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Manufacturing’s Decline A Bigger Problem Than Housing Bubble: BMO

Manufacturing’s Decline A Bigger Problem Than Housing Bubble: BMO.

Heinz shuts down its plant in Leamington, Ont., laying off more than 700 and ending a 104-year-long presence in the town. Three weeks later, Kellogg’s shuts down its plant in London, Ont., erasing 500 jobs. Days after that, drugmaker Novartis announces its pharmaceutical plant in Mississauga will shut down, taking 300 jobs with it.

Add it all up, and what you have is the largest medium-term threat to Canada’s economy, BMO chief economist Doug Porter said in a client note this week.

Porter noted that Ontario has lost 4 per cent of all its manufacturing jobs in the past year — something he understatedly describes as “not good.” Canada overall lost 2.5 per cent of all its manufacturing jobs this year, the Wall Street Journal notes — and that’s despite a recent rise in manufacturing output.

There are now more jobs in health care in Ontario than there are in manufacturing; as recently as 2000, there were twice as many factory jobs as health care jobs.

bmo jobs chart

The decline of factory jobs is taking place even as manufacturing around the world, particularly auto manufacturing, is experiencing a boom — one that appears to bepassing Canada over.

“It would seem to us that this is a much bigger issue for the medium-term Canadian outlook than the more hyped housing bubble/household debt concern,” Porter wrote.

The Bank of Canada appears to disagree, once again reiterating this week that it sees high house prices and record high consumer debt levels as the dominant domestic risk to the economy.

But maybe those two risks aren’t entirely unconnected. As manufacturing employment wanes (even with manufacturing output growing), the real estate boom has picked up much of the slack, and construction employment is at or near record highs in Canada today.

But few market observers, even those optimistic about the future of the housing market, expect this juggernaut to continue. That’s why economists are constantly looking to external demand (i.e. exports) to pick up the economic slack from a housing boom that’s expected to level off.

On that front, there is some hope for good news, BMO economist Robert Kavcic says.

“With the high-profile job cuts in Ontario’s manufacturing sector piling up, there might be some reprieve coming from the weaker loonie and stronger expected U.S. growth,” he writes.

“But keep in mind that a weaker currency won’t help overnight — the impact tends to filter through over the course of at least two years.”

So here’s hoping the housing construction boom keeps up for a few more years, or Canada could get a nasty surprise in future unemployment reports.

 

Are We Headed For Class Warfare? | Zero Hedge

Are We Headed For Class Warfare? | Zero Hedge.

Over the course of the last few years we have vociferously exposed the growing inequalities and divergences between various elements of the status quo society.

With even the President now seemingly inciting class warfare(which as we discussed here and here is becoming an increasingly  new normal “age warfare” issues); we roll out the wayback machine for 150 seconds of clarity from Doug Casey. With roughly half the American people net recipients of government support in some way (and work punished), Casey explains what happens when the entitled elect themselves (as Michael Burry so aptly noted “the party accelerates, and the brutal hangover is inevitable,”) and the social and political consequences.

Several killed in Iraq-Iran pipeline attack – Middle East – Al Jazeera English

Several killed in Iraq-Iran pipeline attack – Middle East – Al Jazeera English.

Violence has reached levels not seen since 2008, when US forces were still fighting for control of Iraq [Reuters]
Unidentified gunmen have killed 18 people and injured six others working on a gas pipeline in Iraq, police sources have told Al Jazeera.

Gunmen in three vehicles used machine guns in the attack on Friday evening in the town of Imam Wais, 65km east of Baghdad.

Fifteen Iranian and three Iraqi workers were killed, while five Iranians and one Iraqi were wounded.

The workers were laying the foundation for a gas pipeline which is set to connect Iraq with neighbouring Iran.

Deadly day

Also on Friday, a series of car bombs and attacks in Iraq killed 18 people, and wounded 37 others, according to Al Jazeera police sources.

A car bomb exploded near a security checkpoint in Ramadi, west of Baghdad, killing six people, and injuring at least ten.

In a drive-by shooting in Baghdad’s Ghazaliyah area, gunmen shot and killed two people, including a government employee, in their car.

Two separate car bombs also exploded near the capital: the first, near a fish market in Nahrawan, killed five people and wounding at least 14, while another exploded in Madain, just south of Baghdad, killing five people and injuring 13.

Violence in Iraq has reached a level this year not seen since 2008, when the country was just emerging from a brutal period of rampant sectarian killings. Nearly 950 people were killed in the month of November alone.

More people died in the first eight days of December 2013 than in the whole of last December, according to AFP news agency figures based on security and medical sources.

Prison break

Elsewhere in the capital on Friday, at least 22 Iraqi detainees facing terrorism charges escaped from a Baghdad prison, after killing at least one prison guard, authorities say.

Following a police manhunt, Iraqi security forces recaptured 13 prisoners and killed one, while another eight prisoners were still at large.

A police colonel said the detainees had seized weapons from guards before their escape from the al-Adela facility in the northern Baghdad area of Kadhimiyah.

The prisoners had lured a guard into their cell while his colleagues were sleeping, claiming an inmate was critically ill. They then stabbed the security guard to death, two senior security officials said.

Several guards were later detained and questioned over suspicions they had helped in the escape, a prison official said.

The jail break was the latest in a series of prison escapes in Iraq. More than 500 inmates escaped, including several al-Qaeda leaders, and dozens were killed, after an al-Qaeda linked group attacked two prisons last July.

The security breaches have cast doubts on the ability of the Iraqi authorities to secure the country amid the countrywide increase in violence.

 

Deutsche Bank Investigated In Gold Manipulation Probe | Zero Hedge

Deutsche Bank Investigated In Gold Manipulation Probe | Zero Hedge.

month ago, regulators in Europe began their investigation into manipulation of the “London gold fixing” (and we explained the methods here). While the complete history of gold manipulation goes a lot deeper than just banging the close on this crucial benchmark (which goes back to first world war); the decision by Germany’s financial regulator (BaFin) to probe Deutsche Bank signals greater concerns over the precious metals markets.  As The FT reportsBaFin has demanded emails and documents from Deutsche Bank as part of an investigation into potential manipulation of gold and silver prices.

 

Via The FT,

Germany’s financial regulator has demanded documents from Deutsche Bank as part of an investigation into potential manipulation of gold and silver prices.

 

 

Deutsche Bank is one of five banks that take part in the twice-daily “London gold fixing”, and one of three banks that take part in the equivalent process for silver.

 

 

Some bankers believe BaFin has come under pressure to show it is willing to get tough on suspected market manipulation. It was widely seen to have been slow to respond to the concerns over possible manipulation in the forex market expressed by other regulators around the world earlier this year.

 

Although the gold and silver fixings are, like Libor, set by small groups of banks, they contrast with the process for setting Libor in that they are based on trading activity rather than theoretical quotes.

 

 

The visit to Deutsche offices signals that BaFin now has greater concerns over the precious metals markets. Officials have asked to observe documents and processes related to precious metals trading as well as to interview bankers, the person said.

 

 

The other banks that take part in the gold fixing are Barclays, Bank of Nova Scotia, HSBC and Société Générale. The other banks involved in silver fixing are Bank of Nova Scotia and HSBC. As the only German member of either fixing, Deutsche is the only bank to come under BaFin’s remit.

Of course, despite day after day of closing price smackdowns (and the very occasaional vertical ramp), we are sure the regulators will find no wrong doing… for, as we noted here,this manipulation is by design, not malfeasance…it’s for your own good…

 

US, Chinese Warships “Nearly Collide” In South China Sea | Zero Hedge

US, Chinese Warships “Nearly Collide” In South China Sea | Zero Hedge. With the recent deployment of China’s air defenze zone, and the subsequent announcement of a comparable zone by South Korea which overlaps not only with China’s own, but with that of Japan, it almost seems like a scenario designed to provoke an escalating conflict on the tiniest of provocations is actively being produced. A scenario such as the one US defense officials revealed today, when a guided missile cruiser operating in international waters in the South China Sea was forced to take evasive action last week to avoid a collision with a Chinese navy ship maneuvering nearby. Hold on: how can two massive ships, visible to the naked eye and certainly to radar from hundreds of miles away, “nearly collide”? Reuters reports that the incident took place on December 5 and involved the USS Cowpens. The Pacific Fleet statement did not offer details about what led to the near-collision. But it did say the incident underscored the need for the “highest standards of professional seamanship, including communications between vessels, to mitigate the risk of an unintended incident or mishap.” The rest of the story is widely known:

Beijing declared the air defense zone over the East China Sea late last month and demanded that aircraft flying through the area provide it with flight plans and other information.   The United States and its allies rejected the Chinese demand and have continued to fly military aircraft into the zone, which includes air space over a small group of islands claimed by China but currently administered by Tokyo.   In the midst of the tensions over the air defense zone, China deployed its only aircraft carrier, the Liaoning, to the South China Sea for maneuvers. Beijing claims most of the South China Sea and is involved in territorial disputes in the region with several of its neighbors.

And so, the waters have been tested, so to speak, with a media “warning” on just how brazen China can be when it comes to its “aggressive” tactics in what we are confident the Chinese media will describe as its own maritime territory, begging the question of just who was provoking whom, especially since the response to a Chinese missile cruiser sailing idly by New York or San Francisco, even if in “international waters”, would hardly see the same controlled reaction by the US. Then again, it has been only two weeks since China’s most recent “escalation.” We are confident that given time, this will be the least of the close shipping encounters that involve Chinese, US, Japanese and/or Korean navies in the East China Sea. After all, one must think of all that, GDP that as WWII taught us, can be easiest gained through some modest, or not so modest, international conflict.

 

Personal debt ratio hits record high of 163.7% – Business – CBC News

Personal debt ratio hits record high of 163.7% – Business – CBC News.

Canadians’ debt ratio increased last quarter, but so did the value of their assets, so the national net worth increased. (The Associated Press)

The amount that Canadians owe compared to their disposable income rose to an all-time record last quarter, although their net worth also increased.

Statistics Canada reported Friday that the level of household credit market debt to disposable income increased to 163.7 per cent in the third quarter from 163.1 per cent in the second quarter.

That means Canadians owe nearly $1.64 for every $1 in disposable income they earn in a year.

‘The seasonal bounce in mortgage borrowing in the previous quarter picked up into the fall’– Royal Bank economist Laura Cooper

Policymakers are fixated on the debt ratio in part because it was at above 160 per cent that households in the United States and Britain ran into trouble about five years ago, contributing to defaults and the financial crisis that triggered the 2008-09 recession.

Debt loads can be influenced by seasonal factors, and although the headline figure is higher, the rate of growth in that ratio was the smallest in 12 years.

“Those figures should be encouraging for policymakers and suggest that the Bank of Canada’s belief that imbalances are evolving constructively is right on the mark,” said Benjamin Reitzes, a senior economist with BMO Capital Markets.

Indeed, while they are borrowing more, Canadians are also worth more as their assets increase by a similar amount. The national net worth increased to $7.5 trillion in the third quarter, up 2.1 per cent from the previous quarter.

On a per capita basis, that works out to $212,700 for every Canadian. The previous quarter, that figure was $208,300.

Canadians saw their financial assets go up in value, as well as their non-financial assets (such as houses) do the same. The value of shares and other equities gained 3.7 per cent in the quarter, while the value of household real estate gained 1.5 per cent.

“The pace of debt accumulation picked up slightly in the third quarter as the seasonal bounce in mortgage borrowing in the previous quarter picked up into the fall,” Royal Bank economist Laura Cooper said.

HOUSEHOLD DEBT RATIO

With files from The Canadian Press

International concern over N Korea execution – Asia-Pacific – Al Jazeera English

International concern over N Korea execution – Asia-Pacific – Al Jazeera English.

The reported execution of North Korean leader Kim Jong-un’s powerful uncle has caused worries over the stability of the isolated country, with various governments expressing concern over the potential implications of the move.

The state-run KCNA news agency announced on Friday that a special military trial was held for the once-influential Jang Song-thaek before he was executed on Thursday.

Jang, who had been branded as “traitor” and dismissed from his positions and powers on Monday, was accused of a string of criminal acts including corruption, womanising and drug-taking.

“The accused Jang brought together undesirable forces and formed a faction as the boss of a modern day factional group for a long time and thus committed such hideous crimes as attempting to overthrow the state,” KCNA reported.
South Korea on Friday expressed “deep concern” over the developments, and said it would prepare for “all possibilities in the future” and coordinate closely with its allies.

“The North usually curbs internal instability by waging provocations externally,” the Ryoo Kihl-Jae, the South Korean unification minister said, warning the purge could be followed by military actions, including another nuclear test.

China, Pyongyang’s major ally and economic lifeline, said Jang’s execution was an “internal matter” but also stressed the need for stability.

“As a neighbour we hope to see national stability, economic development and people living in happiness in the Democratic People’s Republic of Korea,” foreign ministry spokesman Hong Lei said at a regular briefing.

Tokyo said that it was “closely watching the situation”.

“We will calmly monitor the situation while communicating with other countries and collect relevant information,” the Kyodo news agency quoted Chief Cabinet Secretary Yoshihide Suga as saying.

‘Deep concern’

Washington said that the execution was “another example of the extreme brutality of the North Korean regime”.

The North usually curbs internal instability by waging provocations externallyRyoo Kihl-Jae, South Korea’s unification minister

“We are following developments in North Korea closely and consulting with our allies and partners in the region,” Patrick Ventrell, a spokesman for the White House’s National Security Council, said.

London expressed “deep concern about the impact of this unpredictable regime on stability in the region”.

“Our embassy in Pyongyang is monitoring the situation closely and we will continue to maintain close contact with our allies on this,” a Foreign and Commonwealth Office spokesman said.

The official Rodong Sinmun newspaper on Friday carried a photograph of Jang in handcuffs and being held by uniformed guards as he stood trial.

Al Jazeera’s Harry Fawcett, reporting from Bangkok, said the execution has laid bare a massive power struggle in the secretive country.

“It’s an incredibly public condemnation of this once very powerful man,” our correspondent said.

The sacking on Monday suggests Pyongyang is undergoing its biggest leadership upheaval since the death in 2011 of former leader Kim Jong-il, the younger Kim’s father.

‘Wild ambition’

KCNA said earlier this week that Jang had been removed from all his posts and expelled from the Workers’ Party.

“From long ago, Jang had a dirty political ambition. He dared not raise his head when Kim Il-sung and Kim Jong-il were alive,” KCNA said, referring to leader Kim’s grandfather and father, who were previous rulers of the dynastic state.

“He began revealing his true colours, thinking that it was just the time for him to realise his wild ambition in the period of historic turn when the generation of the revolution was replaced.”

Jang was married to Kim’s aunt, the daughter of the North’s founding leader Kim Il-sung, and was widely considered to be working to ensure his nephew firmly established his grip on power in the past two years.

Jang had been a prominent fixture in many of the reports and photographs of Kim Jong-un’s public activities, but his appearances have tapered off sharply this year and he has not appeared in official media since early November.

 

How the Paper Money Experiment Will End – Philipp Bagus – Mises Daily

How the Paper Money Experiment Will End – Philipp Bagus – Mises Daily.

A paper currency system contains the seeds of its own destruction. The temptation for the monopolist money producer to increase the money supply is almost irresistible. In such a system with a constantly increasing money supply and, as a consequence, constantly increasing prices, it does not make much sense to save in cash to purchase assets later. A better strategy, given this senario, is to go into debt to purchase assets and pay back the debts later with a devalued currency. Moreover, it makes sense to purchase assets that can later be pledged as collateral to obtain further bank loans. A paper money system leads to excessive debt.

This is especially true of players that can expect that they will be bailed out with newly produced money such as big businesses, banks, and the government.

We are now in a situation that looks like a dead end for the paper money system. After the last cycle, governments have bailed out malinvestments in the private sector and boosted their public welfare spending. Deficits and debts skyrocketed. Central banks printed money to buy public debts (or accept them as collateral in loans to the banking system) in unprecedented amounts. Interest rates were cut close to zero. Deficits remain large. No substantial real growth is in sight. At the same time banking systems and other financial players sit on large piles of public debt. A public default would immediately trigger the bankruptcy of the banking sector. Raising interest rates to more realistic levels or selling the assets purchased by the central bank would put into jeopardy the solvency of the banking sector, highly indebted companies, and the government. It looks like even the slowing down of money printing (now called “QE tapering”) could trigger a bankruptcy spiral. A drastic reduction of government spending and deficits does not seem very likely either, given the incentives for politicians in democracies.

So will money printing be a constant with interest rates close to zero until people lose their confidence in the paper currencies? Can the paper money system be maintained or will we necessarily get a hyperinflation sooner or later?

There are at least seven possibilities:

1. Inflate. Governments and central banks can simply proceed on the path of inflation and print all the money necessary to bail out the banking system, governments, and other over-indebted agents. This will further increase moral hazard. This option ultimately leads into hyperinflation, thereby eradicating debts. Debtors profit, savers lose. The paper wealth that people have saved over their life time will not be able to assure such a high standard of living as envisioned.

2. Default on Entitlements. Governments can improve their financial positions by simply not fulfilling their promises. Governments may, for instance, drastically cut public pensions, social security and unemployment benefits to eliminate deficits and pay down accumulated debts. Many entitlements, that people have planned upon, will prove to be worthless.

3. Repudiate Debt. Governments can also default outright on their debts. This leads to losses for banks and insurance companies that have invested the savings of their clients in government bonds. The people see the value of their mutual funds, investment funds, and insurance plummet thereby revealing the already-occurred losses. The default of the government could lead to the collapse of the banking system. The bankruptcy spiral of overindebted agents would be an economic Armageddon. Therefore, politicians until now have done everything to prevent this option from happening.

4. Financial Repression. Another way to get out of the debt trap is financial repression. Financial repression is a way of channeling more funds to the government thereby facilitating public debt liquidation. Financial repression may consist of legislation making investment alternatives less attractive or more directly in regulation inducing investors to buy government bonds. Together with real growth and spending cuts, financial repression may work to actually reduce government debt loads.

5. Pay Off Debt. The problem of overindebtedness can also be solved through fiscal measures. The idea is to eliminate debts of governments and recapitalize banks through taxation. By reducing overindebtedness, the need for the central bank to keep interest low and to continue printing money is alleviated. The currency could be put on a sounder base again. To achieve this purpose, the government expropriates wealth on a massive scale to pay back government debts. The government simply increases existing tax rates or may employ one-time confiscatory expropriations of wealth. It uses these receipts to pay down its debts and recapitalize banks. Indeed the IMF has recently proposed a one-time 10-percent wealth tax in Europe in order to reduce the high levels of public debts. Large scale cuts in spending could also be employed to pay off debts. After WWII, the US managed to reduce its debt-to-GDP ratio from 130 percent in 1946 to 80 percent in 1952. However, it seems unlikely that such a debt reduction through spending cuts could work again. This time the US does not stand at the end of a successful war. Government spending was cut in half from $118 billion in 1945 to $58 billion in 1947, mostly through cuts in military spending. Similar spending cuts today do not seem likely without leading to massive political resistance and bankruptcies of overindebted agents depending on government spending.

6. Currency Reform. There is the option of a full-fledged currency reform including a (partial) default on government debt. This option is also very attractive if one wants to eliminate overindebtedness without engaging in a strong price inflation. It is like pressing the reset button and continuing with a paper money regime. Such a reform worked in Germany after the WWII (after the last war financial repression was not an option) when the old paper money, the Reichsmark, was substituted by a new paper money, the Deutsche Mark. In this case, savers who hold large amounts of the old currency are heavily expropriated, but debt loads for many people will decline.

7. Bail-in. There could be a bail-in amounting to a half-way currency reform. In a bail-in, such as occurred in Cyprus, bank creditors (savers) are converted into bank shareholders. Bank debts decrease and equity increases. The money supply is reduced. A bail-in recapitalizes the banking system, and eliminates bad debts at the same time. Equity may increase so much, that a partial default on government bonds would not threaten the stability of the banking system. Savers will suffer losses. For instance, people that invested in life insurances that in turn bought bank liabilities or government bonds will assume losses. As a result the overindebtedness of banks and governments is reduced.

Any of the seven options, or combinations of two or more options, may lie ahead. In any case they will reveal the losses incurred in and end the wealth illusion. Basically, taxpayers, savers, or currency users are exploited to reduce debts and put the currency on a more stable basis. A one-time wealth tax, a currency reform or a bail-in are not very popular policy options as they make losses brutally apparent at once. The first option of inflation is much more popular with governments as it hides the costs of the bail out of overindebted agents. However, there is the danger that the inflation at some point gets out of control. And the monopolist money producer does not want to spoil his privilege by a monetary meltdown. Before it gets to the point of a runaway inflation, governments will increasingly ponder the other options as these alternatives could enable a reset of the system.

Note: The views expressed in Daily Articles on Mises.org are not necessarily those of the Mises Institute.

Comment on this article. When commenting, please post a concise, civil, and informative comment.
Philipp Bagus is an associate professor at Universidad Rey Juan Carlos. He is an associate scholar of the Ludwig von Mises Institute and was awarded the 2011 O.P. Alford III Prize in Libertarian Scholarship. He is the author of The Tragedy of the Euro and coauthor of Deep Freeze: Iceland’s Economic CollapseThe Tragedy of the Euro has so far been translated and published in GermanFrenchSlovakPolishItalianRomanianFinnishSpanishPortugueseBritish EnglishDutchBrazilian PortugueseBulgarian, and Chinese. See his website. Send him mail. Follow him on Twitter @PhilippBagus See Philipp Bagus’s article archives.

 

Gold: Not the Inflation-Hedge You Might Think

Gold: Not the Inflation-Hedge You Might Think.

Iwas in St. Kitts last week for the Liberty Forum conference, where I was a speaker. I also moderated a debate pitting Peter Schiff against Harry Dent on the inflation-deflation question.

Things got really hot. There was some yelling, and at one point, Harry stood up and tossed his mic in frustration. I thought they might go at it.

I want to tell you about this debate…

Peter Schiff is the chief strategist at the brokerage firm Euro Pacific. He has a radio show and has written some books. He’s probably most known as calling for a collapse in the dollar and being generally bearish on the U.S. economy.

Harry Dent is also a well-known financial commentator. He writes a newsletter and is author of several books. He’s probably most famous for his predictions based on demographics. He’s also a vocal deflationist.

Inflation here means generally rising prices. Deflation means prices are generally falling. There are other consequences associated with each. For example, Peter believes interest rates will rise. Harry thinks they will fall. Peter thinks the dollar will lose value, Harry thinks not.

Peter’s argument essentially was that the Fed is printing a lot of money and would continue to do so. Hence, inflation.

Harry’s argument was that the debt deflation dynamics were the more powerful force. The economy has to delever, and as debts are repaid or written off, that process destroys money, more than offsetting the printing press.

They touched on a lot of other things in the course of the debate — past hyperinflations, China’s role and more.

The debate started out calmly enough, but after about 20 minutes, they really starting going at it.

Harry won the debate, in my view. He had a good command of the facts and presented them well. I had also watched the presentations of both before the debate. Harry had marshaled an impressive array of evidence and made a good argument.

My respect for Harry went up. For whatever reason, I had thought of him as a bit of a quack, but he has done a lot of good work on this stuff.

Before 2008, I was solidly in the inflationist camp. But think about what’s happened since 2008. If I told you back then that the Fed’s balance sheet would balloon fivefold — creating lots of money — what would you have guessed the world would look like in 2013?

Wouldn’t you be surprised to see the 10-year Treasury note pay just 2.8%? Wouldn’t you be surprised to find gold languishing at $1,235 an ounce? The inflationist view had interest rates and gold higher — not lower.

So something is clearly not right with the “Fed’s printing money and we’re going to have inflation” argument. At some point, you have to re-evaluate the way you look at the world. Or you just sit content to be wrong. In financial markets, that can be costly.

In this light, I appreciated Harry’s efforts, as his framework was the more challenging one to believe, but it has unquestionably been a better predictor of what’s happened post-2008.

Even in the course of this debate, though, it struck me how many assumptions get passed off as givens.

For example: Commodities will protect you in times of high inflation.

Well, they don’t have a history of doing that.

As James Montier of GMO points out in his most recent research note:

“Commodities are often seen as an inflation hedge; however, this is almost entirely due to the experience of the 1970s and the creation of OPEC, and the domination of energy in the generally used commodity indexes. If you had held the ‘wrong’ commodities, their inflation hedging performance would have looked very different (witness copper and grain).”

Here is the chart:

Copper and Corn Prices vs. Oil Prices, 1970-1982

So during the highly inflationary 1970s, oil was a great investment, but copper and corn were terrible. Commodities generally have lost value over the last century at the rate of almost 2% annually, according to GMO. Yet I see it repeated again and again by various advisers telling their clients/readers to own commodities to protect against inflation.

The same is true of gold.

Here is Montier again:

“Gold is often held up as an inflation hedge. However, the data provide a challenge to this view. [The next chart] shows the decade-by-decade average inflation rate, and the real return to holding gold over the same decade. It doesn’t make pretty viewing for those who believe gold is an inflation hedge. That perception is down to one decade (the 1970s) when it held that inflation and gold were positively correlated. The rest of the time there isn’t a good relationship between gold and inflation.”

And here is the chart:

Gold's Record During Inflation

Yet people repeat — on faith, I guess — that gold will protect them during inflation. The record of gold on this front is spotty. It might. It might not.

Montier’s paper, by the way, concludes that there aren’t any good inflation hedges in the short term. But over the long term, stocks and real estate are good inflation hedges. (He says the best is TIPS — Treasury inflation-protected securities.) In fact, Montier shows that even in countries that have suffered high inflation (or evenhyperinflation) in the 20th century — such as Germany and Italy — stocks still delivered positive real returns. And real estate value correlates with replacement costs, which rise during inflationary times.

After the debate, I sat on a panel with several other speakers. Asked if we’d have inflation or deflation, my first answer was an honest one: “I don’t know.” Forced to guess, I think we have deflation first, inflation later.

In general, the long-term way to bet is that the U.S. dollar in your pocket will buy less tomorrow than today.

Even Harry’s own presentation had a chart that makes it hard to argue any other way:

The Value of the U.S. Dollar, 1900-2010

It is true the dollar can do something different for years at a time. (I mean, look at the 1930s.) But as a long-term investor, I’d rather own businesses or real estate than cash. Then again, I’d rather own cash-spinning businesses and real estate than commodities or gold.

Whatever you do, though, don’t let an old assumption pass uncontested. If you think there’s going to be inflation, you could at least be in the right things. And keep an open mind as to what may happen in 2014. The only certain thing about investing is that there are no certainties. That was my main takeaway from the fiery debate in St. Kitts.

Sincerely,

Chris Mayer
for The Daily Reckoning

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Does the Fed Favor Any Group in Particular? Mark Spitznagel vs. Paul Krugman

Does the Fed Favor Any Group in Particular? Mark Spitznagel vs. Paul Krugman.

Kicking off this Economic Farce Royale… we have Mark Spitznagel explaining why the Fed is the root of all evil… or at least the source of the so-call “wealth gap”. We’ve sprinkled our own comments throughout to keep it lively and (God help us) not too serious.

OK. Round one, *ding, ding*…


Mark Spitznagel

Amajor issue is the growing disparity between rich and poor, the 1% versus the 99%. While the president’s solutions differ from Republicans, they both ignore a principal source of this growing disparity.

The source is not runaway entrepreneurial capitalism, which rewards those who best serve the consumer in product and price. (Would we really want it any other way?) There is another force that has turned a natural divide into a chasm… dun, dun, dun… the Federal Reserve. The relentless expansion of credit by the Fed creates artificial disparities based on political privilege and economic power.

[Go figure…]

David Hume, the 18th-century Scottish philosopher, pointed out that when money is inserted into the economy (from a government printing press or, as in Hume’s time, the importation of gold and silver), it is not distributed evenly but “confined to the coffers of a few persons, who immediately seek to employ it to advantage.”

[Well, yeah…]

In the 20th century, the economists of the Austrian school built upon this fact as their central monetary tenet. Ludwig von Mises and his students showed that an increase in money supply is beneficial to those who get it first and is detrimental to those who get it last. Monetary inflation is a process, not a static effect. To think of it only in terms of aggregate price levels (I’m looking at you Ben Bernanke) is to ignore this pernicious process and the imbalance and economic dislocation that it creates.

As Mises protégé Murray Rothbard explained, monetary inflation is akin to counterfeiting, which necessitates that some benefit and others don’t. After all, if everyone counterfeited in proportion to their wealth, there would be no real economic benefit to anyone. Similarly, the expansion of credit is uneven in the economy, which results in wealth redistribution. To borrow a visual from another Mises student, Friedrich von Hayek, the Fed’s money creation does not flow evenly like water into a tank, but rather oozes like honey into a saucer, dolloping one area first and only then very slowly dribbling to the rest.

The Fed doesn’t expand the money supply by uniformly dropping cash from helicopters over the hapless masses. Rather, it directs capital transfers to the largest banks (whether by overpaying them for their financial assets or by lending to them on the cheap), minimizes their borrowing costs, and lowers their reserve requirements. All of these actions result in immediate handouts to the financial elite first, with the hope that they will subsequently unleash this fresh capital onto the unsuspecting markets, raising demand and prices wherever they do.

The Fed, having gone on an unprecedented credit expansion spree, has benefited the recipients who were first in line at the trough: banks (imagine borrowing for free and then buying up assets that you know the Fed is aggressively buying with you) and those favored entities and individuals deemed most creditworthy. Flush with capital, these recipients have proceeded to bid up the prices of assets and resources, while everyone else has watched their purchasing power decline.

At some point, of course, the honey flow stops—but not before much malinvestment. Such malinvestment is precisely what we saw in the historic 1990s equity and subsequent real-estate bubbles (and what we’re likely seeing again today in overheated credit and equity markets), culminating in painful liquidation.

The Fed is transferring immense wealth from the middle class to the most affluent, from the least privileged to the most privileged. This coercive redistribution has been a far more egregious source of disparity than the president’s presumption of tax unfairness (if there is anything unfair about approximately half of a population paying zero income taxes) or deregulation.

Pitting economic classes against each other is a divisive tactic that benefits no one. Yet if there is any upside, it is perhaps a closer examination of the true causes of the problem. Before we start down the path of arguing about the merits of redistributing wealth to benefit the many, why not first stop redistributing it to the most privileged?

Ooh… Them fightin’ words. OK, we turn to *ahem* America’s leading economist, nobel laureate and pointy head, Paul Krugman. He’ll now take himself too seriously and give us his academic rebuttal. We took a few editorial liberties so you wouldn’t fall asleep…

Round two, *ding, ding*…


Paul KrugmanI’ll be the first to admit that these past few years have been lean times in many respects — but they’ve been boom years for agonizingly dumb, pound-your-head-on-the-table economic fallacies. The latest fad — illustrated by what Mark Spitznagel just wrote above [ouch] — is that expansionary monetary policy is a giveaway to banks and plutocrats generally.

Indeed, his screed actually claims that the whole 1 versus 99 thing should really be about reining in or maybe abolishing the Fed. (Hah… Could you imagine that!) Unfortunately, and I’m sorry for this backhanded compliment, some pretty smart people have bought into at least some version of this dumb story.

What’s wrong with the idea that running the printing presses is a giveaway to plutocrats? Let me count the ways!

First, the situation is utterly the reverse of what Spitznagel claimed. Quantitative easing isn’t being imposed on an unwitting populace by financiers and rentiers; it’s being undertaken, to the extent that it is, over howls of protest from the financial industry. I mean, c’mon! Where are the editorials demanding that the Fed raise its inflation target, right?!

[Crickets…]

Uhh… Beyond that, let’s talk about the economics.

The deliberately misleading… er I mean, naive, version of Fed policy Spitznagel made is that Ben Bernanke is “giving money” to the banks. What it actually does, of course, is buy stuff from the banks, usually short-term government debt but nowadays sometimes other stuff with money that didn’t exist before. But, seriously, it’s not a gift.

To claim that it’s a gift you have to claim that the prices the Fed is paying are artificially high, or equivalently that interest rates are being pushed artificially low. And you do in fact see assertions to that effect all the time. But if you think about it for even a minute, that claim is truly bizarre.

I mean, what is the un-artificial, or if you prefer, “natural” rate of interest? As it turns out, there is actually a standard definition of the natural rate of interest and it’s basically defined on a PPE basis (that’s for proof of the pudding is in the eating). Roughly, the natural rate of interest is something, kind of like the rate that would lead to stable inflation at more or less full employment.

[Uh-huh…]

And we have low inflation with high unemployment, strongly suggesting that the natural rate of interest is below current levels, and that the key problem is the zero lower bound which keeps us from getting there. Under these circumstances, expansionary Fed policy isn’t some kind of giveway to the banks, it’s just a giveaway to the banks that the economy needs.

Furthermore, Fed efforts to do this probably tend on average to hurt, not help, bankers. Yes, I just wrote that with a straight face. Banks are largely in the business of borrowing short and lending long; anything that compresses the spread between short rates and long rates is likely to be bad for their profits. And the things the Fed is trying to do are in fact largely about compressing that spread, either by persuading investors that it will keep short rates at zero for a longer time or by going out and buying long-term assets. These are actions you would expect to make bankers angry, not happy — and that’s what has actually happened.

How, exactly, does expansionary monetary policy hurt the 99 percent? Think of all the people living on fixed incomes, we’re told. But who are these people? I know the picture: retirees living on the interest on their bank account and their fixed pension check — and there are no doubt some people fitting that description. But there aren’t many of them, which makes it ok.

No, the real victims of expansionary monetary policies are the very people who the current mythology says are pushing these policies. And that, I guess, explains why we’re hearing the opposite.

The typical retired American these days relies largely on Social Security — which is indexed against inflation. He or she may get some interest income from bank deposits, but not much: ordinary Americans have fewer financial assets than the elite can easily imagine. And as for pensions: yes, some people have defined-benefit pension plans that aren’t indexed for inflation. But that’s a dwindling minority — which again means it’s perfectly ok — and I assume the effect of, say, 1 or 2 percent higher inflation isn’t going to be enormous even for this minority.

What’s the takeaway? That unless you’re going to go stumping for policy on capitol hill (in which case, there’s no hope for you) you should focus on actionable steps you can take to increase your wealth… instead of engaging in groupthink. As for the policy debate…well, it’s always good for a laugh.

Regards,

The Daily Reckoning

Ed. Note: Whether you’re on a fixed income or not, there are ways you can safeguard and even grow your wealth, regardless of where you stand on the issue debated above. Today’s Daily Reckoning email edition gave readers a chance to get in on a one-time live event that will help them do just that. Didn’t see that offer? Not to worry… The Daily Reckoning will be back tomorrow with another opportunity for you to take advantage of. Be sure you don’t miss that one too. Sign up for the FREE Daily Reckoning email edition, right here.

 

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