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The Daily Reckoning | Monday, November 22, 2010 On the question of a gold standard, Gaining success by allowing failure, Plus, Bill Bonner on losing control... ------------------------------------------------------- Retirement, Plan B: Collect “Pension Paychecks” Every 15 Days...For Life! You can legally sneak onto the “payroll” of America’s best companies and collect work-free “pension paychecks”. Your checks can roll in as often as every 15 days! Total yearly income can run as high as $120,000! Start collecting your own income with this new presentation, right here. Quantitative Easing and the Importance of Job Growth How the Fed Plans to Fight Unemployment Eric Fry Reporting from Laguna Beach, California... As the US stock market gyrates, Ben Bernanke’s pet project, Quantitative Easing (QE), remains the topic of the day. Most of the creditors to the US scorn QE as a reckless dalliance with currency debasement. On the other side, most of the debtors in the US applaud QE as a miracle elixir that’s “good for what ails thee.” Both sides have a point. When you debase a currency, creditors lose and debtors win. And last we checked, the US government owed a lot of money to a lot of people. Lucky for it, minting a dollar bill requires only about two cents worth of paper and ink. So a little bit of extracurricular money-printing really lightens the debt load. Obviously, to the extent that creditors are amenable, printing the money with which to repay them is a terrific idea. The problem is; creditors don’t usually tolerate such shenanigans for very long. Chairman Bernanke insists that his QE project has nothing to do with subtly defrauding creditors. He says he is merely pursuing the Fed’s dual mandate: stable inflation and maximum employment. But QE seems to be all about maximum inflation in the pursuit of stable unemployment. At a minimum, QE reduces the Fed’s dual mandate to a solo mandate: job growth. Chairman Bernanke admits as much. In a speech last week Bernanke remarked, “On its current economic trajectory the United State’s runs the risk of seeing millions of workers unemployed or underemployed for years... As a society, we should find that outcome unacceptable.” Bernanke is clearly favoring the employment mandate over the “stable inflation” one. As such, he insists his QE tactics can grease the gears of economic rejuvenation. Unfortunately, the evidence-to-date contradicts this assertion. “Since November 25, 2008, when the Fed announced that it would begin purchasing debt and mortgage-backed securities by Fannie and Freddie,” observes Evan Lorenz of Grant’s Interest Rate Observer, “the rate for new, conforming 30-year mortgages has declined by 1.6 percentage points to 4.32%, according to Bankrate.com. Yet, new-home sales have fallen. They dropped 26%...[since] the start of the mortgage buying. “Over the same span,” Lorenz continues, “sales of previously lived-in, or ‘existing,’ homes fell 9%...One might argue that the Fed, its pure motives notwithstanding, is making things worse by preventing the market from clearing.” But the housing market is not the only portion of the economy that would provide damning evidence against quantitative easing. Even after two years of mega-billion-dollar meddling by the Federal Reserve, signs of economic recovery remain scant. “The New York Fed’s Empire Index of manufacturing activity took a dive in the current reporting month,” observes David Rosenberg, The Daily Reckoning’s favorite economist, “swinging from +15.73 in October to -11.14 in November, the largest swing ever recorded in a single month and the worst showing since the depths of the recession in April 2009.” Numbers like these are indisputably bad, but maybe they would have been worse if Bernanke hadn’t intervened. Maybe Ben’s intervention in the private sector prevented the arrival of the Great Depression II. Maybe...but probably not. “Some intriguing research in the contrary vein is worth considering,” writes James Grant, taking the baton from his colleague. “‘A Decade Lost and Found: Mexico and Chile in the 1980s,’ by Raphael Bergoeing, Patrick J. Kehoe et al., published in 2002, might serve as a parable for these interventionist times. The paper contrasts the response of Mexico and Chile to the seemingly intractable difficulties each faced in the 1980s. “Despite a similar starting point, the authors write, ‘Chile returned to trend in about a decade and since then has grown even faster than trend. In contrast, output in Mexico has never fully recovered, and even two decades later is still 30% below trend.’ “The difference? Chile let companies fail and markets clear. Mexico, anticipating certain features of the contemporary United States, allowed its archaic bankruptcy system to perpetuate the lives of money-losing businesses and allocated credit by government directive. “The sharp recession that Chile suffered in consequence of its seemingly harsh policies,” Grant continues, “merely proved the preface to a superb recovery. In comparative terms, Mexico stagnated. Washington, DC, please copy.” Here’s an idea: offer Ben Bernanke a generous retirement package, dismantle the Fed, re-establish the dollar’s link to gold...and let the market’s sort it out. Crazy? Maybe not, as guest editor, Charles W. Kadlec, explains below... Revealed: The Full Power and Promise of Science’s Next Decade... ...Could give your family FIVE generations of HUGE WEALTH! Expert researcher breaks his silence after 2 years with this shocking new presentation. Get all the details on the most lucrative science breakthroughs ever published, right here. The Daily Reckoning Presents Gold vs. The Fed: The Record Is Clear Charles W. Kadlek There were no worldwide financial crises of major magnitude during the Bretton Woods era from 1947 to 1971. Lesson: Gold is a more efficient governor of monetary policy that the Federal Reserve. When it last met, the Federal Open Market Committee (FOMC) signaled its desire to increase the rate of inflation by providing additional monetary stimulus. This policy is based on a false – and dangerous – premise: that manipulating the dollar’s buying power will lead to higher employment and economic growth. But the experience of the past 40 years points to the opposite conclusion: that guaranteeing a stable value for the dollar by restoring dollar-gold convertibility would be the surest way for the Federal Reserve to achieve its dual mandate of maximum employment and price stability. From 1947 through 1967, the year before the US began to weasel out of its commitment to dollar-gold convertibility, unemployment averaged only 4.7% and never rose above 7%. Real growth averaged 4% a year. Low unemployment and high growth coincided with low inflation. During the 21 years ending in 1967, consumer-price inflation averaged just 1.9% a year. Interest rates, too, were low and stable – the yield on triple-A corporate bonds averaged less than 4% and never rose above 6%. What’s happened since 1971, when President Nixon formally broke the link between the dollar and gold? Higher average unemployment, slower growth, greater instability and a decline in the economy’s resilience. For the period 1971 through 2009, unemployment averaged 6.2%, a full 1.5 percentage points above the 1947-67 average, and real growth rates averaged less than 3%. We have since experienced the three worst recessions since the end of World War II, with the unemployment rate averaging 8.5% in 1975, 9.7% in 1982, and above 9.5% for the past 14 months. During these 39 years in which the Fed was free to manipulate the value of the dollar, the consumer-price index rose, on average, 4.4% a year. That means that a dollar today buys only about one-sixth of the consumer goods it purchased in 1971. Interest rates, too, have been high and highly volatile, with the yield on triple-A corporate bonds averaging more than 8% and, until 2003, never falling below 6%. High and highly volatile interest rates are symptomatic of the monetary uncertainty that has reduced the economy’s ability to recover from external shocks and led directly to one financial crisis after another. During these four decades of discretionary monetary policies, the world suffered no fewer than 10 major financial crises, beginning with the oil crisis of 1973 and culminating in the financial crisis of 2008-09, and now the sovereign debt crisis and potential currency war of 2010. There were no world-wide financial crises of similar magnitude between 1947 and 1971. At the center of each of these crises were gyrating currency values – either on foreign-exchange markets or in terms of real goods and services. As the dollar’s value gyrates it produces windfall profits and losses, feeding speculation and poor judgment. The housing bubble was fed in part by 40 years of experience with a dollar that lost purchasing power every year. Today, individual investors are piling into gold and other commodities in hopes of finding a safe haven from the FOMC’s intention to decrease the buying power of the dollar and reduce the value of our savings. And what of the seductive promise that a floating dollar would make American labor more competitive and improve the nation’s trade balance? In 1967, one dollar could buy the equivalent of approximately 2.4 euros (based on the pre-euro German mark) and 362 yen. Over the succeeding 42 years, the dollar has been devalued by 72% against the euro and 75% against the yen. Yet net exports have fallen from a modest surplus in 1967 to a $390 billion deficit equivalent to 2.7% of GDP today. The members of the FOMC, like their predecessors, are trying to do the best they can, but they are not really sure what it is that needs to be done. They have kept the federal-funds rate near zero for almost two years, but small businesses find it difficult to get loans and savers suffer from the lost income brought by artificially low interest rates. Now they’re about to advocate higher inflation – i.e., less price stability – in hopes of spurring economic growth. Economists and pundits may disagree on why the gold standard delivered such superior results compared to the recurrent crises, instability and overall inferior economic performance delivered by the current system. But the data are clear: A gold-based system delivers higher employment and more price stability. The time has come to begin the serious work of building a 21st-century gold standard for the benefit of American workers, investors and businesses. Regards, Charles W. Kadlek, for The Daily Reckoning Joel’s Note: Mr. Kadlec is a member of the Economic Advisory Board of the American Principles Project, an author and founder of the Community of Liberty. Outstanding Investments Precious Metals Report BETTER THAN GOLD! One investment should rocket even faster than gold over the next 12-24 months... yielding at least 3-to-1 gains on every dollar invested... GUARANTEED. In fact, I’m so sure of this, I won’t charge you a penny to show you how. Click Here Now For Details. Bill Bonner China: Bull Market or Bubble? The Story Continues... Bill Bonner Reckoning from Baltimore, Maryland... The news last week followed the sun. It began with doubts about Ireland’s solvency...then moved to fears that California would default...and ended on Friday with doubts about China. Word on the street was that the Middle Kingdom wanted to dampen down inflation. They were going to raise rates and tighten credit. The Chinese blame Ben Bernanke for increasing the supply of dollars and causing inflation in emerging markets and commodities. Bernanke points his finger at the Chinese. Replying to charges of reckless endangerment, “they made me do it,” he says. The Chinese wouldn’t raise the yuan...so he has to lower the dollar. That’s what’s nice about paper currencies – you can manipulate them. Which is exactly what the US is doing...trying to manipulate its dollar downward...while simultaneously charging China with being a “currency manipulator.” Which just goes to show how little honor there is among central bankers. Maybe it was the China story. Maybe not. But for one reason or another there was no bullish follow-through on Friday. The Dow barely ended the day in positive territory. Gold stood stock still. So, what is going on in China? We decided to get to the bottom of it. Friday, we had a Chinese businessman in our office. He had come to see us about starting up a venture together in China. “Nobody...nobody...knows for sure what it going on,” said he. “On the one hand, there are plenty of excesses and bad investments in China. There must be. We’ve been growing so fast. And there must be a lot of bad debt hidden in the banking system, for example. “But on the other hand, China is booming. There have never, ever been so many people working so hard to make money. It’s a bit like the US probably was a hundred years ago. Only bigger. Faster. And with more government involvement. “There might be plenty of problems...business failures...bankruptcies...and financial blow-ups. But I doubt that the China story will end any time soon.” We don’t think the story will end. We think it will become more and more fascinating...and more exciting. You can’t grow at such a breakneck speed without breaking someone’s neck. And any time the government is heavily involved in planning an economy, you can be sure the plans will be bad ones. They will control too much...and then they will lose control. Our friend Dylan Grice, analyst at Société Générale, has more on this story: Is it possible they’ve...(sharp intake of breath) already lost control? And if so, who’s to say what will happen if the asset inflation goes into reverse? Maybe when the authorities engineer the slowdown they desire and tell investors it’s safe to buy again, those investors won’t want to buy. In which case a hard landing shouldn’t be beyond the realms of imagination. Forget US de-leveraging, this represents the largest deflationary risk to the world economy So long as China’s credit growth continues at its current pace, aided by the liquidity the Fed is flooding world markets with, and encouraged by artificially low interest rates, the primary risk Ems (Emerging Markets) face today remains that of a bubble. This might sound a very bullish note on which to end. It isn’t. And let me be crystal clear about why: a bubble is not a bullish scenario. It’s not bullish for the EM economies themselves, their citizens or for the world as a whole. The fact is all bubbles end in tears. Tears. Did you hear that, dear reader? Tears. Let’s be sure they’re not our own. And more thoughts... Our brother-in-law is a Baptist minister. At a recent wedding, he had this comment. “I don’t like doing weddings. Statistically, half of all marriages fail. I always worry that my work will be undone. “I prefer funerals. I’ve never had one of them fail. They put a man underground; he stays there.” *** For further reading on why America is doomed to bankruptcy, here is our new friend Laurence Kotlikoff, writing on Bloomberg Opinion: The bipartisan National Commission on Fiscal Responsibility and Reform, led by former US Senator Alan Simpson and former chief of staff to President Bill Clinton, Erskine Bowles, spent nine months studying the nation’s long-term fiscal policy and devising a plan that purports to keep the country from going broke. Speaker of the House Nancy Pelosi must have spent all of nine seconds reviewing the panel’s draft proposal before declaring it “simply unacceptable.” I think Pelosi’s right, but for different reasons. The co-chairmen’s draft proposal includes many provisions that Democrats should love. It would cut military spending, raise the ceiling on payroll taxes for Medicare and Social Security, make the retirement program’s benefit schedule more progressive, kill tax breaks for capital gains and dividends, drop deductions that primarily help the rich, increase benefits for the elderly poor, boost gasoline levies and, to compensate for broadening the tax base, lower rates for everyone, especially for the indigent. There are four recommendations that Pelosi, apparently, doesn’t like: – Raise Social Security’s retirement age by two years, to 69. (Psst, Pelosi, it would do so over 65 years – a very long time.) – Cut the corporate income tax rate. (Psst, this sounds good for business, but it’s actually good for workers because a lower corporate rate will attract more foreign investment, making US workers more productive and helping them earn a higher wage. Many public finance economists like myself consider the corporate income tax a hidden tax on workers.) – Limit growth in Medicare benefit levels. (Not by much.) – Lower rather than raise the top tax rate on the rich. (If you take account of the elimination of deductions, this is a progressive tax reform.) Perhaps her protest is strategic to ensure the plan stays as is. Either that or she doesn’t know how to take yes for an answer. The problem with the proposal isn’t that it helps the rich or hurts the poor. It does neither. The real problem is that it continues to kick the can down the road when it comes to protecting our kids from our nation’s ever growing bills. Look carefully at the plan and you’ll find relatively modest spending cuts and tax increases over the next decade. In 2020, non-interest spending is only 3 percent lower and taxes are only 5 percent higher than the Congressional Budget Office now projects. Together these adjustments total 2.5 percent of gross domestic product. Contrast this with the 8 percent of GDP fiscal adjustment undertaken by the British, not in 10 years, but this year. The co-chairmen’s slides show US finances improving dramatically after 2020, but that’s because of their heroic assumption that the government will limit non-interest spending to 21 percent of GDP instead of letting it rise, over time, to 35 percent of GDP as the CBO says will happen under current policy. The CBO isn’t trying to scare us. The nonpartisan agency is legitimately terrified of the interaction of three developments: the country’s aging population, excessive growth in health-care costs and the introduction of the new health-exchange program. Spending related to these factors explains almost all of the CBO’s post-2020 projected growth in federal non-interest spending. And its forecast is based on highly optimistic assumptions about the growth in health-care costs beyond 2020. For example, the employer-based health-care system, which now insures the majority of the population, is assumed to stay intact. But the system is likely to unravel given the modest penalties employers will face for not insuring their workers and the significant subsidies they can arrange for their low- and moderate-earning workers simply by sending them over to the federal health exchange for health insurance. If this happens, Uncle Sam will find most Americans in its health-care lap. Unfortunately, there is nothing in the draft recommendations that prevent the country from aging or federal health-care benefit levels from rising faster than per capita GDP. Indeed, the proposal endorses letting health-care spending grow faster than GDP. On the other hand, they say “additional steps should be taken as needed” to control health-care spending growth. Where have we heard this before? But if federal spending rises after 2020, as the CBO projects and our demographics and health-care systems appear to dictate, their plan leaves us with a fiscal gap of $153 trillion. Or, in other words, bankrupt. (Laurence Kotlikoff is professor of economics at Boston University, president of Economic Security Planning, Inc. and author of Jimmy Stewart Is Dead.) Regards, Bill Bonner, for The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com Debt Delenda Est Debt was the market’s bête noire, this week and last. In Europe, it snatched up the Irish and carried them off. Then it attacked the Portuguese. Everyone knew the periphery states were going broke. Their cost of borrowing soared. Then, when the search parties reached them, the Irish turned them away. Debt has it usefulness, the Irish figured. They held out until Wednesday, apparently negotiating terms of their own rescue. Why Fed Meddling is Only Prolonging the Financial Crisis Catastrophically Cutting the Deficit The Madness of Inflating Away the Debt Burden I get really tired of hearing how “inflation reduces the burden of debt,” which I say is a Gigantic Load Of Hooey (GLOH). And the fact that I say it with a loud, arrogant voice should convince you that I am absolutely correct, beyond the fact that I am obviously some kind of weirdo lunatic in a manic phase of some kind, in which case it would be dangerous to disagree with me about anything. In Search of Golden Enlightenment Buying Gold for Buoyancy as US the Credit Rating Sinks Looking Back on the Grasshoppers’ Indian Summer It was as though the winter would never arrive. The slumbering summer stock markets of 2010 lept to life. September recorded the best market month since 1939. In early October, with Wall Street jubilating, it cracked the 11,000 ceiling...a mere 3,000 points shy of its October 2007 high. Nothing, not even the facts, could mute the summer chirping of gleeful grasshoppers on that ceiling-cracking Friday. Before Hyperinflation Dollar to Become World’s “Weakest Currency” India and China Continue to Drive Gold Demand The Daily Reckoning: Now in its 11th year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists. Cast of Characters: Bill Bonner Founder Addison Wiggin Publisher Eric Fry Editorial Director Joel Bowman Managing Editor The Mogambo Guru Editor Rocky Vega Editor