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Submitted by Peter Schiff via Euro Pacific Capital,
Dedicated readers of The Wall Street Journal have recently been offered many dire warnings about a clear and present danger that is stalking the global economy. They are not referring to a possible looming stock or real estate bubble (which you can find more on in my latest newsletter). Nor are they talking about other usual suspects such as global warming, peak oil, the Arab Spring, sovereign defaults, the breakup of the euro, Miley Cyrus, a nuclear Iran, or Obamacare. Instead they are warning about the horror that could result from falling prices, otherwise known as deflation. Get the kids into the basement Mom… they just marked down Cheerios!
In order to justify our current monetary and fiscal policies, in which governments refuse to reign in runaway deficits while central banks furiously expand the money supply, economists must convince us that inflation, which results in rising prices, is vital for economic growth.
Simultaneously they make the case that falling prices are bad. This is a difficult proposition to make because most people have long suspected that inflation is a sign of economic distress and that high prices qualify as a problem not a solution. But the absurdity of the position has not stopped our top economists, and their acolytes in the media, from making the case.
A January 5th article in The Wall Street Journal described the economic situation in Europe by saying “Anxieties are rising in the euro zone that deflation-the phenomenon of persistent falling prices across the economy that blighted the lives of millions in the 1930s-may be starting to take root as it did in Japan in the mid-1990s.” Really, blighted the lives of millions? When was the last time you were “blighted” by a store’s mark down? If you own a business, are you “blighted” when your suppliers drop their prices? Read more about Europe’s economy in my latest newsletter.
The Journal is advancing a classic “wet sidewalks cause rain” argument, confusing and inverting cause and effect. It suggests that falling prices caused the Great Depression and in turn the widespread consumer suffering that went along with it. But this puts the cart way in front of the horse. The Great Depression was triggered by the bursting of a speculative bubble (resulted from too much easy money in the latter half of the 1920s). The resulting economic contraction, prolonged unnecessarily by the anti-market policies of Hoover and Roosevelt, was part of a necessary re-balancing.A bad economy encourages people to reduce current consumption and save for the future. The resulting drop in demand brings down prices.
But lower prices function as a counterweight to a contracting economy by cushioning the blow of the downturn. I would argue that those who lived through the Great Depression were grateful that they were able to buy more with what little money they had. Imagine how much worse it would have been if they had to contend with rising consumer prices as well. Consumers always want to buy, but sometimes they forego or defer purchases because they can’t afford a desired good or service. Higher prices will only compound the problem. It may surprise many Nobel Prize-winning economists, but discounts often motivate consumers to buy – -try the experiment yourself the next time you walk past the sale rack.
Economists will argue that expectations for future prices are a much bigger motivation than current prices themselves. But those economists concerned with deflation expect there to be, at most, a one or two percent decrease in prices. Can consumers be expected not to buy something today because they expect it to be one percent cheaper in a year? Bear in mind that something that a consumer can buy and use today is more valuable to the purchaser than the same item that is not bought until next year. The costs of going without a desired purchase are overlooked by those warning about the danger of deflation
In another article two days later, the Journal hit readers with the same message: “Annual euro-zone inflation weakened further below the European Central Bank’s target in December, rekindling fears that too little inflation or outright consumer-price declines may threaten the currency area’s fragile economy.” In this case, the paper adds “too little inflation” to the list of woes that needs to be avoided. Apparently, if prices don’t rise briskly enough, the wheels of an economy stop turning
Neither article mentions some very important historical context. For the first 120 years of the existence of the United States (before the establishment of the Federal Reserve), general prices trended downward. According to the Department of Commerce’s Statistical Abstract of the United States, the “General Price Index” declined by 19% from 1801 to 1900. This stands in contrast to the 2,280% increase of the CPI between 1913 and 2013
While the 19th century had plenty of well-documented ups and downs, people tend to forget that the country experienced tremendous economic growth during that time. Living standards for the average American at the end of the century were leaps and bounds higher than they were at the beginning. The 19th Century turned a formerly inconsequential agricultural nation into the richest, most productive, and economically dynamic nation on Earth. Immigrants could not come here fast enough. But all this happened against a backdrop of consistently falling prices.
Thomas Edison once said that his goal was to make electricity so cheap that only the rich would burn candles. He was fortunate to have no Nobel economists on his marketing team.They certainly would have advised him to raise prices to increase sales. But Edison’s strategy of driving sales volume through lower prices is clearly visible today in industries all over the world. By lowering prices, companies not only grow their customer base, but they tend to increase profits as well. Most visibly, consumer electronics has seen chronic deflation for years without crimping demand or hurting profits. According to the Wall Street Journal, this should be impossible.
The truth is the media is merely helping the government to spread propaganda. It is highly indebted governments that need inflation, not consumers. But before government can lead a self-serving crusade to create inflation, they must first convince the public that higher prices is a goal worth pursuing. Since inflation also helps sustain asset bubbles and prop up banks, in this instance The Wall Street Journal and the Government seem to be perfectly aligned.
Despite Erdogan’s paranoia over “an interest rate” lobby or blaming the Lira’s collapse on the Fed, as Gavekal’s Nick Andrews notes, Turkey is showing no signs of stabilization. As the sell-side scrambles to explain how this is all priced in and “contained,” it is very apparent from the following chart just how vulnerable to contagion the world is if Turkey defaults. The country’s liabilities have multipled dramatically in recent years with over $350 billion of foreign bank exposure to Turkey on an ultimate risk basis.
Fragile and Complacent… (and in denial)
Gavekal notes – Turkey is not, however, showing any signs of stabilization. The lira continues to fall, and policymakers are doing little to contain the situation.
With soaring inflation, a plunging currency and a run for the exits, one would think Turkey would do what other emerging markets did during last year’s taper tantrum, and hike rates.
Instead the new economy minister said recently that this is not necessary, since the country is in tip-top shape. “We couldn’t create an economic crisis in Turkey even if we wanted to, it’s that strong,” said the minister, whose predecessor was purged in the recent corruption scandal.
Turkey has some uniquely bad problems…
Not only is its current account deficit at nearly 8% of GDP – the highest in the MSCI’s emerging markets universe—but the country is also geographically closer and thus more dependent on the eurozone, whose economic recovery is painfully slow. Its political situation is also clearly very unstable.
Still, as the chart below shows, the country’s liabilities have multiplied in recent years – adding to global contagion pressures if Turkey defaults.
Indeed, already fragile Greece is particularly exposed to the Eurasian republic. Turkish credit as a proportion of total Greek bank assets stands at over 5%, compared to 0.7% for the next two largest (Dutch and UK banks).
As Gavekal notes though – Europe’s exposure would likely be mitigated by the European Central Bank with their now standard response of pumping excess liquidity into the euro system to ensure no bank runs out of cash. This might explain why the peripheral eurozone countries are not suffering more fallout from Greece’s exposure to Turkey.
However, with the new template in place, depositors in Europe’s banks exposed to Turkey may well prefer to pull their cash than trust their will be no haircuts for ECB aid…
Paul Craig Roberts and Dave Kranzler
The deregulation of the financial system during the Clinton and George W. Bush regimes had the predictable result: financial concentration and reckless behavior. A handful of banks grew so large that financial authorities declared them “too big to fail.” Removed from market discipline, the banks became wards of the government requiring massive creation of new money by the Federal Reserve in order to support through the policy of Quantitative Easing the prices of financial instruments on the banks’ balance sheets and in order to finance at low interest rates trillion dollar federal budget deficits associated with the long recession caused by the financial crisis.
The Fed’s policy of monetizing one trillion dollars of bonds annually put pressure on the US dollar, the value of which declined in terms of gold. When gold hit $1,900 per ounce in 2011, the Federal Reserve realized that $2,000 per ounce could have a psychological impact that would spread into the dollar’s exchange rate with other currencies, resulting in a run on the dollar as both foreign and domestic holders sold dollars to avoid the fall in value. Once this realization hit, the manipulation of the gold price moved beyond central bank leasing of gold to bullion dealers in order to create an artificial market supply to absorb demand that otherwise would have pushed gold prices higher.
The evidence of gold price manipulation is clear. In this article we present evidence and describe the process. We conclude that ability to manipulate the gold price is disappearing as physical gold moves from New York and London to Asia, leaving the West with paper claims to gold that greatly exceed the available supply.
The primary venue of the Fed’s manipulation activity is the New York Comex exchange, where the world trades gold futures. Each gold futures contract represents one gold 100 ounce bar. The Comex is referred to as a paper gold exchange because of the use of these futures contracts. Although several large global banks are trading members of the Comex, JP Morgan, HSBC and Bank Nova Scotia conduct the majority of the trading volume. Trading of gold (and silver) futures occurs in an auction-style market on the floor of the Comex daily from 8:20 a.m. to 1:30 p.m. New York time. Comex futures trading also occurs on what is known as Globex. Globex is a computerized trading system used for derivatives, currency and futures contracts. It operates continuously except on weekends. Anyone anywhere in the world with access to a computer-based futures trading platform has access to the Globex system.
In addition to the Comex, the Fed also engages in manipulating the price of gold on the far bigger–in terms of total dollar value of trading–London gold market. This market is called the LBMA (London Bullion Marketing Association) market. It is comprised of several large banks who are LMBA market makers known as “bullion banks” (Barclays, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorganChase, Merrill Lynch/Bank of America, Mitsui, Societe Generale, Bank of Nova Scotia and UBS). Whereas the Comex is a “paper gold” exchange, the LBMA is the nexus of global physical gold trading and has been for centuries. When large buyers like Central Banks, big investment funds or wealthy private investors want to buy or sell a large amount of physical gold, they do this on the LBMA market.
The Fed’s gold manipulation operation involves exerting forceful downward pressure on the price of gold by selling a massive amount of Comex gold futures, which are dropped like bombs either on the Comex floor during NY trading hours or via the Globex system. A recent example of this occurred on Monday, January 6, 2014. After rallying over $15 in the Asian and European markets, the price of gold suddenly plunged $35 at 10:14 a.m. In a space of less than 60 seconds, more than 12,000 contracts traded – equal to more than 10% of the day’s entire volume during the 23 hour trading period in which which gold futures trade. There was no apparent news or market event that would have triggered the sudden massive increase in Comex futures selling which caused the sudden steep drop in the price of gold. At the same time, no other securities market (other than silver) experienced any unusual price or volume movement. 12,000 contracts represents 1.2 million ounces of gold, an amount that exceeds by a factor of three the total amount of gold in Comex vaults that could be delivered to the buyers of these contracts.
This manipulation by the Fed involves the short-selling of uncovered Comex gold futures. “Uncovered” means that these are contracts that are sold without any underlying physical gold to deliver if the buyer on the other side decides to ask for delivery. This is also known as “naked short selling.” The execution of the manipulative trading is conducted through one of the major gold futures trading banks, such as JPMorganChase, HSBC, and Bank of Nova Scotia. These banks do the actual selling on behalf of the Fed. The manner in which the Fed dumps a large quantity of futures contracts into the market differs from the way in which a bona fide trader looking to sell a big position would operate. The latter would try to work off his position carefully over an extended period of time with the goal of trying to disguise his selling and to disturb the price as little as possible in order to maximize profits or minimize losses. In contrast, the Fed‘s sales telegraph the intent to drive the price lower with no regard for preserving profits or fear or incurring losses, because the goal is to inflict as much damage as possible on the price and intimidate potential buyers.
The Fed also actively manipulates gold via the Globex system. The Globex market is punctuated with periods of “quiet” time in which the trade volume is very low. It is during these periods that the Fed has its agent banks bombard the market with massive quantities of gold futures over a very brief period of time for the purpose of driving the price lower. The banks know that there are very few buyers around during these time periods to absorb the selling. This drives the price lower than if the selling operation occurred when the market is more active.
A primary example of this type of intervention occurred on December 18, 2013, immediately after the FOMC announced its decision to reduce bond purchases by $10 billion monthly beginning in January 2014. With the rest of the trading world closed, including the actual Comex floor trading, a massive amount of Comex gold futures were sold on the Globex computer trading system during one of its least active periods. This selling pushed the price of gold down $23 dollars in the space of two hours. The next wave of futures selling occurred in the overnight period starting at 2:30 a.m. NY time on December 19th. This time of day is one of the least active trading periods during any 23 hour trading day (there’s one hour when gold futures stop trading altogether). Over 4900 gold contracts representing 14.5 tonnes of gold were dumped into the Globex system in a 2-minute period from 2:40-2:41 a.m, resulting in a $24 decline in the price of gold. This wasn’t the end of the selling. Shortly after the Comex floor opened later that morning, another 1,654 contracts were sold followed shortly after by another 2,295 contracts. This represented another 12.2 tonnes of gold. Then at 10:00 a.m. EST, another 2,530 contracts were unloaded on the market followed by an additional 3,482 contracts just six minutes later. These sales represented another 18.7 tonnes of gold.
All together, in 6 minutes during an eight hour period, a total amount of 37.6 tonnes (a “tonne” is a metric ton–about 10% more weight than a US ”ton”) of gold future contracts were sold. The contracts sold during these 6 minutes accounted for 10% of the total volume during that 23 hours period of time. Four-tenths of one percent of the trading day accounted for 10% of the total volume. The gold represented by the futures contracts that were sold during these 6 minutes was a multiple of the amount of physical gold available to Comex for delivery.
The purpose of driving the price of gold down was to prevent the announced reduction in bond purchases (the so-called tapering) from sending the dollar, stock and bond markets down. The markets understand that the liquidity that Quantitative Easing provides is the reason for the high bond and stock prices and understand also that the gains from the rising stock market discourage gold purchases. Previously when the Fed had mentioned that it might reduce bond purchases, the stock market fell and bonds sold off. To neutralize the market scare, the Fed manipulated both gold and stock markets. (See Pam Martens for explanation of the manipulation of the stock market:http://wallstreetonparade.com/2013/12/why-didn’t-the-stock-market-sell-off-on-the-fed’s-taper-announcement/ )
While the manipulation of the gold market has been occurring since the start of the bull market in gold in late 2000, this pattern of rampant manipulative short-selling of futures contracts has been occurring on a more intense basis over the last 2 years, during gold’s price decline from a high of $1900 in September 2011. The attack on gold’s price typically will occur during one of several key points in time during the 23 hour Globex trading period. The most common is right at the open of Comex gold futures trading, which is 8:20 a.m. New York time. To set the tone of trading, the price of gold is usually knocked down when the Comex opens. Here are the other most common times when gold futures are sold during illiquid Globex system time periods:
– 6:00 p.m NY time weekdays, when the Globex system re-opens after closing for an hour;
– 6:00 p.m. Sunday evening NY time when Globex opens for the week;
– 2:30 a.m. NY time, when Shanghai Gold Exchange closes
– 4:00 a.m. NY time, just after the morning gold “fix” on the London gold market (LBMA);
– 2:00 p.m. NY time any day but especially on Friday, after the Comex floor trading has closed – it’s an illiquid Globex-only session and the rest of the world is still closed.
In addition to selling futures contracts on the Comex exchange in order to drive the price of gold lower, the Fed and its agent bullion banks also intermittently sell large quantities of physical gold in London’s LBMA gold market. The process of buying and selling actual physical gold is more cumbersome and complicated than trading futures contracts. When a large supply of physical gold hits the London market all at once, it forces the market a lot lower than an equivalent amount of futures contracts would. As the availability of large amounts of physical gold is limited, these “physical gold drops” are used carefully and selectively and at times when the intended effect on the market will be most effective.
The primary purpose for short-selling futures contracts on Comex is to protect the dollar’s value from the growing supply of dollars created by the Fed’s policy of Quantitative Easing. The Fed’s use of gold leasing to supply gold to the market in order to reduce the rate of rise in the gold price has drained the Fed’s gold holdings and is creating a shortage in physical gold. Historically most big buyers would leave their gold for safe-keeping in the vaults of the Fed, Bank of England or private bullion banks rather than incur the cost of moving gold to local depositories. However, large purchasers of gold, such as China, now require actual delivery of the gold they buy.
Demands for gold delivery have forced the use of extraordinary and apparently illegal tactics in order to obtain physical gold to settle futures contracts that demand delivery and to be able to deliver bullion purchased on the London market (LBMA). Gold for delivery is obtained from opaque Central Bank gold leasing transactions, from “borrowing” client gold held by the bullion banks like JP Morgan in their LBMA custodial vaults, and by looting the gold trusts, such as GLD, of their gold holdings by purchasing large blocks of shares and redeeming the shares for gold.
Central Bank gold leasing occurs when Central Banks take physical gold they hold in custody and lease it to bullion banks. The banks sell the gold on the London physical gold market. The gold leasing transaction makes available physical gold that can be delivered to buyers in quantities that would not be available at existing prices. The use of gold leasing to manipulate the price of gold became a prevalent practice in the 1990s. While Central Banks admit to engaging in gold lease transactions, they do not admit to its purpose, which is to moderate rises in the price of gold, although Fed Chairman Alan Greenspan did admit during Congressional testimony on derivatives in 1998 that “Central banks stand ready to lease gold in increasing quantities should the price rise.”
Another method of obtaining bullion for sale or delivery is known as “rehypothecation.” Rehypothecation occurs when a bank or brokerage firm “borrows” client assets being held in custody by banks. Technically, bank/brokerage firm clients sign an agreement when they open an account in which the assets in the account might be pledged for loans, like margin loans. But the banks then take pledged assets and use them for their own purpose rather than the client’s. This is rehypothecation. Although Central Banks fully disclose the practice of leasing gold, banks/brokers do not publicly disclose the details of their rehypothecation activities.
Over the course of the 13-year gold bull market, gold leasing and rehypothecation operations have largely depleted most of the gold in the vaults of the Federal Reserve, Bank of England, European Central Bank and private bullion banks such as JPMorganChase. The depletion of vault gold became a problem when Venezuela was the first country to repatriate all of its gold being held by foreign Central Banks, primarily the Fed and the BOE. Venezuela’s request was provoked by rumors circulating the market that gold was being leased and hypothecated in increasing quantities. About a year later, Germany made a similar request. The Fed refused to honor Germany’s request and, instead, negotiated a seven year timeline in which it would ship back 300 of Germany’s 1500 tonnes. This made it apparent that the Fed did not have the gold it was supposed to be holding for Germany.
Why does the Fed need seven years in which to return 20 percent of Germany’s gold? The answer is that the Fed does not have the gold in its vault to deliver. In 2011 it took four months to return Venezuela’s 160 tonnes of gold. Obviously, the gold was not readily at hand and had to be borrowed, perhaps from unsuspecting private owners who mistakenly believe that their gold is held in trust.
Western central banks have pushed fractional gold reserve banking to the point that they haven’t enough reserves to cover withdrawals. Fractional reserve banking originated when medieval goldsmiths learned that owners of gold stored in their vault seldom withdrew the gold. Instead, those who had gold on deposit circulated paper claims to gold. This allowed goldsmiths to lend gold that they did not have by issuing paper receipts. This is what the Fed has done. The Fed has created paper claims to gold that does not exist in physical form and sold these claims in mass quantities in order to drive down the gold price. The paper claims to gold are a large multiple of the amount of actual gold available for delivery. The Royal Bank of India reports that the ratio of paper claims to gold exceed the amount of gold available for delivery by 93:1.
Fractional reserve systems break down when too many depositors or holders of paper claims present them for delivery. Breakdown is occurring in the Fed’s fractional bullion operation. In the last few years the Asian markets–specifically and especially the Chinese–are demanding actual physical delivery of the bullion they buy. This has created a sense of urgency among the Fed, Treasury and the bullion banks to utilize any means possible to flush out as many weak holders of gold as possible with orchestrated price declines in order to acquire physical gold that can be delivered to Asian buyers.
The $650 decline in the price of gold since it hit $1900 in September 2011 is the result of a manipulative effort designed both to protect the dollar from Quantitative Easing and to free up enough gold to satisfy Asian demands for delivery of gold purchases.
Around the time of the substantial drop in gold’s price in April, 2013, the Bank of England’s public records showed a 1300 tonne decline in the amount of gold being held in the BOE bullion vaults. This is a fact that has not been denied or reasonably explained by BOE officials despite several published inquiries. This is gold that was being held in custody but not owned by the Bank of England. The truth is that the 1300 tonnes is gold that was required to satisfy delivery demands from the large Asian buyers. It is one thing for the Fed or BOE to sell, lease or rehypothecate gold out of their vault that is being safe-kept knowing the entitled owner likely won’t ask for it anytime soon, but it is another thing altogether to default on a gold delivery to Asians demanding delivery.
Default on delivery of purchased gold would terminate the Federal Reserve’s ability to manipulate the gold price. The entire world would realize that the demand for gold greatly exceeds the supply, and the price of gold would explode upwards. The Federal Reserve would lose control and would have to abandon Quantitative Easing. Otherwise, the exchange value of the US dollar would collapse, bringing to an end US financial hegemony over the world.
Last April, the major takedown in the gold price began with Goldman Sachs issuing a “technical analysis” report with an $850 price target (gold was around $1650 at that time). Goldman Sachs also broadcast to every major brokerage firm and hedge fund in New York that gold was going to drop hard in price and urged brokers to get their clients out of all physical gold holdings and/or shares in physical gold trusts like GLD or CEF. GLD and CEF are trusts that purchase physical gold/silver bullion and issue shares that represent claims on the bullion holdings. The shares are marketed as investments in gold, but represent claims that can only be redeemed in very large blocks of shares, such as 100,000, and perhaps only by bullion banks. GLD is the largest gold ETF (exchange traded firm), but not the only one. The purpose of Goldman Sachs’ announcement was to spur gold sales that would magnify the price effect of the short-selling of futures contracts. Heavy selling of futures contracts drove down the gold price and forced sales of GLD and other ETF shares, which were bought up by the bullion banks and redeemed for gold.
At the beginning of 2013, GLD held 1350 tonnes of gold. By April 12th, when the heavy intervention operation began, GLD held 1,154 tonnes. After the series of successive raids in April, the removal of gold from GLD accelerated and currently there are 793 tonnes left in the trust. In a little more than one year, more than 41% of the gold bars held by GLD were removed – most of that after the mid-April intervention operation.
In addition, the Bank of England made its gold available for purchase by the bullion banks in order to add to the ability to deliver gold to Asian purchasers.
The financial media, which is used to discredit gold as a safe haven from the printing of fiat currencies, claims that the decline in GLD’s physical gold is an indication that the public is rejecting gold as an investment. In fact, the manipulation of the gold price downward is being done systematically in order to coerce holders of GLD to unload their shares. This enables the bullion banks to accumulate the amount of shares required to redeem gold from the GLD Trust and ship that gold to Asia in order to meet the enormous delivery demands. For example, in the event described above on January 6th, 14% of GLD’s total volume for the day traded in a 1-minute period starting at 10:14 a.m. The total volume on the day for GLD was almost 35% higher than the average trading volume in GLD over the previous ten trading days.
Before 2013, the amount of gold in the GLD vault was one of the largest stockpiles of gold in the world. The swift decline in GLD’s gold inventory is the most glaring indicator of the growing shortage of physical gold supply that can be delivered to the Asian market and other large physical gold buyers. The more the price of gold is driven down in the Western paper gold market, the higher the demand for physical bullion in Asian markets. In addition, several smaller physical gold ETFs have experienced substantial gold withdrawals. Including the more than 100 tonnes of gold that has disappeared from the Comex vaults in the last year, well over 1,000 tonnes of gold has been removed from the various ETFs and bank custodial vaults in the last year. Furthermore, there is no telling how much gold that is kept in bullion bank private vaults on behalf of wealthy investors has been rehypothecated. All of this gold was removed in order to avoid defaulting on delivery demands being imposed by Asian commercial, investment and sovereign gold buyers.
The Federal Reserve seems to be trapped. The Fed is creating approximately 1,000 billion new US dollars annually in order to support the prices of debt related derivatives on the books of the few banks that have been declared to be “to big to fail” and in order to finance the large federal budget deficit that is now too large to be financed by the recycling of Chinese and OPEC trade surpluses into US Treasury debt. The problem with Quantitative Easing is that the annual creation of an enormous supply of new dollars is raising questions among American and foreign holders of vast amounts of US dollar-denominated financial instruments. They see their dollar holdings being diluted by the creation of new dollars that are not the result of an increase in wealth or GDP and for which there is no demand.
Quantitative Easing is a threat to the dollar’s exchange value. The Federal Reserve, fearful that the falling value of the dollar in terms of gold would spread into the currency markets and depreciate the dollar, decided to employ more extreme methods of gold price manipulation.
When gold hit $1,900, the Federal Reserve panicked. The manipulation of the gold price became more intense. It became more imperative to drive down the price, but the lower price resulted in higher Asian demand for which scant supplies of gold were available to meet.
Having created more paper gold claims than there is gold to satisfy, the Fed has used its dependent bullion banks to loot the gold exchange traded funds (ETFs) of gold in order to avoid default on Asian deliveries. Default would collapse the fractional bullion system that allows the Fed to drive down the gold price and protect the dollar from QE.
What we are witnessing is our central bank pulling out all stops on integrity and lawfulness in order to serve a small handful of banks that financial deregulation allowed to become “too big to fail” at the expense of our economy and our currency. When the Fed runs out of gold to borrow, to rehypothecate, and to loot from ETFs, the Fed will have to abandon QE or the US dollar will collapse and with it Washington’s power to exercise hegemony over the world.
Dave Kranzler traded high yield bonds for Bankers Trust for a decade. As a co-founder and principal of Golden Returns Capital LLC, he manages the Precious Metals Opportunity Fund.
This article first appeared at Paul Craig Roberts’ new website Institute For Political Economy. Paul Craig Roberts was Assistant Secretary of the Treasury for Economic Policy and associate editor of the Wall Street Journal. He was columnist for Business Week, Scripps Howard News Service, and Creators Syndicate. He has had many university appointments. His Internet columns have attracted a worldwide following.
The European Central Bank is concerned that national differences in how bad debt is classified could cripple its probe into the health of euro-area banks, according to an internal ECB document.
Bad-debt classification practices across Europe show “material differences that, if not considered, would severely affect the consistency and credibility of the exercise,” according to the undated document obtained by Bloomberg News. A person familiar with the text said it was drawn up in late November and contains the ECB’s latest thinking on the subject. An ECB spokeswoman declined to comment.
The Frankfurt-based ECB is conducting a three-stage assessment of bank assets before it assumes oversight of about 130 lenders across the 18-member euro area this November. Using a strict definition of bad debt could threaten banks in countries hit hardest by Europe’s debt crisis, while a laxer rule may not reveal the true condition of the region’s financial system.
“A more ambitious definition would be consistent with the need to convey to external observers that the AQR is a thorough exercise,” the document said, referring to the Asset Quality Review stage of the Comprehensive Assessment. That’s set to culminate with a stress test run in cooperation with the European Banking Authority before October this year.
The ECB document said that not all countries may be able to comply with simplified definitions of non-performing loans set out in October by the London-based EBA, the EU’s top bank regulator, while saying that alignment to those rules is “of the essence.”
European banks’ bad loans are classified according to a variety of national rules, which makes a comparison among lenders difficult. The European Central Bank is struggling to harmonize the definition of non-performing loans so that it can give more credibility to its assessment of the credit quality of the region’s lenders.
In the first half of last year, total doubtful and non-performing loans as a proportion of lending calculated according to national rules exceeded 21 percent in Greece and were less than 1 percent in Sweden, ECB data show.
“It’s crucial to find common rules and a shared vision to overcome the national lobbies,” Karim Bertoni, a senior analyst on European equities at de Pury Pictet Turrettini & CIE SA in Geneva, said by telephone. “This is the main challenge for the ECB, which would allow a better management of banks and risk control.”
The ECB signaled it would apply the EBA’s simplified definition as a minimum, and where possible increase the level of detail on loans made by banks. The EBA sets financial standards for the 28 nations in the European Union, and is working with the ECB on the final part of the Comprehensive Assessment.
That minimum means the ECB would define as non-performing all exposures, including loans, debt securities, financial guarantees and other commitments, which are past due for more than 90 days. That differs from final, more complex, standards, due to be implemented by EBA by the end of this year, that include data on the likelihood of the borrower repaying. Only half of the countries examined could supply that data, according to the ECB report, while limiting the definition to the 90-day rule “seems feasible for the majority of countries.”
Euro-area lenders from Banco Santander SA (SAN) in Spain to Alpha Bank SA (ALPHA) in Greece will come under ECB supervision, with oversight forming the first pillar of a nascent banking union designed to mitigate future financial turmoil.
ECB policy makers have said the central bank will provide more information on the treatment of non-performing loans and the parameters of the concluding stress test by the end of January.
While the simplified EBA rules should be adhered to in the Comprehensive Assessment as a minimum, adding further detail to the assessment could be possible since ECB officials will already be in contact with bank staff, the document said.
“Given the possibility to perform more granular analysis during the on-site visits, it is proposed that this analysis takes into account a more ambitious definition including the unlikeliness to repay criterion,” according to the document.
The ECB said that as there are so many variations between countries on the definition of forbearance — where banks shift the terms of a loan to account for a change in the debtor’s own income — the only possibility is to accept national definitions where they exist, as well as loans that were considered in that category until the end of 2012 but have since been recategorized.
For countries where no standard definition exists, the ECB said it may ask states to report all loans for which concessions have been granted as forborne.
2013 was a year in which lots of imbalances built up but none blew up. The US and Japan continued to monetize their debt, in the process cheapening the dollar and sending the yen to five-year lows versus the euro. China allowed its debt to soar with only the hint of a (quickly-addressed) credit crunch at year-end. The big banks got even bigger, while reporting record profits and paying record fines for the crimes that produced those profits. And asset markets ranging from equities to high-end real estate to rare art took off into the stratosphere.
Virtually all of this felt great for the participants and led many to conclude that the world’s problems were being solved. Instead, 2014 is likely to be a year in which at least some – and maybe all – of the above trends hit a wall. It’s hard to know which will hit first, but a pretty good bet is that the strong euro (the flip side of a weakening dollar and yen) sends mismanaged countries like France and Italy back into crisis. So let’s start there.
The basic premise of the currency war theme is that when a country takes on too much debt it eventually realizes that the only way out of its dilemma is to cheapen its currency to gain a trade advantage and make its debts less burdensome. This works for a while but since the cheap-currency benefits come at the expense of trading partners, the latter eventually retaliate with inflation of their own, putting the first country back in its original box.
In 2013 the US and especially Japan cheapened their currencies versus the euro, which was supported by the European Central Bank’s relative reluctance to monetize the eurozone’s debt. The following chart shows the euro over the past six months:
For more details:
Euro rises to more than 2-year high vs. dollar; yen falls
The euro jumped to its strongest level against the dollar in more than two years on Friday as banks adjusted positions for the year end, while the yen hit five-year lows for a second straight session.
The dollar was broadly weaker against European currencies, including sterling and the Swiss franc. Thin liquidity likely helped exaggerate market moves.
The European Central Bank will take a snapshot of the capital positions of the region’s banks at the end of 2013 for an asset-quality review (AQR) next year to work out which of them will need fresh funds. The upcoming review has created some demand for euros to help shore up banks’ balance sheets, traders said.
“There’s a lot of attention on the AQR, and there’s some positioning ahead of the end of the calendar year,” said John Hardy, FX strategist at Danske Bank in Copenhagen.
Comments from Jens Weidmann, the Bundesbank chief and a member of the European Central Bank Governing Council, also helped the euro. He warned that although the euro zone’s current low interest rate is justified, weak inflation does not give a license for “arbitrary monetary easing.
The euro rose as high as $1.3892, according to Reuters data, the highest since October 2011. It was last up 0.3 percent at $1.3738.
The currency has risen more than 10 cents from a low hit in July below $1.28, as the euro zone economy came out of a recession triggered by its debt crisis.
Unlike the U.S. and Japanese central banks, the European Central Bank has not been actively expanding its balance sheet, giving an additional boost to the euro.
Here’s what a stronger euro means for France, the second-largest and arguably worst-managed eurozone country:
French Economy Contracts 0.1% In Third Quarter
The final estimate of France’s gross domestic product, or GDP, in the third quarter remained unchanged at the previous estimation of a contraction of 0.1 percent, indicating that the euro zone’s second-largest economy is struggling to sustain the rebound it witnessed in the second quarter with a growth of 0.6 percent.
The third-quarter GDP growth was in line with analysts’ estimates. According to data released on Tuesday by the National Institute of Statistics and Economic Studies, the deficit in foreign-trade balance contributed (-0.6 points) to the contraction in the third quarter, compared to the positive (0.1 percent) contribution made in the preceding quarter.
At the beginning of 2013, most of the eurozone was either still in recession or just barely climbing out. Then the euro started rising, making European products more expensive and therefore harder to sell, which depressed those countries’ export sectors and made debts more burdensome. So now, under the forced austerity of an appreciating currency, countries like France that were barely growing are back in contraction. And countries likeGreece that were flat on their back are now flirting with dissolution.
Recessions – especially never-ending recessions – are fatal for incumbent politicians, so pressure is building for a European version of Japan’s “Abenomics,” in which the European Central Bank is bullied into setting explicit inflation targets and monetizing as much debt as necessary to get there. The question is, will it happen before the downward momentum spawns political chaos that spreads to the rest of the world. See Italian President Warns of Violent Unrest in 2014.
MADRID (Reuters) – Spain’s Economy Minister said on Wednesday that job creation in 2014 would be “significant” as a tentative economic recovery kicks in, but a poll showed most Spaniards do not expect any clear improvement until 2015.
“2014 will see the net creation of jobs, higher even than we predicted in September in the budget, and the jobless rate will fall,” Luis de Guindos told Cadena Ser national radio, declining to put a number on expected jobs created.
Spain exited a recession in the third quarter of last year but the economy is still sickly and with unemployment officially predicted at 25.9 percent in 2014, roughly where it is now, there is little perception of a real recovery on the streets.
Separately on Wednesday, a poll of 1,000 people published in newspaper El Mundo showed that 71 percent of Spaniards believe the recovery and the end of the crisis will start in 2015 at the earliest.
The country is still reeling from a decade-long housing bubble which burst more than five years ago, forcing a 41-billion euro ($56 billion) bailout of the country’s banks, which were glutted with property debt.
The center-right government decreed a labor market reform in late December to encourage employers to take on more part-time workers and to simplify contracting in hopes of fuelling job creation.
“We believe the labor reform will make the market more dynamic … in 2014,” Guindos said in the interview recorded a few days ago.
However one think tank has said the changes fail to tackle Spain’s notoriously two-tiered labor market, with security for long-term fixed contracts and practically none for shorter-term ones.
Guindos added that the economic recovery would take root thanks to an expected tax reform which would look to reverse a personal income tax rise implemented when the government came to power in 2011, and cut
The ongoing debacle of Italy’s Banca Monte dei Paschi (BMPS) took a turn for the worst today. The bank’s largest shareholders (MPS Foundation) approved (read – forced through) a delay in a EUR 3 billion capital raise, which the bank needs to avoid nationalization, until May. The delay (which will cost the bank EUR 120 million in interest) allows MPS more time to liquidate their 33.5% holding before their stake is massively diluted. Management is ‘considering’ resignation and is “very annoyed,” but the city Mayor is going Nationalist with his delay-supporting comments that “we cannot let the third biggest bank in this country fall prey to foreign interests.” So Europe is recovering but they can’t even raise a day’s worth of POMO to save the oldest bank in the world?
Italy’s third-biggest bank Monte dei Paschi di Siena was forced to delay a vital 3 billion euro ($4.1 billion) share sale to raise capital until mid-2014 because of shareholder opposition, plunging its turnaround plan into uncertainty.
The bank’s chairman and its chief executive may now resign after their plan to launch the cash call in January was defeated at an extraordinary shareholder meeting on Saturday due to the vote of Monte Paschi’s top shareholder.
The world’s oldest bank needs to tap investors for cash to pay back 4.1 billion euros in state aid it received earlier this year and avert nationalization
Simple game theory really – why would the largest shareholder “guarantee” losses now when it can try and liquidate more of its exposure over time?
But the cash-strapped Monte dei Paschi foundation – whose stake in the bank is big enough to veto any unwanted decision – forced a postponement until at least mid-May to win more time to sell down its 33.5 percent holding and repay its own debts.
Antonella Mansi, a feisty 39-year-old businesswoman recently appointed head of the Monte dei Paschi foundation, said her insistence on a cash call delay did not amount to a no-confidence vote in the bank’s management.
But she said that carrying out the capital increase in January would massively dilute the foundation’s holding, leaving it with virtually nothing to sell to reimburse debts of 340 million euros.
“We have a precise duty to ensure (the foundation’s) survival. You can’t ask us to let it collapse,” she said.
Management is “very annoyed”…
Chairman Alessandro Profumo, a strong-willed and internationally respected banker who was formerly the chief of UniCredit, said he and CEO Fabrizio Viola would decide in January whether to step down.
“These are decisions one takes in cold blood and in the right place,” Profumo said at the meeting.
“What I have on my mind is a 3 billion euro cash call because we need to pay back 4 billion euros to taxpayers. Today this is uncertain and at risk,” he told a press conference.
Viola, sitting at his side, told reporters he would do everything “so that the ship does not sink”, but that he could not take responsibility for mistakes made by others.
Of course, there is risk either way…
“It’s important to carry out the capital increase as early as possible,” said Roberto Lottici, fund manager at Ifigest. “The risk is that the bank finds itself rushing into a cash call later at a lower price than what it could achieve now.”
“It’s hard to think that the third largest Italian bank can’t find a pool of banks able to support the cash call after May 2014,” said Antonella Mansi, the president of the MPS foundation, at the shareholders’ meeting.
and given the number of jobs involved… local officials are now reacting in favor of the delay (hoping for domestic savior)…
But in Siena, where the bank is known as “Daddy Monte” and is the biggest employer, fears that the cash call might sever the umbilical cord between the lender and the city run high.
Siena mayor Bruno Valentini, whose city council is the top stakeholder in the Monte dei Paschi foundation, said on Friday a postponement might help keep the bank in Italian hands.
“We cannot let the third biggest bank in this country fall prey to foreign interests,” he said. “Monte dei Paschi is not just an issue in Siena, it is a big national issue.”
So, even after all the lqiuidty provision; yields and spreads on European debt back near record lows; calls from US asset managers that Europe is recovering and will be the growth engine; and hopes that Europe’s AQR stress test (and resolution mechanism) will be the gold standard for confidence in their banking system… they still can’t find a group of greater fools to pony up EUR3 billion in real (not rehypothecated) money to save the world’s oldest bank – that’s a day’s worth of Fed POMO!!!!
On an odd side note, we did note a major surge in ECB margin calls this week…
From the United States to Europe and Asia: The world’s central banks are flooding markets with liquidity and pushing deeper into unknown monetary policy territory. Jim Grant tellsGermany’s Finanz und Wirtschaft that he “fears that thisjourney will not end well.” The sharply thinking Wall Street veteran doesn’t trust the theoretical models of the central banks and warns of irrational exuberance in the financial markets adding that “the stock market is increasingly full of stocks that are borne aloft by hope rather than demonstrated performance.”
Mr. Grant, half a decade after the financial crisis hope is rising that the United States finally are on a sustainable path to economic recovery. How are chances that the US economy gets back soon its status as the growth engine of the world?
In the past, the United States has been very resilient even in the face of very unfavorable and even punitive policy measures. The United States seem to want to be prosperous despite of what’s happening in Washington. Therefore, one can never rule out a great unscripted outburst of prosperity. I hope for that to happen, but I don’t predict it. Also, I’m coming increasingly to wonder about the concept of an economy as an integrated whole. People who talk that way don’t appreciate the incredible complexity of individual choices and decisions. Until fairly recently, no one thought about what we now call the economy as anything organic and macro in whole. This wasn’t a concept that entered our collective thinking until the nineteen forties. If you go back and read what economists wrote and what newspapers reported in the early portion of the twentieth century, you see that they would talk about prosperity or depression. But they wouldn’t talk about the economy. They just didn’t see it that way.
Signs of a brighter economic environment have encouraged the Federal Reserve to finally start the tapering of its massive bond purchase program, also known as QE3. What’s your take on this, for most market participants surprising move?
The «non-taper taper», Wednesday’s announcement, is yet another Federal Reserve innovation. To remove the sting from its decision to reduce the gait of its asset purchases, the central bank has vowed to hold its policy rate at zero even when the jobless rate falls below 6½%. «Inflation or bust – or both» would appear to be the Fed’s mantra.
Janet Yellen, who will be the next Fed chairman, has already made clear that she stands behind the recent monetary policy. What can Investors expect from her?
She is the key figure head of our monetary system which is what I call the PhD-standard. In the not so distant past, until a generation or so ago, central bankers were as likely to be ordinary bankers or ordinary business people as they were academics like the college professors who are mainly running the show now in this country. Apparently, in the Federal Open Market Committee, the interest rate setting regime here, nine out of the twelve members this year never had an experience in the private sector. Janet Yellen is the quintessential academic economist who is now in charge of what we ought to call – in the interest of plain speaking – price control. They certainly mean well but they have led us on a path of price administration rather than price discovery.
What do you mean by that?
If you ask economists they will tell you that price controls are a very bad idea. But that’s exactly what these mandarins at the Fed are doing. We are embarked on a unique experiment in monetary manipulation. That kind of central banking might be more accurately called central planning. One time, I therefore asked Fed-Governor Jeremy Stein in an open meeting if he could help us understand the substantial economic difference between central banks manipulating money market interest rates on one hand and traders at commercial banks manipulation Libor at the other. He just denied answering it. Also, since interest rates are artificially low the valuation of all earning assets must be called into question. This is the difficulty investors are facing the world over. We live in a hall of mirrors thanks to the zero interest rate regime and the chronic nonstop interventions by central banks
What are the consequences of these distortions?
One distortion is that people who are in the business of dealing with distressed debt have very little to do these days because there is less and less distressed debt because there are fewer bankruptcies. That’s because interest rates are so low that companies, even in a very bad way, can survive. That reduces in an unintended fashion the dynamism of our economy. In a dynamic society entrepreneurs start things and other entrepreneurs finish them or bankers finish them for the entrepreneurs because the entrepreneurs have failed. Without failure there really can’t be any success. Otherwise you have a futile system of permanent state sponsored enterprises. So our manipulated interest rates have given us a society that, in commercial terms, is much less dynamic than it should be.
But with super low interest rates, central banks like the Fed or the European Central Bank are fighting the low inflation rates which can also cause some serious problems to the economy. The ECB just recently cut its intervention rate in half to one quarter of one percent because it expressed its concern over an inadequate rate of the depreciation of the value of the Euro. Seven tenths of one percent is not good enough, we need two percent, they think.But why is two percent of inflation a good thing? They even acknowledge that the statistical difference between seven tenths of one percent and one and a half percent might all be error. It is very difficult to measure these price indices and to assure that the data are compiled properly and seasonally adjusted in a correct way. It speaks to our collective faith in our economic technicians or to the lack of critical thought that we accept so generally theses numbers as if they were gospel.
Then again, there is still the risk of deflation looming. Examples of how harmful deflation can be are the Great Depression or more recently the economic malaise of Japan.
They never make a distinction between deflation and progress. In the last quarter of the nineteenth century thanks to everything, from the electric light to progress in the process of steal making or the telephone, prices and costs fell for the better part of thirty years. Real wages went up, some people suffered, many didn’t, society progressed and people got richer. Also, in the early nineteen sixties prices as measured by the CPI did not rise by as much as two percent for five years in a row. Nobody cared at that time. But now there is this fear fanned by the professors who run our central banks and we are all hysterics about deflation.
That’s maybe because so many governments and households are so heavily indebted these days. Why shouldn’t we have some mild form of inflation to make the deleveraging process a little bit easier?
By insisting on trying to raise the price level the Fed is in effect resisting the progress of our time. As technology advances one would expect that the cost of production would fall. Digital technology and the accession of all these hundreds of millions of hands in the world labor force ought to be forces for falling costs of making things. And as the cost of production falls so should the cost of selling things. Yet, the Fed, the ECB and other central banks resist this by using monetary policy. And as they resist the tendency of prices to fall in time of technological progress they unintentionally seed the booms and busts in financial markets.
More and more people on Wall Street are screaming alarm about new bubbles of speculation. Do you spot any sings of irrational exuberance?
The massive market of treasury securities is itself in some kind of a bubble. Other examples are junk bonds or biotechnology stocks. Another bubble is the art market as the record auction prices are indicating. A similar case is classic sport cars: Some weeks ago, a Ferrari 250 GTO commanded 52 Mio. $ in a private sale. That’s almost a 50% increase on the record that was achieved last year for another 250 GTO. Investors who are looking for tangible assets find better value in antique furniture or in historic documents.
Another reason why the Federal Reserve is going to start to taper its securities purchases might be fear of exactly such kind of bubbles. Do you think they will ever find a way back to a normal monetary policy?
They say they have everything under control. To do, what they are saying they are going to do, requires both: technique and judgment. But they did not see one clue before the disaster of the years 2007, 2008 and 2009 – absolutely nothing. These people are well intending and most respectable but they are very concrete minded and very fixated on their way of thinking. What a good investor has – and what a bureaucrat typically lacks of – is imagination.
So what could go wrong this time?
What happens if, despite the Obama administration, there is a succession of booming months in job growth and the Fed at first doesn’t react and then, when it finally tries, it’s too late: First, there is a little bit inflation and then there is some more inflation and bond yields suddenly go up. The Fed thinks it has to control this by selling bonds and contributes thereby to the rise in interest rates and the fall in bond prices. And suddenly, there’s a disaster in the bond market.
But there seems to be really not that much investor nervousness in the bond market these days.
What one can observe about interest rates is that they have tended to rise and fall in generation length intervals, at least throughout Europe and North America. Since the early eighties they have been falling now most of the past 31 years. So, one would expect that we are closer to the end of this bull market than to the beginning. Therefore, bond yields are likely to go up in the future, which makes bonds look like a very poor investment.
Also, the setback in the gold market does not flash red lights for inflation. What’s next for the archaic metal after the terrible performance in 2013?
Gold is just an enigma, isn’t it? As an asset it yields nothing and pays no dividend. Therefore, you can’t value it like a common stock or bond. To me, gold is an investment in the almost certain failure of the PhD-standard in central banking. The gold price is down some 25% this year and gold stocks have been destroyed. In fact, the bear market in gold equities is the only bear market I know of these days. But when the world gets a full-on glance of the new Fed Chairman Yellen and understands the measure of the policies that central bankers will likely continue to implement, the gold price will go up a lot against the dollar. Only if the central bankers ever achieve to solve all the problems with fiat money and if governments end their tendency to over-issue uncollateralized debt then gold gets obsolete. But I certainly don’t agree with that promise. I think gold will yet shine as a monetary alternative and maybe serve in my grand children’s life time again as an anchorage to the world’s monetary system.
How should investors behave in such an environment?
At «Grant’s Interest Rate Observer», our ambition is to identify assets that are priced in such ways that you can afford a margin of error, knowing that one is likely to be early or even wrong about certain aspects of a particular situation. With a properly conservative valuation you are protected to a degree against such kind of human errors. A friend of a friend once had a great saying. What this fellow said was: Successful investing is all about having everyone agreeing with you – later. We are trying to live that kind of philosophy: to think of a thing that is now out of favor but has a reason to be in favor.
What would be such a thing?
Russian oil stocks like Lukoil, Gazprom and Rosneft exhibit several of desirable characteristics. There is insider buying – oddly enough. The business seems to be viable or even more than viable. Corporate governance is awful and investor sentiment is almost universally depressed. So here are cheap stocks in an environment of great skepticism toward them and with the added appeal of substantial insider accumulation. Once we looked at these stocks we were even more attracted since these companies are soundly financed which mitigates the risk of being wiped out through bankruptcy.
Russian oil stocks are a little bit exotic, though. What about investment ideas for Western Europe or for the United States?
Nobody knows what is going to happen in Europe. Additionally, we can’t find a lot of buying opportunities. Stocks have already gone up and they don’t seem to reflect the risks of the still precarious macro environment. Of course, there are always risks. But the question is if you are being adequately compensated for that risk. One stock that stands out is the Italian energy company Eni. The ideal hedge against the possible consequences of an overly aggressive monetary policy would be a value-laden equity that could prosper in any macro-economic setting but could shine in an inflationary one. Eni conforms to that description.
And what’s your take on the US stock market?
In the US we’re seeing more to do on the short side than on the long side. As an example it could pay off to take a closer look at story stocks. A story stock is a stock that is highly valued by the price earnings or price revenue calculation. Its price is manly driven by the quality of the narrative brokers are telling about it. So we just recently compiled an index of such kind of stocks because we think the stock market is increasingly full of stocks that are borne aloft by hope rather than demonstrated performance. Examples for such story stocks are Tile Shop Holdings or Boulder Brands.
The Federal Reserve’s balance sheet reached a record $4 trillion, as the central bank pushed on with its unprecedented asset-purchase program.
The Fed’s holdings rose $14.1 billion to $4.01 trillion in the past week, the Fed said today in a statement in Washington. Policy makers said yesterday they will slow monthly purchases of Treasuries and mortgage bonds to $75 billion in January, the first cut to the $85 billion pace they maintained for a year.
“We’re going to be living with a big Fed balance sheet for a long time,” said Josh Feinman, the New York-based global chief economist for Deutsche Asset & Wealth Management, which oversees $1.2 trillion, and a former Fed senior economist. “They’re still missing their dual mandate on both sides and that would call for easy monetary policy with unemployment too high and inflation too low.”
Chairman Ben S. Bernanke has raised assets from $2.82 trillion before the third round of quantitative easing began in September 2012 and quadrupled them since 2008 to attack unemployment after the 2008-2009 recession. He said yesterday the Fed may take “similar moderate steps” at each meeting to slow QE, which also carries potential risks.
“As the balance sheet of the Federal Reserve gets large, managing that balance sheet, exiting from that balance sheet become more difficult,” Bernanke said at his press conference. “There are concerns about effects on asset prices, although I would have to say that’s another thing that future monetary economists will want to be looking at very carefully.”
The assets exceed the U.S. government’s budget and are bigger than the gross domestic product of Germany, which has the world’s third-largest economy. Still, the European Central Bank, Bank of Japan and Bank of England hold more assets relative to the size of their economies, third-quarter data compiled by Haver Analytics show.
Policy makers said yesterday even expanding the balance sheet at a slower pace would keep supporting the labor market.
“The committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery,” the Federal Open Market Committee said in its policy statement.
To contact the editor responsible for this story: Chris Wellisz at email@example.com
The Group of Thirty, a preeminent think tank that brings together dozens of the world’s most influential policy makers, central bankers, financiers and academics, has been the focus of two recent reports for Occupy.com’s Global Power Project. In studying this group, I compiled CVs of the G30’s current and senior members: a total of 34 individuals. The first report looked at the origins of the G30, while the second examined some of the current projects and reports emanating from the group. In this installment, I take a look at some specific members of the G30 and their roles in justifying and implementing austerity measures.
Central Bankers, Markets and Austerity
For the current members of the Group of Thirty who are sitting or recently-sitting central bankers, their roles in the financial and economic turmoil of recent years is well-known and, most especially, their role in bailing out banks, providing long-term subsidies and support mechanisms for financial markets, and forcing governments to implement austerity and “structural reform” policies, notably in the European Union. With both the former European Central Bank (ECB) President Jean-Claude Trichet and current ECB President Mario Draghi serving as members of the G30, austerity measures have become a clearly favored policy of the G30.
In a January 2010 interview with the Wall Street Journal, Jean-Claude Trichet explained that he had been “involved personally in numerous financial crises since the beginning of the 1980s,” in Latin America, Africa, the Middle East and Soviet Union, having been previously the president of the Paris Club – an “informal” grouping that handles debt crisis and restructuring issues on behalf the world’s major creditor nations. In this capacity, Trichet “had to deal with around 55 countries that were in bankruptcy.”
In July of 2010, Trichet wrote in the Financial Times that “now is the time to restore fiscal sustainability,” noting that “consolidation is a must,” which is a different way of saying austerity. In each of E.U. government bailouts – of which the ECB acted as one of the three central institutions responsible for negotiating and providing the deal, alongside the European Commission and the IMF, forming the so-called Troika – austerity measures were always a required ingredient, which subsequently plunged those countries into even deeper economic, social and political crises (Spain and Greece come to mind).
The same was true under the subsequent ECB president and G30 member, Draghi, who has continued to demand austerity measures, structural reforms (notably in dismantling the protections for labor), and extended support to the banking system, even to a greater degree than his predecessor. In a February 2012 interview with the Wall Street Journal, Draghi stated that “the European social model has already gone,” noting that countries of the Eurozone would have “to make labour markets more flexible.” He meant, of course, that they must have worker protections and benefits dismantled to make them more “flexible” to the demands of corporate and financial interests who can more easily and cheaply exploit that labor.
In a 2012 interview with Der Spiegel, Draghi noted that European governments will have to “transfer part of their sovereignty to the European level” and recommended that the European Commission be given the supranational authority to have a direct say in the budgets of E.U. nations, adding that “a lot of governments have yet to realize that they lost their national sovereignty a long time ago.” He further explained, incredibly, that since those governments let their debts pile up they must now rely on “the goodwill of the financial markets.”
Another notable member of the Group of Thirty who has been a powerful figure among the world’s oligarchs of austerity is Jaime Caruana, the General Manager of the Bank for International Settlements (BIS), which serves as the bank for the central banks of the world. Caruana was previously Governor of the Bank of Spain, from 2000 to 2006, during which time Spain experienced its massive housing bubble that led directly to the country’s debt crisis amid the global recession. In 2006, a team of inspectors within the Bank of Spain sent a letter to the Spanish government criticizing then-Governor Caruana for his “passive attitude” toward the massive bubble he was helping to facilitate.
As head of the BIS, Caruana delivered a speech in June of 2011 to the assembled central bankers at an annual general meeting in Basel, Switzerland, in which he gave his full endorsement of the austerity agenda across Europe, noting that “the need for fiscal consolidation [austerity] is even more urgent” than during the previous year. He added, “There is no easy way out, no shortcut, no painless solution – that is, no alternative to the rigorous implementation of comprehensive country packages including strict fiscal consolidation and structural reforms.”
At the 2013 annual general meeting of the BIS, Caruana again warned that attempts by governments “at fiscal consolidation need to be more ambitious,” and warned that if financial markets view a government’s debt as unsustainable, “bond investors can and do punish governments hard and fast.” If governments continue to delay austerity, he said, the markets will have to use “market discipline” to force governments to act, “and then the pain will be large indeed.” In further recommending “structural reforms” to labor and service markets,Caruana noted that “the reforms are critical to attaining and preserving confidence,” by which, of course, he meant the confidence of markets.
The ‘Academic’ of Austerity: Kenneth Rogoff
Kenneth Rogoff is an influential academic economist and a member of the Group of Thirty. Rogoff currently hold a position as professor at Harvard University and as a member of the Council on Foreign Relations. He sits on the Economic Advisory Panel to the Federal Reserve Bank of New York, and previously Rogoff spent time as the chief economist of the IMF as well serving as an adviser to the executive board of the Central Bank of Sweden. Rogoff is these days most famous – or infamous – for co-authoring (with Carmen Reinhart) a study published in 2010 that made the case for austerity measures to become the favored policy of nations around the world.
The study, entitled, “Growth in a Time of Debt,” appeared in the American Economic Review in 2010 to great acclaim within high-level circles. One of the main conclusions of the paper held that when a country’s debt-to-GDP ratio hits 90%, “they reach a tipping point after which they’ll start experiencing serious growth slowdowns.” The paper was cited by the U.S. Congress as well as by Olli Rehn, the European Commissioner for Economic and Monetary Affairs and one of Europe’s stalwart defenders of austerity, who has demanded themeasures be instituted on multiple countries in the E.U. in return for bailout funds.
A Google Scholar search for the terms “Growth in a Time of Debt” and “Rogoff” turned up approximately 828 results. In 2013, Forbesreferred to the paper as “perhaps the most quoted but least read economic publication of recent years.” The paper was also cited in dozens of media outlets around the world, multiple times, especially by influential players in the financial press.
In 2012, Gideon Rachman, writing in the Financial Times, said Rogoff was “much in demand to advise world leaders on how to counter the financial crisis,” and noted that while the economist had been attending the World Economic Forum meetings for a decade, he had become “more in demand than ever” after having “written the definitive history of financial crises over the centuries” alongside Carmen Reinhart. Rogoff was consulted by Barack Obama, “and is known to have spent many hours with George Osborne, Britain’s chancellor,” wrote Rachman, noting that Rogoff advised government’s “to get serious about cutting their deficits, [which] strongly influenced the British government’s decision to make controlling spending its priority.”
The praise became all the more noteworthy in April of 2013 when researchers at the University of Massachusetts, Amherst, published a paper accusing Rogoff and Reinhart of “sloppy statistical analysis” while documenting several key mistakes that undermined the conclusions of the original 2010 paper. The report from Amherst exploded across global media, immediately forcing Rogoff and Reinhart on the defensive. The New Yorker noted that “the attack from Amherst has done enormous damage to Reinhart and Rogoff’s credibility, and to the intellectual underpinnings of the austerity policies with which they are associated.”
As New York Times columnist and fellow G30 member Paul Krugman noted, the original 2010 paper by Reinhart and Rogoff “may have had more immediate influence on public debate than any previous paper in the history of economics.” After the Amherst paper, he added, “The revelation that the supposed 90 percent threshold was an artifact of programming mistakes, data omissions, and peculiar statistical techniques suddenly made a remarkable number of prominent people look foolish.” Krugman, who had firmly opposed austerity policies long before Rogoff’s paper, suggested that “the case for austerity was and is one that many powerful people want to believe, leading them to seize on anything that looks like a justification.”
Indeed, many of those “powerful people” happen to be members of the Group of Thirty who are, with the notable exception of Krugman, largely in favor of austerity measures. Krugman himself tends to represent the limits of acceptable dissent within the G30, criticizing policies and policy makers while accepting the fundamental concepts of the global financial and economic system. He commented that he had been a member of the G30 since 1988 and referred to it as a “talk shop” where he gets “a chance to hear what people like Trichet and Draghi have to say in an informal setting,” adding, “while I’ve heard some smart things from people with a role in real-world decisions, I’ve also heard a lot of very foolish things said by alleged wise men.”
Andrew Gavin Marshall is a 26-year old researcher and writer based in Montreal, Canada. He is Project Manager of The People’s Book Project, chair of the Geopolitics Division of The Hampton Institute, research director for Occupy.com’s Global Power Project and World of Resistance (WOR) Report, and hosts a weekly podcast show with BoilingFrogsPost.