US Federal Reserve Gambles With Untested Policy Tool: Paying Interest On Bank Reserves

Utilizing the “untested” policy tool of paying interest on bank reserves, the US Federal Reserve seems to be gambling away the US economy as well as the worlds’.

This Bloomberg article is a mouthful. (bold highlights mine)

Federal Reserve officials are staking their inflation-fighting credibility on an untested tool: the power to pay interest on bank reserves.

Congress granted the Fed this ability in 2008, and Chairman Ben S. Bernanke, Vice Chairman Janet Yellen and New York Fed President William Dudley have all cited it as a main reason why they’ll be able to keep the U.S. economy from overheating after pumping record amounts of cash into the financial system. Raising the rate, currently at 0.25 percent, is intended to entice banks to keep their money on deposit at the Fed instead of loaning it out and stoking inflation.

With the benchmark overnight lending rate trading at 0.1 percent, less than half the deposit rate, it isn’t clear how much control the central bank can exert over borrowing costs by raising the interest on reserves, said Dean Maki, chief U.S. economist at Barclays Capital. Internal critics also have cast doubt on the tool’s effectiveness. Philadelphia Fed President Charles Plosser said last month it isn’t a cure-all because it doesn’t address the need to shrink the central bank’s balance sheet and reduce the amount of reserves in the system.

“There is some concern in markets about whether the Fed will keep inflation under wraps as it goes through this exit strategy,” Maki said in a telephone interview from his New York office. “It’s unknown exactly what interest on reserves does to the economy.”

Cash in the banking system has ballooned since the credit crisis began in 2007, when the Fed embarked on its unprecedented monetary accommodation, which includes two bond-purchase programs that have swelled the central bank’s balance sheet to a record $2.69 trillion...

The amount of excess reserves climbed to $1.47 trillion this month from $991 billion at year-end and $2.2 billion at the start of 2007, Fed data show.

The Federal Open Market Committee begins a two-day meeting tomorrow and will decide whether to continue with its planned $600 billion of bond purchases through June.

The effectiveness of using interest on reserves, or IOR, as a main policy tool may depend on how closely the federal funds rate, or overnight inter-bank lending rate, follows its movements. The Fed has kept its target for the fed funds rate at zero to 0.25 percent since December 2008.

“The big unknown is how tight the spread between the IOR and effective fed funds rate will be,” said Dino Kos, a managing director at economic-research firm Hamiltonian Associates Ltd. in New York. “If the fed funds rate trades at a stable, and preferably narrow, discount to the IOR, then tightening policy through the IOR is doable. But a wide and unstable spread undermines the strategy.”

More...

The Fed probably would like to mimic the so-called corridor system in Europe, where the deposit rate acts as a floor to the overnight lending rate, according to Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. The U.K. central bank’s benchmark, now at 0.5 percent, is the rate it pays on the reserves it holds for commercial banks. That’s below the overnight sterling London interbank offered rate of 0.57 percent.

The Frankfurt-based European Central Bank pays a rate on the deposits banks park with it overnight. The ECB raised this rate a quarter point to 0.5 percent on April 7, the same day it increased its benchmark refinancing rate by the same margin to 1.25 percent...

Before the Fed boosts the deposit rate, it likely will use reverse repurchase agreements and its new Term-Deposit Facility to gain more control over the federal funds rate, Stanley said. He predicts the Fed will raise rates as soon as November, which he said is an “aggressive” time frame that reflects his concern inflation will accelerate.

In a reverse repo, the Fed lends securities for a set period, draining bank reserves from the financial system. At maturity, the securities are returned to the Fed, and the cash goes back to the primary dealers.

Stanley said he’s skeptical these transactions can operate at a scale big enough to suck sufficient cash from the system to control the federal funds rate. The rate fell as low as 0.08 percent on April 13 after the Federal Deposit Insurance Corp. began adjusting calculations of U.S. banks’ deposit-insurance fees this month to cover all liabilities instead of just domestic deposits.

Yet banks have been the major beneficiaries of this grand experiment via massive ‘risk-free’ subsidies.

From the same article...

The overnight lending rate has traded below the interest rate on reserves for almost two years, partly because Fannie Mae and Freddie Mac, the mortgage-finance companies under government control, became “significant sellers” of funds in the overnight market and aren’t eligible to place cash on deposit at the Fed, according to a December 2009 research paper by the New York regional reserve bank.

The “theory” of interest on reserves is “proved wrong every day: Why would a bank ever lend at less than what they’re earning at the Fed?” Maki said. “There are more issues here than it sometimes is made to sound. Chairman Bernanke mentioned the Fed could raise rates in 15 minutes if they decided to, but it’s not clear they have that kind of control on the funds rate.”

Where Ben Bernanke cheerfully says that “Paying interest on reserves should allow us to better control the federal funds rate”, this looks more like blind optimism than a verified method.

Economic Policy Journal’s Bob Wenzel says that the FED pays “EIGHT times equivalent market rates when they keep the funds as excess reserves” and that this rate is also “more than eight times the rate on one-month T-bills” which is almost like “gifting banks $890 million every three months”

And it’s of no doubt why the financial sector continues to outperform.

Chart from Bespoke Invest

Nevertheless the continued interventions via manipulation of interest rates, the policy of quantitative easings and all other forms of monetary tools including the experiment of paying interest on bank reserves are likely to give us more uncertain outcomes through heightened volatility (bubble cycles) which should translate to even more interventionism.

Do Americans Buy Stuffs They Don’t Need?

One of the most outrageous obsessions by the mainstream is to substitute statistics for human action then apply political correctness when interpreting them.

This Wall Street Journal Blog should be an example (bold highlights mine)

As it turns out, quite a lot. A non-scientific study of Commerce Department data suggests that in February, U.S. consumers spent an annualized $1.2 trillion on non-essential stuff including pleasure boats, jewelry, booze, gambling and candy. That’s 11.2% of total consumer spending, up from 9.3% a decade earlier and only 4% in 1959, adjusted for inflation. In February, spending on non-essential stuff was up an inflation-adjusted 3.3% from a year earlier, compared to 2.4% for essential stuff such as food, housing and medicine.

To be sure, different people can have different ideas of what should be considered essential. Still, the estimate is probably low. It doesn’t, for example, account for the added cost of certain luxury items such as superfast cars and big houses.

Interestingly, people who spend more on luxuries have experienced less inflation. As of February, the weighted average price of non-essential goods and services was up only 0.2% from a year earlier and 82% from January 1959, according to the Commerce Department. By contrast, the cost of all consumer goods was up 1.6% from a year earlier and 520% from January 1959.

The sheer volume of non-essential spending offers fodder for various conclusions. For one, it could be seen as evidence of the triumph of modern capitalism in raising living standards. We enjoy so much leisure and consume so much extra stuff that even a deep depression wouldn’t – in aggregate — cut into the basics.

Alternately, it could be read as a sign that U.S. economic growth relies too heavily on stimulating demand for stuff people don’t really need, to the detriment of public goods such as health and education. By that logic, a consumption tax – like the value-added taxes common throughout Europe—could go a long way toward restoring balance.

It’s absurd to say that we buy stuff which we don’t need.

While the author does say “different people can have different ideas of what should be considered essential”, he seems confused on why people engage in trade at all.

Moreover, saying that Americans "buy stuffs they don’t need" translates to an ethical issue with political undertones: the author seems to suggest that Americans have wrong priorities or have distorted set of choices! Of course the implication is that only the government (and the author) knows what are the stuffs which people truly needs, thus his justification for a consumption tax! (Put up a strawman then knock them down!)

Although the author attempts to neutralize the political flavor of his article by adding an escape clause: that the stats signify as “evidence of the triumph of modern capitalism in raising living standards”.

People buy to express their demonstrated preference. Yet such preference gets screened from a set of given ordinal alternatives (e.g., 1st, 2nd, 3rd, etc..) from which the individual makes a choice or a decision. And that choice (buying) constitutes part of human action.

As Professor Ludwig von Mises explained, (bold highlights mine)

Action is an attempt to substitute a more satisfactory state of affairs for a less satisfactory one. We call such a willfully induced alteration an exchange. A less desirable condition is bartered for a more desirable. What gratifies less is abandoned in order to attain something that pleases more. That which is abandoned is called the price paid for the attainment of the end sought. The value of the price paid is called costs. Costs are equal to the value attached to the satisfaction which one must forego in order to attain the end aimed at.

If I buy beer (1^st order) at this moment at the cost of my other alternatives: a steak (2^nd order) or a chocolate (3^rd order), does my choice for beer represent stuff I don’t need?

The instance that I made a sacrifice (steak and chocolate) to make a choice (beer) makes my decision part of my act to fill a personal unease or a “need”.

It may not be your need, but it is mine. My actions reflect on my preference to solve my need.

The fact that beer is produced and sold implies that it is an economically valuable product (estimated at $325 billion industry for the world for 2008). Many people “needs” it and would pay (hard earned or otherwise) money for it.

The difference lies in the values ascribed to it by different consumers.

Some see beer as a way to socialize, or a way to get entertained or to get promoted or to close deals or as stress relief or a part of the ancillary rituals for other social activities or for many other reasons as health.

Some may not like beer at all!

The point is people consume or don’t consume beer for different reasons. As an economic good, beer is just part of the ordinal alternatives for people to choose from, aside from chocolate or steak or other goods or services.

Suggesting that beer isn’t a stuff we need, as a beer consumer, severely underappreciates the way we live as humans.

Abraham Maslow proposed that human needs come in the form of a pyramid. He breaks them down into 5, namely physiological, safety, social (love and belonging), esteem and self-actualization.

As the Wikipedia explains, (bold highlight mine)

Maslow's hierarchy of needs is often portrayed in the shape of a pyramid, with the largest and most fundamental levels of needs at the bottom, and the need for self-actualization at the top.

The most fundamental and basic four layers of the pyramid contain what Maslow called "deficiency needs" or "d-needs": esteem , friendship and love, security, and physical needs. With the exception of the most fundamental (physiological) needs, if these "deficiency needs" are not met, the body gives no physical indication but the individual feels anxious and tense. Maslow's theory suggests that the most basic level of needs must be met before the individual will strongly desire (or focus motivation upon) the secondary or higher level needs. Maslow also coined the term Metamotivation to describe the motivation of people who go beyond the scope of the basic needs and strive for constant betterment Metamotivated people are driven by B-needs (Being Needs), instead of deficiency needs (D-Needs).

From my example, my choice for a beer may not signify a physiological (basic need), yet they could reflect on my other deficiency needs (emotion or esteem or social needs).

In other words, B (being)-needs may not be D (deficiency)-needs but they still represent as human ‘intangible’ NEEDS.

Bottom line:

Statistics, which accounts for mainstream’s obsessions, fails to incorporate the intangible or non-material aspects of human nature.

It is, thus, misleading to make the impression that by reducing people’s activities to quantitative equations, or to dollar and cents, patterned after physical sciences, governments can manage society efficiently.

As the great Friedrich von Hayek admonished, in his Nobel lecture “the Pretence of Knowledge” (bold highlights mine)

While in the physical sciences it is generally assumed, probably with good reason, that any important factor which determines the observed events will itself be directly observable and measurable, in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process, for reasons which I shall explain later, will hardly ever be fully known or measurable. And while in the physical sciences the investigator will be able to measure what, on the basis of a prima facie theory, he thinks important, in the social sciences often that is treated as important which happens to be accessible to measurement. This is sometimes carried to the point where it is demanded that our theories must be formulated in such terms that they refer only to measurable magnitudes.

Lastly the notion that people don’t know of their priorities seems plain silly and downright sanctimonious.

Besides, governments compose of people too which makes the whole quantitative statistical exercise as self-contradictory.

Central Planning Failure: China’s “Train Wreck” Edition

Think government knows what is best for us?

This from Charles Lane of the Washington Post (hat tip Cato’s Dan Mitchell) [bold emphasis mine]

For the past eight years, Liu Zhijun was one of the most influential people in China. As minister of railways, Liu ran China’s $300 billion high-speed rail project. U.S., European and Japanese contractors jostled for a piece of the business while foreign journalists gushed over China’s latest high-tech marvel.

Today, Liu Zhijun is ruined, and his high-speed rail project is in trouble. On Feb. 25, he was fired for “severe violations of discipline” — code for embezzling tens of millions of dollars. Seems his ministry has run up $271 billion in debt — roughly five times the level that bankrupted General Motors. But ticket sales can’t cover debt service that will total $27.7 billion in 2011 alone. Safety concerns also are cropping up.

Faced with a financial and public relations disaster, China put the brakes on Liu’s program. On April 13, the government cut bullet-train speeds 30 mph to improve safety, energy efficiency and affordability. The Railway Ministry’s tangled finances are being audited. Construction plans, too, are being reviewed.

Liu’s legacy, in short, is a system that could drain China’s economic resources for years. So much for the grand project that Thomas Friedman of the New York Times likened to a “moon shot” and that President Obama held up as a model for the United States.

Rather than demonstrating the advantages of centrally planned long-term investment, as its foreign admirers sometimes suggested, China’s bullet-train experience shows what can go wrong when an unelected elite, influenced by corrupt opportunists, gives orders that all must follow — without the robust public discussion we would have in the states.

This exemplifies what has been wrong in China. Similar to our previous accounts of ghost cities and Potemkin malls, what has largely been touted as the “Chinese growth miracle” seems more like a boom bust cycle from reckless centrally planned ‘delusions of grandeur’ financed by Chinese taxpayers.

And cracks appear to be widening as time goes by. Once malinvestments reach a “tipping point” or a critical mass then these cracks will break into a torrent.

Next, this further shows how wastage and inefficiency of government spending translates into huge negative externality costs. Centralization "orders that all must follow" translates to systemic fragility where losses are borne by everybody "could drain China's economic resources for years", while losses from decentralization are distributed hence anti (less) fragile (Nassim Taleb-Fooled By Randomness).

In addition, the above likewise exhibits how taxpayer resources are wasted on facilities or infrastructure projects that are hardly demanded for by consumers. Because non-profit oriented central planning decision making neglects the risk-reward tradeoffs and are instead guided by political goals, taxpayers end up absorbing the consequences of wrong decisions (sales can't cover debt service and safety issues).

Moreover, this is another example where government finds it too easy to spend someone else’s money. To quote the illustrious economist Milton Friedman “If you put the federal government in charge of the Sahara Desert, in 5 years there'd be a shortage of sand.” Apparently this is a universal trait for politicians and bureaucrats.

And importantly, discretionary power over spending other people’s money becomes too much a temptation to resist claims over other people’s money as one’s own. Thus, concentration of power, enabled by arbitrary laws, serves as breeding and nestling grounds for corruption, in the above case "embezzlement".

Finally central planners believe that they know better of what society needs than of the individual through the markets. As the above also shows, they don’t.

This further validates the knowledge problem proposed by the great F. A. Hayek as evidenced by majestic mistakes which continually plagues the “unelected elite”:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design

Philippine Mining Index Surfs The Commodity Tide

Domestic mining issues have been one of the recent ‘darlings’ of the Philippine Stock Exchange for the second week.

The Rising Commodity Tide

And these have been happening on the backdrop of record metal prices mostly led by precious metals.

Sizzling hot silver (+51% year to date) has skyrocketed reportedly from a massive short squeeze[1] and so with also gold (+5.91%).

Meanwhile copper also drifts near its record price highs even if its year-to-date performance has been lacklustre (marginally down .63%).

Importantly, prices of commodity products lead mining issues, and this phenomenon seems to take place around the world as global mining issues (S&P/TSX), Emerging Market Mining Titans (EMT), Gold Bugs (HUI) and Industrial Metals ($DJAIN) can be seen in an ascending trend (red line).

Philippine Mining Index Surfs The Tide

Domestic Mining issues have likewise been markedly moving higher too.

Since mid-2010, major mining component issues as Philex (black candle), Semirara (blue), Lepanto (green), Atlas (violet) and Manila Mining (orange) have lifted the Philippine Mining Index (red line). These companies constitute about 89% of the Philippine Mining index and whose pecking order shown above are based on market capitalization.

Some may suggest that the current price actions have been prompted by corporate deals. For instance, the yet to be formalized joint venture agreement of Philex with Manila Mining [MA] for the combined development of Philex’s Boyongan with Manila Mining’s Kalayaan properties[2].

While this may be partly true, one should understand the function of the market is to discount the flow of information that are perpetually being disseminated through the ticker tape. I call this the diminishing returns[3] or the marginal value of information as market prices incorporate future expectations rather than the present or the past.

In other words, there are bigger forces than just mergers and acquisitions (M&A) or joint ventures that drive equity share prices. Although, M&A and JVs characterize the climate of the underlying bull market trend.

Looking at the bigger picture, chart actions reveal of the same narrative: Mining issues has been on an uptrend since 2009, but the actions differ in terms of degree and in timing.

As I earlier described in 2009[4], (bold emphasis original)

Since the domestic mining industry remains broadly underinvested and where current crops of mining firms lack the capital to expand or operate, the major catalysts for prospective runs would be speculations on joint ventures and or prospective M&A developments from new investors (they could be foreign or local godfathers)

Actions among the mining components appear to be rotational- a classic symptom of bullmarket driven by inflation. This implies that the next major moves could likely come from those that have been in a reprieve.

A sustained bullmarket in commodities- arising from monetary “pass through” or from BRIC and emerging markets demand- is likely to underpin the secular case for investing in local mines.

Compared to other sectors mines are likely to generate ALPHA.

IT has not always been a boom, nonetheless nearly all of what we have described above been fulfilled.

And the rotation has not been limited to companies within the mining index but signifies largely a phenomenon of the general market, as different sectors flow in a single direction but gets differentiated by timing and by the degree of price motions.

Yet there will always wall of worries to climb.

Anti-Mining Politics, It’s Economics Stupid!

The recent landslide in Compostela Valley that has resulted to 3 fatalities, has largely been blamed on the mining activities.

In the understanding of the public’s anti-mining bias which has been buttressed by the Church, and the attendant environmental hysteria that has been promoted by mainstream media, accidents like this could lead to a political backlash that could risk political outcomes. Though I would say that this is likely to be attention-span based which means public’s attention is usually short term, fickle and limited and would shift to new controversies as they emerge.

Yet the anti-mining political hysteria fails to distinguish that the environmental hazards emanate NOT from market based mining activities but from underground based activities as consequences of the feckless prohibition laws.

As the Inquirer reports[5],

Many of these operations are illegal and unregulated, and there are frequent accidents, Reuters said in a report.

The point is: One CANNOT legislate away demand and supply. Politics can only shift them.

If resources, as mineral commodities, are there for the picking, and considering that these products has been generating higher values (ergo MORE profits), then either the markets or political means will resolve its extraction.

The essence is, since these politicized commodities have imputed economic values, then prohibition laws won’t stop the economics of mining.

It’s downright dimwittedness for anyone to suggest they can.

And if politics is the chosen option, then mining will become either an activity rewarded as concessions to the politically favoured—who would seek to please the political benefactors as their priority than of the environment—or an activity that will be implemented in a guerrilla warfare fashion. Of course, the latter would most likely operate under the inferred blessings of venal local officials.

In addition, in guerrilla type of mining operations, since illegal miners operate under temporary implicit licenses or are reckoned as completely underground, this implies that operators won’t care about the environment since they are illegal anyway.

Besides, illegal operators are most likely to be amateurs from within the locality or from the surrounding areas, instead of professional miners. Thus by rendering illegitimate the industry, this would lead to more frequency of accidents and of damages in larger scales.

Yet unknown to most, because economics is what drives the mining business, prohibition laws would only breed and nurture corruption. High profits and reduced competition would allow illegal operators to payoff politicians and the police.

Again it is all about economics.

So the more the prohibition, the more we can expect accidents from underground activities to take place.

Conclusion

Rising commodities prices have been filtering into global mining issues.

We see the same phenomenon impact the local market.

Momentum appears to favor a continued rise.

Political risks from recent catastrophe may affect mining sentiment on the short run but this should be muted.

In terms of politics, prohibition laws won’t ever succeed to stop the forces of demand and supply. It’s just the distribution that changes.

Yet the above dynamics has once again been validating my predictions since 2003, as published in safehaven.com[6] (there are two more articles I published thereafter[7])

The prospects of a continuing rise in commodity prices due to the tightening of supplies and possibly in combination with mounting demand from the rapidly expanding China and India, or from the steep fall of the US dollar, should highlight the potentials of mining and resource based companies in our region too.

No trend moves in a straight line. Yet, mining issues will function as the main beneficiary of inflationism and the emerging market consumption story.

So I’d stick by them. So should you. (My other favourite industry would be technology)

---

[1] See Hi Ho Silver! April 23, 2011

[2] Philstar.com Manila Mining says deal with Philex on Kalayaan 'done', April 20, 2011

[3] See “I Told You So!” Moment: Being Right In Gold and Disproving False Causations, March 6, 2011

[4] See Prediction Fulfilled: Philippine Mining Index Tops 9,000 (Now 11,300!) November 15, 2009

[5] Inquirer.net 15 buried miners saved, April 24 2011

[6] Safehaven.com The Philippine Mining Index Lags the World, September 26, 2003

[7] Safehaven.com Author Benson Te

Yemeni President To Resign: Another Near Victory For ‘Kids With Stones And Facebook’

Another MENA dictator bites the dust: Yemeni President agrees to step down

From the Wall Street Journal

Yemen's president and the country's top general are hashing out a settlement in which both men would resign within days, people familiar with the situation said, raising crucial questions of who will end up leading a key, though embattled, U.S. counterterrorism ally.

The outlines of a peaceful transition, to a civilian-led transitional government, emerged amid rising tension over the standoff between Yemeni President Ali Abdullah Saleh and pro-democracy protesters backed by Gen. Ali Mohsen al-Ahmar. The general this week broke ranks and declared his support for protesters demanding that the president resign immediately.

Opposing tanks from units loyal to Mr. Saleh and to Gen. Ahmar have faced off in the streets of San'a all week and tens of thousands of antigovernment demonstrators vowed to continue their protest Friday in the capital's Change Square.

It’s almost a validation of what I earlier wrote about—rebutting critiques of MENA revolts spearheaded by “Kids with stones and Facebook”

Today’s defection of Yemen’s key army commanders partially rebuts the idea that incumbents “do not easily yield that power to kids with stones and Facebook”. Maybe not easily, but this only shows that “facebook and kids with stones” have the power to turn the army on their sides.

Don’t forget armies are composite of people---who can be swayed by influences (like networks-families, friends or culture-religion).

As a saying goes... It’s not over till the fat lady sings.

Like it or not, “Kids with stones and Facebook” will play a far crucial role in shaping the geopolitical context than most experts would expect.

As I would like to reiterate, politics is an ongoing process.

People participating in these social (MENA) revolutions may not understand liberty (private property, rule of law and voluntary exchange) enough, in as much as they would like their dictators out. As the 18th President of the US, Ulysses S. Grant, once said,

The right of revolution is an inherent one. When people are oppressed by their government, it is a natural right they enjoy to relieve themselves of the oppression, if they are strong enough, either by withdrawal from it, or by overthrowing it and substituting a government more acceptable.

But slowly and surely social media is helping them get there.

Video: Rob Harmon On How Markets Keep Streams Flowing

In this talk, Rob Harmon shows, where regulations failed, how the markets solved a common pool resource dilemma. His example is the case of the Prickly Pear Creek where the institution of market mechanism has successfully brought back water to a formerly "dewatered" stream.

(hat tip: Briggs Armstrong/Mises Blog)

Hi Ho Silver!

Silver prices went ballistic and has virtually outclassed its commodity peers!

I included the S&P 500 (red) and the emerging market benchmark EEM (blue green) [chart from stockcharts.com]

The parabolic rise of Silver (51% year to date) may give the impression of a bubble at work. Could be, but other commodities have not been emitting the same signals.

Bubbles usually can be identified by across the board ‘rising tide lifts all boats’ increases. The same dynamic can be seen in a ‘flight to real asset’ phenomenon. The difference is with the subsequent outcomes: a boom goes bust while a crackup boom segues into hyperinflation.

The exemplary performance of silver can also due to another fundamental factor: A massive short squeeze!

Writes Alasdair Macleod of Goldmoney, (bold highlights mine)

There are a few banks with large short positions in silver on the US futures market in quantities that simply cannot be covered by physical stock. The outstanding obligations are far larger than the stock available. The lesson from the London Bridge example is that prices in a bear squeeze can go far higher than anyone reasonably thinks possible. The short position in gold is less visible, being mainly in the unallocated accounts of the bullion banks operating in the LBMA market. But it is there nonetheless, and the bullion banks’ obligations to their bullion-unallocated account holders are far greater than the bullion they actually hold.

But there is one vital difference between my example from the property market of 1974 and gold and silver today. The bear who got caught short of London Bridge Securities was right in principal, because LBS went bust shortly afterwards; but in the case of gold and silver, the acceleration of monetary inflation is underwriting rising prices for both metals, making the position of the bears increasingly exposed as time marches on.

No trend goes in a straight line. So silver prices may endure sharp volatilities in the interim.

However, if the short squeeze fundamental narrative is accurate, which will likely be amplified or compounded by the monetary inflation dynamics, then as the fictional TV hero the Lone Ranger would say,

Hi-yo, Silver! Away!

Post Script:

Here is where Warren Buffett made a big mistake.

Berkshire Hathaway reportedly bought 130 million ounces of silver in 1998 at an average of $5.25 per oz. which he subsequently sold at about $7 in 2006. His ideological aversion to metals made him underestimate Silver’s potentials.

Lesson: ideological blind spots can result to huge opportunity costs.

The Festering Culture Of Debt

In Canada, a recent poll manifested that one-third of their residents does not have enough savings.

From Yahoo,

Nearly one-third of Canadians that responded to a recent survey backed by a major Canadian bank said they didn't have enough money to cover living expenses.

An online survey completed for TD Canada Trust (TSX:TD) also found that 54 per cent of the 1,003 people who answered said it was a real struggle or impossible to save.

The report, released Wednesday, says that 38 per cent of respondents said they had no savings and 30 per cent said they didn't have enough money for their living expenses.

In other words, a big segment of Canada’s population has been living on debt.

And the culture of debt has been a festering pandemic since Nixon Shock where the gold anchor was severed from the world’s monetary system.

As the Economist points out in the crisis year of 2008,

Throughout the 1980s and 1990s a rise in debt levels accompanied what economists called the “great moderation”, when growth was steady and unemployment and inflation remained low. No longer did Western banks have to raise rates to halt consumer booms. By the early 2000s a vast international scheme of vendor financing had been created. China and the oil exporters amassed current-account surpluses and then lent the money back to the developed world so it could keep buying their goods.

Those who cautioned against rising debt levels were dismissed as doom-mongers; after all, asset prices were rising even faster, so balance-sheets looked healthy. And with the economy buoyant, debtors could afford to meet their interest payments without defaulting. In short, it paid to borrow and it paid to lend.

Like alcohol, a debt boom tends to induce euphoria. Traders and investors saw the asset-price rises it brought with it as proof of their brilliance; central banks and governments thought that rising markets and higher tax revenues attested to the soundness of their policies.

The culture of debt signifies symptoms of accrued policies shaped by the dominant economic ideology which sees spending as the key force for promoting prosperity or keeping society “permanently in a quasi-boom”.

The war against savings, which is being channeled through policy-based low interest rates (“The remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the boom to last”-General Theory) punishes savers and rewards speculative activities which benefits the wards of central banks—added profits for the banking industry cartel and expanded government spending for politicians.

Never mind the law of diminishing returns on debt to an economy (such as in the US; see right window of the above chart).

Past ephemeral successes [plus sustaining a debt based political economy] will lead global authorities towards path dependent policy choices (which is why I think that global QEs will continue)

Besides, politicians and the bureaucracy sees such policies as even more beneficial to them even if the markets suffer from the convulsions of debt overdose: people will be more captive to them which expands their control over the society.

As Mises Institute’s President Doug French aptly points out, (bold highlights mine)

Those with no savings are more dependent on government and others when the unexpected occurs, whether it's job loss or the washing machine quits. Professor Paul Cantor reminds us in his article, "Hyperinflation and Hyperreality: Mann's 'Disorder and Early Sorrow,'" that "money is a central source of stability, continuity, and coherence in any community. Hence to tamper with the basic money supply is to tamper with a community's sense of value."

When the Fed makes saving seem futile and immediate pleasure seem rational, the world has been diabolically turned upside down. Just one step away from hyperinflation, the central banks' actions are threatening "to undermine and dissolve all sense of value in a society."

"Thus inflation serves to heighten the already frantic pace of modern life, further disorienting people and undermining whatever sense of stability they may still have," Cantor explains.

The government sponsored debt culture fundamentally erodes society’s moral fibers.

Yet most people have either not been cognizant or simply refuses to see (out of blind reverence on government) the deleterious effects of false prosperity (turning bread into stones) policies.

Nevertheless, in the fullness of time, the world will see that the emperor has no clothes.

Video: Public Choice: Why Politicians Don't Cut Spending

Professor Ben Powell in a short video explains, from the public choice perspective, why politicians are intuitively reluctant to cut spending. (source Learn Liberty)

Forbes: World’s 2000 Biggest Publicly Listed Companies

Forbes just published a list of the world’s 2000 biggest publicly listed companies.

Here is the top 10:

By region, the Asia-Pacific had the most entries in the roster with China as the leader.

Forbes Scott DeCarlo quotes Gady Epstein (bold emphasis mine)

The Asia-Pacific region led The Global 2000 again this year with 701 companies, including the most additions to the list of the four regions (11) and by far the biggest increase in profits (they doubled). The biggest profit center was China, no surprise, as 121 companies, including PetroChina, ICBC and Sinopec, returned an aggregate profit of $168 billion. But Japan’s and South Korea’s conglomerate-led rosters provided surprisingly impressive returns: Japan turned from deficit to the region’s second-most-profitable nation and added assets and employees despite losing ten companies (Sumikin Bussan and Makita among them); South Korea added ten companies, more than China, and saw profits surge 178%. New additions: Samsung Life Insurance, Honam Petrochemical.

Meanwhile a large segment of the strong performance of US companies has been imputed to overseas sales.

Notes Mr. DeCarlo, (bold emphasis mine)

The U.S. companies on our list earn an average 26% of revenue outside the country, and world GDP grew at a rate of 5% in 2010. Almost one-quarter of the U.S. firms, names such as Aflac, Colgate-Palmolive and Intel, generate a majority of their sales from overseas operations. Still, the U.S. grip on The Global 2000 has been slipping since 2004, when the number of U.S. constituents was 751. It’s now 536. The U.S. still accounts for the most firms among the top 100 with 28

Incidentally, 4 companies from the Philippines had been included in this elite group.

Three of them, in my view, represents political enterprises.

The Forbes also listed the Global High Performers

These companies, according go to Scott DeCarlo, has been expanding their earnings at 23% annually and returned an average 16% to shareholders over the past five years.

Furthermore, the list has shown growth of 17% which topped the S&P 500 (up 14%) over the same time period with priceline.com, McDermott International and Genting as best performers.

In addition. Mr. DeCarlo notes, 69 of the 130 companies have headquarters outside the U.S. and includes global brand names, such as Spain’s Telefónica, Nestlé (Switzerland) and Christian Dior (France); as well as foreign companies with lower profiles, such as Denmark drug company, Novozymes. Among notable U.S. Global High Performers are Walt Disney, Google, McDonald’s, and Nike.

Read the rest about Global 2000 here.

All these add up to show how globalization has distributed corporate winners across nations.

Reason TV: The Top Five Environmental Disasters that Didn't Happen

Reason TV gives a good account of the failed predictions by environmental doomsayers

(hat tip: Art Carden/Mises Blog)

US Dollar’s Diminishing Role As Reserve Currency

The Wall Street Journal editorial highlights on the baneful effects of the Fed’s inflationist policies, which is being transmitted via the US dollar, to the world. Such paradox had partly been captured by the famous quote attributed to former US Treasury secretary John Connally “our currency, but your problem.

From the Wall Street Journal, (bold highlights mine)

The larger story is that the world is starting to protect, and perhaps ultimately free, itself from America's weak dollar standard. The European Central Bank recently raised interest rates and may do so again to prevent an inflation breakout. China is allowing more trade to be conducted in yuan, a first step toward making it a global currency. At a meeting of developing countries—the so-called BRICs—in China recently, leaders called for "a broad-based international reserve currency system providing stability and certainty." They weren't referring to the dollar.

Even in the U.S., Americans are buying commodities (oil per barrel: $111) and gold ($1,500 an ounce) as a dollar hedge, and the state of Utah recently took steps to make it easier for citizens to buy and sell gold as a de facto alternative currency. Whether or not these prove to be wise investments, they are certainly signals of mistrust in Washington's economic stewardship.

At an economic town hall this week, President Obama blamed "speculators" for rising oil prices. He should have mentioned the Fed and his own Treasury, which have encouraged the world to invest in hedges against the falling dollar. Chairman Ben Bernanke and Mr. Geithner have deliberately pursued a policy of unprecedented monetary and spending stimulus to reflate the economy and boost asset prices. The bill is coming due in a weak dollar, food and energy inflation, and the decline of U.S. economic credibility.

But inflationism eventually will be everyone’s problem.

There will be feedback mechanisms from other nations. And this process is exactly what the Wall Street Journal article has been about. Other nations have been taking defensive maneuvers from a policy of sustained inflationism adapted by the US Federal Reserve.

And one consequence is that the US dollar will shed its pre-eminence as the world’s reserve currency.

Sustained inflationism means that the US dollar will diminish her role as the world’s reserve currency. The above chart shows how this process has been taking place.

The rise of the Euro came amidst the US Technology bust in 2000. Overtime, the Euro has grabbed a larger slice of the reserve currency pie. But it is unclear if the Euro will be a worthwhile substitute as the Euro suffers from the same malaise as the US. The difference is just a matter of degree.

Nevertheless, the great Ludwig von Mises described how the inflation process negates the role of money. (bold highlights mine)

The course of a progressing inflation is this: At the beginning the inflow of additional money makes the prices of some commodities and services rise; other prices rise later. The price rise affects the various commodities and services, as has been shown, at different dates and to a different extent.

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services.

These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them.

Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

It’s a process in motion.

Gold at $1,500 Settles the Jim Rogers-Nouriel Roubini Debate

Celebrity guru Nouriel Roubini has been dead wrong. Prolific investor Jim Rogers has been spot on. They had an impassioned debate in November of 2009.

Professor Roubini earlier said of gold prices,

Maybe it will reach $1,100 or so but $1,500 or $2,000 is nonsense,” Roubini said.

Professor Roubini represents the mainstream econometric model based analysis whom has constantly failed to predict the markets accurately.

As Professor Robert Higgs points out, mainstream (academia) thinking has [bold highlights mine]

little interest in the search for truth, however one might understand or pursue it. To them, their research and publication amounted to a game in which the winning players receive the greatest rewards in salary, research funding, and professional acclaim. They understood that because of cloistered academic inbreeding, economists at the most prestigious universities consider the “smartest guys” to be those who employ the most advanced, complex, and incomprehensible mathematics in their “modeling” and “empirical testing.

Gold’s record price surge has been nominal based.

Economist John Williams, who uses the old methodology (1990 CPI) to compute for inflation, says that gold is still far away from reaching its inflation adjusted high in 1980s.

The USAWatchdog quotes economist John Williams (bold highlights original)

In a recent report, economist John Williams of Shadowstats.com contends a declining U.S. currency is reflected in spiking gas prices. Williams’ said, “. . . the primary problem behind higher oil and gasoline prices is the Fed’s efforts at dollar debasement, but few in the media are willing to blame the Fed . . . Also hitting the dollar, though, are increasing instabilities in and ineffectiveness of political Washington, D.C., as viewed by the rest of the world.”

Williams says gold and silver are nowhere near their former inflation adjusted highs of 1980. Back then, gold hit $850 per ounce and silver $49.45 per ounce. To truly equal that price in today’s inflated money, gold would have to be “$8,331 per troy ounce” and silver would have to be priced at “$485 per troy ounce,” according to Williams’ recent calculations.

Yet Gold’s record price surge isn’t only a US dollar dynamic but against global currencies.

The following charts from gold.org shows of gold trends in different currencies since 1998

Euro

Yen

Pound

South African Rand

Australian Dollar

Canadian Dollar

Indian Rupee

G-5 basket

In my view, surging gold in all currencies seem to be validating Voltaire’s observation—Paper money eventually returns to its intrinsic value ---- zero.

The blunt way to say this is that zero extrapolates to hyperinflation.

Again, all these mainly depend on the prospective actions of global governments, most especially the US Federal Reserve.

Russia’s Putin Says US Federal Reserve Policies Represent ‘Hooliganism’

Even some governments recognize the implicit harm from US Fed policies.

This report from Wall Street Journal Blog (Bold highlights mine)

WSJ Blog AFP/Getty Images Prime Minister Vladimir Putin

Russian Prime Minister Vladimir Putin slammed expansionary U.S. monetary policy, calling it “hooliganism”, in remarks that followed more veiled criticism from China after Standard & Poor’s Corp. cut the outlook on its U.S. debt rating this week.

“We see that everything is not so good for our friends in the States,” Putin told lawmakers Wednesday.

“Look at their trade balance, their debt, and budget. They turn on the printing press and flood the entire dollar zone — in other words, the whole world — with government bonds. There is no way we will act this way anytime soon. We don’t have the luxury of such hooliganism,” he said.

Even as Putin blamed the U.S. for printing money — something for which Russia was criticized during periods of hyperinflation in the 1990s — other Russian officials said there is no alternative to the U.S. dollar and declined to discuss cutting the country’s dollar holdings.

Russia has the world’s third-largest international reserves after China and Japan, with the biggest part in U.S. government debt. However, Russia appears to have cut its direct Treasury holdings significantly in recent months, according to data from the U.S. Treasury.

Russia can be seen as benefiting from the recent policy of the U.S. Federal Reserve, linked to higher commodity prices. But an increase in dollar supply and low interest rates could also lead to a commodities bubble that could wreak havoc on Russia’s finances if oil prices later collapse.

Authorities of some nations earlier admonished the Fed’s actions as stoking a currency war.

The above report reveals that Russia’s Putin recognizes the consequences of the massive money printing operations as one of the bubble cycles and commodity inflation which eventually will sow chaos or devastate global economies again. (Could Putin be reading Austrian economics?)

It is not true that “there is no alternative to the U.S. dollar”. People will intuitively shift to either other foreign currencies or bring back hard currency once the ‘policies of hooliganism’ worsens.

With gold and commodities generally soaring, these represent symptoms of a worldwide “flight to real values” from the ongoing crackup boom.