Money Supply

John Williams, president of the San Francisco Fed, yet another noted dove, thinks nothing can go wrong by printing gobs of money. There is no inflation, and there never will be. They have the 'tools' to avert it. Never mind the explosion of the money supply over the past four years – it is all good. Have no fear though, as Williams notes: "Once it comes time to exit its super-easy monetary policy, the Fed will target a 'soft landing,'" The hubris of these guys is jaw-dropping. We are struck by the continued refusal by Fed officials to even think for a second about the long range effects of their policies. In the meantime, money printing continues to undermine the economy. Wealth cannot be generated by increasing the money supply – all that can be achieved by this is an ephemeral improvement in the 'data' even while scarce capital continues to be malinvested and consumed.

Turkey’s trade deficit has been shrinking and the country has enjoyed the best bond rally in the emerging markets this year due in part to the contributions of airline passengers transporting gold in their baggage. Statistics from Istanbul’s 2 main airports show $1.4 billion of precious metals were registered for export in September.  Iran is Turkey’s largest oil supplier and Turkey has been paying for the oil not only with liras but also with gold bullion. Turkey exported $11.7 billion of gold and precious metals since March, when Iran was barred from the Society for Worldwide Interbank Financial Telecommunication, (Swift) making it nearly impossible for Iran to complete large international fund transfers. Of the $11.7 billion, $10.2 billion or 90% was to Iran and the United Arab Emirates, according to data on Turkey’s state statistics agency’s website. Turkey’s current account deficit is second in the world at $77.1 billion or 10% of GDP while the US currently holds the top spot.   The problem with Turkey switching from a net importer to a net exporter of gold bullion this year is that the foreign trade data is misrepresented. Turkey’s use of precious metals is a key factor to help turn around its nation’s current junk bond rating status.

With the US elections approaching next week, as well as the threat of another fiscal cliff showdown looming, we look at how the expansive Central State has come to dominate both private society (i.e., the community) and the marketplace, to the detriment of the nation’s social and economic stability. We examine six critical dynamics that will lead to the devolution of Peak Government. "Governments, desperate for more revenues, ignore public resentment and loss of trust, which only deepens the disconnect between those in government and the public.  And the private citizenry sees a lack of accountability, soaring public debt, accounting trickery, political dysfunction, and mal-investment of public funds as the hallmarks of their government."

With the unlimited asset purchase announcements by the Fed and ECB recently, the limits of balance sheet expansion will be put to the test. The current levels would have been seen as inconceivable a mere few years ago and now it seems business-as-usual as investors have become heuristically biased away from the remarkable growth. The problem is - central banks are missing inflation targets and credit growth is still declining - need moar easing, forget the consequences.

Two of the saving features that allowed Japan to internalize 30-some years of failed fiscal and monetary policy (and yes, not one, not two, but now 8 failed iterations of quantitative easing) and to offset one relentless deflationary vortex was i) its demographics coupled with an investing culture that favors deposits and bonds over equities, which incentivized its aging population to invest its savings into government bonds, and ii) its trade surplus which led to foreign capital flows to enter the country. Well, as far as i) is concerned, Japan may have reached its demographic limit, since as reported several months ago, Japan's pension funds are now not only selling JGBs to meet redemption and cash needs, but forced to do truly stupid things like investing in the riskiest of assets to generate a return at any cost. In other words, demographics will no longer be a natural source of demand for deficit funds. As for ii), well... here is what has happened with Japan's trade surplus status in recent weeks following the collapse in the country's foreign relationship with China.

While regional independence is superior to both the failing European Union and the façade of special interest controlled democracy, one further action should taken by any jurisdictions that choose secession: Newly restored sovereign nations should repudiate their share of the illegitimate sovereign debt when they exit existing unions and nation-states. Created by distant banking elites buying national politicians and parliaments to load up on sovereign debts that can never be paid off, this massive national debt load is illegitimate and destructive to existing and new national economies. Governments have three ways to deal with debt loads of this magnitude: The first is hyperinflation designed to destroy the payoff value of the debt, second is the official repudiation of the debt or third, a combination of both options. Attempting to hold the bankers accountable is not an option. The first nations to repudiate sovereign debt will have the advantage; and as nations undertake this endeavor, they should keep this in mind: All government bureaucracies grow until contained, taxes rise until curtailed and politicians borrow and seek power until thrown out of office.

Debt.  There isn't a day that passes as of late that the issue of debt doesn't arise.  Federal debt and consumer debt (including mortgages) are of the most concern due to its impact on the domestic economy.   Debt is, by its very nature, a cancer on economic growth.  As debt levels rise it consumes more capital by diverting it from productive investments into debt service.  As debt levels spread through the system it consumes greater amounts of capital until it eventually kills the host. The problem is that during a “balance sheet” recession the consumer is forced to pay off debt which detracts from their ability to consume.   This is the one facet that Keynesian economics doesn’t factor in. It’s time for our leaders to wake up and smell the burning of the dollar – we are at war with ourselves and the games being played out by Washington to maintain the status quo is slowing creating the next crisis that won’t be fixed with monetary bailout.

The International Monetary Fund’s paper, “The Chicago Plan Revisited” by Jaromir Benes and Michael Kumhof highlighted a means to wipe out debt by legislation by using state created money to replace the private banking system and was commented on in The Telegraph by journalist Ambrose Evans-Prichard. The full paper can be read here. In sum, the paper illuminates on a plan created in 1936 by professors Henry Simons and Irving Fisher during the aftermath of the US Depression. It examines how money  created by credit cycles leads to a damaging creation of wealth.   Authors, Benes and Kumhof argue that credit-cycle trauma - caused by private money creation – has been around forever and lies at the root of debt catastrophes as far back as ancient Mesopotia and the Middle East. They claim that not only harvest cycles lead to defaults but rather the concentration of wealth in the hands of lenders would have augmented the outcome.

Once again confusion is rife overnight, following yesterday's main European event, Spain's first "mixed" regional election, which saw Rajoy's PP party in his home state of Galicia eeking a majority by a few seats, offset by wins for nationalist parties in the Basque Country. The immediate read here is that the Galician win is an endorsement of Rajoy's "austerity poilicies" and thus EUR positive (which have yet to be actually implemented as Spanish spending continues to rise, as tax revenues continue to drop), yet it makes the likelihood that Spain requests a bailout before the Spanish regional election on November 25, which is about secession, virtually nil, and thus SPGB negative. Furthermore as Bank of America points out "some euro-area govts may remain reluctant to support Spain’s request as long as yields continue to be low, banks haven’t been recapitalized; probably reinforced by Catalonia elections" but that is a reality tale for another day - the "market" can only handle so much.

Readers may recall that Ron Paul once surprised everyone with a seemingly very elegant proposal to bring the debt ceiling wrangle to a close. If you're all so worried about the federal deficit and the debt ceiling, so Paul asked, then why doesn't the treasury simply cancel the treasury bonds held by the Fed? After all, the Fed is a government organization as well, so it could well be argued that the government literally owes the money to itself. He even introduced a bill which if adopted, would have led to the cancellation of $1.6 trillion in federal debt held by the Fed. Of course the proposal was not really meant to be taken serious: rather, it was meant to highlight the absurdities of the modern-day monetary system. In a way, we would actually not necessarily be entirely inimical to the idea, for similar reasons Ron Paul had in mind:  it would no doubt speed up the inevitable demise of the fiat money system. Control can be lost, and it usually happens only after a considerable period of time during which their interventions appear to have no ill effects if looked at only superficially: “Thus we learn….to be ignorant of political economy is to allow ourselves to be dazzled by the immediate effect of a phenomenon."

Even though we have presented comparable scenarios looking at the coverage of the US money base in gold terms previously, aka "gold coverage" ratio, including once from Dylan Grice, and once from David Rosenberg, now that we have drifted into a new, previously unchartered and very much open-ended liquidity tsunami, it is time to revisit the topic. Luckily, Guggenheim's Scott Minerd has done just that. Not only that, but he presents three distinct gold pricing scenario, attempting to forecast a low, medium and high price range for the yellow metal. To wit: "The U.S. gold coverage ratio, which measures the amount of gold on deposit at the Federal Reserve against the total money supply, is currently at an all-time low of 17%. This ratio tends to move dramatically and falls during periods of disinflation or relative price stability. The historical average for the gold coverage ratio is roughly 40%, meaning that the current price of gold would have to more than double to reach the average. The gold coverage ratio has risen above 100% twice during the twentieth century. Were this to happen today, the value of an ounce of gold would exceed $12,000.” 

One way or another, change is coming. 

"Liquidity trap" was a term coined by John Maynard Keynes in the aftermath of the Great Depression. He argued that when yields are low enough, expanding money supply won't stimulate growth because bonds and cash are already near-equivalents when bonds pay (almost) no interest. Some, like Citi's credit strategy team, would say that it is a pretty apt description of the state of play these days. To their minds (and ours), there is very little doubt that central banks have played an absolutely crucial role in propping up asset prices in recent years, Why have markets responded so resolutely when growth hasn't? The answer, we think, is that in their attempts to free markets from the liquidity trap, central banks are ensnaring markets in what we'll call a "liquidity lure". That lure is three pronged... but tail risks are bound to re-appear and from this position, there is no painless escape.

Last week Dennis Gartman, in his homonymous letter said that he was concerned about the fact that the adjusted monetary base has been falling, rather than rising, taking away the bullish case for gold on the topic of “money printing”. One must therefore remind those with this concern that the credit expansion caused by the backstop of the Fed alone is enough to inflate asset prices. This is consistent with the case we made in our last letter, that a commodity based standard is not as relevant as having a 100% reserve requirement. By the same token, if the reserve requirement is below 100%, it is not that relevant to see the expansion of the monetary base! The “printing of money” will eventually come, when EU corporations begin to default and the Fed has to “ensure there is enough US dollar liquidity”. It happened in 1931-33, in spite of the fact that the adjusted monetary base had been contracting since 1929: The US dollar was devalued from approx. $20.65/oz to approx. $34.70oz and gold was confiscated.