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June 3 - Dow Jones (Judith Burns):

Mr. Greenspan is, again, wrong. It is very much an "economic problem." It is the nature of protracted Credit Bubbles to impart deleterious effects upon the underlying economic structure. As the master of "activist" monetary management, Mr. Greenspan's reign at the helm of Fed saw a move into uncharted territory with respect to marketplace interventions and manipulations. Over this period, confidence flourished - in the markets as well as throughout the real economy - that astute monetary management coupled with Washington stimulus assured a steady economic course with robust growth, interrupted only occasionally by shallow recessions and little cub bear markets.

The Greenspan/Bernanke Fed championed the disastrous doctrine that our central bank should ignore expanding Bubbles, choosing instead a course of aggressive intervention ("mopping up") once they had burst. This analysis failed to consider myriad financial, economic and political realities, including that massive fiscal stimulus would be required - and generally welcomed - in the post-Bubble crisis environment. Today's political and inflationary landscapes are very much an outgrowth of Greenspan's terribly flawed monetary management.

It's difficult for me to get the Q1 2009 "flow of funds" out of my mind. And the Fed's own Credit data refutes Greenspan. During the first half of the nineties, Non-Financial Credit growth averaged $565bn annually. Over that period, Financial Sector borrowings averaged $285bn. By year 2000, Non-Financial Credit growth for the year surpassed $2.0 TN, before peaking in 2007 at $2.545 TN. Annual growth in Financial Sector borrowings surpassed $1.0 TN in 2004, before almost reaching $2.0 TN in 2007. This was the massive expansion of system Credit that inflated asset prices, incomes, corporate profits, and government receipts. This Credit explosion was at the heart of economy-wide structural transformation to consumption, services, de-industrialization and massive imports - not to mention incredible financial leveraging and speculation. And once grossly inflated, it is a very difficult and painful process to return a system to a more even keel.

Greenspan can claim it's a political problem and warn against increased statism. Yet the real dilemma today and going forward is the maladjusted "Bubble Economy" structure that fends off systemic breakdown only through $2.0 TN-plus annual Credit growth. Of course, our politicians have not sat idly as the Credit system buckled and the economy lurched downward. And, indeed, it was Greenspan more than any other individual that was responsible for the public's blind faith in Washington policymakers' capacity to resolve any and all financial and economic problems. As always, politicians have a propensity to try to inflate their way out of jams. And that's why it is critical to maintain a disciplined financial system, a stable and balance economy, and a tough and independent central bank.

But let's get back to the "flow of funds." Federal government borrowings surged from 2007's $237bn to 2008's record $1.239 TN. Federal borrowings expanded at a $1.440 TN annualized rate during the first quarter. As I did with last week's analysis of the "flow of funds," I believe grouping Treasuries with GSE debt and agency MBS issuance today provides a better gauge of the growth in marketable federal debt obligations. This is the current focal point for Bubble analysis.

Combined outstanding Treasury, GSE and MBS obligations surged $1.949 TN, or 15.3%, in 2008 to $14.709 TN. This was a sharp increase from 2007's $1.165 TN, 2006's $532bn, and 2005's $411bn increase. The almost $2.0 TN expansion of "federal" marketable debt compares to 2008's increase of Total Non-Financial Credit of $1.873 TN. After the breakdown in Wall Street finance (i.e. "private-label" MBS, ABS, CDOs, etc.), it was virtually only "federal" obligations that retained the perception of "moneyness" in the marketplace. And, since the onset of the Credit crisis, this "money" has been issued in unprecedented quantities, in the process stabilizing the system yet setting the stage for a future crisis of confidence in "federal" Credit.

I found the most recent Z.1 report so disconcerting because of the parallels now apparent between "federal" Credit and the previous Bubble in mortgage/Wall Street finance. Recall that Total Mortgage Debt growth accelerated from the nineties annual average of $269bn to $1.00 TN by 2003, $1.268 in 2004, $1.438 TN in 2005, and $1.390 TN in 2006. As more mortgage-related securities were issued in the marketplace, the annual growth in ABS surged from about $200bn in 2003 to surpass $800bn in 2006. With the explosion in "private-label" MBS issuance, the asset-backed securities (ABS) market actually doubled in size in just four years to surpass $4.5 TN by the end of 2007.

Back in 2006, acute systemic fragility was being masked by the massive mortgage Credit expansion intermediated through various sophisticated Wall Street structures. The crucial facet of the analysis was that this Bubble was increasingly vulnerable to a crisis of confidence. Not only was there massive issuance, but this boom was being sustained by rapid expansion of Credit of increasingly poor quality. In true Ponzi Finance dynamics, this Bubble was attracting enormous financial flows while having become susceptible to any reversal of speculator sentiments.

There was a confluence of critical dynamics that fostered acute fragility. The scope of annual mortgage Credit expansion necessary to sustain the Bubble (approx. $1.4 TN); the increasingly suspect quality of the underlying mortgages prolonging the boom; the vulnerability associated with inflated home prices; and that much of the mortgage-Credit was being intermediated through "AAA" marketable securities altogether created a quite tenuous situation. The stage had been set for a momentous change in market perceptions.

A major systemic crisis became unavoidable after the revelation of GSE accounting irregularities ensured that Fannie and Freddie would no longer provide the mortgage/MBS marketplace a "backstop bid." Going back to 1994, the GSEs had repeatedly nurtured concurrent booms in mortgage lending and MBS speculation through their aggressive market turmoil-periods of MBS purchases and liquidity creation. Speculators had over the years become quite emboldened, but their source of liquidity in the event of trouble would be nowhere to be found in 2007.

I see ominous parallels to the mortgage/Wall Street finance Bubbles with today's Government Finance Bubble. First, the scope of "federal" government marketable debt issuance - approximately $2.0 TN annually - has quickly reached massive proportions. Especially since little of this ("non-productive") debt is financing real economic wealth creation, there is a rapid deterioration in the quality of this debt being sold. There are clear Ponzi Finance dynamics in play. I would argue that the massive deficit spending has sustained incomes (May Personal Incomes up 1.3% y-o-y), purchasing power and general confidence in our system. But only ongoing massive fiscal stimulus will sustain the current maladjusted economic structure, while this massive inflation of government Credit will over time have problematic inflationary consequences. Acute underlying systemic fragility is masked only by the massive issuance of government "money-like" Credit. The issue is, at its core, more financial and economic than political.

One of the challenges of analyzing Bubbles is appreciating that powerful forces inherently arise to perpetuate them longer than one would have initially believed analytically probable. The tech Bubble went to incredible extremes - and then "doubled." Ditto for the mortgage/Wall Street finance Bubble. As an analyst, however, I've got to assume that the marketplace is today much keener to the problematic nature of Ponzi Finance dynamics.

The key to the rapid implosion of the mortgage/Wall Street Bubble was the combination of its unwieldy scope and the disappearance of the GSE "backstop bid." At $2.0 TN, arguably we've quickly reached ample "scope" in the market for "federal" obligations. As for the "backstop bid," foreign central banks have for some years now been massive buyers of Treasuries and agencies during periods of unwieldy global dollar flows. And with more comments out of China today, there is even greater support for the view that foreign appetite for our debt instruments is waning in the face of the unprecedented inflation in their quantity. Moreover, market perceptions are that Treasuries are bulletproof.

I know better than to try to predict the timing of problems developing in the Treasury and currency markets. But I do see all the makings for the next problematic leg of this financial crisis. As I have written before, our nation's predicament becomes much more problematic when perceptions turn against the Treasury/agency marketplace.

_____

© 2009 Doug Noland

ABOUT THE AUTHOR

Doug Noland is a market strategist at Prudent Bear Funds. Their website is www.prudentbear.com.

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Posted in Monetary Commentary, Guest Commentary, Doug Noland

  

It is said that government interventions have unintended consequences. One of the consequences, presumably unintended, of the Western bank bailout is that the bank bubble itself has continued to expand relatively unimpeded. Believing that bubbles are not necessarily healthy for market-based economies, we wonder how long this state of affairs can continue. Until the next financial crisis? (And when might that be?)

We've pointed out that in our humble opinion, the real religion of the 20th century (and perhaps the beginning of the 21st) is central banking. Society is never so well served, so faith suggests, as when the financial sector and specifically money center banks are well-heeled and healthy. Seldom, it would seem, has their been such a happy alignment between self interest and the public good. If big banks -- their management and their employees -- have sufficient capital, are properly incentivized and appropriately regulated, then society will generally hum along. Prosperity beckons for all.

Thus it is that central banks have lavished trillions on their junior banking partners, ensuring that few major players go out of business and in the process creating a "too big to fail" bracket of companies that is now impressively advantaged. Too big to fail money center banks have got to be investment magnets in the 21st century. Where would you rather put your money? A failing industrial company in the Western rust belt, or shiny money center banks that have just received hundreds of billions from its central banking patron?

This is likely the real reason that BofA can raise US$40 billion in a month. Is it the competence of BofA managers? Or the business model itself? Far more probable is the perception that BofA is part of the too big to fail bracket of firms that will never, ever go out of business. It seems the financial crisis and the bail outs that followed have fundamentally changed the investment universe. The financial sector, always favored, is surely now seen infallible. Placing funds in such a sector is a proverbial "no brainer." How much intelligence, after all, does it take to recommend companies deemed by governments to perform a function so vital that they will never face potential ruin.

We have one basic question when it comes to all this. How long can it go on? If governments have truly succeeded in propping up the financial sector once again, then doesn't it follow that the financial bubble, already the largest bubble in the universe to our way of thinking, will continue to expand? Can it then expand forever? Aren't there laws of physics that militate against such an eternal evolution? In the short run, Western money center banks would seem to be the best investment on earth. In the long run we are not so sure. At some point, we believe, every bubble deflates. Those who believe, therefore, that even central bankers cannot hold up the sky forever, will contemplate investments other than banking institutions. We would, of course, suggest what banks used to hold in abundance: gold and silver.

_____

© 2009 The Daily Bell

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Posted in Monetary Commentary, Guest Commentary, The Daily Bell

  

In their day, serfs apparently paid about 33 percent of their income to their betters. Today, Western citizens often pay close to 50 percent of their income for services provided by their democratic governments. Britain is probably ahead of America in this regard, but not by much. Some Scandinavian countries charge their top wage-earners up to around 70 percent, and this is often mentioned approvingly by those who defend progressive tax strategies. What is ironic is that under the current central banking regimes, government can actually print all the money it needs without resorting to taxes. Granted, the additional money might have an impact on price inflation, but it is certainly feasible.

For Americans anyway, one of the remaining mysteries having to do with the federal levies is why the income tax was passed around the same time as the bill enabling the Federal Reserve -- way back in 1913. There are various theories to explain this. One is simply that revenues were necessary. Another would be that having a tax-and-spend system obscures the workings of the American central bank and makes its money creation a little less obvious. A third explanation would be that the income tax is necessary to drain money from the system that the Fed has added in through its banks. However, this doesn't make much sense on close examination as the money extracted via an income tax is returned to the larger economy through federal spending of some sort.

We're inclined to favor the second alternative. Having now lived through a full-blown economic crisis, we find that much which was once theoretical and questionable has become fairly obvious. For free-market economists, such events as are now occurring provide a kind of time capsule illuminating debates long pursued. In the case of monetary versus fiscal policy what seems to become clear is that the argument over TARP funds of some US$700 billion is a great deal more public than the Fed's expenditure of trillions in secret and without a presentable accounting.

It is perfectly feasible that a central bank can indeed fund all of a nation's needs without a single drop of tax. In fact, were the central bank redirected toward government funding, there is no reason why a given central bank could not print the requisite funds and pay for government services out of the same electronic debt money now issued via money center institutions.

We return to previous considerations of central banking realty. Once one has created a money mechanism, its utility seems strictly one of tradition. Before the advent of central banking, banks were simply warehouses that lent funds based on the amount of gold and silver in their vaults. Of course there were many other ways that one could receive capital, through friends, neighbors or successful business ventures. But once central banking was introduced, the mechanism of bank lending was raised above all others, as a monarch is raised above all the others. The operation of bank-lending was somehow reconfigured not as a greater good, but as the greatest good.

Today, politicians throughout the Western world explain solemnly that "banks have to lend again." Thus, they lavish trillions, as if, throughout history, only the presence of banks and bank lending provided the potential for society's advancement . Yet is this so? Or may one continue the argument that it is human action - individuals trying to better themselves and their communities - that has resulted in most of humanity's most miraculous strides. We continue to like to think so.

The saddest part of the current economic crisis in our opinion is that it is so unnecessary. Were individuals merely allowed to manage their own affairs and their own money, the free-market itself would see that resources were appropriately distributed. Those who worked hard and well would likely be rewarded. Those who worked less hard and with less intelligence would receive lesser compensation. Those who did not work because of indolence or injury, would receive some sort of community care, usually through religious auspices.

Is this sort of approach so awful? What hubris makes it possible for us to think that elected officials can distribute wealth more wisely than the invisible hand? What makes us so certain that our elected officials are wiser, fairer, more efficient. In fact, there is much evidence to the contrary. The tithes demanded by central governments continually rise even as income and opportunity continue to fall. The money that Western governments demand now from citizens will not likely subside any time soon. In fact, the demands and tithes may rise.

_____

© 2009 The Daily Bell

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Posted in Monetary Commentary, Guest Commentary, The Daily Bell

  

In one fell swoop, China profoundly alters gold market synergy.

When China recently expressed its interest in purchasing $80 billion in gold (about 2600 tonnes), it profoundly altered the gold market's long-standing synergy in three significant ways:

First, it used to be that the threat of central bank gold sales would damage market sentiment. Now the threat of significant sales has been met with the threat of significant purchases.

Though the dragon hoard depicted by our good friend, Ed Stein is not yet a reality, China can back its desire to own gold with plenty of cold hard cash. At nearly $1.4 trillion in dollar-based assets, and almost $2 trillion in total reserves, $80 billion would consume a paltry 6% of China's dollar reserves. At the same time 2600 tonnes translates to roughly one-third the U.S. gold reserve -- a significant ambition by any measure. To give you an inkling of how this new synergy might work, when the International Monetary Fund announced recently it would like to sell about 400 tonnes of gold, China joined India in publicly pressing the IMF to sell its entire 3200 tonne hoard. On that news the gold market, which had been in a slow slide as a result of the IMF's announcement, turned and took another run at the $1000 mark.

Second, by becoming gold's most prominent champion, China mounts an aggressive defense of its domestic gold mining industry, and by proxy the rest of the industry as well.

Few people know that over the last few years China has quietly become the world's leading gold producer. Most of that production never leaves China's borders, but goes instead to the national reserves as a hedge against its currency holdings. China, by the simple expedient of defending its own interest, accomplishes much for the gold mining industry as a whole. By posing as a gold buyer of last resort, ready, willing and able to scoop up any sizable offer, China may have very well put a floor under the market price, though we are too early in the game at this juncture to predict what that price might be. There is no question, however, that China has put a floor under long termgold market expectations. One would have to go back to the first Central Bank Gold Agreement in 1999, which strictly limited the sale and leasing of central bank gold, to find an equivalent organized effort in defence of the long term price trend. Many feel that the original CBGA launched the current bull market in gold, and time will tell whether or not China's bold entry onto the gold scene will launch its second leg.

Third, by elevating gold to prominence in its national reserves, China lays the groundwork for the yuan's future use as a prominent reserve currency.

There is little doubt that China would like to make the yuan the currency of choice in the East and a strong measure of gold in its reserves would do much to enhance that possibility. For a comparative history, one would have to go all the way back to the late 1960s and the time of French president Charles DeGaulle. "The Last Great Frenchman" thought it best to hedge the national interest and elevate its future economic prospects by purchasing gold. A substantial amount of metal subsequently left U.S. coffers for European national balance sheets including that of France. DeGaulle was later vindicated when gold rose twenty five times in dollar terms over a short ten year period from $35 an ounce to $875 (1971 to 1980). Some of that same gold would later play a key role in the establishment of the European Union, the European Central Bank and the euro, Europe's currency. China, by its recent actions, appears to have similar intentions both in terms of gold and the yuan.

__

In one fell swoop China has done much to alter the standing gold market synergy. When Congressman Mark Kirk announced China's desire to purchase gold during an interview with Fox News' Greta van Sustern, he noted "across across the board - in private - substantial, continuing and rising concern." Chinese leaders, he added, were sharply critical in private of the US Federal Reserve's policy of "quantitative easing," the modern equivalent of printing money. Kirk went on to say that rising concerns about the dollar and anticipated inflation had prompted China to: "[fund] a second strategic petroleum reserve and they plan to buy $80 billion worth of gold. . . Both of those investments only make sense if you expect significant dollar inflation."

In the years to come, China will continue to steadily build its gold reserves through domestic production. It will also attempt to purchase whatever gold it can on the world market through official sector purchases or whatever additional means it finds at its disposal. In the process it will become the fire-breathing dragon in the gold market's living room - ubiquitous and formidable, a presence that cannot be ignored. At the same time, it will find itself in stiff competition for the available physical gold with an international public which harbors the very same concerns for their own portfolios that Chinese officials expressed to Representative Kirk. Few among gold's growing legions would disagree with China's logic, or its now publicly voiced desire to hedge a potentially disastrous collapse of the dollar.

_____

© 2009 Michael Kosares

ABOUT THE AUTHOR

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Posted in China, Guest Commentary, Gold, Michael Kosares

  

There are several different monetary aggregates used to measure a nation's money supply. These monetary aggregates can be thought of as forming a continuum from most liquid (money as a means of exchange) to the least liquid (money as a store of value).

The following figure indicates compiled data for the most commonly used measures (M0, M1, M2 and M3) from 102 currencies representing 138 countries.

Three of the five monetary unions can be clearly seen above. The remaining two are the IEOM which uses the French Pacific Franc in three member countries, and the East Caribbean Currency Union which uses the East Caribbean Dollar in eight member countries.

The following graph shows the growth of money supply since 1971, a year selected for the reason that the last remaining currency to be convertible to gold, that being the US dollar, was made inconvertible on Aug 15, 1971.

Currency in Circulation

Four currencies (EUR, USD, JPY and CNY) comprise nearly 75% of all circulating banknotes and coins within the public domain.

The following graph shows the historical outstanding stocks of M0 for currencies analysed in this essay.

It is apparent that the quantities of money are increasing in an accelerating fashion. In 1990, the total amount of currency in circulation passed US$1 trillion. Twelve years later, the total amount exceeded US$2 trillion. This doubled again less than six years later in early 2008.

The author is of the opinion that while we may likely experience a continual lowering of asset prices, the substantial increases to the money supply will lead to continuing higher prices for consumer goods.

This may lead to a view that both inflation and deflation are occurring simultaneously, but when one applies the classical definition of inflation - that being an increase to the money supply - such apparent discrepancies disappear.

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© 2009 DollarDaze

ABOUT THE AUTHOR

Mike Hewitt is the editor of DollarDaze.org, a website pertaining to commentary on the instability of the global fiat monetary system and investment strategies on mining companies. His website also provides a no-cost market data feed service with up-to-date quotes on currency exchange rates, commodity prices and major indices. Mike can be emailed at mikehewitt@hotmail.com.

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Posted in Monetary Commentary, Mike Hewitt