Unlike her predecessors, Janet Yellen has never had a youthful dalliance with hawkish monetary ideas. Before taking charge of the Fed both Alan Greenspan, and to a lesser extent Ben Bernanke, had advocated for the benefits of a strong currency and low inflation and had warned of the dangers of overly accommodative policy and unnecessary stimulus. (Both largely abandoned these ideals once they took the reins of power, but their urge to stimulate may have been restrained by a vestigial bias against the excesses of Keynesianism.) Janet Yellen, who has been on the liberal/dovish end of the monetary spectrum for her entire professional career, has no such baggage. As a result, we can expect her to never waver in her belief that stimulus is the answer to every economic question.

The Federal Reserve was originally charged with the single mandate of maintaining price stability. In recent decades that mission evolved into a dual mandate of seeking price stability and full employment. I believe that a Yellen-led Fed will return once again to a single mandate, but now it will focus only on employment. Based on her clear beliefs in the ability of dovish monetary policy to relive human suffering she will be inclined to dig in her heels into the ongoing QE program more than anyone else President Obama may have appointed. This is terrible news for the U.S. dollar and the U.S. economy.

For now at least the crisis in Washington has squelched any immediate discussion of a taper in the remaining months of 2013. Any predictions that a Yellen-led Fed will somehow show more resolve towards responsibility in 2014 or 2015 should be looked at as delusional.

Anyone seeking an interview with Mr. Schiff should contact me at aschiff@europac.net

Thanks

The reality is that the economic indicators the Fed claims to rely on to decide when to taper are all dependent on stimulus money. This is not a mystery to Ben Bernanke. Instead, this entire saga amounted to little more than a “taper fakeout” which sent hard asset investors for a loop.

Months of Anticipation

We can forgive the financial media for being blindsided by the Fed’s non-taper. Even after decades of deception, journalists by-and-large still believe that it is their job to report official pronouncements as fact. Every month of 2013, one Fed official or another has openly discussed the need for or possibility of tapering. In January, it was Lockhart; in February, Bullard; Plosser brought it up in March; and Williams talked taper in April.

Bernanke finally took up the taper torch in May, but it wasn’t until June that he hinted the Fed might start tapering QE “later this year” and end it entirely by the middle of 2014.

The markets went wild on these progressively foreboding statements, sending Treasury and mortgage rates upward and driving gold and silver into their biggest correction since the secular bull market started a decade ago. In spite of Bernanke’s caveats that the bulk of the stimulus would continue for the foreseeable future and that the federal funds rate would remain at record lows, the markets braced for the easy-money spigot to begin closing.

I was on the major news networks calling the Fed on its bluff, but once again, my forecasts were dismissed by anchors and co-panelists. [See the new video: Peter Schiff Was Right - Taper Edition.] Then, on September 18th, the Fed did exactly what I expected.

A Möbius Strip

When the Fed announced that it was backtracking on its previous indications, Bernanke cited the “tightening of financial conditions observed in recent months” as a major reason for delaying the taper.

As an academic economist focused on the history of monetary policy, Bernanke had to know that warning of tapering would cause the market to prepare by raising rates. This is part of a clever strategy to appear serious about withdrawing stimulus but have a convenient excuse to (forever) delay the exit.

After all, if interest rates surged on the mere talk of tapering, imagine what would happen if tapering actually began!

Taper Talk Is Cheap

Bernanke may not understand how to grow a healthy economy, but he’s not foolish enough to dream that he can end QE without affecting interest rates. The real message behind Bernanke’s excuse for putting off tapering is that there is never going to be a taper. If the economy shows sign of improving, the Fed will start talking about tapering again. This will send interest rates higher, which the Fed can point to as “tight financial conditions” in need of further stimulus.

Sure enough, the day after the fakeout was announced, St. Louis Fed Chief James Bullard jumped onto the airwaves claiming that a tightening decision might come as early as October.

While some analysts think the Fed is in disarray, I think they’re trying to have their cake and eat it too. By hinting but not delivering on tightening, they can keep investors second-guessing themselves and ignoring the fact that the promised recovery never materialized.

Regime Uncertainty

On September 18th, the S&P and Dow closed at new record highs on news of the Fed’s taper fakeout. Precious metals surged as well. Whether this precipitated Bullard’s renewed advisory on tapering the following day I do not know, but his comments had the effect of smacking down the previous day’s gains.

Uncertainty over the Fed’s intentions leaves US investors in a bind. Even prominent Wall Street money managers are truly frightened by this market.

My advice remains the same: focus on long-term fundamentals, take advantage of discounts, and avoid the US Treasury bubble. While unfortunate timing may have cost some gold buyers short-term losses, the difference between $1300 and $1800 for gold will look less important when it is trading at $3000 or $5000.

This much is certain, when QE does unravel, the fallout will be devastating. In the meantime, opportunities abound for the precious metals investors.

Just this week, when gold failed to rally on the government shut down, as many assumed that it would, it promptly sold off $40 per ounce, as disappointed speculators bailed out. However, gold investors know that a government shut down in-and-of-itself is not bullish for gold. What is bullish for gold is that the shut down will soon end, and any government functions that were temporarily shut down will start right back up again.

In the end, it’s the government that will shut the economy down. But the one thing they will never shut down is the printing press. Now that is really bullish for gold.

Given the strong anticipation for a taper announcement, today’s relief rally should come as no surprise. However, the Fed’s inaction should be perceived by many as an admission that the economy is fundamentally weak. Once that possibility takes hold, today’s euphoria is likely to dissipate. Perhaps the Fed’s inaction may cause many to wonder if the economy is not as strong as they believed. This could ultimately lead to an even bigger sell off than what we would have seen today if the Fed had come through with a taper announcement.

A major factor in the current “recovery” is the confidence that has been created by rising stock and real estate prices. On Wall Street confidence can become a self-fulfilling prophecy. If the Fed were to make its fears more explicit that confidence could drift away. As a result, I believe that they chose a path of continuous obfuscation. But in so doing they lost control of the message.

The Fed knows that the appearance of economic health would evaporate if stimulus were withdrawn. But like Jack Nicholson in A Few Good Men, it also knows that the markets can’t handle the truth. Over the past year Ben Bernanke and other top Fed officials have tried mightily to communicate to the markets that no decisions had been made on the future and timing of QE reductions and that its moves would depend on the data. On many occasions they even hedged the automatic nature of their data triggers and moved the goal posts that supposedly guided their policy. But as a result of this continuous obfuscation, the Fed lost control of its message.

Despite its efforts toward vagueness, the markets nevertheless made definite conclusions.  In addition to the overwhelming consensus of economists who had predicted a taper announcement for today, many even offered precise measures of how big the taper would be (median forecasts were that bond purchases would be trimmed by between $10 and $15 billion per month). As the Fed had not dashed these expectations strongly enough, today’s non-event comes as a surprise to most. However, as I have mentioned many times in the past, the Fed has checked into a monetary Roach Motel. Getting out will be infinitely harder than getting in. In fact it will be likely impossible to get out without tipping the country back into recession.

If stock and home prices continue to rise, and if the unemployment picture appears to brighten as a result of a shrinking workforce, the Fed may have an increasingly difficult time explaining why they are failing to cut back on a policy that many mistakenly assume is no longer needed. Look for the rhetorical pretzels to get ever more complex and the goalposts that would trigger an action to become completely mobile.

But the reality is that the economy will never regain true health as long as the stimulus is being delivered. Despite trillions already administered, the workforce is shrinking, energy usage is down, the trade balance is weakening, savings are down, inflation is showing up in inconvenient places, debt is up, and wages are flat. So while QE has succeeded in hiding the truth, it hasn’t accomplished anything of substance. Unfortunately, the Fed is only interested in the headlines.

We also must understand that even if the Fed were to deliver a small reduction in bond purchases, such a move would change nothing. The Fed would still be adding continuously to its enormous balance sheet while presenting no credible plans to actually withdraw the liquidity. As I have pointed out many times, it simply can’t do so without pushing the economy back into recession. Although this would be the right thing to do, you can rest assured that it won’t happen.

We should also recall where this all began. When QE1 was first launched Bernanke talked about an exit strategy. At the time I maintained the Fed had no exit strategy. But now questions about an exit strategy have been replaced by much more delicate taper talk. But easing up on the accelerator without ever hitting the brakes will not stop the car or turn it around.

Bernanke has maintained that his purchases of government bonds should not be considered “debt monetization” because the Fed intends to only hold the bonds temporarily. In recent years however talk of actively selling bonds in the portfolio have given way to more passive plans to simply hold the bonds to maturity. But this is a convenient fiction. When the bonds mature, the Fed will have little choice but to roll the principal back into Treasury debt, as private bond buyers could not easily absorb the added selling that would be required to repay the Fed in cash. Judged by his own criteria then, Bernanke is now an admitted debt monetizer.

Following this playbook, the Fed will likely maintain the pretense that tapering is a near term possibility and that it has a credible plan on the shelf to bring an end to QE. In reality the Fed is stalling for time and hoping that the economy will inexplicably roar back to life. Unfortunately, hope is not a strategy.

Entire columns could be written on why the government had little reason to stop this particular merger, (the preponderance of other air carriers and transportation alternatives) or why the entire “anti-trust” apparatus of the government has done, and will do, nothing to support the living standards of average Americans, but the bigger story here involves the diminished scope of the airline industry in general. The difficulties that U.S. carriers face, which is the driver behind the current “urge to merge,” provides us with clear insight into the health of the broader economy.

Over the last few weeks, I have made a few attempts to show how government sleight of hand may be making our economy appear to be healthier than it actually is. For instance, I showed how in recent years initial reports of GDP growth have consistently been far too optimistic, thereby creating a false narrative about the current recovery. I also pointed out how the inflation measures used to calculate GDP have been consistently below other inflation yardsticks, and may have led to overestimates of economic growth. Instead of looking at government yardsticks, I have suggested that the truth can be better observed by looking at the demonstrable changes in living standards.

For instance, compared to prior generations, Americans now save less, use less energy, and devote a greater proportion of their disposable income to meeting basic survival needs. Such outcomes suggest falling living standards. Air travel is another real world metric worth tracking. Americans also use far less air travel than our GDP growth rate would suggest we should.

It may not be too controversial to assert that wealthy working people tend to fly much more than poorer underemployed people. When we are employed (especially at high level jobs) we tend to travel more for business. When our jobs pay well, we have the income needed to travel more on long distance vacations. It should come as the least surprising fact ever that citizens of wealthy nations tend to fly much more than residents of poor nations.

As a result of this basic understanding, the number of airline tickets sold on domestic U.S. carriers should provide a decent barometer of overall economic health. The numbers reveal that more people are flying than in the past, but the increase is less than half of what may have been expected based on the official GDP growth figures.

According to research by the Massachusetts Institute of Technology’s Airline Data Center, in 1995 U.S. carriers had a total number of 470.2 million “enplanements” (which is defined by how many times a passenger takes a trip). In 2012 that figure had gone up to 565.1 million, an increase of approximately 20.2%. This doesn’t sound too bad.

But over those 18 years, the government reported real GDP expansion (after adjusting for inflation) of 2.9% per year on average. That adds up to 52%of growth. At minimum, you might expect the airline industry to keep pace. Instead, the increase has been less than half that.

The Bureau of Transportation Statistics has another data set that doesn’t go back as far but offers a similar trajectory. They report a total of 629.8 million passengers in 2004, and 642.2 million passengers in 2012. This works out to be a 2% increase over nine years. But according to the government, real GDP has risen more than six times that (12.3%) over those nine years. By that yardstick, airline travel is lagging significantly.

Believe it or not, this has happened despite the fact that ticket prices have come down in relative terms. According to the airline industry resource, Airlines.org, the average price for a round-trip domestic ticket was $277.37 (1995 dollars) in 1995. In 2012 that figure had gone up to $355.75 (2012 dollars), an increase of 28% (the U.S. Department of Transportation (DOT) reports a similar figure of 28.4%). In terms of ticket price per passenger mile, the increase is even more modest, just 9% (13.8 cents in 1995 vs. 15.1 cents in 2012). Yet inflation since 1995, as measured by the CPI, is up 55%. This means that in relative terms, the cost of flying on an airplane has actually gone down. The DOT puts the decrease at 14.7% in 2013 dollar terms.

So Americans’ air travel has fallen relative to economic growth even while the cost of flying has fallen by a significant margin. This simply makes no sense unless you allow for the possibility that the economy really isn’t expanding as rapidly as we are being told.  It is possible that the added security and inconvenience of flying  since 9-11 has deterred people from flying, but I doubt that it’s a significant factor. Yes, many carriers now provide fewer amenities to travelers, and baggage charges, change fees, and food charges have certainly increased, but those factors can’t be that determinative. I’ll go with the simplest explanation: as Americans get poorer, our citizens fly less.

As the government takes more and more control of the economy, and as money printing, taxes and regulation become the biggest economic determinants, such an outcome is inevitable. The measurement tools can become distorted and the numbers can become fuzzy, but the outcomes are easier to see. We can’t grow government and the economy at the same time. We must choose one or the other.

 The truth is that our impoverished citizenry can no longer support the airline industry we once had. That’s why American and U.S. Air had to merge in order to stay competitive and profitable. That is the sad truth behind the headlines. The government is correct about one thing, the merger would result in fewer choices and higher fares for customers. But given the reduction of our living standards that outcome is impossible to avoid. If our government really wants to protect consumers and allow for more affordable air travel, a better solution would be to reverse the destructive policies that made the merger necessary in the first place. Ironically blocking the merger could result in more flight reductions and larger fare increases than what might have been the case had the merger been allowed.

It would be impossible to measure the economy without “backing out,” inflation. That is why economists are very careful to separate GDP reports into two categories: “nominal” (which are not adjusted for inflation), and real (which are). Only the real reports matter. The big question then becomes, how do we measure inflation? Just as I reported last week with respect to the biases baked into the government’s GDP revisions, the devil is in the details. 

As it turns out there are a number of official inflation gauges that vie for supremacy. Most people tend to follow the Consumer Price Index (CPI) which is compiled by Bureau of Labor Statistics, a division of the Department of Labor. The CPI is regarded as the broadest measurement tool, but it has been changed many times over the years. Most famously, its formulas were loosened in the late 1990′s as a result of the “Boskin Commission” which said that the CPI overstated inflation by failing to account for changes in consumer behavior. I believe those changes seriously undermined the reliability of the index. But the CPI itself has to contend for relevance with its stripped down rival, the “Core CPI,” which factors out food and energy, which many believe are too volatile to be accurately counted. The core CPI is almost always lower than the “headline” number.

Another set of inflation data, the “GDP Deflator” is compiled by the Bureau of Economic Analysis (part of the Commerce Department), and is used by them to calculate GDP. The deflator differs from the CPI in that it has much more flexibility in weighting and swapping out items that are in its sample basket of goods and services. While the CPI attracts the lion’s share of the media and political attention, it is the deflator that is relevant when looking at economic growth.

On a quarterly basis the two numbers are usually close enough to escape scrutiny. (However, the most recent 2^nd quarter GDP estimates relied on annualized inflation of a ridiculously low .7%!). But if you look at a broader time horizon a very clear pattern emerges that makes a great difference in how we perceive the economic landscape.

Available data sets for both the CPI and the GDP deflator go back to 1947. That 66 year period falls neatly into two phases. From 1947 to 1977 both yardsticks moved together almost identically, both rising 173% over that time. But in the ensuing 36 years (until 2013), the CPI is up almost three fold (292%) while the deflator is only up about two fold (209%). The CPI rising 40% more than the GDP deflator is an extremely significant factor. How did that happen? As it turns out, quarterly inflation assumptions have been, on average, .17% lower for the deflator than for the CPI since 1977. That is a small number. But as with compound interest small numbers add up to big numbers over time.

If you replace the GDP quarterly growth rates using the higher CPI rather the deflator, our current economy would be closer to $13 trillion than 16.6 trillion, about 28% smaller. Even if you were to split the difference between the CPI and the deflator you would still get an economy that is significantly smaller than it appears.

The $64,000 question ($188,000 adjusted by CPI inflation since 1977) is what happened in 1977 to make the CPI and the deflator diverge? Sadly, the details aren’t really made public. What we do know is that the BEA took over the task in 1972, and that the separation occurred a few years later when inflation really started to run out of control. We also know that the deflator is more flexible than the CPI and that the interests of the government are better served by reporting low inflation and higher growth. So in other words, the deflator is likely lower for the same reasons that dogs lick themselves in intimate places: because they want to and they can.

If we had been growing as quickly as the official GDP indicates, why would our labor force have contracted so significantly? Why are we continuously replacing middle class jobs with lower paying ones? Why would we be using 3 percent less energy nationally than we did 10 years ago despite an 8.8% growth in population? Why would Americans be spending a higher percentage of their disposable incomes on basic necessities than they were 10 years ago? These trends don’t conform to healthy GDP growth. So maybe the growth is largely an illusion?

When you take into consideration the likelihood that even the CPI drastically understates inflation, you get a much clearer picture of the true state of the U.S. economy. If you ever wondered how we went from being the world’s largest creditor to its biggest debtor despite all this economic growth, now you know. As the growth was merely a statistical illusion, we have been forced to borrow money to maintain a life style our economy can no longer support.

So the next time you see a GDP report remind yourself that the “deflator” should really be called the “distractor.” It’s there to distract you from the truth.

As a result of this phenomenon, an overall optimism has pervaded the economic discussion that has consistently been unfulfilled by actual performance. The government is continuously over promising and under delivering. Unfortunately, no one seems to care.

Measuring the size of the economy accurately in anything close to real time is difficult, inexact, and messy. That is why the BEA has long pursued a policy of initial quarterly estimates (known as the “advanced estimate”), followed by two or three subsequent revisions as more thorough analysis comes to bear. The first estimates come out about a month after the conclusion of a particular quarter. The second and third revisions then come in monthly intervals thereafter. But in the minds of the media, the public and the politicians, the initial report carries much more weight than the revisions. It is the initial report that attracts the screaming headlines and sets the tone. The revisions are typically buried and ignored. This creates an unfortunate situation where the initial estimates are both the most important and the least reliable.

However, logic would dictate that revisions would fall equally in the up and down categories. After all, government bean counters are expected to report objectively, not to create a narrative or manage expectations. If anything, I believe that the public would be better served if they would adhere to the conservative playbook of under promising. That is exactly what they seemed to be doing before the economic crash of 2008. From 2002 to mid-summer 2008, the BEA revised initial GDP estimates a total of 25 times, 80% of which (20 revisions) were higher than their initial estimate. However, the average amplitude of the upward and downward revisions were equal at .5%. The difference may have been a function of the relatively strong economy that the nation saw over that time (which I believe was a result of the unsustainable and artificial housing boom). See the chart below.

But since mid-2008 we have seen a very different story. 67% of the revisions (12 of 18) have been downward, and those adjustments have been, on average, 50% larger than the upward revisions (.75% vs. .5%). Here’s another way of looking at it: Since mid-2008, revisions have shaved a total of 6 points of growth off the initial estimates. This works out to be an average of 1.3 points of growth per year that some may have expected but that never actually happened.

The pattern of early optimism may stem from the lack of understanding in Washington about how monetary stimulus actually retards economic growth. Many of the statisticians may be former academics who take it as gospel that government spending and money printing create growth. As a result, they expect the initial boost created by stimulus to be sustainable. The evidence suggests that it is not.

But there can be little doubt that these overly optimistic projections have worked wonders on the public relations front. The big Wall Street firms and the talking heads on financial TV set the tone by jumping on the new releases and ignoring the revisions to prior releases. That is precisely what happened last week when the better than expected 1.7% growth in 2nd quarter GDP overshadowed the .7% downward revision to 1st quarter GDP from 1.8% to 1.1%. The initial estimate for 1st quarter GDP, released back in April, was 2.5%. Since the consensus expectation for 2nd quarter GDP was just 1%, the media jumped all over the “good” news, while ignoring the revisions to the prior quarter, and discounting the strong likelihood that Q2 GDP will be revised downward. The nature of our short-term 24-hour news cycle is a big factor in this. Reporters are always looking for the big story of the day, not the minutia of last month. The lack of critical thinking and economic understanding also play a role.

Of course even if you have the discipline to focus on the final estimates, you still aren’t getting the real story. All GDP estimates are based on imperfect inflation measurement tools, which I believe are designed to under report inflation and over report growth. The most recent GDP projection used an annualized .71% inflation deflator to arrive at 1.7% growth. Anyone who believes that inflation is currently running below 1% has simply no grasp of our current economy. Look for more analysis of this topic in my upcoming columns. In the meantime, don’t get excited by initial reports of a healthy recovery. The reality is likely to be more sobering.

Well, it looks like the so-called “technicals” are starting to support my theory, and so this month I’m going to depart from my typical discussion of market fundamentals and take a look at the COMEX gold futures market. It turns out that the same paper markets that helped drive the price of gold down are beginning to run into the hard reality of physical gold demand; their reversal may push gold to new highs.

Reading the Futures

The world of futures contracts is often confusing for ordinary investors. It is mainly the domain of institutions seeking to hedge and professional speculators. I do not recommend passive investors get involved in futures trading, but it is helpful to understand how these financial instruments affect gold’s spot price.

In its most basic form, a gold futures contract is an agreement to buy a set amount of gold at the current spot price with delivery guaranteed at a future date. The attractive part is that you don’t need to pay the full price up front. You can put a down payment on 100 ounces of gold today, knowing that you will only have to complete the payment when the contract comes due. If the price of gold rises in the intervening time, you’ve made a nice profit, because you end up paying today’s price for a product that is worth more in the future. Of course, the person who sold you the contract takes a loss for the same reason. The person buying the contract is said to be “long” gold, while the seller is “short.”

One of the reasons gold futures are so risky is because of the sheer quantity of gold that transactions represent. When you buy a single COMEX gold futures contract, you gain control – and responsibility for – 100 troy ounces of the yellow metal. So when the gold futures market was said to have made “big moves” this last April, that was an understatement – on April 12th, it opened with a sell off of 100 tons of gold!

It gets worse. Traders often leverage (borrow cash) to buy futures contracts, with the down payment they supply known as the “maintenance margin.” The minimum maintenance margin for a single futures contract is only $8,800. If spot gold is at $1,300, then a trader can gain control of $130,000 worth of gold with less than 7% down! Depending on a combination of luck and experience, this massive leveraging can lead to either amazing profits or devastating losses.

Let’s walk through an example, keeping in mind that my figures are very simplified, because a futures contract is not exactly equal to 100 times the current gold spot price. Most of the time, futures prices are a little higher than spot gold.

Say gold is at $1,300, which means a COMEX gold futures contract gives the investor control of about $130,000 worth of gold. A trader buys a contract with only a $8,800 margin. If the price of gold goes up to $1,500, the futures contract is now worth $150,000. The trader can now sell that contract and pocket the difference. He just netted about $20,000 with only $8,800 in seed money. If the trader had simply bought $8,800 worth of physical gold, he would have only earned about $1,350 in the same time period. It is not hard to see how futures trading can seem exciting and profitable on its face.

But what if the price of gold goes down in this scenario? The more the price of gold drops below the contract price of $1,300, the more the investor will be required to add to his margin to maintain the same ratio of down payment to loan value. This is required as assurance that he will not abandon the contract. In the worst case scenario, the trader cannot put up the additional funds and the entire position is liquidated by his broker.

So far, this example is of a trader “going long” with a futures contract. It can be risky, but the potential losses of a long futures trader are nothing compared to the losses someone shorting the market might experience.

Consider the same scenario above, except this time the trader has a short contract. He is desperately betting that the price of gold will drop enough for him cover his short position (buy back the contract he sold) at a lower price. After all, he can not hold the contract to maturity, as he does not actually own any physical gold, and thus would not be able to deliver to the buyer.

The key difference between long and short traders is that shorts are forced to add to margin when the price of gold goes up. Unlike a drop in the price gold, which can only go so low, there is theoretically no limit to how high the price of gold can rise. Someone betting on gold’s demise with short futures contracts when gold enters a big bull market can be completely devastated by their margin calls.

It’s risky enough leveraging into a deal as aggressively as futures traders do, but if traders don’t understand the fundamentals of the asset underlying the contract (in this case, actual physical gold), they can get into a lot of trouble and in turn distort the price of the commodity they are trading. This is precisely what is happening now.

The Short Squeeze

When gold began its price drop in April, we saw a rush of paper gold flee the market, including record-high ETF outflows. Major money managers and hedge funds began selling their gold positions, issuing lower and lower forecasts for the year-end gold price. All of this became a major signal for futures traders to short gold.

The selling feeds on itself as the traders seek to cut their losses, or retain some of the paper profits the earned on the way up. Sometimes the selling is fueled by “stop sell orders,” which are orders on the books that are automatically triggered when prices decline to a specific level, in many cases just below key technical support levels. Stops generally become market sell orders as they are hit, accelerating the decline and thereby triggering even more stops as prices fall lower. Some stops represent long positions being covered; others represent new short positions being established.

This ongoing shorting of gold builds a cycle that feeds on itself. The shorts see others fleeing the market and so continue to short. Meanwhile, the fund managers see the net-short positions increasing and so they continue to sell gold.

This cycle continued right up until gold’s rebound – in July, the gold net-short positions reached record highs.

When gold began to rebound last month, a massive number of shorts were left exposed and many still remain exposed. Gold shorts are stuck holding the losing bet on an asset that is going to do the opposite of what they anticipated.

If the price rally continues, these traders will feel increasing pressure to unwind their shorts before their losses become catastrophic. This “short squeeze,” as it is known in finance, will reverse the vicious cycle and could send gold dramatically higher than when the correction started.

An Unbalanced Ecosystem

To understand this short squeeze, imagine a brand new predator entering a pristine natural ecosystem. The newly introduced predator finds a smorgasbord of prey that have never learned to outrun, outsmart, or avoid this particular predator. Before long, the predator becomes “invasive” and begins to devastate the natural population of its easily-captured food source. Thriving on the newfound resources, the population of the invasive predator surges to new highs – until the prey population collapses.

This is akin to what has happened with gold shorts in the past three months. The more the price of gold (the prey) was driven down, the more gold speculators (invasive species) entered the market to profit from this trend, which only served to drive the price down further.

However, as in a natural ecosystem, this relationship is unsustainable. Eventually there are so many predators that they run out of enough prey to share. This forces the predators to starvation, and eventually the population drops to a sustainable level while the prey manage to grow back to a natural equilibrium.

The overwhelming problems for the shorts is that the gold they sold on the way down will not likely be for sale on the way up. My guess is that the buyers who previously stepped up to the plate were not short-term traders like the speculators who sold. These were buyers who bought gold to own it, not to trade it. For these buyers, like foreign central banks, the gold they bought is not for sale at any price (at least not a price the speculators can afford to pay). The buyers over the past few months have been lying in wait for this opportunity for years.

The result of this price decline is that gold has moved from weak hands to strong. In addition, the weakness in the price of gold has caused gold miners to shut mines, reduce capital expenditures, and limit exploration/development. So gold that was once on the market will be gone, and future supply coming from new production will be diminished. So when the market turns around, how will the shorts cover? Where will the gold they need to buy come from? When traders want back into the ETFs, where will the ETFs get the physical gold they need to buy? How much higher will prices have to rise to bring that supply back onto the market? I really have no answers to these questions, but it sure will be fun for the longs, and painful for the shorts, to find out.

What you and I can really hope for is that this massive short-squeeze becomes the impetus to focus the market back on gold’s fundamentals and begins to drive the yellow metal back toward its previous highs. If I’m right that gold is still grossly undervalued, then this might be the beginning of the biggest rally we’ve yet seen.

Proving that politicians want nothing more than to tell soothing lies to voters, Detroit mayoral candidate Tom Barrow has forcefully asserted that the city’s fiscal crisis is a fiction. In a recent TV interview he described a long term conspiracy by republican and private sector forces to steal assets from Detroit residents, bust the unions, and disenfranchise voters. Not to be outdone in absurdity, MSNBC host Ari Melber concluded that Detroit’s problems result from the libertarian movement to deny residents needed government services. He ignores the fact that Detroit’s government did not whither by choice, but by necessity. Thanks to years of excessive government the city lacks the resources to fund the basic services that even most libertarians support. Others claim that Detroit is just as deserving of federal bailouts as the Big Three or the communities wiped out by natural disasters such as Hurricane Sandy. But there is nothing “natural” about the fiscal disaster in Detroit, and the mistake of bailing out the auto companies should not be compounded on a municipal level.

The real story of Detroit is that its problems are entirely man-made, and can be summed up in seven words. Private enterprise built it, government destroyed it. That is the screaming headline that is unfortunately absent from the media coverage.

In the first half of the 20^th Century, Detroit offered good manufacturing jobs to nearly 200,000 workers. The booming labor market caused the City’s population to swell to 1.8 million by mid Century. But the jobs did not come from government programs or public “investments” in education and training. They were in fact created by the vibrancy of American capitalism, the vision of forward thinking industrialists, the strong work ethic of the labor force, and the relative non-interference from government or organized labor. (“The Big Three” auto companies did not begin to bargain collectively with the United Auto Workers until 1941).

Anyone who has ever had the pleasure of encountering a classic American car like a 1934 Oldsmobile 8 Convertible Coupe or a 1941 Chrysler Town & Country should get a sense of why Detroit prospered as it did. Not only were these cars stunning pieces of engineering and craftsmanship, but they were surprisingly affordable for many middle class Americans. The wealth generated by the makers of these cars, and the myriad of lesser manufacturers that serviced them, flowed to all classes of people in Detroit, allowing the city to build great buildings and civic spaces, establish world class arts institutions, and contributed greatly to the country’s cultural achievements.

But as the city reached its zenith, organized labor and government at the state, federal and local levels combined to kill the goose that laid the golden eggs. Although Detroit continued to produce and prosper into the 1950s, the Vietnam era marked a turning point for the auto industry and the city it represented. While the bureaucratic structure and myopic hubris of the largely unchallenged American auto industry certainly contributed to its decline in the post war years, the real blame falls squarely on labor unions and government. Facing the unshakable power of a monopolized labor force backed by the full might of a democratically controlled political machine, the auto companies had to agree to wage hikes, restrictive work rules, and long-term pension commitments that they simply could not survive.

Politically, the voting block dynamics of a heavily unionized municipality created a perfect storm for Detroit. Mayors and councilman were elected based on the ability to continue to promise more to the unions, who of course showered their preferred candidates with campaign funds. And while the auto companies were free to back candidates of their own, there is no substitute for actual voters. As a result, Detroit has been saddled with generations of corrupt and incompetent governments funded by corrupt, incompetent unions. Both camps have essentially no understanding of how their city was built and how the promises they were making to future generations could never be kept once the industries succumbed under the heavy hand of taxation, regulation, and labor coercion.

Today the population of Detroit has declined more than 60% from its peak and the number of manufacturing jobs has fallen by 90% to fewer than 20,000. Meanwhile the city’s municipal debt is now more than $18 billion, which translates into $25,000 per citizen in a city where fewer than half the adult population is employedand nearly half are functionally illiterate. It has promised more than $3 billion to 20,000 city pensioners ($150,000 each) that it simply doesn’t have. Detroit’s Emergency Manager Kevyn Orr recently showed how the City spends 38 cents of every new tax dollar on these “legacy costs,” a figure he expects will grow to 65 cents. This means that there is no money left to run the city. But rather than acknowledging these problems, Detroit politicians, like the aforementioned mayoral candidate, like to pretend that they don’t exist.

Things are no different in Washington. On a national level we have also promised far more than we can deliver. In addition to our acknowledged current national debt of almost $17 trillion ($53,400 per citizen), there is another $87 trillion in unfunded obligations that the Federal government has promised to pay Social Security and Medicare recipients over the next 75 years. (These figures are over and above the projected revenues those programs are scheduled to bring in.) This difference comes to another $290,000 per citizen. Anyone remotely aware of the financial well-being of the average American will know these figures are well beyond our means. But this hasn’t motivated us to reform entitlements in a way that will render them affordable.

Very few politicians are prepared to level with the American people about our fiscal dead end. Similarly, they will not fully acknowledge the extent that government micromanagement of industry through the tax code and overly restrictive labor and health care policies has severely undermined the ability of U.S. industry to compete internationally. As a result, we have seen a steady disappearance of our manufacturing jobs nationally, just like Detroit has. The big difference of course is that Washington has a printing press. In the end, however, that will make little difference.

The good news is that the same forces that built Detroit could help turn it around, if only they were allowed to function. First off, Detroit needs to default on its debt. This means the bond holders and the citizenry will suffer. But after this painful process is complete, Detroit will have a few things going for it. It will boast abundantly cheap real estate and plenty of desperate workers. If government were to relax employment regulations, cut business and sales taxes, crack down on union intimidation tactics, and eliminate the minimum wage, the employers would sense the opportunity and return. Although industry could not offer the kinds of high paying jobs that it had in the past, Detroit would at least be hiring again. Although the city will be set back generations, at least it would be moving. But the left would erupt in fury. We are programmed to perceive such developments as greedy exploitation rather than the natural manner in which capitalism cures excess and starts again at square one. Liberals would rather the unemployed stay that way rather than suffer the degradations of capitalism. So instead of such honest cures, look for Detroit to borrow its way out of the crisis while pretending to fix its chronic problems. If we laugh at their foolishness, we should all look in the mirror.

Lately, the precious metals have taken a beating, and I’ve been called to defend gold’s future prospects in the media countless times. While I am confident that gold will rebound with a vengeance before long, I think investors are potentially missing an even greater opportunity in that other monetary metal: silver.

To address this oversight, I have compiled a special report called The Powerful Case for Silver, which is available at www.schiffsilver.com. This 14-page report report contains in-depth analysis of what I believe to be the strongest arguments for owning the white metal. What follows is a general overview of the key arguments I make in the report.

The People’s Money

After a couple generations of purely fiat currency in the United States, a lot of people have forgotten that money used to be backed by something of value – gold and silver. It wasn’t until 1965 that the US stopped making its dimes and quarters out of 90% silver, and the dollar was backed by gold internationally until 1971.

In spite of fiat money’s ubiquity, more and more people around the world are waking up to the dangers of paper currency and turning to gold and silver to protect their savings. Silver is particularly useful to everyday citizens around the world because of its smaller value-to-weight. A half-ounce of silver can buy you dinner. A half-ounce of gold can buy dinner for you and 60 of your closest friends. That’s why for centuries, gold has been considered the money of kings, while silver is known as the people’s money.

It’s not hard to see the growing importance of a stable medium of exchange worldwide – look to the Cypriot banking crisis or the barter markets evolving spontaneously in economically devastated countries like Argentina or Greece. Here are places where having an stash of silver versus a roll of banknotes can mean the difference between keeping your family well-fed and having to beg for assistance.

Developed nations are also waking up to this reality, translating into record silver sales at the US Mint and other major bullion producers despite the recent correction in global spot prices. This investment demand is providing a baseline of support to silver’s price and helping to re-establish silver as a universally recognized form of money.

Growing Industrial Demand

Silver conducts heat and electricity better than any other metal on Earth. It is also anti-bacterial. These amazing properties make silver indispensable in a vast array of modern industrial and technological applications.

This industrial demand has been shifting dramatically since the turn of the century, as defunct applications for silver like photographic film have been replaced by new technologies like photovoltaic power. The evolution of silver’s industrial applications continues unabated, with new uses being developed every year.

In spite of a recent dip in demand for industrial silver due to global economic volatility, the fundamentals of the industries consuming silver look promising. The Powerful Case for Silver delves deeper into the latest silver technologies like nanosilver and demonstrates why I believe industry will provide growing demand for silver over time.

Undervalued Relative to Gold

For the majority of human history, the prices of silver and gold have been closely tied to each other. There is estimated to be about 19 times as much silver as gold in the earth, and only 11.2 times more silver than gold has ever been mined. Today, the silver:gold price ratio on the markets is about 65:1. That is out of sync with the relative scarcity of the metals and with the long-standing historic bounds from 12:1 to 16:1.

To understand why silver is being undervalued by the market, it is important to trace the histories of the two precious metals. Over the last two centuries, as world markets were forcibly detached from their monetary backing, clumsy attempts at setting fixed exchange ratios at first cleared and then flooded Western markets with silver. Then, with both metals taken out of circulation, precious metals investment was confined to saving – a role more suited to gold.

As the fiat currency system collapses around us, I expect the precious metals to return to circulation, and silver to once again be valued for its advantages in this role. Though I expect both metals to appreciate significantly, silver may rise much faster in order to realign with its historical price ratio to gold.

Take The Time to Understand Your Investment

I’ve just brushed the surface of The Powerful Case for Silver. Inside the report, you’ll find more detail on all of these points, accompanied by helpful charts and graphs illustrating silver’s future prospects.

The Powerful Case for Silver also provides advice on which silver products are investment-grade and how to go about purchasing them safely.

For those who have been on the fence during this bull market, the recent correction is an excellent opportunity to learn about silver and build a position.

The New York Times had the definitive take on the vicious sell off in gold. To summarize one of their articles:

Two years ago gold bugs ran wild as the price of gold rose nearly six times. But since cresting two years ago it has steadily declined, almost by half, putting the gold bugs in flight. The most recent advisory from a leading Wall Street firm suggests that the price will continue to drift downward, and may ultimately settle 40% below current levels.

The rout says a lot about consumer confidence in the worldwide recovery. The sharply reduced rates of inflation combined with resurgence of other, more economically productive investments, such as stocks, real estate, and bank savings have combined to eliminate gold’s allure.

Although the American economy has reduced its rapid rate of recovery, it is still on a firm expansionary course. The fear that dominated two years ago has largely vanished, replaced by a recovery that has turned the gold speculators’ dreams into a nightmare.

This analysis provides a good representation of the current conventional wisdom. The only twist here is that the article from which this summary is derived appeared in the August 29, 1976 edition of The New York Times. At that time gold was preparing to embark on an historic rally that would push it up more than 700% a little over three years later. Is it possible that the history is about to repeat itself?

At the time The Times article was written gold had fallen to $103 per ounce, a decline of nearly 50% from the roughly $200 it had sold for in the closing days of 1974. The $200 price had capped a furious three-year rally that began in August of 1971 when President Nixon “temporarily” closed the gold window and allowed gold to float freely. Prior to that decision gold had been fixed at $35 per ounce for nearly two generations. That initial three year 450% rally had validated the forecasts of the “gold bugs” who had predicted a rapid rise in gold prices should the dollar’s link to gold be severed. The accuracy of these formerly marginalized analysts proved to be a bitter pill for the mainstream voices in Washington and Wall Street who, for reasons of power, politics and profit, were anxious to confine the “barbarous relic” to the dustbin of history. Incredulous as it may seem now, with gold still priced at $35 per ounce, official forecasts of both the Secretary of the Treasury and the Chairman of the Federal Reserve were that demonetizing gold would undermine its value, and that its price would actually fall as a result.

Of course government experts could not have been more wrong. Once uncoupled from the dollar, gold’s initial ascent in the early 1970′s was fueled by the highest inflation in generations and the deteriorating health of the U.S. economy that had been ravaged by the “guns and butter” policies of the 1960′s. But the American economy stabilized during the mid-years of the 1970′s and both inflation and unemployment fell. When gold reversed course in 1975 the voices of traditional power elite could not contain their glee. When the gold price approached $100 per ounce, a nearly 50% decline, the obituaries came fast and furious. Everyone assumed that the gold mania would never return.

Although the writer of The Times piece did not yet know it, the bottom for gold had been established four days before his article was published. Few realized at the time that the real economic pain of the 1970′s had (to paraphrase The Carpenters 1970′s hit) “Only Just Begun”. When inflation and recession came back with a vengeance in the late 1970′s, gold took off (to quote another 1970′s gem), like a skyrocket in flight. By January 1980, gold topped out at $850 an ounce. The second leg of the rally proved to be bigger than the first.

The parallel between the 1970s and the current period are even more striking when you look closely at the numbers. For example, from 1971 to 1974 gold prices rose by 458% from $35 to $195.25, which was then followed by a two-year correction of nearly 50%. This reduced total gains to just under 200%. The current bull market that began back in 2000 took a bit longer to evolve, but the percentage gains are very similar. (We should allow for a more compressed time frame in the 1970s because of the sudden untethering of gold after decades of restraint.) From its 1999 low to its 2011 peak, gold rose by about 650% from $253 to $1895 per ounce, followed by a two year correction of approximately 37%, down to around $1190 per ounce. The pullback has reduced the total rally to about 370%. The mainstream is saying now, as they did then, that the pullback has invalidated fears that rising U. S. budget deficits, overly accommodative monetary policy, and a weakening economy will combine to bring down the dollar and ignite inflation. But 1976 was not the end of the game. In all likelihood, 2013 will not be either.

The biggest difference between then and now is that until 1975 ordinary Americans were barred by law from buying and owning gold. About the only route available to participate in the earlier stage of the precious metal rally was by hording silver dimes, quarters and half dollars minted prior to 1965. My father indulged in this process himself by sifting through his change, the cash registers of any merchant who would allow him (exchanging new non-silver coins and bills for silver), and by sifting out silver coins from rolls he bought from banks. It was a time-consuming process, and most of his friends and family members thought he was crazy. After all, he had $10,000 worth of pocket change earning no interest.But the $10,000 face value worth of those coins he collected had a melt value of over $350,000 when silver hit its peak.

By the mid 1970′s none of the problems that initially led to the recession in the early years of the decade had been solved. Contrary to the claims of the “experts” things got much worse in the years ahead. It took the much deeper recession of the late 1970′s and early 1980′s, which at the time was the worst economic down-turn since the great Depression, to finally purge the economy of all the excesses. The lower marginal tax rates and cuts in regulation implemented by President Reagan and tight money under Volcker helped get the economy back on track and create investment opportunities that drew money away from gold. As a result gold fell hard during the early 1980′s. But even after the declines, gold maintained levels for the next 20 years that were three to four times as high as the 1976 lows.

Although the economy improved in the 1980′s, the cure was not complete. Government spending, budget and trade deficits continued to take a heavy toll. The U.S. was transformed from the world’s largest creditor to its largest debtor. When the time came to face the music in 2001, the Fed kept the party going by opening the monetary spigots. Then when decades of monetary excess finally came to a head in 2008, the Fed open up its monetary spigots even wider, flooding the economy with even more cheap money.

Unfortunately just like 1976, a true economic recovery is not just around the corner. More likely we are in the eye of an economic storm that will blow much harder than the stagflation winds of the Jimmy Carter years. And once again the establishment is using the decline it the price of gold to validate its misguided policies and discredit its critics. But none of the problems that led me and other modern day gold bugs to buy gold ten years ago have been solved. In fact, monetary and fiscal policies have actually made them much worse. The sad truth is that as bad as things were back in 1976, they are much worse now. Whether as a nation we will be able to rise to the occasion, and actually finish the job that Ronald Reagan and Paul Volcker started remains to be seen. But I am confident that the price of gold will rise much higher, and that its final ascent will be that much more spectacular the longer we continue on our current policy path. Don’t believe the mainstream. Just as before, they will likely be wrong again.

The Best of Peter Schiff

The Japanese stereotype of excessive courtesy is being confirmed by the actions of prime minster Shinzo Abe who is giving the world a free and timely lesson on the dangers of overly accommodative monetary policy. Whether or not we benefit from the tutorial (Japan will surely not) depends on our ability to understand what is currently happening there.

For now most economists still believe that Abe has stumbled upon the magic elixir of economic revitalization. His commitment to pull his country out of the mud by doubling the amount of yen in circulation, and raising the nation’s official inflation rate to 2%, had conferred rock star status on the formerly bland career politician. But just one year after his first critical raves arrived, the audience is heading for the exits. As it turns out, the Japanese miracle may be a simple tale of confidence easily gained, and just as rapidly lost.

In many ways the 75% nine month rally in the Nikkei 225 (that began when Abe was elected prime minister in September 2012), and the subsequent crash that began on May 22, is not all that different from the turbocharged rally, and spectacular crash, that occurred in technology heavy Nasdaq more than a dozen years ago here in the United States.

At the time that Pets.com (the company behind the iconic Sock Puppet) made its IPO, other high flying tech stocks had racked up 1000% gains. While investors scratched their heads, pundits offered reasons why common sense no longer applied to the new economy. We were told that valuations, revenue and profits no longer mattered. And to an extent that now seems absurd, the investing establishment bought into the insanity. But then a funny thing happened, investors woke up and realized that they had nothing but a handful of magic beans that couldn’t grow a beanstalk. When the fog lifted, stocks plummeted…Wile E. Coyote style.

This time around investors in the Japanese market were similarly deluded by fairy tales. Leading economists told them that Japan could cheapen its currency to improve trade, use inflation to create real growth, increase prices to encourage spending, and drastically increase inflation without raising interest rates. In short, monetary policy was seen as substitute for an actual economy.

Initially at least the economic data seemed to confirm the success of Abe’s program. The leading indicator was the yen itself, which dropped like a stone. Given the widely held view that a weak currency is the key to economic success, the 25% decline in the yen was welcomed as good news. Soon thereafter, the inflation that Abe so eagerly sought began to materialize in various sectors of the economy. When the Nikkei reacted positively to these developments, momentum traders from around began to take notice, thereby creating self-fulfilling prophecy.

But it’s no great trick to weaken a currency. Any two bit economy could accomplish that objective. For a nation like Japan that imports nearly all of its raw materials it was inevitable that a drastically cheaper yen would to push up prices. However the rest of the plan, the part about surging exports and growing economic activity, has been much harder to achieve. In fact the data has been downright disheartening. The plunging yen has failed to reverse Japan’s weakening trade balance which has declined for 28 straight months. The trend finally sent Japan into an overall trade deficit 10 months ago for the first time in 30 years. The latest data confirms that while the yen value of exports has increased, actual trade volume has fallen.

While the broad economic data failed to impress, economists and investors were nevertheless hopeful that Abenonmics would eventually work its magic. But recently the bottom has fallen out in a way that should have surprised no one, but somehow managed to do just that. Beginning in April Japanese Government bonds began to sell off sharply. Previously, the Japanese government could borrow funds for 10 years at just 36 basis points.

The truth is that the sub 40 basis point yield on Japanese Government bonds was the most important data point for their economy. At those levels, Japan needed to spend 25% of its tax revenue to service its outstanding debt. While that figure is high, most it is manageable given Japan’s high savings rate. However, with a national debt that exceeds 200% of GDP, the Japanese government could quickly become insolvent in the face of higher debt service costs. If rates on 10 year debt were to ever match the 2% of their inflation target, more half of total tax revenue would be needed to service debt payments.

But the central premise of Abenomics seems to be that the Bank of Japan could push up inflation to 2% without raises the rates on long-term debt. To do this one would have to assume that bond investors would accept negative interest rates, even while a falling yen was eating away at principle and returns on alternative investments would be expected to be more attractive. Such an outcome is not consistent with human behavior.

As a result, in late May a strong sell off in Japanese government bonds caused yields to nearly triple to almost 100 basis points on 10 year debt. And while one percent doesn’t sound like much, it was the rapidity of the ascent that got everyone’s attention. This grim, but very simple, reality seems to have hit Japanese stock investors with a panic unseen since Mechagodzilla took aim at Tokyo. Knowing that even moderately higher rates could counteract any economic gains made by stock market or export growth, the faith in Abenomics has seemed to evaporate almost overnight. Sounds a little like the dot-com bubble, doesn’t it?

Any more rapid escalation in Japanese bond yields should tell us that quantitative easing and growth through devaluation is a cul-de-sac that should be avoided. Japan should be our canary in the coal mine. In the meantime, the drama in Japan is diverting attention away from more important shifts in Asia, more of that in our latest newsletter.

The Best of Peter Schiff

As usual the Federal Reserve media reaction machine has fallen for a poorly executed head fake. It has been fooled by this move many times in the past and for its efforts it has tackled nothing but air. Yet right on cue, it took the bait once more. Somehow the takeaway from Wednesday’s release of the June Fed statement and the Bernanke press conference is that the Central bank is likely to begin scaling back, or “tapering,” it’s $85 billion per month quantitative easing program sometime later this year, and that the program may be completely wound down by the middle of next year.

Although this scenario is about as likely as an NSA-sponsored ticker tape parade for whistle blower Edward Snowden, all of the market segments reacted as if it were a fait accompli. The stock market, convinced that it will lose the support of ultra-low, long-term interest rates, and the added consumer spending that results from a nascent housing bubble, sold off in triple digits. The bond market, sensing that its biggest and busiest customer will be exiting the market, followed a similarly negative trajectory. The sell -off in government and corporate debt pushed yields up to 21 month highs. In foreign exchange markets the dollar rallied off its four-month lows based on the belief that Fed tightening will support the currency. And lastly, the gold market, sensing that an end of quantitative easing would eliminate the inflationary fears that have partially fueled gold’s spectacular rise, sold off nearly five percent to a new two and a half year low.

All of this came as a result of Bernanke’s mild commitments to begin easing back on permanent QE sometime later this year if the economy continued to improve the way he expected. The Chairman did not really elaborate of what types of improvements he had seen, or how much farther those unidentified trends would need to go before he would finally pull the trigger. He was however careful to point out that any policy shift, be it for less or more quantitative easing, would not be dependent on incoming data, but on the Fed’s interpretation of that data. By stressing repeatedly that its data goalposts were “thresholds rather than triggers” the Fed gained further latitude to pursue any stance it chooses regardless of the data.

Yet the mere mention that tapering was even possible, combined with the Chairman’s fairly sunny disposition (perhaps caused by the realization that the real mess will likely be his successor’s problem to clean up) was enough to convince the market that the post-QE world was at hand. This conclusion is wrong.

Although many haven’t yet realized it, the financial markets are stuck in a “Waiting for Godot” era in which the change in policy that all are straining to see, will never in fact arrive. Most fail to grasp the degree to which the “recovery” will stall without the $85 billion per month that the Fed is currently pumping into the economy.

What exactly has convinced the Fed that the economy is improving? From what I can tell, the evidence centered on the rise in stock and real estate prices, and the confidence and spending that follow. But inflated asset prices are completely dependent on QE and are likely to reverse course even before it is removed. And while it is painfully clear that expectations about QE continuance have made a far bigger impact on the stock, bond, and real estate markets than any other economic data points, many must be assuming that this dependency will soon end.

Those who hold this belief have naively described QE as the economy’s “training wheels,” (in reality the program is currently our only wheels.) They are convinced that the kindling of QE will inevitably ignite a fire in the larger economy. But the big lumber is still too dampened by debt, government spending, regulation, and high asset prices to catch fire. So all we have gotten is smoke. A few mirrors supplied by the Fed merely completed the illusion. The larger problem of course, is that even though the stimulus are the only wheels, the Fed must remove them anyway as we are cycling toward the edge of a cliff.

Although Bernanke dodged the question in his press conference, the Fed has broken the normal market for mortgage backed debt. While it’s true that the Fed only owns 14% of all outstanding MBS (the “small fraction” he referred to in the press conference) it is by far the largest purchaser of newly issued mortgage debt. What would happen to the market if the Fed were to stop buying? There are no longer enough private buyers to soak up the issuance. Those who do remain would certainly expect higher yields if the option of selling to the Fed was of table. Put bluntly, the Fed is the market right now and has been for years.

A clear-eyed look at the likely consequences of a pull-back in QE should cause an abandonment of the optimistic assumptions behind the Fed’s forecast. Interest rates are already rising rapidly based simply on the expectation of tapering. Image how high they would soar if the Fed actually tried to sell some of the mortgages it already owns. But the fact is, the mere anticipation of such an event has already sent mortgage rates north of 4%, and without more QE from the Fed in the could soon exceed 5%. Such an increase would deliver a devastating blow to the housing market. More foreclosure will hit just as higher home prices and mortgage rates price legitimate buyers out of the market. Housing prices will fall to new post bubble lows, sinking the phony recovery in the process. The wealth effect will work in reverse, spending and confidence will fall, unemployment will rise, and we will be back in recession even before the Fed begins to taper.

In fact, the back-up in mortgage rates seen over the last month has already produced pain in the financial world, with banks reporting a rapid collapse in refinancing applications. With personal income and wage growth essentially stagnant, individual buyers are extremely dependent on the affordability that ultra-low rates provide. A 50% increase in mortgage rates (an increase from 3.25% to 5%) would price a great many buyers out of the market. Higher rates would also cool much of the housing demand that has been coming from the private equity funds that have been a huge factor in pushing up real estate prices in recent years. Falling home prices would likely trigger a new wave of defaults and housing related bankruptcies that had plunged the economy into recession five years ago.

A similar dynamic would occur in the market for U.S. Treasury debt. Despite Bernanke’s assurances that the Fed is not monetizing the government’s debt, the central bank has been buying nearly 70% of the new issuance in recent years. Already rates on 10 year treasury debt have crept up by more than 50% in less than two months, to over 2.4%. Any actual decrease or cessation in buying (let alone the selling that would be needed to unwind the Fed’s multi-trillion dollar balance sheet) would place the Treasury market under extreme pressure. Since low rates are the life blood of our borrow and spend economy, it is highly likely that higher rates will lead directly to lower stock prices, lower GDP growth, and higher unemployment. Since rising asset prices, and the confidence and spending they produce, are the basis for Bernanke’s rosy forecast, new lows in house prices and a bear market in stocks will quickly reverse those forecasts.

Higher interest rates and a slowing economy will be a a disaster for Federal budget deficits. An increase in unemployment and a decrease in tax will hit just as rising rates make it more expensive for the Fed to finance new and maturing debt. Also the profit checks Fannie and Freddie have been paying the Treasury will turn into bills for losses, as a new wave of foreclosures comes crashing down.

It’s fascinating how the goal posts have moved quickly on the Fed’s playing field. Months ago the conversation focused on the “exit strategy” it would use to unwind the trillions of bonds and mortgages that it had accumulated over the last few years. Despite apparent improvements in the economy, those discussions have given way to the more modest expectations for the “tapering” of QE. I believe that we should really be expecting a “tapering” of the tapering conversations.

I expect that the Fed will continue to pantomime that an Exit Strategy is preparing for a grand entrance, even as their time line and decision criteria become ever more ambiguous. The Fed’s next big announcement will likely be to increase, not diminish QE. After all, Bernanke made clear in his press conference that if the economy does not perform up to his expectations, he will simply do more of what has already failed.

Of course, when the Fed is forced to make this concession, it should be obvious to a critical mass that the recovery is a sham. Investors will realize that yeas of QE have only exacerbated the problems it was meant to solve. When the grim reality of QE infinity sets in, the dollar will tank, gold will soar, and the real crash will finally be upon us. Buckle up.

The Best of Peter Schiff

Most on Wall Street had expected that the Fed would use this June meeting to finally signal that the deceleration of its quantitative easing program is in sight, if not exactly underway. But even these modest expectations have once again been unfulfilled. Although many haven’t yet realized it, the financial markets are stuck in a “Waiting for Godot” era in which the change in policy that all are straining to see, will never in fact arrive. Most fail to grasp the degree to which the “recovery” will stall without the $85 billion per month that the Fed is currently pumping into the economy. Knowing this, the Fed is likely to keep its foot firmly on the accelerator, regardless of the data.

It’s fascinating how the goal posts have moved quickly on the Fed’s playing field. Months ago the conversation focused on the “exit strategy” it would use to unwind the trillions bonds that it has accumulated over the last few years. Despite apparent improvements in the economy, those discussions have given way to the more modest expectations for the “tapering” of QE, which is defined as some type of deceleration of its monthly purchases. I believe that we should really be expecting a “tapering” of the tapering conversations.

In recent months it has been painfully clear that expectations about QE have made a far bigger impact on the stock, bond, and real estate markets than any other economic data points. While some observers have naively described QE as the economy’s “training wheels,” in reality the program is currently our only wheels. But as these particular wheels will eventually take us over a cliff, the Fed should remove them anyway.

Rather than focus on the long term, the Fed is guided by the short term realization that any significant withdrawal of support will cause a steep sell off on Wall Street, a spike in interest rates, and an end to the reflating housing bubble. They are not prepared to tolerate any of these outcomes. As a result I expect that the Fed will continue to pantomime that the Exit Strategy is preparing for a grand entrance even as their time line becomes ever more ambiguous. I believe that the Fed’s next big definitive announcement will be an increase in QE rather than a diminishment.

The Best of Peter Schiff

That’s all, folks. One look at the headlines will tell you the gold bull market is officially over: the stock market is booming, a modest recovery of the US economy is underway, and the dollar is dominating the forex. Time to sell your bullion and get back into US stocks!

Does anyone really believe this story at this point? Haven’t we been through this time and again since 2008? Remember “green shoots”?

The sad truth is that American investors, accustomed to a world of rising stock and housing prices for several generations, are experiencing short-term memory loss. It’s as if their longing for the “good old days” has made them subconsciously suppress any unpleasant memories.

The Return of Irrational Exuberance

But it wasn’t so long ago that irrational exuberance over the housing market had seized investors’ logic, and the same thing is happening to US stocks right now. Fair-weather investors are abandoning gold equities and jumping into the US market in the hopes of making an easy buck, just as people bought property near the housing peak hoping to flip it before those adjustable-rate mortgages reset. This is a game of chicken that makes big banks rich while destroying the savings of average investors.

So-called experts are pointing to the buoyancy of US stocks and weakness of the precious metals as proof of their viewpoint – but the fundamentals of the economy are still dismal. Unemployment remains persistently high and manufacturing continues to struggle. In April, the Fed reported that industrial production shrank 0.5%.

The only growing part of the economy is consumption and services. Indeed, US consumer confidence just hit a 5-year high! But this week’s revisions to first-quarter GDP revealed that the household savings rate fell to an abysmal 2.3% and real disposable income plunged by an annualized rate of 8.4%. It seems that both rising asset prices and consumer confidence are based solely on the expectation of an improving economy that is still unsupported by the data itself.

The Currency War Heats Up

Perhaps people think things are different this time because of the news from the fronts of the international currency war. Everywhere you look, once-strong economies have begun to vie for exports by devaluing their currencies.

Switzerland had one of the strongest European economies before its central bank capped the value of the franc against the euro in 2011, vastly diminishing its citizens’ purchasing power. The Japanese yen, once the most stable currency in Asia, is falling victim to even more grotesque devaluation policies. Out of irrational fear that their exports will not be able to compete with the yen, Australia and New Zealand are the latest to jump into the fray by cutting interest rates.

Dollar By Default?

Many are examining these conditions and concluding that the US dollar is now the last resort for global capital.

However, this is a narrow and flawed view. The foreign exchange market is typically quoted based on relative valuations, examining one fiat currency through the lens of another. It says nothing of the fundamental value of a currency in terms of goods and services. It is entirely possible for all fiat currencies to collapse simultaneously, even as certain currencies “rise” relative to others. In fact, that is the likely outcome of this race to debase, which in turn is tremendously bullish for gold.

The only way to avoid the collateral damage of the currency war is to refuse to participate. That means selling fiat cash and buying precious metals, commodities, and equities. That is precisely what people are doing in those countries where currency devaluation is well underway – from Japan to Switzerland, everyday citizens are buying gold and silver in record quantities.

A Great Paradox

How can it be that people are rushing to buy physical precious metals around the world and yet the price keeps falling?

This correction is being driven by institutional investors in the paper gold market. There is big money betting against gold and on the Fed. I believe they are in for a rude awakening.

This correction was kicked off by whispers that the Fed might start drawing down QE3 in September. That would indeed be reason to re-evaluate one’s precious metals holdings. But, predictably, the Fed immediately backpedaled, insisting that it would, if anything, only “taper” the QE at some point in the future. John Williams, head of the San Francisco Fed, then came out and said, “You could even imagine a scenario where we adjust it downward based on good data and then adjust it back.”

Again, how many times are the mainline financial institutions going to fall for this song-and-dance? It’s as if these investors are parents of a drug addict wiring money yet again on a promise that this time the kid will clean up his act. It’s not going to happen until he hits rock bottom! In the case of the Fed, ‘rock bottom’ means a dollar crisis with US consumer prices spiraling out of control.

Stay The Course

Given all of this, anyone considering abandoning gold and giving the US markets another whirl should think twice. Lots of people make and lose short-term fortunes, but I’ve always encouraged investors to grow their wealth along fundamental long-term trends. Ignoring this advice means gambling your savings on the hope that there will be a greater fool who will come along and buy your inflated assets at even higher prices.

My fundamental strategy may mean enduring deep corrections or missing out on manic rallies, but it has served me well as measured by long-term rates of return. Today, the fundamentals continue to point toward endless money-printing to support a zombie US economy. Meanwhile, gold and silver are being offered at bargain prices.

The Best of Peter Schiff

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The Best of Peter Schiff

This week economists, investors and politicians were treated to some of the “best” home price data since the frothy days of 2006 when home loans were given out like cotton candy and condo flipping was a national pastime. The Case-Shiller 20 City Composite Home price index was up a startling 10.9% for the 12 month period ending in March. Prices in all 20 cities were up, with some (Las Vegas, Phoenix, and San Francisco) notching gains of more than 20%. Meanwhile the National Association of Realtors announced that April pending home sales volume reached the highest level in nearly three years.

The strong housing data is taken as proof that the economy has turned around and that a recovery is under way. Cooler heads may simply see how government policies have channeled money into real estate in order to reflate a bubble that has been collapsing for the last five years. Although the money is entering the market through slightly different paths than it did in 2005 and 2006, its effects on housing, and the broader economy, are the same as they were before the bubble burst. When the inevitable happens again, the ensuing damage will be eerily familiar.

After five years of dismal real estate performance and a lackluster economy, it’s hard to fault people for believing that rising home prices are a good barometer of economic health. There can be little doubt that rising home prices feel good. Even single digit appreciation can make modest home buyers feel like mini-moguls. The effect is magnified in a falling interest rate environment where any appreciation can be instantly turned into an opportunity for cash out refinancing. The “wealth effect” created by such activities then translates into consumer spending and other seemingly positive economic developments. But some things can taste great but be very harmful (cinnamon buns come to mind). It felt good when real estate prices were rising during the pre-financial crisis bubble, but that rise only exacerbated the problems when the bubble burst. The questions we should now be asking ourselves is why are prices rising, are those higher prices sustainable, and what are the costs to the broader economy?

The truth is that most buyers cannot afford today’s prices without the combination of government guarantees and artificially low mortgage rates. The Federal Reserve has been conducting an unprecedented experiment in economic manipulation. By holding interest rates near zero and by actively buying more than $40 billion monthly of mortgage-backed securities and $45 billion of Treasury bonds, the Fed has engineered the lowest mortgage rates in generations. At the same time, Federal control of the mortgage industry has become nearly complete, with government agencies Fannie Mae, Freddie Mac, and the FHA buying or guaranteeing virtually all new mortgages. In addition, a variety of Federal programs, such as the Home Affordable Modification Program (HAMP) are in place to help keep underwater homeowners in homes that they could not otherwise afford. Taken together, these programs create far more favorable terms for home buyers than those that existed before the crash.

The big difference between then and now however is that banks are much more reluctant to extend loans to people with bad credit. But that has not stopped money from flowing into real estate. Ultra low interest rates also mean that fixed income investments, that have long been the staple of hedge funds and private equity funds, no longer deliver decent returns. To find yields in such an environment, many of these professional investment funds have scooped up single family homes out of foreclosure and put them into the rental market in order to generate a decent return on equity. These buyers come to the table with war chests full of cash which puts them in a position to avoid all of the credit obstacles that continue to plague individual buyers.

This trend has allowed a recovery in home sales even while the national home ownership rate has dropped to 65%, the lowest rate since 1995 (down from almost 70% during the last decade). Now that most of the available foreclosures have been picked through (with the rest log jammed with litigation and red tape), many of the new classes of investment buyers are striking deals directly with the large home builders to buy homes before they are even built. It is no coincidence that the southern tier markets with the fastest appreciation, and the fastest declines in inventories, have been those with the greatest participation of institutional investors.

But their activities have a latent downside. The new ownership class is not motivated to buy and hold the way Mom and Dad would. They are not looking for a place to live, raise families, and retire. They are simply looking for a decent return on equity relative to other investments. Many would happily put money in higher yielding bonds where landlord headaches don’t exist. If better deals beckon, or if risks increase in the real estate market, the homes they bought will be dumped even faster.

In the meantime, bidding wars involving hedge funds are forcing real buyers to pay more, oftentimes pricing them out of the market completely. Then as these properties hit the rental market, an absence of qualified tenants will depress rents. Lower rents will in turn put downward pressure on property values. Many rental houses will also sit vacant. Though hedge funds are cash buyers, most borrow large percentages of that cash to lever up their returns. However, when interest rates rise and rents fall, hedge funds will be forced to sell. But where will the buyers come from? The current crop of renters cannot afford to buy even with mortgage rates at historic lows. When rates rise, prices will have to plunge before real buyers could even qualify for mortgages.

The current combination of low rates and investor demand has succeeded in pushing up prices. But that doesn’t mean the market is healthy. For the first quarter of 2013, the Federal Reserve reports a 10% delinquency rate for residential mortgages (those with payments that are at least 90 days past due). This is more than 6 times the rate in the first quarter of 2006. In contrast, credit card delinquencies currently stand at 2.65%, the lowest rate in decades and 31% lower than the rate in the first quarter of 2006. Whether it is by choice, or simply by the ability to pay, Americans are clearly placing a low priority on paying their mortgages.

But rising home prices are currently creating residual benefits even for those who have no intention of selling. In the second quarter of this year, rates on 30 year mortgages hit the lowest level on record. Although the data has not yet been published, it would be logical to assume that homeowners have taken the opportunity to refinance, lower their payments, and in some cases, pull money out. But even if they haven’t, there is evidence to suggest that an owner’s belief that his home has appreciated is enough to encourage greater spending.

The “wealth effect’ from rising home prices combined with the similar influence of rising stock prices creates an aura of recovery. In fact, this week’s revisions to first quarter GDP revealed that consumer confidence and spending are up despite real discretionary per capita incomes plunging at a 9.03% annualized rate. That is worse than the largest plunge during the 2008-2009 crisis (7.52%). Additionally, the household savings rate fell to an abysmal 2.3%, the lowest since the 3rd quarter 2007. Debt-financed consumption supported by inflated asset prices is what led to the financial crisis of 2008. It’s amazing how willing we are to travel down that road again.

Of course rising asset prices are completely dependent on continued Fed support. As we have seen time and again, whenever the Fed even hints at tapering its massive QE programs the stock market sells off. The housing market is even more dependent on that support. Given the risks, it is arguable that no private market for home loans would even exist without government intervention. The bubble that popped in 2008 consisted mainly of government-guaranteed mortgages. This time, the mortgages are not merely government-guaranteed, but government owned.

In the meantime, by blowing more air into a deflating housing bubble, the Fed is misdirecting money into a sector that investment capital should be avoiding. A successful economy can’t be built on housing. Rather, a robust real estate market must result from a healthy economy. You can’t put the cart before the horse. As a nation, we do not need more houses. We built enough over the last decade to keep us well sheltered for years. Private equity funds should be using their investment capital to fund the next technology innovator, not wasting it on townhouses in Orlando and Phoenix.

Of course the real risks in housing center on the next leg down, in what I believe will be a continuation of the real estate crash. We can’t afford to artificially support the market indefinitely. When significantly higher interest rates eventually arrive, the fragile market will again be impacted. We saw that movie about five years ago. Do we really want to see it again?

The Best of Peter Schiff

While the world’s economies jockey one another for the lead in the currency devaluation derby, it’s worth considering the value of the prize they are seeking. They believe a weak currency opens the door to trade dominance, by allowing manufacturers to undercut foreign rivals, and to economic growth, by fighting deflation. On the other side of the coin, they believe a strong currency is an economic albatross that leads to stagnation. But the demonstrable effects of currency strength and weakness reveal the emptiness of their theory.

A country that attracts investment from abroad (through stable and fair governance, low taxes, a growing economy, and a productive labor force) and produces goods that are in demand on the global stage will generally see a rising currency. In essence, this is the reward for a job well done. Strong currencies then help nations stay strong by conferring greater purchasing power to its citizens and businesses, which keeps input costs low, thereby enhancing international competitiveness. Strong currencies also encourage savings, keep real interest rates low, lower capital costs, and allow for greater productivity and higher real wages.

It is often argued that a weak currency confers advantages in foreign trade. But the edge only results from putting exports on sale. Any merchant will tell you that it’s easy to sell more if you cut prices, but most would prefer charging full retail. However, exports are not an end in themselves, they are a means to pay for imports. The goal of an economy is not to work, but to consume. If citizens in one nation buy goods produced in another, they must pay with exports. When a nation’s currency appreciates imports cost less and fewer exports are needed to pay. This means goods and services at home will be cheaper and more plentiful, and citizens won’t need to work as hard to buy them. This is the definition of rising living standards.

But when it comes to relative currency valuations, the United States dollar exists in a world of its own. As the international reserve, the dollar is the de-facto beneficiary of any other country’s intervention. When countries intervene, they do so specifically against the dollar. In addition, many countries, (China and Taiwan for instance) maintain a pegged relationship to the Greenback. Therefore in a world dominated by interventionist banks, the factors that push the dollar have been inverted. The dollar falls when fundamentals either improve abroad or deteriorate at home (both cases increase the propensity for intervention). The rest of the world’s currencies compete on their own merit. As a result, it is not an accident that over the last decade Australia, New Zealand, and Switzerland, three of the world’s strongest economies, have produced strong currencies.

Since 2001, all three have had generally appreciating currencies, accompanied by steadily rising exports, strong economic fundamentals, and low unemployment. From 2001 to 2012, the Kiwi Dollar appreciated by 98% against the U.S. dollar, but its exports in local currency terms increased by 40% (170% in U.S. dollar terms). Over the same time frame, the Aussie dollar appreciated by 103% and exports increased by 102% in local currency (and 305% in U.S. dollar terms). In Switzerland the story was the same, currency up 82%, exports up 53% in local terms and (and 175% in U.S. terms). Where exactly did they encounter export troubles due to their rising currencies?

At the same time, the strengthening currencies made few negative impacts on other aspects of economic performance. At the time when the Swiss bankers caved to international pressure in September 2011 and pegged its previously surging franc to the euro, their economy had shown some of the best economic performance on the Continent. More recently, Australia and New Zealand reported stunning job creation figures. Adjusted for population, the U.S. would have had to create more than 600,000jobs per month to keep pace with Australia, and 900,000 jobs per month to match New Zealand (U.S. job creation has averaged about 169,000 per month over the last year).

These lessons have been wholly lost on the Japanese who are frantically trying (and succeeding) in severely devaluing the yen. Although Japan’s export machine had not suffered from the yen’s appreciation from 2001-2012 (up 30% in local currency exports and 98% in dollar terms), newly installed prime minister Shinzo Abe and his minions at the Bank of Japan believe a weaker yen is the key to renewed economic strength. But the collapse of the yen has helped push up both the Aussie and Kiwi dollars, which has spurred bankers in Australia and New Zealand into taking unneeded and ultimately self-destructive actions. In April they threw in their lot with the interventionists and cut interest rates to stop the rise of their currencies. But the moves fly in the face of the modern playbook which states that policy should be tightened during periods of full employment, strong growth, and surging real estate prices. The misplaced fear of a strong currency seems to trump all other concerns.

While there is little reason to believe that strong currencies stifle exports, there is ample evidence that they increase domestic purchasing power (which is a real test of economic success). In the United States, oil currently sells for about $97 per barrel, about 16% below the $113 high price seen in April 2011. And so while our economy falters, at least consumers are not saddled with surging energy costs. While the 20% devaluation of the yen since that high in 2011 has made Japan the champion of Keynesian economists, it also means that oil in Japan is currently selling for the highest price since the financial crisis of 2008-2009. And it’s not just oil, the Japanese must pay more for everything they import. How this benefits the rank and file has yet to be properly explained.

The latest data confirms that the banzai attack on the yen has not helped Japan’s trade position. The weaker currency led to higher import costs, resulting in the 10th month in a row of trade deficits. Although April exports rose 3.8 percent from a year earlier, the trade deficit widened to 879.9 billion yen ($8.6 billion), the worst April since at least 1979. But the falling yen is creating a clear and present danger in Japan’s enormous bond market. In less than one month, yields on 10 year Japanese Government Bonds have more than doubled, approaching nearly 1%. While those rates may sound manageable for most countries, Japan has the highest debt to GDP ratio in the developed world. If they had to pay 2% (the same rate as its inflation target), the country would need to devote more than half of its tax revenue just to service its debt! Clearly this possibility is dawning on stock investors who pushed down the Nikkei by more 7% today.

Never in the course of history has a country’s economy failed because its currency was too strong. It’s a pathology that simply does not exist. On the other hand, the list of those ruined by weak currencies is extensive. The view that a weak currency is desirable is so absurd that it could only have been devised to serve the political agenda of those engineering the descent. And while I don’t blame policy makers from spinning self-serving fairy tales (that is their nature), I find extreme fault with those hypnotized members of the media and the financial establishment who have checked their reason at the door.

A currency war is different from any other kind of conventional war in that the object is to kill oneself. The nation that succeeds in inflicting the most damage on its own citizens wins the war. The only real way to win is not to play.

The Best of Peter Schiff

At the Las Vegas MoneyShow, Peter Schiff delivered the keynote speech: Too Big to Bail: Why the Next Financial Crisis Will Be Worse Than the Last (33:10)

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The Best of Peter Schiff

A good doctor will not simply make a diagnosis based on measurements. The symptoms and complaints expressed by the patient are at least as important in making a determination as the data provided by diagnostic tools. When the data says one thing and the symptoms continuously say another, it makes sense to question the reliability of the instruments. This would be particularly true if the instruments are furnished by a party with a stake in a favorable diagnosis, say an insurance company on the hook for treatment costs. The same holds true for the U.S. economy. Although our government-supplied data suggests we are experiencing low inflation and modest economic growth, the economy shows symptoms of low growth, rising prices, and diminishing purchasing power

In my latest commentary I discussed how the Big Mac Index (The Economist Magazine’s 30 year data set on Big Mac prices) provided strong anecdotal evidence that inflation in the United States is higher than official figures. More information has come in since then that tells me the same thing: that Americans are downsizing their lives as their incomes fail to keep pace with rising prices. These symptoms are at odds with the widespread belief in an accelerating recovery that has resulted in braggadocio in Washington and euphoria on Wall Street.

Earlier this week Tyson Foods, one of the nation’s largest providers of packaged meat products, announced that although their top line sales revenue increased by almost 2% (roughly in line with U.S. GDP growth), operating margins collapsed by almost 50%, leading to a 43% decline in profit. Consumer shifts away from relatively higher priced/higher margin beef and pork products to lower cost/lower margin chicken products were to blame. Tyson also noted that cost conscious consumers shifted away from higher margin packaged chicken products to fresh meat cuts, thereby sacrificing convenience for cost.

According to government statisticians, the Tyson announcement would reveal modest growth and low inflation. After all, revenue at the company grew and spending on their products had increased modestly. But rising prices were obscured by consumers purchasing lower quality products. Not only are consumers avoiding the beef and pork that they otherwise may have preferred, but they are opting out of the convenience of prepared foods. This behavior is symptomatic of diminished consumer purchasing power. This is known as getting poorer.

The trend corresponds with the steady increase in the share of income that Americans devote to food and energy. According to the Bureau of Economic Analysis data, in 2002 Americans spent about 17.8% of income on food and energy. In the first quarter of 2013 the share had risen by a factor of 20% to 21.3% of income. Increased share of spending on necessities like food and energy is consistent with falling living standards. In the poorest countries almost all of income is devoted to such things.

This week we also learned the seemingly positive news that the March trade deficit narrowed to $38.8 billion. But the reduction didn’t come from increased exports (which actually declined), but by the sharpest drop in imports since February 2009. Oil imports declined to a seventeen-year low, in part due to rising domestic production, but also due to a record low in 13 years in gasoline consumption. While some may argue that is a function of greater energy efficiency, I believe it’s more likely that usage is down because of high prices and high unemployment. Even more significant is that our trade deficit with China in March dropped by a whopping 23.6%, hitting a three-year low. On a year over year basis, the decline in our deficit with China was 90% attributable to the decline in imports.

In contrast to the declining import figures, the government reported that personal spending rose by .2% in March. If we are buying less stuff from abroad, where are Americans spending the extra money? If the prices are stable, and imports are way down, consumer spending should also be down and savings should be up. But the savings rate in March held steady at a meager 2.7%. The sad truth is that Americans are buying fewer Chinese products because they are spending more money on food, rent, utilities, healthcare, insurance, and other necessities that can’t be imported. Again, this is consistent with a falling standard of living, as inflation forces consumers to forgo the things they want in order to buy the things that they need.

It was also announced this week that the big three airlines (United, Delta, and American) will be raising their “change fees” for booked tickets by 33%, from $150 to $200. However, it’s unlikely that such a hike will make much of an impact on CPI. According to the CPI, airline fares in the United States increased only .3% from 2011 to 2012. This mild increase came at a time when airlines were rolling out more new fees than most air travelers could have possibly imagined.

But even if the government fully factored in the increase in fees, they would likely ignore the change in behavior that the increase would elicit. With the cost of changing a ticket so dramatically higher than it has been in the past, it is likely that far fewer Americans would be willing to change their travel plans once their tickets have been purchased. So even while the spending increase may be relatively small, the lost convenience is not factored into the equation. A ticket with low price (or no price) change option is a much better product than a ticket with high penalties.

CPI reports that from 2007 to 2012 air travel increased on average 4% per year. But that’s only half the story. A new study released by MIT reports that during those five years, U.S. airlines cut the number of domestic flights by 14%,with the cuts falling most heavily on mid-sized regional airports. By 2012, the industry also closed more than 20 smaller airports, began using a higher percentage of larger airplanes, and reported record crowding on remaining flights. In other words, air travel not only became more expensive but less convenient and more crowded.

How much loss in value does this inconvenience and lack of flexibility create? It’s hard to say, but we all have experienced it with varying degrees of frustration. But what is sure is that the government isn’t interested in such trivialities.

The combination of these symptoms suggests that the extent to which people are being impoverished by accelerating inflation is not reflected in official government measurements. This explains why unemployment remains high even as GDP appears to rise. It is my belief that the unprecedented expansion of the money supply under the current Fed leadership is pushing up prices for stocks, bonds, real estate, and consumer goods. Market indices neatly capture the price increases for all of these categories except for the latter, which has been concealed by an overly adjusted CPI.

If consumer inflation data were reported more accurately, it would be revealed that much of the apparent growth is an illusion. The patient is getting sicker, but the doctors are too distracted to notice.

“The bottom will drop out of the dollar. The US dollar is going to lose a lot of value. Not only against goods, but against other fiat currencies. The dollar is going to go down, that’s going to push prices up higher in the United States, consumer prices. Eventually the fed is going to have to turn off the presses in order to save the dollar and that’s when the real fun begins, because that’s when this whole bubble economy implodes…”

“Gold has been up for 12 consecutive years. It’s entitled to a correction. It’s incredible how the media has jumped all over this… We’re still at $1,400. I think it’s a bit premature for the people who have been advising their clients not to buy gold for the past decade to be patting themselves on the back.”

Don Draper, Mad Men’s master advertiser likes to say “when you don’t like what they are saying, change the conversation.” When it comes to the current economic weakness, which was confirmed again today by the release of lower than expected GDP data, Washington would love do just that. Fortunately for them, they consistently outdo the master minds of Madison Avenue when it comes to misdirection. If the government doesn’t like what people are saying, they don’t bother just to change the conversation, they change the meaning of the words.

The latest example of this was revealed earlier this week when the Bureau of Economic Analysis (BEA) announced new methods of calculating Gross Domestic Product (GDP) that will immediately make the economy “bigger’ than it used to be. The changes focus heavily on how money spent on research and development (R&D) and the production of “intangible” assets like movies, music, and television programs will be accounted for. Declaring such expenditures to be “investments” will immediately increase U.S. GDP by about three percent. Such an upgrade would immediately increase the theoretic size of the U.S economy and may well lead to the perception of faster growth. In reality these smoke and mirror alterations are no different from changes made to the inflation and unemployment yardsticks that for years have convinced Americans that the economy is better than it actually is.

Today’s data release confirms that the economic “recovery” is weaker than expected and remains heavily dependent on Federal support. Personal spending was indeed up 3.2%, the biggest jump in two years, but real earnings were down by 5.3%, the biggest fall since 2009. Not surprisingly the buying was made possible by a drop in the savings rate, which came in at just 2.6%, the lowest since the 4th quarter of 2007. No doubt, rising home prices and falling mortgage rates (made possible by Fed stimulus) allowed Americans to refinance their homes and to borrow and spend the money that they did not earn. With GDP continuing to disappoint, a statistical make-over couldn’t come at a more convenient time.

In the simplest terms, GDP is calculated by combining a nation’s private spending, government spending, and investments (while adding trade surplus or subtracting trade deficits). Business spending on R&D, a portion of which comes in the form of salaries, has traditionally been considered an expense that does not explicitly add to GDP. But now, the United States will lead the rest of the world in redefining GDP. Washington has now declared that the $400 billion spent annually by U.S. businesses on R&D will count towards GDP. This equates to about 2.7% of our nearly $16 Trillion GDP. The argument goes that, for example, the GDP generated by iPhones has far exceeded the cost spent by Apple to develop the product. Therefore, Apple’s R&D is not an expense but an investment.

The BEA also argues that the cost of producing television shows, movies, and music should count as investments that add to GDP. Supporters of the change often hold up the blockbuster television comedy Seinfeld as an example. Given that the show’s billions in earnings far exceeded its initial costs, they argue that the production expenses should be considered “investments” (like R&D) and be added into GDP.

Economists who have staked their reputations on the efficacy of Keynesian growth strategies have argued that such changes will more accurately reflect the realities of our 21st century information economy. But their analysis ignores the failures so often associated with R&D and artistic productions. For every breakthrough iPhone there are dozens of ill-conceived gizmos that never get off the drawing board. For every Seinfeld, there are countless failures and bombs that leave nothing but losses.

In essence, the new methodology is an exercise in double accounting. For instance, suppose a company employs an accountant who works in the sales department, who is then transferred to the R&D department at the same salary. He still counts beans but now his salary will be billed to the R&D budget rather than sales. In the old methodology, the accountant’s impact on GDP would come only from the personal consumption that his salary allows. Going forward, he will add to GDP in two ways: from his personal consumption and his salary’s addition to his company’s R&D budget. The same formula would apply to a trucker who switches from a freight company to a movie production company (for the same salary). If he moves refrigerators, he only adds to GDP through his personal spending, but if he hauls movie lights, his contribution to GDP is doubled. It makes no difference if the movie bombs.

These double shots are different from traditional investments, which inject savings (or idle cash) back into the marketplace. Until money from personal or corporate savings is invested, it is not adding to GDP.

Another change that will artificially boost GDP concerns how government salaries will be counted. Unlike most private sector compensation, wages, salaries, and pension contributions paid to government workers are added directly to GDP. This distinction makes sense and eliminates potentially double accounting. Profits generated by private companies add to GDP when they are ultimately spent or invested by the company. Wages reduce profits, and therefore reduce GDP. But that reduction is cancelled out by the consumption of the employee receiving the wages. Governments do not generate profits, so salaries are the only way that public spending adds back to GDP.

The new system magnifies the GDP impact of government pensions, which are a principal component of public sector compensation. Going forward, the pensions will be calculated not from actual contributions, but from what governments have promised. Under the old system, if a state had a $10,000 pension obligation but only contributed $1,000, only the $1,000 would be added to GDP. Under the new system the entire $10,000 would be counted. So now governments can magically grow the economy simply by making promises they can’t keep.

The bottom line is that now certain private sector salaries (in R&D and entertainment) will be counted twice and public pension contributions will be counted even if they aren’t made. The economy will not actually be any larger or grow any faster, but the statistics will claim otherwise. With the stroke of a pen, our debt to GDP ratio will come down. Will this soothe the fears of our creditors? Will critics of big government take comfort that spending as a share of GDP may be lower? My guess is that the government is confident that its trick will work, and that distracting attention with a statistical illusion is the sole motivation for the change.

A similar type of hocus pocus has been successfully used to make inflation appear much smaller. A few months ago I produced a video showing how changes in methods used to calculate the Consumer Price Index (CPI) have resulted in a widening gap between increases in real prices and the CPI. The changes, that incorporate such concepts as hedonic adjustments and substation bias, were made to make the CPI more “accurate,” but have instead produced consistently lower results. Although I used a basket of 20 goods for that experiment, I gave particular attention to such things as newspaper and magazine prices and health insurance costs. But just recently I came across another data set that leads to the same conclusion.

Since the late 1980′s, The Economist Magazine has compiled something called the “Big Mac Index,”(BMI) a global survey of the cost of McDonald’s signature hamburger. Although the index is primarily used as a means to compare purchasing power parity around the globe, it also can be used to track the prices of Big Macs in the U.S. over many years.

From 1986 to 2003 the U.S. BMI rose roughly in line with the CPI. Although the burger occasionally rose faster or slower, over that 17 year period both indexes increased by about 68% (or about 4% per year). But from April 2003 to January 2013 the CPI Index is up just 25% percent (from 183.8 to 230.28 or about 2.5% per year) while the BMI is up 61% (from $2.71 to $4.37 or about 6.1% per year), or more than twice the rate of inflation.

What could possibly account for the difference? Has the Big Mac gotten bigger, better, tastier, or healthier? As an iconic product, McDonald’s has been reluctant to change a proven formula. If the Big Mac hasn’t changed, is it possible that our inflation yardstick has?

It has been estimated that if the government used the same methodology to measure inflation that it used during the 1980′s, we would be currently dealing with official inflation that would be many times higher than today’s official 1.5% rate. The Big Mac appears to confirm this.

But now the government appears ready to distort the figures even further. With little resistance from the media or the public, the Obama Administration and Congressional Republicans seem ready to switch the inflation measurements used for Social Security away from the CPI in favor of the even more attenuated “Chain Weighted CPI.” This index, which is consistently lower than the CPI, looks to incorporate changes in spending patterns when consumers switch to more affordable products (in other words, it measures the cost of survival, not the cost of living). And while many admit that this is a manipulation, no one really seems to care.

Similarly clumsy tricks have been used to make our unemployment problem appear less severe. Over the years new methods have been introduced to factor out those who have “dropped out” of the labor force or to count part-time or temporary workers as employed.

All this takes us right back to Don Draper. If you can’t change the conversation, change the words. If that doesn’t work, just change the dictionaries.

In the years following the global financial crisis, economists and investors have gotten very comfortable with very high, and seemingly persistent, government debt. The nonchalance may be underpinned by the assumption that globally significant countries that can print their own currencies can’t get trapped in a sovereign debt crisis. However, it now appears that Japan is preparing to put this confidence to the ultimate stress test.

For the better part of 20 years, successive Japanese governments and central bankers have been trying, unsuccessfully, to use quantitative easing strategies to pump up a deflated asset bubble. The economy has by and large not responded. The sustained and impressive growth that Japan delivered during the 45 years following the Second World War (which had made the country one of the most successful economic stories in world history), has never returned. For the last 20 years Japan has offered a “zombie” economy characterized by low growth, stagnation, and exploding government debt. The Japanese government now owes approximately $12 trillion, a figure representing more than 200% of GDP. The IMF expects that this figure will reach 245% by the end of this year. This gives Japan the unenviable title of having the world’s highest government debt-to-GDP ratio. But Shinzo Abe, the newly elected Prime Minister of Japan, and Haruhiko Kuroda, his newly-appointed Governor of the Bank of Japan, feel much, much more debt needs to be issued to turn the economy around.

The hope that Abe would be a new kind of prime minister with a bold economic formula helped revive the long dead Japanese stock market. Between May and November of 2012, the Nikkei traded within a range of 8200-9400. As Abe’s victory began to be expected, the Nikkei started moving up, reaching 10,000 by the time he was sworn in on December 26 of last year. The euphoria continued throughout the spring and by April 2 the Nikkei stood at 12,003 points. Then on April 4, BOJ Governor Kuroda made good on Abe’s dovish rhetoric and announced a plan to end years of mildly declining prices by doing whatever necessary to create 2% inflation (in reality these price declines have been one of the few consolations to Japanese consumers). To achieve its goals, the government is prepared to double the amount of Yen in circulation. Stocks immediately rallied, and in less than a week the Nikkei had breached 13,000 points, taking the index to a 4 1/2-year high. It is rare that any major stock market can achieve a 50% rally in less than a year. But the rally will be costly.

The Japanese government already spends 25% of tax revenue to service outstanding debt (compared to 6% in the US). These costs become even more astonishing when one considers the extremely low rates Japan pays. Ten-year Japanese government bonds now pay less than 0.6%, and five-year yields are now a little more than 0.20%. How much will debt service costs increase if Abe succeeds in pushing inflation to 2.0%? Two percent rates would triple long term borrowing costs. Given the size of its debts, increases of such magnitude could hit Japan with the force of 10 Godzillas.

Japan has an aging demographic and as more time goes by, the pool of potential bond buyers continues to shrink. Unlike the United States, where individual savers are mostly irrelevant in the sovereign debt market, Japanese investors have largely set the market in their own country. There is evidence to suggest that Japanese savers are increasingly considering overseas sources of yield for protection from the inflation that Abe is so determined to create.

As the Nikkei has moved upward, the Japanese Yen has taken the opposite trajectory, falling more than 20% against the U.S. Dollar since the beginning of 2012, and nearly 12% since the beginning of this year (the decline has been even greater in terms of several other currencies). This steep drop, which has taken a huge bite out of the nominal gains in Japanese stocks is unusual in the foreign exchange markets, and has threatened to destabilize an already weak global financial system.

Earlier this year the falling yen issue sparked a full-fledged headline war. On February 16th, participating members of the G20 issued a statement, clearly aimed at Japan, warning against competitive devaluations and currency wars. A day later, Japan’s Finance Minister stated flatly that Japan was not attempting to manipulate its currency. After some hesitation, the G20 seemed to accept this statement. For now it seems the international powers have fallen in behind Japan. Both IMF Chief Christine Lagarde and Ben Bernanke have praised Abe’s policies. The prevailing opinion seems to be that weakening a currency should not be considered manipulation as long as it’s done to revive a domestic economy, not specifically to harm competitors. Such an opinion qualifies as a great moment in rhetorical shamelessness.

In addition to his plans for inflationary monetary policy, Abe is also attempting to wage war from the fiscal side as well. His Liberal Democratic Party has called for over $2.4 trillion USD worth of public works stimulus over the next 10 years. This spending represents approximately 40% of Japan’s current GDP and, adjusted for population, would be the equivalent of nearly $600 billion USD annually in the United States.

It should be obvious to anyone with even half a brain that Japan’s prior experiments with ever larger doses of quantitative easing have failed. Leaders in both Japan and the United States, however, are following this path with reckless abandon. According to Abe, the entirety of Japan’s economic problems can be blamed on the fact that consumer prices have been declining by one tenth of one percent per year. If only Japanese consumers were forced to pay two percent more per year for the things they need or desire, all would be well.

Abe’s wish may already be coming true. McDonald’s announced this morning that, for the first time in 5 years, the price of hamburgers and cheeseburgers in Japan will be rising by 20% and 25% respectively. No doubt the Japanese will be so excited by this development that they’ll rush to the stores to consume all the burgers they were planning on eating in 2014 before prices go up again. Of course there is no official concern that low-income Japanese will now have to pay more for low cost food.

The idea that informs Abe’s plan, that rising prices entice consumers to buy before the prices go up, is clearly suspect as economic law dictates that demand increases when prices fall. Any store owner will tell you that cutting prices is the best way to move merchandise. Apart from this problem, how does Abe expect consumers to buy more when their currency is losing purchasing power and more of their incomes will be needed to pay interest on the national debt?

The boldness of Abe’s plans should provide the rest of the world with a crash course in the ability of debt accumulation to jumpstart an economy. The good news is that the effects should not take too long to be seen. I believe that we will be treated with a stark lesson on the limitations of inflation as an economic panacea.

Hopefully, failure of this latest Japanese experiment will help convince leaders in the U.S. and Japan that the only true path to prosperity is free market capitalism. Rather than trying to reflate busted bubbles and micro-manage Keynesian style recoveries, politicians and central bankers should recognize their respective roles in creating the problems and get out of the way.

In the opening years of the last decade, most mainstream investors sat on the sidelines while “tin hat” goldbugs rode the bull market from below $300 to just over $1,000 per ounce. But following the 2008 financial crisis, when gold held up better than stocks during the decline and made new record highs long before the Dow Jones fully recovered, Wall Street finally sat up and took notice. The new devotees helped to push gold to nearly $1,900 by September of 2011. For the next year and a half it held relatively steady, trading mostly between $1,500 and $1,800 as more mainstream investors caught the fever. But now it appears that the brief love affair is at an end. It was really only a flirtation as the two were never a good match in the first place. Gold’s new suitors never understood the fundamental case for gold and now they are turning their affection back to their true love: U.S. equities.

This is creating a brutal season for gold investors. The metal is in the midst of its largest pull back in nearly five years, and as the selling has gathered momentum powerful Wall Street voices as diverse as Goldman Sachs and George Soros have declared the end of its nearly fifteen year run of dominance.

The story line put out by most of these analysts is that gold shined as a safe haven during the Great Recession, but its allure has evaporated with the recent “improvements” in the global economy, particularly in the United States. Ironically, this ignores the fact that gold actually performed better in the years leading up to the 2008 financial crisis than it did during or following the crisis. That may be because the inflationary monetary policy that fueled the housing bubble also powered gold. Deflation fears led to gold’s 35% decline in 2008, but once the Fed reopened the monetary spigots gold rallied to new highs. But in 2008 gold fell in concert with nearly every other asset class. This time, it’s falling while other assets are rising. The negative spotlight makes the current decline potentially more meaningful.

Neither the new round of Keynesian expansion in Japan nor the recent fallout from the Cypriot solvency crisis produced gold rallies. Bears cite these failures as the signs that the bull is dead. The latest warning bell came late last week when the Bank of Cyprus announced that it would be selling its gold reserves in order to raise the cash to pay its debts. Concerns quickly spread that other heavily indebted Mediterranean countries with large gold reserves like Greece, Portugal, Italy and Spain would follow suit. The tidal wave of selling would be expected to be the coup de grace for gold’s glory years. While this neat narrative may be sufficient to convince the financial media that an historic shift is underway, wiser minds will see more nuance.

While the vast majority of economists see gold as the “barbarous relic” described by Keynes, the sentiment has not stopped many central bankers from holding huge quantities as currency reserves. It is a curious phenomenon that the countries with the most daunting debt problems have the highest percentage of gold in their foreign exchange reserves. Many of these countries were formerly prosperous, and at various points in their histories had gold-backed currencies that required large reserves. These legacy assets now account for the bulk of their reserve wealth.

The United Stated leads the pack with both the largest amount of gold in reserve (8,133 tons) and one of the highest percentages (76%). Other heavily indebted developed countries are not far behind: Italy has 2,450 tons and 72% of reserves, France has 2,435 tons and 71% reserves, Portugal has 382 tons and 90% reserves, and Greece has 112 tons and 82% reserves. Tiny Cyprus, whose travails are creating global ripples, has just 14 tons (58% of reserves).

In contrast, the quickly developing emerging market economies are conspicuous for very small gold reserves, particularly in comparison to their much larger reserves of foreign currencies. Many of these countries have generated large amounts of U.S. dollar reserves as a result of ongoing trade surpluses. While China has more than 1,000 tons of gold, the cache only represents 2% of their enormous foreign exchange coffers. Even gold loving India has just 10%. Neither Russia, Taiwan, Thailand, Singapore, Mexico, South Korea, Indonesia, Malaysia, Saudi Arabia, nor Brazil has more than 10% (with most having far less than 5%). Bankers and political leaders in all of these countries, particularly India and China, have lamented publicly about the very high percentage of U.S. dollars in their reserves, and have even spoken fondly about the reliability and importance of gold.

The heavy debtors in the Eurozone have few pleasant options to deal with their insolvency. As illustrated by Cyprus, the choices may come down to painful austerity or raiding supposedly sacred bank deposits. The sale of gold reserves may provide a much more palatable option for politicians. After all, do voters really care how much gold sits in national vaults? For now at least, international central bank gold agreements limit the amount of gold that they can sell in a given year. But as these sovereign debt crises deepen for countries like Italy and Portugal, many justly question how long these paper agreements will keep the selling pressure at bay.

While I believe that they may indeed succumb to the temptation, such moves may not be disruptive, or even negative for gold. Large divestitures by some countries may lead to corresponding accumulations cash rich, but gold poor, creditor nations like India, China, Russia, and Indonesia. Such transactions would likely take place through private, direct, and tightly communicated sales. As a result, they would be far less disruptive than would be the case were they to occur in relatively thinly traded public markets as many now fear.

Such a transfer in gold holdings would be the logical result of the drift of the global economy over the past half century. Despite its current disfavor, gold is real wealth. Governments and bankers know this. As the emerging economies gain wealth, and the developed countries dissipate wealth through welfare-state debt accumulation, it is inevitable that the gold follows. It’s not a question of if, but when.

While nations buying gold will pay for their purchases with dollars, the sellers will not re-invest the proceeds into Treasuries. Dollars raised through gold sales will be converted to local currency and used to repay debt. This will put downward pressure on both the U.S. dollar and Treasuries. In addition, emerging market central bankers will be more likely to hold onto gold for the long-term, thereby providing a bullish impact on the market. In essence, such a shift would flush out the weak hands who don’t have the resources to protect their wealth in favor of stronger hands that do.

Creditor nations that buy gold cheap from bankrupt nations forced to sell at distressed prices will see the value of their reserves swell, thereby gaining the independence and confidence they need to finally break their reliance on the U.S. dollar as their principal reserve asset. When the reign of “king dollar” finally comes to a belated end, let’s hope all the gold we allegedly have stored in Fort Knox is actually there. We’re going to need every ounce of it.

Recently by Peter Schiff: Silver Circle Q&A

In the opening years of the last decade, most mainstream investors sat on the sidelines while "tin hat" goldbugs rode the bull market from below $300 to just over $1,000 per ounce. But following the 2008 financial crisis, when gold held up better than stocks during the decline and made new record highs long before the Dow Jones fully recovered, Wall Street finally sat up and took notice. The new devotees helped to push gold to nearly $1,900 by September of 2011. For the next year and a half it held relatively steady, trading mostly between $1,500 and $1,800 as more mainstream investors caught the fever. But now it appears that the brief love affair is at an end. It was really only a flirtation as the two were never a good match in the first place. Gold’s new suitors never understood the fundamental case for gold and now they are turning their affection back to their true love: U.S. equities.

This is creating a brutal season for gold investors. The metal is in the midst of its largest pull back in nearly five years, and as the selling has gathered momentum powerful Wall Street voices as diverse as Goldman Sachs and George Soros have declared the end of its nearly fifteen year run of dominance.

The story line put out by most of these analysts is that gold shined as a safe haven during the Great Recession, but its allure has evaporated with the recent "improvements" in the global economy, particularly in the United States. Ironically, this ignores the fact that gold actually performed better in the years leading up to the 2008 financial crisis than it did during or following the crisis. That may be because the inflationary monetary policy that fueled the housing bubble also powered gold. Deflation fears led to gold’s 35% decline in 2008, but once the Fed reopened the monetary spigots gold rallied to new highs. But in 2008 gold fell in concert with nearly every other asset class. This time, it’s falling while other assets are rising. The negative spotlight makes the current decline potentially more meaningful.

Neither the new round of Keynesian expansion in Japan nor the recent fallout from the Cypriot solvency crisis produced gold rallies. Bears cite these failures as the signs that the bull is dead. The latest warning bell came late last week when the Bank of Cyprus announced that it would be selling its gold reserves in order to raise the cash to pay its debts. Concerns quickly spread that other heavily indebted Mediterranean countries with large gold reserves like Greece, Portugal, Italy and Spain would follow suit. The tidal wave of selling would be expected to be the coup de grace for gold’s glory years. While this neat narrative may be sufficient to convince the financial media that an historic shift is underway, wiser minds will see more nuance.

While the vast majority of economists see gold as the "barbarous relic" described by Keynes, the sentiment has not stopped many central bankers from holding huge quantities as currency reserves. It is a curious phenomenon that the countries with the most daunting debt problems have the highest percentage of gold in their foreign exchange reserves. Many of these countries were formerly prosperous, and at various points in their histories had gold-backed currencies that required large reserves. These legacy assets now account for the bulk of their reserve wealth.

The United Stated leads the pack with both the largest amount of gold in reserve (8,133 tons) and one of the highest percentages (76%). Other heavily indebted developed countries are not far behind: Italy has 2,450 tons and 72% of reserves, France has 2,435 tons and 71% reserves, Portugal has 382 tons and 90% reserves, and Greece has 112 tons and 82% reserves. Tiny Cyprus, whose travails are creating global ripples, has just 14 tons (58% of reserves).

In contrast, the quickly developing emerging market economies are conspicuous for very small gold reserves, particularly in comparison to their much larger reserves of foreign currencies. Many of these countries have generated large amounts of U.S. dollar reserves as a result of ongoing trade surpluses. While China has more than 1,000 tons of gold, the cache only represents 2% of their enormous foreign exchange coffers. Even gold loving India has just 10%. Neither Russia, Taiwan, Thailand, Singapore, Mexico, South Korea, Indonesia, Malaysia, Saudi Arabia, nor Brazil has more than 10% (with most having far less than 5%). Bankers and political leaders in all of these countries, particularly India and China, have lamented publicly about the very high percentage of U.S. dollars in their reserves, and have even spoken fondly about the reliability and importance of gold.

The heavy debtors in the Eurozone have few pleasant options to deal with their insolvency. As illustrated by Cyprus, the choices may come down to painful austerity or raiding supposedly sacred bank deposits. The sale of gold reserves may provide a much more palatable option for politicians. After all, do voters really care how much gold sits in national vaults? For now at least, international central bank gold agreements limit the amount of gold that they can sell in a given year. But as these sovereign debt crises deepen for countries like Italy and Portugal, many justly question how long these paper agreements will keep the selling pressure at bay.

While I believe that they may indeed succumb to the temptation, such moves may not be disruptive, or even negative for gold. Large divestitures by some countries may lead to corresponding accumulations cash rich, but gold poor, creditor nations like India, China, Russia, and Indonesia. Such transactions would likely take place through private, direct, and tightly communicated sales. As a result, they would be far less disruptive than would be the case were they to occur in relatively thinly traded public markets as many now fear.

Such a transfer in gold holdings would be the logical result of the drift of the global economy over the past half century. Despite its current disfavor, gold is real wealth. Governments and bankers know this. As the emerging economies gain wealth, and the developed countries dissipate wealth through welfare-state debt accumulation, it is inevitable that the gold follows. It’s not a question of if, but when.

While nations buying gold will pay for their purchases with dollars, the sellers will not re-invest the proceeds into Treasuries. Dollars raised through gold sales will be converted to local currency and used to repay debt. This will put downward pressure on both the U.S. dollar and Treasuries. In addition, emerging market central bankers will be more likely to hold onto gold for the long-term, thereby providing a bullish impact on the market. In essence, such a shift would flush out the weak hands who don’t have the resources to protect their wealth in favor of stronger hands that do.

Creditor nations that buy gold cheap from bankrupt nations forced to sell at distressed prices will see the value of their reserves swell, thereby gaining the independence and confidence they need to finally break their reliance on the U.S. dollar as their principal reserve asset. When the reign of "king dollar" finally comes to a belated end, let’s hope all the gold we allegedly have stored in Fort Knox is actually there. We’re going to need every ounce of it.

Peter Schiff is president of Euro Pacific Capital and author of The Little Book of Bull Moves in Bear Markets and Crash Proof: How to Profit from the Coming Economic Collapse. His latest book is The Real Crash: America’s Coming Bankruptcy, How to Save Yourself and Your Country.

The Best of Peter Schiff

“I think gold and silver are a better alternative, and I think more people will ultimately put their trust there. But the free market is going to win. When people wake up to the realization that governments are now deliberately creating inflation… market forces will ultimately force governments to provide a more stable currency.”

Dr, Faber says he’s buying gold every month. And he states: “I will NEVER sell my gold in my life, certainly as long as there are people like Bernanke, Obama and the US congress in power”.

This week, while economists should have been closely considering the implications of the actual bankruptcy of Stockton, California, they instead heaped scorn on the perceived ideological bankruptcy of David Stockman. In other words, Stockman trumped Stockton.

Ronald Reagan’s former Budget Director contributed “Sundown in America” a multi-page opinion piece to the Sunday New York Times which loudly and eloquently described the illusions of our current economic system. While I don’t agree with everything Stockman believes, I think he is showing great wisdom and courage in making dire predictions and calling for extreme changes in our policy and politics.

What was perhaps more surprising than the Times’ uncharacteristic decision to run the piece in the first place was the vitriolic and largely ad hominem backlash against Stockman that quickly emerged from across the political spectrum. The attacks have focused primarily on his history and personality, and not on his arguments. One would be hard pressed to find any journalistic reaction that did not use the words “screed” “rant” or “unhinged.” I believe these responses reveal an acute sensitivity from mainstream economists that arises from defending contorted Keynesian logic.

It can’t be easy to take the position that debt doesn’t matter and that spending creates economic growth. To do so with any hope of success requires team unity, and Stockman has never really been a team player. His reputation as an apostate and a naysayer has made him an easy target.

Famously, Stockman left the Reagan White House in protest over the Gipper’s half-finished mandate. Yes, Reagan had cut taxes, but he never really cut spending. Stockman never bought into the easy idea, championed by Jack Kemp and Dick Cheney, that deficits don’t matter and that tax cuts pay for themselves. And although the Reagan revolution did clear the way for a return to better growth in the 80′s and 90′s, Stockman knew that the piper would call someday to collect the debt. Despite his foresight on that topic, his criticism of the Reagan legacy has earned him the derision of the Republican establishment for whom that particular hero worship is sacred.

This may have informed the attack issued by neo-conservative apologist and Iraq war cheerleader, David Frum, who offered a solely psychological assessment: “Stockman provides an insight into the gloomy mindset that overtakes us in older age, it’s a valuable warning to those of still middle-aged that once we lose our faith in the future, it’s time to stop talking about politics in public.” So much for respecting our elders.

Bloomberg’s Jeff Kearns, whose support of Fed policy has earned him regular taps at Ben Bernanke’s televised press conferences, provided the most common mainstream dismissal of Stockman: “His warning that the Federal Reserve’s quantitative easing is steering the world’s largest economy toward a crash is at odds with nine quarters of job growth, record stock prices and unprecedented corporate earnings.” This “he must be wrong because things look good now” position supposes that economics can’t be understood or predicted, only observed. I received very similar treatment back in 2006 and 2007 when I tried to tell the mainstream that the real estate market was a house of cards. How could it be bad, they said, if it goes up every year?

Despite his misalignment with the Republican hierarchy, the Left has an even greater revulsion for Stockman. Since the crisis, he has become perhaps the most respected figure (with the possible exception of Alan Meltzer) to take the position that a system based on fiat currency is doomed. Those who most visibly argue these points, like Ron and Rand Paul, and myself, come from the libertarian movement. As a result, we can be easily dismissed as cranks. However, Stockman was once a card-carrying member of the power elite. His embrace of these principles is taken more seriously and is thus ripe for instant attack from liberal economists.

While the usual suspects of Jared Bernstein and Joe Wiesenthal weighed in with heaps of invective, the loudest heckles have come from, whom else, Paul Krugman. He began his multi-post campaign by questioning the “mystery” of why the New York Times would sully Krugman’s own gravitas by forcing him to share column inches with someone as “non serious” as Stockman. He then offers the back of his hand:

“I thought Stockman would offer some kind of real argument, some presentation, however tendentious, of evidence. Instead it’s just a series of gee-whiz, context- and model-free numbers embedded in a rant – and not even an interesting rant. It’s cranky old man stuff.” For the record, Stockman is only 66.

In actuality, Stockman’s NYT piece offers a litany of objectively dismal facts and cogent explanations of how we got here. While most are celebrating the nominal high of U.S. stocks (see my recent analysis of the current rally), he points out that in the five and half years it has taken for the S&P 500 to set a new high, “Real median family income growth has dropped 8 percent, and the number of full-time middle class jobs, 6 percent. The real net worth of the ‘bottom’ 90 percent has dropped by one-fourth. The number of food stamp and disability aid recipients has more than doubled to 59 million, about one in five Americans.” But Krugman fails to find the currency of his stock and trade, the macro-economic statistical models that attempt to describe how an economy works. In truth, those academic ordeals only matter in getting tenure and impressing the global elite. The real economy is much easier to understand.

Case in point: Stockton, California, which on Monday became the largest U.S. city to file for bankruptcy protection. Stockton, a city of 300,000 and two hours from San Francisco, is following the path blazed by many smaller California municipalities that have been unable to support lavish spending, salary and pension guarantees. And although Stockton has tightened its belt over the last few years (unlike similarly bankrupt San Bernadino, which is not even trying), it lacks the capacity to close the gap. Despite its enormous advantages in geography, infrastructure and location, the city is too bloated with government and clogged with taxes and regulation to allow for robust growth. As a result, Stockton is looking to pin the losses on its creditors.

As Stockman makes clear, the United States has been plagued by the same problems that doomed Stockton. His critics argue that the Federal Reserve’s printing press provides a foolproof immunity to such pedestrian problems. But in the end, these paper protections will only exist on paper. We’re all Stocktonians now.

Recently by Peter Schiff: Flying High on Borrowed Wings

This week, while economists should have been closely considering the implications of the actual bankruptcy of Stockton, California, they instead heaped scorn on the perceived ideological bankruptcy of David Stockman. In other words, Stockman trumped Stockton.

Ronald Reagan’s former Budget Director contributed “Sundown in America” a multi-page opinion piece to the Sunday New York Times which loudly and eloquently described the illusions of our current economic system. While I don’t agree with everything Stockman believes, I think he is showing great wisdom and courage in making dire predictions and calling for extreme changes in our policy and politics.

What was perhaps more surprising than the Times’ uncharacteristic decision to run the piece in the first place was the vitriolic and largely ad hominem backlash against Stockman that quickly emerged from across the political spectrum. The attacks have focused primarily on his history and personality, and not on his arguments. One would be hard pressed to find any journalistic reaction that did not use the words “screed” “rant” or “unhinged.” I believe these responses reveal an acute sensitivity from mainstream economists that arises from defending contorted Keynesian logic.

It can’t be easy to take the position that debt doesn’t matter and that spending creates economic growth. To do so with any hope of success requires team unity, and Stockman has never really been a team player. His reputation as an apostate and a naysayer has made him an easy target.

Famously, Stockman left the Reagan White House in protest over the Gipper’s half-finished mandate. Yes, Reagan had cut taxes, but he never really cut spending. Stockman never bought into the easy idea, championed by Jack Kemp and Dick Cheney, that deficits don’t matter and that tax cuts pay for themselves. And although the Reagan revolution did clear the way for a return to better growth in the 80′s and 90′s, Stockman knew that the piper would call someday to collect the debt. Despite his foresight on that topic, his criticism of the Reagan legacy has earned him the derision of the Republican establishment for whom that particular hero worship is sacred.

This may have informed the attack issued by neo-conservative apologist and Iraq war cheerleader, David Frum, who offered a solely psychological assessment: “Stockman provides an insight into the gloomy mindset that overtakes us in older age, it’s a valuable warning to those of still middle-aged that once we lose our faith in the future, it’s time to stop talking about politics in public.” So much for respecting our elders.

Bloomberg’s Jeff Kearns, whose support of Fed policy has earned him regular taps at Ben Bernanke’s televised press conferences, provided the most common mainstream dismissal of Stockman: “His warning that the Federal Reserve’s quantitative easing is steering the world’s largest economy toward a crash is at odds with nine quarters of job growth, record stock prices and unprecedented corporate earnings.” This “he must be wrong because things look good now” position supposes that economics can’t be understood or predicted, only observed. I received very similar treatment back in 2006 and 2007 when I tried to tell the mainstream that the real estate market was a house of cards. How could it be bad, they said, if it goes up every year?

Despite his misalignment with the Republican hierarchy, the Left has an even greater revulsion for Stockman. Since the crisis, he has become perhaps the most respected figure (with the possible exception of Alan Meltzer) to take the position that a system based on fiat currency is doomed. Those who most visibly argue these points, like Ron and Rand Paul, and myself, come from the libertarian movement. As a result, we can be easily dismissed as cranks. However, Stockman was once a card-carrying member of the power elite. His embrace of these principles is taken more seriously and is thus ripe for instant attack from liberal economists.

While the usual suspects of Jared Bernstein and Joe Wiesenthal weighed in with heaps of invective, the loudest heckles have come from, whom else, Paul Krugman. He began his multi-post campaign by questioning the “mystery” of why the New York Times would sully Krugman’s own gravitas by forcing him to share column inches with someone as “non serious” as Stockman. He then offers the back of his hand:

“I thought Stockman would offer some kind of real argument, some presentation, however tendentious, of evidence. Instead it’s just a series of gee-whiz, context- and model-free numbers embedded in a rant – and not even an interesting rant. It’s cranky old man stuff.” For the record, Stockman is only 66.

In actuality, Stockman’s NYT piece offers a litany of objectively dismal facts and cogent explanations of how we got here. While most are celebrating the nominal high of U.S. stocks (see my recent analysis of the current rally), he points out that in the five and half years it has taken for the S&P 500 to set a new high, “Real median family income growth has dropped 8 percent, and the number of full-time middle class jobs, 6 percent. The real net worth of the ‘bottom’ 90 percent has dropped by one-fourth. The number of food stamp and disability aid recipients has more than doubled to 59 million, about one in five Americans.” But Krugman fails to find the currency of his stock and trade, the macro-economic statistical models that attempt to describe how an economy works. In truth, those academic ordeals only matter in getting tenure and impressing the global elite. The real economy is much easier to understand.

Case in point: Stockton, California, which on Monday became the largest U.S. city to file for bankruptcy protection. Stockton, a city of 300,000 and two hours from San Francisco, is following the path blazed by many smaller California municipalities that have been unable to support lavish spending, salary and pension guarantees. And although Stockton has tightened its belt over the last few years (unlike similarly bankrupt San Bernadino, which is not even trying), it lacks the capacity to close the gap. Despite its enormous advantages in geography, infrastructure and location, the city is too bloated with government and clogged with taxes and regulation to allow for robust growth. As a result, Stockton is looking to pin the losses on its creditors.

As Stockman makes clear, the United States has been plagued by the same problems that doomed Stockton. His critics argue that the Federal Reserve’s printing press provides a foolproof immunity to such pedestrian problems. But in the end, these paper protections will only exist on paper. We’re all Stocktonians now.

Peter Schiff is president of Euro Pacific Capital and author of The Little Book of Bull Moves in Bear Markets and Crash Proof: How to Profit from the Coming Economic Collapse. His latest book is The Real Crash: America’s Coming Bankruptcy, How to Save Yourself and Your Country.

The Best of Peter Schiff

After selling off an astounding 56% between October of 2007 and March 2009, the S&P 500 has staged a rally for the ages, surging 120% and recovering all of its lost ground too. This stunning turnaround certainly qualifies as one of the more memorable, and unusual, stock market rallies in history. The problem is that the rally has been underwritten by the Federal Reserve’s unconventional monetary policies But for some reason, this belief has not weakened the celebration.

Although the Fed has been tinkering with interest rates and liquidity for a century, nothing in its history could prepare the markets for its activities over the last four years. (See ‘The Stimulus Trap’ article in my latest newsletter). And while most market analysts give credit to Ben Bernanke for saving the economy and sparking the rally, they have not fully grasped that market performance is now almost completely correlated to Fed activism. A detailed look at stock market movements over the past four years reveals a clear pattern: upward movements are directly tied to the delivery of fresh stimulants from the Fed. Downward movements occur when markets perceive that the deliveries will stop. In other words, the rally is really just a bender. The rest is commentary.

Since 2008, the Fed has injected fresh cash into the economy with four distinct shots of quantitative easing and has added two kickers of Operation Twist. In recent months, the Fed has dispensed with the pretense of designing, announcing, and serving new rounds of stimulus and is now continuously monetizing over $85 billion per month of Treasury and mortgage-backed debt. The new cash needs a place to go, and stocks, which now often provide higher yields than long term Treasury bonds, and which offer much better protections against inflation, provide the best outlet.

But the four year rally has been punctuated by several sharp and brief drops. It is no coincidence that these episodes occurred during periods in which the delivery of fresh stimulus was in doubt. If the Fed were ever to follow through on its promise to exit the bond market, we believe the current rally would come to an immediate halt. This provides yet another reason to believe that stimulus is now permanent.

A close look at the performance of the S&P 500 over the past four years tells the story.

Source: Yahoo! Finance, Euro Pacific Capital. Past performance is no guarantee of future results. (Click here to enlarge)

In May 2007, with the “Goldilocks” economy of 2005 and 2006 still in control, the S&P finally eclipsed the March 2000 high of the dotcom era. It ultimately hit an all-time high of 1565 in October 2007. But later in the year, things began to unravel when bankruptcies of premier subprime lenders signaled real trouble. A blood bath, though, did not materialize. As late as August 2008, the S&P was trading at nearly 1300, down a less-than-tragic 16% from its high. But when Lehman Brothers, Fannie Mae and Freddie Mac, and AIG imploded almost simultaneously in September 2008, the markets panicked. Hundreds of billions of dollars of potentially worthless debt now sat on the books of the nation’s financial system. No one knew where the next bomb would explode. A stampede thus ensued. (A minor replay of this dynamic just occurred in Cyprus. See my recent commentary for more on this).

Less than a month later the index fell below 900, a fall of more than 30%. By November 21, the S&P had lost another 100 points. Four days later, the Fed introduced the first round of what would come to be commonly known as “quantitative easing”. This consisted of purchasing $600 billion of government-sponsored enterprises debt and mortgage-backed securities. By the day of the announcement (even though nothing had yet been done), the S&P rallied almost 50 points to 851. Still encouraged by the Fed, the S&P was at 931 on January 6, 2009, significantly higher than in late November.

Despite the first round of asset purchases, the market was still in chaos and had not yet stabilized. By early March, the S&P had lost an additional 25%, bringing total “peak-to-trough” losses at more than 50%. On March 18, 2009, the Fed announced that it was going to expand the size of its stimulus program. This time it really got the stock market’s attention. The new guidelines called for a total purchase of $1.25 trillion of MBS and $300 billion of Treasury debt. On the day of the announcement, the S&P opened at 776 and by the time the asset purchases were complete a year later, in March 2010, the S&P was trading at 1171, an increase of 50%.

When the spigots of quantitative easing shut down in the second quarter of 2010 the S&P turned south, declining to a low of 1022 in July (a 13% decline from March). In late August, just before Bernanke delivered his 2010 Jackson Hole speech, in which he would hint at the next round of stimulus (to be later dubbed “QE2″), the S&P was still hovering a full 10% below its post QE1 high. But the expectation of another shot was enough to ignite a rally. When the formal announcement of QE2 came in November, the index had already advanced to 1193. When the program expired at the end of the 2nd quarter of 2011, the S&P stood at 1307, a 25% increase from before Bernanke jawboned the markets at Jackson Hole.

The market response to QE2 was in many ways similar, if less spectacular, than its prior response to QE1. And like the first go-round, the rally ended with the withdrawal of stimulus. In addition, after the cessation of QE2, the markets had to contend with the farce of the U.S. debt ceiling drama. As a result, the S&P declined from a high of 1343 on July 22 to 1123 by August 19, a drop of 16%. This is also the same time period when the U.S. received its downgrade by Standard and Poor’s. Ironically, the U.S. eventually got a temporary reprieve from the spotlight when its problems became overshadowed by funding tensions in Greece and Southern Europe, causing the market to once again flock to the so-called “safe haven” of U.S. assets.

The cover from Europe could only go so far. Pressure soon began to build on the Fed to deliver once again. It acted in September 2011 with its “Operation Twist”, a program that consisted of buying longer-term treasuries while selling an equal amount of shorter dated paper. Although Twist was advertised as being balance sheet neutral, the short-term sales the Fed made were somewhat offset by the extension of credit lines to Europe and an extended commitment to the 0% interest rate policy that at the time called for an end date of mid-2013. The day the Fed announced Operation Twist, the S&P opened at 1203. By the following April it had reached 1400, a return of 16%.

But once again the stimulus began to fade. In the second quarter of 2012, a sell off took hold, and by June 5, the S&P traded as low as 1277, a decline of 9% since April. Cue the Fed! On June 20, the Fed announced the extension of Operation Twist, sparking a new rally which has continued into 2013. This buoyancy has been maintained, in part, by the announcement of QE3 on September 13, 2012, which also included another extension of the zero interest rate policy until at least mid-2015. By October, Fed governors were already mentioning inflation targets and when QE4 was launched on December 12, they clarified that zero interest rate policies would be in place until unemployment fell below 6.5%. The current leg of the rally has been somewhat non-linear as the election, the Fiscal Cliff, and the endless empty headlines out of Europe have continued to put pressure on the markets. Despite these obstacles, the S&P has rallied past 1500 and on March 5, 2013, it closed at 1538, within shouting distance of its all-time high of 1576 on October 11, 2007.

When the Fed made the first round of asset purchases in November of 2008, the market was still in a state of flux. However, since the system stabilized in mid 2009, there has been a reliable correlation between the timing of the programs and the performance of the markets. This intention was stated explicitly in Ben Bernanke’s November 4,2010, Washington Times Op-ed in which he provided the rationale for QE2:

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”

With the Fed on pace to expand its balance sheet by over $1 trillion in 2013, there can be little doubt that much of that money is headed straight into the stock market. Treasury bonds are still offering negative real yields and so there is less incentive than ever to own government paper.

Recently, the New York Post’s Jonathan Trugman pointed out that Citigroup could be considered the poster child of the dubious rally. Since the crisis began, he reports that the Bank has received $45 billion in TARP funding, an additional $45 billion line of credit from the Treasury, and a government guarantee of $300 billion for its own troubled assets. At the same time, its cost of capital (the money it borrows from the Fed) is near zero, while it earns 3% to 5% on mortgages and 12% to 18% on credit cards. But from an operational standpoint, those gifts have failed to create a flourishing, self-sustaining, business. The company had shed almost 100,000 employees from its period of peak employment a few years ago (down to 260,000 employees) and it announced three months ago that an additional 11,000 cuts are to come. But Citi’s share price has risen more than 85 percent since June of 2012, despite scant evidence that the company has turned itself around.

But look what all the Fed intervention has wrought. Each time they have intervened the resulting rally has diminished in intensity, and a sell-off has always ensued when the drug wore off. Through the years, the cycle of stimulus administration has quickened pace and has now arrived at a stage where it is continuous. Currently, the Fed is talking about a potential exit strategy, but as we have argued in the past, and as the chart above surely indicates, any withdrawal of stimulus could likely have dire implications for stocks which will not be tolerated by Washington.

Japan has been unsuccessfully trying to inflate its way out of these problems for the past 20 years (see ‘Japan’s Dangerous Game’ in my latest newsletter). Now many of the indebted nations of the developed world seem intent to follow that example. But the monetary experiment of unending stimulus has, up to now, never been tried on a global scale. No one knows when or how it will end, but I believe it will end badly.

Investing in stocks is supposed to be a way to harness real economic growth, not a way to front run stimulus. Our advice for stock investors is to recognize that and to get as far away from artificially induced highs as possible. More fundamentally sound markets exist. We just have to find them.