Top Economists Recognize Iceland Did it Right

It was six months ago that I wrote about Iceland succeeding where Greece had failed. In that post I pointed out that Iceland allowed its banks to fail, protected its citizens and prosecuted bankers that had committed crime. The result was sharp contraction in GDP in 2009 followed by a normal recovery and return to about 3% growth. When I wrote that last post in February Iceland's credit rating had already recovered to BBB- by Fitch, a lower, but still investment grade rating. Today, Nobel Prize economists and even the IMF (who's prescription for ailing countries is usually more similar to the path of Greece) has recognized that Iceland is a success and has clearly done the right thing.

Via Zerohedge:

Nobel prize winning economist Joe Stiglitz notes:

What Iceland did was right. It would have been wrong to burden future generations with the mistakes of the financial system.

Nobel prize winning economist Paul Krugman writes:

What [Iceland's recovery] demonstrated was the … case for letting creditors of private banks gone wild eat the losses.

Icenews points out:

Experts continue to praise Iceland’s recovery success after the country’s bank bailouts of 2008.

Unlike the US and several countries in the eurozone, Iceland allowed its banking system to fail in the global economic downturn and put the burden on the industry’s creditors rather than taxpayers.

***

The rebound continues to wow officials, including International Monetary Fund chief Christine Lagarde, who recently referred to the Icelandic recovery as “impressive”. And experts continue to reiterate that European officials should look to Iceland for lessons regarding austerity measures and similar issues.

Barry Ritholtz noted last year:

Rather than bailout the banks — Iceland could not have done so even if they wanted to — they guaranteed deposits (the way our FDIC does), and let the normal capitalistic process of failure run its course.

They are now much much better for it than the countries like the US and Ireland who did not.

Krugman also says:

A funny thing happened on the way to economic Armageddon: Iceland’s very desperation made conventional behavior impossible, freeing the nation to break the rules. Where everyone else bailed out the bankers and made the public pay the price, Iceland let the banks go bust and actually expanded its social safety net. Where everyone else was fixated on trying to placate international investors, Iceland imposed temporary controls on the movement of capital to give itself room to maneuver.

Even "more monetary stimulus Krugman" now sees that letting banks fail leads to a quicker recovery. We can see what the alternative brings by looking at Japan where "zombie banks" were preserved at the expense of economic growth resulting in two decades of economic depression.

As you can see from the chart above their growth rate has averaged between zero and one % of GDP. This in spite of the same ZIRP policies that we are now trying here in the US.

I would argue that zero percent interest rates has not been a stimulus but rather have been an impediment to the efficient allocation of capital. Clearly ZIRP has not gotten Japan out of their economic slump.

But Iceland did more than just allow their banks to fail, and this, I believe, is an important lesson for use here in the US:

Barry Ritholtz noted last year:

Rather than bailout the banks — Iceland could not have done so even if they wanted to — they guaranteed deposits (the way our FDIC does), and let the normal capitalistic process of failure run its course.

They are now much much better for it than the countries like the US and Ireland who did not.

Bloomberg pointed out February 2011:

Unlike other nations, including the U.S. and Ireland, which injected billions of dollars of capital into their financial institutions to keep them afloat, Iceland placed its biggest lenders in receivership. It chose not to protect creditors of the country’s banks, whose assets had ballooned to $209 billion, 11 times gross domestic product.

***

“Iceland did the right thing … creditors, not the taxpayers, shouldered the losses of banks,” says Nobel laureate Joseph Stiglitz, an economics professor at Columbia University in New York. “Ireland’s done all the wrong things, on the other hand. That’s probably the worst model.”

Ireland guaranteed all the liabilities of its banks when they ran into trouble and has been injecting capital — 46 billion euros ($64 billion) so far — to prop them up. That brought the country to the brink of ruin, forcing it to accept a rescue package from the European Union in December.

***

Countries with larger banking systems can follow Iceland’s example, says Adriaan van der Knaap, a managing director at UBS AG.

“It wouldn’t upset the financial system,” says Van der Knaap, who has advised Iceland’s bank resolution committees.

***

Arni Pall Arnason, 44, Iceland’s minister of economic affairs, says the decision to make debt holders share the pain saved the country’s future.

“If we’d guaranteed all the banks’ liabilities, we’d be in the same situation as Ireland,” says Arnason, whose Social Democratic Alliance was a junior coalition partner in the Haarde government.

***

“In the beginning, banks and other financial institutions in Europe were telling us, ‘Never again will we lend to you,’” Einarsdottir says. “Then it was 10 years, then 5. Now they say they might soon be ready to lend again.”

And Iceland’s prosecution of white collar fraud played a big part in its recovery:

[The U.S. and Europe have thwarted white collar fraud investigations ... let alone prosecutions.] On the other hand, Iceland has prosecuted the fraudster bank heads (and here and here) and their former prime minister, and their economy is recovering nicely … because trust is being restored in the financial system.

In my previous post I wrote my conclusion which is just as accurate as ever:

Lesson for us in the US

While Iceland sent its banksters to jail, not a single one here in the US has gone to jail for the massive fraud perpetuated on the American people and the international investors who bought the mortgage derivatives thrown together with loans signed by “Linda Green”.  Even now, not a single arrest has been made resulting from the theft of over a $1 Billion after MF Global stole client money from segregated accounts. In addition, rather than bailing out their banks as the US did, they partially nationalized them. The advantage of this is that there is now an expectation that the government won’t bail them out while in the US the big banks know Bernanke and Congress will always bail them out no matter how bad their behavior. They can keep the profits in the good times and be bailed out by struggling Americans in the bad times.

 Worse, rather than the banks being nationalized, they were allowed to sell their losing mortgage derivative to the US Fed, backstopped by the US taxpayer. Then they were on the one hand allowed to switch from “mark to market” to “mark to myth”. That is, just valuating their failed loans at whatever price they deemed correct. Finally, on the other hand as the Fed embarked on its ZIRP (Zero Interest Rate Policy) policy banks were able to use an accounting trick to revalue their own debt to show phantom income as if they had refinanced their own outstanding debt at the lower rate. 

While Iceland’s banks were allowed to fail, Greece is trying to extend and pretend as they always have, following the US’ example. Iceland has endured difficulty but has recovered and is now growing again. The US and Greece however are following the Japanese who have been mired in an economic depression for two decades. We should not expect to have different results.

Yes, You've Seen This Before

I've shown the Dow/Gold ratio before and discussed the reversion I expect to see back to 1:1 but its always interesting to hear others much smarter than me discuss it. Today Mike Krieger re-examines the ratio. From Zero Hedge:

What this chart shows you are secular swings in the economy.  You see how stocks ran up in real terms into the 1929 crash and then plunged versus gold.  You see how they ran up in the next great post- WW2 period into 1968 when they once again plunged versus gold.  Then you can see the great secular bull market in stocks from around 1982 to the bubble peak in 2000.  In both of the prior two periods (one deflationary and one inflationary) the DOW/GOLD ratio got down to about 1:1.  It has been my contention for many years that we will see that same ratio once again.  That would imply another roughly 75% drop in stocks to gold and I expect that this next leg is beginning now.

At any point in time the market can either make you look like a genius or an idiot. Last Monday I noted in a post that it was a good time to buy gold given that fundamentals were stronger than ever even as the price was two standard deviation below the mean. Gold is up about 3% since that post but is still down 8.8% year over year. My point here is that I have no idea what gold is going to do over the short term. I may look smart one day and dumb a month later, The fundamentals however are unchanged from day to day. Keep an eye on the longer term trends. Namely, keep in mind:

1. We're still inching closer to a fiscal cliff.
2. Central banks are still buying gold, especially in the East.
3. Some form of QE is still likely in some form.
4. We still have negative real interest rates.
5. The Euro is still in trouble with members likely to abandon the currency in the next 6-18 months.

I have no idea if this week's rally will continue or not in the short term or not, but I am quite confident that global economic forces are going to push the Dow/Gold ration lower, and quite possibly as far as 1:1. As I've mentioned before,  there will be a time to begin moving from gold back into equities, but I don't expect this to be anytime soon.

Until then, if you must invest in stocks, seek dividend paying stocks. In your 401k they are often called "Growth and Income" funds.

Still Not Convinced We're in a Depression?

The picture above is our image of the Great Depression. Men standing in line for soup. Of course, we don't see too many soup lines these days except for the homeless. We keep the less fortunate hidden away. We give them food stamps, or what today are called EBT cards. Its better this way. It doesn't scare the public or ruin the illusion that everything is OK since 2008. Its easier to feel like things are back to "normal". But they aren't.

Look at the image above and imagine that line extending beyond the picture. Imagine 45 million people standing in that line. That's how many people are on food assistance. Nearly 1 in 7 Americans.

For most people its difficult to imagine 45 million people, just as its nearly impossible to fathom the $1.3 Trillion deficits we've been running for the past four years. The number is astronomical. We use that phrase without thinking. "Astronomical" means the number are so large they're used almost exclusively to measure distances out in space. They weren't meant to be applied to our deficits. Yet here we are.

But if you still aren't convinced the downturn is comparable to the Great Depression, I would point you to this:

 

The Great Depression came about partly as a result of a severe fall off in economic activity (and made worse by poor policies). Economic activity can be measured by the velocity of money.

The easiest explanation of money velocity is to imagine an employer paying an employee their wages. The employee uses their wages to buy food from a store. The store then uses that money to pay their supplier and on and on.

As you can see in the graph above, the velocity of money has fallen below the level of the Great Depression. This is the reason that quantitative easing has failed. The Fed pumps money into the banks by buying treasuries. The banks, in theory are supposed to make loans which circulates more dollars into the economy. But they aren't. The under capitalized banks are either sitting on the cash, earning interest from the Fed on their excess reserves, or they are using the money to speculate on things like oil, corn or wheat and thereby driving up the costs for consumers. This is the reason the Fed's policies are enriching the bankers at the expense of the working poor (who four years ago were among the middle class). 

Once again, we are seeing a Great Depression. Once again, poor policies are extending it. We are now in the fourth year. Japan has experienced over 20 years of the same. Yet our Fed is following the Japanese "solutions" almost exactly, and sadly, expecting different results.

Good Time To Buy Gold

The fundamentals for gold have been getting better and better since 2008 and those that bought were certainly rewarded. For those who missed the opportunity, there is another chance to buy now at a reasonable level before the consolidation we've seen in gold ends and it begins to increase in price once again.

You can see below that gold is completing a similar trading pattern we saw in 2008 where it hit a short term high then sold off. I've mentioned before this sell off was partly because traders and banks were forced by margin calls to sell their best performing assets to meet capital requirements. Since gold was not then a Tier 1 rated asset they had to sell gold and buy Treasuries. I've also previously mentioned that that may change if the BIS makes gold a Tier 1 capital asset.

The recent sell off in the last year has been a healthy consolidation period, the type we would expect to see in any investment with a long term bullish trend. The timing for buying now may be excellent as measured below. In the graph below we see the trailing year over year returns expressed in standard deviation. As long as fundamentals are good (and they are), buying below the mean (measured as zero on the graph) while standard deviation is negative is an excellent time for the long term investor to buy.

Notice in the chart the last time gold was at -2 standard deviations was August 2008. The year following that point provided fantastic returns. As we move into fall I'm expecting gold to resume its climb, but regardless of the short term, the fundamentals right now are outstanding.

When Free Markets Work

 

In an age where every financial market is manipulated and distorted by government "good intentions" its good to be reminded why we have (or had) this system called "free markets". While Obama was sending billions of dollars to "green energy" companies like Solyndra and Fisker who immediately made the money disappear like a segregated account at MF Global, something was going on that politicians missed. And because they missed it, they couldn't destroy it. That was natural gas hydraulic fracturing, or fracking.

Fracking made the recovery of natural gas more economical. As a result, drillers began fracking and increasing production of natgas which has driven the price lower, to the benefit of consumers. So low in fact, that its now competitive with coal, that abundant but dirty alternative. The result? Cleaner, cheaper energy.

From Wolf Richter at  www.testosteronepit.com

But the graph shows something far more important: a narrowing of the gap between coal and gas-fired power generation. It’s not just the low price of natural gas that did it—but a new power generation technology and yes, the usual suspect, Congress.

Gas turbines are an old technology. Most of the energy is wasted as exhaust heat. They’re inefficient, compared to coal-fired steam turbines. But they have an advantage: they can be brought on line quickly to cover peak loads. So coal and gas have been used in parallel: coal to produce low-cost base power and gas to produce more expensive peak power during periods of high demand (daytime, summer).

Gas didn't pose a threat to king coal ... until the arrival in the 1990s of the natural gas combined-cycle (NGCC) turbine: like the classic turbine, it drives a generator, but instead of blowing the “waste” heat out the exhaust, it uses the energy to generate steam that, as in a coal plant, drives a steam turbine that powers another generator. Like their old-fashioned brethren, NGCC plants can be brought on line quickly, but when used for base power, their efficiency can exceed 60%—much higher than that of a coal plant.

A game changer. With natural gas prices as low as they’ve been over the past years, operating costs for power generators have plunged. It doesn’t hurt that NGCC plants have lower capital costs than coal plants—$600 to $700 per kW versus $1,400 to $2,000 kW—relatively short construction times, and environmental benefits. The long-term shift to natural gas looks like this:

Natgas is not just cleaner measured by particulates but also by CO2. As a result of new gas plants, CO2 is now at a 20 year low.

In a surprising turnaround, the amount of carbon dioxide being released into the atmosphere in the U.S. has fallen dramatically to its lowest level in 20 years, and government officials say the biggest reason is that cheap and plentiful natural gas has led many power plant operators to switch from dirtier-burning coal.

Many of the world’s leading climate scientists didn’t see the drop coming, in large part because it happened as a result of market forces rather than direct government action against carbon dioxide, a greenhouse gas that traps heat in the atmosphere.

It was the free market, and not government that found a cleaner way. Contrast that with what we spend on ethanol subsidies and the billions spent in the "stimulus" for bankrupt solar companies and battery companies going bust. It was free markets, not central planning, that made America the wealthiest, most productive country in the world. Returning to free markets will involve some pain as assets are repriced to their true value, but the pain of the adjustment is quick relative to the long term depression Japan has endured by trying to keep zombie banks afloat.


Note on investing in Natgas:
The market price of natgas has fallen below its cost of production. This has meant hard times for gas drillers and anyone invested in them. As I have shown above, the consumers are the true beneficiaries. There are, however, ways of playing this trend in the increased use of natgas for power production. One way is by investing in Master Limited Partnerships of natural gas pipelines. These organizations make their money from "tolls" on the gas that moves through their pipes. These MLP's have a tax advantage similar to Real Estate Investment Trusts, or REIT's  in that they do not have to pay income tax on revenues that are passed through to investors. The result is more money to investors. One Nat Gas MLP is the ETF that tracks the Alerian Natural Gas Index (Ticker MLPG). As of this writing it yields about 6%. In this age of financial fraud, I like investments with lots of proven cash flow. And their is no better way of proving cash flows than when they are paid out to you.

41st Anniversary of the Beginning of Financial Repression

The following article articulates even better than Ron Paul the connection between sound money and a free society with a restricted government.

From Zerohedge:

Via Kenneth Landon, JPMorgan... Yes, JPMorgan
Landon Lowdown: "Brother, Can You Spare $1.37"?
As we await the latest developments out of the Eurozone and Washington, I take a moment to look back on this very important day in history. If you want to understand current events, then you first have to understand history. How did we get here? More specifically for financial markets, how did we end up in this mess -- this economic purgatory? The answer boils down to a simple proposition on the philosophical level, which I will leave to the reader to identify because my doing so would likely ruffle a few too many feathers. So I will keep the discussion on the concrete-bound level. However, I am willing to say that the political philosophy that drove us to the current state of affairs was responsible for the respective concrete measures implemented over the years. The crisis in confidence that we observe today resulted from cumulative effects of those measures. 
This being August 15, 2012, students of the history of monetary economics no doubt are aware that this is the 41th Anniversary of the breakdown of Bretton Woods. It was on this day 41 years ago that President Nixon defaulted on the promise to exchange gold for paper dollars presented for exchange by foreign central banks. Aug 15th marks the anniversary of the collapse of Bretton Woods and the gold-exchange standard that was established after WW II. (Notice that dollar debasement has been bipartisan over the years: Republicans Nixon and Bush and Democrats Carter and Obama have all presided over major declines in the value of U.S. money.)
The current crisis in the global monetary system pales in magnitude to the sundering of gold from central banks' fiat paper currencies in 1971. That is, we are not witnessing the wholesale dismantling of an entire monetary system. What we are witnessing is a loss of confidence in the current monetary system, which, of course, is equivalent to a loss of confidence in central banks' ability to restore stability. However, the decision to renege on the gold-exchange standard that was made 41 years ago is still reverberating today. In *fact*, many or most of the problems observed today are the direct result of wrong-headed discretionary monetary policies.
What was it that made the current morass inevitable once the paper dollar was severed from gold?
 The answer is simple: fiat paper money that is not grounded in any objective standard can be manipulated at the whim of the issuer. Without the requirement to exchange fiat money for gold or some other commodity, the central bank can issue unlimited amounts, thus making its value subject to extreme volatility and, as we have seen, perpetual debasement.

Chart 1 (above) shows the extent of debasement of the value of U.S. money since 1913 when the Fed was established. To summarize in simple terms, a child with 4 cents in his pocket could buy the same amount of candy in 1913 as his descendant could with $1 in 2012. Today, it takes a quarter to buy what a penny did in 1913. The dollar has lost 96% of its purchasing power since 1913! (using CPI statistics) Once the dollar lost all linkage to gold, its value plummeted at an accelerated rate. Since 1971 when Bretton Woods was intentionally dismantled, the dollar has lost 82% of its purchasing power. 82%! Because Nixon sabotaged the last vestige of honest money, a child in 2012 would need $1 to buy the same amount of candy purchased by children for just 18 cents in 1971.
Monetary debasement has rendered obsolete the expression "brother, can you spare a dime?", which was the title of a 1930's Depression-era song that became a common refrain of panhandlers in those days. In 2012, the equivalent would be "brother, can you spare $1.37?"
 An honestly governed gold standard eliminates "discretionary" monetary policy by centralized authorities (i.e., central banks).
Gold is an honest check on the amount of leverage that can build in the financial system and it limits the amount of money the government can borrow. A government that does not have a captive central bank and fiat paper currency cannot borrow massive amounts of money (think Greece). Fiat paper money managed by complicit central banks remove any discipline of free-spending politicians. Thus, central banking and huge deficit spending go hand in hand.
Let's turn to a former Chairman of the Fed to give some added explanation:

"Under a gold standard, the amount of credit that an economy can support is determined by the economy's tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government's promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit.

They have created paper reserves in the form of government bonds which -- through a complex series of steps -- the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of society lose value in terms of goods.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold [in 1933]. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."

Alan Greenspan, 1966

When Greenspan later rose to a position of prominent political power when named Chairman of the Fed, he disavowed his essay about gold. However, that disavowal does not detract from the truth of his written word. His words stand on their own. (What changed since 1966 was Mr. Greenspan and not the truth.)
We are currently witnessing in both Europe and the U.S. a crisis relating to the financing of the modern-day Social Welfare State that goes to the core of the generally-accepted political philosophy upon which they rest. The resolution of the problem is therefore not as simple as coming up with a new policy that is a derivation of previous ones (e.g., using debt to solve debt). The real resolution will come only after a major shift in political power, if seen at all, that results in a significant reduction in spending of the respective governments. Otherwise, it will be more of the same: a continued decline in living standards and individual liberty in countries experiencing this rot. Profligate central banks are a symptom and enabler of the political rot. They are not the cause.


The chart 2 (above) shows the gold content of one U.S. dollar. Today, one dollar buys a pitiful 0.0006 ounce of gold, which compares to about 0.05 ounce a hundred years ago just before the Fed existed. The deprivations that Mr. Greenspan wrote about are illustrated in the sharp decline in the gold content of the dollar.


For point of historical reference, Chart 3 (above) shows the silver content of the Roman Danarius between 64A.D. and 270A.D. You can draw your own conclusions.

"Paper money has had the effect in your state that it will ever have, to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice."

George Washington, in letter to J. Bowen, Rhode Island, Jan. 9, 1787

Sadly, few people understand the process by which paper money leads to "fraud and injustice" as President Washington accurately warned in 1787. If they did, then perhaps days like Aug 15, 1971 would never have happened.
To end with one last quote, this time from a (Fabian) Socialist who knew the importance of gold:

“You have to choose between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the Government. And, with due respect for these gentlemen, I advise you, as long as the Capitalist system lasts, to vote for gold.”

George Bernard Shaw

Shaw wanted to end the Capitalist system and knew, like Greenspan, that gold stood in the way of a Socialist government from achieving its objectives.
August 15, 1971: A day that will live in infamy.

 

Loquiter Enim Se

"It Speaks For Itself"

Five years after the crisis began, I present the returns of various assets. Can you spot the winners?