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Summer 2014 Euro Pacific Capital Newsletter
Posted by Peter Schiff on 07/28/2014 at 12:13 PM

Welcome to the Summer 2014 edition of Euro Pacific Capital's The Global Investor Newsletter. Our investment consultants are standing by to answer any questions you have.  Call (800) 727-7922 today!

First Half Performance Review - Inflation Trumps Grwoth
By: Jim Nelson, Director of Euro Pacific Asset Management

Neighborhood Bully - America Recklessly Throws its Weight Around
By: Peter Schiff, CEO and Chief Global Strategist

The Russian Wild Card - Backed into a Corner, Putin Makes Plans
By: John Browne, Senior Economic Consultant

The Strange Case of German Gold - An Interview with Peter Boehringer
By: Andrew Schiff, Director of Communications and Marketing

Abenomics Update: Consumers Pay the Price
By: Peter Schiff, CEO and Chief Global Strategist

Sector Watch - The Robots are Coming

Argentine Debt Tangle
By: David Echeverria, Investment Consultant, Los Angeles

The Global Investor Newsletter - Summer 2014

First Half Performance Review - Inflation Trumps Growth

By: Jim Nelson, Director of Euro Pacific Asset Management

During the second quarter of 2014 the S&P 500 continued to post new all-time highs while volatility remained remarkably low. Such a combination can potentially lead to complacency. Already a rotation toward more defensive positions is underway. For example, through the first half of the year, total return for the Russell 2000 (a barometer for domestic growth) was just 3.3% (IWM) while total returns for defensive assets like the Treasury Bonds (TLT) and the S&P 500 Utilities sector (XLU), were 12.9% and 18.5%, respectively. See Figure 1.

Internal market dynamics also suggest that inflation expectations are on the rise. During the first half of 2014, the CRB Commodity Index (CRY) and Gold (GLD) were each up over 10%. Again, this compares with the domestic equities, represented by the Russell 2000, returning just 3.3% (IWM). Given that our strategies are designed to outperform in an environment of slowing U.S. growth and rising inflation, we saw solid results in the first half of the year. 

Figure 1 - 1st Half 2014 Comparable Total Returns  

Growth - Cyclical Spring, Secular Fall

In 2013, GDP grew sequentially in each of the first three quarters reaching 4.2% in 3Q13, which was the second highest level since 2006. (BEA, Jan 30, 2014). This momentum was cut short in the first quarter of 2014, which was confirmed when BEA reported annualized 1Q14 GDP at negative 2.9%.[1], the weakest quarter since the end of the Great Recession in 2009. For historical reference, a decline of over 2.5% has been associated with every recession since WW2. While most pundits blamed the surprisingly weak performance on severe winter weather, our research suggests that the unusual cold and snow would be expected to knock just 2% of annualized growth off of GDP. Instead the results were fully six points below earlier expectations that first quarter growth would approach positive 3%.

Despite the dismal first quarter miss, consensus remains that the economy will get right back up on its feet and is on the verge of hitting “escape velocity.” The bullish forecasters base this view on optimistic forecasts for housing, capital investment, and employment. While we do not claim to have an edge on making near-term economic calls, we are somewhat skeptical of all three of these factors.


In 2012 and 2013, the U.S. housing market improved considerably, but this was from historically depressed levels following the Great Recession. From the 2006 peak into early 2012, the Case-Shiller Price Index declined by 35%, which provided an attractive buying opportunity for 1) investors flush with cash (i.e. private equity investors), and 2) households able to borrow at historically low mortgage rates (2012 average 30-yr rate 3.7% vs prior 5-yr avg. 5.3%)[2].  As a result, between 2012 and 2013, existing home sales increased 30% and house prices gained 25%.[3] 

Now, it appears those “easy gains” have ended as 1) cash investors are no longer buying and actually starting to sell, and 2) mortgage rates are set to rise as the Fed continues to Taper its QE program.[4] The impact of these trends is already showing in the data. Since ex-Fed Chairman Bernanke first hinted about Taper in the summer of 2013, mortgage rates have risen almost 100bps (30% increase). Over this same time, MBA Mortgage applications have fallen by 60%, existing home sales have declined 15% and house price gains have slowed.  While another near-term bounce is possible, we believe a sustainable recovery is less likely. Household balance sheets remain stretched, income growth is barely keeping pace with inflation, and affordability is declining (higher house prices plus rising interest rates).

Capital Investment

In 2009, Gross Private Investment collapsed to almost 12% of GDP, which was the lowest level in the post WW2 period and compares with a median level of 19% in the three decades prior to the Great Recession.  Since 2009, Gross Investment has rebounded and is now 16% of GDP. Many growth bulls expect this level to rise over the next few years, noting that the average age of U.S. capital stock (i.e. plant/equipment) is at record highs and needs to be upgraded.  Recently, this view has gained traction with improvements in forward-looking surveys, like the Purchasing Managers Index (PMI).  In the near-term, we do expect a modest bounce in capital investment to make up from weather related disruptions earlier in the year, but we are more skeptical about a multi-year boom. 

First, we believe much of the recovery in private Investment was supported by bonus deprecation tax benefits (initiated during the recession) that enticed many corporations to accelerate investments in 2010-13. These incentives ended on Dec 31, 2013, so businesses have less reason for new investment. For companies to increase investment without government support, sales levels need to increase, which will remain difficult as household balance sheets and incomes remain under pressure. As a note, the current level of private investment (16% of GDP) is below median levels during the thirty years prior to the Great Recession (19% GDP), but it is consistent with the thirty year period following WW2 (17% GDP).

Second, companies have recently been more inclined to acquire rather than try to grow organically.  In the first half of 2014, total U.S. M&A deals were over $750B, which was up 50% from the same period in 2013 and on pace to hit annual levels not seen since 2006-2007.[5] Also, almost 95% of recent deals have been strategic (companies, not private equity, are buying other companies) which compares with just 75% in 2006-07. If companies saw organic opportunities then this cash would be invested in new plant and equipment instead of paying premiums for existing firms. With easy access to relatively cheap capital, we expect the M&A spree to continue, noting that this will actually result in job losses (vs. capital spending that drives job gains). 

Finally, companies that have not found attractive M&A opportunities have been using cash to raise dividends and buy back stock. In the first quarter of 2014, U.S. share buybacks and dividends hit a record level of $241 billion.[6]  Returning excess cash to shareholders is normal when growth prospects are dismal, but the recent trend has been exacerbated by activist investors that are pressuring companies to use leverage to return cash. As a result of this, combined with M&A activity discussed above, business (non-financial) leverage is at record levels.


In the first half of 2014, new job additions totaled 1.4 million (BLS establishment survey), which was the largest six-month increase since 2006.[7] At the end of June 2014, the unemployment was 6.1%, down from 7.0% at the start of the year[8]. The economy has now regained all jobs lost in the Great Recession. But this is strictly a measure of quantity not quality. It is widely understood that low paying and part time jobs have replaced higher paying full time jobs. But even the raw number of jobs has failed to keep pace with population growth. At the end of June, the employment to population ratio was 59%, essentially flat since 2010. This compares with a median level of 62% in the thirty years prior to 2006. To get back to that level, the economy would need to add another 10 million jobs. Assuming the current pace of job gains (using average of Jan-June 2014 gains in the Household survey) and trend growth in the working-age population, it would take another five years for the employment to population ratio to reach that level.

The combination of low employment to population and low labor force participation means that 41% of the working age population is not employed, which compares with pre-Great Recession levels closer to 35%. That means that roughly 100 million people or one-third of the entire U.S. population is not working, hardly a sign of a solid labor market. Further, we expect the level of non-working persons in the U.S. to continue rising as Baby Boomers retire.

In other words, the consensus is making a pile of assumptions about an imminent recovery that just doesn’t hold a tremendous amount of water.

Inflation - Showing life, but Still Dead to the Fed

But while growth is failing to materialize, inflation is on the rise. Back in January of 2012, Fed Chairman Ben Bernanke did something that no Fed Chairman had done before: He publicly set a 2% inflation target. Well, apparently, the Fed is not nearly so impotent as I had believed as it only took 2 and ½ years to achieve this goal (this is if you give full credence to their statistics). The latest CPI report for June 2014 came in at 2.1% year over year. This follows very similar numbers in April and May. More importantly the inflation shows signs of heating up more recently. The last four months of data (March - June) show average annualized month over month changes at 3.2%. Finally, the Fed has rescued us from the abyss.

Figure 2 - 2 year CPI Chart

Not only have they rescued us, but they hit the sweet spot. According to modern day Keynesian theories, with 2% inflation achieved and 0% interest rates, the economy should be humming right along. But the theory is not translating into practice.

Companies are starting to feel the price squeeze and are passing on rising input costs in a variety of ways, in a variety of industries. Hershey just announced an 8% increase on chocolate across the board. Then Mars Candy followed suit by raising their chocolate prices 7%. Starbucks has raised prices between 5 and 20 cents per drink. Chipotle has raised prices between 4% - 12.5% depending on location. The hits keep coming: Adult tickets at Disneyland (4.3%), Netflix (12.5% for new customers), SeaWorld (3.3%), Nike (11%-20%). Food prices have also really picked up recently. Even the federal government (USDA) thinks that prices for fruits and vegetables will rise 6% in the next few months. The Food CPI index over the last four months is ominous, up 4.2% annualized. Beef prices also continue to be at all-time highs. Unfortunately these increases have risen faster than incomes.

Admittedly, short-term changes in inflation are very hard to predict, but we know that the Fed is determined to push inflation much higher (as is every other central bank in the world). The fact that Janet Yellen sees current inflation data as just “noise” implies she does not view inflation as a current risk and that near-term monetary policy decisions will be based solely on the labor market outlook. As discussed in the previous section, we believe underlying trends in the labor market are weaker than headline numbers would imply. Should the Fed agree, then it is unlikely that monetary policy begins to normalize in early 2015 as consensus now expects.


Recent economic data (and asset price movements) indicate U.S. growth is slowing while inflation is rising. Should these trends continue through the year, we expect our portfolios will outperform. That said, with growth and inflation levels already at historically low levels, even minor hiccups can have an outsized influence on their movements in either direction. We view these moves as short-term and we remain focused on our long-term investment thesis and strategy. As such, 2014 may or may not prove to be the year that U.S. growth inflects lower while inflation moves decidedly higher, however our portfolios are well positioned for when it eventually does. In the meantime, we continue to focus our time on managing diversified portfolios comprised of securities that we view as high quality and undervalued.

[1] Bureau of Economic Analysis (BEA), June 25, 2014

[2] Bankrate.com, Bloomberg accessed July 4, 2014

[3] National Association of Realtors (NAR) and Case-Shiller Index, Bloomberg accessed July 3, 2014.

[4] New York Times, DealBook “Investors Who Bought Foreclosed Homes in Bulk Look to Sell”, June 27, 2014.

[5] Business Insider, “2014 Is On Track to Become The Second Biggest Year for M&A in History”, June 30, 2014

[6] Financial Times, “US Share Buybacks and Dividends Hit Record”, June 8, 2014.

[7] Bureau of Labor Statistics (BLS), Establishment Survey, July 3, 2014

[8] BLS, Household Survey, July 3, 2014

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Neighborhood Bully - America Recklessly Throws its Weight Around

By: Peter Schiff, CEO and Chief Global Strategist

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. 

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The Russian Wild Card - Backed into a Corner, Putin Makes Plans

By: Andrew Schiff, Director of Communications and Marketing

While the United States continues to throw its weight around diplomatic summits and global financial markets, Vladimir Putin has emerged as the most visible and active proponent of a post-dollar world.

A few months ago Putin had risked becoming a global pariah when his aggressive stance towards the Ukraine looked like it could unleash the second coming of the First World War. But when the U.S. failed to galvanize Western European opposition (in Germany in particular), and with the crisis failing to spread outside of a few flash points in eastern Ukraine, international attention soon drifted to other hotspots (Iraq, Israel).

But the tragic downing of the Malaysian airliner, more likely than not to be a mistaken attack by Ukrainian separatists, significantly complicates the situation for Putin and Russia, and further galvanized Western interests against him. However, the speed with which conclusions have been drawn about Putin's culpability, despite conflicting evidence, may catalyze the convergence on non-western interests as well. Time Magazine highlighted this, quoting an official Chinese source as saying:

"The Western rush to judge Russia is not based on evidence or logic. Russia had no motive to

bring down MH17; doing so would only narrow its political and moral space to operate in the Ukrainian crisis. The tragedy has no political benefit for Ukrainian rebel forces, either. Russia has been back-footed, forced into a passive stance by Western reaction. It is yet another example of the power of Western opinion as a political tool."

Putin, a former KGB colonel, is seeking to use the crisis to take the offensive against his old American nemesis. In particular, he has unveiled a series of concrete steps that he hopes will lead to the emergence of a Eurasian economic bloc that could operate outside of U.S. dollar-based control. The bounce-back in Russian equity markets since the steep Ukraine-related sell off in February and March, and the large U.S fines imposed on BNP Paribas, have provided him with some leverage.

In May, a monster $400 billion energy supply deal was announced that would keep oil and gas flowing from Russia to China for years to come. As the deal was largely symbolic, many in the Western media took great pains to point out that it did not dictate that payment for the energy would be in currencies other than the dollar. But recent statements appear to be setting the stage for just that. On June 26, The Financial Times reported that Gazprom, Russia's largest natural gas provider, announced that it would be considering issuing bonds in Asian markets denominated in RNB or Singapore dollars and listing shares on the Hong Kong Exchange. When explaining these moves, Gazprom's chief financial officer Andrei Kruglov unsurprisingly characterized them as an effort to attract more Asian investors. However, he used the opportunity to say that "As for settlements in renmimbi or rubles, we are ready for this and we think it's quite normal."

The FT went on to report that other Russian companies, including Norilsk Nickel, have stepped up talks on settling contracts and raising debt in currencies other than the dollar. In addition, Reuters reported on June 24 that Moscow is considering barring state-owned companies and other enterprises deemed to be "strategically important" from holding accounts at foreign-owned banks.Theoretically, this could protect Russian assets from the types of fines and penalties that the U.S. has been imposing around the world.    

On a separate front, Russia has successfully exploited the disintegration of the fragile Iraqi state to further extend influence in the region. Moscow has long been the champion of the Shia governments in the Middle East (Syria and Iran) and has consistently opposed the interests of the U.S.-backed Sunni states of Saudi Arabia, Kuwait and Jordan. Russian power came into stark focus in Syria in 2012 when they were able to check Obama's attempt to oust the Assad regime over reports of chemical weapons use. With the Obama Administration withdrawing support of the hapless Maliki government, the desperate Shia leader has turned to the Kremlin in its struggle against ISIS insurgents. In a jaw-dropping development, Maliki agreed to buy a package of Russian jet fighters and ground attack aircraft. And as if to show the contrast with the famously slow delivery of the American F-16 aircraft that the U.S. sold to Iraq back in 2011, the Russian equipment began arriving almost immediately.

If, as appears increasingly likely, Iraq will disintegrate into Sunni and Shia dominated enclaves, it is not difficult to imagine that Russia will extend its power beyond Iran, straight into Shia Baghdad. The influence would have been bought and paid for by American blood and treasure.

In the lead up to the Second World War, the Western democracies foolishly took for granted that Russia could always be counted on to oppose Nazi Germany. But crafty German diplomacy resulted in the Hitler/Stalin Non-Aggression Pact of 1939, thereby shaking Russia loose from the Alliance. This blunder set the stage for a very different world order. (Only Hitler's unprovoked invasion of Russia in 1941 succeeded in bringing Stalin back to the Allies).

Today the roles are reversed. Germany is the swing vote in the new economic struggle. And as discussed in an earlier article in this newsletter, Germany is chafing in its role as a loyal soldier supporting U.S. interests. In a July opinion piece for Reuters, Ian Bremmer, the founder of the respected geopolitical risk consultancy firm Eurasia Group said, "Germany is alarmed by the United States' tendency to use its economic clout as an extension of its foreign policy, one that the Germans see as increasingly fickle, opaque and misaligned from their own." If Russia and China can manage to pull the increasingly frustrated Germans away from the dollar-based world of infinite monetary stimulus and heavy-handed financial enforcement, the United States will face a very difficult road ahead. Market watchers would be well-advised to keep a close watch on Vladimir Putin.

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The Strange Case of German Gold - An Interview with Peter Boehringer

By: Andrew Schiff, Director of Communications and Marketing

A June 23 Bloomberg News story entitled "German Gold Stays in New York in Rebuff to Euro Doubters" made the seemingly straight-forward case that the German authorities had decided to reverse course on a plan announced in 2012 to bring home some 300 tonnes of German gold that had been on deposit at the New York Federal Reserve since the 1960s. According to the article, German representatives had gone to New York, saw their gold, were convinced that it was in good hands, and decided that the hassle of putting it on a plane and sending it back to Germany was simply unnecessary. The article quoted a spokesman for Chancellor Merkel who said "the Americans are taking good care of our gold" and even quoted Peter Boehringer, one of the leading private advocates of the repatriation movement, as saying their campaign to pressure German authorities "is on hold."

When the Germans originally asked for their gold back, the Federal Reserve had countered with a painfully slow eight-year delivery period. This struck many as strange given that the total request only represented 5% of the gold reportedly held at the Fed's New York vaults. The delay severely whipped up concerns that long-held theories about imaginary gold were actually true. The Bloomberg article appeared to dismiss all these concerns and bring the case to a close. Or did it? Almost immediately,people close to the matter cried foul.

I caught up with none other than Peter Boehringer of the German Precious Metals Society for this exclusive interview.  

AS - The apparent reversal by the German government to no longer look to repatriate its gold from the United States failed to raise any interest in the American press or the financial establishment. Did the move create much of a stir in Germany? Are any mainstream politicians there actively picking up the issue.

PB - The "reversal" has indeed been only apparent - the Bundesbank has not in any way officially changed its repatriation plan that was announced in January 2013 (a plan that I believe was too slow and too little anyway-- 700 tonnes by end 2020 - of which. 300 tonnes from the New York Fed). The primary source for the confusion, especially in the non-German media, came from a factually wrong Bloomberg story. That story began with a completely unfounded headline "German gold stays in NY." I tried to set the record straight in the English-language press, but it is hard to fully "call back" wrong mainstream reports like that one.(via Bloomberg BusinessWeek on June 23, 2014)

Having said this, it is quite possible that the politicians cited in the story (such as Mr. Barthle, a Merkel spokesman) actually intended to "test the waters" of how the German public would react. In that respect, statements like "The Americans are taking good care of our gold. Objectively, there's absolutely no reason for mistrust." could indeed have some significance, as they might be intended as a first step towards stopping even the already painfully slow repatriation process of gold from the Fed. Still, Barthle, or Merkel for that matter, are not in charge of the gold, the Bundesbank is, and they have said nothing.

It is noteworthy that in 2013, a mere 5 tonnes were actually delivered from NY to Frankfurt. And even for these miniscule volumes there is no evidence, either by an external auditor or by video documentation, that real gold bars (allegedly untouched in the Fed´s vaults since the 1960s) have been moved across the Atlantic. Bundesbank has even melted down and allegedly re-cast these bars for no apparent reason! We have not received any audit report of this process, no report from the (unknown) performing smelter, and no bar lists from "old" or newly cast bars.

But to date, no mainstream politician has publicly questioned this strange behavior. It has been left to concerned private organizations like ours to press these concerns. Fortunately our national media has picked up on some of this which may have prompted Mr Barthle´s blind and unfounded "pledge of allegiance" to the U.S.

AS - Is the issue something that is discussed or understood by the average German?

PB - These details are of course not being discussed by the "average German" - soccer seems to be far more important these days. But both the gold community, the financial community, and the international media are taking ever more notice of our continued struggle. A full two and a half years after the initiation of our campaign, I receive at least two interview requests per week.

The Fed´s unwillingness to provide information, Bundesbank's obvious evasions and obfuscations, and Bloomberg´s misleading article are leading to completely unintended reactions by the general public and the independent media: Rather than putting this issue to bed as these authorities may have hoped, we are seeing ever MORE questions being raised.

AS - Officially, at least, what was responsible for convincing German officials that their gold is safely stored and accounted for by the Federal Reserve?

PB - I can of course only speculate here. Given the decade-long mis-information by the Fed and the Bundesbank regarding our national gold, there is no apparent reason for these officials to now call this case "closed" - quite the opposite would be logical. We must therefore assume that the Fed is unwilling or unable to quickly put Germany´s gold at the Fed (1,500 tonnes) on a few planes, thereby sending our property to where it belongs (Frankfurt). It's become harder to not reach the conclusion that  our officials are not complicit in some kind of U.S. led cover-up. So far, due to our public responses, this approach has not worked but rather increased the pressure on Bundesbank to repatriate.

One reason that the gold was unavailable for quick delivery could be multiple ownerships of our bars at the Fed. Given today´s global fractional gold banking scheme, an (allegedly physically existing) bar in a central bank vault could have 10+ owners - and could thereby show up in 10+ central bank balance sheets as either "physical gold" or "gold claim". These two (completely different!) balance sheet items have not been properly differentiated for many decades now. We are potentially talking about non-existent physical bars at a magnitude of tens of thousands of tonnes!

Without proper physical audits, repatriations and allocated storage, no gold "owner" today can be certain that "his" bar in one of these unallocated gold storage vehicles is actually his exclusive property! Our campaign is therefore not only a "German" one - but could have international repercussions of unknown scale.

It is not by accident that since the launch of the first two campaigns in 2011/12 (Germany and Switzerland) - more than ten similar national initiatives have been launched all over the world. The responses of the arrogant central bankers are the same everywhere: Ignore them, call them "conspiracy theorists", insist that "everything is in order with the gold", but give not a shred of evidence (bar lists, audit reports, bar transport to owners). And act only if public pressure forces you to...

AS - How did the Bloomberg article, which is really the only story published by a mainstream American outlet about the reversal, quote you incorrectly or out of context? Has the reporter explained his actions?

PB - I had a friendly 30+ minute conversation with the Bloomberg reporter, explaining all I could. But the only so-called "quotation" of mine which was ultimately used (published months later!) was "Right now, our campaign is on hold". Of course, I never said this sentence. All I did is (truthfully) explain that, unfortunately, nobody in Germany -including our campaign- can legally ENFORCE the dissemination of information from Bundesbank or a quicker repatriation of our gold. When the interview was conducted in May, we had no opportunity for putting even more pressure on BuBa (which we had done several times opportunistically and partly successfully since 2011). The Bloomberg hack somehow twisted this to mean that we were satisfied and that we were no longer pressing the issue.

In hindsight, I however have to THANK  the reporter for involuntarily opening up this new and great opportunity for spreading our message. Since the Bloomberg piece, I am giving interviews on a daily basis - now even to international radio and TV broadcasters with millions of listeners. This gold issue will not go away.

Gold is money. And central bank gold is a potential cornerstone of future currencies which might well HAVE TO be (partially) gold-backed, especially if there is a crash of today´s un-backed paper-currencies. The central banks all over the world therefore have to quickly become much more transparent and have to audit and repatriate their / OUR gold!

Peter Boehringer is the founder and president of "German Precious Metal Society" (est. 2006) - an NGO dedicated to spreading independent information on the relevance of gold and silver as both investment vehicles and as basis for sound money and in turn a sound society. Mr. Boehringer is one of the main initiators of the German public's "Repatriate our Gold" campaign, which is being supported by many prominent signatories as well as by 15,000+ national and international activists. Peter has been writing Germany´s most popular (German language) gold blog since 2003 with a focus both on economic and political implications of gold and silver prices. He is a book author, speaker at liberal and economic conferences, and a frequent writer of articles critical towards the current, credit-based monetary system and its negative implications. He is a fellow of the liberal "Hayek-Society".

Neither Mr. Boehringer nor German Precious Metal Society is affiliated with Euro Pacific Capital or any of its affiliates.  The opinions expressed above are those of the writer and may or may not reflect those held by Euro Pacific Capital.

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Abenomics Update: Consumers Pay the Price

By: Peter Schiff, CEO and Chief Global Strategist

Since the December 2012 election of Shinzo Abe as prime minister, Japan has become the world's most visible petri dish for Keynesian economic principles. Abe assumed office with a radical plan to implement all the major policy tools that Keynesians like Paul Krugman have advocated. His "Abenomics" agenda involved "three arrows" to slay Japan's decades-long economic torpor. The first involved a fiscal stimulus through greater deficit spending, the second was a massive quantitative easing campaign specifically designed to create at least two percent annual inflation, and the third (currently being implemented) is a series of regulatory reforms designed to lower barriers for businesses (this arrow is not particularly Keynesian). 18 months into the experiment, Abe has scored a clear victory, at least among the mainstream press, which has declared Abenomics to be an unbridled success. However,  the actual situation faced by Japanese consumers is universally awful. The numbers, if you care to notice them, speak for themselves.

The most glaring results of Abenomics thus far has been its outright "success" in pushing down the value of the yen and pushing up prices for everyday goods and services. Since Abe began his campaign the Japanese currency has fallen nearly 21% against the U.S. dollar. This has been music to the ears of the vast majority of economists who see a weak currency as the mainspring of economic growth.

In May, it was reported that prices for all items had risen at an annualized rate of 3.4%. This was up from the 3.2% annualized rate in April. Prices for goods (which are more sensitive than domestically-provided services to the falling Yen) have spiked up 5.2% from the previous year. The falling yen has been a big factor in pushing up prices for food and energy which in Japan are largely imported. In May, Japan reported year over year price increases of 11.4% in electricity, 9.6% in gasoline, and 14.3% in fresh seafood (it's a good thing the Japanese don't really like seafood).

For many years Japanese consumers had to deal with the apparent tragedy of price stability, which allowed them to maintain purchasing power despite a stagnant economy. Thank God those days are over! But Abe's policies have failed to work their magic on the broader economy. The Wall Street Journal reports that cash earnings and bonuses in wages rose just .8% year over year in May. Wages did even worse in May, up just .2%. Against a backdrop of surging inflation these tepid growth results mean that purchasing power has fallen 3.6% year over year in May.

The pain has been magnified by the recent hike of the consumption sales tax from five percent to eight percent. The move caused a temporary surge in spending earlier in the year when consumers scurried to make purchases before the tax came into effect. But more recently it has put spending into a deep freeze. In April, consumption fell a seasonally adjusted 13.4%. Those are big numbers.

To add insult to injury, the falling yen has done little to boost Japanese exports. In 2013, despite the decline in the yen, exports declined for the third consecutive year. What Abenomics has delivered, of course, is a surging stock market, driven in large part by zero percent interest rates and a wave of stock buybacks. But, as is the case in the U.S., these developments have delivered benefits primarily to the owners of financial assets. 

Yet, despite all of this, most media outlets in the U.S. and Europe still discuss Abe in heroic terms. How much longer they will be able to keep up the cheerleading is anyone's guess.

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Sector Watch: The Robots are Coming

The "robots are taking over the world" concept has been a staple of science fiction for generations. However, the reality of automated production lines and self-propelled disc vacuums has thus far proved much less intimidating. But the next generation of robots will likely be much more significant. And while we feel that financial markets remain highly distorted by excess liquidity, and that growth stocks always involve higher risk, it is undeniable that transformative innovations can present opportunities.

Recent moves by Google and Amazon highlight the wave in robotics. In 2013, Google purchased eight startups focused on robots, and this year it unveiled dramatic improvements to the driver-less car concept that it first introduced in 2012. Recently, Amazon made a big stir on "60 Minutes" by introducing an internet-controlled air drone delivery system. Although some dismissed it as a stunt, Amazon founder Jeff Bezos insisted that the project was for real.

With the costs to build and develop robots declining, more companies are looking to use robots wherever they can. This is especially true in high cost, high regulation economies like the United States where the costs and benefits of employing humans for routine tasks are becoming less and less compelling. If successful, popular moves to raise the minimum wage in this country to an unrealistic $15 dollars per hour could kick the robotic industry into a much higher gear. And why not? Robots are willing to work longer hours for no pay, and they don't goof off, take sick days or require health benefits.

Already, the fast food industry is experimenting with much greater automation, both in the cooking and in customer interaction. The day when a Big Mac can be produced with no human involvement may be much closer than most people realize. In June, The Netherlands said it plans to start testing driver-less trucks next year and it intends to have them on public roads within five years.

Last year, an all-time high of 179,000 robots were sold world-wide, a 12% increase over 2012, according to the International Federation of Robotics. Between 2008 and 2013, U.S. robot sales increased an average of 12% per year. In terms of annual sales, China is the biggest market, as well as the fastest growing. Japan is the second largest market as well as one of the biggest producers of robots. Currently, Japan has the most industrial robots in the world, more than 300,000.

The main drivers of growth are the automotive and metal industries. Between 2010 and 2013, both industries increased robot investments by an average of 22% per year. Military consumers are also leading early adopters.

Experts predict robots may eventually replace flesh-and-blood soldiers on the ground. Admittedly, the eyebrow-raising concepts introduced by many defense contractors do seem to be much closer to science fiction than to current reality. Apart from taking life, robots are also being designed to preserve it with some companies designing automated systems that can act as full-time caretakers for the aging population that predominates in advanced economies.

While we cannot offer specific advice on particular companies, the robotics sector may be one to look into.

Of course investors should not feel as if robotic companies are somehow responsible for displacing workers or causing unemployment. Labor saving devices, such as fork lifts and steam drills, have always been accused of putting people out of work, but instead they have just increased productivity and allowed workers to find jobs that are more suitable for humans. Remember, the job of an economy is not to create jobs, but to create stuff. If we could produce all that we needed to consume with no human labor, humanity would be much better off. Too bad economists can't figure that out. Maybe they should be replaced by robots.

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Argentine Debt Tangle

By: David Echeverria, Investment Consultant, Los Angeles

Twelve years ago Argentina sent shock waves throughout the international financial community by defaulting on nearly $100 billion US Dollar-denominated debt. Prior to that, Argentina had long been skating along the edge of financial catastrophe, but such a massive default by a country that boasted abundant natural resources and a heritage of wealth was a game-changing event. In order to resolve the crisis, the Argentine government then in power negotiated massive haircuts with the vast majority of its creditors. There were some investors, however, who refused the terms of these haircuts, and held out for more. They had to wait a very, very long time.

Amongst these "holdouts" were a number of hedge funds that purchased the Argentine debt in the secondary market for pennies on the dollar. The hedge funds sensed a chance for victory and settled in for the long haul. Their hope was that their notes would be paid in full when Argentina finally became more financially solvent. This could happen through voluntary action by the government or by order of international courts. If they could prevail, a handsome profit could be reaped.

Fast forward to 2014 and the Argentine state, thanks in part to rising commodity prices, now has billions in reserves and is once again paying on its restructured debt. Not surprisingly, the holdouts have been clamoring for repayment alongside the owners of the restructured debt. Their request, however, was defiantly refused by the president of Argentina, Christina Fernandez de Kirchner, who even went so far as to refer to the holdouts as "vulture funds." Never mind that many of these funds are comprised of pension funds and individual investors, many of whom would not qualify as Masters of the Universe. These are real people to whom Argentina owes money. And unlike the holders of the restructured debt, these investors have never been paid.

The decade-long legal tango finally came to an end last month when the US Supreme Court refused to hear the case, thereby letting stand the decision by the lower U.S. court that demanded Argentina cough up the money. Although the Kirchner administration is looking to find a way out, no escape hatch appears to be at hand. As with other extensions of U.S. financial power, a world dominated by the U.S. offers few places to hide. 

Critics of the decision have said that obligating repayment of holdouts will discourage creditors in future cases from negotiating haircuts and thus make it more difficult for countries to resolve defaults. In other words, it'll make it more difficult for countries to avoid having to pay on their debts. Apparently these people have never heard of moral hazard. Can you imagine what the alternative would have been like had the U.S. courts not obligated repayment? This would have effectively allowed governments around the world to borrow, default, force creditors into some ridiculous "negotiated" haircut, wait a few years, and then do it all over again.

This also forgets the fact that the holdout creditors traded time for money. They could have received lesser payments years ago. Who knows what they could have done with that money and what kind of returns they could have generated had they invested it. So in a very large sense, they have paid a price.

If the courts had not stepped in to compel payment who in their right mind would ever buy sovereign debt knowing that it could simply be defaulted on with so little consequence? It is quite likely that lower credit nations would have faced nearly impossible hurdles with future debt raises had the legal decision not been reaffirmed. But if the various governments of the world have a problem with the recent ruling, I have a much simpler solution: JUST DON'T BORROW THE MONEY IN THE FIRST PLACE. I have yet to a see a news story with a hedge fund manager holding a gun to the head of some foreign government official forcing them to issue debt.  

Euro Pacific celebrates the U.S. Supreme Court's ruling. But we also don't want to wait a dozen years before being paid. As a result, we know that we are not absolved from taking responsibility for the debt we choose to purchase. Even with the court victory, it is far from certain that the holdout investors are happy to have ever purchased Argentine debt.

In general, when buying any kind of sovereign debt, it is crucial to look at basic metrics like GNP per capita, the higher the better. The political composition of the government is also an important factor. Countries with constitutional checks and balances and divisions of power amongst multiple parties are less likely to engage in reckless behavior (obviously this is all relative as the U.S. and EU have shown that the developing world does not have a monopoly on recklessness). Countries that have autocratic executives, entrenched trade unions, and a penchant for populist activism should be scrutinized. 

But it is also important to recognize the "default" can occur in many forms, the most insidious of which is through inflation. While not technically a default, nominal returns are meaningless if they occur in a currency that has been devalued. Thus it is vital to identify debt denominated in currencies where there is less "quantitative easing" and where there are positive real interest rates. While some investors take confidence when small countries issue dollar-denominated debt, the current drift of American fiscal and monetary irresponsibility argues against it. Another option is to find foreign debt where the coupon is indexed to the local inflation metric.

For Americans evaluating returns in terms of USD, it may be worth considering foreign debt denominated in a currency whose underlying value is backed by hard assets. If there is a commodity rise, these currencies may likely rise faster versus the USD. If commodities sink, however, the opposite is likely to occur. Most important in evaluating foreign sovereign debt is to use some common sense. If you watch the news at all, then you probably have a good idea of where you shouldn't be investing.

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Investing in foreign securities involves additional risks specific to international investing, such as currency fluctuation and political risks. Risks include an economic slowdown, or worse, which would adversely impact economic growth, profits, and investment flows; a terrorist attack; any developments impeding globalization (protectionism); and currency volatility/weakness. While every effort has been made to assure that the accuracy of the material contained in this report is correct, Euro Pacific cannot be held liable for errors, omissions or inaccuracies. This material is for private use of the subscriber; it may not be reprinted without permission. The opinions provided in these articles are not intended as individual investment advice.

This document has been prepared for the intended recipient only as an example of strategy consistent with our recommendations; it is not 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.  Dividend yields change as stock prices change, and companies may change or cancel dividend payments in the future.  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.  Past performance does not guarantee future returns, investments may increase or decrease in value and you may lose money.

Opinions expressed are those of the writer and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

Tags:  2014 financial performanceAbenomicsEuro Pacific CapitalGlobal Investor Newsletterinflation sensitive assetsPeter Boehringer,Peter SchiffU.S. financial regulatory policy
Yellen: Where No Man Has Gone Before
Posted by Peter Schiff on 07/25/2014 at 10:38 AM

Although Fed Chairwoman Janet Yellen said nothing new in her carefully manicured semi-annual testimony to Congress last week, her performance there, taken within the context of a lengthy profile in the New Yorker (that came to press at around the same time), should confirm that she is very different from any of her predecessors in the job. Put simply, she is likely the most dovish and politically leftist Fed Chair in the Central Bank's history.  


While her tenure thus far may feel like a seamless extension of the Greenspan/Bernanke era, investors should understand how much further Yellen is likely to push the stimulus envelope into unexplored territory. She does not seem to see the Fed's mission as primarily to maintain the value of the dollar, promote stable financial markets, or to fight inflation. Rather she sees it as a tool to promote progressive social policy and to essentially pick up where formal Federal social programs leave off.


Despite her good intentions, the Fed's blunt instrument policy tools of low interest rates and money supply expansion can do nothing to raise real incomes, lift people out of poverty, or create jobs. Instead these moves deter savings and capital investment, prevent the creation of high paying jobs, and increase the cost of living, especially for the poor (They are also giving rise to greater international financial tensions, which I explore more deeply in my just released quarterly newsletter). On the "plus" side, these policies have created huge speculative profits on Wall Street. Unfortunately, Yellen does not seem to understand any of this. But she likely has a greater understanding of how the Fed's monetization of government debt (through Quantitative Easing) has prevented the government from having to raise taxes sharply or cut the programs she believes are so vital to economic health. 


But as these policies have also been responsible for pushing up prices for basic necessities such as food, energy, and shelter, these "victories" come at a heavy cost. Recent data shows that consumers are paying more for the things they need and spending less on the things they want. But Yellen simply brushes off this evidence as temporary noise.


In her Congressional appearances, Yellen made clear that the end of the Fed's six-year experiment with zero percent interest rates is nowhere in sight. In fact, the event is less identifiable today than it was before she took office and before the economy supposedly improved to the point where such support would no longer be needed. The Bernanke Fed had given us some guidance in the form of a 6.5% unemployment rate that could be considered a milestone in the journey towards policy normalization. Later on these triggers became targets, which then became simply factors in a larger decision-making process. But Yellen has gone farther, disregarding all fixed thresholds and claiming that she will keep stimulating as long as she believes that there is "slack" in the economy (which she defines as any level of unemployment above the level of "full employment.") Where that mythical level may be is open for interpretation, which is likely why she prefers it.


The Fed's traditional "dual mandate" seeks to balance the need for job creation and price stability. But Yellen clearly sees jobs as her top priority. Any hope that she will put these priorities aside and move forcefully to fight inflation when it officially flares up should be abandoned.


These sentiments are brought into focus in the New Yorker piece, in which she unabashedly presents herself as a pure disciple of John Maynard Keynes and an opponent of Milton Friedman, Ronald Reagan, and Alan Greenspan, figures who are widely credited with having led the rightward movement of U.S. economic policy in the last three decades of the 20th Century. (Yellen refers to that era as "a dark period of economics.")


Perhaps the most telling passage in the eleven-page piece is an incident in the mid-1990s (related by Alan Blinder who was then a Fed governor along with Janet Yellen). The two were apparently successful in nudging then Fed Chairman Alan Greenspan into a more dovish position on monetary policy. When the shift was made, the two agreed "...we might have just saved 500,000 jobs." The belief that central bankers are empowered with the ability to talk jobs in and out of existence is a dangerous delusion. As her commitment to social justice and progressivism is a matter of record, there is ample reason to believe that extremist monetary policy will be in play at the Yellen Fed for the duration of her tenure.


For the present, other central bankers have helped by taking the sting out of the Fed's bad policy. On July 16 the Wall Street Journal reported that the Chinese government had gone on a torrid buying spree of U.S. Treasury debt, adding $107 billion through the first five months of 2014. This works out to an annualized pace of approximately $256 billion per year, or more than three times the 2013 pace (when the Chinese government bought "just" $81 billion for the entire calendar year). The new buying pushed Chinese holdings up to $1.27 trillion.


At the same time, Bloomberg reports that other emerging market central banks (not counting China) bought $49 billion in Treasuries in the 2nd Quarter of 2014, more than any quarter since 3rd Quarter of 2012. These purchases come on the heels of the mysterious $50 billion in purchases made by a shadowy entity operating out of Belgium in the early months of this year (see story).


So it's clear that while the Fed is tapering its QE purchases of Treasury bonds, other central banks have more than picked up the slack. Not only has this spared the U.S economy from a rise in long-term interest rates, which would likely prick the Fed-fueled twin bubbles in stocks and real estate, but it has also enabled the U.S. to export much of its inflation.As long as this continues, the illusion that Yellen can keep the floodgates open without unleashing high inflation will gain traction. She may feel that there is no risk to continue indefinitely.


But as the global economic status quo is facing a major crisis (as is examined in this newsletter), there is reason to believe that we may be on the cusp of a major realignment of global priorities. Despite her good intentions, if Yellen and her dovish colleagues do not receive the kind of open-ended international support that we have enjoyed thus far in 2014, the full inflationary pain of her policies will fall heaviest on those residents of Main Street for whom she has expressed such deep concern. 


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

Tags:  central bankersJanet YellenNew YorkerprogressiveQuantitative Easingstimulus
The Bond Trap
Posted by Peter Schiff on 06/23/2014 at 8:13 AM

The American financial establishment has an incredible ability to celebrate the inconsequential while ignoring the vital. Last week, while the Wall Street Journal pondered how the Fed may set interest rates three to four years in the future (an exercise that David Stockman rightly compared to debating how many angels could dance on the head of a pin), the media almost completely ignored one of the most chilling pieces of financial news that I have ever seen. According to a small story in the Financial Times, some Fed officials would like to require retail owners of bond mutual funds to pay an "exit fee" to liquidate their positions. Come again? That such a policy would even be considered tells us much about the current fragility of our bond market and the collective insanity of layers of unnecessary regulation.


Recently Federal Reserve Governor Jeremy Stein commented on what has become obvious to many investors: the bond market has become too large and too illiquid, exposing the market to crisis and seizure if a large portion of investors decide to sell at the same time. Such an event occurred back in 2008 when the money market funds briefly fell below par and "broke the buck." To prevent such a possibility in the larger bond market, the Fed wants to slow any potential panic selling by constructing a barrier to exit. Since it would be outrageous and unconstitutional to pass a law banning sales (although in this day and age anything may be possible) an exit fee could provide the brakes the Fed is looking for. Fortunately, the rules governing securities transactions are not imposed by the Fed, but are the prerogative of the SEC. (But if you are like me, that fact offers little in the way of relief.) How did it come to this?


For the past six years it has been the policy of the Federal Reserve to push down interest rates to record low levels. In has done so effectively on the "short end of the curve" by setting the Fed Funds rate at zero since 2008. The resulting lack of yield in short term debt has encouraged more investors to buy riskier long-term debt. This has created a bull market in long bonds. The Fed's QE purchases have extended the run beyond what even most bond bulls had anticipated, making "risk-free" long-term debt far too attractive for far too long. As a result, mutual fund holdings of long term government and corporate debt have swelled to more $7 trillion as of the end of 2013, a whopping 109% increase from 2008 levels.   


Compounding the problem is that many of these funds are leveraged, meaning they have borrowed on the short-end to buy on the long end. This has artificially goosed yields in an otherwise low-rate environment. But that means when liquidations occur, leveraged funds will have to sell even more long-term bonds to raise cash than the dollar amount of the liquidations being requested.


But now that Fed policies have herded investors out on the long end of the curve, they want to take steps to make sure they don't come scurrying back to safety. They hope to construct the bond equivalent of a roach motel, where investors check in but they don't check out. How high the exit fee would need to be is open to speculation. But clearly, it would have to be high enough to be effective, and would have to increase with the desire of the owners to sell. If everyone panicked at once, it's possible that the fee would have to be utterly prohibitive.


As we reach the point where the Fed is supposed to wind down its monthly bond purchases and begin trimming the size of its balance sheet, the talk of an exit fee is an admission that the market could turn very ugly if the Fed were to no longer provide limitless liquidity. (See my prior commentaries on this, including May 2014's Too Big To Pop)


Irrespective of the rule's callous disregard for property rights and contracts (investors did not agree to an exit fee when they bought the bond funds), the implementation of the rule would illustrate how bad government regulation can build on itself to create a pile of counterproductive incentives leading to possible market chaos.


In this case, the problems started back in the 1930s when the Roosevelt Administration created the FDIC to provide federal insurance to bank deposits. Prior to this, consumers had to pay attention to a bank's reputation, and decide for themselves if an institution was worthy of their money. The free market system worked surprisingly well in banking, and could even work better today based on the power of the internet to spread information. But the FDIC insurance has transferred the risk of bank deposits from bank customers to taxpayers. The vast majority of bank depositors now have little regard for what banks actually do with their money. This moral hazard partially set the stage for the financial catastrophe of 2008 and led to the current era of "too big to fail."


In an attempt to reduce the risks that the banking system imposed on taxpayers, the Dodd/Frank legislation passed in the aftermath of the crisis made it much more difficult for banks and other large institutions to trade bonds actively for their own accounts. This is a big reason why the bond market is much less liquid now than it had been in the past. But the lack of liquidity exposes the swollen market to seizure and failure when things get rough. This has led to calls for a third level of regulation (exit fees) to correct the distortions created by the first two. The cycle is likely to continue.


The most disappointing thing is not that the Fed would be in favor of such an exit fee, but that the financial media and the investing public would be so sanguine about it. If the authorities consider an exit fee on bond funds, why not equity funds, or even individual equities? Once that Rubicon is crossed, there is really no turning back. I believe it to be very revealing that when asked about the exit fees at her press conference last week, Janet Yellen offered no comment other than a professed unawareness that the policy had been discussed at the Fed, and that such matters were the purview of the SEC. The answer seemed to be too canned to offer much comfort. A forceful rejection would have been appreciated.  


But the Fed's policy appears to be to pump up asset prices and to keep them high no matter what. This does little for the actual economy but it makes their co-conspirators on Wall Street very happy. After all, what motel owner would oppose rules that prevent guests from leaving? The sad fact is that if investors hold a bond long enough to be exposed to a potential exit fee, then the fee may prove to be the least of their problems.


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

Tags:  bond mutual fundsexit feeFederal ReserveFinancial Timesinterest rates
Draghi Hits Savers To Salvage Faux Recovery
Posted by Peter Schiff on 06/18/2014 at 2:20 PM
On June 5th, Mario Draghi, President of the European Central Bank (ECB), announced a package of measures, including a policy of negative interest rates, aimed at encouraging or even forcing Eurozone banks to increase their lending to businesses.Although previously imposed by Swiss banks on their depositors, this will be the first time that a central bank has charged negative interest rates. The package also contained a reduction in Base Rate, a further major new Long Term Refinancing Operation (LTRO), a reaffirmation of 'Forward Guidance' to indicate low interest rates for the foreseeable future, and hints that the ECB might in future engage in Bernanke-style Quantitative Easing (QE).
Taken together, the total package is manna from heaven, or money for nothing, for the neo-Keynesians now holding power in most Eurozone governments. However, to Austrian School economists, it amounts to a political acceptance by Germany of a further postponement of the price of economic reality. It raises the eventual price to be paid in future for the illusion of economic growth today. In the meantime, the package likely will discourage savings, while perhaps encouraging imprudent lending, mal-investment, an asset price boom and currency distortions due to a carry trade based on low cost euros.
Stock markets rose strongly on Draghi's news. Amazingly, the 2.58 percent yield on 10-year Spanish government bonds fell below that of 10-year U.S. Treasuries. Given the continued structural problems that plague the Spanish economy, this fact indicates persistent delusions in markets.
It is hoped that charging a negative interest rate of 0.10 percent on bank deposits with the ECB will encourage banks to lend their excess deposits to other banks (in the interbank market) or to lend to corporate or retail borrowers. It is a desperate measure to force banks to take more risks. One of the unforeseen results may be the further development of the so-called "carry trade."
Given the relatively low cost of borrowing euros vis-à-vis other currencies, many investors could be tempted to borrow euros to purchase higher yielding currency (either for an interest rate spread or to use the newly raised funds to invest in the host country). For example, an investor may borrow euros, exchange them for British Pounds and invest the proceeds in the London property market, inflating further what the Bank of England has warned is a dangerous property bubble. In addition, upwards pressure is exerted on Sterling rendering British exports less price competitive. Of course, this suits Eurozone members such as Germany.
Although Draghi's decision to drop the interest rates on the ECB's  massive 400 billion euros Long Term Refinancing Operation (LTRO)has received less publicity, its impact may be just as great. The lower LTRO rate may encourage further risky lending and dubious investment. In the short-term such lending will conceal current bad loans, boost speculation and financial markets. The future costs of default likely will be socialized. But, by then, it is to be hoped that those bankers and politicians responsible will have been promoted or moved on!
In addition, the continuation of ultra low interest rates, under QE, will erode savings further and even discourage the ethos of saving in favor of current spending. The discouragement of saving in favor of current synthetic growth appears to be politically deceptive and deeply destructive of a healthy economy.
Furthermore, some would argue that, with bond markets at record highs, most banks are at far greater risk than appears at first sight. Already, Eurozone banks are far more highly leveraged than their American counterparts. As such, they are especially vulnerable to a dramatic rise in interest rates and a collapse in government bond prices.
Mario Draghi is acknowledged widely for his PR ability. However, more prudent observers see him more as a conjuror. While his policies have not attracted as many headlines as the Federal Reserve's Quantitative Easing program, the full roster of the ECB's liquidity injectors is perhaps more  injurious to economic growth. Draghi has joined and even exceeded the central bank 'monopoly money' policies of the United States, Great Britain and Japan.
It's a shame. The ECB could have been a beacon of sanity in an otherwise insane world.  
John Browne is a Senior Economic Consultant to Euro Pacific Capital. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.
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Tags:  ECBfederal income taxincome taxtaxtaxes
Irwin Schiff's motion to the Supreme Court.
Posted by Peter Schiff on 06/16/2014 at 1:00 PM

My father makes a powerful case that the IRS has been collecting the income tax in violation of law, multiple Supreme Court decisions, and the U.S. Constitution.    At the very least his efforts provide compelling evidence of the sincerity with which he holds his beliefs and that his conduct was in no way criminal.   My father is 86, practically blind, in failing health, yet is still fighting for a cause he wholeheartedly believes in.  He is proceeding without a lawyer and despite his physical limitations and the limited computer access provided in federal prisons, he still managed to put this comprehensive motion together.   Read it yourself and share it with as many people as you can.  My father would appreciate your assistance in making sure that his message is heard.   Even if the courts ignore it, let's try and make sure that the American people do not.    Thanks for your help. 


Tags:  federal income taxincome taxIRSIrwin Schifftaxtaxes
Posted by Peter Schiff on 06/13/2014 at 6:40 AM
Thus far 2014 has been a fertile year for really stupid economic ideas. But of all the half-baked doozies that have come down the pike (the perils of "lowflation," Thomas Piketty's claims about capitalism creating poverty, and President Obama's "pay as you earn" solution to student debt), an idea hatched last week by CNBC's reliably ridiculous Steve Liesman may in fact take the cake. In diagnosing the causes of the continued malaise in the U.S. economy he explained, "the problem is that consumers are not taking on enough debt." And that "historically the U.S. economy has been built on consumer credit." His conclusion: Consumers must be encouraged to borrow more money and spend it. Given that Liesman is CNBC's senior economic reporter, I would hate to see the ideas the junior people come up with.
Before I get into the historical amnesia needed to make such a statement, we first have to confront the question of causation. Just as most economists believe that falling prices cause recession, rather than the other way around, Liesman believes that economic growth is created when people tap into society's savings in order to buy consumer goods that they could not otherwise afford. But consumption does not create growth. Increasing productive output allows for greater consumption. Something needs to be produced before it can be consumed.
But even allowing for this misunderstanding, consumer credit does little to increase consumption. All it accomplishes is to pull forward future consumption into the present (while generating a fee for the banker). This is like giving yourself a blood transfusion from your left arm to your right. Nothing is accomplished, except the possibility of spilling blood on the floor. But it's not even that benign.
If, for instance, a consumer borrows to take a vacation, the debt will have to be repaid, with interest, from future earnings. This just means that rather than saving now (under-consuming) to pay in cash (which under normal circumstances would earn interest and defray the cost) for a vacation in the future, the consumer borrows to vacation now and pays for it in the future. But shifting consumption forward can only create the illusion of growth.
Unlike business credit that can be self-liquidating (businesses borrow to invest, thereby expanding capacity, increasing revenue, and gaining a better ability to repay the loan out of increased earnings), consumer credit does nothing to help borrowers repay. Why would a consumer expect it to be easier to pay for a vacation in the future that he can't afford in the present? Especially when he is using credit to pay, which will add interest costs to the final bill. As a result,  consumer loans diminish future consumption more than current consumption is increased.
In fact, borrowing to consume is the worst use of society's limited store of savings. As explained in my book, How an Economy Grows and Why it Crashes, savings leads to capital formation and investment, which grows productive capacity. When production grows, goods and services become more plentiful and affordable, thereby raising living standards. Consumer credit interferes with this process. Funds borrowed for consumption are not available for more productive uses. Since consumer credit reduces investment, it also reduces future production, which must also reduce future consumption.
Liesman is also mistaken that consumer credit has been the historic foundation of growth in the United States. It may surprise him to know that consumer credit was largely unknown until the second half of the 20th Century. Before that, people simply did not, or could not, buy things on credit. They tended to pay in cash (even for cars) or with the now quaint system of lay-a-way (which is essentially the opposite of consumer credit). Credit cards did not become ubiquitous until the 1970s. It was also much more common for Americans to save money for an uncertain future, the "rainy day," that we were always being warned about. But savings rates now are only a fraction of where they had been for most of our history. Consumers now expect to borrow their way out of any crisis. Yet the American economy enjoyed some of its best years before consumer credit ever became an option.    
What Liesman is really advocating is that consumers borrow money to buy things they cannot afford. What kind of economic advice is that? Especially now that one third of Americans have less than $1,000 saved for retirement; a statistic so shocking that even CNBC recently cited it as a cause for concern. Does he really think that these savings-short Americans should take on even more consumer debt? Does creating a nation of bankrupt seniors who are too broke to retire ever create a more prosperous society?
Contrary to Liesman's asinine contention, it's not consumer credit that built the U.S. economy but its opposite - savings! Under-consumption not excess-consumption is what made America great. By saving instead of spending, consumers provided society with the means to increase investment and production that led to rising living standards for all. Unfortunately, it's consumer credit that is helping to destroy what savings once built.

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

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

Tags:  CPIeconomy
Posted by Peter Schiff on 06/11/2014 at 12:00 PM

The French economist Thomas Piketty has achieved worldwide fame by promoting a thesis that capitalism is the cause of growing economic inequality. Unfortunately, he is partially right. However, the important distinction missed by Piketty and all of his supporters is that state capitalism, not free market capitalism, has reigned supreme in recent decades in the world's leading democracies. It is this misguided attempt to wed the power of the state to the private ownership of capital that has led to the mushrooming of economic inequality. If the public cannot be made aware of the distinction, we risk abandoning the only system capable of creating real improvements for the vast majority of people.


In his book entitled 'Capital in the 21st Century', Piketty, like Karl Marx in 'Das Kapital,' places the hinge of economic tension at the supposed opposition between the competing interest of labor and capital. He believes that "capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based." However, this can only become true if free markets become controlled, or distorted, by the establishment of monopolies, be they private or state owned. 


In the early twentieth century, U.S. Governments were alert to the destruction of free markets by monopolistic cartels and enacted strong anti-trust laws to curb their power. The United States thereafter achieved strong economic results in the first three decades of the 20th Century. In contrast, the socialist governments of post WWII Britain used public funds to establish state owned monopolies, similar to those existing in the Soviet Union. This resulted in dramatic economic declines, that continued into the 1980s when the U.K. was rescued by the free market policies of Margaret Thatcher. Her central strategy was to restore individual freedom by breaking state owned monopolies and reducing the coercive control of trade unions. Her actions unleashed a resurgence of prosperity in Britain that was imitated in many other countries. Her policies were adopted with particular enthusiasm by countries, like Poland, which had only recently shaken off the yoke of Soviet Communism. Poland is now one of the strongest economies in Europe.


History provides ample evidence that when allowed to function properly free market capitalism generates massive national prosperity with high employment, a strong currency and rising standards of living. It is only when the state manipulates and over regulates free markets that capitalism fails. However, capitalism usually takes the blame for the failures of statism.

Piketty asserts that capitalism is "inherently unstable because it concentrates wealth and income progressively over time, leaving behind an impoverished majority. ..." He proscribes even an international wealth tax and higher income taxes, above 80 percent, to redistribute rather than to invest savings. This would essentially create a state monopoly on wealth. But again, history tends to demonstrate that state monopolies create poverty for all but the politically connected elite. 


Even the Soviet Union, a military superpower, was brought to its economic knees by state monopolies. Communist Party Secretaries, Andrapov and Gorbachev, were forced to the recognition that free markets should be introduced within Russia. This led to 'Perestroika' and 'Glasnost' and the freeing of markets in Russia. 


By concluding that capitalism, even if it is confined to just a few countries, will lead to increasing poverty among the masses around the world, many cynical observers may conclude that Piketty is laying out a carefully planned case towards global socialism along the lines first attempted by the Bolshevik Commintern. Some conclude that such a move could be spearheaded by international institutions like the UN and IMF. 


To achieve inherently unpopular global power, national elites must cooperate to bring about such levels of economic chaos and human suffering that people, despairing of ineffective democracy, will look for strong, global government as a welcome solution. To achieve this end the economic problems and human suffering must be extreme and seemingly beyond solution by any national government. By continuing to debase and destroy fiat currencies while preventing the markets from healing themselves, central banks around the world are doing their part to create these conditions. 


However, those who look towards strong global government must realize that likely it will lead to a world of extreme global inequality in which any effective opposition will be impossible. This is the fascistic face behind the cuddly and concerned image that has made Piketty the economic North Star of a new generation. These faulty bearings must be corrected or the world's poor will suffer far more than they need to.

Tags:  CPIeconomy
Posted by Peter Schiff on 06/06/2014 at 11:08 AM

Economists, investment analysts, and politicians have spent much of 2014 bemoaning the terrible economic effects of the winter of 2014. The cold and snow have been continuously blamed for the lackluster job market, disappointing retail sales, tepid business investment and, most notably, much slower than expected GDP growth. Given how optimistic many of these forecasters had been in the waning months of 2013, when the stock market was surging into record territory and the Fed had finally declared that the economy had outgrown the need for continued Quantitative Easing, the weather was an absolutely vital alibi. If not for the excuse of the bad weather, the entire narrative of a sustainable recovery would have been proven false.


Remarkably, this optimism was largely undiminished when the preliminary estimate for first quarter GDP came in at a shocking minus one percent annualized. This number, almost four percentage points lower than the forecasts from the end of 2013, hinted at an economy on a path toward recession. Still, the experts brushed off the report as a weather-related anomaly.


In contrast, I spent the better part of the last five months arguing that the weather was a straw man. I saw a fundamentally weak and contracting economy being artificially propped up by Fed stimulus, illusory accounting, and massive federal deficit spending.  However, while it is difficult to precisely measure the effects of bad weather on the economy, a fresh look at the historical data does tell me that a bad winter usually has an economic effect, but not nearly enough to support the oversize excuses being made by our leading pundits.


According to Rutgers University's Global Snow Lab, the winter of 2014 was one of 18 winters in which North America experienced demonstrably "above the trend line" snow accumulation since 1967 (this is as far back as Rutgers data goes). But there were at least eight winters in that time period that had more snow than in 2014. So it would be a stretch to say that this past winter made a greater impact than the average of the 10 snowiest winters since 1967. Cross-checking those winters with corresponding GDP figures from the U.S. Bureau of Economic Analysis (BEA) reveals some very interesting conclusions.


In general, first quarter (which corresponds to the winter months of January, February, and March) shows annualized GDP growth that is in line with other quarters. For instance, since 1967 average annualized 1st quarter growth came in at 2.7%, slightly above the 2.55% for the average 4th quarter, and below the 2.8% in 3rd quarter and 3.4% in 2nd. But when winter gets nasty, the economy does slow noticeably in the first quarter. So, to that extent my initial analysis likely underestimated its impact.  The bad news for the apologists is that the drag is not nearly enough to explain away the current lethargy.


The average annualized GDP growth for the 10 snowiest winters (not counting 2014) was just .5%. This is more than two percentage points below the typical first quarter. It's also more than two percentage points below the average annualized growth for the 4th quarters that preceded those 10 snowiest winters. This is important, because the economy tends to develop in waves that occur outside of the weather cycle. So based on this, we can conclude that the snow of this year likely shaved two percentage points from 1st quarter GDP growth.


But the negative one percent growth is almost four points off the initial forecasts. So, at best, the winter accounted for half the disappointment. Imagine if we had a mild winter, and 1st quarter GDP came in at a measly 1%. Without a convenient excuse to blame it on, how optimistic would Wall Street be now? Would the Fed really be continuing to taper in the face of such anemic growth? I doubt it.


The apologists also ignore the increased ability of current consumers to shop on the Internet at home even when the snow keeps them from the malls. This is an ability that simply did not exist more than 10 years ago...and should help to minimize the winter slowdowns.


An analysis of the bad winters also reveals a clear tendency for the economy to bounce back strongly in the following quarter. This confirms the theory that pent up demand gets released in the spring. In the ten 2nd quarters that followed the ten snowiest winters, annualized GDP averaged a strong 4.4%, or almost four percent higher than the prior quarter. (The snap back was even more dramatic in the five snowiest winters, when the differential was more than five percent.) Based on this, we should see annualized 2nd quarter growth this year of at least three or four percent. 
However, the raft of statistics that have come in over the past few weeks does not show that this is happening. A horrific trade deficit report came in this week widening to $47 Billion, the highest since July 2012. The data out this week also showed that consumer spending fell .1% in April (for the first time in a year), and that productivity falling in the 1st Quarter by 3.2% in the face of higher labor costs, which grew at 5.7% annualized. And although May's 217,000 increase in non-farm payrolls was in-line with expectation (following the big miss in ADP data earlier in the weak) it nonetheless represents a significant slowdown from April's 288,000 pace. The level of hiring did nothing to push up the labor force participation rate, which remained stuck at a 35 year low of 62.8%. Predictably, almost all of the jobs added were in low paying sectors that will not contribute much to overall purchasing power, like hospitality (mostly bars and restaurants), healthcare, and education. The report included a big drop in the number of construction workers added, which is the latest sign that the real estate sector is decelerating.


But even if growth picks up in the 2nd quarter to 4%, my guess is that most analysts will herald the news as confirmation that the economy is back on track, and discussion of the weather will disappear. However, since half of that four percent will have been borrowed from Q1, Q2's higher growth rate will also be weather-related. But while everyone blamed first quarter weakness on the weather, very few will likely cite it as a cause for any potential second quarter strength. But if you add the minus one percent from Q1 to a potential plus four percent from Q2, the average would still only be just 1.5% growth for the first half of 2014. Despite this, the Fed has yet to revise down its full year 2014 growth estimates of 2.8% to 3.2% that it made at the end of last year. To grow at 3% for the year, even with 4% growth in Q2 (which is above the current consensus estimate), the economy would have to grow at 4.5 percent for the entire second half. Good luck with that. 


So yes, the winter was bad, and yes it had an effect. But it was not likely the driving force of the first quarter slow-down and its effects should be very confined. But that won't stop the pundits from gnawing on that particular bone as long as they can get away with it. Unfortunately, they can get away with it for a long time.

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

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

Tags:  CPIeconomy
Posted by Peter Schiff on 06/05/2014 at 9:44 AM
Even investors who typically eschew precious metals have been hard-pressed to ignore the platinum industry this year. The longest strike in South African history paired with surging Asian demand is set to push the metal back into a physical deficit in 2014 - and could have repercussions for years to come. While gold remains the most conservative choice for saving, the "industrial precious metal" platinum is a compelling investment for those, like me, who are bullish on global net economic growth.

China in the Driver's Seat

As with gold and silver, examining platinum demand takes us to the Eastern hemisphere and China's rapidly expanding economy. In particular, the growing Chinese middle class is generating massive demand for new automobiles, which in turn is consuming plenty of platinum.

For the last ten years, autocatalysts have composed 40-50% of total global platinum demand. Autocatalysts use platinum to clean the emissions of motor vehicles, and 95% of the world's new passenger cars come equipped with them. Both auto production and emissions standards are steadily increasing around the world, especially in the huge emerging market of China.

Global auto production grew 4% in 2013 to almost 89 million units. According to IHS, Inc., world auto sales will continue to grow to more than 100 million units by 2018 - that's 12% growth in the next five years. And you can bet that growth won't be coming from the US.

China's share of global vehicle production has exploded from under 4% in 2000 to an astounding 25% last year. I expect this demand to keep expanding as more Chinese citizens grow wealthier and are able to enter the auto market.

Chinese vehicle production grew almost 15% in 2013 and should grow another 10% in 2014. New emissions standards that went into effect last year are already forcing Chinese auto manufacturers to use more platinum. Indeed, platinum use in Chinese autocatalysts increased 33% in 2013.

I believe this trend will continue as the Chinese government tries to tackle the country's critical pollution crisis. Just last week, the PRC announced that it would be removing 6 million vehicles from China's roads by the end of the year because they no longer meet emissions standards.

Platinum as an Investment

Though industrial applications have the largest impact on its price, platinum remains a sought-after precious metal with growing demand from the investment and jewelry sectors. Jewelry accounts for well over 25% of platinum demand, and that figure has been steadily increasing. Once again, we look east for the most compelling numbers.

Chinese platinum jewelry demand represents about 65% of the world's total and is expected to expand 5% this year. But India is the real bright point - high import tariffs imposed on gold by the Indian government in 2013 have created shortages and very high premiums on the yellow metal, driving consumers to replace gold with platinum. India's platinum jewelry market has seen 30-50% growth every year so far this decade. 2014 should continue that trend with a 35% projected growth in platinum jewelry sales.

While Eastern investors buy physical platinum in the form of jewelry, Westerners are piling into relatively young exchange-traded funds (ETFs) backed by the metal. Platinum ETFs did not exist until 2007, and the first South African-based platinum ETF began just last year. 2013 saw a 55% increase in the amount of physical platinum held by ETFs, totaling 2.5 million ounces.

As short-term traders wake up to the same supply/demand issues summarized in this commentary, the trend of increasing retail investment may well absorb a greater share of the limited supply.

Just as with gold and silver, I believe platinum ETFs are inferior to physical bullion for long-term investment. However, many investors prefer the liquidity they offer, and as a fundamental data point, they should not be ignored.

Supply Goes from Shaky to Shocked

With promising new sources of demand, platinum supplies have been under pressure. To put into perspective how little platinum is available, simply compare it to gold and silver. Over the past decade, about 13.5 times more gold and 100 times more silver have been mined than platinum. The vast majority of the meager platinum supply comes from just two countries - South Africa and Russia. Troubles in both of these countries are pushing supply constraints into a market shock.

Beginning in January, more than 70,000 South African miners went on strike against the three largest platinum producers in the world - Anglo American Platinum, Impala Platinum, and Lonmin. This is the longest strike in South African history and is estimated to have already reduced global platinum production by 40%. About 1 million ounces of platinum will not be mined this year due to the strikes.

No matter when these wage disputes are resolved, they're going to have a deep impact on the platinum industry. Wages are already one of the biggest expenses of mining, and the Association of Mineworkers and Construction Union (AMCU) is demanding a doubling of wages by 2017. They've already rejected an offer of a 10% increase.

This much seems clear: wages are going to go up and the industry will have to restructure its operations to handle the extra expense. The average global all-in cost of production (including capital expenditures and indirect overhead costs) is already at about $1,595 per ounce of platinum - 10% above the current market price.

As the cost of business rises, some industry analysts are forecasting that Lonmin and perhaps other companies will be forced to keep some of their mines closed after the strikes end. This could affect the platinum market for many years into the future. Large mining operations cannot be started and stopped at the drop of a hat, and it may take a significant increase in the price per ounce to justify reopening any shuttered mines.

Meanwhile, there's the possibility that Russia's annexation of Crimea could draw stricter economic sanctions from the United States and the European Union. How this would affect Russia's giant mining industry is hard to tell, though it has already put a lot of upward pressure on the price of palladium, another important platinum group metal (PGM). Russia is the world's largest producer of palladium and is widely suspected of having exhausted its official reserves of the metal. This rumor, combined with the news that Russia has been exporting abnormally large amounts of palladium to Switzerland in anticipation of economic sanctions, helped to drive the metal's price to its highest since 2011 in May.

The rising price of palladium and its ever-deepening physical deficit might even spur more producers to pay the extra for platinum, which can be more efficient than palladium in some autocatalysts. Generally, any limitations on Russian mining are bullish for all PGMs, and I am waiting for platinum to follow palladium's spike.

An Opportunity to Diversify

All told, Thomson Reuters GFMS is predicting at least a 700,000-ounce physical platinum deficit this year. It projects that platinum will pass $1,700 per ounce by the end of 2014, a 18% increase from today's price. Johnson Matthey is even more pessimistic (or optimistic, from the point of view of a platinum investor), predicting a deficit of more than 1.2 million ounces - the largest since 1975.

Even precious metals bears cannot deny the robust fundamentals for platinum this year. Investors who have already formed a bedrock for their portfolio with gold should consider adding physical platinum to increase future returns.

Peter Schiff is Chairman of Euro Pacific Precious Metals, which sells high-quality physical platinum, gold, and silver coins and bars. 

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Tags:  CPIeconomy
Posted by Peter Schiff on 05/29/2014 at 8:54 AM
There can be little doubt that Thomas Piketty's new book Capital in the 21st Century has struck a nerve globally. In fact, the Piketty phenomenon (the economic equivalent to Beatlemania) has in some ways become a bigger story than the ideas themselves. However, the book's popularity is not at all surprising when you consider that its central premise: how radical wealth redistribution will create a better society, has always had its enthusiastic champions (many of whom instigated revolts and revolutions). What is surprising, however, is that the absurd ideas contained in the book could captivate so many supposedly intelligent people.  

Prior to the 20th Century, the urge to redistribute was held in check only by the unassailable power of the ruling classes, and to a lesser extent by moral and practical reservations against theft. Karl Marx did an end-run around the moral objections by asserting that the rich became so only through theft, and that the elimination of private property held the key to economic growth. But the dismal results of the 20th Century's communist revolutions took the wind out of the sails of the redistributionists. After such a drubbing, bold new ideas were needed to rescue the cause. Piketty's 700 pages have apparently filled that void.

Any modern political pollster will tell you that the battle of ideas is won or lost in the first 15 seconds. Piketty's primary achievement lies not in the heft of his book, or in his analysis of centuries of income data (which has shown signs of fraying), but in conjuring a seductively simple and emotionally satisfying idea: that the rich got that way because the return on invested capital (r) is generally two to three percentage points higher annually than economic growth (g). Therefore, people with money to invest (the wealthy) will always get richer, at a faster pace, than everyone else. Free markets, therefore, are a one-way road towards ever-greater inequality.

Since Pitketty sees wealth in terms of zero sum gains (someone gets rich by making another poor) he believes that the suffering of the masses will increase until this cycle is broken by either: 1) wealth destruction that occurs during war or depression (which makes the wealthy poorer) or 2) wealth re-distribution achieved through income, wealth, or property taxes. And although Piketty seems to admire the results achieved by war and depression, he does not advocate them as matters of policy. This leaves taxes, which he believes should be raised high enough to prevent both high incomes and the potential for inherited wealth.

Before proceeding to dismantle the core of his thesis, one must marvel at the absurdity of his premise. In the book, he states "For those who work for a living, the level of inequality in the United States is probably higher than in any other society at any time in the past, anywhere in the world." Given that equality is his yardstick for economic success, this means that he believes that America is likely the worst place for a non-rich person to ever have been born. That's a very big statement. And it is true in a very limited and superficial sense. For instance, according to Forbes, Bill Gates is $78 billion richer than the poorest American. Finding another instance of that much monetary disparity may be difficult. But wealth is measured far more effectively in other ways, living standards in particular.

For instance, the wealthiest Roman is widely believed to have been Crassus, a first century BC landowner. At a time when a loaf of bread sold for ½ of a sestertius, Crassus had an estimated net worth of 200 million sestertii, or about 400 million loaves of bread. Today, in the U.S., where a loaf of bread costs about $3, Bill Gates could buy about 25 billion of them. So when measured in terms of bread, Gates is richer. But that's about the only category where that is true.

Crassus lived in a palace that would have been beyond comprehension for most Romans. He had as much exotic food and fine wines as he could stuff into his body, he had hot baths every day, and had his own staff of servants, bearers, cooks, performers, masseurs, entertainers, and musicians. His children had private tutors. If it got too hot, he was carried in a private coach to his beach homes and had his servants fan him 24 hours a day. In contrast, the poorest Romans, if they were not chained to an oar or fighting wild beasts in the arena, were likely toiling in the fields eating nothing but bread, if they were lucky. Unlike Crassus, they had no access to a varied diet, health care, education, entertainment, or indoor plumbing.

In contrast, look at how Bill Gates lives in comparison to the poorest Americans. The commodes used by both are remarkably similar, and both enjoy hot and cold running water. Gates certainly has access to better food and better health care, but Americans do not die of hunger or drop dead in the streets from disease, and they certainly have more to eat than just bread. For entertainment, Bill Gates likely turns on the TV and sees the same shows that even the poorest Americans watch, and when it gets hot he turns on the air conditioning, something that many poor Americans can also do. Certainly flipping burgers in a McDonald's is no walk in the park, but it is far better than being a galley slave. The same disparity can be made throughout history, from Kublai Khan, to Louis XIV. Monarchs and nobility achieved unimagined wealth while surrounded by abject poverty. The same thing happens today in places like North Korea, where Kim Jong-un lives in splendor while his citizens literally starve to death.

Unemployment, infirmity or disabilities are not death sentences in America as they were in many other places throughout history. In fact, it's very possible here to earn more by not working. Yet Piketty would have us believe that the inequality in the U.S. now is worse than in any other place, at any other time. If you can swallow that, I guess you are open to anything else he has to serve.

All economists, regardless of their political orientation, acknowledge that improving productive capital is essential for economic growth. We are only as good as the tools we have. Food, clothing and shelter are so much more plentiful now than they were 200 years ago because modern capital equipment makes the processes of farming, manufacturing, and building so much more efficient and productive (despite government regulations and taxes that undermine those efficiencies). Piketty tries to show that he has moved past Marx by acknowledging the failures of state-planned economies.

But he believes that the state should place upper limits on the amount of wealth the capitalists are allowed to retain from the fruits of their efforts. To do this, he imagines income tax rates that would approach 80% on incomes over $500,000 or so, combined with an annual 10% tax on existing wealth (in all its forms: land, housing, art, intellectual property, etc.). To be effective, he argues that these confiscatory taxes should be imposed globally so that wealthy people could not shift assets around the world to avoid taxes. He admits that these transferences may not actually increase tax revenues, which could be used, supposedly, to help the lives of the poor. Instead he claims the point is simply to prevent rich people from staying that way or getting that way in the first place.

Since it would be naive to assume that the wealthy would continue to work and invest at their usual pace once they crossed over Piketty's income and wealth thresholds, he clearly believes that the economy would not suffer from their disengagement. Given the effort it takes to earn money and the value everyone places on their limited leisure time, it is likely that many entrepreneurs will simply decide that 100% effort for a 20% return is no longer worth it. Does Piketty really believe that the economy would be helped if the Steve Jobses and Bill Gateses of the world simply decided to stop working once they earned a half a million dollars?

Because he sees inherited wealth as the original economic sin, he also advocates tax policies that will put an end to it. What will this accomplish? By barring the possibility of passing on money or property to children, successful people will be much more inclined to spend on luxury services (travel and entertainment) than to save or plan for the future. While most modern economists believe that savings detract from an economy by reducing current spending, it is actually the seed capital that funds future economic growth. In addition, businesses managed for the long haul tend to offer incremental value to society. Bringing children into the family business also creates value, not just for shareholders but for customers. But Piketty would prefer that business owners pull the plug on their own companies long before they reach their potential value and before they can bring their children into the business. How exactly does this benefit society?

If income and wealth are capped, people with capital and incomes above the threshold will have no incentive to invest or make loans. After all, why take the risks when almost all the rewards would go to taxes? This means that there will be less capital available to lend to businesses and individuals. This will cause interest rates to rise, thereby dampening economic growth. Wealth taxes would exert similar upward pressure on interest rates by cutting down on the pool of capital that is available to be lent. Wealthy people will know that any unspent wealth will be taxed at 10% annually, so only investments that are likely to earn more than 10%, by a margin wide enough to compensate for the risk, would be considered. That's a high threshold.

The primary flaw in his arguments are not moral, or even computational, but logical. He notes that the return of capital is greater than economic growth, but he fails to consider how capital itself "returns" benefits for all. For instance, it's easy to see that Steve Jobs made billions by developing and selling Apple products. All you need to do is look at his bank account. But it's much harder, if not impossible, to measure the much greater benefit that everyone else received from his ideas. It only comes out if you ask the right questions. For instance, how much would someone need to pay you to voluntarily give up the Internet for a year? It's likely that most Americans would pick a number north of $10,000. This for a service that most people pay less than $80 per month (sometimes it's free with a cup of coffee). This differential is the "dark matter" that Piketty fails to see, because he doesn't even bother to look.
Somehow in his decades of research, Piketty overlooks the fact that the industrial revolution reduced the consequences of inequality. Peasants, who had been locked into subsistence farming for centuries, found themselves with stunningly improved economic prospects in just a few generations. So, whereas feudal society was divided into a few people who were stunningly rich and the masses who were miserably poor, capitalism created the middle class for the first time in history and allowed for the possibility of real economic mobility. As a by-product, some of the more successful entrepreneurs generated the largest fortunes ever measured. But for Piketty it's only the extremes that matter. That's because he, and his adherents, are more driven by envy than by a desire for success. But in the real world, where envy is inedible, living standards are the only things that matter.

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

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

Tags:  CPIeconomy
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