Liberty Maven

by John Browne, Senior Market Strategist at Euro Pacific Capital

Earlier this month, J.P. Morgan made an important announcement that received scant coverage in the media: the bank would now accept gold as collateral for loans. The move appears to have been well-timed, for in the ensuing weeks, the price of gold and silver climbed steeply, based largely on political turmoil in the Middle East. But why should Morgan’s decision be of interest to anyone outside the bank?

It can be argued that J.P. Morgan is the world’s premier major bank. As such, its decision to accept gold as collateral offers a rare glimpse into the very private financial decision-making of some of the largest and most sophisticated investors in the world, whether governments, corporations, or wealthy individuals.

By reopening its former gold vaults in New York, as well as new facilities in Far Eastern financial centers – which cater to investors who typically have larger gold reserves than Western counterparts – Morgan is telling the world that gold is gaining greater traction as a medium of exchange.

Given that a bank continually looks to provide services that its clients demand, the move suggests that a strategy has taken hold among the highest echelon of investors based on core holdings of precious metals.

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by Michael Pento, Senior Economist at Euro Pacific Capital (www.europac.net)

Civil revolt is currently spreading across the Arab world. What began in Tunisia has now metastasized into Bahrain, Egypt and Libya. Though two dictators have been ousted, the chances that these regimes will fundamentally transform from autocracy to a system of free markets and property rights are also up in the air. An important question is whether or not Saudi Arabia will eventually get into the mix; and, if so, whether the current struggle in Libya would morph into a proxy war between Saudi Arabia (Sunni Muslims) and Iran (Shiite Muslims). It remains to be seen whether the new regime in Egypt-whatever form it ends up to be – will allow Iran to use the Suez Canal to parade warships across the Mediterranean Sea and into Syria. If so, what would Israel’s reaction to such a perceived provocation be?

There are many unknowns, but what is known is that the turmoil has had an immediate and significant impact on the price of oil. WTI is now trading just below $100 a barrel and Brent Crude is already well above the century mark. If the unrest does indeed spread to Saudi Arabia – which produces 12 million barrels of oil per day and is the second largest producer in the world – mainstream analysts have made some wild predictions about how high the oil price could reach. Rising energy prices will further cripple the third world, which has already been placed under extreme pressure from skyrocketing food costs.

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by Michael Pento, Senior Economist at Euro Pacific Capital (www.europac.net)

In a heated debate on the February 1^st episode of CNBC’s “The Kudlow Report”, financial commentator Donald Luskin offered his “textbook” definition of inflation as “an overall rise in the general price level.” I countered with the “dictionary” definition. My 1988 edition of Webster’s Dictionary defines inflation as follows: “An increase in the volume of money and credit relative to available goods, resulting in a substantial and continuing rise in the general price level.” [Emphasis added.] These differences are not academic and go a long way toward explaining why economists argue so vociferously.

In an inflationary environment, general prices tend to rise, although particular market segments tend to do so at uneven rates. This is hardly controversial. The more disputed question is why prices rise in the first place. As Luskin is well aware, the US Dollar is backed by nothing but confidence and perception. Its value depends upon our collective belief in its current and future purchasing power, and the hope that its supply will be restricted. When its supply is increased, users of the currency lose faith in its buying power and prices rise.

As a corollary, if dollar-holders believe that the US will have no choice but to monetize trillions of dollars of Treasury debt in the near future, the currency will falter. In this manner, currencies that are backed by nothing but confidence tend to behave like stock prices. The share value of a corporation represents the strength of the company. Likewise, the value of a currency represents the strength of a sovereign state.

Looked at through this prism, the fate of the US dollar in the future may not be all that different from the fate of Enron shares in 2001. In the 1990s, Enron was one of the most respected corporations in America, and the share price soared. But once the accounting scandal broke, and Enron’s profits were proven to be illusory, the purchasing power of its shares plummeted. Eventually, the shares became worthless.

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by John Browne, Senior Market Strategist at Euro Pacific Capital

This week, the financial media celebrated as the Dow closed above the 12,000 mark for the first time since June 19th, 2008. For many, this milestone is another sign that the financial nightmare of the past three years will soon fade in the rearview mirror.

The euphoria over share prices has been bolstered by recently released data which catalogs rising consumer confidence and spending, and corporate earnings reports that have beaten estimates. In the meantime, the bond markets have remained resilient, despite evidence of massive public debt problems that bubble beneath the surface. But is this optimism based upon enough sound evidence to support long-term investment?

The recovery in the Dow, to within some 15 percent of its all-time high, should not be much of a surprise to our readers at Euro Pacific, nor should it count as a mark of confidence to anyone. We have always held that ultra-low interest rates distort the investment landscape by forcing yield-starved investors from bonds into equities. Driven by this massive government subsidy, along with a high real rate of inflation, the stock market cannot help but rally. Indeed, the only surprise is that our current rally took so long to develop.

The rally even appears to be immune to the uncertainties created by the unrest in Egypt, which is arguably the largest global political crisis we have seen since the invasion of Iraq in 2003. The big question is: can this rally be trusted for the longer-term? Three factors highlight the risks.

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by Michael Pento, Senior Economist at Euro Pacific Capital (www.europac.net)

There can be little doubt that Fed Chairman Benjamin Bernanke has been a very, very good friend to gold investors. However, some of those who have benefited from his largesse now fear that the recent selloff in gold indicates an imminent end to Bernanke’s monetary high-wire act. Most assume that a cessation of the Fed’s stimulative efforts, if it were to occur, would spell the end of gold’s bull run. But a closer reading of Bernanke’s economic philosophy and the Fed’s own recent history, shows that once central banker begins a strenuous routine starts, it is very hard, if not impossible, for them to dismount.

It is widely believed that the unemployment rate, core inflation and home prices are the three key pieces of economic data that Bernanke and his Fed cohorts rely upon when formulating monetary policy. Although other data points, such as regional manufacturing surveys and the producer price index (which have rebounded significantly in some cases) attract some attention, they do not carry near the weight of the big three. With the unemployment rate remaining north of 9.4%, YOY core CPI inflation still less than 1% and the Case/Shiller Home Price Index down .8% from the year ago period, the Fed is in no mood to downshift. If anything, my guess is that Bernanke will step on the gas.

More importantly, in light of Bernanke’s often stated conclusion that premature Fed tightening in 1937 and 1938 led to a prolongation of the Great Depression, even if the big three metrics were to show marked improvement, any future increase in interest rates will be moderate and held in abeyance for as long as politically possible.

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CSPAN’s show, Newsmakers, aired this weekend. Their guest was Congressman Ron Paul. Most of the questions revolved around economics and the Federal Reserve. It’s refreshing when Dr. Paul is given the proper amount of time to explain his positions without the interruptions that always occur on the mainstream media outlets.

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.

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John Browne, Senior Market Strategist at Euro Pacific Capital

Pre-holiday cheer is certainly evident in the financial markets. The overwhelming consensus is that the Congressional agreement to not raise taxes while extending hundreds of billions in new stimulus will finally allow the recovery to take hold. The good feelings are underscored by less-than-awful employment reports and modest slowdowns in foreclosures. Another point of optimism is the continued buoyancy of the US dollar, which has weakened over the past few months, but has not collapsed.

However, I believe the dollar’s survival remains tenuous and highly dependent on factors outside of the control of US policymakers. As I see it, the dollar is caught between four major forces: American debt levels, weakness of the euro, underlying strength of the yuan and, lastly, threats to its privileged international reserve status.

In 2010, the major collapse of the US dollar, which many of us expected to see, did not materialize.  Indeed, the dollar experienced periods of relative strength, due largely to an absence of apparent domestic inflation and concerns not just about the value of the euro, but its continued survival. In recent weeks, there have been some signs of economic recovery in the United States, of rising inflation in China, and of increasing concern about the euro. As a result, the dollar is finishing the year with some wind in its sails.

For now, the markets seemed convinced that the trillions of dollars injected into the economy by the Fed and the Administration will not be inflationary. I suspect this illogical consensus has in no small part been made possible by the government’s success in disguising the real level of consumer price inflation. However, the level of government debt continues to accelerate, promising serious problems ahead.

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In an interview with the Wall Street Journal Ron Paul discusses his upcoming Fed oversight subcommittee chairmanship. He targets the system rather than individuals, and rightly so, as usual.

An excerpt:

Over the past year, we’ve seen a lot more information about the Fed coming to both Congress and the public. Do you think it’s made a difference?

It hasn’t changed policy. I think it’s made the difference that we understand it a little bit better. And it hasn’t gone well for the Fed. The popularity of the Fed has changed. They’re being challenged from all angles right now. … It isn’t so much what I will do. It’s going to be that these policies are doomed to fail. They always want me to attack Bernanke. It isn’t the individuals. It’s not Greenspan, it’s not Bernanke, it’s the system and it’s not viable. They cannot practice central economic planning through the Federal Reserve. They cannot have stable prices, whatever that means. They cannot prevent prices from going up when the time comes for prices to go up. The perfect example of their ineptness is their mandate to have full employment.

A number of Republicans want to change the Fed’s dual mandate to focus on inflation. What effect do you think it would have?

Probably not a whole lot. But I like the subject because it does go after the Fed. They assume too much responsibility. It brings up the subject of unemployment. Since they have totally failed on that this is a great time to talk about, what good is a mandate?

Read the rest here

by Michael Pento, Senior Economist at Euro Pacific Capital (www.europac.net)

This past Sunday on the CBS program “60 Minutes”, Americans received a massive dose of mendacity from our Fed Chairman. Mr. Bernanke’s shaky delivery, and even shakier logic may cause faith in America’s economic leadership to evaporate faster than the value of our dollar. In particular, Bernanke delivered two massive distortions:Lie #1 – The Fed isn’t printing money. Bernanke stated: “The amount of currency in circulation is not changing…the money supply is not changing in any significant way. What we’re doing is lowering interest rates by buying Treasury securities.” Given that it is the Treasury Department’s Bureau of Engraving and Printing, not the Fed, that actually prints paper money, his statement is technically correct while substantively false. However, Bernanke is buying bank assets with Fed credit. With such an arrangement, printing becomes unnecessary.

According to gentle Ben, credit created to buy something should not be considered money and has no affect on asset prices? But if that’s true, why is he concentrating his buying in the middle of the Treasury yield curve. His stated purpose is to boost bond prices and lower yields in order to stimulate borrowing and aggregate demand. So pushing up bond prices is an act of inflation. Bernanke similarly contradicts himself by saying that he isn’t creating inflation, while at the same time claiming that his easing campaign is designed to boost asset prices to combat the phantom of deflation.

And by the way, the Fed is causing money supply to increase significantly. The compounded annual growth rate of M2 is over 7% in the last quarter. Apparently in the eyes of the Chairman, a 7% annualized increase in the broad money supply isn’t considered significant.

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