Political Metals

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It scares me!

Gold punched through $1,900 today. If the current financial system can withstand the stress and remained intact till the day gold trades at $20,000 an ounce, what will life be like then?

If we’re holding gold at that time, we may be doing fine but we are not likely to be 10 times richer. That’s because nothing much has happened to our gold. Rather, paper currencies would have lost so much purchasing power that it would take 10 times more of the same to buy what we could buy today. A Big Mac will most likely cost around $43 in the US. In Malaysia, NZ and Britain, it’ll like be  around RM76, NZ$54 and £25 respectively (estimates based on Big Mac Index). When a basic meal costs that much, life can be very tough for savers who continued holding on to their paper currencies or other paper assets.

Many of my friends and relatives, from retired professionals to missionaries have been ill advised to rely on supposedly safe or high yielding investments like mutual funds, government managed pension schemes, term deposits or hot stocks to generate passive income or preserve the value of their retirement funds. Despite being presented with information from this website and elsewhere, there’s little affinity shown towards gold or silver. This scares me and for their sake, I hope gold does not get anywhere close to $20,000 before they get on board.

What’s even scarier is the fact that an enormously huge segment of society do not have the means to get on board, even if they wanted to. We’re looking at the 1.4 billion people living on less than NZ$2.25 a day. That’s less than 0.05 ounces of silver! They worry not about the Fed nor the Cartel but about how to provide food, clothing, housing and healthcare with that amount each day. It’s about survival, not savings. Pause for a moment to imagine their plight when gold hits $20,000.  Spare them a thought today, and check out their appeal for assistance.

Why $20,000 gold?

In this recently released documentary, Mike Maloney presents the case for $20,000 gold by stepping back and looking at the big picture. He takes us back, very far back, and paints us a very big picture. This excellent educational video is a must watch, especially if you’re new to the Political Metals space. It’ll be your 90 minutes well spent.

But if you can’t spare the time, I’ve highlighted some of his key points with some new charts below for a quick read.

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Dow/Gold Ratio Chart: Where are we in the Wealth Cycle? 

Using the Dow Jones Industrial Average (Dow) as a measure of performance of the equities market in general, the ratio of the Dow to the price of gold indicates the performance of equities market relative to gold. Currently each point of the Dow is worth about 6oz of gold. During the process of correction after the biggest stock market bubble in history, the ratio is expected to head towards the historical mean (4oz) and overshoot it before finding its fair value again.

The bigger the bubble (deviation from mean), the larger the overshoot. During the present cycle, Mike expects the overshoot to touch 0.5:1 (1 oz of gold worth 2 points of Dow). In its extreme, the Dow would have to collapse from 11,000 to 950 if the price of gold remains at current level of $1,900. Conversely, gold will increase to $22,000 if the Dow remains at current levels.

Relative performance of Dow Vs Gold & Silver since Jan 2000
(Worst reference point, at peak of stock market bubble)

Relative performance of Dow Vs Gold & Silver since March 2009
(Best reference point, at the start of QE1)

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Currency Supply Chart: Where are we in the Inflation/Deflation Cycle?

For simplicity, “money” & “currency” are used interchangeably here. Watch the video to see the difference.

Monetary inflation is the increase in money supply resulting in price inflation (rising prices of goods & services), with a time lag between the former and the latter. The reverse applies to monetary deflation and price deflation. Studying the trend in money supply or the total amount of currency in circulation (CinC) over a period of time gives us an idea of where we are and where we’re heading in terms of inflation and deflation.

Money is created in two stages. The initial Base Money is created by the Fed (or other central banks). More new money is then created (up to 9 times the initial Base Money) within the private banking system through credit. It is loaned into existence. Watch the video to learn more about the money creation process.

The chart above  represents the amount of CinC that’s exclusively created by the private banking system. The highlighted area indicates that this component of the overall money supply has dropped by $1.7T since the 2008 crisis. This is the Debt Collapse or Credit Contraction. Less lending by banks results in less money chasing goods and services, leading to price & asset deflation. It is evident from the chart that a contraction of this magnitude has never happened since 1960. The last time it happened was just before the Great Depression of the 1930s.

In response to this credit contraction, and in an attempt to prevent another Great Depression, the Fed has been rapidly increasing the Base Money supply by creating new money. The recent rate of increase is unprecedented. The first trillion dollars was created over a period of about 90 years. The next $1.4T came into existence over the last 2 years!

This rapid increase in Base Money (red chart) was an attempt to offset the decrease in the credit money (blue chart). When we add these two components of money supply together, we obtain the total CinC (Base Money plus Credit Money) as shown in the chart below.

Notice the contraction at the top of the chart, albeit a smaller one. It is evident that despite the frantic pace of money printing by the Fed, it has not succeeded in offsetting the reduction in money supply due to credit contraction.

The Fed has little choice but to continue creating money.  With such a large perturbation in total currency supply and due to the complexity and size of the monetary system, it is not possible for the Fed or anyone else to create just sufficient money at just the right rate such that the total CinC won’t overshoot its long term trend. The principle that the larger the deviation from the mean, the larger will be the overshoot during the correction applies here as in the stock market above. The fact that there’s an undetermined time lag, between monetary inflation and price inflation further adds to the likelihood that the next round of money printing will result in a massive overshoot. Coupled with other factors, hyperinflation could be just round the corner.

In his book, Rich Dad’s Advisors: Guide to Investing In Gold and Silver: Protect Your Financial Future, and again in his presentation, Mike predicted the following sequence of events:-

1. Threat of deflation - At the onset of the 2008 crisis (Past)
2. Money printing - TARP, QE1, QE2 (Past & more to come)
3. Big inflation - Here and now (anyone disagree?)
4. Real deflation - Asset deflation in real estate & stock market (The severe but short deflation  is ahead)
5. Hyperinflation - Just round the corner?

How does gold perform under inflation and deflation environment? Check out the study by Oxford Economics: “Impact of inflation and deflation on the case for gold”.

Related Resources:

• Fractional Reserve Banking - Two short video clips on money creation
• Crash Course on Banking, Finance & Economy. By Chris Martenson
• Central Banking and the Federal Reserve System (Fed)

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This enlightening discussion between James Turk (GoldMoney) and John Embry (Sprott Asset Management) touches on various significant developments in the gold market in recent past. They talked about the S&P downgrade, QE to infinity, hyperinflation, Jim Sinclair’s $1764 inflection point and looking at the value of gold rather than its price.

They concluded that by looking at the past & present central banks’ role and dynamics of Asian demand, physical gold is now taking the lead in price discovery instead of paper gold.

The Gold cartel is losing control and the era of the tail wagging the dog may soon be over!

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London Gold Market Report
from Ben Traynor | BullionVault
Wednesday 25 May, 08:00 EDT

Euro Price of Gold Hits Third Record in Three Days as ECB “Basically Trapped” by “Horror Scenario” of Greek Default

U.S. DOLLAR gold prices rose to a three-week high of $1528 an ounce Wednesday morning London time, while commodity markets – like global stock markets – failed to add significantly to the gains they made Tuesday after Goldman Sachs issued a bullish note on the sector.

The London Fix on Wednesday morning saw Sterling gold prices set at £942, two pounds below Tuesday afternoon’s new all-time record.

Euro gold prices hit another new record – the third in three days – at €1084 an ounce.

“If we restructure Greek debt, that means Greece defaults,” said Christian Noyer, governor of the Banque de France and a member of the European Central Bank’s governing council, to journalists in Paris on Tuesday, describing the idea of Greek restructuring as a “horror scenario”.

The Greek government was forced on Wednesday to deny rumors that it was about to call a snap election.

If Greek debt were restructured, the ECB would no longer be able to accept Greek government bonds as collateral for loans, warned Juergen Stark – another executive board member – last week.

“They are now like many people in the banking system in calling out for no debt repudiation because they are so exposed,” says Charles Wyplosz, professor of International Economics at the Graduate Institute in Geneva, quoted by the Financial Times.

“The ECB is basically trapped,” says Wyplosz, as it has bought a large amount of Greek government debt through its asset purchase program.

“There is so much uncertainty [in the Eurozone] that the downside risk for gold prices is low in the short term,” says Andrey Kryuchenkov, London-based analyst at VTB Capital.

“People are still frightened about Portugal and about a possible restructuring of the Greek debt, so safe-haven flows will continue.”

Also in Paris, French finance minister Christine Lagarde – who in February pledged that other Eurozone members “won’t abandon Greece” – officially announced her candidacy to become the next managing director of the International Monetary Fund (IMF) on Wednesday.

“It is an immense challenge which I approach with humility and in the hope of achieving the broadest possible consensus,” said Lagarde.

But IMF executive directors from the BRICS countries – Brazil, Russia, India, China and South Africa – issued a joint statement Tuesday criticizing the “obsolete convention” that the head of what’s often called “the central banks’ central bank” should be a European.

Away from the Eurozone crisis, Goldman Sachs – which last month warned that “demand destruction” could see commodity prices fall – appeared to do a volte face on Tuesday, when it raised its price forecasts for the sector.

“We continue to expect that economic growth will likely be enough to tighten key supply-constrained markets,” it said in a report.

“We expect gold prices to continue to climb in 2011 as the resumption of quantitative easing should keep US real interest rates low.”

“Silver [also] appears to be making a tentative recovery,” says one London bullion dealer, who expects silver prices to hit resistance around $39.

Axel Rudolph and Karen Jones, technical analysts at Commerzbank, agree, predicting resistance at Silver’s 55-day moving average of $38.95.

Silver prices today gained over 2% to climb above $37 an ounce.

Goldman Sachs’ note predicted real interest rates would begin to rise in 2012, “likely causing gold prices to peak”. But “even if we remove some accommodation, policy will still be very easy,” Federal Reserve Bank of St Louis president James Bullard said earlier this week.

The Fed’s $600 billion asset purchasing program – widely known as QE2 – is due to end next month.

“We still have a considerable way to go to meet the Fed’s dual mandate of full employment and price stability,” said New York Fed president William Dudley last week, while Chicago Fed president Charles Evans has said monetary accommodation ought to remain “substantial”.

Ben Traynor
BullionVault

By: John Melloy | CNBC

A trade-weighted measure of the U.S. dollar against a broad basket of currencies that includes the Yen, Euro and China’s Yuan is at a post-gold standard low when adjusted for inflation, according to calculations by Deutsche Bank’s economic team. The milestone could be viewed as a failure of the country’s monetary and fiscal policies upon which all paper – or fiat – currencies are based.

The Broad Trade-Weighted Dollar Index, which was created by the Federal Reserve, differs from the more popular “Dollar Index” because it includes a larger group of currencies and is weighted based on foreign trade. The stellar economics team at Deutsche Bank, led by Joe Lavorgna, then adjusts this measure for inflation to get what they believe to be the true measure of the dollar’s value in the world.

“In our risk scenario, little progress on the fiscal front raises the probability of a fiscal crisis and the odds that the Fed becomes the buyer of the last resort,” said David Woo, currency strategist for Bank of America Merrill Lynch, in a note to clients today. “This would accelerate the process of the USD’s demise as the global reserve currency and cause it to decline in a disorderly manner.”

The dollar hit new 2011 lows versus the Euro and the British Pound Thursday as traders increasingly viewed Federal Reserve Chairman Ben Bernanke’s monetary policy press conference a day before as dovish on inflation.

Deutsche Bank: Real broad trade-weighted exchange value of the US Dollar, March 73 = 100.

The Fed described the economy as recovering at a “moderate pace” in its statement, a dovish downgrade from the “firmer” recovery it stated before. The Fed also kept the language that it would remain accommodative for an “extended” period. In his first monetary policy press conference, Bernanke made no hints that his ongoing purchases of $600 billion in Treasury securities would be ended earlier than their June expiration date.

“QE2 has artificially reduced the risk premium of U.S. government bonds to below the level necessary to compensate investors for the worsened U.S. fiscal position,” added Woo.

Gold settled at a record for a 12th time this month on Thursday and is now up 31 percent from a year ago on concern that Bernanke has lost control over inflation. Silver is inches away from its 1980 record and is up 150 percent in the last 12 months.

“The recent parabolic spike in silver and to a lesser degree gold, shows that the market considers a ‘disorderly decline’ of the U.S. dollar an increasing possibility,” said

Jim Iuorio, managing director at TJM Institutional Services. “Devaluing your currency has always been a risky proposition and its success is dependant on knowing how to exit gracefully from monetary stimulus.”

The dollar was convertible into gold until the early 1970s, when President Nixon ended that agreement. Soon after, as the major currencies went from fixed rates to floating, the U.S. dollar established itself as the world’s reserve currency because of its economy’s size and relative strength. Floating, paper currencies are only worth what others deem them to be and the country’s central bank can print as much, or as little, of it as it wants.

To be sure, the dollar’s salve would be a pick-up in the economy as Bernanke’s zero interest rate policy forces more risk-taking, more lending, more investment, and more hiring. That theory took a bit of a hit Thursday as first quarter GDP data was released showing a 1.8 percent increase in economic growth, down from a 3.1 percent increase in the fourth quarter.

“If the economy is on a recovery path, as Ben Bernanke suggests, albeit slower than we would like, then we should anticipate that tax receipts and revenues should improve,” said John Person, president of Nationalfutures.com and co-author of the Commodity Trader’s Almanac. “If that happens, then the US Dollar should gain some strength, or at the least cease the rapid descent. Right now it is very hard pressed to find one dollar bull.”

A showdown in Congress is brewing as the U.S. Treasury is poised to hit its debt ceiling in next month. Following a tough battle over the budget this month, traders selling the dollar are bracing for another partisan battle over the debt ceiling vote and possible austerity measures that could be attached to a lifting of this debt limit. Standard & Poor’s changed the outlook on U.S. debt to “negative” last week based on the possibility of a stalemate in enacting any kind of meaningful fiscal policy by this divided government.

“Since S&P downgrade last Monday it has become abundantly clear by policy makers, if it wasn’t already, that the Fed will print whatever it takes to avoid default and debase the buck to a point where it will be very unlikely to remain the world’s reserve currency,” said Dan Nathan, creator of RiskReversal.com.

As discussed in Stealth QE, Perpectual Motion QE Machine, Jim Rickards postulates that the Fed may end the QE2 come June without going into QE3, by operating a stealth QE program where it can continue to fund debt monetization without expanding its balance sheet.

Today, in what appears to be a direct rebuttal to this idea, ZeroHedge argues that the rolling over of Treasuries Debt and Mortgage Backed Securities (MBS) prepayments are not sufficient to do the job.

Recently there has been a meme spreading in the internet that the Fed does not really need to do QE3 as the central bank can maintain bid interest at sufficiently high levels by merely rolling and extending maturing debt, a form of QE Lite Version 2, where the Fed’s balance sheet is kept constant even as MBS are prepaid and Treasuries mature. The argument goes that based on some “logic” and lots of estimates it is “reasonable” to assume that $750 billion in MBS prepays and Treasury maturities will depart the Fed’s balance sheet and need to be repurchased in the open market in keeping with a pro forma QE Lite V2.0 mandate. This is false. Here’s why.

First: one does not need to engage in complex calculations of what the maturity profile of the Fed’s holdings are - it is there available for anyone with an internet connection to see for themselves. In each and every H.4.1 update (go ahead, click) the Fed lists the maturity portfolio of its assets. The most interesting for the purposes of this analysis is the securities due in under one year. This includes in addition to Treasurys, MBS and Agencies, also the following items completely irrelevant for this exercise: Reverse Repos , Term Deposits, Liquidity Swaps and Other loans. As the chart below shows, and as anyone with a calculator can estimate, there is $141 billion in Treasury, Agency and MBS maturities in under one year (and just $108 billion in purely Treasury holdings). This number is one tenth of the ongoing monetization of $900 billion in USTs and MBSs in the November-June period, or $1,350 billion annualized. In other words: simply rolling MBS and Treasuries will have one tenth the impact of the ongoing quantitative easing program. Period. End of Story.

So what about MBS prepays? Well, as we had thought we had made abundantly clear, the level of Fed MBS prepays is directly correlated with prevailing mortgage rates: the lower the mortgage rate, the more willing the end consumer is to “put” an existing mortgage to the Fed and open a cheaper one. And vice versa: the higher rates go, the less prepays the Fed experiences. Lo and behold: actually looking at the data, confirms precisely this. As the chart below shows, while in H2 2010, when 10 Year, and thus Mortgage rates, were dropping fast, prepays to the Fed, and thus the rate of QE Lite activity was very high: peaking at $45 billion in December. Alas, since then, due to surging rates, the prepay rates has plunged, and the February and March total of $40 billion is less than all of December. Should rates continue to rise, which they will if fears of no QE3 accelerate, and Bill Gross ends up being right, this number will plummet and could potentially hit zero as nobody has an incentive to prepay a mortgage when the existing one is far more economic.

So putting it all together: assuming no QE3, and just continued rolling and transforming MBS in UST purchases, means that the Fed will have about $12 billion in average UST purchases per month from maturity extension, and about $20 billion from MBS prepays. This is at best one quarter of the amount the Fed monetizes per month currently and is largely inadequate to continue funding the US deficit. Also, should the 10 Year rate jump to over 5%, QE Lite will halt indefinitely, meaning the only source of dry powder for future monetization will be rolling maturity extensions, which are about one tenth of current monthly funding needs.

Lastly, and people tend to forget this, the primary reason why the Treasury needs the Fed to be the buyer of only resort is that no matter what happens to interest rates, and cash outlay to the Fed ends up being a revenue item for the Treasury! In fact, the higher the rate, the greater the purported revenue from Ben Bernanke, even though in reality it ends up being a wash transaction. For Tim Geithner the ideal situation would be one where the Fed owned all US interest paying instruments, as interest expense would be shortly reclassified as Treasury revenue. Should the Fed not be a key player in monetization, this is money that would ultimately leave the US. And if rates were to jump the annual interest outlays would actually be quite dramatic.

Source: ZeroHedge

Antal E. Fekete
April 6, 2011

Dear Dr. Paul:

There are serious questions about the legality of Quantitative Easing. You are among the few who are well-qualified and well-placed to get to the bottom of it.

Most people believe, and the media confirm them in that belief, that the Fed can legally create dollars ‘out of the thin air’ in any quantity, and can do with them as it pleases. This may well be the pipe dream of Dr. Bernanke who is quoted as saying that the U.S. government has given the Fed a tool, the printing press, to stop deflation — but it hardly corresponds to the truth. The Fed can create new dollars only if some stringent legal conditions are satisfied, and then, it can only dispose of them in certain ways prescribed by law.

Contrary to a statement of Dr. Bernanke, made before he became the Chairman of the Board of Governors of the Fed, he could not drop freshly printed dollars from a helicopter, no matter how many reasons for such an action he may be able to cite. Another thing the Fed is not allowed to do legally is to purchase Treasury paper from the U.S. Treasury directly. It must be purchased indirectly through open market operations. If you don’t put the Treasury paper through the test of the open market before the Fed is allowed to buy it, the presumption is that the market would reject it as worthless, or would take it only at a deep discount. The law does not allow the F.R. banks to purchase Treasury paper directly from the Treasury because that would make money creation through the F.R. banks a charade, reserve requirements a farce, and the dollar a sham.

If that were the only problem with Quantitative Easing, it would be bad enough. But there is something else that is even more ominous. The fact is that the Federal Reserve banks can purchase Treasury paper only if they pay with F.R. credit that has been legally created.

F.R. credit (F.R. notes and F.R. deposits) is legally created if it has been issued in accordance with the law. The law says that F.R. credit must be backed by collateral security at the time of issuance, usually in the form of an equivalent amount of U.S. Treasury paper. The procedure is as follows.

The F.R. bank seeking to expand credit takes its Treasury paper, owned outright and free from encumbrances, and posts it as collateral with the Federal Reserve agent who will then authorize the issuing of credit. In other words, if the F.R. banks do not have the unencumbered Treasury paper in their possession, then they cannot create additional credit legally.

There is some evidence that the F.R. banks do not have F.R. credit available to make the kind of purchases Dr. Bernanke is talking about as part of his Quantitative Easing. Nor do they have unencumbered Treasury paper in sufficient quantity that they could post with the F.R. agent for authorizing the issue of additional F.R. credit.

The point is that the process of posting collateral first, and augmenting F.R. credit afterwards must under no circumstances be reversed. What the F.R. banks cannot legally do is to buy the Treasury paper first with unauthorized F.R. credit, post the paper as collateral, and justify the illegal issuance of credit retroactively. Nor can they borrow the bond from the Treasury, post it as collateral, and pay for the bond retroactively.

This is an important limitation separating the regime of market-based irredeemable currency from the regime of fiat money involving outright monetization of government debt — the graveyard where the Continental dollar, the assignat, the mandat, the Reichsmark, and the Zimbabwe dollar (among countless others) rest.

At any rate, retroactive authorization of F.R. credit, if that’s what the Fed is up to, would be a violation of both the letter and spirit of the F.R. Act. It would mean converting the dollar into outright fiat money through the back door, bypassing Congress. It would show absolute bad faith on the part of the Chairman of the Federal Reserve Board of Governors, Dr. Ben Bernanke, who certainly knows what the law is. Such a blatant violation of the law would make him totally unfit for the powerful office he occupies. It would call for his immediate and dishonorable discharge by the President, pending Congressional investigation of the matter.

The various violations of the law of which the Fed is accused point to a concerted effort to remove the shackles the law has put on the money spigots lest crooks help themselves to the public purse. These violations are not isolated incidents. They are aiming at the corruption of the monetary order of the nation and the world. Moreover, they would ultimately figure prominently among the causes of the financial instability the world has been suffering from since 1971 and, more recently, since 2008.

Without understanding this fundamental truth, all talk about stabilizing the monetary system and reining in the runaway budget deficit is an exercise in futility.

Yours very sincerely,

Antal E. Fekete

Professor (retired)

Memorial University of Newfoundland

Tel./Fax: +36-1-325-7996

Note: an identical letter has been sent to Congressman Mike Pence of Indiana.

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Professor Antal E. Fekete is a renowned mathematician and monetary scientist.

In 1974 Professor Fekete delivered a talk on gold in Paul Volker’s seminar at Princeton University. Later, Professor Fekete was Visiting Fellow at the American Institute for Economic Research and Senior Editor for The American Economic Foundation. In 1996 his essay, Whither Gold?, was awarded first prize in the international currency essay contest sponsored by Bank Lips, the Swiss bank.

For many years an expert on central bank bullion sales and hedging, and their effects on the gold price and the gold mining industry itself, he now devotes his time to writing and lecturing on fiscal and monetary reform with special regard to the role of gold and silver in the monetary system.

At this moment, when the world’s monetary system appears increasingly shaky, Prof Fekete details why the current paradigm is flawed and how the problems must be dealt with. This is almost taboo in the main stream financial media. Prof Fekete explains it as a gold crisis, not a dollar crisis. Those who doubt it would do well to recall that every fiat money system ever tried – and history is littered with examples – failed.