Friday, November 19, 2010

Paul Krugman is a Keynesian. This is an economic philosophy with which I have deepest disagreements. Keynes believed that in a down cycle of the economy the government should step in and spend money to offset the decreased spending of the private sector. He famously said that in a recession the government should pay one man to dig meaningless and unnecessary holes and pay another man to come along behind him and fill in those holes. In Keynes' theory, this should flatten out the economic cycles of boom and bust. This has a number of very bad effects which you can research for yourself. One of the most pernicious effects is the slow, steady debasement of the dollar. It's lost over 95% of its value since the creation of the Fed in 1913. More importantly, it has a 100% record of failure as a macroeconomic policy, but that doesn't bother the Keynesians.

But we may well have reached an inflection point. Right now the public is being terrified by the pundits in the media who are screaming that all of this Quantitative Easing is going to produce inflation or hyperinflation. Except that it's not. We are not in an inflationary environment. Certain "inflation indicators" have been bid up by speculators who are afraid that it will. This explains the stock market rally of late, and the rise in certain commodity prices, as well as the uptick in interest rates on government bonds. Those prices will come down once it's clear that there's less demand in the real world for the underlying commodity because of economic weakness.

What the Fed is terrified of is deflation. A deflationary event is something that the Fed doesn't know how to extract itself from. And that is exactly what we are being sucked into right now. Core inflation rates are a mere 0.6%, the lowest ever recorded. Bernanke and Co is desperately trying to jumpstart some inflation. I do not believe they will be able to do so. The record on that is also one of 100% failure. It was tried in the 1930's in America and all throughout the 1990's in Japan. But all the propping up of zombie banks and the refusal to acknowledge and write off bad loans, let the underlying assets fall to a market-determined value, and start over is only going to hinder the cycle from completing itself and cleansing the bad debt out of the economy. We are simply going to have to accept that we will endure a deflationary period, and not stand in the way of that cycle. Those who live like the grasshopper in the fable will suffer. Those who live like the ant (i.e. frugally, industriously, and most of all, debt free) will prosper very nicely. You can be one of the ants. All you have to do is get out of debt, live below your means, keep your investments liquid and sheltered, and save money. And as I've said before, buy a little gold and silver. Don't go crazy, but have a little bit on hand. If I am correct that it's God's money, then it will increase in value in a deflation, because that's what money does in a deflation.

Below is an article by Keynesian Paul Krugman from the New York Times. He correctly diagnoses the problem. It's just that his solution (trying to manipulate interest rates lower by stepping in to buy government bonds at the auctions) won't work. Who cares how low the interest rate is when nobody wants to borrow and nobody wants to lend? And there are interest rates that have nothing to do with the Treasury auctions. For instance, my credit card, which plugged along happily for years at 8% or so, is now up to 18%, even though we've got a flawless credit history. We don't care because we pay it off every month, but why did that happen? Lenders have seen a scary wave of defaults, so they're trying to lower their debt exposure and squeeze profit from every source they can to make up for lost income. Ben and Co can't do anything about that, but credit card debt is a significant part of the household budget picture for Joe and Jane Average. We're hosed. We just need to admit it, adjust to that reality, keep calm, and carry on. If we do so, we will emerge out the other side wiser, more disciplined, and having scooped up investments and assets at once-in-a-century low prices.

Axis of Depression

What do the government of China, the government of Germany and the Republican Party have in common? They’re all trying to bully the Federal Reserve into calling off its efforts to create jobs. And the motives of all three are highly suspect.

It’s not as if the Fed is doing anything radical. It’s true that the Fed normally conducts monetary policy by buying short-term U.S. government debt, whereas now, under the unhelpful name of “quantitative easing,” it’s buying longer-term debt. (Buying more short-term debt is pointless because the interest rate on that debt is near zero.) But Ben Bernanke, the Fed chairman, had it right when he protested that this is “just monetary policy.” The Fed is trying to reduce interest rates, as it always does when unemployment is high and inflation is low.

And inflation is indeed low. Core inflation — a measure that excludes volatile food and energy prices, and is widely considered a better gauge of underlying trends than the headline number — is running at just 0.6 percent, the lowest level ever recorded. Meanwhile, unemployment is almost 10 percent, and long-term unemployment is worse than it has been since the Great Depression.

So the case for Fed action is overwhelming. In fact, the main concern reasonable people have about the Fed’s plans — a concern that I share — is that they are likely to prove too weak, too ineffective.

But there are reasonable people — and then there’s the China-Germany-G.O.P. axis of depression.

It’s no mystery why China and Germany are on the warpath against the Fed. Both nations are accustomed to running huge trade surpluses. But for some countries to run trade surpluses, others must run trade deficits — and, for years, that has meant us. The Fed’s expansionary policies, however, have the side effect of somewhat weakening the dollar, making U.S. goods more competitive, and paving the way for a smaller U.S. deficit. And the Chinese and Germans don’t want to see that happen.

For the Chinese government, by the way, attacking the Fed has the additional benefit of shifting attention away from its own currency manipulation, which keeps China’s currency artificially weak — precisely the sin China falsely accuses America of committing.

But why are Republicans joining in this attack?

Mr. Bernanke and his colleagues seem stunned to find themselves in the cross hairs. They thought they were acting in the spirit of none other than Milton Friedman, who blamed the Fed for not acting more forcefully during the Great Depression — and who, in 1998, called on the Bank of Japan to “buy government bonds on the open market,” exactly what the Fed is now doing.

Republicans, however, will have none of it, raising objections that range from the odd to the incoherent.

The odd: on Monday, a somewhat strange group of Republican figures — who knew that William Kristol was an expert on monetary policy? — released an open letter to the Fed warning that its policies “risk currency debasement and inflation.” These concerns were echoed in a letter the top four Republicans in Congress sent Mr. Bernanke on Wednesday. Neither letter explained why we should fear inflation when the reality is that inflation keeps hitting record lows.

And about dollar debasement: leaving aside the fact that a weaker dollar actually helps U.S. manufacturing, where were these people during the previous administration? The dollar slid steadily through most of the Bush years, a decline that dwarfs the recent downtick. Why weren’t there similar letters demanding that Alan Greenspan, the Fed chairman at the time, tighten policy?

Meanwhile, the incoherent: Two Republicans, Mike Pence in the House and Bob Corker in the Senate, have called on the Fed to abandon all efforts to achieve full employment and focus solely on price stability. Why? Because unemployment remains so high. No, I don’t understand the logic either.

So what’s really motivating the G.O.P. attack on the Fed? Mr. Bernanke and his colleagues were clearly caught by surprise, but the budget expert Stan Collender predicted it all. Back in August, he warned Mr. Bernanke that “with Republican policy makers seeing economic hardship as the path to election glory,” they would be “opposed to any actions taken by the Federal Reserve that would make the economy better.” In short, their real fear is not that Fed actions will be harmful, it is that they might succeed.

Hence the axis of depression. No doubt some of Mr. Bernanke’s critics are motivated by sincere intellectual conviction, but the core reason for the attack on the Fed is self-interest, pure and simple. China and Germany want America to stay uncompetitive; Republicans want the economy to stay weak as long as there’s a Democrat in the White House.

And if Mr. Bernanke gives in to their bullying, they may all get their wish.

Saturday, November 13, 2010

Good Article

This is a pretty good description of the psychology of the topping process in a secular bull market. My personal measure is the Superbowl commercial metric. When you see gold dealers or gold producers doing funny commercials during the Superbowl the way you saw tech companies doing in 2000, then it's time to sell gold. Then take that money and look for an asset class that everyone is spitting on and thinks is a fool's investment. By way of example everyone was dissing gold in 1999-2000. It was $265 an ounce then.

Both gold and silver are due for a breather. Silver especially is quite overbought and ripe for one of its periodic crashes of 10% or so, followed by a longish period of consolidation and sideways movement. However, my wave count on silver in particular still indicates that we have quite a bit more upside left in this particular rally. An ideal resolution would be for the correction to take the form of a triangle (a pattern of higher lows and lower highs until the it is squeezed into the "point" of the triangle, whereupon it resumes the move in the same direction as the previous move.)

Anyhow, it's been a pretty breathtaking few months in the PM market. I started buying silver when it was $6 per ounce and gold when it was $420. I've tripled some of my earliest money invested in gold and I've more than quadrupled it in silver. I'm still holding because I don't think this bull is over by an stretch of the imagination.

When to Sell Gold
By: Terry Coxon Thursday, November 11, 2010

By now you have plenty of reason to congratulate yourself for having boarded the gold bandwagon. The early tickets are the cheap ones, and you've already had quite a ride. The best of the ride, I believe, is yet to come, and it should be very good indeed. It should be so much fun that your wallet may start to feel a bit giddy - which can be dangerous. So it would be wise to consider, now, how things will be and how they will feel when the current bull market in gold reaches its "end of days." Because it will end.

Buying at the right time is the key to building profits. Selling at the right time is the key to collecting them.

The 1980 Peak
In 1980, gold briefly touched the then record price of $850 per ounce. In terms of purchasing power, that would be $2,400 in today's dollars. And for the value of the world's entire gold stockpile to attain the same share of the world's total wealth that it represented at the 1980 peak, the price would need to reach $5,800 per ounce.
But so what? Before you can look to those numbers for guidance about what the peak in gold's bull market will look like, you need to consider how the process that drove the earlier bull market compares with what is happening today.

The earlier bull market was driven by price inflation in the world's reserve currency, the dollar, that reached an annual rate of 14%. The more expensive it became to use dollars as a store of value (i.e., the more rapidly the dollar's purchasing power was declining), the more attractive gold became as an alternative way to store value.

The dollar is still the world's reserve currency. (And not just for central banks. Among individuals and private businesses that want to diversify out of their home currency, the dollar is still Number One.) And the force driving the bull market in gold is once again price inflation. But this time it isn't actual price inflation that is on the mind of gold buyers around the world. It is the potential for price inflation that is building up. That build-up is coming from:
Rapid expansion in the U.S. monetary base through the Federal Reserve's asset purchases. Most of that expansion has yet to be reflected in a growth in the U.S. money supply. It is still sitting, like a charge in a capacitor, waiting for something to set it off. There was no similar liquidity bomb stored in the U.S. economy's closet during the years leading up to 1980.

Unprecedented growth in federal government debt, which adds to the political attractiveness of price inflation. There were federal deficits during the 1970s, but nothing like today's - just enough to give the party out of power at any time something to talk about.

The accumulation of U.S. Treasury debt and privately issued dollar debt in the hands of foreign investors. U.S. debt to foreigners wasn't a factor in the years leading up to gold's 1980 peak. This time around, it could be a powerful force for accelerating inflation. Even moderate inflation could spook foreign investors. Their sales of Treasuries and other dollar-denominated IOUs would push down the foreign exchange value of the dollar, which would raise the cost of imports coming into the U.S., which would further stimulate price inflation. A nasty feedback.

And foreign holdings of U.S. debt operate as a second vector feeding the political attractiveness of dollar price inflation. Depreciation of the dollar can be framed as a clever way to shortchange foreign creditors. "It hurts THEM, not US" would be the slogan.

All those factors are working to make price inflation distinctly more severe than it was in the 1970s, which argues for a higher peak price for gold. When the metal does surpass its 1980 peak in purchasing power, the event is likely to be widely reported in the press. I suggest that you not attach any significance to the event. It won't be time to sell.

Sell Signals
But the time to sell will come. Here are the signs I'll be looking for.

Gold and gold-related financial products will be commonplace.

Even today, most financial institutions still hold the "barbarous relic" attitude toward gold. Yes, you can get GLD through any stockbroker, but with a few exceptions, the brokerage firm's heart isn't in it. They offer GLD for the same reason even the best seafood restaurants have a steak on the menu - they know someone will ask for one, even though that's not what they are in business to serve.

Before the bull market is over, that attitude will change. Mainline brokerage firms won't just have gold-related products available, they will advertise them. They will boast about them. They'll claim to specialize in them. And it won't be just the brokers. Your local bank will offer gold-related CDs. Your insurance company may be offering life insurance denominated in ounces.

Gold going mainstream won't mean that the bull market is over, but it will be a sign that it's getting long in the tooth. An early warning signal.

You'll be hearing gold chatter wherever people talk about investing.

The inhabitants of Financial News TV Land will be talking about gold approvingly, and each of them will be trying to suggest he was early in recognizing the gold bull market. You won't be able to get through a golf game or a cocktail party without someone talking about gold. Even your brother-in-law will want to explain it to you.
The gold standard will become respectable.

Today advocates of the gold standard are seen as standing to the good side of whacko, but not by a big margin. But as gold attracts more converts in the investment world, the politicians will want to associate themselves with it by proposing some brand or other of gold convertibility for the dollar. Respectability for the gold standard will be a sign that a majority of the people who are going to buy gold already have.
Other things will look cheap to you.

When gold nears its peak, even if you suspect that that's what's happening, you won't feel certain about it. But when you start seeing investments - probably conventional stocks - that look like strong bargains, treat those sightings as a sign it's time to start selling gold. You know the reasons that led you to buy gold. If you are tempted to sell part of your holdings to buy something whose low price seems to give it better prospects, then you probably will be selling at the right time. You could be selling to the last new buyer.