The Gold Bug

Tuesday, June 28, 2011

Those Stubborn Facts

By Scott Silva

Editor, The Gold Speculator

6-28-11

Gold is stubbornly holding on to $1500/oz, despite the easing of fears of European debt contagion, lower inflation in China, the surprise release of SPR oil, reports of the imminent deal on US debt crisis and the statements that the US economy is on the mend.

History has shown that in uncertain economic times, gold prices rise. Conversely, gold prices fall when other investment asset classes provide stable and predictable returns. Certainly, the good news on the resolution of the Greek debt crisis and the drop in oil prices below $100/bbl from added supply via the SPR release should have started gold on a steady decline. And, as everyone knows, the Fed’s QE2 is ending, as scheduled, at the end of this month. So, in a few days, the stimulus will have fixed the US economy, just as the Washington central planners said it would.

Is there something wrong with this picture? What is missing here? Well, the facts, rather than political desires, drive us to a different conclusion about the state of the US economy.

First, it is a fact that the Fed says it is ending Quantitative Easing 2 (QE2) on June 30, 2011. Under QE2, the Fed bought $600 Billion in US Treasurys and other fixed income instruments for cash in an effort to stimulate the economy. But the Fed created that cash out of thin air. The Fed balance sheet ballooned to $2.8 Trillion. Every new dollar debases the value of dollars already in circulation which pushes prices up. It’s Gresham’s law at work.

And, the truth is the Fed is not ending QE2. As Fed Chairman Bernanke stated last Wednesday at his second press conference, the Fed will continue to reinvest proceeds from maturing issues. So the Fed continues to purchase (or repurchase), rather than sell, flooding more cash into the existing stock. The result is higher prices for all. By every measure, the US economy has slowed, rather than grown as a result of QE2, so continued Fed accommodation is not likely to reverse the trend.

The White House says the US debt crisis may be closer to resolution. The president is now taking part in the talks. But there is plenty of room for mistakes as the August 2^nd deadline approaches. To be effective, the deficit/debt deal needs to address entitlement reform, tax reform, spending caps and potentially the framework for a Constitutional amendment. Some experts say the Congress is already out of time and simply cannot pass such complex legislation in the few remaining weeks. The rating agencies may not wait to downgrade US sovereign debt.

One new wrinkle today is the president’s offer to hike taxes by $600 Billion. The idea is to tax “millionaires and billionaires” at higher rates and end “subsidies for big oil companies” to increase federal revenues. The rhetoric may sound constructive for middle class voters, but the facts to do not support the intended objective. Higher tax rates do not always result in higher revenue. This counterintuitive fact is well known by economists and students of history. In fact the opposite case is true—lower taxes produce more federal revenue. More people pay at the lower rates. Wealthy taxpayers avoid taxes in a high rate environment. For example, when rates are high, investors put money in triple tax free municipal bonds, or move income generating assets to offshore tax havens. Hauser’s law shows US tax revenues since the 1930’s are essentially constant at 19.5% of GDP for wide variations in marginal tax rates. That’s right, federal tax revenue is about the same percentage of GDP whether the marginal tax rate is 28%, as during the Reagan years, or 91% under FDR. In the 1980's, when the top marginal individual rate dropped from 70% to 28%, federal revenue increased 91.3%. The rich pay more when marginal rates are lower and the incentive to avoid taxes are reduced.

Then why does the White House not use these facts? Maybe the notion is not well understood. But these people are well educated and the staff includes expert economic advisors. Or, it could be that the concept is judged too complex for the average American to understand. But the Great Orator should be able to put it in simple terms for us knuckleheads. It’s more likely that it’s easier to stir up class warfare than speak the truth. What we need is the simple truth.

Another area where the truth gets muddled is manipulation of the oil market. Oil speculators are hunted by the CFTC and the SEC, but the Great Manipulator has license to manipulate and regulate the price of oil at will. Washington has kept oil exploration in the US at a standstill, refusing to allow permits for existing leaseholders and barring development of huge new finds in West Texas on the belief it endangers the dune sagebrush lizard. Yet, the president has offered billions of dollars to Brazil's state-owned oil company, Petrobras, to finance exploration of the huge offshore discovery in Brazil's Tupi oil field in the Santos Basin near Rio de Janeiro. No dune sagebrush lizards there, I guess. No US jobs either.

The latest manipulation was the sudden release of 30 million barrels of the US Strategic Petroleum Reserve last Thursday, half of the IEA commitment to replace lost Libya supply over the next sixty days. But oil prices peaked in May, falling $14/bbl before the SPR release on persistent concerns about global growth. Prices at the pump fell in 2010, not because of supply, but lower demand for $3.00/gal gasoline at the height of the recession. So was the surprise release of oil to the supply based on strategic need, or was it a talking point in the re-election campaign. Maybe the SPR can replace its deficit at a lower price in the future. Maybe not. Today, crude oil futures are bidding up.

And that’s not all that’s going up. Consumer prices are up. Producer prices are up. Import source prices are up. Unemployment is up. Reports to the contrary, the US economy is not looking up. US GDP growth is slowing down. Stagflation is setting in. And prospects for renewed prosperity should higher tax and continued deficit spending policies prevail are dim. These are uncertain times. What we need is truth. Most of us know the difference between political rhetoric and reality. In the real world, the stubborn facts have a way of surviving.

So it is no wonder that gold is on the rise. Gold is the safe haven for investors around the world.

Owning gold insulates the investor from debasement of paper currency. Gold is a store of value.

Gold protects individual wealth from political unrest, commodity supply shocks, war and economic uncertainty. Gold survives the thousand slings and arrows of political economies.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and growing inflation? We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Tuesday, June 21, 2011

Fed Holds Economy Hostage

By Scott Silva

Editor, The Gold Speculator

6-21-11

The Fed is holding the US economy hostage. And it’s time for a prisoner snatch.

It was 32 years ago that President Reagan freed the hostages from Iran. He did within hours of his inauguration what Jimmy Carter had failed to do in 444 days--he freed 52 US embassy employees taken hostage and imprisoned by Iran’s Islamic theocracy.

It is not that President Carter did not try to free the hostages held in the Tehran prison since November 4, 1979. One valiant rescue attempt ended in tragedy when two US rescue aircraft collided and burned in the Iranian desert. Jimmy Carter was just not effective at negotiation or, as it turned out, at leading covert military operations.

The US economy was failing during the Carter years. The 1970’s were characterized by “stagflation”, that debilitating mix of high inflation and slow growth. Double digit inflation, single digit growth and lack of leadership forced Carter out after a single term as president.

Many see similarities to the 1970’s in the today’s economic conditions. Oil prices are high, prices for food and other necessities are high, unemployment is high and the economy is limping along, barely growing. The misery index, coined in the 1970’s, has returned as a measure of popular dissatisfaction with the nation’s economic policies.

Studies of the causes of stagflation point to the confluence of economic shock and monetary expansion as the primary cause. In 1974 the economic shock was the OPEC oil embargo; in 2009 it was the financial meltdown. In both cases, the Fed printed more money. In fact, stagflation can arise from monetary policy alone. Barksy and Kilian show in their 2000 work,

A Monetary Explanation of the Great Stagflation of the 1970s, “… the 1986 fall in oil price (which was not accompanied by major shifts in monetary policy stance or similarly drastic movements in other commodity prices), provides a natural experiment, the outcome of which casts doubts on the view that oil price shocks were important sources of inflation in the GDP deflator in the 1970s. In contrast, the monetary explanation…is capable of explaining both the recessionary and the inflationary aspect of stagflation.”

Chairman Bernanke’s Fed policies are similar to Fed policies in the 1970’s. In both periods, the Fed responded to recession by expanding the money supply, although the scale of monetary expansion in the recent case is unprecedented. Under Fed Chairman Burns, monthly money growth, which had averaged 3.2 percent in the first quarter of 1971, jumped to 11 percent in the same period of 1972. The money supply grew 25 percent faster in 1972 compared to 1971.

Money supply growth under Chairman Bernanke has been nothing short of remarkable.

The other significant event affecting the economy in the 1970’s was Nixon’s 1971 decision to abolish the gold standard. Since then, the US Dollar has declined in value with every new paper dollar. Debasement of the Dollar has made many eager to shift out of money bank deposits into hard, commoditized assets precisely because dollars are losing value. Gold prices tripled in 1980-1981; gold has double in price since 2009.

President Reagan recognized the importance of sound money. In 1981, he established the Gold Commission to evaluate returning to the gold standard. Although the Commission’s findings were not accepted at the time, variants of the basic structure have evolved that may be useful today. The advantages of a modern gold billion standard include long term price stability, lower inflation and effective fiscal control.

Former Fed Chairman Alan Greenspan and macro-economist Robert Barro have written in favor of a return to the gold standard. In Gold and Economic Freedom, Greenspan described supporters of fiat currencies as "welfare statists" intent on using monetary policies to finance deficit spending. He has argued that the fiat money system of his day had retained the favorable properties of the gold standard because central bankers had pursued monetary policy as if a gold standard were still in place. Barro puts forward the concept of a "monetary constitution" that would provide stability derived from monetary policy rather than politics, and suggests that the constitution could take the form of a gold standard or some other commodity-base standard equally as well and serve much better than a system based on fiat currency.

So how has the Fed imprisoned the US economy? The Fed has shackled growth by debasing the currency and destroying wealth of individuals and businesses. Ultra-easy monetary policies have driven up prices and fostered malinvestment, which has stalled economic recovery. In its response to the Great Recession, Congress expanded the role of the Federal Reserve, providing it, under the Dodd-Frank Act, sweeping powers over all financial institutions in the economy, and concentrating economic power in one individual, the Chairman of Federal Reserve. It is now within the Chairman’s power to decide the fate of any financial institution, and to step in at his sole discretion to either seize or dismantle any financial institution deemed a “systemic threat” to the economy or the markets. At the same time, the private Federal Reserve is not accountable to anyone, not even to Congress. Congress can enforce no oversight of the Fed, whose internal operations remain secret. The Fed has never allowed its books to be audited.

The consequence of unchecked Federal Reserve power is economic slavery. The Fed is holding the economy hostage to its power-driven need to control every aspect of the economy, from interest rates and reserve deposits to mortgage down payments and debit card fees; and now, from dividend payouts and stock buybacks, to executive compensation and bonuses.

In no other period in the history of the United States has the economy been subject to such broad- reaching regulation and control. It is truly remarkable.

Despite the weight of oppressive and intrusive government policies, there is hope for individuals who recognize the path to freedom and prosperity. It is individual human action, based on the dignity of self-worth and self-interest that creates wealth. Wealth is not created by government or central economic planning.

Scaling back the Fed’s over-reaching authority is not the only step needed to rescue the US economy. As you have read in these pages before, pro-growth tax reform and spending reforms need to be implemented to achieve robust GDP growth and full employment. These are major departures from current Washington policies. Necessary changes may not come until 2012.

We may see then, as we saw in 1981, on inauguration day a bold rescue, of our economy this time, by those with conviction and courage.

By the way, in 1981, as part of the Algiers Accord which ended the hostage crisis, the Iranians insisted on payment in gold rather than US dollars so the US transferred 50 tonnes of gold to Iran while simultaneously taking ownership of an equivalent quantity of Iranian gold that had been frozen at the New York Federal Reserve Bank.

To guard against unchecked debasement of the currency, the prudent investor can buy and own gold. While the US Dollar has declined in value, gold continues to be a store of value. Since 1979, gold prices have increased 670%

Gold is also a proven hedge against economic instability, seen now in Greece, Italy, Spain Portugal and Ireland, which threatens the Euro.

Monday, June 13, 2011

Too Much Money

By Scott Silva

Editor, The Gold Speculator

6-13-11

“One can never have too much money,” goes the Hollywood saying. But that old saw does not apply to Washington.

One of the primary stimulus measures implemented by the Federal Reserve over the last three years has been the injection of cash into the economy by giving money to the banks. The scale of the cash injection is unprecedented- the Fed has pumped nearly $1.6 Trillion into the banks. But the US economy was in a deep recession, with the potential, it was thought, to slip into the Second Great Depression. The Fed and many demand-side economists believed that adding liquidity during a period of deflationary recession would have a stimulative effect on the economy. With more credit from the Fed, banks would lend more, making more money available to consumers to spend and businesses to expand to meet the increased demand. Recession would then give way to broad economic expansion and prosperity, with low unemployment, rising wages and higher GDP.

The notion that increasing the money stock increases aggregate demand has been around for decades. In 1936, John Maynard Keynes first presented the idea in The General Theory of Employment, Interest and Money. Keynes believed that government is more effective than the private sector at stabilizing the business cycle. In his model, control is applied by central bank monetary policy and government fiscal policy. Keynesian theory served as the economic model during the later part of the Great Depression, World War II, and the post-war economic expansion. Japan implemented Keynesian policies in the 1990’s. Since the financial crisis of 2007, the US, the UK and much of the EU have relied on Keynesian stimulus programs as the basis of their recovery efforts.

But robust economic recovery in the United States has proved elusive. Although the recession is officially over, GDP growth has slowed, unemployment remains high and housing prices continue to decline. Prices for food, fuel and other necessities are climbing, but wages have stagnated. Today there are renewed fears that the US economy may be entering a double-dip recession. Why has the stimulus failed?

Keynesian economists such as Paul Krugman, Nouriel Roubini and others say the government stimulus was too small to do the job. Others, such as Ben Bernanke say that we must be patient, that there is a lag before monetary policy measures take full effect. There is little political interest in another round of Quantitative Easing (QE3). The wait and see approach is even more frustrating to people hungry for effective leadership.

Taking the Keynesian view, it’s easy to point a finger at the banks. Despite the addition of massive Fed credit, the banks are not lending. Rather than extending the new Fed credit to consumers and businesses in the form of mortgages, car loans and business loans, the banks are hoarding $1.5 Trillion in “excess reserves”. Certainly, the classic Keynesian expectation is that banks will lend more if given more credit to lend, but that has not been the behavior of the big banks in this era of Fed credit expansion. The banks are treating money as a store of value, rather than capital for investment.

One reason the banks are not lending is they can make money on their excess reserves. The Federal Reserve began paying interest on reserves, for the first time in its history, in October 2008. So rather than make mortgage loans when housing prices are still falling, or make business loans when consumer demand continues to decline, the banks elect instead to pull in their horns. Imagine what $1.5 Trillion in new working capital would do for households and businesses today.

The Austrian economist takes a different view of the current level of excess reserves in the system. First, if Ben Bernanke were an Austrian School economist, there would be no excess reserves in the system, because he would believe in restraint rather than intervention as the guiding monetary principle. Notwithstanding, given the current state of events, the Austrian economist would be happy to see $1.5 Trillion excess reserves not loaned out by the banks. Imagine what the inflation rate would be with another $1.5 Trillion created from thin air chasing scarce commodities today.

We have seen the effects of Fed monetary policy on the US Dollar. The Dollar buys 17% less today than it did in 2009 when the Fed increased its balance sheet with bonds paid for by printing money.

Prudent investors have learned to protect their wealth from the debasement of the currency by the Federal Reserve by buying and owning gold. Since the Fed began expanding the money supply in 2009, gold has nearly doubled in value. Gold has been recognized as a durable store of value for centuries and it is proving again today to be a reliable hedge against economic uncertainty.

In today’s economic climate, one may have too much money, but never too much gold.

Monday, June 6, 2011

Waiting for Godot

By Scott Silva

Editor, The Gold Speculator

6-6-11

Today, more than ever, we need to understand the conditions that bind us, and what we can do to improve our lot. It seems everywhere we look, we see the world turning against us, making it more and more difficult to survive and prosper. Jobs are scarce. Prices are high. Home values have withered away. Returns on savings and retirement assets have eroded. And there seems no end to the slow, numbing decline. No hope that economic spring will eventually arrive.

Life is difficult. But what can a person can do to improve his situation? It seems more and more people today look to the government to provide solutions to their needs. Mortgage payment to high? Not to worry, the government will modify your loan. Own a gas guzzler? No problem, trade your clunker and get a government voucher for your new car. Still out of work? No sweat, the government has extended unemployment insurance payments to 99 weeks. No healthcare? You’re in luck. The government will give you healthcare coverage. After all, according to Congressional proponents, healthcare is a natural right.

Not everyone sits and waits for the government to ease his/her pain in difficult times. The management at Ford motor company worked itself out of the slump in the auto industry without taking Federal bailout funds. Michigan based Chemical Bank was one of 20 US banks that refused federal TARP funds. Several states including Texas, Alaska, Indiana, Mississippi and Louisiana refused federal stimulus funds that would have expanded long term unemployment benefits. So some rational policymakers understand the law of unintended consequences. There is no such thing as a free lunch.

So who is paying for Washington’s largesse? We the Taxpayers, or course. Contrary to popular belief, the Federal government does not produce anything. It consumes tax dollars collected from individuals and businesses then redistributes them. But big government programs exceed federal income, so Washington borrows 40 cents of every dollar it spends on priority programs. One priority in fashion now is the “jobs” priority. With unemployment at 16% (U-6 measure), and the economy slowing to a glacial creep, politicians have renewed the call for a “jobs bill that will put America back to work.”

But that’s just the problem. The government cannot create private sector jobs. Government can only help create the environment for businesses to create jobs. As Ronald Reagan said, “Government cannot solve the problem. Government is the problem.”

Right now the US has the second highest corporate tax rate in the world. Japan has announced that it will cut its corporate tax rate by five percentage points which will leave the US with the highest corporate rate among the 34 wealthy nations of the Organization for Economic Cooperation and Development. It’s no wonder corporations are legally stashing $1.7 Trillion in corporate profits outside the United States. Those same companies are hording about $1.4 Trillion is cash on their balance sheets, foregoing capital expenditures and hiring until the economic path ahead is more certain.

In his last State of the Union address, the President complained that American companies "are hit with one of the highest corporate tax rates in the world. It makes no sense, and it has to change. ...Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years."

Would that the President had followed up on his pro-growth rhetoric with policy. Cutting corporate taxes would help businesses expand and attract more capital from abroad, which would create private sector jobs and increase productivity.

Cutting the US corporate tax rate would also reduce corporate tax avoidance and evasion. The massive pool of investment and profits would flood back into the United States, which would stimulate the economy without printing more money.

Could pro-growth policy become a priority? The Washington rhetoric is sounding more pro-growth, but action remains lacking, so far, at least. It might be that the debt crisis is now overshadowing any reasonable approach to economic recovery. In April, it was the government shut-down crisis. It seems we bump along from one crisis to another with no plan to move forward. There are many who yet cling to the false idea that monetary policy is precise and effective as an economic stimulus tool. Clearly, easy money and massive fiscal stimuli have failed to revive the US economy. Ironically, the recovery measures have served only to slow the economy, raise unemployment, create inflation, debase the currency and add trillions to the US debt.

Is all lost or will we be saved when Godot finally arrives?

Unlike Beckett’s Estragon and Vladimir, I will not wait for my salvation to come from Washington. I choose to protect myself from the absurdities of the central planners. I recognize that the best way to ensure my safety, security and prosperity is to rely on myself, my own capabilities and my own resources, not any government program or promise.

So I study the markets and invest in precious metals. So far, gold and silver have done very well as investments. They have outperformed the Dow Jones Industrial Average and the S&P 500 by substantial margins over the last two years. And there is no reason why gold and silver will not continue to outperform in the next two years, while this or that new recovery policy is announced from Washington.

Wednesday, June 1, 2011

The Sky Is Falling—Up!

By Scott Silva

Editor, The Gold Speculator

5-31-11

There are some who believe the sky is falling; that the world as we know it is coming to an end, society is doomed and everyone should stock up on food, water and AK-47 ammunition.

Well, these certainly are not the best of times, but we are a long way off from judgment day. Not even close. Not even shoutin’ distance. The world did not end at 6:00 pm May 21^st, 2011. And despite the slowdown in the economy, high unemployment, war, political turmoil and national economic failures abroad, there is hope for those of us who see reality with a clear eye. What we see are the natural ebbs and flows of economic systems--booms and busts in the business cycle that have characterized economies since the dawn of society.

So what’s the big deal today? What’s so different today than, say, the recessions of the 1980’s or maybe the 1970’s? Well, for one thing, the numbers are much bigger. The sheer scales of today’s global economies are difficult to compare to those of even twenty years ago. Twenty years ago, a Billion was a big number. Today, we speak in Trillions. Hence the updated Dirksen quote “… a Trillion here, a Trillion there. Pretty soon people will be talking about real money.”

And that’s just what US Treasury Secretary Timothy Geithner is talking about. He says that if Congress does not raise the debt ceiling by $2 Trillion to $16.3 Trillion, the world as we know it will end. The US will default on its debt. The bond market will tank. The stock market will collapse. And the Dollar will cease to exist and means of exchange. Compared to coming decline of the US economy, the Great Depression will seem like just a walk in the park.

This is the same Secretary Geithner who last month said, without a hike in the debt ceiling, the economic world would end on May 2^nd. Then July 22. Now it looks like the date is definitely August 2^nd.

The Secretary may have had a few accounting tricks up his sleeve. But he is running out of excuses. The credit rating agencies are on to him. Pretty soon the gig will be up.

So here’s the question before us: Will raising the US debt ceiling solve our economic problems?

The answer is clear to those who believe in fiscal stimuli and government spending in general. They say, “Yes, and let’s get on with it already.” Others believe raising the Federal debt limit is tantamount to giving drugs to a drug addict in hopes he will quit using. Congress will spend to the legal limit (and maybe a bit more), whatever the legal limit may be.

Today, the Federal debt of $14.3 Trillion exceeds the Gross Domestic Product. According to the Congressional Budget Office, the federal debt will be $18.2 Trillion by 2016 at current borrowing rates. So raising the current limit by $2 Trillion to $16.3 Trillion would only delay judgment day a few years.

The Keynesian solution is to tax more to spend more. More government spending, it is thought, will expand the economy and create prosperity for all. The US has been following that path for two and one-half years, now, along with monetary stimulus known as Quantitative Easing 2 (QE2). Together, QE2 and federal fiscal stimulus spending have exceeded $2.1 Trillion in an effort to revive the US economy and create jobs. So far, according to the Bureau of Labor Statistics these measures have created 700,000 jobs. Meanwhile, 24 million US citizens who want to work are unemployed or underemployed, and economic growth has slowed to 1.8%.

Last month, Standard & Poor downgraded the economic outlook for the US to negative. It’s hard to imagine we could arrive at such a dire crossroad. Is the United States no better at controlling its economic future than, say Greece? And if the end is near, what should I do to protect myself from certain economic disaster.

Well, I could build a fallout shelter and stock up with food and ammunition. But that would not preserve my wealth.

The stock market offers no protection. We have seen stocks crash for far less serious reasons than a US debt default. Some say stocks are booming. But measured in hard currency, such as the Swiss franc, S&P 500 stocks have risen by just 8.4% since Aug. 27, 2010, the day the Fed announced QE2. Measured in gold, the S&P 500 is up just 4.5%.

Some professional bond speculators are shorting US treasuries--too risky for my money.

Real estate? Not the place to be either. Real estate is still in free fall. Today’s S&P/Case-Shiller report shows housing prices dropped 3.6% from last year, a double-dip in the housing recession.

But there is an asset that I can own that acts like a personal life ring--gold. Gold is a store of value that recognized around the world as the ultimate hedge in uncertain economic times.

Gold continues to gain value against the declining US Dollar. We can see from the chart below, the US Dollar has declined in value. The price of gold, on the other hand continues to climb in value. Gold is the asset for me. Its value goes up even though the sky is falling.

Wednesday, May 25, 2011

All-ahead Full for Gold

By Scott Silva

Editor, The Gold Speculator

5-23-11

Gold is riding high now and its price will move higher as more economic data confirms the US economy will remain sluggish for the foreseeable future. Gold regained the $1500/oz level since dropping from its all-time high of $1577.40 on May 2^nd. The week-long sell-off in gold early this month was modest compared to price drops of other commodities. But gold did not experience the parabolic rise of silver, oil, wheat and some other commodities over the last six months. Instead, gold has seen a steady rise in price, a long bull move dating back to January 2001.

What is propelling gold higher? A big part of the answer is government intervention in the financial markets and the stubbornness of monetarists who cling to the false notion that as “Masters of the Universe”, they indeed can control economies at the local, national and global levels. Like the forlorn bond trader Sherman McCoy in Tom Wolf’s Bonfire of the Vanities, Ben Bernanke is coming to realize his “sure thing” is in a reality a colossal cropper.

The economy is not responding to any form of stimulus—not the $835 Billion stimulus package; not near-zero Fed fund rates; not Quantitative Easing 1; not Quantitative Easing 2. By every measure, Washington economic policymakers have failed.

Some say that the emergency actions of the Fed and US Treasury averted a steep depression in 2009. We will never know for sure. What we know from history is free markets recover more quickly from depressions than economies that are “managed” by central planners. The depression of 1920 lasted only two years because President Harding’s hands off monetary policy allowed for natural recovery. The Great Depression lasted eleven years, largely because of FDR’s stimulus spending programs and Fed’s mismanagement of the money supply.

In the current case, bank bailouts and the subsequent easy money policies have created some terrible unintended consequences. Excess liquidity in the system has caused a rapid rise in commodity prices, which is causing inflation at the producer and consumer levels. The US Dollar is losing value compared to other currencies and is losing purchasing power. Demand is weak so, despite low interest rates, businesses are not expanding and unemployment is high.

The numbers tell the story: GDP growth 1.8%; Unemployment 9.0%; Core Inflation 2.1% (actual inflation 6-10%); 2011 Deficit $1.6 Trillion; US Debt $14.3 Trillion.

Something has to change. At his press conference last month, Chairman Bernanke announced he is ending Quantitative Easing 2 on schedule at the end of June. This would be quite a change. But the gold market has said no to the Chairman’s pronouncement. Gold has climbed in price, signaling there will be something like QE3 in late June. At the least, QE3 (sotto voce) will be continued Fed buying and expansion of its balance sheet through reinvestment of proceeds from maturing issues. A more formal QE3 may also be in the offing.

But here’s the rub. Chairman Ben, like Homer’s Odysseus, attempting to navigate the Strait of Messina, must avoid Scylla to port and Charybdis to starboard. Continued easing will accelerate inflation, devalue the Dollar and inhibit business growth (low capital costs favor consolidation rather than organic growth). Any reduction of Fed assets will raise interest rates and slow whatever recovery is underway, which might cause a double-dip recession. Tightening will also impact interest rates on US Debt. All are bad outcomes for the economy.

The Chairman is facing dissent to continued easy money policy by members of the Fed. Last week, Thomas Hoenig, long-serving president of the Federal Reserve Bank of Kansas City, publically challenged the accommodative policies that the central bank has pursued since 2009. While many of the Fed’s Board of Governors and members of the Federal Open Market Committee view near-zero interest rates and massive infusions of cash into the economy as the best path to economic recovery, Hoenig believes the policies are “…sowing the seeds of the next financial crisis. When you put this much money into the economy, it's got to deploy. Some of it is deployed into commodity assets. You're going to have volatility in that environment, and we are seeing volatility.”

“The inflation of the 1980s started in the mid-'60s. It is a slow process along the way, but if you leave policy easy, then inflation will eventually catch hold.

This inflation we're seeing is in everything now. It's not just in gas. Companies are telling me, ‘We're seeing 20 percent price increases in our inputs and passing along 10 percent or more.’ We're starting to see the psychology of inflation slowly change.”

If it were up to Hoenig, the Fed would cut the easy money era short, right now. He is not alone. Narayana Kocherlakota, president of the Minneapolis Fed, has voiced concern that excess bank reserves may create much higher inflation than we are seeing now. Today, Fed banks are holding $1.6 Trillion in excess reserves. Kocherlakota advocates selling $15 billion-25 billion of MBS a month, which would restore Fed balance sheet assets to more traditional levels in five years instead of the 30 it would take for the bonds to mature.

Maybe the Fed and others in Washington will come to realize that the best course of action for the Fed is to take their hands of the wheel and feet off the pedals. They’re not connected anyway. Only free markets determine what is to be.

Time will tell. In the meantime, gold is telling us that prudent investors are hedging their bets that the US economy will turn up sharply anytime soon.

Tuesday, May 17, 2011

One word: Gold.

By Scott Silva

Editor, The Gold Speculator

5-16-11

“I want to say one word to you, Benjamin. Just one word: Gold.” If Mr. McGuire had given that advice to Benjamin Braddock (a.k.a The Graduate) in 1967, Benjamin might be much better off today. Instead, his advice to the young man was “Plastics.”

In 1967, the average price for gold was $34.95/oz. Of course, gold prices were not allowed to float in the US until 1971, but if young Benjamin had invested $4,000 in gold instead of that little red Alfa Romeo Duetto Spider convertible, he would have made a small fortune by now, roughly 42 times his money. A pristine ’67 Alfa Romeo spider is selling for $15,000 or so today.

Why has gold increased so in value? One word: Inflation. The purchasing power of the US Dollar has decreased steadily since 1967. It would take $6.47 today to buy the same item that sold for $1.00 forty-four years ago, a 647% increase in price. Benjamin’s college tuition alone would cost over $212,000 today. Certainly, there have been periods in US history when prices did not rise each year. In the last century, average annual prices fell in 1921, 1927, 1928, 1930-1933, 1938 and 1939. In 2009, average annual prices declined 0.4%, but since then prices have increased each year. According the Bureau of Labor Statistics, the US inflation rate is 2.1%, but this number is understated. Fuel prices are up more 27% from last year. Food prices are up by double digits year-over-year. Import prices are up 11% from last year. Producer prices are up, too. Housing prices remain depressed, but overall, prices for almost all other goods and services are higher now than a year ago, and the year before that.

Some say that high commodity prices cause inflation. Others attribute higher inflation to corporate greed. With gasoline prices at $4.00/gal or more, the lynch mobs are out for Big Oil CEO’s. At a Congressional hearing last week, a senator remarked that “unchecked corporate greed has given them $30 Billion in profits last quarter”. But the US oil refiners are accounting for the higher cost of imported oil, which has been at $98-114/bbl for the last five months. Today US consumers are still paying $4.00/gal to fill their tanks. And they are likely to buy gas at $5.00 or more before demand decreases due to price.

These arguments miss the point about the cause of inflation. Higher commodity prices and corporate greed are not the causes of inflation. Contrary to popular opinion, inflation is not about price increases for goods and services. Inflation is about increases in money supply. The general increase in prices comes only by the increase in money stock. The inflation we are seeing now at every level is in fact due to increases in money supply. This is the case now, and it has been the case for every period of inflation in history.

Aristotle defined the four properties of “good” money. Money must be durable, portable, divisible and have intrinsic value. Aristotle’s definition has stood the test of time. For more than 2,000 years sound money has been proven to be a good medium of exchange as well as a store of value. The only time gold money lost its intrinsic value is when governments debased coins used by the general public (reduced the gold content in a coin by substituting industrial metal at the same weight), while hording pure gold coins for themselves.

Fiat money has never been good money because it lacks intrinsic value. Governments debase fiat money by printing more of it. Increasing the money stock chases good money out in the same way Copernicus described in his 1519 treatise Monetae cudendae ratio: "bad (debased) coinage drives good (un-debased) coinage out of circulation.” This concept has become known as Gresham’s Law. These days, the Fed seems intent on codifying Gresham’s Law. Since 2008 it has printed $2.7 Trillion of the paper stuff to support various fiscal stimulus packages and bank and industry bailouts. More paper money chasing fewer goods and services causes prices to climb. Inflation is a tax on every consumer who buys with paper money.

An example of inflation brought on by the printing of fiat money occurred in the US Civil War era. During the war, both the federal and the confederate governments issued paper currency to finance war expenditures. The federal government issued $450 million “Greenbacks.” Inflation soared. Northern currency fluctuated in value, and at its lowest point, it took 2.59 inflated Greenbacks equaled $1 in gold. The Confederate paper currency lost much more purchasing power; $60-$70 equaled a gold dollar.

At the end of the war, President Johnson authorized the Treasury to repay Federal war bonds with gold. This reduced the outstanding Greenbacks by 20 percent which propped up the value of Greenback dollars and drove down the Greenback price of goods. In the election of 1868, the Democratic presidential candidate Horatio Seymour repudiated the “Ohio Idea,” which proposed that war debts be repaid with Greenbacks rather than gold. Predominantly western Democrats who first offered the fiat money financing idea became known as “Inflationists.” Seymour lost the presidential election to Ulysses S. Grant 214 to 80. Inflationist policies financed other wars including WWI, Vietnam, Iraq, Afghanistan and now Libya (WWII and Korea were paid for primarily by tax increases).

Gold money leads to lower price inflation. Studies show that price inflation is lower under gold standard monetary regimes than in fiat money regimes. The classical gold standard prevailed in all the developed economies in the period from 1880 to 1914. Then, authorities maintained the value of national currency in terms of a fixed weight of gold, or the mint price. During this period, the mint price was set at $20.67 per ounce of gold. Under the gold standard, the purchasing power of gold tends to equal the long-run cost of production.

We can see from the chart, from 1880-1913 inflation averaged about 3 percent annually in Australia and Finland, about 2 percent annually in the Netherlands, and slightly less in the United States. For the other nine countries, the average inflation rate was between plus and minus 1 percent for the period. Average inflation over 33 years of these 13 countries on the gold standard ranged from –0.6 to 3.0 percent.

Today’s economies use fiat money and employ muscular monetary policy such as inflation targeting. Since the collapse of Bretton Woods, central banks have attempted to maintain low inflation and relative price stability. Clearly, these policies are failing. As the chart shows, the average inflation rate was much higher in the modern period (again for 33 years, from 1968 to 2001).

So what can the individual do today to protect his wealth against rising inflation? He can buy and own gold. Gold has maintained its intrinsic store of value against the ravages of inflation and debasement of fiat currencies for decades. Today’s economic environment is characterized by unprecedented expansion of the money supply, which ensures prices will continue to rise for the foreseeable future.

The real price of everything…is the toil and trouble of acquiring it. The

same real price is always of the same value; but on account of the variations

in the value of gold and silver, the same nominal price is sometimes of very

different values.

Adam Smith (1776)

Monday, May 9, 2011

TIME FOR EQUITIES, OR NOT

By Scott Silva

Editor, The Gold Speculator

5-9-11

The recent sell-off in commodities, particularly gold and silver, has caused some investors to consider investing in the broader stock markets. The stock markets have lagged gold and silver the last few years, but earnings are improving and many believe equities are ready to take off. Is this the case? Will the equity markets outperform precious metals over the next six months?

To answer this question, we first must understand the factors that drive the equities and commodities markets. We then can make rational judgments on allocating investment assets.

The largest US equity markets include the NYSE and the NASDAQ, on which over 5,000 issues representing $17.4 Trillion are traded each day. The most frequently used stock market indices are the Dow Jones Industrial Average (DJIA), the Standard & Poor 500, and the NASDAQ Composite.

Earnings are the single most important metric for a company. Equity prices move as a function of future earnings expectations. The key measure is Price/Earnings, or PE ratio. The DJIA is currently trading at 14.4 times earnings; S&P 500 at 16.84; and the NASDAQ at 12.62. These are all lower than PE’s seen a year ago.

Gold and silver do not have PE ratios. The price reflects the value the buyer is prepared to pay for the metal. That value is typically a premium over the value of paper currency. Therefore, precious metals are considered to be stores of value.

Future earnings for equities are driven by many factors including top-line revenue, operating costs and overhead. As large part of operating cost and overhead is personnel cost. In recessions, most companies cut back on personnel and slow production in an effort to save costs. Today, US unemployment remains high, 16% by one government measure (U-6).

Part of operating costs is the cost of money, or interest cost. Low interest rates usually encourage capital expenditure, but since the financial meltdown in 2009, banks have slowed lending, reducing CAPEX for many companies despite very low interest rates. Today, the banks are holding $1.4 Trillion in excess reserves.

Wall Street stock analysts predict earnings for a traded issue using sophisticated financial and market analysis. An important input is company guidance, the company’s own projections for the next quarter or year. But the cat-and-mouse game between Wall Street analysts and company officials can create self fulfilling prophesies that lead to market “surprises”. The company may understate guidance in an effort to lower Wall Street consensus estimates. Printing numbers that “beat” the street usually propels the stock price up.

So what is the outlook for stocks compared to gold and silver?

We see from the chart for the DJIA, there have been two significant technical breakouts since the financial meltdown of 2009. The first was a breakout of the head-and-shoulder pattern on July 20, 2009. This was a run from 9,000 to 11,258 on April 26. 2010, a 25% gain. The second breakout occurred November 29, 2010 at 11,092. That move continued up to 12,876 the high last week, a 16 % hike. The next resistance levels are 13,000, then 13,790 and 14,119.

What could slow gains in the DJIA? Many think inflation is already eating into earnings, and seen more earnings erosion coming. Higher global commodity prices are affecting source prices. Now, higher labor costs are pushing up manufacturing costs in China. High fuel prices continue to hinder the global recovery. Slowing demand is also a factor. US GDP growth slowed to 1.8% for 1Q11, down from 3.2% for the previous quarter. World GDP for 2011 is forecast to slow to 4.4% average down from 4.9% average in 2010.

Stock prices have been pushed up by the Fed’s easy money policy. Near zero interest rates have kept margin rates low. When the Fed tightens, the stock market slips. We have seen rate hikes kill stock rallies before. But tightening (or even just ending Quantitative Easing 2) is likely to impede the fragile recovery. So it is not clear that the Fed will indeed forsake its easy money policy in June as scheduled.

On the other hand, gold and silver have outperformed stocks for the last few years and are likely to outperform stocks for the next year or more. Despite last week’s pullback, today’s market action shows the precious metals are resilient and poised to reach new highs.

This is because the forces that favor the precious metals remain intact. Political unrest in northern Africa the Middle East threaten the major oil supplies. The EU has failed to fix its sovereign debt crisis; more bailouts are required for Greece, Ireland and Portugal. Global inflation is on the rise. Oil is trading above $100/bbl. The US debt crisis will hit states and municipalities, and upset Federal budget negotiations. The US Dollar is likely to remain weak. Uncertainty will continue to be the norm.

Uncertainty will continue to propel the precious metals up. Gold is trading above $1500/oz and silver, hurt by massive increases in margin requirements and selling by large hedge funds last week is leading the precious metals rebound, up 6% today, reaching $37/oz or better as new buyers come in. Technical analysis is pointing to $47/oz for silver in the next few months, a retest of the $50 resistance level. Gold is trending to $1600 over the same period.

To reach the 14,000, the 2008 high, PE’s would need to expand to 16.19 for the DJIA, representing a 12.4% gain today’s price for the index. At $47/oz, silver would have gained 27% from today’s price.

For my money, gold and silver are the better trades.

The question for you to consider is how are you going to protect yourself from the vagaries of the higher prices and economic uncertainty? We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Monday, May 2, 2011

BALANCING ACT

By Scott Silva

Editor, The Gold Speculator

5-2-11

Ben Bernanke is on the tight rope, trying to balance between unemployment and inflation. This is a difficult balancing act; no one before him has successfully reached the twin mandated goals of price stability and full employment using monetary policy alone. But monetary policy is the only tool in the Fed’s tool bag. The Chairman is persistent, but he is on a fool’s mission. His easy money strategy has not created price stability nor reduced unemployment. To the contrary, Fed monetary policy has contributed to precisely the opposite result--growing inflation and high unemployment. And there are unintended consequences of the Fed’s prolonged accommodation, namely, the death of the Dollar and rise of the commodities bubble.

For gold bugs, the Fed’s single-minded easy money policy has been a godsend. Since the Fed began its ultra-low interest rate and Quantitative Easing policies in 2008, the Fed balance sheet increased by $2.1 Trillion and gold has doubled in price. Silver has quadrupled over the same period.

Many consider the price of gold to be the barometer for risk facing the economy. During good times, gold prices tend to lag stocks, bonds, real estate and other investment assets. Gold tends to outperform when there is uncertainty in global economies and dollar-denominated assets are in decline. The Fed’s easy money policies contributed to the real estate bubble, which ended in the financial crisis of 2008 and the drop in the Dollar. Gold led commodities out of the abyss of the financial meltdown.

Over the last two years, massive and continued Quantitative Easing (QE2) combined with economic weakness in the EU and political uncertainty in Africa and the Middle East has weakened the Dollar and pushed gold to record highs. But the weakening Dollar has also fueled inflation in every asset class except real estate, and the US unemployment rate remains above 8%. Clearly the Fed’s monetary actions have failed to achieve mandated goals.

I say it should not be the Fed’s mission to solve the unemployment problem in the United States.

As we have seen, near-zero interest rate policy does not create jobs, and Quantitative Easing does not create jobs. Further, the premise that there is a balance between inflation and unemployment, as represented by the Phillips Curve is fundamentally flawed.

The Fed mandate emanates from the Keynesian notion that there is a trade-off relationship between inflation and unemployment, and that economic prosperity can be achieved by the proper balancing of the two variables. But the stagflation of the 1970’s defeats the Phillips Curve. The current economic situation is proving the theory to be false once again.

Today, the Fed recognizes inflation to be 2.1%, but in fact inflation is closer to 10%. According to the US Labor Department, US unemployment is 8.8%, but actual unemployment (U-6 rate) is 16%. Latest GDP growth has slowed to 1.8%, down from 3.1% in 4Q10. These numbers represent stagflation, the condition of simultaneous high inflation and high unemployment. The Federal Reserve cannot set the magic interest rate that achieves a balance of tolerable inflation and unemployment.

As readers have seen on the pages before, the road to US prosperity is not through government intervention in the markets. On the contrary, it is the private sector that is the engine of growth. Government should help create the environment for private sector growth. US private sector expansion has created more permanent jobs than any government stimulus program, including the 1930’s WPA programs.

The environment that is most conducive of economic growth is one of smaller, less intrusive government. Pro-growth economic policy is one of low corporate and individual tax rates, responsible fiscal policy (much lower government spending), lower government regulation and sound money.

History has shown that tax cuts, not tax increases have stimulated job growth and prosperity in the United States. The “soak the rich” approach to tax policy is a myth. Government revenues actually increase when taxes are reduced. In the1920s, tax rates were slashed from over 70 percent to less than 25 percent. Revenues rose from $719 million in 1921 to $1164 million in 1928, an increase of more than 61 percent.

In the 1930s Hoover and Roosevelt pushed marginal tax rates to more than 90 percent. In the early 1960’s Kennedy cut tax rates to 70 percent which increased revenues to $94 billion in 1961 and $153 billion in 1968, an increase of 62 percent. When Reagan cut tax rates in the 1980’s, tax revenues climbed by 99.4 percent.

In 2003 Bush cut the dividend and capital gains tax to 15 percent each. The U.S. economy added 8 million new jobs from 2003-2007. From 2004 to 2007, federal tax revenues increased by $785 billion, the largest four-year increase in American history.

But tax cuts are not part of the current Washington plan forward. Instead, tax hikes are planned to help fund continued deficit spending. This will continue to pressure the Dollar and impede GDP growth. Industry will continue to bump along like Vonnegut’s Harrison Bergeron, weighted down with excessive regulation and class-leveling “fair” taxes, set by the Handicapper General.

There are better choices for investors seeking to maintain their wealth. Investors can choose to protect their wealth by owning gold and silver. Today’s pullback provides a good entry point. The bull market in gold and silver has a long way to run.