Michael Pento’s Market Commentary
To counter the increasing demands that government reduce its micromanagement of the economy, last week the Obama Administration offered a fig leaf in the form of a white paper entitled “Reforming America’s Housing Finance Market.” In addition to marking the official end of the Bush era “ownership society,” where increasing the level of home ownership was a national priority, the document contains a recommended regulatory overhaul of the Federal Housing Authority (FHA) as well as Fannie Mae and Freddie Mac (together known as Government Sponsored Enterprises “GSE’s”), that intends to bring the share of government owned home loans from the current 95% to 40% over the next 5-7 years.
In the report, the Obama Administration makes the important admission that government interference in housing had dangerously distorted the market. And, while the goal of reducing the government’s footprint in the housing market is certainly laudable, the reform plan is not only too little too late, but fails miserably to address the nucleus of the problem. Even if all the recommendations are adopted, the government would actually extend its explicit guarantees to bail out failing lenders. Most importantly, the proposal completely overlooks the most significant government distortion of the housing market: the Federal Reserve’s manipulation of interest rates. Thus, this plan will insure that government’s role in the mortgage market will likely expand in the years ahead.
Banks are in the business of borrowing on the short end of the yield curve and lending on the long end. Since interest rates are generally lower for shorter time durations, banks make profits by capturing the spread. But if the gap between long term and short term rates narrow, or sometimes vanish completely, banks have a much harder time operating. Rapid and dramatic changes in interest rates also expose banks to money losing risks.
In a free market, whenever the supply of savings contracts the cost of money tends to increase. Those rising interest rates curb the demand for borrowing and increase the propensity to save. Conversely, increased savings rates lower the price of money, thereby encouraging more borrowing. Consequently, in a free economy market forces tend to stabilize interest rate volatility. However in the United States interest rates are anything but free.
When interest rates are set by a few people behind closed doors, as they are by the Federal Reserve, massive distortions can occur in the supply demand metric. For example, the S&L crisis of the late 80’s and early 90’s was brought about by the loose monetary policy of the 70’s. Rising interest rates, which were a direct response to rising inflation, soon found S&L’s paying out more on their short-term borrowed funds than they were collecting on their long term assets. The consequences for those imbalances caused by our central bank rendered nearly one thousand banks insolvent.
To mitigate this problem, early in the last decade banks began turning more and more to securitization as a way to unload the mortgages on their books by packaging and selling loans to outside investors. Not only does securitization bring in fees and reduce banks’ risk exposure but it also sucks in more capital to the real estate market, while increasing financial sector profits. It’s no wonder that the securitization market grew to over $10 trillion in the U.S. before the credit crisis of 2008. On paper this was a good solution to the problem, but additional government involvement in the securitization market threw in a monkey wrench.
Given the size and diversity of the investment market in the U.S. and around the world, there was adequate private demand for securitized mortgages. With relatively low risk and more generous yields than government debt, pension funds and other institutional investors bought heavily. However, as the Federal Reserve continued to lower rates and as the government engineered housing boom finally went bust, this private label demand dried up almost completely. The GSEs now provide financing for 9 out of 10 mortgages. Therefore, the real estate market today is virtually 100% distorted and manipulated by government forces.
Treasury Secretary Geithner—the President’s main pitch man for the program—touted the proposed solution of a hybrid federal reinsurance plan that would include a standing federal catastrophic reinsurer for private guarantors of mortgage-backed securities. The government has already clearly shown that its erstwhile implicit guarantee is now in fact explicit for GSE debt. That condition would remain intact. However, now government involvement would also morph into an explicit guarantee to reinsure private label mortgages. Therefore, in typical government fashion, the proposed reforms are merely a repackaging of the previous sham. Even if the plan were to be successfully carried out, the GSEs would still account for nearly half of all mortgage financing. Only now the government would also back private insurance for private label MBS with yet another explicit guarantee in case of emergency. Who can doubt that such conditions will inevitably arise? As to how this can ever satisfy the need to remove moral hazard or getting the government out of the housing market is beyond me.
In other words, there is no meaningful governmental withdrawal from the market. Most importantly, the plan does nothing to address the Fed’s role in making interest rates much lower and more volatile than they would otherwise be. Unfortunately the housing market will remain in government control for years to come and another real estate crisis will inevitably occur.
By Peter Schiff
Based on his recent public comments, Fed Chairman Bernanke seems determined to give the U.S. dollar the reputation of Egypt’s Hosni Mubarak: an unwanted relic of the past that everyone agrees must go, but stubbornly clings to a privileged position. The dollar is currently the world’s ruling currency, but, as with Mubarak, I believe that growing public discontent will spur regime change quicker than most pundits expect.
By Peter Schiff
A lot of people ride motorcycles, but there’s a reason most don’t try to be Evel Knievel. Sure, there’s a big reward if you can land a jump over 14 school buses – but what if you don’t?
A new craze among our competitors is to push gold buyers into “leveraged accounts.” In one of these accounts, the dealer lends you money to buy gold, on the assumption that gold will go up faster than the rate of interest on the loan. In other words, if you call with $5K, they’ll give you another $20K in credit to make a $25K total purchase of gold bullion.
The sales pitch is that since we all know gold is going up, you might as well maximize your returns by leveraging up. What they don’t often mention is what happens if gold goes through a correction. You’ll likely be asked to send in more cash for a “margin call.” If you don’t, they’ll sell your gold for a substantial loss.
The following article was written by Mary Anne and Pamela Aden for the February 2011 edition of Peter Schiff’s Gold Letter.
The year ended with a bang – record or multi-year highs in gold, copper, silver, palladium, cotton, tin, cattle, and other commodities. 2010 was a particularly great year for the precious metals, as they beat stocks, bonds, and the dollar. It seems like a perfect moment to take stock of gold’s bull run and forecast where it might go next.
Gold has now closed in on 10 years of consistent yearly rises, gaining 30% in 2010. Silver was even more impressive, gaining 83.5% last year. Yet, with all this bullishness, Americans are just now becoming aware of the lasting power of precious metals. Disbelief is turning into acceptance.
Michael Pento’s Market Commentary
In a heated debate on the February 1st episode of CNBC’s “The Kudlow Report”, financial commentator Donald Luskin offered his “textbook” definition of inflation as “an overall rise in the general price level.” I countered with the “dictionary” definition. My 1988 edition of Webster’s Dictionary defines inflation as follows: “An increase in the volume of money and credit relative to available goods, resulting in a substantial and continuing rise in the general price level.” [Emphasis added.] These differences are not academic and go a long way toward explaining why economists argue so vociferously.
In an inflationary environment, general prices tend to rise, although particular market segments tend to do so at uneven rates. This is hardly controversial. The more disputed question is why prices rise in the first place. As Luskin is well aware, the US Dollar is backed by nothing but confidence and perception. Its value depends upon our collective belief in its current and future purchasing power, and the hope that its supply will be restricted. When its supply is increased, users of the currency lose faith in its buying power and prices rise.
As a corollary, if dollar-holders believe that the US will have no choice but to monetize trillions of dollars of Treasury debt in the near future, the currency will falter. In this manner, currencies that are backed by nothing but confidence tend to behave like stock prices. The share value of a corporation represents the strength of the company. Likewise, the value of a currency represents the strength of a sovereign state.
Looked at through this prism, the fate of the US dollar in the future may not be all that different from the fate of Enron shares in 2001. In the 1990s, Enron was one of the most respected corporations in America, and the share price soared. But once the accounting scandal broke, and Enron’s profits were proven to be illusory, the purchasing power of its shares plummeted. Eventually, the shares became worthless.
The shares did not collapse simply because Enron issued more shares and diluted value. The big change came when investors lost faith in Enron. Likewise, the US dollar may lose value because of garden-variety dilution, but the real leg down will occur if holders of US government debt lose faith that they will be paid in full. Even if there is the mere perception such an outcome is likely, it will cause the dollar to tank and aggregate prices to rise.
The Fed and Treasury have set out on a deliberate strategy of creating inflation in order to monetize most of the $14.1 trillion national debt— a debt that is growing by well over a trillion dollars per year!
The charts tell the tale. There can be little doubt that the dollar is being debased. The graph below traces the growth of the monetary base, which consists of physical currency and Fed bank credit:
No doubt here. The supply of high-powered money has exploded.
But it is not only the monetary base that has expanded; take a look at M2, an aggregate of money and money substitutes:
Since the recession began in December, 2007, the M2 money supply has increased by over 18%.
Next is the chart of the CRB Index, a group of 19 commodities used to track the overall price of raw materials:
The index clearly shows a strong trend upward, suggesting a general loss of value by the USD.
Yet, for my money, the trajectory of gold prices is the best yardstick to measure that value of the dollar. Below is a ten-year chart of the dollar price of gold. It is self explanatory.
Now, let’s look at some charts of the US dollar vs. other fiat currencies.
Here’s a two-year chart of the USD vs. the Australian dollar:
Here’s a two-year chart of the US dollar vs. the Canadian dollar:
Finally, a two-year chart of the US dollar vs. the Japanese Yen:
Most dollar defenders point to the relative stability of the hallowed Dollar Index, but this only points to a deep flaw in that index; namely, it contains such a high percentage (58%) of the equally challenged euro that it vastly understates the dollar’s weakness.
In our recent “Kudlow Report” debate, Luskin claimed that rising commodity prices no longer provided good inflation signals, saying that “for the last decade or so, the canaries [commodity prices] that we’re using in this mine shaft just aren’t functioning right.”
I’m not sure why Luskin has decided to stop relying on market prices to determine the rate of inflation. Apparently, he now prefers dubious inflation metrics provided by the very government that creates the inflation. This is equivalent to trusting Enron’s bookkeepers over an independent audit. For a smart guy, such faith is surprising.
By contrast, US dollar-holders around the world are increasingly losing faith in our currency and our government. They are tiring of the Fed’s 26-month marathon of zero percent interest rates, and the Treasury’s ballooning balance sheet. They are fearful that their bonds cannot withstand the twin threats of devaluation and default. That’s why the dollar is losing its reserve currency status and inflation rates are rising. But hey, at least Luskin can keep the faith – I just hope he doesn’t mind being the only one.
Utah Could Use Gold, Silver Under Sound Money Act
New American – The Utah State Legislature is considering a bill that would require the state government to accept taxes and pay obligations in gold or silver upon demand. The “Sound Money Act” cites the US Constitution’s requirement that “no state shall make anything but gold and silver a tender in payment of debts.” That clause has never been repealed, though it was ignored by the courts as the US was gradually taken off the gold standard. This groundbreaking piece of legislation (and fantastic promotional video) could be the start of a movement among the states to return to Constitutional money. Among the coins Utah would accept are: American Gold Eagles, Australian Kangaroos, Canadian Maple Leafs, and South African Krugerrands.
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Emerging Markets Feeling the Heat of High Inflation Rates
Economic Times – Emerging markets are struggling under the burden of inflation ‘exported’ from the US. As the Fed prints hundreds of billions of new dollars, export-based economies feel pressured to print an equivalent amount of their local currency to keep their manufacturers from being choked off from the developed markets. The BRIC bloc (Brazil, Russia, India, and China) are all hiking interest rates to try to contain the flood of dollars pouring in, but the Fed’s inflation is too much, too fast. As a result of strengthening currencies abroad, the Economic Times expects rising prices in “commodities such as gold, silver, crude oil, and various other metals.”
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Are Investors Becoming Too Bearish on Gold?
Minyanville – January saw investors selling gold bullion and mining shares, but the metal is starting to look oversold. Much of the correction is due to recent rate hikes in emerging markets, leading some to believe the threat of inflation is waning. However, Euro Pacific Precious Metals’ own Chief Economist Michael Pento notes that real interest rates are set to be negative for some time, which historically drives the gold price up. It is noted that since so many gold market timers are quick to sell on even potentially bearish news, the gold market is probably far from the euphoria which characterizes a bubble. Also noted is how many traders are shorting gold, which “makes it a virtual certainty that at whatever price point a reversal eventually occurs, it will be a violent one.” That means a fast leap upward may be due in February. Mr. Pento maintains a price target of $1,600/oz by the end of 2011.
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Gold Standard Fully Supported By… Alan Greenspan!?
Zero Hedge – Joining a chorus that now includes the President of the World Bank and the President of the Kansas City Fed, former Fed Chairman Alan Greenspan has publicly voiced his support for a return to the gold standard. Mr. Greenspan, credited by many with planting the seeds for the current dollar crisis, conceded on Fox Business Network that “some mechanism has got to be in place that restricts the amount of money which is produced, either a gold standard or a currency board, because unless you do that, all of history suggests that inflation will take hold.” The re-indexing required to create a new gold standard from the remaining US stockpile would yield a gold price of $6,300/oz.
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Michael Pento’s Market Commentary
In current economic analysis, inflation is largely in the eye of the beholder, and depending on how you choose to look, very different stories emerge. In the U.S., food and beverages count for just 16.4% of the CPI calculation. The Chinese apparently believe that the basic necessities of life should count for more, assigning a 33% weight to the nutritional components. These differences in measurement are partially responsible for the divergent inflation climate in both countries, and make most people believe that inflation is fickle and localized. From my perspective, inflation is a global wave that will ultimately swamp all shores.
As the world’s economic leaders gather in Davos Switzerland, much of the discussion has been focused on a report jointly issued by the Global Economic Forum and McKinsey & Co. which forecasts a $100 trillion increase in global debt in the coming decade. The authors of the report argue that such an increase will be needed to maintain global economic health. Strangely, while acknowledging how the massive increase in credit caused the global financial crisis of 2008, the report’s authors admit no fear of even greater leverage today. They conclude: “Credit is the lifeblood of the economy, and much more of it will be needed to sustain the recovery and enable the developing world to achieve its growth potential.”
But the global credit stock has already doubled from $57 trillion in 2000 to $109 trillion in 2009, with disastrous consequences. The WEF report wouldn’t be so alarming if it wasn’t emanating from a gathering of global central bankers, business leaders and politicians. These are, unfortunately, the folks with all the power to turn these ideas into reality.
In his State of the Union address, President Obama kept pace with the madness in Davos by vowing to “slash” government debt by just $400 billion in 10 years. However, almost simultaneously the Congressional Budget Office upped its 2011 deficit projection to $1.48 trillion, which is over $400 billion more than it previously forecasted — effectively wiping Obama’s cuts before they are even formally proposed.
The myopia extends into the legislative branch. In a recent appearance on NBC’s Meet the Press, Senator Harry Reid said, “When we start talking about the debt, the first thing people do is run to Social Security. But Social Security is fully funded for the next 40 years.” Apparently the Senator pays no attention to the non-partisan CBO either. Last week the office states that Social Security will run permanent deficits beginning this year, 5 years sooner than expected. If we aren’t going to be honest about the insolvency of Social Security and Medicare, how can they possibly be fixed, and how can the costs ever be contained? The unfortunate truth here, once again, leads to the conclusion that financing our nation’s entitlement programs will be done courtesy of the Federal Reserve.
The CBO also said that the government will run up an additional $12 trillion in debt over the next decade if current taxing and spending policies remain in effect. Their report contained this foreboding comment: “…a growing level of federal debt would also increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates.” The fact that our elected leaders fail to understand basic economics, or simply bury their heads in the sand, underscores why inflation will be a major factor in the years ahead.
For me, there is no escaping the conclusion that inflation will continue to surge. Inflation is, after all, the increase in money supply. And there appears to be no escaping the likelihood of massive floods of new money rolling off presses around the world, especially in Washington. But to a degree that is virtually ignored by many economists, a currency’s purchasing power is not only affected by money supply growth but also from the mere perception of it. Just like Enron shares became worthless overnight, if the U.S. is deemed to be insolvent because it cannot pay back its debt, the currency could plummet in a very short period of time, even if that pending supply of dollars has yet to be printed.
When you understand these basic issues, the decision to include precious metals, and other stores of value, in investment portfolios becomes a foregone conclusion.
By Peter Schiff
Back in October of 2009, when Congress first announced the formation of a commission to investigate the cause of the 2008 financial crisis, I knew immediately that their ultimate conclusions would support the agendas of their respective political parties. (Watch the video blog I recorded that day) Particularly, I knew that the commission’s Democrat majority would use the crisis to justify more government involvement in the financial markets. These concerns have now been fully validated.
Michael Pento’s Market Commentary
There can be little doubt that Fed Chairman Benjamin Bernanke has been a very, very good friend to gold investors. However, some of those who have benefited from his largesse now fear that the recent selloff in gold indicates an imminent end to Bernanke’s monetary high-wire act. Most assume that a cessation of the Fed’s stimulative efforts, if it were to occur, would spell the end of gold’s bull run. But a closer reading of Bernanke’s economic philosophy and the Fed’s own recent history, shows that once a central banker begins a strenuous routine, it is very hard, if not impossible, for them to dismount.
It is widely believed that the unemployment rate, core inflation and home prices are the three key pieces of economic data that Bernanke and his Fed cohorts rely upon when formulating monetary policy. Although other data points, such as regional manufacturing surveys and the producer price index (which have rebounded significantly in some cases) attract some attention, they do not carry near the weight of the big three. With the unemployment rate remaining north of 9.4%, YOY core CPI inflation still less than 1% and the Case/Shiller Home Price Index down .8% from the year ago period, the Fed is in no mood to downshift. If anything, my guess is that Bernanke will step on the gas.
More importantly, in light of Bernanke’s often stated conclusion that premature Fed tightening in 1937 and 1938 led to a prolongation of the Great Depression, even if the big three metrics were to show marked improvement, any future increase in interest rates will be moderate and held in abeyance for as long as politically possible.
Despite the fact that some economic data is improving, the foundation of the economy is getting worse. Consumers are now increasing their borrowing again–as evidenced by last week’s number on consumer credit–and our government is now massively overleveraged. But leaving alone the deteriorating nature of these forward looking metrics, the Fed’s own history provides unexpected good news for those holding tight to their gold positions.
The Fed began its last round of rate hikes in June of 2004 when Fed Chairman Alan Greenspan began a sequence of consecutive 25 basis point increases. The Maestro bumped rates 14 times before passing the baton to Bernanke in February of 2006, who continued the program with three more ¼ point increases. The combined efforts took rates from 1% to 5.25% in the span of two years. However, the tightening program did nothing to tarnish the luster of gold. Here’s why.
Since the Fed increased interest rates very slowly from an extremely low level, money supply continued to expand during the long, slow, deliberate campaign of 25 basis point increases. From June 2004 through June 2006 the M2 money supply increased 9.3%, rising from $6.27 trillion to $6.85 trillion. Total loans and leases from commercial banks jumped from $4.61 trillion to $5.71 trillion during that same time period, an increase of 24%. As a result, over the time that the Fed’s dynamic duo waged their phony war against the asset bubbles of the mid 2000’s, the price of gold increased from $395 to $623 per ounce.
The truth is that increases in money supply and bank lending aren’t curtailed very much by a Fed Funds target rate that is increased very slowly from a starting point that is decidedly below the rate of inflation. Currently, Fed Funds is decidedly below the rate of inflation, and is likely to stay there for some time. Therefore, investors need not necessarily fear a run on gold once Bernanke eventually lifts rates from zero percent….if he ever makes that decision.
In addition, investors should keep their eyes on the damage created by these ultra low rates. An enormously destructive housing bubble grew out 1% and 1.5% rates that were in place from November of 2002 thru August of 2004. In our current round, the Fed has kept interest rates near zero since December 2008…more than two years! Why should we expect a different outcome this time around?
A key point to mention is that the credit crisis and collapse of the housing market were not caused by a the Fed bringing rates to 5.25%. Rather real estate prices simply went too high because rates were too low in the years prior. The low rates were the problem. And once home prices became unaffordable to most consumers, banks then became insolvent because millions defaulted on mortgages. After their capital became significantly eroded they were subsequently unable to lend.
The bottom line is that if Bernanke should ever attempt a “dismount” from massive monetary easing, investors should take solace not because he is likely to “stick” the landing, but because the exercise will likely be so futile that owners of gold should continue to shine.
By Peter Schiff
In the early fall of 2009, just before I announced my candidacy for the U.S. Senate, I was introduced to a number of Washington-based political analysts and journalists. Among the group was Stuart Rothenberg, writer of the Rothenberg Political Report, a classic “inside the Beltway” publication targeted at those whose lives and livelihoods revolve around national politics. His acerbic comments regarding my candidacy in the months that followed reveal the enormous chasm that separates the real world from Washington.