Peter Schiff: The Trap the Fed Has Created The Stimulus Trap
For years we have been warned by Keynesian economists to fear the so-called “liquidity trap,” an economic cul-de-sac that can suck down an economy like a tar pit swallowing a mastodon. They argue that economies grow because banks lend and consumers spend. But a “liquidity trap,” they argue, convinces consumers not to consume and businesses not to borrow. The resulting combination of slack demand and falling prices creates a pernicious cycle that cannot be overcome by the ordinary forces that create growth, like savings or investment. They say that a liquidity trap can even resist the extraordinary force of monetary stimulus by rendering cash injections into useless “string pushing.” Some of these economists suggest that its power can only be countered by a world war or other fortunately timed event that leads to otherwise politically unattainable levels of government spending.Putting aside the dubious proposition that the human desire to strive and succeed can be permanently short-circuited by an economic contraction, and that modest expected price declines can quell our desire to consume, the Keynesians have overlooked a much more dangerous and demonstrable pitfall of their own creation: something that I call “The Stimulus Trap.” This condition occurs when an economy becomes addicted to the monetary stimulus provided by a central bank, and as a result fails to restructure itself in a manner that will allow for robust, and sustainable, growth. The trap redirects capital into non-productive sectors and starves those areas of the economy that could lead an economic rebirth. The condition is characterized by anemic growth and deteriorating underlying economic fundamentals which is often masked by inflation or asset price bubbles (I look at how stimulus has impacted the U.S. stock market in the March edition of my newsletter).Japan has been caught in such a stimulus trap for more than a decade. Following a stock and housing market boom of unsustainable proportions in the 1980s, the Japanese economy spectacularly imploded in 1991. The crash initiated a “lost decade” of de-leveraging and contraction. But beginning in 2001, the Bank of Japan unveiled a series of unconventional policies that it describes as “quantitative easing,” which involved pushing interest rates to zero, flooding commercial banks with excess liquidity, and buying unprecedented quantities of government bonds, asset-backed securities, and corporate debt. Although Japan has been technically in recovery ever since, its performance is but a shadow of the roaring growth that typified the 40 years prior to 1991. Recently, conditions in Japan have deteriorated further and the underlying imbalances have gotten progressively worse. Yet despite this, the new government is set to double down on the failed policies of the last decade.I believe that the United States is now following Japan into the mire. After the crash of 2008, we implemented nearly the same set of policies as did Japan in 2001. In the past two years, despite the surging stock market and apparently declining unemployment rate, the size and scope of these efforts have increased. But as is the case in Japan, we can clearly witness how the stimulus has perpetuated stagnation. (See my analysis of the new plans of the Japanese government).
The Fed's Tightening Pipe Dream by Peter Schiff
Testifying before the US Senate this past Tuesday, Fed Chairman Ben Bernanke made an extraordinary claim about its bloated balance sheet: “We could exit without ever selling by letting it run off.” What Bernanke means here is that the Fed could simply hold its Treasuries and agency bonds until they mature, at which point the government would then be forced to pay the Fed back the principal amount. Through this process, the Fed’s unprecedented and inflationary position will be gradually and placidly unwound.
Growing rumors last month of a potential “tightening” of monetary policy – seemingly confirmed by the Fed minutes released on Feb. 20th – have spooked the precious metals markets, leading to a 5.8% correction in gold and 10.2% in silver.
However, these fears are preposterous on two counts.
First, the Fed just spent the past year and a half extending the maturities of its entire portfolio. That was the entire purpose of Operation Twist. The average maturity of the entire portfolio is now over 10 years. That means any wind-down using the strategy Bernanke outlined would play out over the course of decades – not months or years.
Fortunately for hard asset investors, it is unlikely to play out at all.
The second reason these fears are unfounded is that there is no exit strategy. Listening to Bernanke’s testimony, it was clear that here was a man simply speculating about when an exit might be undertaken – or perhaps if it would ever be taken. Senator Corker from Tennessee accused Bernanke during the hearing of being “the biggest dove since World War II.” “I think it’s something you’re rather proud of,” the Senator continued. The Chairman’s response to the charge of recklessly endangering the nation’s currency? “In some respects, I am.”
The Fed Chairman has been talking about tightening for some time. In 2010, he said, “As the expansion matures, the Federal Reserve will need to begin to tighten monetary conditions to prevent the development of inflationary pressures.”
Back then, the same mainstream analysts were predicting recovery and a reversal of quantitative easing (QE). Instead, we have subsequently seen QE2, Operation Twist, and now QE3 to eternity.
While these mainstream commentators are at best guessing as to why or when the Fed might reverse course, I understand that it is extremely unlikely to do so for the foreseeable future. In fact, I’ve bet my net worth on it.
There is no exit strategy because the results of the Fed withdrawing its artificial support would be disastrous for the US Treasury and in the short-term, the US economy.
The Fed is expected to buy nearly 90% of new Treasury bonds in 2013, according to Bloomberg. This is a tremendous subsidy that has kept 10-year Treasury yields below 1.95% on average this year so far. Last year, with 10-year yields averaging 1.8%, the Treasury spent $360 billion on interest payments alone. That represented nearly 10% of all expenditures.
Let’s assume a Fed tightening causes these rates to triple – not unreasonable for a government facing over 100% debt-to-GDP. If these rates triple by 2015, and another $2 trillion or so is added to the debt, then interest would make up over 30% of annual federal expenditures. Just interest. Then, there are principal repayments, Medicare/Medicaid, Social Security, the Armed Forces, and all the other entitlements for which the Treasury is responsible. Is Washington going to default on our creditors, our seniors, or our men and women in uniform?
When the Noose Tightens Around the Dollar The Pound Gets Pounded By Peter Schiff
As the global currency war intensifies, the majority of attention has been paid to the 17% fall of the Japanese yen against the U.S. dollar over the past few months. The implosion has given cover to the sad performance of another once mighty currency: the British pound sterling. But in many ways the travails of the pound is far more instructive to those pondering the fate of the U.S. currency.
Japan has a unique economic and demographic profile which makes it a poor stalking horse. Newly elected Prime Minister Shinzo Abe and the Bank of Japan have clearly and forcefully committed Japan to a policy of inflation at any cost. Even in a world of serial money printers their plans stand out as exceptional. Britain, on the other hand, is charting a more conventional course to the same destination.
The UK government, under conservative Prime Minister David Cameron and Chancellor of the Exchequer George Osborne, has succeeded in bringing marginal discipline to their budgetary imbalances. From 2009 to 2012, British government expenditures rose a total of just 1.6%, which was far below the official pace of inflation. (In contrast, U.S. federal spending grew by 7.9% over that time period). Since 2009 the British have kept their debt-to-GDP ratio lower than America’s and have cut into that metric at a faster rate. But while the British are conservative when compared to their American cousins, they are hardly austere when compared to Germany (which continues to have a nearly balanced budget and extremely low debt to GDP). Paul Krugman blames Britain’s lackluster economic performance on their misguided experiment with austerity.
The monetary side of the equation also puts the UK within the spectrum of its peers. Ever since the Great Recession began in 2008 the Bank of England, led by outgoing Governor Mervyn King, has been far more stimulative than the European Central Bankers in Frankfort (but not quite as much as the Federal Reserve or the Bank of Japan). In contrast to the permanent and ongoing bond-buying quantitative easing programs underway in the U.S. and Japan, the Bank of England has engaged in such measures only selectively.
Given the relatively moderate approach pursued by the British, the poor performance of their currency may be hard to fathom. The deciding factor may be that the Pound Sterling is not nearly as vital to investors, or as integrated into the global economy, as the U.S. dollar or the euro. The greenback, being the world’s reserve currency, has always benefited from demand that is independent of its economic fundamentals. The euro benefits from the size of the euro zone and the legacy of German banking discipline. The pound enjoys no such privileges and as a result foreign central banks do not feel as pressured to prop it up. As a result, over the past few years the pound has been… pounded. Since July 2010, the currency is down 26.7% against the U.S. dollar, and in recent months it has started falling faster than all other developed currencies except for the Abe-pummeled yen. Since October 1, 2012 the pound has fallen by 4% against the dollar and 8% against the euro.
The pound’s health is made more suspect by the extreme challenges faced by the Bank of England as it tries to stimulate the most admittedly inflation prone economy among the major Western nations. Unlike the Federal Reserve, which is tasked by statute to combat both inflation and unemployment, the BofE has only a single mandate: to keep inflation contained. On that score it has been failing habitually. Inflation in the UK has been north of its 2% target for the past five years (the current official rate is 2.7%). In its most recent inflation projections, Mr. King admitted that it will stay that way for years to come, and that it may exceed 3% this year and next. With its currency weakening and inflation accelerating, the mandate of the BofE would clearly indicate that the time has come for monetary tightening.
However, like all central bankers, Mr. King, and his successor, the Canadian Mark Carney, will not be bound by such triflings as statutory mandates and past promises. In his press conference last week, Mr. King spoke of “looking past” current inflation figures to a time when he expects inflation will moderate. When the choice is between inflation and the political pain of economic contraction, bankers (at least those who don’t speak German) will choose inflation every time.
While the American media has poked fun at the Bank of England’s backtracking, they somehow do not understand that the Federal Reserve would be doing the same if not for the advantages given to us by the dollar’s reserve status. Our ability to monetize the vast majority of the annual government deficit while exporting our inflation through half trillion dollar trade deficits and the overseas sale of hundreds of billions of Treasury bonds annually means that we do not yet face the pressures bearing down on the Bank of England.
For now at least Cameron is sticking to his guns and making the politically difficult case to voters that today’s hard choices will yield benefits down the road. This puts all the pressure on the Bank of England to satisfy the calls for stimulus. The Federal Reserve is fortunate in that the Obama Administration shares none of Cameron’s fiscal determination.
Peter Schiff on CNBC Asia (2/5/13)
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The Bernanke Shock by Peter Schiff
The financial world was shocked this month by a demand from Germany’s Bundesbank to repatriate a large portion of its gold reserves held abroad. By 2020, Germany wants 50% of its total gold reserves back in Frankfurt – including 300 tons from the Federal Reserve. The Bundesbank’s announcement comes just three months after the Fed refused to submit to an audit of its holdings on Germany’s behalf. One cannot help but wonder if the refusal triggered the demand.
Either way, Germany appears to be waking up to a reality for which central banks around the world have been preparing: the dollar is no longer the world’s safe-haven asset and the US government is no longer a trustworthy banker for foreign nations. It looks like their fears are well-grounded, given the Fed’s seeming inability to return what is legally Germany’s gold in a timely manner. Germany is a developed and powerful nation with the second largest gold reserves in the world. If they can’t rely on Washington to keep its promises, who can?
Where is Germany’s Gold?
The impact of Germany’s repatriation on the dollar revolves around an unanswered question: why will it take seven years to complete the transfer?
The popular explanation is that the Fed has already rehypothecated all of its gold holdings in the name of other countries. That is, the same mound of bullion is earmarked as collateral for a host of different lenders. Since the Fed depends on a fractional-reserve banking system for its very existence, it would not come as a surprise that it has become a fractional-reserve bank itself. If so, then perhaps Germany politely asked for a seven-year timeline in order to allow the Fed to save face, and to prevent other depositors from clamoring for their own gold back – a ‘run’ on the Fed.
Now, the Fed can always print more dollars and buy gold on the open market to make up for any shortfall, but such a move could substantially increase the price of gold. The last thing the Fed needs is another gold price spike reminding the world of the dollar’s decline.
Speculation Aside
None of these theories are substantiated, but no matter how you slice it, Germany’s request for its gold does not bode well for the future of the dollar. In fact, the Bundesbank’s official statements are all you need to confirm the Germans’ waning faith in the US.
Last October, after the Bundesbank had requested an audit of its Fed holdings, Executive Board Member Carl-Ludwig Thiele was asked in an interview why the bank kept so much of Germany’s gold overseas. His response emphasized the importance of the dollar as the world’s reserve currency:
“Gold stored in your home safe is not immediately available as collateral in case you need foreign currency. Take, for instance, the key role that the US dollar plays as a reserve currency in the global financial system. The gold held with the New York Fed can, in a crisis, be pledged with the Federal Reserve Bank as collateral against US dollar-denominated liquidity.”
Thiele’s statement can lead us to only one conclusion: by keeping fewer reserves in the US, Germany foresees less future need for “US dollar-denominated liquidity.”
Casey Research chairman Doug Casey interviews financial pundit and author Peter Schiff. Their conversation covers a range of issues: gold, the validity of the US dollar, the Federal Reserve system and the Schiff family’s fight with the IRS.
Peter Schiff talks about Why government Should not be in the student loan business.
Peter Schiff lays economic sense into some deluded leftist’s mind.
And Schiff in case anyone wants to get a knee-jerk reaction is a Minarchist. He is not for corporatist crony capitalism. He is for a free market and de-regulation of government intervention.
EXCLUSIVE - The Oprah Winfrey Interview we should have seen: Ben Bernanke Confessing to Years of Performance-Enhancing Economic Doping.
Gold and Silver Prices Are Down - So What, Buy More: Peter Schiff
http://usawatchdog.com/peter-schiff-get-real-money-gold-and-silver-as-the-fed… Peter Schiff, CEO of Euro Pacific Precious Metals, thinks talk from the Fed of stopping the $85 billion a month money printing (QE) is preposterous. Schiff says, “They can’t do it… . The minute they try to take the cheap money away, the phony economy is going to crumble.” What’s not going to crumble is the gold and silver market. Even though the precious metals are down recently, Schiff says, “So what, buy more. Look at the sell off as an opportunity to unload more of your fiat currency and get some real money.” Join Greg Hunter as he goes One-on-One with money manager Peter Schiff.
Peter Schiff Doubles Down on Inflation Prediction
Lauren Lyster, formally of RT America’s Capital Account, interviews Peter Schiff.
Watch the video. And good for yahoo for hiring someone as good as Lauren.
After four years of unprecedented balance sheet expansion and monetary easing by the Federal Reserve, many critics of Fed policy have warned of the potential for massive inflation (or even hyperinflation) as a consequence. Peter Schiff, CEO and chief global strategist of Euro Pacific Precious Metals, is one of them.
Meanwhile, the headline Consumer Price Index most recently showed a 1.8% increase, a number that monetary doves lean on as evidence that there is no inflation and that central banks should not be constrained in their money printing ways.
Related: Bill Gross: Fed’s “Hot Air” Will Keep Bond Bubble Aloft in 2013
New York Times columnist and economist Paul Krugman is among those who recently took aim at Schiff for his inflation predictions, saying people in Schiff’s camp need to rethink their approaches to modeling the economy. Schiff in turn has responded in an article and video post, attacking the CPI as “meaningless.”
“It is sheer propaganda,” Schiff tells The Daily Ticker. “Prices are rising at a much more rapid rate than the CPI would suggest.”
Schiff points to changes in methodologies for calculating CPI as one problem. The index reports on price movements and consumer choices and substitutions. Schiff looked at Bureau of Labor Statistics price changes for 20 goods and services between 1970 to 1980 and again between 2002 and 2012, decades that Schiff says were both periods of large deficits and loose monetary policy.
Schiff found that his basket of goods increased 61% faster than CPI for the period between 2002 and 2012. In contrast, his basket rose just 5% faster than CPI from 1970 to 1980.
“How can you believe these statistics when the numbers are so flawed?” Schiff asks in response to his research on CPI. “I don’t care what the government is telling me. If the government weatherman tells me it’s a sunny day and I can see it’s pouring rain, I’m not gonna believe the government, I’m gonna go outside with an umbrella.”
As for the true state of inflation, Schiff argues it’s closer to 7% or 9% and going higher. And he sticks to his claims that we could have hyperinflation if foreign central banks start selling dollars.
Peter Schiff: Inflation Propaganda Exposed
Peter Schiff goes on a beautiful, hilarious rant about the economic stupidity of Paul Krugman and Keynesian theory: “Let’s hire more teachers and fill potholes!”
(from The Peter Schiff Show, 1/14/13)
Okay, so you want big government. It’s expensive and the middle class is going to have to pay for it.
