Merrill Lynch: The Wealthy Are Turning to Physical Gold for Safety

And so it begins...

Each person has to allow for their own circumstances, and provide for their daily needs as well as their longer term investment decisions.

Speculation and leverage are a trap in this market, because it is permeated by abusive practices and a deterioration of the conditions necessary to free markets.

It is truly amazing that the world continues to allow New York, Chicago and London to set the short term prices for their goods and labor.

The status quo will do all in its power to perpetuate itself, and hold the line on meaningful change and reforms for a variety of all too human motivations. This, we believe, is what has been causing this series of bubbles, booms and busts. Bernanke is fighting the last economic crisis.

As we can, provisions should be made for the troubles to come. We did not get where we are overnight, and we will not repair ourselves in a year either.


UK Telegraph
Merrill Lynch says rich turning to gold bars for safety
By Ambrose Evans-Pritchard
Last Updated: 10:32AM GMT 09 Jan 2009

Merrill Lynch has revealed that some of its richest clients are so alarmed by the state of the financial system and signs of political instability around the world that they are now insisting on the purchase of gold bars, shunning derivatives or "paper" proxies.

Gary Dugan, the chief investment officer for the US bank, said there has been a remarkable change in sentiment. "People are genuinely worried about what the world is going to look like in 2009. It is amazing how many clients want physical gold, not ETFs," he said, referring to exchange trade funds listed in London, New York, and other bourses.

"They are so worried they want a portable asset in their house. I never thought I would be getting calls from clients saying they want a box of krugerrands," he said.

Merrill predicted that gold would soon blast through its all time-high of $1,030 an ounce, and would hit $1,150 by June.

The metal should do well whatever happens. If deflation sets in and rocks the economic system it will serve as a safe-haven, but if massive monetary stimulus gains traction and sets off inflation once again it will also come into its own as a store of value. "It's win-win either way," said Mr Dugan.

He added that deflation may prove the greater risk in coming months. "It's very difficult to get the deflation psychology out of the human brain once prices start falling. People stop buying things because they think it will be cheaper if they wait."

Merrill expects global inflation to hover near zero, with rates of minus 1pc in the industrial economies. This means that yields on AAA sovereign bonds now at 3pc will offer a real return of 4pc a year, which is stellar in this grim climate. "Don't start selling your government bonds," Mr Dugan said, dismissing talk of a bond bubble as misguided. (Government bonds are a safe haven for now on the short tend of the curve, but to say there is no bubble on the long end is remarkable. The only vairable is how long before that bubble bursts. The real question is whether the risk is worth the return for you, and that will vary. It seems insane to hold the long end when you can take the shorter end. - Jesse)

He warned that the eurozone was likely to come under strain this year as slump deepens. "There is going to be friction as governments in the south start talking politically about coming out of the euro.

I don't see the tensions in Greece as a one-off. It is a sign of social strain in countries that have lost competitiveness." (Wait until it really gets rolling in the US, UK, Russia and China. Then there will be headlines - Jesse)

Daily Telegraph
Gold rush erupts over financial crisis
By Nick Gardner
January 10, 2009 12:01am

THE global financial crisis has sparked a new gold rush.

Worried investors seeking a safe home for their money are ploughing billions of dollars into the precious metal in a bid to preserve their wealth.

Demand has now reached such unprecedented levels that the Perth Mint, Australia's biggest wholesaler of gold coins and bars, has been forced to ration its sales.

Perth Mint's bullion sales rose 194 per cent in the December quarter compared with the corresponding period in 2007, while silver bullion sales were up 140 per cent.

The mint has suspended sales of all gold bars and all bullion coins - except its 1oz "Kangaroo" gold bullion coin.

On Monday, after a three-month suspension, it will expand its range of bullion coins for sale but the restrictions remain in place for minted gold bullion bars so the mint can sell some gold to as many customers as possible.

"We are working three shifts a day, six days a week, and still can't keep up with demand," Perth Mint CEO Ed Harbuz said. "I've never known anything like this in the precious metals market.

"We would be working Sundays too but we are having difficulty getting enough staff."

Non-minted gold in the form of cast bars produced by Perth Mint's local refinery can still be bought, although customers who want the bigger bars often have to wait several weeks.

One customer recently bought $500,000 worth of bullion and wanted it delivered so he could hold it personally.

"For very big orders we normally keep the gold in our depository for security reasons," Mr Harbuz said.

"Orders of $10 million or more are not unusual. Often the orders are much larger if we are dealing with pension funds or institutional investors."

The December Non-Farm Payrolls Report: Portrait of a Ponzi Economy

The 'headline number' is the seasonally adjusted net change in jobs. The drop out of the range that was held in the prior years is obvious on this chart.



This is the (in)famous Birth Death Model from the Bureau of Labor Statistics in which they add jobs as a 'plug' to account for new jobs being generated by the economy from smaller business. The trend is very regular as can be seen on this chart. So regular in fact that it is exposed as imaginary, useless. They do not even bother to trend it with the overall economy and jobs market. The only good thing that can be said about it is that it is added to the non-adjusted jobs number first, so its effects are swallowed up by the seasonal adjustment in many months.



This chart shows the drop off in jobs growth was precipitous. We believe that it was much less precipitous ex government fudging. The recessionary decline was masked by the government. Well, its obvious now.



It always good to remind ourselves of the huge swings in jobs numbers before the seasonal adjustments. It is those adjustments, and the huge revisions made to the series both in the prior month and in whole sections of the numbers, that hide a multitude of statistical sins.



This chart shows the peak in the economy, and the beginning of the decline. As one can see it was not the sudden onset of the housing collapse that brought down the economy. Rather, it was the rot underneath the foundations of the economy that triggered the housing collapse, and all the other Ponzi schemes that are now collapsing.

Fixing the 'housing problem' will not fix the rot in the economy, which was papered over by the Fed's reflation starting in 2003. But there is a lot of money to be made by a lot of people in that fix, so we can expect a signficant amount of graft and waste before the real work begins.



Here is another view of the Jobs Trend that nicely demonstrates the rise off the bottom of the economy as a result ofthe Fed reflationary efforts, first under Greenspan and then Bernanke. It was a parabolic bubble which has now collapsed and is declining in a nicely defined parabola. That's a sixth order polynomial describing the trend.

2008 Stock Market Performance by Country

Charts in the Babson Style for Midweek January 7

It looks like a pivotal moment on the charts.

Pivotal: being of crucial importance; central, key. By pivotal is meant a key decision point on the chart.

The rally which we have had so far is within the bounds of a 'technical bounce.'

What the market does tomorrow after the Jobs Report will help us to decide if it was indeed just a technical rally, or if it is something else, up to and including a trend change into a more sustained bear market rally that might be substantial.

The Jobs Report number tomorrow in combination with how the market will react to it, is almost a coin flip at this point with a shading to bearish only because of the trend. The number should be 'bad.' We'd estimate north of 500,000, perhaps higher.

It is our estimate that any number less than 550,000 is discounted in already and will be fuel for a short covering rally with cries of 'bottom.' Any number over 710,000 will be a shock and probably will bring the market lower.

And in between is a gray area. We do not believe for one minute that the recession is at its bottom, and that blue skies are in sight.. But that may mean little when hot, restless money comes off the table, aching for higher returns and risk, eventually to be consumed by beta.

The gambler jumps in, the trader waits. We have only hedged positions on the table as of the market close, not including our long term holdings, none of which are related to equities at this time. Our goal is not to give up any money by overtrading.

Is China Losing Its Taste for US Debt?

International Herald Tribune
U.S. debt is losing its appeal in China
By Keith Bradsher
Thursday, January 8, 2009

HONG KONG: China has bought more than $1 trillion in American debt, but as the global downturn has intensified, Beijing is starting to keep more of its money at home - a shift that could pose some challenges to the U.S. government in the near future but eventually may even produce salutary effects on the world economy.

At first glance, the declining Chinese appetite for U.S. debt - apparent in a series of hints from Chinese policy makers over the past two weeks, with official statistics due for release in the next few days - comes at an inopportune time. On Tuesday, the U.S. president-elect, Barack Obama, said Americans should get used to the prospect of "trillion-dollar deficits for years to come" as he seeks to finance an $800 billion economic stimulus package.

Normally, China would be the most avid taker of the debt required to pay for those deficits, mainly short-term Treasury securities. In the past five years, China has spent as much as one-seventh of its entire economic output on the purchase of foreign debt - largely U.S. Treasury bonds and American mortgage-backed securities.

But now, Beijing is seeking to pay for its own $600 billion economic stimulus - just as tax revenue falls sharply as the Chinese economy slows. Regulators have ordered banks to lend more money to small and midsize enterprises, many of which are struggling with slower exports, and Chinese bankers say they are being instructed to lend more to local governments to allow them to build new roads and other projects as part of the stimulus program.

"All the key drivers of China's Treasury purchases are disappearing," said Ben Simpfendorfer, an economist in the Hong Kong office of the Royal Bank of Scotland. "There's a waning appetite for dollars and a waning appetite for Treasuries. And that complicates the outlook for interest rates." (The reason that China has been buying Treasuries is to sterilize the impact of their dollar trade surplus and to support their industrial exports policy. These are not 'investment.' - Jesse)

Fitch Ratings, the credit rating agency, forecasts that China's foreign reserves will increase by $177 billion this year - a large number, but down sharply from an estimated $415 billion last year.

In the United States, China's voracious demand for American bonds has helped keep interest rates low for borrowers ranging from the government to home buyers. Reduced Chinese enthusiasm for buying those bonds takes away some of this dampening effect. (And China will be under increasing pressue to maintain the peg of the yuan to the dollar at an artificially low rate despite their currency controls - Jesse)

But with U.S. interest rates still at very low levels after recent cuts to stimulate the economy, it is quite cheap for the U.S. Treasury to raise capital now. And there seem to be no shortage of buyers for Treasury bonds and other debt instruments: Prices for U.S. debt have soared as yields have declined. (Buying of the debt is heavily concentrated in safe haven buying domestically and a small number of foreign central banks. It is vulnerable at these prices - Jesse)

The long-term effects of this shift in capital flows - with China keeping more of its money home and the U.S. economy becoming less dependent on one lender - are unclear, but the phenomenon is something economists have said is long overdue. (The result will be few Chinese exports to the US and a stronger renminbi - Jesse)

What is clear is that the effect of the global downturn on China's finances has been drastic. As recently as 2007, tax revenue soared 32 percent, as factories across China ran flat out. But by November, government revenue had actually dropped 3 percent from a year earlier. That prompted Finance Minister Xie Xuren to warn Monday that 2009 would be "a difficult fiscal year." (China must stimulate their domestic economy and raise the median wage to encourage consumption of their own production - Jesse)

A senior central bank official mentioned last month that China's $1.9 trillion in foreign exchange reserves had actually begun to shrink. The reserves - mainly bonds issued by the U.S. Treasury and by Fannie Mae and Freddie Mac, the mortgage finance companies - had been rising quickly ever since the Asian financial crisis in 1998. (There was a massive dumping of Agency debt by the foreign central banks, but a parabolic increase in Treasury purchases as we have previously documents - Jesse)

The strength of the dollar against the euro in the fourth quarter of last year contributed to slower growth in China's foreign reserves, said Fan Gang, an academic adviser to China's central bank, at a conference in Beijing on Tuesday. The central bank keeps track of the total value of its reserves in dollars and a weaker euro means that euro-denominated assets in those reserves are worth less in dollars, decreasing the total value of the reserves.

But the pace of China's accumulation of reserves began slowing in the third quarter along with the slowing of the Chinese economy, and appears to reflect much broader shifts.

China manages its reserves with considerable secrecy, but economists believe about 70 percent is in dollar-denominated assets and most of the rest in euros. The country has bankrolled its huge reserves by effectively requiring its entire banking sector, which is state-controlled, to hand nearly one-fifth of its deposits over to the central bank. The central bank, in turn, has used the money to buy foreign bonds.

Now the central bank is rapidly reducing this requirement and pushing banks to lend more money instead. (Good this is what they must do to encourage real capital investment that does not flee at the first whiff of a crisis - Jesse)

At the same time, three new trends mean that fewer dollars are pouring into China - and as fewer dollars flow into China, the government has fewer dollars to buy American bonds and help finance the U.S. trade and budget deficits.

The first, little-noticed trend is that the monthly pace of foreign direct investment in China has fallen by more than a third since the summer. Multinational companies are hoarding their cash and cutting back on the construction of factories. (FDI cuts and runs quickly in a crisis - Jesse)

The second trend is that the combination of a housing bust and a two-thirds fall in the mainland Chinese stock markets over the past year has resulted in moves by many overseas investors - and even some Chinese - to get money quietly out of the country. They are doing so despite China's fairly stringent currency controls, prompting the director of the State Administration of Foreign Exchange, Hu Xiaolian, to warn in a statement Tuesday of "abnormal" capital flows across China's borders; she provided no statistics.

China's most porous border in terms of money flows is with Hong Kong, a semi-autonomous Chinese territory that has its own internationally convertible currency. So much Chinese money has poured into Hong Kong and been converted into Hong Kong dollars that the territory has had to issue billions of dollars' worth of extra currency in the past two months to meet the demand, shattering its previous records for such issuance.

A third trend that may further slow the flow of dollars into China is the reduction of its huge trade surpluses.

China's trade surplus set another record in November, at $40.1 billion. But because prices of Chinese imports like oil are starting to recover while demand remains weak for Chinese exports like consumer electronics, most economists expect China to run trade surpluses closer to $30 billion a month.

That would give China a sizable sum to invest abroad. But it would be considerably less than $50 billion a month that it poured into international financial markets - mainly U.S. bond markets - during the first half of 2008.

"The pace of foreign currency flows into China has to slow," and therefore the pace of China's reinvestment of that currency in foreign bonds will also slow, said Dariusz Kowalczyk, the chief investment officer at SJS Markets, a Hong Kong securities firm.

For a combination of financial and political reasons, the decline in China's purchases of dollar-denominated assets may be less steep than the overall decline in its purchases of foreign assets. (Their industrial policy of export to the US is the reason - Jesse)

Many mainland Chinese companies are keeping more of their dollar revenues overseas instead of bringing them home and converting them into yuan for deposit in Chinese banks. In essence, they would not show up on the central bank's books. So, overall Chinese demand for dollars would not be falling as much as the government's demand for dollars, said Sherman Chan, an economist in the Sydney office of Moody's Economy.com.

Treasury data from Washington suggest the Chinese government might be allocating a higher proportion of its foreign currency to the dollar in recent weeks and less to the euro. The data also suggest China is buying more Treasuries and fewer bonds from Fannie Mae or Freddie Mac.

Figures from the U.S. Federal Reserve and the Treasury point to a sharp increase in Chinese holdings of Treasury bonds in October. China passed Japan in September as the largest overseas holder of Treasuries, and took a commanding lead in October, with $652.9 billion compared to $585.5 billion for Japan.

But specialists in international money flows caution against relying too heavily on these statistics. They mostly count bonds that the Chinese government has bought directly, and exclude purchases made through banks in London and Hong Kong; with the financial crisis weakening many banks, the Chinese government has a strong incentive to buy more of its bonds directly.

The overall pace of foreign reserve accumulation in China seems to have slowed so much that even if all the remaining purchases were U.S. Treasuries, the Chinese government's overall purchases of dollar-denominated assets will have fallen, economists said.

But China's leadership is likely to avoid any complete halt to purchases of Treasuries for fear of looking like it is torpedoing the chances for a U.S. economic recovery at a vulnerable time, said Paul Tang, the chief economist at the Bank of East Asia here.

"This is a political decision," he said. "This is not purely an investment decision."

India's Enron - Lessons Learned from the West

Snatch the bonus from my hand, grasshopper, and you may be worthy of a seat on the Board.

Reuters
Accounting scandal at Satyam could be India's Enron
By Sumeet Chatterjee
Wed Jan 7, 2009 10:32am EST

BANGALORE (Reuters) - The head of Indian outsourcing firm Satyam Computer Services resigned on Wednesday, disclosing that profits had been falsely inflated for years and sending its shares tumbling nearly 80 percent.

India's biggest corporate scandal in memory threatens future foreign investment flows into Asia's third-largest economy and casts a cloud over growth in its once-booming outsourcing sector.

The news sent Indian equity markets into a tailspin, with Bombay's main benchmark index tumbling 7.3 percent in a firmer session for world markets and the Indian rupee fell.

Ramalinga Raju, founder and chairman of India's fourth-largest software services exporter, said in a statement that Satyam's profits had been massively inflated over recent years but no other board member was aware of the financial irregularities. (Executive incompetency defense. The brown sahibs have learned their lessons well - Jesse)

"If a company's chairman himself says they built fictitious assets, who do you believe here? This has put a question mark on the entire corporate governance system in India," said R.K. Gupta, managing director at Taurus Asset Management in New Delhi. (It questions the integrity India's equity market and government, for certain. They need to hire Chris Cox of the SEC and Hank Paulson of Treasury as consultants to help them reform their regulatory process. - Jesse)

Raju, who founded Satyam more than two decades ago and who took it public in 1991, said about $1 billion or 94 percent of the cash on the company's books was fictitious. (They are holding that many dollars? LOL - Jesse)

The 54-year-old Satyam chairman came under close scrutiny last month after the company's botched attempt to buy two construction firms partly owned by its founders, which Raju said on Wednesday was a final attempt to resolve the problem of the fictitious assets. (A continuing exercise in acquisitions to mask accounting transgressions. Silicon Valley should have patented their accounting techniques. - Jesse)

"It was like riding a tiger, not knowing how to get off without being eaten," Raju, a management graduate from Ohio University, said in his letter, adding he was prepared to face up to the legal consequences. (OU! Top beer drinking school per capita in North America. Keggers par excellence. - Jesse)

Satyam said its managing director and co-founder B. Rama Raju, Raju's brother, had also resigned. It did not give any reason for the resignation. (But he didn't know about it, he was as innocent as the Madoff boys - Jesse)

The company's difficulties multiplied when the World Bank, a major customer, barred Satyam from new business, citing "improper benefits" given to Bank officials. (A little Enron, and a little Tyco - Jesse)

"In a bull market people forgot about it (corporate governance)," said Singapore-based Ashish Goyal, chief investment officer at Prudential Asset Management. "In a bear market chickens are coming home to roost, so it gets highlighted at a time like this." (The Ponzi schemes start collapsing when the easy money dries up and the lack of real growth and profitability is exposed - Jesse)

Just three months ago, Satyam received a Golden Peacock award from a group of Indian directors for excellence in corporate governance. (ROFLMAO! What did he do, twenty consecutive quarters of beating his EPS estimates by a penny? - Jesse)

By close of trade, Satyam's share value slumped to about $550 million from around $7 billion as recently as last June.

New York-listed Satyam specializes in business software and back-office services for clients such as General Electric and Nestle.

INDIA'S "ENRON"

"I think there is no future for this stock. This case for India is similar to what happened to Enron in the U.S.," said Jigar Shah, senior vice-president at Kim Eng Securities.

"It will not stop at Satyam. Many more companies will come into scrutiny like that. There is a strong possibility investments in India will be affected."

The scandal set off a wave of condemnation from Indian market regulators and government officials, and prompted banker Merrill Lynch to terminate its engagement with Satyam. (Yes but did they give back the ring? - Jesse)

"It's going to impact the Indian outsourcing industry. Customers are going to be concerned about offshoring firms in India," said Sudin Apte, country head of Forrester in the western city of Pune.

Satyam said it would go ahead with a planned board meeting on Saturday to consider a share buyback following a rash of broker downgrades even after its acquisitions were called off last month. (OMG, stock buybacks! You can't make this stuff up. Buy back with WHAT? I hope they at least have time for facials at the meeting. apres meeting. - Jesse)

ADP Jobs Report Shows Deep Jobs Losses Across the Economy

This report does not include government employment.

It is considered an indicator of the national Non-Farm Payrolls Report which will be released on Friday morning.

ADP
ADP National Employment Report
Wednesday, January 7, 2009, 8:15 A.M. ET

Nonfarm private employment decreased 693,000 from November to December 2008 on a seasonally adjusted basis, according to the ADP National Employment Report®. This month’s ADP Report incorporates methodological improvements intended to improve the correspondence between the nonfarm private employment estimates shown in the ADP Report and estimates published in the Bureau of Labor Statistics’ Employment Situation Report.

December’s ADP Report estimates nonfarm private employment in the service-providing sector fell by 473,000. Employment in the goods-producing sector declined 220,000, the twenty-third consecutive monthly decline. Employment in the manufacturing sector declined 120,000, marking its twenty seventh decline over the last twenty eight months.

Large businesses, defined as those with 500 or more workers, saw employment decline 91,000, while medium-size businesses with between 50 and 499 workers declined 321,000. Employment among small-size businesses, defined as those with fewer than 50 workers, declined 281,000. (Notice the big hit taken by the smaller businesses, where most jobs had been created in the prior recovery. This is not good, and bodes ill for safe haven aspect of the broader stock equity indices. - Jesse)

Sharply falling employment at medium- and small-size businesses clearly indicates that the recession has now spread well beyond manufacturing and housing-related activities.

In December, construction employment dropped 102,000. This was its twenty-first consecutive monthly decline, and brings the total decline in construction jobs since the peak in January 2007 to 809,000.

A Budget Forecast from President-elect Obama

"Trillion dollar deficits for years to come, even with an economic recovery."

Should we get Bernanke a truss?

Yikes!

Obama Says Deficit Likely to Approach $1 Trillion
By Julianna Goldman and Roger Runningen

Jan. 6 (Bloomberg) -- President-elect Barack Obama said he expects to inherit a $1 trillion budget deficit and that similar shortfalls are in store “for years to come” as the government grapples with a recession and other spending demands.

A “trillion dollar deficit will be here before we even start the next budget,” Obama said after meeting in Washington with his economic advisers, including Peter Orszag, who has been designated as director of the Office of Management and Budget.

“Potentially we’ve got trillion-dollar deficits for years to come, even with the economic recovery we are working on...”

Bill Poole: The Fed is Now Expanding Its Balance Sheet by Printing Money

We have long held Paul Volcker, William Poole and Jerry Jordan in high respect as former Fed governors. When they speak we listen, although Jerry seems to be more reticent, enjoying his retirement these days.

In a discussion with Kathleen Hays this afternoon during her "On the Economy" show on Bloomberg Television, Bill Poole took uncharacteristically sharp exception to the latest decisions by the Bernanke FOMC from their December Meeting minutes.

"The Fed is now expanding its balance sheet by printing money."

He was also visibly perturbed that the FOMC appears to no longer be stepping up to managing the money supply which is its mandate, but rather is allowing the Board of Governors to expand the money supply 'willy-nilly' with no eye to targets, just an uncoordinated roll out of special facilities.

For a minute we had to make sure this was Bill Poole speaking and not Willem Buiter, who delivered a round house commentary at Jackson Hole on the Bernanke Fed.

Yes, this is not the first time you have heard this, that the Fed is now printing money, monetizing the debt, especially if you are a regular reader here.

But it was unmistakable that in Bill Poole's mind the FOMC has now "crossed the Rubicon" and "will greatly regret their recent decisions in the future."

Jimmy Rogers has it right. "Bernanke’s going to keep printing money until they run out of trees."

The Fed is confident that they know how to stop inflation after the Volcker era, this much they have said, and it is clear they are acting on that belief.

A lot of theories are going to be road-tested, and the experiment in monetary and Keynesian economics will be rigorous.

This will be interesting, indeed.

Facilis descensus Averno;
Noctes atque dies patet atri ianua Ditis;
Sed revocare gradum superasque evadere ad auras,
Hoc opus, hic labor est.

Smooth is the descent, the way down below;
Day and night the gates of Hell stand wide open;
But to retrace your steps, and return to clear skies:
This is the task, this is the real work.

Vergil, Aeneid

The Treasury Bubble and the Central Banks: Imbalance à Go Go

The astute observer may notice a trend change in the way that foreign central banks choose to deploy their dollar reserves while supporting their industrial policies.

There should be little doubt why there is a bubble in Treasuries, and why the Federal Reserve is in the market buying mortgage debt.

Willem Buiter Warns of a US Dollar Collapse While China Makes a Move

This UK Telegraph story below is a bit florid in its reporting based on selective quotations from an otherwise phlegmatic column by the Maverecon, Willem Buiter in the Financial Times titled Can the US Economy Afford a Keynesian Stimulus?

Its an interesting essay, and it is hard to argue with his thesis, since it has been the recurrent theme of this blogwriter since 2000. He is directionally correct.

But M. Buiter seems to miss the key placement of pieces in this stage of the game, seeing only one aspect of the play. He sees the weakness of the US, and the corruption and mismanagement of the US financial system, which, somewhat ironically, describes that of Europe as well (and Russia and China). The European banking system has been a house of cards for some time.

He believes that the rest of the world will shun US financial investments based on the broken myth of US financial efficiency. It was an illusion, and it has been dispelled. And we do not think that it was ever really the linchpin of the dollar hegemony.

Many private parties have already fled US financial investments, and in turn a great deal of money has come back to the US from the developing nations. So here we are.

The question is not whether the US can afford a Keynesian stimulus package.

The real question can the rest of the world afford a US Keynesian stimulus package? And if not, what will the world do about replacing the US dollar as the world's reserve currency and the basis for most international trade?

More specifically, how will China, Japan and Saudi Arabia migrate to an industrial policy that is independent of the need to export goods to the United States while maintaining low wages and domestic consumption, and relatively low defense spending?

China, not depending on the US military as a shield, will likely make the first moves, as they are reported to be making tentative steps in this direction, as in this overstated report from AsiaNews.it Chinese Yuan Set to Replace US Dollar. The odds are high that China will play into a US geopolieconomic strategy by attempting to do the obvious, in an obvious way.

This is not to say that there will be no change, ever. There will, since the dollar has not always been the faux gold standard, and will not always be.

But there is a decided lack of original thinking on the matter, and a definite lack of will to do much about it, in the rest of the world.

So until then, it is status quo, and the US can afford anything it wishes. Because it can, and it will.
That is the current position of the pieces on the board.


UK Telegraph
Willem Buiter warns of massive dollar collapse
By Edmund Conway, Economics Editor
05 Jan 2009

Americans must prepare themselves for a massive collapse in the dollar as investors around the world dump their US assets, a former Bank of England policymaker has warned.

The long-held assumption that US assets - particularly government bonds - are a safe haven will soon be overturned as investors lose their patience with the world's biggest economy, according to Willem Buiter.

Professor Buiter, a former Monetary Policy Committee member who is now at the London School of Economics, said this increasing disenchantment would result in an exodus of foreign cash from the US.

The warning comes despite the dollar having strengthened significantly against other major currencies, including sterling and the euro, after hitting historic lows last year. It will reignite fears about the currency's prospects, as well as sparking fears about the sustainability of President-Elect Barack Obama's mooted plans for a Keynesian-style increase in public spending to pull the US out of recession.

Writing on his blog, Prof Buiter said: "There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place."

He said that the dollar had been kept elevated in recent years by what some called "dark matter" or "American alpha" - an assumption that the US could earn more on its overseas investments than foreign investors could make on their American assets. However, this notion had been gradually dismantled in recent years, before being dealt a fatal blow by the current financial crisis, he said.

"The past eight years of imperial overstretch, hubris and domestic and international abuse of power on the part of the Bush administration has left the US materially weakened financially, economically, politically and morally," he said. "Even the most hard-nosed, Guantanamo Bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed."

He said investors would, rightly, suspect that the US would have to generate major inflation to whittle away its debt and this dollar collapse means that the US has less leeway for major spending plans than politicians realise.

Is the Comex Doing Fractional Reserve Delivery of Gold?

An acquaintance who works for a small precious metals fund sent this to us today, asking if we had ever heard of anything like it.

The short answer is no, but this is not a strong area of specific expertise and recent experience for us, and we never attribute to a bad intent what we can attribute to sheer incompetency, especially when dealing with large organizations.

But when one is promised specific bars with specific serial numbers of a specific size and weight one week, and they are not available the next week when you confirm that you wish to receive them, that brings up the same kind of red flags that have been so notoriously ignored by regulatory agencies in other recent cases. Of course the Comex is no Bernie Madoff.

It does bring into question the integrity of the Comex records and their contracts, and the condition of their audits and inventories. We would have a fit if someone did this to us after an online auction or a personal purchase transaction. Why should the Comex be allowed to sell what it does not have, and then dictate new terms after the fact? Especially when this same customer had been routinely taking delivery off emini contracts from Comex before this.

And it does put a fresh emphasis on the old adage, "When in doubt, take it out."

We accumulated 3 emini gold contracts on CBOT for December delivery and we had been given serial numbers and weights last week for the 3 bars we were to receive.

Today we are informed that Comex is invoking a rule in which they can deny delivery of individual mini bars (roughly 33 ounces) and issue you only a Warehouse Delivery Receipt (WDR) against your mini-contract unless you have 3 WDR's, and then they'll issue you a 100 oz. bar.

Otherwise, if you have only 1 or 2 mini-contracts, you only own a WDR, which you sell by shorting a mini against it. If you own a WDR for a 100 oz., they encourage you to safekeep the gold at the Comex and hold a vault receipt.

CLEARLY, the Comex has run out of the bars that were being delivered to holders of emini contracts. Our back-office guy told us that he's been doing Comex deliveries for 30 years and he's never seen anything like this, and he's never heard of this rule on the mini contract. (update: its in the contract if you read it - Jesse)
Fortunately we have 3 WDR's and we will be getting delivery of a 100 oz. Comex gold bar.

But this whole episode brings into the question the validity of the Comex gold inventory. More importantly, the Comex is now going to issue WDR's, which are paper.

Are they becoming a "fractional" reserve depository, where they can issue several WDR's against the same bar of gold, knowing that some of those people will opt to keep storage on Comex and never require actual physical delivery?"

JP Morgan's Forecast of Commodity Price Changes From Index Rebalancing

You may click on the link as usual for the full story and a detailed breakdown of the analysis.

In summary JP Morgan's forecast of the commodity index rebalancing which will done around January 8-9th is:

...we expect the rebalancing to have the greatest impact in gold, COMEX copper, crude oil, gold, and live cattle. We estimate that the rebalancing of the two indices is expected to result in $877 million of selling in gold, $699 million of buying in COMEX copper, $528 million of selling in live cattle, and $523 million of buying in crude oil.

We would expect the impact of the index rebalancing to be felt this week because of 'frontrunning' of the index changes by the big commodity trading desks. Indeed we may find that by the time the changes are realized, the impact may be significantly discounted.

Financial Times - Alphaville
Beware, commodity index rebalancing ahead
By Izabella Kaminska
Jan 05 15:34

The major commodity indices rebalance their respective asset weightings once a year (or occasionally more) — and with that comes a mass dose of buying and selling. The 2009 rebalancing is expected to start sometime this week.

Luckily, JP Morgan has produced its best guess of how the 2009 reweightings of the DJ AIGCI and the S&P GSCI indices will impact the market.

The weightings for both indices are released ahead of time, but begin to kick in the first few working days of the new year. In the case of the DJ-AIGCI — which JP Morgan estimates has $25bn in funds tracking it — the new weightings come into force during the roll period that begins January 9th. The S&P GSCI index weightings kick-in after its January roll which commences January 8th. JP Morgan estimates about $50 bn of investment into that index...

Paulson Hitting a High Note in Treasury Debt Issuance

One might surmise that Treasury is hitting a hard high note on the Three Year Treasury issuance because this is the preferred duration of the central banks of China, Saudi Arabia and Japan among others, on behalf of their people.

At some point the Ten Year Note may become the favorite product of Mr. Bernanke, our own central banker, as a chaser to the the junk bond cocktails he is chugging down now.

As an aside, check out the action on the long end of the curve today in Big Daddy, the 30 Year Bond.

Across the Curve
Treasury Supply
By John Jansen
January 5th, 2009

Henry Paulson is not following the sage counsel of TS Eliot and is instead going out with a bang rather than Eliot’s whimper.

The Treasury announced today that they will auction $30 billion 3 year notes on Wednesday. The increase in issuance here is stunning. The 3 year was reintroduced in November at $25 billion. In its previous reincarnation it was a quarterly issue.

The US government has a desperate need for cash and in their infinite wisdom the debt managers chose to place this bond on a monthly cycle. In the span of two months they have bumped the total from $25 billion to $30 billion. If we start with the November issue and make the poor assumption that they will not tweak this again, the Treasury will raise an incredible $353 billion the 3 year sector in the year that ends October 31 2009.

The Treasury also announced the reopening of the 10 year note for a second time. Treasury issued $20 billion in November and $16 billion when they reopened it in December.

Prior to November the 10 year auction occurred eight times each year. This is the first announcement of the expanded monthly cycle for that issue and they will sell $16 billion this time. That means that the taxpayers have issued $52 billion to the public of this mega issue.

Previously the Treasury had announced that it would sell $8 billion TIPS tomorrow.

I rarely wade into the bill pit but to make the point I would be remiss if I did not note the supply in that market.

Each Monday since time immemorial Treasury has issued three month bills and six month bills. Today is no different and they will raise in total $53 billion in those auctions.

I do not have the auction dates but the Treasury will also sell $24 billion four week bills and $35 billion special 70 day bulls this week.

Sister Consolata taught me very well in grammar school ( they taught grammar in the 1950s. We would diagram sentences) and the sum of those numbers is $166 billion.

Against that background, I suggest that Hank Paulson is leaving a blazing trail of glory in his wake.

Obama Uses the "S" Word

In a televised interview with House Speaker Nancy Pelosi, president-elect Obama stressed the need to quickly craft an economic recovery plan because "the employment report at the end of this week will be sobering."

The plan to be considered by the new Congress, which will be sworn in tomorrow, is expected to include middle class and small business tax cuts.

A small group of Republicans will continue to oppose any aid not directed at wealthy individuals and large corporations in a histrionic show of newly-discovered indignant fiscal responsibility.

The resultant plan will be a band-aid on a gaping wound. The work of substance is yet to be seen.

Privatized Social Security, Italian Style

Here are a few lessons which can be learned from the Italian experiment with privatized Social Security:

1. The average person does not understand, and is incapable of understanding and accepting, the relationship between higher return and higher risk.

2. The Wall Street bankers and economists apparently do not understand this either, so we ought not to be too hard on the average person for their shortcomings.

3. Higher risk investments are always and everywhere inappropriate choices for a fixed income investment plan with near term payment goals.

4. When the going gets tough, everyone will expect to get bailed out, in shameless geometric proportion to their social standing, influence, and personal income.

5. When it comes to economics the average person will suspend their common sense for as long as is possible.

6. Those in positions of power will promote the suspension of common sense and popular delusions for the sake of confidence. This is why it is called a confidence game.

7. If the fundamentals of an economic plan are 'confusing,' seeming to provide superior returns for extended periods of time with no effort, it is a fraud. (eg. the US dollar.)

8. Whatever pension plans are promoted for the public MUST include all government officials, including the Ministers, Legislators, and Judiciary, to have any hope of success.

9. Whenever the private financiers 'help' the legislators make a troublesome problem disappear the eventual losses are certain to be especially heavy.

10. Despite what this Bloomberg story says the US avoided nothing because of voter outrage; the public and private pension funds are simply being stolen. (See #6 above).

Bloomberg
Italian Pensions Sapped by Private Funds Bush Backed
By Andrew Davis and Alessandra Migliaccio

Jan. 5 (Bloomberg) -- Italy did for retirement financing what President George W. Bush couldn’t do in the U.S.: It privatized part of its social security system. The timing couldn’t have been worse.

The global market meltdown has created losses for those who agreed to shift their contributions from a government severance payment plan to private funds meant to yield higher returns. Anger is rising both at the state, which promoted the change, and money managers such as UniCredit SpA and Arca Previdenza, which stood to profit.

Prime Minister Silvio Berlusconi’s administration is now considering ways to compensate as many as 1.2 million people who made the switch, giving up a fixed return for private plans linked to financial markets. It’s also letting people delay redemptions on retirement funds to avoid losses after Italy’s benchmark stock index fell 50 percent in 2008, destroying 300 billion euros ($423 billion) in wealth.

Italy’s experience shows how difficult it is to solve a problem facing governments from the U.S. to Europe to Japan as populations age and the old system of taxing workers to support retirees becomes unsustainable. Bush failed to persuade Congress to let workers put a portion of their Social Security taxes into privately invested accounts as voter opposition increased.

Standard Plan

For a quarter of a century, employers in Italy have paid about 7 percent of each worker’s annual salary into the severance system, called TFR. Workers received lump-sum payouts whether they retired, were fired or simply changed jobs.

Someone earning 80,000 euros a year would receive more than 200,000 euros in TFR after 35 years on the job and more than 60,000 euros after a decade of work. The fund pays a fixed return that aims to exceed inflation.

The program was a tempting target for a government struggling to meet its pension obligations. Italy spends about 14 percent of gross domestic product on pensions, the most in the European Union. Spain spends 9 percent and the U.K. 7 percent.

Italy has the EU’s lowest birthrate of 1.3 children per woman. By 2050, the country will have fewer than two working-age people for each person over 65, the lowest ratio in the EU, according to Eurostat, the bloc’s statistics agency.

Pensions Cut

Previous governments adopted measures to lower pension payouts and force workers to retire later. Benefits will drop to as little as 30 percent of a worker’s final salary from about 75 percent now, creating an incentive for Italians to seek higher returns by moving severance funds into a complementary plan.

Gaetano Turchetta, a Rome office manager, made the irreversible move to a private plan after a union representative boasted of the potential for 20 percent annual returns. The 43- year-old father of three now says he would sign with “two hands and two feet” if he could switch back.

“What do I want from the government?” he said. “Just not to become a burden on my kids.”

The TFR plan was meant to dent Italy’s risk-averse culture and lure more people to investment funds, said Biagio Masi, head of Banca Sella SpA’s insurance unit, who called the shift a “world-shattering change in mentality.” (Government as debt dealer for the bankers - Jesse)

Low Investment Rate

Eight percent of Italians invested in stocks in 2008, half the level of 2002, according to an Oct. 30 report commissioned by Acri, the country’s savings bank association. About 80 percent favored keeping their savings in the bank and 25 percent have a private pension or life insurance, the report said.

Money managers such as UniCredit, Italy’s largest bank, and Arca Previdenza, the biggest pension fund manager, lobbied customers to make the change, seeing it as an opportunity to kick-start a moribund fund management industry. (Fee Seeking - Jesse)

Funds under management in Italy have shrunk by a quarter in the past seven years, according to the Bank of Italy. The value of pension funds is equal to about 3 percent of GDP, compared with more than 90 percent in the U.S.

Even with full-page newspaper ads, billboards and telephone hotlines spurring Italians to switch, only 1.2 million people, or 10 percent of the eligible private-sector workers, chose to give up the TFR for private plans before the June 2007 deadline, according to fund regulator Covip. Italian lawmakers approved the reform at the end of 2006. It was part of the 2007 budget proposed by former Prime Minister Romano Prodi’s government.

Caveat Emptor - Buyer Beware - In Times of General Corruption

Here are some excerpts from the Op-Ed piece by Michael Lewis and David Einhorn that appeared in the NY Times on Saturday.

It is a portrait of government in partnership with a corrupt financial system, in a remarkably cynical and materialistic age, generally ignored by a frightened and complacent people.

And where was the outrage? Where was the rest of the world? Turning a blind eye to the corruption and enjoying the returns. Like many of Madoff's enablers and investors they thought they were insiders, the smart ones, and saw only the gains, ignoring the rest, and the eventual outcome.

This is not an historical review, as the problems still remain, a little exhausted, but largely uncorrected. No confessions of guilt, just denials, excuses, diversions and coverups.

Caveat Emptor. Buyer beware.


NY Times
The End of the Financial World as We Know It
By MICHAEL LEWIS and DAVID EINHORN
January 3, 2009

AMERICANS enter the New Year in a strange new role: financial lunatics. We’ve been viewed by the wider world with mistrust and suspicion on other matters, but on the subject of money even our harshest critics have been inclined to believe that we knew what we were doing. They watched our investment bankers and emulated them: for a long time now half the planet’s college graduates seemed to want nothing more out of life than a job on Wall Street...

Incredibly, intelligent people the world over remain willing to lend us money and even listen to our advice; they appear not to have realized the full extent of our madness...

Our financial catastrophe, like Bernard Madoff’s pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today’s financial markets is immense...

Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that’s the problem: there is no longer any serious pressure from outside the market. The tyranny of the short term has extended itself with frightening ease into the entities that were meant to, one way or another, discipline Wall Street, and force it to consider its enlightened self-interest...

Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become. Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors.

The instinct to avoid short-term political heat is part of the problem; anything the S.E.C. does to roil the markets, or reduce the share price of any given company, also roils the careers of the people who run the S.E.C. Thus it seldom penalizes serious corporate and management malfeasance — out of some misguided notion that to do so would cause stock prices to fall, shareholders to suffer and confidence to be undermined. Preserving confidence, even when that confidence is false, has been near the top of the S.E.C.’s agenda.

It's not hard to see why the S.E.C. behaves as it does. If you work for the enforcement division of the S.E.C. you probably know in the back of your mind, and in the front too, that if you maintain good relations with Wall Street you might soon be paid huge sums of money to be employed by it...

In the middle of all this, Treasury Secretary Henry M. Paulson Jr. persuaded Congress that he needed $700 billion to buy distressed assets from banks — telling the senators and representatives that if they didn’t give him the money the stock market would collapse. Once handed the money, he abandoned his promised strategy, and instead of buying assets at market prices, began to overpay for preferred stocks in the banks themselves. Which is to say that he essentially began giving away billions of dollars to Citigroup, Morgan Stanley, Goldman Sachs and a few others unnaturally selected for survival...

A New Year's Resolution on US Financial Markets from the Incoming Administration

These are strong, almost startling words from Bart Chilton, part of Obama's incoming administration, currently on the CFTC.

The message is good and to the point. The illustration of the performance of the regulators over the past ten (not eight) years is remarkable, an indictment of the existing Federal regulatory system as a whole.

Actions will speak louder than words. We will all look forward to seeing what happens in Washington over the next few months, and in particular, what is done by the CFTC and the SEC in reforming US financial markets.

Washington
Time to restore mission of regulators
By Bart Chilton
January 1, 2009

In the building that currently houses the president-elect's transition team, there used to be an imposing bronze plaque with the visage of the Securities and Exchange Commission's redoubtable third chairman, William O. Douglas. It was emblazoned with the inspiring legend, "We are the Investor's Advocate."

For many decades, the SEC enjoyed the reputation of living up to the noble standard of public service. The plaque no longer graces the entryway of the SEC's new quarters, and with the recent revelations of failure to detect and prosecute incidents of egregious securities fraud and abuse, both internally and externally, the agency's reputation has been severely tarnished.

These types of disclosures make us as public servants ask some fundamental questions: Why are we here? The Founding Fathers had the answer: We are employed to protect the common wealth and serve the public good. We are not here to serve amorphous philosophical, economic or ideological concepts such as "financial markets" or "economies."

Our task is to serve the public -- those people in the hinterlands, many of whom have recently lost 30 percent or more of their retirement funds and/or home values and who now face losing their jobs. Our "client," our "constituent," is the American consumer and worker, the businessman or woman who generates and uses the products and services that comprise our "markets" and our "economy." If we fail to protect, first and foremost, these individual Americans, we cannot succeed in assuring the strength of our economy, nor in protecting the integrity of our financial market system.

Do we need to have statutes and regulations in place to ensure reliability of the marketplace? Of course we do, but over the past decade "the marketplace" has been exalted to a position perceived as virtually omnipotent and omniscient, while consumer protections have been generally neglected. The consequence lies scattered around us.

By veering too sharply to the right and letting go of the regulatory reins, we provided neither the market nor the consumer a great service. Rather we harmed both, and have a long hike to escape the resulting global economic meltdown. We must be careful not to over-correct -- not to go so far in the other direction that we stifle innovation and market growth. But it is clearly time for federal financial regulators to re-evaluate our current statutes and regulations, and to put "common sense rules of the road," as the president-elect has suggested, in place to protect consumers and bring our economy back into balance.

The SEC isn't the only federal financial regulator to have failed in serving the public. The Treasury Department appears to have lost its way as well, when a $700 billion bailout package, purportedly written to ensure against unconscionable executive compensation was, within weeks after passage, found to have a loophole allowing such compensation.

Federal banking regulators seem to be off course, permitting casino-like buying and selling of trillions of dollars worth of virtually worthless transactions. When gasoline topped $4 a gallon, the Commodity Futures Trading Commission dropped the ball, unable to oversee speculation's uneconomic role in the U.S. commodities markets.

In decades past, the CFTC has been charged with being too tied to the industry, too closely aligned with the regulated, and overly concerned with protecting "markets" rather than consumers. We've made good progress, and there are very fine people in all of these agencies and departments, but we too can and must do much better.

I have advocated a comprehensive legislative reform of the laws governing over-the-counter trading, and requested that authority over these critically important markets be vested in the Commodity Futures Trading Commission. The CFTC, a small agency in comparison to the SEC, has exclusive jurisdiction over risk-management markets in the United States, and has in recent years carved several significant notches in its enforcement belt.

At any one time, this small agency, with one-tenth the enforcement staff of the SEC, is investigating or prosecuting anywhere between 750 and 1,000 individuals or entities for violations of the Commodity Exchange Act. The agency has, just in the past year, tagged bad actors with more than $630 million in fines and settlements, in actions involving fraud, manipulation and other misconduct. Not a bad record for a small agency operating on a shoestring budget -- and we'd be able to do even more if given the authority.

With the collapse of the economy, the transition of government already under way with the new Obama administration, and the appointment of an excellent new federal financial regulatory team, it will soon be time to implement this new legislation, and similar consumer protection initiatives.

Also, we need to restore the clarity of our own mission in government: that we are here to assure financial opportunity and market fairness to the public. We need to regain the public trust.

With a shared vision of our mission and much needed reforms, our duties and responsibilities will flow clearly. Chief among these duties is a strong and aggressive enforcement arm. Markets must be free from fraud and manipulation for them to operate as they should -- for all Americans. This baseline approach to enforcement protects consumers and allows for open and free markets that are able to grow and innovate.

Investor's Advocate: A good legend, apparently forgotten. All federal financial regulators should use a new door sign: Consumers First. Everything else will follow.

Bart Chilton is a commissioner on the Commodity Futures Trading Commission, a Democrat, and a member of the Obama transition team.

The Last Time the Feds Devalued the Dollar to Save the Banks

The Last Time the Feds Devalued the Dollar to Save the Banks
14 January 2009

We dipped once again into the Federal Reserve Bulletin Publication from June, 1934 to take a closer look at the growth of the monetary base, and found an interesting graphic that shows the accounting for the January 1934 devaluation of the dollar and the subsequent result on Bank Reserves in the Federal Reserve System.

As you will recall, the Gold Act, or more properly Executive Order 6102 of April 5, 1933, required Americans to surrender their gold coinage and certificates to the Federal Reserve Banks by May 1, 1933. There were no prosecutions for non-compliance except one benchmark case which was brought voluntarily by a person who wished to challenge the act in court.

After a substantial portion of the gold was turned in by US citizens and taken from their bank based safe deposit boxes, the government officially devalued the dollar from 20.67 to 35.00 per ounce in the Gold Reserve Act of January 31, 1934.

The proceeds from this devaluation were used to provide a significant boost to the Federal Reserve member bank positions as shown in the first chart below.

The inflation visited on the American people because of this action helped to take the CPI as it was then measured up 1200 basis points from about -8% to +4% by the end of 1933. To somewhat offset the monetary inflation the Fed also contracted the Monetary Base which served the nascent recovery in the real economy rather poorly and is viewed widely as one of a series of policy errors.

Considering that the actions did little for the employment situation this was painful medicine indeed to those who were dependent on wages.



Fortunately at the same time FDR was initiating the New Deal programs which, despite continual opposition from a Republican minority in Congress, managed to provide a small measure of relief for the 20+% public that was suffering from unemployment and wage stagnation.

People ask frequently "Will the government seize gold again?"

While there is no certainty involved in anything if a government begins to overturn the law and seize private property, one has to ask for the context and details first to understand what happened and why, to understand the precedent.

Technically, the government did not engage in a pure seize of private property, since at that time the US was on the gold standard, and much of the gold holdings of US citizens were in the form of gold coinage and certificates.

Governments always make the case that the currency is their property and that the user is merely holding it as a medium of exchange. The foundation of the argument was that the government required to recall its gold to strengthen the backing of the US dollar against the net outflows of gold for international trade. The devaluation helped with this as well, since dollars brought less gold for trade balances.

People also ask, "Why didn't the government just revalue the dollar without trying to recall all the gold from the American public?"

The answer would seem to be that this would have been more just, more equitable recompense for the public. The Treasury could have purchased gold from the public to support its foreign trade needs.

But it would have left much less liquidity for the banks.

One can make a better case that the recall of the gold, with the subsequent revaluation to benefit a small segment of the population in the Banks, was a form of seizure of wealth without due compensation. Hence the lack of active prosecutions.

So, will the government take back gold again to save the banks by devaluing the dollar?

Highly unlikely, because they not only do not need to this, since the dollar is no longer backed by gold, and is a form of secular property except perhaps for gold eagles, but they do not have to, because they are devaluing the dollar already to save the banks.

This time the confiscation of wealth to save the banks is called TARP.

If one thinks about it, US Dollars are being created and provided directly to the banks to boost their free reserves significantly, at a scale comparable and beyond to 1933-34.

The confiscation of wealth is being spread among all holders of US dollars and dollar assets, foreign and domestic, in the more subtle form of monetary inflation.

Granted, the government must be more opaque to mask their actions in order to sustain confidence in the dollar while the devaluation occurs, but this is exactly what is happening, and all that is required to happen in a fiat regime.

There is no need to seize widely held exogenous commodities like gold and oil, but merely dampen any bellwether signals that a significant devaluation of the dollar is once gain being perpetrated on the American people in order to save the banks.

Its fascinating to look carefully at this next chart below.



First, notice the big drop in gold in circulation of 9.8 million ounces, or roughly 36% of the measured inventory at the end of 1932. Think someone was front-running the dollar devaluation? We suspect that the order went out to start pulling in the gold stock to the banks.

The reduction in gold in circulation AFTER the announcement of the Gold Act in April would be about 3.9 million ounces, or roughly 22% of the gold remaining in circulation in March 1933.

Considering that all gold coinage held by banks in the vaults was automatically seized, the voluntary compliance rate is not all that impressive. We are not sure how much of this was being held in overseas hands by non-US entities.

But beyond a doubt, there was a unjust, if not illegal, seizure of wealth by requiring citizen to turn in their gold to the banks, which was then revalued at the beginning of 1934 by 69% from 20.67 to 35 dollars.

It would have been much more equitable to devalue the dollar and to change the basis for dollar/gold first, before requiring private citizens to surrender their holdings. But of course, this would have lessened the liquidity available for direct infusion into the Federal Reserve banks.

Chicago Fed Says Take Interest Rates "Below Zero" and Monetize Debt (to Devalue Dollar)

Quantitative easing to mimic interest rates 'below zero' effectively penalizes the buyers of US bonds and dollar savings by providing a negative rate of return after inflation.

Inflation is desirable if you are a net debtor and you control the value of the method of your payment, ie. cheaper dollars to pay off service your debt.

We have to wonder how well negative real interest rates will support the enormous increase in the supply of Treasury debt that is coming to market this year because of a soaring national debt of about two trillion dollars.

The obvious target buyers are the exporting countries such as OPEC, Japan and China. We also suspect the Fed will start buying the yield curve, quietly and indirectly if not transparently.

Other central banks, such as Europe, will be expected to follow suit and devalue their own currencies through lower rates, to decrease the perceived impact of a dollar devaluation, in a group 'ratcheting down' of the developed nations' currencies.

This will require 'management' of the price of real things like commodities. Fortunately the price for most of them is set in London and New York. Life is tough for an exporting nation when you are riding the dollar reserve currency regime and an industrial policy of 'beggar your people' to support it.

The boundary constraint on the Fed in a purely fiat regime is the value of the US dollar and the Treasury debt. Greenspan's Fed managed to inflate its way out of the tech crash of 2000-2 with bubbles in equities and housing prices, a significant dollar devaluation, but an amazingly resilient bond thanks to official buying by a few foreign central banks.

Alan Greenspan famously stated, in a repudiation of his earlier views while responding to Congressman Ron Paul, that a fiat dollar as the reserve currency is viable because "the Federal Reserve does a good job of essentially mimicking a gold standard and...the Fed does not facilitate government expansion and deficit spending."

We expect to see Bernanke and the Congress test the limits of monetary and Keynesian economic theory again this year, and the acceptance of the US dollar and fiat currencies as a faux gold standard, as being of the utmost integrity and impartiality, immutable and nationless.

We tend to remain skeptical of the outcome however, keeping in mind the words of George Bernard Shaw, "You have a choice between the natural stability of gold and the honesty and intelligence of the members of government. And with all due respect for those gentlemen, I advise you, as long as the capitalist system lasts, vote for gold."

The major challenge for the governments of the world for the remainder of this decade, other than blowing us all to pieces, will be to create a viable alternative to the US dollar as the world's reserve currency and a major vehicle for international trade.

This could be one for the record books.



Reuters
Evans says Fed needs to mimic below-zero rates
By Ros Krasny
Sat Jan 3, 2009 8:18pm EST

SAN FRANCISCO (Reuters) - A grim economic outlook highlights the need for the Federal Reserve to step up quantitative measures to boost growth, with official interest rates already effectively at zero, Charles Evans, president of the Chicago Fed, said on Saturday.

Evans said that based on the outlook for rising unemployment, falling industrial production and a wider output gap, economic models suggest rates should be below zero.

"If it were not constrained by zero, those models would want to push it below zero, but that's not possible," Evans told reporters after a panel at the American Economic Association's meeting in San Francisco.

Quantitative easing, a way to flood the banking system with large amounts of money, "is a way to mimic below-zero rates and provide support to the economy," he said. (They would intend to create a monetary inflation to take the 'real rate' below zero. "Quantitative Easing" is Fedspeak for "printing money." - Jesse)

The process often involves buying up large quantities of assets from banks, such as the Fed's latest programs to buy mortgage-backed securities. (This is known as "monetizing debt." - Jesse)

In December, the Federal Open Market Committee, the Fed's policy-setting body, took the surprising step of lowering the federal funds rate to a range of zero to 0.25 percent. Cash fed funds had been trading below the previous 1 percent target rate for several weeks.

In his remarks, Evans, who is a voting member of the FOMC in 2009, said the Fed's various lending programs should help cushion the impact of the year-old U.S. recession but a large traditional fiscal stimulus plan is also needed, even with the problems it could create over the longer term.

"I believe a big stimulus is appropriate," Evans said. "But it is sobering to be deploying large amounts of taxpayer funds at a time when our fiscal balance sheet is already coming under significant stress."

Without the Fed's programs to help unfreeze credit markets and to-the-bone rate cuts, "the downturn -- and its costs to society -- would be even more severe than what we are currently facing," said Evans.

Since the financial market crisis erupted, the Fed has created several new programs aimed at bypassing the traditional banking system and smashing through the credit-market logjam, including the direct purchase of mortgage-backed securities.

Even so, the U.S. jobless rate appears on pace to exceed 8 percent in 2009, from the most recent reading of 6.7 percent in November, Evans said.

Although the current recession started with the collapse of the U.S. housing market, Evans said many non-financial industries now face the risk of "long-term structural impairment." (It was the Fed's reflationary effort after the Crash of 2000-2 that created the housing bubble. - Jesse)

Evans said fiscal programs to support growth "must be large in order to be effective and to instill badly needed confidence" given the severity of the downturn. (We have an intuition that the Congress will meaningfully explore the concept of 'large' government programs - Jesse)

President-elect Barack Obama has said that signing a major economic stimulus package will be his first priority when he takes office on January 20, with a goal of creating 3 million jobs over two years.

Evans also said the market crisis that erupted in 2007 showed huge holes in financial regulation.

"Significant weaknesses have been revealed in our system of financial regulation. ... These failures call for a reassessment of the roles of market discipline and our regulatory structures," he said

US Equities Are Short Term Overbought - Watch Treasuries and VIX for a 'Tell'

With the McClellan Oscillator, although the reading is now at an extreme high, it will be the character of the decline from the extreme that will tell us if we are going to get a sideways consolidation or a serious decline for the first month of the new year.



The Bullish Percent is running in neutral, although the SP is at a high reading in its channel. IF the indicators turn lower and break down then we will see a correction lower, and perhaps a major decline.



There is an abnormally large amount of money hiding in Treasuries. If this starts coming out of the safe havens and into stocks we may see follow through. Keep an eye on the yield curve, especially the longer end.

Corporate profit forecasts have not fully discounted the severity of the recession. On the bullish side, the Fed is pouring money into the economy, as noted in the Adjusted Monetary Base.

If they do manage to trigger a sustained rally it may be sharp. There was a significant rally after the Crash of 1929. However, we don't expect this until later in the first quarter, and it will be met with waves of selling and a new low unless the Fed can do something truly exceptional.

We like ot use the January Indicator if its a down month, because the correlation to a predictable result is higher.

Money Supply: A Primer

You walk into a Merchant and a sign says, "All Items on Sale Today for Cash Only No Credit."

You are interested in purchasing an item. The Merchant, being a crafty sort asks "How much money do you have to spend(in US dollars)?"

How would you answer that if you are being truthful?

You might start by looking into your wallet and pockets, and counting all the cash and coins you have with you at that moment.

M0: Monetary Base

This is equivalent to the monetary base, or M0. It is money you have that is immediately available requiring no change or conversion. There is very little risk to the merchant, unless it happens to be counterfeit which is easily verified.

"Not enough" says the Merchant. "I am sorry, but do you have more?"

M1

Then you remember that in addition to cash, you have your checkbook with a current balance in it, and a debit card to an account you maintain in a local bank, but with no overdraft or lines of credit provisions.

That plus the currency in your pockets is M1. See the difference? You do not have ALL your money in your pockets for immediate presentation, but with a little transactional effort the money is readily available and it is inherently your money, it belongs to you. It is just being held elsewhere besides your pockets and wallet. The merchant assumes a little more risk, but he can quickly call your bank to verify that the funds are available for the check, and the debit card is even more mechanized. More risk, a little more delay, but almost as 'good as cash.'

"I am sorry sir," says the Merchant, "but this is still not enough to exchange for such a valuable object as I have for sale here."

M2

You think about it, and remember that you have a savings account across the street at the bank, and a money market fund at your brokerage office next door, that have more of your money on deposit. You have no cards for those accounts, but it would be an easy thing to walk next door or across the street and obtain the cash.

This is M2. There is a more complex transaction involved, since the transfer is not electronic as in the case of a debit card, and you must leave the store to obtain the money in the form of currency unless they bring it over to you. But it is your money that is available to you on demand. There is a small amount of risk of your bank not being solvent when you need the money, but these are slight inconveniences compared to the safety of not carrying around large sums of money that earn no interest in the form of cash.

"I am so sorry," says the Merchant. "But this item is far too valuable to part with for such a sum as you have offered."

M3

You think about it, and remember that you have a large Certificate of Deposit at the bank across the street that matures in one year. There is a small penalty if you redeem it today to receive your money since you promised it to them for a time in exchange for a specific return, and you must fill out some paperwork, but it is still your money. It involves no sale of an asset or conversion.

That is M3. It involves money that is still yours without borrowing, but has additional conditions set up on it for its retrieval.

One could make the case, and perhaps appropriately so, that while certificates of deposit with a term contract that might effect their value are money, they are not readily available money since the terms of the CD's may differ greatly. They are not 'liquid' and the value before maturity is not always certain due to a penalty.

MZM

If one takes all the things we describe as M2, but takes out the time deposits or certificates of deposit, and includes ALL money market funds, that is what the Fed considers to be the broadest measure of liquid money, or Money of Zero Maturity (MZM). "Zero maturity" means that the money is not tied up for a period of time to mature to its full value.

Are credit cards or loans Money? No,those are all forms of borrowing something that is not yours that you promise to return with conditions. You are receiving money that was not yours.

Credit Is Not Money.

Credit, or debt, is the 'potential' for money, a way of receiving it.

Whether water is held in a canteen, a well, a cistern, or a private lake, it is still water and it is yours if you own it. So too money is still money if it is yours, no matter under what conditions you hold it or save it for your use.

The cloud of credit, or debt depending on your perspective, is the potential for money as it is defined in our economy. It is a source of money. At a given point in time, you either have the money as your property or you do not.

But the source is not the money itself, and the source can be different and can change over time. In our society borrowing is so common and so technologically convenient that there is little difference in most people's mind between credit and money.

But the difference is that if you spend real money, you incur no obligation for it in the future. You receive no payment request from another at the end of the month.

That is what money is, at least in our economy, and the various measure of money as it is held and shifts through the economy and a variety of transactions, where it flows and rest in pools, and moves again. A measure of the money supply is a snapshot in time.

How money increases or decreases, and how it is stored or held, is a significant indicator of economic activity for those who study such things. It is also significantly affected by custom, technology, and the prevailing mood and perception of the public.

The best and broadest measures of money supply are either MZM, or M2, now that M3 is no longer being reported by the Fed. This can easily be seen from the illustrations.

As springs feed into brooks, and brooks streams, and streams into rivers, and rivers into lakes, so the money supply components change in size and shape over time as money flows from its various sources. The speed of the flow is the 'velocity of money' and as one can easily understand that flow will have a different force and speed depending on when you measure it, and whether you are measuring one of the streams or a major river.

People often prefer to jump into discussions and turn them into debates (arguments) with hair-splitting definitions (what is 'control' of the money supply) and red herrings (why does a dollar cross the road?) before defining any terms or facts and setting some boundaries for the analysis, because their goal too often is not understanding, but to promote some theory or point of view. 'Winning the argument' is their objective, not a search for the truth.

Money is the instrument of the official economy. This gives money a certain arbitrariness over time because, after all, it is the product of a committee. Official money is the creation of government, managed by its agents, validated by the people who use it.

Official money rises and falls from favor to disfavor, as do governments. What if you were a citizen of Zimbabwe? Or the US in the 1860's? Or Germany in 1922? How would you feel about your official money then? Why is it different for you now? What would change your opinion?

What is the 'natural growth rate' of the money supply? Zero?

The discussion of how money supply increases, and who or what determines the supply, and what an appropriate level of growth would be is a matter for discussion on another day. So too is the strange phenomenon of 'natural forms of money' that keep turning up in every era and nearly every society.

But for now at least you have the means to understand what money supply is and how it is measured, and how it is different from potential money, or credit, the representations of money, and asset stores of wealth.

Closing the Books on the First Year at Le Café Américain

Opened for business in December 2007, and added a statistical counter in the beginning of February 2008.



This seems to be the 'run rate.'



Thanks for stopping by throughout the year, and a special thanks for those who were kind enough to drop a note to say 'hello.' It is always good to make your acquaintance.