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Real Crash 2014
China
Posted by Peter Schiff on 02/06/2014 at 10:06 AM

Gold is the simplest of financial assets - you either own it or you don't. Yet, at the same time, gold is also among the most private of assets. Once an individual locks his or her safe, that gold effectively disappears from the market at large. Unlike bank deposits or stocks, there is no way to tally the total amount of gold held by individual investors.

I like to call this concept "dark gold." This is the real, broader gold market that exists below the surface-level transactions on the major exchanges. It's impossible to know precisely how much dark gold exists around the world, but we do know that it is enough to render "official" gold holdings insignificant. That's why I don't buy and sell gold based on the decisions of John Paulson, or even J.P. Morgan Chase. It is a long-term investment that requires a deep understanding of the nature of money - and how little Wall Street's media circus really matters.

Observing Dark Gold

Think of dark gold like dark matter. Dark matter is a mysterious substance that scientists hypothesize is an essential building block of our universe. All we know is that the universe is a certain size and that a huge amount of its mass is unobservable - this is what we've come to call dark matter.

We haven't yet looked directly at dark matter. We can only observe phenomena that suggest there is a substance we aren't seeing and can't quite measure.

Likewise, dark gold is an essential building block of global financial stability. But the extremely private nature that makes it so valuable also makes it nearly impossible to directly observe.

But every now and then, we get a glimpse into the hidden undercurrents of dark gold. In the past year, the Federal Reserve slipped up in a big way and momentarily poked a hole that we can peek through to see what's happening with some of the largest stores of dark gold in the world.

Gib Mir Mein Gold!

A year ago, the big news was that the Bundesbank, Germany's central bank, would begin the process of repatriating a portion of its foreign gold reserves, including 300 metric tons stored at the New York Federal Reserve Bank. 

The controversy really started in late 2012, when Germany simply wanted to audit its gold reserves at the Fed. They were denied this access, so the Germans switched their approach. If they weren't allowed visitation with their holdings, they would instead demand full custody. In response, the Fed said it would oblige - within seven years!

As of the end of 2013, a Bundesbank spokesman reported that only 5 tons had been transported from New York to Germany so far, leaving the repatriation far behind schedule.

"But wait," some might argue, "the repatriation process might be delayed, but we know the gold is there. Central bank holdings constitute the most visible gold in the world. These institutions report their holdings to the world regularly. The gold at the Fed isn't dark gold at all!"

If this is a true and certain fact, then why was the Bundesbank denied a third-party audit of its gold in the Fed's vaults? The closest we've seen was an internal audit by the US Treasury last year. Of course, the US government holds the sovereign privilege of answering to no one but itself, but that hardly makes for reassuring statistics on which to base one's investments.

Golden Distractions

The truth is that we have no clue of the official gold reserves of any central bank in the world. All the Fed has to do to convince me otherwise is let an outside party into its vaults and count the gold. They've shown lots of paper; now show us the money!

It is very simple to count bars of gold where they exist. And it is clearly moral (and generally good business) to return assets that are held in trust when the creditor demands them. The Fed's reluctance on both counts suggests that there is more to this story than meets the eye.

Fortunately, the veracity of the Fed's claimed gold holdings has little bearing on the long-term precious metals investor. It's the same with gold futures contracts and the daily spot price. These have no effect on whether or not you have a chest of real money buried in your backyard.

So why is it important that intelligent investors do keep some gold "buried" in their possession? Germany's repatriation scandal begins to answer this question. The maneuverings of the New York Fed are like the patter and flourish of a magician - it distracts you from the real trick being played.

Or, in this case, where the most impressive piles of dark gold reside.

China Going For Gold

I'd bet that Western central banks are very pleased that the media has latched onto the dustup between Germany and the Fed. It means they are paying much less attention to the massive unreported stores of gold that many observers believe China has been accumulating, and which could have dire repercussions for the US dollar reserve system.

China last reported its gold reserves in 2009, clocking in at 1,054 metric tons. In the official rankings, this makes China's reserves the sixth largest in the world. Germany comes in second with 3,387 metric tons (or so they hope), and all nations trail the United States' claimed 8,133 metric tons.

Many speculate that China's reserves have grown far beyond its official number in the past five years. However, the People's Bank of China (PBOC) is playing its cards close to its chest.

Last year, a deputy governor of the PBOC tried to convince the world that its reserves have not changed much since 2009. He explained that the Chinese government is keeping a limit on its gold reserves, because "if the Chinese government were to buy too much gold, gold prices would surge, a scenario that will hurt Chinese consumers."

But a quick look at the numbers coming from the Chinese government shows that they just don't add up. 

China is the largest producer of gold in the world, pulling an estimated 437 metric tons of gold from the earth in 2013 - way more than runner-up Australia, with only 259 metric tons.

On top of this, China imported far more gold than any other country in the world in 2013. Via Hong Kong alone, China imported 1,158 metric tons of gold last year - a more than 107% increase from 2012.

This gold is not leaving the country in large quantities. Sure, China is the biggest exporter of gold jewelry to the Western world, but the value of these trinkets is negligible compared to the thousands of tons of bullion they are creating and importing.

Jim Rickards has estimated that China has probably added at least 1,000 metric tons to its reserves every year since 2010, meaning it has well over 4,000 metric tons today.

This is a conservative estimate. Wikileaks documents claim that China actually imported more than 2,000 metric tons from Hong Kong in 2011 alone.

If this is the case, when China does finally reveal how much gold it's holding, it will leap from the sixth largest reserves in the world to the second, easily surpassing Germany in a single bound. 

They might even give the US a run for its money.

Out From Under

It's no longer a secret that China would prefer a "de-Americanized world." Whether it's the PBOC or average Chinese consumers hoarding all this dark gold, the effects will be the same when China decides it is fed up with the funny-money central banking system long dominated by the US dollar.

It certainly seems like the East is preparing for this endgame. Several new physical gold vaults have opened in Singapore in the past year, Moscow recently launched a spot gold exchange, and Dubai is planning a new spot gold contract for this year. Let's not forget that the Hong Kong Exchange bought the London Metals Exchange in 2012, and there have been rumblings of physically moving it to Hong Kong.

If China were to initiate a gold-backed currency attractive to international trade partners, its government and citizens are poised to become extremely wealthy and powerful overnight. Americans, on the other hand...

Are You Afraid of the Dark?

Some investors avoid the gold market because of its innate unofficial nature. But in a time when governments are in a race to tax anything that moves and inflate anything that prints, gold's privacy becomes the difference between preserving wealth or facing destitution.

I challenge my readers to worry less about the short-term movements in the gold futures market, or even which central bank has what holdings. Understand that gold is a deep, global market that has witnessed the rise and fall of countless empires. Your decision is simple: you either own it, or you don't.

Peter Schiff is Chairman ofEuro Pacific Precious Metals, a gold and silver dealer selling reputable, well-known bullion coins and bars at competitive prices. 

Click here for a free subscription to Peter Schiff's Gold Letter, a monthly newsletter featuring the latest gold and silver market analysis from Peter Schiff, Casey Research, and other leading experts. 

And now, investors can stay up-to-the-minute on precious metals news and Peter's latest thoughts by visiting Peter Schiff's Official Gold Blog.



Tags:  Chinagold
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The Eastern Lust For Gold
Posted by Peter Schiff on 12/04/2013 at 10:23 AM
Having replaced savings with debt on both the national and individual levels, I think it's well past time for Westerners to take a few lessons from our creditors in the East. Many Americans consider gold a "barbarous relic," but in Asia, the yellow metal remains the bedrock of individual savings plans. This means that either greater than half of the world's population are barbarians, or they've held onto an important tradition that our culture has forgotten.

A Culture of Gold

One of the most important elements of Eastern gold demand is that it is not limited to educated investors or the higher classes, as often seems to be the case in the West. Throughout Asia, no matter one's social status, precious metals are the first assets people choose to protect their wealth. There is not even a glimmer of doubt about the enduring value of hard money.

A recent Bloomberg article quotes a Chinese woman, "I don't know anything about the stock market and I don't have enough money to buy property, so I figured gold is the safest choice."

Some might write off this philosophy as naïve, but her logic is founded in centuries of tradition, borne of hard-won experience. The same goes in India and across South Asia, where gold is an essential part of local religious customs. From wedding dowries to temple offerings, gold carries a caché in Asia that most Westerners can't fathom.

Consider the US as a comparison. Here, newlyweds are more likely to receive a house full of fancy appliances than any assets that might form the foundation of long-term financial independence.

After a couple of generations of US-dollar dominance, Americans have become lazy with our wealth. While we exploit our economic power by going into debt for fancy cars, big-screen TVs, and expensive smart phones, our creditors are steadily stockpiling gold.

A River of Gold from West to East

Asia's love affair with gold became worldwide news when the price of the yellow metal dropped last April. Asian consumers saw the price drop as a fortunate buying opportunity, and metals dealers were swamped with orders for both bullion and jewelry. Premiums skyrocketed across the continent, but this did not slow demand.

With all this demand, shouldn't gold's global spot price have continued rising? Unfortunately, many Westerners were selling into the Eastern demand. In fact, the stagnant spot price concealed a historic transfer of real wealth.

The rising price of gold over the past decade had lured many Western investors into the paper gold market through precious metals exchange-traded funds (ETFs). To ETF investors intent on fast growth rather than long-term capital preservation, the recent drop in price was viewed as a sell signal, not an opportunity.

By the end of September, gold ETFs had sold off about 700 metric tons of physical gold - more than half of it in just the second quarter. The World Gold Council reports that the majority of these outflows have been absorbed by Asian demand.

However, Western selling was enough to keep the global spot price from recovering. Instead of more capital flowing into gold, it was the gold itself which was flowing from Western financial institutions to Eastern households.

The latest data shows that consumer demand for physical gold in the first three quarters of 2013 hit a historical record of 2,896.5 metric tons. 90% of the year-over-year increase in this demand came from Asia and the Middle East.

Meanwhile, Americans have been distracted by one record high after another in the domestic stock market.

Governments Intervene

When reporting on Asian gold demand, the Western media tends to focus on nations like India, which has practically declared war against gold buyers this year in a misguided attempt to curb its trade deficit.

The Indian government raised tariffs on the metal to a record 10%, and now requires importers to re-export 20% of their gold. India's central bank even went as far as asking temples around the country to divulge how much gold they were storing, though many refused.

Thailand and Vietnam have taken similar steps to subdue their populations' gold demand, even though the primary outcome has been to increase gold smuggling.

These governments' measures have received the most attention because they fit nicely into the Western narrative that gold is an old-fashioned asset that does more harm than good in modern economies. But the truth is that the only ones harmed by gold are Western governments!

China Rising

Last month, China officially surpassed India as the world's largest consumer of gold. Unlike New Delhi, Beijing is encouraging its citizens' gold lust by easing restrictions on the gold trade. The People's Bank of China (PBOC) is preparing to expand the number of businesses allowed to import and export gold on a large scale. It has also increased the amount of tax-free gold citizens are allowed to bring into the country.

Meanwhile, China is finally pulling away from the US dollar. A month after China's government news agency called for a "de-Americanized world," a deputy governor at the PBOC said, "It's no longer in China's favor to accumulate foreign-exchange reserves."

Simply put, China is planning to wind down its own stimulus program of buying US dollars, and instead allow the value of the yuan to appreciate. In preparation for this shift, China has been diversifying its foreign exchange reserves into gold. The PBOC has not released official numbers on its gold reserves since 2009, but experts have begun to speculate that its current holdings are far larger than previously estimated.

A Rude Awakening

This is the time when the West realizes that its great reservoir of wealth has run dry, as the gold has all flowed East.

When China stops buying US Treasuries, the Fed will remain the only major buyer of US debt. This will drive interest rates up, thereby sticking the US government with obligations it cannot possibly fulfill. Ultimately, this will be the death knell for the dollar, as the Fed will be forced to significantly expand its QE program to assume the role as Treasury-buyer of last resort.

Mom-and-pop gold buyers throughout the East probably do not understand all the subtleties of the foreign exchange markets, but an undying appreciation for gold is built into their culture. Make no mistake: the East is the engine of the 21st century global economy - and it is riding on rails of gold.

This holiday season, consider breaking with our recent Western tradition of giving gifts of no enduring value. Instead, take the opportunity to turn some of your paper dollars into gifts that will still have value when your kids are grown.

Peter Schiff is Chairman of Euro Pacific Precious Metals, a gold and silver dealer selling reputable, well-known bullion coins and bars at competitive prices. 

Click here for a free subscription to Peter Schiff's Gold Letter, a monthly newsletter featuring the latest gold and silver market analysis from Peter Schiff, Casey Research, and other leading experts. 

And now, investors can stay up-to-the-minute on precious metals news and Peter's latest thoughts by visiting Peter Schiff's Official Gold Blog.



Tags:  Chinafederal reservegold
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Treasury's Last Pillar Crumbles
Posted by Peter Schiff on 01/03/2013 at 7:20 AM
With the return of Shinzo Abe and his Liberal Democratic Party to power in Japan, the market for US Treasuries may be losing its last external pillar of support. Re-elected on September 26th, Abe has quickly set a course for limitless inflation, saying Japan must "free itself from deflation and the strong yen." This is significant to the global economy as Japan is the largest foreign power left with a strong appetite for US Treasuries. If this demand falters, the Fed may be the only remaining buyer of new Treasury issuance.
 
Abe's Plan
 
This election marks Abe's second turn in the premier's seat. He first held the position from 2006 to 2007, when he abruptly resigned as the first of a string of unpopular one-year premierships. Notably, in the intervening time, the LDP lost its lower house majority to an opposition party for the first time since its formation in 1955. The victors, the Democratic Party of Japan, had been formed in 1998 on a platform of reducing corruption and making Japan more progressive.
 
Unfortunately, as we know from our past century of experience in America, progressivism is not the cure for an ailing economy. The DPJ was predictably unsuccessful at reining in the bureaucracy, but did manage to push through a damaging doubling of the national sales tax and additional entitlement spending.
 
Similarly to President Obama's 2008 election, the Japanese people were sold a lot of rhetoric about hope and change and, lacking any sincere alternatives, decided to give the new guys a shot. The results were equally disappointing on both sides of the Pacific. 
 
While American voters decided to throw good votes after bad in 2012, the Japanese preferred to return to the devil they know. The only problem is, he's still a devil.
 
Abe has essentially promised to return to the failed but feel-good policies of LDP government for the last 3 decades; namely, he will prop up failing industrial giants and attempt to print his way out of an economic slump.
 
Saving Grace or Pain in the $%&?
 
The yen hit a post-war high against the US dollar in 2011 and has remained strong. For sound-money enthusiasts, this has been cause for celebration. But for Keynesian demand-siders, it's a crisis.
 
Rather than attribute decades of sluggish growth to an interventionist industrial policy, Abe and his cadres are blaming the strong yen. In response, Abe has called for the Bank of Japan to target at least 3% inflation.
 
For some time, the only saving grace for Japanese citizens who are unable to find jobs or secure financing has been that prices have been stable or falling. Abe intends to rob them of that salve while doing nothing to address the underlying infection.
 
While some Americans may feel a self-interested sense of relief that one of the major dollar-alternatives is being undermined from within, they are misunderstanding the knock-on consequences of this move.
 
The Last Major Pillar
 
For the Treasury to continuing having successful auctions at current rock-bottom interest rates, someone has to be purchasing. A lot. 
 
Before 2008, most of the demand came from foreign central banks - especially China. Since the financial crisis began, China and many emerging market banks have dramatically reduced their purchases and even become net sellers. 
 
The deficit has been made up by the Federal Reserve, domestic personal and institutional investors, and a few foreign holdouts led by Japan. In fact, Japan is about to overtake China as the largest foreign holder of US government debt.
 
This is significant in that the other two sources of funding - Fed and US domestic - are essentially intertwined. The more Treasuries the Fed purchases, the higher inflation becomes, which harms the US economy even further, which leaves domestic funds less wealth to invest in Treasuries. In my view, the foreign influx of capital has been the key third pillar that has kept this vicious domestic cycle from playing out in full.
 
How It Crumbles
 
Prime Minister Abe's plan to devalue the yen could thus be disastrous for both US and Japanese government finances. As the yen devalues, Japanese domestic investors - who make up the bulk of owners of Japanese Government Bonds (JGBs) - will be under intense pressure to sell out and find higher yields elsewhere. 
 
This flight of capital will threaten Tokyo with default, so the likelihood is that the Bank of Japan will begin directly buying JGBs on an even larger scale (as our Fed has done since the financial crisis) instead of buying US Treasuries. They may even become net sellers of Treasuries in order to finance their bailout of Tokyo while controlling inflation.
 
This will, in turn, put tremendous pressure on US Treasury investors. As the outflows mount, the Fed will no doubt announce another program to buy Treasuries under the guise of promoting economic stability. If the Fed becomes the permanent crutch of the Treasury, we can expect inflation to get higher and higher - driving more and more investors out of Treasuries.
 
Decoupling Continues
 
It is clear that Washington and Tokyo are but two sides of the same coin. Japan's debt-to-GDP is about 212%, while the US has just crossed 100%. Both are highly dependent on domestic investor interest in government debt to keep the charade going, and neither have prospects of paying their debts without real write-downs for investors. 
 
Unfortunately, neither government is using the time before this real crash strikes to even attempt to shore up their positions. The platform of Shinzo Abe seems poised to undermine Japan's ability to continue subsidizing US government debt. Left without any significant external supports, Treasuries will be in an extremely weak position when attention shifts from the EU sovereign debt crisis to the our own tattered finances.
 
Fortunately, there are ways for investors to escape Abe and Obama's tandem cliff-dive. Recent data shows that China continues to build a viable alternative. The South Korean won and Taiwan dollar are now significantly more correlated to the movements of the yuan than the yen or the US dollar. These booming economies will sustain demand for commodities as they build real wealth. With the old statesmen of sovereign debt compromised, I expect the up-and-comers to continue to turn to gold and silver in droves.

Peter Schiff is CEO of Euro Pacific Precious Metals, a gold and silver dealer selling reputable, well-known bullion coins and bars at competitive prices. 

Click here for a free subscription to Peter Schiff's Gold Letter, a monthly newsletter featuring the latest gold and silver market analysis from Peter Schiff, Casey Research, and other leading experts. 

And now, investors can stay up-to-the-minute on precious metals news and Peter's latest thoughts by visiting Peter Schiff's Official Gold Blog.


Tags:  ChinadollarinflationJapantreasuriesyen
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Why Buy the Cow?
Posted by Peter Schiff on 03/05/2012 at 6:08 PM

The communist revolutions in the 20th century sought to nationalize the wealth generated by privately held industries back to the "exploited" workers on whose backs the profits were supposedly derived.America has made the rejection of this idea and its support of free market principles the centerpiece of its economic narrative. However, as a result of our current and proposed tax policies towards corporate shareholders, our government collects a portion of industrial output that would inspire envy in even the most rabid Bolshevik.

 

The purpose of a corporation is to generate profits for owners (all other functions are secondary to this goal). Public corporations distribute these profits through dividends. But as a result of America's system of double taxation, where income is taxed on the corporate level and then again on the personal level, government receives a much bigger share of corporate income than the owners themselves. I also address this topic in my latest video blog .

 

Suppose a publicly held U.S. corporation made one million dollars in income over the course of a year. Currently its profits would be taxed at a 35% level (for the purpose of this example I will not factor in the lower rate that is applied to its first $100K of profits), meaning that the company would have to pay $350,000 directly to the government (assuming it earned its income without special tax breaks). Of the $650,000 that remained, the typical dividend-paying corporation might distribute 40 percent to shareholders (this is known as the "payout ratio" and the actual average is slightly below 40%). So in this instance the company would pay $260,000 (40% of $650,000) to shareholders. The remaining $390,000 would typically be held as "retained earnings," and would be used to maintain and replace depreciating equipment, make capital investments, fund research and development, and expand operations. If the company did not make such investments it would be impossible for it to survive and its ability to perpetuate profit distributions would be limited. 

 

These retained earnings still represent assets to shareholders, but their primary purpose is to generate future profits and higher dividends. However, shareholders do not directly benefit from those retained earnings until future distributions are paid. Sure they can sell their shares at a gain, paying a capital gains tax in the process, but this merely transfers those deferred benefits to the new buyer.

 

When received by shareholders, the $260,000 in dividends are taxed again at a rate of 15 percent (according to current law). As a result, shareholders receive just $221,000 of the million dollar profit. The $39,000 in dividend taxes are added to the $350,000 "off the top" corporate tax to bring the government's total take of the company's profits to just a shade under $390,000. In other words the government gets about 75% more cash flow from the company than the actual owners. Looked at in a slightly different way, the government gets about 65% of the non-retained earnings while shareholders, who put up the money and take all the risk, get 35%. Does this seem fair?

 

This level of taxation puts American corporations at a noticeable disadvantage vis-a-vis companies in the countries against which we are most keenly competing. In China, the slicing of the pie is much more favorable to owners. There, corporations are taxed at a rate of 25% and dividends at 10%. Using these numbers (and the same payout ratio used for the U.S. corporation), the Chinese government gets 51% of distributed corporate profits and shareholders get 49%. In Hong Kong (which is part of Communist China), the situation is even better. There, the corporate tax rate is 16% and the personal dividend rate is zero. If you do the math there, the government gets 33% and the shareholders get 67%. 

 

This comparison raises an interesting point. If shareholders in communist China are allowed to keep more of their earnings than shareholders in capitalist America, which nation is more communist and which more capitalist?

 

Late last month the Obama Administration and Mitt Romney offered competing proposals on corporate tax reform that both politicians say would make U.S. corporations more competitive. Romney's plan lowers the corporate tax rate to 25% while maintaining the dividend tax at 15%. This makes things slightly better, sending 54% of distributed earnings to the government and 46% to shareholders (not quite as generous as Communist China). Not surprisingly however the Obama plan will make things much more difficult.

 

Although the President proposes lowering the corporate tax rate to 28% he also wants to scrap the dividend tax and instead tax the distributions as ordinary income. In practice, the vast majority of individual recipients of dividends fall into the higher end of the income spectrum. Which means a very large chunk of these dividends will be taxed at the highest personal rate of 39%. But Obama also wants to subject these high earners to a surtax to pay for his health care initiative, which means that many of the recipients will be taxed at a rate of 44% (this also accounts for the phase out of personal deductions for higher earners!) So for these high-income earners, using our current example, the new distribution split with the government under Obama's proposals will be about 70/30 in favor of the government. This is actually worse than the status quo.

 

But it's actually much worse than that. The corporate income tax is just one of the veins that corporations open for government. Think about all the other taxes that corporations pay, such as the payroll taxes and sales taxes. Sure they pass those taxes on to their employees and customers, but the revenue flows 100% to the government with shareholders getting nothing but a bill for the cost of collection.

 

Then there are all of the taxes paid directly by the employees themselves on their wages and salaries. Sure, this money belongs to employees and not shareholders, but if not for the profit-making activities of corporations, those wages and salaries, and resulting taxes, could not have been paid. And while employees derive benefits from those after tax distributions too, shareholders get nothing.When all of these channels are factored in, think about how much more the government derives in taxes from corporate activity than its owners receive in dividends. Who knows how high this figure is, but I'm sure the government's take is many multiples of what shareholders receive.

 

Back in the 19th Century, America really was a capitalist country. We had no corporate tax and no personal income tax. Shareholders got 100% of distributed corporate income. As a result of this structure, U.S. corporations grew rapidly and helped spark the fastest economic expansion the world had ever seen. But that was then, this is now.

 

Given the current numbers, even if our leaders were dyed-in-the-wool Marxists, what would be their motivation to nationalize Fortune 500 companies? If they already receive the lion's share of profit distributions, what would be the point? Such a move risks upsetting the management structures and destroying the remaining profit motive. It would risk killing the goose that lays the golden egg. If government nationalized a company, it would also have to manage it. Does anyone think bureaucrats would make better decisions than private owners? What's worse, if those decisions produced losses rather than profits, the government would have to absorb them. Under the current systems, the government gets the lion's share of the profits, but private shareholders are stuck with 100% of the losses.

 

There is actually a name for our present system: fascism. While fascism and communism are both forms of socialism, at least the fascists are smart enough to know that if the means of production are nationalized, employees and owners won't work as hard, and the government will lose revenue. 

 

It's a shame that the country that was once the beacon of freedom and economic liberty no longer has the ability to recognize what capitalism actually looks like. Unless corporate owners are appropriately rewarded for their risks, U.S. corporations will not regain their lost dominance, Americans will not regain their lost liberty, and our standard of living will continue to fall. As it stands now, the United States has become a people of the government, by the government and, most importantly, for the government.



Tags:  Chinacommunismcorporate taxesfascism
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Pentonomics - The Chinese Have Stopped Laughing
Posted by Michael Pento on 07/29/2011 at 10:21 AM

The economy continues to prove that it didn’t need a stalemate between democrats and republicans over whether or not we should expand our credit limit in order to poop the bed. Gross Domestic Product climbed a paltry 1.3% in the second quarter of this year following a severely downgraded Q1 print of just 0.4%. Growth in the first quarter was revised down from a 1.9% prior estimate. Also today, the Institute for Supply Management-Chicago Inc. said its business barometer fell to 58.8 in July, from 61.1 in the prior month. And the Thomson Reuters/University of Michigan final index of consumer sentiment fell to 63.7 this month, which was the weakest since March 2009, from 71.5 in June.

Where are all those shills who assured us last year that 2011 would display a “V” shaped recovery in jobs and the economy? I know, I heard some of them today saying that the second half of this year is going to be great!  Their reasoning was the same as it always is. Earnings are going to be wonderful because half of S&P 500 companies' earnings are in foreign currencies. Then, thanks to our crumbling currency, those foreign earnings translate into a ton of U.S. dollars—those dollars don’t buy you very much, but who cares as long as we are able to say we beat Wall St. expectations.

The poor, lonely Tea Party is vilified as being inhuman and behaving as insane children for not allowing the country to bankrupt itself as quickly as possible—even by members of their own party (read here what John McCain had to say for yourself). I guess the philosophy of McCain and his friends is that we should raise the debt ceiling to infinity and beyond and just pay our creditors back with more printed money. After all, the National Debt has grown from $400 billion in 1971 to $14.4 trillion today, so what’s a few more trillion between now and 2013? The dollar has lost 98% of its purchasing power in the last 40 years, so why not keep on defaulting on our debt through inflation and destroy the last few vestiges of the middle class. Sounds like a plan to me. It’s just business as usual. They urge us to keep up the spirit of cooperation and goodwill that has served to render this country insolvent.

The only problem is that the Chinese have stopped laughing at Geithner’s so called “strong dollar policy” and are now allowing the Renminbi to rise against the greenback (up nearly 6% in the last year). If we continue down this road much longer the only buyer of U.S. debt will be the Fed. That’s the real down grade to come. Not from the credit rating agencies, but from our foreign creditors. Once we have a failed Treasury auction, it will engender a vicious cycle. Debt service expense will soar, which causes out of control deficits. The Fed will be forced to purchase more of the debt and inflation rates become intractable, thus destroying GDP growth. Runaway debt, interest rates and inflation is what  the Tea Party is trying so hard to avoid and it is a cause worth fighting for!



Tags:  Chinacreditdebtdebt ceilingeconomyGDPGeithner
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AFTER THE DOLLAR: WHAT COMES NEXT?
Posted by Peter Schiff on 06/01/2011 at 2:06 PM

THE DOLLAR'S TERRIBLE FATE

 

My readers are familiar with my forecast that the US dollar is in terminal decline. America is tragically bankrupt, unable to pay its lenders without printing the dollars to do so, and enmeshed in an economic depression. The clock is ticking until the dollar faces a crisis of confidence like every other bubble before it. The key difference between this collapse and, say, the bursting of the housing bubble is that the US dollar is the backbone of the global economy. Its conflagration will leave a vacuum that needs to be filled.

 

Mainstream commentators often discuss three main contenders for the role: the euro, the yen, or China's RMB (known colloquially as the "yuan"). These other currencies, however, each suffer from a critical flaw that makes them unready to carry the reserve currency role in time for the dollar's collapse. When it comes to fiat alternatives, it appears the world would be going out of the frying pan and into the fire.

 

EURO: FRAYING AT THE EDGES

 

The euro is a ten-year-old experiment in uniting divergent political, economic, and cultural interests under one monolithic fiat currency held in the hands of one very powerful central bank.

 

If managed correctly, such a currency could serve to keep its member-governments honest - but that is not the world in which we live. Instead, the fiscally irresponsible members are discussing ditching the currency at the first sign of trouble. That is, they'd rather have their own national currencies to inflate in order to cover over their burdensome public debts. So, in order to keep the euro together, creditor states have been strong-armed into bailouts of the debtors - even though such measures violate the compact that created the common currency.

 

The question becomes: how long do Germans - still wrought with the memory of Weimar hyperinflation and the rise of the Third Reich - want to keep printing euros to pay the debts of the spendthrift Greeks? How many German politicians will ride to electoral victory on promises of unending bailouts and higher prices across Europe? This is the fundamental flaw of the euro.

 

And, of course, Greece isn't the only problem. Ireland and Portugal are vying for second-worst debt crisis in Europe. Spain, representing over 12% of eurozone GDP, saw sovereign yields jump from 4.1% at the beginning of 2010 to 6.6% by the end of the year. Yields on most other eurozone countries have been rising as well - a clear indication that the eurozone is an increasingly risky bet.

 

While a euro secession by the PIGS could actually leave a stronger currency region at the end, it would be a traumatic event. That prospect is undermining confidence in the euro at just the time when the world is considering where to go next.

 

Perhaps a mature currency that didn't falter so easily amidst the recent global financial crisis would be a good contender for the world's reserve. The euro, by contrast, is both young and in serious trouble. If less than two-dozen nations are too immense a burden for the euro to shoulder, should we expect better results when it's stretched across two hundred?

  

YUAN: CAPITALIST COUNTRY, COMMUNIST CURRENCY

 

The investment community is slowly coming around to my long-held excitement about the miraculous growth of China. This is no frenzy. In fact, if anything, I think many are still too skittish when it comes to this market. Yet, those that are jumping on the bandwagon are now proclaiming the Chinese yuan as the logical successor to the dying dollar. But while China is becoming an immense economic force, the yuan itself is hobbled by the country's communist past.

 

Foremost, China enforces stern capital controls on the yuan. A reserve currency must be freely and easily exchangeable with other currencies. Even within China's borders, one cannot exchange large amounts of yuan for dollars or any other currency.

 

China is slowly undertaking reforms to relieve these controls, but remember they were not put there arbitrarily. The controls allow China to suppress the value of the yuan, thereby maintaining artificially high exports, among other consequences. If China allowed the yuan to trade freely, it would lose the power it maintains over its money - and by extension, its people.

 

Let's remember that all fiat currencies are routinely manipulated and inflated. The People's Bank of China has reported M2 growth of over 140% in the past five years - almost entirely to maintain a stable exchange rate with a depreciating dollar. Given rampant inflation, combined with exchange restrictions and a serious lack of transparency, the yuan is simply not ready for primetime.

  

YEN: BLACK HOLE OF DEBT

 

The Japanese yen is the third amigo at the international fiat fiesta. While it doesn't suffer the structural risks of the euro, the yen is subsisting in an environment of massive sovereign debt. Japan's debt-to-GDP ratio is the highest of any developed country at 225%, meaning there is a perpetual impetus to print more yen to pay it back. The yen must endure this debt-noose, making it a poor alternative to the USD, which suffers the very same problem.

 

While I believe Japan is in a much better position because it generally maintains a net trade surplus and because most of their debt is held domestically, it's still not a stable unit with which to conduct world trade.

 

Perhaps more importantly, with a world seeking yen reserves, the price of yen would increase drastically. This is politically unpalatable in Japan, where the export lobby is constantly trying to push the yen down to boost their sales overseas.

 

These two factors combine in such a way as to make the yen a plainly infeasible reserve currency. The appreciation in yen value would simultaneously make Japan's debt problems worse and cause its export industry to suffer greatly, meaning that Japan probably doesn't want this role any more than we want her to have it.

 

As an aside, if you type "yen as reserve currency" into Google, it will ask, "Did you mean: yuan as reserve currency?" I guess even the world's smartest search engine doubts the yen could fill that role.

 

THE SIMPLEST ANSWER IS OFTEN THE BEST

 

As J.P. Morgan famously said to Congress in 1913, "gold is money and nothing else." Morgan meant that gold was unmatched in its effectiveness as a store of value and medium of exchange.

 

Given that his namesake bank started accepting physical gold bullion this past February as counterparty collateral, why should the trend of a widespread return to gold be considered only a remote possibility? On the contrary, it should be expected - if for no other reason than every other currency is fundamentally dismal.

 

Markets are powerful things, and require a reliable medium of exchange. The call for sound money is not just philosophical; it is derived from the market itself. Throughout human history, merchants have always turned to pure gold and silver over every pretender. This is not the first experiment in a paper money system, nor is it the first widespread debasement of money. In fact, the lessons of history were impressed upon our well-read Founding Fathers to the point that they included the following clear language in the Constitution: "No state shall... make any Thing but gold and silver Coin a Tender in Payment of Debts."

 

While it has always been possible that another fiat currency would rise up to take the dollar's place, and thereby keep this irrational experiment in valueless money going awhile longer, the particular circumstances that abound today make it seem less and less likely to me. Instead, I'm seeing signs that the world is moving back to gold at a breakneck speed.

 

This is a return to normal and has many positive implications for the global economy. It's certainly a trend we can all welcome, and profit from.



Tags:  chinadollarrmbyenyuan
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Pentonomics - The Clock is Ticking
Posted by Michael Pento on 03/04/2011 at 6:10 PM

As I said yesterday, if you borrow trillions of dollars over the course of a couple of years—most of which are printed—and you make money free for more than two years; you will get a little bit of growth but whole ton of inflation. Gold and oil are rising yet again this morning and the consumer is getting pinched by a surging cost of living that isn’t susceptible to core rate mollifications.

The Non-Farm payroll report for February showed that the U.S. gained 192k net new employees. Average hourly earnings rose to $22.87 from $22.86 in the prior month, today’s report showed. The average work week for all workers held at 34.2 hours. And the unemployment rate ticked down to 8.9%.

That is the good news and it is mostly in the rear view mirror. Now we have the following facts to deal with: companies are operating at peak margin levels, the S&P dividend yield is very close to the lowest in its history (1.71% vs. the average 4.35%), inflation rates that are rising and interest rates that are sharply rising off their all-time lows.

Most investors and main stream pundits are cheering the success and validation of Keynesian borrowing and spending economics. But I see things quite differently. What lies ahead now is the need for a massive contraction in private and public spending and at the same time a surge in borrowing costs as the Fed unwinds its balance sheet. Of course the above has to happen very soon before oil gets back to $147 per barrel, the dollar collapses, the bond vigilantes wake up and inflation destroys the economy.

The proof of Ben's success can be seen in comparing how the foreign exchange markets reacted to the recent crisis in the Middle East with how they reacted to the financial crisis of 2008. Back then, investors looking for safety abandoned their foreign currency positions and piled into the U.S. dollar (the market for U.S. Treasury Bonds in particular). As a result of these fund flows, the U.S. dollar surged 20% from August to November 2008.

However, during this latest round of global destabilization the dollar experienced no such rally. In fact, the greenback shed about 5% of its value since the Tunisia revolution began in December of 2010. The reason should be clear; the Fed has placed international investors on notice that it will unleash even greater doses of dollar debasement at the first whiff of additional economic weakness, deflation threat, or dollar appreciation. Just this week, Bernanke once again made clear that despite what he considers to be a better growth outlook at home and abroad, and spreading global inflation, the United States will not pull back from monetary accommodation, even as other nations conspicuously do so. The architect of U.S. monetary policy has stated explicitly that dollar debasement will continue for the indefinite future.

Knowing this, why would any international investor seeking a "safe haven" choose to park assets in U.S. sovereign debt? If Bernanke is to be believed, continued economic weakness in the U.S. will cause low-yielding Treasuries to lose value due to inflation while the weakening dollar erodes the underlying value of the bond in real terms. This is a one-two punch that sane investors will seek to avoid. It is no coincidence that a record percentage of U.S. Treasury auctions are now being bought by central banks, for whom sanity is a lowly consideration.

But in reality, the Fed has much less influence over the dollar's value than do central bankers in Beijing. There is little disagreement among economists that without Chinese support, the dollar would be a dead duck. But for the last twenty years or so the monetary arrangement that pegged the yuan against the dollar served the interests of both countries. The U.S. enjoyed a flood of cheap imports, the benefits of ultra-low interest rates, and a strong currency. The Chinese received a booming export economy, which accounted for about a third of the country's GDP, and the ownership of a significant portion of the future of the United States. To maintain this peg, the People's Bank of China had to print trillions of yuan and perpetually hold more than $1 trillion U.S. dollars in reserve.

But recently, having led to rampant money supply growth and inflation in China, the peg has become more trouble than it's worth, particularly from the Chinese perspective. The latest reading on YOY money supply growth has China's M2 increasing by 17.2%; which has helped send their reported CPI up 4.9% YOY.

Inflation in China is pushing up the prices of its exports. According to the latest survey released February 14th from Global Sources (a primary facilitator of trade with Greater China), export prices of various China products are likely to increase in the months ahead, especially if the cost of major materials and components continues to soar. The survey of 232 Chinese exporters revealed that 74% of respondents said they boosted export prices in 2010. The U.S. Bureau of Labor Statistics reported in early January that its China import price index rose 0.9% in the fourth quarter after holding steady for the previous 18 months. And Guangdong, the biggest exporting province, said recently that it would increase minimum wages by around 19% this March.

But here is the rub; China maintains its peg in order to keep export prices from rising in dollar terms. But the peg is now causing export prices to rise anyway. As a result, the policy is a dead letter. The simple fact is that the threat to China's exports will exist whether they let their currency appreciate or not. But a strong currency offers the benefit of greater domestic consumption, while a weaker currency offers nothing.

The Chinese government will take the path that preserves and balances their economy while enriching their entire population, rather than go down the road to never ending inflation. For China the realistic hope is that the greater purchasing power of a strong currency will enable their growing middle class to supplant U.S. consumers as the end market for China's own manufacturing efforts. However, for the U.S. the challenge will be to develop a diversified manufacturing base in an expeditious manner before surging interest rates, a plummeting dollar and soaring inflation overwhelm the economy.

The dollar's recent reaction to the turmoil in the Middle East and China's inflation problem illustrate that we have come to a watershed moment in American history. The decade beginning in 2010 should prove to be the decade in which the U.S. dollar loses its status as the world's reserve currency. As bad as that blow may be, the loss may provide the shock needed to get our economy back on a sustainable path. The real danger lies in refusing to adapt to the changing environment. Our current economic stewards are acting as if the dollar's status is written in stone, when in fact it's hanging by a thread.



Tags:  chinadollargold
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Pentonomics - Taps for the Dollar
Posted by Michael Pento on 03/02/2011 at 8:47 AM
It now appears that the United States has finally succeeded in its efforts to destroy confidence in the U.S. dollar. Given the currency's reserve status, its ubiquity in financial markets, and the economic power and political position of the United States, this was no easy task. However, to get the job done Washington chose the right man: Fed Chairman Ben Bernanke. Thanks to Bernanke's herculean efforts, investors across the globe have now been fully weaned from their infantile belief that the U.S. dollar will remain the ultimate safe haven currency. 

The proof of Ben's success can be seen in comparing how the foreign exchange markets reacted to the recent crisis in the Middle East with how they reacted to the financial crisis of 2008. Back then, investors looking for safety abandoned their foreign currency positions and piled into the U.S. dollar (the market for U.S. Treasury Bonds in particular). As a result of these fund flows, the U.S. dollar surged 20% from August to November 2008.

However, during this latest round of global destabilization the dollar experienced no such rally. In fact, the greenback shed about 5% of its value since the Tunisia revolution began in December of 2010. The reason should be clear; the Fed has placed international investors on notice that it will unleash even greater doses of dollar debasement at the first whiff of additional economic weakness, deflation threat, or dollar appreciation. Just this week, Bernanke once again made clear that despite what he considers to be a better growth outlook at home and abroad, and spreading global inflation, the United States will not pull back from monetary accommodation, even as other nations conspicuously do so. The architect of U.S. monetary policy has stated explicitly that dollar debasement will continue for the indefinite future.

Knowing this, why would any international investor seeking a "safe haven" choose to park assets in U.S. sovereign debt? If Bernanke is to be believed, continued economic weakness in the U.S. will cause low-yielding Treasuries to lose value due to inflation while the weakening dollar erodes the underlying value of the bond in real terms. This is a one-two punch that sane investors will seek to avoid. It is no coincidence that a record percentage of U.S. Treasury auctions are now being bought by central banks, for whom sanity is a lowly consideration.

But in reality, the Fed has much less influence over the dollar's value than do central bankers in Beijing. There is little disagreement among economists that without Chinese support, the dollar would be a dead duck. But for the last twenty years or so the monetary arrangement that pegged the yuan against the dollar served the interests of both countries. The U.S. enjoyed a flood of cheap imports, the benefits of ultra-low interest rates, and a strong currency. The Chinese received a booming export economy, which accounted for about a third of the country's GDP, and the ownership of a significant portion of the future of the United States. To maintain this peg, the People's Bank of China had to print trillions of yuan and perpetually hold more than $1 trillion U.S. dollars in reserve.

But recently, having led to rampant money supply growth and inflation in China, the peg has become more trouble than it's worth, particularly from the Chinese perspective. The latest reading on YOY money supply growth has China's M2 increasing by 17.2%; which has helped send their reported CPI up 4.9% YOY.

Inflation in China is pushing up the prices of its exports. According to the latest survey released February 14th from Global Sources (a primary facilitator of trade with Greater China), export prices of various China products are likely to increase in the months ahead, especially if the cost of major materials and components continues to soar. The survey of 232 Chinese exporters revealed that 74% of respondents said they boosted export prices in 2010. The U.S. Bureau of Labor Statistics reported in early January that its China import price index rose 0.9% in the fourth quarter after holding steady for the previous 18 months. And Guangdong, the biggest exporting province, said recently that it would increase minimum wages by around 19% this March.

But here is the rub; China maintains its peg in order to keep export prices from rising in dollar terms. But the peg is now causing export prices to rise anyway. As a result, the policy is a dead letter. The simple fact is that the threat to China's exports will exist whether they let their currency appreciate or not. But a strong currency offers the benefit of greater domestic consumption, while a weaker currency offers nothing.

The Chinese government will take the path that preserves and balances their economy while enriching their entire population, rather than go down the road to never ending inflation. For China the realistic hope is that the greater purchasing power of a strong currency will enable their growing middle class to supplant U.S. consumers as the end market for China's own manufacturing efforts. However, for the U.S. the challenge will be to develop a diversified manufacturing base in an expeditious manner before surging interest rates, a plummeting dollar and soaring inflation overwhelm the economy.

The dollar's recent reaction to the turmoil in the Middle East and China's inflation problem illustrate that we have come to a watershed moment in American history. The decade beginning in 2010 should prove to be the decade in which the U.S. dollar loses its status as the world's reserve currency. As bad as that blow may be, the loss may provide the shock needed to get our economy back on a sustainable path. The real danger lies in refusing to adapt to the changing environment. Our current economic stewards are acting as if the dollar's status is written in stone, when in fact it's hanging by a thread.



Tags:  Ben BernankeChinafedMiddle East
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Pentonomics - China is Ahead of the Curve
Posted by Michael Pento on 02/08/2011 at 8:20 PM

The only thing melting up faster than the U.S. equity market these days is U.S. Treasury yields. The Ten year note is trading at 3.66% this morning—I wonder if Bernanke views that as a successful outcome of QEII? Meanwhile, Freddie Mac says the average rate on a 30 year fixed rate mortgage hit 4.81% this week, up from 4.17% in November of 2010. I guess rising rates are just one of those unintended consequences that Bernanke just didn’t count on. But those rising rates are helping the housing market to rollover. CoreLogic says that YOY home prices declined by 5.4%.

So the Fed will take falling home prices as a reason to continue counterfeiting 2.0 indefinitely. But China is dealing with their inflation by raising rates yet again. They upped their benchmark 1 year deposit rate by ¼ point to 3%. That’s the third time in four months that they have raised interest rates. The Chinese stock market is down for 2011 while the U.S. exchanges are up. But we are living on borrowed time once again. While the rest of the world is cutting spending and strengthening their currencies, we have dramatically stepped up our borrowing and printing practices. Bernanke and Co. maybe blind to inflation but I can assure the bond market has taken off the rose colored glasses.

Consumer credit rose for the third consecutive month led by the first increase in credit card charges in over two years. Credit increased by $6.1 billion to $2.41 trillion! I guess the frugal U.S. consumer lasted as long as one of “The Situation’s” girlfriends on “Jersey Shore.” Congratulations Mr. Bernanke!



Michael Pento, Senior Economist at Euro Pacific Capital is a well-established specialist in the “Austrian School” of economics. He is a regular guest on CNBC, Bloomberg, Fox Business, and other national media outlets and his market analysis can be read in most major financial publications, including the Wall Street Journal. Prior to joining Euro Pacific, Michael worked for a boutique investment advisory firm to create ETFs and UITs that were sold throughout Wall Street. Earlier in his career, he worked on the floor of the NYSE.

Tags:  Chinainflation
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China's Inflation Problem Looms Large
Posted by Peter Schiff on 01/19/2011 at 3:25 PM

The global economy has become so unbalanced that even government ministers who would normally have trouble explaining supply or demand clearly recognize that something has to give. To a very large extent the distortions are caused by China’s long-standing policy of pegging its currency, the yuan, to the U.S. dollar. But as China’s economy gains strength, and the American economy weakens, the cost and difficulty of maintaining the peg become ever greater, and eventually outweigh the benefits that the policy supposedly delivers to China. In the first few weeks of 2011 fresh evidence has arisen that shows just how difficult it has become for Beijing. 

Twenty years ago, China’s leaders decided to ditch the disaster of economic communism in favor of privatized, export-focused, industry. The plan largely worked. Over that time, China has arguably moved more people out of poverty in the shortest amount of time in the history of the planet. But somewhere along the way, China’s leaders became addicted to a game plan that outlived its usefulness. 

In order to maintain the peg, China must continually buy dollars on the open market. But the weaker the dollar gets, the more dollars China must buy. And with the U.S. Federal Reserve pulling out all the stops to create inflation and push down the dollar, Beijing’s task becomes nearly impossible. Last week, it was announced that China’s foreign exchange reserves, the amount of foreign currency held at its central bank (mostly in U.S. dollars), increased by a record $199 billion in 4th quarter 2010, to reach $2.85 trillion. These reserves currently account for a staggering 49% of China’s annual GDP (if the same proportional amount were held by the U.S., our measly $46 billion in reserves would have to increase 163 times to $7.5 trillion).

In order to buy these dollars, the Chinese central bank must print its own currency. In essence, China is adopting the Fed’s expansionary monetary policy. In the U.S. the inflationary impact of such a strategy is mitigated by our ability to export paper dollars in exchange for inexpensive Chinese imports. Although prices are rising here, they are not rising nearly as much as they would if we had to spend all this newly printed money on domestically produced goods. The big problem for China is that, unlike the U.S., the newly printed yuan are not exported, but remain in China bidding up consumer prices. As a result, inflation is becoming China’s dominant political issue.

It was recently announced that in November China’s consumer price index rose 5.1% from the same time a year earlier, with food prices rising more than 10%. As unrest builds, the Chinese government has unleashed a series of policies to address the symptoms.

-Peter Schiff



Tags:  Chinainflation
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