to provide markets a Benjamin Strong-like “coup de whiskey” – he should instead fear the dangerous instability central bankers have wrought on global markets and economies.

It would also be oversimplistic and misguided to see strengthening currencies as tempering “price inflation”.

In a world of fiat currencies and globalization, strengthening currencies could be a sign of a bubble in progress rather than of a structural advancement

The chart above shows that the race to devalue through unlimited or open ended QEs between Fed’s Bernanke and ECB’s Draghi have been transmitted through a rally in commodities priced in the US dollar (CCI:USD) and the Euro (CCI:XEU).

Put differently, both currencies, the US dollar and the Euro, have now been devaluing against the broad based benchmark of commodities. In the Austrian school of economics, these could signify as seminal signs of a crack-up boom

And contra mainstream empirical analysts, we must be reminded that the valuation of a monetary unit, according to the great Ludwig von Mises[24], depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money. Thus, even the richest country can have a bad currency and the poorest country a good one

A good example seems to be Brazil’s real. The real has firmed against the US dollar since 2008 post Lehman debacle (yahoo chart left window).

The supposed leakage from the sterilzation process from Brazil’s huge foreign reserve accumulation—where government bonds issued by Brazil’s central bank to sterilize foreign exchange purchases, has been used as collateral by banks to issue debt thereby expanding their balance sheets—has fueled a credit boom in Brazil’s economy. Claims on government have skyrocketed in 2011 as the real soared (right window).

The Brazilian government recently tried to curb through a series of tightening via interest rate hikes which may have prompted for the recent economic weakening.

The recent economic boom which could have been orchestrated through a covert quantitative easing scheme by Brazil’s central bank has been questioned by Jonathan Wheatley at the Financial Times blog[25] as a possible product of a central bank fueled boom-bust cycle.

Have inflows, then, been driving Brazil’s credit boom – and has the government been guilty of quantitative easing? It is hard to explain the expansion of credit from about R$500bn in 2005 to about R$2.2tn today on the basis of economic growth alone. Over that period, GDP growth has averaged 4 per cent a year – hardly a Chinese performance.

If quantitative easing really is the answer, it doesn’t just put the Brazilian government’s account of its monetary policies in question. It questions the basis of the whole Brazilian growth story.

By the way, Brazil’s government has recently joined the stimulus bandwagon with a $66 billion infrastructure stimulus[26].

The point being: In a world where central banks compete to destroy their currencies through devaluation, rising currencies may signify as symptoms of relative devaluation and they could also mask the bubble policies that underpins the statistical economic growth.

It would also be an error to likewise view rallying commodities signs of economic recovery, China who plays a major role in the commodity business, seems to be struggling from a bubble bust.

Despite the recent announcement of what seems as a reluctant and limited bailout program through infrastructure spending and through extension of bank loans to state owned enterprises, the deteriorating conditions of China’s shadow banking system[27] seems to be worsening. In addition, China’s oil imports continue to plummet[28] which is most likely a manifestation of a rapidly slowing economy.

Where commodities rise against a broad spectrum of fiat currencies, then this should be a cause of concern as they could be symptoms of the transition to a crack-up boom.

Again the from great Professor von Mises[29]:

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.

FED-ECB Policy Impact on Asia, Philippine Peso and the Phisix

Asian currencies have rallied strongly in response to the FED-ECB easing programs.

While Asian currencies have been on an upswing from previous pledges to inflate since June, as shown by the JP Morgan Bloomberg ADXY[30] Asian basket of currency index (upper window), the biggest of the advances came from last week (lower window).

The Philippine Peso has been slightly up by .6% to 41.42 a US dollar from 41.68 last week but has strong year to date gains of 5.5%--in harmony with the scintillating gains of the local equity market.

I believe that the interim response from the FED-ECB policies, designed to prop up financial assets, will likely provide strong support to the global stock markets including the Philippine Phisix perhaps until the yearend, at least.

The mining index, which has underperformed all sectors, will likely expunge its year to date losses at least by the yearend.

The mining index will likely retake command of the leadership in 2013 as it has outperformed biyearly since 2007[31].

In a world where central bank policies become the dominant factor in establishing price levels, the new normal is to expect dramatic price swings in both directions and of the amplification of risks

Former Federal Reserve Governor Kevin Warsh in a recent CNBC interview nails it[32].

If you continue to look at the markets right now, where asset prices continue to melt up where asset prices are driven less by fundamentals in particular companies and more by speeches and policies come out of Washington you are taking this risks. Risk are highest in the economy when measures of risk ARE lowest, when I look at the VIX at this level and you compare that to the headlines you guys read every morning they certainly do not seem in sync that’s when shocks happen

But given the projected substantial infusion of steroids, the current environment strongly favors an upswing. That’s until real problems will resurface such as concerns over the quality of credit, and or price inflation becomes more pronounced and or if politics becomes an obstacle to the central banks inflationism and or a combination of the above.

And since no trend goes in a straight line where I expect some interim reprieve from the bullish momentum, I would use any interim corrections as opportunity to position on resource issues.

No Justification for Bubbles

As a final note the FED-ECB policies will affect Asian economies and markets immensely as I have discussed before[33].

These policies will likely incentivize strong capital flows into the region, as investors “search for yields” or seek refuge to protect their savings from deliberate and sustained currency debasement—in reality these accounts for as the capital flight dynamic.

Capital inflows coupled with domestic negative real rates regime will likely translate into serial bubble blowing dynamics.

So yes, the risks of bubbles in Asia will become more enhanced. Even the local central bank or the Bangko Sentral ng Pilipinas (BSP) has recently acknowledged of such risks[34] which they arrogantly claim they can control.

In addition, domestic and global bubbles will increase the risks of a global stagflation which is likely slam emerging markets harder.

The risks of ballooning bubble or stagflation will likely become evident in 2013-2014.

Yet the idea that bubbles are good for Asia emanates from a warped, demented and disoriented understanding of economic reality and theories.

Costs are not benefits. What seem as the illusion of progress through asset price inflation has in reality been transfers of resources from the rest of society to the owners of financial assets (stocks bonds and property).

The benefits which accrue to these politically privileged sectors do not take into account the social and economic costs of these transfers[35].

Bailouts benefit the rich at the expense of the poor. Rampant speculations fueled by inflationism are not productive undertaking which adds to products and services to the society. Addiction to debt for speculation or for consumption leads to bankruptcy. The shrinkage of purchasing power of the currency through price inflation hurts the middle class and the poor most.

Misallocated capital cannot be seen as “benefits” since at the end of the cycle, misdirected capital will be exposed as wasted or consumed capital through a bubble bust or a financial crisis. In short, boom bust cycles destroy capital, lowers society’s standard of living or impoverishes people.

The Asian crisis of 1997 as a consequence of the prior inflation boom reveals of how Thailand’s GDP per capita[36] fell by 66% and only recovered when imbalances were allowed to clear. It took roughly 10 years for Thailand’s per capita GDP to recover the high of 1996.

Myopic thinking that mistakes symptoms as causes and that promotes short term ‘benefits’ at the expense of long term ‘costs’ is very unhelpful and will not help produce better returns.

---

[1] See ECB’s Mario Draghi Unleashes “Unlimited Bond Buying” Bazooka, Fed’s Ben Bernanke Next? September 7, 2012

[2] See I Told You So Moment: US Fed’s Bernanke Unveils Open Ended QE 3.0 Bazooka September 14, 2012

[3] Lance Roberts QE3 And Bernanke's Folly - Part I Advisor Perspectives dshort.com September 14,2012

[4] See German Court Clears Way for ESM Fund, September 12, 2012

[5] OpenEurope.org.uk What will the German Constitutional Court ruling mean for the eurozone? September 12, 2012

[6] Gideon Rachman Democracy loses in struggle to save euro Financial Times September 10, 2012

[7] Cullen Roche A Disturbing Look Inside the Mind of Ben Bernanke, Pragmatic Capitalism, September 13, 2012

[8] See Poker Bluff: No Quantitative Easing 3.0? June 5, 2011

[9] See Phisix: Why The Correction Cycle Is Not Over Yet September 2, 2012

[10] See Phisix: The Correction Cycle is in Motion August 27, 2012

[11] Bespokeinvest.com Breadth Breakout? September 14, 2012

[12] Bespokeinvest.com Breadth Finally Makes a Higher High September 13, 2012

[13] Danske Research The Fed takes a major step forward, September 14, 2012

[14] San Francisco Chronicle European Stocks Fall on Concern Spain, German May Harm ECB Plan September 11, 2012

[15] Bloomberg.com Corporate Bond Sales in U.S. Busiest in Six Months as Fed Acts September 14, 2012

[16] Zero Hedge The Fed's Balance At The End Of 2013: $4 Trillion September 3, 2012

[17] Zero Hedge Rosenberg: "If The US Is Truly Japan, The Fed Will End Up Owning The Entire Market" September 14, 2012

[18] Zero Hedge, BofA Sees Fed Assets Surpassing $5 Trillion By End Of 2014... Leading To $3350 Gold And $190 Crude September 14, 2012

[19] See Bank of Japan Hearts the Stock Market May 08, 2012

[20] See Quote of the Day: Dissenting Opinion on Open Ended QE at the FOMC September 16, 2012

[21] Garett Jones Future money and today's NGDP Econolog September 14, 2012

[22] See Swiss National Bank’s Currency Interventions Spawns Property Bubble August 14, 2012

[23] Doug Noland QE Forever Credit Bubble Bulletin Prudentbear.com September 14, 2012

[24] Ludwig von Mises CHAPTER 1—STABILIZATION OF THE MONETARY UNIT —FROM THE VIEWPOINT OF THEORY (1923) The Causes of Economic Crisis p.18 Mises.org

[25] Jonathan Weathley Quantitative easing, Brazilian style Beyond BRICs September 10, 2012 Financial Times Blog

[26] See Brazil’s Government Unveils $66 Billion Stimulus August 16, 2012

[27] See More Signs that China’s $2.4 Trillion Shadow Banking System is in Big Trouble September 14, 2012

[28] Zero Hedge Chinese Crude Imports Plunge To Mid-2010 Levels September 11, 2012

[29] Ludwig von Mises, III. INFLATION AND CREDIT EXPANSION, Interventionism An Economic Analysis

[30] Bloomberg.com JP Morgan Bloomberg Asian Dollar Index ADXY

[31] See Graphic of the PSE’s Sectoral Performance: Mining Sector and the Rotational Process July 10, 2011

[32] See Video: Former Fed Governor on Bernanke’s QE: Unproven Experiment , Risks of Exit have to be Higher September 15, 2012

[33] See The Impact of Open Ended QEs on Asia: Bubbles or Stagflation September 15, 2012

[34] See Fatal Conceit: Philippine Authorities to Avert Asset Bubbles September 10, 2012

[35] See Inflationism Promotes Inequality, Immorality and Economic Hardship September 15, 2012

[36] KNOEMA.com GDP per Capita by Country Thailand

Ben Bernanke Plays with the Inflation Fire

From Bloomberg,

Federal Reserve Chairman Ben S. Bernanke spent six years pushing for an inflation goal. Now that he has it, some investors are betting he’ll breach the 2 percent target in the short run to lower unemployment.

The Fed chairman told lawmakers last week that an increase in energy costs will boost inflation “temporarily while reducing consumers’ purchasing power.” He also said the central bank will adopt a “balanced approach” as it pursues its twin goals of price stability and full employment, which it defines as a jobless rate of between 5.2 percent and 6 percent.

Things that team Bernanke could be working on with the 'inflation goal': inflating away debt, boosting asset prices to give strength to balance sheets of the embattled banking and financial industry, the money illusion or the lowering real wages by inflation and currency devaluation.

I don’t think inflation targeting has been about competitive devaluation, as central bankers have collaborated in conducting current monetary policies. Neither has these been the money illusion.

I am sure Mr. Bernanke is aware that elevated inflation (upper window) and high unemployment (lower window) coexisted in the 1970s, known as the stagflation era. In short, Mr. Bernanke understands the risk of inflation, i.e. inflation does not solve the unemployment problem. In reality, in contrast to mainstream thinking, inflation even worsens economic performances by distorting economic calculation of entrepreneurs and businesses which impairs the market's functionality through the division of labor.

So by process of elimination this leads us to Bernanke’s primary goal of saving the banking system and the welfare state.

Yet Mr. Bernanke’s inflation goal is like playing with fire. Since the world's monetary system operates in a de facto US dollar standard, Bernanke's playing with fire translates to the risk that we all get burned.

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]