Inflation Drifts Below Target - Why This Isn't Good News

The Treasury and Federal Reserve have been reporting that the inflation rate is "running somewhat below" their target rate of 2.0%. n the latest Board meeting, the decision was made to continue the current policy of buying $85 billion a month in bonds, and there is speculation this amount may be raised. 

So, is "inflation below target a good thing? In short, no. First, let me point out that the "inflation rate" they are talking about isn't the same one you think you are familiar with. The Federal Reserve uses the  Personal Consumption Expenditures (PCE) price index. The rest of the country uses various flavors of the Consumer Price Index (CPI). The CPI is near worthless for the evaluation of everyday prices and the PCE is even worse. By the way, the real rate of inflation, using the pre-1980 methodology, is running almost 10%.

There are two factors that make the current situation dangerous. First, the Fed's purchase of massive quantities of bonds is artificially driving money into other investments such as equities. This is the primary reason for the recent rises in the stock market. It's not an economic recovery. It's a bubble. Secondly, the 4.4 trillion dollars the Fed has already "printed" is a significant inflationary pressure. Every month the Fed buys up more bonds raises the water level behind the inflation dam. Right now, the 4.4 trillion, and the tens of trillions held by foreign banks, and the tens of trillions converted to Eurodollars are not accounted for in the inflation equation. When the bond market collapses, these factors will come into play rapidly.

If you are in the stock market (most people are, either directly or indirectly through pension plans, etc) be aware that conventional advisers such as Dave Ramsey are lying to you when they say the stock market is a great long term investment strategy. It isn't. The history proves it. And right now is the most dangerous time to be in the market since 1928. Be ready to move quickly.

Hyperinflation Warning - The Eurodollar Menace

The existence of the Euro-dollar market increases the total amount of dollar balances

available to be held by nonbanks throughout the world for any given amount of money (currency plus deposits at Federal Reserve Banks) created by the Federal Reserve System. It does so by permitting a greater pyramiding on this base by the use of deposits at U.S. banks as prudential reserves for Euro-dollar deposits.

- Milton Friedman, Selected Papers, No. 34

Not to be confused with the Euro currency, the monetary unit of the Eurogroup, a Eurodollar is;

"U.S.-dollar denominated deposits at foreign banks or foreign branches of American banks. By locating outside of the United States, eurodollars escape regulation by the Federal Reserve Board."[1]

I present a simplistic scenario to explain the effects and dangers of the Eurodollar:

Suppose a country creates a currency as a medium of exchange. Let’s say they start with 1 million units. If they then create 1 million more units, it is reasonable to assume the value of each unit, both the existing ones and the new ones, are decreased by half. (The reciprocal of the total number of units). This is classic monetary inflation.

Original unit value = 1

Unit value after doubling the number of units = 0.5

Unit value after quadrupling the number of units = 0.25

…etc

Now suppose that the number of units is doubled, but all the new units “disappear”

Original number of units = 1 million

New units created = 1 million

Total number of units = 2 million

1 million units “disappear” – 1 million

Number of units in circulation = Still 1 million

Therefore, each unit value is still = 1, because the newly created units disappear and don’t have an effect on the value of the original units

This is what happens when U.S. dollars are created by the Federal Reserve and get converted to Eurodollars. Because of the U.S. dollar’s status as the world's reserve currency, other nations must convert (buy) U.S. dollars to conduct international trade. Some of these dollars are kept overseas and never return to the U.S. Just like in our example, they disappear.

This is a great deal for the U.S because it means it get goods essentially for free. As a nation, the U.S. can print dollars and trade them for imported goods. Because the dollars don’t come back, they do not cause inflation. It’s a free ride the country has been on since the end of the Second World War. This is the basis of America’s wealth. Not innovation, not the American work ethic; Trickery.

But in the end, the trick is on the U.S. All those Eurodollars didn’t really disappear. They are still out there. When the rest of the world decides to adopt a new reserve currency, a process that is well under way, they will no longer have a need for the 9.7 trillion dollars they now hold. The dollars will come flooding back into the U.S., inflation will quickly degenerate into hyper-inflation and the real losers will be those required to own dollars – the American taxpayer.

Are you prepared?

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[1] http://www.investopedia.com/terms/e/eurodollar.asp

What's Behind the Gold Price Plunge?

Since my time at REFCO (yes, that REFCO) I have maintained that gold is the most manipulated market in the world, behind fiat currencies of course. But what is going on with the dramatic price moves in gold lately?

First we need to examine what initiated the sell-off. It wasn't some world event or major development; the price move started after brokerage houses and Goldman Sachs notified private investors of an impending liquidation of gold by some large hedge funds. Has this happened? Not yet, and it probably won't.

Most of the price pressure has come from uncovered short futures positions. This isn't unusual in itself, considering the technical status and alleged overbought condition of the market. But we need to look at the bigger picture to get a clear understanding...

The Japanese have embarked on a qualitative easing campaign and the Federal Reserve is pressuring the Euro Zone to do the same. The answer to why, of course, is to prevent an uncontrolled crash of the Dollar because of the massive qualitative easing done by the Fed themselves in the past few years. There is an incredible amount of dollars out there that potentially represent a tremendous inflationary pressure. While the Federal Reserve tells their deflationary fairy tale on the one hand[1], on the other they are desperate to control the dollar. Gold presents a clear and present danger to the Fed's plan and so it is entirely likely they instructed Goldman Sachs and others to deflate gold.- Keep in mind, Goldman Sachs and the rest of the investment and fund houses will win no matter what. They are partners in crime with the Federal Reserve.

My advice -  I am not a "gold-bug" by any means. But ANY hard asset is better than dollars. If you have physical gold, hang on to it. Buy some if you have some extra funds, but don't tie up all your investment in it. The effort to prop up the dollar may get very ugly and gold volatility may go insane. If you have derivatives of any kind, and especially gold derivatives, you are gambling with your wealth. You might as well be at the casino.

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[1] In a recent blog post, Gold Does Not Glitter, Paul Krugman tries to make the case that the gold price drop is proof there is no inflation danger.

Hyperinflation Warning - Debt Phase Transition

The Federal Reserve has been “printing money” on a massive scale for the last several years in support of various stimulus programs; a process they now call Quantitive Easing, or QE. Keynesian theory allows that spending, even deficit spending, results in economic growth. And this has actually been the case during various periods in the 20^th century. For example, increased spending during World War II resulted in a post-war economic boom. Keynesian theory supporters can point to several other examples. 
However, according to the Federal Reserve; 

"QE did not dramatically increase bank loans and the growth of broader monetary 
aggregates." 

What makes the current situation different? -  Economic growth is dependent on the utility of debt.

Let us consider the famous Widget Company. Say the Widget Company manufactures 100 widgets a day. They can take out a loan to buy additional or better equipment to increase their output to 500 widgets a day. Obviously then, the ability of the company to borrow money has some utility. If every dollar borrowed enables the company to earn more than a dollar, the Utility of Debt is said to be greater than 1.

Extrapolated to the entire economy, the same general principle applies. Historically every dollar created by the Federal Reserve has resulted in more than one dollar in increased economic activity. But there is a limit. Eventually a point is reached where the new dollar creates less than one dollar in new economic activity. This point was reached somewhere in the 1950’s. 

Debt Phase Transition is the term applied when the creation of a new dollar actually causes a contraction of economic activity. We have recently reached that point. We have reached a point of debt saturation. No amount of money creation (money printing) can cause economic recovery. Furthermore, the increase in money supply only makes the problem worse since each new dollar actually decreases activity. 

The only possible solution is the reduction of debt, and this can happen in only three possible ways – 1.) Repay the debt, 2.) Default the debt, and 3.) Erase the debt through hyperinflation.

It should be obvious that neither of the first two possibilities will ever happen. (If you do not agree, please see upcoming posts for proof.)

This leaves only hyperinflation. The massive amounts of money being put into the system has not caused inflation yet because it isn’t being used. Money Velocity is very low. (See chart below). But this money still exists, along with huge amounts that has been transferred out of the country because of our multi-decade trade imbalance. All of these excess dollars constitute a large reservoir that will flood the economy when the holders of these dollars decide to exchange them for something else – a process that has already begun.

At no time in the history of man and money has there been such a buildup of excess currency. The hyperinflation that must result will be unprecedented and will make previous hyperinflation events seem insignificant.

BRICS Deliver Serious Blow To the U.S. Dollar

The 5th annual BRICS[1] Summit has wrapped up in Durban, South Africa, and an agreement was signed by the member countries to establish an international development bank to bypass the International Monetary Fund. More importantly, the agreement also provides for the establishment of a new currency to replace the dollar in international trade.

Since the so-called Bretton Woods System, established in 1944[2], the U.S. has enjoyed the benefits of being the worlds official reserve currency. This privilege has enabled the U.S. to prosper by creating an artificial demand for the dollar. With their new arrangement the BRICS countries have abandoned this convention.[3] 

BRICS nations comprise 20% of the global Direct Foreign Investment and this figure is set to rise dramatically. Trade among the group is expected to reach $500 billion in the next 7 years. The group also collectively holds 4.4 trillion USD in reserve. Since they, and presumably other third world countries who join them, will no longer have a need to buy dollars, this will remove a major foundation of the dollars strength. 

Why are they doing this? The short answer is; They are losing the currency wars. The U.S., Europe and Japan have lowered interest rates to near zero, putting extreme upside pressure on the BRICS currencies.

What does it mean to you? Again, the short answer; Inflation. And eventually hyper-inflation as all of the reserves are dumped, along with the trillions in market operations by the Federal Reserve in recent years, there will be a literal flood of dollars and no demand for them.

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[1] BRICS is an acronym for Brazil, Russia, India, China and South Africa

[2] http://www.imf.org/external/about/histcoop.htm

[3] The Bretton Woods System was officially abandoned in 1971, but the U.S. dollar continued to be used as the worlds reserve currency. For a concise history see- footnote 2