By Simon Grey, on February 8th, 2012
The Federal Reserve Open Market Committee (FOMC) has made it official: After its latest two day meeting, it announced its goal to devalue the dollar by 33% over the next 20 years. The debauch of the dollar will be even greater if the Fed exceeds its goal of a 2 percent per year increase in the price level.
The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. [Emphasis added.]
The black letter of the law mandates stable prices. “Stable,” by the way, is defined as: a : firmly established : fixed, steadfast <stable opinions>
b : not changing or fluctuating : unvarying <in stable condition>
Quite simply, the Federal Reserve is commanded, by law, to maintain stable (i.e. not fluctuating or changing) prices. Failure to do this is a clear violation of the law.
Now, there is no way to argue that debauching the dollar by 33% over 20 years will maintain stable prices because the economics of the situation is very simple: If you increase the supply of money without a consequent increase in the production of consumer goods, prices will increase. That is, prices will not be stable. The laws of supply and demand always apply, and money is no exception. Increasing the amount of currency in a system will, ceteris parabis, lead to an increase in nominal prices. Always.
As such, the Federal Reserve System is in clear violation of its charter. It should have its charter revoked and be disbanded, and those who acted to violate its charter should be arrested for violating the law.
By Simon Grey, on January 30th, 2012
Make no mistake, the problem does not lie with The Fed per-se. The Fed’s “low interest rates” are there to permit the profligacy of the government, yet the longer it goes on and the more the government abuses this deadly embrace the further into the coffin corner The Fed and Congress go. As the debt accumulation rises the maximum interest rate that can be absorbed goes down until finally you reach the boundary where even a slight increase in rates results in instantaneous bankruptcy.
Denninger is a smart man—well-versed in the law, particularly constitutional law, and has an immense knowledge of politics and economics. And yet, here he is once again calling for enforcement of the laws governing The Fed even though history has shown repeatedly and conclusively that it is politically impossible to manage inflation through a central bank. In theory, it is possible that a central bank will act prudently and responsibly, and not inflate the currency. In reality, though, a central bank is nothing more than yet another mechanism by which the government can tax the people.
This is why the solution to inflation is ending the fed, or at least government-mandated fiat currencies, and to allow multiple competing currencies. Relying on the government to properly manage a monopolistic money supply is an exercise in futility. Though it would be theoretically better to do it this way, history has shown quite clearly that a competitive currency market is preferable to a government-controlled currency, and it is therefore better to accept the fluctuations of market-based currency system over the guaranteed degradation of a government monopoly.
By The Gold Report, on January 12th, 2012
 Volatility in the markets isn’t going away any time soon and Mike Niehuser, founder of Beacon Rock Research, expects 2012 to be a year of extreme swings. Niehuser draws parallels to the beginning of 2009, which was a short period of time that produced some very high returns. In this exclusive Gold Report interview, Niehuser shares his market outlook and names a host of companies that are positioned to take off.
The Gold Report: What was your prediction for gold prices in 2011 and how did last year’s investment ideas work out?
Mike Niehuser: Depending on how you want to spin it, we were a little conservative in some respects, but for year-end 2011, we nearly hit it right on the nose. Our forecast for 2011 included the price of gold ranging from $1,300/ounce (oz) to $1,500/oz with the potential with some catalyst to go over $1,600/oz by year-end. In reality, gold traded up to $1,500/oz for the first half of the year making us look smart, then exploded to $1,900/oz and retreated back to where we thought we would end up at year-end at $1,600/oz.
So very close on price, but, more important, we missed the mark on the catalyst, which is the story of the year. We thought the catalyst would be the accelerating deterioration of the U.S. dollar in combination with typical seasonal demand late in the year, but this was blown out by the debt crisis in both the U.S. and Europe, with a wildly different impact on metal and stock prices. Understanding the difference could be very important to making it through 2012.
TGR: What difference are you referring to?
MN: As the U.S. dominates the world’s media, those in the U.S. see the world from a closed system. We know closed systems become more unstable over time. The result is that news media can move into hyper drive, which is what happened with the debt ceiling fiasco last summer. This is especially the case where politics are concerned. In reality with the U.S. dollar’s role as the world reserve currency, the debt is not an issue so long as foreigners are willing to accept dollars or treasuries on the cheap, and we can continue to kick the can down the road almost indefinitely.
The timing of our new-found austerity came at the wrong time with Europeans dealing with their own austerity issues. It would appear that the combination sparked fears of global currency devaluation sending gold and silver to record levels. As the U.S. economy improved, debt as an issue moved off the front page. The issue did not subside in Europe and the U.S. dollar remained strong relative to the euro, leading to a relative decline in interest rates, gold and, consequently, mining equities. I really thought 2011 had the potential to look like 2010 for mining stocks, but it really started to look like 2008, which led to the best buying opportunity of a lifetime in the first quarter of 2009.
TGR: So what are you seeing for metal prices and mining stocks in the coming year?
MN: The old adage that the only constant was volatility is no longer a cliché. While the U.S. economy is showing strength and the U.S. dollar is strong, there has never been more uncertainty in my lifetime; 2012 could be a very volatile year to the extremes. I was born just prior to the Cuban Missile Crisis, but holding catalysts for volatility constant, which is a bit absurd to even suggest, we would expect gold to trade over a wider range and higher than the prior year, say between $1,400–1,700/oz with the potential for some catalyst for the upside to $1,800/oz or $1,900/oz. Demand destruction by higher gold prices may have upset seasonal factors for good and there may be any number of catalysts that may impact prices almost at any time.
TGR: So what kind of catalyst are you looking for?
MN: Well, it’s not any one catalyst, but it is the unperceived impact of any particular catalyst on a potentially unrelated event. Not only the type and relationship of the catalyst but also the timing is important. Working backwards from Dec. 21, 2012, the end of the world by the Mayan calendar, we have a national election in the U.S.; certainly by some timetables Iran is predicted to have a nuclear weapon at some advanced stage of development; and I believe Greece has some event in the month of March. On top of this we are likely to see more political grandstanding early in 2012 on any number of issues including extension of the payroll tax cuts, unemployment benefits and, of course, the federal debt ceiling. Not to be facetious but we will also have the Federal Reserve Chairman Ben Bernanke committing to more frequent press conferences in the name of transparency. Among the international or political challenges of 2012, the Federal Reserve may touch on more of these than you might imagine.
TGR: Are you not giving the Federal Reserve too much credit in world affairs?
MN: Certainly not if the U.S. dollar is the world’s reserve currency. Originally the Fed was charged with the mission as an economic stabilizer to provide an elastic currency in times of financial panic and a lender of last resort for failing banks. The Fed has since suffered mission creep and is now charged with maintaining full employment and, most recently, reduction of systematic risk. One can argue that with banks getting bigger since 2008, the potential for moral hazard has, in fact, increased with larger banks still too big to fail. This may be chump change. Bernanke has said he has no exposure to Europe, but it is apparent that through “temporary U.S. dollar liquidity swaps,” the Fed now may, in effect, have become a global lender of last resort. Systematic risk domestically and globally may be assured. Once again, put it on the credit card.
TGR: Do you think there is a chance that the Fed may accommodate another stimulus program since this is an election year?
MN: This is rather doubtful considering the need has gone away with the stabilization in the U.S. economy. But given the mission of the Fed to pursue full employment, forgetting a moderating unemployment rate, there are still over 10 million unemployed, and millions more under-employed, and they vote. It is interesting that with changes in the voting members at the Fed that there will be fewer stimulus hawks. Sort of like a football team losing their defensive line. Another stimulus program, even talk of one, would be a huge catalyst. Even without a stimulus, the Fed holding short-rate interest rates near zero for the foreseeable future is damaging to a functioning economy in allocating investments. With zero interest rates, basically price controls, funds flow to non-productive assets like gold and other tangibles or consumables rather than fixed assets and equipment for some future return. This also encourages our consumer-driven economy, which is spend now, save later, or better yet pass the buck and kick the can. In any event, we know how well this worked in the last decade.
TGR: It would appear that all that uncertainty should be pretty good for gold?
MN: In the long run, it is without doubt bullish for gold. It is unavoidable but it may take a very long time. Remember that the late Roman Empire was financed through the gradual salting of freshly minted coins with base metals. This is not much different than deficit spending and transfer payments from taxpayers to the entitled or government salaries and pensions. Saving and investment is punished while spending and consuming is encouraged. In the short term, should interest rates increase either by the Fed in the short end or the market requiring higher yields on longer maturities, positive real interest rates could erase gains in metal prices. This seems to be impossible. More likely, as the president has now used a recess appointment for the new head of the Consumer Financial Protection Bureau, the financial markets now have an unvetted regulator in a new bureau accountable only to an independent Federal Reserve. Bankers are risk averse and primarily wish to protect their jobs. I have heard it from bankers’ mouths, you won’t see lending until they know they have a job. So even with near zero interest rates—negative real rates—a sluggish economy will hold down inflation and with a strong U.S. dollar, gold could have a tough time in the new year.
TGR: So with gold trading over such a wide range are you bullish on mining stocks?
MN: I think it is important to remember that only a few short years ago you would have traded your first born for prices at these levels. Even with higher costs of exploration and production, the cream still rises to the top. We should embrace the idea of higher costs as it rewards the productive who are willing to educate themselves and take risks to meet a need. This is so basic and so important. The most important disclosure I can make is that I am an optimist. Also, I believe that sooner or later the market rewards investors seeking companies with low relative valuations that are building shareholder value.
As I said, this feels a lot like the beginning of 2009, which was a short period of time that produced some very high returns. I can’t claim we are at the bottom but getting past seasonal tax loss selling, this is a good time to look for companies with good stories. If companies are better known, I look for production or catalysts for increasing or extending production, important for increasing fundamental value or new discoveries. In this environment, you have a lot to pick from.
TGR: Can you give me some examples?
MN: Two of the best well-known examples that fit this profile include Minefinders Corp. (MFL:TSX; MFN:NYSE) and Alexco Resource Corp. (AXR:TSX; AXU:NYSE.A). Both have operating mines in stable jurisdictions and have profitable operations with good potential for increasing or extending production, as well as significant “blue sky” potential.
Minefinders is currently operating a low-cost heap leach gold-silver Dolores mine near Chihuahua. It is on schedule to meet guidance of about 65–70 thousand ounces (Koz) gold and 3.3–3.5 million ounces (Moz) silver in 2011. It is working on expanding with a mill operation to increase recoveries of higher grade ore from underground. This may add production in 2014; in the meanwhile it could bring its La Bolsa heap-leach gold project into production. This could add another 40 Koz gold starting in 2013. In addition, Minefinders is accelerating exploration of its La Virginia project with potential of generating a resource. Profitable operations should fund these activities, reducing the need to go to the market and risk diluting shareholders.
Also, Alexco just finished its first year of profitable silver production at its Bellekeno mine in the Yukon. We believe it will optimize operations, increasing production of silver as well as lead and zinc as a by-product. It is also working to open two new mines to provide additional feed to the mill. Alexco should also be updating its resource estimate at Bellekeno and may produce new resource estimates at its Bermingham and Flame & Moth targets. Alexco should also be able to fund initiatives from production. It is on course to meet current guidance of 2 Moz silver in 2011 and has the goal to achieve midtier producer status in the next decade by producing 7–10 Moz of silver annually.
We also believe Aurcana Corporation (AUN:TSX.V) fits this profile but is still largely under investors’ radars. Aurcana has expanded processing at its La Negra silver and base metal mine in Mexico from 800 to 2,000 tons per day. In addition to production from La Negra, Aurcana is scheduled to commence production at its Shafter silver mine by June 2012 with annual production of about 4 Moz silver in its first year of operations. We visited the project prior to the holidays and were very impressed. Also, Aurcana has hired Dr. Peter McGaw to locate additional mineralization at each project to extend mine life. The potential to increase profitability and identify additional mineralization could lift the investment profile of Aurcana.
TGR: What early stage precious metal exploration companies are you watching?
MN: While clearly at the riskier end of the investment spectrum, most junior explorers are near their 52-week lows, so there is clearly an opportunity for bottom-up stock selection. There are a number of companies that have completed successful drill programs or are drilling historic resources and are close to announcing initial resources. Explorers now at the lower end of their trading range, while continuing to advance their projects, may receive favorable investor attention and experience appreciation by meeting milestones.
One of my favorites is Redstar Gold Corp. (RGC:TSX.V), which recently acquired the Unga gold project in the Aleutian Islands in Alaska. In 2011 it drilled about a dozen holes late in the season in hopes of upgrading a historic resource in the near term. While early in the exploration at Unga, there are possibly 30 kilometers (km) of vein structures. The mineralization is reminiscent of vein swarms seen in Patagonia. Should Redstar complete a compliant resource, investors should have a better idea of the project’s potential. The Unga project is in addition to the company’s high-grade gold Newman Todd project in the Red Lake Gold Camp in Ontario and about a dozen projects generated in Nevada from the acquisition of AngloGold Ashanti’s Nevada database.
Similarly, Argentex Mining Corp. (ATX:TSX.V; AGXM:OTCBB) is scheduled to produce an updated resource in the first quarter of 2012 on its Pinguino project in the Santa Cruz Province of Argentina. The updated resource will focus on silver-gold mineralization near surface. In addition to the potential for a new precious metal resource, Argentex has blue sky potential having encountered mineralization in 16 of 19 veins drilled. This is only about a third of veins identified on the project. As Argentex has about $10 million in the bank, it is not trading much higher than cash per share.
Also, we visited Revolution Resources Corp.’s (RV:TSX; RVRCF:OTCQX) Champion Hills project in North Carolina last year. The company has completed about 15,000 meters (m) of drilling at Jones-Keystone and Loflin prospects and is working to complete an NI 43-101-compliant resource. Gold mineralization is similar to Romarco Minerals Inc.’s (R:TSX) Haile project located in South Carolina. Should it produce a significant resource, this should raise the investment profile of Revolution and demonstrate the potential of its growing land position.
We also visited High Desert Gold Corp.’s (HDG:TSX.V) Gold Springs project a couple months ago. Gold Springs is located on the Nevada-Utah border. The company recently announced a resource with about 233,000 gold equivalent ounces on one of 18 targets. This new deposit is open laterally and at depth with reasonable expansion potential. High Desert owns 60% of the project in partnership with Pilot Gold Inc. (PLG:TSX). High Desert recently completed a ZTEM geophysical survey allowing it to identify a number of blind targets and selectively expand the project to district scale, which is more important than the new resource. Additional drilling should lead to additional resources. We think High Desert has the potential to eventually build a several million ounce gold resource.
Probably our most intriguing idea is Gold Port Resources Ltd. (GPO:TSX.V). The company has a gold project in Guyana. Gold Port is still very early and located in a challenging rainforest setting. It is currently working to upgrade an historic resource of 94 million tonnes grading 0.7 grams/tonne gold and 0.15% copper. This historic resource was established over a decade ago at much lower metal prices by Coeur d’Alene Mines Corp. (CDE:NYSE). In the near term, should Gold Port confirm a fraction of the historic resource, it may move the company’s shares out of penny stock status.
TGR: Is your focus solely on precious metals?
MN: Primary gold and silver projects generally command a premium to base metal projects. But there are large copper-gold projects with a bias toward gold that should attract more investor attention if they can grow in size. Two companies that come to mind are Northern Freegold Resources Ltd. (NFR:TSX.V) and Kiska Metals Corp. (KSK:TSX.V).
Northern Freegold has already identified a million-plus gold deposit in the Yukon. The company recently completed a drill program on an adjacent gold-copper porphyry and is scheduled to produce a compliant resource in the coming months. This new target extends only over about 1km of a 6–8km anomaly. We believe the project has the potential to be competitive with Western Copper and Gold Corp.’s (WRN:TSX; WRN:NYSE.A) Casino project in size and grade but with a gold bias and with fewer infrastructure challenges.
Kiska also has a multi-million ounce gold equivalent deposit at its Whistler gold-copper project near Anchorage, Alaska. The company has discovered five additional porphyry targets and has completed 30,000m of drilling in 2011. Kiska is now aggressively exploring the large Island Mountain target. The gold mineralized zone comes to surface. The metallurgy is good and investors may take note of this target, which is still open in three directions. We believe in time the Whistler project has the potential to resemble other large projects in Alaska and British Columbia.
TGR: Thank you for your insights.
Mike Niehuser is the founder of Beacon Rock Research LLC, which produces research for an institutional audience and focuses in part on precious, base and industrial metals, oil and gas and alternative energy. Previously a vice president and senior equity analyst with the Robins Group, he also worked as an equity analyst with The RedChip Review. He holds a bachelor’s degree in finance from the University of Oregon.
By Doug Gentry, on December 30th, 2011
Was it Popeye’s friend, Wimpy, who kept asking for a hamburger on credit? Today’s credit markets are anything but robust, with reduced demand and supply for borrowed funds. Always eager to find obscure terms for modern dilemmas, economists refer to this condition as a liquidity trap. With a little prodding from Facebook friend and neighbor, Patrick, we’ll give the concept a once over.
Jumping to the conclusion (and resisting the academic approach of a slow, careful warm-up) there is bad news and good news about liquidity traps. The bad news is that they make it difficult for the Federal Reserve to execute monetary policy. Creating 100s of billions of dollars has a muted impact on our economic recovery. The good news is that the liquidity trap dampens the significant inflation we might expect with the creation of all that money.
OK, back to the beginning. During times of slow or no growth and high unemployment the Federal Reserve can create/inject money, largely by increasing reserves that banks have in their accounts with the Fed. They can do this by buying U.S. treasury bonds on the open market, or even by buying troubled/toxic assets from banks. This increase in the supply of money allows interest rates to fall, which in term spurs demand for more consumption and investment. This is classic monetary policy. With mild downturns this is often enough to increase growth and kick start the economy. For the most recent 2007-2009 recession the Fed took these actions, a number of times in a number of ways, and those actions were not sufficient. Now the target short term interest rate – the Fed Funds rate – is essentially at zero. The Fed can’t lower the interest rates any further. Here’s a graph of the Fed Funds rate since 1980. The big peak at the beginning of the graph was the result of aggressive Fed action to contain inflation. Now, though, the rate has sunk to the very floor.
 Fed Funds Rate – St. Louis FRED database One thing that is happening is that while reserves are building up in our financial system, the banks are holding on to them rather than increasing their lending. Some argue that the banks are using the added funds to improve their balance sheets, which were hurt by the dramatic loss in value of securitized mortgages and other derivative assets, and to build up enough cash to pay executive bonuses. The banks argue that demand for credit by qualified borrowers is low. I don’t put much credence in the latter explanation. One apt analogy for this situation is that the Fed is trying to push on the end of a string, in order to get the economy going.
There is another layer to the liquidity trap concept, and that has to do with the buying public’s (people and business) expectation for inflation. The theory goes that if buyers expect inflation in the future, they will increase buying now. They expect the value of their cash or savings to go down during inflationary times, so they seek to use it now, while its value is still high. This works with traditional monetary policy where an injection of money would be expected to increase inflationary pressures.
On the other hand if purchasers believe that inflation will be controlled, then there is less pressure to buy now. That’s what is happening now. Despite what some politicians suggest, inflation is not right around the corner, and buyers are in no hurry to convert their cash into goods. We see evidence of this with the continuing low interest rates on U.S. bonds. Expectations of high inflation would push those interest rates up. Low inflation expectations, even in the face of increasing money supply is another symptom of a liquidity trap.
This scenario played out, to grim effect, in Japan in the 1990s, as their central bank poured money into the banking system and no one responded. Their “lost decade” was one of almost zero growth.
This paper by a New York Federal Reserve staff economist explains things in more detail, complete with impenetrable equations.
By Ajay Shah, on November 7th, 2011
On 25 October, Dr. Subbarao announced a 25 basis point hike in the policy rate. Alongside this, he made statements that were widely interpreted as being dovish:
Keeping in view the domestic demand-supply balance, the global trends in commodity prices and the likely demand scenario, the baseline projection for WPI inflation for March 2012 is kept unchanged at 7 per cent. Elevated inflationary pressures are expected to ease from December 2011, though uncertainties about sudden adverse developments remain.
…
Inflation is broad-based and above the comfort level of the Reserve Bank. Further, these levels are expected to persist for two more months. … However, reassuringly, momentum indicators, particularly the de-seasonalised quarter-on-quarter headline and core inflation measures indicate moderation, consistent with the projection that inflation will begin to decline beginning December 2011.
…
The projected inflation trajectory indicates that the inflation rate will begin falling in December 2011 (January 2012 release) and then continue down a steady path to 7 per cent by March 2012. It is expected to moderate further in the first half of 2012-13. This reflects a combination of commodity price movements and the cumulative impact of monetary tightening. Further, moderating inflation rates are likely to impact expectations favourably. These expected outcomes provide some room for monetary policy to address growth risks in the short run. With this in mind, notwithstanding current rates of inflation persisting till November (December release), the likelihood of a rate action in the December mid-quarter review is relatively low. Beyond that, if the inflation trajectory conforms to projections, further rate hikes may not be warranted.
WPI inflation is not interesting in thinking about monetary policy. The WPI basket is not consumed by any household. The right measure of inflation that all of us should focus on is the CPI.
We just released an updated batch of seasonally adjusted data, and the news for inflation, for September 2011, is bad. CPI-IW grew at an annualised (seasonally adjusted) rate of 20.15% in September 2011. As a consequence, the 3-month moving average inflation went up from 8% in August to 11.77% in September. If we compute the policy rate as the halfway mark (8%) and subtract out this latest value of the 3-month moving average inflation rate (11.77%), the policy rate expressed in real terms is -377 basis points.
Here’s the picture of what’s been going on with point-on-point seasonally adjusted CPI-IW inflation:
The key fact about India’s inflation crisis is: “Headline inflation”, which I would define as the year-on-year rise of CPI-IW, has been outside the target range of 4-5 percent in every single month from February 2006 onwards. High inflationary expectations have now set in. Given what is happening on prices of both tradeables and non-tradeables, I find myself skeptical about the sanguine picture on inflation that was painted on 25 October.
The bottom line: Headline inflation (year-on-year rise of CPI-IW) went up from 8.99% in August to 10.06% in September. This is inconsistent with a sanguine analysis of inflation on 25 October.
Or perhaps the econometricians at RBI have some aces up their sleeves. Will point-on-point seasonally adjusted inflation, under the benign influence of a strongly negative real rate, veer back into the 4-5 per cent range by December 2011? Stay tuned. So far, the score is: September 2011, 20.15%.  
By Bron Suchecki, on November 1st, 2011
Very good two page analysis of negative lease rates by Pollitt & Co’s John Paul Koning, including central bank activity in this market. Quote:
What sort of “non-banks” might be supplying leased gold to the market-making banks at these extremely negative rates? As we already pointed out, central banks seem willing to lend only at positive rates, which leaves only one other source: the investing public. …
The public effectively lends gold to banks when they deposit their physical gold in unallocated form at a bank. … The negative interest rate received by the borrowing bank is probably in the form of client fees or bid-ask spreads. …
By serving as the cheapest source of lent gold, the investing public has effectively priced central banks out of the gold lending market.
The Perth Mint does a bit of leasing and certainly no one is paying us to borrow metal. However, unallocated accounts at bullion banks do attract an account keeping fee, as Koning notes, and this is effectively paying the bank to use your metal.
Another factor as to why investors may be prepared to pay people to borrow their metal is that it can be cheaper than the costs of storing it (ie Allocated). I do also think the derived negative rates are a theoretical interbank no counterparty risk rate. Once you add in a premium for the counterparty risk the actual rate is positive.
Finally, there is a mathematical relationship/arbitrage between the futures markets and GOFO (and thus lease rates) and this could also have an impact (not something I’ve been following too closely). 
By Ajay Shah, on October 18th, 2011
A lot is being written about inflation in India today. I thought it’s worth writing about the fascinating insights into inflation that come from focusing on the distinction between tradeables and non-tradeables.
What is a tradeable
A tradeable is a product which can be transported across the world at relatively low cost. As an example, steel is tradeable while cement or paint are mostly non-tradeable barring special short-hop opportunities like Gujarat-Karachi or Amritsar-Lahore or Calcutta-Chittagong or Trivandrum-Colombo.
Steel is a nice tradeable that one can think clearly about. There are no barriers to the movement of steel worldwide. Hence, there is only a world price of steel. The quoting convention used worldwide is to express the price of steel in USD. The price of steel in India is thus the world price of steel multiplied by the INR/USD exchange rate, plus a markup for freight (The cif/fob ratio).
If there is a customs duty of (say) 10%, then the price of steel in India is 1.1 times the world price of steel expressed in rupees. For the rest, nothing changes when a customs duty is introduced. Gram for gram, every fluctuation in the INR/USD or the world price of steel shows up in the domestic price of steel.
Non-tradeables are things like cement (which are hard to transport) or haircuts (which are impossible to transport).
Measurement
Before we can analyse and control inflation, we must measure it well. Inflation is defined as the rise in the price of the average household consumption basket. The CPI is the best measure of inflation in India.
Everything in the CPI basket can be classified into the two categories: tradeable vs. non-tradeable. As a thumb rule, WPI non-food non-fuel is a rough measure of tradeables inflation. Fluctuations in food and services prices, which make the CPI diverge away from WPI non-food non-fuel, are a measure of non-tradeables.
Year-on-year inflation reflects an averaging over 12 months. If you want to get a faster sense of what is going on, you need to look at point-on-point seasonally adjusted changes. These yield early warnings of inflation, which are 5.5 months ahead on average. Such data is updated every Monday by us. The shift from y-o-y inflation, to p-o-p SA inflation, is a free lunch in measurement and monitoring.
The WPI is a useful database of many price time-series in India. But the overall WPI is useless in thinking about inflation in India: there is no household in India which consumes the WPI basket.
The use of WPI inflation, and the exclusive use of y-o-y inflation, are litmus tests of professional competence in the Indian landscape.
The function of the central bank
The job of RBI is to deliver low and stable inflation: to deliver y-o-y CPI inflation of between 4 to 5 per cent.
They have failed in this task. From February 2006 onwards, in every single month, y-o-y CPI inflation has exceeded 5 per cent. This is an important time for introspection at RBI and outside it. What have we done wrong, in the structuring of RBI, which has got us into this mess?
It is useful to think of this as a principal-agent problem. The people of India are the principal. RBI is the agent. The principal hires the agent and gives him resources. In return, the agent has to be held accountable. Delivering low and stable inflation is the accountability mechanism. It is a quantitative monitorable measure of the performance of the central bank. That we have sustained failure on this function, from February 2006 onwards, suggests that we should be modifying the nature of the contract between the principal (the people of India) and the agent (RBI).
How RBI can influence the price of tradeables
RBI has absolutely no say on the world price of steel. In that sense, the prices of tradeables are beyond the control of RBI.
When RBI raises the interest rate, more capital comes into India, which tends to give an INR appreciation, thus making tradeables cheaper. Thus, an RBI rate hike does impact upon the domestic price of tradeables.
It is also worth pointing out that the central banks of most major countries are high quality inflation targeters. They deliver on their mandate of delivering low and stable inflation. As a consequence, inflation in the global tradeables basket tends to be low and stable. Tradeables prices are a helpful source of price stability, most of the time.
(That a large part of the CPI basket is tradeable, and seemingly beyond the control of the central bank, is no excuse. There are dozens of high quality central banks visible in the world, with very large shares of the CPI basket in tradeables, who are delivering on inflation targets. We in India should not accept excuses).
How RBI can influence the price of non-tradeables
Non-tradeables reflect aggregate demand and aggregate supply in India. RBI can influence these by raising or lowering the short-term interest rate. When interest rates are made slightly higher, household consumption and investment demand are slightly lowered.
A critical feature of non-tradeables inflation is expectations. If people expect 10% inflation, they tend to wire high price rises into their negotiation of wage and other contracts. This generates inflationary momentum. Particularly in a place like India, where the institutional structure of monetary policy is primitive, economic agents have little confidence in the ability of policy makers to rein in inflation. As a consequence, inflation is highly persistent. Once high inflation sets in, economic agents expect high inflation to continue. There is a great deal of momentum in inflation.
For years now, some economists have argued that inflation will subside by itself. It will not. Inflation does not mean-revert to the target zone of 4 to 5 per cent by itself. We are now in a trap of high inflationary expectations. This structure of expectations will need to be broken. This can happen in two ways. RBI needs to turn a new coat, and convince people that it now cares about inflation without any other conflicts of interest. And, rate hikes have to take place.
There are two paths to inflation control: changing the structure of expectations and reducing aggregate demand. The former is almost a free lunch. It only requires institutional change. The latter is hard work; it inflicts pain.
What about supply factors?
Some argue that supply bottlenecks in India – such as hideous rules about mandis – are the cause of inflation.
The trouble with this explanation is that the supply bottlenecks have always existed. They have existed in high inflation times and in low inflation times. It is, thus, not possible to claim that supply bottlenecks have caused the inflation crisis which began in February 2006.
Can rate hikes deliver inflation control?
When C. Rangarajan was RBI governor, there was an inflation crisis, and rate hikes did deliver on inflation control. The phase of price stability ushered in then lasted all the way till February 2006. This shows us that even in India, it can be done.
We have to remember that in his time, the monetary policy transmission was much weaker than what we see today. With a bigger wall of capital controls, domestic rate hikes did not deliver inflation control by impacting on the INR (through higher capital inflows). With a smaller and weaker Bond-Currency-Derivatives Nexus, the monetary policy transmission from the short rate into aggregate demand was inferior, then. Yet, he got it done.
Conversely, with a very primitive financial system and monetary policy transmission, the central bank of Zimbabwe delivered a nice hyperinflation. We can quibble about the potency of the monetary policy transmission, but we should not doubt the ultimate domination of monetary policy in shaping inflation. In the long run, little else matters in shaping inflation.
Part of the story of the 1990s lies in clarity of purpose at RBI and policy credibility. Rangarajan’s period had good quality speeches, which did not dilute the message on inflation control as the dharma of the central bank. In contrast, in recent times, RBI has repeatedly written low quality speeches. To an expert reader, they have conveyed the lack of knowledge on monetary economics at RBI. To the non-expert reader, they have waffled on the subject of taking responsibility, and have encouraged the average economic agent to think that high inflation is here to stay.  
By The Gold Report, on October 17th, 2011
 Casey Research Chief Economist Bud Conrad believes the United States is acting as a late-stage empire, acting aggressively on the world stage, lowering its moral standards and debasing its currency. In this exclusive interview with The Gold Report at the Casey Research/Sprott Inc. “When Money Dies” Summit, he explains the options for how the inevitable collapse will occur.
The Gold Report: At the Casey Research/Sprott Inc. Summit, you gave a presentation called, “A Crisis of Confidence.” After all the government stimulus from the U.S. and the rest of the world aimed at injecting liquidity and keeping interest rates low, why didn’t any of it work? Why is the economy still hurting?
Bud Conrad: First, printing money doesn’t create wealth. Putting bits in a computer doesn’t create wealth. When politicians hand out money, they are the ones who get powerful and the banks get wealthy. The middle class with savings gets hurt. What creates wealth is people working and creating things.
Internationally, the Chinese are papering over their slowing growth rate by providing liquidity, but paper money systems will collapse. That is the reality. The global financial system is supremely unstable. When people wake up to the fact that this is a “king ain’t got no clothes” economy, we will see a run to the exits.
TGR: It seems like we are saying that the currency is going to fail because of debt to gross domestic product (GDP), not because governments can print money. If governments were disciplined, then would printing money be a problem?
BC: When the U.S., and therefore every other country, went off the last vestige of the gold standard, we were placed in a fairyland. That is even more important than the debt. It is linked. Debt is the result of the ability to print money. If there were redeemability, the U.S would have stopped issuing debt when it ran out of money. Without fiat currency, the country wouldn’t have reached the current level of debt.
No government is disciplined. My question is: “Why are people letting them get away with it? Why aren’t people out protesting in the streets?” Thousands of bankers should be in jail right now. There is an attitude of resignation in young people today that dismays me. Maybe they know they can’t fight city hall.
TGR: If we are all resigned that whatever is going to happen will happen, how can people protect themselves?
BC: A lot of people probably believe that everything will be okay. When we have a financial collapse and people stop getting their payments and they see bankers and government contractors getting rich, maybe people will take matters into their own hands. It could be dangerous to be in the streets because people who are hungry will rob you.
TGR: If the bubble has already broken in the U.S. stock and real estate market and is getting ready to burst in China, are there any upside opportunities?
BC: In a paper money/fiat currency collapse, the things to hold are real assets—gold and oil will look like you are making money. Gold doesn’t change. It is just gold. When the price goes up, the metal isn’t any different. Only the dollar is going down.
There is also a moral component to the question. A lot of people are getting out of the country. This is where I was born and where my family lives and I am an American so I probably won’t go anywhere, but a lot of people are considering moving out of the U.S. to protect themselves and their assets.
TGR: What is your biggest fear for your children?
BC: That the government has turned it into a totalitarian state where the people don’t have personal freedoms to assemble, think and live their lives without surveillance, over-taxation and subservience to the state. I worry that my children and grandchildren could be impoverished by conflict, by a society that dissipates it resources in wars that only destroy wealth, rather than creating anything.
I also worry about how they will fuel their economic growth. Fossil fuels created the abundance of our generation like humanity has never experienced before. We have used half of the dinosaur remains out there. If we use it all up, then we will have to reduce the number of people on the planet. Now we need to start thinking about what is next. I don’t know how my grandchildren will live in an abundant society when energy becomes so expensive and scarce that we have big wars over it. It’s already happening. Energy explains the conflicts in the Middle East more than religion ever could.
TGR: You have said we are entering Cold War II. Can you explain that?
BC: Everyone is uncomfortable with the role we played in the Middle East. They fear we could enter a World War III. But a cold war is not a conflict between the main parties. We didn’t battle with the Russians directly. We fought in Vietnam. The same is going on with China in an economic war over resources. The U.S. bombs the place in hopes that a new government will come in and give us cheap oil while China is busy winning contracts for the access to resources in many far-flung regions from oil in Africa to soybeans in South America. China is building cultural centers and roads to mines in an attempt to gain the favor of the people while gaining access to resources. Our approach of bombing people just makes enemies and is very expensive. It is another example of the stupidity of a late-stage empire.
TGR: You have referred to the fight over access to oil, but I hear the U.S. is the Saudi Arabia of natural gas. Can that replace oil in the future?
BC: Like any extractive resources, we have to approach this new technology with care. Fracking can leave a messed up underground and contaminate water. But natural gas is abundant and affordable and it can make a difference.
TGR: What about uranium?
BC: The problem is not just the radiation and the bad design of the early plants revealed by Fukushima. The problem is that it isn’t price competitive. We can build nuclear plants safely, but it isn’t cost effective compared to oil or natural gas. There will still be a uranium mining business in replacing spent nuclear fuel, but not in building new plants for a while.
TGR: You mentioned we will soon have two retirees collecting benefits for every one worker. What is the solution for the imbalance between workers and beneficiaries short of older people wandering off into the desert so they won’t be a liability on their families?
BC: The government will continue to print money to meet its obligations to retirees, but the problem is that those dollars won’t buy as much in the future. That is why people are trying to find protection for their retirement assets. Those relying on Social Security will find it difficult.
TGR: We have heard about a possible economic slowdown or collapse in China, but it has one of the highest personal savings rates in the world. Wouldn’t that mitigate some of the economic turmoil of a real estate bubble bursting?
BC: China is strong because it has gone through so many revolutionary problems during the lifetime of people who can still remember. The Chinese know how bad it can be so they fight to avoid returning to economic subsistence levels. What China has done economically puts Japan’s economic miracle to shame. The country has overbuilt during the last few years, but it has a lot of people and the one-child policy is being dismantled. It will manage any bubble bursting well. We, in the U.S., have an arrogance of wealth and that blinds us to possible problems. That is why we are unwilling to take the strong necessary steps to right our economic disasters of too much debt, too much government and little concern for concentrating on economic development.
TGR: You said you are expecting a recession next year and a weaker economy or “stagflation.” Will that be limited to the U.S. or will it impact the entire world economy?
BC: The U.S. economy will suffer greatly because we are unprepared for how serious the situation will become, but this is a worldwide phenomenon. Inflationary central bank printing is going on in Europe and China so they will be impacted as well. The world is interconnected so what happens in the U.S. does spill over into other economies and the other way around. The European weak countries failing will cause several big European banks to fail, be nationalized and cause debt crisis for U.S. banks as well. International contagion is particularly true when the U.S. starts wars to divert people from thinking about the economy. Wars damage productivity of personal consumption and therefore the perceived wealth of individuals.
I think of the U.S. as a late-stage empire. There are lots of ways to collapse. The Third Reich collapsed cataclysmically. The British Empire wound down in a gentlemanly fashion. I think the U.S. is headed to Roman type of collapse where the internal dissipation was as big a problem as the external conflicts. We have a culture of corruption with no accountability. In this most recent crisis, no bankers have been indicted, never mind convicted, compared to the Savings and Loan crisis, when thousands went to jail.
TGR: How are you protecting your wealth?
BC: I have some precious metals and energy. I expect interest rates to rise.
TGR: You are predicting a weaker economy. When are interest rates going to move?
BC: How about now? I warn you, I have been wrong before. I predicted the debasement of currency would require higher interest rates to get people to invest. I didn’t give enough credit to the Federal Reserve’s ability to manipulate the market. We are now at record low rates and the government deficit is at such extremes that rates can only go up. I don’t know how it will all unravel. But at some point people will wake up to this sham and they won’t want to keep their money in banks. Then they will go buy physical assets, gold and food and, sometime later, real estate.
TGR: After all this bailing out, what will be the trigger point for a collapse?
BC: We all want to know that. We look at the numbers and I can’t see it going on for the rest of the decade. When it goes, it could go very rapidly. The markets feed on themselves more now than at any other point in time. What happened over a period of years in the Great Depression could take weeks this time around. Currency collapse could happen quickly. The collapse is already happening in Europe and more countries may follow Greece.
This is not war; it is merely the collapse of a currency. People aren’t wiped out by the thousands. But their savings are. Currency disintegration is not unusual. It happens all the time—about once a generation a collapse happens in every country. The fact that the U.S. dollar is the second oldest in existence today is an anomaly, an anomaly that may come to an end soon.
Bud Conrad holds a Bachelor of Engineering degree from Yale and an MBA from Harvard. He has held positions with IBM, CDC, Amdahl and Tandem. Conrad, a futures investor for 25 years and a full-time investor for a decade, is also sought after as keynote speaker in Dubai, New Zealand, Vancouver, New York and many other cities. He has appeared on TV on CNBC, FOX, and on many radio shows. As chief economist at Casey Research, he produces original analysis.
By B.P.T., on September 30th, 2011
With the stock market swinging up and down as the economies in the United States and Europe appear to be heading back towards a recession, it could be a good idea to move your savings out of the stock market and into safer asset classes. However, the Federal Reserve has stated that it plans to keep interest rates as low as possible for the foreseeable future, and has taken steps to drive interest rates even lower than the current record lows by swapping longer term debt for short term debt. Because of this, interest rates on savings accounts are hovering around 0%, making them a poor choice with inflation rates over 3%. Bonds are the other common alternative, but they are also seeing their rates driven down by the actions of the Federal Reserve, and they are affected by many of the same economic risks as stocks.
Since the stock and bond markets appear to be too risky at this time, and savings accounts paying near 0%, one alternative that allows savers to avoid risk and obtain a higher return on their savings is certificates of deposit, or CDs. According to the SEC, CDs are protected by the same insurance as savings accounts (currently $250,000), yet offer a higher yield than savings accounts, making them an attractive investment. However, savers are generally required to keep their deposit locked up in the CD for a fixed amount of time that can range from six months to 10 years, so it is important to ensure that the principal invested in the CD will not be needed until the CD matures, or a penalty could be imposed for early withdrawal. Other considerations to keep in mind are whether the CD offers a fixed rate, whether it can be called early by the bank, how often the earned interest is paid, and if a CD is offered by a broker instead of a bank, the reliability of the broker must be investigated, since they act as an intermediary between the saver and the bank where the funds will be stored.
Almost every bank offers CDs of some kind, and most banks will sell CDs to investors without requiring them to open a savings or checking account at the bank, so there are plenty of options available to people looking for a safe place to put some savings. I suggest researching the options online to see which CD is best for you, but when I checked today, Discover Bank offered rates that were well above the national average, along with easy funding options and reasonable early withdrawal fees. If you have some spare cash sitting around in a savings or checking account that is earning little to no interest and you know you won’t need it for some time, a CD could be a good investment choice.
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By The Gold Report, on September 13th, 2011
The money supply increases naturally by exactly the amount of increases in productivity in a healthy economy, notes Stansberry & Associates Investment Research Founder Porter Stansberry. He doesn’t have to point out that the economy isn’t healthy, nor that the money supply expands every time the printing presses run to bail out a failing business and bring on a new iteration of quantitative easing. The solution is a simple (albeit not necessarily easy) one, Porter tells us in this exclusive Gold Report interview: Return to the gold standard. That will happen, he says, when the people say, “Enough!”
The Gold Report: You’ve written a lot about the gold standard recently, and an article in your S&A Digest argues that we should greatly prefer gold-backed money because it would limit the ability to increase the money supply. It goes on to point out that increasing the money supply essentially causes inflation. If regulations prohibited governments from expanding the money supply, would fiat currency be as good as the gold standard?
Porter Stansberry: In theory, it could be, but in practice that’s never happened. I suspect that the market wouldn’t have much faith in such rules, and they’d be abused eventually. During the Volcker and Greenspan Federal Reserve periods, from roughly 1981– 2006, two central bankers created a de facto gold standard because they remained relatively consistent vis-à-vis money supply targets.
Volcker absolutely targeted money supply, as did Greenspan up until about 1999. He moved away from that stance due to Y2K fears and then the 2001–2002 recession. So we’ve seen long periods in fiat systems where money supply growth was targeted and fairly reliable.
The problem, of course, is that the gold-standard rules don’t apply across the banking systems. When the Fed was targeting money supply, bankers lobbied for all kinds of changes related to reserve ratios, which allowed them to massively increase the leverage on their balance sheets. Famously, the investment banks—Bear Stearns, Lehman Brothers and others—went from, say, 15:1 to 50:1. That had a tremendous impact on the amount of credit in the economy, which ultimately led to the collapse we well remember. Then the Fed started to radically increase the money supply to help reduce the impact of those bad loans.
That’s a long way of saying that efforts to mirror a gold standard by rule have never been effectual in history, and they haven’t worked in America over the past 40 years.
TGR: So changing the reserve requirements, in essence, increased the money supply.
PS: Let’s talk definitions. When I’m talking about the monetary base, I’m talking about the size of the Fed’s balance sheet, which is the foundation of the U.S. fractional reserve banking system. When you increase the size of the Fed’s balance sheet, you can have multiple increases of the actual money supply from that base. By targeting that base, Volcker restrained credit growth in the economy. Greenspan was less successful at that because he chose to expand the monetary base for political reasons.
In any case, just controlling the monetary base did not control the impact of increases to banks’ balance sheets and leverage ratios, simply because they lobbied successfully to change the rules. They got permission to increase their leverage. The monetary base didn’t change, but the money supply increased due to the actions of the banks. It would have been impossible under a gold standard for the simple reason that the banks would be subject to runs on their gold. That doesn’t happen in a paper system.
I’m not saying that there would never be another run on a bank, but bankers would have a palpable fear of losing control under a gold standard because the market discipline is so much fiercer now. They never would have leveraged 50:1 under a gold standard. It would have been completely implausible.
But as long as there’s this notion that they can get a bailout of any size by turning on the printing press, maybe the discipline isn’t quite so sound. That’s exactly what we’re seeing. So rather than allowing runs on the bank or rather than allowing banks to default and for depositors to lose, the government is printing as much money as is required and is giving it to the banks.
TGR: Is expanding the money supply actually a bad thing?
PS: In a healthy economy, the money supply would increase naturally by exactly the amount of increases in productivity. In fact, one of the main features of the gold standard is that it creates a balance between creditors and debtors. Creditors are more willing to lend money because they know the money they’re going to be repaid will be sound. Likewise, borrowers are more reluctant to take on debt because they know there’s not an easy way to repay it.
One of the main reasons you should prefer a gold standard is that it limits increases in the money supply to real increases in productivity. A second reason is that it simultaneously limits the availability of credit. Those limits mean that powerful interests in the economy and/or the government can’t simply create whatever credit they need to buy whatever assets they want. In a true free market, credit is relatively difficult to come by and can’t be manipulated by the various interest groups.
But in a free market that uses paper currency, it’s very difficult to actually maintain ownership of key assets because competitors in the marketplace may have access to political capital that allows them to buy whatever they want. You see this all the time in various industries, particularly those influenced by the government. In media, for instance, a very small number of vested interests end up owning and controlling all media properties because they have access to credit that their competitors don’t. That’s very difficult to pull off in a gold-standard system.
TGR: When you say they have access to credit that their competitors don’t, are you talking about on a worldwide basis?
PS: I’m talking particularly about the U.S. system, where the well-connected, money center banks—J.P. Morgan, Bank of America, etc.—essentially have access to unlimited amounts of credit, and they can finance almost any kind of takeover they choose, especially if it’s favored by the government that they do so. They can do that because, again, there’s so much flexibility in the monetary base, and credit is so easy to come by. It can be printed. You can’t print gold, so under a gold standard, the government wouldn’t allow the banks to have that much credit because it wouldn’t be able to bail them out.
TGR: So if the U.S. went to a gold standard, wouldn’t international companies have an advantage over those based in the U.S?
PS: No, not at all. If our currency were backed by gold, it would be very difficult for foreign investors to buy U.S. assets. One of the big calamities of our current situation is that by devaluing the dollar by 20% over the last three years—which is what’s happened—our government has made everything in the U.S. 20% cheaper for foreign investors. We’re burning the family furniture to keep the heat on in this country.
It doesn’t make any sense to devalue an economy the size of the U.S. by 20% merely in the hopes of making the stock market or employment go up a couple of percentage points. Giving away your country by devaluing your currency in order to produce economic activity is madness. That couldn’t happen under a gold standard.
TGR: One of your articles drew the link between devaluing the currency and calling it what it is: inflation. Your great chart, the CRB Futures Index Growth since 1955, shows a spike in 1971 when the U.S. went off the gold standard, and then bounces around rather wildly, never going back to the ‘71 levels. Presumably, that shows how the dollar’s purchasing power has declined, and you relate it to inflation. Interestingly, you also wrote that well-known economists—including some at Stansberry & Associates—continue insisting that there’s no inflation. What arguments do they use to support their viewpoints, and why are those arguments flawed?
PS: The most well-known person in the deflationist camp is Robert Prechter, but there are many others, including some who work for me who are persuaded by those arguments. We have a running debate because I think these people are foolish to be able to look at any long-term chart of the dollar’s purchasing power and claim any deflation’s going on.
TGR: When did this trend in decreasing purchasing power begin?
PS: Pick your date, and the dollar has lost 90% of its purchasing power from that day. A good way of thinking about this is to think about being a millionaire in 1900. To be a millionaire in 1900 was just unheard-of rich. At the time, gold was worth $20 an ounce, so to be a millionaire then, you’d have been worth 50,000 ounces of gold. And today? That amount of gold is worth about $100 million.
So gold’s supply-and-demand dynamics haven’t changed that much, and its intrinsic value, I would argue, hasn’t changed at all. What has changed, of course, is that the value of our dollar has collapsed by almost 100%. If you go through history and you realize that in 1971 gold was worth $35 per ounce, you can see that it’s declined 97% since then.
Just during the time Greenspan was at the Federal Reserve, the purchasing power of the dollar fell by about 50%. There’s no deflation in our money supply, and therefore no real lasting decline in prices. For people to say otherwise, I think, is incredibly stupid. No evidence whatsoever suggests that a fiat-backed currency system will ever cause a lasting deflation. And to believe that a short-term decline in prices in one market or another is tantamount to deflation is simply bad economics. It’s not true at all.
You have to look at broader measures of prices to see the impact of inflation, and you have to understand the impact of increasing the monetary base. If you increase the monetary base threefold, over time you’re going to see a very large increase in prices. Then, beyond all these nuts-and-bolts aspects, just look at history. Where is the fiat currency that collapsed because it became too valuable?
TGR: Part of the logic in going to a gold standard is to eliminate the inflation or eliminate the devaluation of the dollar. Isn’t some level of inflation a good thing?
PS: Why? Why should the monetary system favor one party over another? Why should debtors have an advantage over creditors? Doesn’t that retard lending? Doesn’t it retard economic growth when creditors constantly worry what the inflation rate’s going to be?
TGR: Speaking of economic growth . . .
PS: The fastest period of wealth creation in American history happened in the decade of the 1880s, during which the U.S. was on the gold standard. If you go back all through history, you find that economies do better with sound money. It’s no mystery why. You can’t make long-term investments without stability in the money. The instability does nothing but increase the prestige and power of the vested interests who control money supply, interest rates and the inflation rate. It makes it impossible for everyone else to do business.
Why isn’t a gold standard automatically the status quo in a democracy? Why would anyone ever want to get away from that, allowing the government to have both the swords of justice and the scales of money under its control? The outcome is always the same disaster. Credit grows uncontrollably and eventually the printing presses have to get turned on to pay back all the debt. Needless to say, we’re in the midst of one of those scenarios now.
TGR: Were any economists in 1971 warning that at some point down the road, abandoning the gold standard would trigger these credit problems and massive inflation?
PS: Absolutely, and some great economists were raising these issues as early as 1933, when FDR began to really move the U.S. away from the gold standard by making gold inconvertible, meaning that you couldn’t go exchange your dollars for gold at the bank. From that point forward, we were really on a pseudo-gold standard. All the economists who warned about what would happen were right.
TGR: And people apparently didn’t know the history of fiat currencies.
PS: True. Also, of course, it takes a lot longer for paper systems to break down than people expect because they’re completely reliant upon the confidence of the people using the system, and it’s in everybody’s best interest to play “hear no evil, see no evil”—nobody wants to see the whole house of cards crumble. But eventually it does crumble and people hedge their potential inflationary losses by buying gold and silver. That’s happening now.
TGR: A common argument is that there isn’t enough gold either in vaults or in the ground to return to the gold standard. The amount of gold above the ground was estimated at 158,000 tons in 2008, or 5 billion ounces. The nominal gross domestic product (GDP) in the U.S. is $14 trillion.
PS: The nominal GDP has nothing to do with the monetary base, which is where to look in terms of understanding a healthy ratio between gold and the dollar. The monetary base in the U.S. is a fraction of the GDP—about $2.865 trillion. Even so, if you tried to back every single dollar with an ounce of gold, you’d have an astronomical price of gold—that won’t work.
You want a gold standard that you can get to without taking 50 years or without greatly reducing the amount of money in circulation in your economy—a sensible transitional period that isn’t so deflationary that everyone goes bankrupt. Going from a situation in which we’d had inflation of 4–6% a year over the last 40 years to a period where you’re actually having deflation of the monetary base by 4–6% a year in order to get back on the gold standard would devastate debtors. You want a transition that treats creditors and debtors fairly and gets the economy back on a fixed standard, from which point we can move forward.
But you don’t need an ounce of gold backing every single dollar to maintain the standard in the vault. You need good lines of credit so that demand can be met. That was done over long periods of time, hundreds of years, very safely, very effectively, with relatively small amounts of gold in reserve.
Obviously, you need more reserves during times of crisis when people are nervous about the system. But what makes the system work is that the price at which people can demand gold remains unchanged. And people need faith that balance will return even if there’s a disruption in the demand system. After the Civil War, for instance, it was important that the greenback returned to its prewar value, that the gold standard was reinstated at the same price. And that price remained in effect all the way until 1933. So it’s not important to have an ounce of gold to back every single dollar; it is important, however, to have a reserve system that works, confidence that it works, and the political will to stick to the price to ensure that it keeps working.
TGR: That good credit you mentioned, especially when you hit economic bumps—where does that credit come from?
PS: The various large bullion banks would have swap lines with one another. If there’s an economic problem in Germany, for example, the Fed might lend gold to the German Central Bank to meet requests for the redemption. You can do it any way you want.
TGR: Would other countries also have to return to the gold standard to have that international credit option?
PS: The U.S. could do it alone, but it would certainly work a lot better if more of our trade partners agreed to the same standard. The economic area would be larger, too, so there would be more diversification of labor and more economic growth.
TGR: You’ve suggested that we could return to a gold standard by setting a target date 10 years in the future and then allowing the market to reach the appropriate price level. Taking only 10 years to get it back in balance sounds optimistic.
PS: It really depends on what you want the price to be. After the Civil War, it took 14 years because it was important to the bankers at the time that we return to the right price.
You probably could set the price easily between, let’s say, $5,000 and $8,000 per ounce of gold, and have the reserves necessary to make the system work today at the Treasury. People could go exchange dollars for gold as much as they wanted, and have confidence in the system at that price. You could do it right now.
TGR: What would be the catalysts to spark the move to return to the gold standard?
PS: I think the catalysts will be the destruction of the dollar and the ongoing inflation. Look at corn prices. When people around the world can’t afford food because the U.S. dollar has lost its purchasing power, it leads to revolutions, unrest, violence, people abandoning the dollar, failures of banks, collapsing markets and all these volatilities that we see. In my mind, returning to the gold standard is inevitable because nothing in human nature has changed in 4,000 years. As long as there is paper currency, it will be debased, and it will cause problems. Sooner or later, people will tire of it and return to gold. I think we’re in the middle of that transition as we speak.
TGR: If we’re in the middle of it, when do you suppose we’ll actually have a plan to go back to a gold standard? Steve Forbes says it’ll happen within the next five years.
PS: I think it’ll happen during the next Administration. At some point, to get people back to work, to get the country moving in the right direction, we’ll have to make a big economic readjustment. We’re going to have to get rid of the large overhead costs of government, return to lower taxes, and return to sound money.
TGR: Do you really think anything like that can happen, considering the recent debacle over the debt ceiling in Congress?
PS: I personally think we’re going to have an enormous dollar crisis, and that we’re only in the very beginning of it. The dollar has lost 20% of its value since 2008. I think it will lose another 20% over the next 12 months, and the population in America will get really tired of that very quickly. I expect a big political change in this country when people are fed up and say, “We’ve had enough—enough bank bailouts, enough of the money printing, enough of our wages being stolen by inflation. We want a system that doesn’t depend upon the good graces of politicians for its value. We want to use gold as money so that our savings are protected.”
TGR: So the people rather than the politicians will provide the political will needed to return to the gold standard?
PS: Absolutely. Politicians are never leaders in political thought. They follow the polls.
TGR: You’ve made it pretty clear that had we been on the gold standard we wouldn’t be struggling with this economic crisis. You mentioned people’s wages being stolen by inflation. Millions of Americans aren’t even making wages these days because they’ve lost their jobs. And we still have that tremendous debt load hanging over us.
PS: There’s no doubt at all that if we had been on a gold standard we would have never seen a credit bubble the size of the one we have now. It would have been very difficult for us to have the kind of economic problems we’re having.
As for the debt, there’s 400% of debt-to-GDP in the U.S. right now—not future liabilities, not Medicare out to 100 years from now. We can’t get people back to work and jumpstart our economy because we cannot afford to pay these debts. These debts are also the reason why we have to keep printing more money. We’re absolutely drowning in debt, and the only way out is to paper those debts over by printing enormous amounts of money that will devalue people’s wages through inflation and also, of course, diminish their net worth by lowering the value of everything they own.
The total debt in our country right now is $56 trillion, and the Fed has monetized roughly only $3 trillion of it through quantitative easing (QE) so far. We haven’t even begun to see this happen yet. We’re going to see QE3, then QE4, and on and on. And, in general, each level will be larger than the previous, so the numbers will get bigger and bigger as the Fed races against the market to devalue these debts.
TGR: Then how do we get back on the gold standard?
PS: Sooner or later people will say, “Enough!” I can’t tell you when that day will arrive, but I’d be surprised if the next Administration comes and goes without a return to gold.
TGR: This has been a pretty compelling conversation, Porter, and a lot of our readers will want to watch your video/read your essay that goes beyond what we’ve talked about today.
But before we let you go, you’ve said that unless investors are willing to speculate and start shorting equities, they probably should stay out of the equity market because you’re looking at a long, serious bear market. You advise these people to put 50% of their money into short-term Treasuries and 50% into gold. What’s the logic of the Treasuries if you expect the dollar to be devalued?
PS: One-year Treasury bills offer some protection from inflation because they have such a short-term duration. You won’t lose a lot to inflation with such instruments. They pay you something to hold them, too—although not very much.
The reason for holding these instruments is to reduce the volatility of the gold holdings. If you’re not going to hold other securities, all you want is to keep the value of your account stable. Taking half of the uptick in gold over the last year—a gain of maybe 20% and there’s no way that price inflation has been 20% in the last year—you’ve made a net gain in real terms.
If people are simply able to retain the purchasing power of their savings in the midst of this massive global monetary crisis, they’ll have done a great job. The thing to do now is not to lose, and the safest way not to lose is to go half gold, half cash.
On the other hand, investors who are in a position to be able to speculate can look at my newsletter’s portfolio and see that we’re long certain stocks that are positioned to profit from these problems and we’re short the stocks that are positioned to suffer from them.
After serving a stint as the first American editor of the Fleet Street Letter, the oldest English-language financial newsletter, Porter Stansberry began Stansberry & Associates Investment Research, a private publishing company, 11 years ago. S&A has subscribers in more than 130 countries and employs some 60 research analysts, investment experts and assistants at its headquarters in Baltimore, Maryland, as well as satellite offices in Florida, Oregon and California. They’ve come to S&A from positions as stockbrokers, professional traders, mutual fund executives, hedge fund managers and equity analysts at some of the most influential money-management and financial firms in the world. Porter and his team do exhaustive amounts of real world, independent research and cover the gamut from value investing to insider trading to short selling. Porter’s monthly newsletter Porter Stansberry’s Investment Advisory, deals with safe value investments poised to give subscribers years of exceptional returns. You can learn more about Porter and his ideas by clicking here.
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