Quote of the Day: Gold Standard from the Fringes to the Mainstream

The gold standard once thought as a ‘barbaric relic’, is like the proverbial phoenix rising from the ashes.

When the gold standard has been mentioned as “no longer unthinkable” by the lefty New York Times, we understand that the public's outlook of gold as money has moved from the fringes into the mainstream.

Today’s quote from Martin Hutchinson and John Foley (hat tip Jeffrey Tucker Mises Blog- yes vindication for Henry Hazlitt)

But further chipping at the dollar’s credibility, further downgrades of United States credit or other harmful results from years of very low interest rates could bring more people around to the idea of a new reserve currency. A return to the gold standard remains unlikely, but it’s no longer unthinkable.

Prices signals have been working their way to affect the public’s psychology where…

…Denial, apparently, has been transitioning into acceptance.

It seems like the psychological Kubler Ross Grief cycle process at work here. The higher gold prices are, the more the public will embrace the thought of the return of the gold standard.

Global Equity Meltdown: Political Actions to Save Global Banks

“However, hanging onto money is highly risky in a time of monetary inflation. The security-seeker does not understand this. Keynesian economists do not understand this. Politicians do not understand this. The result of inflationary central bank policies is the production of uncertainty in excess of what the public wants to accept. But the public does not understand Mises' theory of the business cycle. Voters do not demand a halt to the increase in money. It would not matter if they did. Central bankers do not answer to voters. They also do not answer to politicians. "Monetary policy is too important to be left to politicians," the paid propagandists called economists assure us. The politicians believe this. Until the crisis of 2008, so did voters.” Professor Gary North

Local headlines blare “Global stocks gyrate wildly; sell-off resumes in markets”[1]

To chronicle this week’s action through the lens of the US Dow Jones Industrial Average (INDU), we see that on Monday August 8th, the major US bellwether fell 635 points or 5.5%. On Tuesday, the INDU rose 430 points or 4%. On Wednesday, it fell 520 points 4.6%. On Thursday, it rose 423 points or 3.9%. The week closed with the Dow Jones Industrials up by 126.71 points or 1.13% on Friday.

All these wild swings accrued to a weekly modest loss of 1.53% by the Dow Jones Industrials.

Some ideologically blinded commentators argue that these had been about aggregate demand. So logic tell us that aggregate demand collapsed on Monday, jumps higher on Tuesday, tanked again on Wednesday, then gets reinvigorated on Thursday and Friday? Makes sense no?

How about fear? Fear on Monday, greed on Tuesday, fear on Wednesday, and greed on Thursday and Friday? Do you find this train of logic convincing? I find this patently absurd.

Confidence doesn’t emerge out of random. Instead, people react to changes in the environment and the marketplace. Their actions are purposeful and seen in the context of incentives (beneficial for them).

And that’s why many who belong to the camp of econometrics based reality gets wildly confused about the current developments where they try in futility to fit only parts of reality into their rigid theories.

And part of the realities that go against their beliefs are jettisoned as unreal.

So by the close of the week, these people end up scratching their heads, to quip “weird markets”.

Weird for them, but definitely not for me.

Political Actions to Save the Global Banking System

Yet if there has been any one dynamic that has been proven to be the MAJOR driving force in the financial markets over the week, this has been about POLITICS, as I have been pointing out repeatedly since 2008[2].

I am sorry to say that this has not been about aggregate demand, fear premium, corporate profits, conventional economics or mechanical chart reading, but about human action in the context of global policymakers intending to save the cartelized system of the ‘too big to fail’ banks, central banks and the welfare state.

As I pointed out last week[3],

Important: The US has been downgraded by the major credit rating agency S&P after the market closed last Friday, so there could be an extended volatility on the global marketplace at the start of the week. This largely depends if such actions has already been discounted. The first thing on Monday is to watch Japan’s response.

The S&P’s downgrade tsunami reached the shores of global markets on Monday, where the US markets crashed by 5.5%.

It is very important to point out that the market backlash from the downgrade did NOT reflect on real downgrade fears, where US interest rates across the yield curve should have spiked, but to the contrary, interest rates fell to record lows[4]!

And as also correctly pointed out last week, the US Federal Reserve’s FOMC meeting, which was held last Tuesday, introduced new measures aimed at containing prevailing market distresses.

The FOMC pledged to:

-extend zero bound rates until mid-2013, amidst growing dissension among the governors,

-maintain balance sheets by reinvesting principal payments of maturing securities,

and importantly, keep an open option to reengage in asset purchases[5].

Some have argued that the Fed’s policies has essentially been a stealth QE, as the steep yield curve from these will incentivize mortgage holders to refinance. And this would spur the Fed to reinvest the proceeds.

According to David Schawel[6],

A surge of refinancing will reduce the size of the Fed’s MBS holdings and allow them to re-invest the proceeds further out the curve

The Fed’s announcement on Tuesday, basically coincided or may have been coordinated with the European Central Bank’s purchases of Italian and Spanish bonds or ECB’s version of Quantitative Easing. The combined actions resulted to an equally sharp 4% bounce by the Dow Jones Industrials.

Mr. Bernanke has essentially implemented the first, “explicit guidance” on Fed’s policy rates, among the 3 measures he indicated last July 12th[7].

The resumption of QE and a possible reduction of the quarter percentage of interest rates paid to bank reserves by the US Federal Reserve signify as the two options on the table.

My guess is that the gradualist pace of implementation has been highly dependent on the actions of the financial markets.

I would further suspect that given the huge ECB’s equivalent of Quantitative Easing or buying of distressed bonds of Italy and Spain, aside Ireland and Portugal, estimated at US $ 1.2 trillion[8], team Bernanke perhaps desires that financial markets digest on these before sinking in another set of QEs.

And to consider that US M2 money supply[9] has been exploding, which already represents a deluge of money circulating in the US economy, thus, the seeming tentativeness to proceed with more aggressive actions.

Wednesday saw market jitters rear its ugly head, as rumors circulated that France would follow the US as the next nation to be downgraded[10]. The US markets cratered by 4.6% anew.

On Thursday, following an earlier probe launched by the US Senate on the S&P for its downgrade on the US[11], the US SEC likewise opened an investigation to a possible insider trading charge against the S&P[12].

Obviously both actions had been meant to harass the politically embattled credit rating agency. The possible result of which was that the S&P joined Fitch and Moody’s to affirm France’s credit ratings[13].

To add, 4 Euro nations[14], namely Italy, Belgium, France and Spain has joined South Korea, Turkey and Greece[15] to ban short sales. A ban forces short sellers to cover their positions whose buying temporarily drives the markets higher.

These accrued interventions once again boosted global markets anew which saw the INDU or the Dow Industrials soar by 3.9%.

Friday’s gains in global markets may have been a continuation or the carryover effects of these measures.

Unless one has been totally blind to all these evidences, these amalgamated measures can be seen as putting a floor on global stock markets, which essentially upholds the Bernanke doctrine[16], which likewise underpins part of the assets held by the cartelized banking system and sector’s publicly listed equities exposed to the market’s jurisdiction.

Thus, like 2008, we are witnessing a second round of massive redistribution of resources from taxpayers to the politically endowed banking class.

Gold as the Main Refuge

AS financial markets experienced these temblors, gold prices skyrocketed to fresh record levels at over $1,800, but eventually fell back to close at $1,747 on Friday, for a gain of $83 over the week or nearly 5%.

From the astronomical highs, gold fell dramatically as implied interventions had been also extended to the gold futures markets. Similar to the recent wave of commodity interventions, the CME steeply raised the credit margins of gold futures[17].

We have to understand that gold (coins or bullions) have NOT been used for payments and settlements in everyday transactions. So gold cannot be seen as fungible to legal tender imposed fiat cash (for now), even if some banks now accept gold as collateral.[18]

In an environment of recession or deleveraging—where loans are called in and where there will be a surge of defaults and an onrush of asset liquidations to pay off liabilities or margin calls, fiduciary media (circulating credit) will contract, prices will adjust downwards to reflect on the new capital structure and people will seek to increase cash balances in the face of uncertainty—CASH and not gold is king. Such dynamic was highly evident in 2008 (before the preliminary QEs).

Thus, it would signify a ridiculous self-contradictory argument to suggest that record gold prices has been manifesting risks of ‘deflation’.

Instead, what has been happening, as shown by the recent spate of interventions, is that for every banking problem that surfaces, global central bankers apply bailouts by massive inflationism accompanied by sporadic price controls on specific markets.

Alternatively, this means that record gold prices do not suggest of a fear premium of a deflationary environment, but instead, a possible fear premium from the prospects of a highly inflationary, one given the current actions of central banks.

This panic-manic feedback loop or in the analogy of Dr. Jeckll and Mr. Hyde’s “split personality” which characterizes the global markets of last week has been materially different from the 2007-2008 US mortgage crises.

Not only has there been a divergence in market response across different financial markets geographically (e.g. like ASEAN-Phisix), the flight to safety mode has been starkly different.

The US dollar (USD) has failed to live up to its “safehaven” status, which apparently has shifted to not only gold but the Japanese Yen (XJY) and the gold backed Swiss Franc (XSF).

It’s important to point out that the franc’s most recent decline has been due to second wave of massive $55 billion of interventions by the SNB during the week. The SNB has exposed a total of SFr120 billion ($165 billion!) over the past two weeks[19]. The pivotal question is where will $165 billion dollars go to?

Bottom line:

This time is certainly different when compared to 2008 (but not to history where authorities had been predisposed to resort to inflation as a political solution). While there has been a significant revival of global market distress, market actions have varied in many aspects, as well as in the flight to safety assets.

This implies that in learning from the 2008 episode, global policymakers have assimilated a more activist stance which ultimately leads to different market outcomes. Past performance does not guarantee future results.

The current market environment can’t be explained by conventional thinking for the simple reason that markets are being weighed and propped up by the actions of political players for a political purpose, i.e. saving the Global Banks and the preservation of the status quo of the incumbent political system.

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[1] Inquirer.net Global stocks gyrate wildly; sell-off resumes in markets, August 12, 2011

[2] See Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?, November 30, 2008

[3] See Global Market Crash Points to QE 3.0, August 7, 2011

[4] See Has the S&P’s Downgrade been the cause of the US Stock Market’s Crash?, August 9, 2011

[5] See US Federal Reserve Goes For Subtle QE August 10,2011

[6] Schawel, David Stealth QE3 Is Upon Us, How Ben Did It, And What It Means Business Insider, August 9, 2011

[7] See Ben Bernanke Hints at QE 3.0, July 13, 2011

[8] Bloomberg, ECB Bond Buying May Reach $1.2 Trillion in Creeping Union Germany Opposes, August 8, 2011

[9] FRED, St. Louis Federal Reserve, M2 Money Stock (M2) M2 includes a broader set of financial assets held principally by households. M2 consists of M1 plus: (1) savings deposits (which include money market deposit accounts, or MMDAs); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds (MMMFs). Seasonally adjusted M2 is computed by summing savings deposits, small-denomination time deposits, and retail MMMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1.

[10] The Hindu, Fears of France downgrade trigger massive sell-off in Europe, August 11, 2011

[11] Bloomberg.com U.S. Senate Panel Collecting Information for Possible S&P Probe, August 9, 2011

[12] Wall Street Journal Blog SEC Asking About Insider Trading at S&P: Report, August 12, 2011

[13] Bloomberg.com French AAA Rating Affirmed by Standard & Poor’s, Moody’s Amid Market Rout, August 11, 2011

[14] USA Today 4 European nations ban short-selling of stocks, August 11, 2011, see War against Short Selling: France, Spain, Italy, Belgium Ban Short Sales, August 12, 2011

[15] Business insider 2008 REPLAY: Europe Moves To Ban Short Selling As Crisis Spreads, August 11, 2011, also see War Against Market Prices: South Korea Imposes Ban on Short Sales, August 12, 2011

[16] See US Stock Markets and Animal Spirits Targeted Policies, July 10, 2010

[17] See War on Gold: CME Raises Credit Margins on Gold Futures, August 11, 2011

[18] See Two Ways to Interpret Gold’s Acceptance as Collateral to the Global Financial Community, May 27, 2011

[19] Swissinfo.ch Last ditch defence of franc intensifies, August 10, 2011

War on Gold: CME Raises Credit Margins on Gold Futures

This time the interventionist war is being directed on the gold futures markets

From Bloomberg,

Gold declined from its record above $1,800 an ounce after CME Group Inc. (CME) boosted margins on futures contracts, prompting some investors to sell the metal after a four-day rally.

Bullion for immediate delivery dropped as much as 0.8 percent to $1,779.20 and traded at $1,788.25 at 12:58 p.m. in Singapore. Earlier, the metal rallied as much as 1.2 percent to $1,814.95 on concern that global economic growth is stalling as governments in the U.S. and Europe remain constrained by debt.

CME, the world’s largest futures market, raised margins on gold contracts by 22 percent with effect from the close of business today, according to a statement on its website. The initial-margin requirement, or the minimum amount of cash that speculators must keep on deposit, will rise to $7,425 per contract from $6,075, CME said. The margin for hedging will also increase 22 percent, rising to $5,500 from $4,500, it said.

For governments and their allies, desperate times calls for desperate measures.

D-Day for the US Federal Reserve’s QE 3.0

This is the day where the Fed will likely be announcing QE 3.0 or another asset purchasing program under a new format, template or name.

Wall Street has been bleeding profusely and the sentiment can be captured by this comment by Harvard’s Kenneth Rogoff

From Bloomberg,

Federal Reserve policy makers are likely to embark on a third round of large-scale asset purchases, moving “more decisively” to secure the U.S. recovery, said Harvard University economist Kenneth Rogoff.

“They certainly should do something right away,” said Rogoff, a former International Monetary Fund chief economist who attended graduate school with Fed Chairman Ben S. Bernanke. It’s “hard to know” if Bernanke would immediately be able to gain the support of Federal Open Market Committee members, Rogoff said in an interview today on Bloomberg Television.”

This validates what I earlier wrote

Besides, who would like to see a market crash with them on the helm, and not be seen as “doing something”? Today’s politics, embodied by the Emmanuel Rahm doctrine has mostly been about the need to be seen “doing something” even if such actions entail having adverse long term consequences. Actions by the ECB, SNB and BoJ have all revealed and exemplified such tendencies. Even the debt ceiling bill was forged from the need to do something to avert an Armageddon charade.

Danske Bank’s Research team also sees a FED QE today: (bold emphasis original)

Developments have moved significantly in the wrong direction for the US economy over the past months. We believe this will be enough for Fed to launch new stimulus measures at its meeting today. The main arguments are the following:

1. Growth will be significantly lower than Fed forecast in June.

2. Unemployment is very far from target and not coming down.

3. Fiscal tightening in coming years leaves Fed as the only entity to support growth

further and counter the significant drags on the US economy.

4. Action is needed to fight the current confidence crisis in the markets.

Of course, I see this as a setup meant to save the tripartite cartel of welfare state-central bank and banking system.

Now here is how I think the market’s possible reaction to a QE 3.0 (or its variety)

For the market to respond positively to the Fed’s QE 3.0, this will likely be another huge “shock and awe” delivery type. Otherwise, they may end up like the ECB’s sputtering Bazooka (perhaps they used the 2^nd world war type-L.O.L!) where the stock market fell hard despite actual bond purchases.

Today gold will most likely fall from its lofty record perch. Gold may fall because of profit taking from the "buy the rumor sell the news" dynamic, a smaller than expected QE delivery package or NO QE.

But the difference will be in the degree of decline. Profit taking off a significantly packaged QE will still be substantial perhaps back to the 1700 level, but this would come amidst a backdrop of sharply rebounding global equity markets. Some will misread this as eroding "fear premium". It isn't.

However a market perceived insufficient QE, or a “NO” QE would translate to bigger fall for gold prices along with another round of crashing equity markets.

As of this writing US futures are modestly up while Europe’s 3.5% decline has been reduced to less than 1%.

This is the day.

Here is a 1980s MTV 'This is the Day' from a band called The The.

The lyrics appear suited for the Wall Street cartel and the Bernanke Team,

THIS IS THE DAY -- Your life will surely change.
THIS IS THE DAY -- Your life will surely change.
You could've done anything -- if you'd wanted
And all your friends and family think that you're lucky.
But the side of you they'll never see
Is when you're left alone with the memories
That hold your life together like
Glue...

Again, it's time to profit from political folly.

Has the S&P’s Downgrade been the cause of the US Stock Market’s Crash?

Hardly so, it would seem.

Since the announced downgrade last Friday, coupon yields of US sovereign issues have been collapsing across the yield curve.

This has HARDLY been signs of an intuitive market response to a credit rating downgrade, where interest rates should be surging higher!

Instead, this looks likely a typical market reaction when the confronted with the prospects of recession.

What has been happening has been a rotation away from equities to bonds, since the debt downgrade crisis episode surfaced.

The currency market hardly exhibits the same downgrade reaction too. Instead of a selloff, we see the US dollar consolidating for the past two sessions. Over the span of two weeks, the US dollar has been inching higher.

Overall, the US dollar has not outperformed (as the previous bear market) or functioned as safehaven currency but has not collapsed either.

Yet gold prices continues to spike to record levels, which is now at 1,740s! (goldprice.org)

Of course gold prices has been suggestive of aggressive activism by central bankers to counteract this ongoing meltdown.

And with the appearance that ECB’s Bazooka (QE), estimated at $1.2 trillion, has fizzled out or has sputtered, more QEs could be in the pipeline.

Such market dissonance is telling.

Hot: Gold now $1,700!

From Bloomberg,

Hot: Swiss National Bank Intervenes to Halt a Surging Franc

My skepticism about the Swiss franc has been validated. You simply just can’t trust central bankers. Not even the Swiss variety.

The Swiss National Bank (SNB) surprised the currency market as it intervened by ‘injecting liquidity’ in an attempt to forestall the upsurge of the franc.

The SNB apparently went ahead of the Japanese who are mulling to do the same.

From the Marketwatch (bold emphasis mine)

The Swiss National Bank on Wednesday moved to halt the rise of the Swiss franc, saying the strength of the currency was "threatening the development of the economy and increasing the downside risks to price stability in Switzerland." The euro EURCHF +2.08% jumped 1.8% versus the Swiss currency to trade at 1.1061 francs, while the U.S. dollar USDCHF +1.80% jumped 1.4% to 77.61 centimes. Calling the franc "massively overvalued at present," the SNB said it would move its target for three-month Libor as close to zero as possible, narrowing the taret range to 0% to 0.25% from 0% to 0.75%.

The SNB said it will simultaneously "very significantly increase" the supply of liquidity to the Swiss franc money market over the next few days, and that it aims to expand banks' sight deposits at the SNB from around 30 billion Swiss francs to 80 billion Swiss francs. In a statement the central bank said it is "keeping a close watch on developments on the foreign exchange market and will take further measures against the strength of the Swiss franc if necessary."

Under such environment gold prices continue to streak at fresh record levels, which as of this writing has been drifting around the 1,665-1,670 range

from Kitco.com

I would suspect that part of this intervention, aside from publicly wishing for a weaker franc, is to flood the system with money to mitigate the losses being endured by European equity markets.

My guess is that the US will be next pretty soon.

How the US Debt Ceiling Crisis Affects Global Financial Markets

In my own time, governments have taken the place of people. They have also taken the place of God. Governments speak for people, dream for them, and determine, absurdly, their lives and deaths. Ben Hecht in Perfidy (via David Harsanyi)

Any moment now the ‘divisive’ issue over the US debt ceiling will likely reach settlement.

And by this I mean that the debt ceiling will be raised and that a landmark deal will be made over fiscal dynamics of the US in the coming years.

The supposed GOP Boehner Bill HR 2693 which recently passed the House[1] but was rejected by the Senate[2] already exposed such eventuality. That’s because the House bill proposed a new debt ceiling from US $14.294 trillion[3] to possibly $16.994 trillion—a figure cited by Zero Hedge[4]!

If this is true then such an increase would largely depend on the willingness of foreigners to finance the US government. Otherwise, we should expect the US Federal Reserve to step up the plate[5] with serial asset purchasing programs or interest rates in the US will rise that could heighten risks of the highly leveraged banking system, and equally, menace the deep in the hock US government.

What is being deliberated in real time is the mechanics governing the debt ceiling bill. On what increasingly seems like ‘staged dispute’ supposedly based on ‘ideology’—cut along party lines of tax increases versus government spending, the emerging compromise will account for a farcical display of attaining fiscal discipline.

As of this writing, the Bloomberg reports a working framework being threshed out[6],

The tentative framework includes immediate spending cuts of $1 trillion and creation of a special committee to recommend additional savings of up to $1.8 trillion later this year. The new panel would have to act before the Thanksgiving congressional recess in late November and Congress would have to approve its recommendations by late December or government departments and programs, including defense and Medicare, would face automatic, across-the-board cuts, the person said.

No more than 4 percent of Medicare would be subject to cuts, and beneficiaries would be unaffected as reductions would apply to providers, the person said. Social Security would be untouched.

These proposed spending cuts will likely signify as reduction in the growth rate of future spending, rather than actual spending cuts. In addition “additional savings” are likely to come in the form of tax increases.

What gradually is being revealed is that the “extend and pretend” or “kick the can down the road” policies would only widen the door for more inflationism that would set up a major crisis down the road that would make 2008 pale in comparison.

The kernel of the US debt ceiling crisis has been encapsulated by the chart below from the Wall Street Journal.

As the Wall Street Journal editorial accurately writes[7],

This is the road to fiscal perdition. The looming debt downgrade only confirms what everyone knows: Congress has made so many promises to so many Americans that there is no conceivable way those promises can be kept. Tax rates might have to rise to 60%, 70%, even 80% to raise the revenues to finance these promises, but that would be economically ruinous.

As writing on the Wall, there have been three credit rating agencies, outside the largest, that has downgraded the credit standing of the US, namely Weiss Ratings, Egan-Jones Ratings Co. and Beijing based Dagong Global Credit Rating[8]

The left believes that an inexhaustible Santa Claus fund exists to finance political programs which would hardly affect the distribution of resources or how the economy operates. They see the world in a prism of social stasis, where people’s actions are homogenous and can be easily manipulated.

The left believes that forcing others to pay for supposed “rights”, or in actuality, for veiled privileges that benefits vested interest groups in the name of social welfare—they would advance the cause of the economy. They ignore the reality that resources are scarce and forced redistribution represents a zero sum game-where one benefits at the expense of the other. Yet, the politically blinded left never seem to realize that restricting choices available to people leads to violence.

And worst, markets are increasingly being held hostage by political brinkmanship as political leaders try to extract negotiation leverage by spooking the marketplace with veiled threats of Armageddon[9]

The great libertarian H. L. Mencken was eloquently precise when he wrote[10]

Civilization, in fact, grows more and more maudlin and hysterical; especially under democracy it tends to degenerate into a mere combat of crazes; the whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by an endless series of hobgoblins, most of them imaginary.

Part of such endless series of hobgoblins to promote expansive government power and unsustainable welfare programs grounded on the antics of ‘default’ has resulted to the dramatic flattening of the US yield curve (stockcharts.com).

The spike in the 3 month T-Bills runs in contrast to the actions on the longer maturity term structure, which registered declines in the yields and thus the flattening of the curve.

Add to these has been the recent languor seen in major global equity markets and another record run in gold prices.

US equities represented by the S&P 500 fell sharply this week (3.92%) while the volatility index (VIX) spiked along with it. In addition, the debt issue has weighed on the US dollar (USD).

So essentially, gold prices seem to tell us that there would be more inflation ahead.

Hence political bickering and jawboning have placed considerable stress in the marketplace.

Again, this shows that in today’s milieu neither economics nor corporate fundamentals determine the direction of markets but political developments, which runs in defiance of conventional wisdom.

The fact is that the US has been in a covert default mode, through consecutive Quantitative Easing or credit easing, the purchasing power of the US has been on a decline. The current purchasing power of the US dollar has been lower than when these debts had been contracted. Thus the stealth default.

As Murray N. Rothbard wrote[11],

Inflation, then, is an underhanded and terribly destructive way of indirectly repudiating the "public debt"; destructive because it ruins the currency unit, which individuals and businesses depend upon for calculating all their economic decisions.

Unless politicians face up to these realities, the US will default sooner or later. And much of these near term moves to default will be through inflationism.

And again policy choices or political direction is likely to be path dependent in accordance to how political institutions have been designed; fundamentally to sustain or preserve the status quo of the cartelized system of central banks-‘too big to fail’ banking system-welfare based government.

At the end of the day, the debt ceiling will be raised and inflationism will prevail, as day of reckoning will be postponed.

All these will be reflected on the marketplace.

Again profit from political folly.

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[1] Yahoo.com House passes Boehner’s debt ceiling plan–and Senate puts it on ice, July 29,2011

[2] USA Today House rejects Senate debt bill; Obama wants compromise, July 30, 2011

[3] Wikipedia.org 2011 U.S. debt ceiling crisis

[4] Zero Hedge, Here Is Boehner's Amended Amended Bill, July 29, 2011

[5] See Falling Markets, QE 3.0 and Propaganda June 12, 2011

[6] Bloomberg.com Deal Framework Reached on Raising U.S. Debt Ceiling, July 31, 2011

[7] Wall Street Editorial The Road to a Downgrade A short history of the entitlement state. July 28, 2011

[8] US News Money Meet 3 Ratings Agencies That Have Already Downgraded the U.S., July 22, 2011

[9] Guardian.co.uk US debt battle: Showdown on Capitol Hill, July 18, 2011

[10] Wikiquote.org H. L. Mencken

[11] Murray N. Rothbard Repudiate the National Debt, lewrockwell.com

James Grant on Faith based Paper Money and the Gold Standard

Wall Street Journal’s Holman W Jenkins Jr. interviews James Grant (hat tip Laird Smith) [bold emphasis mine]

The gold standard, he says, citing the "late, great" libertarian economist Murray Rothbard, was the "people's system. If you didn't like the currency, you could exchange your paper for gold and that sent a message."

More from Mr. Jenkins interview of James Grant

The "fiat" dollar, he adds ruefully, "is one of the world's astounding monetary creations. That a currency of no intrinsic value is accepted as money the world over is an achievement that no monetary economist up until not so many decades ago could have imagined. It'll be 40 years next month that the dollar has been purely faith-based. I don't believe for a moment it's destined to go on much longer. I think the existing monetary arrangements are so precarious, so ill-founded and so destructive of the economic activity they are supposed to support and nurture, that they will be replaced by something better."

How exactly the transition to a new gold standard might take place is a puzzle, but Mr. Grant says he's seen many "impossible" things come to pass in his career. A certain "social spontaneity" might take a hand. He points to GLD—the ticker symbol for an exchange-traded fund whose gold holdings now make it equivalent to the world's 10th largest central bank. "At the margin," he says, "people are registering dissent from the judgment of our central bankers by bidding up the price of gold."

Read the rest here

Chart from Sharelynx/goldchartrus.com

Anyone who thinks that today’s economic climate poses little risk for dramatic transitions in today’s monetary architecture should look at my post below on Dead Currencies.

They are likely to be overestimating the strength of today’s system which have increasingly been based on serial bailout policies, especially in developed economies.

Once the tipping point from the accretion of political mistakes have been reached, we are likely to see a hastening of the implosion of today’s money system.

And as a popular Wall Street maxim goes:

Past performance does not guarantee future results.

As for the return of the gold standard, that’s something unclear for now. But as history has shown, economic forces could compel us to drastically embrace this option once the motion of monetary collapse becomes entrenched and accelerates.

Gold and the precious metal group, based on the price trends relative to the incumbent 'faith based' currencies of major economies, seem to be showing their revitalized role as man's default currency or the public's dissent over the judgment of central bankers as Mr. Grant rightly observes.

Ultimately, the fate of our currency system depends on the direction of monetary politics which constitutes a substantial tail risk that the mainstream continues to ignore.

I Told You So Moment: The Phisix At Milestone Highs

First they ignore you, then they laugh at you, then they fight you, then you win- Mahatma Gandhi

It’s not that we didn’t see this coming, the Philippine Phisix closed this week at a milestone record nominal HIGH at 4,458.

For me, this signifies another “I told you so” moment, as cynics both from the mainstream economics and the mechanical charting camp have mistakenly stated that this won’t be happening soon.

Epic Breakout on a Divergent Marketplace

Yet such monumental breakout came amidst a wobbly and seemingly discordant global equity market.

It’s not that this epic moment has been isolated or represents a unique trait seen exclusively to the Phisix only, but rather, the ASEAN majors have been one of the best performing equity markets of late. In short, as I have repeatedly been pointing out, this has been a regional dynamic.

By our latest reckoning, the Philippines along with Indonesia, Malaysia and Thailand have been in the top 20[1] among the 78 bourses worldwide.

The abbreviated price actions of the FTSE ASEAN 40 (ASEA) Exchange Traded Fund [ETF], which is a newly constructed bellwether, exhibit this new height.

This has happened as most of Asia seems on the upside, as represented by the Dow Jones Asia Pacific index (P1DOW). Meanwhile, the US S&P 500 (SPX) seems edgy, but still has been manifesting upward inclinations.

Only the European benchmark (stoxx 50) appears to be the odd man out, considering the festering debt crisis which seems to be spreading to the PIIGS.

And nowhere has this seeming exceptional deviation by the ASEAN majors imply of “decoupling”.

As the charts above from CLSA/Businessinsider indicate[2], over the past two decades returns of Asian bourses have been converging.

This gives credence to my repeated assertions[3] that in the world of globalization, the correlation of global equity markets have been tightening.

Yet to view performance digressions as “decoupling” risks false and misleading interpretations of events that may result to wrong prognosis, overconfidence and consequent errant actions that could lead to monetary and psychic losses.

One would further note that divergent actions occur mostly during crisis or recessions, as in the Asian crisis of 1997, the dot.com bust in 2000 and the US mortgage bubble crash of 2008. However, the boom phase of a bubble cycle tends to show signs of re-convergence.

Not every of the market signals I earlier alluded to[4] participated in the confirmation of the local boom. Europe’s ongoing crisis has partly taken some steam off from the global equity market re-convergence.

If there is any lesson from the above, it is that the local and ASEAN boom would likely become stronger if global equity markets would act in consonance. Oppositely, a further widening of divergences would put to doubt the string of current advances.

Gold-Phisix Correlation Redux

There is another noteworthy development that needs to be emphasized, as the Phisix and ASEAN bourses have reached record territories, so has gold prices.

As I previously wrote about how gold’s price actions seem to lead the Phisix[5],

The implication is: for as long as the trend of gold prices remains to the upside, the Phisix will likely follow unless domestic factors become powerful enough to impel a disconnect.

Prices of gold have served as reliable barometer so far.

Alternatively, this also means that accrued corporate earnings or micro economics or mainstream’s macro views can hardly explain this phenomenon.

Consumption demand, which has been the popular perspective, can hardly explain the broad based increases in commodity prices along with equity prices.

Of course correlation does not imply causation or that there presents no causal relationship between gold and the Phisix.

The point is: both gold and the Phisix account for as symptoms of an underlying pathology, which has largely been an unseen factor.

Again correlation does not represent causation. Yet the degree of correlation may vary according the causal relationship dynamics that underpins these markets.

In my view, I see this relationship anchored on the unfolding (Austrian) business cycle or bubble cycle fueled by monetary policies.

And the political process in fostering such boom phase of this bubble cycle has clearly been at work.

In the US, Federal Reserve chairman Ben Bernanke recently placed the QE 3.0 option on the table[6] partially confirming my forecasts[7].

Although Mr. Bernanke partly backtracked[8] from his earlier stance by stating that while QE 3.0 is in the cards it will not be used soon.

I see this as part of the mind conditioning-communication tactical tools used by the central bankers (or the signaling channel) to influence market expectations (aside from indirect market interventions).

The important point is that the Fed seems to be projecting the idea of renewed access to QE which is a sign of imminence. The question isn’t about an IF, but rather a WHEN.

And the commodity markets seem to have been affirming such expectations. Even the perennial laggard Natural Gas (NATGAS) appear to be on the rise. Silver, oil (WTIC) and the CRB Reuters (CCI) have been on climbing higher, despite the string of recent interventions.

Of course I don’t think Mr. Ben Bernanke would automatically employ QE or its variant, that’s because QE is a political tool designed at attaining political ends.

QE 3.0 will likely be tied to the congressional vote on the US debt ceiling, the deadline[9] of which is on August 2^nd is fast approaching.

The political pressure to raise the debt ceiling continues to intensify as major credit rating agencies as the S&P and Moody’s has warned of a possible downgrade[10] if a deal won’t be reached.

Higher prices of Credit Default Swaps (CDS)—an insurance against default risks—on US sovereign debt (see left window below[11]) has been attributed to the recent political impasse.

Although in perspective, the rising prices of US CDS can be seen amidst a backdrop of general concerns over credit risks for most of the world[12] (including the Philippines which is two notches below the US), but especially for many European countries over a one month frame. In short, politicking may have led to the misplaced focusing effect for many politically blinded observers.

The above reveals that the causation link of higher US CDS prices and political stalemate over the debt ceiling seems unclear.

The other major factor that could prompt Ben Bernanke to reactivate QE 3.0 soon is if the debt crisis in the Eurozone escalates to the point of putting US banks at risk. As pointed out in the past[13], QE 2.0 has reportedly benefited foreign banks or had been used as an indirect channel to conduct bailouts of Eurozone banks through the Eurodollar market.

I wouldn’t know which of these events would prompt Mr. Bernanke to trigger the next version of QE, but one thing is certain, given the trillions of bailouts thrown to US banks (demonstrated preference or actions as proof of the order of priorities), combined with ideological or doctrinal leanings and path dependency, plus reluctance to adapt fiscal discipline as the necessary path for reform, all these point towards the QE option to secure or safeguard the tripartite government-banking system-central bank political structure.

All these imply that monetary accommodation will prevail over marketplace for a longer period of time which should support the current risk environment.

And given that the global transmission of credit easing (QE) policies and artificially suppressed interest rates everywhere would have different impacts on different asset classes, the gold-phisix correlations, unless the latter would be influenced more by domestic factors, will likely be sustained.

Market Breadth and Internals Point to Further Strength

Since financial markets are driven by psychology, underpinned by the above forces, people’s outlook can be measured from actions being undertaken from different financial market indicators.

The milestone breakout by the Phisix has been bolstered by the broader market.

Market breadth has been broadly positive as all sectors posted gains (left window).

Again the Philippine composite has been elevated by mostly the mining sector followed by the financial sector, particularly led by Metrobank [PSE: MBT].

Advance decline spread (weekly basis) has likewise turned significantly positive (right window).

Market internals have also demonstrated broad bullishness.

Average daily trades (weekly basis) and daily number of issues traded (weekly basis) has dramatically improved.

While no trend goes in a straight line, such congruent positive actions are likely signs of continuity. Importantly, such trends could reaccelerate.

Philippine Peso Driven by Portfolio Investments

This week the Philippine Peso has partially departed from its tight correlation with the Phisix.

The monumental advance of the Phisix saw the Peso soften instead. The Peso seems to reflect more on the region’s actions than to confirm the Phisix’s vigorous advances. Or maybe currency intervention by the local central bank could also be a factor.

Although one week does not a trend make, I think that the Peso should eventually make more confirmations of the actions of the Phisix and vice versa.

As I keep saying[14],

this has been premised mostly on the favorable relative demand for Peso assets, aside from the lesser inflationary path by the Peso based on the supply side.

There is no proof stronger than this.

The chart above from the World Bank[15] and yahoo finance shows that Philippine Peso has hardly been driven by remittances, which has been peddled by the mainstream, but by virtue of correlations based causal logic the net capital flows (manifested mostly by portfolio investments).

For as long as the net capital flows (again mostly by portfolio investments) continue to expand, some of which will be evidenced in the actions of the Philippine Stock Exchange, we should then expect that this would be reflected on a rising Peso.

Bottom line: Again momentum, via various market signals, favors the confirmation of this week’s epic breakout.

We should see the Phisix at 4,900-5,000 by the yearend barring any exogenous shocks.

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[1] See How Global Equity Markets have Measured Up to the PIIGS Crisis, July 13, 2011

[2] Weisenthal, Joe This Is What Global Market Correlation Looks Like, Businessinsider.com, July 11, 2011

[3] See ASEAN’s Equity Divergence, Foreign Fund Flows and Politically Driven Markets, June 5, 2011

[4] See I Just Can’t Get Enough: Philippine Phisix Emits Intensely Bullish Signals, July 3, 2011

[5] See How External Forces Influence Activities of the Phisix, May 29, 2011

[6] See Ben Bernanke Hints at QE 3.0 June 13, 2011

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

[8] See Ben Bernanke on QE 3.0: Not Now, But An Open Option, July 15, 2011

[9] Reuters.com Obama, lawmakers press ahead for elusive debt deal, July 16, 2011

[10] Bloomberg.com Moody’s Downgrade Warning Adds Pressure on U.S. Debt Deal, July 14, 2011

[11] Zero Hedge, US Default Risk Jumps To Highest Since February 2010 On Debt Ceiling Worries, July 14, 2011

[12] Bespoke Invest, Changes in Sovereign Debt Default Risk Over the Last Month, July 16, 2011

[13] See Political Interventions has Led to the Widening of Divergences in Global Asset Markets, June 26, 2011

[14] See I Just Can’t Get Enough: Philippine Phisix Emits Intensely Bullish Signals, July 3, 2011

[15] Worldbank.org, Generating More Inclusive Growth, Philippine Quarterly Update June 2011