All posts tagged bernanke

Let’s face it, European countries are bankrupt. First it was Greece and Ireland. Now it’s Portugal. Pretty soon it’ll be Spain and Italy.

Politicians will never admit there’s a problem. Portugal’s prime minister just said that they don’t need any financial assistance. Just like Greece’s prime minister said last March, he claims they want to help themselves out of this mess. And like Ireland’s minister of foreign affairs said last November, there’s no need to panic. Of course a couple of weeks later both prime ministers came begging for aid. Portugal will probably do the same.

Everyone wants someone else to bail them out, and pay for their transgressions.  And other nations are rushing in to buy the sovereign debt – using freshly minted money of course. Maybe these saviors know that their own balance sheets are somewhat murky and hopefully someone else will return the favor in the future?

After all, printing more money to buy another country’s debt is a splendid idea. Keeps the world economy chugging along without having to deal with any of the difficult issues. Like reducing debt. (I’ve never quite understood the notion of solving a country’s excessive debt problem by rolling it over in to more expensive debt. But financiers make money selling debt, so that’s what economists (who secretly harbor dreams of working on Wall Street) will advise the governments to do). But there is a crisis of sorts and whenever there is a crisis anywhere, people flock to the US and to the relative safety of US treasuries.

Everyone and their mother seem to be making financial and investment predictions for the rest of 2011. So I’ll do the same.

1. For the first half of the year the US dollar and government bonds will appreciate – especially against the Euro.

2. Also during the first half of 2011, Gold and Silver prices will drop from their spectacular highs as the US dollar appreciates. But I think Gold prices will stay above $1000/ounce.

3. But eventually, probably during late-summer, people will realize that all the major countries are printing money and using it to prop up failing countries and companies by buying debt, the US dollar and treasuries will slide. And Gold and Silver prices will start to rise again.

4. This collapse in treasuries will be precipitated by multiple bankruptcies in the municipal bond markets.
In the past 2 years, 15 municipalities have filed bankruptcy. According to a recent article in WSJ:

Mr. Bernanke downplayed the notion that many state and local governments run the risk of defaulting and that the municipal bond market could be headed for turmoil. The muni market, he says, has been functioning “reasonably well,” with lots of bond issuance and liquidity in trading. “We’re not seeing extraordinary stress,” he says. Some analysts have been warning that a crisis is looming in the muni market. Mr. Bernanke described these warnings as overly pessimistic. He also said the Fed, which has some limited authority to buy short-term municipal debt, has “no expectation or intention to get involved in state and local finance.” If states are to be bailed out, he said, “it would have to be Congress.”

Isn’t that exactly what he said right before Fannie Mae and Freddie Mac went bankrupt? Let’s face it. There will be a muni-bond meltdown, and Bernanke will scare congress into bailing them out. Bernanke is just a bare-faced liar. Actually, he got tired of being called a bare-faced liar which is why he sports a beard. But regardless, the only reason he brought it up is because it is an issue that will become pertinent within the next 18 months.

Incidentally, previous Fed Chairman, Alan Greenspan, said exactly the same about the housing bubble back in 2005. That it wasn’t an issue and there was nothing to be worried about. As an economist, he should have seen it was a bubble, of his own creation.

This collapse of muni-bonds will scare the pants of regular Americans and foreign investors. As the last bastion of fixed income for the retired, the wealthy and global pension-funds, muni-bond defaults will trigger a major panic. Citizens and investors will realize that they’ve been hoodwinked by the government and Wall Street, and they can’t trust either of them.

5. This will cause a flight to gold and silver, possibly the last and most intense run in this bull market.
I predicted back in December 2005 that “the US is going to enter a period of inflation and recession brought on by the trade & budget deficit and precipitated by the devaluing dollar” and that at $508, it was a great time to buy gold. I still believe it is. If you haven’t already established a position, make sure you buy both gold and silver on dips. If you don’t know how to buy, read through the previous posts on gold and silver. Hopefully, this major rush in gold will not trigger the complete collapse of global currencies. And if it does, it’s still a few years away, so it’s not an 2011 prediction.

Disclaimer: I’m short a Euro ETF, long gold and silver (bullion and mining stocks). None of this should be construed as investment advice.

Almost a year after the historic collapse of Lehman Brother, Fed Chairman Dr. Ben Bernanke announced that the worst recession since 1930 is finally over!

recession next exitHowever, this is only from a “technical perspective”, and unemployment for 15 million Americans (officially 9.7%) will continue, if not get worse. In fact, it may stay this way for nearly 4 more years according to other economists.

So what does this mean? The operation was a success but the patient still died!

Apparently pumping a trillion dollars in to the economy will create a technical expansion even if the net benefit to society is negative. What happens when the government pulls the plug on throwing money at the ecnomy? Won’t the GDP decline again, pushing us back in to a double dip recession?

And what happens if our lenders make this decision for us? Supposing China and Japan no longer want to buy our 30 years bonds at a measley 3 or 4%. What if the interest rates go up to 8%? Will we be able to afford $1 trillion dollars a year in interest payments? Will we start issuing notes for the interest payments? Nah, we’ll just devalue the currency and let inflation help us out of this mess. Either that or the government stimulus will continue indefinitely, aka monetary policy Zimbabwe-style! Oh wait, isn’t that the same thing?

Check out this 12 minute video from 60 Minutes. There’s another wave of mortgage defaults on the way, this time from Alt-A & Option-Arm (also called Negative-Amortization or Neg-Am) loans. As opposed to the subprime loans which were worth almost $1 Trillion, these two groups make up nearly $1.5 Trillion.  According to Amhurst Capital, they expect a 70% default rate on the Option-Arms based on the current default rate which is occurring at 3% interest rates!

Right now there’s a 3-5 year overhead supply of housing inventory on the market. Along with these coming defaults and the fact that 10% of Americans are behind on their mortgage, you should expect house prices to be depressed for a very long time. I’ll think we’ll have more clarity when home prices actually hit bottom, which might be another 12-24 months from today.

I’m sure glad I sold my condo in summer 2005! The bank now owns and I’m thinking of putting in a very low-ball offer. An offer so low, it’ll cashflow well and at least break-even if rents drop 50%!
(Check out these cheap real estate deals).

If you’ve been reading the news, you know that at yesterday’s FOMC meeting, Bernanke dropped the interest rates to an unbelivable 0.25% (a cut of 75 basis points). Apparently he thinks that cheap credit will solve the problems facing the US economy right now. Unfortunately, its not the cost of credit but the availability of credit that is the issue. Credit is drying up and making it cheaper isn’t going to make any difference.

Last Monday, the Treasury was able to auction $35 Billion worth of 3 month T-bills at 0%, which means there’s a demand for liquidity and safety. Return of principle is more important than return on principle!

However, the government is using this money (and another few hundred billions) to bail out bankrupt financial firms, insurance companies, and auto manufacturers. It is running printing presses around the clock creating pictures of dead presidents and is inflating the money supply at a 17% annual rate. This is inflationary in the long run and will cause the devaluation of the dollar.

In the long term, Bernanke (or Bernie for short) is more worried about saving the economy than fighting inflation. (He’s not really concerned about the devaluing dollar either). And while the price of everything may increase, he’s hoping that real estate prices will stay flat instead of tanking, and that’s how he’s going to engender “a soft landing for the real estate market”.

Looking at the dollar index over the past few days, the dollar has started showing signs of weakness. Now that the interest rates in the US are even lower than in Japan, maybe people will start using the US Dollar as the new currency of choice for the carry-trade!

You could sell the US Dollar and buy the Australian Dollar or the New Zealand Dollar, both of which have a much higher yield than the US Dollar. (Note: this is not a recommendation, just an example of how to execute the new carry-trade). I bought some Australian Dollar ETF (FXA) yesterday morning in anticipation of a rate cut for my retirement account. The yield on FXA is currently 8%! It’s up nearly 5% since then and I’m happy to say my retirement account is down only 4% for the year – if only all my investments had fared so well this year!

Anyway, with interest rates close to zero I’m reminded of an 80’s song called “Turning Japanese“! Enjoy.

Not too long ago, the Federal Reserve could only buy Treasuries. If it injected any liquidity in to the financial markets, it was limited to reserve bank credit. Nowadays, it can give generous cash gifts to investment banks, mortgage lenders, money market funds, consumer finance companies and any other financial company it feels like bailing out.

In essence the Federal Reserve has turned into a hedge fund. It still owns some Treasuries and gold, but a lot of its assets now include agency debt, repurchase agreements from various financial companies, pieces of Bear Sterns and AIG debt, and foreign currency paper. Pretty soon, it’ll include actual mortgages and consumer debt! After all, the American consumers are the only group that hasn’t been explicitly bailed out yet.

According to newsletter writer Ed Bugos, people will stop eventually believing Bernanke’s rhetoric of deflation. Massive reinflation efforts are under way and eventually gold prices will start to reflect this. My stock portfolio which is heavily weighted towards Gold and Energy Stocks has gotten massacred in the past 10 days.

So do I bail or do I maintain the conviction that printing money hand over fist leads to inflation and an increase in gold prices? For the time being, I’m going to maintain the status quo, but given that we’ve seen the worst trading week since 1931, its getting tough to stick to one’s beliefs.

Wasn’t it Milton Friedman who said “The markets can remain irrational longer than you can remain solvent“?

Well the $700 billion bailout plan was defeated. Wall Street didn’t like it and the market dropped a jaw-dropping 777 points. Was the bailout that vital to the health of the US economy?

Jim Rogers didn’t think so. Here’s a news report from the 25th of September ago:

Treasury Secretary Henry Paulson’s proposed bailout plan is “astonishing, devastating, and very harmful for America,” internationally-known investor Jim Rogers told The New York Sun.

Rogers says the current monetary climate in Washington reminds him of when then-Fed Chair Arthur Burns refused to let anyone fail.

Rogers insists Washington is making the same mistake again.

“We’re in for the worst recession since World War II, as well as higher long-term interest rates, higher inflation, higher taxes, a weaker dollar, and substantially lower stock prices,” Rogers says.

Even worse, Rogers believes it’s “embarrassing to see how little the presidential candidates know or grasp what’s going on, just like the current administration.”

But what about the almost 779-point boost in the Dow Jones Industrial Average that lasted for two days? “It’s only a matter of time before reality sets in and the market heads down again,” Rogers says.

“I wouldn’t buy now because it’s insane,” says Rogers, who believes investors “were foolishly sucked in by hysteria and a buying panic.”

Rogers, who bought dollars a couple of months ago, now thinks the greenback rally may have come to an end. He’s now buying more Chinese shares.

I’ve been insanely busy with college so I wasn’t even sure how the dynamic duo of Paulson & Bernanke came up with $700 billion. What were the calculations that led to that number? I couldn’t really find anything about it – most reports were rather vague. And if the risk-analysis departments of banks couldn’t figure out the worth of the toxic assets they owned, how did batman and robin figure them out?

A lot of people believe that printing money and turning on the cheap, easy credit spigot will keep the US from experiencing a 30s-style Depression. I really wonder if that is a likely scenario. It doesn’t seem to be working for Japan (although to be fair, they have cultural differences such as their not letting businesses fail, which is probably distorting their business cycle). Also, if its true that excess liquidity and cheap credit caused much of these problems in the first place, how can the solution be the same as the cause?

Here’s what Ron Paul said on the issue over the weekend:

This is Wall Street in big trouble and sucking in Main Street…and dumping all the bills on Main Street. You can’t solve the problem of inflation, which is the creation of money and credit out of thin air, by creating more money and credit out of thin air…

What they’re doing now, they’re propping up a failed system so the agony lasts longer. They’re doing exactly what we did in the Depression.

Saddling the American Taxpayer with an additional Trillion Dollars of Debt doesn’t seem like a good way of boosting the economy. The way things are going, the national debt is set to increase by a Trillion Dollars per year until 2017, after which it should increase by two Trillion a year!

If you still believe that bailing out foolish and greedy bankers is the right thing to do, check out my comments in  a previous post.  It’s a pretty interesting discussion.

So now that the bailout plan failed, is the US economy doomed? I don’t think so. Here’s an interesting article from the Heritage Foundation which suggests that the government is on a partially correct path regarding the financial markets.

And if you want something that’s even more optimistic about the US economy, I suggest reading Reality Check: The Unreported Good News About America by Dennis Keegan. He’s a hedge fund manager and he actually came and gave a speech to my class last week. While I don’t fully share his gung-ho optimism, he’s worth many millions and I’m not, so that should give you a good idea of whom to listen too! But he did say that chaos brings opportunities and people still make money in bad times, which I fully agree with.

And finally, Citi announced that it would be buying Wachovia. Isn’t that kind of strange considering that Wachovia was thinking of buying Morgan Stanley a week or two ago!

I’m often extremely pessimistic on the state of the US economy. In public settings my doom and gloom predictions seem to depress people so I tend to restrict my rants solely to my blog. So it makes me happy when I read an article that agrees with my thoughts on the state of affairs.

by Bill Bonner

America’s largest mortgage finance companies, Fannie and Freddie, have so much water in their lungs it will take at least $25 billion of the public’s money to save them. Possibly $300 billion. Were it up to us, we’d leave them on the beach.

But, last week, the U.S. Senate bent down and pressed its large mouth onto those gaping traps of the mortgage twins – gurgling into them a corrupt breath of life. Since the two hold one out of every two mortgages in the nation, in effect, Congress is nationalizing the U.S. housing stock itself. Henceforth, citizens will pay not only their taxes to the government, but their mortgage payments too.

In America itself, how this came to be is the subject of little concern. But despite the lack of interest, it is the subject of the next 500 words or so.

At a speech in Vancouver, James Kunstler seemed positively delighted. Finally, gasoline over $4 a gallon was going to do what generations of artistic scorn could not – destroy Fannie and Freddie’s collateral. Kunstler’s critique of American suburban vernacular architecture is that its products are not real houses at all – but “cartoon houses.” They have porches that look like real porches from a distance, but they are too narrow to sit on. They have shutters too – nailed to the wall, making them completely useless. They may have “picture” windows…looking out on nothing…or no windows at all. And they wouldn’t exist at all were it not for cheap credit and cheap gasoline.

Of course, the same may be said of America’s – and Britain’s – entire economies during the last 20 years. The loose credit that built cartoon houses also constructed cartoon economies; they look like real economies, but they are essentially perverse, consuming wealth rather than creating it.

For proof, we return to Fannie and Freddie. Here were two companies that appeared to be helping Americans own houses. But since they were created, homeowners’ equity – that portion of the house actually owned and paid for by the homeowner – fell from 70% to below 50%. Currently, Americans’ total equity is lower than their mortgage debt. As a whole, the nation’s homeowners are “upside down,” in other words. Nearly 9 million Americans have zero or negative equity already – and house prices are still falling.

How comes this to be? The answer is simple: lenders lent more than the houses were worth to people who couldn’t pay it back anyway. This Looney Tune approach to finance radiated to all points of the economy. People pretended that they earned more – spending more and more money to buy more and more goods and services – but wages did not really increase. Then, they bought houses – believing the roofs over their heads were investments, rather than consumer items. With no down payment, no proof of income, and zero interest loans – for most of the new buyers, home ownership was merely a dangerous conceit. Now that the roofs have caved in, it is a staggering burden.

The “consumer economy” was always a mockery. No serious economist ever suggested that you could get richer by consuming wealth. But that didn’t make consumerism unpopular. The more people consumed, the more GDP went up. GDP measures output, not wealth creation; but who could tell the difference? In a cartoon economy – no one. Besides, spending made people feel as though they were getting richer.

Then, whenever the consumer threatened to come to his senses, the feds rushed to “stimulate” him – by giving him more of what he least needed, more credit. More spending kept the cartoon economy running – allowing the consumer, the businessman and the speculator to add to his burden of debt. In 1971, when the United States went off the gold wagon, household debt was less than 50% of GDP. Now, it is more than 100%. And now, the poor consumer’s knees buckle; he will be forced to work the rest of his life just to keep up with his debt burden, let alone pay it off.

Even the rentiers were bamboozled by their own claptrap. Stocks rose from ’82 to 2000…fell heavily to 2002 and bounced back. For the last 10 years, shareholders have gotten little for their effort. In July of ’98, the FTSE hit a high of 5,458. This month, it has reached 5,625. And in America, if stock prices were quoted in gallons of gasoline, the Dow would take the driver no further in 2008 than it did 40 years ago.

The cartoon capitalists did it all backwards; they are supposed to exploit the workers, not be exploited by them. But while consumers and investors were going nowhere, corporate managers and Wall Street hustlers were getting rich. The two Bozos running Fannie and Freddie, for example, pocketed about $32 million between them last year – during a period in which the companies lost almost $5.2 billion – not to mention the losses to shareholders. And on Wall Street, managers paid out $250 billion in bonuses in the 4 years leading up to the credit crunch. The firms declared a profit and paid bonuses when the bets were made; they didn’t wait to see how they turned out. Thus did the big banks and big brokers become capitalists without capital, dependent on the gullibility of investors to keep them in business. And when investors began to wise up, they turned to the public for capital support.

What kind of scam is this? It may look like capitalism from a distance. But this is not real capitalism; this is cartoon capitalism – run by clowns, who sell freak investments to chump investors, and encourage the lumpen householder to ruin himself.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

Bill Bonner is the founder and editor of The Daily Reckoning . He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis . I strongly recommend his latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics.

Since I mentioned that Fannie Mae and Freddie Mac were going to go bankrupt, their stocks have plummeted 50%. I think its time to start shorting other financial sectors like consumer credit card companies.

I’m finally back in the US! Last week, I heard Dr. Marc Faber, of GloomBoomDoom
fame, on CNBC India. While gold is currently at a whopping $973/Oz, on that day gold had briefly touched $950/Oz for the first time ever.

Dr. Faber said two things that were very interesting:

1. Gold is a bargain at $950/Oz

2. Fed Chairman, Ben Bernanke doesn’t understand how the economy works

Seems like he agrees with Jim Rogers!

I’ve been advising everyone to invest in gold since it was $500/Oz. Of all the people I know, maybe 3 or 4 actually followed my advice and bought some gold. Most people thought I was stupid and vehemently disagreed with me. Most of their arguments consisted of the following points:

1. Gold has been a terrible investment for most of history and in fact had declined from its peak in the early 80’s for 17 years.

2. Gold doesn’t pay interest and you’re blocking your money.

3. Gold has no real use. It’s just some rich people who are propping up the prices.

While, these are all valid points, they didn’t touch the main point of gold being a store of value. In times of uncertainty and times of hyperinflation, gold always does well. Whenever there is a lack of confidence in the banking system, gold prices tend to shoot up.

John Lee, portfolio manager at Macau Capital Management, has a good explanation:

Banks create dollars out of thin air and loan them to people. Even though money is created out of thin air, once the borrower pays back the loan, the transaction is complete and those borrowed dollars perish in bank’s books. In this scenario, the dollar’s purchasing power is preserved through non-dilution.

However, as we have witnessed through the recent subprime fiasco, many parties are getting away without fulfilling their obligation to repay a loan. Institutions were bailed out as the Fed bought their mortgage positions at face value with new money. Consumers were bailed out as lenders were elbowed to freeze foreclosures, freeze rate resets, forgive loans, and make lower payments.

Such compromises erode confidence in the system. If one person can get dollars through borrowing without paying back, and yet another had to work to obtain and save dollars, it is surely not an incentive to earn and keep dollars. Rather, it is a no brainer to borrow dollars and spend unabashedly. Savers are the most risk averse bunch of people, and when the monetary rules are muddied, they will opt out. This is how a run on the dollar starts.

Interestingly, unlike Faber or Rogers, Lee maintains that Bernanke does know what he’s doing and that its the correct course of action for the Federal Reserve.

Today, the USA is the world’s largest debtor nation. Regardless of how high oil is, there is no room to raise rates with tens of trillions of dollars in debts to be serviced.

Don’t blame Bernanke for our problems; even if Volcker were to be the chairman today, he would have acted in exact same way as Bernanke did.

The ideal dream for debtors is inflation, which is precisely what the Fed is advocating – expanding money supply through lowering interest rates and direct handouts. The Fed’s action is entirely logical acting on behalf of the average American, which is heavily in debt.

While I would contend that debasing a currency just because you can’t afford the interest payments is a wrong thing to do, Lee does at least agree that fiat money always results in hyperinflation.

The deflation camp has been on the wrong side throughout EVERY fiat money experiment thus far. The bear camp contends that the debt burden will eventually become so large that eventually the debt bubble will blow and the prices of everything stocks to real estate to copper and zinc will collapse.

Fiat money systems have always resorted to hyperinflation and destruction of the currency without fail. If hyperinflation could be avoided in a fiat system by the creation of the Fed, the Argentines in 2002 surely would have figured it out and avoided their hyperinflationary disaster.

He also thinks that the Federal bailout will lead to a further weakening in confidence which will cause the dollar to drop further.

The idea that the Fed and the government will allow debt cleansing lasses faire style is patently absurd in my opinion. Central bank action has spoken louder than words in the past six months as record $1 trillion+ has being printed to rescue banks. For instance, England’s largest mortgage lender, Northern Rock, has been nationalized. And as for the consumers, loan amounts are reduced without penalty or conditions, mortgage rate resets are postponed, federal guarantee limits are set to increase.

Here we go back to psychology. It is not so much about the amount of bail out money being printed, but rather that the smart money took issue with the way the handouts were given unconditionally across the spectrum. Confidence in the dollar was further eroded.

Ok, so what’s his point? Lee thinks that gold is heading much higher.

Gold is money and a refuge of capital when a defective fiat money system shows its ugly head. Gold is universally recognized, portable, divisible, liquid, and limited in supply which makes it the only real viable option as store of wealth. Today’s gold price has not fully priced in dollar’s deep and terminal issues and there is nothing that can be done to stop the further rise in gold. The Fed can talk tame CPI to try stabilizing commodity prices but the effect will be limited. Mind you, gold’s rising popularity should be seen as positive; the fall of the dollar system levels the playing fields for global consumers and producers.

The markets can easily handle $3,000 – $5,000 oz. gold in the near term horizon with minimal disturbance. It is when gold rises too much over $5,000 too fast that we might start to worry about global inflation panic.

Wow, gold at $5,000/Oz! That’s a bold prediction. I’m not sure if I agree with him, but I’m still sticking to my belief that gold will reach somewhere between $2,500 and $3,000 in this cycle. Look for gold to break $1000/Oz around the middle of March when Bernanke drops the federal funds rate another 50 basis points.

And whether or not Bernanke knows anything about the economy is still up for discussion. The popular consensus seems to be that he doesn’t!

Check out this excellent, excellent video where Ron Paul rips Bernanke a new one. He explains why lowering the interest rates is screwing the US citizens. Low rates leads to a weak dollar which causes inflation (since we import nearly everything from foreign countries).

By lowering the rates, the Feds are enabling inflation. Which they probably want because it makes it is much easier to pay back all the money the government has borrowed from foreigners. The government currently needs around $2 Billion per day to sustain itself. Paying back foreign countries with dollars that are worthless is quite an enticing option.However, it doesn’t come without any cost. Putting more dollars in circulation devalues the current value of each existing dollar. If the Fed increases the money supply by 10% per year, the value of each dollar of your savings is decreased by a corresponding 10% too. Since you’re not getting 10% interest in the bank, your savings are being eroded every year. This is what Ron Paul was concerned about. The savings of elderly people are being eroded while simultaneously, everything is getting more expensive.

As the cost of everything goes up, eventually the cost of real assets will catch up. Real assets include commodities like gold, wheat, corn, lumber, oil and especially investments like real estate. So the low interest rates has the effect of propping up real estate prices and engendering the so-called soft landing in the real estate market. However, since its mostly wealthy people who own multiple properties that are leveraged with mortgages, as the value of the dollar drops and the value of real estate increases, they get to pay down their mortgage with cheaper dollars while simultaneously enjoying the appreciation in their properties.

This is basically a redistribution of wealth from the poor and middle classes to the wealthy. So you should either vote for Ron Paul or invest in gold (pretty easy to do), foreign currencies (slightly more difficult) or cash-flowing properties (pretty difficult right now). The worst thing to do is nothing or whine about how unfair life is.