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The Biggest Loser
Posted by Peter Schiff on 02/01/2013 at 12:34 PM

In Switzerland, it's not just the clocks that are cuckoo. Over the past four years Swiss politicians and central bankers have gone on an unprecedented buying spree of foreign exchange reserves. In 2012, their cache swelled to as much as $420 billion worth of various currencies, primarily the euro. This figure is a seven-fold increase since 2008 and equates to 70% of the country's annual GDP. The sum translates to $200,000 per family of four, enough to keep the Swiss in clocks, chocolates, and fondue for many years to come. The Swiss leadership will claim the money has been "invested" with an eye to the future, but what they've done is impoverished themselves in the present.  Although such a decision seems perverse, it makes perfect sense when seen through the lens of today's presiding economic thinking.

For the past few generations Switzerland has enjoyed some of the strongest economic fundamentals in the world. The country boasts a high savings rate, low taxes, strong exports, low debt-to-GDP, balanced government budgets, and prior to a few years ago one of the most responsible monetary policies in the world. These attributes made the Swiss franc one of the world's "safe haven" currencies. But in today's global economy, no good deed goes unpunished.

Central bankers around the world, particularly in Washington, Frankfurt and Tokyo, have been engaged in a massive and coordinated campaign of currency debasement to combat the recession. But for years the Swiss refused to join in the printing parade. As a result, investors around the world wisely decided to park their savings in the reliable Swiss franc. From December of 2008 to August 2011 the franc appreciated an astounding 59% against the U.S. dollar and approximately 30% against the Japanese yen. More importantly, the franc gained 42% against the euro. As the Eurozone completely surrounds Switzerland, its trade with those countries represents the vast majority of its international transactions.

During this massive run up in its currency, the Swiss economy continued to prosper. Wages and purchasing power increased and GDP grew consistently faster than other countries in Western Europe. Despite generally positive export statistics, some Swiss exporters noticed that at times the strong franc put them at a disadvantage against foreign competitors. In addition, the strengthening currency helped keep a lid on consumer prices, giving Switzerland a consistently low inflation rate with occasional bouts of actual deflation. Despite the fact that Switzerland was an island of economic health amidst a sea of problems, the reigning economic orthodoxy convinced Swiss leaders that their strong currency was a burden rather than a blessing. More pointedly, the rise in the franc was seen as a repudiation of the expansionary policies occurring in other countries. And so the Swiss government decided to join the currency killing party.

In early August 2011, the Swiss National Bank took a series of steps to reverse the fortunes of the franc. In the simplest terms, they sold francs and bought foreign currencies, most notably the euro. The announcement included a promise to buy unlimited quantities of foreign exchange to maintain a floor of 1.20 francs per euro. In so doing, the Swiss essentially outsourced their monetary policy to the Eurozone. Any moves taken by the European Central Bank would need to be matched by the Swiss. Ironically, it was fear of this outcome that kept the Swiss from adopting the euro in the first place. Despite the former bias toward independence, the Swiss have de facto adopted the euro anyway. Since that time, the franc has fallen 16% against the dollar, Swiss foreign exchange reserves have skyrocketed, and investors who bought francs as a means to escape debasement have been betrayed.

Productive nations generate excess goods and services that can be sold abroad and their growth and stability attract investment funds from abroad. These conditions will tend to increase demand for the nation's currency, thereby pushing up its price. A strong currency keeps capital and raw materials costs low, enabling more productive workers to earn higher real wages. But according to most economists, a strong currency will bring down an economy because it destroys international competitiveness and can even lead to lower prices (deflation) which they see as economic quicksand. These fears have ignited a "global currency war" in which countries are expending huge amounts of national savings in order to ensure that their currencies stay cheap. In today's economic logic we must fail in order to succeed.

But it is very easy to have a weak currency. All that is needed is an unlimited willingness to print. A strong currency requires real fiscal discipline and actual production. Yet, like the weight loss TV show, economists believe that the winner of a currency war is the biggest loser. You win not by killing your competitors, but by killing yourself! It's like a student convincing his parents that an "F" is a better grade than an "A." And if a straight "F" report card results in parental accolades rather than anger, the students will lack any incentive to improve performance. Similarly, as nations like Switzerland strive to reduce their own grades, the failing nations have a reduced incentive to change their study habits. Without outside support, nations with collapsing currencies would see huge increases in consumer prices. The resulting fall in living stands would force productive reform.

I take the minority position that just as it is better to be rich than poor, a strong currency is better than a weak one. Although much more credentialed economists may try to muddle the arguments, the truth may be seen when a particular position is taken to its logical extreme. If a weaker currency is preferable to a stronger one, then logic would dictate that a currency of no value will be preferable to one with an infinite value. But how would economies with these drastically different currencies operate?

It is true that the country with the zero value currency will tend to see full employment and strong exports. The relative low cost of labor will mean that the locals could be easily employed in even the most marginal activity. But since holders of other currencies will be able to outbid the domestic population for all of their production, everything produced will be exported. Imports will be zero as the local population would be unable to afford anything produced in countries with more valuable currencies. As a result, actual consumption would be extremely low. In essence this economy would be analogous to impoverished, subsistence level economies such as Bolivia, Zimbabwe, and Haiti.

In contrast, a country with an infinitely valuable currency would see the best of all possible worlds. Even the smallest amount of money would allow citizens to buy huge amounts of goods from abroad. An evening's babysitting money would deliver more purchasing power than months of hard labor in poorer countries. The strong currency would mean that consumption would soar even while hours worked fell. Savings would increase in value, and people would have more ability to travel and pursue leisure activities. In essence, we are describing a rich economy.

Placed in such a context, it's easy to see the preferred option. Those who believe in the benefits of weak currencies do not specify when a falling currency becomes a bad thing. Clearly there must be a tipping point where lost purchasing power overcomes supposed gains in growth. Yet they are silent on that point. My position is that a rising currency is always good. No magic tipping point needs to be identified.

The problem is that economists now believe that the goal of an economy is to provide employment, not goods and services. They see a job as an end in and of itself, rather than as a means for people to get the things they really want. But if we can get all that we want without having to work, who needs to bother? A strong currency takes us closer to this goal. It is a testament to how far the "science" of economics has fallen that this goal has been utterly forgotten.

But this junk science is killing real growth. As long as this "black is white" ideology remains in place, the biggest printers will continue to be the biggest actual losers.

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

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Tags:  euroswiss francSwiss National Bank
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Damn the Torpedoes
Posted by Peter Schiff on 06/08/2012 at 7:25 PM
Last week in an interview on CBS Network News, Economist Mark Zandi, the chief economist for Moody's, unwittingly revealed a central error of the global economic establishment. Zandi has made a career out of finding the middle ground between republican and democrat economic talking points. As a result of this skill, he has been rewarded with large quantities of airtime from media outlets that want to appear non-partisan, despite the fact that his supposedly neutral analysis often leaves listeners frustrated. When asked about the recent deterioration in the global economy, Zandi said that "the worst possible scenario" at present would occur if Greece were to leave the Eurozone. He claimed that the economic gyrations and liquidations of bad debt that would result from such an exit would be sufficient to create a vicious cycle that could drag the global economy back into recession. As a result, he urged policy makers to take whatever steps necessary to maintain the current integrity of the 17 nation Eurozone. Given what most economists now know, few would actively argue that Greece's entrance into the Eurozone back in 2001 was a good idea. In fact most concede it was a terrible idea based on bad forecasting and outright fraud. There is little disagreement over the fact that Greece grossly misrepresented its financial position in order to gain initial entry into the monetary union. It is also widely agreed upon that in the ensuing decade Greece exploited its monetary advantages to borrow irresponsibly. Much has been written about how the fundamental misfit between Greece's economy and currency gave birth to a deeply flawed system that was destined to run off the rails. Most also agree that the countries like Greece and Germany are too economically and culturally disparate to exist under the same monetary umbrella. But despite all this, Zandi wants to maintain the status quo. In his opinion, it is so imperative to prevent the deflationary consequences of an economic restructuring that it is preferable to prop up a failed system, perhaps indefinitely, rather than allow a newer, healthier system to replace it. In the process, the moral hazard created not only assures that Greece will become an even greater burden on Europe, but so too will other nations whose leaders will be emboldened in their profligacy by the anticipation of similar help. From Zandi's perspective (and he is certainly in the majority on this point) the goal of economic policy is to keep GDP growing. It follows then that he will oppose large-scale debt liquidations which drag down GDP in the short term. But sometimes debt needs to be liquidated. Bad ideas need to be abandoned. Once economies stop throwing good money after bad, capital is freed up to flow into more economically viable purposes. But economists and politicians never look at the long term. Their job seems to be to manage the economy for the next election. The same "damn the torpedoes" mentality dominates economic thinking with respect to the U.S. economy as well. Years of artificially low interest rates, and government subsidies that direct capital towards certain sectors and away from others, has created an economy with too little savings and production, and too much borrowing and consumption. The ultra-low interest rates currently supplied by the Fed serve to perpetuate this unsustainable artificial economy. Higher rates would work quickly to redirect capital to the more productive sectors. But high rates could bring deflation and liquidation, which few economists are prepared to risk. We have too many shopping malls selling stuff, but not enough factories making stuff. We have too many kids in college studying liberal arts, and not enough in the workforce acquiring skills that will actually increase their productivity. Banks are loaning too much money to individuals to buy houses, and not enough money to entrepreneurs to buy equipment. We have too many tax-takers riding in the wagon, and not enough taxpayers pulling it. The list is long, but the solutions are short. We need to let interest rates rise to market levels, and allow the economy to restructure without government interference. We need to stop beating a dead horse and hitch our wagon to an animal that can really pull. The process will be painful for many, but like ripping off a band-aid, the pain will be over relatively quickly. However, since a painful restructuring means recession, politicians resist the cure with every fiber of their beings. So instead of a genuine recovery, one that will provide productive jobs and rising living standards, we get a phony recovery that produces neither. Preserving a broken system merely to avoid the pain necessary to fix it only makes the situation worse. Propping up sectors that should be contracting prevents resources from flowing to other sectors that should be expanding. Keeping workers employed in nonproductive jobs prevents them from gaining productive employment elsewhere. Encouraging activity or behavior the market would otherwise punish discourages alternatives that it would otherwise reward. Unfortunately, leaders on both sides of the Atlantic put politics above economics, and economists like Mark Zandi provide the cover they need to get away with it. For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.

Tags:  euroeuropeGreecejobs
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The Golden Rule Reinterpreted
Posted by Peter Schiff on 05/07/2012 at 11:08 AM

 In an April speech in Berlin, Dr. Andreas Dombret, a member of the Executive Board of the Deutsche Bundesbank (the German central bank), offered a startlingly frank assessment of the current problems in Europe.  Although his comments were meant to apply to the tensions and imbalances that exist between the northern and southern tier of the 17-member eurozone, they shed inadvertent light on the broader global economy.

 

Rebuffing calls that Germany do more to support the faltering southern economies, Dr. Dombret said:

 

...Exchange rate movements are usually an important channel through which unsustainable current account positions are corrected....In a monetary union, however, this is obviously no longer an option. Spain no longer has a peseta to devalue; Germany no longer has a deutsche mark to revalue. Other things must therefore give instead: prices, wages, employment and output.

 

The question now is which countries have to shoulder the adjustment burden. Naturally, this is where opinions start to differ. The German position could be described as follows: the deficit countries must adjust. They must address their structural problems, reduce domestic demand, become more competitive and increase their exports.

 

In economics it is axiomatic that positive and negative current account balances will ultimately be offset by changes in relative currency valuations. The currencies of surplus countries are supposed to rise and the currencies of the deficit countries are supposed to fall. But the current global political alignment has altered this process. Like many of his German and continental peers in government and finance, Dombret is likely in favor of maintaining a common currency at all costs. But as he outlines, when currencies fail to adjust something else has to give. He insists that the giving come from those who have been getting.

 

Given their weak economies and strained fiscal positions, it should be evident that citizens of Greece, Portugal, Spain and Italy have been living beyond their means. Their relative prosperity over the last decade has largely been maintained by the purchasing power of the euro which itself has been buoyed by the strong German economy. Rather than forcing Germans, whose savings rates and current account surplus results from years of fiscal prudence, to lend even more money and suffer higher inflation so that the southern tier can receive more monetary stimulus, Dombret argues the citizens of deficit economies must spend less while working, producing and saving more.  In other words, their living standards must match their productivity.

 

Economic dynamics do not change with scale. And as it happens, there is a much bigger and equally flawed currency bloc in the world than the one Dr. Dombret is seeking to cure. In that larger bloc, the exact same dynamic of surplus and deficit nations is playing out within an inflexible monetary straightjacket.

 

In order to maintain exports and to manage economic expectations, many nations (most notably China) have instituted fixed exchange rates between their own currencies and the U.S. dollar. Although this system is not governed by a formal treaty like the one that binds the 17-nation eurozone, it has given rise to a virtual bloc of currencies that are unnaturally tethered, even while the underlying economics are drifting apart. And although there has been some recent flexibility from China on exchange rates, there is nearly universal consensus that these movements would be far more pronounced absent significant central bank manipulation.

 

Like the nations of southern Europe, the United States consumes far more than it produces. But rather than closing the gap by producing more and consuming less, both have followed a far less painful path. They have borrowed instead. Who can blame them? After all, it's far more enjoyable to consume than produce. And as we have seen in many financial arenas, a borrower will tend to borrow for as long as a lender is willing to lend, especially if there are no immediate adverse consequences.

 

Both Germany and China produce more than they consume. It is from these resulting surpluses that the deficit nations are borrowing. But these two creditor nations are currently showing different policy drifts with respect to their hard-earned savings. In Europe, German leaders are showing increasing reluctance to sacrifice the living standards of their own citizens to perpetuate an imbalanced economic system. The Chinese on the other hand appear to heartily encourage such a policy. This difference can be attributed to their respective political systems. In Germany, public opinion matters. In China, not so much.

 

The currency peg of the Yuan against the dollar, which China has enforced with varying degrees of exactitude over the past few decades, has helped the Chinese government exert greater influence over the growth and contours of its economy. But the policy has created hardships for Chinese citizens (such as disproportionately low rates of consumption and high rates of inflation). But lacking any means to overtly influence public policy, Chinese citizens have had little choice but to take it on the chin. German citizens on the other hand are much freer to voice their discontent. And in fact, fears of a voter backlash have been determinative in setting Berlin's agenda.  

 

The question for the global economy is whether China will become more like Germany, or Germany more like China. From my perspective the answer is clear. German leaders are unlikely to risk the scorn of voters by repudiating their cultural aversion to overly accommodative monetary policy. In China, the decisions will be more pragmatic.  Currently Beijing perceives advantages in the status quo. But ultimately the costs, in terms of increasing foreign exchange reserves and rising inflation, may force its hand. When that happens, the United States and Southern Europe will be in the same boat.  

 

To many, the "Golden Rule" is an idea that underscores the value of civility and fair dealing. But there is another, less magnanimous definition: "He who has the gold makes the rules." In the current global economy, the surplus countries have the gold and sooner or later we will be living by their rules. 

 

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Tags:  currencyeurogoldinflationyuan
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The Dollar's Lucky Streak
Posted by Peter Schiff on 01/10/2012 at 10:19 AM

Recent U.S. economic data, such as the modest drop in the unemployment rate and the massive expansion of consumer credit, have suggested that the American economy is finally recovering. Opposite conclusions are being thrown at Europe, where many are convinced that recession is returning. Not surprisingly then, the dollar is currently hitting a multi-year high against the euro. The strength of the dollar itself is often held up as one of the major proof points that the U.S. economy is “improving.” But the data points that I believe really matter continue to suggest an economy on life support. I believe that the dollar is rising for reasons that have nothing to do with America’s economic health. 

The ongoing sovereign debt crisis in Europe is unquestionably the center ring in the current economic circus. Given the difficulty of setting policy across borders and national interests, the negotiations in Europe have been messy, acrimonious, inconclusive, and conducted under the glaring lights of global media scrutiny. The action has diverted attention away from America’s problems, which in many ways are even greater than those in Europe. In contrast, America’s ability to print the world’s currency at will, and the nearly seamless agreement of policy between the Administration and the Federal Reserve, means that the United States has been able to virtually ignore the issues that Europe has been forced to confront. This relative calm has been mistaken for strength, and the dollar has beckoned as the ultimate safe haven currency.

The fact that the dollar is perceived as a safe haven acts as a self–fulfilling prophesy. Investors flee the euro and pile into dollars. The dollar then rises to reflect the demand. The increase validates the decision to buy in the first place, and the rising dollar then attracts even more buyers looking to profit from its appreciation. It’s a nice ride while it lasts.

Most “safe haven” dollar purchases are directed toward U.S. Treasuries. As a result U.S. interest rates are far lower than they would otherwise be without this inflow of spooked liquidity. But objectively speaking, the U.S. and Italy, for instance, have very similar national debt profiles. Yet interest rates in Washington are currently 600 basis points lower than they are in Rome. This means that Americans can borrow and spend much more. The result of all this extra debt financed consumption is a boost in employment and GDP. The positive economic impact makes the dollar even more attractive, thereby perpetuating the cycle.

If rates in Italy (or Spain for that matter) were as low now as they were two years ago, those countries would not be experiencing the problems they are today. Their borrowing costs would never have risen and their budgets would still be manageable. Similarly, higher interest rates in the U.S. would completely take the shine out of our economy. Imagine what would happen here if rates were just 200 basis points higher, let alone 600? U.S. consumers, homeowners, corporations, and governments are particularly dependent on cheap financing. As bad as things are in Europe, they would be even worse here. 

In other words, contrary to popular belief, the problems in Europe are helping, not hindering, the U.S economy – at least in the short-term. Over the long term, borrowing and spending more money to finance consumption and government red ink will not help the U.S. economy achieve a sustainable balance. If safe haven flows were to reverse (which could result from an improvement in Europe), the dollar would fall, interest rates and consumer prices would rise, and the U.S. economy would be right back in recession. The only “good news” is that such a positive development in Europe appears unlikely in the short-run.

All self-perpetuating virtuous cycles are vulnerable to a sudden break in the positive feedback loop. When reality rears its ugly head, and the spell breaks, the reverses can be vicious. It happened with dot com stocks, it happened with real estate, and I believe it will happen with the dollar and Treasuries. Even if Europe does not resolve its problems, the day of reckoning will still eventually arrive. The unfortunate truth is that the longer it takes, the worse it will be, as we will have that much more debt to reckon with.



Tags:  currencydollareurofederal reserve
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WAS 2011 THE END OF THE GOLD RUSH?
Posted by Peter Schiff on 01/04/2012 at 4:28 PM

For such a wonderful year for precious metals investors, the final calendar quarter left little to celebrate. Just as people now take for granted that their phones will also take pictures, play music, and surf the internet, many investors have come to expect gold and silver to move up in a straight line.

In fact, in a recent CNBC interview one analyst claimed that gold's recent correction proves that it is not really a safe haven. In truth, such a statement merely proves how little some analysts know about markets.

However much the fundamentals may be on your side, there are always mitigating factors that affect price movement. In the case of gold and silver, the temporary resurgence of the dollar versus other fiat currencies alternatives has been the dominant factor - but even that isn't the whole story.

STAMPEDE OUT OF EUROS

The critical factor that has been in play the past few months has been the European debt crisis going critical. I have said all along that the US is in worse shape than the EU overall because the EU has less will and capacity to resolve - or even temporarily paper over - its problems. The flip side is that, absent the massive stimulus the US has received, Europe has been forced to deal with its sovereign debt problems first.

Global investors have been spooked since the credit crunch of 2008. That means they are more likely to follow the herd rather than stick to the fundamentals. It takes a certain firmness of character to watch your investments sell off by double digits and not have a moment of self-doubt.

So, what we're seeing is big moves into and out of asset classes. But what is important to understand about these circumstances is not the scale of the moves but the direction of the trend.

Right now, the dollar is riding high. But it's still down over 30% over the last decade as measured by the generous US Dollar Index. Gold, by contrast, is up over 350% in that period. Of course, past performance does not guarantee future results, but the fundamentals have not changed. It's worth remembering that mainstream analysts chose the dollar over gold in almost every report over the last 10 years, based on a blind faith in the power of the US government to centrally plan the American economy. The market proved them wrong.

Once again, the mainstream narrative is that the real danger is in Europe and therefore the US offers a safe haven. This has caused a stampede out of euros and into dollars. But as we've seen over the last few years, the euro and dollar can decline simultaneously - and will continue to do so as more and more investors realize that the real safe haven is gold.

SHOOTING STRAIGHT UP

There is a reason assets don't move up in a straight line. Besides varying liquidity needs and risk appetites of investors, there are also built-in mechanisms to flush speculators out of a skyrocketing market.

As silver approached $50 this past April, the COMEX raised margin requirements for futures contracts on the metal, thereby pushing many speculators out of the market. While this practice presumably prevents speculators from overusing leverage, it also has the effect of crushing the short-term price of the metal. Both gold and silver have been subject to increased margin requirements this past year.

While we can now rest assured that future price increases are driven more by long-term investment than short-term speculation, it is not without costs. Speculators serve to reduce volatility in a market by buying in anticipation of future scarcity and vice versa. So, pushing out the speculators may increase volatility in the future. However, it's my feeling that in truth no gains have been lost at all - they have merely been postponed.

IS THIS THE TOP?

In order to determine whether the recent sideways movement of gold and silver is cause for concern, let's look at what lies ahead for 2012.

It is clear from 2011 that the new Tea Party members of Congress are not strong enough to stop the fiscal bleeding, and with the Occupy Wall Street movement in full swing, President Obama doesn't have a lot of room to compromise. Washington has been reduced to short-term measures to "pay" its bills, and the bills are mounting faster than ever.

Meanwhile, Ben Bernanke's Federal Reserve seems intent on pushing all the boundaries of monetary policy. In its most recent ploy, the Fed has engaged in a covert bailout of Europe through the use of currency swaps. From an investment perspective, this goes to show how deluded dollar investors are - they're buying into a currency that is being printed for any and all comers. This news should have caused the dollar to tank and gold and the euro to rise, but again, the fear trade is overriding all other considerations.

2012 should see more trouble from Europe, and therefore potentially more dollar buying. This might even be the year we see a few members exit the euro. However, there is no way to know how the euro will react in the short-term to such events, as such scenarios may already be priced into the market. In any event, long-term, the eurozone will be stronger without its weaker members. If they cannot mend their profligate ways, better to force them out now than compromise the solvency of the stronger members.

For smart investors, dollar strength caused by euro fears is simply an opportunity to buy contra-dollar assets on the cheap. Yes, I believe sub-$30 silver and sub-$1600 gold are still cheap for what's ahead. And with 2012 forecasts of $2,200 by Morgan Stanley, $2,050 by UBS, and $2,000 by Barclays, it appears I'm not alone.

Peter Schiff is CEO and Chief Global Strategist of Euro Pacific Precious Metals, a gold and silver coin and bullion dealer offering honest products at competitive prices.  

 

If you would like more information about Euro Pacific Precious Metals, click here or go to our website, www.europacmetals.com. For the fastest service, call 1-888-GOLD-160


Tags:  currencydollareurogoldprecious metalssilver
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The Great Western Crackup
Posted by Peter Schiff on 12/02/2011 at 1:09 PM

From World War II until very recently, the West - specifically Europe and the United States - was on a course for greater centralization, greater integration, and greater economic intervention. But this consensus is breaking down. In Europe, the euro has gone from steadily adding new members to now facing the prospect of having its weaker members quit. In America, the US Congressional Supercommittee has now officially failed in its mandate to bring even meager cuts to the bleeding US deficit.  

This is the beginning of the end. Both the EU and US are politically paralyzed, seeming only to be able to make compromises that involve more spending, more debt, and more central planning. The results are all too predictable to free-market thinkers: bailouts leading to moral hazard, low interest rates leading to ballooning debt, and eventually a cascade of systemic failures - leading to more bailouts.

This was confirmed yet again on Wednesday when central bankers on both sides of the Atlantic announced a coordinated tidal wave of new money to bailout the Western banking system yet again. Now, we're left with a world where the only thing you can trust is the gold and silver in your pocket.

LIKE LEMMINGS OFF A CLIFF

The poison of Keynesianism has left the politicians unable to even listen to free-market solutions. Personally, I have found it nearly impossible to find a Keynesian professor or official to debate me - even though (or perhaps because) I have a track record of accurate economic predictions. You would think at least one of them would want to tell me why I'm wrong... to offer some excuses for their failure to predict the dot-com bubble, the housing bubble, or anything that has come after that.

This is just an illustration of what we, as investors and citizens, are facing. The halls of power, the media, and academia are completely closed off from reality. They're clutching their theories and hoping that they don't end up having to work for a living like the rest of us.

EUROPE

I have repeatedly stated that the fact that Germany has been resistant to printing more euros is the main argument in favor of the euro. Of course, the mainstream consensus is the opposite. The same people who pushed for entitlement programs that Western nations couldn't afford are now arguing that the EU must use the power of the printing press to "help" bankrupt Greece, Italy, Spain, and others. Really, this is just a secret tax on those who chose to save for a rainy day, and it will lead the euro on the road to ruin just like the US dollar.

If Greece, Italy, et al, can't take the austerity that comes with staying in the euro, they should withdraw and see how the bond markets treat them without the implicit backing of Northern Europe. Either way, they must be made to face the market consequences of their previous spending.

Unfortunately, with this past Tuesday's announcement that the EU would provide another $10.7 billion bailout to Greece and Wednesday's bank bailout announcement, there is no sign that Europe's politicians are going to allow market forces to play out. Instead, repeated bailouts will ensure that other ailing economies, like Italy or Portugal, do not make the necessary cuts in time to avoid needing their own bailouts. And no one, save perhaps China, can afford to bail out the likes of Italy.

Thus, like pulling off a bandaid, the politicians have made the euro crisis more painful by drawing it out. This means more risk and more volatility for investors, causing them to abandon the supranational currency in droves.

AMERICA

Abandoning the euro looks like a wise course of action, but it becomes extremely unwise when you buy dollars instead. Remember, my concern with Europe is that they have started down a path that may lead them to the sorry state of the US. If you're worried that your refrigerator doesn't get as cold as it used to, you don't move your perishables to another fridge that won't even turn on!

The current state of the dollar is the nightmare scenario for the euro: no significant member-states are thriving, bailouts are assumed and given without significant debate, and the money supply is growing rapidly to cover the debts. At worst, the EU could be facing a rump euro comprised of the healthier Northern economies or years of debt monetization to try to "save" the PIIGS. But the US has already spent decades monetizing its debt and is now facing a 'game over' scenario. Remember, the EU might be going along with the latest bank bailout scheme, but the US Fed spearheaded it and the swaps are denominated in dollars.

The failure of the Congressional Supercommittee shows how laughable Washington - and, by extension, the dollar - has become. The Federal Reserve is frantically buying Treasuries at auction to make up for wilting demand from foreign creditors, such that it may soon hold 20% of all outstanding Treasury debt. Meanwhile, the Supercommittee failed in its meager mandate to slow the growth of new spending by $100 billion a year, barely a dent in an annual deficit that runs over $1 trillion a year - not to mention the $15 trillion in debt already accumulated. The failure caused ratings agency Fitch to downgrade its outlook on US credit, potentially joining S&P soon in stripping the US of its AAA. Perhaps the analysts at Fitch realize that if the Fed were to stop buying Treasuries, say because consumer prices started rising too quickly to ignore, then rising interest rates would add additional trillions to the debt problem, making default inevitable. Or maybe they're starting to realize that getting paid back the whole coupon in worthless dollars is just another form of default.

In short, the US is going to be mired in economic depression for the foreseeable future, with no reform efforts likely, and so the Fed will continue printing as much as it can to paper over the problem. This is tremendously bearish for the dollar, even moreso than a euro facing the loss of a few weak member-states.

THE BUCK STOPS HERE

The knee-jerk buying of US dollars, which has sent metals prices on a roller coaster this fall, represents pure market manipulation by the Fed. Private buyers and foreign governments were selling dollars and Treasuries before this recent market action sent confusing signals. We saw a short rally, but on Wednesday's bank bailout news, dollar selling resumed. Overall, the trend remains: the Fed will continue to buy a greater and greater share of US debt until all the new money it's printing sends inflation into the double digits.

So, in a world where the two major reserve currencies are both faltering, where is global capital going to find safety?

A look at history sees periods of monetary debasement and market mania followed by a return to more fundamental values. Every successful civilization in history has relied on sound money to grow, always in the form of precious metals. With globalization, we live in a world where investors don't have to live with their governments' bad choices. Allocating a portion of your portfolio to precious metals means being able to sit on the sidelines and laugh at the comedy of the sovereign debt crisis. It means that when new dollars or euros are printed, your metals simply go up in price.

That is the ultimate resolution to this crisis. More banks, institutions, and individual investors will simply withdraw from the fiat money system and rely on precious metals as their reserve asset. As they do so, the fiat system will be all the weaker for the those left behind. After this period of uncertainty, a new consensus is sure to form, and the 24% run up this year alone indicates that gold may play a central role.



Tags:  dollarEUEurosupercomittee
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U.S. Economy, Inflation, China, Euro, and Gold
Posted by Staff on 01/14/2011 at 3:15 PM
Peter comments on the U.S. economy, inflation, China, euro, and gold.

Tags:  Chinaeurogoldinflationjobs
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Don't Fear the Euro - I'll Take the Euro in a Pinch
Posted by Michael Pento on 10/22/2010 at 3:50 PM

The latest commentary from Michael Pento, Senior Economist of Euro Pacific Capital:

When the euro hit a low of $1.1917 against the US dollar on June 7th, 2010, the airwaves crackled with assertions that the European common currency, beset by Greek debt problems and intra-union discord, was destined to trade at parity with the greenback. They were wrong. Since then, the euro has risen over 17% against the dollar, hitting $1.3961 today. The current upswing, delivered courtesy of the Fed, has at least temporarily silenced the euro's critics. It should also serve to impugn the notion that the US dollar holds a permanent position as the world's reserve currency.

Together, the 27 countries that comprise the European Union represent the largest single market in the world. Its GDP on a purchasing power parity (PPP) basis was $16.5 trillion in 2009, which is greater than the $14.2 trillion US economy in that year. The economies of the 16 countries in which the euro is legal tender produced a GDP of about $10.5 trillion on a PPP basis. That is equivalent to 74% of US total output in '09. Therefore, the economy of Europe, however measured, is similar in size and scope to that of the US and should be viewed with the same gravitas.

Rather than the comparative size of the two massive markets, the primary issue is that the US dollar accounts for 62% of global central bank reserves, even though it represents less than 25% of global GDP. In comparison, the euro represents just 26% of FX reserves. Why does the US economy deserve such a tremendous over-weighting of central bank reserves, and is this a net benefit to dollar investors? I argue that since their currency holdings are so vastly concentrated, global central banks are in a tenuous and vulnerable position. Should they ever need to reduce their dollar holdings - especially in concert - it would place tremendous downward pressure on the US currency. Meanwhile, no such over-owned condition (along with concomitant pent-up selling pressure) exists for any other currency.

Currently, the gross national debt of the US stands at 93% of GDP. The European Commission projects that their gross national debt will reach 84% of output this year and 88.2% in 2011. The Congressional Budget Office projects our national debt to reach over 100% of GDP in 2012, whereas the national debt of the EU will not reach 100% of output until 2014, according to the European Commission. Finally, US interest rates are much lower than those of the eurozone. From the looks of it, it's not the euro analysts should distrust, but the dollar.

But What Happens the Next Time Down?

Investors the world over have traditionally flocked to the US dollar for safety. Many well remember the fall of non-dollar currencies in 2008, when the Dollar Index surged 27% and crushed most commodity prices, including gold. How do we know that the next international crisis won't cause the same global flight into the "safety" of US dollars and out of secondary currencies like the euro? The answer can be found in comparing the Fed's current approach with the strategy it employed two years ago.

Ben Bernanke's initial response to the credit crisis of 2008 was fairly muted. Given today's era of accommodation, it may surprise investors to be reminded that the Fed left interest rates unchanged throughout the entire panic period from April 30ththru October 8th, 2008, despite the fact that the S&P 500 dropped 37% during that time. And Bernanke only slightly increased the monetary base by $160 billion during that drubbing in equities. So, given the uncertainty and confusion that reigned and the Fed's promises of stability, global investors flocked to the dollar, as they have done in Pavlovian fashion ever since the Bretton Woods Agreement was signed more than 65 years ago.

However, since the initial crash, the Fed has abused the dollar so disastrously that the remaining well of confidence has dried up. Ben sent out a fleet of helicopters to demonstrate to the world that he would not tolerate the appreciation of the USD or allow price levels to contract. While other central banks are beginning to tighten policy, the Fed has only promised more "quantitative easing."

On the fiscal side, lawmakers in Washington have diverged from their counterparts in Berlin and London by refusing to consider any measures that would address growing debts. While austerity takes hold around the world, profligacy still runs rampant in the US. 

In short, we are sending a loud and clear message to global investors: "You will be severely punished for seeking shelter in our currency and bond market!" The monetary base has doubled since the crisis, to $2 trillion, and the announcement of another dramatic increase is expected at the conclusion of the next FOMC meeting on November 3rd. The Fed has engineered robust "growth" rates in all the monetary aggregates, but yet has gone on record for the first time in its history saying that the rate of inflation is too low. All this has resulted in the US dollar losing nearly 13% of its value since June.

I went on record last summer saying that selling euros (or most any other currency) to buy US dollars is sort of like exchanging your ticket on the Titanic for a ride on the Hindenburg. The only safe forms of money are those that act as a store of wealth, preferably because their value will not be recklessly diluted by fiat. The Fed has put the world on notice that the dollar can no longer be viewed as a safe-haven currency. No such notice has been posted by the European Central Bank. And although no fiat currency is really safe, it is clear some are abused much less than others. 

During the next phase of the crisis, it is likely that investors will be more cognizant of these facts than they were in 2008. As a result, I would expect them to seek shelter outside the dollar, perhaps in other currencies but also in commodities and precious metals. The days of panic dollar spikes may finally be over.



Tags:  dollareuro
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