02 June 2013

Ben Bernanke's Commencement Address at Princeton


There is nothing particularly earth shattering revealed here, just a few choice tidbits perhaps.

I just enjoyed this speech. I wish that Ben and his colleagues were better candidates for a new edition of profiles in courage, possessed a greater breadth of empathy for those whom their decisions effect,  and understood the difference among technical knowledge, sentimentality, and real wisdom.

And I like the Princeton campus. I attended classes in Japanese language and culture for a couple years on Nassau Street as I recall. I also took my GMATs there in one of the classrooms, far too early on a Saturday morning, many years ago. There's a nice lunch place on the corner. It's a very pretty place.

Ben S. Bernanke speaking at the Baccalaureate Ceremony at Princeton University, Princeton, New Jersey
June 2, 2013

The Ten Suggestions

It's nice to be back at Princeton. I find it difficult to believe that it's been almost 11 years since I departed these halls for Washington. I wrote recently to inquire about the status of my leave from the university, and the letter I got back began, "Regrettably, Princeton receives many more qualified applicants for faculty positions than we can accommodate." (1)

I'll extend my best wishes to the seniors later, but first I want to congratulate the parents and families here. As a parent myself, I know that putting your kid through college these days is no walk in the park. Some years ago I had a colleague who sent three kids through Princeton even though neither he nor his wife attended this university. He and his spouse were very proud of that accomplishment, as they should have been. But my colleague also used to say that, from a financial perspective, the experience was like buying a new Cadillac every year and then driving it off a cliff. I should say that he always added that he would do it all over again in a minute. So, well done, moms, dads, and families.

This is indeed an impressive and appropriate setting for a commencement. I am sure that, from this lectern, any number of distinguished spiritual leaders have ruminated on the lessons of the Ten Commandments. I don't have that kind of confidence, and, anyway, coveting your neighbor's ox or donkey is not the problem it used to be, so I thought I would use my few minutes today to make Ten Suggestions, or maybe just Ten Observations, about the world and your lives after Princeton. Please note, these points have nothing whatsoever to do with interest rates. My qualification for making such suggestions, or observations, besides having kindly been invited to speak today by President Tilghman, is the same as the reason that your obnoxious brother or sister got to go to bed later--I am older than you. All of what follows has been road-tested in real-life situations, but past performance is no guarantee of future results.

1. The poet Robert Burns once said something about the best-laid plans of mice and men ganging aft agley, whatever "agley" means. A more contemporary philosopher, Forrest Gump, said something similar about life and boxes of chocolates and not knowing what you are going to get. They were both right. Life is amazingly unpredictable; any 22-year-old who thinks he or she knows where they will be in 10 years, much less in 30, is simply lacking imagination. Look what happened to me: A dozen years ago I was minding my own business teaching Economics 101 in Alexander Hall and trying to think of good excuses for avoiding faculty meetings. Then I got a phone call . . . In case you are skeptical of Forrest Gump's insight, here's a concrete suggestion for each of the graduating seniors. Take a few minutes the first chance you get and talk to an alum participating in his or her 25th, or 30th, or 40th reunion--you know, somebody who was near the front of the P-rade. Ask them, back when they were graduating 25, 30, or 40 years ago, where they expected to be today. If you can get them to open up, they will tell you that today they are happy and satisfied in various measures, or not, and their personal stories will be filled with highs and lows and in-betweens. But, I am willing to bet, those life stories will in almost all cases be quite different, in large and small ways, from what they expected when they started out. This is a good thing, not a bad thing; who wants to know the end of a story that's only in its early chapters? Don't be afraid to let the drama play out.

2. Does the fact that our lives are so influenced by chance and seemingly small decisions and actions mean that there is no point to planning, to striving? Not at all. Whatever life may have in store for you, each of you has a grand, lifelong project, and that is the development of yourself as a human being. Your family and friends and your time at Princeton have given you a good start. What will you do with it? Will you keep learning and thinking hard and critically about the most important questions? Will you become an emotionally stronger person, more generous, more loving, more ethical? Will you involve yourself actively and constructively in the world? Many things will happen in your lives, pleasant and not so pleasant, but, paraphrasing a Woodrow Wilson School adage from the time I was here, "Wherever you go, there you are." If you are not happy with yourself, even the loftiest achievements won't bring you much satisfaction.

3. The concept of success leads me to consider so-called meritocracies and their implications. We have been taught that meritocratic institutions and societies are fair. Putting aside the reality that no system, including our own, is really entirely meritocratic, meritocracies may be fairer and more efficient than some alternatives. But fair in an absolute sense? Think about it. A meritocracy is a system in which the people who are the luckiest in their health and genetic endowment; luckiest in terms of family support, encouragement, and, probably, income; luckiest in their educational and career opportunities; and luckiest in so many other ways difficult to enumerate--these are the folks who reap the largest rewards. The only way for even a putative meritocracy to hope to pass ethical muster, to be considered fair, is if those who are the luckiest in all of those respects also have the greatest responsibility to work hard, to contribute to the betterment of the world, and to share their luck with others. As the Gospel of Luke says (and I am sure my rabbi will forgive me for quoting the New Testament in a good cause): "From everyone to whom much has been given, much will be required; and from the one to whom much has been entrusted, even more will be demanded" (Luke 12:48, New Revised Standard Version Bible). Kind of grading on the curve, you might say.

4. Who is worthy of admiration? The admonition from Luke--which is shared by most ethical and philosophical traditions, by the way--helps with this question as well. Those most worthy of admiration are those who have made the best use of their advantages or, alternatively, coped most courageously with their adversities. I think most of us would agree that people who have, say, little formal schooling but labor honestly and diligently to help feed, clothe, and educate their families are deserving of greater respect--and help, if necessary--than many people who are superficially more successful. They're more fun to have a beer with, too. That's all that I know about sociology.

5. Since I have covered what I know about sociology, I might as well say something about political science as well. In regard to politics, I have always liked Lily Tomlin's line, in paraphrase: "I try to be cynical, but I just can't keep up." We all feel that way sometime. Actually, having been in Washington now for almost 11 years, as I mentioned, I feel that way quite a bit. Ultimately, though, cynicism is a poor substitute for critical thought and constructive action. Sure, interests and money and ideology all matter, as you learned in political science. But my experience is that most of our politicians and policymakers are trying to do the right thing, according to their own views and consciences, most of the time. If you think that the bad or indifferent results that too often come out of Washington are due to base motives and bad intentions, you are giving politicians and policymakers way too much credit for being effective. Honest error in the face of complex and possibly intractable problems is a far more important source of bad results than are bad motives. For these reasons, the greatest forces in Washington are ideas, and people prepared to act on those ideas. Public service isn't easy. But, in the end, if you are inclined in that direction, it is a worthy and challenging pursuit.

6. Having taken a stab at sociology and political science, let me wrap up economics while I'm at it. Economics is a highly sophisticated field of thought that is superb at explaining to policymakers precisely why the choices they made in the past were wrong. About the future, not so much. However, careful economic analysis does have one important benefit, which is that it can help kill ideas that are completely logically inconsistent or wildly at variance with the data. This insight covers at least 90 percent of proposed economic policies.

7. I'm not going to tell you that money doesn't matter, because you wouldn't believe me anyway. In fact, for too many people around the world, money is literally a life-or-death proposition. But if you are part of the lucky minority with the ability to choose, remember that money is a means, not an end. A career decision based only on money and not on love of the work or a desire to make a difference is a recipe for unhappiness.

8. Nobody likes to fail but failure is an essential part of life and of learning. If your uniform isn't dirty, you haven't been in the game.

9. I spoke earlier about definitions of personal success in an unpredictable world. I hope that as you develop your own definition of success, you will be able to do so, if you wish, with a close companion on your journey. In making that choice, remember that physical beauty is evolution's way of assuring us that the other person doesn't have too many intestinal parasites. Don't get me wrong, I am all for beauty, romance, and sexual attraction--where would Hollywood and Madison Avenue be without them? But while important, those are not the only things to look for in a partner. The two of you will have a long trip together, I hope, and you will need each other's support and sympathy more times than you can count. Speaking as somebody who has been happily married for 35 years, I can't imagine any choice more consequential for a lifelong journey than the choice of a traveling companion.

10. Call your mom and dad once in a while. A time will come when you will want your own grown-up, busy, hyper-successful children to call you. Also, remember who paid your tuition to Princeton.

Those are my suggestions. They're probably worth exactly what you paid for them. But they come from someone who shares your affection for this great institution and who wishes you the best for the future.

Congratulations, graduates. Give 'em hell.

--------------------------------------------------------------------------------

1. Note to journalists: This is a joke. My leave from Princeton expired in 2005.

01 June 2013

Financial Sector: Bigger and More Profitable Than Ever


Recovery, for some.

Just like justice.

And affordable healthcare.

Source: Atyant Capital


The Longer Term Fundamentals of the Gold Market As They Are Today


There should be no doubt in anyone's mind that the fundamentals for world gold supply and demand have changed dramatically over the past ten years at least.

The world's central banks, most significantly in the West, had been selling bullion from their central bank reserves since 1989. The first chart below shows the long decline in the official gold reserves of the central banks through the long bear market from 1979 through 2000, and even in the beginning of the bull market.


There was an explicit public arrangement called the Washington Agreement struck in 1999 to regulate that official selling after a particular central bank had disrupted the market.
"Under the agreement, the European Central Bank (ECB), the 11 national central banks of nations then participating in the new European currency, plus those of Sweden, Switzerland and the United Kingdom, agreed that gold should remain an important element of global monetary reserves and to limit their sales to no more than 400 tonnes (12.9 million oz) annually over the five years September 1999 to September 2004, being 2,000 tonnes (64.5 million oz) in all.

The agreement came in response to concerns in the gold market after the United Kingdom treasury announced that it was proposing to sell 58% of UK gold reserves through Bank of England auctions (aka Brown's Bottom), coupled with the prospect of significant sales by the Swiss National Bank and the possibility of on-going sales by Austria and the Netherlands, plus proposals of sales by the IMF. The UK announcement, in particular, had greatly unsettled the market because, unlike most other European sales by central banks in recent years, it was announced in advance. Sales by such countries as Belgium and the Netherlands had always been discreet and announced after the event. So the Washington/European Agreement was at least perceived as putting a cap on European sales."
There is some speculation as to the reason why the UK's Brown decided to engage in that rather extraordinary action, against the counsel of his own advisors, but that does not concern us here. 

This outright selling in gold by central banks is different from the leasing of gold by central banks, which is generally not transparent and openly announced. In this leasing operation, bullion banks pay a small lease rate to the central bank for the right to use that gold as collateral and for sale, with the promise to replace it after a period of time with a fee. It is a subject of controversy how much of the existing stock of central banks has been committed to the market through leasing arrangements. The number is not insubstantial. The gold is likely to have been sold or otherwise committed, and must be repurchased to be returned.

There is a very high likelihood that gold collateral has been rehypothecated, or used many times with a number of parties holding claim to it. This is a common practice and is referred to as fractional gold reserves. These most often take the form of 'unallocated bullion' which is when a certificate of ownership is issued, but no particular bars have been identified. And as we saw in the failure of MF Global, even allocated bullion ownership, in which specific bars are committed and paid for, ownership can be a rather philosophical concept in which possession is nine-tenths of the law.

The second chart shows the period from 2000 to 2012, with emphasis on 'the Turn' which is when central banks turned from net sellers to net buyers of gold. I cannot stress enough how important this is to the fundamental outlook.


Economists, pundits and investment managers can say whatever they like, but the proven fact remains that the world's central banks, on the whole, do not agree with them that gold is not an important store of value, and likely to become more important in the future. It is somewhat ironic that these same fellows would uphold the power of the central bank on one hand, and say things like Don't fight the Fed, or Bernanke says what the market is, but then will turn around and suggest you ignore what the central banks of the world are doing on the whole. It is hard to imagine that this is not someone woefully ignorant of current trends or with some other agenda who would take such an obtuse position.

And of course we also have the statement and opinions of those who say, personally I think gold is barbaric and useless, but then will say, money is based on consensus, and so fiat money is sound. Again, the clear consensus of the central banks is that gold is an important facet of their reserves, and the importance to their future plans is growing, for whatever reasons they have not yet disclosed.

The third chart demonstrates the significant increase in gold bullion acquired by the Chinese. This is both private and official purchases. A large producer in their own right, China exports little of their domestic production, and is a large net importer. Several other countries are following the same pattern, the common thread being that they are the high growth countries who have the need to increase their reserves, or whose people have new wealth they wish to deploy.


The fourth chart shows the well established fact that the increase in the gold supply through mining is relatively inelastic with regard to price. It takes significant effort and capital to create new mining operations, and there is a natural decay in the productivity of existing mines as with most natural resources. The estimate is that the gold supply can increase through mining at roughly 2% per year. This is one of the features that has long made gold attractive as a form of money.

As demand increases therefore, the price of gold must rise. If someone wishes to hold the price steady, new supplies of gold must be found, and they will not be discovered in mines.


There is a fairly well established 'scrap market' in which old jewelry and other gold objects can be purchased and melted down for bullion. But this market again is not robustly elastic although it can respond to higher prices more readily than mining operations.

So for ready access to gold to meet market demands, other sources of gold must be found.

This is where we get into the concept of 'fractional reserve gold' and 'paper gold' in which ownership is more of a financial concept than a hard reality. This includes both the leasing of official reserves, and the use of unallocated reserves that would be discovered in purchasing programs and perhaps even some well known funds.

One would hope that highly transparent audits of such things would exist from impeccable sources, but sadly that does not seem to be the case.

Leverage and rehypothecation are two of the largest factors in the recent financial crises, in addition to the mispricing of risk and fraudulent representations.

I think one of the more remarkable features of the current situation is the storage of official bullion in custody in New York and London. Venezuela was one of the first countries to demand that their gold be repatriated from New York, and this has happened despite much scoffing and derision by the usual pundits.

But then in response to domestic requests and changing circumstances, the German central bank requested that some portion of their gold be returned from out of country.

The German gold had been stored out of country in response to concerns that the gold was not safe, given the divided nature of the country and fears of a Soviet incursion. Obviously with their country reunited and at peace, it would make sense to return things to normal.

They had already received much of their gold back from London, in large part because it was incurring significant storage fees. They are also requesting their gold back from France.
By 2020, the Bundesbank intends to store half of Germany’s gold reserves in its own vaults in Germany. The other half will remain in storage at its partner central banks in New York and London. With this new storage plan, the Bundesbank is focusing on the two primary functions of the gold reserves: to build trust and confidence domestically, and the ability to exchange gold for foreign currencies at gold trading centres abroad within a short space of time.

The following table shows the current and the envisaged future allocation of Germany’s gold reserves across the various storage locations:

31 December 2012  31 December 2020
Frankfurt am Main31 %  50 %
New York45 %  37 %
London13 %  13 %
Paris11 %  0 %

To this end, the Bundesbank is planning a phased relocation of 300 tonnes of gold from New York to Frankfurt as well as an additional 374 tonnes from Paris to Frankfurt by 2020.

What is so remarkable is the response from New York. The Fed is agreeing to return a portion of Germany's gold in SEVEN YEARS. 

Until the fundamentals change, the offtake of gold will continue to deplete supply, until the price moves to strike an equilibrium.

And as I have attempted to show at some length and detail on this site, the recent sell off in the price of gold was largely motivated by speculation in paper gold on western markets, specifically London and New York, that resulted not in a decrease in demand but an increase in demand that led quickly to spot shortages, delays, and premiums over the paper price for actual bullion.

I do not know the future. It is patently obvious that China and Russia and a few other countries, are making a concerted effort to increase their gold reserves for some reason. There is significant speculation that the nations will be changing to a new form of reserve currency for trade that will be backed at least partially by gold.  In addition, several countries are said to be making plans to back their national currencies by gold in some manner as the devaluations of world currencies obtain momentum.  I think these all these plans are under serious discussion today. There is no doubt that international discussion have been going on for some time.

I am aware that there are other, more specialized and sophisticated, studies out there about the gold and silver markets.  Much of them are with regard to the shorter term for traders.  But there are a few extraordinary efforts conducted by groups like GATA, data compilers like the World Gold Council, and individuals such as Eric Sprott, who has done a remarkable job of attempting to derive the demand and supply data for gold over a longer period of time.

My goal here is to present what I like to think of as the bigger picture.  My own analysis of the global economy started in 1992 in a brief return to academics, and a natural interest as someone involved in international business. 

Starting with the Asia currency crisis of the 1990's and the collapse of the rouble, my thinking led me to assume that there was going to have to be a significant change in the structure of the global trading arrangements with regard to currencies.  Up to that point in 1999 I had no interest in gold whatsoever.  I discovered gold and silver in my process of thinking about other things, and everything I had anticipated seems to have been unfolding, with variations of course.

There is the little detail that the second credit bubble tied to housing has collapsed, and the powers that be will not take the banks down, but are going to try and reflate the financial paper, particularly bonds and equities, by devaluing the major developed currencies.  They are doing fairly well of hiding its effects, but at some point it is going to bite.  A lot of the shenanigans going around now are trying to position the public, weakest segments first, into picking up the tab.

Make of this what you will, but I think the facts are sound. I suggest you look at this, and then come to their own conclusions.  It may provide a framework with which to interpret events as they continue to unfold.

Taibbi: Allegedly SEC Policy Not To Pursue Investment Management Fraud Allegations LIke Madoff


It sometimes looks like open season on the small investor and the public at large with some very selective enforcement of the laws.

"All animals are equal, but some are more equal than others."

Why Didn't the SEC Catch Madoff? It Might Have Been Policy Not To
By Matt Taibbi
May 31, 5:20 PM ET

More and more embarrassing stories of keep leaking out the SEC, which is beginning to look somehow worse than corrupt – it's hard to find the right language exactly, but "aggressively clueless" comes pretty close to summing up the atmosphere that seems to be ruling the country's top financial gendarmes.

The most recent contribution to the broadening canvas of dysfunction and incompetence surrounding the SEC is a whistleblower complaint filed by 56-year-old Kathleen Furey, a senior lawyer who worked in the New York Regional Office (NYRO), the agency outpost with direct jurisdiction over Wall Street.

Furey's complaint is full of startling revelations about the SEC, but the most amazing of them is that Furey and the other 20-odd lawyers who worked in her unit at the NYRO were actually barred by a superior from bringing cases under two of the four main securities laws governing Wall Street, the Investment Advisors Act of 1940 and the Investment Company Act of 1940.

According to Furey, her group at the SEC's New York office, from a period stretching for over half a decade through December, 2008, did not as a matter of policy pursue cases against investment managers like Bernie Madoff. Furey says she was told flatly by her boss, Assistant Regional Director George Stepaniuk, that "We do not do IM cases."

Some background is necessary to explain the significance of this tale...

Read the entire news story here.