Many states can’t pay their bills. Their unfunded obligations total trillions of dollars. Some of these states will want a bailout from Congress. Do you want to pay for this, or should the politicians and the unions who created these messes feel the pain instead of you?

I wrote Congress telling them to oppose any bailout of our corrupt and incompetent state governments.

I encourage you to do the same, using our “No Bailouts” campaign. The hardwired letter to Congress reads . . .

“No government money, whether borrowed or taxed, should ever be used to bail out private financial interests, or wasteful state governments.”

If you want to add to this letter you may borrow from or copy what I wrote . . .

Many states are bankrupt because of . . .

* Overly-generous pension deals with government employee unions
* Pork, waste, and bloated programs
* High taxes and draconian regulations that drive away businesses and destroy jobs

The politicians and unions in these states are hoping . . .

* Congress will bail them out by increasing the national debt and raising taxes — a burden on our children
* The Federal Reserve will bail them out using legalized counterfeiting to buy state and local bonds — inflating away the retirement savings of millions of honest taxpayers by creating trillions of new dollars out of thin air

You must stop these things from happening.

Last year, the Public Employee Pension Transparency Act was introduced in the House. It would have barred any federal agency, including the Federal Reserve, from bailing out state pension programs. A similar bill should be introduced this year. The states broke their pension programs, and the states should fix them.

If you want to help the states . . .

* End all unfunded mandates
* Repeal federal regulations and simplify the tax code so that it will be easier for business to create jobs again

It’s time for the states to start downsizing their bloated spending. Federal bailouts will only delay what needs to be done, and spread the damage from the guilty to the innocent.

END LETTER

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Jim Babka
President
DownsizeDC.org

D o w n s i z e r – D i s p a t c h

Official email newsletter of DownsizeDC.org, Inc. & Downsize DC Foundation.

by John Browne, Senior Market Strategist at Euro Pacific Capital

While the markets have known for almost three months that the 2010 election delivered the House of Representatives to the tea-infused Republican Party, I did expect a greater reaction on Wall Street to the formalities of the opening sessions of Congress yesterday.

If the Republicans make good on their campaign promises, we will see cuts in government spending and an end to fiscal stimulus. Given that short-term stock market performance is very much dependent on such government assistance, the current rally is hard to fathom. Meanwhile, gold and silver have experienced a counterintuitive correction (although to be honest, pundits are making much more of this 4% pullback than the size of the move merits). Could it be that the markets now believe that fiscal restraint in Washington is the best pathway to growth? Can a leopard really change his spots?

Not likely, I say. Rather, I believe that we are simply seeing some short-term momentum. Speculators tend to buy and sell on momentum, while investors tend to accumulate on dips and sell on fundamental changes.  Anyone with a pragmatic view of Washington must realize that real change is unlikely.

Most new Republican representatives are well-meaning and genuinely wish to honor their election pledges of reducing the massive government spending and regulations that are strangling the US economy. If they hold enthusiastically to their good intentions, austerity likely will hit America as the natural counteraction to the massive and irresponsible asset booms of the late ’90s to mid-aughts. The question is whether these Republicans will stick to the guns when voters feel the pinch. My feeling is that they are more likely to seek political cover.

Given that many European countries opted for austerity in 2010, it is instructive to gauge the current political situation across the Atlantic as a preview of what may confront Washington.

Throughout Europe, strikes and riots have paralyzed major cities. Several major EU member-states, such as Belgium, Italy and France, appear increasingly likely to follow Greece and Ireland into requiring bailouts. Already the Swiss central bank has announced that it will not accept the bonds of Ireland or Greece, now rated as ‘junk,’ as collateral, even for repurchase financing.

Greater and greater pressure is being placed on Germany to bail out the insolvent states. As they do so, it will become more likely that German politicians will abandon their own domestic austerity plans.

In modern politics, it is apparent that the more senior politicians become, the less they appear to exhibit courage and integrity. In England, Prime Ministers Winston Churchill and Margaret Thatcher were notable exceptions. I served under the latter. It was greatly disillusioning to witness how she was ultimately brought down by a majority of her own senior lieutenants at the first sign of political trouble.

As in many areas of human endeavor, including war and commerce, new blood provides enthusiasm, but rarely sets policy. As the new Republican representatives fill the airwaves with strong statements demanding meaningful cuts in government spending and regulation, their leaders are already showing signs of wilting.

I have met Speaker John Boehner and like him. However, his statement of January 5th that he would urge “adult” behavior by his party filled me with misgiving. America needs the enthusiasm of youth, not the caution of the old, in revolutionizing the role of its government. As proof of this point, Representative Paul Ryan, the new House budget chief, admitted on day one that the promised cuts of a paltry $100 billion could now be “substantially less” than $50 billion, or less that 1/3 of one percent of the $14 trillion Treasury debt.

The acid test will be whether Republicans muster the courage required to freeze the Treasury debt limit. Should they fail to hold the line, a green light will be given to the inflationists, and a cut in America’s vital AAA credit rating may be forthcoming.

Should the dollar and the euro move nearer to collapse in tandem, an international financial and economic meltdown will threaten. The resulting devastation of consumer confidence will encourage US and EU politicians to panic and hyper-inflate. At that point, could China, with $2.5 trillion of cash, bailout the economies of America and the EU, valued at a combined $30 trillion?

For now, few are focused on this endgame scenario. The dollar remains relatively firm on the foreign exchange and precious metal prices have fallen back marginally. Long-term investors should use the opportunity to prepare for the long haul.

Peter Schiff, CEO of Euro Pacific Capital, and host of The Peter Schiff Show, broadcasting live from WSTC Norwalk CT from 6pm – 8pm Eastern time every weeknight, and streaming at www.schiffradio.com

The United States Postal Service announced this week that all future first class postage stamps sold will be the so-called “forever stamps” that have no face value but are guaranteed to cover the cost of mailing a first class letter, regardless of how high that cost may rise in the future. Currently these stamps are sold for 44 cents, but will increase in price if and when the Post Office hikes rates.

Apart from sounding the death knell of the one cent stamp, the news is interesting on two fronts: it provides insight into remarkably irresponsible government accounting, and it provides investors with the most attractive Federally-guaranteed inflation protected asset available on the market today.

Over the past fifty years, the USPS has raised the rates on first class postage 20 times. During that time the stamp prices have gone up more than 1,100%. Given the increasing frequency of rate hikes (three in the last four years) the Post Office claims it made the move to forever stamps to save money on printing costs and to increase customer convenience. The public seems to appreciate the product and has snapped up a staggering 28 billion forever stamps since they became available in 2007.

But the real reason behind the permanent switch is that it allows the Post Office to hide its insolvency behind phony accounting numbers, setting itself up for a massive taxpayer financed bailout in the not too distant future.

Much the way Greece used phony accounting to qualify for euro zone inclusion, the USPS is using creative accounting to avoid making significant cuts in current wages and benefits. By offering forever stamps, the Post Office moves forward future revenues to pay current expenses. But every forever stamp sold today represents a stamp not sold in the future. The revenues booked now will not be put in escrow to deal with revenue shortfalls that are guaranteed to plague the Post Office in the years ahead. This simply kicks farther down the road any intractable fiscal problems that the USPS can’t solve through more conventional means.

The Post Office also ignores that their ability to sell higher priced forever stamps in the future will be restricted. Those individuals and institutions who hoard the stamps now could offer them for sale in competition with the Post Office. Even though the Post Office will not redeem forever stamps for cash, there is no law against reselling them for whatever price the market will bear. How many forever stamps will the Post Office be able to sell at full price if customers can buy them at a discount on Ebay?

On that note, forever stamps provide the most conservative investors with a much more attractive alternative to zero interest checking accounts, low yielding Treasury bonds, or even inflation protected government securities (known as TIPS).

Given these stamps will always be completely liquid, the only way an investor can lose money on forever stamps is if the price of postage goes down. There may not be a single human on the planet who thinks that this is a likely scenario. On the other hand, if postage rates rise with inflation then the stamps are a very, very safe bet.

And unlike Treasury bonds or TIPS, investors do not have to pay a premium above face value for the privilege of buying stamps. While it is true that stamps do not pay interest, the extremely low rate offered by government securities should not fundamentally alter the investment calculations comparing bonds with stamps. More significantly, stamps are backed by an actual tangible service, postal delivery, whereas U.S. Treasury debt is backed by nothing but a printing press.

Forever stamps are about as close to a sure thing as most people will ever get. Over the past 10 years stamps are up 29%, while the S&P 500 is up a measly .1%. With labor and other costs continuing to mount inside the Post Office, there can be little doubt that many price hikes are coming. Minimum investment in forever stamps is just 44 cents, with no brokerage fees. Plus as an added bonus, if you use the stamps yourself, you pay no income tax on your capital gains.

Sure, without a federal bailout there is a chance the Post Office will go under, and those forever stamps will end up lining bird cages. However, given the track record of government bailouts and the clout of unionized postal workers, chances are very high that the Post Office will always get the bailouts it needs. As a result, forever stamps are a better bet than Treasury debt. They also have prettier pictures.

Peter Schiff is CEO of Euro Pacific Capital and host of The Peter Schiff Show.

You can watch the entire show here at CSPAN.org.

by Peter Schiff, president of Euro Pacific Capital, and host of The Peter Schiff Show, broadcasting live from WSTC Norwalk CT from 6pm – 8pm Eastern time every weeknight, and streaming at www.schiffradio.com

There is an old adage on Wall Street: no one rings a bell to signal a market top or bottom. Yet, I have found that bells do ring; it’s just that few people know exactly what sound to listen for.

Perhaps the biggest and most liquid of all markets is for US government bonds. That market has been rallying for almost thirty years. The bull can be traced back to 1981, when Treasury bond yields peaked at about 15%. At that time, high inflation and a weakening dollar had justifiably squelched demand for Treasuries. Even the ultra-high interest rates were not enough to attract buyers.

But this was also when the proverbial bell was rung. Fed Chairman Paul Volcker had signaled, by jacking up interest rates so high, that he would stop at nothing to break the back of inflation. Volcker’s iron will, and Reagan’s unflinching support, restored demand for Treasuries for the next three decades.

We have arrived today at a similar inflection point. After falling steadily for 30 years, bond yields are now heading north with a full head of steam.

Many are taking the recent moves in stride. The consensus is that despite the recent spike, yields are still historically low, and that they are unlikely to go much higher from here. Once again, most on Wall Street are either tone deaf or plugging their ears.

For years, the Fed has been able to prevent market forces from correcting our growing economic imbalances by inexorably pushing rates lower. This happened in 1991, 2001, and most notably in 2008. These easing campaigns succeeded in boosting the economy in the short term by greatly increasing the amount of debt held by both the private and public sectors. As such, these episodes have allowed our economy to delay and magnify the ultimate reckoning.

Just like a junkie who requires ever-increasing doses of heroine to achieve the same high, the Fed has needed to take rates ever lower to boost the economy after its previous stimulants had faded.

To stimulate after the bursting of the housing bubble (which itself resulted from the low interest rates used to juice the economy following the bursting of the dot-com bubble), the Fed lowered interest rates to practically zero. At that point, rates could go no lower. However, when that stimulus failed, the Fed decided to bring on the heavy artillery in the form of “quantitative easing,” or as it is known in the vernacular, “printing money to buy government debt.”

Lowering the federal funds rate, its traditional weapon, tends to make the most impact on short-duration debt. By its own words, the goal of quantitative easing (QE) was to lower long-term interest rates. It was hoped that this would achieve what low short-term rates had not: an increase in stock and real estate prices, a rise in household wealth, and consequently greater consumer spending, economic growth, and job creation.

However, the Fed’s plan backfired. The selling pressure on long-term bonds is overwhelming the Fed’s buying pressure. Spiking rates (which move inversely to price) are powerful evidence that the bond bubble has finally burst. The Fed threw everything but the kitchen sink at the bond market to force yields lower, yet they rose anyway. If bond prices failed to rise given such a Herculean effort to lift them up, there can be only one direction for them to go: down.

In true form, few on Wall Street hear the ringing. In a shocking display of rationalizing cognitive dissonance, some (such as Wharton Professor Jeremy Siegel in a WSJ op-ed) have even suggested that the spike in yields is proof that quantitative easing is working. Siegel heralded higher rates as indicative of economic resurgence, which supposedly was the Fed’s goal all along. In other words, QE2 worked so well, we skipped the lower rates and went directly to the higher rates that go with growth!

There is also a widespread belief that long-term rates will remain contained at historically low levels. Four percent is seen as the ceiling above which ten-year yields will not rise. I believe this ceiling will prove to be of the thinnest glass. Once yields easily break that level, they may quickly rise above five percent, where they will likely encounter some resistance, before heading significantly higher.

In fact, if rates approach six percent next year, we will be seeing a ten-year high in ten-year yields. If our economy is this fragile with record low rates, image how much weaker it will be with rates at ten-year highs? If the Fed believes that lower rates revive an economy through the ‘wealth effect,’ what does the Fed feel will happen when higher rates produce a reverse ‘wealth effect’?

Not only does this bell herald the end of the bond bull, but it also marks the end of the Fed’s ability to artificially engender economic “growth” through monetary policy. More significantly, the new tax compromise President Obama is about to sign will add more than $900 billion in new debt onto the government’s balance sheet over the next 10 years. This will put additional upward pressure on interest rates, and more political pressure on the Fed to monetize the debt.  It is no coincidence that the real upward movement in yields began immediately after the tax/stimulus deal was brokered in Washington.

What lies ahead is a new era of rising interest rates, soaring consumer prices, increasing unemployment, economic stagnation, and lower living standards. Instead of stimulating the economy, quantitative easing and deficit spending will prove to be a lethal combination. Bondholders beware, the bell tolls for thee.

by John Browne, Senior Market Strategist at Euro Pacific Capital

Despite America’s economic problems, the US dollar has maintained its respected status the world over – and has even managed to maintain value in comparison to other currencies. It appears that the dollar will likely finish 2010 at the same levels that it started. Even today’s announcement of more tax cuts and stimulus, which will guarantee widening federal deficits for years to come, could not put a dent in the dollar. The dollar’s charmed life stands in strong contrast to the euro, which is currently suffering from its internal flaws and the Europeans’ unfortunate recognition of reality.

Given Washington’s monetary irresponsibility over the past decade and a half, many market observers have wondered if the euro could one day become the world’s top currency. In the early to mid-2000s, when the euro surged more than 60% against the dollar, this was in fact a popular view. But unlike all other currencies on the planet, the euro is not a sovereign currency managed by a single country. It is dependent on the collective political will of the leaders of the European Union (EU).

In the bust that followed the Greenspan/Bernanke dollar-based boom, the US economy started to deleverage significantly. Unwilling to accept the political cost of a possible failure of its banking system, the Federal Reserve decided to re-inflate out of deflation and devalue the US dollar. Meanwhile, the European Central Bank (ECB), heavily influenced by Germany, decided that deflation was necessary and inevitable. As painful as it was likely to prove, the Europeans had appeared until recently ready to face the music and delever their economies.

Unfortunately, Europe’s banks had, for years, invested enthusiastically in the debt of their member sovereign states. In addition, they had greedily invested in the debt securities of US and domestic real estate. The collapse of real estate prices on both continents exposed these massive risks and revealed the high degree of interconnection between the world’s major banks.

As the EU is not yet a super state with a single government, the response to austerity is far from even. For instance, German voters are extremely angry at bailing out what they see as nations with profligate governments – the likes of Greece, Portugal, Italy, et al. They feel that those who invested or, as the Germans see it, speculated in European sovereign state bonds should suffer at least some of the downside. The problem is that the speculators were largely European banks. Acceptance of the real losses would bankrupt major banks, likely creating a chain reaction across the European and even US banking sectors. European politicians are now showing less inclination to tolerate such an outcome.

But European citizens are growing restless. They are vehemently opposed to the idea that their governments should incur massive debts to rescue what they term ‘banksters.’ European politicians are becoming panicked, not knowing where to turn. Some urge quantitative easing (like the Americans!). Others maintain that this will only magnify the problem and that austerity must be continued. Varied and often-conflicting public statements by government officials are creating an air of political and monetary uncertainty for the euro.

The situation within the EU has become so serious that the future of the world’s second major reserve currency is now in question.

Meanwhile, sentiments expressed by the American Tea Party movement have gained considerable weight. Americans have received the Fed’s second wave of quantitative easing with far less enthusiasm than the first. Increasingly uncertain statements now emanate from Washington. Furthermore, the US government has still to face the problem of default threatened by many politically important states, such as New York, New Jersey, and California. This political uncertainty has spread to the dollar.

In response, some major nations, led by China and including Russia, are soliciting political support for the removal of the US dollar’s privileged status as reserve currency. Together, the US dollar and the euro account for some 70 percent of world central bank reserves. But both currencies face great internal political uncertainty and high relative volatility. As a result, global investors are looking for alternatives.

In these uncertain circumstances, precious metals continue to establish new nominal price records. Unless there is a miraculous internationalization of the yuan, I think precious metals have a rare opportunity to regain their historic status as the global reserve, a status subverted by the dollar only in the past century.

As a mortgage broker during the manic years of the housing boom, I witnessed reckless financial practices on a wide scale. As a result, I was not surprised by the “robo-signing” mess that now threatens the mortgage sector. Unfortunately, the scandal is only a small tip of the iceberg that threatens to take down the entire US banking system.

The “too big to fail” (TBTF) banks that acted as middle men in the mortgage machine knew that the mortgage-backed securities (MBS) they packaged and sold to investors didn’t meet the standards they claimed. In essence, MBS buyers were sold Ferraris but took delivery of PT Cruisers. Because of these material misrepresentations, TBTF banks could be forced to repurchase hundreds of billions of MBS that they sold to investors. Since they don’t have that kind of cash lying around, it’s likely they will turn to their federal benefactors for another bailout.

If the Treasury is solvent enough to offer such a bailout, there might never be a proper investigation of how the mortgage market blew up. As a former industry insider, I hope I can shed some light.

Historically, real estate prices in the United States were driven by supply and demand, and generally tracked the rate of inflation. Securitization changed that. Mortgages no longer remained with the lender extending the loan, but were sold to an investment bank that would, in turn, create MBS and sell them to investors. During the housing bubble, trillions of dollars of these securities were churned out. When banks found themselves with loans that did not conform to minimum requirements for securitization – rules meant to protect MBS investors from the risk of widespread defaults – their response was to sprinkle these “subprime” loans into other MBS bundles. Auditors only sampled about 5-10% of the loans making up any one MBS, so if a particularly egregious loan was rejected, it could simply be shuffled into another MBS. In the rare case that the loan was spotted a second time, it was shuffled again.

Meanwhile, the banks largely didn’t share the poor audit results with potential MBS investors. They were savvy enough, however, to use the poor showing to negotiate lower prices from wholesalers who sold them raw mortgage loans. This is like a grocery store demanding refunds from farmers who supply E. coli-tainted spinach, but selling the produce to consumers anyway – with no warning, and at full price!

Emboldened by recent auditor testimony of such practices, and citing failure to properly service mortgages according to signed contracts, a group of investors has filed suit to force the banks to repurchase their toxic MBS. In response, the banks have publicly stated that servicing problems are “contained” and present no broad systemic risk, even while it becomes increasingly clear their problems extend far beyond technical breaches of procedure. As more information concerning the extent of potential bank fraud comes to light, more such lawsuits are a certainty. The situation presents lawyers with a once-in-a-lifetime opportunity.

As a result, I expect uncertainty and headline risk to haunt US banking stocks for some time. Housing prices will likely fall much further as foreclosure sales are delayed and homeowners increasingly decide that strategic default is their best decision. As I mentioned, I don’t believe the banks can withstand this tidal wave without a flood wall of federal funds.

Which brings us back to the great question of this economic crisis: should we consider these banks “too big to fail”? Or, rather, is it time that they must fail?

As recently as April 2006, I was still an optimistic mortgage broker. If I had heard of Peter Schiff or the Austrian School of economics, I may have thought twice about signing a three-year commercial lease and spending thousands on office equipment. But, like most people at that time, I couldn’t see how real estate prices could ever fall. By 2007, my business was floundering. As cracks in the housing market started to show, small brokers were vilified in the media and squeezed out of the market as banks raised their underwriting guidelines to eliminate “unscrupulous” external loan brokers. So, small shops like mine closed one after another. Meanwhile, the big banks continued to purchase and underwrite billions in loans, even while they were aware of declining underwriting standards and fraud within their ranks. I vividly recall that as my business was drying up, my only option to continue my trade was to return to a big bank. They were the only ones still making money as the market collapsed.

Fortunately, my ultimate perception (aided by Peter’s analysis) that the housing market would not improve any time soon led me to make a pragmatic decision: get out and move on. I took the losses, and I lived to fight another day. Nobody bailed me out, and nobody is bailing out the individual homeowners across the country faced with upside-down mortgages. The much touted Homeowner Assistance Modification Program (HAMP) has proven to be a bust, a byzantine maze of red tape and frustration awaiting any homeowner who seeks its aid.

An increasing number of homeowners are making their own pragmatic decision: stop paying the mortgage, save money, stay in the home as long as possible, and, eventually, get out and move on. The moral hazard created by the Wall Street bailouts has encouraged business-as-usual from the TBTF banks, who have largely refused to restructure underwater mortgages, and has promoted more foreclosures as homeowners orchestrate their own private rescue packages. Over the next few years, I imagine it will be increasingly clear to Americans that when it comes to the big banks, it’s time to cut our losses, get out, and move on. Take it from someone who has done so, and never looked back.

It seems the current Chairman of the Federal Reserve is of the belief that diluting the dollar is the cure for everything from a recession to male pattern baldness. And like other snake-oil salesmen before him, Mr. Bernanke is heavy on promises and light on results. Here are five prescriptions that money printing can’t fulfill:

1. Lower the corporate tax rate. The US corporate tax rate is the second highest in the developed world, after Japan. Lowering this tax would help American businesses compete with foreign corporations and unleash the entrepreneurial spirit of our workforce. In addition, lowering taxes on capital goods purchases and retained earnings would also encourage expansion projects, new hiring, and therefore general business development.
2. Reduce crippling regulations. There isn’t a much better example of the current environment of excessive red tape than the number of “Czars” running around the White House: 28, at last count. Ronald Reagan had just one. These sub-cabinet level offices simply advise the President on how to further fetter American businesses and launch umpteen “independent probes” every time an issue comes up. But even officials not given the Imperial Russian title are busy making life hell for small- and medium-sized businesses because there is too much power in Washington. 
3. Learn to compete with foreign workers. The federal minimum wage is $7.25 per hour, and mandated benefits and regulations add even more to the cost of employment. We need to repeal these laws and allow wages to adjust freely to market conditions. Initially, incomes may drop, but if we also lower taxes while reducing the rate of inflation, workers’ real disposable income may actually increase. Meanwhile, as our economy’s underlying strength is rebuilt, American workers will finally be able to compete with foreign workers on a level playing field. If we ignore these reforms, high-quality jobs will continue to flow overseas.
4. Improve America’s educational system. According to a recent report put out by the National Academies of Science and Engineering, the US ranks 21st in science and 25th in math out of 30 industrialized nations. And, according to the World Economic Forum, the United States’ K-12 education system now ranks 48th in the world. How can our workers compete in the 21st century without the necessary technological skills to fill highly paid positions? We need to dramatically reform our public educational system by injecting a massive dose of free markets into the mix. Whether this involves charter schools, private schools, vouchers, or a combination, public schools must be forced to compete for students and funding. If consumers were given a true choice by offering tax credits to those parents that opt-out of the public system, it would go a long way towards establishing an environment that purges mediocrity and rewards excellence.
5. Balance the federal budgets. Balancing a budget simply means spending only what you take in as revenue. If we were to adopt that simply strategy, it would ensure that: tax rates would never have to rise sharply just to service debt, the Fed would never have to print money to ‘monetize’ the debt, interest rates would be lower, and spending that benefits one generation would never be paid for by generations to come. A stable currency, low taxes and the ability to pay down debts are necessary ingredients for a growing workforce and a viable middle class.

Unlike the snake oil of printed money, these genuine therapies take time and effort, and sometimes have painful side effects. The quack remedies offered by Dr. Bernanke promise to cure all ills with no effort on the part of the patient.

If the measures I propose are established in concert, we would lay the groundwork upon which to rebuild the country’s goods-producing sector. If allowed to flourish, manufacturing can create the needed jobs to lower the long-term unemployment rate and restore the county’s economic vitality.

The Fed’s plan, by contrast, has only one predictable consequence: inflation. Indeed, Bernanke has already been remarkably successful in sending asset prices higher. Not only are most commodities soaring in dollar terms, but the broader measures of the money supply have started to surge as well. The compounded annual rates of change in MZM and M2 over the last month are 13.3% and 9.1% respectively. The prices-paid component of the September ISM manufactures survey jumped to 71, and the YoY increase in the PPI is 4%. Sure, we can look to the Dow or the stabilization of home prices and say the Fed’s magic is working, but just because the headache has gone away doesn’t mean you’ve cured the stroke. We can look to the inflation indicators to see that the Fed has failed to stop the bleeding.

Remember, the Fed is now printing dollars to purchase the bulk of US Treasuries at auction, in a process called debt monetization. It is that process of the Fed expanding the money supply to subsidize federal debt that is causing domestic prices to surge. It will not be very long before the consumer acutely suffers from this dangerous policy. On this point, history is clear: inflation has caused the destruction of every middle class and every economy that has sought it as a solution.

There are no quick fixes to our current economic predicament, but there are fixes. It’s up to the American people to decide they’ve had enough of Ben ‘Rasputin’ Bernanke and they’re ready for some tough medicine. When that happens, I’ve got some great specialists to recommend.

by Peter Schiff, president of Euro Pacific Capital, and host of The Peter Schiff Show, broadcasting live from WSTC Norwalk CT from 6pm – 8pm Eastern time every weeknight, and streaming at www.schiffradio.com

There has been so much discussion recently about “QE 2″ that you would think the entire financial sector were about to embark on a transatlantic cruise. Unfortunately, they, and we, are not so lucky. In the year 2010, “QE 2″ doesn’t refer to a sumptuous ocean liner, but a second, more extravagant round of “quantitative easing” – stimulus. In the past, this technique was simply called “printing money.” As if the nation has not already suffered enough from the first round, Captain Ben Bernanke and the Fed are determined to compound the damage by hitting us with another monetary juggernaut. Their stated goal is to boost the economy and create jobs. However, since economic growth cannot be achieved by printing money, their QE 2 will sink just as surely as the Titanic.

The intent of QE 2 is to lower interest rates to promote job growth and avoid the apparently growing threat of deflation. But the very idea that the economy is weak because interest rates are too high is laughable. Deflation is the market’s cure for the asset bubbles that have recently burst, so any attempt to avert it will only weaken the economy further.

In fact, one of the reasons the US economy is in such bad shape is that interest rates are already too low. Low rates have encouraged excess borrowing, by both individuals and governments, and discouraged saving, fueling new asset bubbles at the expense of legitimate investment. As a result, the dead weight of debt has simply overloaded our economy, and our creditors are getting nervous. What we need now is to make hard choices, not engage in more easing – to deleverage, not borrow more.

Worse still, by keeping rates too low, the Fed has enabled the US government to grow significantly larger than it otherwise could had its borrowing been restrained by higher rates. Absent these low rates, Washington likely wouldn’t have passed expensive new healthcare and financial regulation reforms; they would be too busy trying to keep the lights on in the Capitol.

For this and other reasons, the bogeyman of deflation is really not a concern at all. It’s not a threat because falling consumer prices could serve as a relief for many suffering from layoffs and pay cuts in the recession. Even if it were a threat, it’s not even likely because so much liquidity has already been created and an infinite amount could still be created at will by the Fed. Consumer prices are already rising across the board, despite a contracting economy, so what’s all this talk about deflation?

The Fed is quick to point to falling real estate prices. But a drop in real estate will no more cause consumer prices to fall than the real estate boom caused them to rise. Real estate prices are too high, and the economy will never truly recover unless they are allowed to fall. It is interesting that when real estate prices were rising, the Fed did not raise rates to bring them down, but now that they are falling, the central bank feels compelled to lower rates to prop them up. If falling real estate prices threaten deflation, why did the Fed not perceive an inflation threat when real estate prices were rising?

My thinking is that, at the end of the day, all this deflation talk is a red herring. The true purpose of QE 2 is to disguise the decreasing ability of the Treasury to finance its debts. As global demand for dollar-denominated debt falls, the Fed is looking for an excuse to pick up the slack. By announcing QE 2, it can monetize government debt without the markets perceiving a funding problem. If the truth were known, a real panic would ensue. So, the Fed pretends buying treasuries is simply part of its master plan to boost the economy, even though, in reality, it is simply acting as the buyer of last resort.

If the Fed really wanted to help the economy, it would raise rates quite dramatically. Instead of preparing for QE 2, it should be unloading the debt it purchased during QE 1. Of course, that is not so easy to do – which is precisely why I was against QE 1 from the beginning. However, even though the exit will be painful, going down with the ship will be even more unpleasant.

Higher interest rates and a commitment from the Fed to refrain from purchasing Treasury debt would force the government to dramatically reduce spending. If we combine less government spending with fewer regulations, reform our tax code in a way that stops punishing savings and investment, stop all government subsidies for real estate so that prices can fall to affordable levels, and allow all insolvent entities to fail, then a real recovery will take hold.

If the Fed refuses to set sail on QE 2, then her loyal passengers might complain, but at least the US will be on solid monetary ground as it tried to rebuild a viable economy. If instead we board QE 2 (and QE 3 and QE 4 thereafter), then we are headed to a sea full of icebergs called interest rate spikes, and all on board will surely drown in a sea of worthless Federal Reserve Notes.

Peter Schiff is president of Euro Pacific Capital and host of The Peter Schiff Show.

by John Browne, Senior Market Strategist at Euro Pacific Capital

As the recession and resultant stimulus packages add to higher unemployment and increasing public-sector deficits, the government is seeking to boost the value of overseas earnings that are accrued by US corporations. To aid in this effort, the Fed is being pressured to erode the value of the US dollar, thereby making foreign sales more lucrative in nominal terms. But this form of stealth protectionism will fail just as surely as more overt trade barriers.

Like all commodities, the relative value of currencies is influenced by reward, risk, and future expectations.

The interest rate earned by holding a particular currency represents the ‘reward’ end of the equation. Assuming similar risk profiles, money tends to flow towards the currencies with higher interest rates.

Relative risk is in the eye of the beholder and often is difficult to quantify. In the main, investors view a nation’s balance of payments deficit as a major risk factor in evaluating the relative value of its currency.

Another long-term measure of risk is government debt as a percentage of Gross Domestic Product (GDP). If a large national trade deficit is accompanied by a relatively large debt-to-GDP ratio, the level of risk is increased.

Given the current state of the global economy, it should be clear to all that the US dollar is being priced higher than is warranted and the Chinese yuan is priced lower.

For over a decade, China has exported into an American market that was open and receptive to cheap products. In response to the demand for these new products, the Chinese yuan should have risen sharply against the US dollar to balance the massive Chinese trade surpluses.

However, the Chinese have pegged the yuan to the dollar, preventing a natural rebalancing of the two currencies from taking place. Not only has this generated a politically dangerous and economically unsound trade imbalance, but it has made the dollar appear stronger than it should, given the frail state of the American economy.

Left alone, internal pressures and common sense would have driven the Chinese government to eliminate the peg. To understand why, consider this: even if China didn’t accept one more dollar, any attempt to spend its massive reserves would cause the dollar to drop like a stone. How long should we expect them to keep digging themselves into this hole?

Unfortunately and quite predictably, Washington isn’t allowing the market to naturally correct. Instead, the Fed is attempting to devalue the currency by the printing press. Now we can expect not only the deluge of foreign exchange reserves to flood our economy, but also additional dollar tsunamis emanating from our own central bank. This makes a tragic situation worse, and risks instigating a full-blown trade war between the world’s largest consumer and its largest producer.

Meanwhile, other countries whose economies are heavily dependent on trade, such as Japan, Switzerland, and South Korea, are finding their exports hit hard by the simultaneous devaluations of the US dollar and the Chinese yuan.

On October 2nd, the Financial Times (FT) headline was: “France Pushes for Currency Accord”. It was reported that even China was supportive of the French initiative. Then, on October 5th, the FT headline was: “Call for Global Currencies Agreement”. This time the call was from a group of some 420 of the world’s leading bankers. Finally, on October 6th, the FT headline was: “IMF Chief Warns on Exchange Rate Wars”. Clearly, certain government leaders and bankers are aware of the risks of competitive currency devaluations. The question is whether parliamentary politicians will support currency stability in the face of increasing recession. The two most influential central banks – the Fed and People’s Bank of China – certainly aren’t setting a good example for the rest.

Only when currencies are allowed to float freely will trade imbalances be corrected. Washington’s attempt to force the issue is only doing harm to the world economy by introducing uncertainty and punishing the prudent. The Fed has gone radioactive, setting off a global currency meltdown. Perhaps only gold can truly shield investors from the fallout.

by Peter Schiff, CEO of Euro Pacific Precious Metals and author of the hit economic fable How an Economy Grows and Why It Crashes

Much of the content of the latest Fed statement, released on September 21, echoes the central bank’s previous post-credit crunch pronouncements: there is still too much slack in the economy, interest rates are still going to be near-zero for an “extended period,” and the Fed will continue to use payments from its Treasury purchases to buy yet more Treasuries.

But this recent statement uses a new turn of phrase that should have Americans very upset. The Fed says that “measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate.” Though the wording treads lightly, it should not be taken lightly. It may signal the final push toward dollar collapse.

The Fed’s dual mandate, since an amendment in 1977, has been to promote “price stability” and “maximum employment.” While often discussed as if both goals are complementary facets of one mandate, they tend to have been at odds during every recession since the Great Depression.

The problem is that central banks tend to keep interest rates too low for too long (usually to create a feeling of prosperity credited to the government), which then causes major asset bubbles. When the bubbles pop, there is a period of high unemployment during which prices are supposed to fall. Then, the central bank must choose between boosting short-term employment through inflation or defending price stability by allowing assets to return to a reasonable market value. Aside from the early 1980s chairmanship of Paul Volcker, the Fed has always chosen more inflation.

But they’ve never admitted it.

The Fed statement said, “inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.” Notice that there is no mention of a deflation threat here — as quantitative easing has effectively quashed that possibility — but rather “subdued inflation for some time.”

The Fed defines inflation differently than I do, as an increase in consumer prices rather than the amount of dollars in circulation. By my definition, massive inflation has already been created, which is reflected in the fact that prices for houses, consumer goods, stocks, and bonds haven’t fallen steeply and stayed down since the dot-com and mortgage bubbles popped.

But even by the Fed governors’ definition, they acknowledged that we are experiencing inflation — just not enough for their taste.

Apparently, according to the renegade policy of the Fed, we’re not paying enough for food, energy, clothing, healthcare, or education. No matter that nearly 20% of the population is unemployed or underemployed, that each US taxpayer’s share of the federal debt is now some $121,000, or that average tuition at a private university is set to rise 4.5% this year to $27,325. Apparently, these factors do not affect “price stability.”

Some might say that a certain amount of inflation must be permitted when unemployment is so high — that the dual mandate involves trade-offs. If that were the case, then when we were in a boom period like the ’90s or mid-2000s, the money supply should have been shrunk. Also, there is ample evidence that falling prices during the Great Depression actually provided life-saving relief to the unemployed.

The truth has always been that whatever the question you ask the Fed, the answer is inflation. With prices drifting steadily upward since its establishment in 1913, I dare to ask: has the Fed ever achieved its dual mandate?

The market has certainly lost any hope of price stability in dollar terms. Since the Fed statement was released, gold prices have hit new all-time nominal highs, silver is the highest since the Hunt brothers tried to corner the market in 1980, and the Aussie dollar (a commodity currency) is nearing its own record highs. Even housing is headed back up. Meanwhile, the dollar index has hit a new 7-month low. In short, holders of US dollars are trading for any real assets they can acquire.

A confounding factor is the strong performance of US dollar-denominated bonds. When the Fed creates inflation, that erodes the value of fixed-asset investments like bonds, which can’t adjust their returns to the new price level. So many commentators are pointing to the record low bond yields as evidence that inflation is not a threat. But this is a misreading of the situation.

What is overlooked is that when the Fed prints more dollars, it typically uses them to buy bonds. Traders know this, so they are stocking up on bonds at ridiculous prices just to flip them to the Fed. They don’t care that, in the long run, the Fed’s policies will destroy the bonds’ value because in the short run, the weak dollar policy serves as a tremendous subsidy to bond sellers.

All the salient indicators tell me that the global dollar crisis has entered a new phase. The Fed is getting more aggressive about money printing because it really doesn’t have any other politically viable options. I’ve always said the Fed uses inflation to give appearance of prosperity, but I never expected them to come out and say it! You don’t give warning when you’re about to rob somebody, because then the victim might take precautions — in this case, buying gold and foreign equities.

We should be angry at what the Fed has pledged to do to us, and frankly I’m surprised there hasn’t been more of an uproar. But more important is to figure out how you are going to protect yourself.