Stocks and Precious Metals Charts - Slip Sliding Away Into MMT - Non-Farm Payrolls on Friday

"We are warned against sharing in her sins and in her punishment;—against being found, when the end comes, mere children of this world and of its great cities; with tastes, opinions, habits, such as are found in its cities; with a heart dependent on human society, and a reason moulded by it;—against finding ourselves at the last day, before our Judge, with all the low feelings, principles, and aims which the world encourages; with our thoughts wandering, wandering after vanities; with thoughts which rise no higher than the consideration of our own comforts, or our gains; an admiration of the splendour and the fashions of the world, an affectation of refinement, an habitual self-esteem, and an utter ignorance of the number and the heinousness of the sins which lie against us."

John Henry Newman, The City of Antichrist


"It would be no sin if statesmen learned enough of history to realize that no system which implies control of society by privilege seekers has ever ended in any other way than collapse."

William Dodd, US Ambassador to Germany, 1933


"I was in Moscow doing business when the rouble was dying after the collapse of the Soviet Empire [and with the collapse of that political force, the failure of the state dictated exchange rates for their currency].  It made a lasting impression."

Jesse 2010

A value-dictated, purely fiat, currency exists through force and fraud. As the fraud grows thin and obvious, the greater and more pervasive the force must become. If imports are needed, wars of aggression will follow to extend and maintain the 'sphere of influence', a euphemism for control. When force finally falters, the currency collapses. A value-dictated, purely fiat currency is not an innovation— it is among the oldest forms of tyranny.

MMT is the Scientology of economics.

Stocks failed in their rally attempt.  Tomorrow is another day.

Gold and silver managed to find their footing.  They'll need to hang in there.

Non-Farm Payrolls on Friday.

Have a pleasant evening.

SP 500 and NDX Futures Daily Charts - Let It Be Written, and Let It Be So

"A society becomes totalitarian when its structure becomes flagrantly artificial: that is, when its ruling class has lost its function but succeeds in clinging to power by force or fraud. Such a society, no matter how long it persists, can never afford to become either tolerant or intellectually stable..."

George Orwell

This is the underlying message in the  young adult three book series The Hunger Games.

Stocks were able to rally higher today, back almost to levels of a few weeks ago,  on the better than expected estimate of GDP for the 3Q.     That GDP number was dependent on a few one offs like government spending, largely of the military kind, and on a more favorable trade balance.

Excelsior.

The exercise today was very much about proving that the Fed did the right thing in ending QE III, and that there need be no large decline in equities.  There is no coincidence in any of this.

There is a natural tendency to be optimistic and to wish for good things to happen.  The difficulty is when those steering the ship keep making poor decisions and following policies that are not productive.  And this unfortunately is the case today.

What will it take to change my mind?  A real media wage that is growing commensurate with GDP, so that domestic consumption can also grow and fuel the real economy without artificial stimulant and welfare spending on corporations and the military-industrial complex.

Fair enough?  Until then in my personal judgement the economy is neither self-sustaining nor stable. Yes I understand about lags.  And six years is one hell of a lag for those not receiving the beneficence of a trickle down corporatist welfare state.

Have a pleasant evening.

John Law and the Mississippi Bubble

John Law and the Mississippi Bubble by Richard Condie, National Film Board of Canada

Gold Premiums in Vietnam Hit $217 Over Spot In Heavy Demand

I think you have had to experience a collapsing currency first hand in order to truly appreciate the fundamentals of monetary value, and how these things can take on what seems like a force of nature.

I was doing business in Moscow during the 1990's, and saw the slow motion collapse of the rouble. Or at least it seemed like a slow motion collapse at first, until it gained quite a bit of momentum despite the measures the State took to maintain their 'official rates.'

Russia had a sovereign currency, right?  And so does Vietnam, and many of the other countries that experienced extraordinary currency depreciation, otherwise known as monetary inflation, since WW II.  Perhaps they just needed some better monetary theorists, or official enforcers with hairier knuckles. Their financial elite seems to have had plenty of false bravado.

But then again, they were not us. We are different. We are unique. We are the masters of all that we survey and purvey, the beauty of the world, the paragon of animals.  London and New York are where the elite meet to eat.

Here is what is happening with gold prices in southeast Asia now.  Ding dong.

This from Goldcore:

The Vietnamese Central Bank sold another 25,700 taels (1 tael = 37.5 grams or 1.2 troy ounces) at a gold bar auction on Friday in order to try and satiate the massive public demand for gold in Vietnam.

The Central Bank hopes that the sale of gold into the market will reduce the very high premiums paid by gold buyers in Vietnam, the largest buyer of gold in Southeast Asia after Thailand and one of the largest physical buyers of gold per capita in the world.

Vietnamese people hold gold as a store of wealth for protection against war, inflation and currency depreciation. In recent months, the bursting of bubbles in the stock market (see chart) and property market and the continuing devaluation of the dong has led to record demand in Vietnam and a surging premium over the spot price of gold.

Today, the premium was close to 5.5 million dong which is the equivalent of a very high premium of $217 per ounce over spot.

Greenspan: Role Of Central Bankers Is to Try to Replicate the Stability of the Gold Standard

Greenspan said on any number of occasions that his model was that a 'fiat currency' works when it emulates the rigor of the gold standard.

I am using this post as a placemarker to gather a few citations along these lines. Sometimes people doubt these things, and it is not always easy to go back and find the actual idea in print.

I will place other example here as I find them but it is not a high priority because Alan Greenspan has never deviated from this point of view. One of the most poignant examples I have was when Ron Paul asked him if he still believed in what he wrote in his famous essay on Gold and Economic Freedom.

And Greenspan answered that he would not change a word.

I think the squaring up of what Greenspan believed, and what he did as Fed Chairman, is one of the more interesting conundrums that I hope that time will explicate. 

The other of course is why the flaming liberal and 'socialist' Obama is really closer to Richard Nixon in his performance and outlook than most would care to admit, on either the right or the left. 

This is from a 2007 Interview by National Public Radio with Alan Greenspan on Turbulence and Exuberance

Greenspan: Well actually, we were not fundamentally regulators [at the Fed]. The vast portion of our efforts were not involved in bank regulation.

NPR: No, but you were regulating interest rates, which have a profound effect on world economies.

Greenspan: You're raising really a very interesting question. I have always argued that the gold standard of the 19th century was a very effective stabilizer. It kept inflation essentially at zero, and I felt it was critical for the tremendous growth that occurred for the American economy in the latter part of the 19th century. When we went off the gold standard essentially in 1933, we then had to have what we call "fiat money" which is essentially money that is - it's printed paper money. Which unless we restrict the volume of, can be highly inflationary.

The type of interest rate regulation that I and indeed most central banks in the last 20 years have been involved in...has been to try to replicate the laws and rules that were governing the gold standard.

And so it is an odd situation where all the central bankers -- while none of them are advocating a return to the gold standard -- nonetheless try to replicate the various types of interest rate policies that the gold standard would have created. And it is an interesting question whether you call that regulation, or basically functioning of a central bank in stabilizing the economy."

I remember all such statements of Greenspan's vividly because they were one of the few times in which I felt that he was telling the truth, at least as he sees it.

I think that a fiat currency can 'work' if it emulates the rigor of an external standard. And exceptions that can be made to this rigor during times of exogenous shocks could be a quite useful tool for monetary policy.

The problem is that it NEVER seems to work out that way in the real world. It does not take long for financiers and politicians to discover the heady power and easy money to be had in manipulating the markets and the fiat currencies to their own advantage, the public and the real economy be damned. And then a pigfest ensues, and a nation's savings and civic virtue are consumed.

"And, indeed, since the late '70s, central bankers generally have behaved as though we were on the gold standard. And, indeed, the extent of liquidity contraction that has occurred as a consequence of the various different efforts on the part of monetary authorities is a clear indication that we recognize that excessive creation of liquidity creates inflation, which, in turn, undermines economic growth.

So that the question is: Would there be any advantage, at this particular stage, in going back to the gold standard? And the answer is: I don't think so, because we're acting as though we were there. So I think central banking, I believe, has learned the dangers of fiat money, and I think, as a consequence of that, we've behaved as though there are, indeed, real reserves underneath the system."

Greenspan, A., Hearing on Monetary Policy Report, US House Committee on Financial Services, 20 July 2005, Washington D.C.

From: Jude Wanniski < jwanniski@polyconomics.com
To: Ben.S.Bernanke@ * * * * *.GOV
Subject: Fwd: Re: Savings glut
5:44 pm, 7/21/2005

I thought you should see this. Greenspan was plain awful in his testimony this week. But members of Congress don't know any better, so they slobber all over him. He again said we don't need a gold standard, because he has demonstrated since he came to the Fed in 1987 that the central bank could "replicate" the gold standard.

Take a look at the dollar/gold price from 1987 until today and you will see how terrific he has been in replicating the gold standard. I can't wait for him to leave, Ben, because he now has so much invested in his Fed legacy as a Maestro that he could never admit he screwed up almost all along the way.

Famous 2005 Exchange Between Ron Paul and Alan Greenspan about the Gold Standard


Related: Why There Is Fear and Resentment of Gold's Ability to Reveal the True Value of Financial Assets

Gold Daily and Silver Weekly Charts - Currency Wars

I have concluded that it is almost impossible to understand what is happening in the precious metal markets without understanding that the world is in a currency war,  And this includes how the currency war is being conducted, and why.

The US dollar reserve currency arrangement to support world trade was created in the waning days of World War II, with the demise of the gold standard and the ascendancy of the Pax Americana.  It is called the Bretton Woods System.  It evolved quite a bit since then, especially when Nixon closed the gold window in 1971 and declared the US dollar a purely fiat currency.  Since then the world has gotten by on what some have called Bretton Woods II.

After sixty years, it is fairly clear that the dollar trading regime has had a good run, but has now outlasted its effective life span. The nail in the coffin is the economic instability in the US, and the need for the Federal Reserve to go to ZIRP and print buckets of money to support their domestic policy needs.

While this makes sense for the US, it does not make sense for the rest of the world. This is similar to the reason why the Eurozone is failing. The ECB conducts monetary policy to suit the needs of a few core countries, and the periphery suffers. And that monetary policy is covering up the rot at the core I might add.

The situation is similar with the dollar and world trade. The Anglo-American Banking cartel grew up around the US dollar reign, and is still very powerful, being supported by most of the systemically important international banks.

But all things come to an end, and the world is looking for a better solution to the world as it is now, not how it was sixty years ago. But change comes slowly and with difficulty.

I will be very surprised if gold and silver do not play a role in what is to come.

I did remark on this and also on bitcoin intraday. You can read it here.

Great changes are occurring, that cut across political and economic lines.  And these are manifesting as a 'currency war' that is much broader than a mere race to devalue and manipulate national currencies to support industrial trade policies.  Always keep that in mind.

Have a pleasant evening.

A Message From the Banking and Brokerage System

"At this late stage in the history of American capitalism I'm not sure I know how much testimony still needs to be presented to establish the relation between profit and theft."

Lewis H. Lapham


"In an oligarchy, private ownership is merely a concept, subject to interpretation and confiscation."

Jesse, Trustee to Seize and Liquidate Even the 'Stored' Customer Gold and Silver Bullion From MF Global

No comment about the bank notice below is necessary for those who understand what this means. And if one does not understand it at this point, no comment is sufficient.

Paper currency held in a bank is not a 'risk free' asset. To the contrary, it is like walking around with a very large and willfully powerful counterparty that has one hand in your pocket.  And in troubled times, a 'warehouse receipt' or a line item on a bank account statement held in another country is little more than another piece of paper.

And in the case of 'digital money' they do not even have to have a hand in your pocket.  They hold everything, all your savings, up front, and you have to apply for your money at a window, where they determine how much you may have.  And that window can be closed anytime at will.

They take your wealth, pay you almost nothing for it, and then offer you protection, with limits, from themselves.

The deregulation of banks and the overturn of Glass-Steagall was intended to create a license to steal, by design.  Hundreds of millions were spent in a decade long effort lobbying for it. These were the protections that were given to us, and fought for by our fathers and grandfathers.  And we squandered away that wisdom, having unlearned the lessons of the past.

This is predatory financial capitalism and modern monetary theory unrestrained by the rule of law and transparency.  This is the lesson from Cyprus, and of MF Global.  And it is no different in the US or UK, except in the matter of time and degree.    None are safe where there is no justice for all.

And the financial sociopaths and their enablers have no limit to their greed,  no sense of boundaries, and certainly no shame.  

The Banks must be restrained, and the financial system reformed, with balance restored to the economy, before there can be any sustainable recovery.

Fiat Monetary Theory: The Gamblers

'The Gamblers'

"The historical behavior of interest rates and growth rates in U.S. data suggests that the government can, with a high probability, run temporary budget deficits and then roll over the resulting government debt forever.

The purpose of this paper is to document this finding and to examine its implications. Using a standard overlapping-generations model of capital accumulation, we show that whenever a perpetual rollover of debt succeeds, policy can make every generation better off.

This conclusion does not imply that deficits are good policy, for an attempt to roll over debt forever might fail. But the adverse effects of deficits, rather than being inevitable, occur with only a small probability."

Ball, Elmendorf, Mankiw, The Deficit Gamble

As with most Ponzi schemes, modern fiat currencies are a matter of degree, belief, and tipping points.

There are always limitations in any system, and in paper money systems the debt must be balanced by real growth and investment, an organic growth that makes the rolling debt burden, which is really the basis of the money itself, sustainable and productive.    That growth must be broadly based in order to support consumption from within the system itself, and this implies income commensurate with increasing productivity.

The failure of every fiat currency has been tied to the abuse of power, in the non-organic use of created money not to increase the productive growth of the economy, but to establish monopolies, cartels, speculation, and of course, aggressive war, all in pursuit of the outsized enrichment of a relative few who define themselves as an elite.

And human nature being what it is, all paper money systems have failed within a few hundred years.

There is a variation of  Fiat Monetary Theory, also known as fiat money, which seeks to distinguish itself by its name in addition to its penchant for sophistry, called Modern Monetary Theory.

This variant eliminates the debt problem by switching from a debt based currency to a pure fiat currency issued directly by the government. The longer term problem of currency revulsion, or the rejection by the people of the stated value of the currency, is resolved by greater use of government force.

The resort to force is a tell tale marker of all ideological cults which are unable to achieve a natural stability and an informed, willing acceptance.  That force may include psychological persuasion including propaganda and ridicule.

We are seeing something like this today in Europe, with the compulsion to enforce austerity as the technocrats and careerists refuse to admit that, that by its very design, the Eurozone is inherently unstable. 

And the reforms required to avert disaster are unthinkable, because they will diminish their wealth and power.   And so they become increasingly desperate and self-destructive.

Since the leaders are naturally superior, it is the people that have failed them, because they did not believe enough, work hard enough, sacrifice enough. And so they must be punished.

Here Is Something To Think About With Regard to Money

Here is something to think about as the Fed continues to expand its Balance Sheet by buying Treasury (and mortgage debt), with an emphasis on systemic limitations that become a little more apparent at the ZIRP boundary where organic money growth is stultified.

As you may recall, the Fed refunds all profit it makes, that is revenue in excess of expenses, back to the US Treasury. And that includes all the interest collected on the bonds its holds.

So as the Fed buys Treasury debt, and holds it to expiration, it refunds all of the interest payments back to the Treasury, less their expenses.

As long as there is at least one Primary Dealer available to make a market in Treasury debt, the Fed, which is technically prohibited from buying the bonds directly from the Treasury, there is a fairly strong measure of control over both the interest paid and the amount of debt which can be issued.

As a thought experiment, what would it be like if the Fed expressed a willingness to buy ALL outstanding Treasury debt at a set schedule of prices?  What are the limiting factors?  What happens to the debt payments of the Treasury?

Now what would happen if the Bank of England or the European Central Bank stated the same policy for all the relevant sovereign debt?  Would it be the same?  Or why would it be different? 

At the end of the day, the value of a fiat currency is intimately involved in confidence in the mature judgement and trustworthiness of the parties involved in its issuance. 

This is why, although it was superficially 'clever,'  the platinum coin was such a dodgy idea to resolve what was essentially a financing disagreement.

As I have said, at the end of the day, the only limiting factor on the Fed and the Treasury is the value at market of the currency, especially with regard to international transactions.

Isn't fiat currency grand?

Here are two very simple models of currency supply 'management.' The 'considerations' could be thought of as degrees of freedom.

I could have added a significant amount of detail to both pictures, but I wanted to capture the 'essence' of the system in each.  

In the Tripartite Market System the level of debt issuance and its price takes the agreement of at least three parties:  the Treasury, the Fed, and the Debt Market as represented by the Primary Dealer.  In this system it is the level of debt issuance that is managed, and the prices paid for it.

In the Unilateral System the Treasury determines the level of dollar issuance according to its needs.

I *think* one can contrive a non-debt based system that involves more than one party, and does not necessarily require a non-governmental party to be directly involved.

Technically the existing arrangement between the Congress and the President is a two party system.  The Congress authorizes expenditures and the President ratifies, enacts, and adminsters them. 

The 'debt ceiling' arrangement in which Congress refuses to 'pay' by deferring to finance its own previously authorized expenditures is a bit of an anomaly and a symptom of dysfunction.

The Legacy of the Fed and the US Experiment with Fiat Currency In One Chart

Please notice that the CPI really 'gets some legs' when Nixon closed the gold window and released the modern monetary theory from its next to last restraint, the bond vigilantes being the last thin blue line.

And below that a quote on the modern monetary system, in which I detect the root of Paul Krugman's confusion about money.

To his credit, Krugman does recognize the liquidity trap, which sets him head and shoulders apart from the Austerians. He just does not understand the markets and how they work in practice rather than theory, and the absolutely compelling need for reform. But that puts him in with most regulators, central bankers, and the herd of academic economists.

Shifting Mandates: The Federal Reserve’s First Centennial
Carmen M. Reinhart and Kenneth S. Rogoff

For presentation at the American Economic Association Meetings, San Diego,
January 5, 2013

Session: Reflections on the 100th Anniversary of the Federal Reserve

Read the entire paper in PDF form here.


h/t Bill P and Business Insider

"The current world monetary system assigns no special role to gold; indeed, the Federal Reserve is not obliged to tie the dollar to anything. It can print as much or as little money as it deems appropriate [History suggests that while they technically can print as much as they wish, there is an effective upper bound along with a law of diminishing returns in there somewhere. Weimar and John Law, amongst others, tended to show that. - Jesse]

There are powerful advantages to such an unconstrained system. Above all, the Fed is free to respond to actual or threatened recessions by pumping in money. To take only one example, that flexibility is the reason the stock market crash of 1987—which started out every bit as frightening as that of 1929—did not cause a slump in the real economy.

While a freely floating national money has advantages, however, it also has risks. For one thing, it can create uncertainties for international traders and investors. Over the past five years, the dollar has been worth as much as 120 yen and as little as 80.

The costs of this volatility are hard to measure (partly because sophisticated financial markets allow businesses to hedge much of that risk) [O brave New World, that has such derivative sophisticates in it. - Jesse] but they must be significant. Furthermore, a system that leaves monetary managers free to do good also leaves them free to be irresponsible—and, in some countries, they have been quick to take the opportunity." [Yes, THOSE countries may experience a financial collapse because of a monetary credit bubble, no doubt because of a lack of economic sophisticates. - Jesse]

Paul Krugman, The Goldbug Variations, 22 November 1996

Synchronized Easy Money: Central Banks Cutting Key Rates - Denmark Goes Negative

"Decency, security and liberty alike demand that government officials shall be subjected to the same rules of conduct that are commands to the citizen. In a government of laws, existence of the government will be imperiled if it fails to observe the law scrupulously. Our Government is the potent, the omnipresent teacher. For good or for ill, it teaches the whole people by its example.

Crime is contagious. If the Government becomes a lawbreaker, it breeds contempt for law; it invites every man to become a law unto himself; it invites anarchy."

Louis D. Brandeis, US Supreme Court Justice, Olmstead v. United States, 1928

Gentleman, start your presses, and rig the markets to both enhance the effect in some and to hide it in others.  And this produces a mindset towards manipulation in all the key market participants.

Bob Diamond is a sociopathic child of a monied culture of privilege and deceit, a collegiality of crime.

They may try to bury the stench of corruption in the banking system by further diluting the value of money, but this will not restore vitality to the real economy.  It will only continue the malicious trends and increase the misery of the people.  And this energizes the feedback loop of repression.

Eventually the monied interests must accept reform, but because of the credibility trap this will be something that is more likely forced upon them when they go too far.

US Non-Farm Payrolls Report for June on Friday. It may appear a little better than expected, or it may not.

The monthly figures, as are several key market indicators and prices, all a part of the show, masking the real trends at times like these. This was shown clearly in the manipulation of LIBOR by the Bank of England, in addition to the extracurricular privateering of the banks for their own accounts.

USAToday
Central banks worldwide cut key interest rates
By David McHugh, Associated Press
5 July 2012

FRANKFURT, Germany – The European Central Bank has cut its key interest rate by a quarter percentage point to a record low of 0.75% to boost a eurozone economy weighed down by the continent's crisis over too much government debt.

The move followed a rate cut by China's central bank and new stimulus measures by the Bank of England as global financial authorities seek to shore up a slowing global economy.

Stock markets rose briefly on the news, mainly because China's rate cut was unexpected. But the gains did not last long as investors seemed worried about the extent of the slowdown in the global economy. Germany's DAX was up 0.4% while the Dow futures were flat...


 

Reuters
Denmark cuts rates, one to negative for first time
By John Acher and Ole Mikkelsen
5 July 2012

* Central bank cuts main policy rate by 25 bps to 0.20 pct
* Cuts CD rate by 25 bps to negative 0.20 pct
* Keeps current account rate unchanged at 0.0 pct
* Lifts current account limits

COPENHAGEN, July 5 (Reuters) - Denmark's central bank cut interest rates by a quarter point on Thursday, shadowing the European Central Bank's action earlier in the day, in a historic move that put one of its secondary rates below zero for the first time.

"The interest rate reduction is a consequence of the reduction by the European Central Bank of its monetary policy rates by 0.25 percentage point," the Nationalbank said in a statement.  (a spiral of competitive devaluations of fiat currency - Jesse)

The Nationalbank cut its lending rate to 0.20 percent from 0.45 percent and lowered its certificates of deposit (CD) rate to negative 0.20 percent from 0.05 percent to match the ECB's move and to curb strength in the Danish currency... 

Bernanke and the Banks Say 'Trust Me' and for Many Gold Is the Answer

Gold = 1 / T,
where T stands for the Trust that people have in the fiat Monetary System and the financial complex running it. Jim Grant points the finger at the central bankers, but they are merely creatures, albeit powerful actors, in a system of privilege and legalized looting.

In other words, the price of gold will run higher in response to the opacity, crony capitalism, insider dealing, abuses of power, and arbitrary valuations in the financial system and the overall system of governance.

Gold, and to a growing extent silver, are the safe havens for the world. This flight to safety is the fundamental driver of the precious metals bull market.

And I think that the ownership of gold and silver is still highly selective, based often on culture, financial sophistication, or a general predisposition against trust in monolithic organizations.

As a recognition of what is happening penetrates more deeply into the public consciousness, the spike in the price of precious metals may be much more impressive.

Is this weakening of confidence justified? One must ask themselves, how deeply has the corruption in the system been reformed?

Has transparency been restored, and the confidence of the members of the system been regained by things other than public relation campaigns, forced choices, subtle coercion, market manipulation, and even blatant propaganda?

These crony capitalists are so inward looking and corrupt that their policy response is to continue the looting and intensify the deception until confidence in the system is restored.

There is plenty of free choice to be had in this brave new world, from 401k's to the election ballot, as long as one chooses from what they give you.

That is the answer, the fundamental driver of the valuation.

"A bubble is a bull market in which the user of the word "bubble" has not fully participated. You can think of gold as a stock that went from 2⅝ to 18 in a dozen years. I'm not sure that's a bubble. It is the nature of gold that its valuation must forever be a mystery. It earns nothing. It pays no dividend. No conference call, no management to call up and complain to.

What I do think is gold is simply the reciprocal of the world's faith in the institution of managed currencies. It is one divided by T, where T stands for trust. And trust is a shrinking number and will continue to shrink. Therefore, I am still bullish on gold.

If a bubble connotes absurdity, what is absurd are the monetary conditions that supported this gold bull market. Gold is an expression of the world's justifiable distrust of the way our central bankers conduct their affairs. The poetry of it is that it can't be quantified. The central banks are unworthy opponents. The Fed has pledged 0% money-market rates for the next two years, so that's not much competition. And the governments of the world are taking under advisement this notion called financial repression—short-circuiting market mechanisms, capital controls, punitive taxes or intrusive taxes and the like."

Jim Grant: Gold Still Looks Good, Japan Still Doesn't - Barron's

"The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks." Lord Acton

But before the people finally come to reform the Banks, the monied interests will throw quite a few patsies, traditional scapegoats, and red herrings on the fire in their stead. And if they have their way, they will burn down society rather than give up their seats at the top of the hill.

Eisenbeis: What's A Central Bank To Do Besides Printing Money (And Pursue A Hidden Agenda?)

I thought this was a fairly nice thumbnail sketch of the problem facing the world's central banks vis à vis the US dollar as reserve currency and globalization. I have to add that this current impasse was not unforeseen.

I suggest you take a look at a very brief description of Triffin's Dilemma.

The Triffin dilemma is a theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives. This dilemma was first identified by Belgian-American economist Robert Triffin in the 1960s, who pointed out that the country whose currency foreign nations wish to hold (i.e. the global reserve currency) must be willing to supply the world with an extra supply of its currency to fulfil world demand for this 'reserve' currency (foreign exchange reserves) and thus cause a trade deficit.

The use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: some goals require an overall flow of dollars out of the United States, while others require an overall flow of dollars in to the United States. Currency inflows and outflows of equal magnitudes cannot both happen at once.

The Triffin dilemma is usually used to articulate the problems with the US dollar's role as the reserve currency under the Bretton Woods system, or more generally of using any national currency as an international reserve currency.

The problems with any domestic currency operating as the world's reserve currency are well known, and yet the United States decided to pursue this after Nixon closed the gold window. Perhaps that is because the risks to the many were outweighed by the benefits to a few.

I enjoyed the author's flat out statement that "it is undeniable that the world's central banks collectively have flooded world financial markets with liquidity by printing money."

If someone tells you that central banks, in a fiat regime, cannot create money out of nothing, then they simply do not know what they are talking about, no matter how many rhetorical flourishes and convoluted rationales they may produce. They can do it, they are doing it, and they will keep doing it until they reach what they consider to be a sustainable equilibrium, or they exhaust their ability to print based on the limits I have previously described.

The problem is that none of the equilibria they have produced in the last twenty years have been sustainable, except for a few years, and the half life of the monetary bubbles appears to be contracting.

The US dollar is at the end of its rope as the reserve currency for the world. Nothing could be more clear.   What will be done about this is another matter.  The Anglo-American banking cartel will enter the next phase of the evolution of money resisting change every step of the way.  What they most desire is to maintain and extend their control of a worldwide fiat currency, not even in the interests of their own people, but for the benefit of a few.

Institutional Risk Analyst
What's a Central Bank to Do?
By Bob Eisenbeis, Cumberland Advisors
April 25, 2011

Faced with largely the same set of facts when it comes to their inflation outlook, some of the world's major central banks have come to markedly different conclusions about the appropriate policy.

The ECB began to exit from its accommodative policy by increasing its policy rate by 25 basis points to 1.25% on April 7. The ECB noted that growth was improving moderately, but inflation had increased to 2.6% and was up from 2.45% the previous month. The rise was largely due to increases in energy, food, and commodity prices. The concern was the potential second round effects and that these increases could become embedded in inflation expectations.

The same day, the Bank of England kept its policy rate at 0.5%, despite the fact that inflation had been running well above its target rate of 2% for more than a year and was likely to remain so through 2011. Again, the Committee noted that the near term path for inflation was higher due to energy, imported commodities and other goods. Concern was also expressed about inflation expectations having risen in the UK, the US and the euro area relative to what they had been before the financial crisis. Finally the UK real economy was softer than that of the EU generally with output having declined by 0.5% in the fourth quarter of 2010.

While the FOMC will meet this week, Fed Chairman Ben Bernanke and Vice-Chair Janet Yellen have already signaled that they view the recent increases in commodity, energy and food prices as transitory. Governor Yellen in particular provided an extremely thorough and detailed dissection of the inflation data and her views on the real economy and employment in her April 11th speech in New York. She indicated clearly that the causes of the run-up in food, energy and commodity prices were rooted in increases in global demand, combined with energy supply shocks and uncertainty about oil flow from the Middle East. Like the Chairman, she expressed the view that the increases were transitory.

Most notably she attempted to debunk the widely discussed view that accommodative policies in the US were the cause of the increase in global prices. She was very clear that the main concern was for the US expansion and employment situation, that the current stance of policy was appropriate, and that QE II would be completed as scheduled. So we don't expect any notable news coming from this week's FOMC meeting.

These three views on the appropriate stance of policy and how individual-country central banks may think about policy shows a growing disconnect between traditional approaches to monetary policy and globalization. For example, the US economy historically has been largely isolated from the rest of the world. International markets were not particularly significant (exports and imports were roughly balanced and accounted for less than 13% of GDP). Inflation was largely a domestic issue and could be directly affected by changes in US policy rates. From the 50s through 70s, the main channel for monetary policy was through housing: when interest rates exceeded the Reg Q ceilings that banks and thrifts could pay for funds, the supply of funding to housing was cut off. Then construction declined and the effects rippled through the rest of the economy. Most of the economic models have that structure and international isolation embedded within them. Yet this is not the world that policy makers are now dealing with, as the above descriptions of the causes of the current inflation aptly illustrate.

If the major causes of inflation are external to an economy, and policy makers have domestic tools and targets for inflation and local employment, either explicitly or implicitly, then how should they respond to externally generated causes of inflation? What is the link between the central bank's domestic policy interest rate tool and the external causes of price increases? These key questions are not currently addressed within contemporary policy frameworks employed by the FOMC, the ECB, or the Bank of England, as best one can determine.

In the current inflation environment, one can justify any one of three alternatives, and some of these are clearly being adopted. Furthermore, all can be mostly right or mostly wrong.

First, a policy maker could attempt, as the US did during the 1970s oil crisis, to insulate the real domestic economy from the contraction supply shock by keeping rates low. This policy seemed appropriate and was politically acceptable, especially since the price increases were viewed as temporary. But it clearly failed, and we paid the cost with higher inflation.

Second, if one believes that the energy, food and commodities price increases are transitory, then no response is called for; and this can justify focusing on domestic employment, as is currently being done in both the US and UK. Even if the increases are permanent, doing nothing may be the appropriate policy. Permanent increases in energy, commodity, and food prices will shift these prices relative to other goods and services and generate substitution and accommodative responses by business and consumers. We may, for example, drive less and adopt more hybrid transportation alternatives -- moves that are already beginning to take place -- than we would if the energy price increases were viewed as being temporary.

But doing nothing also has its own risks. Maintaining an accommodative policy too long risk overheating an economy and fueling both an increase in domestically-produced goods and services prices and passing along the increased prices of external goods and energy prices as second round effects. As always, timing is everything when it comes to exiting from an accommodative policy.

Third, a central bank can move to increase its policy rate to choke off inflation, as the ECB has begun to do. But this policy has certain risks associated with it. If the causes of the inflation are external to the economy, then one would not expect those prices to be responsive to a policy move by a domestic central bank. But the increase in rates will clearly impact those domestic and non-international activities that are affected by rising interest rates. Economic activity in those areas will contract, including production, employment, and prices. So the impact of responding to an external inflation source is to force a decline in an aggregate price index by contracting domestic economic activity. This seems a risky path indeed. Right now it may appear less so because policy, as ECB President Trichet stated, is still viewed as being extremely accommodative.

So what is a central bank to do, especially when policy is overly accommodative? While Vice-Chair Yellen may argue that the increase in world prices is not our fault, it is undeniable that the world's central banks collectively have flooded world financial markets with liquidity by printing money.

This situation is likely to become even worse in the near term if Japan resorts to inflation as a means to finance the cleanup and rebuilding necessitated by the recent earthquake, tsunami, and nuclear disasters. When domestic economies are no longer insulated from international markets and forces, individual central banks can no longer go-it-alone with their policy decisions. In such a world, perhaps the best policy is to remove the distortions cause by current policies, and then attempt to avoid extremes. Unfortunately, how to get from here to there in a non-disruptive way is not at all obvious, as the ECB may soon find out..

What this means for investors is that market uncertainty is likely to remain high for some time to come, and attempting to play in international markets carries with it huge foreign-exchange and real risks that need to be hedged.

Although I may say uncomplimentary things occasionally about Messrs. Bernanke and Greenspan and their colleagues on Wall Street and in government, I most definitely do not think they are fools, or naive, or uncomprehending of what they are doing. Therefore I find their actions difficult to square with a sincere fulfillment of their stated objectives, and the oaths of their offices, unless there is another dimension to their plans which has not been disclosed, and which I do not yet understand.

"And some of us who have already begun to break the silence of the night have found that the calling to speak is often a vocation of agony, but we must speak. We must speak with all the humility that is appropriate to our limited vision, but we must speak...Perhaps a new spirit is rising among us. If it is, let us trace its movements and pray that our own inner being may be sensitive to its guidance, for we are deeply in need of a new way beyond the darkness that seems so close around us."

Martin Luther King

Gold Daily Silver Weekly Charts - Panic Hits the Money Printers As Benny Signals QE -> infinitum

It will be interesting to see how the Non Farm Payrolls report comes out tomorrow.

I am starting to feel a little more comfortable with this chart formation, but follow through is confirmation. 1375 is a key overhead resistance. Don't expect Benny and the Banks to roll over too easily.

One of the Federales put out a Buiter-like commentary Is Gold Money?. No, it is not legal tender these days, but it is an almost universally recognized store of value now as it has been for about the last 6,000 years. Sometimes enlightened, well-disciplined regimes have sanctioned it as official 'money.' But certainly not those inward looking bureacracies who could not find with both hands the bubble(s) they have recklessly created out of you know where.

This sort of rhetoric is sometimes an indicator that the Fed is getting nervous because the Asian and Latin American puppies are not eating their latest brand of ersatz puppy chow, preferring red meat to waste paper. 

I do not support the gold standard for the US because the system is too weak and corrupt to bear it at this time.  As long as gold and silver trade freely those who have a mind to it can use it to protect themselves against devaluation if they wish.

But if one is on some standard, it forces you to be more transparent and overtly devalue your currency, should you wish to do things like bail out your friends on Wall Street.   Electronic digits on the other hand are much more amenable to a bureaucracy which prefers to conduct its business using opaque financial transactions in a self-serving manner,  lacking in sufficient independent oversight.

Oh I see where Benny came out today and signalled QE to the limit, and gold and silver spiked higher.  Now it all seems more clear to me.

A nice fade.  Thanks.  And let's hope Ron Paul gets that audit soon.

As Matt Damon said in one of the best poker movies, Rounders:

Mike McDermott to Teddy KGB: "Well you feelin' satisfied now Teddy? Because I can go on bustin' you up all night."

Caution: language

Oh by the way, JPM Hid Doubts On Madoff Fraud - NYT

And there will be more.

Let Gold and Silver Rally, Jamie - Leave Blythe Alone!

Inflation and Deflation: US Money Supply Figures - We're Not In Kansas Anymore Toto

Here are the latest Money Supply Figures from the St. Louis Fed.

I start with the narrowest measure, the Monetary Base and widen out to M2 which is the broadest measure of US money supply currently available, with MZM serving a similar function for the short term.

Previously I have commented on the 'shadow M3' figures done by a few enterprising fellows. As you may recall the Fed stopped publishing M3 a few years back. M3 itself was not the issue but rather the Fed chose to stop reporting a key component of M3 called 'eurodollars' or US dollars held offshore in Europe or anywhere else.  The rationale was that it was too expensive to obtain this data. There are those who found this to be a bit disingenuous for a non profit seeking organization that operates on a cost plus budget.

Those who are attempting to estimate M3 gather what actual remaining data  they can, and estimate eurodollars by  'modeling' them based on trends and correlations as they were in place when the Fed stopped reporting.

As I cautioned before from my own work in the BIS currency reports, there were huge flows of dollars into Europe during what I called the eurodollar short squeezes. The problem with BIS however is that their reporting lags by almost nine months, so the figures are never really current.

I suspect that as these figures unfold we will see that the Fed has created and made available large amounts of dollars that were presented to European institutions, and that this money is not being captured in any of the existing money supply figures, except perhaps the Monetary Base, and that estimates of M3 are likely to the low side because of this change in trend of eurodollars.

So what does all this mean, what is the important 'takeaway?'  It means that deflation is not occurring at the moment because the Fed has taken those actions which it said it would do, plain and simple.  On the other hand there is some inflation appearing but nothing notable with the exception of health care, service fees particularly financial, and a few hard assets. This could start changing even in the face of slack aggregate demand, but not in the face of another significant economic collapse such as in Europe or China. 

And unfortunately recent evidence suggests strongly that the Fed has been misrepresenting what it has done in the financial crisis.  This is unfortunate because it suggests that not only other things were misrepresented, but that there is an ongoing coverup of what has been done, and likely what is being done today.    Coverups tend to feed on themselves, and provoke other new abuses of the public trust.  Also it calls into question all that a private and guarded institution has said in the past based on their reputation.  I do not think people fully realize the implications of this yet. 

In this stage of the Currency War we seem to be in something like the phase of WW II called the 'Phoney War' that occurred between September 1939 and May 1940.   But it does seem to be heating up.

Those who wish deflation to occur badly enough will find it where they will, whether it be in M3 estimates or credit figures. I find it highly ironic that when estimated M3 recently seemed to be showing deflation it was embraced by a particular chatboard site who previously had forbidden its mention when it had showed inflation some years ago. Further, credit is not money. Credit is a source of money creation as is the Fed's balance sheet. The Fed's Balance Sheet is not 'money' per se. It is a source of money creation.

It should also be remembered at this point that a fiat currency is backed by the economy of a country and its official cashflows (primarily taxes) as well as its reserves. As a country's GDP and cashflow deteriorates the soundness of its currency can deteriorate even if the nominal levels of money remain unchanged. I think we are seeing quite a bit of this today.  This deterioration in the backing of a currency is no different from a devaluation in its effect.

Can deflation occur? Absolutely. Give me control of the Fed and I will give you a rip snorting deflation by raising the overnight rate to 20 percent and calling in the reserves so to speak.

But one cannot deal in possibilities when investing, merely safeguard or hedge against them based on the estimates of probability. Well, you can deal in possibilities, but this is largely a means of self-deception, a means of continuing to embrace a theory or investment strategy that has been proven incorrect when it is too difficult to give it up and admit your error.  That difficultly may arise from practical matters, but it is my experience that it is normally attributable to stubbornness, or pride, and sometimes even corruption.

"Faced with the choice between changing one's mind and proving that there is no need to do so, almost everyone gets busy on the proof." John Kenneth Galbraith

Obviously gold and silver and some other things have been rallying smartly for the past ten years in response to the decisions made by the Fed and the US government of both political parties, whether they will admit it or not. When this changes, when the dilution of the currency stops and begins to recover to strength, then I would think it appropriate to change my own particular investment strategy, which is hedged against the unexpected even now. But not until then.  I do not expect inflation to obtain serious traction until foreign governments start rejecting the dollar in size, or the velocity of money begins to obtain some traction in the real economy.   The Fed assures us that they will act to control the spread of inflation when the time comes. But for now the banks appear overstuffed with cheap liquidity, something I like to call hot money.

This type of abundantly cheap, hot money tends to seek higher beta or risk, often in the form of equities and dodgy financial schemes and investments, rather than productive lending.  As the CEO of a Fortune 500 was heard to observe in private, having paid an absolutely eyebrow raising sum for another company in the heady time of the tech bubble, "Yes I paid a high price, but my currency (company stock) is cheap."  He was willing to take an outsized risk because he believed that his overvalued currency was going to become worth a lot less.  He just did not realize at the time that it would eventually become nearly worthless. It did and he was sacked.  I think the analogy to Ben and his Fed, and the way in which they are throwing dollars around, to private and especially to foreign banks,  is quite analogous.  The looting will continue until the value of the overpriced stock is depleted.  That Wall Street will be taking about 8 percent of the total short money supply as its bonuses this year speaks volumes about the value of the dollar and its future.

I saw this coming in 2001 but have to admit I was terribly wrong on timing in 2004, having underestimated the Fed's willingness to obtain international banking cooperation, primarily from Japan the UK and Europe, to generate a massive housing bubble. I will not make that mistake again I hope.

And if you have been wrong in your assumptions or assessment, it is never a shameful thing to admit it, gather yourself together, and go forward from there, because all this indicates is that you have received new information and that you accept it, which is the high mark of intellect and objective science.

Even the mighty Nobel laureate Paul Krugman has recently expressed his disillusionment with Mr. Obama's Hooverism, Freezing Out Hope.

"What’s even more puzzling is the apparent indifference of the Obama team to the effect of such gestures on their supporters. ... Mr. Obama almost seems as if he’s trying, systematically,... to convince the people who put him where he is that they made an embarrassing mistake."

Contrast this with his earlier chastisement of those who were already recognizing that Barry the reformer was either an ineffective nincompoop or an establishment shill.

"Look, Obama didn’t pose as a Nation-type progressive, then turn on his allies after the race was won. Throughout the campaign he was slightly less progressive than Hillary Clinton on domestic issues — and more than slightly on health care. If people like Ms. [Naomi] Klein are shocked, shocked that he isn’t the candidate of their fantasies, they have nobody but themselves to blame." Paul Krugman, NYT June 16, 2008

I am not going to get into the relative merits of one course of public policy decision or another here. My point rather is to demonstrate once again that with a fiat currency the matter of inflation or deflation, within a range of exogenous constraints, is a public policy decision tied intimately into the form of government that one holds as its objective and the nature of the society that you wish to encourage.

I do not wish to single out Krugman with the tautological indictment of being human. He almost appears as a Diogenes, a beacon of objectivity, compared to his ideological counterparts. Too often economists cloak themselves in the robes of a quantitative and objective science, with such canards as the efficient markets hypothesis, supply side economics, the inefficiency of regulation versus unregulated markets, and bailoutism as hard facts, when they are nothing more than arguments in favor of one set of government policies or another.

And far too often they are doing it for pay it appears, which is intellectual dishonesty, malpractice if you will, that is inexcusable and contemptible, one of the reasons why economics is considered by some a disgraced, although not irredeemable, profession these days.  But since these fellows are generally associated with the 'greed is good' school, which elevates the ends above all else, once ought to expect to hide the silverware, whiskey and women when they come to town.

Many things are possible, but not all things are equally probable. As Walter Bagehot famously observed, 'Life is a school of probability.'

For a nation that is a net debtor, deflation is tantamount to suicide. But other nations, most recently Germany in the past century, committed a form of national suicide in service to hubris, and an elite few, and a mistaken understanding of what constitutes a civil society and what it means to be human. They are certainly not the only society to have done this, and I would not presume that they are the only people who will have fallen prey to this self-destruction in the future.

So there is some precedent for disaster. Germany was certainly not the only society to have done this, given the examples of China, Russia, Japan, and Italy, and I would not presume that they are the only people who will fall prey to this self-destruction as well. Having high ideals or having previously suffered oppression is no guarantee of future goodness. Rather it is the attitude of yourself in relation to the 'other.' That is the whole of the law.

Indeed, such a temptation to dehumanisation is tailor made for a generation raised on the notion of their natural goodness, accepting themselves as they are, rejecting and tearing down any external standards of goodness and worth in other people. They see no need to change and work together, but rather to give in, to wallow, in their basest and most selfish impulses, self-centeredness, the greed-is-good meme of the me generation, in a time of general apostasy to all but the lowest form of our self. Class War and the Decline of the West

The madness of crowds seems to have been all the rage in the twentieth century, and what I see now are people who are more technically proficient, more cunning, more skilled in the ways of mass deception and intrigue, but alas, perhaps not more compassionate and wise, and understanding of what it means to be human, truly content with themselves, and simply happy.

So bear these things in mind and protect yourselves as best you can despite the temptations and deceptions of our all too human frailties. It will not be easy, but it was not easy for our parents or grandparents, and theirs and those before them, because it never is. That is the nature of this world.  And even the once triumphant West at some point must learn to pull together again, or founder in a new season of infamy.

"For we wrestle not against flesh and blood, but against principalities and powers, against the rulers of the darkness of this world, against spiritual wickedness in high places." Eph 6:12

Why the Official Antipathy to Gold and Silver? The Second Oldest Profession

Every so often someone asks, 'Why do the government and the banks manipulate the price of gold and silver?'

There is a great deal of circumstantial evidence to support this, even some blatant quotes pertinent to the topic from the likes of Volcker, Greenspan, and Bank of England governor Eddie George. Of course it can all be denied. People can deny anything, even well known historical events with many witnesses, if it suits their bias and purposes.

But putting aside the operational aspects, what is the motive?

Most recently a correspondent from India asked the question 'why do the banks wish to control silver from the short side? Why would they not blow it into a bubble like they do with stocks and make their profit there? Why do the banks wish to hold these prices down and make people think badly of silver and gold which we here value so much?'

When asked this, I will usually attempt some explanation that begins with the fact that the banks involved are the Primary Dealers for the most part, and very involved with the Federal Reserve and the government on a variety of levels in the issuance and arbitrage of official US debt.

The motive therefore involves aspects from an 'official' monetary perspective. It will often include a reference to Gibson's Paradox, a paper by Larry Summers involving the price of gold and its perceptual relationship with the long end of the curve. It might include Volcker's and Greenspan's comments about the price of gold casting a negative light on the stability of the currency if it rises too high or too quickly. I may even get into the Second Bank of the United States, and Andrew Jackson's populist role in exposing its frauds, and refusing to renew its Charter in favor of constitutional money.

But if I am ever asked about this in the future, I can think of no better, no more concise statement of a possible motive for the manipulation of gold and silver than this:

“The central economic problem plaguing this country since 1913 has been the presence of the Federal Reserve System. Without the Federal Reserve System’s debt-currency scheme having effectively supplanted the constitutional monetary system based upon silver and gold, it would have been impossible - not simply improbable, or difficult, but impossible - for politicians in the public sector and speculators in the private sector to have amassed the staggering level of unpayable, unconstitutional, and unconscionable debt that now bears down upon this country.”

Dr. Edwin Vieira, Jr., Going to the Roots of the Problem

It's enabling the fraud, always and everywhere, and the power obtained in controlling the supply and issuance of money.  There are those who are involved in productive labor, and those who wish to unproductively tax it. It is an old story with deep roots in history.

And once again, the government and the financiers seem to have formed an unholy alliance to harness the real economy with excessive, unjust, and unproductive taxes for the private benefit of a privileged few, protecting and promoting their schemes when they win, and covering and subsidizing their losses when they do not. In either case the money is coming out of the real economy, and like a paraiste is starving it of its vitality.

So there is your motive, from what might be called the second oldest profession. Find out what people need to have, and then seek to control it to obtain your wealth by exacting a tax on it, but without having to deliver anything for it, a mere exploitation of informational and procedural advantage.

There is a difference between amassing capital, building a business, and assuming the risks for its success and failure, and this modern form of banking which is nothing more than an enormous tax on the productive economy granted by a corrupted government that turns a blind eye to fraud and abuses. And when its schemes go wrong, it obtains subsidies and relief from its partners in government.

As Andrew Jackson noted of the Second Bank of the United States, the predecessor to the Fed which came back into being 80 years after:

"Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I intend to rout you out, and by the grace of the Eternal God, will rout you out."

China and the Goldfinger Syndrome

I have had some interesting discussions recently with correspondents about the problem which China has with its very large US dollar reserves.

To summarize what I think, China is attempting to diversify their portfolio of US Treasury dollar holdings. They are obviously accumulating 'real goods' including stockpiles of basic materials, gold, silver, oil and investments in the means of production in their own region and in key regions around the world.

This is more difficult than it might appear on the surface. Real goods are often strategic, and governments are sometimes reluctant to allow them to be acquired by a government considered a potential threat. The first difficulty is the strategic importance of some assets, such as the China's offer for the purchase of Unocal.

But there is also a need for confidentiality, stealthiness if you will. If word were to leak out that 'China is dumping its Treasuries' there would be a run on the market and the Chinese could lose a portion of their reserve wealth rather quickly.

Now, would it matter. Well, yes. It would matter because US dollars are still the currency of choice for most international trade including the all important international commodity, oil. If you think that philosophically dollars have no value because they are just paper, I would be more than happy to dispose of them for you. Limited time offer, of course.

I also posited that China, while accumulating its real goods quietly against the constraint of perturbing the markets, could do short term hedges against the less catastrophic scenario of further dollar devaluation by going into the very deep and liquid financial assets markets, and hedging risk with CDS and other obvious investments including shorts of various types.

As anyone who has attempted to acquire a company or take a substantial position in or out of an asset or company, at some point you can affect the price, making other participants aware that the asset is in play, and end up selling or buying against yourself. In the case of China it could also trigger a run on the bank of the US, which is an immediate endgame.

With regard to the use of financial instruments, someone raised the obvious issue of counter party risk. Well, of course it is an issue. But less so if you are merely hedging a portion of the portfolio for the devaluation scenario, and not a catastrophic default. And the choice of counter parties can be managed to some degree. It is a big world out there and the Swiss are always open for a bet.

But correctly, if there is a catastrophic failure of the dollar, they will be carrying banks and brokers around the world out on stretchers and almost all financial assets, or bets, will be in default. Those who are holding leap puts as insurance against a collapse may as well be holding food vouchers for a restaurant in Brigadoon.

China would most likely not lose the value of its reserves in the extreme case of a US default, even if every one of their remaining Treasuries and the financial hedges on those Treasuries became worthless. Why?

It's the Goldfinger Syndrome. As you may recall, Auric Goldfinger did not wish to steal the US gold supply, at that time the currency of the nation, from Fort Knox. He merely wished to eliminate it, making his own substantial gold holdings significantly more valuable. It is a form of increasing value through deflation, a concept that is much more familiar these days thanks to quite a few amateur economists patiently waiting for the US dollar to gain in value because of it.

If the US were to actually default, the value of real goods, from basic materials to gold and silver and oil, would absolutely soar in terms of dollars of course, but in most other fiat currencies of the developed world as well. The perception of the risk of a fiat currency would border on hysteria.

Returning to the deflation meme, the elimination of US financial assets from the 'world currency base' would make all the other currencies extremely valuable, and China would be flush with them. For real goods are a form of currency suitable for the exchange of wealth. They are merely less liquid, and not often used as the unit of value anymore. But real goods are a form of currency. They just cannot be printed, except perhaps on the Comex and at the LBMA it appears, and they would be absolutely discredited and out of business.

So, that is something to think about. China need do nothing but slowly and stealthily acquire real goods, and hedging their positions along with way with financial instruments, waiting for the US to play itself into some beneficial outcome for them. I think the financial hedging is important because of the relative illiquidity of some of the real goods, and the difficultly of acquiring them in sufficient supply without triggering a 'run on the dollar.' The financial markets are deeper and more discreet than the markets for real goods.

The problem facing the holders of dollars is not inflation or deflation, per se. They are merely particular manifestations of currency risk, and the uncertainty of holding substantial assets denominated in a fiat currency that is risky, meaning something abnormal or unstable in the classic sense of the term. A serious deflation or inflation are both unusual and risky.

This is not hair-splitting. Rather it is essential to understanding why gold can increase in value during periods of both a significant deflation and inflation, which on the surface seem like opposites. In fact they are similar if view in the terms of probability. They are both the opposite of currency stability, what I call currency risk. The further one gets out on the probability curve with a currency, the better gold looks in relation to it. Gold is the ultimate in stability, almost inert, and highly resistant to corrosion and decay, bordering on the timeless, comparatively uniform in its supply.

There are those who say that when the time comes, and what is happening becomes apparent, they will buy some real goods, foodstuffs, land, gold and silver. I can assure you that when that time comes, there will be little or none available at almost any price. One has to have lived through a currency crisis first hand to understand the phenomenon.

You are holding a currency in decline and there is little or no place to spend it except as a throwaway, because no one wants it anymore. Barter becomes predominant, and any hard currency is king. This is how it was in Russia in the 1990's with the old rouble before it finally imploded, at which time I was thankfully out of country. It was quieter than you might imagine, despite the headline antics of their mafia, and a sense of quiet desperation as people watched their life savings simply evaporate.

There is almost no doubt in my mind that this is how the Chinese are playing this, and certainly Russia and a few others as well, who are playing the long game. It explains some of the recent moves in price of certain forward looking assets, a phenomenon so little understood by the many, even now.

I still see the greater probability for the US as a devaluation and a stubborn stagflation for quite a few years. But the policy errors being committed by Bernanke and the Obama Administration are making the possibility of an actual collapse more likely than I would have thought even six months ago. I suppose it is never well to underestimate the self-destructive tendencies of obsessive greed.

See also The Last Bubble: The Problem of Unresolved Debt in the US Financial System and Currency Wars: Selling the Rope