Quantcast
Real Crash 2014
Articles RSS  Subscribe
 
The Clock is Ticking in Switzerland
Posted by Peter Schiff on 11/24/2014 at 10:26 AM
For most of my career in international investing, I had always placed a great deal of faith in Switzerland's financial markets. In recent years, however, as the Swiss government has sought to hitch its wagon to the flailing euro currency and kowtow increasingly to U.S.-based financial requirements, this faith has been shaken. But this week (November 30th) a referendum in Switzerland on whether its central bank will be required to hold at least 20% of its reserves in gold, will offer ordinary Swiss citizens a rare opportunity to reclaim their country's strong economic heritage. It's a vote that few outside Switzerland are following, but the outcome could make an enormous impact on the global economy.
 
Traditionally, the Swiss franc had always attracted international investors looking for a long-term store of value. That's because the Swiss government had always kept sacred the idea of conservative central banking and fiscal balance. When the idea of the European common currency was first proposed, the Swiss were wise to stay out. They did not want to exchange the franc for an unknown and untried pan-national currency. The creators of the euro had suggested that it would become the heir to the strong Deutsche mark. Instead, it has become the step-child of the troubled Italian lira and the Greek drachma.  In retrospect, the Swiss were wise to take no part in the experiment.
 
But the decision of the Swiss government in 2011 to peg the franc to the euro, in order to prevent the franc from rising, has meant that the nation has adopted the euro de facto. In order to effect this peg, the Swiss government has had to intervene massively in the currency exchange market to buy and stockpile euros, thereby weakening the franc. The raw numbers are so staggering that rank and file Swiss have taken notice. Over the last few years the Swiss economy has stagnated along with the rest of Europe, and Swiss citizens have come to understand that the current policy will require an open-ended commitment to keep doing more of the same. This frustration has given birth to the referendum movement.
 
In 1999, Switzerland became the last industrial nation to go off the gold standard, a system that had served the world well for centuries. At that time, the Swiss National Bank held about 2,600 tons of gold, representing about 41% of its total currency reserves. By the end of 2008 its gold holdings had dwindled to just 21% of reserves. And as of August this year, they had fallen to just 7.9%. The raw tonnage has fallen over that time to just 1,040 tons, a 60% decline from 1999.
 
But the real action can be seen in the Swiss National Bank's holding of foreign currencies, mostly the euro, which now sits at a whopping 453 billion francs' ($495 billion). That's about 56,000 francs ($61,000) per man, woman and child in the country, almost 90% of which have been accumulated in just the past six years. The stated aim of all these purchases is to depress the value of the franc against the euro. Currency valuation directly translates into purchasing power, which means that the Swiss are poorer for these efforts. For a family of four that means the Swiss government has diverted almost $33,000 worth of purchasing power every year for the past six years to citizens of other European countries who had mistakenly adopted the euro. That's a lot of money, even for a rich country.
 
Swiss politicians have said that purchases have been needed to protect the citizenry from falling prices and from the diminished exports that would result from a rising currency (In my  latest newsletter, read how this central bank concern about deflation is strictly a 21st century paranoia). Putting aside the evidence to suggest that the Swiss economy has prospered under a rising currency, this idea assumes that exports are a means, rather than an end. The purpose of exports is to pay for the stuff that you import and consume. There are many things that the Swiss people want that they don't make. To get those things, they export the things that they do make (i.e. watches, chocolate, cheese, etc.). The beauty of a strong currency means that you don't need to export as much of the stuff you make to get the stuff you want. In other words, you don't have to work as hard to enjoy greater consumption. Swiss living standards could have been much higher today if Swiss bankers and politicians had not tethered the franc to the euro.
 
A 20% gold reserve requirement would severely limit the ability of the Swiss government to continue its pegging policy. In order to reach the new target reserve levels, the Bank would either have to sell hundreds of billions of currency reserves or buy thousands of tons of gold on the open market. Critics contend that this would be a disaster for Switzerland. But the large amount of gold reserves before 1999 did not weigh on the Swiss economy. In fact, before that time, it was the envy of the world. While other countries were undermined by the promises politicians made with a printing press, the Swiss economy prospered thanks to the discipline provided by gold.  Economists and politicians who are urging the Swiss to reject the proposal make the case that inflation is a prerequisite for growth, but many Swiss know that that is a lie.
 
While the pundits see little chance of success for the gold vote, I am encouraged by the recent results of another recent Swiss referendum that rejected the imposition of what would have been the highest minimum wage in the world. Swiss voters were smart enough to understand that an arbitrarily high wage costs would simply destroy employment opportunities without offering any tangible benefits in return. Perhaps they will be equally wise about the usefulness of sound and stable currency.
 
As an American, I envy the choice that the Swiss have given themselves. If successful, the vote could be seen as the first major counterattack against the forces of fiat currencies and unlimited global QE. A successful outcome may also mean the requirement for the Swiss government to buy gold would add significant demand in the gold market and should thereby help put the metal back on track.
 
All eyes should now be focused on the Swiss voters.  I wish them courage.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on YouTube

Catch Peter's latest thoughts on the U.S. and International markets in the Euro Pacific Capital Fall 2014 Global Investor Newsletter!

PERMALINK | ADD YOUR COMMENT | EMAIL | PRINT | RSS  Subscribe
 
The Abenomics Death Spiral
Posted by Peter Schiff on 11/19/2014 at 9:53 AM
As Japanese Prime Minster Shinzo Abe has turned his country into a petri dish of Keynesian ideas, the trajectory of Japan's economy has much to teach us about the wisdom of those policies. And although the warning sirens are blasting at the highest volumes imaginable, few economists can hear the alarm. (A longer version of this article can be found in Euro Pacific Capital's Global Investor newsletter.)
 
Data out this week shows the Japanese economy returning to recession by contracting for the second straight quarter (and three out of the last four quarters). The conclusion reached by the Keynesian apologists is that the benefits of inflation caused by the monetary stimulus have been counteracted, temporarily, by the negative effects of inflation caused by taxes. This tortured logic should be a clear indication that the policies were flawed from the start.
 

Although the Japanese economy has been in paralysis for more than 20 years, things have gotten worse since December 2012 when Abe began his radical surgery.. From the start, his primary goal has been to weaken the yen and create inflation. On that front, he has been a success. The yen has fallen 23% against the dollar and core inflation, which was running slightly negative in 2012, has now been "successfully" pushed up to 3.1% according to the Statistics Bureau of Japan.

 

But there is no great mystery or difficulty in creating inflation or cheapening currency. All that is needed is the ability to debase coined currency, print paper money or, as is the case of our modern age, create credit electronically. These "successes" should not come as a surprise when one considers the relative size of Abe's QE program. For much of the past two years the Bank of Japan (BoJ) has purchased about 7 trillion yen per month of Japanese government bonds, which is the equivalent of about $65 billion U.S. [Forbes 9/24/14, Charles Sizemore] While this is smaller than the $85 billion per month that the Federal Reserve purchased during the 12-month peak of our QE program, it is much larger in relative terms.

 

The U.S. has roughly 2.5 times more people than Japan. Based on this multiplier, the Japanese QE program equates to $162.5 billion, or 91% larger than the Fed's program at its height. But, according to IMF estimates, the U.S. GDP is 3.3 times larger than Japan. Based on that multiplier, Japanese QE equates to $214.5 billion per month, or 152% larger. And unlike the Federal Reserve, the Bank of Japan hasn't even paid any lip service to the idea that its QE program will be scaled back any time soon, let alone wound down.

 

In fact, Abe's promises to do more were spectacularly realized in a surprise move on October 31 when the BoJ, claiming "a critical moment" in its fight against deflation, announced a major expansion of its stimulus campaign. (The fact that official inflation is currently north of 3% - a multi-year high, seems to not matter at all.)

 

At the same time the BoJ also announced its intention to roughly triple its pace of its equity and property purchases on Japan's stock market. According to Nikkei's Asian Review (9/23/14), the BoJ now holds an estimated 7 trillion yen portfolio of Japanese stock and real estate ETFs. Even Janet Yellen has yet to cross that Rubicon.

 

And what has this financial shock and awe actually achieved, other than 3% inflation, a weaker yen, a stock market rally, and continued international praise for Abe? Well, unfortunately nothing other than a bona fide recession and a growing threat of stagflation.

 

The weaker yen was supposed to help Japan's trade balance by boosting exports. That didn't happen. In September, the country reported a trade deficit of 958 billion yen ($9 billion), the 27th consecutive month of trade deficits. The deterioration occurred despite the fact that import prices rose steeply, which should have reduced imports and boosted exports. And while some large Japanese exporters credited the weak yen for easier sales overseas, small and mid-sized Japanese businesses that primarily sell domestically have seen flat sales against rising fuel and material costs.

 

But price inflation is not pushing up wages as the Keynesians would have expected. In August, Japan reported real wages (adjusted for inflation) fell 2.6% from the year earlier, the 14th straight monthly decline. This simply means that Japanese consumers can buy far less than what they could have before Abenomics. This is not a recipe for happy citizens.

 

Japanese consumers must also deal with Abe's highly unpopular increase of the national consumption tax from 5% to 8% (with a planned increase to 10% next year). The sales tax was largely put in place to keep the government's debt from spiraling out of control as a result of the fiscal stimulus baked into Abenomics. And while economists agree nearly universally that the price increases that have resulted from the sales tax have caused a sharp drop in consumer spending, they fail to apply the same logic that price increases due to inflation will deliver the same result.

 

A bedrock Keynesian belief is that falling prices create recession by inspiring consumers to delay purchases until prices fall further. According to the theory, even a 1% annual drop in prices could be sufficient to decimate consumers' willingness to spend. Conversely, they believe rising prices, otherwise known as inflation, will spur spending, and growth, as it inspires people to buy now before prices rise further. But if consumers have clearly been put off by rising prices due to taxation, why would they be encouraged if they were to rise for monetary reasons? Don't look for an explanation, there isn't any. In reality, as any store owner will tell you, shoppers shop when prices are low and stay at home when prices are high.

 

Despite the bleak prospects for Japan, Abe continues to bask in the love of western economists and investors. In an October 6 interview with the The Daily Princetonian, Paul Krugman, who has emerged as Abe's chief champion and apologist, responded to a question about the European economic crisis by saying "Europe need something like Abenomics only Abenomics, I think, is falling short, so they need something really aggressive in Europe." A Bloomberg article ran on November 18 under the headline "Abe's $1 Trillion Gift to Stock Market Shields Recession Gloom." So according to Bloomberg, Abenomics is not responsible for the country's fall back into recession, which hurts everyone, but it is responsible for the surging stock market, which primarily benefits the wealthy.

 

One wonders how much more bad news must come out of the Japanese experiment in mega-stimulus before the Keynesians reassess their assumptions? Oh wait...I'm sorry, for a second there I thought they were susceptible to logic. But those who are not blinded by left-wing dogma should take a good look at where the road of permanent stimulus ultimately leads.

 

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube



PERMALINK | ADD YOUR COMMENT | EMAIL | PRINT | RSS  Subscribe
 
Contemplating Stocks without QE
Posted by Peter Schiff on 11/13/2014 at 11:32 AM
Some influences on the stock market are casual, subtle or open to interpretation, but the catalyst behind the current stock market rally really shouldn't be controversial. As far as stocks go, we have lived by QE. The only question now is, whether we will die without it. A larger version of this article appears in the fall edition of Euro Pacific Capital's Global Investor newsletter. 
 
Since the financial crisis of 2008 stock prices have only risen when the Fed is either expanding its balance sheet, hinting that it is about to do so, or actively recycling assets to hold down long term interest rates. Absent any of these aggressive moves, stocks have shown a clear tendency to fall. Curiously, while most investors now believe that QE is in the past, few would argue that the bull market is in danger. But a quick look at how much influence the Fed's operations have had on market performance should send a chill down Wall Street. The Chart below should speak for itself:
 ALL ABOUT QE

Created by EPC using data from the Federal Reserve and Bloomberg
 
When the markets crashed in the fall of 2008, the Fed announced QE1, a plan to purchase $600 billion in mortgage-backed securities (MBS) and agency debt, which was later expanded in March 2009 by another $750 billion. QE1 expanded the Fed's balance by 247%, to $1.43 trillion. Over that time, the S&P 500 put in a rally of 71%.
 
But from April to November 2010with QE on hiatus and the Fed's balance sheet hardly expanding, stocks declined by about 11%. But when Fed Chairman Ben Bernanke strongly hinted in August 2010 that the Fed was ready to launch another round of QE, the markets rallied 18% in five months. By the time QE2 ran its course, the Fed' balance sheet had swelled by 29.4%, and the S&P 500 had rallied about 25%.
 
But when the curtain came down on QE2, and Wall Street had no hints that an encore was imminent, the S&P 500 put in a wicked 16% sell-off between July and August 19. So on September 21, 2011, Bernanke announced the implementation of "Operation Twist," authorizing the purchase of $400 billion of long term Treasury bonds financed by the sales of shorter term bonds, thereby extending the average maturity of the Fed's portfolio and lowering long term interest rates. It was hoped that Twist would offer the benefits of QE without expanding the Fed's balance sheet. 
 
Once again the markets responded, rallying about 25% from the end of September 2011 to the end of April 2012. But when Operation Twist stopped twisting, another sell-off predictably ensued. From April 27, 2012 to June 1, 2012, the S&P dropped 9%. So on June 20, 2012 the Fed extended Twist to the end of 2012, which sparked a summer rally that helped stocks regain all the losses from earlier in the year. But by September the rally slowed and another fall threatened. Perhaps the twisting wasn't enough?
 
At this point I believe the Fed finally understood: No stimulus, no rally. And so on September 13, 2012, the Fed announced QE3, an open-ended commitment to purchase $40 billion agency mortgage-backed securities per month. This eliminated the need for embarrassing QE re-launches every time the markets or the economy stalled. But the $40 billion monthly rate was apparently not enough to move stocks. From the time of the announcement to the end of 2012, the S&P declined about 2.3%. So then on December 12, 2012 the Fed doubled the size of QE3 to $85 billion per month. The rest is history.
 
Since the launch of QE3, the U.S. has seen lackluster economic performance, a deteriorating geo-political landscape, and, somewhat incongruously, a nearly relentless stock market rally. By the time that QE3 ran its course last month the Fed's balance sheet had expanded by another 63% (to $4.2 billion) and the S&P 500 had surged 36%. 
 
Although the rally in stocks continued during the taper of QE, the rate of increase slowed along with the rate of balance sheet expansion. Full throttled $85 billion per month QE persisted from September 2012 to December 2013. During that time, stocks rallied about 26%, and the Fed's balance sheet grew by 45% to $3.7 trillion. Since the taper began (to the end of the program in October), however, the Fed's balance sheet has grown just 12% (through October 22, 2014), with the S&P 500 virtually matching that with a 12% increase. Very neat correlation.
 
But now that QE is apparently a thing of the past, it is alarming how little anxiety has been sown on Wall Street. To be bullish on stocks now, one must completely ignore not only the role QE played in driving up stock prices over the past six years, but discount any negative effects that a reduction of the Fed's balance sheet could create. Most economists recognize that to normalize policy the Fed must reduce the amount of securities it holds. Logical analysis should lead you to believe that stocks would not fare well.
 
But this does not mean I predict a crash in stocks. I simply expect, as no one else seems to, that the Fed will go back to the well as soon as the markets scream loud enough for support. At that point, it should become clear to everyone that there is no exit from the era of QE and that there is nothing normal or organic about the current rally.
 
It's also possible that the Fed will re-launch QE even if stocks don't fall. That's because low inflation is conveniently emerging as its biggest fear. However, in another article in my newsletter, I show that this concern is a recent development designed to prepare the country for more stimulus, even if the stock market says we don't need it.
 

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube



PERMALINK | ADD YOUR COMMENT | EMAIL | PRINT | RSS  Subscribe
 
It's The Economy, and They're Not Stupid
Posted by Peter Schiff on 11/06/2014 at 12:49 PM
The sharp rebuke to the Obama administration delivered by the mid-term elections should not be construed as an endorsement of the GOP, which remains as unpopular as ever. Rather, as has been the case in the last few election cycles, voter revolts have hinged on continued dissatisfaction with the strength of the economy and the diminishing financial prospects of ordinary citizens. Given the apparent improvements in the economy, this fact continues to baffle the media which have concluded that Democrats simply failed to effectively communicate the successes that the Administration has achieved. Fortune Magazine offered a more complex conclusion that we have a good economy, but it's just not the kind that benefits the middle class. I believe the truth is far simpler: Voters are dissatisfied with the economy because it is bad and getting worse. Although this unpleasant reality can be masked by economic doublespeak and government accounting gimmicks, the truth comes out in the ballot box. 
 
According to voter exit polls conducted by CNN, 78% said they are worried about the economy, with 69% saying that, in their view, economic conditions are not good. 65% responded that the country is on the wrong track vs. only 31% who believed that it is headed in the right direction. Why should this be so if, as we have been told repeatedly, the economy is accelerating after five straight years of economic growth? After all, during the post war years, we have experienced recession on average, every seven years, and it has been almost that much time since our last recession. Unemployment has fallen all the way back down to pre-recession levels, the stock market is soaring to record heights regularly, the dollar is surging, the deficit is down by more than half in the last four years (to just a half a trillion) energy prices are falling, and the real estate market has had a great run over the last four years. So what's with the doom and gloom? Shouldn't we be satisfied? 
 
I have been saying for years that the "recovery" is largely an illusion created by the effects of zero percent interest rates, quantitative easing, and deficit spending. The asset bubbles that have been created as a result of these policies have primarily benefited the owners of stocks, bonds, and real estate (the rich), while simultaneously deterring the savings and capital investment that is needed to actually create good paying jobs and increased purchasing power for Johnny and Sally Sixpack. So as the Dow churns higher, and the cheerleaders on CNBC try to outshine one another on their economic enthusiasm, the mood on Main Street continues to sour. (see my article about how QE has juiced the financial markets, in the latest edition of my Global Investor newsletter.)
 
So which is it? Are the rank and file too stubborn, or too ill-informed, to understand that the economy is actually improving, or are they right, and it actually isn't. Very few people are making the latter determination. Instead they have held up other fears, in the form of border security, Ebola, or Obamacare, to explain the drubbing of Democrats in this election as merely a referendum on the President. But the exit polls make clear that those dogs won't hunt.
 
As the effects of quantitative easing begin to wane, the economy will slow down, as it already clearly has over the last few months, and stock and real estate prices will flatten out, and ultimately fall (see the article in my latest newsletter on the dependency of stock prices on stock prices). At that point, the call to do something big will return, and few should doubt that the historically dovish Fed and Federal Government (no matter who is in charge) will deliver fresh doses of fiscal and monetary stimulus. But we must be aware that these cures have not helped in the past, and they will not help in the future. In fact, they are the primary reason why the economy has not become healthy enough to increase voter satisfaction. The stimulus acts more like a sedative that has preserved an unhealthy debt-fueled, asset-bubble economic model and has prevented a healthier, more self-sustaining economy from rising in its place.
 
Instead of recognizing this phony economy for what it is, economists have instead conjectured that we have passed into an age of "secular stagnation." They have produced models that say we simply are incapable of growing at levels that we have in the past, and that citizens have to come to grips with lowered expectations. They cite a variety of ridiculous reasons why this is so: The impact of technology, the rise of the emerging markets, the glut of savings, persistent deflationary forces, etc. But there is nothing new under the sun. Human beings haven't changed, and neither have the laws of economics. There is no natural reason why our society has lost the capacity to grow. Instead, we have simply chosen to perpetuate a broken system because we refuse to suffer through the withdrawal symptoms that will surely accompany a change in course.
 
In a recent Investment Outlook piece that was heavy on philosophy, Bill Gross, the "bond guru" formerly of Pimco and now of Janus, made a similar conclusion. Although he acknowledges the inherent weaknesses and flaws in the stimulus-based economy, he concludes that there are simply no alternatives because we are addicted, and we will not be able to find the political will to suffer through a change. He may be right. But the first step in fixing a problem is acknowledging that one exists. The voters are trying to tell us that. Too bad no one is listening. 
 
And while Republicans may now be basking in their good fortune, they would be wise to keep the celebrations in check. The same problems that angered voters today will still be in place two years from now, only by then, they will likely be worse. Republican majority in both houses will firmly affix targets on their backs, and will invite the kind of backlash that was recently directed at Democrats.
 

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube



PERMALINK | ADD YOUR COMMENT | EMAIL | PRINT | RSS  Subscribe
 
Governments Need Inflation, Economies Don't
Posted by Peter Schiff on 10/15/2014 at 11:06 AM
In an article in the UK's Telegraph on October 10, veteran economic correspondent Ambrose Evans-Pritchard laid bare the essential truth of the nearly universal current embrace of inflation as an economic panacea. While politicians, CEOs and economists talk about demand stimulus and the avoidance of a deflationary trap, Evans-Pritchard reminds us that inflation is all, and always, about debt management.
 
Every year the levels of government debt as a percentage of GDP, for both emerging market and developed economies, continue to go higher and higher. As the ratios push out into uncharted territories, particularly in Europe's southern tier, the ability to "inflate away" debt through monetization remains the only means available to postpone default. Evans-Pritchard quotes a Bank of America analyst as saying that even "low inflation" (not to mention actual deflation) is the "biggest threat to the dynamics of public debt." IMF Managing Director Christine Lagarde ramped up the rhetoric further when she recently told the Washington Press Club that "deflation is the ogre that must be fought decisively." In other words, governments need inflation to remain viable. It's the drug they just can't do without.  
 
But as this simple truth is just too embarrassing to admit, politicians and central bankers (and their academic, journalistic, and financial apologists) have concocted a variety of tortured theories as to why inflation is not just good for overly indebted governments, but an essential economic good for all. In a propaganda victory that even Goebbels would envy, it is now widely accepted that purchasing power must decrease for an economy to grow.
 
Despite centuries of economic evidence to the contrary,they argue that if prices do not rise by at least 2% per year consumers will not spend, business will not hire, and economies will slip into an intractable deflationary death spiral. To prevent this, they recommend governments spend without raising taxes. Not only would such a move involve a direct stimulus by increased government spending, but the money printed by the central bank to finance the deficit will push up prices, which they argue is very healthy for the economy. As the Church Lady used to say, "How convenient."
 
Offering voters something for nothing is the Holy Grail of politics. But as a matter of reality, voters should know that a free lunch always comes with a cost. This isn't even economics, its physics.
 
When increased government spending is paid for with higher taxes, workers notice that their paychecks have been reduced. This provides clear evidence that government spending comes with a cost. But this bright line is much more difficult to see when the spending is paid for by inflation (printing money). But the net impact on consumers is the same.  
 
Inflation does not reduce the nominal amount of one's paycheck. But rising prices reduce the amount of goods and services it can buy. So when governments run deficits, workers will be stuck with the bill. Whether they pay though higher taxes or inflation, their standard of living will be diminished. The main difference is that workers know to blame government for higher taxes, which explains why politicians prefer inflation.
 
To give cover to this tendency, economists have come up with the bizarre concept that falling, or even stable, prices squelch demand and deter consumption. The idea is that if consumers know that something will cost less in the future (even if it's just 2% less) they will defer their purchases indefinitely, perhaps waiting for the cost of their desired product or service to approach zero. They argue that this can push an economy into a deflationary spiral of falling prices and diminished demand which may be impossible to escape.
 
But this idea ignores the time value of a product or service (people will tend to pay more for something they can enjoy sooner rather than later) and the economic law that shows how demand goes up as the price falls. But common sense has absolutely nothing to do with the current practice of economics. Instead, the dominant argument is that inflation is needed to seed the economy with demand.  
 
However, this argument is merely a smoke screen. The only thing that inflation can do is to help governments spend. Economies do just fine with low inflation. In fact during the late 19th century, in the Great Sag, the United States experienced sustained deflation while creating much faster economic growth than we have seen in the last few generations. As recently as during the early 1960s the U.S. experienced consistently low inflation (barely 2%) and strong economic growth based on government figures. But in their call for more inflation, modern economists tend to forget or downplay those periods.
 
But inflation is actually more economically harmful than taxation. By blurring the link between higher government spending and reduced purchasing power, the public is less likely to oppose government expansion. And therein lies the truth. Inflation is not needed to grow economies but to grow governments.
 
The problem is particularly acute in Europe where countries of radically different fiscal characteristics have been locked into a politically unworkable monetary union. On one side are countries like Italy, Spain, and France whose governments have been notorious for offering generous benefits for which they can't pay. Before adopting the euro, these countries had currencies that were not known for their bankability. Germany, on the other hand, had built its reputation on balanced budgets and a strong Deutsche Mark. But given the strict monetary restrictions that were needed to grease the skids toward union, the European Central Bank has not been able to create inflation as freely as the U.S. or Japan. As a result, the debt crisis there has been placed in particularly sharp focus, as the problem is perceived to be much larger than in other developed countries that can print at will.
 
The calls for more inflation in Europe should be raising hackles on the streets of the Continent. But Keynesian economists have provided cover for politicians for years, and true to form, they have again risen to the occasion. While it is understandable that governments are motivated to champion inflation, it is harder to see why professional economists are similarly inspired. Perhaps they believe modern economics has the magic ability to create something from nothing. But the idea that a properly applied macroeconomic formula can somehow circumvent the laws of supply and demand is ludicrous and dangerous.
 
Of course, the idea that governments can hold inflation to just 2% per annum is preposterous. Once it breaches that level, governments will be powerless to contain it. The endgame will be hyperinflation. That is because escalating levels of debt will prevent them from raising interest rates high enough to break the inflationary spiral. The last time that inflation really got out of hand was back in the early 1980s when a boldly inspired Federal Reserve was able to put the genie back in the bottle by hiking interest rates all the way up to 18%. The economy not only survived that harsh medicine, but it prospered as a result. Does anyone seriously believe that we could survive even a quarter of that dosage today?
 
Since the central banks are now destined to forever remain behind the inflation curve, it will continue to accelerate until the real threat of hyperinflation looms much larger than did the contrived threat of deflation.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

Catch Peter's latest thoughts on the U.S. and International markets in the Euro Pacific Capital Summer 2014 Global Investor Newsletter!

PERMALINK | ADD YOUR COMMENT | EMAIL | PRINT | RSS  Subscribe
 
The Sound Money Business: Four Years Past and Future Forecast
Posted by Peter Schiff on 10/03/2014 at 12:53 PM
Yesterday, I launched a new website and announced the rebranding of my gold bullion dealer from Euro Pacific Precious Metals to SchiffGold. I started this company four years ago to provide a trustworthy option for my Euro Pacific Capital brokerage clients, but it has since grown to become a major US gold dealer in its own right. This landmark for my company comes in the midst of a historic time for the precious metals. The past four years have had highs and lows. We have been experiencing the inflation of remarkable new asset bubbles, and gold’s response has been mixed. But I have reason to believe that over the next four years, gold and silver investors will witness shocking macroeconomic events that put to rest any doubts about the importance of having sound money in every portfolio.

Short-Term Memory Lane

It’s hard to believe that when I started my gold company in the summer of 2010, the Federal Reserve was already finishing its first round of quantitative easing (QE1). Yet even that massive inflationary program was not enough to paper over the fallout from the credit crisis of ’07-’08. Because the economy did not “return to normal,” Fed Chairman Ben Bernanke had his excuse to begin a second round of QE just a few months later.

The government had already started the circular narrative that confuses the markets to this day: “The economy is in genuine recovery, but it still requires ongoing emergency stimulus from the Fed.” 

The announcement of QE2 spurred many of our initial customers to make substantial purchases of gold and silver. The rest of the market soon caught up. In the year following QE2, gold rocketed to its current record-holding high of just over $1900. 

As QE2 ended, “Operation Twist” began, and before long QE3 was introduced. In order to prevent their currencies from appreciating against a now increasingly worthless US dollar, nations around the world joined the money-printing party. These foreign governments wrongly believed that they were dependent on exporting their goods to the US for dollars, when in fact stronger currencies would have allowed them to keep the fruits of their labor to enjoy at home. This has developed into the ongoing international “currency war,” in which countries are racing to see which can impoverish their citizens fastest. 

The currency war has been a boon to the US dollar, which has appeared fairly stable relative to other currencies. However, just because you and a fellow skydiver both fall in tandem doesn’t change the fact that you’re both headed toward the ground. Short-sighted speculators have ignored this reality, and the precious metals have taken an undeserved beating.

What the Future Holds

QE3 has been winding down throughout 2014, and investors are eagerly awaiting news of a rate hike from the Fed. After all, if the economy is as healthy as the government claims, we should no longer be in need of these multiyear emergency measures.

Unfortunately, the Fed's zero interest-rate policy (ZIRP) is the very thing making the economy appear healthy. It has boosted stocks and financed corporate acquisitions. It has also allowed the federal government to continue operating under a crushing debt load. Even a rise in rates to historically average levels could very well bankrupt the federal government and many of America’s remaining industrial giants.

Neither Fed Chairwoman Janet Yellen nor Washington want to bear responsibility for the painful process of raising rates. Instead, I have long forecast that the Fed will follow QE3 with QE4, and so on. After all, each round of QE is like trying to put out a fire with gasoline, it only makes our economic problems burn hotter.

Meanwhile, our creditors will continue to make careful moves to extricate themselves from the US dollar reserve system, like China’s recent currency swap deals with other emerging markets or its rapid liberalization of domestic gold markets.

This means that a stagnant job market and poorly disguised inflation is the “new normal” for Americans. Forget about sending the kids to college – it’s going to be a struggle for many families just to make ends meet. Those who don’t own gold and silver will see their dollar savings and quality of life diminish at a faster and faster rate.

Helping You Turn Paper Into Gold

My new motto for SchiffGold is “Helping you turn paper into gold.” This has been our mission for the last four years, and it will only gain urgency in the next four. 

While the precious metals may have seemed like they were riding a roller coaster recently, serious investors must learn to see past the short-term noise to understand the important fundamental signals. By all accounts, the global dollar reserve system is in its death throes. At the first major crack, we are likely to see the biggest gold rally the world has ever seen. At that point, it will matter less whether you bought in at $600, $1200, or $1900, because those prices will all seem so cheap as to be quaint. Remember $1.20 a gallon gas? That wasn’t too long ago, and yet we know that we’ll never see that price at the pump again.

SchiffGold will continue to help customers redeem as many paper dollars as possible for physical gold and silver – trading a devaluing asset for one that has been on a 12-year uptrend. I am proud of how my gold company has weathered the storm of overwhelming negative sentiment towards precious metals. While doubters abandoned ship, we were the first to introduce innovative new products that increased investor liquidity, like the 
Valcambi CombiBar and the Silver Barter Bag. When others laid off brokers, we were training passionate new specialists in the intricacies of precious metals investing. The result is that, as I understand it, we have the most loyal customer base of any US gold dealer.

We’ve managed to accomplish this without resorting to selling the high-margin products that make up the bulk of many major dealers’ revenue. Soon after forming my company in response to these widespread shady dealings, we launched the 
Classic Gold Scams educational campaign. In the years since, we have exposed nearly every scam and ripoff imaginable. More recently, several unscrupulous dealers have come under investigation and closed their doors. 

The years spent growing my gold company from scratch have been exciting, but our greatest work has yet to be done. Our mission will continue as long as the US government remains committed to obliterating the value of the dollar, and investors seek out an honest guide to safety.

 

Peter Schiff  is Chairman of gold bullion dealer SchiffGold and CEO of stock brokerage firm Euro Pacific Capital. Schiff became internationally known by successfully forecasting the collapse of the dot-com bubble, the US housing market bubble, and the bankruptcy of major global banks. He is also the author of several bestselling books, including "Crash Proof: How to Profit from the Coming Economic Collapse”released in 2007 before the financial crisis struck, and the more recent “How An Economy Grows And Why It Crashes” and “The Real Crash: America’s Coming Bankruptcy". Follow his latest thoughts at Peter Schiff's Gold News.

PERMALINK | ADD YOUR COMMENT | EMAIL | PRINT | RSS  Subscribe
 
Economic Atonement
Posted by Peter Schiff on 09/30/2014 at 12:15 PM
This Friday is Yom Kippur, the day when Jews around the world ask forgiveness for their transgressions from the year past. Rabbis remind the penitent to dwell on their sins of omission, in which they did nothing when a more thoughtful and proactive action was needed, and sins of commission, in which they actively participated in an unjust action. And while not all economists are Jewish, Gene Epstein the economics editor at Barron's, offered his thoughts on how this applies to the group. 
 
While Gene is certainly on to something, I think he could have gone much further in his finger pointing. Increasingly, economists are calling the tune to which businesses and consumers dance. Since their words and opinions matter, they may consider seeking forgiveness for what they have said, and what they have not.

 

Sins of Omission

 

Despite clear evidence that elevated prices in stocks, bonds and real estate remain a direct consequence of zero percent interest rates and quantitative easing, the crowd has asserted again and again that the prices are justified by the surging U.S. economy. There is very scant evidence upon which to base such an opinion.

 

Most economists have held very tightly to the view that was widely shared at the end of 2013; that 2014 will be the year that the U.S. economy finally shakes off the malaise of the Great Recession. And even though the script has failed to live up to these expectations, the economists haven't seemed to notice.

 

During the First Quarter of this year, the economy contracted at an astounding annual pace of 2.1%. But economists and politicians were very insistent that the severe miss was solely a result of the difficult winter. Although severe winters can be a drag on an economy (my research shows that the 10 roughest winters over the last 50 years knocked about two points off the normal first quarter GDP), the snow could not fully explain a five point miss from what had been forecast by the consensus at the end of 2013. But that's exactly what they did.

 

This omission was compounded by their reaction to the 2nd quarter rebound, which showed the economy expanding by 4.6%. But while the crowd was ready to dismiss the very weak first quarter GDP as being a weather-related anomaly, they were not willing to acknowledge the role played by the same anomaly in artificially boosting second quarter GDP. My research, based on figures from the Bureau of Economic Analysis, has shown that strong second quarter rebounds almost always follow sub-par weather-related first quarters. This makes intuitive sense as well. Activity that is delayed in winter gets unlocked in spring. But economists look at the second quarter as if it represents the entire year. But already plenty of evidence has emerged that should sow doubts on the remainder of the year.

 

Even with the strong second quarter, economists are choosing to gloss over the fact that growth in the entire first half came in at just 1.25%, far below the projections that most have for the calendar year. To get to 2.5% GDP growth, which would be typical of a weak year, not the first year of a long-awaited recovery breakout, GDP would have to come in at 3.75% for the entire second half. To hit 3% for the year, second half growth would need to be 4.75%.

 

But this will have to occur without the tail winds of Fed QE support and at a time of heightened geopolitical concerns, and a housing and stock markets that look increasingly weak and vulnerable to correction. As a result, economists should take off their rose-colored glasses and ratchet down their full year estimates to conform more closely to reality. But that is not happening.

 

Sins of Commission

 

Rather than seeing, hearing, and speaking no evil, some leading figures are much more culpable in spreading bad information. While this list could prove lengthy, here are the top two offenders.

 

Fed Chairwoman Janet Yellen - In her September press conference, Yellen made the stunning assertion that the Fed's balance sheet, which in recent years has swelled to a gargantuan $4.5 trillion, will likely be reduced in size to "normal levels" by the end of this decade. While most accept this statement at face value, Yellen must know the absolute inability of the Fed to deliver on this promise.

 

To bring its balance sheet back to pre-crises levels of around $1 trillion, the Fed must sell about $3.5 trillion of debt over the next five years, or a pace of about $700 billion per year. This is a negative equivalent of about $58 billion per month in QE. Additionally, Yellen has claimed that this can be done without actively "selling" assets, and without tipping the economy back into recession. This claim is so fantastical that it must be considered active deception, a grave sin indeed.

 

First, if QE was necessary to inflate asset prices and create a wealth effect to drive consumer spending and power the recovery, how can the process be reversed without unwinding its effects and producing an even larger recession than the last? If the recovery is already stalling with interest rates still at zero, how can it gather more upward momentum if the Fed raises rates back to normal levels?

 

Secondly, if the Fed does not actively sell bonds into the market, it must hope to draw down the balance sheet by simply allowing older bonds to mature. This ignores the fact that the maturation process is far too slow to accomplish the task by the end of the decade, and it assumes that the Fed will not have to buy any new Treasury or Mortgage-backed bonds over that time. But in order to provide financing for ongoing Federal budget deficits, or to stimulate the economy if there were another economic downturn, the Fed would have no choice but to start buying again with both hands. Since the current "recovery" is already 15 months longer than the average post-war recovery, it would be illogical to assume that we can make it through the next five years without another recession.

 

Of course, by affirming its intention not to actively sell any of its holdings, Yellen is attempting to defray any concerns the markets might have over the impact such sales would have on bond prices. Lost on everyone, including Yellen herself, is that the impact on the markets is the same regardless of how the Fed's balance sheet shrinks. Even if the Fed allows bonds to mature, the Treasury would then be forced to sell an equivalent amount of bonds into the market to repay the Fed. The fact that a distinction without a difference reassures anyone shows just how delusional market participants remain.

 

World bank President Jim Yong Kim - In an interview at September's Clinton Global Initiative, the World Bank president urged the European Central Bank to follow the same "successful" experiments in quantitative easing that had been pioneered by the Federal Reserve. As proof of the policy's success, Kim pointed to the stronger GDP growth that is expected in the US in 2015 and 2016. In other words, he is attempting to prove his point not by what has happened thus far, but by what the consensus expects to happen in a year or two. This is no way to argue a point. Dr. Kim is a smart guy and I suspect he knows this, hence another sin of commission.

 

It would be difficult to make the case that six years of Quantitative Easing has created a healthy US economy. In addition to the subpar first half of 2014 GDP growth, the labor market, consumer sentiment, and wage growth all show signs of stagnation. So Dr. Kim has no choice but to hang his hat on a bright future that he, and most mainstream economists, expect to be right around the corner. But dressing up a future possibility as a current certainty is a major foul in the business of economic forecasting. Dr. Kim, and others who have made similar claims, should fast an extra day.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube



PERMALINK | ADD YOUR COMMENT | EMAIL | PRINT | RSS  Subscribe
 
A New Fed Playbook for the New Normal
Posted by Peter Schiff on 09/17/2014 at 10:43 AM
While many economists and market watchers have failed to notice, we have entered a new chapter in the short and checkered history of central banking. This paradigm shift, as yet unaddressed in the textbooks, changes the basic policy tools that have traditionally defined the sphere of macroeconomic decision-making.
 
The job of a central banker is supposed to be the calibration of interest rates to achieve the optimal rate of growth for any particular economic environment. It is hoped that successful decisions, which involve perfectly timed moves to raise rates when the economy overheats and lower them when it cools, would bring consistency and stability to the business cycle that many fear would be dangerously erratic if left unmanaged. That's the theory. The practice is quite different.
 
Over the past thirty years or so, interest rates have been lowered far more often than they have been raised. This makes sense. Bankers, being human, would rather err on the side of good times not bad. They would rather leave the punch bowl out there a little too long than take it away too soon. Over time, this creates a huge downward bias. But things have really become distorted over the past eight years, a time period during which interest rates have never gone up. They just go down and stay down.
 
Back in the early years of the last decade, Alan Greenspan ventured into almost unknown territory when he lowered interest rates to 1% and left them there for more than a year. But in today's terms, those moves look hawkish. In the wake of the 2008 financial crisis, Ben Bernanke brought interest rates to zero, where they have remained ever since.
 
But old habits die hard, and economists still expect that rates can and will go back to normal. They assume that since the economy is now apparently on solid footing, the period of ample accommodation is over. In reality, we have built an economy that is now so leveraged that it needs zero percent interest rates just to tread water.
 
Based on statistics from the Bureau of Economic Analysis, from 1955 to 2007 Fed Funds rates were on average 230 basis points higher than average GDP growth (5.7% vs. 3.4%). But from 2008-2013, Fed Funds rates have been less than half the rate of GDP growth (0.44% vs. .92%). Rates lower than GDP, in theory, should stimulate the economy. But instead we are stuck in the mud.
 
Twenty-odd years ago the textbooks still seemed to work. A recession hit in 1991, which brought GDP close to zero. In response, the Fed cut rates by more than 200 basis points (from 5.7% in 1991 to 3.5% in 1992.) As expected, 1992 GDP rebounded to a reasonably healthy 3.6%. But the rate cuts did little for asset prices. In that year the S&P 500 crept up just 4.4% and the Case-Shiller 10-City Composite Index of home prices actually fell almost 2% nationally.    
 
Compare that to 2013. With Fed Funds still near zero, GDP actually fell to 2.2% from 2.3% in 2012. But asset prices were a different story. Stocks were up 26% and real estate up 13.5%. It would appear that interest rates have lost their power to move GDP and can now only exert pressure on asset prices.  As a result, rates are no longer the main attraction in central banking. The real action takes place elsewhere.
 
The Fed and other central banks have made the active purchase of financial assets, known as quantitative easing, to be their main policy tool. QE is a more powerful drug than interest rates. It involves actual market manipulation by the purchases of bonds on the open market. Whereas zero interest rates could be compared to a general stimulant, QE is a direct shot of adrenaline to the heart. When the next recession comes, the syringe will likely come into greater use.

Since 1945 the U.S. economy has dipped into recession 11 times. The average length of the recoveries between those recessions was 58.4 months, or just under five years. The current "recovery" is already 73 months old, or 15 months longer than the average. How will the Fed deal with another contraction (which seems likely to begin within the next year or two) with rates still at or very close to zero? QE appears to be the only option.
 
Given that reality, the big question is no longer whether the Fed will raise or lower rates, but by how much they will ramp up or taper off QE. When the economy contracts, QE purchases will increase, and when the economy improves, QE will be tapered, and may even approach zero for a time. But interest rates will always remain at zero or, at the least, stay far below the rate of inflation. This will continue until QE loses its potency as well.
 
Mainstream economists will be quick to dismiss this theory, as they will say that policy is now on course for normalization. Although economic growth in 2013 was nothing to write home about, the set of indicators that are normally followed by most economists, point to a modest recovery, exuberant financial markets, and falling unemployment. But if that is the case, why has the Fed waited so long to tighten?
 
The truth is the Fed knows the economy needs zero percent rates to stay afloat, which is why they have yet to pull the trigger. The last serious Fed campaign to raise interest rates led to the bursting of the housing bubble in 2006 and the financial crisis that followed in 2008. This occurred despite the  slow and predictable manner in which the rates were raised, by 25 basis points every six weeks for two years (a kind of reverse tapering). At the time, Greenspan knew that the housing market and the economy had become dependent on low interest rates, and he did not want to deliver a shock to fragile markets with an abrupt normalization. But his measured and gradual approach only added more air to the real estate bubble, producing an even greater crisis than what might have occurred had he tightened more quickly.
 
The Fed is making an even graver mistake now if it thinks the economy can handle a measured reduction in QE. Similar to Greenspan, Bernanke understood that asset prices and the economy had become dependent on QE, and he hoped that by slowly tapering QE the economy and the markets could withstand the transition. But I believe these bets will lose just as big as Greenspan's. The end of QE will prick the current bubbles in stocks, real estate, and bonds, just as higher rates pricked the housing bubble in 2006. And as was the case with the measured rate hikes, the tapering process will only add to the severity of the inevitable bust.

So while the market talks the talk on raising rates, the Fed will continue to walk the walk of zero percent interest rates. The action has switched to the next round of QE. In fact, since none of the Fed's prior QE programs were followed by rate hikes but by more QE, why should this time be any different? The most likely difference will be that eventually a larger dose of QE will fail to deliver its desired effect. When that happens, who knows what these geniuses will think of next. But whatever it is, rest assured, it won't be good.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

Catch Peter's latest thoughts on the U.S. and International markets in the Euro Pacific Capital Summer 2014 Global Investor Newsletter!

PERMALINK | ADD YOUR COMMENT | EMAIL | PRINT | RSS  Subscribe
 
Doubling Down on Inflation
Posted by Peter Schiff on 09/10/2014 at 1:39 PM
Friday's release of disappointing August payroll numbers should have been a jarring wake-up call warning Wall Street that the economy has been treading on thin ice. Instead the alarm clock was stuffed under the pillow and Wall Street kept sleeping. The miss was so epic in fact (the 142,000 jobs created was almost 40% below the consensus estimate) that the top analysts on Wall Street did their best to tell us that it was all just a bad dream. Mark Zandi of Moody's reacted on Squawk Box by saying "I don't believe this data." The reliably optimistic Diane Swonk of Mesirow Financial told Reuters the report "sure looks like a fluke, not a trend".
 
But the opinions of those that really matter, the central bankers in charge of the global economy, are likely taking the report much more seriously. Given that this is just the latest in a series of moribund data releases, such as news today that U.S. mortgage applications have fallen to the lowest levels in 14 years, caution is justified. Unfortunately very little good comes from central bank activism. Recent statements from Fed officials across the United States and recent actions from ECB president Mario Draghi reveal their growing resolve to fight too low inflation, which they believe is the biggest threat to recovery. There are many things that are contributing to the global woes. But low prices are not high on the list.
 
Since the markets crashed in 2008, central banks around the world have worked feverishly to push up the prices of financial assets and to keep consumer prices rising steadily. They have done so in the official belief that these outcomes are vital ingredients in the recipe for economic growth. The theory is that steady inflation creates demand by inspiring consumers to spend in advance of predictable price increases. (The flip side is that falling prices "deflation," strangles demand by inspiring consumers to defer spending). The benefits of inflation are supposed to be compounded by rising stock and real estate prices, creating a wealth effect for the owners of those assets which subsequently trickles down to the rest of the economy. In other words, seed the economy with money and inflation and watch it grow.
 
Thus far the banks have been successful in creating the bubbles and keeping inflation positive, but growth has been a no show. The theory says the growth is right around the corner, but like Godot it stubbornly fails to show up. This has been a tough circle for many economists to square.
 
Two explanations have emerged to explain the failure. Either the model is not functioning (and higher inflation and asset bubbles don't lead to growth) or the stimulus efforts thus far, in the form of zero percent interest rates and quantitative easing, have been too timid. So either the bankers must devise a new plan, or double down on the existing plan. You should know where this is going. The banks are about to go "all in" on inflation.
 
Despite their much ballyhooed "independence", central bankers have proven that they operate hand in glove with government. They are also subject to all the same political pressures and bureaucratic paralysis. There is an unwritten law in government that when a program doesn't produce a desired outcome, the conclusion is almost never that the program was flawed, but that it was insufficient. Hence governments continually throw good money after bad. The free market discipline of cutting losses simply does not exist in government.
 
This is where we are with stimulus. Six years of zero percent interest rates and trillions and trillions of new public debt have failed to restore economic health, but our conclusion is that we just haven't given it enough time or effort. My theory is a bit different. Maybe zero percent interest rates and asset bubbles hinder rather than help a real recovery. Maybe they resurrect the zombie of a failed model and prevent something viable and lasting from gaining traction? This is a possibility that no one in power is prepared to consider.
 
But what if they succeed in getting the inflation, but we never get the growth? What if we are headed toward stagflation, a condition that in the late 1970s gripped the U.S. more tightly than Boogie Fever? It may come as a surprise to the new generation of economists, but high inflation and high unemployment can coexist. In fact, the two were combined in the 70s and 80s to produce "the Misery Index." But according to today's economic thinking, the Index should not be possible. Inflation is supposed to cause growth. If unemployment is high they say there is no demand to push up prices. But it's the monetary expansion that pushes prices up, not the healthy job market.
 
The tragedy is that if the policy fails to produce real growth, as I am convinced it will, the price will be paid by those elements of society least able to bear it, the poor and the old. Inflation and stagnation mean lost purchasing power. The rich can mitigate the pain with a rising stock portfolio and more modest vacation destinations. But they won't miss a meal. Those subsisting on meager income will be hit the hardest.
 
Many economists are now trying to make the case that the United States had hit on the right stimulus formula over the past few years and is now reaping the benefit of our bold monetary experimentation. They continue the argument by saying Europe and Japan were too timid to implement adequate stimulus and are now desperately playing catch up. But this theory is false on a variety of fronts. First off, the U.S. is not recovering but decelerating. Annualized GDP in the first half of 2014 has come in at just a shade over one percent, which is lower than all of 2013, which itself was lower than 2012. The unemployment rate is down, but labor participation is at a 36-year low, and wages are stagnant. We have added more than $5 trillion in new public debt, but very little to show for it. We are not the model that other countries should be following but a cautionary tale that should be avoided.
 
It is also spectacularly wrong to assume that the problems in Europe and Japan can be solved by a little more inflation. Higher prices will just be a heavier burden for European and Japanese consumers, not an elixir that revitalizes their economies. The problems in Europe, Japan and the U.S. all have to do with an oppressive environment for savings, investment, and productivity that is created by artificially low interest rates, intractable budget deficits, restrictive business regulation, antagonistic labor laws, and high taxes. Since none of the governments of these countries have the political will to tackle these problems head on, they simply hope that more monetary magic will do the trick.
 
So as the Fed, the ECB, the Bank of Japan, and all the other banks that follow suit, push all their chips into the pot and hope that a little more inflation will save us from the abyss, we can wish them luck. It's going to take a miracle.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

Catch Peter's latest thoughts on the U.S. and International markets in the Euro Pacific Capital Summer 2014 Global Investor Newsletter!

PERMALINK | ADD YOUR COMMENT | EMAIL | PRINT | RSS  Subscribe
 
Neighborhood Bully - America Recklessly Throws its Weight Around
Posted by Peter Schiff on 08/15/2014 at 7:08 AM

On June 30, U.S. authorities announced a stunning $9 billion fine on French bank BNP Paribas for violations of financial sanctions laws that the United States had imposed on Iran, Sudan and Cuba. In essence, BNP had surreptitiously conducted business with countries that the United States had sought to isolate diplomatically (sometimes unilaterally in the case of Cuba). Although BNP is not technically under the jurisdiction of American regulators, and the bank had apparently not broken any laws of its home country, the fine was one of the largest ever issued by the United States and the largest ever levied on a non-U.S. firm. The Treasury Department and the Federal Reserve made clear that unless BNP forks over the $9 billion (equivalent to one year's of the company's total earnings), the U.S. will prevent the bank from engaging in dollar-based international transactions. For an institution that makes its living through such transactions, that penalty is the financial equivalent of a death sentence. The fine will be paid.

 

It is widely rumored that Germany's Commerzbank will be the next European institution to face Washington's wrath. It is rumored that it will face a penalty of at least $500 million, an amount that is roughly equivalent to one year of the bank's income. 

 

As if choreographed by a financial god with a wicked sense of humor, the very next day marked the official implementation of the Foreign Account Tax Compliance Act (FATCA), a new set of laws that will require all foreign financial institutions to routinely and regularly report to the U.S. Internal Revenue Service all the financial activities of their American customers. The law also requires that institutions report on all their non-American customers who have ever worked in the U.S. or those persons who have a "substantial" connection to the U.S. (Inconveniently the law fails to fully define what "substantial" means). Failure to report will trigger 30% IRS withholding taxes on any dollar-based transactions made by clients who the U.S. has determined to be American...either by birth, marriage, or simply association.

 

Given that the United States is one of only two nations in the world (the other being Eritrea) that taxes its citizens on any income received, regardless of where that income was earned and where the tax payer lived when they earned it, the FATCA laws are an attempt to extend American tax authority and jurisdiction (by unilateral dictate) to the four corners of the Earth. The Economist magazine, which is not known for alarmist reporting, described FATCA as "a piece of extraterritoriality stunning even by Washington standards." (For those of you who did not pay attention during world history class, "extraterritoriality" is an attempt by one country to enforce its own laws outside of its own borders).

 

What's worse is that many accountants and analysts have estimated that the compliance costs that the United States has imposed on these non-constituent banks (which have limited ability to lobby or influence U.S. lawmakers) will far outweigh the $800 million in annual revenue that the law's backers optimistically estimated. In a June 28th article, The Economist quotes an international tax lawyer saying that FATCA is about "putting private-sector assets on a bonfire so that government can collect the ashes." The laws are particularly irksome to many because the United States typically refuses to subject itself to the same standards it requires of others. When foreign governments ask Washington for financial information from its citizens, the U.S. government hypocritically trots out privacy laws and poses on the altar of civil liberties. In fact, despite its war on foreign tax havens, for non-Americans the United States is by far the world's largest tax haven.

 

But as is the case with BNP, the foreign banks will have little choice but to comply. Given the importance that U.S. dollar-based transactions play in daily banking operations, U.S. authorities call the tune to which everyone must dance. However, the complexity and opacity of the laws have at least generated some mercy from the U.S. which has allowed foreign banks more time to implement compliance procedures. In many ways this is similar to how the Obama administration has extended Obamacare mandates to a persistently confused and overwhelmed public. This is cold comfort.

 

The FATCA and the BNP developments have occurred just a few months after the U.S. has finished tightening the screws on a variety of Swiss banks that had attempted to follow the bank privacy laws that exist in their home country. Through heavy-handed tactics, U.S. authorities made it impossible for the Swiss banks to transact business internationally unless they played ball with Washington and turned over all information the banks possessed on U.S. customers. Not surprisingly, the U.S. prevailed. Additionally, June marked the end of Germany's farcical campaign to repatriate the hundreds of tons of gold that are supposedly on deposit at the Federal Reserve Bank of New York. After asking for its gold back two years ago, and after having only received the smallest fraction of that amount over the ensuing years, the Germans have decided to make a virtue of necessity and drop its demands to receive its gold. (see Interview with Peter Boehringer)

 

But the fate of BNP appeared to kick up a storm that went beyond the usual grumblings that American financial muscle-flexing usually inspires. A few days after the fine was announced, French Finance Minister Michel Sapin questioned its legality by pointing out that the offending transactions were not illegal under French law. (The Obama Administration reportedly ignored requests by French President François Hollande to reduce the fine). Going further, Sapin appeared to bring into question the entire monetary regime that has granted the U.S. its unique unilateral power: "We have to consider...the consequences of pricing things in dollars when it means that American law applies outside the U.S.....Shouldn't the euro be more important in the global economy?" (Bloomberg, 7/5/14) Politicians, French or otherwise, rarely deliver such explicit statements.

 

As if on cue, a few days later Christophe de Margerie, the CEO of French national energy company Total SA, raised eyebrows when he made repeated comments at a conference in France that the euro should be used more often in international oil transactions, saying "Nothing prevents anyone from paying for oil in euros." Perhaps these are the opening salvos in what may be a long war.

 

The anger is particularly acute in Germany where the United States has already come under criticism for a series of surveillance and espionage revelations, including illegally tapping Chancellor Merkel's cell phone, and planting spies in the upper echelons of Germany's military. Bloomberg recently compiled a selection of frustration with the United States' actions from Germany's leading newspapers. Among the highlights: 

  • "The EU should think about introducing similar senseless rules and then punishing U.S. companies for violating them" (Frankfurter Allgemeine Zeituing).   
  • "The United States is not really our friend. Friends treat each other with respect, the way Russia and Germany treat each other, and they do not try to order each other about" (Handelsblatt).

When Germans hold up Russia as a better ally than America, you realize how fundamentally the world is changing. And as we know, Vladimir Putin is doing all that he can to construct a post-dollar financial system (see related article). 

 

These types of frictions should be expected now that America finds its economic and diplomatic influence to be waning. The failures of the American military to create stability in Afghanistan and Iraq, of American diplomacy in heading off crises in Syria, the Ukraine and Palestine, and most importantly the culpability of the American financial system in bringing the world to the brink of financial ruin in 2008, have left the United States with few good options with which to exert her influence. The predominance of the dollar and its reserve status around the world provides the leverage that America's other failed institutions no longer can. 

 

This power is magnified by the ridiculous Keynesian notion that a strong currency is a liability and a weak currency is necessary for a healthy economy. This means that every bad move by the Federal Reserve needs to be matched by its counterpart bank in Frankfort and London. As such, America can debase its currency and serially acquire debt while avoiding the consequences that lesser countries would inevitably encounter.

 

For the moment the backlash against these laws has been limited to those Americans living abroad who are increasingly finding themselves to be financial lepers. Many local banks and mortgage companies are seeking to avoid the heavy hand of the IRS and FATCA by simply closing their doors to Americans. Even non-financial firms abroad have shown increasing reluctance to hire Americans as a result of the tax complications. As a result, it is well documented that the number of Americans renouncing their citizenship has skyrocketed in recent years.

 

The real danger of course is that the United States overplays its hand and arrogantly goes too far. While many would believe that that milestone has come and gone, the truth is that the U.S. has yet to pay a price broadly for its actions. The dollar's reserve status is as yet intact, and U.S. Treasury debt is being sold at generationally low yields. But the longer this goes on, the greater the danger becomes. 

 

Arrogance breeds contempt. The more reckless the United States becomes in throwing its weight around, the greater the temptation will become for the rest of the world to jettison the dollar like an unwanted house guest. If that happens, the value of U.S. dollar-based investments, and the living standards of all Americans, will pay a very heavy price. 

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show.



PERMALINK | ADD YOUR COMMENT | EMAIL | PRINT | RSS  Subscribe
BECOME A PREMIUM MEMBER!
Tom Woods Right Banner
newsletter
MARKET NEWS
Proudly show you are a Peter Schiff fan with this Schiff Head Cap.
America's Coming Bankruptcy - How to Save Yourself and Your Country
Display stickers that send the perfect message.
Join Schiff Premium now and get unlimited access to SchiffRadio.com.
Proudly show you are a Peter Schiff fan with this Schiff Head Cap.
America's Coming Bankruptcy - How to Save Yourself and Your Country
Become a Sponsor
Nothing discussed on the show is an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular investing strategy. All securities involve varying amounts of risk, and their values will fluctuate, and the fluctuation of foreign currency exchange rates will also impact your investment returns if measured in U.S. Dollars. Dividend yields change as stock prices change, and companies may change or cancel dividend payments in the future. Investments may increase or decrease in value and you may lose money. International investing may not be suitable for all investors.
Copyright © 2002-2014 SchiffRadio.com. All rights reserved. Terms & Conditions  |  Privacy Policy  |  Acknowledgments
This site is Created and Managed by Nox Solutions LLC.
Support Our Sponsors
Audible.com Ad
The Real Crash updated
The Global Investor
Euro Pacific Weekly Digest