Dollar sinks and gold soars

http://latimesblogs.latimes.com/money_co/2010/09/dollar-falls-gold-record-fed-interest-rates-inflation.html

Investors and traders dumped the dollar and sent gold to yet another record high Tuesday, taking their cues from the Federal Reserve’s apparent readiness to drive interest rates down further and inflation up.

The markets’ verdict was clear: They believe Fed Chairman Ben S. Bernanke is willing to debase the dollar to avoid the risk of the economy falling into deflation.

The Fed didn’t announce any change in policy Tuesday, but financial markets read a shift in the Fed’s statement on inflation as a sign that the central bank soon could launch a huge new round of “quantitative easing” -- meaning, a massive program of Treasury bond purchases, perhaps totaling upwards of $1 trillion.

The goal would be to pull longer-term interest rates lower, pump up the supply of money in the financial system and, the Fed would hope, eventually boost inflation.

But any move to flood the system with more dollars would be expected to drive down the greenback’s value. So would lower bond yields, by encouraging investors to look to other countries’ bonds for better returns.

Gold, meanwhile, got a boost as the anti-dollar -- the alternative to paper currencies. What’s more, anyone who expects the Fed to succeed too well, unleashing sharply higher inflation in the next few years, naturally would be drawn to gold as a classic inflation hedge.
With the Fed “now explicitly committed to inflation, investing in gold and foreign currencies becomes an easy decision,” said Peter Schiff, head of Euro Pacific Capital and one of the central bank’s biggest critics.

The possibility of a new Fed program of Treasury purchases drove bond yields sharply lower. The 10-year T-note yield slid to 2.57% from 2.70% on Monday, the biggest one-day drop since June 4. The five-year T-note yield fell to a 21-month low of 1.30% from 1.41%.

But bond investors should recognize the risk here: If the Fed eventually gets consumer prices rising at a faster pace, locking in these yields could mean being stuck with securities earning less than the inflation rate.

M3

Click on chart to enlarge.

When money supply M3 (dark blue line) declines this precipitously, the chances of an economic recovery decline with it. By the way, M3 is no longer recorded as an official government statistic. Hmmm...

Almost two years of zero interest rate policies have not revived the economy or brought unemployment numbers down. 4.5% mortgage rates have not resuscitated the housing market. Fed Chairman Ben Bernanke was hinting at exiting fiscal stimulus programs a few months ago due to a "recovering economy."

I see failure. "Jobless recovery" is an oxymoron. The Fed's only hope is more monetary stimulus, more printing of USDollars, a second round of quantitative easing, debt monetization, etc., whatever opaque choice of words our government officials use. After all, they can't lower interest rates below zero.

In order to combat deflation, Bernanke's biggest fear, QE 2.0 will be implemented after the next financial crisis, to once again "save our financial system." But all it will do is stoke inflation, while debasing the Dollar, and reducing our standard of living.

Jim Rickards on the decline of the Roman Empire

This is a must-hear interview by Jim Rickards on the (economic) decline of the Roman Empire, currency debasement, government budgets, taxation, and complexity of society.

http://www.kingworldnews.com/kingworldnews/Broadcast/Entries/2010/7/26_Jim_Rickards__files/Jim%20Rickards%207%3A26%3A2010.mp3

The potential perils of paper gold and silver ETF's

I've blogged on this topic several times, and it's worth revisiting.

http://dailyreckoning.com/golden-shell-games/

The gist of the article states that the GLD and SLV ETF's are good proxies for the spot price of their respective precious metals, but in the event of "failures to deliver" physical gold and silver, the prices between the ETF's (paper contracts) and the physical prices would decouple, as the physical shortage would cause the prices of the actual metals to soar, while the ETF prices would languish. The reason is the precious metals COMEX futures contracts and ETF's are not backed by allocated bullion. They are derivatives, much like mortgage-backed securities were derivatives of the actual mortgages themselves. Buyers of said derivatives lost everything when subprime home borrowers defaulted on their mortgages. Holders of COMEX precious metals futures contracts, and the GLD and SLV ETF's would be similarly exposed to counterparty risks.

So if you believe you can trade the fluctuations of gold and silver prices, then the GLD and SLV ETF's may be a cost-effective trading vehicle. But if you are looking to hedge against inflation, currency debasement, and/or financial crisis, owning physical gold and silver may be a safer play, despite hefty premiums.

See disclaimers in the side bar.

Disclosure: no position in GLD or SLV.

Warren Buffett bearish on currencies

Even Buffett is sounding the currency debasement alarm bells.

http://www.marketwatch.com/story/buffett-bearish-on-currencies-holding-value-2010-05-01

I agree with his overall take, but strongly disagree with this one comment:

Still, Buffett noted that as long as the U.S. borrows in U.S. dollars, there's "no possibility of default."

"You don't default when you can print your own currency," he added.

A country can absolutely default when it can print its own currency. The German Weimar Republik defaulted in the early 20's, as has Zimbabwe recently. Besides, hyperinflation is essentially a technical default. Paper is only worth as much as what value people attach to it. In a currency crisis, it can plummet overnight.

Venezuela devalues currency

This is what happens when a currency is devalued.

http://www.reuters.com/article/idUSN096521320100109

Hint: currency debasement is occurring worldwide by sovereign governments, including the US. It's done by either market forces or by government mandate--or both. Either way, consumer purchasing power and wealth is destroyed, even as debts are deflated.

Et tu, Euro?

Many financial pundits have declared the eventual death of the USDollar as the world's reserve currency, as the Fed continues it's currency debasement program (despite claims of a "strong dollar policy"). Some have taken this cue to pile into the Euro, believing it to be a safe haven from USDollar destruction.

No so fast. It seems the southern nations in the EU are having huge debt problems--much like its ally in north America. This includes Greece, Italy, Spain, Portugal, and Ireland (albeit a northern European country). Their sovereign debt has either been downgraded, or in danger of imminent downgrades, exacerbating the debt problems as their borrowing costs increase with each downgrade. These indebted countries want more Euros, but the more fiscally sound EU countries refuse to print more currency, desiring currency stabilization. Hence, the bifurcation and increased tensions among EU countries.

If Greece were to opt out of the Euro in order to resolve their sovereign debt problem (it certainly isn't the correct long-term solution, but it temporarily alleviates their fiscal problems), expect other nations to follow suit, putting the Euro itself in danger of being scuttled.

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/6804156/Greece-defies-Europe-as-EMU-crisis-turns-deadly-serious.html

These are indeed interesting times. So what other currencies are acceptable havens in a world of cascading currency debasement? Countries rich with natural resources should perform relatively well in a global credit contraction. The currencies of Norway, Canada, Australia, and Brazil (how things have turned around--Brazil's real has traditionally been an inflation hot potato) are good candidates.

But the ultimate store of value--real money with no counter party liability, leads us back to gold and silver.

Jim Cramer jumping on the gold bandwagon

Jim Cramer of CNBC's Mad Money was praising gold's all-time new highs today, as well as a couple gold mining ETF's. Which caused me to pause, as he's been bashing the shiny metal for a while. To his credit, I believe his trust fund owns Agnico, a gold miner.

Could this about-face be the death knell for gold's ascent? Perhaps a correction is in order, and I did take a little profit off the table yesterday. Cramer has been a good contrarian indicator, as I believe most of his calls are wrong-way bets (sorry, Jim, but your track record is questionable), but that doesn't mean gold will stop climbing in price. A correction is expected after recent surges, but the secular bull market for gold since 2001 is still intact, in my opinion. In which case, I'm with Cramer on this one. Booyah!

As long as central bankers worldwide are accomodative with low interest rates and stimulative monetary policies, gold has nowhere to go but up.

I started buying gold and silver coins and mining shares last November, gradually adding to my holdings ever since on dips. With the exception of one, all the mining shares have appreciated triple digits since then, yet Cramer is only now touting the yellow metal. Curious, but predictable.

Does this mean I will exit all my precious metals holdings? After all, as a contrarian, you want to bet against the extreme majority. When sentiment gets too exuberant, you sell. Likewise, when there's blood in the streets, you buy. In other words, has the trade become too crowded? Absolutely not. Because even though some people are now understanding the logic behind holding precious metals as an inflation hedge and as a reliable store of value, very few have acted on this knowledge. I would argue most people don't understand the value of gold--or just have a distaste for the yellow metal. Most won't jump aboard until the mania phase kicks in at much higher prices, when everyone and their brother will be recommending gold as a speculative bet, without understanding its intrinsic role as a means of preserving purchasing power.

The prudent strategy is to sell into that mania--not buy into it. The parabolic rise in gold and silver prices probably won't occur for a few more years, the normal lag time behind an increase in the money supply. Inflation usually doesn't kick in until these massive liquidity injections eventually flow through the economy via bank lending. But then again, we are in uncharted territory. This is a monetary experiment run by mad scientists at the Fed and US Treasury. No country has ever printed so many trillions of dollars so quickly.

An orderly decline of the dollar will cause a steady climb in gold and silver. But should there be a run on the dollar in a currency crisis, the mania phase in hard assets will go into high gear almost overnight.

See disclaimers on the sidebar.

Disclosure: long gold and silver, and long gold mining shares.

Unfunded US government liabilities

This is an old theme, but needs repeating: the US government is bankrupt, so our financial leaders feel compelled to keep printing US Dollars like confetti.

http://www.sprott.com/Docs/MarketsataGlance/MAAG_10_2009.pdf

The countermeasure to protect your purchasing power when currency debasement occurs is not well-traveled, but is becoming increasingly transparent: buy real assets.

Countertrends will reappear occasionally, but the trajectory of the dollar is well-established.

Shocking, but revealing quotes from the Fed

In rare moments of candor from Federal Reserve officials:

"The last duty of a central banker is to tell the public the truth."

— Alan Blinder, Vice Chairman of the Federal Reserve, in an interview on The Nightly Business Report on PBS, 1994

Dallas Fed President, Richard Fisher, espoused [in a rare moment of clarity and candor] back on April 16, 2007,

“I have spoken in previous speeches of our “faith-based currency,” a term I use only slightly tongue in cheek. The dollar—like the euro, the yen, the British pound and other currencies—is what economists call a fiat currency. It is backed only by the federal government’s power to raise the revenues needed to meet its obligations and by the rectitude of the U.S. central bank. If the market were to lose faith in either assumption, the dollar would be debased.”

This is an article about Robert Mundell, "Father of the Euro":
http://www.dailymarkets.com/contributor/2008/10/20/china-should-buy-all-imf-gold-father-of-the-euro-robert-mundell/

"China Should Buy All IMF Gold Says “Father of the Euro” Robert Mundell

Robert Mundell, the Nobel Prize-winning economist from Columbia University who is regarded as the inventor of the euro told the annual fall dinner meeting of the Committee for Monetary Research and Education (the CMRE) in New York that China, with its huge dollar surplus, has a great interest in buying gold to hedge its dollar exposure but is unlikely to do anything disruptive to the world economic order.

Mundell proposed that if the International Monetary Fund really does sell its gold, as is occasionally proposed, China should purchase all of it. Since Mundell is officially an adviser to the Chinese government, presumably it already has heard this suggestion from him."

Precious metals manipulation

In surprising actions and admissions of guilt, the CFTC gave an update on their ongoing investigation of silver manipulation at the COMEX, and the Fed admitted to gold swaps with foreign central banks. These gold bug conspiracy theorists aren't so nutty after all.

http://news.silverseek.com/SilverSeek/1253632847.php

http://www.gata.org/node/7819


Folks, the cat is out of the bag that the Federal Reserve Bank, US Treasury Department, commercial bullion banks (foreign and domestic), and the recent Administrations have all been culprits in a long-running price suppression scheme for gold and silver. The cracks are being slowly exposed.

Profligate spending has its unintended but predictable consequences--the debasing of a currency, in this case, the USDollar. This, in turn, saps confidence in the world's reserve currency. Rising prices in gold and silver are open indicators of that phenomenon, so it stands to reason central bankers are motivated to suppress precious metals prices.

Sovereign funds are no longer willing to be held hostage to the US Treasury's printing presses. Neither are hedges funds or individuals looking to preserve their wealth. And neither should you.

Countries in default--a blueprint for the US?

Countries which have defaulted on their bond obligations: first Russia in 1998, then Argentina in 2001, Iceland last November, Ecuador last December, and Ukraine on the brink.

More emerging countries are at risk. What's important to note is that in each case, the local currency was debased due to exorbitant printing of said currency. This was done in response to governments looking to print their way out of a huge deficit problem. This monetary and fiscal easing caused hyperinflation, which then caused interest rates to soar. This further exacerbated the ballooning debt, and eventually, the countries could not meet their debt covenants. This caused the country to shut down, as the government IOU's were now worthless, and credit disappeared.

The US Treasury and Federal Reserve Bank are essentially implementing these same policies of easy money and quantitative easing--only on a much grander scale. Exactly how they expect a different outcome for the US is beyond me.