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Governments Need Inflation, Economies Don't
Posted by Peter Schiff on 10/15/2014 at 11:06 AM
In an article in the UK's Telegraph on October 10, veteran economic correspondent Ambrose Evans-Pritchard laid bare the essential truth of the nearly universal current embrace of inflation as an economic panacea. While politicians, CEOs and economists talk about demand stimulus and the avoidance of a deflationary trap, Evans-Pritchard reminds us that inflation is all, and always, about debt management.
 
Every year the levels of government debt as a percentage of GDP, for both emerging market and developed economies, continue to go higher and higher. As the ratios push out into uncharted territories, particularly in Europe's southern tier, the ability to "inflate away" debt through monetization remains the only means available to postpone default. Evans-Pritchard quotes a Bank of America analyst as saying that even "low inflation" (not to mention actual deflation) is the "biggest threat to the dynamics of public debt." IMF Managing Director Christine Lagarde ramped up the rhetoric further when she recently told the Washington Press Club that "deflation is the ogre that must be fought decisively." In other words, governments need inflation to remain viable. It's the drug they just can't do without.  
 
But as this simple truth is just too embarrassing to admit, politicians and central bankers (and their academic, journalistic, and financial apologists) have concocted a variety of tortured theories as to why inflation is not just good for overly indebted governments, but an essential economic good for all. In a propaganda victory that even Goebbels would envy, it is now widely accepted that purchasing power must decrease for an economy to grow.
 
Despite centuries of economic evidence to the contrary,they argue that if prices do not rise by at least 2% per year consumers will not spend, business will not hire, and economies will slip into an intractable deflationary death spiral. To prevent this, they recommend governments spend without raising taxes. Not only would such a move involve a direct stimulus by increased government spending, but the money printed by the central bank to finance the deficit will push up prices, which they argue is very healthy for the economy. As the Church Lady used to say, "How convenient."
 
Offering voters something for nothing is the Holy Grail of politics. But as a matter of reality, voters should know that a free lunch always comes with a cost. This isn't even economics, its physics.
 
When increased government spending is paid for with higher taxes, workers notice that their paychecks have been reduced. This provides clear evidence that government spending comes with a cost. But this bright line is much more difficult to see when the spending is paid for by inflation (printing money). But the net impact on consumers is the same.  
 
Inflation does not reduce the nominal amount of one's paycheck. But rising prices reduce the amount of goods and services it can buy. So when governments run deficits, workers will be stuck with the bill. Whether they pay though higher taxes or inflation, their standard of living will be diminished. The main difference is that workers know to blame government for higher taxes, which explains why politicians prefer inflation.
 
To give cover to this tendency, economists have come up with the bizarre concept that falling, or even stable, prices squelch demand and deter consumption. The idea is that if consumers know that something will cost less in the future (even if it's just 2% less) they will defer their purchases indefinitely, perhaps waiting for the cost of their desired product or service to approach zero. They argue that this can push an economy into a deflationary spiral of falling prices and diminished demand which may be impossible to escape.
 
But this idea ignores the time value of a product or service (people will tend to pay more for something they can enjoy sooner rather than later) and the economic law that shows how demand goes up as the price falls. But common sense has absolutely nothing to do with the current practice of economics. Instead, the dominant argument is that inflation is needed to seed the economy with demand.  
 
However, this argument is merely a smoke screen. The only thing that inflation can do is to help governments spend. Economies do just fine with low inflation. In fact during the late 19th century, in the Great Sag, the United States experienced sustained deflation while creating much faster economic growth than we have seen in the last few generations. As recently as during the early 1960s the U.S. experienced consistently low inflation (barely 2%) and strong economic growth based on government figures. But in their call for more inflation, modern economists tend to forget or downplay those periods.
 
But inflation is actually more economically harmful than taxation. By blurring the link between higher government spending and reduced purchasing power, the public is less likely to oppose government expansion. And therein lies the truth. Inflation is not needed to grow economies but to grow governments.
 
The problem is particularly acute in Europe where countries of radically different fiscal characteristics have been locked into a politically unworkable monetary union. On one side are countries like Italy, Spain, and France whose governments have been notorious for offering generous benefits for which they can't pay. Before adopting the euro, these countries had currencies that were not known for their bankability. Germany, on the other hand, had built its reputation on balanced budgets and a strong Deutsche Mark. But given the strict monetary restrictions that were needed to grease the skids toward union, the European Central Bank has not been able to create inflation as freely as the U.S. or Japan. As a result, the debt crisis there has been placed in particularly sharp focus, as the problem is perceived to be much larger than in other developed countries that can print at will.
 
The calls for more inflation in Europe should be raising hackles on the streets of the Continent. But Keynesian economists have provided cover for politicians for years, and true to form, they have again risen to the occasion. While it is understandable that governments are motivated to champion inflation, it is harder to see why professional economists are similarly inspired. Perhaps they believe modern economics has the magic ability to create something from nothing. But the idea that a properly applied macroeconomic formula can somehow circumvent the laws of supply and demand is ludicrous and dangerous.
 
Of course, the idea that governments can hold inflation to just 2% per annum is preposterous. Once it breaches that level, governments will be powerless to contain it. The endgame will be hyperinflation. That is because escalating levels of debt will prevent them from raising interest rates high enough to break the inflationary spiral. The last time that inflation really got out of hand was back in the early 1980s when a boldly inspired Federal Reserve was able to put the genie back in the bottle by hiking interest rates all the way up to 18%. The economy not only survived that harsh medicine, but it prospered as a result. Does anyone seriously believe that we could survive even a quarter of that dosage today?
 
Since the central banks are now destined to forever remain behind the inflation curve, it will continue to accelerate until the real threat of hyperinflation looms much larger than did the contrived threat of deflation.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

Catch Peter's latest thoughts on the U.S. and International markets in the Euro Pacific Capital Summer 2014 Global Investor Newsletter!

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The Sound Money Business: Four Years Past and Future Forecast
Posted by Peter Schiff on 10/03/2014 at 12:53 PM
Yesterday, I launched a new website and announced the rebranding of my gold bullion dealer from Euro Pacific Precious Metals to SchiffGold. I started this company four years ago to provide a trustworthy option for my Euro Pacific Capital brokerage clients, but it has since grown to become a major US gold dealer in its own right. This landmark for my company comes in the midst of a historic time for the precious metals. The past four years have had highs and lows. We have been experiencing the inflation of remarkable new asset bubbles, and gold’s response has been mixed. But I have reason to believe that over the next four years, gold and silver investors will witness shocking macroeconomic events that put to rest any doubts about the importance of having sound money in every portfolio.

Short-Term Memory Lane

It’s hard to believe that when I started my gold company in the summer of 2010, the Federal Reserve was already finishing its first round of quantitative easing (QE1). Yet even that massive inflationary program was not enough to paper over the fallout from the credit crisis of ’07-’08. Because the economy did not “return to normal,” Fed Chairman Ben Bernanke had his excuse to begin a second round of QE just a few months later.

The government had already started the circular narrative that confuses the markets to this day: “The economy is in genuine recovery, but it still requires ongoing emergency stimulus from the Fed.” 

The announcement of QE2 spurred many of our initial customers to make substantial purchases of gold and silver. The rest of the market soon caught up. In the year following QE2, gold rocketed to its current record-holding high of just over $1900. 

As QE2 ended, “Operation Twist” began, and before long QE3 was introduced. In order to prevent their currencies from appreciating against a now increasingly worthless US dollar, nations around the world joined the money-printing party. These foreign governments wrongly believed that they were dependent on exporting their goods to the US for dollars, when in fact stronger currencies would have allowed them to keep the fruits of their labor to enjoy at home. This has developed into the ongoing international “currency war,” in which countries are racing to see which can impoverish their citizens fastest. 

The currency war has been a boon to the US dollar, which has appeared fairly stable relative to other currencies. However, just because you and a fellow skydiver both fall in tandem doesn’t change the fact that you’re both headed toward the ground. Short-sighted speculators have ignored this reality, and the precious metals have taken an undeserved beating.

What the Future Holds

QE3 has been winding down throughout 2014, and investors are eagerly awaiting news of a rate hike from the Fed. After all, if the economy is as healthy as the government claims, we should no longer be in need of these multiyear emergency measures.

Unfortunately, the Fed's zero interest-rate policy (ZIRP) is the very thing making the economy appear healthy. It has boosted stocks and financed corporate acquisitions. It has also allowed the federal government to continue operating under a crushing debt load. Even a rise in rates to historically average levels could very well bankrupt the federal government and many of America’s remaining industrial giants.

Neither Fed Chairwoman Janet Yellen nor Washington want to bear responsibility for the painful process of raising rates. Instead, I have long forecast that the Fed will follow QE3 with QE4, and so on. After all, each round of QE is like trying to put out a fire with gasoline, it only makes our economic problems burn hotter.

Meanwhile, our creditors will continue to make careful moves to extricate themselves from the US dollar reserve system, like China’s recent currency swap deals with other emerging markets or its rapid liberalization of domestic gold markets.

This means that a stagnant job market and poorly disguised inflation is the “new normal” for Americans. Forget about sending the kids to college – it’s going to be a struggle for many families just to make ends meet. Those who don’t own gold and silver will see their dollar savings and quality of life diminish at a faster and faster rate.

Helping You Turn Paper Into Gold

My new motto for SchiffGold is “Helping you turn paper into gold.” This has been our mission for the last four years, and it will only gain urgency in the next four. 

While the precious metals may have seemed like they were riding a roller coaster recently, serious investors must learn to see past the short-term noise to understand the important fundamental signals. By all accounts, the global dollar reserve system is in its death throes. At the first major crack, we are likely to see the biggest gold rally the world has ever seen. At that point, it will matter less whether you bought in at $600, $1200, or $1900, because those prices will all seem so cheap as to be quaint. Remember $1.20 a gallon gas? That wasn’t too long ago, and yet we know that we’ll never see that price at the pump again.

SchiffGold will continue to help customers redeem as many paper dollars as possible for physical gold and silver – trading a devaluing asset for one that has been on a 12-year uptrend. I am proud of how my gold company has weathered the storm of overwhelming negative sentiment towards precious metals. While doubters abandoned ship, we were the first to introduce innovative new products that increased investor liquidity, like the 
Valcambi CombiBar and the Silver Barter Bag. When others laid off brokers, we were training passionate new specialists in the intricacies of precious metals investing. The result is that, as I understand it, we have the most loyal customer base of any US gold dealer.

We’ve managed to accomplish this without resorting to selling the high-margin products that make up the bulk of many major dealers’ revenue. Soon after forming my company in response to these widespread shady dealings, we launched the 
Classic Gold Scams educational campaign. In the years since, we have exposed nearly every scam and ripoff imaginable. More recently, several unscrupulous dealers have come under investigation and closed their doors. 

The years spent growing my gold company from scratch have been exciting, but our greatest work has yet to be done. Our mission will continue as long as the US government remains committed to obliterating the value of the dollar, and investors seek out an honest guide to safety.

 

Peter Schiff  is Chairman of gold bullion dealer SchiffGold and CEO of stock brokerage firm Euro Pacific Capital. Schiff became internationally known by successfully forecasting the collapse of the dot-com bubble, the US housing market bubble, and the bankruptcy of major global banks. He is also the author of several bestselling books, including "Crash Proof: How to Profit from the Coming Economic Collapse”released in 2007 before the financial crisis struck, and the more recent “How An Economy Grows And Why It Crashes” and “The Real Crash: America’s Coming Bankruptcy". Follow his latest thoughts at Peter Schiff's Gold News.

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Economic Atonement
Posted by Peter Schiff on 09/30/2014 at 12:15 PM
This Friday is Yom Kippur, the day when Jews around the world ask forgiveness for their transgressions from the year past. Rabbis remind the penitent to dwell on their sins of omission, in which they did nothing when a more thoughtful and proactive action was needed, and sins of commission, in which they actively participated in an unjust action. And while not all economists are Jewish, Gene Epstein the economics editor at Barron's, offered his thoughts on how this applies to the group. 
 
While Gene is certainly on to something, I think he could have gone much further in his finger pointing. Increasingly, economists are calling the tune to which businesses and consumers dance. Since their words and opinions matter, they may consider seeking forgiveness for what they have said, and what they have not.

 

Sins of Omission

 

Despite clear evidence that elevated prices in stocks, bonds and real estate remain a direct consequence of zero percent interest rates and quantitative easing, the crowd has asserted again and again that the prices are justified by the surging U.S. economy. There is very scant evidence upon which to base such an opinion.

 

Most economists have held very tightly to the view that was widely shared at the end of 2013; that 2014 will be the year that the U.S. economy finally shakes off the malaise of the Great Recession. And even though the script has failed to live up to these expectations, the economists haven't seemed to notice.

 

During the First Quarter of this year, the economy contracted at an astounding annual pace of 2.1%. But economists and politicians were very insistent that the severe miss was solely a result of the difficult winter. Although severe winters can be a drag on an economy (my research shows that the 10 roughest winters over the last 50 years knocked about two points off the normal first quarter GDP), the snow could not fully explain a five point miss from what had been forecast by the consensus at the end of 2013. But that's exactly what they did.

 

This omission was compounded by their reaction to the 2nd quarter rebound, which showed the economy expanding by 4.6%. But while the crowd was ready to dismiss the very weak first quarter GDP as being a weather-related anomaly, they were not willing to acknowledge the role played by the same anomaly in artificially boosting second quarter GDP. My research, based on figures from the Bureau of Economic Analysis, has shown that strong second quarter rebounds almost always follow sub-par weather-related first quarters. This makes intuitive sense as well. Activity that is delayed in winter gets unlocked in spring. But economists look at the second quarter as if it represents the entire year. But already plenty of evidence has emerged that should sow doubts on the remainder of the year.

 

Even with the strong second quarter, economists are choosing to gloss over the fact that growth in the entire first half came in at just 1.25%, far below the projections that most have for the calendar year. To get to 2.5% GDP growth, which would be typical of a weak year, not the first year of a long-awaited recovery breakout, GDP would have to come in at 3.75% for the entire second half. To hit 3% for the year, second half growth would need to be 4.75%.

 

But this will have to occur without the tail winds of Fed QE support and at a time of heightened geopolitical concerns, and a housing and stock markets that look increasingly weak and vulnerable to correction. As a result, economists should take off their rose-colored glasses and ratchet down their full year estimates to conform more closely to reality. But that is not happening.

 

Sins of Commission

 

Rather than seeing, hearing, and speaking no evil, some leading figures are much more culpable in spreading bad information. While this list could prove lengthy, here are the top two offenders.

 

Fed Chairwoman Janet Yellen - In her September press conference, Yellen made the stunning assertion that the Fed's balance sheet, which in recent years has swelled to a gargantuan $4.5 trillion, will likely be reduced in size to "normal levels" by the end of this decade. While most accept this statement at face value, Yellen must know the absolute inability of the Fed to deliver on this promise.

 

To bring its balance sheet back to pre-crises levels of around $1 trillion, the Fed must sell about $3.5 trillion of debt over the next five years, or a pace of about $700 billion per year. This is a negative equivalent of about $58 billion per month in QE. Additionally, Yellen has claimed that this can be done without actively "selling" assets, and without tipping the economy back into recession. This claim is so fantastical that it must be considered active deception, a grave sin indeed.

 

First, if QE was necessary to inflate asset prices and create a wealth effect to drive consumer spending and power the recovery, how can the process be reversed without unwinding its effects and producing an even larger recession than the last? If the recovery is already stalling with interest rates still at zero, how can it gather more upward momentum if the Fed raises rates back to normal levels?

 

Secondly, if the Fed does not actively sell bonds into the market, it must hope to draw down the balance sheet by simply allowing older bonds to mature. This ignores the fact that the maturation process is far too slow to accomplish the task by the end of the decade, and it assumes that the Fed will not have to buy any new Treasury or Mortgage-backed bonds over that time. But in order to provide financing for ongoing Federal budget deficits, or to stimulate the economy if there were another economic downturn, the Fed would have no choice but to start buying again with both hands. Since the current "recovery" is already 15 months longer than the average post-war recovery, it would be illogical to assume that we can make it through the next five years without another recession.

 

Of course, by affirming its intention not to actively sell any of its holdings, Yellen is attempting to defray any concerns the markets might have over the impact such sales would have on bond prices. Lost on everyone, including Yellen herself, is that the impact on the markets is the same regardless of how the Fed's balance sheet shrinks. Even if the Fed allows bonds to mature, the Treasury would then be forced to sell an equivalent amount of bonds into the market to repay the Fed. The fact that a distinction without a difference reassures anyone shows just how delusional market participants remain.

 

World bank President Jim Yong Kim - In an interview at September's Clinton Global Initiative, the World Bank president urged the European Central Bank to follow the same "successful" experiments in quantitative easing that had been pioneered by the Federal Reserve. As proof of the policy's success, Kim pointed to the stronger GDP growth that is expected in the US in 2015 and 2016. In other words, he is attempting to prove his point not by what has happened thus far, but by what the consensus expects to happen in a year or two. This is no way to argue a point. Dr. Kim is a smart guy and I suspect he knows this, hence another sin of commission.

 

It would be difficult to make the case that six years of Quantitative Easing has created a healthy US economy. In addition to the subpar first half of 2014 GDP growth, the labor market, consumer sentiment, and wage growth all show signs of stagnation. So Dr. Kim has no choice but to hang his hat on a bright future that he, and most mainstream economists, expect to be right around the corner. But dressing up a future possibility as a current certainty is a major foul in the business of economic forecasting. Dr. Kim, and others who have made similar claims, should fast an extra day.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube



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A New Fed Playbook for the New Normal
Posted by Peter Schiff on 09/17/2014 at 10:43 AM
While many economists and market watchers have failed to notice, we have entered a new chapter in the short and checkered history of central banking. This paradigm shift, as yet unaddressed in the textbooks, changes the basic policy tools that have traditionally defined the sphere of macroeconomic decision-making.
 
The job of a central banker is supposed to be the calibration of interest rates to achieve the optimal rate of growth for any particular economic environment. It is hoped that successful decisions, which involve perfectly timed moves to raise rates when the economy overheats and lower them when it cools, would bring consistency and stability to the business cycle that many fear would be dangerously erratic if left unmanaged. That's the theory. The practice is quite different.
 
Over the past thirty years or so, interest rates have been lowered far more often than they have been raised. This makes sense. Bankers, being human, would rather err on the side of good times not bad. They would rather leave the punch bowl out there a little too long than take it away too soon. Over time, this creates a huge downward bias. But things have really become distorted over the past eight years, a time period during which interest rates have never gone up. They just go down and stay down.
 
Back in the early years of the last decade, Alan Greenspan ventured into almost unknown territory when he lowered interest rates to 1% and left them there for more than a year. But in today's terms, those moves look hawkish. In the wake of the 2008 financial crisis, Ben Bernanke brought interest rates to zero, where they have remained ever since.
 
But old habits die hard, and economists still expect that rates can and will go back to normal. They assume that since the economy is now apparently on solid footing, the period of ample accommodation is over. In reality, we have built an economy that is now so leveraged that it needs zero percent interest rates just to tread water.
 
Based on statistics from the Bureau of Economic Analysis, from 1955 to 2007 Fed Funds rates were on average 230 basis points higher than average GDP growth (5.7% vs. 3.4%). But from 2008-2013, Fed Funds rates have been less than half the rate of GDP growth (0.44% vs. .92%). Rates lower than GDP, in theory, should stimulate the economy. But instead we are stuck in the mud.
 
Twenty-odd years ago the textbooks still seemed to work. A recession hit in 1991, which brought GDP close to zero. In response, the Fed cut rates by more than 200 basis points (from 5.7% in 1991 to 3.5% in 1992.) As expected, 1992 GDP rebounded to a reasonably healthy 3.6%. But the rate cuts did little for asset prices. In that year the S&P 500 crept up just 4.4% and the Case-Shiller 10-City Composite Index of home prices actually fell almost 2% nationally.    
 
Compare that to 2013. With Fed Funds still near zero, GDP actually fell to 2.2% from 2.3% in 2012. But asset prices were a different story. Stocks were up 26% and real estate up 13.5%. It would appear that interest rates have lost their power to move GDP and can now only exert pressure on asset prices.  As a result, rates are no longer the main attraction in central banking. The real action takes place elsewhere.
 
The Fed and other central banks have made the active purchase of financial assets, known as quantitative easing, to be their main policy tool. QE is a more powerful drug than interest rates. It involves actual market manipulation by the purchases of bonds on the open market. Whereas zero interest rates could be compared to a general stimulant, QE is a direct shot of adrenaline to the heart. When the next recession comes, the syringe will likely come into greater use.

Since 1945 the U.S. economy has dipped into recession 11 times. The average length of the recoveries between those recessions was 58.4 months, or just under five years. The current "recovery" is already 73 months old, or 15 months longer than the average. How will the Fed deal with another contraction (which seems likely to begin within the next year or two) with rates still at or very close to zero? QE appears to be the only option.
 
Given that reality, the big question is no longer whether the Fed will raise or lower rates, but by how much they will ramp up or taper off QE. When the economy contracts, QE purchases will increase, and when the economy improves, QE will be tapered, and may even approach zero for a time. But interest rates will always remain at zero or, at the least, stay far below the rate of inflation. This will continue until QE loses its potency as well.
 
Mainstream economists will be quick to dismiss this theory, as they will say that policy is now on course for normalization. Although economic growth in 2013 was nothing to write home about, the set of indicators that are normally followed by most economists, point to a modest recovery, exuberant financial markets, and falling unemployment. But if that is the case, why has the Fed waited so long to tighten?
 
The truth is the Fed knows the economy needs zero percent rates to stay afloat, which is why they have yet to pull the trigger. The last serious Fed campaign to raise interest rates led to the bursting of the housing bubble in 2006 and the financial crisis that followed in 2008. This occurred despite the  slow and predictable manner in which the rates were raised, by 25 basis points every six weeks for two years (a kind of reverse tapering). At the time, Greenspan knew that the housing market and the economy had become dependent on low interest rates, and he did not want to deliver a shock to fragile markets with an abrupt normalization. But his measured and gradual approach only added more air to the real estate bubble, producing an even greater crisis than what might have occurred had he tightened more quickly.
 
The Fed is making an even graver mistake now if it thinks the economy can handle a measured reduction in QE. Similar to Greenspan, Bernanke understood that asset prices and the economy had become dependent on QE, and he hoped that by slowly tapering QE the economy and the markets could withstand the transition. But I believe these bets will lose just as big as Greenspan's. The end of QE will prick the current bubbles in stocks, real estate, and bonds, just as higher rates pricked the housing bubble in 2006. And as was the case with the measured rate hikes, the tapering process will only add to the severity of the inevitable bust.

So while the market talks the talk on raising rates, the Fed will continue to walk the walk of zero percent interest rates. The action has switched to the next round of QE. In fact, since none of the Fed's prior QE programs were followed by rate hikes but by more QE, why should this time be any different? The most likely difference will be that eventually a larger dose of QE will fail to deliver its desired effect. When that happens, who knows what these geniuses will think of next. But whatever it is, rest assured, it won't be good.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

Catch Peter's latest thoughts on the U.S. and International markets in the Euro Pacific Capital Summer 2014 Global Investor Newsletter!

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Doubling Down on Inflation
Posted by Peter Schiff on 09/10/2014 at 1:39 PM
Friday's release of disappointing August payroll numbers should have been a jarring wake-up call warning Wall Street that the economy has been treading on thin ice. Instead the alarm clock was stuffed under the pillow and Wall Street kept sleeping. The miss was so epic in fact (the 142,000 jobs created was almost 40% below the consensus estimate) that the top analysts on Wall Street did their best to tell us that it was all just a bad dream. Mark Zandi of Moody's reacted on Squawk Box by saying "I don't believe this data." The reliably optimistic Diane Swonk of Mesirow Financial told Reuters the report "sure looks like a fluke, not a trend".
 
But the opinions of those that really matter, the central bankers in charge of the global economy, are likely taking the report much more seriously. Given that this is just the latest in a series of moribund data releases, such as news today that U.S. mortgage applications have fallen to the lowest levels in 14 years, caution is justified. Unfortunately very little good comes from central bank activism. Recent statements from Fed officials across the United States and recent actions from ECB president Mario Draghi reveal their growing resolve to fight too low inflation, which they believe is the biggest threat to recovery. There are many things that are contributing to the global woes. But low prices are not high on the list.
 
Since the markets crashed in 2008, central banks around the world have worked feverishly to push up the prices of financial assets and to keep consumer prices rising steadily. They have done so in the official belief that these outcomes are vital ingredients in the recipe for economic growth. The theory is that steady inflation creates demand by inspiring consumers to spend in advance of predictable price increases. (The flip side is that falling prices "deflation," strangles demand by inspiring consumers to defer spending). The benefits of inflation are supposed to be compounded by rising stock and real estate prices, creating a wealth effect for the owners of those assets which subsequently trickles down to the rest of the economy. In other words, seed the economy with money and inflation and watch it grow.
 
Thus far the banks have been successful in creating the bubbles and keeping inflation positive, but growth has been a no show. The theory says the growth is right around the corner, but like Godot it stubbornly fails to show up. This has been a tough circle for many economists to square.
 
Two explanations have emerged to explain the failure. Either the model is not functioning (and higher inflation and asset bubbles don't lead to growth) or the stimulus efforts thus far, in the form of zero percent interest rates and quantitative easing, have been too timid. So either the bankers must devise a new plan, or double down on the existing plan. You should know where this is going. The banks are about to go "all in" on inflation.
 
Despite their much ballyhooed "independence", central bankers have proven that they operate hand in glove with government. They are also subject to all the same political pressures and bureaucratic paralysis. There is an unwritten law in government that when a program doesn't produce a desired outcome, the conclusion is almost never that the program was flawed, but that it was insufficient. Hence governments continually throw good money after bad. The free market discipline of cutting losses simply does not exist in government.
 
This is where we are with stimulus. Six years of zero percent interest rates and trillions and trillions of new public debt have failed to restore economic health, but our conclusion is that we just haven't given it enough time or effort. My theory is a bit different. Maybe zero percent interest rates and asset bubbles hinder rather than help a real recovery. Maybe they resurrect the zombie of a failed model and prevent something viable and lasting from gaining traction? This is a possibility that no one in power is prepared to consider.
 
But what if they succeed in getting the inflation, but we never get the growth? What if we are headed toward stagflation, a condition that in the late 1970s gripped the U.S. more tightly than Boogie Fever? It may come as a surprise to the new generation of economists, but high inflation and high unemployment can coexist. In fact, the two were combined in the 70s and 80s to produce "the Misery Index." But according to today's economic thinking, the Index should not be possible. Inflation is supposed to cause growth. If unemployment is high they say there is no demand to push up prices. But it's the monetary expansion that pushes prices up, not the healthy job market.
 
The tragedy is that if the policy fails to produce real growth, as I am convinced it will, the price will be paid by those elements of society least able to bear it, the poor and the old. Inflation and stagnation mean lost purchasing power. The rich can mitigate the pain with a rising stock portfolio and more modest vacation destinations. But they won't miss a meal. Those subsisting on meager income will be hit the hardest.
 
Many economists are now trying to make the case that the United States had hit on the right stimulus formula over the past few years and is now reaping the benefit of our bold monetary experimentation. They continue the argument by saying Europe and Japan were too timid to implement adequate stimulus and are now desperately playing catch up. But this theory is false on a variety of fronts. First off, the U.S. is not recovering but decelerating. Annualized GDP in the first half of 2014 has come in at just a shade over one percent, which is lower than all of 2013, which itself was lower than 2012. The unemployment rate is down, but labor participation is at a 36-year low, and wages are stagnant. We have added more than $5 trillion in new public debt, but very little to show for it. We are not the model that other countries should be following but a cautionary tale that should be avoided.
 
It is also spectacularly wrong to assume that the problems in Europe and Japan can be solved by a little more inflation. Higher prices will just be a heavier burden for European and Japanese consumers, not an elixir that revitalizes their economies. The problems in Europe, Japan and the U.S. all have to do with an oppressive environment for savings, investment, and productivity that is created by artificially low interest rates, intractable budget deficits, restrictive business regulation, antagonistic labor laws, and high taxes. Since none of the governments of these countries have the political will to tackle these problems head on, they simply hope that more monetary magic will do the trick.
 
So as the Fed, the ECB, the Bank of Japan, and all the other banks that follow suit, push all their chips into the pot and hope that a little more inflation will save us from the abyss, we can wish them luck. It's going to take a miracle.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

Catch Peter's latest thoughts on the U.S. and International markets in the Euro Pacific Capital Summer 2014 Global Investor Newsletter!

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Neighborhood Bully - America Recklessly Throws its Weight Around
Posted by Peter Schiff on 08/15/2014 at 7:08 AM

On June 30, U.S. authorities announced a stunning $9 billion fine on French bank BNP Paribas for violations of financial sanctions laws that the United States had imposed on Iran, Sudan and Cuba. In essence, BNP had surreptitiously conducted business with countries that the United States had sought to isolate diplomatically (sometimes unilaterally in the case of Cuba). Although BNP is not technically under the jurisdiction of American regulators, and the bank had apparently not broken any laws of its home country, the fine was one of the largest ever issued by the United States and the largest ever levied on a non-U.S. firm. The Treasury Department and the Federal Reserve made clear that unless BNP forks over the $9 billion (equivalent to one year's of the company's total earnings), the U.S. will prevent the bank from engaging in dollar-based international transactions. For an institution that makes its living through such transactions, that penalty is the financial equivalent of a death sentence. The fine will be paid.

 

It is widely rumored that Germany's Commerzbank will be the next European institution to face Washington's wrath. It is rumored that it will face a penalty of at least $500 million, an amount that is roughly equivalent to one year of the bank's income. 

 

As if choreographed by a financial god with a wicked sense of humor, the very next day marked the official implementation of the Foreign Account Tax Compliance Act (FATCA), a new set of laws that will require all foreign financial institutions to routinely and regularly report to the U.S. Internal Revenue Service all the financial activities of their American customers. The law also requires that institutions report on all their non-American customers who have ever worked in the U.S. or those persons who have a "substantial" connection to the U.S. (Inconveniently the law fails to fully define what "substantial" means). Failure to report will trigger 30% IRS withholding taxes on any dollar-based transactions made by clients who the U.S. has determined to be American...either by birth, marriage, or simply association.

 

Given that the United States is one of only two nations in the world (the other being Eritrea) that taxes its citizens on any income received, regardless of where that income was earned and where the tax payer lived when they earned it, the FATCA laws are an attempt to extend American tax authority and jurisdiction (by unilateral dictate) to the four corners of the Earth. The Economist magazine, which is not known for alarmist reporting, described FATCA as "a piece of extraterritoriality stunning even by Washington standards." (For those of you who did not pay attention during world history class, "extraterritoriality" is an attempt by one country to enforce its own laws outside of its own borders).

 

What's worse is that many accountants and analysts have estimated that the compliance costs that the United States has imposed on these non-constituent banks (which have limited ability to lobby or influence U.S. lawmakers) will far outweigh the $800 million in annual revenue that the law's backers optimistically estimated. In a June 28th article, The Economist quotes an international tax lawyer saying that FATCA is about "putting private-sector assets on a bonfire so that government can collect the ashes." The laws are particularly irksome to many because the United States typically refuses to subject itself to the same standards it requires of others. When foreign governments ask Washington for financial information from its citizens, the U.S. government hypocritically trots out privacy laws and poses on the altar of civil liberties. In fact, despite its war on foreign tax havens, for non-Americans the United States is by far the world's largest tax haven.

 

But as is the case with BNP, the foreign banks will have little choice but to comply. Given the importance that U.S. dollar-based transactions play in daily banking operations, U.S. authorities call the tune to which everyone must dance. However, the complexity and opacity of the laws have at least generated some mercy from the U.S. which has allowed foreign banks more time to implement compliance procedures. In many ways this is similar to how the Obama administration has extended Obamacare mandates to a persistently confused and overwhelmed public. This is cold comfort.

 

The FATCA and the BNP developments have occurred just a few months after the U.S. has finished tightening the screws on a variety of Swiss banks that had attempted to follow the bank privacy laws that exist in their home country. Through heavy-handed tactics, U.S. authorities made it impossible for the Swiss banks to transact business internationally unless they played ball with Washington and turned over all information the banks possessed on U.S. customers. Not surprisingly, the U.S. prevailed. Additionally, June marked the end of Germany's farcical campaign to repatriate the hundreds of tons of gold that are supposedly on deposit at the Federal Reserve Bank of New York. After asking for its gold back two years ago, and after having only received the smallest fraction of that amount over the ensuing years, the Germans have decided to make a virtue of necessity and drop its demands to receive its gold. (see Interview with Peter Boehringer)

 

But the fate of BNP appeared to kick up a storm that went beyond the usual grumblings that American financial muscle-flexing usually inspires. A few days after the fine was announced, French Finance Minister Michel Sapin questioned its legality by pointing out that the offending transactions were not illegal under French law. (The Obama Administration reportedly ignored requests by French President François Hollande to reduce the fine). Going further, Sapin appeared to bring into question the entire monetary regime that has granted the U.S. its unique unilateral power: "We have to consider...the consequences of pricing things in dollars when it means that American law applies outside the U.S.....Shouldn't the euro be more important in the global economy?" (Bloomberg, 7/5/14) Politicians, French or otherwise, rarely deliver such explicit statements.

 

As if on cue, a few days later Christophe de Margerie, the CEO of French national energy company Total SA, raised eyebrows when he made repeated comments at a conference in France that the euro should be used more often in international oil transactions, saying "Nothing prevents anyone from paying for oil in euros." Perhaps these are the opening salvos in what may be a long war.

 

The anger is particularly acute in Germany where the United States has already come under criticism for a series of surveillance and espionage revelations, including illegally tapping Chancellor Merkel's cell phone, and planting spies in the upper echelons of Germany's military. Bloomberg recently compiled a selection of frustration with the United States' actions from Germany's leading newspapers. Among the highlights: 

  • "The EU should think about introducing similar senseless rules and then punishing U.S. companies for violating them" (Frankfurter Allgemeine Zeituing).   
  • "The United States is not really our friend. Friends treat each other with respect, the way Russia and Germany treat each other, and they do not try to order each other about" (Handelsblatt).

When Germans hold up Russia as a better ally than America, you realize how fundamentally the world is changing. And as we know, Vladimir Putin is doing all that he can to construct a post-dollar financial system (see related article). 

 

These types of frictions should be expected now that America finds its economic and diplomatic influence to be waning. The failures of the American military to create stability in Afghanistan and Iraq, of American diplomacy in heading off crises in Syria, the Ukraine and Palestine, and most importantly the culpability of the American financial system in bringing the world to the brink of financial ruin in 2008, have left the United States with few good options with which to exert her influence. The predominance of the dollar and its reserve status around the world provides the leverage that America's other failed institutions no longer can. 

 

This power is magnified by the ridiculous Keynesian notion that a strong currency is a liability and a weak currency is necessary for a healthy economy. This means that every bad move by the Federal Reserve needs to be matched by its counterpart bank in Frankfort and London. As such, America can debase its currency and serially acquire debt while avoiding the consequences that lesser countries would inevitably encounter.

 

For the moment the backlash against these laws has been limited to those Americans living abroad who are increasingly finding themselves to be financial lepers. Many local banks and mortgage companies are seeking to avoid the heavy hand of the IRS and FATCA by simply closing their doors to Americans. Even non-financial firms abroad have shown increasing reluctance to hire Americans as a result of the tax complications. As a result, it is well documented that the number of Americans renouncing their citizenship has skyrocketed in recent years.

 

The real danger of course is that the United States overplays its hand and arrogantly goes too far. While many would believe that that milestone has come and gone, the truth is that the U.S. has yet to pay a price broadly for its actions. The dollar's reserve status is as yet intact, and U.S. Treasury debt is being sold at generationally low yields. But the longer this goes on, the greater the danger becomes. 

 

Arrogance breeds contempt. The more reckless the United States becomes in throwing its weight around, the greater the temptation will become for the rest of the world to jettison the dollar like an unwanted house guest. If that happens, the value of U.S. dollar-based investments, and the living standards of all Americans, will pay a very heavy price. 

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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Posted by Peter Schiff on 08/06/2014 at 5:12 PM
During my Senate campaign, I gave away some of my dad's books to my supporters, and one that I really liked as a kid was "The Kingdom of Moltz".

The book was originally a chapter in my father's book, "The Biggest Con". The story was a fable, much like "How an Economy Grows and Why it Crashes", and was ultimately edited out of "The Biggest Con".  Years later, my father published "The Kingdom of Moltz" as a separate book.

I can't think of a word that is more misunderstood in economics today than inflation. This book offers a humorous but effective explanation of what inflation really is. I always loved this book, especially the illustrations.

I still have some original books left, brand new in boxes, and I would like to commemorate the Peter Schiff Show by offering copies of the book to my loyal listeners, autographed by me, for $25.00. My father, the author, is not able to autograph them personally.  Just complete this form to order and I will get a signed copy out to you right away, with my thanks for being a fan of the Peter Schiff Show.

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Inflation Trumps Growth
Posted by Jim Nelson and Peter Schiff, Euro Pacific Asset Management on 08/04/2014 at 7:31 AM

With the first half of 2014 now in the books, many investors are happy with the performance thus far, especially given the economic headwinds that few saw coming. The 26% rally in U.S. stocks in 2013 gave way to a more modest 7% gain in the first half of 2014. Most see this as a positive development in a maturing market. But beneath the surface, important trends are emerging that should give investors reasons to re-evaluate their assumptions.

 

During the second quarter of 2014 the S&P 500 continued to post new all-time highs while volatility remained remarkably low. Oftentimes such a combination reflects investor complacency which can be dangerous. Already a rotation toward more defensive positions is underway. For example, through the first half of the year, total return for the Russell 2000 (a barometer for domestic growth) was just 3.3% (IWM) while total returns for defensive assets like Treasury Bonds (TLT) and the S&P 500 Utilities sector (XLU), were 12.9% and 18.5%, respectively. 

 

The latest crop of price data and the market's own internal market dynamics also suggest that inflation expectations are on the rise. During the first half of 2014, the CRB Commodity Index (CRY) and Gold (GLD) were each up over 10%. Again, this compares with the domestic equities, represented by the Russell 2000, returning just 3.3% (IWM). Rising U.S. inflation and slowing U.S. growth are not the conditions that many investors have prepared for. At Euro Pacific our global strategies are designed to outperform in such an environment. As a result we saw solid results in the first half of the year. 

 

Figure 1 - 1st Half 2014 Comparable Total Returns

 

There can be little doubt that the growth momentum that buoyed the market in 2013 came off track in 2014. GDP had grown sequentially in each of the first three quarters of 2013 reaching 4.2% in 3Q13, which was the second highest level since 2006. (BEA, Jan 30, 2014). This momentum was cut short in the first quarter of 2014, which was confirmed when BEA reported annualized 1Q14 GDP at negative 2.9%.,the weakest quarter since the end of the Great Recession in 2009.  While most pundits blamed the surprisingly weak performance on severe winter weather, our research suggests that the unusual cold and snow would be expected to knock just 2% of annualized growth off of GDP. Instead the results were fully six points below earlier expectations that first quarter growth would approach positive 3%.Even if the newly released preliminary estimate for 2nd quarter GDP does not get revised downward (as is usually the case with these figures), 1st half growth will come in at just 1%, or 2% annualized. This is far below the forecasts that held sway back at the end of 2013.

  

Despite the dismal first half miss, consensus remains that the economy will get right back up on its feet and is on the verge of hitting "escape velocity." The forecasters base this view on optimistic view on the outlook for housing, capital investment, and employment. While we do not claim to have an edge on making near-term economic calls, we are somewhat skeptical of all three of these factors.

 

Housing

 

In 2012 and 2013, the U.S. housing market improved considerably, but this was from historically depressed levels following the Great Recession. From the 2006 peak into early 2012, the Case-Shiller Price Index declined by 35%, which provided an attractive buying opportunity for investors who were flush with cash (i.e. private equity investors), and those solvent households that were able to borrow at historically low mortgage rates (2012 average 30-yr rate 3.7% vs prior 5-yr avg. 5.3%)[2].  As a result, between 2012 and 2013, existing home sales increased 30% and house prices gained 25%.

 

Now, it appears those "easy gains" have ended as 1) cash investors are no longer buying and actually starting to sell, and 2) mortgage rates are set to rise as the Fed continues to Taper its QE program.[ The impact of these trends is already showing in the data. Since ex-Fed Chairman Bernanke first hinted about the QE Taper in the summer of 2013, mortgage rates have risen almost 100bps (30% increase). Over this same time, MBA Mortgage applications have fallen by 60%, existing home sales have declined 15% and house price gains have slowed.  While another near-term bounce is possible, we believe a sustainable recovery is less likely. Household balance sheets remain stretched, income growth is barely keeping pace with inflation, and affordability is declining (higher house prices plus rising interest rates).

 

Capital Investment

 

In 2009, Gross Private Investment collapsed to almost 12% of GDP, which was the lowest level in the post WW2 period and compares with a median level of 19% in the three decades prior to the Great Recession. Since 2009, Gross Investment has rebounded and is now 16% of GDP. Many growth bulls expect this level to rise over the next few years, noting that the average age of U.S. capital stock (i.e. plant/equipment) is at record highs and needs to be upgraded. Recently, this view has gained traction with improvements in forward-looking surveys, like the Purchasing Managers Index (PMI). In the near-term, we do expect a modest bounce in capital investment to make up from weather related disruptions earlier in the year, but we are more skeptical about a multi-year boom. 

 

First, we believe much of the recovery in private Investment was supported by bonus deprecation tax benefits (initiated during the recession) that enticed many corporations to accelerate investments in 2010-13. These incentives ended on Dec 31, 2013, so businesses have less reason for new investment. For companies to increase investment without government support, sales levels need to increase, which will remain difficult as household balance sheets and incomes remain under pressure. As a note, the current level of private investment (16% of GDP) is below median levels during the thirty years prior to the Great Recession (19% GDP), but it is consistent with the thirty year period following WW2 (17% GDP).

 

Second, companies have recently been more inclined to acquire rather than try to grow organically.  In the first half of 2014, total U.S. M&A deals were over $750B, which was up 50% from the same period in 2013 and on pace to hit annual levels not seen since 2006-2007. Also, almost 95% of recent deals have been strategic (companies, not private equity, buying other companies) which compares with just 75% in 2006-07. If companies saw organic opportunities then this cash would be invested in new plant and equipment instead of paying premiums for existing firms. With easy access to relatively cheap capital, we expect the M&A spree to continue, noting that this will actually result in job losses (vs. capital spending that drives job gains). 

 

Finally, companies that have not found attractive M&A opportunities have been using cash to raise dividends and buy back stock. In the first quarter of 2014, U.S. share buybacks and dividends hit a record level of $241 billion. Returning excess cash to shareholders is normal when growth prospects are dismal, but the recent trend has been exacerbated by activist investors that are pressuring companies to use leverage to return cash. As a result of this, combined with M&A activity discussed above, business (non-financial) leverage is at record levels. This bodes poorly for a surge in real investment.

 

Employment

 

In the first half of 2014, new job additions totaled 1.4 million (BLS establishment survey), which was the largest six-month increase since 2006. At the end of June 2014, the unemployment was 6.1%, down from 7.0% at the start of the year. Government officials have crowed that the economy has now regained all jobs lost in the Great Recession. But this is strictly a measure of quantity not quality.

 

It is widely understood that low paying and part time jobs have replaced higher paying full time jobs. But even the raw number of jobs has failed to keep pace with population growth. At the end of June, the employment to population ratio was 59%, essentially flat since 2010. This compares with a median level of 62% in the thirty years prior to 2006. To get back to that level, the economy would need to add another 10 million jobs. Assuming the current pace of job gains (using average of Jan-June 2014 gains in the Household survey) and trend growth in the working-age population, it would take another five years for the employment to population ratio to reach that level.   

 

The combination of low employment to population and low labor force participation means that 41% of the working age population is not employed, which compares with pre-Great Recession levels closer to 35%. That means that roughly 100 million people or one-third of the entire U.S. population is not working. This is hardly a sign of a solid labor market.

 

In other words, the consensus is making a pile of questionable assumptions about the pillars upon which a continued recovery would be based.

 

Inflation - Showing life, but Still Dead to the Fed

 

But while growth is failing to materialize, inflation is on the rise. Back in January of 2012, Fed Chairman Ben Bernanke did something that no Fed Chairman had done before: He publicly set a 2% inflation target. Well, apparently, the Fed is not nearly so impotent as we had believed. It only took 2 and ½ years for the Fed to achieve this goal (this is if you give full credence to their statistics). The latest CPI report for June 2014 came in at 2.1% year over year. This follows very similar numbers in April and May. More importantly inflation shows signs of heating up more recently. The last four months of data (March - June) show average annualized month over month changes at 3.2%. Finally, the Fed has rescued us from the abyss.

 

Figure 2 - 2 year CPI Chart

 

Not only have they rescued us, but they hit the sweet spot. According to modern day Keynesian theories, with 2% inflation achieved and 0% interest rates, the economy should be humming right along. But the theory is not translating into practice.

 

Companies are starting to feel the price squeeze and are passing on rising input costs in a variety of ways. This is true across many industry verticles. Hershey just announced an 8% increase on chocolate across the board. Then Mars Candy followed suit by raising their chocolate prices 7%. Starbucks has raised prices between 5 and 20 cents per drink. Chipotle has raised prices between 4% - 12.5% depending on location. The hits keep coming: Adult tickets at Disneyland (4.3%), Netflix (12.5% for new customers), SeaWorld (3.3%), Nike (11%-20%). Even the federal government (USDA) forecasts that prices for fruits and vegetables will rise 6% in the next few months. The Food CPI index over the last four months is ominous, up 4.2% annualized. Beef prices also continue to be at all-time highs. Unfortunately these increases have risen faster than incomes.

 

Conclusion

 

Recent economic data (and asset price movements) indicate U.S. growth is slowing while inflation is rising. Should the Fed continue to reverse the former while ignoring the latter, we expect portfolios that are built with inflation sensitive assets and non-dollar exposure will outperform.

 


[1] Bureau of Economic Analysis (BEA), June 25, 2014

[2] Bankrate.com, Bloomberg accessed July 4, 2014

[3] National Association of Realtors (NAR) and Case-Shiller Index, Bloomberg accessed July 3, 2014

[4] New York Times, DealBook "Investors Who Bought Foreclosed Homes in Bulk Look to Sell", June 27, 2014

[5] Business Insider, "2014 Is On Track to Become The Second Biggest Year for M&A in History", June 30, 2014

[6] Financial Times, "US Share Buybacks and Dividends Hit Record", June 8, 2014

[7] Bureau of Labor Statistics (BLS), Establishment Survey, July 3, 2014

[8] BLS, Household Survey, July 3, 2014





Tags:  CPICRB Commodity IndexGDPGreat RecessionGross Private Investmentinflationjob losses
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Summer 2014 Euro Pacific Capital Newsletter
Posted by Peter Schiff on 07/28/2014 at 12:13 PM

Welcome to the Summer 2014 edition of Euro Pacific Capital's The Global Investor Newsletter. Our investment consultants are standing by to answer any questions you have.  Call (800) 727-7922 today!

First Half Performance Review - Inflation Trumps Grwoth
By: Jim Nelson, Director of Euro Pacific Asset Management

Neighborhood Bully - America Recklessly Throws its Weight Around
By: Peter Schiff, CEO and Chief Global Strategist

The Russian Wild Card - Backed into a Corner, Putin Makes Plans
By: John Browne, Senior Economic Consultant

The Strange Case of German Gold - An Interview with Peter Boehringer
By: Andrew Schiff, Director of Communications and Marketing

Abenomics Update: Consumers Pay the Price
By: Peter Schiff, CEO and Chief Global Strategist

Sector Watch - The Robots are Coming

Argentine Debt Tangle
By: David Echeverria, Investment Consultant, Los Angeles

The Global Investor Newsletter - Summer 2014



First Half Performance Review - Inflation Trumps Growth

By: Jim Nelson, Director of Euro Pacific Asset Management


During the second quarter of 2014 the S&P 500 continued to post new all-time highs while volatility remained remarkably low. Such a combination can potentially lead to complacency. Already a rotation toward more defensive positions is underway. For example, through the first half of the year, total return for the Russell 2000 (a barometer for domestic growth) was just 3.3% (IWM) while total returns for defensive assets like the Treasury Bonds (TLT) and the S&P 500 Utilities sector (XLU), were 12.9% and 18.5%, respectively. See Figure 1.

Internal market dynamics also suggest that inflation expectations are on the rise. During the first half of 2014, the CRB Commodity Index (CRY) and Gold (GLD) were each up over 10%. Again, this compares with the domestic equities, represented by the Russell 2000, returning just 3.3% (IWM). Given that our strategies are designed to outperform in an environment of slowing U.S. growth and rising inflation, we saw solid results in the first half of the year. 

Figure 1 - 1st Half 2014 Comparable Total Returns  

Growth - Cyclical Spring, Secular Fall

In 2013, GDP grew sequentially in each of the first three quarters reaching 4.2% in 3Q13, which was the second highest level since 2006. (BEA, Jan 30, 2014). This momentum was cut short in the first quarter of 2014, which was confirmed when BEA reported annualized 1Q14 GDP at negative 2.9%.[1], the weakest quarter since the end of the Great Recession in 2009. For historical reference, a decline of over 2.5% has been associated with every recession since WW2. While most pundits blamed the surprisingly weak performance on severe winter weather, our research suggests that the unusual cold and snow would be expected to knock just 2% of annualized growth off of GDP. Instead the results were fully six points below earlier expectations that first quarter growth would approach positive 3%.

Despite the dismal first quarter miss, consensus remains that the economy will get right back up on its feet and is on the verge of hitting “escape velocity.” The bullish forecasters base this view on optimistic forecasts for housing, capital investment, and employment. While we do not claim to have an edge on making near-term economic calls, we are somewhat skeptical of all three of these factors.

Housing

In 2012 and 2013, the U.S. housing market improved considerably, but this was from historically depressed levels following the Great Recession. From the 2006 peak into early 2012, the Case-Shiller Price Index declined by 35%, which provided an attractive buying opportunity for 1) investors flush with cash (i.e. private equity investors), and 2) households able to borrow at historically low mortgage rates (2012 average 30-yr rate 3.7% vs prior 5-yr avg. 5.3%)[2].  As a result, between 2012 and 2013, existing home sales increased 30% and house prices gained 25%.[3] 

Now, it appears those “easy gains” have ended as 1) cash investors are no longer buying and actually starting to sell, and 2) mortgage rates are set to rise as the Fed continues to Taper its QE program.[4] The impact of these trends is already showing in the data. Since ex-Fed Chairman Bernanke first hinted about Taper in the summer of 2013, mortgage rates have risen almost 100bps (30% increase). Over this same time, MBA Mortgage applications have fallen by 60%, existing home sales have declined 15% and house price gains have slowed.  While another near-term bounce is possible, we believe a sustainable recovery is less likely. Household balance sheets remain stretched, income growth is barely keeping pace with inflation, and affordability is declining (higher house prices plus rising interest rates).

Capital Investment

In 2009, Gross Private Investment collapsed to almost 12% of GDP, which was the lowest level in the post WW2 period and compares with a median level of 19% in the three decades prior to the Great Recession.  Since 2009, Gross Investment has rebounded and is now 16% of GDP. Many growth bulls expect this level to rise over the next few years, noting that the average age of U.S. capital stock (i.e. plant/equipment) is at record highs and needs to be upgraded.  Recently, this view has gained traction with improvements in forward-looking surveys, like the Purchasing Managers Index (PMI).  In the near-term, we do expect a modest bounce in capital investment to make up from weather related disruptions earlier in the year, but we are more skeptical about a multi-year boom. 

First, we believe much of the recovery in private Investment was supported by bonus deprecation tax benefits (initiated during the recession) that enticed many corporations to accelerate investments in 2010-13. These incentives ended on Dec 31, 2013, so businesses have less reason for new investment. For companies to increase investment without government support, sales levels need to increase, which will remain difficult as household balance sheets and incomes remain under pressure. As a note, the current level of private investment (16% of GDP) is below median levels during the thirty years prior to the Great Recession (19% GDP), but it is consistent with the thirty year period following WW2 (17% GDP).

Second, companies have recently been more inclined to acquire rather than try to grow organically.  In the first half of 2014, total U.S. M&A deals were over $750B, which was up 50% from the same period in 2013 and on pace to hit annual levels not seen since 2006-2007.[5] Also, almost 95% of recent deals have been strategic (companies, not private equity, are buying other companies) which compares with just 75% in 2006-07. If companies saw organic opportunities then this cash would be invested in new plant and equipment instead of paying premiums for existing firms. With easy access to relatively cheap capital, we expect the M&A spree to continue, noting that this will actually result in job losses (vs. capital spending that drives job gains). 

Finally, companies that have not found attractive M&A opportunities have been using cash to raise dividends and buy back stock. In the first quarter of 2014, U.S. share buybacks and dividends hit a record level of $241 billion.[6]  Returning excess cash to shareholders is normal when growth prospects are dismal, but the recent trend has been exacerbated by activist investors that are pressuring companies to use leverage to return cash. As a result of this, combined with M&A activity discussed above, business (non-financial) leverage is at record levels.

Employment

In the first half of 2014, new job additions totaled 1.4 million (BLS establishment survey), which was the largest six-month increase since 2006.[7] At the end of June 2014, the unemployment was 6.1%, down from 7.0% at the start of the year[8]. The economy has now regained all jobs lost in the Great Recession. But this is strictly a measure of quantity not quality. It is widely understood that low paying and part time jobs have replaced higher paying full time jobs. But even the raw number of jobs has failed to keep pace with population growth. At the end of June, the employment to population ratio was 59%, essentially flat since 2010. This compares with a median level of 62% in the thirty years prior to 2006. To get back to that level, the economy would need to add another 10 million jobs. Assuming the current pace of job gains (using average of Jan-June 2014 gains in the Household survey) and trend growth in the working-age population, it would take another five years for the employment to population ratio to reach that level.

The combination of low employment to population and low labor force participation means that 41% of the working age population is not employed, which compares with pre-Great Recession levels closer to 35%. That means that roughly 100 million people or one-third of the entire U.S. population is not working, hardly a sign of a solid labor market. Further, we expect the level of non-working persons in the U.S. to continue rising as Baby Boomers retire.

In other words, the consensus is making a pile of assumptions about an imminent recovery that just doesn’t hold a tremendous amount of water.

Inflation - Showing life, but Still Dead to the Fed

But while growth is failing to materialize, inflation is on the rise. Back in January of 2012, Fed Chairman Ben Bernanke did something that no Fed Chairman had done before: He publicly set a 2% inflation target. Well, apparently, the Fed is not nearly so impotent as I had believed as it only took 2 and ½ years to achieve this goal (this is if you give full credence to their statistics). The latest CPI report for June 2014 came in at 2.1% year over year. This follows very similar numbers in April and May. More importantly the inflation shows signs of heating up more recently. The last four months of data (March - June) show average annualized month over month changes at 3.2%. Finally, the Fed has rescued us from the abyss.

Figure 2 - 2 year CPI Chart

Not only have they rescued us, but they hit the sweet spot. According to modern day Keynesian theories, with 2% inflation achieved and 0% interest rates, the economy should be humming right along. But the theory is not translating into practice.

Companies are starting to feel the price squeeze and are passing on rising input costs in a variety of ways, in a variety of industries. Hershey just announced an 8% increase on chocolate across the board. Then Mars Candy followed suit by raising their chocolate prices 7%. Starbucks has raised prices between 5 and 20 cents per drink. Chipotle has raised prices between 4% - 12.5% depending on location. The hits keep coming: Adult tickets at Disneyland (4.3%), Netflix (12.5% for new customers), SeaWorld (3.3%), Nike (11%-20%). Food prices have also really picked up recently. Even the federal government (USDA) thinks that prices for fruits and vegetables will rise 6% in the next few months. The Food CPI index over the last four months is ominous, up 4.2% annualized. Beef prices also continue to be at all-time highs. Unfortunately these increases have risen faster than incomes.

Admittedly, short-term changes in inflation are very hard to predict, but we know that the Fed is determined to push inflation much higher (as is every other central bank in the world). The fact that Janet Yellen sees current inflation data as just “noise” implies she does not view inflation as a current risk and that near-term monetary policy decisions will be based solely on the labor market outlook. As discussed in the previous section, we believe underlying trends in the labor market are weaker than headline numbers would imply. Should the Fed agree, then it is unlikely that monetary policy begins to normalize in early 2015 as consensus now expects.

Conclusion

Recent economic data (and asset price movements) indicate U.S. growth is slowing while inflation is rising. Should these trends continue through the year, we expect our portfolios will outperform. That said, with growth and inflation levels already at historically low levels, even minor hiccups can have an outsized influence on their movements in either direction. We view these moves as short-term and we remain focused on our long-term investment thesis and strategy. As such, 2014 may or may not prove to be the year that U.S. growth inflects lower while inflation moves decidedly higher, however our portfolios are well positioned for when it eventually does. In the meantime, we continue to focus our time on managing diversified portfolios comprised of securities that we view as high quality and undervalued.


[1] Bureau of Economic Analysis (BEA), June 25, 2014

[2] Bankrate.com, Bloomberg accessed July 4, 2014

[3] National Association of Realtors (NAR) and Case-Shiller Index, Bloomberg accessed July 3, 2014.

[4] New York Times, DealBook “Investors Who Bought Foreclosed Homes in Bulk Look to Sell”, June 27, 2014.

[5] Business Insider, “2014 Is On Track to Become The Second Biggest Year for M&A in History”, June 30, 2014

[6] Financial Times, “US Share Buybacks and Dividends Hit Record”, June 8, 2014.

[7] Bureau of Labor Statistics (BLS), Establishment Survey, July 3, 2014

[8] BLS, Household Survey, July 3, 2014

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Neighborhood Bully - America Recklessly Throws its Weight Around

By: Peter Schiff, CEO and Chief Global Strategist


On June 30, U.S. authorities announced a stunning $9 billion fine on French bank BNP Paribas for violations of financial sanctions laws that the United States had imposed on Iran, Sudan and Cuba. In essence, BNP had surreptitiously conducted business with countries that the United States had sought to isolate diplomatically (sometimes unilaterally in the case of Cuba). Although BNP is not technically under the jurisdiction of American regulators, and the bank had apparently not broken any laws of its home country, the fine was one of the largest ever issued by the United States and the largest ever levied on a non-U.S. firm. The Treasury Department and the Federal Reserve made clear that unless BNP forks over the $9 billion (equivalent to one year's of the company's total earnings), the U.S. will prevent the bank from engaging in dollar-based international transactions. For an institution that makes its living through such transactions, that penalty is the financial equivalent of a death sentence. The fine will be paid.

It is widely rumored that Germany's Commerzbank will be the next European institution to face Washington's wrath. It is rumored that it will face a penalty of at least $500 million, an amount that is roughly equivalent to one year of the bank's income. 

As if choreographed by a financial god with a wicked sense of humor, the very next day marked the official implementation of the Foreign Account Tax Compliance Act (FATCA), a new set of laws that will require all foreign financial institutions to routinely and regularly report to the U.S. Internal Revenue Service all the financial activities of their American customers. The law also requires that institutions report on all their non-American customers who have ever worked in the U.S. or those persons who have a "substantial" connection to the U.S. (Inconveniently the law fails to fully define what "substantial" means). Failure to report will trigger 30% IRS withholding taxes on any dollar-based transactions made by clients who the U.S. has determined to be American...either by birth, marriage, or simply association.

Given that the United States is one of only two nations in the world (the other being Eritrea) that taxes its citizens on any income received, regardless of where that income was earned and where the tax payer lived when they earned it, the FATCA laws are an attempt to extend American tax authority and jurisdiction (by unilateral dictate) to the four corners of the Earth. The Economist magazine, which is not known for alarmist reporting, described FATCA as "a piece of extraterritoriality stunning even by Washington standards." (For those of you who did not pay attention during world history class, "extraterritoriality" is an attempt by one country to enforce its own laws outside of its own borders).

What's worse is that many accountants and analysts have estimated that the compliance costs that the United States has imposed on these non-constituent banks (which have limited ability to lobby or influence U.S. lawmakers) will far outweigh the $800 million in annual revenue that the law's backers optimistically estimated. In a June 28th article, The Economist quotes an international tax lawyer saying that FATCA is about "putting private-sector assets on a bonfire so that government can collect the ashes." The laws are particularly irksome to many because the United States typically refuses to subject itself to the same standards it requires of others. When foreign governments ask Washington for financial information from its citizens, the U.S. government hypocritically trots out privacy laws and poses on the altar of civil liberties. In fact, despite its war on foreign tax havens, for non-Americans the United States is by far the world's largest tax haven.

But as is the case with BNP, the foreign banks will have little choice but to comply. Given the importance that U.S. dollar-based transactions play in daily banking operations, U.S. authorities call the tune to which everyone must dance. However, the complexity and opacity of the laws have at least generated some mercy from the U.S. which has allowed foreign banks more time to implement compliance procedures. In many ways this is similar to how the Obama administration has extended Obamacare mandates to a persistently confused and overwhelmed public. This is cold comfort.

The FATCA and the BNP developments have occurred just a few months after the U.S. has finished tightening the screws on a variety of Swiss banks that had attempted to follow the bank privacy laws that exist in their home country. Through heavy-handed tactics, U.S. authorities made it impossible for the Swiss banks to transact business internationally unless they played ball with Washington and turned over all information the banks possessed on U.S. customers. Not surprisingly, the U.S. prevailed. Additionally, June marked the end of Germany's farcical campaign to repatriate the hundreds of tons of gold that are supposedly on deposit at the Federal Reserve Bank of New York. After asking for its gold back two years ago, and after having only received the smallest fraction of that amount over the ensuing years, the Germans have decided to make a virtue of necessity and drop its demands to receive its gold. (see Interview with Peter Boehringer)

But the fate of BNP appeared to kick up a storm that went beyond the usual grumblings that American financial muscle-flexing usually inspires. A few days after the fine was announced, French Finance Minister Michel Sapin questioned its legality by pointing out that the offending transactions were not illegal under French law. (The Obama Administration reportedly ignored requests by French President François Hollande to reduce the fine). Going further, Sapin appeared to bring into question the entire monetary regime that has granted the U.S. its unique unilateral power: "We have to consider...the consequences of pricing things in dollars when it means that American law applies outside the U.S.....Shouldn't the euro be more important in the global economy?" (Bloomberg, 7/5/14) Politicians, French or otherwise, rarely deliver such explicit statements.

As if on cue, a few days later Christophe de Margerie, the CEO of French national energy company Total SA, raised eyebrows when he made repeated comments at a conference in France that the euro should be used more often in international oil transactions, saying "Nothing prevents anyone from paying for oil in euros." Perhaps these are the opening salvos in what may be a long war.

The anger is particularly acute in Germany where the United States has already come under criticism for a series of surveillance and espionage revelations, including illegally tapping Chancellor Merkel's cell phone, and planting spies in the upper echelons of Germany's military. Bloomberg recently compiled a selection of frustration with the United States' actions from Germany's leading newspapers. Among the highlights: 

  • "The EU should think about introducing similar senseless rules and then punishing U.S. companies for violating them" (Frankfurter Allgemeine Zeituing).   
  • "The United States is not really our friend. Friends treat each other with respect, the way Russia and Germany treat each other, and they do not try to order each other about" (Handelsblatt).

When Germans hold up Russia as a better ally than America, you realize how fundamentally the world is changing. And as we know, Vladimir Putin is doing all that he can to construct a post-dollar financial system (see related article).  

These types of frictions should be expected now that America finds its economic and diplomatic influence to be waning. The failures of the American military to create stability in Afghanistan and Iraq, of American diplomacy in heading off crises in Syria, the Ukraine and Palestine, and most importantly the culpability of the American financial system in bringing the world to the brink of financial ruin in 2008, have left the United States with few good options with which to exert her influence. The predominance of the dollar and its reserve status around the world provides the leverage that America's other failed institutions no longer can. 

This power is magnified by the ridiculous Keynesian notion that a strong currency is a liability and a weak currency is necessary for a healthy economy. This means that every bad move by the Federal Reserve needs to be matched by its counterpart bank in Frankfort and London. As such, America can debase its currency and serially acquire debt while avoiding the consequences that lesser countries would inevitably encounter. 

For the moment the backlash against these laws has been limited to those Americans living abroad who are increasingly finding themselves to be financial lepers. Many local banks and mortgage companies are seeking to avoid the heavy hand of the IRS and FATCA by simply closing their doors to Americans. Even non-financial firms abroad have shown increasing reluctance to hire Americans as a result of the tax complications. As a result, it is well documented that the number of Americans renouncing their citizenship has skyrocketed in recent years. 

The real danger of course is that the United States overplays its hand and arrogantly goes too far. While many would believe that that milestone has come and gone, the truth is that the U.S. has yet to pay a price broadly for its actions. The dollar's reserve status is as yet intact, and U.S. Treasury debt is being sold at generationally low yields. But the longer this goes on, the greater the danger becomes. 

Arrogance breeds contempt. The more reckless the United States becomes in throwing its weight around, the greater the temptation will become for the rest of the world to jettison the dollar like an unwanted house guest. If that happens, the value of U.S. dollar-based investments, and the living standards of all Americans, will pay a very heavy price. 

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The Russian Wild Card - Backed into a Corner, Putin Makes Plans

By: Andrew Schiff, Director of Communications and Marketing


While the United States continues to throw its weight around diplomatic summits and global financial markets, Vladimir Putin has emerged as the most visible and active proponent of a post-dollar world.

A few months ago Putin had risked becoming a global pariah when his aggressive stance towards the Ukraine looked like it could unleash the second coming of the First World War. But when the U.S. failed to galvanize Western European opposition (in Germany in particular), and with the crisis failing to spread outside of a few flash points in eastern Ukraine, international attention soon drifted to other hotspots (Iraq, Israel).

But the tragic downing of the Malaysian airliner, more likely than not to be a mistaken attack by Ukrainian separatists, significantly complicates the situation for Putin and Russia, and further galvanized Western interests against him. However, the speed with which conclusions have been drawn about Putin's culpability, despite conflicting evidence, may catalyze the convergence on non-western interests as well. Time Magazine highlighted this, quoting an official Chinese source as saying:

"The Western rush to judge Russia is not based on evidence or logic. Russia had no motive to

bring down MH17; doing so would only narrow its political and moral space to operate in the Ukrainian crisis. The tragedy has no political benefit for Ukrainian rebel forces, either. Russia has been back-footed, forced into a passive stance by Western reaction. It is yet another example of the power of Western opinion as a political tool."

Putin, a former KGB colonel, is seeking to use the crisis to take the offensive against his old American nemesis. In particular, he has unveiled a series of concrete steps that he hopes will lead to the emergence of a Eurasian economic bloc that could operate outside of U.S. dollar-based control. The bounce-back in Russian equity markets since the steep Ukraine-related sell off in February and March, and the large U.S fines imposed on BNP Paribas, have provided him with some leverage.

In May, a monster $400 billion energy supply deal was announced that would keep oil and gas flowing from Russia to China for years to come. As the deal was largely symbolic, many in the Western media took great pains to point out that it did not dictate that payment for the energy would be in currencies other than the dollar. But recent statements appear to be setting the stage for just that. On June 26, The Financial Times reported that Gazprom, Russia's largest natural gas provider, announced that it would be considering issuing bonds in Asian markets denominated in RNB or Singapore dollars and listing shares on the Hong Kong Exchange. When explaining these moves, Gazprom's chief financial officer Andrei Kruglov unsurprisingly characterized them as an effort to attract more Asian investors. However, he used the opportunity to say that "As for settlements in renmimbi or rubles, we are ready for this and we think it's quite normal."

The FT went on to report that other Russian companies, including Norilsk Nickel, have stepped up talks on settling contracts and raising debt in currencies other than the dollar. In addition, Reuters reported on June 24 that Moscow is considering barring state-owned companies and other enterprises deemed to be "strategically important" from holding accounts at foreign-owned banks.Theoretically, this could protect Russian assets from the types of fines and penalties that the U.S. has been imposing around the world.    

On a separate front, Russia has successfully exploited the disintegration of the fragile Iraqi state to further extend influence in the region. Moscow has long been the champion of the Shia governments in the Middle East (Syria and Iran) and has consistently opposed the interests of the U.S.-backed Sunni states of Saudi Arabia, Kuwait and Jordan. Russian power came into stark focus in Syria in 2012 when they were able to check Obama's attempt to oust the Assad regime over reports of chemical weapons use. With the Obama Administration withdrawing support of the hapless Maliki government, the desperate Shia leader has turned to the Kremlin in its struggle against ISIS insurgents. In a jaw-dropping development, Maliki agreed to buy a package of Russian jet fighters and ground attack aircraft. And as if to show the contrast with the famously slow delivery of the American F-16 aircraft that the U.S. sold to Iraq back in 2011, the Russian equipment began arriving almost immediately.

If, as appears increasingly likely, Iraq will disintegrate into Sunni and Shia dominated enclaves, it is not difficult to imagine that Russia will extend its power beyond Iran, straight into Shia Baghdad. The influence would have been bought and paid for by American blood and treasure.

In the lead up to the Second World War, the Western democracies foolishly took for granted that Russia could always be counted on to oppose Nazi Germany. But crafty German diplomacy resulted in the Hitler/Stalin Non-Aggression Pact of 1939, thereby shaking Russia loose from the Alliance. This blunder set the stage for a very different world order. (Only Hitler's unprovoked invasion of Russia in 1941 succeeded in bringing Stalin back to the Allies).

Today the roles are reversed. Germany is the swing vote in the new economic struggle. And as discussed in an earlier article in this newsletter, Germany is chafing in its role as a loyal soldier supporting U.S. interests. In a July opinion piece for Reuters, Ian Bremmer, the founder of the respected geopolitical risk consultancy firm Eurasia Group said, "Germany is alarmed by the United States' tendency to use its economic clout as an extension of its foreign policy, one that the Germans see as increasingly fickle, opaque and misaligned from their own." If Russia and China can manage to pull the increasingly frustrated Germans away from the dollar-based world of infinite monetary stimulus and heavy-handed financial enforcement, the United States will face a very difficult road ahead. Market watchers would be well-advised to keep a close watch on Vladimir Putin.

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The Strange Case of German Gold - An Interview with Peter Boehringer

By: Andrew Schiff, Director of Communications and Marketing


A June 23 Bloomberg News story entitled "German Gold Stays in New York in Rebuff to Euro Doubters" made the seemingly straight-forward case that the German authorities had decided to reverse course on a plan announced in 2012 to bring home some 300 tonnes of German gold that had been on deposit at the New York Federal Reserve since the 1960s. According to the article, German representatives had gone to New York, saw their gold, were convinced that it was in good hands, and decided that the hassle of putting it on a plane and sending it back to Germany was simply unnecessary. The article quoted a spokesman for Chancellor Merkel who said "the Americans are taking good care of our gold" and even quoted Peter Boehringer, one of the leading private advocates of the repatriation movement, as saying their campaign to pressure German authorities "is on hold."

When the Germans originally asked for their gold back, the Federal Reserve had countered with a painfully slow eight-year delivery period. This struck many as strange given that the total request only represented 5% of the gold reportedly held at the Fed's New York vaults. The delay severely whipped up concerns that long-held theories about imaginary gold were actually true. The Bloomberg article appeared to dismiss all these concerns and bring the case to a close. Or did it? Almost immediately,people close to the matter cried foul.

I caught up with none other than Peter Boehringer of the German Precious Metals Society for this exclusive interview.  

AS - The apparent reversal by the German government to no longer look to repatriate its gold from the United States failed to raise any interest in the American press or the financial establishment. Did the move create much of a stir in Germany? Are any mainstream politicians there actively picking up the issue.

PB - The "reversal" has indeed been only apparent - the Bundesbank has not in any way officially changed its repatriation plan that was announced in January 2013 (a plan that I believe was too slow and too little anyway-- 700 tonnes by end 2020 - of which. 300 tonnes from the New York Fed). The primary source for the confusion, especially in the non-German media, came from a factually wrong Bloomberg story. That story began with a completely unfounded headline "German gold stays in NY." I tried to set the record straight in the English-language press, but it is hard to fully "call back" wrong mainstream reports like that one.(via Bloomberg BusinessWeek on June 23, 2014)

Having said this, it is quite possible that the politicians cited in the story (such as Mr. Barthle, a Merkel spokesman) actually intended to "test the waters" of how the German public would react. In that respect, statements like "The Americans are taking good care of our gold. Objectively, there's absolutely no reason for mistrust." could indeed have some significance, as they might be intended as a first step towards stopping even the already painfully slow repatriation process of gold from the Fed. Still, Barthle, or Merkel for that matter, are not in charge of the gold, the Bundesbank is, and they have said nothing.

It is noteworthy that in 2013, a mere 5 tonnes were actually delivered from NY to Frankfurt. And even for these miniscule volumes there is no evidence, either by an external auditor or by video documentation, that real gold bars (allegedly untouched in the Fed´s vaults since the 1960s) have been moved across the Atlantic. Bundesbank has even melted down and allegedly re-cast these bars for no apparent reason! We have not received any audit report of this process, no report from the (unknown) performing smelter, and no bar lists from "old" or newly cast bars.

But to date, no mainstream politician has publicly questioned this strange behavior. It has been left to concerned private organizations like ours to press these concerns. Fortunately our national media has picked up on some of this which may have prompted Mr Barthle´s blind and unfounded "pledge of allegiance" to the U.S.

AS - Is the issue something that is discussed or understood by the average German?

PB - These details are of course not being discussed by the "average German" - soccer seems to be far more important these days. But both the gold community, the financial community, and the international media are taking ever more notice of our continued struggle. A full two and a half years after the initiation of our campaign, I receive at least two interview requests per week.

The Fed´s unwillingness to provide information, Bundesbank's obvious evasions and obfuscations, and Bloomberg´s misleading article are leading to completely unintended reactions by the general public and the independent media: Rather than putting this issue to bed as these authorities may have hoped, we are seeing ever MORE questions being raised.

AS - Officially, at least, what was responsible for convincing German officials that their gold is safely stored and accounted for by the Federal Reserve?

PB - I can of course only speculate here. Given the decade-long mis-information by the Fed and the Bundesbank regarding our national gold, there is no apparent reason for these officials to now call this case "closed" - quite the opposite would be logical. We must therefore assume that the Fed is unwilling or unable to quickly put Germany´s gold at the Fed (1,500 tonnes) on a few planes, thereby sending our property to where it belongs (Frankfurt). It's become harder to not reach the conclusion that  our officials are not complicit in some kind of U.S. led cover-up. So far, due to our public responses, this approach has not worked but rather increased the pressure on Bundesbank to repatriate.

One reason that the gold was unavailable for quick delivery could be multiple ownerships of our bars at the Fed. Given today´s global fractional gold banking scheme, an (allegedly physically existing) bar in a central bank vault could have 10+ owners - and could thereby show up in 10+ central bank balance sheets as either "physical gold" or "gold claim". These two (completely different!) balance sheet items have not been properly differentiated for many decades now. We are potentially talking about non-existent physical bars at a magnitude of tens of thousands of tonnes!

Without proper physical audits, repatriations and allocated storage, no gold "owner" today can be certain that "his" bar in one of these unallocated gold storage vehicles is actually his exclusive property! Our campaign is therefore not only a "German" one - but could have international repercussions of unknown scale.

It is not by accident that since the launch of the first two campaigns in 2011/12 (Germany and Switzerland) - more than ten similar national initiatives have been launched all over the world. The responses of the arrogant central bankers are the same everywhere: Ignore them, call them "conspiracy theorists", insist that "everything is in order with the gold", but give not a shred of evidence (bar lists, audit reports, bar transport to owners). And act only if public pressure forces you to...

AS - How did the Bloomberg article, which is really the only story published by a mainstream American outlet about the reversal, quote you incorrectly or out of context? Has the reporter explained his actions?

PB - I had a friendly 30+ minute conversation with the Bloomberg reporter, explaining all I could. But the only so-called "quotation" of mine which was ultimately used (published months later!) was "Right now, our campaign is on hold". Of course, I never said this sentence. All I did is (truthfully) explain that, unfortunately, nobody in Germany -including our campaign- can legally ENFORCE the dissemination of information from Bundesbank or a quicker repatriation of our gold. When the interview was conducted in May, we had no opportunity for putting even more pressure on BuBa (which we had done several times opportunistically and partly successfully since 2011). The Bloomberg hack somehow twisted this to mean that we were satisfied and that we were no longer pressing the issue.

In hindsight, I however have to THANK  the reporter for involuntarily opening up this new and great opportunity for spreading our message. Since the Bloomberg piece, I am giving interviews on a daily basis - now even to international radio and TV broadcasters with millions of listeners. This gold issue will not go away.

Gold is money. And central bank gold is a potential cornerstone of future currencies which might well HAVE TO be (partially) gold-backed, especially if there is a crash of today´s un-backed paper-currencies. The central banks all over the world therefore have to quickly become much more transparent and have to audit and repatriate their / OUR gold!

Peter Boehringer is the founder and president of "German Precious Metal Society" (est. 2006) - an NGO dedicated to spreading independent information on the relevance of gold and silver as both investment vehicles and as basis for sound money and in turn a sound society. Mr. Boehringer is one of the main initiators of the German public's "Repatriate our Gold" campaign, which is being supported by many prominent signatories as well as by 15,000+ national and international activists. Peter has been writing Germany´s most popular (German language) gold blog since 2003 with a focus both on economic and political implications of gold and silver prices. He is a book author, speaker at liberal and economic conferences, and a frequent writer of articles critical towards the current, credit-based monetary system and its negative implications. He is a fellow of the liberal "Hayek-Society".

Neither Mr. Boehringer nor German Precious Metal Society is affiliated with Euro Pacific Capital or any of its affiliates.  The opinions expressed above are those of the writer and may or may not reflect those held by Euro Pacific Capital.

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Abenomics Update: Consumers Pay the Price

By: Peter Schiff, CEO and Chief Global Strategist


Since the December 2012 election of Shinzo Abe as prime minister, Japan has become the world's most visible petri dish for Keynesian economic principles. Abe assumed office with a radical plan to implement all the major policy tools that Keynesians like Paul Krugman have advocated. His "Abenomics" agenda involved "three arrows" to slay Japan's decades-long economic torpor. The first involved a fiscal stimulus through greater deficit spending, the second was a massive quantitative easing campaign specifically designed to create at least two percent annual inflation, and the third (currently being implemented) is a series of regulatory reforms designed to lower barriers for businesses (this arrow is not particularly Keynesian). 18 months into the experiment, Abe has scored a clear victory, at least among the mainstream press, which has declared Abenomics to be an unbridled success. However,  the actual situation faced by Japanese consumers is universally awful. The numbers, if you care to notice them, speak for themselves.

The most glaring results of Abenomics thus far has been its outright "success" in pushing down the value of the yen and pushing up prices for everyday goods and services. Since Abe began his campaign the Japanese currency has fallen nearly 21% against the U.S. dollar. This has been music to the ears of the vast majority of economists who see a weak currency as the mainspring of economic growth.

In May, it was reported that prices for all items had risen at an annualized rate of 3.4%. This was up from the 3.2% annualized rate in April. Prices for goods (which are more sensitive than domestically-provided services to the falling Yen) have spiked up 5.2% from the previous year. The falling yen has been a big factor in pushing up prices for food and energy which in Japan are largely imported. In May, Japan reported year over year price increases of 11.4% in electricity, 9.6% in gasoline, and 14.3% in fresh seafood (it's a good thing the Japanese don't really like seafood).

For many years Japanese consumers had to deal with the apparent tragedy of price stability, which allowed them to maintain purchasing power despite a stagnant economy. Thank God those days are over! But Abe's policies have failed to work their magic on the broader economy. The Wall Street Journal reports that cash earnings and bonuses in wages rose just .8% year over year in May. Wages did even worse in May, up just .2%. Against a backdrop of surging inflation these tepid growth results mean that purchasing power has fallen 3.6% year over year in May.

The pain has been magnified by the recent hike of the consumption sales tax from five percent to eight percent. The move caused a temporary surge in spending earlier in the year when consumers scurried to make purchases before the tax came into effect. But more recently it has put spending into a deep freeze. In April, consumption fell a seasonally adjusted 13.4%. Those are big numbers.

To add insult to injury, the falling yen has done little to boost Japanese exports. In 2013, despite the decline in the yen, exports declined for the third consecutive year. What Abenomics has delivered, of course, is a surging stock market, driven in large part by zero percent interest rates and a wave of stock buybacks. But, as is the case in the U.S., these developments have delivered benefits primarily to the owners of financial assets. 

Yet, despite all of this, most media outlets in the U.S. and Europe still discuss Abe in heroic terms. How much longer they will be able to keep up the cheerleading is anyone's guess.

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Sector Watch: The Robots are Coming


The "robots are taking over the world" concept has been a staple of science fiction for generations. However, the reality of automated production lines and self-propelled disc vacuums has thus far proved much less intimidating. But the next generation of robots will likely be much more significant. And while we feel that financial markets remain highly distorted by excess liquidity, and that growth stocks always involve higher risk, it is undeniable that transformative innovations can present opportunities.

Recent moves by Google and Amazon highlight the wave in robotics. In 2013, Google purchased eight startups focused on robots, and this year it unveiled dramatic improvements to the driver-less car concept that it first introduced in 2012. Recently, Amazon made a big stir on "60 Minutes" by introducing an internet-controlled air drone delivery system. Although some dismissed it as a stunt, Amazon founder Jeff Bezos insisted that the project was for real.

With the costs to build and develop robots declining, more companies are looking to use robots wherever they can. This is especially true in high cost, high regulation economies like the United States where the costs and benefits of employing humans for routine tasks are becoming less and less compelling. If successful, popular moves to raise the minimum wage in this country to an unrealistic $15 dollars per hour could kick the robotic industry into a much higher gear. And why not? Robots are willing to work longer hours for no pay, and they don't goof off, take sick days or require health benefits.

Already, the fast food industry is experimenting with much greater automation, both in the cooking and in customer interaction. The day when a Big Mac can be produced with no human involvement may be much closer than most people realize. In June, The Netherlands said it plans to start testing driver-less trucks next year and it intends to have them on public roads within five years.

Last year, an all-time high of 179,000 robots were sold world-wide, a 12% increase over 2012, according to the International Federation of Robotics. Between 2008 and 2013, U.S. robot sales increased an average of 12% per year. In terms of annual sales, China is the biggest market, as well as the fastest growing. Japan is the second largest market as well as one of the biggest producers of robots. Currently, Japan has the most industrial robots in the world, more than 300,000.

The main drivers of growth are the automotive and metal industries. Between 2010 and 2013, both industries increased robot investments by an average of 22% per year. Military consumers are also leading early adopters.

Experts predict robots may eventually replace flesh-and-blood soldiers on the ground. Admittedly, the eyebrow-raising concepts introduced by many defense contractors do seem to be much closer to science fiction than to current reality. Apart from taking life, robots are also being designed to preserve it with some companies designing automated systems that can act as full-time caretakers for the aging population that predominates in advanced economies.

While we cannot offer specific advice on particular companies, the robotics sector may be one to look into.

Of course investors should not feel as if robotic companies are somehow responsible for displacing workers or causing unemployment. Labor saving devices, such as fork lifts and steam drills, have always been accused of putting people out of work, but instead they have just increased productivity and allowed workers to find jobs that are more suitable for humans. Remember, the job of an economy is not to create jobs, but to create stuff. If we could produce all that we needed to consume with no human labor, humanity would be much better off. Too bad economists can't figure that out. Maybe they should be replaced by robots.

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Argentine Debt Tangle

By: David Echeverria, Investment Consultant, Los Angeles


Twelve years ago Argentina sent shock waves throughout the international financial community by defaulting on nearly $100 billion US Dollar-denominated debt. Prior to that, Argentina had long been skating along the edge of financial catastrophe, but such a massive default by a country that boasted abundant natural resources and a heritage of wealth was a game-changing event. In order to resolve the crisis, the Argentine government then in power negotiated massive haircuts with the vast majority of its creditors. There were some investors, however, who refused the terms of these haircuts, and held out for more. They had to wait a very, very long time.

Amongst these "holdouts" were a number of hedge funds that purchased the Argentine debt in the secondary market for pennies on the dollar. The hedge funds sensed a chance for victory and settled in for the long haul. Their hope was that their notes would be paid in full when Argentina finally became more financially solvent. This could happen through voluntary action by the government or by order of international courts. If they could prevail, a handsome profit could be reaped.

Fast forward to 2014 and the Argentine state, thanks in part to rising commodity prices, now has billions in reserves and is once again paying on its restructured debt. Not surprisingly, the holdouts have been clamoring for repayment alongside the owners of the restructured debt. Their request, however, was defiantly refused by the president of Argentina, Christina Fernandez de Kirchner, who even went so far as to refer to the holdouts as "vulture funds." Never mind that many of these funds are comprised of pension funds and individual investors, many of whom would not qualify as Masters of the Universe. These are real people to whom Argentina owes money. And unlike the holders of the restructured debt, these investors have never been paid.

The decade-long legal tango finally came to an end last month when the US Supreme Court refused to hear the case, thereby letting stand the decision by the lower U.S. court that demanded Argentina cough up the money. Although the Kirchner administration is looking to find a way out, no escape hatch appears to be at hand. As with other extensions of U.S. financial power, a world dominated by the U.S. offers few places to hide. 

Critics of the decision have said that obligating repayment of holdouts will discourage creditors in future cases from negotiating haircuts and thus make it more difficult for countries to resolve defaults. In other words, it'll make it more difficult for countries to avoid having to pay on their debts. Apparently these people have never heard of moral hazard. Can you imagine what the alternative would have been like had the U.S. courts not obligated repayment? This would have effectively allowed governments around the world to borrow, default, force creditors into some ridiculous "negotiated" haircut, wait a few years, and then do it all over again.

This also forgets the fact that the holdout creditors traded time for money. They could have received lesser payments years ago. Who knows what they could have done with that money and what kind of returns they could have generated had they invested it. So in a very large sense, they have paid a price.

If the courts had not stepped in to compel payment who in their right mind would ever buy sovereign debt knowing that it could simply be defaulted on with so little consequence? It is quite likely that lower credit nations would have faced nearly impossible hurdles with future debt raises had the legal decision not been reaffirmed. But if the various governments of the world have a problem with the recent ruling, I have a much simpler solution: JUST DON'T BORROW THE MONEY IN THE FIRST PLACE. I have yet to a see a news story with a hedge fund manager holding a gun to the head of some foreign government official forcing them to issue debt.  

Euro Pacific celebrates the U.S. Supreme Court's ruling. But we also don't want to wait a dozen years before being paid. As a result, we know that we are not absolved from taking responsibility for the debt we choose to purchase. Even with the court victory, it is far from certain that the holdout investors are happy to have ever purchased Argentine debt.

In general, when buying any kind of sovereign debt, it is crucial to look at basic metrics like GNP per capita, the higher the better. The political composition of the government is also an important factor. Countries with constitutional checks and balances and divisions of power amongst multiple parties are less likely to engage in reckless behavior (obviously this is all relative as the U.S. and EU have shown that the developing world does not have a monopoly on recklessness). Countries that have autocratic executives, entrenched trade unions, and a penchant for populist activism should be scrutinized. 

But it is also important to recognize the "default" can occur in many forms, the most insidious of which is through inflation. While not technically a default, nominal returns are meaningless if they occur in a currency that has been devalued. Thus it is vital to identify debt denominated in currencies where there is less "quantitative easing" and where there are positive real interest rates. While some investors take confidence when small countries issue dollar-denominated debt, the current drift of American fiscal and monetary irresponsibility argues against it. Another option is to find foreign debt where the coupon is indexed to the local inflation metric.

For Americans evaluating returns in terms of USD, it may be worth considering foreign debt denominated in a currency whose underlying value is backed by hard assets. If there is a commodity rise, these currencies may likely rise faster versus the USD. If commodities sink, however, the opposite is likely to occur. Most important in evaluating foreign sovereign debt is to use some common sense. If you watch the news at all, then you probably have a good idea of where you shouldn't be investing.

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INTERNATIONAL INVESTING MAY NOT BE SUITABLE FOR ALL INVESTORS. TO SEE IF IT IS SUITABLE FOR YOUR INVESTMENT OBJECTIVES AND RISK TOLERANCE, CLICK HERE TO RECEIVE MORE INFORMATION OR CALL 1-800-727-7922 TO SPEAK TO AN INVESTMENT CONSULTANT.

Investing in foreign securities involves additional risks specific to international investing, such as currency fluctuation and political risks. Risks include an economic slowdown, or worse, which would adversely impact economic growth, profits, and investment flows; a terrorist attack; any developments impeding globalization (protectionism); and currency volatility/weakness. While every effort has been made to assure that the accuracy of the material contained in this report is correct, Euro Pacific cannot be held liable for errors, omissions or inaccuracies. This material is for private use of the subscriber; it may not be reprinted without permission. The opinions provided in these articles are not intended as individual investment advice.

This document has been prepared for the intended recipient only as an example of strategy consistent with our recommendations; it is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular investing strategy.  Dividend yields change as stock prices change, and companies may change or cancel dividend payments in the future.  All securities involve varying amounts of risk, and their values will fluctuate, and the fluctuation of foreign currency exchange rates will also impact your investment returns if measured in U.S. Dollars.  Past performance does not guarantee future returns, investments may increase or decrease in value and you may lose money.

Opinions expressed are those of the writer and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.








Tags:  2014 financial performanceAbenomicsEuro Pacific CapitalGlobal Investor Newsletterinflation sensitive assetsPeter Boehringer,Peter SchiffU.S. financial regulatory policy
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Yellen: Where No Man Has Gone Before
Posted by Peter Schiff on 07/25/2014 at 10:38 AM

Although Fed Chairwoman Janet Yellen said nothing new in her carefully manicured semi-annual testimony to Congress last week, her performance there, taken within the context of a lengthy profile in the New Yorker (that came to press at around the same time), should confirm that she is very different from any of her predecessors in the job. Put simply, she is likely the most dovish and politically leftist Fed Chair in the Central Bank's history.  

 

While her tenure thus far may feel like a seamless extension of the Greenspan/Bernanke era, investors should understand how much further Yellen is likely to push the stimulus envelope into unexplored territory. She does not seem to see the Fed's mission as primarily to maintain the value of the dollar, promote stable financial markets, or to fight inflation. Rather she sees it as a tool to promote progressive social policy and to essentially pick up where formal Federal social programs leave off.

 

Despite her good intentions, the Fed's blunt instrument policy tools of low interest rates and money supply expansion can do nothing to raise real incomes, lift people out of poverty, or create jobs. Instead these moves deter savings and capital investment, prevent the creation of high paying jobs, and increase the cost of living, especially for the poor (They are also giving rise to greater international financial tensions, which I explore more deeply in my just released quarterly newsletter). On the "plus" side, these policies have created huge speculative profits on Wall Street. Unfortunately, Yellen does not seem to understand any of this. But she likely has a greater understanding of how the Fed's monetization of government debt (through Quantitative Easing) has prevented the government from having to raise taxes sharply or cut the programs she believes are so vital to economic health. 

 

But as these policies have also been responsible for pushing up prices for basic necessities such as food, energy, and shelter, these "victories" come at a heavy cost. Recent data shows that consumers are paying more for the things they need and spending less on the things they want. But Yellen simply brushes off this evidence as temporary noise.

 

In her Congressional appearances, Yellen made clear that the end of the Fed's six-year experiment with zero percent interest rates is nowhere in sight. In fact, the event is less identifiable today than it was before she took office and before the economy supposedly improved to the point where such support would no longer be needed. The Bernanke Fed had given us some guidance in the form of a 6.5% unemployment rate that could be considered a milestone in the journey towards policy normalization. Later on these triggers became targets, which then became simply factors in a larger decision-making process. But Yellen has gone farther, disregarding all fixed thresholds and claiming that she will keep stimulating as long as she believes that there is "slack" in the economy (which she defines as any level of unemployment above the level of "full employment.") Where that mythical level may be is open for interpretation, which is likely why she prefers it.

 

The Fed's traditional "dual mandate" seeks to balance the need for job creation and price stability. But Yellen clearly sees jobs as her top priority. Any hope that she will put these priorities aside and move forcefully to fight inflation when it officially flares up should be abandoned.

 

These sentiments are brought into focus in the New Yorker piece, in which she unabashedly presents herself as a pure disciple of John Maynard Keynes and an opponent of Milton Friedman, Ronald Reagan, and Alan Greenspan, figures who are widely credited with having led the rightward movement of U.S. economic policy in the last three decades of the 20th Century. (Yellen refers to that era as "a dark period of economics.")

 

Perhaps the most telling passage in the eleven-page piece is an incident in the mid-1990s (related by Alan Blinder who was then a Fed governor along with Janet Yellen). The two were apparently successful in nudging then Fed Chairman Alan Greenspan into a more dovish position on monetary policy. When the shift was made, the two agreed "...we might have just saved 500,000 jobs." The belief that central bankers are empowered with the ability to talk jobs in and out of existence is a dangerous delusion. As her commitment to social justice and progressivism is a matter of record, there is ample reason to believe that extremist monetary policy will be in play at the Yellen Fed for the duration of her tenure.

 

For the present, other central bankers have helped by taking the sting out of the Fed's bad policy. On July 16 the Wall Street Journal reported that the Chinese government had gone on a torrid buying spree of U.S. Treasury debt, adding $107 billion through the first five months of 2014. This works out to an annualized pace of approximately $256 billion per year, or more than three times the 2013 pace (when the Chinese government bought "just" $81 billion for the entire calendar year). The new buying pushed Chinese holdings up to $1.27 trillion.

 

At the same time, Bloomberg reports that other emerging market central banks (not counting China) bought $49 billion in Treasuries in the 2nd Quarter of 2014, more than any quarter since 3rd Quarter of 2012. These purchases come on the heels of the mysterious $50 billion in purchases made by a shadowy entity operating out of Belgium in the early months of this year (see story).

 

So it's clear that while the Fed is tapering its QE purchases of Treasury bonds, other central banks have more than picked up the slack. Not only has this spared the U.S economy from a rise in long-term interest rates, which would likely prick the Fed-fueled twin bubbles in stocks and real estate, but it has also enabled the U.S. to export much of its inflation.As long as this continues, the illusion that Yellen can keep the floodgates open without unleashing high inflation will gain traction. She may feel that there is no risk to continue indefinitely.

 

But as the global economic status quo is facing a major crisis (as is examined in this newsletter), there is reason to believe that we may be on the cusp of a major realignment of global priorities. Despite her good intentions, if Yellen and her dovish colleagues do not receive the kind of open-ended international support that we have enjoyed thus far in 2014, the full inflationary pain of her policies will fall heaviest on those residents of Main Street for whom she has expressed such deep concern. 

 

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






Tags:  central bankersJanet YellenNew YorkerprogressiveQuantitative Easingstimulus
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