Financial Commentary | Alan's Finance Blog

Gift Wrapped Liquidity

December 2nd, 2011 No Comments Posted in Finance, Financial Commentary

Is the ECB about to give Europe’s governments and banks the biggest Christmas present of their lives…?

WITH CHRISTMAS a little over three weeks away, the European Central Bank may be about to hand indebted European governments – not to mention its banking sector – the biggest gift they ever received: an unlimited credit backstop.

It is now being widely reported that there ‘only ten days left to save the Euro’. Even Metro – the free newspaper found discarded by commuters on British trains and buses each morning – made it their front page splash today.

The FT’s Wolfgang Munchau was pushing this meme earlier in the week – but it was European commissioner for economic and monetary affairs Olli Rehn that really got it going with these comments yesterday:

“We are now entering the critical period of ten days to complete and conclude the crisis response of the European Union…There is no one single silver bullet that will get us out of this crisis.”

The ten day dead deadline refers to the European leaders’ summit at the end of next week. Is such a deadline justifiable? Will the Eurozone begin to disintegrate if no convincing solution comes out of that summit?

Quite possibly. Predictions of Eurozone demise within the fortnight could turn out to be self-fulfilling. An ultimatum has been laid down – if politicians appear to have ignored it, it could be fatal for what little confidence investors have left in Europe.

All of which could go some way towards explaining yesterday’s coordinated central bank action. The headline move was the lowering by 50 basis points (half a percentage point) of the cost of borrowing US Dollars. This makes sense given the speed at which international capital is fleeing Europe, as investors head for the perceived safety of the world’s sole reserve currency.

The coordinated central bank statements, though, seem to be preparing the ground for something else too. The following paragraph was common to all six of the central banks involved in the action (The Federal Reserve, the ECB, the Bank of England, the Bank of Japan, the Bank of Canada and the Swiss National Bank):

‘As a contingency measure, these central banks have also agreed to establish temporary bilateral liquidity swap arrangements so that liquidity can be provided in each jurisdiction in any of their currencies should market conditions so warrant. At present, there is no need to offer liquidity in non-domestic currencies other than the US Dollar, but the central banks judge it prudent to make the necessary arrangements so that liquidity support operations could be put into place quickly should the need arise. The swap lines are available until 1 February 2013.’

In other words, central banks are preparing to step up their provision of currencies other than the Dollar. This could be a sign that the ECB is about to take a more active role in the Eurozone crisis.

Indeed, each central bank’s statement had a version of the following, taken from the ECB, dealing with its own particular currency:

‘The Governing Council of the European Central Bank (ECB) decided in co-operation with other central banks the establishment of a temporary network of reciprocal swap lines. This action will enable the Eurosystem to provide Euro to those central banks when required, as well as enabling the Eurosystem to provide liquidity operations, should they be needed, in Japanese Yen, Sterling, Swiss Francs and Canadian Dollars (in addition to the existing operations in US Dollars).’

Here’s a rough outline of where we stand in this crisis:

Investors are wary of Eurozone government bonds. This reluctance to lend to governments has pushed borrowing costs to unsustainable levels in Italy and Spain. France may be next.

It is hoped that the Eurozone’s rescue fund, the European Financial Stability Facility, will be able to solve this problem by ensuring there is sufficient demand at government bond auctions to bring yields back to sustainable levels – for example by offering partial guarantees on losses. However, the EFSF lacks the necessary funds to do this for larger countries, and is having trouble raising cash itself.

French finance minister Francois Baroin has called repeatedly for the EFSF to be given a banking license so it can borrow from the ECB (Germany is dead against this). And here’s what Bank of France governor and ECB Governing Council member Christian Noyer said yesterday: “In a period of intense market disruption, it is essential to ensure that the monetary policy transmission mechanism actually works. This may involve temporary and exceptional interventions on those market segments where dysfunctions are most apparent.”

European leaders now have a de facto ultimatum: sort this out by the end of next week, or else.

There is an ongoing push, led by Germany, for a ‘fiscal union’ – involving greater oversight of national budgets and the like. But fiscal integration is preventative measure – not a solution to a crisis that has already erupted.

Markets are looking for a solution this side of Christmas. The only agent in a position to act that quickly is the ECB.

ECB president Mario Draghi spoke to the European Parliament this morning. While he gave his support to what he called “a new fiscal compact”, he did make some comments that may hint at further ECB action over and above its ongoing bond purchase program (which clearly isn’t working, as Italian and Spanish bond yields attest).

“As you know, the ECB’s monetary policy is constantly guided by the goal of maintaining price stability in the Euro area over the medium term,” said Draghi.

“And when I say this, I mean price stability in either direction. This applies to both the setting of official interest rates and the implementation of non-standard measures.” (emphasis ours).

There was also this potential hint:

“I am confident the new surveillance framework will restore confidence over time. I am also quite sure that countries overall are on the right track. But a credible signal is needed to give ultimate assurance over the short term.” (emphasis again ours)

Might that “credible signal” be an offer to provide whatever liquidity is needed to assuage fears in key markets?

There are several mechanisms, for example, by which the ECB might seek to prop up government bond prices (and thus keep yields down). It could find a way, as touched on above, to get more Euros into the hands of the EFSF. It could buy the bonds directly at auction (unlikely, and currently forbidden by several European treaties, but at this stage of the crisis little can be ruled out…). Or perhaps some other method would be found.

The net aim is the same whatever the mechanism: to get Euros to governments who need to roll over their Euro-denominated debt. If there are insufficient investors willing to hand over their Euros, logic suggests that one solution is to turn to the ECB, from whence Euros originate. The ECB, after all, has access to an unlimited number of Euros.

There are also fears over the banking sector, which yesterday suffered a swathe of downgrades from Standard & Poor’s (which in turn may have precipitated the central banks’ announcement). Lower ratings could seriously impair some banks’ ability to borrow in the money markets – which is also a reason we see the world’s lenders of last resort priming their pumps.

In short, get ready for a world of uncapped credit availability, as the authorities step up their fight against deleveraging – like the cavalry in a Western, riding over the hill when all hope seems lost. Saddle up, Draghi!

Long term, a liquidity boost would tend towards a higher gold price, other things equal. However, there could be significant downside risk for gold, with or without a solution being announced at next week’s summit. If markets are unconvinced, we could see the sort of mass liquidation that has been common in recent weeks – and that has hit gold and silver along with stock markets.

If, on the other hand, the markets buy whatever the Euro leaders are cooking, then we could see some weakening of safe haven demand for gold, at least in the immediate term.

Either way, though, Europe will still be in a mess. Growth is sluggish (today’s Eurozone purchasing manager’s index shows a manufacturing sector shrinking at an accelerating rate).

Outstanding debts, therefore, will either be dealt with via default, or they will have their real value diminished – which means reducing the value of money itself. Default or devalue remain the watchwords for creditors.

So while the ECB may be convinced that it has ‘ten days to save the Euro’, if it ramps up its liquidity provision it could end up doing the exact opposite.

Ben Traynor

Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK’s longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

(c) BullionVault 2011

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.

Tags: Bullionvault, Finance, financial articles, Financial Commentary, Gold

Where Would We Be Without Rules?

December 2nd, 2011 No Comments Posted in Finance, Financial Commentary, Gold

“Where would be if we didn’t have rules?”

“FRANCE!”

“And where would we be if we had too many rules?”

“GERMANY!”

– UK comedian Al Murray, the (very British) Pub Landlord

“The GREAT DEPRESSION was caused by the Gold Standard,” reckons NYU professor and professional media star, Nouriel Roubini.

Like pretty much everyone else, Roubini thinks the Gold Standard’s tiresome rules brought about that cataclysm. Those manacles meant having to swap paper for bullion every time investors and savers got jumpy about the size of your deficit, your debt or your money-printing.

Really, what an idea! So 80 years later, the Gold Standard is deader than punk. Yet here we are in another depression again.

What’s caused this catastrophe if gold was to blame before?

“First, it is Europe itself that is in crisis. Not finance. Not the economy. Europe. Its culture. Its genius. Its unconscious conscience. Its immemorial and its memory. All that makes up its bases and its origins. Its heart, that beats more and more faintly. Its soul. Its common and hidden grammar. The distinction, that it invented, between law and right. Or between man and citizen. The articulation, that is its own, of multiple forms of the Multiple and of the unique name of the One…”

There’s more of this – much, much more – from French “superman and prophet” (© Vanity Fair) Bernard Henri Lévy. A “vain, pontificating dandy” according to the professional pie-thrower who’s been attacking Lévy’s enormous hair since the mid-80s, the nouveau philosophe “[has] no equivalent in the United States,” according to his biog’ on the Huffington Post. Which is lucky for the US. Because in France, Lévy “is accorded the kind of adulation that most countries reserve for their rock stars,” says the UK’s Guardian.

Scarier still, he’s best-friends-forever with French president Nicholas Sarkozy. Most scary of all, Lévy would in fact make a clear and sensible point, if only he swapped the word “Europe” for “money” above. Deflation is a “deterioration of the monetary standard” just as much as inflation, as sometime Reagan advisor and WSJ editor Jude Wanniski noted in 1982. No less disastrous for everything built on the grammar, culture and genius of money than its apparent opposite, deflation is “characterized by falling prices”. And as money rises in value, “it affects more and more debtors in global Dollar contracts” – the Dollar still being money today, and the only cash that counts in a panic.

Research shared with BullionVault today shows that, in 8 out of 10 of the best weeks for equities since 2007, the Dollar fell on the currency market. It rose in each of the worst 10 weeks for stocks. You might have noticed this mechanism gutting your portfolio again this month, as well. But what of the Dollar’s sometime challenger for reserve currency status?

“The Euro represents the mutual confidence at the heart of our community,” declared Wim Duisenberg, then-president of the European Central Bank, when accepting the Charlemagne Prize on behalf of, well, on behalf of the Euro currency itself, in 2002.

“It is the first currency that has not only severed its link to gold, but also its link to the nation-state. It is not backed by the durability of the metal or by the authority of the state.”

Lacking those two legal attributes – attributes held by pretty much all money ever until the mid-20th century – the Euro did have rules, however. “In order for [monetary union] to function smoothly,” as the European Council still says today (just above a warning that “this page is under revision”), “member states must avoid excessive budgetary deficits. Under the provisions of the Stability and Growth Pact, they agree to respect two criteria:

“A deficit-to-GDP ratio of 3% and a debt-to-GDP ratio of 60%.”

Now, if everyone had stuck to those rules, perhaps the Euro would have avoided this crisis. (Not adding the debt of your entire banking sector to the deficit, as Ireland did in 2008, would have helped too.) But nobody kept to 3-and-60, because those rules were just rules, and they were there to be broken.

“If a Member State exceeds the deficit ceiling, the excessive deficit procedure (EDP) is triggered at EU level. This entails several steps – including the possibility of sanctions – to encourage the Member State concerned to take measures to rectify the situation.”

Tough talk! The “possibility” of sanctions would “encourage” miscreants to “take measures”, or so the Growth & Stability Pact pretended. Yet as we wrote a year ago, nearly 12 months to the day, the “ghost of the Mark” (as Nobel-winning economist and ‘father of the Euro’ himself Robert Mundell called it) saw the Euro’s strict rules – learnt and applied during 50 years of Teutonic discipline – over-run at every turn.

The European Central Bank’s own target for money-supply growth first became merely a “reference value”, and then it was ignored outright. Set at 4.5% per year to start, it hit well over 12% at the height of the banking bubble in 2006-7;
Luxembourg aside, all member states have long since breached the Eurozone’s government deficit and debt ceilings – Germany included;
Barred by its founding treaty from financing government deficits directly, the ECB first bailed-out commercial banks by lending to them against government bonds put up as collateral, and then threw the whole thing over by agreeing to buy and hold government bonds outright – the weaker, the better, of course.

There has been resistance, of course. But it was awful late in coming. German ECB member Axel Weber stood down in February 2011, proclaiming discomfort at the majority of his central-bank colleagues voting to buy government bonds to shore up Athens, Dublin and Lisbon. Yet this was over nine months after the first Greek deficit crisis, and a mere eight years after Germany and France breached the 3-and-60 rules themselves. Where were his principles when breaking the rules didn’t matter?

Six months after Weber, the ECB’s chief economist Jürgen Stark also made a principled stand, announcing that he would leave his post, two years early, in December. Why? Because “If the central bank starts to finance governments, it decreases the incentive for governments to address the root causes of the crisis,” as Starck told an interviewer last week.

“It is not so much that bond purchases will lead to inflation at this particular moment. The ECB regularly draws down the liquidity again; it later soaks up the money spent. What is important and problematic is that the interest rate on government bonds is affected by the purchase of bonds and thus has a fiscal effect.”

Buying bonds, in short, means that the independent ECB policy wonks “influence the conditions under which governments can borrow,” says Stark. “This is absolutely not our job.” Given that everyone knows the rules are being broken, of course, “There is an open discussion about extending our mission,” says the ECB man. “This not only affects our independence, it threatens it.

“Principles apply…Rules are there to give direction, especially in times of crisis.”

How brave, insightful and utterly naïve! Tilting at windmills, Stark misses the one true lesson of the Great Depression’s Gold Standard just as badly as Nouriel Roubini does. Hasn’t anyone got a library card these days?

“The advantage of gold, in theory, is that it affords a safeguard against the dishonesty of Governments,” writes British philosopher Bertrand Russell in a dusty tome from 1935. “This would be all very well if there were any way of forcing Governments to adhere to gold in a crisis, but in fact they abandon gold whenever it suits them to do so.”

Replace the word “gold” with the words “Europe’s Growth & Stability Pact”, and you’d think it was the end of November 2011. And just like the Euro’s would-be saviors today – or at least, just like those world-improvers who don’t believe rules should get in the way – Russell thought the only solution to mankind’s economic problems was “an international Government”. That way, tiresome democracy would be made irrelevant as expert technicians did the best for all in all possible ways.

Now voters in Greece, Ireland, Portugal, Spain and most plainly Italy have shown they can’t handle democracy – not in a rules-based currency system. Time and again they have voted for people and policies which now make the rules aimed at defending the State’s independence impossible. Little wonder their sovereignty’s now vanishing, along with the rules.

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 head of research at BullionVault – winner of the Queen’s Award for Enterprise Innovation, 2009 and now backed by the World Gold Council market-development and research body – where you can buy gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2011

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.

Tags: Bullionvault, Finance, financial articles, Financial Commentary, Gold

Gold Jumps after Central Banks Launch “Prudent” Liquidity Measures, S&P Downgrades “Leave Banks Facing Short-term Funding Concerns”

December 1st, 2011 No Comments Posted in Gold

London Gold Market Report

U.S.DOLLAR gold bullion prices leapt 1.7% in 30 minutes Wednesday lunchtime in London – hitting $1744 an ounce – following an announcement of coordinated action from central banks worldwide aimed at increasing Dollar liquidity in the global financial system.

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank will all lower the price on existing Dollar liquidity swap arrangements by 50 basis points (0.5 percentage points), effective Monday.

As well as strengthening Dollar liquidity provision, the central banks “judge it prudent” to make arrangements to offer enhanced liquidity provision in other currencies ” so that liquidity support operations could be put into place quickly should the need arise”, a Bank of England statement said.

On the currency markets the Dollar fell sharply following the central banks’ announcement.

Despite its rally, the price of gold bullion this lunchtime remained only marginally above where it began the month.

Spot market silver bullion prices also surged – jumping 3.5% to $32.51 per ounce in the space of 36 minutes – while stocks and commodities also rallied.

By Wednesday lunchtime in London the FTSE was up over nearly 3% on the day – while Germany’s DAX was up more than 4%.

A few hours earlier, ratings agency Standard & Poor’s cut its ratings on 15 of the world’s largest banks late Tuesday – while at the same time raising its rating for two Chinese banks.

Bank of America, Barclays, Citigroup, Goldman Sachs, HSBC, JPMorgan Chase, Morgan Stanley, Royal Bank of Scotland and UBS all had their debt ratings cut by one notch each – reportedly as a result of changes in ratings methodology at S&P.

Despite this technical explanation, the downgrades “will likely raise concerns about their short term funding,” says Andrew Fraser, investment director at Standard Life Investments, speaking before the central banks’ announcement.

“They will be sidelined by money market funds who are the traditional buyers of that short-term paper.”

S&P could also change its outlook on France’s AAA rating from stable to negative “within a week, perhaps 10 days” reports French newspaper La Tribune, citing an anonymous diplomatic source.

European leaders meantime “are now entering the critical period of 10 days to complete and conclude the crisis response of the European Union,” European economic and monetary affairs commissioner Olli Rehn said Wednesday.

The next European leaders’ summit is due to take place on December 9.

Eurozone finance ministers meantime agreed Tuesday on measures aimed at boosting the Euro area’s rescue fund, the European Financial Stability Facility.

One mechanism will be a “partial protection certificate” for government bond investors, worth 20-30% of the initial amount invested. These certificates, will be detachable and separately tradable, according to an official EFSF statement.

The other measure agreed involves creating “one or more Co-Investment Funds”, to attract additional investment.

“Both options are designed to enlarge the capacity of the EFSF,” said Klaus Regling, the rescue fund’s chief executive.

“[However] it is really not possible to give one number for leveraging because it is a process…we will need money as we go along.”

The EFSF’s current effective lending capacity if €440 billion, backstopped by guarantees from Eurozone governments. Some of that €440 billion is already committed in loans, however, while the guarantees offered by countries like Italy and Spain have been compromised by those countries’ recent fiscal difficulties.

There are widespread concerns that the EFSF is not large enough to rescue either of those two nations should they require a bailout.

“We will have to look at the IMF,” Dutch finance minister Jan Kees de Jager told reporters after Tuesday’s meeting.

“We have talked about leverage though private money, but it would be two or two and a half times an increase so not sufficient… I think countries in Europe and outside of Europe should be prepared to give more money to the IMF.”

Tuesday’s meeting also brought an agreement to release €8 billion of bailout funding to Greece.

A poll of economists by newswire Reuters meantime shows a majority expects the ECB to cut interest rates when it meets next week.

Switzerland has become the number one destination for Italian exports – primarily owing to a large jump in gold bullion shipments, Italian business daily Il Sole 24 Ore reports.

In Vietnam meantime a number of gold bullion refiners are reported to have shut down their processing operations following a central bank draft decree that some fear will hand a monopoly to a single refiner, Saigon Jewelry Co.

The State Bank of Vietnam has previously allocated gold bullion import quotas to refiners, one trader in Ho Chi Minh City says.

“Over the last few months [though] only the Saigon Jewelry Co was allocated quotas.

SBV governor Nguyen Van Binh last week announced that the central bank has “administratively acquired” SJC – the latest in a series of moves aimed at regulating Vietnam’s gold market.

Ben Traynor

Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK’s longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

(c) BullionVault 2011

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.

Tags: Bullionvault, Financial Commentary, Gold, money crisis

The Money Crisis’ First Blush

November 24th, 2011 No Comments Posted in Financial Commentary

“I cannot think of anything which would more surely lead to a danger of all-round deflation than the collapse of international monetary confidence.”

- Roy Jenkins, then British chancellor, debate on the London Gold Pool, 18 March 1968

This SUMMER’S FIRST U.S. debt downgrade came after Washington failed to fix the debt ceiling one way or the other. Three months later, and Washington just failed again.

Yet that first downgrade also saw 10-year Treasury yields fall to 3.0% as US debt prices rose. And today, with a second downgrade nailed on, that yield is already down below 2.0%.

What gives? Why is the financial world piling into US debt – driving its price higher – even as the security of that very debt risks being de-rated further below the magic risk-free AAA mark?

“Most risk and return models in finance start off with an asset that is defined as risk free,” explains an NYU professor. “The expected returns on risky investments are then measured relative to the risk-free rate.” The loss of “risk free” as a concept thus plays hell with Wall Street’s investment confidence, let alone its models.

Pricing stock-market options using the Black Scholes equation, for instance, starts by assuming that “it is possible to borrow and lend cash at a known constant risk-free interest rate.” Remove the “risk free rate”, and things fall apart faster than Long Term Capital Management, the hedge fund built on Black-Scholes’ model, which collapsed when the world changed but the equation didn’t.

More urgently, messing with the concept of “risk free rate” also plays havoc with the insurance and banking businesses. “A reduction in the risk-free rate increases lending profitability by reducing funding costs and increasing the surplus the monopolistic bank extracts from borrowers,” the IMF explains. “Insurance contract cash flows…are discounted using a locked-in discount rate determined at inception date,” say consultants PwC, “[calculated as] the risk-free rate plus liquidity premium.”

So no risk-free rate, no baseline for banks or insurers, those multi-trillion-dollar industries pervading pretty much every deal, order and purchase you can think of today outside the black economy. But even cash-only gangsters aren’t free of the crisis hitting the financial world’s only other competitor for the role of “risk-free” reference point. Because in Eurozone bonds, the very denomination itself is now in question.

“Reintroducing the national currency would require essentially all contracts – including those governing wages, bank deposits, bonds, mortgages, taxes, and most everything else – to be redenominated in the domestic currency,” warned economics professor Barry Eichengreen of Eurozone break-up in 2010. The currency historian thought this hurdle was “insurmountable”; no member state would quit the Euro because the procedural obstacles were too great.

“Exit is effectively impossible.” But in reality? It will be a real mess – a big, ugly, deflationary mess in which lending collapses and trading grinds to a halt.

Irony guarantees that we get the word “crisis” from the Greek, of course, via the Romans. Transliterated with a “k”, it means “decision, judgement, event, issue, turning-point of a disease” according to the Shorter Oxford Dictionary – and that monetary madness which is the Euro has certainly reached one fork in the road or another.

The Esperanto Experiment clearly can’t go on, won’t go on, as it is. Whatever replaces or mutates it, one immediate horror is not knowing whose contracts with whom might be about to lose a surer foundation than the very ink in which they’re written. Not just inside the Eurozone; around one-third of UK banks’ lending is owed across the Channel. London-based asset managers are also “reducing their Eurozone exposures,” says eFinancialNews, “for fear of capital controls freezing Euros and other assets held” inside the fissuring union.

“When the wall is lifted, the Euros might be new Drachma or new Pesetas or new Lira – you don’t know what they’ll be,” the website quotes Alan Brown, chief investment officer at Schroders. But no matter the flood of non-Eurozone money getting (and staying) out of the Eurozone, there’s more money pouring in, as Eurozone institutions pull back their money from outside. Over the 12 months to September, says ECB data, net portfolio inflows to the 17 member states hit €335 billion – more than 10 times the volume over the previous year, and “all the more significant” says Reuters “[because of] ample evidence that overseas investors have been exiting Eurozone securities.”

“As Eurozone banks and other Eurozone entities lose access to funding markets abroad, they are forced, at least partly, to sell foreign assets,” the newswire quotes Morgan Stanley. “This creates the rather counterintuitive result that stress in funding markets abroad induce repatriation flows that support rather than hurt the Euro.”

Witness peripheral Europe outside the Eurozone, for example. What used to be called the “New EU” states risk being drained of capital as banks in core-member countries liquidate assets to hoard money closer to home or are told to stop new lending by their domestic regulators. That means the local currency falls (see the Polish Zloty for instance). Hence the crisis-defying strength of the Euro on the currency market. Less bothered by 2011′s money crisis than Lehman’s collapse in 2008 or the first Greek deficit crisis of early 2010, the Euro’s strength is no less bizarre than US Treasury debt rising in value as Washington’s credit rating is cut. But that’s deflation for you – a dash for cash that sells first, asks questions later, and holds currency…the very stuff called into crisis…above everything else.

Thus Roy Jenkins’ unwitting paradox of 43 years ago, quoted up top, still holds true. It is hard to imagine a more deflationary event than the collapse of confidence in the monetary system. “Feelings are reasons too,” as Glyn Davies wrote in his History of Money, and short term, currency and near-cash Treasury debt look the only refuge from the system beneath them. As the US and Eurozone crises roll on, however, crushing Dollar-dependent and Euro-denominated asset prices worldwide, it’s unsurprising to find demand to own physical gold and silver bullion surging worldwide, not least as the precious metals join the indiscriminate price fall.

Gold and silver’s zero-yield is plainly risk free. Their value isn’t denominated in any one currency or system. If this first blush of crisis turns red with anger, escaping all currency risk-free could become very much more popular still. Three-thousand years of monetary use will likely stand out as the 10-year Euro experiment and 40 years of Dollar dependency unwind together.

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 head of research at BullionVault – winner of the Queen’s Award for Enterprise Innovation, 2009 and now backed by the World Gold Council market-development and research body – where you can buy gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2011

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.

Tags: Bullionvault, Financial Commentary, Gold, money crisis

Italy: One Step Closer to the Endgame

November 5th, 2011 No Comments Posted in Financial Commentary

By: Ben Traynor, BullionVault

Is there an alternative to monetizing Italy’s debt…?

SO THE Italian government today asked the International Monetary Fund to monitor its reform program.

It may or may not be coincidence that the G20 summit, which ended today, saw discussion about boosting global liquidity by the use of Magic Money – otherwise known as the IMF’s Special Drawing Rights.

Italy needs a miracle. Its debt dynamics are truly horrible. Take a look, for example, at the recent spike in 12-Month Treasury Bill yields – which are now at pre-crisis levels (i.e. before central banks started putting unprecedented downwards pressure on interest rates):

Italian 12-Month Treasury Bill Yields

Source: Bloomberg

There are rumors that the spike in T-Bill yields last week was a result of a large MF Global position being unwound as the brokerage went bust. That may go some way toward explaining the timing of the spike, but there are good reasons for investors to shy away from short-term Italian debt – and they go beyond the scary headlines we’re seeing every day.

Back in July, Italy’s Ministry of Economy and Finance made an intriguing move. It cancelled an auction of medium- and longer-dated bonds scheduled for the following month. From now on, it said it would regularly offer 12-month Treasury Bills instead.

According to its Treasury Department, Italy has over €280 billion of debt redemptions coming due over the next 12 months (including this month’s debt). That’s almost two-thirds of an (unleveraged) EFSF. More than half of this debt is due by the end of March next year.

The average maturity on Italian sovereign debt is around seven years – not too but, but not too great either. Furthermore, as we’ve seen, Italy plans to issue a lot of new short-term debt – at a time when yields on newly-auctioned debt are hitting Euro-era highs. It won’t be long before higher borrowing costs make it impossible for Italy to service its debt.

Small wonder then that the debt markets are taking a long hard look at Italy’s debt dynamics. There seems little prospect – short of intervention – that borrowing costs on new Italian debt will fall significantly any time soon.

The European Central Bank is already buying Italian debt on the open market. Will it go that step further and buy it at source – in effect printing money to cover Italy’s borrowings and running costs?

Without wishing to put too much emphasis on nationality, it may prove significant that an Italian is now president of the ECB. Mario Draghi has been director general of Italy’s Treasury and governor of its central bank.

Weighed against that is that government debt monetization is anathema to the ECB – and what’s more, it’s prohibited from doing it.

Article 104 of the Treaty on European Union, for example, says this:

‘Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (hereinafter referred to as “national central banks”) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments’

Where there’s a European will, though, there’s usually a way. Some sort of convoluted arrangement involving the EFSF (or its planned successor, the ESM) perhaps.

An ECB-fuelled solution has seemed a likely endgame for a while now (though there is now the tantalizing prospect of SDRs too). Italy’s dire debt problems suggest it may be closer than some people realize.

Ben Traynor

Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK’s longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

(c) BullionVault 2011

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.

Tags: Finance, Financial Commentary, Gold, italy

It Ain’t Money If I Can’t Print It!

October 11th, 2011 No Comments Posted in Finance, Financial Commentary

Peter Schiff

By: Peter Schiff, CEO of Euro Pacific Capital

I have been forecasting with near certainty that QE2 would not be the end of the Fed’s money-printing program. My suspicions were confirmed in both the Fed minutes on Tuesday and Fed Chairman Ben Bernanke’s semi-annual testimony to Congress yesterday. The former laid out the conditions upon which a new round of inflation would be launched, and the latter re-emphasized – in case anyone still doubted – that Mr. Bernanke has no regard for the principles of a sound currency.

Tuesday’s release of the Fed minutes contained the first indication that a third round of quantitative easing (QE3) is being considered. The notes described unanimous agreement that QE2 should be completed, along with the following comment: “depending on how economic conditions evolve, the Committee might have to consider providing additional monetary policy stimulus, especially if economic growth remained too slow to meaningfully reduce the unemployment rate in the medium run.” Since the unemployment situation is deteriorating, and by all accounts will continue to do so, the Fed is essentially pledging to keep the spigot turned on. The committee also decided to look only at current “overall inflation” in making their judgments, as opposed to “inflation trends.” Since new dollars take awhile to circulate around the economy and raise prices, this means the Fed is sure to be too late in tightening once inflation starts to run away, causing more dislocations in the American economy.

If anyone had lingering faith that Mr. Bernanke actually has a plan to end the US government’s addiction to cheap money, the Chairman’s semi-annual testimony to Congress should have washed it away. In addition to claiming that his money-printing has helped the US economy, Bernanke told Congress that gold is not money, people buying gold are not concerned about inflation, and the external value of the dollar has no influence on its domestic purchasing power. He even took a moment to stump for President Obama’s plan to raise the debt ceiling.

By claiming that gold is not money, the Chairman demonstrates his ignorance of much of monetary history. He told Congressman Ron Paul that he had no idea why central banks hold gold, before speculating that it might have something to do with tradition. Yes, traditionally gold is money, which is precisely why central banks hold it. And gold is money because central bankers like Mr. Bernanke cannot be trusted with a paper substitute.

Bernanke further disputes the facts by claiming that the only reason people are buying gold is to hedge against uncertainty, or “tail risks” as he calls them. My advice to the Chairman is to ask the people who are actually buying it. As someone who has been buying gold myself for a decade, I can assure him that my gold buying has nothing to do with “uncertainty.” In fact, it’s just the opposite. I am buying gold because of what is certain, not what is uncertain. I am certain that Mr. Bernanke’s incompetence will destroy the value of the dollar and unleash runaway inflation.

If it were true that people bought gold to protect themselves from market uncertainty, as the Chairman claims, then the metal should have spiked in the midst of the ’08 credit crunch. Instead, it fell along with most other assets. People instinctively fled into US dollars and Treasuries because of their long record of stability. What Bernanke doesn’t understand is that his irresponsible monetary policy is undermining that faith in US assets, built up over generations. That is what’s driving gold: easy money, negative interest rates, and quantitative easing.

Finally, by claiming that the dollar’s exchange rate has no effect on domestic prices, Mr. Bernanke demonstrates that he probably lacks the competence to be a bank teller, let alone Chairman of the Federal Reserve. A weaker dollar means Americans have to pay more for imported goods. But it also means domestic producers have to pay more for raw materials and imported components, which raises domestic production costs as well. It also means that more domestically produced goods are exported, reducing the supply and raising the price of what is left for Americans to consume. This is Econ 101.

Given the Chairman’s confusion on the basics of economics, perhaps it’s no surprise that he’s put quantitative easing right back on the table, where, despite prior rhetoric, it has been all along. The Fed has always known that QE3 is coming; it’s just looking for an excuse to launch it.

The problem is that fighting a recession with QE is like fighting a fire with gasoline. As the flames of recession reignite, more QE, while dousing it momentarily, will only produce an even larger economic inferno.

At one point, Bernanke said, “The right analogy for not raising the debt ceiling is going out and having a spending spree on your credit card and then refusing to pay the bill.” He’s got the analogy right, but his conclusions are completely wrong. Yes, Congress has gone on a spending spree and it’s time to pay up. But raising the debt ceiling is like taking out a Mastercard to pay the Visa… it just makes the problem worse. If you or I go out one night, get drunk, and run up a huge credit card bill, we know that the way to fix it is to buckle down and pay it back. We might postpone vacation plans or put off buying a new car, we might cancel our cable TV subscription or gym membership. The point is that we would have to reduce current consumption to make up for the overspending in the past.

Obama claims that raising the debt ceiling is about getting a hold of the federal debt. Have you ever heard of anyone getting out of debt by taking on more debt? Has anyone ever reduced their debt without reducing current consumption? How can the Fed Chairman endorse such a preposterous idea?

Bernanke actually went a step further and warned against reducing current federal spending too sharply, claiming that such a move might impede the “recovery.” He apparently believes that it is the role of the Congress to go on spending sprees, and his role to pay the mounting bills with freshly printed dollars. The fact that this formula has produced larger and larger economic crises does not seem to bother him. I guess ignorance is bliss.

Tags: Euro Pacific Capital, Finance, Financial Commentary, Gold, Peter Schiff

Debt Deal is a Blank Check

August 2nd, 2011 No Comments Posted in Finance, Financial Commentary

Peter Schiff

By supposedly compromising to raise the debt ceiling, Congress and the President have now paved the way for ever higher levels of federal spending. Although, the nation was spared the trauma of borrowing restrictions, the actual risk of default existed solely in the minds of Washington politicians. But the real crisis is not, nor has it ever been, the debt ceiling. The crisis is the debt itself. Economic Armageddon would not have resulted from failure to raise the ceiling, but it will come because we succeeded in raising it. This outcome falls along the lines that I had forecast.

Both parties are now pretending that the promised cuts in spending outweigh the increase in the debt limit. But the $900 billion in identified cuts are spread over a decade and are skewed toward the end of that period. There are an additional $1.4 trillion in cuts that the plan assumes will be identified by a bi-partisan budget committee. But similarly empowered panels in the past have almost never delivered on their mandates.

More importantly, none of these “cuts” are actually binding. There is plenty of time for future Congresses to reverse what was so laboriously agreed to over the past few weeks. My guess is renewed economic weakness will be used to justify ultimate suspension of the cuts. In addition, most of the spending reductions were already scheduled to take effect before this agreement. So what did we really get?

The Congressional Budget Office currently projects that $9.5 trillion in new debt will have to be issued over the next 10 years. Even if all of the reductions proposed in the deal were to come to pass, which is highly unlikely, that would still leave $7.1 trillion in new debt accumulation by 2021. Our problems have not been solved by a long shot.

Essentially, the structure announced today allows both political parties to talk about reform without actually changing anything. To underscore that point, the deal involves less than $25 billion in immediate cuts! This is less than a rounding error in a $3.8 trillion dollar budget. This is politics as usual.

Even these estimates are based on rosy economic assumptions that have no chance coming to fruition. For example, for the current fiscal year, Washington estimates GDP growth at 4%. But actual growth for the first half of 2011 is below 1%! If our government is over-estimating our current year’s growth by a factor of 4, how accurate could their forecasts be ten years into the future? A more honest assessment of likely economic performance would reveal future budget deficits spiraling out of control.

Some might say that the primary goal of this deal was to avoid the dreaded credit rating downgrade. Unfortunately, the deal addresses none of the ratings agencies’ stated grievances. If they fail to follow through on their downgrade warnings, the rating agencies will lose whatever credibility they have left. For political reasons, the downgrades may not come right away, but they are inevitable. But as has happened so often in the past, by the time the tardy downgrades arrive, the market will have likely already rendered its verdict.

The debt ceiling itself merely represents a self-imposed limit on US borrowing. Since Congress can vote to raise the limit, its existence has been more of a political nuisance than an actual barrier. The operative factor is not how much we allow ourselves to borrow, but how much our creditors are willing to lend. That type of ceiling can’t be raised by an Act of Congress. Once our creditors come to the conclusion that they have lent beyond our capacity to repay, they will be very reluctant to lend more. As trillions in short-term Treasuries mature, the dwindling pool of buyers will demand higher rates of return to compensate them for the risk. But our government is in no condition to afford those higher rates without gutting the rest of the budget.

Last week, it was revealed that despite Obama’s warnings that a default would immediately occur if the debt ceiling were not raised, the administration had already agreed to prioritize interest payments to avoid default. Such preferential treatment is only possible because current interest rates are so low and debt service represents only about 10% of total revenue. When the pool of willing lenders evaporates, net interest payments could quickly consume more than 50% of federal revenue. This is particularly true since rising rates will also plunge the economy into a recession that will substantially reduce revenues – even as debt payments surge.

At that point, prioritizing interest payments would mean deep sacrifices in the rest of the federal budget – including Social Security, Medicare, and the Armed Forces. The question then becomes: will US politicians really be willing to take the political heat that would emerge from prioritizing interest payments to foreign creditors over payments to American voters?

I expect that as soon as our creditors decide that they are no longer willing to lend to us at ultra-low rates of interest, we will refuse to repay what they have already lent.

Besides default or major cuts to domestic spending, inflation provides the only other means for the government to deal with this intractable crisis. Because of its political palatability, inflation is, in fact, the most likely outcome. Once we go down that path, we risk high inflation turning into hyperinflation, which would decimate the remainder of our economy. So, as our leaders congratulate themselves for saving the nation, the reality is that they may have just sold it down the river.

Euro Pacific Capital, Inc.
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Tags: debt deal, Euro Pacific Capital, Finance, Financial Commentary, Peter Schiff

It Ain’t Money If I Can’t Print It!

August 2nd, 2011 No Comments Posted in Finance, Financial Commentary

Peter Schiff

By: Peter Schiff, CEO of Euro Pacific Capital