Archive for August, 2010:
Gold “Caught in Bind” as Stocks Fall, Fresh Easy Money Looms, Dow/Gold Ratio Falls
By: Adrian Ash, BullionVault
London Gold Market Report
THE PRICE OF GOLD held in a tight range as London re-opened after the Summer Bank Holiday on Tuesday, slipping $3 an ounce to $1235 as world stock markets fell again to near the end of August some 6% down on the month.
Silver prices reversed an earlier 1.5% drop to trade back at $19.12 an ounce.
“A disappointing day for precious metals,” says one Hong Kong dealer in a note.
“Despite its safe haven status, gold came off in tandem with stocks, re-visiting Friday’s low.”
The US Dollar slipped back against the Euro today, but crude oil dropped back through $74 per barrel and government bonds rose everywhere, nudging 10-year US Treasury yields back down to 2.50%.
“Gold is caught in a bind,” reckons Tokyo trader Kazuhiko Saito at Fujitomi, speaking to Reuters.
“Slowing growth and deflation worries are generally negative for commodities, putting a cap on gold prices. [But] at the same time, easy monetary policy continues to keep expectations alive that investment funds will return to gold, putting a firm floor under the market.”
A raft of better-than-expected data from Japan and Germany was outweighed according to several London analysts by Monday’s poor Personal Income stats in the US, where income-growth continues to lag price inflation.
The Bank of Japan said yesterday it’s injecting ¥10 trillion ($117bn) into commercial banking loans, with a further ¥920bn ($10bn) of economic stimulus promised by the Tokyo government.
But the Nikkei stock index still sank 3.6% on Tuesday, however, falling to a new 16-month low – even as the Japanese Yen eased back on the forex market – after New York’s Dow Jones Industrial Average closed Monday down 1.4% to finish just a few points above the 10,000 mark, unchanged from April 1999.
The Dow/Gold Ratio ended Monday down at 8.1, meaning it would take a little over 8 ounces of gold at current prices to purchase one unit of the DJIA.
The ratio peaked just shy of 43 ounces in Sept. 1999. Averaging 12 ounces since 1928 – and falling to record lows of two ounces and then one ounce in 1932 and 1980 respectively – the ratio fell to a 19-year low of 7.4 ounces in Feb. 2009.
“It is a data-heavy week,” says Walter de Wet at Standard Bank today, noting the release of manufacturing indices for all major economies, plus US jobless data on Friday.
“This could keep the market nervous…and US equities remain under pressure. The strength in US Treasury bonds is supported by expectations of possible bond purchases by the US Fed, and [we] view these expectations of further monetary easing as positive for gold.”
Meantime, says Standard Bank’s commodity team, “We continue to see gold buying in the physical market, although it has slowed. With gold closer to $1240 an ounce, there also appear to be some gold scrap-selling coming through.”
Tuesday morning’s sharp drop in Sterling pushed the gold price in British Pounds back above £800 an ounce – more than 8.4% above late July’s three-month lows.
Euro investors wanting to buy gold today saw the price tick back towards €31,300 per kilo, meantime, just shy of last Thursday’s eight-week highs.
In Germany this weekend, a row erupted over Dr Thilo Sarrazin, an executive member of Germany’s central-bank, whose new book – which accuses Muslim immigrants of being a drain on the economy – has shot to the top of the best-seller charts.
A former member of the Berlin Senate, Dr Sarrazin “has repeatedly and persistently made provocative statements, especially on issues relating to immigration,” the Bundesbank said in a press release on Monday, “categorically distancing” itself from his comments on Islam and “the Jewish gene”, and threatening to take “prompt action”.
Adrian Ash
Formerly City correspondent for The Daily Reckoning in London and head of editorial at the UK’s leading financial advisory for private investors, Adrian Ash is the editor of Gold News and head of research at BullionVault – winner of the Queen’s Award for Enterprise Innovation, 2009 – where you can buy gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.
(c) BullionVault 2010
Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.
The Best Way to Bet on America
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| Chris Mayer |
There is lots of ugly economic news out there, but one key bright spot is world trade. In the US, one particular industry will enjoy windfall profits from exports this year. That industry is agriculture.
In 2009, world trade took a big hit in the wake of the financial crisis. Global exports fell 12%. Governments tried to protect their home teams and a wave of tariffs and other protectionist measures followed. This was what happened during the Great Depression, too, as the Smoot-Hawley Tariff Act raised tariffs on more than 900 goods.
As a result, world trade sank by 25% during the early years of the Great Depression. But that hasn’t happened this time around. In fact, the emerging economies of the world are already exporting and importing more than they were before the 2008 crisis.
In the US, a big winner is agriculture. US farmers are looking at record exports of $14 billion this year. The heat wave frying European crops (in particular Russian crops) helps that. But even before the drought, in just the first four months of the year, the US enjoyed a $4 billion trade surplus in agriculture. For years, the US has been the world’s largest exporter of corn, wheat and soybeans. It is a leading exporter of many other agricultural goods.
Today, US farmers are cashing in on demand from emerging markets, particularly Asia. China has been trying to build self-sufficiency in food. But it has a long list of hurdles, chiefly a shrinking supply of arable land and water shortages. Also, the median Chinese farm is less than one acre. This hinders the economies of scale that come from big farms.
In any event, US farmers are sending more and more goods to the Far East. So perhaps it is no surprise that first US grain export depot built in 25 years is not on the rim of the Gulf of Mexico, but on the Columbus River in Washington state, about 60 miles from the Pacific Ocean. The new Port of Longview grain terminal will handle 8 million tonnes a year. (The Port of Louisiana is the still the top grain export hub in North America, although California recently passed Louisiana as the top point of departure for US cotton.)
We’ll need more depots like the new Port of Longview. American infrastructure has had a hard time keeping up with surging ag exports. Outside of Seattle, for instance, 80 rail cars filled with dried peas sat for three weeks on the train tracks waiting for a ship to unload them.
It’s not an isolated example. A soybean exporter in, say, Minnesota, could normally ship 40 tons of beans to Malaysia in 15-20 days. With recent bottlenecks, it took 60 days. There are plenty of stories of everything from hazelnuts to soybeans tied up in shipping bottlenecks for weeks.
The US isn’t used to such export strength. As The Wall Street Journal noted, “America’s trading infrastructure grew imbalanced, with a huge capacity to import goods but an attenuated capacity to export them. Loads of grain or corrugated paper leaving the US took a back seat to the DVDs and toys coming in.”
That’s the problem. For too long, the US economy has been all about overindulged consumers. There were too many stores selling too much junk, too many houses people couldn’t afford and too much debt on all of it. This part of the economy grew to grotesque proportions, stimulated by easy credit.
But underneath it all, there is still the old world of making things. In my last issue of Capital & Crisis, I wrote about the surprising strength of American manufacturing. American agriculture is also a bright star in the US firmament and an appealing place to invest.
The future of American agriculture is very bright indeed, as a recent report from the FAO makes very clear. You can find the report, entitled “How to Feed the World in 2050,” right here.
This excerpt from the report sums up the investment case:
Even if total demand for food and feed grows more slowly [over the next 40 years], just satisfying the expected food and feed demand will require a substantial increase of global food production of 70% by 2050, involving an additional quantity of nearly 1 billion tonnes of cereals and 200 million tons of meat.
In addition to the usual assortment of resource issues such as water and soil and climate change, there are some topics you wouldn’t think of otherwise, such as biodiversity. Take a look at this:
The gene pool in plant and animal genetic resources and in the natural ecosystems which breeders need as options for future selection is diminishing rapidly. A dozen species of animals provide 90% of the animal protein consumed globally and just four crop species provide half of plant-based calories in the human diet.
I won’t highlight too much of this report, because I’d be repeating myself. If you’ve read my observations for the last year or so, you know all you need to know about what’s happening in the world’s market for food. Still, if you need an overview, the FAO’s report covers most of the issues.
Farmers with windfall profits will have more money to expand production next year. That’s more money for things such as seed and tractors and fertilizers. As long as its export markets remain open, US farmers should have a great year.
As a long-term investment, Lindsay (NYSE:LNN) should benefit as farmers spend some of that money on irrigation equipment. The economics are attractive, as the machinery significantly boosts yields and makes more efficient use of water.
I also like the non-US ag plays, because high crop prices and the rising demand for food bode well for agriculture around the globe. In Canada, Viterra (TSX:VT) is a good long-term holding. It should rebound after excessive rains in Western Canada hurt grain production. In China, Migao (TSX:MGO), makes fertilizers for high-end crops such as fruits, vegetables and tobacco. It’s growing capacity, and as the financials reflect the additions, it should report good earnings.
Those are just a few. There are plenty more. The business of producing food should continue be a good one.
Chris Mayer,
for The Daily Reckoning
Why A Devaluation Wave Could Push Markets To March 2009 Lows
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As I said in last week’s column, liquidity indicators and leading economic indicators have deteriorated quickly since March. At the same time sentiment indicators reached levels usually seen at stock market highs. All three are the main components of my forecasting model.
Now my model is presenting an even clearer message that the next recession and a bear market are in the offing. And we should expect a test of the March 2009 lows.
Moreover, I have massive doubts that these lows will hold, because …
The Stock Market Has Become
Fatally Expensive
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Forget about Wall Street’s misleading songs about cheap valuations. These analysts constantly use dubious figures, like estimated operating earnings, to come up with such evaluations. If you want history to be on your side, stick to time-honored valuation metrics such as 12-months trailing GAAP earnings or yearly dividend yields.
The latter are especially fitting because they cannot be manipulated whatsoever. The money distributed to share holders as dividends has to be real!
Just look at the long-term, S&P 500 chart below …
The middle panel shows the price/earnings ratio using 12-months trailing GAAP earnings. As you can see the market is at a relatively high 17.59. This is near the upper boundary of 18 to 20.
And the only time this boundary was drastically exceeded was during the stock market bubble years, and in 2008 when earnings went negative for the first time in U.S. history.
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Dividend yields as shown in the bottom panel are at 2.06 percent and convey the same message: The stock market is expensive.
Stock market history holds another insight for us …
The market moves in long-term cycles from undervaluation to overvaluation and back again. After the bubble burst in 2000, the market never reached levels historically associated with undervaluation. Not at the depths in 2002 — not in March 2009.
Therefore, I fully expect the secular bear market that began with the bursting of the stock market bubble in 2000 to push valuations down to historically undervalued levels. That is single-digit P/E ratios and dividend yields around 6 percent or more.
And it could happen within the next 18 months, driving the indexes below their March 2009 lows.
Best wishes,
Claus
Play the Yield Curve with New ETNs
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Many individual investors spend their time thinking about stocks. Which stocks are going up? How high are they going? Should I buy now?
These can be important questions, but stocks aren’t the only financial market. So why do eyes glaze over when the bond news comes on? My guess is that people don’t understand how big the bond market is — or how much influence it has on everything else.
Today we’re going to talk about one aspect of bond trading and how exchange-traded products give you a new opportunity to play it. Let’s look at the …
Treasury Yield Curve
As you know, prevailing interest rates depend on many factors including the amount of time the borrower will need the money. For instance, if I loan you cash for a week, I have some assurance you’ll still be around and able to pay me when the loan comes due. If the loan is for thirty years, though, neither one of us can be certain what will happen.
In other words, longer-term loans carry more risk. Therefore, lenders want extra reward for taking on that extra risk.
This is why, under normal circumstances, long-term interest rates are higher than short-term rates. How much higher? It varies, and this is where the yield curve helps us. The yield curve is simply an illustration of current interest rates across the maturity spectrum.
Let’s look at an example of the yield curve using U.S. Treasury debt, which are essentially loans — you the investor are loaning the government your money. Here’s what it looked like as of Wednesday, August 25 …
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The vertical axis is the current interest rate. The horizontal axis is time to maturity. As of this date, 30-day T-bills were at 0.16 percent, two-year T-notes were at 0.48 percent, ten-year notes were yielding 2.43 percent, and the thirty-year bond yield was 3.48 percent. Put all these on a graph and you get a nice, upward-sloping curve.
Now here is the important part: How steep is the curve? Even more important, is it getting steeper or flatter? This brings us to another graph, one that my Money and Markets colleague Mike Larson shared with you last week. It’s called the “2-10 Spread.”
This number as shown in the chart below is simply the current yield on ten-year Treasury securities minus the current yield on two-year Treasury paper.
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As you can see, earlier this year the 2-10 spread was up around 290 basis points (2.90 percent). Now it’s almost down to 200 bps. This is a massive move in a fairly short time.
That means the gap between the interest rate for ten-year money vs. two-year money is smaller than it was just a few months ago. Consequently, the yield curve is getting flatter.
This makes a huge difference to traders and especially to bankers since banks make their profits by borrowing short-term and lending long-term. They have a hard time when the yield curve is flatter than usual.
Yet with the Federal Reserve keeping short-term rates close to zero and private borrowers unwilling (or unable) to commit to long-term loans, the yield curve seems unlikely to steepen in the near future.
All is not lost, though …
The nice thing about financial markets is that whenever there is movement, there is also opportunity. However, until recently strategies to play the yield curve were only available to professional investors.
But now, thanks to the exchange-traded fund revolution, you have the potential to profit from changes in the yield curve, too.
In fact, Barclays just launched two new products that make it easy:
- iPath U.S. Treasury Steepener ETN (STPP)
- iPath U.S. Treasury Flattener ETN (FLAT)
STPP and FLAT try to capture changes in the 2-10 Treasury spread. When the spread goes up (i.e. the yield curve gets steeper), STPP is supposed to benefit. And when the spread gets smaller — meaning the yield curve is flattening — FLAT is designed to go up in value.
Note that neither of these products has anything to do with whether interest rates are falling or rising. What counts is the spread, or the distance, between two-year and ten-year yields. If the spread widens or narrows and you forecast the change correctly, you can make money no matter what interest rates do.
There Are Risks,
Of Course …
STPP and FLAT are exchange-traded notes (ETNs), not ETFs. This means they are essentially a form of bond issued by a bank — Barclays, in this case. So ETN holders could be left holding the bag if Barclays defaults on its debts. You can read more about ETNs in this 2009 Money and Markets column.
Also be aware that no matter what you think about the yield curve, there is no point in owning both STPP and FLAT at the same time. Because their objectives are opposite, losses in one will probably cancel out any gains in the other.
As with any new ETF or ETN, liquidity is a concern so be sure to use limit orders if you decide to try them out.
Last but not least, these products are leveraged, which means both gains and losses will be magnified.
Am I recommending either STPP or FLAT right now? No. I write about them because I want you to see some innovative examples of how the investment world is changing. You have plenty of opportunities. ETFs and ETNs just make it easier to find them.
Best wishes,
Two Ways to Prepare for “Tail-Events”
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With bond yields and stock markets in the world’s major developed economies petering away, more people are asking: Where can we find investment returns?
Wall Street’s answer: Emerging markets.
The long-term growth prospects in emerging markets are certainly attractive. But with the propensity for another round of global economic crisis and the intertwining of economies, the risk associated with those investments is quite high.
The economic outlook for major economies has deteriorated rapidly. That means we’ll almost certainly see more shocks or “tail-events” in financial markets.
And given the nature of the economic crisis — one defined by unsustainable debt — history suggests those shocks will come in the form of sovereign debt defaults and currency devaluations.
These types of events by definition are thought to be “low probability” occurrences. But as we’ve seen in recent years, they tend to show up with surprising frequency in crisis environments, and they tend to be very destructive.
And it’s prudent to expect that events like these will raise the specter of risk for every region of the world and will likely damage investment returns for the entire global economy.
So, with this backdrop in mind and with asset prices and bond yields falling, where do you find returns?
Here are two ways to consider …
Return Mechanism #1:
Cash
We’re experiencing a balance sheet crisis. And it’s left consumers, companies and governments trying to climb their way out of a hole of debt.
That’s why it’s becoming abundantly clear that deflation is a big threat, despite all of the money printing. You can flood the world with paper currencies, but you can’t make those who have been buried by debt spend or borrow again.
There’s obvious and significant deflation in some key areas of the economy, for example housing. And other broader price measures are poised to follow.
In a deflationary environment cash is king …
As prices fall, your money buys more. But that money tends to be harder to earn.
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In this environment cash can provide shelter and generate returns …
Raising cash can help you avoid being exposed to the tail-events likely in store for financial markets.
As for returns, it’s important to pay attention to real returns. Real returns are returns after the effect of inflation, or in this case, perhaps deflation. It’s the true measure of whether or not your purchasing power (or wealth) has increased.
For example, if consumer prices decline by 3 percent, the purchasing power of your cash would increase by 3 percent … the equivalent of earning a 3 percent return.
Return Mechanism #2:
Opportunistic Trading
The tail-events I mentioned represent a lot of risk, but only if you’re on the wrong side. Positioned correctly, they represent opportunity.
So what is the correct position in this environment? The answer is the same as it would be in any investment environment …
Investors should always be positioned in such a way that the expected return of an investment more than compensates them for the risk taken.
With the increasing probability of a double-dip recession and more emergency policy responses likely to come, the risks of traditional buy and hold strategies clearly outsize the potential rewards.
Instead, the better reward-to-risk profile is more likely found on the short side: Positioning for a fall in stocks, commodities and many foreign currencies, especially those relative to the safe-haven favored U.S. dollar, as markets adjust to a protracted period of depressed demand.
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An even better payoff could come if tail-events, like sovereign debt defaults and currency devaluations, materialize.
We’re already seeing the scrutiny return in Europe …
This week S&P downgraded Ireland’s government debt. And sovereign credit default swaps for the weaker European countries recorded the sharpest monthly increase on record.
The deflation threat has clearly caught many people by surprise. And with the reality that yields will remain at record lows for the foreseeable future, achieving investment returns by traditional strategies and asset classes has proven to be difficult.
I’ve described a few ways to generate return in this environment. But remember, return OF capital can be every bit as important a concern as return ON capital in this crisis period.
Regards,
Why M&A Activity Is Heating Up
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The markets have been taking a beating over the past few weeks. Plunging existing home sales, disappointing jobless claims and weak manufacturing activity numbers are to blame.
However, as you can see in the chart below one of the “positives” is the rising number of mergers and acquisitions (M&A) in July and August.
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Some of the billion-dollar-plus deals include:
- First Niagara Financial Group, Inc. agreeing to acquire NewAlliance Bancshares Inc. for $1.5 billion in the biggest merger of U.S. lenders since October 2008,
- Dell Inc. offering to buy 3Par Inc. for about $1.15 billion, as a way to boost its growing corporate data-center business. Then it sweetened the deal after Hewlett-Packard made a $1.6 billion offer,
- Korea National Oil Corp. making a hostile $2.9 billion bid for U.K. explorer Dana Petroleum Plc.,
- Pactiv Corp., the maker of Hefty trash bags, agreeing to be bought by Rank Group Ltd. for about $6 billion,
- Intel agreeing to pay $7.68 billion for McAfee …
And of course the one that stands out most is:
BHP Billiton Ltd.’s whopping $40 billion hostile bid for Potash Corp. of Saskatchewan Inc., which could make 2010 the busiest year for natural resources deals.
This much M&A activity typically suggests a healthy corporate environment where companies can leverage their success into expansion.
But These Are Not Normal Times,
and These Are Not Normal Markets
One key reason we’re seeing a good number of acquisitions is that interest rates are so darn low the stronger companies are able to issue dirt-cheap debt and easily find willing buyers. Then these companies can put on their predator hat and go on the hunt for vulnerable peers.
Of course many of their peers have beaten-down share prices that reflect the current, weak economic conditions. The net result: A lot of good companies that would have remained independent in a healthy economy with normal credit markets will be absorbed into the few companies with the strongest credit or cash positions.
So this is a great time for companies with access to the credit markets or a strong cash position. Unfortunately for much of the rest of corporate America, it’s time to hide under a rock.
I continue to see an active M&A environment going forward. So I believe you should consider a long M&A trade or two for your portfolio.
In fact, I am spending much of my time right now looking for potential acquisition targets. And I expect to be giving my Manera’s Universal Speculator members one or two potential trades in the coming weeks, as well as a high-probability currency trade.
Best wishes,
Jeff Manera
Editor, Manera’s Universal Speculator
Why weekly charts work
Many traders get so involved with the market on a daily or even an intraday basis, that they somehow lose out on the bigger picture. Weekly charts are enormously helpful in giving clues to the future direction of the market.
In today’s video we examine one of the biggest markets in the world, the S&P 500, using a weekly chart. The video runs about two minutes in length and I think you will find it both educational and informative.
As always our videos are free to watch and there are no registration requirements.
Enjoy the video and be sure to share your thoughts.
http://www.ino.com/info/620/CD3336/&dp=0&l=0&campaignid=3
All the best,
Adam Hewison
President of INO.com
Co-founder of MarketClub
Efficient Market Hypothesis: R.I.P.
By Elliott Wave International
Of all the belief systems of Wall Street, few can claim the devoted following of the Efficient Market Hypothesis, the idea that stock prices adhere to the same laws of supply-and-demand that govern retail products. Once coined the theoretical “Parthenon” of economics, this notion has consistently endured the test of time —– until now. Academics and advisors across the globe are currently exposing crack after crack in the “Efficient” model so deep as to bring the entire theory crashing to the ground.
“The EMH is not only dead,” writes a July 29, 2010 news source. “It’s really, most sincerely dead.” (Minyanville)
As to what caused the theory’s collapse — one recent business journal offers this insight:
“Financial markets do not operate the same way as those for other goods and services. When the price of a television set or software package goes up, demand for it generally falls. When the prices of a financial asset rises, demand generally rises.” (The Economist)
Here’s the thing. SIX years ago, Elliott Wave International president Bob Prechter pronounced the exact same finding in his April 2004 Elliott Wave Theorist. (Read that full-length publication today, absolutely free by clicking on the hyperlink) In that groundbreaking report, Bob presented the compelling picture below that shows how investors increase their percentage of stock holdings as prices rise, and decrease them as prices fall:
The next question is why? Answer: Motivation: i.e. the purchase of goods and services is about need; while the purchase of stocks is about desire. Here, Bob Prechter’s 2004 Theorist takes the rein:
“The fact is that everyday in finance, investors are uncertain. So they look to the herd for guidance. Because herds are ruled by the majority — financial market trends are based on little more than the shared mood of investors — how they feel — which is the province of the emotional areas of the brain (limbic system), not the rational ones (neocortex)… Buyers, in a rising market appear unconsciously to think, ‘The herd must know where the food is. Run with the herd and you will prosper.’ Sellers in a falling market appear to unconsciously think, ‘The herd must know that there’s a lion racing toward us. Run with the herd or you will die.’”
Prechter and contributor Wayne Parker then expanded on his landmark observation in the 2007 Journal of Behavioral Finance. (Also available, absolutely free by clicking on the hyperlink)
In the end, it’s not enough to just tear down the long-standing EMH. One must build another, more accurate model up in its place. And in the 2004 Theorist, Bob Prechter does just that with the Wave Principle, which reconciles the technical and psychological sides of stock market behavior into this key point: Herding impulses, while not rational, are also NOT random. They unfold in clear and calculable wave patterns as reflected in the price action of financial markets.
As the mainstream media continues to jump on board Prechter’s Financial/Economic Dichotomy Theory, you can read both of Prechter’s original writings. Enjoy your complimentary access to the 2004 April 2004 Elliott Wave Theorist and the 2007 Journal of Behavioral Finance.
This article was syndicated by Elliott Wave International and was originally published under the headline Efficient Market Hypothesis: R.I.P.. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.
Carts and Horses
By: Peter Schiff, Euro Pacific Capital, Inc.
In a CNBC debate last week, former Labor Secretary Robert Reich presented a set of contradictory beliefs that unfortunately reflect the conventional wisdom of modern economists. In a discussion with Wall Street Journal columnist Stephen Moore, Reich correctly and comprehensively listed the reasons why American consumers could spend so lavishly before the crash of 2008 and why they can no longer keep up the pace. But instead of making the logical conclusion that former levels of spending were unsustainable and that spending should now reflect current conditions, he advocated that government take on additional debt so that tapped out consumers can spend like they used to.
To achieve this, Reich called for lowering taxes on working Americans and raising taxes on the rich. He argued that middle-income Americans are more likely to spend additional dollars while the rich are more likely to save and invest. As a “demand-side” economist, Reich made clear that spending is superior to savings and investing as a catalyst for growth.
To put it simply: Reich believes that the cart pushes the horse. In his worldview, businesses produce goods and services simply because consumers spend. Therefore, anything that increases spending fuels growth. Unfortunately, he fails to see what should be strikingly obvious: capital formation must precede production, which then allows for consumption.
In a complex society like ours, those relationships are hard to see. However, if we break it down to a simpler level, it becomes more obvious (as I try to accomplish in my new book: How an Economy Grows and Why it Crashes). For example, let’s take a look at a simple barter-based economy consisting of only three people: a butcher, a baker, and a candlestick maker.
If the candlestick maker wants cake, he can’t simply demand that the baker hand it over. The cake needs to be produced, and the baker has to expend labor and material to produce it. Unless the candlestick maker offers the baker something of value in exchange, the cakes won’t get baked. The ability of the candlestick maker to demand cake from the baker is a function of his ability to supply candles to trade. Without production, consumption can’t occur.
What if the candlestick maker gets sick and produces no candles? As the baker would be unwilling to give his cakes away, he would likely stop baking cakes for the candlestick maker. Economic activity would naturally contract until the candlestick maker recovers.
But according to Reich, if the candlestick maker doesn’t have anything to trade, the government should step in and give him candles. But where will the government get them? It could take them from the candlestick maker; but if he is not making candles, how will he pay the tax? Even if there were a few candles left to tax, any that the government took would simply transfer demand from the candlestick maker to the government. No new demand is created.
Alternatively, if the butcher is still healthy, the government could tax him, and give his steaks to the candlestick maker to buy cakes. However, this doesn’t create new demand either. It simply transfers demand from the butcher to the candlestick maker.
Some may feel that a barter-based metaphor doesn’t hold water because the ability to expand the money supply and create credit gives an economy far more flexibility. This is a deceptive argument. Although money is more efficient than barter, it doesn’t change the dynamic between production and consumption.
But Reich suggests that printed money can stimulate demand just as effectively as real candlesticks. But what good will the paper offer the baker if there are no candlesticks to buy? All the baker can do is bid up the prices of those goods, like steaks, that continue to be produced. Similarly, if the government simply prints money and gives it to people to spend, no new production occurs. Prices merely rise to reflect the increase in the supply of money relative to the supply of consumer goods.
In a more complex economy, the relationship between production (supply) and spending (demand) still holds. Every consumer either lives off his own productivity or the productivity of someone else. When individuals work, the wages earned result from the productivity of labor. The ability to consume is directly related to the production of goods or services that result from one’s efforts. However, if people waste their labor in unproductive jobs, little real demand is created.
In the Soviet Union, everyone had a job, yet workers had to stand in line for hours for basic necessities. Although everyone worked (for the government), production was too low. This lack of production meant wages delivered relativity little in the way of purchasing power.
Since production cannot be created by government stimulus, neither can demand. To the extent that there are savings, demand can be brought forward by stimulus – but only at the cost of future demand, plus interest. If stimulus could produce demand, then no nation would be poor. Taken to its logical end, Reich’s argument suggests that African poverty would be wiped out if African governments simply printed money more freely. In reality, Africans are not poor because they lack currency to spend; they are poor because their corrupt and inept governments inhibit production by soliciting bribes, denying property rights, abrogating contracts, preventing the accumulation of capital, and nationalizing profits.
Reich is correct about one thing: Americans are indeed broke. But rather than encouraging the country to spend itself deeper into debt, he should call for greater savings so that we have the means to invest in new businesses and new industries. That is the true road back to solvency, but it will only work if we have less government spending, fewer regulations, lower taxes (particularly on those with the highest propensity to save and invest), and higher interest rates.
Unfortunately, Reich and his allies are calling the shots in Washington. The country cannot recover until the only thing politicians stimulate is demand for new economic leadership.
For in-depth analysis of this and other investment topics, subscribe to The Global Investor, Peter Schiff’s free newsletter. Click here for more information.
Why Gold Is Not In a Bull Market
What is a Bull Market?
What is a ‘Bull’ market? It is a market in an upward price phase of a market with the expectation that it will be followed by a ‘Bear’ or downward phase of a market. This mindset is common to all markets. Sayings like, “everything the at goes up must come down” is pretty standard and taken as part of life itself, but few examine it to see if it is really true. Why should everything that goes up come down? For some years now gold has been thought of as moving in the opposite direction to the U.S. Dollar. So if gold goes up it must come down must also mean that if the Dollar goes down it must come up? Is that true? The history of currencies in the last few thousand years tell us something quite different. Currencies have gone down and never come up again, just disappeared. Gold has always retained a monetary value. Since the eighties to 1999, gold has gone down and in this century has gone up. So we take issue with the saying, in the light of the history of gold. Even though the ‘powers that be’ have tried to discredit gold and underlying money, the vast majority of central banks have retained most of their gold because they believed it to be a very valuable reserve asset.
What sort of Market is Gold?
A very accurate saying is doing the rounds at the moment, it is, “People buy gold, not to make money, but because they have money.” This has always been true, because gold is the Ultimate Money! Unlike commodities it is hardly consumed. Lost yes, but not consumed as other metals and commodities are. It is held as a measure of wealth by bankers, funds, individuals.
The gold market is important in the context of this subject too, because gold is not an ordinary market, it is different from any other. It comes into its own when trust breaks down, when fear rises and confidence falls. And pre-1971 it was always money. This is important because the gold price has defined by a currency price since the early thirties. Why do we say this?
Before then the price of a currency was defined by gold. Each note of currency at one time was described as the number of ounces it represented. It was a bill, a representation of the gold backing it. It was a gold I.O.U. Then the switch came mentally in the murky monetary days somewhere between the dropping of the gold Standard and the Nixon Administration’s floating of the gold price away from the Dollar. Take a look at these two notes we have put here in the article. 
Put your cursor on the corner of each in turn and enlarge them so you can read the writing. You will see what we mean by a ‘bill’ representing gold. Gold always had a role as money and now has a role in backing money as a reserves asset. Roughly translated this means when push comes to shove gold will be money always. It is this role, as money to a greater or lesser extent that makes it different to any other money.
The next question is how can money be in a ‘bull’ market? It is a misnomer because it conveys the wrong concept to investors.
Is Gold in a ‘Bull’ market then?
No! It is money that is in the long process of returning to the center stage of the monetary system.
While this happens, prudent individual and institutional investors are acquiring it, while they can, ahead of the devaluing of un-backed currencies.
We do not believe that the gold price is going to fall back below $300 an ounce and probably not below $1,000. Gold will not enter a bear market by falling as equity markets are prone to do today. It is not an item whose demand will fall away. We expect that once its rise does plateau at some point it will remain at whatever level it reaches. Many do feel that the current investment demand will peter out once confidence returns to un-backed currencies. We find it more than difficult to believe that as we watch monetary authorities from the corners of the world moving to acquire more for their long-term reserves while worrying about the future of the currencies they have in their reserves.
Central banks have started to re-acquire it, while previous sellers of gold have stopped selling their gold. [The I.M.F. managed to acquire 403 tonnes of it from its Members, but the balance of the gold held by the I.M.F. is held on behalf of its members and is not the property of the I.M.F. itself.] Central banks are the very authorities that deemed gold to be money before they invented un-backed currencies. As the world’s governments try to retain their international competitiveness by moving their exchange rates down, their role as a measure of value is being debauched. This gives rise to the need for something to measure currencies against. It will happen eventually, we believe in a careful process. First we expect a basket of currencies to be used. In time, gold will be introduced into that basket, if not from the outset.
Where do Central Bankers see Gold in the next 25 years and why?
By: Julian D. W. Phillips, Gold/Silver Forecaster – Global Watch – GoldForecaster.com
