The great day has come and gone when the Fed would once again ride to the action, not daring to be left behind by the ECB’s perverse vaunting of its new ‘unlimited’ programme of bond purchases. But the few, brief sentences from Bernanke contain such a miasma of error that it is hard to know where to begin if we are to restore a fresh breeze of economic rationale to this swamp of non sequiturs and wilful misunderstandings. It is not enough that crude, Krugmanite Keynesianism clings to the cheap parlour trick of using money illusion to fool unemployed wage-earners into lowering the reservation price of their labour, but now we must battle against banal, Bernankite Bubble-blowing – the hope that money illusion will fool cash-constrained asset owners instead. It is not only that Bernanke’s policies will inevitably assist the zombie companies and the obsolescent industries to absorb scarce resources (not least on bank balance sheets) to a much greater degree than is justified, there is also the danger that lax money misleads even today’s supramarginal businesses into over-estimating the depth and duration of demand for their products, ultimately undermining many otherwise sound undertakings and reducing these, too, when the cycle next turns, to the ranks of the Living Dead.
Global gold production remains at its level of the late '90s, even though prices have risen to over $1,700 per ounce from $252 per ounce in 1999 or roughly 16% per annum in dollar terms. Only Rio Tinto and Ivanhoe's Oyu Tolgoi mine in Mongolia stand out as a major new gold mines expected to begin production in the near future. Bulls note that global production has remained impervious to the price of gold. This may continue to be the case due to the increasingly obvious geological constraints being seen in the gold mining sector. Resource nationalism is beginning to become an important factor again. This will also almost certainly affect supply at a time when demand is increasing from people throughout the world and many hedge funds, pension funds and central banks’ due to geopolitical, systemic and monetary risks. The lesson of QE is that fiat currencies increasingly grow on trees. Gold does not. This is the primary reason that gold will continue to protect investors in the coming months.
Pump it up, until you can feel it, Pump it up, when you don't really need it...
Earlier this week, former U.S. president Bill Clinton gave the keynote address to the Democractic National Convention in an effort to lend some of his popularity to Barack Obama. With the unemployment rate still stubbornly high at 8.1%, Obama has lost many of the enthused voters who put him into the Oval Office in 2008. Clinton was tapped to deliver the speech not only because of his image of a wonkish pragmatist but because of his presiding over the booming economy of the late 1990s. Like a prized mule, Clinton was dragged out to give Democrats someone to point to and say that his policies were the hallmark of smart governance. Today, Clinton still takes credit for Greenspan’s manipulated boom. His supporters on the left love nothing more than to point at his presidency as vindication of the backwards theory that higher taxes equal more growth. Clinton wasn’t a policy wonk; he was a politician who dipped into the Social Security trust fund to give an appearance of balancing the budget while the national debt still climbed higher. Through all of his financial scandals, womanizing, aggressive foreign policy approaches, and possible cover ups, it is actually fitting that Clinton is still looked to by the political establishment as someone worthy of respect. He is representative of F.A. Hayek’s timeless lesson: in government the worst rise to the top and state power corrupts.
Simon Black recounts a recent experience as he pulled in to a gas station in Italy; he whipped out his American Express card and asked the attendant in broken Italian to turn on the pump. He acted like Simon had just punched him in the gut, wincing when he saw the credit card. "No... cash, only cash," he said. I didn’t have very much cash on me, so I drove to the next station where a similar experience awaited me. This is a trend that is typical when economies are in decline– cash is king. Businesses often won’t want to spend the extra 2.5% on credit card merchant fees... but more importantly, distrust of the banking system and a debilitatingly extractive tax system pushes people into cash transactions. You can’t really blame them.
If you haven’t heard yet, the committee which is drafting the platform for next week’s US Republican National Convention has announced that they are including a proposal to return to the gold standard. Big news. Remember, a gold standard is a monetary system in which individual currency units are fixed to an amount of gold held by the government; under a gold standard, the paper money supply cannot be expanded without also increasing the amount of gold on hand. At present, the market value of the federal government’s gold holdings only amounts to about $250 billion which constitutes a mere 2.5% of US money supply. Clearly one of the key risks in this scenario is that the US government would need to acquire as much gold as they can get their hands on, likely through Roosewellian-style gold confiscation, and if so - the safest place for your gold is going to be a snug safety deposit box in a place like Hong Kong or Singapore.
Money printing isn't creating inflation because the velocity of money has declined, right?
The lunatics are running the asylum. This is the only conclusion one can come to when considering the nonchalance with which what was once considered an extraordinary policy with a firm 'exit' in mind is now propagated as a perfectly normal 'tool' to be employed at the drop of a hat. We refer of course to so-called 'quantitative easing' (QE), which really is a euphemism for money printing. Apart from his sole focus on short term outcomes, an important point that seems not be considered by the FOMC's Rosengren this week is the question of what should happen if the 'open-ended' QE policy were to fail to achieve its stated goals. He seems to assume that it will succeed in lowering unemployment and creating 'economic growth' as a matter of course. It goes without saying that money printing cannot create a single molecule of real wealth. If it could, then Zimbabwe wouldn't be a basket case, but a Utopia of riches. We must infer from Rosengren's idea of implementing open-ended QE until certain benchmarks in terms of unemployment and 'growth' are achieved, that in case they remain elusive, extraordinary rates of money printing would simply continue until the underlying monetary system breaks down.
The easing of credit conditions (in other words, the enhancement of banks’ ability to create credit and thus enhance their own purchasing power) following the breakdown of Bretton Woods — as opposed to monetary base expansion — seems to have driven the growth in credit and financialisation. It has not (at least previous to 2008) been a case of central banks printing money and handing it to the financial sector; it has been a case of the financial sector being set free from credit constraints. Monetary policy in the post-Bretton Woods era has taken a number of forms; interest rate policy, monetary base policy, and regulatory policy. The association between growth in the financial sector, credit growth and interest rate policy shows that monetary growth (whether that is in the form of base money, credit or nontraditional credit instruments) enriches the recipients of new money as anticipated by Cantillon. This underscores the need for a monetary and credit system that distributes money in a way that does not favour any particular sector — especially not the endemically corrupt financial sector.
Expansionary monetary policy constitutes a transfer of purchasing power away from those who hold old money to whoever gets new money. This is known as the Cantillon Effect, after 18th Century economist Richard Cantillon who first proposed it. In the immediate term, as more dollars are created, each one translates to a smaller slice of all goods and services produced. How we measure this phenomenon and its size depends how we define money.... What is clear is that the dramatic expansion of the monetary base that we saw after 2008 is merely catching up with the more gradual growth of debt that took place in the 90s and 00s. While it is my hunch that overblown credit bubbles are better liquidated than reflated (not least because the reflation of a corrupt and dysfunctional financial sector entails huge moral hazard), it is true the Fed’s efforts to inflate the money supply have so far prevented a default cascade. We should expect that such initiatives will continue, not least because Bernanke has a deep intellectual investment in reflationism.
For a presidential election taking place when the US debt/GDP has for the first time in 70 years crossed above 100%, in which over 50 million Americans collect food stamps and disability, in which M2 just crossed $10 trillion, in which total US debt is about to pass $16 trillion, and when total nonfarm employees in America (133,235,000) are the same as they were in April of 2005, it is quite surprising that economics has not taken on a more decisive role in the electoral debate. But while both candidates may, for their own particular reasons, not want to bring up the slow motion trainwreck that is the US economy now, in 4 years whoever is running for president will not be so lucky, because as the US debt clock shows, assuming current rates of progression, things are about to get far, far worse.
Two weeks ago we observed that the broadest money aggregate tracked by the Fed, M2, was less than $10 billion away from crossing the historic $10 trillion mark. As of this week, this number now officially has 14 digits for the first time ever, or $10,035,100,000,000 to be precise (technically the non-seasonally adjusted number crossed $10T last week, but for some reason bank deposits need to be seasonally adjusted, so waiting for the traditionally fudged data seemed appropriate). And we have a $50 billion increase in savings deposits, aka deferred buying power to those who still have the capacity to save, in one week to thank for putting $10 trillion in the rearview mirror.
Market-top economics could be an entire university course, if people cared enough about such phenomena. Most only consider the signs of a market top months or years after a crash when some unyielding economics researcher puts the pieces together. As human-beings we have developed an uncanny ability to rationalize what we know to be bad news and convince ourselves, "This time is different," despite the fact that it usually never is. In a previous article we provided analysis on economic/equity decoupling (cognitive dissonance) and showed that the economy as we know it cannot persist--we are either due for a literal gap-up in leading economic conditions, or we are due for a serious correction in US equities. With today's 5.4% slip in existing home-sales, let's go with the latter.
One used to describe how the Chinese economy is like (exactly who started saying that is no longer clear): a bicycle. Anyone with the experience of riding a bicycle knows that you can’t ride it too slowly, or else you fall over. There was a common belief that China has to grow at least at 8% annual rate (now the number seems to have come down to 7.5%), or there will not be enough jobs being created so that there will be social unrest, that kind of thing. We are not sure if we have ever had much faith in such theory. To our mind, the society has something seriously wrong if it requires 8% or more economic growth in order to keep it stable. And if this is true for China, the Chinese society is very wrong indeed (or perhaps the Chinese society has been seriously wrong with or without this implicit 8% requirement). Now, the Chinese government is now worried about growth (we won’t speculate if the government is panicking or not). Even if China successfully reflates its economy to 7-8% growth (via mal-investments in already over-capacity industries), we are genuinely not impressed if that is going to mean even lower return on investment and even lower corporate profit. That means we have come to an uncomfortable conclusion that China is just not the place we would like to be in, regardless of GDP growth.
According to the just released M2 update, the broadest publicly tracked monetary aggregate (because the Fed doesn't have enough money to keep track of M3) just hit $9,991.5 billion, a $43 billion increase from last week. In other words, this is the last week in which M2 is under $10 trillion. So enjoy it while the "complete lack of penetration" of the monetary base into broader monetary aggregates, and of the Fed's reserves so tightly locked up in bank vaults, is still only 13 digits (most of it comprising of bank deposits which of course represent no inflationary threat at all). Next week it will be a record 14 digits for the first time, and well on its way to surpassing the $15 trillion held in the deposit-free shadow banking system as the importance (and inflationary convexity) of the two is rapidly interchanged.