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Bernanke Is Making the Crisis Worse

By Bud Conrad, Chief Economist, Casey Research

The Fed is a corrupt and powerful institution, and Chairman Bernanke is making the global crisis worse. His new speech given last week in Europe was terribly misguided and will upset markets as the Chinese and Germans won’t ignore his challenges. Bernanke’s interpretations of the markets have been wrong since before he was appointed to head the Fed, and his actions are doing nothing but aggravating the situation.

In this seminal speech, titled “Rebalancing the Global Recovery,” Bernanke not only defended QE II as the right policy, but also attacked the monetary policy of China, the biggest holder of U.S. debt, an action that must be understood for how misdirected it is.

Here are a few excerpts from the speech:

On our “tepid” recovery

    In sum, on its current economic trajectory the United States runs the risk of seeing millions of workers unemployed or underemployed for many years.
    Indeed, although I expect that growth will pick up and unemployment will decline somewhat next year, we cannot rule out the possibility that unemployment might rise further in the near term, creating added risks for the recovery.

On China

    The strategy of currency undervaluation has demonstrated important drawbacks, both for the world system and for the countries using that strategy.

    … For large, systemically important countries with persistent current account surpluses, the pursuit of export-led growth [i.e., China and its strategy] cannot ultimately succeed if the implications of that strategy for global growth and stability are not taken into account.

On defending QEII as the right policy

    Following up on this earlier success, the Committee [i.e., the Federal Open Market Committee] announced this month that it would purchase additional Treasury securities. In taking that action, the Committee seeks to support the economic recovery, promote a faster pace of job creation, and reduce the risk of a further decline in inflation that would prove damaging to the recovery.

    Fully aware of the important role that the dollar plays in the international monetary and financial system, the Committee believes that the best way to continue to deliver the strong economic fundamentals that underpin the value of the dollar, as well as to support the global recovery, is through policies that lead to a resumption of robust growth in a context of price stability in the United States.

Mike Shedlock of Mish’s Global Economic Trend Analysis provides some sensible criticisms of Bernanke’s speech. Shedlock’s conclusion: “If Bernanke was trying to spook the markets, provoke China, cause a currency war, and get Congress to launch an extremely foolish set of tariffs, he would have been hard pressed to deliver a more powerful speech.”

[Click here for a commentary by Greg Robb from MarketWatch on the implications of Bernanke’s criticism of China.]

The basic problem with QE 2 is that printing electronic money does nothing to improve the unemployment situation. Purchasing $600 B of government debt delays the government from having to make tough decisions about its $1.5 trillion deficits for six months and coincidentally gets us from the $13.7 trillion of gross government debt to the legislated debt ceiling of $14.3 trillion that the Republicans are willing to fight over not increasing. Studies show that this kind of policy has little effect on the growth of the economy but hurts the currency.

The bottom line is this: The imbalances that the Fed is forcing on China’s central bank are difficult for them to absorb. They will lose money if they value the yuan higher, because they hold so many Treasuries, which are denominated in dollars. The difference in interest rates is also complex, but part of the reason that China is not in a position to jump to our request to increase the value of the yuan rapidly. They pay higher interest on the yuan they issue in trade for dollars, so they are not happy with receiving the close-to-zero interest on U.S. Treasuries. We should be careful how we handle our relationship with the biggest holder of our debt (as shown below).

Bernanke will achieve some terrible goals here, including escalating the currency wars and destroying the dollar even more. If his policies are moved forward, he can confirm his experiment of proving that printing money will destroy its value. Doing it so personally and aggressively will bring responses much larger than he understands from other countries, and our government is on a path of dollar destruction that will work.

Deflation is a bogus bogeyman used by central bankers to hide behind in implementing policies of money printing. We are destroying our relationships around the planet. It is also a one-way path, as there is no return (or “exit,” as the Fed watchers use the term). Once confidence is lost in our policies, this will escalate out of control. I fear this is the start of that one-way street to eventual hyperinflation. It will still take years, but I think the first steps are already taken.

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[Read more about Bud’s big-picture view of the economic situation and implications of what he’s calling the “financial wars” in the next edition of The Casey Report. If you want to learn of the inevitable fallout of these financial wars and how they will affect your investments, try it risk-free for 3 full months, with money-back guarantee. Details here.]

Band-Aid Solutions

By Puru Saxena, November 19

BIG PICTURE – Lets face it, governments always try to ‘kick the can down the road’.  Rather than deal with economic issues in the here and now, they prefer to postpone the pain.  Unfortunately, in their attempt to avoid painful economic recessions, the policymakers sacrifice the purchasing power of their currencies and they end up creating even bigger troubles for the future.  

Look.  The ‘Great Recession’ in the developed world was brought about by excessive debt and consumption. In the boom years, millions of Americans borrowed copious amounts of money to buy real-estate; they used their homes as a source of funding (home equity withdrawals) and spent way beyond their means.  In those heady days, everyone was convinced that real-estate prices could not decline on a country wide basis.  Unsurprisingly, the bankers gladly supported this misconception by providing cheap fuel to the raging speculative fire.  The end result was that unworthy debtors were able to purchase several properties and real-estate prices appreciated considerably. 

Unfortunately, when interest-rates went up and credit became scarce, the house of cards collapsed.  When boom turned to bust, millions of American homeowners were left with negative equity (Figure 1) and the entire banking system came to its knees.  When that happened, the American policymakers embarked on a fear-mongering campaign and they misled the public into believing that it was essential to save the banks.  During the depth of the financial crisis, we were repeatedly told that the ‘too big to fail’ banks had to be saved, or else the consequences would be dire.

After the establishment succeeded in its scare tactics, it unleashed its ‘stimulus’ and used tax payers’ money to bail out the insolvent financial institutions.  In the name of national interest, the Federal Reserve created trillions of dollars out of thin air and it purchased toxic mortgage-backed-securities from the commercial banks.  Furthermore, instead of marking down the value of these securities, the American central bank bought the dubious assets at face value!  Thus, the American taxpayers bailed out the banks and the risk was transferred from the private-sector to the state.

In addition to nationalising the bank’s losses, the Federal Reserve dropped the short term interest rate to near-zero and it started buying US Treasury securities.  Supposedly, these Band-Aid solutions were necessary to prevent an economic depression and somehow they would revive the world’s largest economy. 

By dropping the Fed Funds Rate to almost zero, the American central bank hoped to achieve the following benefits:

a. Reduce the borrowing cost of the banks (so they paid next to nothing for deposits)
b. Stimulate private-sector credit growth

In hindsight, the Federal Reserve succeeded in lowering the banks’ borrowing cost but it failed in reviving private-sector credit growth.  After all, American households were already leveraged to the hilt and they refused to go even deeper in debt.

In our view, these drastic policy measures were unnecessary and they failed to get to the root of the problem – too much debt.  Instead of nationalising the banks’ losses by using tax payers’ money, the American government should have restructured debt in an orderly manner.  Insolvent institutions should have been allowed to fail, bondholders should have received a hair cut on their bad loans, and the total outstanding debt should have been reduced.  If anything, in order to help the masses, the American establishment should have guaranteed all the bank deposits and taken steps to assist the distressed homeowners.

Instead, the American policymakers focused on helping the banks, and in the process, they increased the public’s debt burden!  Furthermore, by transferring private sector risk on to the public’s balance-sheet, the American establishment has seriously undermined the quality of the nation’s balance-sheet. 

It is noteworthy that over the past decade, America’s federal debt has more than doubled! Today, it stands at US$13.64 trillion and has morphed to 93.5% of GDP!  The fact that this surge in debt has produced pathetic economic growth and done very little to bring down unemployment, is proof that Keynesianism does not work. 

Unfortunately, the American establishment has not learnt from past mistakes and it continues to follow disastrous economic policies.

By now, it should be clear to everyone that the first round of quantitative easing failed to stimulate the world’s largest economy.  So, if the initial ‘stimulus’ did not work, what are the odds that additional quantitative easing will do the trick? 

The truth is that quantitative easing has never worked and this time around, the end result will be no different.  In fact, we are prepared to bet our bottom dollar that quantitative easing will fail miserably in reviving economic growth in America.  To make matters worse, if the Federal Reserve continues to create money like there is no tomorrow, the stage will be set for an inflationary holocaust.

As an investor, it is crucial for you to understand that although monetary inflation causes asset prices to rise in nominal terms, it does not impact them uniformly.  For instance, when inflationary expectations are low and confidence in the government is high, monetary inflation benefits financial assets (stocks and bonds).  Conversely, when inflationary fears are elevated and investors have lost faith in the government, monetary inflation tends to benefit hard assets (precious metals, energy and soft commodities). 

Figure 2 captures this inverse correlation between financial assets and gold.  As you can see, between 1980 and 2000, monetary inflation benefited the Dow Jones Industrial Average (Dow) and during that period, gold performed poorly.  However, since the turn of the millennium, monetary inflation has benefited hard assets and American stocks have underperformed relative to gold.  At present, the Dow to gold ratio is at 8.4 and if history is any guide, over the following years, gold should continue to appreciate more than American stocks.

In our view, the ongoing bull market in hard assets will carry on for as long as the Federal Reserve and its counterparts continue to engage in quantitative easing.  Now, it is conceivable that over the following months, several central banks in the developed world will announce further stimulus and this should turbo charge the commodities boom. 

It is our contention that as long as the bond vigilantes are asleep at the wheel, the ‘risk trade’ will continue to flourish.  However, no boom lasts forever and at some point, when the bond vigilantes get spooked, sharply higher interest rates will end up killing the commodities bull.  When that happens is anybody’s guess, but we suspect that the good times will continue for another 2-3 years.

Despite the fact that quantitative easing will not succeed in the developed nations, we remain optimistic about hard assets and continue to favour the stock markets of the developing economies in Asia.

This article is written by Puru Saxena and with his kind permission, O B Research has been privileged to publish his work on our website. To find out more about his work, please visit:


India and China Continue to Drive Gold Demand

By Frank Holmes, 10 November

The World Gold Council’s (WGC) latest quarterly recap shows global gold demand is getting stronger despite rising gold prices. Gold rose 28 percent to record the highest average price for a quarter ever at $1,226.75 an ounce while gold demand jumped 12 percent on a year-over-year basis to 921.8 tons during the quarter.

Jewelry demand, which increased 8 percent on a year-over-year basis, accounted for 57 percent of overall demand, while investment demand rose 19 percent to account for 31 percent of total demand.

It appears consumers and investors, especially in India, China, Russia and Turkey, are growing accustomed to higher gold prices. At the end of the third quarter, gold demand in India had already exceeded that of 2009 and demand levels in China are ahead of last year’s pace.

The WGC says “these results demonstrate that consumers in these countries are becoming accustomed to high price ranges…and consumers are preferring to make gold jewelry purchases at current prices in order to avoid purchasing at higher prices in the future.”

Investment demand rose despite a 7 percent decline in investment in ETFs, which has been the biggest driver in investment demand of late.

Chinese investors seeking protection from rising interest rates directed a considerable portion of their savings into gold products, causing demand for gold bars to jump 44 percent. Net retail investment in China reached 45 tons, breaking the previous record of 40 tons set in the first quarter of 2010.

We’ve said this many times, as the economy recovers and per capita incomes in countries such as China and India rise, consumers and investors within those countries will likely see gold as a key investment vehicle because of the cultural connection carried over thousands of years.

Additionally, the official sector—central banks—were net buyers of gold with Russia, Sri Lanka, Thailand and Philippines increasing their holdings. This offset the International Monetary Fund’s continued selling of gold under the current Central Bank Gold Agreement.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

This article is written by Frank Holmes and with his kind permission, O B Research has been privileged to publish his work on our website. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. To find out more about Frank Holmes’ work, please visit:


Gold’s Allure Tied to Interest Rates

By Michael Pento, 17 November, 2010

The continued bull market in the price of gold has been one of the staple discussions in the financial media for the better part of a decade. But, in that time, almost no consensus has emerged to explain the phenomenon. If you ask ten Wall Street pundits to explain the upward movement, you will most likely get nearly ten different answers. 

While most logically identify global currency debasement as a primary cause, others say that gold is driven by: fear of economic uncertainty, central bank gold hording, international political conflict, or the ebb and flow of the Indian wedding season. The truth is the main drivers for the price of gold are the level and direction of real interest rates and the intrinsic value of the dollar.

Most people (outside of Washington) understand that printing money dilutes the value of the currency being printed. When a currency drops, the nominal price of hard assets in that currency generally rises. But the relationship between gold and monetary expansion is not that simple.

The act of central bank money printing temporarily drives down nominal interest rates, while at the same time creating inflation and lowering the intrinsic value of the currency that is printed. Therefore, subtracting rising rates of inflation from falling nominal interest rates results in a falling real rate of interest. Once real rates become negative, the liability of holding gold, which offers no interest income, disappears. The more real interest rates fall, the greater incentive for investors to own gold.

However, sometimes other factors come into play that prevent a debased currency from losing value against other currencies. It all depends on the actions taken by other central bankers. Hence, investors cannot divine the direction of gold simply by determining the state of nominal interests rates in the US or by the dollar’s value relative to other currencies.

This brings up two questions; should owners of gold fear rising yields on Treasuries, or a rise of the dollar against, say, the euro? The answers to those questions can be found by examining whether the rise in nominal rates is also accompanied by rising real interest rates and if the rise in the dollar is due to a decrease in its supply.

For example, back in January of 1977, the dollar price of gold began an epic bull market, which ended just prior to February of 1980. Gold soared from $135 dollars per ounce to just under $860 per ounce during those three years. This move occurred while nominal rates were rapidly rising. The yield on the Ten Year Treasury soared from 7.2% in January of 1977 to 12.4% in February of 1980. But the increase in yield was just in nominal terms because the YoY change in the CPI jumped from 5.2% in January of 1977 to 14.2% in February of 1980. During that bull market in gold, real interest rates fell from a positive 2% to a negative 1.8%, despite the fact that nominal rates increased by 520 bps.

Yesterday’s release from the BLS showed the October Producer Price Index increased by .4%, while the YoY increase in PPI jumped 4.3%. However, the Fed will most likely seize upon the month-over-month change in the core rate, which registered a negative .6%. Bernanke will overlook the largest YoY increase in PPI since May and instead worry about the deflation anticipated by core prices. That means he will find cover to print more money, thus – at least for now – keeping nominal rates from rapidly rising, while pushing inflation even higher. Real interest rates should fall and the price of gold should thus remain in its secular bull market. In my opinion, there is little danger that nominal rates will outpace the increase in the rate of inflation until the Fed unwinds its balance sheet like it did under Paul Volcker 30 years ago.

Likewise, an increase in the value of the dollar against another currency likely indicates that the central bank of the other country is lowering real interest rates and diluting the purchasing power of that currency at a greater pace than the Fed. It does not necessarily indicate that the supply of dollars is contracting or that our currency’s intrinsic value has increased.

There will come a time when the Fed’s pursuit of inflation causes a massive crisis of confidence in our bond market and in our currency. A sudden and dramatic spike in nominal rates would send real interest rates rising and cause devastation in most markets, including gold. However, because the Fed’s likely answer to such a crisis would be to create more inflation, any pullback in gold should be muted as compared to stocks, bonds, and other commodities.

This article is written by Michael Pento of Europac and with their kind permission, O B Research has been privileged to publish their work on our website. To find out more about Europac, please visit:

Quantitative Easing Explained (Animation)

By Jason Hamlin, on November 17th, 2010

This is a must-watch video that explains quantitative easing, the actions of the Fed, Ben Bernanke and the fleecing of the taxpayer by Goldman Sachs. It is amazing that there is not greater outrage about what is happening, but the majority of Americans simply don’t understand these financial shenanigans.

“The printing money is the last refuge of failed empires and banana republics and the Fed does not want to admit this is their only idea.”

The Fed and government are committed to a policy of ‘QE to infinity’ as nations around the world race to debase their currencies. Your only refuge against this stealth form of theft is to own physical gold and silver. Not only will you protect your wealth and purchasing power, but you will help to force a short squeeze of the large commercial banks such as JPMorgan that have been manipulating the prices.

This article is written by Jason Hamlin and with his kind permission, O B Research has been privileged to publish his work on our website. To find out more about his work, please visit:

http://www.goldstockbull.com/