THE GOLD MARKET: The Players, Part II

Central Banks are a very special case as a player in the gold market. They will act in secret and try to have as little impact on the market as they can. When they buy they want as low a price as possible and will refrain from buying if the price is too high, in their opinion. Their purchases will be large, spread over years. Recently it was revealed that the Chinese central bank had doubled its gold reserve. That news excited a lot of people (plus the news that China also told its people to buy gold and began holding talks to use a “bag” of currencies for oil purchases). Lost or ignored was the fact that the change had taken six years to implement and that no one could say when China stopped buying. China has recently said that they would not buy when the price was too high. One person I talk to suggested that the recent push to $1200 was due to Chinese buying. An article I found suggested that the Chinese stopped buying at around $920. No one seems to know.

There are rumors that other nations will begin buying gold for their reserves, putting more upward pressure on gold and downward pressure on the dollar. We won’t know if any bank was buying until well after the fact. Certainly, if countries do try to move away from the dollar, gold will play some part in their strategy. Considering their options, among the currencies of the world, there aren’t many realistic choices. But the moves into gold will not be big, on their scale of things, just considering their interest in keeping the dollar as highly valued as they can. It would do them no good to cause the dollar to plummet, in spite of the warnings of some American writers.

If central banks should be buying, it will be very good for the gold bugs. Central bank buying would be a step into bringing gold back into currency support. It would support the gold price, level out the market some.

Another issue is that the gold held by central banks is currently valued at next to nothing, in the $30 range. Someone wrote that the U.S. government could undercut the market by pricing its gold at market. He didn’t explain how that would work. Everyone knows how much gold is held by the central banks. It isn’t a secret. I don’t think that people take the $30 number seriously. No one thinks that there will be sales from the cnetal banks of any considerable proportions. Who cares how they value it? Even at the market price, the number of dollars held by central banks as reserves would still dwarf their gold holdings. The central banks would want the gold market to be stable. I don’t see the problem, at least based upon what I know today.

Let’s move on to the speculators. Speculators are in and out of markets in short bursts. They go where they see opportunities in short-term price swings. They actually help even out the market and provide a valuable service. One good barometer of a person’s understanding of markets and capitalism is how they regard speculators. Speculators often don’t agree with each other. When they do, the market will swing in their direction, at least briefly. If your goal is safety from the depreciation of the dollar, their short-term activity will have little meaning.

The hedge funds have found gold. They have put a lot of money into gold and gold related investments in a very short time. I think that it is possible that it was their activities pushing the gold prices up in the short-term, maybe even this last push. I read comments from one of them who stated that he was concerned about inflation, price inflation I suppose. He didn’t say why he had this concern. There is a problem with the recent entry of hedge funds into the gold markets, I think. These people are marketers, they want to offer products that people will buy, that is, use it as a place to put their money. The hedge fund makes money, at least in part, from just selling the investment. I expect that this is just a new found opportunity to them, like the tech stocks were in the 90’s. I don’t expect them to stay, at least for the duration. If the economy appears to be coming back and significant price inflation doesn’t pop up in the next year, I expect to see the hedge fund pack up and go somewhere else. The fad will be over. The assets in the hedge gold fund will be either liquidated or sold to another investment company. This may happen slowly, in which case the impact will be minor. I mean, they won’t want to announce that they are leaving. It isn’t good marketing. We may have seen the end of the hedge fund impact on the gold price because they may not have access to more money and the price is high, compared to what it was when they first entered the market. That isn’t a prediction, actually. We will just have to wait and see, just as we will with any other element in the gold market.

Recent articles have also found a few mutual funds, generally more aggressive stock funds, are also investing in bullion and etfs. As far as the safety-oriented person is concerned, their presence, commitment, and understanding of this market should be regarded as just as the hedge funds.

The London Exchange is the primary market for gold in the world. Why am I including it in a survey of different elements that participate in this market? There is a claim that the London Market is practicing a form of fractional banking. That is, they are selling more gold than exists in their safe-keeping. They buy and sell London Good Delivery (LGD) bars of a certain weight and fineness. The estimate is that whether measured in weight or dollar amounts the 100% turnover in LGDs is high, weekly by dollars, daily by weight. I am not too worried about this. People participating in the London market are not going to be seeking to ask for delivery of their gold holdings, at least for a while. If the market starts moving that way, the London market management can move to acquire the necessary gold. If the claim of overselling their supply is true it does mean that the market is less volatile than it would be. Prices might be slightly higher, but the market price would move faster one way or the other to attract the necessary supply or demand. If true, it isn’t a major problem because the London market is not acting like the Fed, for example. They are not constantly making new pretend LGDs. The creation of LGDs is contained to a certain level and no more. My view of the people who are yelling “fraud”, if the allegation is true, is that they are correct to the extent that the London market is doing so and not admitting it. But the significance is far less than the allegations would imply. It would be significant if many of the market participants suddenly demanded delivery of the gold they owned. If that happened, I think we would have many other more serious problems to concern us than the short fall of the amount of gold available from the London market.

Similar concerns have been voiced about etfs, that they cannot have the amount of gold in hand to cover their investors. As a practical matter, this claim could be accurate. You would need to look closely at the prospectus to see what is allowed. (I will look soon.) I expect that as money flows in they have given themselves time to acquire the gold. There might also be provision for holding funds for redemptions. Practicalities aside, I expect that you will find that they work to have a 100% gold backed fund.

The final group that I know of that makes up the gold market is those who are looking for safety from the currency of their own country. They expect their currency to buy less and less stuff as time goes on and gold to at least maintain that purchasing power. These people come from all over the globe and have varying degrees of understanding of the economic, political, or personal freedom issues involved. They have varying proportions of their personal assets in gold, and they own the gold in various forms. As with the other elements in this market, I don’t think it is really possible to discern the size of this group in terms of numbers or dollars. It may be growing, but not fast, not as fast as you would expect. It is a group that will be buying primarily. They will be mainly fully invested, as much of their assets as they have decided to place in gold. They will rarely be sitting waiting with cash in hand for a drop in price. They might be as the price continues higher, but I don’t think that the last few days showed any real support from this group.

Of the groups that I have mentioned, the jewelry and industrial users, the central banks, and those seeking safety are the elements who are in the market for the longer-term and will be the primary upward pressure on the dollar price.

The most helpful inference to draw from this listing is that short-term movements in the gold dollar price do not necessarily reflect a market response to the dollar or the U.S. government’s monetary policies in any significant way. Rumors of strengthening of the U.S. economy will send the gold price down. Rumors or actual changes in U.S. interest rates will send the price down. Strengthening in the U.S. dollar, short-term, maybe daily, will send the price down.

However, as long as the U.S. continues to export dollars, keep interest rates low, especially near zero, and encourage bank credit expansion, there will be upward pressure on the dollar. These problems will continue as long as the U.S. government insists on spending more than it possibly take in by taxes. They will continue for as long as the U.S. government insists on trying to provide services that it cannot possibly afford. They will continue into the next decade as long as U.S. politicians refuse to address the coming fiscal impossibility of Social Security and Medicare funding. There is no reason to think at this time that the U.S. dollar will stop sliding. There is reason to fear a higher rate of price rises in the U.S., including much higher oil prices. There are good reasons to expect gold to continue to rise sufficiently to maintain the purchasing power of your assets.
At this point it is not clear if productive assets will perform sufficiently that their profits will exceed the rate of inflation plus taxes and provide an increase in wealth. That depends upon many coming problems. The first one on the horizon is Obama’s medical bill. Will it promise expansive spending? The next very big one within the next year will be the Fed’s ability to soak up all of the excess Fed member bank reserves that now exist (see other posts). Watch the Fed. I will be and talking about it here.

THE GOLD MARKET: The Players, Part I

The recent strong upward push and rapid decline in the dollar price of gold should provide some grounds for thought. I wouldn’t say concern. Gold is the place for safety from concern.

I decided that this survey might be helpful after seeing and hearing some people respond to the recent gold price movements. They were looking at the market solely from their own perspective and couldn't understand why the market might go down or what it meant regarding their own purposes. By knowing that there are other perspectives and purposes in this market a gold investor can get a better feel for his position and what movements in the market mean to him.

The point is to understand about the recent up and down in the gold market is that it is made up on many different elements. The market is thin enough that nearly any of those elements can drive the price when the mood strikes them. In this case, I think that we have seen a certain speculative group, short-term buyers and sellers move the market. My reasoning is that the fall took place on news, more than rumor, but news that offered a glimmer of economic recovery. It was just a glimmer. The people who sold were taking profits or decided that there was no prospect of immediate profits.

The profit motive is different from the safety motive. If you are thinking profit but also safety in some fashion, your thinking may be confused. Safety from the dollar means that as the dollar depreciates, you maintain your purchasing power by being in gold. There is no profit. In fact there is a lack of profit. Buying gold, regarding it as a currency, is like the late-18C miser who put his savings in the mattress. It didn’t earn him anything. Fortunately for him, it tended to increase in purchasing power during that period. Buying gold means that you believe that the dollar will depreciate faster than the return of any actual reasonable investment over the next few years.

There is a way that you could be increasing your wealth vs. the dollar without there being price inflation or as much price inflation as your gold holding has appreciated. The value of gold should compensate for the expansion of the money supply, inflation. No matter what your view of what price inflation in the U.S. has been over the last twenty years, the money supply has expanded faster. Along with the expansion of our domestic money supply, we have exported hundreds of billions of dollars every year for twenty years. This wild expansion is what has and will fuel the rise of gold. We will see that as well in the fall of the dollar, which as fallen by over a third in the last decade. A recent report on imports showed a nearly 4% increase in import prices alone (year to year). If the world economy heats up, increases in import prices will quicken, the dollar will continue to fall and this will fuel increases in the price of gold. All of this will be true before you add in any domestic price inflation. Thus, your gold investment will tend to gain more than your loss of purchasing power. This will happen regardless of what is happening now domestically because it is the result of the export of all of the dollars over the last twenty years.

In the near future I will discuss the different options that you have for putting your money in gold. I think that these different options relate to the level of risk that you see from the government and society.

But for this entry, I am going to discuss the different elements in the gold market and what influence they have on the market.

Probably the biggest, continuous element in the gold market is the jewelry industry, which includes, in a very broad sense of jewelry, the country of India. Aside from their general fascination of gold, they have traditions that create a large demand for gold during the “marriage seasons”, which are generally warmer weather periods. Up until this year, India was the largest importer of gold. Their demand has fallen slightly, due to the higher price, but they are still a steady constant upward pressure on the gold market. They are more likely to buy newly mined gold since they will melt it down and use it, consume it. Within India there is a large market for gold that has been used, which they will melt and reuse. We see a little of that industry in the U.S., consider the TV ads we have seen offering to buy gold jewelry.

Who is overtaking India as the largest importer? China. As their economy prospers their demand for quality consumer goods is also raising, including their desire for fine jewelry. Again this is consumer activity.

Use of gold for industrial use and jewelry reduces the supply. I don’t have the figures as to how much gold is taken off the market every year by these uses vs. gold production (about 2,500 metric tons). The actual figures aren’t really that much help. What you have to keep in mind is that these uses will continue and that they will reduce the availability of gold for safety purposes, and thus the price will continue to rise faster than you would expect as long as these two elements continue.

Industrial and jewelry consumption of gold will continue but they will be sensitive to price levels. At some price point, jewelry demand especially, will start to fall off. At some price point, jewelry will be melted and return to the world market. We will also see whatever gold is stored in jewelers safes reappear. When this happens, increased supply will begin to blunt the upward price pressure. To what extent will depend upon the general context at the time.

Industrial use is somewhat less sensitive to price. Usually, the amount of gold used in a specific product is very small and makes up a tiny portion of the overall cost of production. The importance of gold is very high in those products, often making the difference between performance and not. So, in those products, the gold price will not make much of a difference. There are other products containing gold that are more a consumer fad, e.g., gold covered sushi. As the price goes up these products and usages will be less popular. At some point we will see gold covered audio cables disappear from the shelves, but that won’t make much difference to the world gold price.

Another important element in the gold market is the professional trader. These are the people who make the market, who have traded in gold for years, or who have been selling gold to people for some time. I would say that they are becoming a smaller minority as time goes on. The diminution of their influence will be seen in wider price swings. They don’t necessarily have any ideological connection to the metal and may consider the market from a strictly technical perspective. They would tend to see the current market as over bought and consider the recent pullback as a much needed correction. They may sell gold short when the market goes up rapidly and would be a breaking force.

Next week, Part II

Inflation Watch Update

These are some thoughts and observations about inflation: the prospect and what we are seeing specifically in prices.

As a reminder: inflation refers to the money supply
I use the term “price inflation” to talk about prices and the cost of living.

I saw someone saying that the price for small things like candy, fruit juice, stuff for less than a dollar or so, has gone up significantly in the past year or two. I don’t spend money on these things and don’t have a perspective. It would be interesting to hear form some people and their experiences of recent price changes.

I have also seen reports that segments of our produce production have been wiped out by weather. While this might have an impact on prices, it is not inflation and would be remedied by imports and the next harvest. It is important to keep a perspective on what is caused by government manipulation and what is caused by natural or market forces. Another example is oil or gasoline prices. The oil market is also heavily regulated and constricted domestically and in many other countries, which would tend to push the prices up due to shortages. A rising oil price due to government imposed shortages is not inflation or price inflation, however.

At the same time, housing prices and markets have been held up artificially over the last several months, which means that housing prices still have a ways to fall. If you are contemplating selling, do it soon.

Unfortunately, many, if not all, of the people who are arguing that significant price inflation is coming are very strident and projecting very extreme scenarios. Perhaps it is the result of the apparent indifference or ignorance of the American people. Maybe it is because of the propaganda emanating from the Fed, the Treasury, and the administration. Whatever, the stridency has a tendency to either make people anxious or drive them away. I am trying to offer a reasonable discussion and inference.

The major problem that is presented in looking into the economic future is the timing. In generally good conditions, you have considerable uncertainty mainly because of the multiplicity of actors and their perchance of doing things you don’t expect, usually good things, but still things different than you expected, so your decisions do not pan out.

In this situation, you know that what the government is doing is not good and will have adverse consequences. In fact there have already been adverse consequences, really bad ones. What you don’t know is how much worse the situation can get and when.

Price inflation can come at us from many different directions. We can see the dollars overseas come storming back, which would increase the circulating money enormously. (This is a favorite scenario of the scare mongers.) The Fed might try to stop or reverse the potential of price inflation by increasing interest rates, in which case we would see a business slow down and possible a reduction in availability of goods, while the money supply continued to go up, and we have price inflation during a recession, the 70’ again.

In a few years we will see inflation when the baby-boomers hit Social Security and Medicare, especially if their retirement funds continue to be wiped out.

We will see price inflation as Obama continues to spend money and the Fed accommodates him by buying the debt and pump money directly into the economy and keeping interest rates low. (This is actually not as bad as what they normally do which is expand bank credit, which has a multiplier effect.)

In other words, with all the money that the Fed is creating and will create, it is nearly impossible that price inflation won’t descend upon us. The ground has been laid for general inflation, i.e., the expansion of bank credit and thus many different messes, including price inflation.

Right now the banks have unlimited opportunity to make loans. There is plenty of demand and their Fed reserves are 10 times what they need. Bankers, however, are businessmen, government controlled businessmen, but still profit driven. They are conservative, cautious, and frightened by the mortgage crisis. They do not want to be taken over by the government. So they aren’t lending right now. Haven’t been for maybe a year or more.

You can see the problem of a lack of credit available in many of the business failures and the coming wave of commercial real estate foreclosures. Further, the Fed is trying to keep them from loaning out the money by giving the banks interest payments for the money in their reserves. I don’t really understand the reasoning here. Why did they give them the reserves only to pay interest on them to keep the banks from using it. Doesn’t make sense to me.

What the banks are really waiting for is the rebuilding of their capital structures (and for the banks forced to take government money, they are waiting until they can also pay that money back). Once their capital structures are in place, they will look for very secure, “safe” opportunities to loan money. We are not likely to see any asset bubbles soon. (Some say that the recent, rapid rise in the gold price is a bubble, but that is only true if it were financed by Fed created credit, for which I have seen no evidence.)

The Fed says that it will be able to soak up the excess reserves before it becomes a problem. Ha! Who can believe them. They will not own up to creating the last two asset bubbles (for starters). They won’t own up to what inflation really is. They are self-deluding. They think low interest rates are vital to a growing economy. They will also be pressured to keep interest rates low to support Obama’s spending plans. They will also want to keep interest rates low to keep the interest payments on the national debt from swamping the budget. The way they keep interest rates low is by creating bank credit. Increased bank credit is inflation. There is no way that the Fed is going to manage this mess without real inflation that will reach consumer prices. You can’t fault the hyper-inflation bugs. Any serious look at the situation has got to make you frightened!

So, what is going to happen. Here is where I find a limb to go out on.

Things are going to drift for a while. It may seem like the economy is going to recover, and it will in important ways. This is one problem with some of those who are expecting the worst, they do not give the American economy any credit. The American economy has a lot of strength and productive capability which is trying to dig its way out of the mess the government created. It is cutting costs where it can and looking for ways to become more productive, to carry the new burden placed upon it, just as it has done for years. Businesses are beginning to show profits, real ones. Unemployment seems to have reached its peak. I don’t think that the credit situation has worked its way out of its problems and that could cause a problem. If the Fed comes running in with more made up money, we could go back into recession. Things are touchy.

The banks are continuing to recover and build their reserves. The banks are, I think, the weak link, because in spite of their business orientation, they are creatures of the government. They have to be, with all the regulations and interference from the government. Some people complain that the regulators and the banks have become too buddy-buddy. The critics don’t understand that everyone in that community understands who is in control. It isn’t the bankers. So when the banks recover, they will try to do as their masters want, and open the credit window. It will start slowly at first, but over time, probably not a long time, the bankers will be back to lending profusely. Then it will be Katy bar the door, because the money, created money, will flow.

Sometime within the next two to five years we will be seeing significant price rises. This is my expectation now. I don’t feel as if I am being overly pessimistic, just as reasonable as I can be.

In a wider perspective of preparedness, I also think that oil prices will still have some upwards pressure. Commodity oil prices have gone up to the $70 range in spite of the worldwide recession. If the recovery is beginning why wouldn’t there be more demand for gas and other oil products? The supply has not grown in any significant way. Also, it was noticed this week that China is now buying more cars than the U.S. Isn’t that a demand for oil? Oil futures are showing higher prices.

I would say that we have some time to make some preparation, if you haven’t already. Don’t go overboard. You want to consider gold and dollar protection, as well as where profits might lurk, both short and long-term.

So, there is lots to consider in making your own plans. Just don’t expect the end of civilization, not based upon today’s information.

On the other hand, who knows what Obama’s supporters will do when it is obvious that his efforts are to no avail? They could riot and destroy everything in their path. They are the next storm troopers, just waiting for their opportunities. See, it is easy to expect the end of civilization!

More on inflation as I actually have something to add.
I have comments on gold, the dollar, and the Fed’s actions coming.

The Fed's Explosion of Money

There is a lot of research that I want to do for this blog. Some is reasonablely interesting like looking at the thoughts of capitalist economists and supporters of freedom. Some is like driving nails into your head, e.g., looking at government statistics. Of particular interest to me is the activities of the Fed. The Fed is always important, because it is so important to the economy, unfortunately. It is even more so now, and I have been in their website lately.

Specifically, I wanted to look at the manipulation of bank credit by the Fed. The Fed makes a lot of information available online. Some is very revealing. Other parts are difficult to dig through. I am only in the early phase of my work, but I found something that you might find interesting, and frightening.

I was looking for member bank’s deposit information. I found two such listed entries in a release of weekly data on the Fed’s open market operations page. These two entries were derived in different ways, in spite of being listed with identical titles. They tracked each other, so I don’t think that it is a major issue. They also vary a lot from one week to the next. I haven’t yet figured out why. The Fed does a lot of different things to the member’s deposit accounts, so there are a lot of moving parts. I also figure that over time you can see trends. But what I found is amazing.

I began collecting the data from the two listings beginning with the first week in 2007. Throughout 2007 and most of 2008, the levels of the two listings vary with a band of about $15 B on what I call MD1, with a bottom of say $5 B, and $25 B on MD2, with a lower figure of maybe $8 B (approximations). Then in September 2007, all hell broke loose.

Why is this important? The Member’s Deposits is the primary tool the Fed uses to expand bank credit and thus the money supply. Each bank (I am talking about the large banks) must have 10% of its demand deposits (checking account deposits) in its “reserve” account at the Fed. If it falls short the bank can borrow (from the discount window or from another bank). The Fed can also add or take money away from this account. When it adds, the bank can expand its demand deposits by making more loans. The Fed can also change the percent of deposits required and what constitutes the required deposits. The current practice is one of the loosest that I know of since the Fed was created.

So here we have these important deposits staying fairly level for a year to two. Actually the records accessible online go back into the 90’s. I want to look at it all. Now I say level. Actually when I look closer I expect to see an upward trend. I haven’t looked because what I found just blew everything else away.
Okay. What did I find? Up until mid-September, 2008, the average for MP1 was, say, $8 B, and for MP2 $15 B. By the end of September each was about $100 B, by the end of the year $800 B, today $1 T. There is no limit on bank lending. This isn’t a gentle push. This is a demand that banks loan money, lots of money. They aren’t, not yet, but they will. (I've got an Excell graph. If I figure out how to upload it, I'll put it in. It is the hockey stick!)

Notes and Commentary On "Crash Proof 2.0" Part 2

Chapter 5, p. 148: 2009 UPDATE

This chapter is about the stock market and the Dow Jones Industrial Average, which was at its recent low under 7000 when Schiff was writing. It is now in the 9600 range. Probably, Schiff would call this a bear rally.

p. 150: He expects to Dow to go to 4000 to 5000 and last for 5 to 10 years. ???? Unexplained.

p. 151: He refers to GE, which hit $5.72 in March, 2009 is now at $16.08 at a P/E of 12. He considers the Price/Earnings Ratio to be important. 12 is way below the traditional average.

p. 152: “Therefore, much of the big profits earned by such companies through their financial activities from the 1990’s on…were phony.” Here we are again. Jump. Phony because the financing was supported and the interest rates kept low by the Fed’s massive money creation. But how that makes the finance arm’s profits more phony than any other part of the company I do not know. It is true that those activities cannot be sustained because the Fed’s inflationary policies cannot be sustained. But dollars from one sector spend just as well (or poorly) as dollars from another sector.

Chapter 6, p. 186: 2009 UPDATE

For this chapter I have nothing to add or criticize. Not bad

Chapter 7, p. 227: 2009 UPDATE

p. 228: “As I noted in the chapter [of the first edition], the Social Security Trust Fund is a pure case in point [of a Ponzi scam].” Okay, this is not a big point, as far as the book is concerned. It is as far as he goes, however. He did not explain the Social Security Trust Fund in the chapter. He mentioned it. He did explain Social Security. He did not explain that Social Security is a very big problem looming just around the corner.

Nor did he explain that Medicare, which is already bursting out of its direct tax revenue and eating into the General Account, i.e., income taxes, etc., is an even bigger problem than Social Security, and it is starting now. The correct description is that Medicare is selling its special Treasury Bonds in its Trust Fund back to the Treasury. It is a fraud.

Perhaps, and this is just a perhaps, Schiff is so much of a finance guy that no other issues are big to him.

p. 231: “Out of this pseudo economy emerged the now-dominant service sector….” Here we are back to the service sector. Now, at least, it is only “dominant” in stead of providing services as the only thing we do rather than manufacturing.

I do not want to attribute this to Schiff without some evidence, but maybe the reason why he places the service sector here is because he cannot find another culprit for the deficit. I don’t know. But harping on the service sector only undermines what is often decent material. What he sees as the service sector is also very narrow. But, ultimately, he just doesn’t look at our economy as part of the world economy. It is. So is our service sector. Services, as long as your not restricting the definition narrowly to menial tasks done locally, are actually easier to transport and provide than physical goods. Looking at the U.S. as part of the world, offering services makes us very flexible in a rapidly changing technological world.

p. 234: “China funds about 50 percent of our borrowing,….” The numbers do not add up. Let’s say that our trade deficit is $800 B and that our federal deficit is $1 T. So, Schiff is saying that China receives three fourths of our trade deficit, and the put all of it into our Treasuries. Our total imports, which went down this year, were only $2.4 T, which means that China would have to be on the selling end of more than half of our imports. No, they weren’t. If he is going to throw numbers out, I wish he would give us some idea where they came from. I do not want to accuse him of making them up, really.

What numbers that I can find shows that out of the total U.S. federal debt of over $10 T, 25% is foreign owned. It could be that foreigners are buying 50% of new debt, expanded debt. I would still like to see his source.

p. 235: “In effect we imported foreign goods and exported inflation.” My very words. Where do services stand in this statement?

“…foreigners get to keep their goods….” This is part of his “decoupling” thesis, often mentioned but not explained in this book in either edition. I think I know what he is trying to say. The problem derives as to why the Chinese exports are so attractive, to focus on the country that Schiff refers to most often. They do not want many of the things that they build for us. The goods they do want they buy in as large a quantities that they can afford. I don’t see that the production capacity that they use for export is of much value within their country. Their general population is, after all, low income.

I will say that I generally agree with his analysis of the federal bond market. The current low rates cannot continue, the market will not buy a continuous stream that shows no end, ultimately, the buying of bonds by the Fed, with or without the trick of expanding bank credit, will reach consumer prices, with the help of dollars held overseas coming home. Price inflation will rise, and tend to rise at an increasing rate.

A general note, which applies since the last chapters are about investment advise. Schiff has not discussed the Fed’s major tactic of expanding the credit supply via the use of member bank’s deposits. It may not be relevant, or desirable in this book, but I often wonder if he knows.

Chapter 8, p. 273: 2009 UPDATE

p. 275: Schiff apparently has many other writings on the internet in which he explains much of his thinking. He left a lot out of the earlier edition of this book. Now, in the revision/add on, he sort of writes as if the reader had read the other stuff as well. Here, finally, he recounts some of his broader views that make some sense of the first edition.

p. 280: Another problem I have here is that he states several events as facts. They vary well might be, but I would like to see myself. Schiff does not give me a way to find out. There are no references. Okay, finding out is not as difficult as it once was. Go internet.

“The world is rapidly waking up to reality.” This time some evidence would really be worthwhile. I do not see this happening. I think that the central bankers around the world are still the same central bankers. They have not all of a sudden had a brain transplant. Private actors, currency traders, businessmen, investors, etc., may be, but again, having some reference to substantiate this would be helpful. Schiff acts as if anything he says is to be totally accepted. Please.

“I’m talking prosperity and growth unlike anything we could imagine when those nations had their wings freighted with the United States’ excessive debt and trade imbalances.” Does Schiff realize that all of these countries are less free than the U.S. was prior to the 60’s? Further, I do not understand how their internal economies, or even several countries, or the entire rest of the world, is going to absorb the production that the U.S. has received, or even a significant portion of it, without experiencing drastic reductions in the prices of everything. It isn’t as if there is all kinds of ready money, real or otherwise, sitting around to buy what the U.S. can no longer buy. How does Schiff expect that to work. The central banks in the other countries look at their economies not that differently from the Fed. If they see prices begin to drop they may just as well act as the Fed would and pump money into their economies, and bang, have the same problems we have. Schiff needs to explain how this works. I don’t see it.

“We are already seeing signs of decoupling….” Meaning that foreigners are tending to buy fewer U.S. Treasury Bonds, sell dollars, and not expect to sell goods to the U.S.. So, where does he see this?

p. 281: As the world’s producers begin making more for themselves and less for us, they will demand even more basic commodities, while recent capacity reductions will further limit supply.” But also, we will be demanding less, and therefore some supply will be opened up. But, as I said before, it is less obvious how the other countries are going to be able to take advantage of “making less for us” without prices dropping, which means that they will have less ability to pay higher commodity prices.


Chapter 9, p. 309: 2009 UPDATE

p. 311: “I do not believe there will be an official decree to replace the dollar as the world’s reserve. It will simply lose that status due to independent market forces. My guess is that central banks will began [sic] to hold more of their reserves in other currencies, such as the euro, yen, or Chinese renminbi, and significantly higher percentages in gold.”

Let’s consider what the situation would be if the U.S. had not been exporting inflation, i.e., made up dollars. Let’s say that the $10 T that is currently being held by foreign central banks and the $1 T held by foreign private interests were part of a stable currency. Of course, that could not have happened, because about 30 years ago our total liquid money supply was about $1 T. What would have happened is that as we sent dollars overseas to buy goods, they would have held on to them, pretty much as they held on to the made up money. Dollars would have disappeared from circulation in the U.S., and prices would have had to go down, simply because there were fewer dollars around to spend on things. Wages would have gone down, too, but not as much. This scenario would be just like the last few decades of the 19C. Internationally, the dollar would be bid up consistently, year by year, making foreign goods even cheaper and more attractive. Our standard of living would improve, especially as we became more productive and allowed our creative people to create. What a world.

The point of going through that scenario is to point out what would happen in countries whose currencies would be chosen to be reserves. Every yen taken out of circulation in Japan is one less yen being used for prices in that country. There isn’t much of a yen bond market. The situation would be similar for the euro.

As I mentioned in an earlier note in this commentary, the central banks in those countries do not view falling prices as a good, and would tend to make more money to replace money that was effectively exported, and the cycle would begin, as it did here.

I do not think that gold would be the general response because it is too restrictive. Central banks could not do what they consider their responsible activities of controlling the business activity within their countries.

Schiff has this unrealistic view of what other countries are like. They have an even lower attitude toward the free market than our “leaders” do, and less experience. (I am willing to consider exceptions, but those would not be major economies, I expect.) I would not expect milk and honey in China, Japan, Korea, and certainly not in Europe.

On the other hand, I think that Schiff’s expectation that gold will continue to rise in the long run, or even intermediate, is accurate. What’s to stop it?

“…the fact is that the world does not need a reserve currency. Rather than replacing the dollar with some other flawed fiat alternative, the world could simply return to the traditional gold standard that existed prior to Brentton Woods.”
Well, yes, that is what it should do. But, to do so, it would have to recognize why. The Chinese do not. And I see no reason to think that anyone in the governments of the other major players understand either. The fact is that governments that exist today prefer fiat currencies, and really have no problem with a fiat currency as a reserve. If they have a problem with the dollar it is because the U.S. has gone overboard, in their opinion.

p. 313: “…but I’m also surprised at the extent to which the European Central Bank (ECB) and other foreign central banks have adapted inflationary policies.”
Mr. Schiff, U.S. central bank policies were patterned upon foreign central banks. We did not invent the central bank, the Europeans did.

The balance of this section is, in my opinion, sound.


Chapter 10, p. 335: 2009 UPDATE

In this section Schiff sort of ping-pongs around, accurately demonstrating the problem with suggesting the thing to do in our current situation. What to do?

If his expected economic disasters come to pass, it is very unclear when they will. This leaves the asset holder in a difficult quandary. If his second collapse is as drastic as he expects, then holding the right things will wipe them out just as much as holding the wrong things. The most important assets to hold may be gold, food, and weapons. That is the worst-case scenerio. Frankly, if you expect the worst case, you should be moving to a small town in an agricultural area, get to know your neighbors, help on farms, buy some gold coins and bullion, and hunker down. Holding foreign stocks might not be helpful.

If, on the other hand, you expect things to be hard fought, that the efforts by yourself and other Objectivists and people who want freedom are going to have enough of an effect to keep things running well and then turn around, owning foreign stocks, gold indirectly, and a selection of solid U.S. companies would make sense. I do not think that someone who felt that reason has a good chance of prevailing today would give up entirely on U.S. companies.
Not a good set of choices, sorry.

Notes and Commentary on "Crash Proof 2.0" Part 1

p. vii: “More importantly, while most believe that the economic collapse is over, the reality is that it has only just begun. What we have witnessed thus far are merely the events that have set the collapse in motion. It will take some time for all the dominoes to fall. But fall they will, perhaps even more spectacularly now than how I initially envisioned back in 2005.”

p. viii: “…you to see that our problems today are the consequences of pernicious fundamental trends that I have recognized and warned about for years.”

Maybe. They were not really in the book. He did warn about the residential real estate mess. Credit to Schiff. Lots of credit to Schiff. I think that he has shown some ability there.

Yet, the thesis of the book, the collapse of the dollar, has not occurred. We’ll see what he has to say.

Chapter 1, p. 24: 2009 UPDATE

p. 27: “…and provide the capital investment that entrepreneurs need to create jobs and finance the production of exportable goods.” ???? Where did this emphasis on exportable goods come from? Why does he get so excited about exportable goods? Why does “exportable” matter? Why not just goods, goods for everyone?

I need to say that the sections that I am not commenting about are at least decent, and often good.

p. 29: “But buying stuff we couldn’t afford with money we didn’t have was what got us into this fix.” While this is true, it is superficial. I fear that as long as he focuses on consumer oriented thinking, he will be letting our opponents off. What he needs to focus on, which he has elsewhere, is the inflation that underlies the consumer spending. Much of this behavior is driven by the cheap money policy and the mistaken notion that the key factor in an economy is consumer demand. With an emphasis on production and the manipulation of the money supply stopped, people would not benefit from over spending and the practice would be less prevalent.

“Rather than encouraging American borrowers to once again tap the savings of foreigners….” We weren’t getting the savings of foreigners, we were getting our own previously made inflation dollars back. This is one of his worst statements in that, one, he is claiming something that sounds so vile and, two, he says it with no support, in this case, with not even a supporting explanation. I expect that he is referring to the U.S. federal debt that is purchased by foreign central banks with dollars they hold in their reserves. These dollars come into the local economy as exports are sold to the U.S. The exporter then trades his dollars to the central bank in exchange for local currency. As long as the local currency is not being inflated for this exchange, then the process to then is neutral. The problem comes when the central bank just holds the currency instead of allowing it to continue ciruclarating in international commerce. This is a drain on the local economy. But these are still dollars created by inflation. When the central bank then buys U.S. federal debt, it is putting our inflated dollars back into our economy, which is then spent as “real dollars” here, and will tend toward pushing up prices. It is still difficult to see how we are tapping into the savings of foreigners.

At the end of the page he actually said, “worst-case scenario” regarding the “crash” he has been predicting with each book. That means that the outcome that he has been using to frighten his readers is now regarded as a worst case.

p. 31: “I have always said, however, that it wouldn’t happen overnight.” Ahhh. Please show me where in the first book that was said. In this book he seems to be encompassing all of what he has said anywhere as opposed to just Crash Proof. What is a crash but an overnight event.

p. 32: “It’s absolutely unarguable that they [foreign economies], not we, are the engine of economic growth.” This very arguable statement is an assumption that undermines his entire argument. If he recognized that there is a strong foundation still in the U.S., he would be a better analyst and predictor. He is good in some respects. He could be better. Schiff is an intelligent man. I do not understand why he would make this statement and provides no support. As I say, I have not looked at everything he has written or said, but in what I have seen, including his most public presentation, Crash Proof, he offers little evidence to support his conclusions.


Chapter 2, p. 53: 2009 UPDATE

“Clearly recent events have proven my point: Wall Street, the U.S. government, and the mass media have been using manipulated data to foster a falsely optimistic view of a ….” I don’t see where he gets this. It isn’t the data that confuses those people. It didn’t confuse Schiff. What confuses most people are their ideas, their philosophy. Schiff’s confusion on this point is a reason why I am not impressed with the claims by his supporters that Schiff is a defender of reason or a follower of Ayn Rand. He just doesn’t demonstrate a recognition of the importance of ideas. His point here is that if these people looked at good data they would act differently. No, they wouldn’t.

He does end the paragraph with the accurate point: “Even more distressing, to my mind, is that the experts did not actually understand the problems threatening our economy.” That is correct. I wish he would show that he, Schiff, knows why those experts did not understand.

p. 58: “Note, too, that a 1 percent fed funds rate provided the stimulus that sparked the housing bubble and made teaser rates so enticingly low.” While this is technically true, it is not really helpful. I mean, how does the Fed keep the rate at 1 percent and how does that “provide the stimulus”? Without that information I think many people, including many who reasonably agree with him, are left with a floating abstraction. It needs to be explained.

p. 61: “…our economy is fundamentally broken.”

“But we spent an excessive amount of money on consumer goods with the result that we don’t have the manufacturing bases….” Still don’t see how spending on consumer goods, excessive or otherwise, or importing a lot of it destroys our manufacturing base.

His basic point in this section is correct. We have not learned from our previous mistakes.

“When the problems predictably worsen, let’s hope Washington finally learns the proper lesson.” He is right about the lesson to be learned. But he doesn’t understand that Washington as it is now constituted (and the last administration as well) is incapable of learning.

Chapter 3, p. 83: 2009 UPDATE

p. 84: “…where I had predicted earlier that the Dollar Index would likely bottom out at around 40, I now see a bottom closer to 20 or maybe even lower.” It was around 70 in March, 2008. He does say when or how fast. The timeline would be the difference between a crash and a decline. I do not disagree with a decline, a continuing decline. I wouldn’t begin to suggest a number. A crash won’t happen. Strategies for retaining value in your assets would differ between a crash and a decline. A slower decline would offer some chances to do something about it, if we had the opportunity. A swift decline or a crash would bring us to a desperate situation.

p. 85: “As our trading partners see it, they were watching their best customer go down the tubes, and their first reaction was to come to its rescue.” Yes. And the fact that they have $10 T in dollars and bonds. They are not going to want to see that go down the tubes either. Which has been my point.

This section is an excellent description of the interrelatedness of our world economy. The U.S. is a very significant part of it. Schiff’s decoupling would shrink the world economy drastically, and the consequences he relates in this section would happen again. His tag line that they should stop manufacturing for us and do it for themselves is so screwy.

p. 88: “The problem is that too many people lack the sophistication to understand why [foreigners supporting the U.S. dollar and selling goods to the U.S. is harmful].” Again, he shows that he does not understand the importance of ideas. The currency and bond traders of the world, the manufacturers and exporters of the world, and businessmen, wealthy people, and so on, are not unsophisticated. To the extent that they are making bad decisions as envisioned by Schiff, they are miss-trained. They have bad philosophies. But, to some extent, they are making some reasonable decisions, since Schiff is incorrect in claiming that the U.S. is an economy without foundation.

p. 89: The last sections are reasonably good. The bond market is going to see higher interest rates, even if the Fed tries to support low interest rates. There will just be too many bonds. The Fed will have to flood the market with credit. Schiff does not mention this but things will be rockier as Obama’s plans play out. After that we will get the huge increases in Social Security and Medicare spending, and we will have taxes that will take up every bit of capital and discretionary spending.

“When this rally ends, the bottom is going to fall out of the dollar.” So we are back to the collapse. Well, I think that the post-panic government actions, plus Obama’s programs could do it. Interestingly, Schiff has not mentioned Obama’s programs directly. He is focused only on the bailout. He hasn’t mentioned Social Security and Medicare.


Chapter 4, p. 118: 2009 UPDATE

p. 122: “If we were still on a gold standard, as was the case during the 1930’s….” While technically we were on the gold standard in the 30’s, it was not a real one. FDR famously sat down with one of his “economics” advisors every morning and decided what the gold price should be. There was also lots more gold than there were gold certificates, meaning the Fed could make as much money as it wanted, and did.

Schiff constantly refers to inflation in terms of “printing presses”. I think that this is so misleading to people. It is so simplistic. I understand that using accurate terms is more cumbersome, but accuracy and precision of language is important.

p. 123: “…and now that we are in a downturn, we have even more inflation because the money supply is growing even faster.” Is it? I know it will. But it isn’t now. Credit is still dead; no lending is going on. This is why his using the term “printing press” is a problem. He is not using in his descriptions what he does know, that inflation in the U.S. is caused by bank credit expansion, and the lowering of the dollar because of the size of the foreigner dollar holdings the exist because of credit expansion in the past. So he knows that, although the Fed is certainly trying to get banks to lend, they aren’t. Thus, there is no inflation now. That will reverse, and with the amount of new government debt, the idea of stimulus, and the goal of low interest rates, bank lending will pick up, grow and grow and grow. Inflation. It will burst out somewhere.

“Many argue that all this money printing is not inflationary as it merely replaces the money lost due to debt defaults. However, this naïve view fails to account for the loss of output represented by defaulted loans.” ????? The loans were mortgage-backed securities based on loans to people who couldn’t make their payments. Where is the loss of output? My problem is that I do not see the connection between these two sentences. He does not deny that the bail-out money is replacing reserves and capital, and is not particularly inflationary (it is not good for us). And a recession has a loss of output. Is he saying that since there was a loss of output that there should be less money in the system? Is this loss of output permanent? I am not seeing these connections.

p. 125-6: “Why Inflationary Pressures Will Prevail” This is a very curious section. He talks quickly about a vast array of economic actors, including commodities, consumer goods, credit, farms and mines, retailers, etc. But nowhere does he talk about the Fed and its money machine? When someone tries to declare what is going to happen at this level of detail, they are always wrong, because the number of actors and factors is too large. He needs to stay on the broader level on which he usually works.

p. 126: “The Real Game Changer” This analysis of the value of the dollar in international trade is correct, but I wonder at the size of the impact. I think the bigger impact within the country will be the Federal budget, the higher interest rates, and most important, the Fed’s actions. The fall of the dollar will have its impact, but will not be as big as Schiff thinks. He seems to go back and forth as to what is most important. But he always returns to the value of the dollar in international trade. I wonder why? The reason that I say that it will not be as big a deal as he thinks is that international trade is not a large segment of our economy. We have already seen a nearly 50% drop in the value of the dollar against the Euro and the Yen, even the Canadian Dollar is much stronger against our currency, but we have seen little effect within the country. Perhaps he is expecting the U.S. government debt to have fewer buyers. This idea ignores the trillions of dollars that will still be out there and the very few places that it can be placed.
The one way in which his analysis could be correct is if some major holder dumps their dollars. The major players include England, the Euro Block, Japan, China, probably Canada, and maybe one or two of the oil producing countries. One of them would have to decide to start selling their large holdings of dollars. One of the first events would be the other countries buying to protect their vast holdings of dollars.

Crash Proof, 2.0; Review

Peter Schiff’s newly published book has an unusual organization. It is the original Crash Proof, exactly as originally published, with updates written in 2009 at the end of every chapter. He has changed none of his positions. At least some of his positions and predictions came to pass. He crows about this repeatedly. I don’t hold this against him, mind you. In fact, in his business, where often even if the market goes the way you predicted, you are wrong about why, so everyone is wrong. Being right significantly is worth crowing about.

Since the whole original book is intact, all of my original problems remain. I will not repeat them (see the original review on this blog).

The “Updates” generally extend the ideas in the original text, including the ones with which I disagreed. In some cases, he makes clearer what those ideas are, and why his original ideas are not quite right.

I thought that the following quotation demonstrates what may be his biggest confusion: “…but I’m also surprised at the extent to which the European Central Bank (ECB) and other foreign central banks have adapted inflationary policies.” (p. 313) He has consistently treated the U.S. as a country that acts differently than every other country. Yet the concept of the central bank and how it should function is a European invention. The fiscal policy that our country follows was created by our old friend Keynes, an Englishman. All of the central bankers in the world went to the same schools, read the same texts and authors, and talk and communicate all the time. Why does he think that they wouldn’t all act the same?

Even worse is the following: “I’m talking prosperity and growth unlike anything we could imagine when those nations had their wings freighted with the United States' excessive debt and trade imbalances.” Does Schiff realize that all of these countries are less free than the U.S. was prior to the 60’s? Why is just not selling to the U.S. going to bring on the days of milk and honey?

Also wrong about that quotation is that the trade imbalance is the result of foreigners holding on to our dollars. If they had not held on to the dollars, the foreign central banks would not be faced with the problem with where to put the money, and they would not be funding our debt. If other nations, especiall China in recent years, had spent the money, the dollar would be much lower, we would have had to finance our own debt and interest rates would have had to be higher and there would have been more restraint. I'm not saying that our problems are the fault of other nations. They are responsible for the number of dollars they hold on to.

A criticism concerning understanding the book comes from the fact that Schiff has written and talked (audio and video posts) a great deal on the web. His stronger supporters are familiar with this material. I have read one or two things, seen two or three short videos, and heard one audio piece that went on for about an hour. In the online material somewhere, Schiff has developed some ideas that did not appear in the first book, but he mentions briefly in the 2.0. Most importantly among them is the idea of “decoupling”. This is very important in Schiff’s thinking, but it is not explained in his book. I do not think that I can adequately present the idea with its supporting argument. Generally what decouples is the Asian economies from U.S. purchases and government debt. As a result they have “prosperity and growth unlike anything we could imagine”.

I disagree. To have that growth in mature economies, they would have to have freedom. The reason they got there was the support of the country that was, and hopefully will be again, the freest in the world, the U.S. If the U.S. hadn’t existed, they would not have cleared the 19C.

The last three chapters contain advise as to how an investor can protect himself and perhaps even profit while the U.S. economy suffers. There is some interesting advise there. Schiff does recognize the major issues, e.g., timing and changes in the laws. As with my above comments, I don’t think that he realizes that what happens in the U.S. is going to have significant adverse effects elsewhere. (In my notes that I will publish after this review I discuss what would have to happen in the “decoupling”). Without considering what could happen in other countries, I think that Schiff’s discussion lacks completeness. It is still worth reading, if you keep both the shortcomings in mind.

I also think that his comments on Treasury Bonds and the actions by the Fed are decent.

Actually, if it weren’t for his shortcomings regarding the rest of the world, he would be good. Certainly much better than most of what you can find these days.