Authored by Guy Haselmann of Scotiabank,
FED – Encouraging the Melt-Up Trade, While Regulating Bubbles Away
The Fed moved ‘all-in’ in 2008/09 when it pushed rates to zero and embarked on QE. Since the Fed basically used its final chips via this action, it became trapped playing ‘this hand’ until the bitter end. The stakes are enormous and grow over time. The only way the Fed can ‘win’ is – as Yellen said today – “to do everything possible to promote a very strong recovery”. Tapering too soon could be calamitous toward this objective. Yet, the longer it continues, the more the risks aggregate. However, Yellen seemed to calmly indicate today that any unintended consequences or dangers to financial stability are worth the risk.
There is an inability, and lack of good options, for providing any additional monetary or fiscal accommodation, should the economy weaken or should a global crisis arise. This is what makes the Fed’s current policy experiment such a high-stakes experiment. Here is why policy-makers are in such a predicament:
Every economic or business cycle decline over the past three decades has been met with the same response: monetary or fiscal stimulus. Policy makers have been quick to offer accommodation, but they have been slow to withdraw the stimulus which is always politically more difficult.
Fiscal accommodation over the years has resulted in large deficits and debt which are now leading to contentious discussion about how to reel them in.
Monetary authorities have stair-stepped the Fed Funds Rate down, but eventually hit zero and ran out of room.
Effectively, both stimulatory mechanisms are broken.
Yellen had to field several questions about potential market bubbles, but she deflected them aggressively saying that she did not believe that “bubble-like conditions” existed. Whether she believes that or not, it would have been counter-productive for her to admit it. She mentioned that should bubbles begin to form, the Fed has the regulatory tools to control them. She can’t possibly believe this (or can she); but regardless, she must try to convince the market that the Fed is monitoring them and can contain them.
Basically, she has given the market the green light to “melt-up”. The only question is how much higher will the Fed’s ‘gift’ drive prices? She indicated the Fed has no choice but to continue with this policy until it succeeds (or will it ultimately fail?).
As perverse as this seems, Yellen likely ensured that an equity market crash (someday) is inevitable. Yellen’s failure to acknowledge any signs of bubble-like conditions encourages more risk-taking and speculation. Therefore, this fact, combined with her hints of a continuation of policy, should lead to a bubble; if one hasn’t been created already. And, all bubbles eventually pop.
Alternatively, it is possible that Fed policy fails and economic growth begins to slip. In this scenario, a significant re-pricing (lower) of financial assets would occur.
Since banks are in a much stronger position today than in 2008, the Fed probably has limited concern about a market crash – as long as the banking system remains healthy. The Fed probably doubts a crash could be as bad as 2008, and it know it know possesses a slew of liquidity facilities (established in 2008) which could be implemented quickly if necessary.
“The question isn’t who is going to let me; it’s who is going to stop me.” – Ayn Rand
On December 23, 2013, the U.S. Federal Reserve (the Fed) will celebrate its 100th birthday, so we thought it was time to take a look at the Fed’s real accomplishment, and the practices and policies it has employed during this time to rob the public of its wealth. The criticism is directed not only at the world’s most powerful central bank – the Fed – but also at the concept of central banks in general, because they are the antithesis of fiscal responsibility and financial constraint as represented by gold and a gold standard. The Fed was sold to the public in much the same way as the Patriot Act was sold after 9/11 – as a sacrifice of personal freedom for the promise of greater government protection. Instead of providing protection, the Fed has robbed the public through the hidden tax of inflation brought about by currency devaluation.
The Fed is, unlike any other federal agency, owned by private and public shareholders – mainly large banks and influential banking families. It operates with as much opacity as possible, and only in the past two decades has the public become aware of this deception, thanks in large part to former Congressman Dr. Ron Paul, and the advent of the Internet.
The build-up of massive amounts of debt will result in the end of the U.S. dollar as the world’s de facto reserve currency. This should come as no surprise: Previous world reserve currencies, starting with Portuguese real in 1450 and continuing through five reserve currencies to the British pound, which capitulated its position in 1920, have had a lifespan of between eighty and 110 years. The U.S. dollar succeeded the British pound, but its peg to gold was broken domestically in 1933, and internationally in 1971, when President Nixon closed the gold window. This resulted in unrestricted and exponential debt creation that will likely see the U.S. dollar’s reserve currency status end sooner rather than later.
Why the Fed Hates Gold
The Fed has many reasons for being at war with gold:
1. Gold restricts a country’s ability to create unlimited amounts of fiat currency.
2. The gold held by the Fed and the United States has not been officially audited since 1953; there are several credible indications that this gold has been leased or swapped, and probably has several claims of ownership. Germany’s Bundesbank was told in January 2013 that it would have to wait seven years to repatriate 300 tonnes of its gold currently held by the Federal Reserve Bank of New York. The only plausible explanation for this delay is that the gold is not available.
3. Gold is the only money that exists outside the control of politicians and bankers. The Fed would like to control all aspects of the global economy, and gold is the last defense of the individual who wishes to protect his or her wealth.
4. Historically, gold serves as the most stable measure of purchasing power. Gold owners begin to measure risk in terms of ounces of gold, and this provides a broader perspective — the “gold perspective.” It takes into account factors that are considered unquantifiable through the narrower “fiat perspective” that banks and financial media prefer to use. It also shows up real inflation.
Two Policies the Fed Uses to Rob Savers and Taxpayers
Under the gold standard, governments are more transparent in raising funds through direct taxation. Under a fiat system and a central bank, they have to be much more secretive. There are two policies or practices currently being used to transfer wealth from the public to the government. These are:
1. Financial Repression
Financial repression is a hidden form of wealth confiscation that employs three tactics:
(i) indirect taxation through inflation;
(ii) the involuntary assumption of government debt by the taxpayer (like the Fed’s purchase of Fannie Mae and Freddie Mac CDOs);
(iii) debasement or inflation brought about through unbridled currency creation and capital controls; and
2. Government’s Position on Bail-ins and the Illusion of FDIC Insurance
Many believe their bank deposits are insured against bank failure, as this is the Fed’s main argument for its existence. This is far from the truth, since the FDIC could only cover .008 percent of the banks’ derivative losses in the event of major bank failures. Banks legally see depositors as “unsecured creditors,” as proven by the Cyprus bail-in.
The Fed’s Real Accomplishment
When measured against gold, the U.S. dollar has lost 96 percent of its purchasing power since the Fed’s inception in 1913. This is mainly through currency debasement, which leads to inflation. Real inflation, if measured using the original basket of goods used until the Boskin Commission in 1995 changed the rules, is running about 6 percent higher than is officially acknowledged, according to John Williams of ShadowStats.com. The CPI used to measure a “fixed standard of living” with a fixed basket of goods. Today, it measures the cost of living with a constantly changing basket of goods, measured with metrics that are themselves constantly changing.
History shows countries following the gold standard have a higher standard of living, stronger morals, and an aversion to costly wars.
Thanks to the Fed’s irresponsibility, foreign governments and investors are exiting the dollar and U.S. Treasuries, leaving the Fed as the buyer of last resort. This has painted the Fed into a corner, because it will be difficult, if not impossible, to curtail its bond and CDO purchases through its QE program, or to raise interest rates without crashing the markets.
When economists and historians can objectively look back at this past century, they will likely find the Fed, as well as the world’s other central banks, indirectly or directly responsible for:
• Personal income tax (introduced the same year as the Federal Reserve Act)
• Two world wars
• Several smaller unproductive wars
• The expropriation of U.S. gold in 1934
• The Great Depression
• Loss of morality in money and government
• Expansion of government to unprecedented levels
• The many economic bubbles that left countless investors ruined
• The decimation of the U.S. dollar’s purchasing power
• The spread of moral hazard throughout the global financial community
• Destruction of the middle class
• Migration of gold from West to East
The main thesis is that gold will continue rising because several exponential, long-term and irreversible trends will continue forcing the need for greater and greater government debt, and government debt is the main driver of the price of gold, as we can see in Figure 1. For the past decade, debt and the gold price have shared a conspicuously close relationship.
These trends—the rising and aging population, dwindling natural resources, outsourcing and movement away from the U.S. dollar—continue to develop.
As the following in-depth presentation notes, this has been going on since the Fed’s inception:
Today’s release of the 2013 edition of the Global Shadow Banking Monitoring Report by the Financial Stability Board doesn’t contain anything that frequent readers of this site don’t know already on a topic we have covered since 2009. It does however have a notable sidebar which explains the magic of “(un)fractional repo banking” – a topic made popular in late 2011 following the collapse of MF Global – when it was revealed that as part of the Primary Dealer’s operating model, a core part of the business was participating in UK-based repo chains in which the collateral could be recycled effectively without limit and without a haircut, affording Jon Corzine’s organization virtually unlimited leverage starting with a tiny initial margin.
Naturally, any product that can allow participants infinite leverage is something that all “sophisticated” market participants not only know about, but abuse on a regular basis. The fact that this “unfractional repo banking” is at the heart of the unregulated $71.2 trillion shadow banking system, the less the general public knows about it the better.
Which is why we were happy that the FSB was kind enough to explain in two short paragraphs and one even simpler chart,just how the aggregate leverage for the participants in even the simplest repo chain promptly becomes exponential, far above the “sum of the parts”, and approaches infinity in virtually no time.
From the FSB:
As a simple illustration of the way in which repo transactions can combine to produce adverse effects on the system that can be larger than the sum of their parts, suppose that investor A borrows cash for a short period of time from investor B and posts securities as collateral. Investor A could use some of that cash to purchase additional securities, post those as further collateral with investor B to receive more cash, and so on multiple times. The result of this series of ‘leveraging transactions’ is thatinvestor A ends up posting more collateral in total with investor B than they initially owned outright. Consequently, small changes in the value of those securities have a larger effect on the resilience of both counterparties. In turn, investor B could undertake a similar series of financing transactions with investor C, re-using the collateral it has taken from investor A, and so on.
Exhibit A2-5 mechanically traces out the aggregate leverage that can arise in this example.Even with relatively conservative assumptions, some configurations of repo transactions boost aggregate leverage alongside the stock of money-like liabilities and interconnectedness in ways that might materially increase systemic risk. For example, even with a relatively high collateral haircut of 10%, a three-investor chain can achieve a leverage multiplier of roughly 2-4, which is in the same ball park as the financial leverage of the hedge fund sector globally. It is therefore imperative from a risk assessment perspective that adequate data are available. Trade repositories, as proposed by FSB Workstream 5, could be very helpful in this regard.
So… three participants result in 4x leverage; four: in roughly 6x, and so on. Of course, these are conservative estimates: in the real, collateral-strapped world, the amount of collateral reuse, and thus the number of participants is orders of magnitude higher. Which means that after just a few turns of rehypothecation, leverage approaches infinity. Needless to say, with infinite leverage, even the tiniest decline in asset values would result in a full wipe out of one collateral chain member, which then spreads like contagion, and destroys everyone else who has reused that particular collateral.
All of this, incidentally, explains why down days are now prohibited. Because with every risk increase, there is an additional turn of collateral re-use, and even more participants for whom the Mutual Assured Destruction of complete obliteration should the weakest link implode, becomes all too real.
That, in a nutshell, are the mechanics. As to the common sense implications of having an unregulated funding market which explicitly allows infinite leverage, we doubt we have to explain those to the non-Econ PhD readers out there.
There is a reason why US consumer revolving (credit card) credit growth is getting lower and lower and lower and at last check posted a mere 0.2% annual increase.
That reason is that as the NY Fed disclosed moments ago, federal student loans officially crossed the $1 trillion level for the first time ever. Notably: the quarterly student loan balance has increased every quarter without fail for the past 10 years!
And just to prove that while credit card balances are plunging due to more stringent bank repayment requirements, this is more than offset by borrowers shifting to student loans, where the delinquency rate on student loans is soaring and has just hit an all time high of 11.83%, an increase of almost 1% compared to last quarter. Even according to just the government lax definition of delinquency, a whopping $120 billion in student loans will be discharged. Thank you Uncle Sam for your epically lax lending standards in a world in
which it is increasingly becoming probably that up to all of the loans will end up in deliquency.
Since the SDR is just an aggregate of fiat currencies, it cannot really change the fundamentals of the current status quo.
Many observers believe the U.S. dollar (USD) will lose its status as the world’s reserve currency sooner rather than later. Proponents of this view often mention China’s agreements with various trading partners to settle trade in their own currencies rather than the dollar as evidence of this trend.
More substantial evidence can be found in the diversification of reserves held by many nations. The euro now makes up about a fourth of all currency reserves:
Here is the IMF (international Monetary Fund) page on voluntarily reported currency reserves: Currency Composition of Official Foreign Exchange Reserves (COFER). Note the large amount of reserves that are not “allocated,” i.e. the currency being held is not specified.
Some see the replacement of the U.S. dollar by some other currency as a welcome development, not just for the world economy but for the U.S., as the reserve currency has substantial burdens. Regardless of whether such a replacement would be positive or negative, many analysts see no plausible alternative to the USD as the primary reserve currency for a host of reasons.
Another camp sees China’s purchases of gold as paving the way for China’s currency (renminbi a.k.a. yuan) to replace the dollar as the global reserve currency. Those who have studied China’s policy makers doubt this is the goal; rather, they see China as most likely pursuing a multi-polar world in which no one nation issues the reserve currency.
One set of observers has long held that the ideal replacement for the dollar is a hybrid currency issued by the IMF called SDRs (Special Drawing Rights). The IMF describes the SDR thusly:
“The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs can be exchanged for freely usable currencies.”
The four currencies are the U.S. dollar, the euro, the Japanese yen and the British pound. China is widely seen as working toward floating the renminbi (that is, no longer pegging it to the dollar) so it could be included in the SDR currency.
The SDR seems to many to be the ideal replacement of the USD as the reserve currency, especially if China’s currency joins the basket of currencies that make up the SDR.
Though the advantages of a multi-currency basket are fairly self-evident, questions remain if the SDRs are a realistic or practical option. These questions come to mind:
1. Since the SDR is just a basket of currencies, doesn’t it simply aggregate the weaknesses of all fiat currencies? In other words, what happens to the value of the SDR when priced in gold, oil or other commodity if every nation in the basket prints its currency with abandon? The SDR will lose value just like any any fiat currency, because it is simply a composite fiat currency.
2. Couldn’t a nation simply hold all currencies in the SDR in the same percentages as in the SDR basket? Clearly, this is possible: a nation could acquire the same basket of currencies held by the SDR and in the same weighting. In that case, what is the purpose of the SDR?
3. What happens to the relative value of one of the constituent currencies in the SDR if the issuing nation experiences a currency crisis or devalues its currency by one means or another? Clearly, the relative weighting of that currency would decline within the SDR basket.
The SDR, then, does nothing to impede currency crises or devaluations; it is simply a risk-management tool that works by diversifying the risk of holding too much of any one currency. But since any nation can pursue the same risk-management strategy directly by diversifying its reserves with multiple currencies, what’s the point of holding SDRs as a risk-management tool?
4. Since the SDR is just an aggregate of existing currencies, it is not an independent currency. An independent currency would need to be supported by either enforceable taxation rights or some commodity or basket of commodities: gold, for example, or a “bancor”-type basket of commodities (gold, oil, grain, etc.) owned by the issuing nation/entity.
(Another potential independent currency that could serve as a reserve currency is a non-state issued digital currency such as Bitcoin: Could Bitcoin (or equivalent) Become a Global Reserve Currency? (November 7, 2013). Digital currencies’ valuation is based not on taxation or gold but carefully managed scarcity.)
Since the SDR is just an aggregate of fiat currencies, it cannot really change the fundamentals of the current status quo.
Boiled down to its essence, the SDR is presented as a shortcut solution to deeply seated problems. The reserve currency problem cannot be fixed by a basket of fiat currencies, as fiat currencies (and the trade imbalances they generate) are the problem.
Here are the only two charts that matter:
First, the Fed now owns a third or 32.47% of all 10 Year equivalents, up 32.22% from the prior week, and rising at a pace of 0.3% per week.
Second, the Fed is now monetizing a record 70% of all net US 10 Year equivalent issuance.
That is all.
Source: Stone McCarthy and RBS
Talking Real Money: World Monetary Reform
By Michael O’Brien
Today’s AM fix was USD 1,283.25, EUR 955.23 and GBP 801.53 per ounce.
Yesterday’s AM fix was USD 1,276.00, EUR 951.25 and GBP 798.75 per ounce.
Gold rose $4.40 or 0.35% yesterday, closing at $1,273.30/oz. Silver slipped $0.19 or 0.92% closing at $20.56. Platinum fell $5.55 or 0.4% to $1,424.20/oz, while palladium fell $9.50 or 1.3% to $727.97/oz.
Gold inched up again after Federal Reserve Chairman nominee Janet Yellen said the U.S. economy and labor market must improve before QE is reduced. This lifted confidence as silver prices recovered from their lowest levels since August. “The focus for the bullion market may shift to the upcoming testimony by Yellen,” James Steel, an analyst at HSBC, commented. “Chinese gold demand remains brisk. However, gold is likely to remain on the defensive in the near term”, wrote Steel.
The latest long term gold trend research from Nick Laird at ShareLynx indicates that the price of gold may rise in the near future. In the chart below, Nick references those periods from the past when it was prudent to buy and to sell. He also indicates that this particular period, November 2013, may be a prudent time to to buy. This chart reaffirms GoldCore’s long term outlook for the price of gold.
Long Term Gold Trend (www.sharelynx.com)
“Sometimes it’s not enough to know what things mean, sometimes you have to know what things don’t mean.” Bob Dylan
The Bank of England says the UK recovery has taken hold and Chancellor George Osborne is reported as saying “the report was proof the government’s economic plan was working.” The governor of the Bank of England, Mark Carney, said the bank will not ‘consider’ raising interest rates until the jobless figure falls below 7%.
However, The Bank of England threw a get-out-of-jail card on the table and said that there was a two-in-five chance of the unemployment rate reaching the 7% threshold by the end of 2014. And then added that the corresponding figures for the end of 2015 and 2016 are around three in five and two in three respectively. What exactly does the Bank of England mean or what does this not mean?
The financial crisis of 2007-2008 has sparked the most intense interest in international monetary reform since Richard Nixon closed the gold window at the New York Fed and devalued the U.S. dollar in 1971. Nixon’s action was widely seen at the time as presaging the end of the dollar-based world trade and financial system. On the face of it, this probably wasn’t an unreasonable expectation at the time. Within fewer than ten years, however, it was proven to be far off the mark. The dollar fell alright, but by the middle 1980s had recovered strongly.
In retrospect it is clear why the dollar sceptics were wrong. To begin with, the U.S. economy was still the world’s largest and the U.S. was still the leader of the “free world,” that is to say the world outside the communist bloc. The NATO countries of Western Europe were wholly dependent on the U.S. for security as well as for markets.
The same applied to Japan, South Korea and Taiwan, while the signatories of the secret UK/USA intelligence agreement (the U.S., UK, Canada, Australia and New Zealand) represented the Anglo core of the old British Empire, a group with no interest in seeing the dollar replaced. Communist Russia and China were in no position to register an opinion, much less offer an alternative. By default, the dollar soldiered on, thanks to the geopolitical realities of the time.
But what about today’s realities? Continue this fascinating story in our November edition of Insight – Talking real money: World Monetary Reform.
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A man with a camera who stumbled on a military special forces exercise in a small Cape Breton town had his patriotism gruffly questioned by an undercover soldier, and was quizzed about whether he belonged to an anti-government movement.
Robert Westbrook said he was also threatened with arrest and he worried the undercover soldier would lash out and strike him.
“He takes a few steps back and clenches his fist and jaw angrily,” Westbrook wrote in an account he posted online. ” I truly think for a moment that he’s going to take a swing at me.”
Westbrook, 46, lives in Port Hawkesbury, N.S., on Cape Breton Island. The town of 3,366 is the last place Westbrook says he’d expect to run into undercover Canadian special forces troops participating in an exercise.
But that’s what happened the night of Oct. 25, when Westbrook was confronted by two soldiers dressed in civilian clothes who demanded to know who he was and why he had a camera.
The military has refused an interview on the incident, and only responded to CBC News queries about the incident after several calls and emails and six days of waiting.
Official stone-walling notwithstanding, CBC News has come to learn the exercise included members of Canadian Special Operations Force Command, or CANSOFCOM, as it’s called, and likely included members of the special operations and counterterrorism unit Joint Task Force II.
JTF2 is a highly-secretive unit, and its activities are most often kept under wraps by the government.
Their work has included hunting Taliban leaders and bomb makers in Afghanistan, as well providing military close protection to high-ranking government officials in war zones overseas, including the prime minister.
The unit’s soldiers make up a so-called force of last resort in Canada if ever the country is threatened by violent extremist attack or terrorism.
Although the Port Hawkesbury exercise featured Canadian special operations soldiers, it’s believed the two soldiers who confronted Westbrook were not elite assaulters, but supporting troops.
One soldier identified himself as a military policeman, although he was not clothed in the standard military police black uniform or cherry red beret. The other soldier called himself “Adam,” and said he was running security for the military “training evolution” that was taking place at that abandoned call centre, just two blocks from Westbrook’s house.
Westbrook told CBC News he went down to check out the unusual activity at the abandoned call centre.
“There was quite a bit of activity. So, we thought this was quite strange,” he said.
No sign of military exercise
The call centre was a town landmark that once employed as many as 300 locals, but it has been closed for a couple of years.
Now the only activity in the almost 10,000-square-metre office block was a small military recruiting office. But that couldn’t account for the 50 or 60 civilian cars and trucks Westbrook said he saw that night.
Westbrook is a freelance photographer, and started taking pictures.
After a few minutes, Westbrook says the first soldier drove up and identified himself as military policeman.
“It puzzled me to no end because … there was no evidence of any military involvement, there were no signs stating that, no announcement to the public that there was going to be an exercise here. There was no one in uniform, and no military vehicles at all.”
Westbrook says he told the officer that he was just there to take some pictures.
‘Asked if I was a patriot’
About seven minutes later, Westbrook says, a soldier called “Adam” burst onto the scene demanding to know who Westbrook was and why he was taking pictures.
Westbrook says he was on public property throughout the encounter and wasn’t breaking any laws.
He recorded the conversation on his iPod.
Westbrook says he told “Adam” he was a freelance photographer.
“He immediately got more aggressive and asked if I was patriotic, which I thought was quite a strange question, and I didn’t really answer that because I didn’t think it was relevant, and I said so.”
According to the recording, “Adam” then dropped the name of the local RCMP detachment commander, Sgt. Shelby Miller, who he said was a “good friend,” with whom he was in “direct contact.”
“So, I don’t want to call Shelby Miller and have him come down here and deal with this,” “Adam” said.
Westbrook said he viewed this exchange as a threat of arrest. It got his back up and, as a result, Westbrook says he dug in his heels.
“I was quite insulted by that because I wasn’t breaking the law and I was fully aware that I wasn’t breaking the law. At that point [“Adam”] got quite visibly upset. I thought he might actually punch me.”
Westbrook edited down a seven-minute version of his audio recording and posted it on YouTube. It’s been viewed nearly 7,000 times.
The recording shows “Adam” returning to that question about Westbrook’s patriotism.
“Clearly, you’re not patriotic, ” he said, before turning to a new tack: “Are you here as some sort of anti-government movement?” he said.
“Adam” eventually walked away, and so did Westbrook.
‘Committed to positive community relations’
Westbrook says politically he’s “middle of the road,” and at least as patriotic as the next person.
“If by patriotism you define that as love of one’s country, yeah, I would say I am patriotic. I love Canada. That is why I chose to become a citizen here.”
Westbrook was an American who married a Canadian woman and became a citizen in August.
But the encounter with soldiers of his new country’s army left him shaking his head about the professionalism of those who planned the secret exercise.
“It doesn’t seem to make a lot of sense that they would be interested in that level of secrecy and yet expect no reaction when they locate themselves in a call centre that has been a major employer over the past decade in the area and expect people to not ask questions.”
Miller, the RCMP detachment commander, says he was aware the military exercise was taking place, but that he’s not friends with “Adam.”
“Never met the man,” Miller said.
In the end, defence officials provided a brief written statement.
“The Military Police are firmly committed to positive community relations,” the statement said.
“Additional training will now be afforded to unit members involved to better prepare them for situations of this nature.”