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“Based on its current assessment, the Committee judges
that it can be patient in beginning to normalize the stance of monetary
policy. The Committee sees this guidance as consistent with its previous
statement that it likely will be appropriate to maintain the 0 to 1/4
percent target range for the federal funds rate for a considerable time
following the end of its asset purchase program in October, especially
if projected inflation continues to run below the Committee's 2 percent
longer-run goal, and provided that longer-term inflation expectations
remain well anchored.” Dec 17, 2014; FOMC Statement
That paragraph is the only part of the growing FOMC
statement that matters -aside from the sometimes entertaining dissenting
votes, in this case three, which didn’t really dissent from the enerally
easiest money policy ever; now on its seventh year and counting. I don’t
care how many different names it has - QE, ZIRP, twist, liquidity, etc.
– it is the longest running monetary intervention in the Fed’s history.
 That’s a hard data point.
The rate of growth in US money supply in the
post 2008 period, even with a lower than historic participation of
the commercial banks, has been more than 50% greater than in its long
run history.
It has averaged 11% yoy post 2008 compared to about
7% on average for its longer-term history (including post 2008). I’ve
published these graphs often to remind us of just how unprecedented
the current situation really is –i.e., the US money supply has
doubled since the crisis! So far it’s mostly just gone into asset
prices, fooling pundits into confusing damage to the capital foundation
of the economy with economic growth (i.e., inflationary rents
with profit). It will affect other prices too, don’t worry.
The lags on these things can be great.
The outbreak of price inflation in Russia only started
this year, even though its banks inflated way worse (than now) in the
years prior to 2008 without any real fallout occurring from it before now.
As we have seen in our own markets, imbalances can be
maintained longer than people expect.
I have written about why we haven’t seen an outbreak of
inflation (in prices) in the US and/or Canada, yet.
At the risk of deviating too much let me just summarize
the main factors in my analysis,
1. Fed tightening cycle 2004-08 produced a demand shock,
commodity prices collapsed temporarily
2. Post 2008 money expansion was not as great as we expected even if it is
greatest on record
3. Deflation expectations were initially dominant and resulted in cash
hoarding post 2008, up to 2012
4. World’s largest banking systems are impaired and have not generally joined
in with the central banks
5. Expanding economic output post 2008 likely absorbed some of the effects of
money growth
I don’t think we have to abandon economic logic to understand why price
inflation has been relatively low in North America -even though it is
true that most gold bulls expected it to be higher immediately after 2008.
The Heart of the Matter; Western Governments Have Become Fundamentally
Insolvent
What is truly at risk here is THE monetary experiment that
started in 1971. It is different than the one that preceded it
(1945-71), which was also different than the systems that preceded (1933-45;
1895-1933; etc.).
What makes it so vividly different is that it is only
since 1971 that the world has been completely off of some type of gold
related standard (excepting the Swiss who abandoned their gold linkage in the
nineties).
That’s just a few generations.
When it happened, gold bugs and other free market
economists warned of the consequences of a 100% government managed fiat
money system. In fact, they’d been warning of the move in that direction for
a while before too. After some initial vindication in the seventies -
during the early transition from the failed gold exchange standard to
the new fangled fiat dollar based international floating exchange rate regime
- gold bugs fell into some discredit again when the new system didn’t
spiral out of control in the eighties.
Not only did the US dollar survive, but the government
continued to thrive, and importantly, to grow.
Year after year the first genre of doom and gloomers
warned of the consequences of the accumulation of public debt, back when
it was approaching just $1 trillion! They warned of the unsound banking
schemes springing up on the back of the new US dollar standard. They crashed.
And then got bigger than ever.
The first genre was too far ahead of the accumulation of
the imbalances, let alone their peaking points.
Moreover, the liquidation of malinvestments (built up
during the sixties’ and seventies’ easy money policies) brought about by
the Volcker Fed’s absolute brake on money supply growth bought the new system
some time. It allowed markets to clear all previous imbalances and
embark on a new growth path regardless of the failure of Reagan either
to return the economy to laissez faire (its own management) or honest money.
The Fed talked tough on inflation for several more years
but the banking system continued to inflate at a modest pace through the
eighties and early nineties, and ultimately Volcker’s credibility was diluted
by the Greenspan Put, and later, under Bernanke, a general return to
Keynesian style monetary policies like those in operation during the
sixties and seventies...all of this inevitable and predicted by the gold
community.
But even before, all through the eighties and then the
nineties, the doom and gloomers kept warning.
Throughout this period, however, the government continued
to thrive. There was no social collapse, and the US dollar’s foreign
exchange rate, while often weak, did not collapse either. Although the government and
the public debt expanded tenaciously, moreover, stocks climbed ever higher,
and the baby boomer generation fell in love with them. Interest rates
generally fell, despite constant and incorrect calls by the gold crowd.
The dollar benefitted from the fiery implosion of other less sound currencies
and the collapse of communist blocs –which contributed to productive and
innovative free market forces. By the late nineties it even appeared
that the Fed had eliminated the out of control 1970’s inflation once and for
all.
Only after the tech bubble – at the height of the “cult of
equity” – and the strong dollar policy of the late nineties burst at the
seams early in the new millennium did the gold bugs see some indication again
for the first time in decades. But otherwise, the narrative for most
people is tired and old...even though a few decades is such a short
period in the context of how long the world has been on a gold/silver
standard.
That’s why even you may be immune to understanding what i
am about to tell you.
For, here’s what is different today than it was in the
nineties, eighties, or especially in 1978 when Volcker slammed on the
brakes for three years and allowed interest rates to normalize (they soared
to ~20% in the US...higher elsewhere): the public debt has
reached a point where the government cannot afford for the Fed to exit.
It has grown practically 20-fold since Volcker’s exit, in dollar terms, and
more than tripled relative to GDP. Plus, today there’s a bunch of
unfunded debt that is destined to come into play mañana.
 The only other time the debt/gdp ratio has been
this high in the US was during WWII. Back then, after the war, the
US went on a diluted gold exchange standard and the debt was
subsequently reduced, especially relative to GDP, as economic
policy shifted back to laissez faire again, at least until
the sixties. Today the lure for the increase in public
indebtedness is not war; at least not any world war, not yet
anyway. Today there is a plethora of agendas funded by
this roundabout and indirect form of taxation and slavery - i.e.,
mainly progressive welfare policies supporting the causes of statists on both
the left and right of the contemporaneous political spectrum, the war on
drugs, the war on terror, and so on.
It has been a free for all for decades. And just as the
gold bugs predicted (I became one in 1999). Thank you, Mr. Nixon! For,
the incentives are built right into the new monetary system this time.
One of the policies made easier by the less restrictive
fiat dollar based monetary order is the Fed’s interest rate
suppressions, since it requires monetary expansion -i.e., an elastic
currency. This type of policy tilts the playing field in favor of the
borrower (and against the saver); it encourages greater consumption at
the expense of saving; it also encourages more borrowing than would
occur otherwise as borrowers will tend to overestimate how much debt
they can carry, particularly if they have a hand in setting the interest
rate.
And since, unlike real debt, politicians aren’t putting up
their own collateral, it encourages them even further! Call it one of
the unintended consequences of the new gold-less monetary system, but this is
why debt/gdp levels are off the charts in almost every western developed
nation that is party to this monetary system. The consequence of all
this is that the Fed and its biggest customer cannot afford to exit
the current policy in almost any form. And it certainly cannot afford a
Volcker style abandonment of the Fed’s paradigm. Please don’t
underestimate what this means. It means they are now trapped by the policy.
No reset, like that which occurred under Volcker, is
possible today. They have to keep inflating in order to keep interest
rates from normalizing. Today, with the debt/gdp ratio three times as high as
it was at the dawn of the current monetary order, a mere 8% interest
rate could bankrupt the US government -with almost all of its revenues
going to the payment of interest at those levels. Indeed, when we say that
these governments are insolvent we mean that they can no longer afford
to abandon the inflationary paradigm.
They survive now ONLY by robbing Peter to pay Paul. This
has not always been the case! It is new!
Although the warnings are old.
But the day those warnings warned of has arrived, and the
evidence is the central bank’s fear about exiting, let alone abandoning
the policy. We’re seven years into a boom and they haven’t even started to
tighten!
You can see the inflationary ideology entrenching, as well
as the higher long term money printing rate.
There may be several ways to postpone the reckoning but
there is only one way to clear it.
Nothing short of sharp meaningful spending cuts (double
digit percentages here to start with), massive privatization schemes,
debt repudiation (between governmental departments), tax cuts, and getting
rid of the Fed will do. The last one is most important as it supports
the system that produced a government that has become an enormous
parasite on a host (the economy) that has seen its capital severely impaired.
But these aren’t popular fixes. They won’t be popular
until we are inundated with a price revolt -which, once it arrives, they
won’t be able to stop because they can’t afford to stop printing and
normalize rates!
And that’s what we mean by TEOTMSAWKI.
Are Those Dead Canaries and Butterflies Flapping on the Horizon?
Oil and gas prices continued to collapse earlier this
week, putting further pressure on the energy producers, and their
downstream factors. Russia’s central bank raised rates sharply in reaction to
the Ruble’s collapse. And China tightened just the week before. So far
these ripples have done more to support the Bund and UST’s. For much of
2014, the monetary backdrop has been one of lessening “stimulus” in
the largest economies - although the ECB and BOJ are aiming to change
that in 2015 - but of increasing money growth in many of the emerging
economies (Turkey, Israel, Hungary, India, Mexico and some of
the South American countries, South Africa, etc.), which has
benefitted the US dollar.
Perhaps the biggest question for the short term is whether
the oil price decline works in favor of wall street or whether, since it
was related to a sector specific boom, it is a canary, or omen of impending
doom (for the more general boom in stocks, and particularly government
bonds).
I think it has to be viewed as a canary, and I think the
situation in emerging markets should be viewed as an example of what is
to come to the shores of the more advanced economies when those little
waves merge with the rolling tsunami. Perhaps the Fed’s rhetoric
indicates that it agrees with our assessment, or else it would have
taken the oil price ‘cut’ as an opportunity to withdraw the “considerable
time” phrase and at least hint towards an exit. Instead, however,
ostensibly reacting to lower inflation expectations, stagnating real
estate values, and perhaps worried about some of the dead canaries in the
global economic pipeline, the Fed decided to put off withdrawing the
inference and asked investors to be patient with it about its decision
to withdraw ZIRP and to begin some kind of policy toward interest rate
normalization.
[We have been daring them since 2009, btw.]
The next day the Fed also announced a 2-year extension of
the Volcker rule on private equity for the big investment banks (up to 5
years for some of the smaller ones), thereby postponing the liquidation of
billions of dollars worth of those assets. The Dow rallied over 400
points on the day of the news, and the day after the FOMC pump and dump,
ultimately halting the precious metals recovery in its tracks.
Is the Fed’s rhetoric and Volcker rule delay going to be
enough to forestall the bust we have been looking for? Will the ECB and
BOJ come through and re-inflate as expected in 2015? And if yes, will it be
too little too late? Have the markets gotten too far in front of it?
These are questions i too am pondering.
Is Russia Selling Gold to Defend Ruble?
 Further weighing on precious metals
values last week were rumors that Russia was selling some of its
recently acquired gold reserves in a panic to hasten the slide in its
currency, which has accelerated recently. The speculation
arose because Russia reported a small decline in f/x reserves for
November (a few billion dollars), and then larger ones of over $100
billion in the first two
weeks of December. The central bank had accumulated
about $415 billion in foreign currency reserves through November with
gold representing about 10% of its total holdings.
Bloomberg reported on Friday that it did NOT sell any gold in November
despite the drop in the value of its foreign exchange reserves that
month. Instead, it continued to buy despite the Ruble already being down a
lot.
It remains to be seen if Russia has sold any gold in
December given the much larger sales of currency reserves reported. If
they sold 25% of their total currency reserves to defend the Ruble it is hard
to believe they wouldn’t have sold some gold. Most of the street thought
it had. So the first thing i have to say about it is that it’s in the
market! But I’d be surprised if Russian authorities sold more than the bears
expected.
So far its accumulation of gold has appeared to represent
part of a long term strategy of some kind.
Moreover, common sense dictates it would be a quickly
defeated strategy, with minimal benefit. It makes far more sense to sell
dollars and euros and/or other currencies before selling gold. We have to
assume that Putin is aware of the likelihood that selling its gold would
benefit the US dollar more than the Ruble.
Buying gold on rumors of Russian selling, or news of minor
gold sales, is the prudent strategy.
What Caused the Ruble’s Collapse?
Perhaps the Ruble’s slide was catalyzed by the oil price
collapse, but its cause lay elsewhere.
Some analysts, claiming that the Ruble is sounder than the
US dollar, have argued that the collapse is undeserving, or that it was
designed by US neocons to force Putin into compliance over the Ukraine
and other foreign policy issues. Bloomberg blamed it on Putin’s gamble
to fund his forays into the Ukraine.
Every single one of those views is gravely mistaken.
You all recall my view on the Ukraine. The US media simply
reports information it gets from Washington, which tends to contradict
much of the news from independent sources on the ground and online. I do
not believe their portrayal of Russia as aggressor, and I believe that
the US/EU/NATO alliance is overstepping its bounds with its own
influence of affairs in the Ukraine and its cover up of the violent coup that
started it.
Granted, the Ruble’s crash could be overdone, but I will
stop short of recommending Russian investments.
I have heard that Jim Grant on the other hand likes
Russia. He may know something about where Russian economic policy is
headed. I don’t. All i know is what kind of policy led to the current
collapse of the Ruble.
Russian Monetary Policy
Last year i looked at the emerging markets situation
because the Indian rupee was falling out of bed, and the financial
illiterates blamed it on the Fed’s plan to taper in combination of the want
of Indians to buy gold and other goods the poor Indian economy cannot
provide -so it is at the mercy of foreign exchange traders.
However, I argued that India ran an aggressive monetary
policy, which it continues to this day, and that the effects were just
coming home to roost. In September 2013, I showed that “India had the second
highest rate of price inflation (over seven years) out of 40 of the
largest countries on the planet covered by the OECD – behind Russia –
and that it ranked 8th in the same group in terms of how much it expanded
M1.”
In the same report I wrote:
“...the other four currencies having trouble (Turkish
Lira, Indonesian Rupiah, Brazilian Real, and South African Rand), dubbed
the “fragile 5”, ranked similarly high in the dishonesty of their
monetary policies in a group that will probably expand to include the
Ruble, the Icelandish currency, the Mexican and Chilean Pesos, and maybe
even the Chinese Yuan. All of these countries are guilty of inflationary
monetary policies that are frankly many times worse than their counterparts
at the Fed.”
I showed this clearly with the following chart comparing
M1 as indexes all starting from a base of 100 in the year 2000 and
ending in 2013 (source: OECD). Turkey and Russia lead the long term 10-15yr
rankings.
 In February this year, based on a similar ranking,
and still pretty much before this collapse even started, I wrote
that, “The next worst offender of the sound money policy over
the last 10 years was not the Fed. It was Russia. After that it is
Iceland, Israel, Chile, and China...In Russia, the central bank’s
first deputy recently admitted that a number of countries,
including Russia, were going to experience a bout of
stagflation. But likewise there, “Consumer prices grew 6.5% last
year, above the 5%-to-6%...”
There you have it. Recall our rankings, updated
through to Aug/Sep 2014, from the OECD.
Note that Russia has fallen down the list a little and
that it has slowed the growth of M1 more significantly than many other
countries, especially in the post 2008 period. However, it is still inflating
faster than many other countries - and at least as fast as the US. While
that is down from annual rates of nearly 50% year over year in the
period leading up to the 2008 economic crisis there is one important point to
make here.
Because of the US dollar’s weakness in the 2002-07 period,
a lot of countries got a free pass on their very unsound monetary
policies, and they took advantage. Indeed, when i saw that happening i knew
the US dollar would soon bottom. However, although the Russians had
inflated their money supply by four or five times as much as the Fed,
the currency had fallen less than 20 percent against the US dollar in this
period.
 Clearly something has been due,
particularly when price inflation started to show up earlier
this year. It is probably overdone now. I don’t know. But the cause
of this debacle can no more be blamed on US conspirators than we can
blame the Rupee’s collapse on gold importers. It’s their own
economic policies. There has been weakness in the Lira, Peso, Rand as
well as the Rupee (more might be deserved), but currencies like
Hungary’s Forint and the Israeli Shekel are overdue for a hit based on
this data alone.
But so is the USD, which is far too high in the rankings
above for a reserve currency issuer.
Russia Made its Choices
The US debt/gdp ratio is the third highest of the G20
behind Japan and Italy, and basically one of the highest in the
world...almost as high as the worst of the European countries involved in the
EU crisis.
Russia today has one of the lowest debt/gdp ratios: less
than 10%.
The interesting thing is that it has fallen from nearly
100% before its massive inflation from 1999-2007.
That is, the Russians faced their demons and instead of
liquidating the state they hyperinflated the public sector debt away.
Sooner or later that had to come home to roost on its exchange rate.
What will the US and European countries do?
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