Alan's Finance Blog

Inflation Propaganda Exposed

Economists who hold the popular view that expanding the money supply will provide the best medicine for our ailing economy dismiss the inflationary concerns of monetary hawks, like me, by pointing to the supposedly low inflation that has occurred during the current period of rampant Fed activism. In a recent blog post aimed specifically at me, Paul Krugman noted that the sub 2.5% increases in the Consumer Price Index (CPI) over the past few years are all that is needed to prove me wrong. In fact, Krugman and others have even suggested that the CPI itself overstates inflation and that the Fed would be better able to help the economy if less strict methodologies were used. However, there is plenty of evidence to suggest that the CPI is essentially meaningless as it woefully under reports rising prices.

Magazines and newspapers provide a good case in point. The truth has not been exposed through the economic reporting that these outlets provide, but in the prices that are permanently fixed to their covers. For instance, from 1999 to 2002 the Bureau of Labor Statistic’s (BLS) “Newspaper and Magazine Index” (a component of the CPI) increased by 37.1%. But a perusal of the cover prices of the 10 most popular newspapers and magazines (WSJ, Washington Post, Time, Sports Illustrated, U.S. News & World Report, Newsweek, People, NY Times, USA Today, and the LA Times) over the same time frame showed an average cover price increase of 131.5% (3.5 times faster than the BLS’ stats). This is not even in the same ballpark.

Some defenders of the BLS may conclude that prices were held down by the availability of free online news content or the convenience of digital delivery. But that is beside the point. Prior to the digital age, the BLS could have claimed that newspaper costs were held down by public libraries that provided free access. It’s also true that online publications deliver less value on some fronts. Not only do many people enjoy the tactile process of reading physical newspapers or magazines, but they offer the secondary value in helping to kindle fires, housebreak puppies, pack dishes, and line birdcages.

Another stunning example is found in health insurance costs, which is a major line item for most families. According to the BLS we can all breathe easy on that front because their “Health Insurance Index” increased a mere 4.3% (total) in the four years between 2008 and 2012.  Interestingly, over the same time, the Kaiser Survey of Employer Sponsored Health Insurance showed that the cost of family health insurance rose 24.2% (5.5 times faster). But even if the BLS had reported higher costs, it wouldn’t have made much of a difference in the CPI itself. Believe it or not, health insurance costs are assigned a weighting of less than one percent of the overall CPI. In contrast, the Kaiser Survey revealed that in 2012 the average total cost for family health insurance coverage was $15,745, or almost one third of the median family income.

If the BLS could be so blatantly wrong in reporting the prices of newspapers and health insurance, should we believe that they are more accurate on all other sectors? If the inaccuracy of these two components were consistent with the rest of the CPI’s components, inflation could now be reported in double-digits!

Even more egregious than the manner in which prices are currently reported is the way that CPI methods have been changed over the years to insure that most increases are factored out.  Since the 1970′s, the CPI formula has changed so thoroughly that it bears scant resemblance to the one used during the “malaise days” of the Carter years. Main stream economists dismiss criticism of the changes as tin hat conspiracy theories. But given the huge stakes involved, it’s hard to believe that institutional bias plays no role. Government statisticians are responsible for coming up with the formulas, and their bosses catch huge breaks if the inflation numbers come in low. Human behavior is always influenced by such incentives.

The newer CPI methodologies are designed to report not just on price movements, but on spending patterns, consumer choices, substitution bias, and product changes. In other words, the metrics have been altered to track not so much the cost of things, but the cost of living (or more accurately, the cost of surviving). But if you simply focus on price, especially on those staple commodity goods and services that haven’t radically changed in quality over the years, the under reporting of inflation becomes more apparent.

As reported in our Global Investor Newsletter, we selected BLS price changes for twenty everyday goods and services over two separate ten-year periods, and then compared those changes to the reported changes in the Consumer Price Index (CPI) over the same period. (The twenty items we selected are: eggs, new cars, milk, gasoline, bread, rent of primary residence, coffee, dental services, potatoes, electricity, sugar, airline tickets, butter, store bought beer, apples, public transportation, cereal, tires, beef, and prescription drugs.)

We know that people do not spend equal amounts on the above items, and we know their share of income devoted to them has changed over the decades. But as we are only interested in how these prices have changed relative to the CPI, those issues don’t really matter. We chose to look at the period between 1970 and 1980 and then again between 2002 and 2012, because these time frames both had big deficits and loose monetary policy, and they straddle the time in which the most significant changes to the CPI methodology took effect. And while the CPI rose much faster in the 1970′s, the degree to which the prices of our 20 items outpaced the CPI was much higher more recently.

Between 1970 and 1980 the officially reported CPI rose a whopping 112%, and prices of our basket of goods and services rose by 117%, just 5% faster. In contrast between 2002 and 2012 the CPI rose just 27.5%, but our basket increased by 44.3%, a rate that was 61% faster. And remember, this is using the BLS’ own price data, which we have already shown can grossly under-estimate the true rate of increase. The difference can be explained by how CPI is weighted and mixed. The formula used in the 1970′s effectively captured the price movements of our twenty everyday products. But in the last ten years it has been quite a different story.

If these price changes in our experiments had been fully captured, CPI could currently be high enough to severely restrict Fed action to stimulate the economy. Instead, the Fed is operating as if inflation is extremely low. As a result, they are making a huge policy mistake that will come back to haunt us. During the last decade the Fed spent many years denying the existence of a housing bubble, even as a mountain of evidence piled up to the contrary. That error caused the Fed to hold interest rates too low for too long, blowing more air into the bubble and imposing enormous negative consequences on the economy. The Fed, now similarly blind to the inflation threat, is repeating its mistake, only this time the negative consequences will be even more dire.

Apart from the statistical problems that hide inflation, there are also macroeconomic factors that have helped keep prices down despite the quantitative easing. Massive U.S. trade deficits and foreign central bank dollar accumulation mean that much of the printed money winds up in foreign bank vaults, not U.S. shopping centers. As foreign consumer goods flow in, and dollars flow out, a lid is kept on domestic prices. In effect, our inflation is exported as foreign central banks monetize our deficits and recycle their surpluses into U.S. Treasuries. The demand has pushed down bond yields which has allowed the U.S. government to borrow inexpensively. Of course, when the flows reverse, bond prices will fall, yields will climb, and a tidal wave of dollars will wash up on American shores, drowning consumers in a sea of inflation.

Unlike Krugman and the Keynesians, I would argue that it is impossible to create something from nothing. I believe that printing a dollar diminishes the value of all existing dollars by an aggregate amount equal to the purchasing power of the new dollar. The other side takes the position that the new money creates tangible economic growth and  that real economic value can therefore be created by putting zeroes onto a piece of paper. I think that those making such absurd claims should bear the burden of proof. For more on the interesting topic of hidden inflation, see my video that I just posted.

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show.

Peter Schiff – Lessons from Black Monday

By: Peter Schiff, CEO of Euro Pacific Capital

25 years ago, on another Monday in late October, the financial world seemed to disintegrate in a heartbeat. Though the 205 point drop in the Dow last Friday (the technical anniversary of the ’87 Crash) was somewhat reminiscent of its 108-point drop on Friday, October 16, 1987, the real action in ’87 was on the Monday that followed.  And while this Monday is not nearly as black, it is important that we use the opportunity to recall the circumstances that nearly sent the stock market into cardiac arrest.

While there were technical reasons that allowed the snowball to gather so much mass, it was major economic problems that started it rolling. Those issues remain to this day, but have grown much, much larger. But while they terrified the market 25 years ago, they don’t rate a second look today. Whether investors have gotten wise, or merely oblivious, is the question we should be asking.

Though most simply remember the 1987 Crash as one panicked selling day, Black Monday was just the largest drop in a string of bad days. On the Wednesday before, the Dow sold off 95 points (then a record) and dropped another 58 points on the Thursday. On Friday the selling got worse, with the Dow setting another record with a 108 point drop. After thinking about it over the weekend, investors decided to preserve what remained of their gains by selling on Monday. Unfortunately, everyone got the same idea at the same time.

It is true that the Crash was in some ways a technical phenomenon. As of August of 1987, stocks had surged 75% from January 1986, and 40% from January 1987. After such an upswing, it was inevitable that investors were on edge. Rather than taking profits, many on Wall Street instead hedged their positions using the new, and largely untested, trading programs that were designed to put a floor under losses if the markets turned south. But when the selling came in waves, the machines went into overdrive. Selling begat selling and an automated rout ensued. When the dust settled, the Dow was down 22% in a single day.

If that was all there was to the story, we would be left with a neat cautionary tale about the folly of placing too much faith in machines. But that is a distracting sideshow. In truth, the market was spooked by concerns over international trade and government debt, which then became known as the “twin deficits.” After widening earlier in the 80′s, investors had hoped that these gaps would come under control. But as Ronald Reagan’s second term wore on, those hopes faded.

From 1982 to 1986, the U.S. trade deficit had expanded 475%from $24 billion to $138 billion. Most economists blamed the trend on the dollar gains in the early 1980′s, which had apparently made U.S. products uncompetitive. As it was assumed that a weakened dollar would solve the problem, in 1985 the leading western democracies and Japan announced the Plaza Accords to systematically push down the dollar against the Japanese yen and the Deutsche mark. By 1987, the plan had “succeeded” devaluing the dollar 51% against the yen. But by the second half of that year it became apparent that the Plaza Accord had failed in its real mission to cut down on the U.S. trade deficit. Despite the plunging dollar, the deficit expanded that year by another 10% to $152 billion.
At around that time, the U.S. government budget deficits also became a major concern. Everyone remembers Ronald Reagan as a small government champion, but many conveniently forget that he presided over a significant expansion in government spending. Federal deficits rose 199% from 1980 ($74 billion) to 1986 ($221 billion). Although the deficit came down to $150 billion in 1987, many were frustrated that it remained stubbornly high by historic standards.

As early as August of 1987, concern over the twin deficits, which together accounted for 6.4% of the nation’s $4.76 trillion GDP became critical. Given the prior run up in stocks, this was enough to convince many investors to head towards the exits. Before Black Monday (October 19), the Dow had already declined 18% from its August peak.

When we look back at those events from the current perspective, it almost seems comical. Government deficits now approach $1.5 trillion annually and annual trade deficits exceed $500 billion. Today’s twin deficits now add up to more than 13% of current GDP (twice the level of 1987). But today’s investors are largely untroubled. Oftentimes news of a falling dollar and wider deficits will spark a stock rally, and the issues barely rate a mention in a presidential debate.
Are investors today simply more sophisticated than they were then? Have they lost an irrational fear of deficits? To the contrary, I believe that we have arrived at a point where money printing and government stimulus has replaced manufacturing and private sector productivity as the foundation of our economy (see my lead commentary in the October 2012 edition of the Euro Pacific Global Investor Newsletter for more on this). As a result, most investors are now blind to the dangers of deficits. But that does not mean that they don’t exist.

When America’s creditors wake up, particularly those foreign governments now shouldering the lion’s share of the burden, concerns over our twin deficits will return with a vengeance. As the problems now loom larger than ever, so too will the economic and market implications when the issues come to a head. Interest rates will surge and the dollar will fall. But the U.S. economy is not nearly as well equipped as in 1987 to withstand the stresses. Given the relative size of our imbalances, the manner in which they are being financed, and the diminished state of our manufacturing sector, higher interest rates and a weaker dollar will exact a much greater toll.

Despite this, I do not believe that the stock market is as vulnerable to another Black Monday. With the Federal Reserve so committed to its current course of quantitative easing, it seems to me unlikely that they will allow such a steep one-day drop. Also, with bond yields so low, domestic investors are currently presented with fewer attractive options. If anything, the next Black Monday is more likely to occur in the currency and/or bond markets, with safe haven flows moving into gold not treasuries.

Euro Pacific Capital, Inc.
10 Corbin Drive, Suite B
Darien, Ct. 06840
800-727-7922
www.europac.net
schiff@europac.net

Ron Paul – Gold is Good Money

Last year the Chairman of the Federal Reserve told me that gold is not money, a position which central banks, governments, and mainstream economists have claimed is the consensus for decades.  But lately there have been some high-profile defections from that consensus.  As Forbes recently reported, the president of the Bundesbank (Germany’s central bank) and two highly-respected analysts at Deutsche Bank have praised gold as good money.

Why is gold good money?  Because it possesses all the monetary properties that the market demands: it is divisible, portable, recognizable and, most importantly, scarce – making it a stable store of value. It is all things the market needs good money to be and has been recognized as such throughout history.  Gold rose to nearly $1800 an ounce after the Fed’s most recent round of quantitative easing because the people know that gold is money when fiat money fails.

Central bankers recognize this too, even if they officially deny it.  Some analysts have speculated that the International Monetary Fund’s real clout is due to its large holdings of gold.  And central banks around the world have increased their gold holdings over the last year, especially in emerging market economies trying to protect themselves from the collapse of Western fiat currencies.

Fiat money is not good money because it can be issued without limit and therefore cannot act as a stable store of value. A fiat monetary system gives complete discretion to those who run the printing press, allowing governments to spend money without having to suffer the political consequences of raising taxes.  Fiat money benefits those who create it and receive it first, enriching government and its cronies.  And the negative effects of fiat money are disguised so that people do not realize that money the Fed creates today is the reason for the busts, rising prices and unemployment, and diminished standard of living tomorrow.

This is why it is so important to allow people the freedom to choose stable money.  Earlier this Congress I introduced the Free Competition in Currency Act (H.R. 1098) to permit people to use gold as money again. By eliminating taxes on gold and other precious metals and repealing legal tender laws, people are given the option between using good money or fiat money. If the government persists in debasing the dollar – as money monopolists have always done – then the people would be able to protect themselves by using alternatives such as gold that are both sound and stable.

As the fiat money pyramid crumbles, gold retains its luster.  Rather than being the barbarous relic Keynesians have tried to lead us to believe it is, gold is, as the Bundesbank president put it, “a timeless classic.”  The defamation of gold wrought by central banks and governments is because gold exposes the devaluation of fiat currencies and the flawed policies of government.  Governments hate gold because the people cannot be fooled by it.

Ron Paul

European Debt Crisis: “Imagine the Worst and Double It”

Just how will the sovereign debt crisis end?

By Elliott Wave International

We’ve all heard the line: Let me give it to you straight.

And in speaking to his counterparts in Spain, an Irish economist did just that.

Ireland has this banking advice for Spain: imagine the worst and double it. [emphasis added]

Like Ireland, Spain sought a bank bailout after being felled by a real-estate crash. Now, just as the Irish did, the Spanish are awaiting the results of outside stress tests gauging the size of the hole in the banking system.

Bloomberg, June 14

Stress test or no, EWI’s Global Market Perspective has known that Spain’s banking system is frail. In May, the publication gave its subscribers this chart-supported insight:

A 17-year high in the percentage of non-performing Spanish loans is merely one illustration of the Continent’s illness. After falling to a four-decade low of less than 1% in 2007, delinquencies have spiked eightfold in the past five years. The percentage stands at its highest level since 1994.

Global Market Perspective, May 2012

By itself, a subsidiary of Spain’s largest bank, Banco Santander, absorbed Q1 bad loan losses of 475-million euros.

Italy is in the same sinking economic boat. The June Global Market Perspective showed how much the eurozone’s third largest economy is also drowning in bad debt.

The Italian and Spanish economies are in shambles as borrowing costs have skyrocketed for both countries.

But the recent spotlight has been on Greece. Now that the Greek election is over and voters appear ready to embrace austerity, should we be optimistic about the future of the euro zone?

You owe it to yourself and your investments to find out. Remember, even if you believe you’re not directly invested in Europe, there’s a very good chance that some of the companies in your portfolio are.

Get Ahead of What Is Still to Come in This FREE Report from Elliott Wave International The debt crisis in Europe continues to play out in the political, social and financial worlds. What will be next? With commentary and analysis from February 2010 through today, this timely report gives you an important perspective on the European debt crisis and what it could mean for your portfolio. Read Your Free Report Now: The European Debt Crisis and Your Investments >>

Trickle Up Economics

The political left wing has long tried to cast doubt on the fairness, and even the efficacy, of free market capitalism by branding it as a “trickle down” system.  This epithet is meant to show how the middle and lower classes are dependent on scraps of wealth that happen to fall from the buffet table of the rich. This characterization of an unfair and inefficient system has helped them demonize policies that lower taxes (if they also extend to the wealthy) and reduce regulation on business.

To correct these supposed problems, they have long called for policies to redistribute wealth or for government to inject funds directly into the economy.  Either mechanism puts money into the hands of everyday consumers who they claim to be the true engines of economic growth. They believe that consumer spending lies at the root of the economic pyramid. When people spend, business owners are able to sell more products, hire more workers, and reap more profits. In essence, they believe in a system of “trickle up” economics, whereby prosperity flows upward from government into the lower and middle classes and ultimately to the upper class.

Conversely, they argue, if consumers aren’t buying, business sales decline and workers lose jobs. The jobless spend less than the employed, putting even more pressure on businesses. This leads into a vicious cycle of falling sales and increased unemployment. They believe that if a shock is not applied to reverse the cycle it is possible for an economy to regress, in theory, right back to the Stone Age. Using such logic, it is easy to identify the foundation upon which the economy rests: it’s the spending, stupid. Some progressives have likened this process to a natural ecosystem wherein government spending is the rain that makes grass grow. The grass attracts zebras and antelopes (consumers), which then offer sustenance to the lions (capitalists).

If this is your diagnosis, then your prescription should be patently obvious: restore the demand lost through unemployment and get people spending again. How to accomplish this is also equally simple: take the money from the rich who really aren’t using it anyway. Without entering into a parallel discussion of fairness, demand side economists simply see the redistribution of money from the rich as a way to generate economic growth, which benefits society as a whole. As they see it, the rich have more money than they need to satisfy their own personal demand. No matter how rich, a single individual can only eat in so many restaurants, buy so many cars, or go see so many movies. The money they don’t spend is saved instead, thereby sucking needed demand out of the economy. In contrast, the lower and middle classes spend a much higher percentage of their net worth. To break the vicious cycle, all that is needed is to direct these idle funds where it will be spent rather than saved. In a June 19th Wall Street Journal cover story, reporter Jon Hilsenrath underscores this point in explaining why the impact of the Fed’s low interest rate policies are being weakened by the current preference for high credit score borrowers. Says Hilsenrath, “Financially secure households are less likely than lower-income households to spend their interest rate savings. Wealthier households are more likely to save or invest.”

A policy prescription such as this is seductive. It allows people to advocate a moral position (it’s a shame that the poor don’t have as much as the rich) in purely practical terms (redistribution creates economic growth). And if spending is the panacea, then government can easily wipe out suffering, even if they lack the political ability to raise taxes. After all, what stops them from printing all the money needed for people to spend the economy back to health? According to Nobel Prize-winning economist Paul Krugman, only the political cynicism of Republicans, who try to wring votes out of Americans’ misplaced hopes for upward mobility and their stubborn fixation on thrift, prevents this painless and readily available cure.

But as usual, they have it exactly backwards. The savings that they find so unproductive is actually the foundation upon which the economy rests. Nothing can be consumed until it is produced. The act of spending is meaningless without something to buy. The savings of the rich forms the capital that funds business investment which increases productivity. The more that society produces, the more that can be consumed. The key here is the supply, not the demand. The grass that feeds the zebras comes from seeds, not rain. Capitalists provide the surplus seeds that are planted.

Demand always exists and does not need to be stimulated by cash redistribution. 21st century Americans are no more desirous of cell phones than their parents were. But in 1980 cell phones were in very limited supply and were therefore very expensive. They were the trophy possessions of the super-rich. The reason why they are now as ubiquitous as key chains is not that government stimulated demand, but that industry figured out how to supply them far more efficiently. The supply satisfied the demand. Investment in the telecom sector, which came from real savings of Americans, allowed for that increased productivity.

In this example, the savings of the wealthy and the innovation of entrepreneurs combined to create a huge benefit for society. Call it trickle down if you want, but it would be more honest to simply call it effective. This is the system that built this country. Relying on trickle up will surely destroy it.

What is Money?

Excerpted from the new economic bestseller, The Real Crash
By Peter Schiff, CEO of Euro Pacific Precious Metals

Today, we’re accustomed to thinking of small greenish paper rectangles as the definition of money, and we think of the US government as the only source of money. To honestly discuss sound money, we need to realize where our current money customs came from.

At first, it was every man for himself. You ate or wore what you could pick or catch.

Barter was the first advance. If you had some extra meat, and your neighbor had an extra fur, you might make a direct exchange. If food, water, clothing, and simple tools are the only goods on the market, barter is fine – you can always find someone who has what you want and wants what you have.

But as soon as there’s basic manufacturing and prosperity begins increasing, barter becomes inadequate. Say you’re a hunter and you want a bed, but the only bedmaker in town is a vegetarian. What do you do then? You would have to figure out what the bedmaker wanted (maybe tofu), and then find someone who had tofu and wanted meat. If you couldn’t find that person, you would have to find a fourth person (someone who wanted meat, and had the hats that the tofu maker wanted), or try to convince the vegetarian bedmaker to take the meat and trade it for something else.

Meat, however, spoils, and so the bedmaker would have to unload it pretty quickly. So, unable to get your hands on anything the bedmaker wants to consume, you trade your meat for some salt and approach the bedmaker.

“Look, I know you don’t want salt, but think of all the people who do. They use it to preserve their meat and flavor their soup. And this stuff is nonperishable, so you can hold it as long as you want. And if, when the tofu dealer comes through town, he doesn’t want salt, you can explain to him what I’ve explained to you – he can use it to buy something he wants.”

If you and the bedmaker agree, you’ve just created money. Organically, more people in your community begin taking salt for payment, even if they have no intention to use it, because they know others will accept it.

But – and this is important – the value of salt money is not entirely dependent on other people accepting it as payment. If, for some reason, folks stopped taking salt as payment, you could use it as, well, salt.

Salt was a pretty good currency, especially before refrigeration, because it was widely demanded, divisible down to the grain, very portable, easy to weigh, and could easily be tested for counterfeit by tasting it. Romans used salt for money.

But just because salt served as money didn’t mean there would be no other form of money in circulation. Tobacco leaves might be widely accepted as payment. So might gold or silver.

The Greatest Invention Ever?

The point is that money arises naturally in society, as a way of aiding in voluntary economic transactions. It was one of the greatest inventions ever. Money not only made it easier for people to buy what they wanted, it also made saving much more possible – you could accumulate excess money to spend at a later point.

While saving is frowned upon by the elites today, it’s an essential element in economic progress. By making it easier for people to save, money did two crucial things. First, it inspired more industriousness: there was now incentive to work harder to earn more in a day than you could spend in a day. Second, savings enabled ambitious entrepreneurs to make big capital investments: labor-saving machines, warehouses, transportation.

If the saver didn’t have any big plans in mind for his money, he could still make it productive by lending it out. Finance was nearly impossible without money. Sure, you could give your neighbor a pig this year in exchange for a pig and a chicken next year, but there would be a lot more opportunity for squabbling (“this pig isn’t as healthy as the pig I gave you last year”).

With a commodity money, where there is little or no deviation in quality, and using universal, objective measures, like weight, you can lend with the confidence that what you get back will be of the same quality as what you loaned out.

Money also made specialization more practical. If you were really good at one thing – manufacturing nails (to borrow Adam Smith’s famous example) – you could make a living just by making nails. Without money, someone who spent his whole day making nails would have to find (a) someone with excess food who wanted nails, (b) someone with excess shelter who wanted nails, (c) someone with clothes to spare who also wanted nails at that moment, and so on.

Once money is introduced, the nail seller only needs to find (a) people with money who want nails, and (b) different people with everything the nail seller needs who want money. Facilitating specialization creates efficiencies, as folks get to divide up labor according to skill and interest.

In countless ways, money improves society.

Competing Currencies

In the past, different types of commodity money competed. Salt had its advantages, but also disadvantages – you had to keep it dry, it was easy to spill. In Rome, rising sea levels made it much harder to get salt over the years.

Meanwhile, gold had a lot going for it. It’s fairly easy to store. Like salt, it’s easy to divide, but also easy to combine: you can make blocks, or coins of different weights or denominations, which can be standardized. It doesn’t rust. It doesn’t tarnish or undergo other unpleasant reactions with chemicals.

Like any money, gold has underlying value. Mostly, we think of its decorative value – across nearly every culture, gold is considered beautiful. Women love it, and pleasing women’s fancies is universally considered a good thing. It has industrial uses due to its resistance to corrosion and how thin it can be hammered.

Gold is also rare enough to be valuable, but plentiful enough that it can be widely circulated. Its supply grows, but never very quickly.

No authority had to declare gold to be money. It arose as a good medium of exchange, and in many cases it won out in competition against other moneys. It didn’t always win out to the exclusion of other types of money, but it was probably the most successful money ever, thanks not to some order from above, but thanks to gold’s own attributes.

This is very important: money doesn’t come from government; it comes from civil society.

From “The Real Crash” by Peter D. Schiff. Copyright © 2012 by the author and reprinted by permission of St. Martin’s Press, LLC. Click here to order from Amazon

Peter Schiff is CEO of Euro Pacific Precious Metals, a gold and silver dealer selling reputable, well-known bullion coins and bars at competitive prices.

Listen: EWI’s Chief Analyst Hochberg Explains Recent Action in Stocks, U.S. Dollar and More

Listen to Hochberg explain the problems with using lagging economic indicators like earnings

By Elliott Wave International

EWI Chief Market Analyst Steven Hochberg talks with MarketWrap radio on May 10, 2012, about recent market action and where we are in the long-term trend, among many other topics.

Listen to Hochberg explain why using lagging economic indicators like earnings as a forecasting tool is like driving down the highway while looking in the rear-view mirror.

Enjoy this free audio clip — and then take advantage of a limited-time offer to learn even more about EWI’s big-picture forecast for U.S. and Europe (see offer details below).

When the markets were still going up at the beginning of 2012, were you warned that they would soon go down? Elliott Wave International has just made its May 2012 Elliott Wave Financial Forecast available FREE for a limited time. No one should invest a dime in U.S. or European markets until they read this 10-page report at least 3 times. With a $29 value, this single issue of the May 2012 Elliott Wave Financial Forecast will give you the complete big-picture forecast for U.S. and Europe — financially, economically and socially. Get up to speed and ahead of the markets today. Download your free 10-page report now >>

Europe’s Financial Fiasco: Migrating to the United States?

History may repeat itself

By Elliott Wave International

Few Americans realize that the Great Depression started in Europe.

Now as then, the global economy is fragile.

The economy is clearly vulnerable to a debilitating wave of debt deflation. The threat is approaching quickly from an important source: Europe. The same sequence of events occurred in 1929, when deflation started overseas before lapping onto U.S. shores. In Germany, for instance, real GDP fell 1% in 1929 after growing 8.2% in 1927 and 2.8% in 1928. Other economic indicators peaked as early as 1927. At the time, economically-weak Germany was the equivalent of today’s so-called PIIGS (Portugal, Ireland, Italy, Greece and Spain).

Financial Forecast , January 2012

Lending in France also began to decline as early as 1927-28. And about a year before the October 1929 crash, net capital inflows fell in several European countries. In other words: European economies began to deteriorate before the Great Depression began in the U.S.

In Q4 of 2011, the eurozone was already nearing zero economic growth, vs. the U.S. and Asia:

Also, a chart from our May 2012 Financial Forecast (data through May 3) shows European stock markets headed south before the S&P 500:

We know that deflation started in Europe just prior to the Great Depression; today the risk is “contagion.” With this in mind, consider the evidence that a deflationary trend may already be unfolding in the U.S. Here are some recent headlines:

• Illinois Faces 25% Cost Increase to Borrow $1.8 Billion — Bloomberg (4/30)
• States Scaling Back Worker Pensions to Save Money — Associated Press (5/1)
• Cash-Strapped NY Town Cancels July 4 Fireworks — WNBC-TV (5/9)
• Half of Detroit’s Streetlights May Go Out as City Shrinks — Bloomberg (5/24)
• CBO: Fiscal cliff likely to cause recession — CNNMoney (5/22)
• No ‘Barn Burner’ for Job Growth — CNBC (5/4)
• Student debt clock strikes $1 trillion — CBS Moneywatch (5/8)
• Shortfall in California’s Budget Swells to $16 Billion — New York Times (5/12)
• [Senator] Coburn: U.S. “going to get another downgrade” — CBS News (5/23)
• Home Prices Hint at Slow Housing Recovery — Wall Street Journal (5/29)

Here are recent headlines about Asia:

• Japan’s jobless rise stokes slowdown fear — Marketwatch (5/29)
• Hedge Funds Circle as Japan’s Asset Bubble Grows — Bloomberg (5/21)
• World Bank warns of China slowdown — CNNMoney (5/23)

Mounting evidence notwithstanding, most economists still say nothing about deflation. Then again, most economic observers were equally mute about deflation before the Great Depression.

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Position Yourself for the Rest of “Conquer the Crash”

The earlier you prepare, the better

By Elliott Wave International

To this day, I wonder why Robert Prechter’s book Conquer the Crash has not been more widely recognized. It described in advance much of what happened in the 2008 financial crisis.

Published in 2002, the book provided detailed descriptions of then-future economic scenarios. They were detailed vs. general. Prechter was specific in a way that would prove right or wrong; there was no gray.

This is from the book:

There are five major conditions in place at many banks that pose a danger: (1) low liquidity levels, (2) dangerous exposure to leveraged derivatives, (3) the optimistic safety ratings of banks’ debt investments, (4) the inflated values of the property that borrowers have put up as collateral on loans and (5) the substantial size of the mortgages that their clients hold compared both to those property values and to the clients’ potential inability to pay under adverse circumstances. All of these conditions compound the risk to the banking system of deflation and depression.

Conquer the Crash, second edition, (p. 179)

That’s just one excerpt about one topic in a 456-page text. Perhaps you see why I believe the book deserves more credit. Yet even that one paragraph from the book turned out to be a virtual mirror of what came to pass. And much of what he predicted is unfolding today: the JPMorgan trading fiasco, massive withdrawals at Greek banks, downgrades of Italian and Spanish banks and much more. Those are just a few headlines.

The broader point is that Conquer the Crash prepared its readers. Around the time the book’s second edition published in 2009, the Chicago Sun-Times remarked

And the credit implosion is still not over. Please take a look at the chart:

In the Conquer the Crash quote in the first part of this article, you’ll notice the last three words are “deflation and depression.”

The world has yet to completely pass through these economic valleys.

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Damn the Torpedoes

Last week in an interview on CBS Network News, Economist Mark Zandi, the chief economist for Moody’s, unwittingly revealed a central error of the global economic establishment. Zandi has made a career out of finding the middle ground between republican and democrat economic talking points. As a result of this skill, he has been rewarded with large quantities of airtime from media outlets that want to appear non-partisan, despite the fact that his supposedly neutral analysis often leaves listeners frustrated.

When asked about the recent deterioration in the global economy, Zandi said that “the worst possible scenario” at present would occur if Greece were to leave the Eurozone.  He claimed that the economic gyrations and liquidations of bad debt that would result from such an exit would be sufficient to create a vicious cycle that could drag the global economy back into recession. As a result, he urged policy makers to take whatever steps necessary to maintain the current integrity of the 17 nation Eurozone.

Given what most economists now know, few would actively argue that Greece’s entrance into the Eurozone back in 2001 was a good idea. In fact most concede it was a terrible idea based on bad forecasting and outright fraud. There is little disagreement over the fact that Greece grossly misrepresented its financial position in order to gain initial entry into the monetary union. It is also widely agreed upon that in the ensuing decade Greece exploited its monetary advantages to borrow irresponsibly.

Much has been written about how the fundamental misfit between Greece’s economy and currency gave birth to a deeply flawed system that was destined to run off the rails. Most also agree that the countries like Greece and Germany are too economically and culturally disparate to exist under the same monetary umbrella. But despite all this, Zandi wants to maintain the status quo. In his opinion, it is so imperative to prevent the deflationary consequences of an economic restructuring that it is preferable to prop up a failed system, perhaps indefinitely, rather than allow a newer, healthier system to replace it.  In the process, the moral hazard created not only assures that Greece will become an even greater burden on Europe, but so too will other nations whose leaders will be emboldened in their profligacy by the anticipation of similar help.

From Zandi’s perspective (and he is certainly in the majority on this point) the goal of economic policy is to keep GDP growing. It follows then that he will oppose large-scale debt liquidations which drag down GDP in the short term. But sometimes debt needs to be liquidated. Bad ideas need to be abandoned. Once economies stop throwing good money after bad, capital is freed up to flow into more economically viable purposes. But economists and politicians never look at the long term. Their job seems to be to manage the economy for the next election.

The same “damn the torpedoes” mentality dominates economic thinking with respect to the U.S. economy as well.  Years of artificially low interest rates, and government subsidies that direct capital towards certain sectors and away from others, has created an economy with too little savings and production, and too much borrowing and consumption. The ultra-low interest rates currently supplied by the Fed serve to perpetuate this unsustainable artificial economy. Higher rates would work quickly to redirect capital to the more productive sectors. But high rates could bring deflation and liquidation, which few economists are prepared to risk.

We have too many shopping malls selling stuff, but not enough factories making stuff.  We have too many kids in college studying liberal arts, and not enough in the workforce acquiring skills that will actually increase their productivity.  Banks are loaning too much money to individuals to buy houses, and not enough money to entrepreneurs to buy equipment.  We have too many tax-takers riding in the wagon, and not enough taxpayers pulling it.  The list is long, but the solutions are short.

We need to let interest rates rise to market levels, and allow the economy to restructure without government interference.  We need to stop beating a dead horse and hitch our wagon to an animal that can really pull.  The process will be painful for many, but like ripping off a band-aid, the pain will be over relatively quickly.  However, since a painful restructuring means recession, politicians resist the cure with every fiber of their beings.  So instead of a genuine recovery, one that will provide productive jobs and rising living standards, we get a phony recovery that produces neither.

Preserving a broken system merely to avoid the pain necessary to fix it only makes the situation worse.  Propping up sectors that should be contracting prevents resources from flowing to other sectors that should be expanding.  Keeping workers employed in nonproductive jobs prevents them from gaining productive employment elsewhere.  Encouraging activity or behavior the market would otherwise punish discourages alternatives that it would otherwise reward.

Unfortunately, leaders on both sides of the Atlantic put politics above economics, and economists like Mark Zandi provide the cover they need to get away with it.