Purchasing Power

In the past months and right after implementing Quantitative Easing Unlimited Edition, the Fed began surfacing the idea that an exit strategy is at the door. With the latest releases of weak activity data worldwide, the idea was put back in the closet. However, a few analysts have already discussed the implications of the smoothest of all exit strategies: An exit without asset sales; a buy & hold exit. We have no doubt that as soon as allowed, the idea will resurface again. Underlying all official discussions is the notion that an exit strategy is a “stock”, rather than a flow problem, that the Fed can make decisions independently of the fiscal situation of the US and that international coordination can be ignored. This is logically inconsistent as we address below...

Over the years, Jim O'Neill, former Chairman of GSAM, rose to fame for pegging the BRIC acronym (no such luck for the guy who came up with the far more applicable and accurate PIIGS, or STUPIDS, monikers, but that's neither here nor there). O'Neill was correct in suggesting, about a decade ago, that the rise of the middle class in these countries and their purchasing power would prove to be a major driving force in the world economy. O'Neill was wrong in his conclusion as to what the ultimate driver of said purchasing power would be: as it has become all too clear with the entire world drowning in debt (and recently China), it was pure and simply debt. O'Neill was horribly wrong after the Great Financial Crisis when he suggested that it would be the BRIC nation that would push the world out of depression. To the contrary, not only is the world not out of depression as the fourth consecutive year of deteriorating economic data confirms (long since disconnected with the actual capital markets), but it is the wanton money (and bad debt) creation by the central banks of the developed world (as every instance of easing by China has led to an immediate surge of inflation in the domestic market) that has so far allowed the day of reckoning, and waterfall debt liquidations, to take place (and certainly don't look at the stock index performance of China, Brazil, India or Russia). Despite his errors, he has been a good chap having taken much of the abuse piled upon him here at Zero Hedge somewhat stoically, as well as a fervent ManU supporter, certainly at least somewhat of a redeeming quality. Attached please find his final, farewell letter as Chairman of the Goldman Asset Management division, as he moves on to less tentacular pastures.

We have commented numerous times on the inexorable rise in Spanish non-performing loans (NPLs). Since the Spanish economy started to weaken at the end of 2006, NPLs have been rising sharply; but the subsequent collapse of the Spanish property market exacerbated the matter further, causing a spike in NPLs in 2007 and 2008. Since then, the Euro area crisis and subsequent sharp rise in unemployment have led NPLs at Spanish banks to make new record highs. However, they are not alone. Italian banks did not suffer a property market collapse and so the rise in NPLs started later than in Spain and was not as severe. However, as JPMorgan notes, the sharp rise in unemployment we have seen since mid 2011 has led to an acceleration in NPLs at Italian banks. What should be most worrying for incoming PM Letta, is that from the respective troughs for each country (the trough for Spain was a lot earlier than for Italy, about two years in actual fact), Italy is looking eerily similar. The rise in NPLs at Spanish banks over the past two years has had a lot to do with the recession and rise in unemployment. To the extent that Italian unemployment has only started to rise sharply a year and a half ago, the future path for NPLs at Italian banks looks set to follow that of Spain. So why aren't bond spreads blowing wider? Answer below...

We recently showed 220 years of US Treasury bond yield history but all too often, the average investor is unfortunately unaware of the relationship between bond yields (interesting on a relative-value perspective) and bond prices (the thing that matters for your portfolio's returns). The two measures are inextricably linked obviously (a higher yield implies a lower price and vice versa) but the relationship is not a straight line - it has 'convexity'. The following charts may help understand the upside-downside changes from 'yield' movements, what the Fed is doing to the relationship, and how inflation expectations impact these changes.

The crypto-currency Bitcoin is still merely a speck on the global monetary landscape. It is young, experimental, and for all we know, it may ultimately fail to break into the monetary mainstream. However, on a conceptual level some are willing to call it a work of genius and arguably the most exciting development in the field of money for more than 130 years. The outcome is probably binary: Either Bitcoin ultimately fails and the individual Bitcoins end up worthless. Or Bitcoin takes off and Bitcoins are worth hundreds of thousands of paper dollars, paper yen, paper euros, or paper pounds. Maybe more. Those who buy Bitcoin as a speculative investment should consider it an option on the future success of the crypto-currency. We still consider gold to be the essential self-defense asset in the ongoing paper money crisis. The brand-new crypto-currency Bitcoin has to first earn its stripes as a monetary asset by proving itself as a ‘common’ medium of exchange. That is why we view Bitcoin very differently from gold, although the attraction of both has its origin in the demise of entirely elastic, politicized state fiat money. In the meantime, the debasement of paper money continues.

The political class set in motion the eventual obliteration of our economic system with the creation of the Federal Reserve in 1913. Placing the fate of the American people in the hands of a powerful cabal of unaccountable greedy wealthy elitist bankers was destined to lead to poverty for the many, riches for the connected crony capitalists, debasement of the currency, endless war, and ultimately the decline and fall of an empire. The 100 year downward spiral began gradually but has picked up steam in the last sixteen years, as the exponential growth model, built upon ever increasing levels of debt and an ever increasing supply of cheap oil, has proven to be unsustainable and unstable. Those in power are frantically using every tool at their disposal to convince Boobus Americanus they have everything under control and the system is operating normally. Nothing could be further from the truth.

The paper price of gold crashed to $1,325 in the wake of this huge trade. It is now hovering around $1,400. Our first reaction is to suggest that this is only an aberration, and that the fundamentals of the depreciating value of paper currencies will eventually take the price of gold much higher, making it a buying opportunity. But what we can't predict is whether big players might again deliver short-term downturns to the market. The momentum in the futures market can make swings surprisingly larger than the fundamentals of currency valuation would suggest; but the fundamentals will drive the long-term market more than these short-term events. The fight between pricing from the physical market for bullion and that from the "paper market" of futures is showing signs of discrimination and disagreement, as the physical market is booming, while prices set by futures are seemingly pressured to go nowhere. In short, we think this is a strong buying opportunity.

"You will not see economic growth until you liquidate the debt and liquidate the malinvestment out there," is the hard truth that former Congressman Ron Paul lays on Bloomberg TV in this wide-ranging interview. Paul is concerned at "the erraticness of the dollar... and its devaluation," explaining that, "people think the gold price up and down is a reflection of something wrong with gold; no, I say it is something wrong with the dollar." The topic gravitates to inflation, which Paul explains is far from missing as, "Bond prices go up. Stocks are going up. Housing prices are starting to go back up again. Education costs are going up," adding that, "CPI is not reliable." Paul is buying gold, believes "we are in as much trouble as Greece," and while fascinated by the free market nature of Bitcoin, he notes that while he doesn't fully understand it, "if I can't put it in my pocket, I have some reservations about that."

That Congress has had aspirations on collecting sales tax on online purchases, which comprise an increasingly bigger portion of all retail sales in the US, in the past is nothing new. However, following last night's passage of the Marketplace Fairness Act in the Senate with a cloture busting 74 votes for (and 20 against), the US may be very close to finally adopting a uniform standard taxing all online transactions, regardless of physical jurisdiction or any other geographic boundaries. As Ars Technica reported last night, "your tax-free days of online shopping are numbered. If S743, also known as the Marketplace Fairness Act, becomes law, the millions of Americans who have been able to avoid sales tax online will have to start paying it. Given the broad support shown by today's US Senate vote, some version of it is likely to come to fruition."

Let's get down to the facts of the recent banker gold & silver paper price smash and the lies about the banker gold & silver paper price smash being propagated by the mass media and banking shills like Paul Krugman so everyone can understand why this smash will blow up in the face of the very bankers that executed it at some point down the road. Retail individuals AND global institutions all around the world are finally beginning to understand that physical ownership of gold and silver is how to counter banker fraud & intervention into the gold and silver markets and this realization is going to produce massive blowback.

Due to decades of unreserved credit growth that temporarily boosted the appearance of sustainable economic growth and prosperity, rational economic behavior cannot produce real (inflation-adjusted) economic growth from current levels. The nominal sizes of advanced economies have grown far larger than the rational scope of production that would be needed to sustain them. This fundamental problem explains best the current state of affairs: malaise (i.e., bank system de-leveraging and economic stagnation) spreading through the means of production and the need for increasing policy intervention to stabilize goods, service and asset prices (by depressing the first three and inflating the last?). We live and work in a contrived meta-economy that can be managed through narrow channels in financial and state capitals. Given the overwhelming past misallocation of capital cited above, we think the most important realization for investors in the current environment is that price levels of goods, services and assets may be biased to rise but they are not sustainable in real (inflation-adjusted) terms. The crowd is ignoring the obvious, as all signs point towards the next currency reset.

The main take away from events in Japan is that the BOJ shifted from a tactic of interventions (under former Governor Masaaki Shirakawa) to one of monetary policy (under current Governor Haruhiko Kuroda) . What strikes us is that the monetary policy is precisely to... well, destroy their money and in the process any chance of having a monetary policy. In our view, it was exactly because the Fed’s (undisclosed) intention was to engage in never ending Quantitative Easing, that Japan was forced to implement the policy undertaken by Kuroda. Coordination with the Fed was impossible. With Mr. Kuroda’s policy, we now have the BOJ with a balance sheet objective, the Fed with a labour market objective (or so they want us to believe), the European Central Bank with a financial system stability objective (or a Target 2 balance objective) and the People’s Bank of China (and the Bank of Canada) with soft-landing objective. It is clear that any global coordination in monetary policy is completely unfeasible. The only thing central banks are left to coordinate is the suppression of gold.

Here is Part 2 of my article “The Argument of Bitcoins v. Gold Laid to Rest, originally released at my blog, www.theundergroundinvestor.com on April 9, 2013. Yes, money that is real and tangible is really better than money that is just a digital valuation backed by air.

As we have been warning for a while now, Japan wanted inflation and is certainly getting it, just in all the wrong places. While Abe has been desperate to transfer the collapse in the yen and the (transitory) surge in the Nikkei to the all important increase in wages, and the much sought-after wealth effect, the reality is that corporate input costs are rising far faster than revenues, and wages will be the last thing profit and earnings-conscious companies raise. As for the Japanese consumer, trained by 30 years of deflation, any profits in the stock market will be promptly converted to cold hard cash and bank deposits which represents that vast majority of Japanese financial assets, which means a double whammy for companies who will also see a drop in sales volumes, crushing margins even more as a result. One company which could no longer tolerate soaring energy and food costs (both of which we described previously here and here), is McDonalds, and as the FT reports, the fast-food chain announced today that the price of its entry-level hamburger would increase by 20% from ¥100 to ¥120, while a cheeseburger would now cost ¥150 instead of ¥120.

It's time to go in for the kill. Buy as much physical Gold as you can.