When Infinite Inflation Isn’t Enough

By Peter Schiff

If no one seems to care that the Titanic is filling with water, why not drill another hole in it? That seems to be the M.O. of the Bernanke Federal Reserve. After the announcement of QE3 (also dubbed “QE Infinity”) created yet another round of media chatter about a recovery, the Fed’s Open Market Committee has decided to push infinity a little bit further. The latest move involves the continuing purchase of long-term Treasuries when Operation Twist expires, thereby more than doubling QE3 to a monthly influx of $85 billion in phony money starting in December. I call it “QE3 Plus” – now with more inflation!

Inflation By Any Other Name

In case you’ve lost track of all the different ways the Fed has connived to distort the economy, here’s a refresher on Operation Twist: the Fed sells Treasury notes with maturity dates of three years or less, and uses the cash to buy long-term Treasury bonds. This “twisting” of its portfolio is supposed to bring down long-term interest rates to make the US economy appear stronger and inflation appear lower than is actually the case.

Riding Into the Sunset or a Brick Wall

By Peter Schiff

A month ago, I presented the case for why Fed Chairman Bernanke would have strong motivation to launch another round of quantitative easing (QE) before the election. In short, it would save him his job. Now, I didn’t predict with certainty that he would do so – only the few men at the FOMC knew that for sure – but it seemed likely. Shortly thereafter, Bernanke not only announced more stimulus, but promised to keep it flowing to the tune of an additional $40 billion a month until conditions improve. As I had written, this is essentially the election platform of the Obama-Bernanke ticket: we will keep the party going indefinitely.

Unfortunately, though these are two powerful men, they are not above the law of economics. While critics have dubbed this program “QEternity” or “QE-Infinity”, it will end much before that. We are witnessing a massive bubble in US government debt, and we’ve reached the point where no one in charge believes it will ever end – an excellent contra-indicator.

The Fed’s Campaign

By Peter Schiff

This past Friday, as Fed Chairman Ben Bernanke delivered his annual address from Jackson Hole – the State of the Dollar, if you will – I couldn’t help but hear it as an incumbent’s campaign speech. While Wall Street was hoping for some concrete announcement, what we got was a mushy appraisal of the Fed’s handling of the financial crisis so far and a suggestion that more ‘help’ is on the way.

It is important to remember that it’s not just President Obama’s job on the line in this election; in two years time, the next President will have the opportunity to either reappoint Bernanke or choose someone else. So we must understand what platform Bernanke is running on, as his office has an even greater effect on global markets than the President’s.

Bernanke has been the perfect tag-team partner for George W. Bush and then Barack Obama as they have pursued an economic policy of deficits, bailouts, and stimulus. Without the Fed providing artificial support to housing and US debt, Washington would have already been shut out of foreign credit markets. In other words, they would have faced a debt ceiling that no amount of bipartisan support could raise. Fortunately for the politicians, Helicopter Ben was there to monetize the debts.

China, Metals, and Your Money

I’m in Shanghai, and the “China Miracle” is in full bloom. Few variables are more important in the world of metals investment than the strength and sustainability of the extraordinary bull run the Chinese economy has enjoyed for years. So many pundits, critics, and cheerleaders keep pouring out opinions on this question that they saturate the news – but leaves no one the wiser.

I’m sorry to say that, as arrogant as I am, I do not have quite the hubris to tell you that I have figured China out and know what is and will be.

But I can tell you that I’ve traversed China from south to north, from east to west. I’ve spent days driving through the countryside, passed through China’s largest cities and smallest villages. I have seen a China that is visibly, radically different than the China I saw for the first time a mere six years ago. Ten percent growth compounded over six years is a 177% difference – and the reality behind such numbers is unmistakable. Yes, there is still great poverty here and a lot of people living on a subsistence basis, but this is not a poor country. The fraction that has been lifted to middle class and above is enormous, and the country’s GDP is now the second largest in the world.

Shanghai itself may not be the financial capital of China any more, as in a politically dominated economy like this, all the big decisions get made in the political capital of Beijing, but the wealth here is tremendous. The proliferation of high-­tech buildings, modern houses, shopping malls, expensive cars, and more defies belief.

But the real shocker is the modernization of small towns and villages. Oxen have been replaced with tractors, rags replaced with bright new clothes, mud brick and thatch replaced with real brick and glass and electricity and satellite TV. The material improvement in the lives of hundreds of millions of people is spectacular.

To me, the most important economic consideration is that whatever the degree of misallocation of capital may be here, the allocation of most capital is to infrastructure, factories, power generation, mine development, agriculture, housing, and generally to durable and productive assets. China is gearing up to flood the world with products on a scale that could be an order of magnitude greater than what we’ve seen so far.

What if the EU disintegrates and the US sinks back into recession? What will China do with all its productive capacity then? Some would be wasted – factories and luxury cars can both rust for lack of capital to maintain them – but the productive capacity would still exist. With the investment already made, my guess is that the cost of goods manufactured in China would plummet. Particularly with so many state­-owned enterprises – for which jobs and production may become more important than profit – selling at no profit would be better than shutting down. The central committee may even see flooding the world with inexpensive products as a way to help China’s trading partners while helping themselves.

Is China in a bubble? Could the China Miracle turn into a China Nightmare?

I suppose it could; some massive misallocations of capital will certainly have to be liquidated. But a system that was already misallocating capital to an extreme degree can see major improvement simply by misallocating capital to a lesser degree.

Remember that unlike the US, the Chinese government is not borrowing money to build a network of high­-speed trains across the country; it’s paying for it out of excess savings. On the household level, people who save 40% of their income every year could lose half their savings and still have a lot more net worth than the average, highly indebted American. And they’ll still want new cars, or electric bikes, or even airplanes (I’m told that civil aviation has been legalized in China).

By the way, those high-­speed trains are linking more and more cities and are seeing heavy usage. You don’t have to drive out of the cities to an airport; you don’t have to be there an hour before departure time; you don’t need to spend hours making connections; and there are many other advantages. Most critical is that the population density, I’m told, is sufficient to make the thing turn a profit. Plus, where there’s high-speed rail, the regular lines are freed up for cargo only – and those trains now carry cargo up to 200kph!

My point is that if China is in a bubble, and if it does pop, this system will still be here, as will all the new highways, houses, factories, etc. This is not a deeply indebted nation of lawyers and hairdressers, but a cash-­rich nation building up its productive capacity. If growth here were cut in half, it would still be substantially greater than in the US or EU.

What about social unrest? Well, that’s one reason for China to keep manufacturing, even if profit drops off; but my sense is that, a few idealists aside, there is very little real pressure or even desire for major reform. People can see that things are improving, and they just want to better themselves.

What about China’s military buildup and saber-­rattling regarding those islands it and Japan both claim? Well, I was having dinner recently in a very large Chinese restaurant, where a large group of people were making round after round of toasts. The strength of the anti­-Japanese sentiment that the alcohol loosened was astounding. Many Chinese – even though few are left alive who witnessed it – deeply, deeply resent Japan’s invasion during WWII. But I haven’t met anyone here who wants war – they’d much rather just become richer than Japan and show the world who is smarter and better.

Similarly, I’d have to say that there is some sense of people here wanting to take over the world, but they don’t want to conquer it; they want to buy it. China wants to be an economic superpower and seems prepared to remove any obstacles to that goal – including outdated Marxist ideas.

Whether that’s good or bad is an important discussion, but it’s not what we’re here for today. The point for now is that all of this is bullish for China’s continued demand for raw materials, including metals.

One more factor I’d like to touch on is the question of “internal demand” – are there enough people in China with the money and the desire to buy the output of China’s factories and keep the economy here growing? I don’t think so… not all of the output of all of the factories. But reduced demand from the rest of the world does not mean no demand, and China’s internal demand is certainly growing.

An anecdote: I happened to be near the famous Kumbum Monastery near Xining, Qinghai, in western China, so I stopped in for a look. The ancient Tibetan architecture and relics were fascinating, but I noticed that the biggest gold-­plated temple of them all was not ancient, but built five years ago. The monks are repaving the streets with heavy blocks of tight­fitting granite. I saw – literally – piles of cash at the Buddha’s feet and elsewhere, as the throngs left their offerings. But I saw only one other Westerner the whole day I was there. The renewal of this monastery is a testament to China’s capacity to spend internally.

What I am trying to say is that China’s economy may slow, but I don’t think it will dry up and blow away. There may be a lot more correction in metals in the near term, driven by lower demand from China, as the growth rate moderates. But mid-­ to long­-term, major demand is baked in the cake. There will be money to be made in metals and mining for decades to come – and should we be so lucky as to get a meltdown before the metals peak, what a fantastic buying opportunity that would be.

We’ll be watching to see how that unfolds and will let you know when we see major turning points and buying opportunities.

The Return of the Gold Standard

By Peter Schiff

In my latest book, The Real Crash: America’s Coming Bankruptcy – How to Save Yourself and Your Country, I devote a full chapter to the merits of the historical gold standard and reasons to reinstate it. What I did not mention and few investors notice is that central banks are already returning to gold as the ultimate safe haven asset.

I believe this change in policy, combined with continued inflation of Western currencies, is creating a stable floor for the gold price and an even brighter upside potential.

A Strategic Shift

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

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

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

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

Taking the Long View

The depth of this new strategy has been on display throughout the precious metals correction of the past few months. Emerging market central banks have continued to be aggressive buyers. This is very bullish. As governmental actors, central banks seek out stability and predictability. When they shift course, they do so only deliberately and gradually, much like aircraft carriers. Western central banks have set a clear course toward inflation, while emerging market banks are shifting toward sound money.

The implications here are enormous for private investors. We now see the biggest market participants buying the yellow metal massively on the dips. What’s more, because central banks enjoy substantial clout in the gold market, their purchasing decisions have an outsized effect on price. Institutional investors are coming to once again see precious metals as a ‘legitimate’ form of investment. It is this positive feedback loop that will serve to stabilize gold as it re-emerges as a reserve asset.

It’s Still the One

Gold remains the bedrock of reserve holdings at central banks, even in a world dominated by fiat currencies. Apparently, when it comes to a paper-based global monetary system, it’s easier to talk the talk than walk the walk. Government officials the world over, but especially in the developed world, have been quick to call gold an anachronism – unsuitable for a modern, globalized economy. But these same governments have never found it in themselves to sell off their holdings, or for that matter, to surrender even a substantial fraction of them. Those who have clamored the loudest have, in fact, behaved the most conservatively.

The US, which has a whopping 75 percent of its reserve holdings in gold, and the Western European countries, which have an average of approximately 64 percent of their reserve holdings in gold, seem to believe no one should own gold – except them! It shouldn’t surprise anyone that emerging market central banks have spotted the double standard. As they advance economically, these nations are less likely to do what Washington tells them is right and more likely to think for themselves. And with an average of less than 20 percent of their reserve holdings in gold, they clearly know they have some catching up to do.

Behind the smoke and mirrors then, central banks in the developed world are hoarders. Central banks in the emerging markets are scramblers. Significantly, nobody is selling, only buying.

The Fiat Fantasy Meets Reality

What is causing the rush back to gold? Two words: excess debt. Independent central banking has always been more of a dream than a reality. Politicians knew from the beginning that they could run up the tab and then corner central bankers into bailing them out via inflation, AKA stealth default. Regrettably, central bankers have dutifully obliged – no one, for example, has yet resigned in protest. Only a few have ever defied their governments, and only for short periods.

Of course, governments throughout history have created the conditions for their own collapse by tampering with their money supply to pay debts. Undermining the currency means undermining the entire economy, which lowers tax receipts and creates more debt. Soon, the unintended consequences of the policy overwhelm its intended consequences, and the state collapses – along with the jobs of those central bankers. Committed, nonetheless, the central bankers are.

Valuation Insurance

Against this historical cycle, the best insurance policy is physical gold. Those with the most of it will best weather the coming rounds of competitive devaluation. No wonder that central banks in the emerging markets are scrambling to play catch-up to their developed-world counterparts.

How much gold will central banks stockpile? We cannot and do not know for sure. What we can and do know for sure is that they have prudently decided on a strategic shift in policy. This is creating a floor for the price of gold and a brighter future ahead for those who are prepared for the return of sound money.

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What is Money?

By Peter Schiff
Excerpted from the new economic bestseller, The Real Crash.

Today, we’re accustomed to thinking of small greenish paper rectangles as the definition of money, and we think of the US government as the only source of money. To honestly discuss sound money, we need to realize where our current money customs came from.

At first, it was every man for himself. You ate or wore what you could pick or catch.

Barter was the first advance. If you had some extra meat, and your neighbor had an extra fur, you might make a direct exchange. If food, water, clothing, and simple tools are the only goods on the market, barter is fine – you can always find someone who has what you want and wants what you have.

But as soon as there’s basic manufacturing and prosperity begins increasing, barter becomes inadequate. Say you’re a hunter and you want a bed, but the only bedmaker in town is a vegetarian. What do you do then? You would have to figure out what the bedmaker wanted (maybe tofu), and then find someone who had tofu and wanted meat. If you couldn’t find that person, you would have to find a fourth person (someone who wanted meat, and had the hats that the tofu maker wanted), or try to convince the vegetarian bedmaker to take the meat and trade it for something else.

Meat, however, spoils, and so the bedmaker would have to unload it pretty quickly. So, unable to get your hands on anything the bedmaker wants to consume, you trade your meat for some salt and approach the bedmaker.

“Look, I know you don’t want salt, but think of all the people who do. They use it to preserve their meat and flavor their soup. And this stuff is nonperishable, so you can hold it as long as you want. And if, when the tofu dealer comes through town, he doesn’t want salt, you can explain to him what I’ve explained to you – he can use it to buy something he wants.”

If you and the bedmaker agree, you’ve just created money. Organically, more people in your community begin taking salt for payment, even if they have no intention to use it, because they know others will accept it.

But – and this is important – the value of salt money is not entirely dependent on other people accepting it as payment. If, for some reason, folks stopped taking salt as payment, you could use it as, well, salt.

Salt was a pretty good currency, especially before refrigeration, because it was widely demanded, divisible down to the grain, very portable, easy to weigh, and could easily be tested for counterfeit by tasting it. Romans used salt for money.

But just because salt served as money didn’t mean there would be no other form of money in circulation. Tobacco leaves might be widely accepted as payment. So might gold or silver.

The Greatest Invention Ever?

The point is that money arises naturally in society, as a way of aiding in voluntary economic transactions. It was one of the greatest inventions ever. Money not only made it easier for people to buy what they wanted, it also made saving much more possible – you could accumulate excess money to spend at a later point.

While saving is frowned upon by the elites today, it’s an essential element in economic progress. By making it easier for people to save, money did two crucial things. First, it inspired more industriousness: there was now incentive to work harder to earn more in a day than you could spend in a day. Second, savings enabled ambitious entrepreneurs to make big capital investments: labor-saving machines, warehouses, transportation.

If the saver didn’t have any big plans in mind for his money, he could still make it productive by lending it out. Finance was nearly impossible without money. Sure, you could give your neighbor a pig this year in exchange for a pig and a chicken next year, but there would be a lot more opportunity for squabbling (“this pig isn’t as healthy as the pig I gave you last year”).

With a commodity money, where there is little or no deviation in quality, and using universal, objective measures, like weight, you can lend with the confidence that what you get back will be of the same quality as what you loaned out.

Money also made specialization more practical. If you were really good at one thing – manufacturing nails (to borrow Adam Smith’s famous example) – you could make a living just by making nails. Without money, someone who spent his whole day making nails would have to find (a) someone with excess food who wanted nails, (b) someone with excess shelter who wanted nails, (c) someone with clothes to spare who also wanted nails at that moment, and so on.

Once money is introduced, the nail seller only needs to find (a) people with money who want nails, and (b) different people with everything the nail seller needs who want money. Facilitating specialization creates efficiencies, as folks get to divide up labor according to skill and interest. In countless ways, money improves society.

Competing Currencies

In the past, different types of commodity money competed. Salt had its advantages, but also disadvantages – you had to keep it dry, it was easy to spill. In Rome, rising sea levels made it much harder to get salt over the years.

Meanwhile, gold had a lot going for it. It’s fairly easy to store. Like salt, it’s easy to divide, but also easy to combine: you can make blocks, or coins of different weights or denominations, which can be standardized. It doesn’t rust. It doesn’t tarnish or undergo other unpleasant reactions with chemicals.

Like any money, gold has underlying value. Mostly, we think of its decorative value – across nearly every culture, gold is considered beautiful. Women love it, and pleasing women’s fancies is universally considered a good thing. It has industrial uses due to its resistance to corrosion and how thin it can be hammered.

Gold is also rare enough to be valuable, but plentiful enough that it can be widely circulated. Its supply grows, but never very quickly.

No authority had to declare gold to be money. It arose as a good medium of exchange, and in many cases it won out in competition against other moneys. It didn’t always win out to the exclusion of other types of money, but it was probably the most successful money ever, thanks not to some order from above, but thanks to gold’s own attributes.

This is very important: money doesn’t come from government; it comes from civil society.

From “The Real Crash” by Peter D. Schiff. Copyright © 2012 by the author and reprinted by permission of St. Martin’s Press, LLC. Click here to order from Amazon.

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Walking Along the Hyperinflationary Cliff

Mark Motive’s Gold Commentary

Would you walk along the edge of a cliff? Sure, you walk around every day (and you’re probably pretty good at it), but knowing that the result of a small misstep would be catastrophic, you’d probably think carefully before walking along a cliff. In fact, you’d probably stay far away from the cliff altogether.

Today, the US economy is walking at the edge of a fiscal cliff. Yes, we’ve managed our way through crises before, but today the risks of even a small policy mistake are greater than ever before. And if we misstep, we’ll fall into the abyss of hyperinflation.

Hyperinflation, defined by economist Phillip Cagan, is a period in which prices rise at 50% or more per month. In some historical cases of hyperinflation, prices rose by a million times over the course of a year! As you can imagine, hyperinflation of this magnitude devastates an economy. However, even a comparatively lower degree of inflation (e.g. 10-20%) can effectively wipe out the purchasing power of savings within a short period of time.

As the talking-heads look at the official Consumer Price Index (CPI) statistics and doubt whether there is currently any inflation, some alternative voices argue that we are already experiencing the early effects of high inflation. After all, anyone who has bought food, driven a car, or paid a medical bill is uncomfortably familiar with the speed at which many prices are rising.

Currently, there are four overarching structural issues driving decisions that can create catastrophic inflation in the US:

Debt growth over economic growth: When a business borrows money, it hopes to make a return that is greater than the cost of the debt itself. The US, however, seems to have forgotten this fundamental business principle decades ago. In fact, many now believe that the US economy requires increasing amounts of debt to maintain the same amount of growth. Consider the data since 2008: the national debt has grown by about 67% but real GDP has been essentially flat. When growth becomes dependent on more-and-more debt, lenders walk away – a process which has already started in the US. Long-time lenders like China have been buying less Treasury debt, and the Federal Reserve has stepped in to make up the difference. This is all due to a preference for debt growth over genuine economic growth.

Deficits and debt monetization: Once government spending reaches a certain level in excess of revenues, the resulting deficits become unfundable by traditional means (i.e. the bond market). Almost always, the central bank steps in to fund the difference by printing currency out of thin air. While austerity is what is truly needed to restructure the unsound economy, the medicine is often too bitter for politicians to swallow; in effect, the economy becomes addicted to deficits. Once a central bank starts monetizing the deficit, that economy is walking along a hyperinflationary cliff.

Diminished capacity to handle crises: Each round of boom-bust that Washington puts us through diminishes our capital stock. In plain English, we’re eating away at the foundation of our economy. In the Great Depression, the US still had tremendous manufacturing and other productive capacities. Now, we specialize in building housing subdivisions and managing retail stores. Our ability to ‘get by’ is diminished, and therefore this crisis is likely to be even deeper and scarier than the ’30s or ’70s.

An insolvent banking system: Despite the economic ‘reforms’ touted by the mainstream media, Western banks remain mired in bad debts. To operate profitably, the banking system needs cheap and easy access to credit. If the Fed were to raise short-term rates, the financial sector would quickly become unprofitable and many major banks would likely collapse. Indeed, the Fed’s highly touted ‘stress tests’ earlier this year inconspicuously did not test higher interest rates – presumably because all the tested banks would flunk. In order to protect the banking system from its past recklessness, central banks are prevented from turning off the printing presses even if the economy has returned to growth.

Today, it might not be clear whether hyperinflation is on the horizon. However, by the time inflation is obvious to the masses, it is too late to do anything about it for two main reasons: 1) The price level is a lagging indicator, because the money printing happens first and leads to higher prices, and 2) By the time everyone notices skyrocketing consumer prices, they have already been priced into the hard assets that could possibly protect investors. Wise investors see the threat of inflation when the money is printed (which has been going on ferociously since 2008) and they move their money into inflation-resistant assets.

Many of your friends and colleagues will be complacent. These are probably the same folks who several years ago missed the warning signs that the housing bubble was about to collapse and that the banking system was about to implode. By the time everyone is talking about inflation, there won’t be much you or the Fed can do except watch our standard of living evaporate.

Despite the nebulous nature of inflation forecasting, the risk of falling off the economic cliff is great enough to warrant action today.