Eric Sprott On Bonfire of the Currencies

Tyler Durden's picture

By Eric Sprott

Bonfire of the Currencies

World governments just can’t get enough conflict these days. They’ve now resorted to battling each other with money printing.1 The devaluation race is in full gear, and it’s tough to keep track of who’s winning. It’s been just wonderful for investors, of course. In addition to contending with 0% interest rates, they now have to navigate through increased currency volatility and uncertainties associated with potential inflation. Gold and silver are benefitting greatly from this ‘currency war’ as investors seek safe harbor in hard money. We can’t say we’re surprised to see gold and silver where they are, but it has been surprising to witness just how willing and open governments are to blasting their own currencies down in value. Although we have complete confidence that the economists at the world’s various central banks know exactly what they are doing, we’re content to own precious metals investments in the meantime until such a day arises when the currency war winner is finally announced.

Just to make sure you’re up to date in currency war news, the most recent devaluation shot was fired by the Federal Reserve on August 17, 2010, when it initiated its permanent open market operations (POMO) to stimulate economic activity. The central bank announced its intention to reinvest the proceeds of its maturing mortgage-backed security holdings back into Treasury bonds. Combined with recent comments by the Federal Open Market Committee (FOMC) on increasing the US inflation rate (through money printing), world governments have been coerced into action. They’ll be damned if they let the US devalue against their own respective currencies and slam their exports, so everyone’s devaluing in tandem. It’s literally a "race to the bottom", with all major currencies on the potential fiat currency chopping block.

By our count, no less than 23 separate countries have now intervened in the foreign exchange market in some way since September 21, 2010. The goal for all is to increase the supply of their respective paper currencies in order to drive them down in value. In the cases where countries can’t print outright, they have intervened through capital controls or "open mouth" operations (ie. talking down your currency in policy meetings, etc.). Both approaches have significantly increased the currency market’s volatility. Japan’s October 5th announcement of a "new fund" to purchase assets ranging from government to corporate bonds has forced other countries to pursue the same policy, and the world now awaits similar announcements from the United States and UK in the form of new Quantitative Easing programs.2

Investors aren’t clueless, however, and many are shifting capital to protect themselves. A large number of commodities are now benefitting from the uncertainty created by the devaluation race. Gold, silver, oil, copper, wheat, sugar and platinum are all on the run, and yet we have no reported inflation! Kudos go to the Central Banks for orchestrating that economic miracle. Nonetheless, regardless of what the CPI says, it’s clear that investors are proactively preparing themselves for more printing, and gold and silver seem to be the most popular choices for investors seeking safe harbor.
If you haven’t participated in gold’s recent rise, don’t fret, because the fun has only just begun. While gold and silver bullion have increased by 20% and 32% since January 1, 2010, respectively, gold stocks as represented by the Market Vectors Gold Miners ETF (GDX), the Philadelphia Gold and Silver Index (XAU), the NYSE Arca Gold Bugs Index (HUI) and the S&P/TSX Global Gold Index have all trailed gold’s performance for the entire year. You wouldn’t expect the senior gold producers to be trailing behind gold in this environment. After all, at $1,300 gold, these companies literally have a license to print money. What better business is there to be in right now? These are companies that can process an ounce of gold for $800 and sell it for $1,300, with virtually no sales risk. What other investment sector can boast that kind of margin in this environment?

Chart A

We believe the gold producers present an excellent investment opportunity right now. To explain why, consider the NYSE Arca Gold Bugs Index (HUI). The HUI is a modified equal-dollar weighted index of companies involved in major gold mining. The HUI was designed to give investors exposure to near-term movements in the gold price by focusing on companies that do not hedge their gold production beyond 1.5 years. The HUI was launched with a base value of 200 in March 1996 and includes some of the largest gold mining companies in the world. Despite a 35% increase in the price of gold since March 2008, the HUI has barely moved at all. As Chart A illustrates, this gold equity index is currently trading at the same approximate level it was when gold was barely over $1,000. The current HUI valuation doesn’t reflect the operating leverage that the $350 increase in the spot gold price could potentially have on earnings – which brings us to an important point that investors often overlook in gold stocks.

Because of the nature of gold mining’s fixed costs, any increase above the total cost per ounce significantly increases a gold producer’s net income on a percentage basis. Consider a hypothetical gold producer with cash costs of ~$500 per ounce, which is around the industry average. At $1,000 gold, this company generates an EBITDA of $500 per oz per ounce mined. Simple enough. But most mining companies have extra costs on top of their operating expenses. For a new gold project these extra expenses will typically add another $300 or so per oz. So for every ounce mined, our gold mining company is now only generating $200 of margin based on 2009 input costs and $1,000 gold. With $1,350 gold, however, and the same cost structure of $500 in operating costs and $300 in additional costs, our hypothetical gold company has now increased its margin from $200 to $550 an ounce, representing an increase of 175%! We don’t believe current gold equity valuations reflect this potential margin increase at all, but they soon will. A re-rating is just around the corner.

Class B

The bullish case for gold stocks is even more compelling if you consider the historical trend going back to 2000. Chart B plots the HUI index in gold terms. When this ratio is rising, it means that gold companies as measured by the HUI are outperforming gold. Conversely, when this ratio falls it means gold is outperforming the HUI. As you can see, the recent relative underperformance to gold is not in line with the historical trend. Chart B illustrates that gold stocks are currently trading at the same relative valuation they did when gold was priced at $313/oz! We were investing in gold stocks in 2003 and did not find them to be rich in valuation. We believe this discrepancy indicates that gold stocks have a ways to appreciate in order to match the underlying metal’s recent performance.

For those readers who are more technically inclined, the HUI Index chart is signaling a very bullish uptrend. For a more astute confirmation, we asked our prime technical analyst Ross Clark from CIBC Wood Gundy to review the HUI’s technical patterns. Ross has always had a very accurate perspective on the gold market in our opinion. As he explained to us, "Capitulation in the dollar (October 1st) is generally followed by a low in mining stocks within six weeks. When the HUI is pushing through to new highs (as seen this month) it is normal for it to pause, making a three to four week correction. If it holds in the mid 400’s we can look forward to a three to four month run with an 80% to 90% rise (emphasis ours). This targets the upper 800’s in the HUI by the end of the first quarter." It is very rare to have fundamental and technical analysis align to predict such a strong move in an equity sector.

Now is the time to own gold stocks. Most gold companies will report their Q3 earnings at the end of October. Due to a higher year-over-year average spot gold price (which has increased 27.8% to $1,228/oz in Q3 2010 vs. $961/oz in Q3 2009), virtually every precious metal company is forecast to exhibit substantial net income growth. These fantastic net income results will be augmented by higher by-product prices (average silver, copper, and zinc prices were up 28.7%, 24.2%, and 14.8% year-over-year), which should set the stage for banner year-over-year earnings increases.

One of the best axioms for investing is painfully obvious, but so often forgotten by seasoned investors: it’s all about earnings. Earnings are what drive stock prices over the long term. Investors seek out earnings growth wherever they can find it, and we can’t think of a single equity sector that exhibits better year-over-year earnings growth potential than the gold producers. Despite the buzz you’ve heard about gold and silver over the last two months, the stocks haven’t caught up. We expect that to change over the next two quarters as investors realize how much stronger gold producers’ earnings will be at $1,350 gold. As countries decide to burn their currencies in the devaluation race, gold has responded, and now it’s the producers turn to perform. We’ll gladly take the earnings.



1 Wheatley, Jonathan (September 27, 2010) "Brazil in ‘currency war’ alert" Financial Times. Retrieved on October 22, 2010 from:

2 Ishiguro, Rie (October 5, 2010) "FACTBOX-BOJ to set up fund to buy JGBs, corporate debt" Reuters. Retrieved on October 22, 2010 from:

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ZeroPower's picture

$1350 gold? Fine whatever. 1300 SPX. Wheres the higher return, chief?

Teaser's picture

sure looks like gold to me.  In fact as far back as I can see from here, it looks like gold.  Pretty much since they invented the printing press in 1999, sure seems like the return is in gold and not  spx.  But, I could be wrong.  You can't even eat gold!

DavidPierre's picture

A week away ... Fed's announcement of how badly they intend to debauch the Dollar.

Talk ... "it's already in the market" ... may or may not be true.

Markets moved and realigned ahead of this announcement in expectations of Fed "help" but have they moved too far or not enough?

Whatever they announce, it better be "good"!

How perverse is this announcement really? 

A "bad" announcement in the market is one where the Fed only trashes the Dollar a little. 

A "good" one is where they completely capitulate with a $1 Trillion+ shovel job... "the bigger the better" a thought process where people are HOPING that the Dollar gets debased. Good for over indebted idiots ( the federal government) short term ... it will "lessen the bite" of debts but now people understand what they are wishing for. This especially applies to bond buyers, do they really want the Fed to let the inflation genie out of the bottle?

How good are their 3.5% 30 year bonds going to look when inflation cranks up past 10%?

TIPS auction actually goes "negative". This means that these "inflation protected" bonds were returning LESS money than invested!  Why would anyone accept negative rates on one of these bonds, or ANY bonds for that matter? Why not just buy a lump of "golden crap"? ... doesn't pay any interest but who cares, nothing else does either.

It really doesn't make sense, everyone knows that governments are in a currency war where the winner is whoever devalues the most the fastest, so why are buyers lining up hundreds deep to lock in low interest rates with the promise of being paid back in depreciated currency? Maybe it's something in the water, who knows but this phenomenon is surely not logical.

No matter the amount of freshly printed currency (debt) is announced markets can't hold together for more than a week or two. If you were packed to the gills with Dollar denominated Treasuries wouldn't you use the Fed's "bid" to unload these? Especially if you were a foreigner (China comes to mind here) that had more Dollars than desired?

Foreigners have lost roughly 15% on their Dollar holdings over the last couple of months so why would they want to hold on longer to take a further beating? Especially while the Fed is advertising that they intend to increase the downward pressure? ... something in the water?

"The madness of crowds" ... everyone participating and  NOBODY calling this spade. This is pure fear and desperation of the Fed, the ensuing panic will be global and unlike anything ever seen. In retrospect, all we needed (other than a Gold standard) was to let the economy and markets recede back in 1996 and the 2000-2002 time frame. But NO, damn the torpedoes and full steam ahead!

Blow the bubbles, spin the reality, fake the numbers, bankrupt the Treasury and screw the people because no one will be the wiser until the next administration!

This IS the next administration and the shit has already hit the fan. The policy response? ...turn up the fan speed and start shoveling more, ...yeah, that ought to do it!

{p.s.  CFTC commissioner Bart Chilton spoke today regarding the ongoing Silver price manipulation. He appears to be a man of honor.  God bless him. May his guardian angel diligently watch his back.  The Gold and Silver mafia scam has some very powerful and dangerous entities running the show. CFTC didn't run his background cheque well enough before appointing him! Bravo Mr. Chilton! }

{p.s.s.  Sprott Asset Management Chief Investment Strategist John Embry tells Eric King of King World News that the long-awaited commercial signal failure in the gold and silver markets may be imminent. Excerpts from the interview can be found at King World News here:

Via LeMetropoleCafe !!!

billhilly's picture

Right on, David.  Very accurate comments IMHO.

Also, Bart Chilton IS the man!  Thanks finally to someone in "office" for speaking the truth.

CitizenPete's picture


CFTC puts spotlight on silver trades

By Gregory Meyer in New York and Jack Farchy in London

Published: October 26 2010 18:41 | Last updated: October 26 2010 18:41

A senior US commodities regulator has alleged fraud in silver trading more than two years after investigators began a probe into the market.

Bart Chilton, commissioner at the Commodity Futures Trading Commission, said “members of the public” and “publicly available documents” convinced him the silver markets are tainted by violations of federal commodities law.

Waterfallsparkles's picture

Bernankie trying to buy the Election for the Dems.  Talk about Election contributions.  How many Billion has the Fed printed to get Dems Elected.

The FED appears to be trying to manipulate the results of the Election by the printing of Dollars.

svendthrift's picture

They assist the dominant party every cycle.

Bill Lumbergh's picture

Let us not forget he was not exactly re-confirmed with a lot of enthusiasm...who knows what backroom deals were made...Benny might be making good on some of those right now.

midtowng's picture

Bernanke printed more dollars, and cut interest rates far more in 2008.

tmosley's picture

The second chart is the same as the first one.

MiguelitoRaton's picture

Yes Tyler, we would like to see the real second chart. I guess Sprott liked the first one so much he used it twice ;-)

the rookie cynic's picture

It's a giant geo-political game of chicken, ain't it?

Quite a drama really: oil, nukes, land wars in Asia, fading empires, rising stars, trade imbalances, strikes, riots, guess is that the PTB will empty the bag of dirty tricks to try to win this thing.

Why do I get the feeling this is not going to end well?

B9K9's picture

Gold promoters attempt to persuade (potential) investors that Ben can act unilaterally without concern for other countervailing forces.

This in incorrect - dangerously so. In point of fact, there are significant global geo-political realities that give pause to continued advance of preferred monetary policies.

Simply ask yourself this question: does a strong dollar or weak dollar policy help the USA achieve its mission objectives with regard to control of ME oil?

If you think the (so called) WoT will benefit from a highly depreciated dollar, then gold and other risk-on investment strategies might be suitable. If not, then not so much.

Think it through fellow ZH space-monkeys.

tmosley's picture

The king can order the tide not to come in, but it comes in all the same.

Market forces will prevail, whether they do so slowly, as a tide coming in, or suddenly, as in the collapse of a dike.

Internet Tough Guy's picture

Oil has gone up sharply since the beginning of the war on terror.

i-dog's picture

"help the USA achieve its mission objectives with regard to control of ME oil?"

That is no longer part of their plan and this has nothing to do with the price of oil. The Feds could care less about that ... Ben can print as many dollars as he needs to buy barrels at $100, $150, $200, $500, whatever. "Control" of ME oil is also less of a concern when nobody can afford (or be permitted) to drive any more and all manufacturing has been driven offshore. Domestic US oil sources will be adequate to drive all the machinery on the cotton and soy plantations.

23 countries have so far been deemed to be recently debasing their currencies. I haven't looked any further than the headlines yet, but I would assume that all those currencies are controlled by the same central banking cartel ... and therefore with a single objective in mind that has nothing to do with "protecting a local currency against the dollar".

This is all to do with a coordinated effort to destroy credibility in the present currency mix and attempt to introduce a single centrally controlled global currency as a "solution to the crisis of confidence" ... which will more than likely be an electronic currency backed by some fictitious manipulated entity like an SDR. If it is an electronic currency, then an international ID system will ensure that all slaves worldwide (at least in the developed countries, initially) will be "branded" with some form of ID that will enable tracing and taxing every single transaction. It would also mean that they can instantly withdraw the means of spending this so-called "money" anywhere and anytime they like!

thermroc's picture

Does anyone really still believe they're in control of this shit can?

The wheels are off, the axles sparking and bare arses are dangerously close to the tarmac.

Do you really think they give a fat rat's about their mission objectives in ME? Smell the wind dude, it's going down.

Man I'll bet there were guys in Moscow, Christmas '89, saying "does a strong rouble or weak rouble policy help the USSR achieve its mission objectives with regard to control of ME oil?"

Get a fucking clue dude. Go buy some gold.

pitz's picture

Yup.  Lots of juniors, however, are in bubbles compared to the seniors. 

Brutlstrudl's picture

Yeah, they went up with the rest of the market. I'm betting they will come down into a buying op. keep some powder dry. and keep your physical in a deep hole. Gold and Silver, Bitchez

cowdiddly's picture

Gold Stocks? Nah I think Ill just buy the real deal.

traderjoe's picture

Yes. Owning gold stocks means you are still reliant on the FRN-based system. Buying gold means you can transact outside of it (if need be). 

anvILL's picture

I'm with you. Buying gold stocks is more likely to be profitable from here, and I do own some. But it doesn't cast a vote against the current system while buying physical does.

MeTarzanUjane's picture

Ok, before I read this I'm going to clear my mind. I have a feeling it's going to be utter nonsense but I will try to make my way through it without punching my LCD monitor because they are getting expensive and time consuming to replace.

Here goes.

i-dog's picture

You really should be using Twitter to tell all your imaginary friends what you are doing next. We couldn't give a fuck!

Stop wasting space and bandwidth on this blog with your twitterish comments, you twit!

ihedgemyhedges's picture

Yet the same applies to "companies with operating earnings from abroad", correct?  A weak dollar is "good" for them, right?  So why isn't a weak dollar "good" for gold and gold stocks?  And to the rest of you, no, you can't eat gold.  No, you can't eat gold stox.  No, you can't eat shares of AAPL.  No, you can't eat shares of IBM, even the repurchased ones........You can't even eat wheat futures, unless you take physical delivery and then grind it up to make bread...............

THE DORK OF CORK's picture

Its easy for Sprott to look Olympus like down on goverments devaluation attempts - but there is huge disequilibrium between the holders of debt and Labour - debt has squeezed out all Labour and has stifled capital development in areas where there is still residual excess demand.

This has created the absurd globalism we see today of shipping vast amounts of commodities and capital and its accompanying labour. 

My only problem is that they are making the mistake of devaluing against each other rather then money - this is happening by default rather then design.

This so called capitalism is really a creature of the CBs attempt to keep down the price of fiat against Gold and really nothing else - this creates internal  vacuums that are filled by debt money that exploit Labour and resources without paying for economic externalities

thermroc's picture

I think you're right, and I think Shanghai Cooperation Organization think you're right.

Expect Russia and China to implement massive devaluation against gold, blowing up West in the process. Revenge is sweet.

Gloomy's picture

I own mining stocks-but I fret alot. When crap really hits the fan and prices go through the roof, these babies will be nationalized by bankrupt governments. I hope to get out in time. But I sure am worried. For that concern, I have some physical.

MiguelitoRaton's picture

I've thought about this as well. There are many factors like location (Canada probably won't screw the US), what the US does (if we nationalize others will follow), long-term repercussions (South American miners/countries may not nationalize for fear of an aircraft carrier showing up on their coast or merely be starved of capital and having the foreign companies pull-out and trade dwindle). I don't think such an action will be taken lightly. It would require a real shitstorm to cause rampant nationalization (outside of a few like Venezuela). In Mexico, you might worry about narco terrorists taking over mines, but the government would not want to lose all of the capital investment for future mines that is required and the jobs that they would also lose in the process. But yes, if it gets REALLY ugly like $10K/oz. then all bets are off on nationalization. Now that said, the governments could start imposing resource taxes (windfall profits taxes) of say 50% of gross, which is tantamount to nationalization. As we start approaching that point, it would be wise to start converting from mining shares to physical, or even productive land...

MeTarzanUjane's picture

I knew a real goldbug once and I asked him if he'd fuck his own mother if it moved the price of gold up $10/oz. He said he was going to buy a 500 count bottle of Viagra.

RockyRacoon's picture

Apparently going back and reading the article didn't clarify anything for you.

MiningJunkie's picture

Who has made more money over the past ten years other than Eric the Great?

As for the S&P versus gold, the Manipulators have been managing the S&P consistently (to the upside) while failing to manage gold (to the downside). Take out the manipulation and you have a 700 SPX against a $5,000 gold price.

Long live Eric the Great!

Gloomy's picture

When is he gonna get his silver etf started?

Geoff-UK's picture

Gold is up, PHYS not so much.

I like Eric Sprott, but don't trust him to deliver my AU on demand as much as I trust myself to already have it in my floor safe.

midtowng's picture

I finally sold my PHYS. I didn't like its movements compared to gold.

I'm sticking with CEF.

traderjoe's picture

I've read some of the online criticisms of PHYS. Doesn't seem that shareholder friendly to me. Don't know why people would pay a premium for it...

Geoff-UK's picture

Good luck getting your gold from anyone "holding it for you' when price does a moonshot.

Gordon Freeman's picture

While I like gold as much as anyone, it is this kind of lazy, made-up, bullshit "analysis" that gives the naysayers their ammo.  WTF is this "production cost" happy horseshit?? Let's see, let's plug in $500, and a $300 fudge factor, and presto! instaprofits!  When gold was at $600, they would plug in $250, etc.  It's all complete bullshit, in a very crooked industry, run by criminals.

The only reason needed to buy gold and the miners is that fiat currency is doomed, and miners stocks will be dragged along for the ride (although they will do their damnest to try to fuck it all up)

Snidley Whipsnae's picture

The estimated shortage of physical gold in unassigned accounts at bullion banks is ~20,000 tons. The shortage may be more or it may be less but that there is a large shortage of physical gold is beyond question, proven by CFTC testimony and some more recent revelations.

If a mere 10% of those with unallocated accounts at bullion banks were to suddenly demand physical delivery the LBMA and CFTC would collapse and the price of physical would go ballistic.

Has anyone other than me noticed that the SCO (Shanghai Cooperative Organization) is almost never mentioned in any press releases, and seldom mentioned on the internet? Back when the SCO was formed the US asked to be invited as a 'non participating' observer and was denied.

Perhaps this is why;

"As well as these problems there is growing evidence of disruptive intent behind the gold policy of the ex-communist nations. I recently covered this in an article that tied in the relationships of the Shanghai Cooperation Council. In that article I pointed out that the substantial majority of today’s gold-buying nations are members of, or are associated with this organisation. As if to confirm these fears, in the last few days Iran, which is an associate member of the SCO, announced it is now buying gold. Furthermore, China is restricting the export of rare earth metals, which with the energy policies emanating out of the SCO membership, has the appearance of a coordinated attack on the Western economic system. If such a conspiracy exists, gold is central to it."


DosZap's picture


"If a mere 10% of those with unallocated accounts at bullion banks were to suddenly demand physical delivery the LBMA and CFTC would collapse and the price of physical would go ballistic."

Unless I am incorrect an Unallocated account has no standing in recieving PHYSICAl.

You can cash out,but not demand physical.

Have to be allocated for that.

Snidley Whipsnae's picture

Right, my bad. I meant to say allocated accounts, and some with allocated accounts have been moving their physical gold recently.

OTOH, how much unallocated gold has been 'leased out' at low interest, sold by bullion banks, and is now gone missing? How would the bullion banks come up with, oh, 20,000 tons of gold in today's markets to replace the unallocated gold that they have 'leased' or sold?

lawrence1's picture

You might want to read fofoa´s latest post about oil and gold in which he describes in detail how the House of Saud have been replacing their oil with gold for decades and now the bullion and central banks have leased their gold probably many times over. Maybe more than just the LMBA and Comex are in deep shit.  And dont they deserve it.

DosZap's picture

Might wanna read what the HEAD Sheik said about PEAK OIL also.

He said no way Jose'.

One well, largest in world has had 70 Billion Bbls taken out, he stated it had another 80 Billion plus left.

ONE well.

So, he said, forget peak oil, as we have way more than needed.

Snidley Whipsnae's picture

Thanks, I have been following FOFA for some years and am aware of 'Another's' comments regarding oil and gold never flowing in the same direction.

The Saudis suddenly 'discovered' a few months ago that they had more than twice as much gold in their possesion than they previously announced. Surley a simple oversight. :)

I would not be at all surprised to hear that the Saudis have more gold than all the central banks in the world combined.

I do believe that the arrangement worked out between the Saudis and the US consisted of some US military protection, some Saudi acceptance of fiat dollars for oil, and some gold for oil. I believe that is pretty close to FOFA'S conclusion and I find it credible.

working class dog's picture

The long only ETF's , GLD, SGG, USO all are examples of investment institutions who are speculators not BONAFIDE HEDGERS, are forcing the purchase of the underlying commodities, and thereby forcing the price up. Self fullfilling prophecy, how do you say tulip bubble in Gold. By the way the Fed has REDUCED ITS BALANCE SHEET, in case anybody is interested. Too much talk of Printing money, only tells me the crowd is wrong in the short term and we are due for a reaction exactly opposite to what the money printing crowd is saying. Just an observation.

Snidley Whipsnae's picture

Do you think the Fed is going to try to strengthen the dollar against other fiat currencies?

Do you think that the Fed is going to stop purchasing treasury issues, increase overnight interest rates, and let interest on treasuries rise in general?

BTW, the Fed reducing it's balance sheet when the velocity of money is very low has little effect on the economy. The Keynesians have found that out in spades. Excess reserves have found their way into other economies, causing inflation abroad. 

If the Fed raises interest rates what do you predict for the housing industry?

This Hussman article might be of interest to you:

"In either case, the hallmark of a liquidity trap is that holdings of money become "infinitely elastic." As the monetary base is increased, banks, corporations and individuals simply choose to hold onto those additional money balances, with no effect on the real economy. The typical Econ 101 chart of this is drawn in terms of "liquidity preference," that is, desired cash holdings, plotted against interest rates. When interest rates are high, people choose to hold less cash because cash doesn't earn interest. As interest rates decline toward zero (and especially if the Fed chooses to pay banks interest on cash reserves, which is presently the case), there is no effective difference between holding riskless debt securities (say, Treasury bills) and riskless cash balances, so additional cash balances are simply kept idle."

In addition:


A related way to think about a liquidity trap is in terms of monetary velocity: nominal GDP divided by the monetary base. (The identity, which is true by definition, is M * V = P * Y. The monetary base times velocity is equal to the price level times real output).

Velocity is just the dollar value of GDP that the economy produces per dollar of monetary base. You can also think of velocity as the number of times that one dollar "turns over" each year to purchase goods and services in the economy. Rising velocity implies that money is "turning over" more rapidly, so that nominal GDP is increasing faster than the stock of money. If velocity rises, holding the quantity of money constant, you'll observe either growth in real output or inflation. Falling velocity implies that a given stock of money is being hoarded, so that nominal GDP is growing slower than the stock of money. If velocity falls, holding the quantity of money constant, you'll observe either a decline in real GDP or deflation.

The belief that an increase in the money supply will result in an increase in GDP relies on the assumption that velocity will not decline in proportion to the increase in money. Unfortunately for the proponents of "quantitative easing," this assumption fails spectacularly in the data - both in the U.S. and internationally - particularly at zero interest rates.

working class dog's picture

Another  thought from an amateur economist and private investor (myself)

The fiat currency system is here to stay, there may be adjustments to it here or there, but it is here to stay. The gold standard doesn't work, it causes wars, and reduces incentives to develop economies. Granted if allowed to run out of control or be co-opted by wealthy special interests, the majority of the people get hurt with a fiat system. People get hurt in the  gold system as well. The USA expanded it's economy due to expansion of real value credit. We increased our standard of living to the highest in any recorded history due to real value credit expansion. We don't need a Black George Bush in the white house. We don't need media hyped idiots like Sarah Palin, what we need is a man like Davey Crockett or Ella Grasso (past Governor of Ct.), or a women like Eleanor Roosevelt as president.  To get there we need $10.00 per gallon gas, and no jobs. Than we will pull the real leaders from the depths of our 250 million. This is what it will take. Look around the world the ecomonies are coming back. It takes time, and I think zero hedge should investigate the Fed Balance Sheet is shrinking not rising , because the Fed is also selling other assets and allowing certain liquidity programs to expire.

Snidley Whipsnae's picture

"real value credit" = demand pulled forward at the cost of interest on the borrowed funds for the demand. At some point, and we are nearing it, the interest paid on demand pulled forward becomes a huge drag on the economy. We are there!

The fiat debt based money system is a total catastrophy and will not continue.

"We increased our standard of living to the highest in any recorded history due to real value credit expansion"

Our standard of living rose because we were borrowing money from the future. Money that we had not earned, both in the public and private sectors. Now we are too deeply indebted to ever repay what we owe in constant dollars. So, we will inflate the dollars away to near nothingness or will outright default on our obligations.

Shrinking or rising Fed balance sheet is meaningless when at ZIRP and the velocity of money is stagnant. See Hussman post in my other comments.

I do not understand your comments about politicians. Pols have little to say except what they are told to say by bankers.

"We are coming back" Coming back to more of the same that got us here?

The dollar has been mismanaged almost out of existance. Gold is not rising in purchasing power, the dollar is falling. To stop the rise of gold against the dollar means the Fed/treasury have to raise interest rates to strengthen the dollar. To raise interest rates is to crash the US economy and the banking system. We will soon see if they have the nads to go for higher interest rates.


A_MacLaren's picture

Eric may not be considering that investors actually foresee something much worse on the horizon.

A situation wherein digital claims on ownership are discounted to physical holdings.