Bearish News

Lots of wisdom in this guest-post by Jesse of Jesse’s Cafe Americain.

By Jesse

Well, the good news for everyone is that nothing seems inevitable here, that there is almost always a choice, but it is often wrapped up in a nice looking rationale, with all the compulsion of a necessity, for the good of the people. Us versus them in a battle for survival and all that.  And clever leaders on the extremes provide the ‘them’ to be dehumanized and objectified.  The leftist wishes to murder the bankers, and the fascist the lower classes and outsiders.  The extremes of both end up making life miserable for almost everybody except for a privileged few.

And so I reiterate that in a purely fiat currency, the money supply is indeed fiat, by command.

People like to make arguments about this or that, about how so and so has proved that the Fed does not or cannot do this or that, that banks really create money only by borrowing, that borrowing must precede this or that.

It’s mostly based on a fundamental misunderstanding of what money is all about, with a laser beam focus on hair-splitting technical definitions and loquacious arguments more confusing than illuminating, lost in details.  In a simple word, rubbish.

Absent some external standard or compulsion, the only limiting factor on the creation of a fiat currency is the value at exchange of the issuers bonds and notes, and currency which is nothing more than a note of zero duration without coupon.

If I had control of the Fed, unless someone stopped me I could deliver to you hyperinflation or deflation without all that much difficulty from a technical standpoint. The policy reaction of those who might be in a position to fire or lynch me is another matter.  The Fed not only has the power to influence money creation in the private banking system.  It has the ability to expand its balance sheet and take on existing debt of almost any type at will and at any price it chooses.

But that is the case as long as the Fed has at least one willing partner in the primary dealers, and the Treasury is in agreement. And even that requirement for a primary dealer is not all that much of an issue given the amounts of existing sovereign and private debts of which the Fed might avail itself for the forseeable future.

So at the end of the day, a thinking deflationist is almost reduced to the argument that ‘the authorities will not allow it’ or ‘will choose deflation rather than inflation’  And this is technically correct. However, let us consider my earlier statement about those who might fire or lynch one for making a highly unpopular choice.

It is economic suicide for a net debtor to willingly engage in deflation when they have other options at their disposal, and especially when those decisions involve people outside the system.

That is not to say that the deciders could not opt for economic suicide, but the people designated to suffer and die for that choice and cause might not take kindly to it. Deflation favors the creditors significantly, and those creditors tend to be a minority of domestic elites and foreign entities.   Both the extremes, hyperinflation and deflation, are choices best implemented in autocratic governments.

There are those who observe that Franklin Roosevelt ‘saved capitalism’ by his actions in the 1930′s and I believe they are correct. If one considers the various other outcomes in large developed nations to the Great Depression, whether it be Italy, Germany, Russia, or Spain, the US came out of it fairly intact politically. People conveniently overlook the undercurrent of insurrection and violence that was festering amongst the suffering multitudes, and the growth of domestic fascist and communist organizations.  There were several plots to overthrow the elected government by military means, although the history books tend to overlook them.

So it is really about making the best choice amongst bad choices. This is why governments choose to devalue their currency, either with quantitative easing, or explicitly against some external standard as the US did in 1933. Because when the debt is unpayable, it must be liquidated, and the pain will be distributed in a way that best preserves the status quo.

Hyperinflation and a protracted deflation are both very destructive choices. So therefore no rational government will choose either option.

They *could* have those choices imposed upon them, either by military force, political force, or by economic force. Economic force is almost always the cause of hyperinflation.

So you can see why a ‘managed inflation’ is the most likely outcome at least in the US. The mechanism has been in place and performing this function for the last 100 years.

The problem or twist this time around comes when the monetary stimulus does not increase jobs and the median wages, because of some inherent and unreformed tendency in the economy to focus money creation and its benefits to a narrow portion of the populace. The result of this is stagflation which although not indefinitely sustainable can be maintained for decades.  Most third world republics are like this.  A vibrant and resilient middle class is sine qua non for a successful democratic republic, and this has strong implications for the median wage.  The benefits and the risks of growth and productivity must be spread widely amongst the participants.  Oligarchies tend to spread only the risks, keeping most of the benefits to themselves.

This is essentially the reasoning that occurred to me when I looked at the US economy and monetary system in the year 2000.

The one point I remain a little unclear on is how ‘hard’ the law is regarding the direct monetization of debt issued by the Treasury. I am not an attorney, but I am informed by those familiary with federal statutes that this is a gray area in the existing law but currently prohibited.  But it is easily overcome as I said with the inclusion of one or two amiable primary dealers who will allow the debt issued by Treasury to ‘pass through’ their hands in the market, on its way to the Fed at a subsidized rate.  For this reason, and for purposes of policy matters, and occasional economic warfare, countries may tolerate TBTF financial institutions with whom they have ‘an understanding.’

I have also come to the conclusion that no one knows the future with any certainty, so we must rely probability and risk management to guide our actions.

So really absent new data the argument is pointless, a matter of uninformed opinions. The dollar will continue to depreciate, and gold and silver and harder currencies appreciate, until the fundamental situation changes and the US economic system is reformed.

I think there are other probable outcomes that involve world government and a currency war, and this also is playing out pretty much as I expected.  Fiat currency can take on the characteristics of a Ponzi scheme, whose survival is only possible by continuing growth until all resistance is overcome.

This is the conclusion I came to in 2000. I admit I was surprised by the Fed’s willingness to create a massive housing bubble, and the willingness of the US government to whore out the middle class in their deals with mercantilist nations; their hypocrisy knows no bounds.

So that is the basis of much of my thinking and I wanted to take a moment to share it with you in a compact, highly condensed format.

I remain a little unsettled on the issue of hyperinflation, because there is the possibility that a large bloc of countries could join together to repudiate the dollar. Since so much dollar debt is held in these foreign hands, that is the kind of exogenous force that could trigger a bout of what might be termed hyperinflation. I don’t see the dollar going to zero in this, but rather the dollar having a couple of zeros knocked off it, with a new dollar being issued. I have read John Williams case for hyperinflation several times now, and see nothing more compelling in it.

Indeed I think the reissue of the dollar with a few zeros gone is inevitable. It is the timing of that event that is problematic. It could be one year, or it could be fifty years. There is a big difference there for your investment strategy.

And yes, the government could just get medieval on your asses, and seize all the gold and silver, force you to take the value of the dollar at whatever they say it should be. They could also seize all the farm land, all the means of production, and tell certain groups of people to get on freight trains for resettlement in Nevada. I think we can stipulate that governments can do this, and the people can accept it to varying degrees. If you wish to make this the dominant assumption in your planning then by all means.

For those who simply say “I disagree” or “Go read so and so he has proved this or that” I say that people believe lots of things, and can find data selectively to support almost any outcome they prefer,  But the market is the arbiter here, and the verdict so far is beyond all question. The Fed is doing exactly what they said they would do, so there should be no surprises. And they have more in their bag of tricks.

If there is new data I would certainly adjust my thinking but absent that I now consider this settled to my satisfaction, and wish to turn instead to more thinking on what changes need to occur to prevent the system breaking down, and restoring it to some semblance of reasonable functionality.

Re-published with author permission.

Guest post from SovereignMan.com. Published with author permission.

By Simon Black

Doing his best to appear convincing yesterday, President Obama outlined his plans to make deep cuts to America’s budget deficit.

“If our creditors start worrying that we may be unable to pay back our debts, it could drive up interest rates for everyone who borrows money…” This is some of the clearest language we’ve seen yet– that official policy is to screw the people who work hard and save their money in order to benefit debt junkies.

Low interest rates, however, have had little positive effect. Unemployment is still painfully high, and inflation is now shifting into third gear.

The dollar falls almost daily to embarrassing record lows against world currencies, commodities… basically anything that’s NOT the US dollar… as institutional investors and money managers look for a better store of value.

The euro a questionable option. The dollar is fundamentally weak because of the US government’s ongoing efforts to debase the currency… but the euro is equally weak because of many member states’ economic fragility.

Portugal is officially broke, though Portuguese people refuse to accept budget austerity. Greek, bond yields are now over 13% as that country’s Finance Minister George Papaconstantinou hinted at debt restructuring. Spain is living solely by the grace of critical liquidity injections from China. Et cetera.

And then there’s Japan. Already in debt over 200% of GDP, post-tsunami spending will likely send debt levels surging. Furthermore, Japanese exports depend on a weak currency, and we have already seen world central banks coordinate efforts to weaken the yen when it rose beyond the low 80s versus the dollar.

Between these three currencies, the dollar, euro, and yen, total M2 money supply represents roughly $30 trillion, and the total size of their sovereign debt markets is even higher.

This provides plenty of liquidity for banks and money managers– if they lose confidence in the dollar, there’s a large enough market in euro and yen to move capital into those currencies without causing a major swing in prices.

Unfortunately, none of those three currencies is really a good option. Perhaps even more unfortunately, there is not enough liquidity in smaller, more suitable currencies to be able to absorb large capital inflows.

Singapore, for example, has a fairly sound currency and strong economy. The government has allowed its currency to appreciate in order to offset inflation, and the Singapore dollar has risen to an all time high against the US dollar of S$1.25.

Total M2 money supply in Singapore, however, only amounts to $325 billion, and the sovereign debt market is roughly $100 billion… far too small to absorb trillions of dollars in institutional wealth.

Money supply in Chile stands at $123 billion, $301 billion in Norway, $735 billion in Switzerland, and $1,200 billion in Australia. In total, these currencies are a drop in the bucket compared to the $30 trillion in dollars, euros, and yen.

Over time, have appreciated significantly. We’re seeing record highs in the Chilean peso, Swiss franc, Aussie dollar, etc. Eventually, though, governments will reach their breaking points and intervene. Even the soundest currency and strongest economy is susceptible to intervention.

Conversely, gold is one of the only stores of value that isn’t controlled by a single government authority; its price and value cannot be dictated by bureaucrats and politicians… and unlike the price of corn, rice, oil, and gas, the gold price is not politically sensitive.

With a total market size of roughly $8 trillion at today’s prices, gold is much larger than the basket of smaller currencies like the franc or peso… and devoid of any political sensitivity, gold is quickly becoming the preferred place to park capital.

Picking it up at its all-time high of $1470 may be psychologically difficult, but as long as world central bankers continue to print and debase their currencies, more and more money is available to flow into gold.

There’s no need to rush out and buy every ounce you can today; there will be ups and downs, particularly over the next few months as the market tries to figure out if/when QE3 will happen.

The long-term prospects for gold, however, are solid. The price of gold is fueled by increased debt, the expansion of money supplies and geopolitical instability, all of which are in abundant supply.

Despite what you hear about recovery, the fundamentals of the world’s economic problems have not been addressed… merely papered over with temporary magic tricks.

A real discussion of the challenges and solutions is years away, and until that happens, trillions of dollars more will be printed, a great deal of which will flow into the gold market.

In a future letter, I’ll tell you why you should store it overseas.

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This article courtesy of SovereignMan.com: Notes From The Field, a free newsletter dedicated to individual freedom, internationalization, asset protection and global finance. For a complimentary subscription, visit http://www.SovereignMan.com.

It truly is stunning to watch. From campaign to presidency, Mr. Obama has transformed from bank critic into a bankster’s BFF. From a supposed champion of liberty and civil rights into a Patriot Act extender.

From questioning the war on drugs (and talking about snorting cocaine in his book), to prosecuting medical-marijuana clinics in states that dare to question Federal policies.

Guest post by Jesse, re-published with author permission.

You walk into a Merchant and a sign says, “All Items on Sale Today for Cash Only No Credit.”

You are interested in purchasing an item. The Merchant, being a crafty sort asks “How much money do you have to spend(in US dollars)?”

How would you answer that if you are being truthful?

You might start by looking into your wallet and pockets, and counting all the cash and coins you have with you at that moment.

M0: Monetary Base

This is equivalent to the monetary base, or M0. It is money you have that is immediately available requiring no change or conversion. There is very little risk to the merchant, unless it happens to be counterfeit which is easily verified.

“Not enough” says the Merchant. “I am sorry, but do you have more?”

M1

Then you remember that in addition to cash, you have your checkbook with a current balance in it, and a debit card to an account you maintain in a local bank, but with no overdraft or lines of credit provisions.

That plus the currency in your pockets is M1. See the difference? You do not have ALL your money in your pockets for immediate presentation, but with a little transactional effort the money is readily available and it is inherently your money, it belongs to you. It is just being held elsewhere besides your pockets and wallet. The merchant assumes a little more risk, but he can quickly call your bank to verify that the funds are available for the check, and the debit card is even more mechanized. More risk, a little more delay, but almost as ‘good as cash.’

“I am sorry sir,” says the Merchant, “but this is still not enough to exchange for such a valuable object as I have for sale here.”

M2

You think about it, and remember that you have a savings account across the street at the bank, and a money market fund at your brokerage office next door, that have more of your money on deposit. You have no cards for those accounts, but it would be an easy thing to walk next door or across the street and obtain the cash.

This is M2. There is a more complex transaction involved, since the transfer is not electronic as in the case of a debit card, and you must leave the store to obtain the money in the form of currency unless they bring it over to you. But it is your money that is available to you on demand. There is a small amount of risk of your bank not being solvent when you need the money, but these are slight inconveniences compared to the safety of not carrying around large sums of money that earn no interest in the form of cash.

“I am so sorry,” says the Merchant. “But this item is far too valuable to part with for such a sum as you have offered.”

M3

You think about it, and remember that you have a large Certificate of Deposit at the bank across the street that matures in one year. There is a small penalty if you redeem it today to receive your money since you promised it to them for a time in exchange for a specific return, and you must fill out some paperwork, but it is still your money. It involves no sale of an asset or conversion.

That is M3. It involves money that is still yours without borrowing, but has additional conditions set up on it for its retrieval.

One could make the case, and perhaps appropriately so, that while certificates of deposit with a term contract that might effect their value are money, they are not readily available money since the terms of the CD’s may differ greatly. They are not ‘liquid’ and the value before maturity is not always certain due to a penalty.

MZM

If one takes all the things we describe as M2, but takes out the time deposits or certificates of deposit, and includes ALL money market funds, that is what the Fed considers to be the broadest measure of liquid money, or Money of Zero Maturity (MZM). “Zero maturity” means that the money is not tied up for a period of time to mature to its full value.

Are credit cards or loans Money? No,those are all forms of borrowing something that is not yours that you promise to return with conditions. You are receiving money that was not yours.

Credit Is Not Money.

Credit, or debt, is the ‘potential’ for money, a way of receiving it.

Whether water is held in a canteen, a well, a cistern, or a private lake, it is still water and it is yours if you own it. So too money is still money if it is yours, no matter under what conditions you hold it or save it for your use.

The cloud of credit, or debt depending on your perspective, is the potential for money as it is defined in our economy. It is a source of money. At a given point in time, you either have the money as your property or you do not.

But the source is not the money itself, and the source can be different and can change over time. In our society borrowing is so common and so technologically convenient that there is little difference in most people’s mind between credit and money.

But the difference is that if you spend real money, you incur no obligation for it in the future. You receive no payment request from another at the end of the month.

That is what money is, at least in our economy, and the various measure of money as it is held and shifts through the economy and a variety of transactions, where it flows and rest in pools, and moves again. A measure of the money supply is a snapshot in time.

How money increases or decreases, and how it is stored or held, is a significant indicator of economic activity for those who study such things. It is also significantly affected by custom, technology, and the prevailing mood and perception of the public.

The best and broadest measures of money supply are either MZM, or M2, now that M3 is no longer being reported by the Fed. This can easily be seen from the illustrations.

As springs feed into brooks, and brooks streams, and streams into rivers, and rivers into lakes, so the money supply components change in size and shape over time as money flows from its various sources. The speed of the flow is the ‘velocity of money’ and as one can easily understand that flow will have a different force and speed depending on when you measure it, and whether you are measuring one of the streams or a major river.

People often prefer to jump into discussions and turn them into debates (arguments) with hair-splitting definitions (what is ‘control’ of the money supply) and red herrings (why does a dollar cross the road?) before defining any terms or facts and setting some boundaries for the analysis, because their goal too often is not understanding, but to promote some theory or point of view. ‘Winning the argument’ is their objective, not a search for the truth.

Money is the instrument of the official economy. This gives money a certain arbitrariness over time because, after all, it is the product of a committee. Official money is the creation of government, managed by its agents, validated by the people who use it.

Official money rises and falls from favor to disfavor, as do governments. What if you were a citizen of Zimbabwe? Or the US in the 1860′s? Or Germany in 1922? How would you feel about your official money then? Why is it different for you now? What would change your opinion?

What is the ‘natural growth rate’ of the money supply? Zero?

The discussion of how money supply increases, and who or what determines the supply, and what an appropriate level of growth would be is a matter for discussion on another day. So too is the strange phenomenon of ‘natural forms of money’ that keep turning up in every era and nearly every society.

But for now at least you have the means to understand what money supply is and how it is measured, and how it is different from potential money, or credit, the representations of money, and asset stores of wealth.

Visit Jesse’s Cafe Americain