May 4, 2024

Japan Joins The QE Race – Who Can Print The Most Money?

September 19, 2012 by Leave a Comment

After what appeared to be a coordinated effort by Europe and the U.S. to print their way to prosperity, Japan quickly joined the race to eternal QE with the surprise announcement of additional monetary easing.

TOKYO—The Bank of Japan took surprisingly strong steps to further ease its monetary policy on Wednesday, following similar steps by the Federal Reserve, as it tries to tackle entrenched deflation, an export-sapping strong yen and the impact of slowing global growth.

The central bank’s policy board decided at the end of a two-day meeting to increase the size of its asset-purchase program—the main tool for monetary easing with near-zero interest rates—to ¥80 trillion ($1.01 trillion) from ¥70 trillion.

The move came after the Fed introduced another round of quantitative easing last week, which put renewed upward pressure on the yen.

“These measures in pursuit of powerful monetary easing will make financial conditions for such economic entities as firms and households even more accommodative by further encouraging a decline in longer-term market interest rates and a reduction in risk premiums,” the central bank said in a statement released together with the rate decision.

Board members voted unanimously to expand the scope of the asset-purchase program. The BOJ also decided to leave its policy rate, or the unsecured overnight call loan rate, unchanged in a 0.0%-0.1% range.

Japan has been in an endless loop of money printing ever since stocks and real estate crashed in the early 1990’s after one of the biggest financial bubbles in history.  Twenty years of quantitative easing and monetary stimulus have resulted in stagnant wages, the largest debt to GDP ratio in the world and a stock market that is still off 75% from its high.  Except for printing additional money, Japan seems flat out of options for reviving its economy.

Courtesy yahoo finance

Does anyone really expect this desperation tactic to cure Japan’s problems?

Filed Under: Currency debasement, Featured, Gold Tagged With: , , , , , , , ,

$10,000 Gold Possible As Fed Ramps Up Money Printing

September 17, 2012 by Leave a Comment

In the wake of the near death of the financial system in 2008, the Federal Reserve engaged in two rounds of quantitative easing and pumped trillions of dollars into banks and other financial institutions.  Ben Bernanke insists that such drastic actions by the central bank were necessary to prevent a depression, a claim that economists will no doubt be debating for decades.

What may not be open to debate, however, is the wisdom of the Fed’s decision to engage in non stop money printing with the announcement of QE3.  A policy tool previously applied to prevent a financial collapse has now become a routine operation in a desperate attempt to ramp up economic growth.  The Federal Reserve seems oblivious to the fact that no nation in history has ever increased its wealth and real economic growth by resorting to the printing presses.

Three most probable outcomes of the Fed’s open ended money printing operations:

1. Continued decline in economic growth.

Following the Fed’s announcement of another round of permanent QE, Egan-Jones Cuts U.S. Rating.

Egan-Jones Ratings Co. cut its credit rating for the U.S. one level to AA-, citing the potential for the Federal Reserve’s third round of large-scale asset purchases to weaken the dollar and drive up inflation.

U.S. debt to gross-domestic-product has risen to 104 percent from 66 percent in 2006, Egan-Jones said today in a report. The firm lowered the U.S. to AA in April. Yields on 10- year Treasuries have fallen five basis points since the end of that month to 1.86 percent.

The Fed’s latest program will “stoke the stock market and commodity prices, but in our opinion will hurt the U.S. economy and, by extension, credit quality,” Egan-Jones said. “The increased cost of commodities will pressure profitability of businesses, and increase the costs of consumers, thereby reducing consumer purchasing power.”

The Fed yesterday announced its third round of large-scale asset purchases since 2008, saying it will buy $40 billion of mortgage debt a month. The central bank didn’t set any limit on the ultimate amount it would buy or the duration of the program. Policy makers also extended the prospect of near-zero interest rates until mid-2015 and said policy will stay accommodative “for a considerable time” even after the economy strengthens.

2. Continued destruction of the purchasing power of the U.S. dollar. 

Federal Reserve policies have contributed to a dramatic decline in the purchasing power of the U.S. dollar for decades, resulting in a lower standard of living for Americans.  Expanded money printing will accelerate this trend.

3. Continued increase in the price of gold.

Courtesy: Kitco.com

The decade long rally in gold will dramatically accelerate.  A Barron’s interview asks Could Fed Miscalculations Lead to $10,000 Gold?

These are times that try an asset manager’s soul. The world’s economy is a soft-paste porcelain vase set on a wobbly plant stand in the heart of an active earthquake zone. The Middle East is sending out foreshocks of war. The South China Sea is a smoking caldera of tension. Social unrest in the EU threatens tidal waves. And, according to the agitated rats and snakes of the financial press, China is headed into a recession.

Hedging against the most pessimistic case without crippling the upside potential of a better or even miraculous case appears to be as unsolvable as the proverbial Gordian knot. Alexander the Great “solved” the intellectually challenging knot riddle by severing it with his sword. Scott Minerd, chief investment officer of Guggenheim Partners, offers a more reasoned but equally simple solution to the hedging conundrum: gold. In extreme circumstances—like miscalculations regarding inflation by the Federal Reserve—the metal could hit $10,000 per troy ounce, he asserts. Thursday, after the Fed disclosed its latest financial-stimulus scheme, the metal rose about 2% to $1,768.

Minerd frets about the Fed’s ability to reduce its swollen $2.9 trillion balance sheet if rates suddenly were to rise. Because the assets have longer-term durations, their market value immediately would tumble. If rates rose 1%, the Fed would have a $150 billion capital deficit, he says. This would have negative ramifications for the dollar. Minerd says the über-wealthy have been migrating toward hard assets like gold, real estate, and art. Every portfolio should be partially composed of such assets, he asserts. Is yours?

Gold and Silver Blog has long argued that gold would eventually advance to at least $5,000.  The latest Fed actions make that price target seem conservative.

Filed Under: Currency debasement, Featured, Gold, US Debt Crisis Tagged With: , , , , , , , , ,

Fed’s Open Ended Money Printing Will Destroy The Purchasing Power Of U.S. Dollar

September 14, 2012 by Leave a Comment

By Axel Merk

May we suggest a Twitter version of today’s FOMC statement: “Don’t worry, be happy! ” – No, the economic outlook hasn’t improved. In fact, the Fed may want you to take a valium to stomach the ride ahead. Alternatively, if you don’t get mollified by the Fed’s “communication strategy”, you may want to consider taking action to protect the purchasing power of your hard earned dollars.

Here’s the challenge: the Federal Reserve (Fed) wants to keep interest rates low across the yield curve (from short-term to long-term rates) to aid the economic recovery. But good economic data might send the bond market into a tailspin, i.e. raise long-term rates and thus cause massive headwinds to the economic recovery. We got a taste of how quickly the bond market can sell off earlier this year when the economy appeared to pick up some steam. Higher interest rates would further encourage the major deleveraging that market forces still warrant, not a desirable scenario from our understanding of Fed Chairman Bernanke’s thinking.

Engaging in further rounds of asset purchases (“Quantitative Easing”, “QE3”, “QEn+1”) may alleviate some of those upward pressures on interest rates, but the moment a program is announced, the market prices it in and looks ahead, threatening to mitigate any lasting impact of QEn+1. Picture the Fed as trying to hold a carrot in front of the donkey, well, market, to make us believe another stimulus is coming, without actually giving it. That way, the Fed can print less money to achieve its goals. The Fed calls it communication strategy.

Some have suggested a more open-ended approach to asset purchases. But that would likely come with some sort of guidance as to when to stop it, such as when a certain level of unemployment or nominal growth is reached. Given that everything Bernanke has done has been signaled well ahead of time (the blogosphere is full of the “best kept secret”, the likelihood of more QE), introducing a completely new concept is rather un-Bernanke-ish. You may not agree with Bernanke, but as an investor please don’t act surprised.

In recently released FOMC minutes, the Fed tells us that it might communicate to the market that rates may remain low even as the economy recovers. Bingo! We have long argued that Bernanke considered the early monetary tightening during the Great Depression as a grave mistake, as it undid all the “progress” that had been achieved. But more to the point, the Fed needs to get our attention away from the economy. By keeping the link to the economy, the Fed will always struggle to keep the upper hand on the bond market. So forget about the carrot: we need valium, not carrots. By communicating with the market that rates will remain low independent of how the economy might perform, the bond market just might not be selling off as aggressively as economic growth picks up.

That’s exactly the path we believe the Fed is going to go down. It will be interesting, however, to see what the Fed’s explanation will be. We doubt they will use the valium analogy. Some Fed watchers would like to see a nominal GDP target or something similar, but don’t bet your donkey on Bernanke going that far.

The basic challenge is – and we are interpreting here as we don’t think the Fed or any central banker in office would ever frame it this way: the Fed wants to have inflation, wants to move the price level higher to bail out home owners, wants to push up nominal wages, and wants to push up nominal GDP to make the debt burden more bearable. But the Fed doesn’t want the market to price in inflation, as that would push interest rates up.

That’s why we may be heading ever more into the “Land of Make-Believe.” But as investors enjoy their valium, the U.S. dollar is at risk of melting away under their feet. Drugged up, we are too busy laughing at Greece and doling out advice to Europe to notice that our “don’t worry, be happy” approach might lead to rather unhappy purchasing power. If you think you are above the fray, let me just ask whether you have watched the euro in recent months? As of late, that perceived weakling of a currency appears to be giving the greenback a run for its money. We are not suggesting that investors dump their U.S. dollars and exchange them all for euros. However, we would like to encourage investors to consider embracing currency risk, for example through a managed basket of currencies, as a way to manage the risk posed to the purchasing power of the U.S. dollar. Adding currency exposure to a portfolio may have valuable diversification benefits.

Some sympathize with the ever greater complexity of monetary activism around the world. But it’s really rather simple: there’s too much debt in the world. To deal with the debt, countries may deflate, default or inflate. In the US, we have what both Bernanke and his predecessor Greenspan have called the printing press; as such, so their argument goes, the U.S. dollar is safe – in nominal terms at least. Greece is not capable of procuring valium, which creates a different set of challenges. But stop pitying Greece and consider taking action to protect your purchasing power at home.

Please sign up to our newsletter to be informed as we discuss global dynamics and their impact on gold and currencies. You can also engage with me directly at Twitter.com/AxelMerk where I provide real-time updates on the economy, currencies, and global dynamics..

Axel Merk
President and Chief Investment Officer, Merk Investments
Merk Investments, Manager of the Merk Funds

Filed Under: Bullion Sales, Currency debasement, Featured, Gold, US Debt Crisis Tagged With: , , , , , , , , , , ,

Ron Paul – “The World Will Abandon The Dollar As The Global Reserve Currency”

September 3, 2012 by 4 Comments

In August Ron Paul accused the U.S. Treasury “guilty of counterfeiting dollars” by virtue of its monopoly power on money in America.  Paul noted that the expanding role of the Federal Reserve in monetizing government debt has resulted in a massive debasement of the purchasing power of the U.S. dollar.

Continued reckless money printing by the Federal Reserve and massive government deficits will ultimately result in the loss of confidence by holders of  U.S. dollars.  Ron Paul sees the U.S. dollar inexorably losing its status as global reserve currency unless the dollar is backed by precious metals or commodities.

Evidence of the horrendous loss of purchasing power by the U.S. dollar is not hard to understand.  The average citizen sees it everyday as higher prices and lower incomes relentlessly lower our standard of living.   The systematic destruction of the U.S. dollar’s purchasing power can be seen in a chart published by the Federal Reserve Bank of St. Louis.

How Long Will the Dollar Remain the World’s Reserve Currency?

By: Congressman Ron Paul

We frequently hear the financial press refer to the U.S. dollar as the “world’s reserve currency,” implying that our dollar will always retain its value in an ever shifting world economy.  But this is a dangerous and mistaken assumption.

Since August 15, 1971, when President Nixon closed the gold window and refused to pay out any of our remaining 280 million ounces of gold, the U.S. dollar has operated as a pure fiat currency.  This means the dollar became an article of faith in the continued stability and might of the U.S. government.

In essence, we declared our insolvency in 1971.   Everyone recognized some other monetary system had to be devised in order to bring stability to the markets.

Amazingly, a new system was devised which allowed the U.S. to operate the printing presses for the world reserve currency with no restraints placed on it– not even a pretense of gold convertibility! Realizing the world was embarking on something new and mind-boggling, elite money managers, with especially strong support from U.S. authorities, struck an agreement with OPEC in the 1970s to price oil in U.S. dollars exclusively for all worldwide transactions. This gave the dollar a special place among world currencies and in essence backed the dollar with oil.

In return, the U.S. promised to protect the various oil-rich kingdoms in the Persian Gulf against threat of invasion or domestic coup. This arrangement helped ignite radical Islamic movements among those who resented our influence in the region. The arrangement also gave the dollar artificial strength, with tremendous financial benefits for the United States. It allowed us to export our monetary inflation by buying oil and other goods at a great discount as the dollar flourished.

In 2003, however, Iran began pricing its oil exports in Euro for Asian and European buyers.  The Iranian government also opened an oil bourse in 2008 on the island of Kish in the Persian Gulf for the express purpose of trading oil in Euro and other currencies. In 2009 Iran completely ceased any oil transactions in U.S. dollars.  These actions by the second largest OPEC oil producer pose a direct threat to the continued status of our dollar as the world’s reserve currency, a threat which partially explains our ongoing hostility toward Tehran.

While the erosion of our petrodollar agreement with OPEC certainly threatens the dollar’s status in the Middle East, an even larger threat resides in the Far East.  Our greatest benefactors for the last twenty years– Asian central banks– have lost their appetite for holding U.S. dollars.  China, Japan, and Asia in general have been happy to hold U.S. debt instruments in recent decades, but they will not prop up our spending habits forever.  Foreign central banks understand that American leaders do not have the discipline to maintain a stable currency.

If we act now to replace the fiat system with a stable dollar backed by precious metals or commodities, the dollar can regain its status as the safest store of value among all government currencies.  If not, the rest of the world will abandon the dollar as the global reserve currency.

Both Congress and American consumers will then find borrowing a dramatically more expensive proposition. Remember, our entire consumption economy is based on the willingness of foreigners to hold U.S. debt.  We face a reordering of the entire world economy if the federal government cannot print, borrow, and spend money at a rate that satisfies its endless appetite for deficit spending.

Filed Under: Currency debasement, Featured, Gold, US Debt Crisis Tagged With: , , , , , , , , ,

Fed’s Easy Money Policies Will Continue – Why Bernanke Must Err On The Side Of Inflation

August 28, 2012 by Leave a Comment

By Axel Merk

To print or not to print? Odds are that Fed Chairman Bernanke has been contemplating this question while drafting his upcoming Jackson Hole speech. The one good thing about policy makers worldwide is that they may be fairly predictable. As such, we present our crystal ball as to what the Fed might be up to next, and what the implications may be for the U.S. dollar and gold.

First off, we may be exaggerating: on process rather than substance, though. That is, Bernanke isn’t just thinking about whether to print or not to print as he is sitting down to draft his speech. Instead, he considers himself a student of the Great Depression and has been pondering policy responses to a credit bust for some time. Consider the following:

  • Bernanke has argued that going off the gold standard during the Great Depression helped the U.S. recover faster from the Great Depression than countries that held on to the gold standard for longer.
    • Bernanke is correct: subject to many risks, debasing a currency (which going off the gold standard was) can boost nominal growth. Think of it this way: if the government takes your purchasing power away, you have a greater incentive to work. Not exactly the mandate of a central bank, though.
    • Note by the way that by implication, countries that hold on to the gold standard invite a lot of pain, but have stronger currencies. Fast forward to today and compare the U.S. to Europe. While neither country is on the gold standard, the Federal Reserve’s balance sheet has increased more in percentage terms than that of the European Central Bank since the onset of the financial crisis. Using a central bank’s balance sheet as a proxy for the amount of money that has been “printed”, it shouldn’t be all that surprising that the Eurozone experiences substantial pain, but the Euro has been comparatively resilient.
    • Possibly the most important implication: Bernanke considers the value of the U.S. dollar a monetary policy tool. When we have argued in the past that Bernanke might be actively working to weaken the U.S. dollar, it is because of comments such as this one. This is obviously our interpretation of his comments; a central banker rarely says that their currency is too strong, although such comments have increasingly been made by central bankers around the world as those pursuing sounder monetary policy have their economies suffer from competitive devaluations elsewhere.
  • Bernanke has argued that one of the biggest mistakes during the Great Depression was that monetary policy was tightened too early. Here’s the problem: in a credit bust, central banks try to stem against the flow. If market forces were to play out, the washout would be severe and swift. Those in favor of central bank intervention argue that it would be too painful and that more businesses than needed would fail, the hardship imposed on the people is too much. Those against central bank intervention point out that creative destruction is what makes capitalism work; the faster the adjustment is, even if extremely painful, the better, as the recovery is healthier and stronger.
    • If the policy choice is to react to a credit bust with accommodative monetary policy, fighting market forces, and then such accommodation is removed too early, the “progress” achieved may be rapidly undone.
    • We are faced with the same challenge today: if monetary accommodation were removed at this stage (interest rates raised, liquidity mopped up), there’s a risk that the economy plunges right back down into recession, if not a deflationary spiral. As such, when Bernanke claimed the Fed could raise rates in 15 minutes, we think it is a mere theoretical possibility. In fact, we believe that the framework in which the Fed is thinking, it must err on the side of inflation.

Of course no central banker in office would likely ever agree with the assessment that the Fed might want to err on the side of inflation. But consider the most recent FOMC minutes that read:

  • An extension [of a commitment to keep interest rates low] might be particularly effective if done in conjunction with a statement indicating that a highly accommodative stance of monetary policy was likely to be maintained even as the recovery progressed

As the FOMC minutes were released three weeks after the FOMC meeting, many pundits dismissed them as “stale”; after all, the economy had somewhat improved since the meeting. Indeed, it wasn’t just pundits: some more hawkish Fed officials promoted that view as well. But to make clear who is calling the shots, Bernanke wrote in a letter dated August 22 (the same date the FOMC minutes were released) to California Republican Darrell Issa, the chairman of the House Oversight and Government Reform Committee: “There is scope for further action by the Federal Reserve to ease financial conditions and strengthen the recovery.” Various news organizations credited the faltering of an incipient U.S. dollar rally on August 24 with the publication of this Bernanke letter.

For good order’s sake, we should clarify that the Fed doesn’t actually print money. Indeed, printing physical currency is not considered very effective; instead, liquidity is injected into the banking system: the Fed increases the credit balances of financial institutions in accounts held with the Fed in return for buying securities from them. Because of fractional reserve banking rules, the ‘liquidity’ provided through this action can lead to a high multiple in loans. In practice, one of the frustrations of the Fed has been that loan growth has not been boosted as much as the Fed would have hoped. When we, and Bernanke himself for that matter, have referred to the Fed’s “printing press” in this context, referring to money that has been “printed”, it’s the growth in the balance sheet at the Federal Reserve. That’s because the Fed’s resources are not constrained; it’s simply an accounting entry to pay for a security purchased; that security is now on the Fed’s balance sheet, hence the ‘growth’ in the Fed’s balance sheet.

Frankly, we are not too concerned about the environment we are in. At least not as concerned as we are about the environment we might be in down the road: that’s because we simply don’t see how all the liquidity can be mopped up in a timely manner when needed. At some point, some of this money is going to ‘stick’. Even if Bernanke wanted to, we very much doubt he could raise rates in 15 minutes. To us, it means the time for investors to act may be now. However, talking with both existing and former Fed officials, they don’t seem terribly concerned about this risk. Then again Fed officials have rarely been accused of being too far sighted. We are concerned because just a little bit of tightening has a much bigger effect in an economy that is highly leveraged. Importantly, we don’t need the Fed to tighten: as the sharp selloff in the bond market earlier this year (and the recent more benign selloff) have shown, as soon as the market prices in a recovery, headwinds to economic activity increase as bond yields are rising. That’s why Bernanke emphasizes “communication strategy”, amongst others, to tell investors not to worry, rates will stay low for an extended period. This dance might get ever more challenging.

In some ways, Bernanke is an open book. In his ‘helicopter Ben’ speech a decade ago, he laid out the tools he would employ when faced with a collapse in aggregate demand (the credit bust we have had). He has deployed just about all tools from his toolbox, except for the purchase of foreign government bonds; recently, he shed cold water on that politically dicey option. Then two years ago, in Jackson Hole, Bernanke provided an update, specifying three options:

  • To expand the Fed’s holdings of longer-term securities
  • To ease financial conditions through communications
  • To lower the interest rate the Fed pays on bank reserves to possibly 10 basis points or zero.

We have not seen the third option implemented, but the Fed might be discouraged from the experience at the European Central Bank: cutting rates too close to zero might discourage intra-bank lending and cause havoc in the money markets.

As such, expect Bernanke to give an update on his toolbox in Jackson Hole. The stakes are high as even doves at the Fed believe further easing might not be all that effective and could possibly cause more side effects (read: inflation). As such, we expect him to provide a framework as to why and how the Fed might be acting, and why we should trust the Fed that it won’t allow inflation to become a problem. For investors that aren’t quite as confident that the Fed can pull things off without inducing inflation, they may want to consider adding gold or a managed basket of currencies to mitigate the risk to the purchasing power of the U.S. dollar.

Please sign up to our newsletter to be informed as we discuss global dynamics and their impact on gold and currencies. Please also follow me on Twitter to receive real-time updates on the economy, currencies, and global dynamics.

Axel Merk
President and Chief Investment Officer, Merk Investments
Merk Investments, Manager of the Merk Funds

Filed Under: Currency debasement, Featured, Gold, US Debt Crisis Tagged With: , , , , , , , ,

Gold – The Escape From Slavery

August 22, 2012 by Leave a Comment

By Axel Merk

Vice President Joe Biden was accused of racism when suggesting a Romney administration would “unchain banks” that in turn might put the black audience he was talking to back into “shackles.” The political uproar overshadows a reality that knows no racial boundaries: a person in debt is not a free person; a nation in debt is not a free nation. Does it mean those with large bank accounts are free? Not so fast…

We don’t want to downplay the horrific crime of slavery, but want to provide food for thought: debt is often taken on voluntarily; once taken on, however, one is forced to work to pay off one’s debt. To be unshackled from banks and creditors, investors may want to consider living debt free and owning gold. Let us explain.

Chains and Dollar

Access to credit may fundamentally change one’s lifestyle. On the plus side, it opens the path to home ownership and access to capital goods, be that a car, or these days even a mattress or exercise machine. But it also makes the creditor, rather than oneself the boss. One symptom of the building credit bubble that caught my attention a decade ago was the rise of Spanish language billboards promoting mortgages. Proud immigrants in search of the American dream were lured into mortgages they could ill afford. Rather than focusing on feeding themselves and their family, the focus shifted to serving the bank. That shift only became apparent once the loan became too expensive to service, either because interest rates were resetting to higher levels or because someone lost their job and thus their income, but the debt remained.

Berkshire Hathaway CEO Warren Buffett famously discusses in his annual shareholder letters that the insurance business is a great business to be in, as policyholders pay him to hold money:

“Insurers receive premiums upfront and pay claims later. … This collect-now, pay-later model leaves us holding large sums — money we call ‘float’ — that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit. …”

Indeed, Buffett has said that he would never allow his firm to be in a situation where he is at the mercy of banks. It doesn’t mean he will never borrow money. But it means that when borrowing money, he always wants to be in a situation where he could pay it back if needed. Consumers have seen all too often that they only qualify for a loan when they don’t really need it. Jamie Dimon, CEO of JPMorgan Chase has said responsible banks act like mothers: they will decline your loan request if it is too risky for you.

One cannot be a truly free person with debt. While bankruptcy may have been downgraded to a mere business transaction in the U.S., some countries continue to put those that can’t pay into prison. The neighborhood surrounding Dubai’s airport has seen thousands of abandoned cars, often Ferraris or other expensive vehicles, as the formerly rich fled the country after their fortunes turned to avoid debtors prison.

Anyone is likely to argue that a nice pile of cash in a bank account will make one feel financially secure – some place that pile at $100,000. Some at a million; as a million bucks isn’t what it used to be, the wealthy often say they are not comfortable if they don’t have $10,000,00 or more. We have met people with very modest means that feel that they are wealthy; and others that have lots of money, but don’t feel wealthy. Aside from the fact that some of them might simply have a distorted sense of reality, the wealthy often also carry a great deal of debt. Those able to manage their debt thrive in this low interest rate environment. But let even a wealthy person with debt hit a road bump, say lose a job (or face an obstacle in refinancing a loan) and such a person may quickly join the lower ranks of the 99%. In our assessment, highly accommodative monetary policy is a greater driver of an increasing wealth gap than the policies of either Democrats of Republicans.

But even with $100 in a bank account, what does one really hold? One owns a promise by the bank to pay $100. The $100 bill is a Federal Reserve Note; it’s a piece of paper issued by the Federal Reserve. That $100 bill could be returned to the Fed; in return the Fed would issue a credit balance to your account (you would have to go through a bank, as the Fed won’t open accounts for individuals). The “resources” of the Fed are without limit: through its various quantitative easing programs, the Fed has increased the credit balances of the financial institutions where it has purchased securities. The Fed literally creates money out of thin air, with the stroke of a keyboard. Even prudent central banks like to see a little bit of inflation; it means that the dollar bills you hold erode in purchasing power, giving you an incentive to put the money to work to make up for the shortfall.

Importantly, the $100 bill in your bank account is really someone else’s loan – the bank’s loan, the Fed’s loan. In fact, if you take out a loan from a bank, you will pay a merchant, who will in turn deposit the proceeds in his or her bank. As such, we talk about credit in a society. For simplicity’s sake, let the banks hold 10% in reserves; $100 in bank reserves with an offsetting $100 in demand deposit liabilities can thus be multiplied into $100 in bank reserves plus $900 in loan assets with an offsetting $1,000 demand deposit liabilities through the leverage of the fractional reserve banking system as banks lend and new deposits are made in a circular fashion. Between the Fed and the banks and the banks and their depositors the system can have a multiplier effect of about 100; that is, $100 created by the Fed can lead to $10,000 in credit. That’s why we sometimes call the credit created by the Fed (the monetary base) super credit. In the current environment, banks have not been aggressive in lending, and as such, we have not seen the “velocity” of money pick up. A key reason why many are concerned about the Fed’s increase in monetary base is because it has the potential to fuel inflation. Indeed, a key reason I personally hold a lot of gold is not because of the environment we are in, but because I am concerned about how all the liquidity that has been created might be mopped up one day. Federal Reserve Chairman Bernanke claims he can raise rates in 15 minutes; we think there may be too much leverage in the economy to have the flexibility when the time is needed; the political will to induce a severe recession to root out inflation may not be there.

It’s all about debt. So if one doesn’t want to have debt, what is one to do? The answer is real assets that are free of claims. Real estate held free and clear might be one answer, although keep in mind that governments tax real estate, thus making home owners tenants of the government. As the housing bust since 2008 has shown, the fact that many others owe a lot of money on their property changes the dynamics of this real asset.

The purest form of a debt free asset is gold. Gold is true money, the only form of money that isn’t someone else’s liability. While central banks might be able to lower the gold price by dumping their own reserves, central banks cannot print more gold – it’s very difficult to ramp up gold production. If your bank goes broke, if Greece goes broke, gold will still be there. Some call gold a relic from the past. To us, it’s the purest indicator of monetary policy, precisely because it has little industrial use. We created the cartoon below last year after CNBC’s Steve Liesman suggested to me on the air that gold might not be accepted in a store.

Cash vs. Gold

Mind you, we are not suggesting that everyone should sell all they own and buy gold instead. Everyone should consult with his or her financial adviser for specific investment advice. Specifically, one must be keenly aware of the volatility the price of gold can have relative to the U.S. dollar; given that we have a lot of our expenses in U.S. dollars, one has to be aware of the fluctuating value of the investment relative to the U.S. dollar. But we want to get investors to be keenly aware that we live in a credit driven society. We also believe that the developed world has made too many promises, too much debt has been issued.

Governments with too much debt may a) engage in austerity to pay off their debt; b) default outright; c) default though inflation. All scenarios suggest to us to hold assets that are debt free. We see gold playing a very important part in portfolios that take the risk into account that our policy makers continue to spend and “print” more money than is prudent. We don’t need actual money to be printed – credit creation through quantitative easing – is far more powerful.

Please sign up to our newsletter to be informed as we discuss global dynamics and their impact on currencies. Please also follow me on Twitter to receive real-time updates on the economy, currencies, and global dynamics.

Axel Merk
President and Chief Investment Officer, Merk Investments
Merk Investments, Manager of the Merk Funds

Filed Under: Currency debasement, Featured, Gold, US Debt Crisis Tagged With: , , , , , , , , , , , , ,

Gold, Dow and Oil All Plunge On Economic Weakness – Is Gold Still A Safe Haven?

June 21, 2012 by 1 Comment

The combination of increasingly ominous economic reports along with the Fed’s failure to announce bold new monetary initiatives resulted in a brutal reassessment of risk by investors.  Stock, commodity and precious metal markets all plunged with the Dow down 250 points, gold down by $41.60 per ounce  to $1,566 and silver off by 4.4% to $26.98.  Crude oil in New York trading was off 4%, dropping below $80 a barrel for the first time in eight months.

Since the end of May, the Dow had rallied over 700 points on rumors of massive coordinated central bank easing.  Investor optimism changed in a flash after yesterday’s FOMC announcement that Operation Twist would continue in an effort to further reduce long term interest rates.  Markets were clearly expecting more concerted action.  The Fed has already suppressed interest rates to all time lows with little to show for it.  In addition, the crisis in the Europe is on the verge of spinning out of control as insolvent sovereign states comically attempt to bail out insolvent banks.

The steep sell offs in oil and other commodities since early May have been a screaming warning sign of a steep slowdown in the global economy.   Further adding to investor concerns is the inability of policy makers to address fundamental economic problems that have beset the global economy since 2008.  Government borrowing, spending and a storm of money printing  has only made the fundamental problem of excessive debt burdens worse.  Now, as the world rapidly slides back into recession, we have to wonder – where do we go from here?

 

Oil - courtesy stockcharts.com

Gold - courtesy stockcharts.com

Despite Bernanke’s frequent remarks that “We stand ready to act” and his assertion that the Fed has many “tools in the toolbox”, the worst nightmare seems to be unfolding – a Fed that is out of options (or out of touch) as the world economy marches to the brink of a financial meltdown.

Will the world slide into a deflationary abyss as central banks stand aside and allow free markets to clear the debt excesses of the past two decades?  Not likely based on the entire history of the Federal Reserve.  What is highly likely, however, is that as the United States reaches the limits of credit expansion and taxation, neither the public nor our elected politicians will accept austerity as the road to restructuring the economy and national balance sheet.   Reality be damned as we reach the tipping point – the public will demand their entitlements and the politicians who resist will be voted from office.  The pressure on the central bank to “solve” our economic problems through an endless series of QE follies will result in a national financial nightmare.

Where does gold go from here as the world financial system totters on the brink?  No one can predict the short term moves in gold, but in a very uncertain world, there is one undeniable  dictum – “Gold is money.  Everything else is credit.”  (JP Morgan -1912).

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Bernanke Broods Over New Ways To Print Money – Waiting For Gold To Explode

March 8, 2012 by Leave a Comment

Perhaps it was the realization that the U.S. Federal Reserve was losing to the ECB in the money printing race.  Perhaps it was the realization that the only way to prevent a debt imperiled economy from imploding was by supplying new doses of the only remedy left in the Fed’s medicine bag.  In any event, Federal Reserve Chairman Bernanke made it clear today that his determination to continue quantitative easing has not diminished.

In an effort to silence critics who equate QE with currency debasement and inflation, the Chairman has come up with an improved version of QE that will boost the economy without creating inflation or boosting oil prices – in effect, the modern equivalent of turning lead into gold.  The new and improved version of QE even comes with a new and impressive sounding moniker -“sterilized bond-buying”.

The Wall Street Journal’s explanation of how this new money creation engine of the Fed would actually work probably left many lesser mortals scratching their heads.  See if you can follow how new money creation by the Fed creates wealth and prosperity, while maintaining a sound dollar and zero risk of inflation blow-back.

Third, in the new novel approach, the Fed could print money to buy long-term bonds, but restrict how investors and banks use that money by employing new market tools they have designed to better manage cash sloshing around in the financial system. This is known as “sterilized” QE.

The Fed’s objective under any of these programs would be to reduce the holdings of long-term securities in the hands of investors and banks. The Fed believes that reducing the amount of long-term bonds in the hands of investors drives down long-term interest rates, encourages more risk-taking, and thus spurs spending and investment by households and businesses.

Under the third approach, the Fed would create new money as it buys long-term bonds. But then it would effectively lock up the money rather than letting it loose in the broader economy. The Fed would do this by borrowing the money back from investors for short periods—say, 28 days—in exchange for some low interest rate it would pay investors.

Will this new genius wealth creation mechanism of the Fed actually work or will it wind up driving gold into the stratosphere as the average American finally begins to realize that not only does the Emperor have no clothes, but that he is also delusional?

Here’s the take on the new and improved QE (sorry, I meant to say “sterilized bond-buying”) by astute observer Jim Sinclair, who is never at a loss to expound on the monetary mess we are in.

This would be a hat trick because it assumes the Fed would borrow back funds they have created by good ole debt monetization. It assumes there is no purpose to QE in the first place. It is monetary double talk beyond MOPE or maybe MOPE at a spiritual level. It is an attempt to intellectually cloud the process and to give plausible believability to PR lies.

This is a statement that says we will step on the gas and then equally apply the brakes which means you go absolutely nowhere. It is a statement that is total gobbledegook to deflect the fact that QE is going to infinity. It is a statement that only those who do not understand monetary science might give credibility to.

The claim that QE can be controlled by equal stimulation and draining adds up to nothing whatsoever. The idea that the Fed could so perfectly orchestrate pulling and pushing is denied by the fact of where we are right now.

Only gold can protect you from this sinking ship without hope of rescue as there is no captain at the helm.

I am horrified by today’s total distortion of fact of how the monetary mechanism works by the Federal Reserve. We will win the war by jamming the accelerator to the floor and jumping on the brakes simultaneously, therefore stimulating the dead cat bouncing economies of the Western world to prosperity and avoid sovereign debt failure.

My god that is nonsense.

Meanwhile, for those keeping score, the European Central Bank has powered ahead of the Federal Reserve in the money printing race.  The Fed’s balance sheet has ballooned to triple its size from 2008 as the Fed printed $2 trillion in new dollars to purchase mortgage backed securities and treasury debt (effectively financing 40% of the U.S. Government’s deficit).  As of the end of February, the Fed’s balance sheet stood at $2.94 trillion.

Faced with the total collapse of the banking system, wild money printing by the European Central Bank (ECB) makes the Fed look like an amateur.  After dishing out $1.4 trillion to 800 problem banks since December, the ECB’s balance sheet has exploded to $3.96 trillion.

Other central banks worldwide are following the desperate actions of the Fed and the ECB.  The combined balance sheets of the ECB, Federal Reserve, England, Germany, Switzerland, Japan and China and Great Britain has expanded from $6 trillion in mid 2007 to over $15 trillion today.

Most of the central bank money has been used to liquify insolvent banks by purchasing bank assets of dubious value.  A good portion of the funds received by banks has in turn wound up as idle excess reserves, as the banking industry refuses to expand lending to already over-leveraged or insolvent borrowers.

There will be one surefire way to determine when the money created by the central banks eventually works it way into the real economy – the price of gold will explode upward with a concurrent rise in inflation and wide spread debasement of virtually every world currency.  In the meantime, as we watch the “QE to infinity” process unfold before our eyes, gold remains on the bargain table.

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How Would Gold Perform In A Full Blown Depression?

September 12, 2011 by Leave a Comment

“We need to do massive stimulus, otherwise there’s going to be another Great Depression.  Things are getting worse, and the big difference between now and a few years ago is that this time around we’re running out of policy bullets.”  – Professor Nouriel Roubini

As the global financial system lurches towards financial Armageddon, would a safe haven asset such as gold maintain its value in a severe depression?

This and other questions were addressed in a Barron’s interview with Martin Murenbeeld, chief economist for Canada’s DundeeWealth, an asset management firm.  Murenbeeld has held senior positions with various gold mining firms for 40 years and turned bullish on gold in 2001.

In response to questions from Barron’s, Mr. Murenbeeld provided the following insights on the gold market and where he thinks prices are headed.

-Murenbeeld told Barron’s that the recent surge in gold prices was related to investor worries over impaired sovereign balance sheets, monetary reflation, global financial instability and strong demand for physical gold from Asia.  In addition, global gold production has barely increased.  Murenbeeld sees an average gold price of $2,200 in 2012 and only a 10% chance that gold will pull back to the $1,500 range.

-The current gold bull market could last another 10 years due to expanded Asian demand and unprecedented adverse financial conditions in the world economy.  Murenbeeld says history “has shown that gold prices…go through very long cycles.”  The last gold bull market of the early 1980’s was one of the shortest on record.

-Regarding the current disconnect between gold bullion and gold stocks, Murenbeeld notes that during times of severe financial stress, bullion outperforms gold stocks since investors avoid equity issues in general.  Over the long term, however, gold stocks have outperformed bullion.

-If the world enters a major depression, gold prices would likely drop since “demand for everything falls off.”  Murenbeeld notes, however, that monetary response to a depression would be fast and aggressive which would quickly propel gold prices higher.

-Murenbeeld says that current demand for gold in “unprecedented” and due to Federal Reserve policies, the introduction of gold ETFs and huge demand for physical gold by billions of consumers in Asia.

-In response to how world governments will deal with the current severe financial problems, Murenbeeld said “during my working life the risk of monetary debasement – the outright printing of money supply in the developed countries has never been higher.  Thus, we see the unprecedented interest in gold…Most likely governments will meet the bulk of their debt obligations with currency devaluations and the monetizing of debt”.

-As far as the possibility that investors will lose interest in gold, Murenbeeld says that could happen if “confidence in monetary and fiscal policies is restored”.   (Not much chance of that happening any time soon in this writer’s opinion.)

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Fed Lays Groundwork For Price Explosion In Gold

August 10, 2011 by Leave a Comment

Gold hit another all time high of $1,779.10 before pulling back to close at $1745.10, up $26.90.  Gold has advanced strongly over the past year as the Federal Reserve engaged in quantitative easing and extremely loose monetary policy.  Over the past 30 days gold has gained $198 and over the past year, a stunning $548.70 per ounce.

At the conclusion of the Federal Open Market Committee (FOMC) meeting on Tuesday, the Fed announced that it would maintain its zero interest rate policy through the middle of 2013.   The Fed does not normally make commitments that limit future policy flexibility and three of the seven members of the FOMC  voted against the pledge to maintain zero interest rates.

The Fed has held interest rates at zero for 32 months now with little to show for it as debt burdened consumers continue to reduce spending.  With inflation running at 5 to 10% (depending on whose stats you believe), real interest rates are negative and savers are seeing the purchasing power of their dollars destroyed by Fed policies.

The FOMC also said that they expect “a somewhat slower pace of recovery over the coming quarters” and that future action might be taken to “promote stronger economic recovery.”  Since the Fed has already exhausted all normal policy tools, the FOMC seems to be positioning itself for another round of quantitative easing.  Some analysts speculate that the Fed will discuss further easing measures later this month at the Fed’s annual conference in Jackson Hole, Wyoming, where QE2 was launched.

Further fiscal stimulus seems improbable given the restrictions put on future spending by Congress as part of the debt limit agreement.  In a sign of how desperate the financial condition of the United States has become, all eyes are now turned towards the Fed.

Since zero interest rates and two rounds of money printing have done little to turn around the US economy, the expectation is that the Fed will need to do more of what failured before, except on a grander scale.  I expect that as the economy continues to weaken, the Fed will announce a “shock and awe” campaign of massive money printing accompanied by an explicit statement that they are committed to higher inflation.

Federal Reserve policies have been the primary factor pushing the price of gold higher.  The inevitable announcement of further quantitative easing will be trigger that pushes gold prices thousands of dollars higher.

Consider the statement of the former Fed Chairman Alan Greenspan who on a “Meet the Press” interview arrogantly proclaimed that the United States could never default because “The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.”  This is what the United States has come to under the easy money policies of the Federal Reserve and a government that believes prosperity can be created by oceans of debt.  Is it any wonder that the currency is collapsing and the purchasing power of the dollar declining precipitously?

Meanwhile, Kenneth Rogoff (of This Time It’s Different fame) who attended Harvard with Bernanke, tells Bloomberg that the Fed should explicitly set a high inflation target and engage in massive quantitative easing.

Federal Reserve policy makers are likely to embark on a third round of large-scale asset purchases, moving “more decisively” to secure the U.S. recovery, said Harvard University economist Kenneth Rogoff.

“They certainly should do something right away,” said Rogoff, a former International Monetary Fund chief economist who attended graduate school with Fed Chairman Ben S. Bernanke.

“Out-of-the-box policies are called for, especially much more aggressive monetary policy, however unpopular that may be,” said Rogoff, 58, a former Fed economist who like Bernanke earned a Ph.D. from the Massachusetts Institute of Technology. The Fed is “going to move more decisively,” Rogoff said.

Rogoff recommended the Fed say in “very clear statements” that it’s trying to create “moderate inflation.” “In the classic classroom QE, it’s open-ended,” Rogoff said. “You say, ‘I’m trying to create inflation of, let’s say 2 or 3 percent, and I’m going to do whatever it takes.’”

The extreme policy measures recommended by Greenspan and Rogoff prove that the US has already passed the tipping point and has only one policy option left.  If the Fed does not print like crazy, the whole rotten edifice of towering debts will collapse, plunging the country into a deflationary collapse.

Gold will have price corrections as it continues to move upward but the ultimate price will be many thousands of dollars higher than today.  Gold investors should continue to accumulate positions, especially on price weakness and enjoy the unfolding of one of the greatest bull markets in history.

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