Egypt hits the wall

Egypt to Start Foreign Exchange Auctions as Reserves Plunge
The North African nation’s central bank said the sales and purchases of U.S. dollars will take place periodically and aim to “preserve foreign-currency reserves and ration their use,” according to an e-mailed statement today. The new mechanism will support the dollar interbank market, it said. Egypt’s net international reserves have slumped almost 60 percent in the two years since the start of an uprising that ousted former President Hosni Mubarak.

“The current level of foreign-currency reserves constitutes the minimum and critical level that must be preserved” to meet necessary needs like repaying external debt and importing “strategic commodities,” the central bank said in the statement.
Egypt needs dollars for food. If food prices rise, Egypt will go hungry.

Market Vectors Egypt Index ETF (EGPT) rallied post-Spring, but it will reach new lows as the currency collapses.


Blurring of gender roles, rise of women during negative mood

From Hong Kong:
More teenage girls joining street gangs
Social workers at Youth Outreach, who take in 200 children off the streets every night at their Sai Wan Ho drop-in centre, say that in their early teens girls are often physically stronger than boys and have a more mature personality, making them natural authority figures.

"A lot of the gang leaders are now girls and they are getting younger and more masculine," said social worker Ted Tam Chung-hoi, 33, who has worked with Youth Outreach for 10 years.

Irrational hatred of guns is driven by negative social mood

Magical thinking dominates during periods of negative social mood, which is why people favor policies that do not work. The evidence overwhelmingly shows that guns are not responsible for crime or death, only the proximate cause. In other words, more people are shot in America because Americans own guns. In other nations, they are more likely to be stabbed, poisoned, run over by cars, blown up by homemade bombs, set of fire, etc. Furthermore, adjusted for gun ownership, the rate of gun deaths are extremely low. That is to say, there are nations with far less gun ownership that have higher rates of gun violence. What explains the higher American homicide rate is its diversity. A comparison of Hispanic murder rates with Latin American nations, a comparison of African-American murder rates with Caribbean or African nations, a comparison of Asian-American murder rates with Asian murder rates, and a comparison of white murder rates with European murder rates, shows the United States is generally safer. That is to say, the immigrants to the U.S. are generally less violent, especially when factoring in crimes such as assault, rape and home invasions, than people in their ancestral nation. Despite its much stricter gun control, Europe has been the scene of more mass school killings than the United States.

California gun sales jump; gun injuries, deaths fall

Civil unrest, civil war and secession coming to America? Or World War III?

I tend to dismiss articles such as the one linked below, which ascribe a conspiracy to the inevitable (such as the collapse of the dollar), but from the standpoint of socionomic analysis, it doesn't matter whether it is true or not. What matters is that people believe it, the mood it reveals, and for forecasting purposes, whether people will act on it. When we look at Catalonia, Scotland or any secession movement, it doesn't matter if Catalans or Scots believe there is a conspiracy against them, or if their post-secession economic forecast is 180 degrees wrong, what matters is what they believe going into a secession vote.

In socionomics, we are often looking from the center out, from the standpoint of a group or individual. However, one can also see action from without. That is to say, a nation may not feel negatively towards a foreign power, but the negative action of that power could lead to war. Similarly, when looking at secessionists and anti-government sentiment, we could be seeing the intentional instigation of anti-government behavior because the government is also beholden to social mood. To use a recent example, the Oklahoma City bombing was partially blamed on talk radio and anti-government media. However, one could have just as easily blamed government policies and propaganda targeting guns, since the assault weapon ban and Brady bill preceded the attacks.

Catalonian secession cropped up so quickly, that one can reasonably ask if the Spanish government or Spanish people have not taken some anti-Catalonian action? In the case of Quebec, it's almost entirely a domestically driven movement, but outside pressure could be the trigger that makes Quebecois decide to leave once and for all. In the U.S., we see secessionist talk, but often the response to Southern nationalism is to deride Southern rednecks and say that America is better off without them. And certainly, in the run-up to the Civil War, the North was pressing its economic and political advantage upon the South.

What it boils down to in places such as the United States, where there are no established movements, is that secessionist movements will not be organic. Secession will be a reaction, not the action. The action will be oppression, the rise in authoritarianism that comes during negative social mood. The drive for secession will be the reaction to authoritarianism; it is the asymmetric response to a threat from a superior enemy.

As I've written before, negative social mood is necessary, it is part of the cycle of history. Negative social mood is the reaction that balances the positive social mood, cleaning out the failed policies of government, bankrupting the failed businesses, and settling long-simmering disputes. The particulars of how it is settled can be a net positive or negative for a nation: the United States, Russia, Germany, Japan and China all traveled divergent paths in the early 20th Century, and the choices they made impacted their nations for decades.

There's no need for secession or violent conflict, civil or international. However, governments that fail to understand social mood will make mistakes. They will behave in ways that leave their opposition with no way to act except via violent means, or they will respond to peaceful movements with violence.

Consider the current gun debate in the United States. The history is clear: last time this debate took place, there was a major act of domestic terrorism, and that happened while social mood was still net positive. Today, social mood is negative and falling. A wise government would look to defuse the situation, but instead, nearly every action of the government feeds conspiracy theories. Those inclined to believe conspiracy theories will always believe in them, but those who normally do not believe in them, start believing them when the government behaves as predicted by the theorists.

The latest from “DHS Insider”
RB: [Over talk/Unintelligible] ...know who was selected or elected twice now. You know who his associates are. And you are saying this is way over the top? Don’t forget what Ayers said - you talked to Larry Grathwohl. This guy is a revolutionary. He does not want to transform our country in the traditional sense. He will destroy it. And he’s not working alone. He’s not working for himself, either. He has his handlers. So don’t think this is going to be a walk in the park, with some type of attempt to rescue the country. Cloward-Piven. Alinsky. Marx. All rolled into one. And he won’t need the rest of his four years to do it.

DH: I need you to be clear. Let’s go back again, I mean, to those who speak out about what’s happening.

RB: [Edit note: Obviously irritated] How much clearer do you want it? The Second Amendment will be gone, along with the first, at least practically or operationally. The Constitution will be gone, suspended, at least in an operational sense. Maybe they won’t actually say that they are suspending it, but will do it. Like saying the sky is purple when it’s actually blue. How many people will look at the sky and say yeah, it’s purple? They see what they want to see.

So the DHS, working with other law enforcement organizations, especially the TSA as it stands right now, will oversee the confiscation of assault weapons, which includes all semi-automatic weapons following a period of so-called amnesty. It also includes shotguns that hold multiple rounds, or have pistol grips. They will go after the high capacity magazines, anything over, say 5 rounds.

They will also go after the ammunition, especially at the manufacturer’s level. They will require a special license for certain weapons, and make it impossible to own anything. More draconian than England. This is a global thing too.
People are agitated about guns, and nothing the government is doing today is designed to calm the population. It's doing the exact opposite, driving people to buy more guns and ammunition.

Now here's more of the conspiracy:
During all of this, and you’ve got to remember that the dollar collapse is a big part of this, our country is going to have to be redone. I’ve seen - personally - a map of North America without borders. Done this year. The number 2015 was written across the top, and I believe that was meant as a year. Along with this map - in the same area where this was - was another map showing the United States cut up into sectors. I’m not talking about what people have seen on the internet, but something entirely different. Zones. And a big star on the city of Denver.

Sound like conspiracy stuff on the Internet? Yup. But maybe they were right. It sure looks that way. It will read that way if you decide to write about this. Good luck with that. Anyway, the country seemed to be split into sectors, but not the kind shown on the internet. Different.

DH: What is the context of that?

RB: Across the bottom of this was written economic sectors. It looked like a work in progress, so I can’t tell you any more than that. From the context I think it has to do with the collapse of the dollar.

Most people cannot conceive of a collapse in the U.S. dollar. Despite the economic forecasts that have existed for nearly 40 years now, the vast majority of people do not expect a collapse of the dollar. Even those who buy precious metals and expect the dollar to undergo a crisis haven't thought through what the world will look like if the dollar collapses. I would bet that a larger percentage of the population believes that Obama wants to destroy America and the U.S. dollar. Therefore, if the dollar does collapse, what's going to be the response? Besides anger at Wall Street and Washington, will people have serious debates about the monetary system? Will they gravitate to Ron Paul? Or will they believe that the collapse was a conspiracy, part of a plot by a government that is simultaneously trying to confiscate their weapons and violate the most important right listed in the Bill of Rights?

A Survey of U.S. Secessionism: Negative Social Mood Will Vent — but Where?
Examples from the past and present show that common enemies often forestall civil wars. War with Carthage redirected ancient Rome’s internal conflict for many years. Once Rome defeated its enemy, civil war intensified and the empire began its famous decline. The Spanish-American War in the decades following the U.S. Civil War provided a common enemy that helped to heal the residual bitterness between North and South. The 1919 Anglo-Afghan War united long-adversarial Pashtun tribes against the British. As Euan Wilson described in the January 2010 Socionomist, the intensity of the Chinese Civil War waned when Japan expanded its incursion from northern China into Manchuria. After Finland lost its common enemy and oppressor, Russia, during the Russo-Japanese war, it promptly erupted in civil war. A prolonged political enmity followed, but it eased when Finns again faced a common enemy in World War II. In 2009, previously hostile Pakistan and Afghan Taliban factions united to oppose the buildup of 17,000 U.S. troops. Recent reports show Taliban groups again bonding as they face the current 30,000 troop American surge.

...Politicians and government propagandists are well aware that the portrayal of a common enemy can rouse emotional solidarity and group identity, which in turn redirects internal dissent and discord. Alexander De Conde’s History of American Foreign Policy says William Seward, Lincoln’s Secretary of State, advocated “a policy of hostility or war” against several European nations to “win back the loyalty of the seceded states and avoid civil war.” But Lincoln famously urged “one war at a time” and refused to initiate or respond to foreign provocations during the war.
What's the most likely response to growing secessionist talk in the United States? A foreign war.

No to gold standard, Yes to gold reserves

Arguments for using gold in the monetary system range from those advocating a hard gold standard to the concept of Freegold. One would need to read through the archives of FOFOA to fully understand freegold, but I like to state it simply as allowing gold to freely float against other currencies. Gold would function as a wealth preservation asset for the wealthy and central banks, and to the extent it was needed, it could be used to balance accounts between nations. There would still be fiat money, in essence the role of money and savings are bifurcated—central banks accumulate gold instead of dollars or U.S. Treasuries. However, it is a voluntary system, in the sense that no formal laws are written requiring gold. This voluntary system would essentially function as a formal system, however, since central banks that do not have gold would have trouble maintaining the value of their currency in the absence of extremely prudent management.

You may think the concept of freegold or a free floating gold price isn't going to happen. If you believe this, however, you aren't watching the reserves of central banks. Central banks have switched from selling gold to buying gold, led by China and other emerging markets. However, even central banks that do not buy gold have seen their gold reserves increase due to the rising gold price.

Here is the euro reserves:

The price of gold has increased more than 500% from its lows in 2000, lifting it's share of reserves from 30% to more than 60% of the Eurosystem. A double in the gold price, to $3300 an ounce, would lift gold reserves to more than 80% of assets (holding foreign currency steady).

Gold is well on its way to balancing the balance sheets of central banks. The Federal Reserve and other central bankers are expanding their balance sheets to prop up their banking systems, which means gold needs to rise higher to balance the books. The trend is obvious though, to any who are watching. Gold will balance the books of the central banks, and gold will replace foreign currency holdings, particularly the U.S. dollar. The dollar as reserve currency is coming to an end; gold as reserve asset is coming into being.


China's aristocrats

Chairman Mao was an emperor, and although there is no emperor today, the ruling Communist Party resembles the aristocracy under empire more than anything else. Bloomberg has the family trees and connections between the founding families.

Mapping China’s Red Nobility


For those with time to spare

Here's Kyle Bass talking about sovereign debt risk and Japan.

At one point, he relates a conversation with a Japanese central bank official. Bass says something to the effect of, "How can you complain about monetization of debt, when you're doing it?" And the central bank official replies, "It will be money printing when the market says it is money printing." Bass rightly views this as talking out both sides of the mouth, but the official is also correct. Global central banks are monetizing debt at a rate sufficient to generate substantial inflation (easily 10% per annum as a low estimate), but this is being offset by massive credit destruction and a reluctance to loan/borrow on the part of banks and individuals.

Eventually, this will change and it will be a psychological change. At the time of the shift, people will explain it as fundamental, but it really isn't. Central bankers are playing musical chairs, only they do not know how many chairs are remaining. Therefore, they will continue inflation until the music stops and the first central bank has no chair.

Thus, the central bank official is correct in his reading of the market. His mistake is that he is making policy. There will be no escape when the music stops.

Social mood can provide a clue as to when a shift will occur, and the direction doesn't matter. If there is a greater negative mood, foreigners may impose a devaluation on the yen. If social mood suddenly improves, Japanese borrowers will generate the inflation. Any volatility, up or down, will puncture the equilibrium and send the yen careening.


One vote for Prechter's Grand Supercycle top

Some perspectives from Prudentius
"The past isn't dead; it isn't even past." And we all know that America is Rome. Late Rome.

But which late Rome? The late Republic? Or the late Empire? Do we deserve an Augustus? Or are we just waiting for our Alaric?

Tonight I thought we'd hear from one of the leading experts on the subject. That's right - let's give a big hand to Aurelius Prudentius Clemens (no relation to Sam). Courtesy of our capable medium, Sister M. Clement Eagan, C.C.V.I. (Incarnate Word College, San Antonio, TX, 1965), we'll speak with Prudentius live and in blank verse - from the very special year 403.
He goes on to quote the Roman poet:
To curb this madness, God has everywhere
Taught nations to accept the selfsame laws
And Romans to become -- all by the Rhine
And Danube washed, by Tagus' golden flood,
The great Ebro and Hesperia's horned stream,
The Ganges and warm Nile with seven mouths,
He bound them by a common law and name
And brought them into bonds of brotherhood.
In all the world they live as citizens
Within their native city's sheltering walls,
United round the same ancestral hearth.
Tribes far apart and sundered by the sea
Are brought together through appeals and trials
In common courts, through their commerce and trades
In crowded marts, through intermarriage
With those of other climes; for many bloods
Are intermingled in a single race.

This Roman poet is expressing the exact same ideas expressed by Americans today, a world united by a single government, even bringing forth a single race through intermarriage. A peak social mood sentiment, only made possible by a global peace kept by a global hegemon.


America is doomed; Neo-Hoover/FDR administration is about to crush the economy

China has only two years to rebalance before the U.S. consumer is removed from the global economy by a tax storm. China will be forced to rebalance away from the U.S. in two years if they don't take action now, as the entire global economy finally "decouples" from the United States.

Obamacare will blow a hole through the budget and cause a debt and currency crisis in the United States unless there are massive tax increases to close the hole. Currently, taxes must rise by 5% of GDP to close the budget deficit, but when Obamacare kicks in, it will add a couple more percentage points. The most likely tax is a VAT tax, which will also hit imports, and cause the price of retail products to rise substantially, killing off the consumer economy.

Any company, industry or nation relying on the U.S. consumer is headed for major trouble because this will hammer the economy worse than 2008. If taxes do not rise, the U.S. dollar is toilet paper. If global growth is strong, emerging markets will pick up U.S. slack, keeping commodity prices elevated. If the global economy weakens, commodities could take a bruising, especially since a China rebalancing means a drop in infrastructure investment, and therefore commodity demand will fall. Gold and possibly silver will be the exception as this crisis could metastasize into a major financial crisis, reminiscent of the United Kingdom in the 1970s.

Here's a conversation about the coming taxes, most likely a VAT tax by 2014. Financial Sense News Hour December 22, 2012.

Know your social mood: North Korea is opening up

North Korea is slowly opening up the country with economic reforms. Chinese businessmen are the main participants given North Korea's political isolation.

Evolving Pyongyang
However, the interpreter also told him that the unofficial private markets in North Korea, which were highly opposed by Kim Jong Il, are thriving nowadays. The middle-aged women who sell products on the streets of Dacheng and Shunan districts no longer need to worry about being arrested. Farmers are allowed to sell 30-50 percent of their harvest in these markets.


Euro shorts evaporate

Speculators may have turned net long this week, if the trend continued into Friday. However, the euro is surprisingly weak given the amount of buying. A volatile move is coming, one way or the other.


SEC cracks down on Chinese auditors, stocks could face delisting

This is from early December:

SEC Starts Proceedings against Affiliates of Five Accounting Firms
The Chinese affiliates of Deloitte, Ernst & Young, KPMG, PricewaterhouseCoopers and BDO were charged with violating the Securities Exchange Act and the Sarbanes-Oxley Act, the SEC said on December 3.
The Sarbanes-Oxley Act requires foreign public accounting firms to provide the regulator with audit paperwork involving companies trading on U.S. markets.

The SEC did not reveal the names of the nine Chinese companies in connection with its charge.
An administrative judge will schedule a hearing and determine the appropriate "remedial sanction" against the firms, it said.

This is the latest:

Auditing Spat Dividing U.S. and China Turns Ugly
"It concerns national sovereignty and is against the (Chinese government's) secrecy law for foreign regulators to get China-based accounting firms' auditing papers as they wish," the official said. "We have different thinking on securities regulation" than the SEC. "China cannot give the U.S. the freedom to enter China and investigate wherever they want."
If there isn't a resolution, all the Chinese stocks on the U.S. exchanges may be forced to delist.


Voters continue swerving from left to right, right to left

It is almost a truism in this period of negative mood: voters will elect the opposite end of the political spectrum in the next election. The only potential exception to the rule is, if the winning party pursues a radical agenda, they can secure reelection.

Japan is now about to test this exception: LDP wins absolute majority
The LDP has won 277 seats, more than the absolute majority of 266, in the 480-member House of Representatives. Absolute majority allows the party to allocate chairpersons to all 17 standing committees of the chamber and also secure a majority in all of them.

The LDP's coalition partner, New Komeito, has won 28 seats.

Combined, they have 305 seats. Attention is now focused on whether the 2 parties will win a total of 320, the two-thirds majority that allow bills to be enacted in a re-vote if they are rejected by the upper house. The LDP and New Komeito are short of a majority in the upper house.

The Democrats have won only 48 seats and are likely to lose more than two-thirds of the party's pre-election strength of 230 seats.

Newly-formed Japan Restoration Party led by former Tokyo Governor Shintaro Ishihara has won 43 seats.

Your Party led by former administrative reform minister Yoshimi Watanabe has won 13 seats.
This represents a major win for right-wing parties. The four parties mentioned all have right-wing economic platforms. For political reasons, those not in power may vote against the majority, but at least in theory, there's a 75-80% coalition in favor of tax cutting and deregulation.

LDP leader Shinzo Abe has a radical agenda that goes well beyond tax cutting though.

Everyone Is Talking About A Japanese Game-Change That Could Finally Break The Back of The Yen
BOJ's Shirakawa Calls Abe's 3% Inflation Target Unrealistic
The right-wing politician, who has recently returned to head the main opposition Liberal Democratic Party after giving up his premiership five years ago due to poor heath, is also calling for "unlimited" monetary easing by the BOJ and a reduction in the policy rate to zero or below zero from the current range of zero to 0.1%.

Shirakawa brushed off Abe's call for underwriting construction bonds to be issued for financing public works spending, saying that the BOJ has already been buying large amounts of JGBs, and even that could be interpreted as financing fiscal needs.
One big difference between the LDP and the Restoration Party is that the former favors a Keynesian approach, whereas the latter prefers a supply-side approach. However, the key policy shift is the 3% inflation target. If successful, it would change the global economy, let alone Japan.

Abe will need to hit his target if he wants to avoid his earlier fate and the fate of every Japanese PM since the mid-2000s. Here's what the LDP is up against:

Source: Prime-Ministerial Unpopularity Contest at the Edge of the Japanese Abyss


Massachusetts is stupid

Amazon To Collect Taxes From Massachusetts Residents
Online retailer Amazon.com has reached a deal with Massachusetts to start collecting the state’s 6.25 percent sales tax from Bay State residents.

...Gonzalez says the deal will help level the playing field for traditional “brick and mortar” stores in Massachusetts that are competing with Internet retailers.

I Want It Today
But now Amazon has a new game. Now that it has agreed to collect sales taxes, the company can legally set up warehouses right inside some of the largest metropolitan areas in the nation. Why would it want to do that? Because Amazon’s new goal is to get stuff to you immediately—as soon as a few hours after you hit Buy.
Kiss local retail good-bye.

Disease spike in NYC

Study Shows Soaring STD Rates In Many Areas Of New York City
The study said 33 percent of all the ZIP codes in New York City were in the top quintile citywide for multiple sexually-transmitted diseases during a survey taken in 2010. Among the most severe examples is ZIP code 10474 in Hunts Point, the Bronx, where rates of hepatitis C, chlamydia, gonorrhea and HIV/AIDS all ranked in the top 20 percent of all New York City ZIP codes.
Disease outbreaks increase during periods of negative social mood.


More thoughts on dematerialized gold, or paper gold

Last week I wrote in Dematerialized gold in India—it's about the rupee, not gold
Many gold bugs are pointing to this story as evidence of a lack of physical gold. The reality is much simpler: India is trying to defend its currency and cut imports. The aim is to redirect speculative and financial demand into a paper market, with the goal of reducing imports. There's not really a conspiracy here, at least not the one the gold bugs are looking for. If there's a "real" reason behind the move, it is to protect the value of the rupee.
The gold bugs are transferring their belief about paper gold onto the Indian government's attempts to spread the gold demand into financial products. One of the constant arguments made by gold bugs is that many people who buy paper gold think they are getting physical.

I do not believe this is the case. There are derivative products for everything, including single-stock futures, for those who wish to engage in speculation. In the grand scheme of things we could argue about the growth of simulacra, but at the micro level, there are people who simply wish to speculate and who prefer the virtual nature of the transaction.

That said, the move to paper gold does reflect a great truth in the gold bugs' argument. Without the existence of gold futures, gold ETFs and gold derivatives, physical gold prices would be higher. India wouldn't care about gold imports if the rupee were stronger; it cares because gold is becoming a drag on the rupee and could result in a self-reinforcing cycle that wrecks the currency. Gold bugs will say that will happen to all fiat paper eventually (and I agree), but the reality is that if India had a domestic supply of gold, the Indian government would not be pushing paper gold today.

The issue with gold is that it is money. Some countries lack food, others energy, others consumer goods. If their citizens run a large trade deficit, this will put pressure on the currency, pushing its exchange value lower (in the long-term). In the case of gold, however, it is also a signal of the health of a currency.

In the end, India's problem is not really gold. It is about weakness in the political-economy. They are dealing with a symptom, rather than a cause. The greatest proof of this is China. Why has Chinese gold demand surpassed that of Indians? China is India's mirror case: the government promotes physical ownership of gold. Physical gold products are on sale at state-owned banks, alongside brochures for precious metals accounts.

China has a politically dangerous trade imbalance and the concurrent problem of massive fiat currency reserves piling up on the central bank's balance sheet. Gold importation is a perfect solution: it reverses the trade balance and slows the flow of foreign currency. It also has the effect of being non-competitive with Chinese firms: instead of importing consumer goods, Chinese are saving. They may use those savings to consumer foreign goods in the future, or not. Buying gold today is the ultimate currency "sterilization" for the Chinese central bank. Instead of the PBOC issuing renminbi to buy U.S. dollars from Chinese importers, Chinese are using the dollars to import gold. They achieve all of their policy goals without the cost of rapidly rising forex reserves.


Euro shorts ease up

China's economy slowly winds down

China has put up annual GDP growth of more than 7% this year, slower than previous years, but still impressive. M2 continues to grow at mid-double digits rates. The Shanghai Composite Index, meanwhile, is probing new 3 year lows and is within striking distance of the crisis lows! The actual low set on November 4, 2008 at 1706.7, a decline of 13.8% from today's close, a significant decline, but not unimaginable. Currently, at a November 2012 close of 1980, the Shanghai Composite is trading at levels last seen in November, December and January of 2008-2009.

I had to readjust the axis on the Shanghai Composite for the chart below, it was set at 2000. This shows continued deceleration in M2 and the sliding stock market.

Where is this headed? Some economic indicators are turning up, but the money supply figures indicate things are edging closer to deflation. What's most interesting is the hot money from QE3 flowed into China, yet didn't manage to push money supply higher; instead we saw the third month-on-month decline in M2 this year.

Technically, the 2008 lows are strong support. Psychologically, they are strong as well. However, it is a fragile psychology. The initial reaction will be: with 4 years of strong economic growth, why are stocks at 2008 crisis levels? Chinese stocks are some of the cheapest in the world, now is the time to buy!

The next reaction will be: what is wrong? If the answer to that question is debt and unsustainable earnings based on real estate and other speculative projects, then the lows could be breached with authority.


Gold and silver miners cheap relative to gold and silver

Junior gold miners ETF could rally 100% and still not reach the relative price levels seen in early 2011. The big miners (GDX) could stand to rally 50%, while silver miners (SIL) could pop 30%. This is all based on the recent past: GDXJ and SIL have less than 3 years of history. This shows how undervalued the sector is, as the past three years of data ignores the peak levels hit at the top of the financial bubble.

Dematerialized gold in India—it's about the rupee, not gold

Gold bugs are reading this situation wrong, as they did before with regards to Indian gold taxes.
'Demat gold to arrest rising demand'

In India, the high price of gold fails to make a significant dent in massive consumer demand, where gold is used as savings and doubles as wedding jewelry. This leads to massive imports of gold, which causes a current account deficit for India, which weakens the currency, which then makes gold more attractive as an investment. In a normal economic cycle, rising prices would eventually kill demand, but in financial markets there is a positive feedback loop. Rising prices make the asset more attractive, leading to more buying and higher prices, until everyone is involved in the bubble and prices collapse. (I don't think Indian gold demand is a speculative bubble, but the effects of rising prices are the same because one component of demand is speculative.)

Many gold bugs are pointing to this story as evidence of a lack of physical gold. The reality is much simpler: India is trying to defend its currency and cut imports. The aim is to redirect speculative and financial demand into a paper market, with the goal of reducing imports. There's not really a conspiracy here, at least not the one the gold bugs are looking for. If there's a "real" reason behind the move, it is to protect the value of the rupee. As the chart below shows, gold has been a steady winner in rupees and is already back near a new nominal high. If this is smoke, the fire is a slowly unfolding run on the rupee.


Self-determination: coming to a country near you!

Separatists winning in Catalonia, Spain: early results
With half of votes counted, the ruling Convergence and Union alliance, or CiU, was winning 48 seats in the 135-seat local parliament, well down from its current 62 seats.

The separatist Republican Left, or ERC, was winning 20 seats, with two other smaller separatist parties taking a total of 16 seats, giving the four parties 60 percent between them.

Regional President Artur Mas, of CiU, had campaigned on a pledge to hold a referendum on independence, in response to a resurgent separatist movement among Catalans who are frustrated with Spain in a deep economic crisis.
The Reuters article says the main party losing seats may derail a referendum. I see the opposite: the main party lost seats because it is a latecomer to the independence movement.

The recent outbreak of secession talk in the United States could very well end up in the same place as Catalonia. While the U.S. federal government claims states cannot secede, the United States supports secession and self-determination all over the world, from Tibet to Kosovo, sometimes even fighting wars to create new countries. In the not too distant future, you may read news of U.S. states seceding, appealing to the U.N. charter and receiving support from China and Russia.

This article from ABC lays out some of the problems related to secession. The main one is economic: people who choose security over self-determination will obviously opt for security, as seen in Quebec and as will probably be seen in Scotland. In places where the desire for self-determination is stronger, or where there's a strong economic foundation, secession will gain support as social mood declines.


Anti-foreigner sentiment continues to grow

Many Hongkongers urge cut in number of mainland immigrants
In the poll results released yesterday, more than half - 53 per cent - said new immigrants enjoyed welfare benefits, but did not contribute to society, four out of 10 said migrants both enjoyed welfare benefits and contributed to society, while only 3 per cent thought they made contributions without enjoying welfare.

French woman sings, faces racist rant on Melbourne bus
Australian police were Thursday investigating after bus passengers were caught on camera hurling a torrent of threatening and racist abuse at a French woman in an incident that went viral on YouTube. The woman and a group of friends were returning from a day at the beach when one of them

began singing in her native tongue, prompting an angry reaction from some of the passengers on the packed bus.
One aggressively demanded she "speak English or die" and then threatened to cut her breasts off. Another man pushing a pram joined in, shouting: "I'll fucking boxcutter (knife) you right now, dog."

The woman was then told "everybody on the bus wants to kill you" before the incident ended with a bus window being smashed.
Funniest part of the story: Australian police consider the French to be a different race.

American democracy + multiculturalism + negative social mood = recipe for major conflict

SPIEGEL: During your career, you have kept your distance from Western style democracy. Are you still convinced that an authoritarian system is the future for Asia?

Mr. Lee: Why should I be against democracy? The British came here, never gave me democracy, except when they were about to leave. But I cannot run my system based on their rules. I have to amend it to fit my people's position. In multiracial societies, you don't vote in accordance with your economic interests and social interests, you vote in accordance with race and religion. Supposing I'd run their system here, Malays would vote for Muslims, Indians would vote for Indians, Chinese would vote for Chinese. I would have a constant clash in my Parliament which cannot be resolved because the Chinese majority would always overrule them. So I found a formula that changes that...
"It's Stupid to be Afraid"


Excellent post by Mish puts the kibosh on yuan as new reserve currency

There has been a flurry of yuan talk of late, about a new yuan-bloc of nations that are using the renminbi more than the U.S. dollar. While the renminbi continues to grow in importance and currency reforms continue to expand the use of the yuan, the facts on the ground differ from the hype. China doesn't want the yuan to be the reserve currency.

Furthermore, although Mish doesn't get into this, China's currency reform is creating structural weakness, not strength, in the short-term. Over the next few years, the risk of a currency crisis in China will rise because pent up demand for foreign assets on the part of Chinese individuals and companies will drain the central banks reserves. Any policy missteps could lead to a rush for the exits, rather than a slow and steady rebalancing of the economy.

I see yuan hype as mostly coming from U.S. dollar bearishness. People are trying to figure out what will replace the U.S. dollar. Looking at "recent" history, the two reserve currencies were the British pound and then the U.S. dollar—two major superpowers with large numbers of colonies/allied/client states around the globe. Looking ahead, odds favor a multipolar solution, which argues for gold or some type of global fiat currency as the new reserve currency.

Anyway, on to Mish:

Is the Yuan About to Replace the Dollar as the World's Reserve Currency?
Three Essential Facts

1. China's bond markets are not big enough or deep enough for the Yuan to displace the US dollar.
2. Contrary to what most think, having the reserve currency is a a curse more than a blessing.
3. Neither China nor the US wants to be the global reserve currency.

The first point alone seals the fate in my opinion but let's take a closer look at the "curse of the reserve currency".


Bad news for China, if true

Conservatives dominate latest line-up for new Communist Party leadership
However, the sources said that the Politburo Standing Committee's likeliest line-up was now packed with conservatives including vice-premier and Chongqing party chief Zhang Dejiang , 65, propaganda chief Liu Yunshan , 65, Shanghai party boss Yu Zhengsheng , 67, and Tianjin party chief Zhang Gaoli , 65.

They said the biggest surprise was the omission of two reform-minded protégés of party general secretary Hu Jintao - party organisation department head Li Yuanchao , who turns 62 this month, and Guangdong party chief Wang Yang , 57 - mainly due to their relative youth and opposition from conservative party elders, including former premier Li Peng .
I expected the fall of Bo Xilai, a victory for reformers, to be followed by a reform-dominated Politburo. Instead, it appears conservatives are taking control, dashing the hopes for serious reform. There may still be economic reform, after all many major economic reforms occurred under Jiang Zemin, but it also could mean the party will maintain its tight grip on the economy.

An opening of the economy could provide the growth spurt necessary to ease the transition to a consumer economy. Without reform, the dead weight of state owned enterprises will tip the economy in the other direction, leading to much slower growth and a potential currency crisis in coming years.


Best election trade: buy Romney at Intrade

If you are able to trade on Intrade, a good bet is to buy Romney contracts, currently trading at $3.13. They will pay $10 in the event Romney wins and expire worthless should Obama be reelected.

Based on current polling, I expect Obama could win an extremely close race, but most polling is based upon a heavy Democrat turnout. I believe that polling assumption is wrong and Republicans will turn out in higher numbers than in 2008. Depending on the strength of that turnout, I believe a Romney "landslide" is in the cards.

You can also bet on state-by-state elections. Ohio is right in line with the Presidential contract because Ohio is seen as the lynch pin of the election. There's no advantage to buying Ohio then, since it's the same payout as with Romney. However, one could speculate on Pennsylvania or Michigan (I lean towards Pennsylvania). Currently Pennsylvania is $1.68 and Michigan is $1.59.

I can't trade with Intrade due to U.S. government restrictions. If I could trade, though, I'd drop the $300+ needed to pick up 100 Romney contracts.


Chinese fighters join Syrian battle

Uygur separatists join civil war in Syria, party daily says
Uygur separatists from the northwestern autonomous region of Xinjiang are battling Syrian government forces alongside al-Qaeda and other extremist groups, an official newspaper reported yesterday.

Radical members of the ethnic Turkic minority had been travelling to Syria since May to join the fighting in missions organised by groups opposed to Beijing's rule over Xinjiang, the Global Times, a tabloid affiliated with the Communist Party mouthpiece People's Daily, said.


Hot money pushes yuan higher

A Citibank report says that 90% of hot money is coming from North America and 80% of it is going to China. Deflation is not what China needs in the long-run, but that is what it will get if the currency continues to appreciate.

Citigroup Capital flows to tracking reports, the renminbi assets are the most important the flow of the current round of hot money. October 26 Flow report shows that Asia (October 24 week) single-week inflows of $ 1.3 billion, most of which inflow of RMB ETF (exchange-traded funds), the scale of over 1.1 billion U.S. dollars, accounted for about 85% of the total.

In addition to the ETF, the Hong Kong H shares and RMB-denominated fixed-income products is also hot money put into focus.

花旗追踪报告:热钱90%来自北美 80%被中国吸引


China real estate news: group spend 100 million yuan to buy 616 apartments in Guiyang

The headline uses an idiom that means "something malevolent comes back haunt," it literally translates as the ashes burning again. The story is about a real estate speculating group (made famous by the Wenzhou groups), investors who pool their money to buy property. Is the monster back or is this the last gasp of the bubble? Second and third tier cities aren't as bubbly as Beijing and Shanghai, but this story is getting a lot of play regardless.

“炒房团”死灰复燃 富豪掷1亿贵阳买616套商业公寓


Beijing high-end property price cut by 1,000,000 yuan

Chinese financial media is asking whether another wave of price cuts is underway, but industry sources say that these cuts are limited and won't impact the broader market.

北京惊现特价房直降100万 新一轮降价潮能否再现?

Must read: the loans are the deposits, money multiplier is bunkum

Steve Keen goes over the money creation system again in: The myth of the money multiplier
if the Money Multiplier model doesn’t really describe how money is created, and how reserves figure in this, what does?

The short answer is “endogenous money”: bank lending creates deposits, so the decisions of banks to provide loans determine the level of money, and reserves are largely irrelevant. But today I want to attempt a longer answer that actually puts reserves in the picture, so I’m going to model (take a swig of coffee) a system with 3 banks: a “Buyer Bank” where a Buyer has both a deposit account and a credit card (or line of credit); a “Seller Bank” where a Seller has a deposit account, and a Central Bank that keeps the Reserve Accounts of both banks.

It’s an incomplete and unrealistic model because the money flow goes only one way – from Buyer to Seller, and therefore from Buyer Bank to Seller Bank – and therefore Buyer Bank must ultimately run out of Reserves. But it’s still effective in showing the basics of a more complete model in which money flows both ways.
He warns that it is a wonkish article, but it goes over the concept in depth. For those still trying to grasp the idea, it's worth a read. Here's one critical part, emphasis mine:
I hope the answer to that question is now obvious: of course it won’t. The Central Bank will either give Buyer Bank time to find the Reserves, or lend them to it. To do otherwise – to refuse to transfer Reserves from Buyer Bank to Seller Bank – would void the purchase made by the Buyer from the Seller (and note that this could happen with the Cash purchase just as easily as with the Card one). The system of commerce would break down. We’d have an interesting social system the instant after the Central Bank did such a thing, but it wouldn’t be called capitalism.

I hope this also explains why, in every country in the world where Reserve Requirements exist (and that’s not every country – Australia, for one, doesn’t have them), they are backward-looking: they depend on the level of deposits existing in the previous reporting period “and thus after banks have extended the credit demanded by their customers”. It should also explain the comment made by Alan Holmes over half a century ago that the Fed has “little or no choice” about doing this:

In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. The question then becomes one of whether and how the Federal Reserve will accommodate the demand for reserves. In the very short run, the Federal Reserve has little or no choice about accommodating that demand.
Reserves come later. The central bank is the caboose, not the engine of money creation!


French nationalists occupy major mosque construction site

The media is not covering this, likely out of fear of angering Muslims. It won't do much good though, it is being picked up by Christian and Islamic news organizations. Furthermore, this doesn't look like a one-off event, but rather the possible start of a movement.

French Youth Occupy Mosque over the Islamization of France
The mosque is in the city of Poitiers, where Charles Martell drove away Muslim invaders in 732. The protesters hung a banner on the mosque that read "Generation Identitaire" and demanded a referendum on immigration and mosque construction. The banner also included the number 732.

After police arrived, the protesters left peacefully and three were detained for "incitement of racial hatred" and damage to property.

Muslim leaders, who aren't used to this kind of thing in France, expressed incomprehension over the stunt.

"We are thunderstruck ... these are people who are stuck in the year 732, and who don't see that the world has changed," Poitiers imam El Haj Boubaker told France's BFM-TV. "People can live differently than in a mindset of war and conflict."

French activists occupy mosque building site
Condemnation came from the French government which described the action as "hateful provocation, and from the Muslim national umbrella organisation, the French Muslim Council (CFCM), which spoke of its "strong indignation" and condemned an occupation "without precedent in French history." Around midday the demonstrators agreed to leave after negotiations with the local authorities. A spokesman for the activists, Damien Rieu, confirmed that they were "going calmly to the exit" after "negotiating."

"We were planning to stay longer but as we had no intention whatsoever of a physical confrontation we are leaving," Rieu said. French Prime Minister Jean-Marc Ayrault, who is in the Philippines "firmly" condemned a "provocation that reveals an unacceptable religious hatred." Interior Minister Manuel Valls also condemned "hateful and inadmissible provocation" and "questionable confusions" of the group which on its Internet site refers to Charles Martel, who "nearly 1,300 years ago stopped the Arabs at Poitiers."

China's ever distorted real estate market

Hangzhou moves to rein in land prices
According to a report by House China, an online property news agency, the local government will stop the bidding when the bid for a site reaches a level that is 49 per cent higher than the opening bid. Then the bidders will have to bid with the floor area they are willing to provide for building subsidised housing on the site. The developer that allocates the most floor area for subsidised housing would win the site.


Hong Kong dollar strengthens

HK dollar is following the renminbi higher.

HKMA intervenes to curb HK dollar strength after capital inflows
“The recent increase in demand for the local currency is related to a less strained European market, weakness in the USD and declining US interest rates, which have prompted capital inflows into currency and equity markets in the region,” an HKMA spokesman said in a statement.

Traders said the recent strength in the Hong Kong dollar against the US dollar was in line with other Asian currencies because the US Federal Reserve’s quantitative easing measures had weakened its currency.

The Hong Kong dollar is pegged at 7.8 to the US dollar but can trade between 7.75 and 7.85 to the US dollar. Under the currency peg, the HKMA is obliged to intervene when the Hong Kong dollar hits 7.75 or 7.85 to keep the band intact.

“The appreciation trend of RMB recently has attracted some money flows into Asia, including Hong Kong, to buy stocks and properties,” said Kenix Lai, senior market analyst at Bank of East Asia, referring to the strength in China’s renminbi that hit a record high against the US dollar this week.


Sany sues Obama over wind farm project

Political protectionism ahead of the election.
China backs suit against Obama over wind farm deal
China on Friday said it hoped the United States would "fairly" handle a lawsuit filed by a Chinese-led company against President Barack Obama over a blocked wind farm project.

Ralls Corporation, a company registered in the US and controlled by directors of an arm of Chinese engineering giant Sany, sued Obama in a US court this month for signing a September 28 order to block the project in Oregon.

It has also sued the Committee on Foreign Investment in the United States (CFIUS) for barring the multi-million dollar investment over what Obama described as national security concerns.

Japanese firms accelerating exit from China

Two of the hottest words in Japan are "China risk" and "shed Sinicization" as Japanese firms shift their manufacturing base from China to Southeast Asia. Japanese firms are looking to Malaysia for rare earths and Myanmar as a potential market. Some firms are also moving production of value-added products back to Japan.

The impact for China should be limited unless the Japanese help start a trend. This wouldn't be the doing of the Japanese, rather economic weakness and other factors would make investors wary about China. Having seen the Japanese rapidly pull out and open new operations in neighboring countries, other foreign investors would have less of a psychological hurdle once they started thinking about such a move.

日本企业加紧“脱中国化” 制造基地向东南亚转移

Spooked by China, Japanese companies looking to Cambodia

Euro shorts lighten up, reverse prior week's move


Articles for the day

In China, a Power Struggle of a Different Order
As the Communist Party in China prepares for a once-in-a-decade leadership transition next month, it is also planning to take a giant step — to break up the monopolies enjoyed by its gargantuan state-owned enterprises.

Are Neo-Nazis Aiding Greek Cops With "DIY Law Enforcement"?
The BBC's Paul Mason reports on recent demonstrations surrounding the performance of a controversial play as tensions escalated and the Golden Dawn party "de-arresting" demonstrators - pulling them from police detention, as the police do nothing.
Greece is a perfect encapsulation of the peak social mood blowback, when the bubbles burst and public mood does a 180. More here: Alarm at Greek police 'collusion' with far-right Golden Dawn

Questions over China's Int'l Investment Position
This has "led to a currency mismatch and significant risk exposure to the forex reserve's depreciation," said Zhang Monan, research fellow at the State Information Center, a policy think tank under the nation's top economic planner, the National Development and Reform Commission.

By contrast, he said, Germany does not face similar pressure even though it is also a trade surplus country. This is because it does not need to keep a large forex reserve since the euro is a reserve currency.

Encouraging companies and individuals to hold more forex and invest the money themselves can also help end the cycle Stiglitz described, Zhang said, as is the case with Japan, which holds only 17.6 percent of forex assets in its national reserve.

Since the second half of last year, China's forex reserves have shown a month-on-month decline several times. Some experts believe that this is partly because domestic companies and individuals have started keeping more U.S. dollars in their accounts. There have been signs of stronger capital flows out of China, which many economists and regulators believe is the result of heavier Chinese investments overseas.

Chinese nationals and companies have been the main force driving recent capital outflows, a SAFE official said. In fact, "our analysis has found that the amount of withdrawal of foreign investors' investment principals has fallen compared to one year before."


Yuan futures arrive

The internationalization of the yuan contiunes......
Yuan Steps into Futures on Hong Kong Platform
China's internationalization of the yuan, also called the renminbi, is gaining pace now that the operator of the Hong Kong Stock Exchange has unveiled the world's first deliverable offshore yuan futures.

CME Group Inc., the largest U.S. futures exchange operator, said it would launch deliverable offshore yuan futures, similar to those in Hong Kong but with longer maturities, in Chicago by the end of this year to complement its portfolio of yuan-traded products, which currently includes only cash-settled onshore yuan futures and non-deliverable forwards (NDFs).

Maritime disputes in China increase as social mood declines

The political economists will tell you that maritime disputes are increasing because China is a rising power and it is trying to make a space for itself in the Pacific. To that the socionomist will ask, "so why are the Chinese fighting each other?"
Blood in the Water
Since 2001, maritime disputes have led to 26 large-scale violent conflicts between local government forces. According to Sun Shuxian, a maritime law expert and co-author of Research on Sea Area Demarcation Policies, clashes on the sea have resulted in hundreds of deaths and injuries.

The last four boundaries may soon be resolved if a new proposal by China's coastal regulator is accepted by the State Council in November. The State Oceanic Administration (SOA) is expected to submit a proposal on four major sea boundaries in the regions of Jiangsu-Shandong, Shanghai-Jiangsu, Shanghai-Zhejiang and Zhejiang-Fujian.


Changes in U.S. Credit Market 2005-2012, animated pie chart

Watch as the federal government share of the total credit market grows and grows......an interesting secondary trend to watch is that the financial and household sectors started expanding their share of the credit market again in 2012, while the federal government's share growth is slowing. The Fed will consider it a success if federal debt growth is exceeded by private credit growth, while a rising share of federal debt is consistent with deflation.

Note that totals do not add to 100% because this is not the entire market (only state & local debt declined as a share of the total credit market in 2012), but from 2005 until the most recent quarter, these sectors consistently accounted for between more than 88% and less than 90% of the total credit market.
f0BmdM on Make A Gif, Animated Gifs
make animated gifs like this at MakeAGif

This data comes from the Fed Z1 report, Table L.1, Credit Market Debt Outstanding.

Euro shorts increase


Voters swing left, right in local European elections

The bigger story is in Belgium, where secessionists won a large victory.
Communists win Czech local elections
Czech voters have repudiated their centre-right government’s austerity policies, handing the left, including a resurgent Communist party, a striking victory in local elections that threatens the administration of Petr Necas, prime minister.

Mr Necas's Civic Democrats (ODS) won only 12.3 per cent of the vote in elections which ended on Saturday, about half the vote they took in regional elections four years ago – a sign of increasing voter dissatisfaction with policies of tax rises and spending cuts aimed at driving the deficit to 2.9 per cent of gross domestic product by 2013.

Secessionist wave sweeps Belgium
Flemish nationalists made sweeping gains across northern Belgium in local elections on Sunday, a success that will bolster separatists’ hopes for a break-up of the country.
Bart De Wever, leader of the New Flemish Alliance (NVA), is set to become mayor of the northern city of Antwerp, Belgium’s economic heartland, after his party emerged as the largest one ending about 90 years of socialist rule.

Soon after the ballot results emerged, Mr De Wever, who had turned the tough mayoral race into a referendum on Flander’s independence for Belgium, demanded that the country’s prime minister give greater independence to the Dutch-speaking north.

Yuan move political, and now it's done

Headline says it all.
Beijing says yuan has reached equilibrium against US dollar

Coal and Romney


Protectionist moves against Huawei increase

If the United States deems Huawei a strategic threat, then all U.S. allies will also move against the company because their networks are closely tied in with the U.S. No surprise then, that the Anglosphere is moving as one, with Canada and the United Kingdom following in American footsteps (and all following Australian footsteps).

UK panel probes Huawei
On Friday, a United Kingdom Parliament committee said that it is investigating Huawei's business in the UK after governments from Australia and Canada also expressed concerns this week.

The UK Parliament's intelligence and security committee is investigating the relationship between Huawei and the BT Group Plc, the London-based telecommunications giant. Huawei supplies telecom equipment to BT, the Guardian and Reuters reported on Friday.
The Chinese also noticed that 73 Congressmen own Cisco stock:

美73名国会议员持股思科 封杀华为实为利益图谋
美国针对华为再调查加拿大或跟风 狙击“中华”扩大化

Yuan rise probably, hopefully not political

Steel prices have rebounded and as of August and home prices ticked higher after initial weakness, so the strength in the yuan looks like a rebound. It may be politically induced for economic reasons, but I don't think it is politically motivated. Also, I hope it isn't politically motivated, because it would be sending the yuan in the wrong direction at exactly the wrong time.
China's yuan hits record high amid US pressure
China's currency hit a record high against the US dollar on Friday, in what analysts said could be a response to US political pressure over claims the yuan is vastly undervalued.

The upcoming US presidential election and expectations the US government will soon release its semiannual report on exchange rate policies could have prompted Beijing to guide the yuan higher, analysts said.

Social mood watch: increasing injuries in young children

Injury Rate for Young Kids Increased Again Last Year
Injuries to young children in the U.S. increased for the fourth straight year in 2011, continuing a reversal of a longer-term downward trend that some say may be linked to distracted parents in an age of smartphones.
Or social mood!
The number of injuries in this age group has increased each year since 2007, when there were 2.20 million, or 10.9 per 100 children. The numbers are an estimate based on a sampling of emergency rooms.

Renminbi breaks to 2012 highs

The best thing for the renminbi is to remain stable here, but the recent rally to May levels certainly puts a damper on concern of renminbi declines here. The PBOC doesn't want to see the renminbi strengthen either, however, since it will hurt the export sector and facilitate dollar purchases by Chinese, who continue to diversify out of the renminbi.


WTO will fall apart

Here's Andy Xie on the rise of protectionism. It wouldn't take much to deep-six the WTO, but it could continue to exist as a powerless organization in the face of rising tariffs and trade disputes.
The End of the WTO's Golden Era
The difficulties in resolving the inequities from globalization through increasing taxes will eventually shift politics to focus on trade directly. The rules for governing multinational activities will become more complicated in future. The barriers against outsourcing will multiply. Import duties may rise. Selective use of anti-dumping cases will be used more frequently to protect existing industries.

The golden era of the WTO system is coming to an end. Indeed, trade disputes could multiply sufficiently to overwhelm the WTO system.

Economists tend to blame the trade protection policies of the Western economies for causing or worsening depressions. The reality is probably more complicated. The labor market has limited capacity to cope with globalization. The political backlash against globalization is inevitable when the later moves too fast.

Trade has grown twice as fast as GDP in the past two decades. This relationship is unlikely to continue. The best scenario is for the two to grow at the same pace. The global economy will probably be stuck around 2 to 2.5 percent. So would trade.


Belated euro COTS chart: euro shorts and euro hold steady

Here's the updated chart for October 2 data.

Protectionism: it's on like Donkey Kong

This looks to be the beginning of serious protectionism efforts by U.S. industry and the U.S. government.
Cisco Bashes Huawei, Cuts Ties With ZTE
Speaking to CRN recently, Cisco CEO John Chambers took aim at Huawei in particular, telling the trade journal, "they've got some people really questioning, do they play by the rules, of which I'm clearly one of them who says, no they don't."

Earlier in the week, it was reported by Reuters that Cisco cut ties with ZTE after an internal probe determined that Cisco products were being sold to Iran by the Chinese telecommunications equipment maker in contravention of the U.S. sanction regime against that country.

China's ZTE says Cisco has ended cooperation
In a statement late Tuesday, ZTE confirmed media reports that Cisco earlier this year scrapped a 2005 strategic cooperation agreement which included purchases of equipment from the US Company.

"In July 2012, Cisco informed the company (ZTE) that it terminated the strategic cooperation agreement entered with the company in 2005, mainly in relation to the company's purchase of routers and other products," ZTE said.
Cisco is clearly using the opportunity to attack its rivals. The Huawei situation is more natural, since there's bad blood between the firms, but the move against ZTE smacks more of opportunism.


Steel prices continue to sharply rebound in China

Chinese customer buys 95-kilo gold bar for 35,000,000 yuan

A Chinese customer at Caibai bought a 95-kilo bar. He frequently buys and sells gold, this time making a huge purchase due to QE3. He sees gold breaking $1800 an ounce. In USD, his purchase is worth more than $5 million. Were gold to rally $50, this customer would stand to gain about $150,000 or close to ¥1 million。

金价再创新高 投资客买95公斤金条价值3500万元


State of play in Q32012: Fed and U.S. government policy is not enough to offset deflation

The U.S. national debt cannot be “inflated away” using typical policy tools, inflation is not possible without the government taking “extreme” measures, deflation remains the greatest threat and most government action will at best only cause stagflation.

U.S. national debt

In discussing the U.S. debt situation, it is first important to set the table.

U.S. GDP: $15.2 trillion
U.S. Federal Debt (hereafter referred to as federal debt): $16.0 trillion (as of September 2012)
U.S. Federal Public Debt: $11.0 trillion

The difference between the two debt figures is intragovernmental debt, such as the Social Security “trust fund.” Just looking at these numbers, we see that debt now exceeds GDP. This means if U.S. debt grows 1%, the economy must grow 1% just to keep the debt/GDP ratio constant. Currently, the U.S. is struggling to achieve 2% GDP growth and has a budget deficit of about 8% of GDP. It also means that if interest rates are 5%, the government must collect 5% of GDP in taxes just to pay interest on the debt. Historically, the federal government has collected about 20% of GDP. Put these two facts together, and the U.S. is only a few years away from debt levels that will bankrupt the government, should interest rates rise. (Japan, with government debt at more than 200% of GDP, is a disaster waiting to happen.)

The public debt number represents all the bonds held by everything from central banks to the individual investor. The rest is owed to government agencies, mainly Social Security. As the Social Security trust fund depletes in the next decade, Congress will not have the money to redeem those bonds, so it will issue new bonds to the public, basically rolling those bonds into the public debt column. In other words, it will eventually become public debt. Legally, Congress could change the Social Security program at any time and if it wanted to, it could effectively cancel out that debt and cut benefits, but that would require a politically unpopular and improbable act.

U.S. Federal Spending: $3.6 trillion
U.S. Federal Revenue: $2.3 trillion
U.S. Budget Deficit: $1.3 trillion (FY2012 through July 2012)

The budget deficit is more than 8% of GDP. That means if GDP does not grow by 8%, the debt/GDP ratio will get worse every year this large deficit remains (and despite rosy forecasts, it probably will remain). If you remember the deficit debates of the late 1980s and 1990s, there is no comparison, back then deficits that were 3% of GDP sparked outrage. Also, in the 1990s, the economy grew much faster than deficits and debt was shrinking as a percentage of GDP, even before the Republican Congress and Bill Clinton compromised and slowed federal spending growth. We are now in the opposite situation, where the growth of debt is reaching the point of escape velocity once compound interest takes over. When the government reaches the point of issuing bonds to pay interest, it will be game over.

Excessive debt slows growth

A widely cited statistic from a paper by Kenneth Rogoff and Carmen Reinhart, (whose book on government debt titled, “This Time Is Different: Eight Centuries of Financial Folly” examines the history of government debt and has made them two of the most sought after experts on the topic) says that when governemnt debt-to-GDP ratios reach 90%, GDP slows by about 1%. (Source: Growth in a Time of Debt) Some critics challenge this stat, but debt-to-GDP is now over 100% and growing at 8%-plus per annum. I think its a reasonable to assume it is now a drag on growth.

This is important because some budget control plans (specifically the widely referenced Ryan plan) assume stronger GDP growth. The longer the U.S. runs large deficits, the harder it will be to get back to 3% growth and the worse the situation becomes. At some point, the deficit reaches an unsustainable level and the government cannot slow its growth.

When will the debt become unsustainable?

The debt would be unsustainable once debt-to-GDP was high enough that interest payments consumed a large portion of government revenues. The Treasury provides us with a total interest rate on Treasury debt (Average Interest Rates on U.S. Treasury Securities), currently 2.65% (less than half the interest rate from 2001). Budgeted interest expense was $251 billion, or 6% of spending, plus non-cash interest of $203 billion for the Social Security Trust Fund, for a total of $454 billion. Far from unsustainable today, but that assumes rates stay low.

However, as we've seen with Greece and other indebted countries, once investors believe the debt is unsustainable, it is unsustainable. Collapse comes swiftly because interest rates rise rapidly. Interest rates are currently low and appear as though they'll stay that way for a few more years; and foreign governments and central banks will likely continue to support the U.S. dollar and U.S. Treasury market, allowing Uncle Sam more time to get the situation under control. Still, as the Social Security trust fund depletes and that debt goes on the books, cash interest expenses will rise (it would be above 10% of the budget today). If interest rates doubled (not difficult from such low levels) and the debt continues to grow, interest expense could quickly become 25% of the budget.

Can the deficit be cut?

Look again at the deficit and federal spending: the deficit is close to 40% of the budget. Social Security, Medicare and defense make up about 60% of spending. Had the tea partiers won in August 2011 and stopped the debt ceiling from increasing, the government would have had to immediately cut 40% of spending―and if it refused to touch these three large programs, the rest of the government would face an almost total shutdown.

The obvious area to cut is the wars in Afghanistan and Iraq, but even President Obama believes these are important (and in his acceptance speech at the 2012 Democratic Convention, he said he wants to spend the savings). The passage of Obamacare means that, even if the wars did end, most of those savings and probably more than 100% of it, would be spent on healthcare. Furthermore, Medicare and Social Security are growing as a percentage of the budget and will grow to 100% within a few decades: simply put, unless defense, Social Security and Medicare are cut, the budget cannot be balanced. Rising interest costs on the debt will mean even deeper cuts are needed.

To put the entitlement liability into numbers, the present value of the future liabilities (if all existing programs continue unchanged) is estimated at $120 trillion, a truly impossible number. Massive cuts are coming to entitlements no matter what: they can either come early and help balance the budget, or they will come later when the government goes broke.

Also, with a high and rising debt-to-GDP ratio, the U.S. is beyond the point at which GDP growth alone can close the budget deficit.

But wait, there's more

Thus far I've only spoken about the U.S. government. What about the private sector? Total credit in the United States is about $55 trillion: The private sector has debt of almost $40 trillion, while state, local and federal government combine for more than $14 trillion (this figure uses the federal public debt number). Even if there was no federal debt, private sector debt is unsustainable and requires deleveraging because it is about 250% of GDP. This is the total of all consumer debt, mortgages, banking sector debt, etc, as shown in the chart below.

The private sector began deleveraging in 2008, as the following chart shows. Debt is being destroyed, either through repayment or default―a lot was defaulted on by banks in 2008. Many homeowners defaulted on their mortgages or credit card debt. Since 2009, much of the deleveraging has happened because people slowly repay their debt over time (each monthly mortgage payment is for interest and principal) and they have not been taking out new debt.

In contrast, federal deficit spending has offset the deleveraging in the private sector, helping push total credit market debt up about $1 trillion since 2008, to $54.6 trillion. If the federal government did not offset this deleveraging, economic growth would have been negative over this period.

Put another way, the bulk of the deleveraging took place in 2008 and 2009―the crisis―and this was stopped by massive federal government and Federal Reserve intervention. The financial sector still needs to repay or default on trillions upon trillions in debt and that's why the risk of a crash is constantly in the background―if it happens in a “disorderly” manner, we get 2008 again.

Were the U.S. federal deficit small, it could continue replacing the private sector debt, moving private debt onto the public balance sheet as it did with the savings & loan crisis at the end of the 1980s. Instead, the federal debt is already hitting unsustainable levels.

Here we reach the ultimate dilemma, the Hobson's choice. On one side is Scylla, a rising U.S. federal budget deficit that slows the economy and eventually leads to national bankruptcy. On the other is Charybdis, a contracting economy that is being propped up by deficit spending, the ending of which will plunge the nation into deep recession. There is no good choice here, the is no painless way out, there is only the choice of pain today or more pain tomorrow.

Here's a look at the historical trend in debt by sector:

Inflate it away

Hang on, critics say, there is a solution: inflation. If the money depreciates, the debt becomes smaller. For example, if inflation is 5% and real GDP growth is 2%, then the nominal GDP (inflation plus real growth) will be about 7%. That nominal growth will bring in tax revenue, lower the debt-to-GDP ratio, and the situation will quickly go back to what we saw in the 1990s, where rising revenue and slowing spending can quickly stabilize and even reverse the deficit.

It'd be great if things were that simple, but we live in a more complex world. In the first place, as noted above, most of the future deficit is entitlements―spending that adjusts for inflation and will rise sharply due to changing demographics. Parts of the federal budget will rise as fast as the CPI and inflation does nothing to address those costs. Alan Auerbach, an econ professor at the University of California, Berkeley, estimates 90% of the budget would increase along with inflation because future government spending is almost 100% entitlements. If entitlements were reformed by delinking them from inflation, then it would be easier to implement an inflation policy―but no one is talking about ending cost of living adjustments because that would be the end of their political career.

Inflation also requires trapped investors. A 30-year Treasury bond worth $1,000 today at 3% interest will decline in value by about 50% if interest rates climbed to 8%, because the money investors receive back 30-years hence will be greatly devalued. The problem here is that investors (including foreign central banks) don't want to hold 30-year bonds, they are increasingly holding short-term bonds of 2 years or less.

The federal government likes a short-term debt structure because it hides the cost of the deficit through lower interest rates. However, this not only makes inflating near impossible (since the government constantly has to issue new bonds), it is also extremely dangerous. Investors hold short-term debt when they fear that interest rates could rise because they get their money back quickly and can buy new bonds at higher interest rates, avoiding the devaluing scenario outlined above. Even without resorting to an explicit policy of inflation, the federal government is increasingly at risk of a bond market crisis.

This risk is similar to the maturity transformation used by financial companies. There was fear that even blue chip firms such as General Electric (GE) could go bust in 2009 because they borrow heavily in the short-term commercial paper market and continually roll it over to finance long-term projects. It is like an old fashioned bank run: your money is lent out to your neighbor for 30-years, but you want your money today. In the case of a financial firm, it borrows 30-day paper at a low interest rate and lends it out at a high rate. If people stop buying that paper, however, the firm is bankrupt.

In other words, even if a firm or country can continue in existence, if it has a lot of short-term debt and for whatever reason, investors today fear it will go bankrupt, then it will go bankrupt because it relies on short-term funding. One of the notable aspects of this type of crisis is the inversion of the yield curve. Short-term interest rates surge, while long-term rates stay lower, because the government faces an immediate financing crisis.

In sum, inflation won't reduce the budget deficit and its effect on the bond market could trigger a crisis.

This isn't news to the Treasury

Despite the government's dismal fiscal picture, the U.S. government is not run by idiots―which is why the U.S. government is considering floating rate notes. From the linked article:
While it may seem like odd timing to start issuing floating-rate debt, since most analysts predict interest rates are unlikely to get much lower, Wall Street analysts say the changes make some sense.

...For one thing, the new debt products wouldn't necessarily increase Treasury's exposure to short-term fluctuations in rates. That is because the floating-rate notes mainly would be used in place of short-term debt―bills and notes that are issued with maturities of less than two years. Treasury is constantly issuing new bills, mainly to replace maturing debt.

Issuing a floating-rate note of two years in place of a series of three-month bills also would reduce the number of times Treasury would have to sell new debt, which it does via auction. That is appealing, bankers say, especially in light of the recent debt auctions of heavily indebted countries such as Spain and Italy. Those debt sales have been nail-biting events for the financial markets.

In early August 2012, the Treasury announced floating-rate securities are coming, possibly by late 2013.

In adopting this course, the U.S. government tacitly anticipates the exact scenario I mention above. Taking this step is a positive move, since it shows forward thinking, but it won't make inflating the debt away any more realistic. What it does do, however, is potentially avoid a Greek-style panic in the bond market because the government won't have to rollover as much debt.

Markets allow investors to fight inflation

In addition to the government's own costs rising with inflation, another reason inflation is a bad policy: it is not an unknown. In the past, individuals had few ways of dealing with inflation and information moved slowly. Today, it is possible to hedge inflation risk instantly in financial markets. If the government tries to inflate, interest rates will go up and the cost of the debt will remain the same in real terms. If investors sense the inflation coming, they will even accelerate the inflation rate as they convert cash to hard assets and cause interest rates to overshoot as they sell bonds. The Federal Reserve would be caught between a rock and hard place, with the economy in even worse shape.

In conclusion, if the government tries to inflate, it will find itself running in place, while running the risk of destroying the currency.

Hyperinflation hysteria

Some analysts expect the U.S. dollar will hyperinflate and this will destroy the debt. Depending on the definition of hyperinflation, this could mean a range of inflation rates, but most people bring up Wiemar Germany, Hungary and Zimbabwe as extreme examples. People toss these out as examples of hyperinflation, but in reality, hyperinflation was a symptom of societal collapse, not the cause of it. Both Germany and Hungary saw hyperinflation after losing a major war. Germany experienced civil war in the post-war period, with the constant threat of communism, while Hungary was taken over by the Soviet Union. Zimbabwe engaged in genocidal war against white farm owners, destroying the nation's economy in the process. Unless you expect the U.S. to lose a major war or for civil war to breakout, there's little chance for Wiemar levels of hyperinflation.

No signs of hyperinflation

I explained how the private economy is already deleveraging and the government's massive deficits are only offsetting this force. Some people think this situation could change quickly and people will start borrowing again, but there are major factors at work: demographics, social mood and peak debt.

Aging people do not take out loans. Global inflation soared in the 1970s because the Baby Boomers were starting families, borrowing to buy homes and cars. Newly created money went right into the economy and the overall effect created a psychological impact that made everyone want to join in.

Today, it is the opposite. Boomers are retiring and selling off assets to repay debt. The psychological impact is such that even younger Americans view debt negatively and do not want to borrow. Young Americans are already bogged down with student debt. We also have a test case overseas: witness Japan's 20-years of deflation/low inflation, in part caused by a similar demographic change that started earlier.

Aside from demographics is the change in social mood. American attitudes towards debt have shifted and Americans believe the country is on the wrong track, headed for worse economic times. This does not lead people to take out loans and bet on rising asset prices.

Finally, there's the idea of peak debt. To put it into individual terms, consider the college graduate of 2012 saddled with tens of thousands of dollars in debt, who can only find low wage labor in this tight economy. This debt will hang over them for years until it is repaid, delaying family formation and home buying—two life events that drive the demand for debt.

In order to see hyperinflation, even the mild variety that doesn't require warfare or a communist takeover (inflation rates of say 50%, instead of 50,000,000%), we need to see changing attitudes surrounding debt and the economy. At first, people will become very optimistic and take out more and more debt, only later realizing that this was the start of hyperinflation.

Not only is hyperinflation unlikely, there are even signs that we have seen the end of inflation for the time being. During the hyperinflation in Wiemar Germany, the financial sector rapidly expanded and came to dominate the economy. People were paid twice a day, and they immediately ran to the bank to cash their pay check before the value of the mark fell. Bank workers almost quadrupled from 1913 to 1923. The public also borrowed heavily and bought stocks.

In the early 1990s, right after the savings and loan crisis, financial stocks made up around 7% of the S&P 500 Index (SPY). This grew to roughly 22% at the market peak in 2007, and it has fallen to 14% recently. This growth in the financial sector occurred along with the massive $50 trillion in credit created by the economy. Credit functions like money in the economy and for this reason, if there's any comparison to Wiemar Germany, it may be the growth in debt and the financial sector from 1980 to 2008.

In fact, a strong case can be made that inflation is in the rear-view mirror. While some prices are higher due to specific supply and demand situations (such as rising Asian demand and the U.S. drought lifting food prices), prices alone are not inflation. Inflation refers to the growth in the total supply of money and credit, while deflation refers to the contraction of money and credit. When total credit and money supply increase, the value of existing money and credit declines, and vice versa. It is this process that leads to a general rise or decline in prices.

Here is hedge fund manager Hugh Hendry on the topic (starting around the 7:45 market in this video: Print More Money to Avoid Bigger Slump Hendry)

"In my crazy head, in this day and age when everyone is anticipating inflation, not just inflation―hyperinflation―I'm saying to you...what if we saw it? What if we saw it between 2002 and 2007, and it wasn't the quantitative easing of the Federal Reserve, it was the mercantilistic trading policies of the surplus countries, which kind of suppressed the value, kept their exchange rates cheap and therefore created these foreign exchange reserves, these sovereign wealth funds are really just quantitative easing programs, and if we look at that 5 year period, gold broke a 27-year trend and actually went up. It went from $250 to $1000.

The dollar lost 40% of its value―40! That is one of the biggest collapses in the dollar ever. 40%. Oil went from 10 bucks to 150. (as you said) But maybe we've had all the inflation. And today, prices are falling. Retail prices are falling. And yet, everyone wants to talk about hyperinflation. I'm just curious at these...shifting players, and how they don't seem to be aligned, expectations versus reality are a little bit skewed."

Hendry has also said, “The road to hyperinflation is via hyperdeflation.” There may yet be hyperinflation, but it will occur after a period of hyperdeflation that causes world governments to enact hyperinflationary policies.

Credit creation is driven by borrowers, not bankers

The key argument against inflation is that we live in a credit economy. Most people look to the money supply when they look for inflation and they point to rising M2, but credit functions as money and the total amount of credit is more than 5 times the amount of money.

Here's Steve Keen, as Australian economist, on the subject. In a post from January 31, 2009 titled “The Roving Cavaliers of Credit”, Keen demolishes the standard model of money creation. Here are two snippets from a very long post:

Thus rather than credit money being created with a lag after government money, the data shows that credit money is created first, up to a year before there are changes in base money. This contradicts the money multiplier model of how credit and debt are created: rather than fiat money being needed to “seed” the credit creation process, credit is created first and then after that, base money changes.

Here's a grossly simplified explanation. Most people think of money creation like this: a saver deposits money in the bank and then the bank loans the money to borrowers. If the banks want to lend more money, but don't have enough deposits, the Federal Reserve can increase money supply―it prints up some money and sends it to the banks, who then loan it to people. In this model, the Federal Reserve can “create money” and cause inflation.

In reality, there are no deposits and the central bank isn't giving the banks money to lend. When you walk into a bank and ask for a mortgage, you are responsible for creating credit, and since credit also functions as money, your action, together with the bank's, creates money. Later, the central bank will create new base money to give the banks reserves, in order to stabilize the banking system.

In plain English: banks create money when they lend money to a borrower. The system is demand driven by borrowers, and the loans are the deposits.

Here is Professor Keen again:

In some ways these conclusions are unremarkable: banks make money by extending debt, and the more they create, the more they are likely to earn. But this is a revolutionary conclusion when compared to standard thinking about banks and debt, because the money multiplier model implies that, whatever banks might want to do, they are constrained from so doing by a money creation process that they do not control.

What Keen is telling us here is that banks are not restrained by regulations or the central bank. Let me explain in more detail: the way the money multiplier works, according to standard models of banking taught in most economics classes, is that when you deposit $100 in the bank, the bank has to keep an amount in reserve. If the reserve requirement is 10%, the bank (Bank A) must hold $10 for reserves and can lend $90 to a borrower. The borrower takes this $90 and puts it in their bank account (at Bank B), and that bank lends out $81 and keeps $9 for reserves. If we follow this to the end, it means the banking system can loan out $1000 dollars on $100 of deposits.

In the money multiplier system, the banks are constrained by reserve requirements and they cannot lend an unlimited amount. But Keen is telling us, this isn't how it works. Instead, the banks have no deposits. A borrower borrows $100 and this becomes deposits at another bank. Later, if deposits aren't sufficient, the central bank creates money to fill the reserves.

The central bank is following the lead of the banks, not constraining their actions. The Federal Reserve doesn't create money, it keeps the banking system afloat by lifting the money supply in concert with rising credit. The Fed is a passive actor―it needs the banks to lend, otherwise there is no money creation.

Keen goes on to explain what does regulate the banks:

However, in the real world, they do control the creation of credit. Given their proclivity to lend as much as is possible, the only real constraint on bank lending is the public’s willingness to go into debt. In the model economy shown here, that willingness directly relates to the perceived possibilities for profitable investment―and since these are limited, so also is the uptake of debt.

What limits bank lending is the desire of people to borrow. When people believe they can make money borrowing, they do so. During inflationary periods, prices of everything rise because the money supply is expanding. It is profitable to borrow money and buy stocks, houses, farm land or whatever asset is rising in value.

If Keen is right, then banks cannot lend money if people don't want to borrow. They can try cutting rates, but if people expect prices will fall, then even 0% interest loans are unprofitable. With private debt-to-GDP of 250%, the public cannot afford to finance the debt it has and wants to reduce the total. They don't want loans, if anything, they want debt relief!

It might shock you that the IMF agrees. In a recent working paper titled, “The Chicago Plan Revisited”

In a financial system with little or no reserve backing for deposits, and with government-issued cash having a very small role relative to bank deposits, the creation of a nation’s broad monetary aggregates depends almost entirely on banks’ willingness to supply deposits. Because additional bank deposits can only be created through additional bank loans, sudden changes in the willingness of banks to extend credit must therefore not only lead to credit booms or busts, but also to an instant excess or shortage of money, and therefore of nominal aggregate demand.

Now consider U.S. demographic changes and “peak” debt levels. Americans do not want to take on more debt because they cannot afford it―they are maxed out. Also, as the nation ages, more people are moving out of the peak borrowing years of middle age and into the debt repayment stage of their life. If people repay more debt than is created by new lending, the amount of total supply of money and credit shrinks.

Without credit growth, the economy is stagnant. In order for the government to create inflation in the absence of economic growth, it must offset the deleveraging of the private sector. The federal government must borrow the money that Americans won't borrow themselves.

Can't the Federal Reserve just print money?

Keep the above in mind as we travel deeper into the rabbit hole. I'm going to show you why the Federal Reserve not only isn't all powerful, it is basically a trend follower.

Most of the time, central banks follow interest rates, they do not set them! (see: De-mystifying RBA Setting of Interest Rates) Consider that Federal Reserve interest rate cuts have failed to spur the market, but in come cases, bond investors have pushed yields into negative territory (German bonds being one recent example, see: Europe: When losing money makes sense). Bond investors are willing to accept negative interest rates, but the central bankrates are higher. Even now, in the midst of unprecedented central bank policy, central bankers are following the market, not leading it!

Here's another thing you probably didn't realize. The Federal Reserve does not print U.S. dollars, it prints Federal Reserve Notes. What is a FRN? It is a debt instrument. The Federal Reserve does have printing presses, but when the Fed “creates money,” it buys existing credit paper. As in Keen's model, the bank creates credit when it makes a loan to a borrower. Later, it will sell some of those loans to the Federal Reserve, which will give it FRNs to hold as reserves.

Previous to the crisis, the Fed would mainly buy U.S. Treasuries from banks. After the crisis, the Fed started accepting other debts of much lower quality in an effort to support the banking system.

As Steve Keen as shown, the standard model is completely wrong. The Fed isn't creating new money, it is back-filling the already created credit money. If we imagined a world with no new debt, the Fed would have nothing to buy and would be unable to create any new money. The Fed is entirely dependent on the willingness of banks to loan, and the banks are entirely dependent on the willingness of borrowers to borrow, a total reversal of what is taught in standard economics classes and textbooks!

However, the U.S. government to create inflation. The U.S. government is also a borrower and if it decides to spend vast sums of money, it can print Treasuries and sell them to the Federal Reserve, which will give them FRNs they can use to buy goods and services (or just mail checks to everyone).

But, you may be thinking, why can't they just print paper money? They can't, not physically and they won't, because they don't want to. The Federal Reserve published its 2012 New Currency Budget, and it shows no ramp in currency printing and no plans for it. There's no sign of a plan to create a sea of paper money. As for their plans, consider that the $500 and $1000 bill (and even higher denominations) were taken out of circulation decades ago. Governments are increasingly moving towards digital currency because it cannot hide. Drug dealers starting switching to the euro a few years ago because the euro has a 500-euro note, which means more cash can be moved physically via euros. There's no evidence of government plans to return to a cash economy. Printing cash would generate inflation: in a cash economy, if I borrow $1000 and then default, the $1000 in cash is still in the economy. But in today's credit based economy, when I default, the $1000 is destroyed.

The Federal Reserve could credit everyone's bank account with money. They could add a zero to every account and devalue the U.S. dollar by 90%. However, this is another extreme solution, something never before done by the Federal Reserve. It would require a political decision in Washington, D.C.

An estimate of the required deflation

There are many ways to estimate how much the Federal Reserve would need to print in order to create inflation. One way is to consider the ratio of credit money to M2. Assuming the economy will return to its “starting position” in 1980, when base money (M2) was one-third of credit money, the economy either needs to deleverage $25 trillion or the Fed needs to print $8 trillion. I do not hold this out as a definite estimate, but I believe these huge numbers are reflective of the depth of the current crisis.

Are there any solutions to the debt crisis?

If inflation isn't a solution, the only real solutions are cutting government spending and wiping out the debt, because spending and debt are causing the problem. The choice is between voluntarily cutting spending and wiping out debt, with the benefit of long-term planning, or waiting for a market panic that requires instant cuts, with little time for debate.

The death of the dollar is greatly exaggerated

Since there's no sign of spending discipline anywhere in Washington, D.C., many people expect the death of the U.S. dollar. If the dollar did die, it would collapse rapidly, leaving no time for people to adjust. Instead of inflation over the course of years, all the inflation might happen in a week or month. The price of oil would shoot to $200 a barrel, gold would go to $10,000 an ounce and that would be it for inflation. Americans' standard of living would drop, they would be unable to import foreign goods and American goods would be very cheap, driving an export boom. It would be similar to the collapses seen in the Asian Crisis, Russian default and elsewhere.

As mentioned above, however, the government already anticipates potential market crises. If those in charge want to stay in power, they will certainly defend the currency, in any event, U.S. finances are not yet as bad as Greece's.

And that brings up a major ace up the sleeve of Uncle Sam. Europe (with a bigger welfare state and worse demographics) and Japan (the worst demographics and government debt-to-GDP above 200%) are likely to collapse first and in every instance thus far, panic means U.S. dollar and U.S. Treasury buying (even last year's downgrade of U.S. Treasuries led to lower interest rates as investors panicked).

Until the crises around the globe play themselves out, the U.S. and the greenback are safe by virtue of being the healthiest horse in the glue factory. Besides investor buying, the world relies on the U.S. dollar as reserve currency and therefore almost all governments and central banks work to support the dollar. Exporting nations in Asia and South America also do not want a weak dollar because it will damage their economy. When the Federal Reserve launched it's second round of quantitative easing, the Brazilian finance minister complained of a “currency war.” Nobody wants to see a very weak dollar and the loss of the dollar as reserve currency because the entire global economy is built on a the dollar.

Finally, only the U.S. has large and liquid stock and bond markets. The eurozone was a potential competitor, but we see how that is going. Other nations are too small. Consider the plight of a major financial center, Switzerland: the country instituted a peg with the euro because so much money flowed in to Swiss banks, it forced the franc higher and threatened to kill the Swiss economy. The only market that can handle a massive global wave of money is the United States.

The U.S. can use these strengths to kick the can and delay the crisis, or it could make use of the cheap debt to reform, but the death of the dollar won't arrive until the situation is so bad that nothing can delay it.

As an aside, this is why $5,000 price targets for gold are not crazy and why many analysts have very high price targets for gold, such as $10,000 or more. If the U.S. dollar did fail as a safe haven, a lot of money would rush into very, very small markets by comparison, including gold. I don't expect those high gold prices in the near future because I see the dollar holding up, but the logic is sound.

Ending the dollar as reserve currency

I doubt the U.S. could achieve a major bout of inflation without ending the U.S. dollar as reserve currency and replacing it with gold. One way to achieve a rapid devaluation of the dollar, while maintaining some control over the global financial system (desired by the politicians), would be for Federal Reserve (or U.S. Treasury) to devalue the U.S. dollar against gold. The Fed would step into the market and announce that it would pay $5,000 (a low estimate for a gold revaluation) per ounce of gold. They would choose a price at which the U.S. 8,000 tons of gold is large enough to dominate the market and offset government debt levels. Currently, U.S. gold is worth about $400 billion (at $1600 an ounce), so a move to $5,000 would increase the value to about $1.3 trillion.

Jim Rickards, in his book Currency Wars: The Making of the Next Global Crisis , outlines a fictional scenario where the Russians decide to launch a gold currency to weaken the United States by damaging the U.S. dollar. He argues that a scenario such as this is increasingly likely and that the U.S. should choose to use gold, rather than have it forced upon them. He has also dubbed the United States the “Saudi Arabia of gold” due to its holdings, the largest in the world.

Gold can handle it

Gold is already becoming the safe haven of choice because if the dollar fails, the entire global financial system will collapse, meaning no currency is safe. Any country with a favored currency would see their economy collapse if they allowed it to appreciate (see the Swiss reaction to the decline in the euro), so they would all depreciate their currencies in response. In contrast, many central banks still hold literally tons of gold and no one would need to stop “hot money” from flowing into gold because it wouldn't be as disruptive to the economy.

Think of it this way: if Chinese yuan is 6 to $1, and a pen costs 6 yuan, it also costs $1 for an American.

Now, what happens if China's currency collapses to 600 to $1? Suddenly that pen is very cheap and everyone in America would buy as many as they could. So when we see a single currency depreciate against others, it's goods and services become very cheap, and other economies exports become very expensive, causing massive economic disruption.

What happens if everyone devalues against gold? The price of gold rises in dollars, euros, yen and yuan, the relationship between the currencies will not change as dramatically. Gold can act as a pressure valve because it can absorb capital inflows without as much economic disruption.

Revaluing against gold also takes away the desire for a safe haven by folding it back into the U.S. dollar and the global financial system. Instead of thinking of how to protect their assets, investors would invest their money, with many gold holders selling their gold to collect their profit. However, while a number of advocates for monetary reform have suggested revising gold's role, they remain on the fringe in Washington, D.C.

Debt wipeout

Another possible scenario is a debt jubilee. Taken from the Biblical jubilee, where every 50 years slaves were set free and debts canceled, a modern jubilee (as proposed by Steve Keen) would have the government or central bank send a certain amount of cash to every citizen. The money must be used to pay down debt, but if a person has no or little debt, they would receive a cash infusion to their bank account. This is similar to the Federal Reserve's quantitative easing program, but the money would go directly into the economy.

For example, let's say the government sends every American $50,000. If you have a mortgage of $100,000, your balance is cut to $50,000. If you owe $25,000 in student loans, you are debt free and have $25,000 to spend. If you are debt-free, you receive $50,000 to spend as you please. It would be a quantitative easing program for the people, not the banks, and it would cut debt levels massively by wiping out debt and devaluing the currency simultaneously.

The worst case

I don't call this a solution, but it would eliminate the debt―the U.S. government goes full banana republic and starts spending even vaster sums of money, printing the cash to pay for it. The federal government would “print” Treasury bonds and sell them to the Federal Reserve, which would give it cash to spend into the economy. Or the government would simply have the U.S. Treasury directly spend into the economy. The government wouldn't worry about taxes anymore, it would simply print money and spend it.


Hyperinflation is unlikely without an explicit political decision. The two cases of hyperinflation during U.S. history occurred during the Revolutionary War and the Civil War. The historical evidence from around the globe supports the hypothesis that a government must collapse, be feared to collapse, or engage in willful destruction of its economy (Zimbabwe) in order for its currency to become completely worthless.

This doesn't rule out high rates of inflation, but as I explained above, deflation is far more powerful today and without an “extreme” and explicit policy of inflation, it's unlikely there will be any. Even if there is inflation, it doesn't get the U.S. government out of its debt problems or impossible entitlement spending estimates.

The most likely course is the one we are on: global central banks will hold deflation at bay for as long as possible, until they cannot and global investors send the markets lower once again. I do not expect a Japan scenario for the West, it will be far messier because the culture and political systems are more volatile.

Even if the deflation scenario wins out, inflation becomes more and more likely with each passing day. Governments always act far too late: the U.S. government passed Glass-Steagal after the Great Depression; they repealed it at the top of a 20-year bull market; they passed Sarbanes-Oxley after Enron went bankrupt and Dodd-Frank after the 2008 crisis. In security, the U.S. upped airline security after 9/11; they made passengers take off their shoes after the shoe bomber passed security; they started doing full body checks after the underwear bomber was discovered, etc. If there is ever an explicit policy to inflate, it will almost certainly come after a major deflationary wave has wiped out enough debt to reboot the economy―and therefore will come at precisely the wrong time.

For this reason, it makes sense to hold some gold. I expect that even if spot gold prices tumble during another 2008-style crisis, it may be hard to obtain physical metal as premiums rise (this happened during the first phase of the 2008/9 decline). Once an inflationary policy is announced, gold prices will take off. There may only be a very small window, if any, for investors waiting for the last possible moment. And should world governments choose to reform the global monetary system, it will likely include revalued gold.