New From Sprott: "Have We Lost Control...Yet?"

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Fri, Jun 28, 2013 - 9:30am

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Have we lost control yet?
By Eric Sprott & Etienne Bordeleau


Recent comments by the Federal Reserve Chairman Ben Bernanke have shocked the world financial markets. It all started on May 22nd, 2013, at a Testimony to the US Congress Joint Economic Committee, where he first hinted at tapering the Fed’s quantitative easing (QE) program. Then, on Wednesday, June 19th, during the press conference following the FOMC meeting, the Chairman outlined the Fed’s exit strategy from QE.

Since the first allusion to tapering, volatility has been on the rise across the board (stocks, currencies and bonds) (Figure 1A). Moreover, the yield starved, hot money that had flown to emerging markets has been rushing for the exits, triggering significant declines in emerging market (EM) equity and bond markets (Figure 1B). Finally, the prospect of the end of monetary accommodation has triggered rapid and significant decreases (increases) in the price (yield) of longer dated Treasury bonds (also Figure 1B).

FIGURE 1A: VOLATILITY INCREASING FIGURE 1B: ASSET PRICES DECLINING


It has been clear to us for some time that the Fed was uncomfortable with the relative certainty (i.e. Bernanke Put) that has prevailed in the markets since the introduction of QE-infinity last fall. Officials definitely wanted the market to start thinking about a future without non-conventional monetary policy. However, we seriously doubt that the resulting chaos is what they had anticipated. This was evident in the Chairman’s response to a journalist’s question about the rapid rise in rates, saying the FOMC was “a little puzzled by that”.1 The genie is really out of the bottle now.

Indeed, we believe that the recent “market appeasement rhetoric” by James Bullard and Narayana Kocherlakota (Presidents of the St. Louis and Minneapolis Federal Reserve, respectively)2,3 are further proof that the Federal Reserve has realized it went too far and that it is now in damage control mode. (Update: William Dudley, President of the New York Fed mentioned in a June 27th speech that “asset purchases would continue at a higher pace for longer” if the economy was to grow slower than the FOMC’s estimate)4.

However, as the Bank for International Settlements (BIS) so elegantly put it in its most recent annual report, “[…] central banks continue to borrow time for others to act. But the cost-benefit balance is inexorably becoming less and less favourable.” To this they add: “expectation that monetary policy can solve these problems [deleveraging, financial stability] is a recipe for failure”.5 Clearly, the Federal Reserve knows this and wants to exit their QE program. But can they really?

A large portion of the current economic growth depends on housing. However, mortgage rates are closely tied to long-term treasury rates. While housing affordability is still relatively good because of low house prices, significantly higher mortgage rates might slow the housing market. Furthermore, banks are still very cautious about lending and most borrowers have difficulty accessing credit. While gentle increases in yields are good for banks (who lend long and borrow short), meteoric increases in yields (as in Figure 1B) are damaging because they are hard to hedge and create large losses on the banks securities portfolios (mostly composed of government bonds and mortgage-backed securities) as well as mark-to-market losses on their derivatives portfolios. So, the large and rapid increases in rates the talk of tapering has engendered will damage the economic growth the Fed has been working so hard to engineer, potentially requiring even more stimulus down the line.

The US government itself would also suffer from increases in yields. In its Annual Report, the BIS shows that even a small increase in interest rates would have a large impact on the projected government debt-to-GDP ratio. As shown in Figure 2, under the CBO’s base case scenario (bottom line), the US debt-to- GDP ratio would hover around 110%, whereas a 1% increase in rates would take it to 118% in 10 years (middle line). According to the Chairman’s comments, the fiscal drag that has been partly to blame for the lackluster performance of the economy should subside going forward. But, larger debt servicing costs (because of higher rates) will put more pressure on government finances, forcing it to spend an ever increasing portion of its budget on interest payments. This will have the effect of increasing the fiscal drag, going against the hopes of the Fed.

FIGURE 2: U.S. GENERAL GOVERNMENT DEBT PROJECTIONS UNDER ALTERNATIVE SCENARIOS - AS A PERCENTAGE OF GDP


To add to all this uncertainty, the situation in the Euro Zone’s periphery is far from stabilized. Following the surprise Cyprus bail-in, international bank regulators have made a push for a democratization of this alternative to outright government bail-outs of banks. This idea is quickly gaining traction amongst central planners. We recently discussed the shortcomings of the BIS’s “Template For Recapitalising Too-Big-To- Fail Banks”.6 The BIS, again in its annual report, reiterated that “we need resolution regimes to make it possible for large, complex institutions to fail in an orderly way.” As uninsured depositors and bank bond holders realize that they do not benefit from government guarantee anymore, bank funding costs will rise and funding might dry up for peripheral European banks.

Conclusion: At the last FOMC meeting, by prematurely announcing the timeline and the specifics of an exit from QE, Bernanke might have lost control of rates and volatility. The current US economic growth is still feeble and hinges on housing, which would be slowed down by raising rates. Banks, while better capitalized than pre-crisis, are still not lending to most borrowers and would be dearly affected by too fast increases in rates. Moreover, European woes still threaten the stability of the international financial system and the recent rush to the exit might further exacerbate funding pressures for weak European banks. Finally, the US government (amongst others) debt load, while already unsustainable, would keep on climbing if rates were to increase only by 100bps.

The chaotic reaction by market participants and the corresponding increase in yields now risks destabilizing this very fragile equilibrium. It is yet unclear whether or not the damage control from the other Fed Presidents will put a lid on yields and market volatility, or if the damage to the Fed’s (poorly executed) exit strategy is permanent.

1 https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20130619.pdf
2 https://www.stlouisfed.org/newsroom/displayNews.cfm?article=1829
3 https://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=5128
4 https://www.bloomberg.com/news/2013-06-27/dudley-says-qe-may-be-prolonge...
5 83rd Annual Report, Bank for International Settlements, Basel, 23 June 2013, pages 4 and 6.
6 We discuss this in the Sprott Thoughts article: “The Dijssel_Bomb”. https://sprottgroup.com/thoughts/articles/the-dijssel-bomb

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  147 Comments

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SilverSurfers
Jun 28, 2013 - 10:59pm

Pals

at the local bridge club. So, do they all talk a good game? Let see.

Thomas Peterffy
David Siegal
Steve Wynn
Leon Cooperman
Steve Schwarzman
Sheldon Adelson
Harold Simmons
Charles Koch
B Wayne Hughes
Kenneth Langone
Rich Devos
Joe Ricketts
Bernard Marcus
Mortimer Zuckerman
Donald Trump
Steve Forbes
Gina Rinehart
Larry Tisch
Rob Walton
Boone Pickens
Meg Whitman
Phil Anshutz
Mel Gibson
Ruth Caleb
Rupert Murdoch

This is what you call pounding the payment in the 21st Century.

Re: Stopping Socialism in America

Sir,

Do you want to stop the spread of socialism and all those who pander it? If so, do you know who, where, how and by whom to strike at the heart totalitarian socialism for immediate concrete results? If not, then I am your attack dog, who is seeking to do the same. Totalitarians enslave the people as tax mules or state dependents, by income taxes and printable paper money. Income tax changes are not politically feasible at this time. Printable paper money is vulnerable if the alternative real gold and silver money is freed from price manipulation. Real money use forces balance budgets and that is the route to stopping corrupting socialism and totalitarianism. I can end real money price manipulation and just need and am asking for a little help.

Sincerely, Derrick Michael Reid BS JD

Times up for snake and madusa, can anyone indicate if JPM went long Ag?

yes or no? Ag did move up nicely today

BagOfGold
Jun 28, 2013 - 10:48pm

StevenBHorse...

has thoughts of the pizza eaters eating themselves to death!...Oopsey!...So sorry Steven!!!...

Bag Of Gold
tmosleySpartacus Rex
Jun 28, 2013 - 10:40pm

Spartacus

You said "dealer asking prices on AGEs and ASEs".

That is spot plus a premium.

Spartacus Rex
Jun 28, 2013 - 10:16pm

Looks like...

My Better Half is ready (finally) for dining out, so Cheers Everybody. Especially those who are riding high on yesterday's Gift Horse Today!

Spartacus Rex
Jun 28, 2013 - 9:49pm

@ Tmosely

'PRICES' not 'premiums'. Where did I lose you?

Spartacus Rex
Jun 28, 2013 - 9:47pm

Gold and Silver to Make Long-Term Gains by Jason Farrell

Citigroup expects both gold and silver to surge in the long term.

Via Zero Hedge:

“Gold and silver appear to be in the process of finding a bottom; however, the price action could continue to be choppy in the coming weeks. Ultimately, we expect both precious metals to move much higher in the long term, with the potential for silver to be the outperformer, as was the case from 2008-11.”

CitiFX, a division of Citigroup, is using the bottoming process for the metals from 2008 as a template. Gold corrected 34% during that year. The recent drop in gold below $1,200 is 36% below the high reached in September 2011. Even if the correction gets closer to the 44% crash seen in the mid-1970s, Citi expects the bullish trend to remain intact.

“Whether we are seeing a pattern more like 2008 or the 1970s,” says CitiFX, “we do not see this as just the beginning of a bear market in gold; rather, this should simply be another correction in the upward trend.” Should gold find its bottom soon, they forecast, the next leg up could reach $3,500 by 2016.

The real drivers of the metals markets are still intact… global banking stress, high sovereign debt, the creeping possibility of another Euro crisis. All will remain long-term drivers of higher gold and silver. To the list, The Daily Reckoning would add central bank purchases of bullion.

With both gold and silver both getting crushed, some perspective is essential. Our April 15 issue of The Daily Reckoning lamented gold was “due for a rest” after its 11-year bull ride. We also forecast $3,500 in the long term. Keep your eye on the long-term trend. Weak prices now spell one thing: B-U-Y-I-N-G O-P-P-O-R-T-U-N-I-T-Y.

Jason Farrell

For The Daily Reckoning https://dailyreckoning.com/gold-and-silver-to-make-long-term-gains/

Spartacus Rex
Jun 28, 2013 - 9:43pm

U.S. Senate to Retroactively Punish Runaway Tax Slaves

[Edit: Because Sheople are dumb animals who do not comprehend the meaning of Article I Section 9 Clause 3 (No ex post facto Law shall be passed) much less Amendment V ] by Simon Black. Years ago, it was virtually unheard-of for someone to give up his/her U.S. citizenship.

Then, one by one, a handful of famous cases surfaced… like Sir John Templeton, who renounced his U.S. citizenship in 1964 and moved to the Bahamas.

At the time, Templeton was able to save $100 million that he would have otherwise had to pay in taxes to the U.S. government.

But for anyone who views Templeton poorly for his lack of patriotism, it’s important to note that the man was one of the greatest philanthropists in history. And rather than finance more bombs, guns, and military folly at the height of the Vietnam War, he chose to channel his wealth into improving the lives of millions of people around the globe.

There have been dozens of other notable cases, both before and since… from the writer Henry James (who renounced in 1915 to protest America’s refusal to join Great War) to Tina Turner.

Not to mention thousands of people that no one has ever heard of.

In the first quarter of 2013, 679 individuals renounced their U.S. citizenship. This was 47.6% more than during the first quarter of 2012… certainly a significant growth rate. And it’s almost as many as renounced for the entire year in 2009.

For certain people, the stranglehold of the U.S. tax system is simply too much to bear. After all, the United States is almost alone in the world in terms of countries that tax nonresident citizens on their worldwide income.

In other words, if you’re a U.S. citizen, yet never set foot on U.S. soil, you’re subject to paying a huge portion of your earnings to Uncle Sam forever.

For some people, this becomes a major breaking point. They weigh their obligations to their families against the morality of financing a corrupt, dysfunctional government… and the decision to renounce becomes clear.

In 2008, the United States government passed a rule governing the procedure of renunciations. They deemed that a “covered expatriate,” i.e., a person of some wealth, would have to pay an exit tax before renouncing on the mark-to-market gains across his/her entire estate.

This exit tax is basically the same thing as an estate tax… or death tax. So to the U.S. government, renouncing citizenship is a bit like dying. It’s a bit strange.

“Covered expatriates” are individuals whose annual income tax liability (i.e., what you owe the IRS) exceeds $155,000 on average over the preceding five years and/or someone whose net worth exceeds $2 million.

Despite these existing rules, however, some U.S. senators are now working to reintroduce legislation that would bar covered expatriates from entering the United States. And it would retroactively apply to covered expatriates who renounced 10 years ago (when the term “covered expatriate” didn’t even exist.

This may end up being problematic for some people who have renounced over the last 10 years. But more importantly, consider what it says about the Land of the Free.

Most U.S. citizens are born on U.S. soil or to U.S. parents completely by accident. And what the government is telling us is that our accident of birth obliges us to lifelong service to the state, even though we never signed up for any of it.

If they say we must pay, we must pay. If they reinstitute a draft and say we must go die, we must go die. If they say they need to steal our Social Security, seize our IRAs, or inflate our currency away, then we must yield.

And if at any point, we stand up and say, “Wait a sec. I never signed up for any of this. You can have your citizenship back,” then they bar us for life as a penalty.

This all seems rather curious for a nation that was founded by foreigner settlers in search of a better life.

Yet we must either gleefully accept being born into state slavery… or they’ll treat us as if we are dead. It’s hardly seems an appropriate way for an enlightened civilization to treat people.

Sincerely,

Simon Black
Original article posted on Laissez Faire Today https://dailyreckoning.com/u-s-senate-to-retroactively-punish-runaway-tax-slaves/

PaPaSpeed
Jun 28, 2013 - 9:40pm

India.

https://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2013/6/28_E...

"Here’s what’s interesting about these numbers, Eric: As they (Indians) can’t buy gold, they are going to buy silver. If you tell the Indian population they can’t buy gold, they want to buy something real. They don’t want fiat paper. They are going to buy silver. And maybe in June or July, which we don’t have data on, when the restrictions and costs have shot up here (in India to buy gold), maybe they will buy even more (silver).

(Another example) It’s impossible for China to replace, if they imported over 800 tons of gold last year, and let’s say you couldn’t really buy it, the number they would have to buy is something like 48,000 tons of silver to replace that (gold equivalent). We only mine 25,000 tons a year, and there’s only 10,000 tons of that available for investment. And it looks to me like they (India and China) are buying it all right now."

tmosley
Jun 28, 2013 - 9:26pm

@Spartacus

Yes, of course, but that is not a part of this particular test. That level of premium increase is only weak evidence for manipulation breakdown, as premiums have gone that high and higher before. Dramatic, unprecedented price premiums would be strong evidence for manipulation failure over business as usual, but we haven't seen those yet.

Spartacus Rex
Jun 28, 2013 - 9:04pm

@ Tmosely

Correct me if I am wrong but we BOTH get that these "prices" are primarily the results of MOPE & Manipulation, as well as the fact that the Fed IS definitely accommodating the Big Boys in order to cover their naked & hypothecated A**es, Right? Seriously look and see how much Dealer asking prices on ASE's & AGE's have risen already just since yesterday! https://www.texmetals.com/american-silver-eagle.html & https://www.texmetals.com/american-gold-eagle-coin.html

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