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.
By Peter Schiff
Last month, I addressed the hype around gold confiscation, and debunked the myth that collectible or numismatic coins would offer effective protection. But there is another sales pitch that many dealers will use while trying to “up sell” you to numismatics. They may argue that on investment merits alone, numismatics are a better bet. While this may be a more rational line of thinking than the typical confiscation con, it is bad advice for investors hoping to protect their assets in an economic slump.
Think Like a Pro, Not a Schmo
I have long urged investors to keep 5-10% of their portfolios in physical precious metals, and add even more exposure when appropriate through the Perth Mint certificate program and mining stocks. This advice, far outside of the Wall Street mainstream, stems from my view of the kind of crisis we are approaching.
The following article was written by Mary Anne and Pamela Aden for the January 2011 edition of Peter Schiff’s Gold Letter.
In May, gold hit an all-time record high, and then, in September, silver reached a 30-year high. It was super bullish action, exciting to watch and to be part of, and it’s not over yet.
The gold price reached yet another record high on December 31, while silver, copper, palladium, and the CRB commodity index went on to reach new bull market or record highs. While gold has stolen most of the headlines with its 30% run up this year, silver has actually returned an incredible 83.5%… making it the star of 2010.
Gold Imports by China Soar Almost Fivefold
Bloomberg – The Shanghai Gold Exchange reported that gold bullion imports into China have jumped five-fold since 2009. This reflects strong demand for gold investment among the Chinese, whose local currency, the yuan, is being rapidly devalued to maintain its exchange rate with the US dollar. While prices at the grocery store are rising 5-6% a year in yuan terms, they are falling in terms of gold as the Chinese standard of living rises. The sheer numbers quoted in the report indicate that the Chinese government may have lifted all of its restrictions on gold imports. Still, the result is surprising given China’s status as the world’s largest producer of gold – proving that private demand is outstripping their immense supply. The World Gold Council expects Chinese demand to increase another 43% next year.
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Gold Jumps on China’s Fund Approval
The Australian – Gold saw a jump this month after the Chinese government approved the mainland’s first fund giving Chinese citizens access to foreign gold ETFs. Chinese citizens have not previously had access to gold through the stock exchange, as Americans do with ETFs like GLD and CEF. This new Chinese fund will purchase shares in Western ETFs, rather than purchasing and storing its own gold. Still, this is viewed as a major milestone in the entrance of the Chinese into the gold markets.
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Gold Becoming a Hedge Against “Monetary Uncertainty”
CNBC.com – Famed analyst Dennis Gartman explains that precious metals demand is no longer driven by simple inflation concerns, but rather widespread monetary uncertainty. The eurozone is in danger of breaking apart; Washington is working overtime to undermine the value of the US dollar; and, no other paper currency is prepared to fill the void created by the big two. In fact, most other candidates – such as emerging market currencies – are largely backed by dollars and euros. So, central banks are turning to the only viable alternatives: gold and silver.
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By Peter Schiff
The United States Postal Service announced this week that all future first class postage stamps sold will be the so–called “forever stamps” that have no face value but are guaranteed to cover the cost of mailing a first class letter, regardless of how high that cost may rise in the future. Currently these stamps are sold for 44 cents, but will increase in price if and when the Post Office hikes rates.
Michael Pento’s Market Commentary
The Fed’s lucky streak of luring bond investors with low interest rates may be drawing to a close. Nevertheless, the extended period of low borrowing costs has bred a new breed of investor. To the bulls and bears, we can now add the ostriches – those who bury their heads in the sand of declining debt service ratios while refusing to face up to intractable levels of total US government debt. If these ostriches were to actually look at the numbers, they would realize that it is their investments which are made of sand.
As the issuer of the world’s reserve currency, the US government has enjoyed the benefits of low interest rates despite its inflationary practices. When we run a trade deficit with a country like China, they have a strong incentive to ‘recycle’ the deficit back into our dollars and Treasuries. This practice has hidden what would otherwise be much higher borrowing costs and much lower purchasing power for the dollar. This artificial price signal allows people like Paul Krugman to claim that the Obama Administration’s stimulus programs should be much larger. Because our yawning fiscal deficits have not driven bond yields significantly higher, he sees no reason to curtail spending. Krugman wants to spend like its World War III, and then has the nerve to call those worried about the budget mindless zombies!
Krugman is just one partisan Democrat shouting at mirrors, but the misunderstanding has struck the right-wing as well. Last week, in a debate with me on CNBC’s The Kudlow Report, Brian Wesbury, Chief Economist of First Trust Advisors and writer for The American Spectator, claimed that our $9.3 trillion national debt is of little consequence because our GDP is a far greater. However, he failed to note that our $14.7 trillion of GDP only yields about $2.2 trillion in revenue for the Treasury. To fully access that entire GDP, the government would have to raise all tax brackets to 100% without producing any reduction in output or decrease in revenue. This is, of course, preposterous. As was demonstrated in the 1970s, even small increases in marginal tax rates have a substantial negative impact on output. A healthier appraisal would center on the fact that our publicly traded debt is now 422% of our annual tax revenue.
Wesbury did mention that if the government could not raise revenue to pay off the bonds, it could simply monetize the debt with few significant consequences. Apparently, paying back one’s creditors in worthless paper is not technically “default” to an economist.
So neither Krugman nor Wesbury, both intelligent, highly educated economists, see our current course leading to imminent crisis. Unfortunately, both have been led astray by the low debt service ratio which has masked our economy’s underlying insolvency. To see through the haze, you have to look at the numbers behind this so-called “deleveraging consumer” and then look at the debt of the nation.
The data point most utilized by those who espouse the idea of a healthy consumer is the household debt service ratio (DSR), a metric that relates debt payments to disposable personal income. This figure peaked at 13.96% in the third quarter of 2007; it has since dropped by 15%, to 11.89%. It is hard to see this as a significant amount of deleveraging, especially when looking at longer term trends. But it gets worse! Most of that modest decline is simply a function of lower interest rates, which have made debt easier to bear. Total household debt has gone down much less. This figure peaked at $13.92 trillion in Q1 2008, and has since declined only 3.5% to $13.42 trillion. How’s that for deleveraging?!
It’s also worth noting that back in the first quarter of 2008, most homeowners were sitting on a pile of home equity to offset that debt. Today, most of the equity has vanished, yet the debt still remains.
When looking at the national debt, the situation is even more depressing. At the end of 2006, total debt held by the public was $4.9 trillion. According to the Treasury Department, the average interest rate paid on that debt was 4.9%. Therefore, the annualized interest payment at that time was $240 billion. At the end of 2010, our publicly traded debt has increased to $9.3 trillion, but the average interest rate on that debt has plummeted to just 2.3%. So, despite an 87% increase in debt in just a 4-year time span, the annualized debt service payment actually fell 11% to $213 billion. Krugman and Wesbury look at this and see progress.
Meanwhile, the average maturity on our debt has declined to 5.5 years. Compare that with the UK’s gilts, which average about 14 years, or even to Greece’s bonds, which average about 8 years. Falling interest rates and reduced durations have merely given the illusion of solvency to the US as compared to these other ailing sovereigns.
By 2015, our publicly traded debt is projected to be at least $15 trillion. Even if interest rates simply revert to their average level – not a stretch, given surging commodity prices and endless Fed money printing – the debt service expense could easily reach over $1 trillion, or about 50% of all federal revenue collected today. Just imagine what would happen if rates were to rise to the level of Greece, nearly 12% on a 10-year note, as opposed to our current 10-year yield of just 3.5%. I bet Athens, Georgia wouldn’t look much better than its namesake. Don’t forget: as interest rates rise, GDP growth slows, sending the debt-to-GDP ratio even higher.
Earlier this year, it wasn’t the nominal level of debt that suddenly sent euroland into insolvency, but rather a spike in debt service payments. Right now, the US national debt is the biggest subprime ARM of all time. Much like homeowners who thought they could afford a mortgage that was 10 times their annual incomes, Messrs. Krugman and Wesbury are blinded by deceptively low current rates of interest. These ostriches won’t poke their heads up to see the writing on the wall: low rates and quantitative easing cannot coexist for long. As rates continue to rise, the reality of US insolvency will be revealed.
By Peter Schiff
There is an old adage on Wall Street: no one rings a bell to signal a market top or bottom. Yet, I have found that bells do ring; it’s just that few people know exactly what sound to listen for.
Perhaps the biggest and most liquid of all markets is for US government bonds. That market has been rallying for almost thirty years. The bull can be traced back to 1981, when Treasury bond yields peaked at about 15%. At that time, high inflation and a weakening dollar had justifiably squelched demand for Treasuries. Even the ultra-high interest rates were not enough to attract buyers.
Michael Pento’s Market Commentary
Despite the fact that the S&P is up over 80% in the last 21 months, US financial firms are currently tripping over each other in their zeal to raise their S&P 500 and GDP targets for 2011. JPMorgan’s chief US equities strategist, Thomas Lee, came out on December 3rd with a target of 1425 on the S&P for 2011, which would be a 15 percent gain. Barclays Capital last Thursday released a 1420 estimate. Not to be outdone, Goldman Sachs also recently released its forecast, and it sees a more-than-20 percent increase next year, to 1450. Meanwhile, PIMCO’s idea of a “new normal” has translated into a 2011 GDP forecast raised from 2-2.5% to 3-3.5% due to “massive” government stimulus.
In the midst of this collective ‘hurrah,’ very little attention is being paid to what is going on over in the bond market. With my due condolences to Fed Chairman Bernanke, the yield on the 10-year Treasury note has increased from 2.33% on October 8th to 3.29% today. And, if there is any notice at all given to that recent run-up in yields, it is merely explained away as a sign of robust growth returning to the economy.
In reality, growth doesn’t cause an increase in interest rates; it is either lack of savings or inflation that is responsible. To refute the ‘robust growth’ reasoning, turn your attention to the fact that the spike in yields just happened to coincide with the news that the unemployment rate jumped to 9.8% in November.
A slightly broader explanation for the surge in borrowing costs might be the failure of the Bowles-Simpson deficit commission to implement any cost cutting measures. Or, perhaps it was the intimation from Bernanke himself that QE III may already be under construction in his infamous interview on 60 Minutes. Or, maybe it is the fact that the $150.4 billion November budget deficit was the highest total for that month… ever, and was the 26th straight month of red ink! I often wonder to myself, where in the midst of all this good news do I summon a bearish attitude?
I think it’s pretty clear that ‘robust growth’ is going the way of ‘green shoots’ and knickers – right into the dustbin of history.
So, what will the increase in interest rates – ignored by all of Wall Street – actually mean for the economy in 2011?
For starters, the National Home Price Index already fell 2% in the third quarter of 2010. On a national basis, home prices are 1.5% lower year-over-year, and 15 out of the 20 cities measured were down over the last 12 months. On a month-over-month basis, 18 cities posted a price decline in September, compared to 15 MoM drops in August, and just 8 cities experiencing price reductions in the July report. Therefore, home prices, which were already headed lower before this recent spike in mortgage rates, are set to take another tumble downward. According to Freddie Mac’s weekly survey of conforming mortgages, the average rate on the 30-year fixed is at its highest level in six months. 30-year rates averaged 4.61% for the week ending Dec. 9, up from 4.46% last week. It’s the fourth week in a row that the mortgage rate has increased. The ramifications for the real estate market and bank lending are clear. Lower home prices will send more mortgages under water and force many more homes into foreclosure. Higher borrowing costs will lower the demand for borrowing and place more strain on the capital of lending institutions.
On top of that, household debt as a percentage of GDP still stands at a lofty 91%. It should be clear that with near double-digit unemployment, the last thing consumers can now tolerate is a significant increase in debt-service payments.
The rising cost of money is even worse news for the federal government and its chronically ballooning debt problem. According to the Federal Reserve’s Flow of Funds Report, total non-financial debt reached an all-time high of $35.8 trillion in the third quarter of 2010. In fact, household debt, business debt, and government debt increased at a 4.2% annual rate last quarter.
To put that record level of nominal debt into perspective: in 1980, the total non-financial debt-to-GDP ratio was 144%. In the height of the credit boom, at the end of 2007, that figure was 226%. Today, the figure stands at a mind-blowing 243%! So you can forget about all that deleveraging talk. The US is in fact still leveraging up, both in nominal terms and as a percentage of GDP.
I think the rising cost of money will become the story of 2011. Its effect on consumers, the real estate market, and government borrowing costs will be profound. Apparently, most major brokerage firms have no fear of soaring interest rates causing our economy to implode. However, it’s clear to me that the bond market has already started to crack due to inflation and massive oversupply from the Treasury. Prudent investors should think twice before overlooking what could be the initial holes in the biggest bubble in world history – the full faith and credit of the United States.
