Michael Pento’s Market Commentary
This past Sunday on the CBS program “60 Minutes”, Americans received a massive dose of mendacity from our Fed Chairman. Mr. Bernanke’s shaky delivery, and even shakier logic may cause faith in America’s economic leadership to evaporate faster than the value of our dollar. In particular, Bernanke delivered two massive distortions:
Lie #1 – The Fed isn’t printing money. Bernanke stated: “The amount of currency in circulation is not changing…the money supply is not changing in any significant way. What we’re doing is lowering interest rates by buying Treasury securities.” Given that it is the Treasury Department’s Bureau of Engraving and Printing, not the Fed, that actually prints paper money, his statement is technically correct while substantively false. However, Bernanke is buying bank assets with Fed credit. With such an arrangement, printing becomes unnecessary.
According to gentle Ben, credit created to buy something should not be considered money and has no affect on asset prices? But if that’s true, why is he concentrating his buying in the middle of the Treasury yield curve. His stated purpose is to boost bond prices and lower yields in order to stimulate borrowing and aggregate demand. So pushing up bond prices is an act of inflation. Bernanke similarly contradicts himself by saying that he isn’t creating inflation, while at the same time claiming that his easing campaign is designed to boost asset prices to combat the phantom of deflation.
And by the way, the Fed is causing money supply to increase significantly. The compounded annual growth rate of M2 is over 7% in the last quarter. Apparently in the eyes of the Chairman, a 7% annualized increase in the broad money supply isn’t considered significant.
Lie #2- Bernanke is “100 % confident” that, when necessary, the Fed can control inflation and reverse its accommodative monetary policy. He stated, “We’ve been very, very clear that we will not allow inflation to rise above 2 percent. We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time.” He failed to mention that the Fed doesn’t have the will to drain money from the system, without which all tools are useless. The Fed has consistently demonstrated its unwillingness to take the appropriate actions when necessary. In claiming he is 100% confident in his ability to control inflation, Mr. Bernanke ignores the record that during his tenure he has misdiagnosed the economy.
In June of 2006, Bernanke culminated his inflation fighting efforts by raising the Fed Funds target rate to 5.25%, after CPI inflation reached 4.2%. But that interest rate was enough to help burst the housing bubble and to spark an international credit crisis. Bernanke was completely unaware that the Fed actions had created an economy that had become completely addicted to artificially-produced low interest rates and inflation.
Shortly after the collapse of the real estate market and the ensuing truncated deflationary-depression, Bernanke took interest rates to near zero percent. But if the Fed was ever really serious about unwinding excessive leverage, the time had clearly arrived. Instead, the U.S. economy has become more addicted to free money than at any other time in our history.
Commodity prices are soaring once again and the real estate market, banking sector, and the overall economy cling precariously on the arm of government induced bailouts and low interest rates. Even worse, our government has massively increased its level of debt, which now stands at just below $14 trillion. Once the rate of inflation eclipses the Fed’s 2% target rate, which appears likely, how then will the Fed raise rates to contain it? Could the economy then withstand an increase in the cost of home ownership? Most importantly, when will Mr. Bernanke find it politically tenable to dramatically increase debt service payments for the Federal government? In truth, there is never a convenient time to have a severe recession or a depression. Unfortunately, reality can be extremely inconvenient.
Bernanke was accurate in saying that the economy is not expanding at a sustainable pace. Of course, his prescription was the same as it always is; print more money in the misguided belief that inflation will lead to growth. As such, he indicated that it’s possible that the Fed may actually expand bond purchases beyond the $600 billion announced last month. (Remember that the $600 billion comes after the $1.7 trillion that has already been printed, which failed to produce anything much beyond a weaker dollar). Therefore, the country can look forward to yet more inflation, continued anemic GDP growth, a poorer citizenry, and a vastly lower standard of living.
On the bright side, the next segment on 60 Minutes outlined some of the new social networking capabilities being created by Mark Zuckerberg and Facebook. In other words, although our economic misery will likely increase, it should become much easier to share the bad news with friends.
By Peter Schiff
Today’s payroll report severely disappointed on the downside and left economists scratching their heads to explain the weakness. The explanation, however, is plain as day. As I have been saying for years, the US economy will not create jobs as long as the Fed keeps interest rates artificially low, and Congress keeps stimulating spending and consumer debt, punishing employers with mandates, regulations, and taxes, crowding out private investment with massive government borrowing, and preventing market forces from restructuring our out-of-balance economy.
By Peter Schiff
If you’ve spent enough time in the gold community, you might be under the impression that the most imminent threat to the average American isn’t terrorism or unemployment, but rather gold confiscation. Starting with the fact that FDR confiscated gold during the last Great Depression, and continuing to the quite accurate forecast that we are headed into an even Greater Depression, unscrupulous coin dealers have been pushing investors to buy expensive “numismatic” or “collectible” coins that they claim would be protected from government seizure. The only problems are that the original motive for confiscation no longer applies and the “protection” offered by major coin dealers wouldn’t actually help you keep your gold.
The following article was written by Mary Anne and Pamela Aden for the December 2010 edition of Peter Schiff’s Gold Letter.
Gold is in full gear too, barely looking back over the last two years. It has practically doubled since the heat of the financial crisis (see Chart 1).
By Peter Schiff
Given the opposing views of the potentially parsimonious new Congress and the continuously accommodative Federal Reserve, there is a movement afoot among Republicans to eliminate the Fed’s “dual mandate.” Prior to 1977, the Fed only had one job: maintaining price stability. However, the stagflation of the 1970s inspired politicians to assign another task: promoting maximum employment. This “mission creep” has transformed the Fed from a monetary watchdog into an instrument of social policy. We would do well to give them back their original job.
Michael Pento’s Market Commentary
Certain deflationists have recently gone on record saying that the increase in the Fed’s balance sheet is meaningless with regard to creating inflation because our central bank can’t print money, it can only create bank reserves. The problem with their view is that it both disregards the definition of money and ignores the process of creating bank reserves.
Money is commonly defined as “a medium that can be exchanged for goods and services and is used as a measure of their values on the market, including among its forms a commodity such as gold, an officially issued coin or note, or a deposit in a checking account or other readily liquefiable account.” The Fed creates a “readily liquefiable account” when creating excess bank reserves, so it is also creating money. Since inflation is properly defined as an increase in the money supply, the Fed unquestionably creates both money and inflation when it creates reserves.
The deflationists’ error is to suppose that because the amount of currency has not grown, the money supply hasn’t grown. But the Fed never creates currency – all the printing is handled by Treasury; instead, it creates bank deposits which are held at the Fed. In ignoring this “base money,” the deflationists make no distinction between having the Fed’s balance sheet at $800 billion or $3 trillion. Doing so is a huge mistake for both making investment decisions and predicting asset price levels.
In short, for deflationists to be correct, they must contend that only money which is currently in circulation can be considered inflationary, i.e. lead to rising prices. Therefore, they must also believe that all increases in demand and time deposits should not be included in the money supply and should not be considered inflationary. This isn’t just wrong, it’s grossly wrong.
Not only do the Fed’s monetary additions increase the money supply, but the effect can be vastly multiplied through the fractional reserve system.
Also, the process of creating bank reserves always first involves the purchase of an asset by the central bank. The Fed issues electronic credits to banks in exchange for bank assets, including Treasuries. Its purchases drive up the demand for those assets, bringing about rising prices. In fact, Bernanke has clearly stated that the purpose of his “quantitative easing” program is to raise the rate of inflation, which in his mind is too low.
What the Fed is accomplishing is a reduction in the purchasing power of the US dollar. It creates inflation by vastly increasing the money supply and thus, lowers the confidence of those holding the greenback. If international confidence in the dollar is shaken, most dollar-based asset prices will increase — with the exception of US debt.
Deflationists also ignore the rise in prices that is occurring because of the potential insolvency of the US government. It is not dissimilar to what happened to Enron shares. Once the accounting scandal broke, the purchasing power of Enron shares plummeted. It was not because of an increase in the number of shares outstanding, but because of an epiphany on the part of investors that the company was totally bankrupt. Logically, shares representing a stake in a doomed company lost all of their value. Likewise, aggregate prices will soar if global investors lose confidence in the dollar due to the realization that the US is incapable of servicing its debt.
Whatever the deflationists may claim about the money supply, the objective indicators are not looking good for Uncle Sam. The dollar’s decline is abundantly evident when compared to gold, commodity prices, other currencies, real estate, and the list goes on. The national debt now stands at over $13.7 trillion, some 94% of GDP. Either due to an insolvent currency backed by a bankrupt nation or because of the Federal Reserve’s endless money printing, I have no doubt that the deflationists have it completely wrong.
Michael Pento’s Market Commentary
The continued bull market in the price of gold has been one of the staple discussions in the financial media for the better part of a decade. But, in that time, almost no consensus has emerged to explain the phenomenon. If you ask ten Wall Street pundits to explain the upward movement, you will most likely get nearly ten different answers.
While most logically identify global currency debasement as a primary cause, others say that gold is driven by: fear of economic uncertainty, central bank gold hording, international political conflict, or the ebb and flow of the Indian wedding season. The truth is the main drivers for the price of gold are the level and direction of real interest rates and the intrinsic value of the dollar.
Most people (outside of Washington) understand that printing money dilutes the value of the currency being printed. When a currency drops, the nominal price of hard assets in that currency generally rises. But the relationship between gold and monetary expansion is not that simple.
The act of central bank money printing temporarily drives down nominal interest rates, while at the same time creating inflation and lowering the intrinsic value of the currency that is printed. Therefore, subtracting rising rates of inflation from falling nominal interest rates results in a falling real rate of interest. Once real rates become negative, the liability of holding gold, which offers no interest income, disappears. The more real interest rates fall, the greater incentive for investors to own gold.
However, sometimes other factors come into play that prevent a debased currency from losing value against other currencies. It all depends on the actions taken by other central bankers. Hence, investors cannot divine the direction of gold simply by determining the state of nominal interests rates in the US or by the dollar’s value relative to other currencies.
This brings up two questions; should owners of gold fear rising yields on Treasuries, or a rise of the dollar against, say, the euro? The answers to those questions can be found by examining whether the rise in nominal rates is also accompanied by rising real interest rates and if the rise in the dollar is due to a decrease in its supply.
For example, back in January of 1977, the dollar price of gold began an epic bull market, which ended just prior to February of 1980. Gold soared from $135 dollars per ounce to just under $860 per ounce during those three years. This move occurred while nominal rates were rapidly rising. The yield on the Ten Year Treasury soared from 7.2% in January of 1977 to 12.4% in February of 1980. But the increase in yield was just in nominal terms because the YoY change in the CPI jumped from 5.2% in January of 1977 to 14.2% in February of 1980. During that bull market in gold, real interest rates fell from a positive 2% to a negative 1.8%, despite the fact that nominal rates increased by 520 bps.
Yesterday’s release from the BLS showed the October Producer Price Index increased by .4%, while the YoY increase in PPI jumped 4.3%. However, the Fed will most likely seize upon the month-over-month change in the core rate, which registered a negative .6%. Bernanke will overlook the largest YoY increase in PPI since May and instead worry about the deflation anticipated by core prices. That means he will find cover to print more money, thus – at least for now – keeping nominal rates from rapidly rising, while pushing inflation even higher. Real interest rates should fall and the price of gold should thus remain in its secular bull market. In my opinion, there is little danger that nominal rates will outpace the increase in the rate of inflation until the Fed unwinds its balance sheet like it did under Paul Volcker 30 years ago.
Likewise, an increase in the value of the dollar against another currency likely indicates that the central bank of the other country is lowering real interest rates and diluting the purchasing power of that currency at a greater pace than the Fed. It does not necessarily indicate that the supply of dollars is contracting or that our currency’s intrinsic value has increased.
There will come a time when the Fed’s pursuit of inflation causes a massive crisis of confidence in our bond market and in our currency. A sudden and dramatic spike in nominal rates would send real interest rates rising and cause devastation in most markets, including gold. However, because the Fed’s likely answer to such a crisis would be to create more inflation, any pullback in gold should be muted as compared to stocks, bonds, and other commodities.
By Peter Schiff
While it’s true that history repeats itself, the patterns should always be separated by a generation or two to keep things respectable. Unfortunately, in today’s economic world, it seems the cycle can be counted in months.
On July 24, 2009, just as the Federal Reserve unleashed its first quantitative easing campaign (now called “QE1” – an echo of the reclassification of the Great War after still more destructive subsequent developments), Fed Chairman Ben Bernanke wrote an opinion piece in the Wall Street Journal to soothe growing concerns about excess liquidity. He assured the public that the Fed had an “exit strategy.”
Michael Pento’s Market Commentary
It seems the Fed has given up on the idea that the country can build a viable and stable economy through the conventional means. Instead, our central bank has resorted to once again growing GDP and increasing employment by the creation of asset bubbles. This is a dangerous game that no one, least of all the Fed, knows how to play.
We learned this past Wednesday that the FOMC decided to increase its purchases of longer-dated Treasuries by $600 billion within the next eight months. That means the Fed is on course to fund about 75% of our annual deficit! Such figures are the stock in trade of banana republics. While most of the rest of the world is fighting inflation and strengthening their currencies, we are doing everything in our power to end the dollar’s status as the world’s reserve.
Canada, China, India, Brazil, and Australia have all recently taken steps to raise interest rates and/or curtail bank lending. Compare that to the US, which has left interest rates at near-zero for almost two years. While other central bankers are tamping down expansionary rhetoric, Fed Chairman Bernanke is on record saying that he will do everything in his power to push up inflation (which he considers too low) and dilute the dollar. Foreign central banks and other investors may soon reconsider their plans to park cash in dollar-denominated assets. In fact, there has been a series of angry statements from top economic policymakers in Beijing, Berlin, Moscow, and Sao Paolo that show rising discontent with Washington.
The Fed rationalized its decision to upset the global monetary order in a November 4th op-ed by Chairman Bernanke entitled, “What the Fed did and why.” Here’s an excerpt:
“Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation. Our earlier use of this policy approach had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits. Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable.”
But the facts contradict Bernanke’s claims that monetary policy has not pushed up inflation. The Fed began the current round of accommodation in September of 2007 with a 50 basis point reduction in the Fed funds rate. At that time, the M2 money stock was $7.40 trillion. It has since jumped 18.5% to $8.77 trillion. This increase is showing up in the form of higher prices.
The 19 commodities that make up the CRB Index have soared 55% since the beginning of 2009. Unless the Chairman desires to return to an environment where oil is trading at $147 a barrel, these surging commodity prices are already placing consumers and corporations under inflationary duress.
Here’s where the danger lies ahead. Before the recession began in 2007, the ratio between M2 and the monetary base was about 10:1. If the Fed sticks to its announced schedule, the size of the base should grow from $1.96 trillion to about $2.6 trillion by June of 2011. Once banks start lending again and expanding base money through the fractional reserve system, M2 could increase exponentially. An increase in the money supply to $26 trillion (in line with the historic 10-to-1 ratio) would result in a major inflationary shock. However, even if the money multiplier were to remain much lower, the M2 money stock would still be much higher than today. In fact, the compounded annual increase of M2 in the last 4 weeks is currently over 9%.
Unless Bernanke has a “road to Damascus” moment, the money supply will continue to grow and inflation will accelerate over the course of the next few years. To make matters much worse, the interest expense on the nation’s debt could reach over 40% of all revenue by the year 2015.
Faced with negative real interest rates, rapidly rising inflation, and a chronically weak dollar, foreign holders of US Treasury debt and other dollar-denominated holdings may begin to lose their nerve. They may start to repatriate their savings and thereby send Treasury yields soaring. The Fed – which is the Treasury’s buyer of last resort – will then be faced with a perilous decision. The central bank will have to either join foreign sellers of US debt in sending interest rates higher (in the hopes of giving the dollar some footing and allowing high rates to encourage the return of real buyers) or ramp up the printing presses to keep the long end of the yield curve from spiking. It should be obvious that the Fed has already made that decision. They will never allow rates to rise. The debt will be monetized.
I have no doubt that Bernanke will be remarkably successful in his stated goal of driving inflation higher. I simply disagree with his nonchalance about the long-term consequences. There is currently no easy exit strategy for the Fed. There is only the prospect of Americans suffering through either a deflationary depression or hyperinflation. To survive such storm requires careful planning. If only we could convince the big chief to stop doing his rain dance…
Super-Rich Investors Buy Gold by Ton
Reuters – A survey of private wealth managers catering to high net worth individuals has shown that the world’s ultra-rich are selling currencies and buying gold “by the ton.” One notable difference from past downturns is the demand for physical gold, as opposed to just ETFs and mining stocks. Anecdotal evidence from bankers shows the wealthy buying tons of gold for physical delivery, then storing the assets away from the banking system.
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Drinks Are Free as Bartenders Refill Punchbowl
Bloomberg – Noted Bloomberg columnist William Pesek openly challenges the myth of central bank independence. In the 13 years since the Bank of Japan was granted “independence,” it has left interest rates near zero the entire time. To explain why, Pesek brings the illustration to American shores. He imagines what would happen if Fed Chairman Bernanke were to try to raise interest rates under present conditions. The answer? Immediate Congressional subpoena, followed by a quick resignation. ECB President Trichet is in the same boat, but with 16 irrational captains. And Pesek sees the problem as only getting worse. Come to think of it: when was the last time you heard anyone in Washington say the words “exit strategy”?
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Gold May Climb to Record $1,650 an Ounce on Fed Easing, Goldman Forecasts
Bloomberg – The headline says it all. Goldman Sachs, which in August cautiously raised its guidance on gold to $1,300 by the end of this year, is now forecasting that the bull trend will continue until this time next year. This is all predicated on the Fed continuing its easy-money policies with abandon. If trends were to reverse, then a re-evaluation would be necessary. Meanwhile, with no sign that the Fed is even considering a reversal, Goldman’s new price target is looking to become obsolete faster than Betamax.
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Commodities to Extend Rally on Federal Reserve’s “Game Changer,” UBS Says
Bloomberg – The Fed’s second round of quantitative easing (QE2) will be a “game changer” for copper, gold, and palladium, according to a report from UBS commodities analysts. A new round of inflation is a “virtual certainty”, which is bullish for commodity prices. The report cited a Goldman Sachs estimate that the ultimate tally for QE2 will be $1 trillion. UBS’ gold target for 2011 has been raised to $1,400/oz.
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