The Gold Debit Card (Patent Pending)

No, not gold status, gold bullion.

For the past few years I've watched the Fed print money to deal with the economic malaise we've experienced since 2008. It became evident that rather than let markets clear, deleverage and reform the rot in our economic system, that we would "extend and pretend". First it was to get us through the initial crisis that saw our financial system on the brink. Then, as time went by I saw that "pretending" had become the new normal. Congress didn't do any substantial reform. Frank-Dodd was passed essentially as an empty bill with no realistic plans towards its implementation. Even today, the CFTC has delayed implementing position limits on gold and silver futures allowing JP Morgan and HSBC to (allegedly) manipulate the prices by creating naked short positions out of thin air. The Fed, once they had dropped interest rates to zero, seemed to have only one policy tool left: PRINTING DOLLARS.

Once I recognized this, it became clear that the US dollar which had already been devalued under President Bush and Fed Chair Alan Greenspan, would be massively further devalued bu President Obama and current Fed Chair Ben Bernanke. At first I looked to other currencies, primarily the Euro, but soon it became apparent that the rot and dysfunction in the financial markets was not a uniquely American problem, it was the entire western world and Japan.The US, Europe, Japan, Great Britain and even Switzerland (!) have all embarked on quantitative easing (printing) to deal with profligate spending, an excess of debt and faltering economies. No currency, it seems, will be a refuge or preserve purchasing power. Only gold seems to be up to the task.

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$3,350 Gold & $190 Crude

The consequences of unlimited quantitative easing are just now being contemplated as "endless easing" becomes official policy rather than a thought experiment. One consequence will be the repricing of assets, including gold and silver, in the ever devalued currency of the USD. For now, the US dollar is still the "petrodollar" that oil is primarily priced, so a devaluation of the dollar means the price of oil must go up as the dollar is devalued.

BofA has their own take on it given that the Fed will increase their balance sheet from $2.2 Trillion to $5 Trillion over the next few years. From Zero Hedge:

n other words, for once we actually were shockingly optimistic on the US economy. Assuming BofA is correct, and it probably is, this is how the Fed's balance sheet will look like for the next 2 years:

Or, in terms of US GDP, the Fed's balance sheet will have "LBOed" just shy of 30% of all US goods and services.

 

It gets worse:
Since the Fed is effectively becoming the marginal player in both the MBS and Treasury markets, a very relevant question is how much private market debt is left to sell. Short answer: not much. According to BofA's calculation, the Fed will own more than 33% of the entire mortgage market by 2014.
 That's half the story.
On the Treasury side, in just over 2 years, "Fed ownership across the 6y-30y portion Treasury curve is likely to reach about 50% by end of 2013 and an average of 65% by end of 2014." You read that right: in just over 2 years, the Federal Reserve will hold two thirds of the entire bond market with a maturity over 5 years (which by then will be part of the Fed's ZIRP commitment, yield 0% and essentially be equivalent to cash).
No wonder that David Rosenberg is worried that the Fed will soon run out of securities to buy (well, there are always equities of course, but the Fed will not monetize those until some time in 2015 when hyperinflation is raging).
And speaking of hyperinflation (and our earlier note that nothing "else is equal") the real question is if indeed the Fed will own $5 trillion in "assets" in 27.5 months, what does that mean for gold and crude? The answer is plotted below:

 



In case it is unclear, the answer is:

• $3350 gold
• $190 oil.

In coming days I'll provide analysis as to why continued QE will not work, except to inflate the price of commodities and (temporarily) the stock market.

To Infinity and Beyond!

 

 I was going to write a long post on the effects of QE3 to infinity announced by the Fed when I came across an extremely well written piece that describes both the plus side and coming negative side of endless printing on different asset classes. It supports the goal of this blog to examine the macro economic environment to preserve and grow wealth. You can read it here. I have also shown it below:

The Dark Side Of QE: The Next Chapter In Our Story

I am about to tell a story with a very happy beginning and a very sad end. Unfortunately, it happens to be the story we are living in today, but because we are still in the happy part of the story most people cannot see what is coming ahead. I will provide that for you here.

The immediate knee jerk reaction to the Fed's announcement today is that the Fed printing $40 billion per month and pumping it into the banking system is fundamentally strong for every type of asset in the world. Those that graduated from college in 2009 and have only been watching the market for a few years would believe this is a fact.

In essence: buy everything and just keep on buying.

Now that we know we are on the path of QE to infinity it is very important to understand how an endless running stream of new money fundamentally impacts assets differently. You'll notice a repetition of the word fundamentally because for long periods of time assets can move in the opposite direction of their fundamentals. Think of the 100% par value of subprime mortgage tranches in early 2006 or the multi-billion dollar valuation of Pets.com in 1999. Over time assets have a tendency, like gravity, to revert back to their fundamental value. This is what causes booms, busts, opportunity, and disaster.

Before we go any further, let's quickly review how QE actually works. The Fed shows up at the doorstep of primary dealer (the largest) banks with a printed bag full of money and asks them if they can come in and buy some mortgage bonds. The banks agree, hand them the bonds, and take the bag full of cash. The banks now have a new lump sum of money to spend or do with what they like. This is also new money that did not exist in the economy before which is how the money supply is increased. In reality, there are no knocking on doors with bags of money, this process takes place electronically with a few key strokes from either side. The outcome, however, is the same.

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More Money Printing- QE3 Has Arrived

The Fed, in a move that is no surprise at all, has announced indefinite monetary stimulus. Though this blog has focused on wealth preservation that has assumed more QE all along, its still disheartening to see our country continue to move down the road to ruin and a weaker dollar. My readers, of course, are well positioned to profit from the latest move but one wonders, what of the rest of America who will now face higher prices in both food and gas as this depression drags out longer?

I'll have more on the Fed's latest move later.

Is Silver About to Explode Upwards?

Bill Murphy on the (possible) end to JP Morgan's silver manipulation.

Pay attention at 17:21. It would seem that Russia too is taking advantage of artificially low prices at the expense of us (Americans).

S&P 500: from 1,400 to 400?

There's a correlation between the  10 year US Treasury and the S&P 500, which represents the 500 largest US companies. Prior to 2008 they moved in tandem when graphed against each other. Take a look at the graph below from 1999 to 2008.

You can see that the orange line tracks the black line very well for much of the last 10 years up until 2008. This was when quantitative easing started. Quantitative easing artificially inflates the price of stocks (along with most everything else) since the stocks are priced to reflect the new, lower valued US dollar.

Since that point the two lines diverge. The question is, when will they re-converge? And will it be because interest rates are rising or because the stock market, represented here by the S&P 500 index, comes down? Its an important question because if rates are held down by the Fed through continued through operation twist, then the index needs to fall from 1,400 to 400!!!

You may recall from my previous post, Three Graphs Explaining When to Dump Gold and Buy Stocks, that I am looking for the Dow/gold ratio to decline to close to 1:1. What these two concepts have in common is that US stocks, whether represented by the broad index of the S&P 500 or the more narrow index of the Dow, will have to decline for these to ration to "revert" back to normal in the case of the US Treasury and to complete an 18 year cycle in the Dow/gold ration.
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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.