Tag: finance

Submitted by Gail Tverberg of Our Finite World blog,

The two big stories of our day are:

(1) Our economic problems: The inability of economies to grow as rapidly as they would like, add as many jobs as they would like, and raise the standards of living of citizens as much as they would like. Associated with this slow economic growth is a continued need for ultra-low interest rates to keep economies of the developed world from slipping back into recession.

 

(2) Our oil related-problems: One part of the story relates to too little, so-called “peak oil,” and the need for substitutes for oil. Another part of the story relates to too much carbon released by burning fossil fuels, including oil, leading to climate change.

While the press treats these issues as separate stories, they are in fact very closely connected, related to the fact that we are reaching limits in many different directions simultaneously. The economy is the coordinating system that ties together all available resources, as well as the users of these resources. It does this almost magically, by figuring out what prices are needed to keep the system in balance—how much materials of which types are needed, given what consumers can afford to pay.

The catch is that the economic system is not infinitely flexible. It needs to grow, to have enough funds to (sort of) pay back debt with interest and to make good on all the promises that have been made, such as Social Security.

Energy use is very closely tied to economic growth. When energy consumption becomes slow-growing (or high-priced—which  is closely tied to slow-growing), it pulls back on economic growth. Job growth becomes more difficult, and governments find it difficult to get enough funding through tax revenue. This is the situation we have been experiencing for the last several years.

We might think that governments would be aware of these issues and would alert their populations to them.  But governments either don’t understand these issues, or only partially understand them and are frightened by the prospect of what is happening. The purpose of my writing is to try to explain what is happening in terms that people who are used to reading the Wall Street Journal or Financial Times can understand.

I am not an economist, so I can’t speak to the question of what economists are saying. I do know that what economists say tends to change from time to time and from researcher to researcher. For example, in 2004, the International Energy Agency prepared an analysis with the collaboration of the OECD Economics Department and with the assistance of the International Monetary Fund Research Department (Full Report, Summary only). That report said, “.  . . a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second year of higher prices. Inflation would rise by half a percentage point and unemployment would also increase.” This finding is consistent with the issues I am concerned about, but I expect that not all economists would agree with it. Oil prices are now around $100 per barrel, not $35 per barrel.

The Tie of Oil and Other Forms of Energy to the Economy

Oil and other forms of energy are used to power the economy. Historically, rises and falls in the use of oil and other types of energy have tended to parallel GDP growth (Figure 1).

There is disagreement as to which is cause and which is effect—does GDP growth lead to more oil and energy demand, or does the availability of cheap oil and other types of energy power the economy? In my view, the causality goes both ways. Oil and other types of energy are needed for economic growth. But if people cannot afford oil or other types of energy products, typically because they don’t have jobs, then energy use will drop. And if oil prices drop too low, we will be in real trouble because oil production will stop.

How Oil Limits Work

People tend to think of limits as working in the same manner as having a box with a dozen eggs. Once the last egg is gone, we are out of luck. Or a creek dries up from lack of rainfall. The water is no longer available, so we have lost our water source.

With the benefit of the economy, though, limits are more complicated than this. If we live in today’s economy, we can purchase another box of eggs if we run short of eggs, assuming markets provide eggs at a price we can afford. If the creek runs dry, we can figure out a different approach to getting water, such as buying bottled water or hiring a tanker to get water from a source at a distance and bringing it to where it is needed.

Oil limits are a kind of limit we often hear concerns about. Being able to drill oil wells at all and refine the oil into products of many kinds requires a complex economy, one that can educate engineers working in oil extraction and can build paved roads, pipelines, and refineries. The economy needs to be able to produce high tech equipment using raw materials from around the world. Thus, there must be an operating financial system that allows buyers at one end of the globe to purchase materials from the other end of the globe, and sellers to have the confidence that they will be paid for contracted products.

If a company wants to extract oil, it can almost always figure out places where this theoretically can be done. If a company can gather together all of the things it needs—trained workers; enough high tech extraction equipment of the right type; enough pollution-fighting equipment, to prevent oil spills and spills of radioactive water; and leases on land where drilling is to done, then, in theory, oil can be extracted.

In fact, the big issue is whether the extraction can be done in a sufficiently cost-effective manner that the whole economic system can be supported. Even if the cost of extraction “looks” fairly cheap, such as in Iraq, or in some of the older installations elsewhere in the Middle East, the vast majority of the revenue that is generated from oil extraction (often as much as 90%) goes to support the government of the country where the oil is extracted (Rogers, 2014). This revenue is needed for many purposes: desalination plants to provide water for the people; food subsidies, especially when oil prices are high because food prices will tend to be high as well; new ports and other infrastructure; and revenue to provide jobs and programs to pacify the people so that the government will not be overtaken by revolt.

A major issue at this point is the fact that most of the easy-to-extract oil is already under development, so companies that want to develop new projects need to move on to locations that are more difficult and expensive to extract (Bloomberg, 2007). According to oil industry consultant Steven Kopits, the cost of one major category of oil production expenses increased by an average of 10.9% per year between 1999 and 2013. In the period between 1985 and 1999, these same expenses increased by 0.9% per year (Kopits, 2014) (Tverberg, 2014).

When production costs are higher, someone loses out. It is as if the economy is becoming less and less efficient. It takes more people, more energy products, and more equipment to produce the same amount of oil. This leaves fewer people and less energy products to produce the goods and services that people really want, putting a squeeze on the economy. The economy tends to grow less quickly because part of the goods and services available are being channeled into less productive operations.

The situation of the economy becoming less and less efficient at producing oil is called diminishing returns. A similar problem exists with fresh water in many parts of the world. We can extract more fresh water, but it takes deeper wells. Or we have to ship in water from a distance, using a pipeline or trucks. Or we need to use desalination. Water is still available but at a higher per-gallon price.

Diminishing Returns is Like a Treadmill that Runs Faster and Faster

There are many ways we can reach diminishing returns. One easy-to-illustrate example relates to mining metals. We usually extract the cheapest-to-extract ores first. An important cost consideration is how much waste material is mixed in with the metal we really want–this determines the ore “grade.” As we are gradually forced to move from high-grade ores to lower-grade ores, the amount of waste material grows slowly at first, then dramatically increases (Figure 2).

We know that this kind of effect is happening right now. For example, the SRSrocco Report indicates that between 2005 and 2012, diesel consumption per ounce of refined gold has doubled from 12.7 gallons per ounce to 25.8 gallons per ounce, based on the indications of the top five companies. Such a pattern suggests that if we want to extract more gold, the price of gold will need to rise.

The economy is affected by all of the types of diminishing returns that are taking place (oil, fresh water, several kinds of metals, and others). Even attempting to substitute “renewables” for nuclear and fossil fuels electricity production acts as a type of diminishing returns, if such substitution raises the cost of electricity production, as it seems to in Germany and Spain.

If the total extent of diminishing returns is not very great, increased efficiency and substitution can act as workarounds. But if the combined effect becomes too great, diminishing returns acts as a drag on the economy.

Oil Increases are Already Higher than the Economy Can Comfortably Absorb

For oil, we can estimate the historical impact of increased efficiency and substitution by looking at the historical relationship between growth in GDP and growth in oil consumption. Based on the worldwide data underlying Figure 1, this has averaged 2.0% to 2.4% per year since 1970, depending on the period studied. Occasional years have exceeded 3%.

The problem in recent years is that increases in the cost of oil production have been much higher than 2% to 3%. As mentioned previously, a major portion of oil extraction costs seem to be increasing at 10.9% per year. To make this comparable to inflation adjusted GDP increases, the 10.9% increase needs to be adjusted (1) to take out the portion related to “overall inflation” and (2) to adjust for likely lower inflation on the portion of oil production costs not included in Kopits’ calculation. Even if this is done, total oil extraction costs are probably still increasing by about 5% or 6% per year—higher than we have historically been able to make up.

According to Kopits, we are already reaching a point where oil limits are constraining OECD GDP growth by 1% to 2% per year (Kopits, 2014) (Tverberg, 2014). Efficiency gains aren’t happening fast enough to allow GDP to grow at the desired rate.

A major concern is that the treadmill of rising costs will speed up further in the future. If it is hard to keep up now, it will be even harder in the future. Also, the economy “adds together” the adverse effects of diminishing returns from many different sources—-higher electricity cost of production, higher metal cost of production, and the higher cost of oil production. The economy has to increasingly struggle because wages don’t rise to handle all of these increased costs.

As one might guess, when economies hit diminishing returns on resources that are important to the economy, the results aren’t very good. According to Joseph Tainter (1990), many of these economies have collapsed.

Why Haven’t Governments Told Us About these Difficulties?

The story outlined above is not an easy story to understand. It is possible that governments don’t fully understand today’s problems. It is easy to focus on one part of the story such as, “Shale oil extraction is rising in response to higher oil prices,” and miss the important rest of the story—the economy cannot really withstand high oil (and water and electricity and metals) prices. The economy tends to contract in response to a need to use so many resources in increasingly unproductive ways. We associate this contraction with recession.

We have many researchers looking at these issues. Unfortunately, most of these researchers are focused on one small portion of the story. Without understanding the full picture, it is easy to draw invalid conclusions. For example, it is easy to get the idea that we have more time for substitution than we really have. Financial systems are fragile. The world financial system almost failed in 2008, after oil prices spiked. We are still in very worrisome territory, with many countries continuing a policy of Quantitative Easing and ultra low interest rates. We may have only a few months or a year or two left for substitution, not 40 or 50 years, as some seem to assume.

Of course, if governments do understand the worrisome nature of our current situation, they may not want to say anything. It could make the situation worse, if citizens start a “run on the banks.”

The other side of the issue is that if governments and citizens don’t understand the full story, they may inadvertently do things that will make the situation worse. They certainly won’t be looking long and hard at what collapse might look like in the current context and what can be done to mitigate its impacts.

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In what many thought was a miracle of modern money-printing-driven yield-chasing, Puerto Rico managed to get $3.5 billion of bonds off last week with no problem (albeit at a 8.73% yield). The issue (while perhaps not as surprising as the low yield issues of Uganda we have reflected on previously) raised some eyebrows and in the trading since its release, FINRA noticed something concerning.  The bonds, as Bloomberg reports, are supposed to ‘minimum denomination $100,000’ blocks and yet 75 trades this week have been for no more than $25,000 violating regulations which deem these for “institutional purchasers” and strongly suggesting the heavy hedge fund demand was nothing more than a pump-and-dump scheme to unsophisticated retail investors. PR bonds have plunged from par to $92 this week.

• *PUERTO RICO SOLD $3.5 BLN OF GENERAL-OBLIGATION DEBT MARCH 11
• *FINRA SAYS IT’S EXAMINING TRADING IN NEW PUERTO RICO BONDS

 

 

 

Puerto Rico borrowed $3.5 billion at 8.73% yield maturing in 2035 – funding itself through June 2015 and staving off imminent default risk with the biggest ever high-yield muni offering! As Bloomberg notes,

Hedge funds made up the majority of buyers in the tax-exempt deal, according to David Chafey, chairman of the island’s Government Development Bank.

 

Sale documents stipulate that “the bonds shall be issued in the minimum denomination of $100,000 and any integral multiple of $5,000 in excess thereof,” unless one of the three largest rating companies raise Puerto Rico to investment grade.

However, once the bonds were free to trade March 11, things changed…

Since then, they changed hands in at least 75 transactions less than $100,000, data compiled by Bloomberg show. The bonds’ highest price, 100 cents on the dollar, was for a $25,000 trade at 10:47 a.m. in New York on March 12.

This is a problem that FINRA is looking into…

Trades below the minimum amount for investors that don’t already own at least $100,000 of the debt violate the Municipal Securities Rulemaking Board’s Rule G-15 subsection F, said Martha Haines.

 

The rule Haines referenced states that brokers and dealers can’t execute a trade of a municipal security that’s below the minimum denomination of the issue, according to the MSRB’s website.

 

“These are intended for institutional purchasers, or at least for people that can afford the risk by making it a minimum denomination of $100,000,” said Haines, who teaches municipal finance at the Maurer School of Law at Indiana University in Bloomington.

A glance at the chart shows both the illiquidity in the market (huge bid-offers) and the major drop on Friday as FINRA unveiled its probe (suggesting those wanting to get rid – hoping to find greater fools – dumped them fast).

However,

Given the commonwealth’s challenges, the debt should be held by investors who are aware of the possibility of default, said Sean Carney, a municipal strategist for New York-based BlackRock Inc., the world’s largest asset manager.

 

“It’s irresponsible,” Carney said about trades below $100,000. “It’s not what the deal was meant to do — to keep the risk with those who understand it.” 

Of course, this could be merely splitting across accounts (or smal lupsizing from already $100,000 accounts) and all be a big misunderstanding… you decide which is more likely.

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Submitted by Doug French via the Ludwig von Mises Institute of Canada,

CNBC’s Rick Santelli used his “Santelli Exchange” segment on March 14th to highlight the wisdom of Hazlitt’s Economics in One Lesson written in 1946.

The financial network’s tea party rabble rouser and sparring partner to economist Steve Liesman said, Warren Buffett had talked that morning about reading Timothy Geithner’s new book Stress Test: Reflections on Financial Crisis and the Oracle of Omaha said maybe the government saved the world back in 2008.

Santelli highlighted chapter six from Hazlitt’s great work where he wrote that if government makes loans, that private lenders won’t make, to entities that can’t pay back, economic signals get destroyed, and chaos ensues. Hazlitt also emphasized that all credit is debt.

Another Hazlitt fan, Jim Grant of Grant’s Interest Rate Observer, delivered the Henry Hazlitt Memorial Lecture in Auburn, Alabama less than a week after Santelli’s comments.  Grant said, “I can’t imagine what the world would be like without Economics In One Lesson.”

Full Jim Grant presentation below

 

The  very witty Grant spoke in a humbled tone of being asked to provide the Hazlitt lecture at the Mises Institute, comparing it to a baseball journalist being asked to speak in Cooperstown.   Grant’s hero was one of the few giants in financial journalism where, Grants said, “the pinnacle, is still at sea level.”

At the young age of 22 Hazlitt figured out the future involves too many factors for anyone to predict, not to mention just knowing what the relevant factors are. Grant admitted it took him 40 years in the business to finally realize he couldn’t understand the future.

Unfortunately the folks working at the Eccles Building have not come to this realization. The PhDs believe they can depreciate the currency at the proper rate to cause everyone gainful employment and live happily ever after.

Hazlitt was on the job during a depression that no one ever mentions—the 1920-21 downturn. Christine Romer called the episode, “a bump in the road.” Grant disagrees. While Romer may use analytics to make her case, he mentions the song that came out in 1921, “Ain’t We Got Fun.” After reciting a few lines, Grant told the audience, “They don’t write songs about recessions. It was a depression.”

Prices plunged in 1920-21, but the Fed, having just been created a few years before was “not quite out of short pants.” Lord Keynes had not written The General Theory and there were no Bernankes or Yellens running the central bank. In response to deflation, the Fed raised interest rates.

Grant looked into the camera and asked, “How did we ever recover, Dr. Krugman? I know you’re watching.”

Of course no one has heard of this depression because it was over so quickly and they certainly don’t talk about it at the Fed’s monthly meetings. The government did not enable capitalism’s losers with low rates and bailouts. Before they knew it the economy was back on track. Murray Rothbard said the only way to treat depression is with laissez faire. “This experience would seem to prove Rothbard right,” Grant said.

The financial historian and wordsmith emphasized that it was not just crops and commodities that fell in price, but also stocks. Coca-Cola traded at just 1.7 times earnings and yielded 5 percent. Radio Company of America shares traded at one times earnings. At the time, the tender new Fed was not yet in the securities boosting business as it is today, where “a higher stock market is part of public policy.”

Like Santelli, Grant mentioned 1946 and a couple of Hazlitt columns that “could have been written yesterday.”    “Economic experts see deflation as the problem,” cracked Hazlitt snidely in one piece while titling another, “The Fetish of Low Interest Rates.” He explained that lowering rates by government fiat requires more money (inflation).

Today’s investors don’t realize artificially low rates make stocks artificially high in price as future earnings are capitalized at a lower than natural discount rate to create present values. The Fed’s stomping on rates has distorted this calculus making the market “a house of mirrors.” Valuations would be much different if interest rates were “organic, free-range, and local,” instead of being nurtured in the Fed’s “hothouse.”

While Grant and his audience of hard money true believers look with disdain on the Fed’s distorting rate policy, corporate executives are all for it. Executives for Homebuilder Toll Brothers thanked their banker on a recent earnings call for arranging a loan with a two percent rate. Grant pointed out the company should give credit where credit is due and thank Janet Yellen.

Hazlitt was not a trained economist, but as Lew Rockwell writes, “he was familiar with the work of every important thinker in nearly every field. At an early age, he lacked in formal education but ended in knowing more than most learned men of any age; and he certainly was more principled than most.”

Hazlitt would, by his estimation,  write 10 millions words, mostly about economics. He was surprised when Economics in One Lesson became his signature work. “He wrote it to expose the popular fallacies of its day,” Rockwell explains. “He did not know that those fallacies would be government policy for the duration of the century.”

What Janet Yellen is doing has been done time and time again since John Law’s system created the Mississippi Bubble in 1720. It never ends well. As long as there is an over-reaching government and ever-expanding central bank, Hazlitt will be looked to for guidance and inspiration.  He warned us then. He warns us now.

 

 

 

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There is a reason why in the past we have referred to Russia simply as Gazpromia. Here is why…

 

 

And a little more color on this soon-to-be-critical company… Pages 10-12 are of particular importance…

 

Gazprom Investor Day Presentation – Mar 3 2014

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This month the main drivers of the foreign exchange market have been official developments rather than macro-economic factors that often shape investors’ decisions. 

 

In addition to Russia/Ukraine and China developments, it was the ECB’s failure to take more measures to address the tightening of financial conditions, and falling inflation, that finally managed to convincingly push the euro above the $1.38 area that had capped it since last October.

 

It was also comments by Draghi on March 13 that have thus far put the euro’s high in just below $1.3970. This past week, it was a seemingly more hawkish Federal Reserve than expected, with the help of new Chair stripping the veneer of the traditional strategic ambiguity of language (“considerable period = around six months), that was the chief spur to the dollar’s recovery.

 

Perhaps these factors make the technical condition of the market an even more important source of insight than may usually be the case.  We turn first to the Dollar Index, which many look at for a rough proxy for the US dollar, even though it is far too Euro-centric. The Yellen-inspired rally saw the Dollar Index retrace, almost to the tick, half of what it had lost since the year’s high was recorded on January 21 near 81.40.

 

However, in order to signal more than the proverbial “dead cat” bounce, it needs to establish a foothold above 81.60, even though the 5-day moving average is poised to cross above the 20-day in early in the week ahead. Alternatively, on the downside, a break of 79.60-80 would suggest a new leg down has begun.

 

The positive technical tone of the euro has not been broken, even though it fell to nearly $1.3750 and closed below it 20-day moving average for the first time in over a month.   It finished the week just in the 5-cent 5-month trading range ($1.33-$1.38).  It found good bids below $1.38. To truly weaken the technical picture, the euro has to take out the $1.3680-$1.3700 area. The new trading range seems to be $1.3750-$1.4000 and since the bottom end of the range was last tested, the rule of alternation implies risk to the upside.

 

The price action in the dollar-yen is uninspiring. It remains, as it has since the beginning of February in a relatively narrow trading range. The JPY1101.20 area marks the lower end, while the upper end is around JPY102.80. The range was extended in early March to almost JPY103.75 but was not sustained. Three-month implied volatility fell to new lows since late-2012 before the weekend, suggesting that continued range trading is likely.

 

With the April 1 retail sales tax nearly at hand, Japanese economic data is largely immaterial. Until the impact of the tax is clearer, the monetary and fiscal policies are on hold. Most expect additional BOJ measures in Q3 around the time the government could decide on a supplemental budget and whether to postpone the second step increase in the retail sales tax.

 

Sterling peaked on February 17 and was trading at its lowest level since February 12 before the weekend. The 5-day moving average crossed below the 20-day on March 12. It has approached a key retracement objective near $1.6470. This will be an important area in the coming sessions. A convincing break may give it the momentum to cut through the 100-day average which is near $1.6425 and target the $1.6300-50 area. However, we are more inclined to see sterling’s recent downdraft as primarily a technical correction and start of a bear trend.

 

The $0.9140 target we suggested for the Australian dollar last week, assuming the $0.9100 level was breached, held. The price action warns that a sideways trend rather than an uptrend is more likely. If the $0.9140 area is on the top, then $0.9085 is on the downside. A break of this range likely points to the direction of the next half cent move or so.

 

While the Australian and New Zealand dollars compete with each other for the strongest major currency this month, the Canadian dollar has been competing with sterling for the weakest. Year-to-date, there is no competition. The Canadian dollar has fallen about 5.3% against the US dollar. Sterling, the second weakest currency, so far this year, is off by 0.4%.

 

The market thought that Bank of Canada Poloz’s reluctance to rule out a rate cut actually makes it more likely. It doesn’t. While Poloz’s comments were sufficient to arrest the Canadian dollar’s advance, it took the FOMC and Yellen to push it down. In particular, the US dollar rose convincingly above CAD1.12, which it had tried several times this year to do and failed.

 

Better than expected retail sales and a CPI reading not as soft as the market feared saw the Canadian dollar bounce, but the US dollar helped support in the CAD1.1170 area. This area needs to be taken out to signal anything important.

 

The US dollar remains range-bound against the Mexican peso. If the proximate range is MXN13.15 to MEX13.35, the greenback is near the middle of the range. The technical indicators are not generating strong signals. The disappointing economic data and dovish central bank make us more inclined to buy the dollar as it approaches the lower end of the range.

 

Observations from the speculative positioning in the CME currency futures: 

 

1.  The pace of position adjustment picked up over the course of the  reporting period that ended on March 18.  The general pattern was to add to gross longs and cut gross short foreign currency positions.  The Canadian dollar was the only currency futures that we track here that saw an increase in gross shorts. Sterling was the only one that saw a gross longs pared.

 

2.  There were three adjustments that we regard as substantial, which we define as a gross adjustment of 10k contracts or more.  The short gross yen positions were culled by nearly 30k contracts to 85.2k.  It is the biggest short covering since July 2012.  It underscores our argument that the yen’s safe haven appeal is more about short covering that fleeing to Japan.  Gross short Canadian dollar positions jumped 20k contracts to 97.6k.   It is the largest jump in shorts since last December.  This was before the FOMC meeting that saw the Canadian dollar sell-off to new multi-year lows.  The gross long Australian dollar positions more than doubled to 21.6k contracts, reflecting a 13k increase, bolstered perhaps by ideas the next move for the Reserve Bank of Australia is a hike.

 

3.  The 53.0k net long euro contracts is the most since last November.  The 61.1k net short yen contracts is the smallest since last October.  The net long Swiss franc futures position of 15.1k contracts is the largest since June 2011.  The 24.5k net short Australian dollar contracts is the smallest since last November.

 

4.  The short-term speculative market was ill-prepared for the unexpected hawkishness of the Federal Reserve the day after the reporting period ended.  Some who were stopped out may be part of the bargain hunting seen before the weekend, such as in the euro and Australian dollar.

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Submitted by Peter Schiff of Euro Pacific Capital,

The red flags contained in the national and global headlines that have come out thus far in 2014 should have spooked investors and economic forecasters. Instead the markets have barely noticed. It seems that the majority opinion on Wall Street and Washington is that we have entered an era of good fortune made possible by the benevolent hand of the Federal Reserve. Ben Bernanke and now Janet Yellen have apparently removed all the economic rough edges that would normally draw blood. As a result of this monetary "baby-proofing," a strong economy is no longer considered necessary for rising stock and real estate prices.

But unfortunately, everything has a price, even free money. Our current quest to push up asset prices at all costs will come back to bite all Americans squarely in the pocket book. Death and taxes have long been linked by a popular maxim. However, there also exists a similar link between debt and taxes. The debt we are now incurring in order to buttress current stock and real estate will inevitably lead to higher taxes down the road. However, don’t expect the taxes to arrive in their traditional garb. Instead, the stealth tax of inflation will be used to drain Americans of their hard earned purchasing power.

I explore this connection in great length in my latest report Taxed By Debt, available for free download at www.taxedbydebt.com. But diagnosing a problem is just half the battle. I also present investing strategies that I believe can help Americans avoid the traps that are now being laid so carefully.

The last few years have proven that there is no line Washington will not cross in order to keep bubbles from popping. Just 10 years ago many of the analysts now crowing about the perfect conditions would have been appalled by policies that have been implemented to create them. The Fed has held interest rates at zero for five consecutive years, it has purchased trillions of dollars of Treasury and mortgage-backed securities, and the Federal government has stimulated the economy through four consecutive trillion-dollar annual deficits. While these moves may once have been looked on as something shocking…now anything goes.

But the new monetary morality has nothing to do with virtue, and everything to do with necessity. It is no accident that the concept of "inflation" has experienced a dramatic makeover during the past few years. Traditionally, mainstream discussion treated inflation as a pestilence best vanquished by a strong economy and prudent bankers. Now it is widely seen as a pre-condition to economic health. Economists are making this bizarre argument not because it makes any sense, but because they have no other choice.

America is trying to borrow its way out of recession. We are creating debt now in order to push up prices and create the illusion of prosperity. To do this you must convince people that inflation is a good thing…even while they instinctively prefer low prices to high. But rising asset prices do little to help the underlying economy. That is why we have been stuck in what some economists are calling a "jobless recovery." The real reason it's jobless is because it's not a real recovery!  So while the current booms in stocks and condominiums have been gifts to financial speculators and the corporate elite, average Americans can only watch from the sidewalks as the parade passes them by. That's why sales of Mercedes and Maseratis are setting record highs while Fords and Chevrolets sit on showroom floors. Rising prices to do not create jobs, increase savings or expand production. Instead all we get is debt, which at some point in the future must be repaid.

As detailed in my special report, when President Obama took office at the end of 2008, the national debt was about $10 trillion. Just five years later it has surpassed a staggering $17.5 trillion. This raw increase is roughly equivalent to all the Federal debt accumulated from the birth of our republic to 2004! The defenders of this debt explosion tell us that the growth eventually sparked by this stimulus will allow the U.S. to repay comfortably. Talk about waiting for Godot. To actually repay, we will have few options. We can cut government spending, raise taxes, borrow, or print. But as we have seen so often in recent years, neither political party has the will to either increase taxes or decrease spending.

So if cutting and taxing are off the table, we can expect borrowing and printing. That is exactly what has been happening. In recent years, the Fed has bought approximately 60% of the debt issued by the Treasury. This has kept the bond market strong and interest rates extremely low. But a country can't buy its own debt with impunity indefinitely. In fact the Fed, by winding down its QE program by the end of 2014, has threatened to bring the party to an end.

Although bond yields remain close to record low territory, thanks to continued QE buying, we have seen vividly in recent years how the markets react negatively to any hint of higher rates. That's why any indication that the Fed will lift rates from zero can be enough to plunge the markets into the red. The biggest market reaction to Yellen's press conference this week came when the Chairwoman seemed to fix early 2015 as the time in which rates could be lifted from zero. That possibility slapped the markets like a frigid polar wind.

Janet Yellen may talk about tightening someday, but she will continue to move the goalposts to avoid actually having to do so. (Or as she did this week, remove the goalposts altogether). As global investors finally realize that the Fed has no credible exit strategy from its zero interest policy, they will fashion their own exit strategy from U.S. obligations. Should this happen, interest rates will spike, the dollar will plunge, and inflation's impact on consumer prices will be far more pronounced than it is today. This is when the inflation tax will take a much larger bite out of our savings and paychecks.  The debt that sustains us now will one day be our undoing.

But there are steps investors can take to help mitigate the damage, particularly by moving assets to those areas of the world that are not making the same mistakes that we are. In my new report, I describe many of these markets. Just because the majority of investors seem to be swallowing the snake oil being peddled doesn't mean it's wise to join the party. I urge you to download my report and decide for yourself.

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As we reported earlier, while Ukraine military forces are either slowly leaving the Crimea or joining the Russian army, one outpost, that at the Crimean airforce base of Belbek, remains undaunted by Russian demands to hand over the premises as the Russian ultimatum to surrender has expired, and moments ago wire services reported that shots were fired as Russian forces stormed the front gate of the Crimean outpost. Watch a live webcast from the scene below as the Russian force take control of the last place of presence of Ukraine forces in the Crimea.

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One could see this one coming from a mile away.

It was a week ago that we highlighted the latest implied IMF proposal on how to reduce income inequality, quietly highlighted in its paper titled “Fiscal Policy and Income Inequality“. The key fragment in the paper said the following:

Some taxes levied on wealth, especially on immovable property, are also an option for economies seeking more progressive taxation. Wealth taxes, of various kinds, target the same underlying base as capital income taxes, namely assets. They could thus be considered as a potential source of progressive taxation, especially where taxes on capital incomes (including on real estate) are low or largely evaded. There are different types of wealth taxes, such as recurrent taxes on property or net wealth, transaction taxes, and inheritance and gift taxes. Over the past decades, revenue from these taxes has not kept up with the surge in wealth as a share of GDP (see earlier section) and, as a result, the effective tax rate has dropped from an average of around 0.9 percent in 1970 to approximately 0.5 percent today. The prospect of raising additional revenue from the various types of wealth taxation was recently discussed in IMF (2013b) and their role in reducing inequality can be summarized as follows.

• Property taxes are equitable and efficient, but underutilized in many economies. The average yield of property taxes in 65 economies (for which data are available) in the 2000s was around 1 percent of GDP, but in developing economies it averages only half of that (Bahl and Martínez-Vázquez, 2008). There is considerable scope to exploit this tax more fully, both as a revenue source and as a redistributive instrument, although effective implementation will require a sizable investment in administrative infrastructure, particularly in developing economies (Norregaard, 2013).

We summed this up as follows: “if you are buying a house, enjoy the low mortgage (for now… and don’t forget – if and when the time comes to sell, the buyer better be able to afford your selling price and the monthly mortgage payment should the 30 Year mortgage rise from the current 4.2% to 6%, 7% or much higher, which all those who forecast an improving economy hope happens), but what will really determine the affordability of that piece of property you have your eyes set on, are the property taxes. Because they are about to skyrocket.”

Sure enough, a week later the Telegraph reports that UK Treasury officials have begun work on a mansion tax that could be levied as soon as next year, citing  a Cabinet minister.

“Danny Alexander, the Liberal Democrat Chief Secretary to the Treasury, told The Telegraph that officials had done “a lot of work” on the best way to impose the charge. The preparatory work would mean that a Government elected next year might be able to introduce the charge soon after taking office.  Mr Alexander said there was growing political support for a tax on expensive houses, saying owners should pay more to help balance the books.

After all it’s only fair. It is also only fair, for now, to only tax the uber-rich, who are so defined merely in the eye of the populist beholder. However, said definition tends to be fluid, and what will be a tax on, i.e., £2  million properties tomorrow, will be lowered to £1  million, £500,000 and so on, in 2, 3, etc, years.

And in a world which as Zero Hedge first defined years ago as shaped by the “fairness doctrine“, the one word that was so far missing from this article, can be found momentarily:

“There’s a consensus among the public that a modest additional levy on higher value properties is a fair and reasonable thing to do in the context of further deficit reduction,” he said. “It’s important that the burden is shared.”

There you have it: “fair.” Because there is nothing quite like shaping fiscal (and monetary) policy based on what the du jour definition of fair is to 1 person… or a billion. Especially if that billion has a vote in the “democratic” process.

It gets betters:

Mr Alexander said the new tax would not be “punitive” and insisted that the Lib Dems remained in favour of wealth creation.

So if it’s not “punitive” it must be… rewarding? And how long until the definition of fair, far short of the projected tax windfall, is expanded to include more and more, until those who were previously for the “fair” tax, suddenly become ensnared by it? As for wealth creation, perhaps in addition to the fairness doctrine it is time to be honest about what socialism really means: “wealth redistribution.”

Telegraph continues:

That may be a seen as a challenge to Vince Cable, the Business Secretary, who first called for the mansion tax and has criticised high earners.

 

The Lib Dems and Labour are both in favour of a tax on expensive houses. Labour says the money raised could fund a new lower 10p rate of income tax.

 

The Lib Dems have suggested that the tax should fall on houses valued at £2  million and more.

 

The Treasury last year estimated that about 55,000 homes are in that range, though the Lib Dems say the figure is closer to 70,000.

To be sure not everyone is for the tax:

David Cameron has opposed a mansion tax but George Osborne, the Chancellor, is said to be more open to the idea. Most of the homes that might be affected are in London and the south-east of England.

 

Boris Johnson, the Tory Mayor of London, promised last week to oppose any move towards the tax, which he described as “brutally unfair on people who happen to be living in family homes”.

 

Some critics have questioned the practicality of the policy, asking how the State would arrive at valuations for houses.

Well, they will simply draw a redline above any number they deem “unfair”, duh. As for the London housing bubble, it may have finally popped, now that all those who bought mansions in London will “suddenly” find themselves at the “fair tax” mercy of yet another wealth redistributionist government.

Unfortunately, for the UK, the “mansion tax” idea, , gloriously populist as it may be, may be too little too late.

As we reported late last week in “The Music Just Ended: “Wealthy” Chinese Are Liquidating Offshore Luxury Homes In Scramble For Cash“, the Chinese offshore real estate buying juggernaut has now ended courtesy of what appears to be China’s credit bubble bursting. So if the liquidation wave truly picks up, and since there is no greater fool left (you can forget about sanctioned Russian oligarchs investing more cash in the City in a world where asset freezes and confiscations are all too real), very soon London may find that there is nobody in the “fair” real estate taxation category left to tax.

But that’s ok – because that’s when one simply expands the definition of what is fair to include the not so wealthy… and then again…. and again.

Finally, if anyone is still confused, the IMF-proposed “mansion tax” is most certainly coming to the US, and every other insolvent “developed world” nation, next.

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As of Friday, the Ukraine has, as we predicted a month ago, been officially divided in two.  As AP reported earlier, “two almost simultaneous signatures Friday on opposite sides of Europe deepened the divide between East and West, as Russia formally annexed Crimea and the European Union pulled Ukraine closer into its orbit. In this “new post-Cold War order,” as the Ukrainian prime minister called it, besieged Ukrainian troops on the Crimean Peninsula faced a critical choice: leave, join the Russian military or demobilize. Ukraine was working on evacuating its outnumbered troops in Crimea, but some said they were still awaiting orders.”

However, it appears it is not so much a question of figuring out how to evacuate the troops, but rather motivating them. As RIA reports, “less than 2,000 of Ukrainian troops serving in Crimea decided to leave the peninsula for Ukraine, the Russian Defense Ministry said on Saturday. “As of March 21, less than 2,000 out of 18,000 Ukrainian servicemen staying on the territory of the Republic of Crimea decided to go to Ukraine,” the ministry said in a statement.

Those willing to continue their service in the Ukrainian armed forces will be provided with transport to carry their families and belongings to the Ukrainian territory, the ministry added. So while Russia is saying good riddance of foreign troops situation in its brand new territory, it is at least being kind enough to provide the means to depart.

Meanwhile, Russia, already in control of the critical warm water port of Sevastopol, just became the brand new owner of virtually the entire Ukraine navy fleet.

A total of 147 military units in Crimea have hoisted Russian flags instead of Ukrainian and applied to join the Russian armed forces.

 

“St. Andrew’s flags of the Russian Navy have been raised on 54 out of 67 vessels of the Ukrainian Navy, including eight warships and one submarine,” the defense ministry said.

 

Ukraine’s only submarine, the Zaporizhzhia, joined the Russian Black Sea Fleet earlier on Saturday and will be soon relocated to its base.

So while the last vestiges of Ukraine military presence in the Crimea slowly disappear, one place that still refuses to give in to Russians, is the Belbek air force base in east Crimea, made known several weeks ago for the stand off between Russian and Ukraine troops. As shown on the picture below, the troops are waiting for order from Kiev, while the Russian soldiers have all the time in the world to wait as the besieged base is emptied out. AFP adds that some 200 unarmed pro-Russian protesters stormed the base, as the soldiers have barricaded inside and are throwing smoke bombs.

 

Ukrainian commander at Belbek airforce base in #Crimea has told his forces to stand their ground despite Russian deadline to leave

— Sky News Newsdesk (@SkyNewsBreak) March 22, 2014

All of that is to be expected. However, what one should pay close attention to, is the latest pro-Russia rally which is taking place in the Eastern city of Donetsk, one where the crowd earlier was chanting for a return of the pre-coup Ukraine president, Yanukovich.

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— ???????? ???? (@vezhlivo) March 22, 2014

Why the importance? Because whether the protest is real or fabricated, any additional provocations against the prevailing pro-Russian population will surely be used as a pretext by Putin to continue his “expansion” campaign into East Ukraine under the same pretext as he has made all too clear previously: to protect the minority population. And, as the west has shown all too clearly with a whole lot of meaningless sanctions, there is nobody to stop him.

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Friday’s AM fix was USD 1,338.50, EUR 970.21 and GBP 810.57 per ounce.

Thurday’s AM fix was USD 1,327.00, EUR 962.64 and GBP 802.78 per ounce.     

Yesterday, gold climbed $15.27 to $1342.27 at about 7AM EST before it fell back off in New York, but it still ended with a gain of 0.44%. Silver rose to as high as $20.579 at one point, but it then fell back off and ended unchanged on the day.

Euro gold rose to about €966, platinum gained $2.30 to $1432.00, and copper climbed slightly to about $2.95. Palladium prices, meanwhile, closed at a level not seen in more than 2 years with the rally linked to worries about risks to Russian supplies of the metal.

Palladium surged 3.1% to the highest since 2011 on concern supply from Russia may be restricted.

Gold finished higher on Friday, partially recovering from a four-session losing streak on the back of a weaker U.S. dollar, but the metal’s prices still suffered from their worst weekly loss since November – down over 3.5%.



Gold in U.S. Dollars, 5 Days – (Bloomberg)

Gold had become overbought after its surge to 6 month highs and was due profit taking and a correction. A perception of an abatement of tensions between Russia and the West has contributed to the pullback this week. Momentum could lead to further falls next week but we expect weakness will be short lived.

 

Gold’s Technicals
There is a risk that gold could fall below immediate support at $1,320/oz and the next levels of support are at $1,300, $1,240 and then back where we started the year at $1,200. A 50% retracement would not be unusual after the speed of recent gains and that would take us to the psychological level of $1,300/oz again.  

Gold in U.S. Dollars, 1 Year – (Bloomberg)

A political solution needs to be found as governments continue to opt for economic sanctions of various degrees, it could degenerate into a full blown trade and economic war. Were this to occur the benefits of free trade and globalization that we have seen in recent history would be at risk – creating real challenges for the global economy.

The premiums that risk assets such as stock markets command could quickly be lost as market participants reevaluate asset allocations in the light of the more risky economic and geopolitical situation.

Gold in U.S. Dollars, 43 Years – (Bloomberg)

Hopefully, calm and wise counsel will prevail and a diplomatic political solution will be found. However, in the meantime, gold continues to be an important asset to own in order to hedge these and other geopolitical and economic risks.

 

Yellen At Fed – Print Baby Print
It was very welcome to see a woman taking over the helm of the Federal Reserve. However, we cannot allow our goodwill in this regard to cloud judgement and impact our analysis of her and the Fed’s performance and policies.

Yellen gave mixed messages, both on the economy and on monetary policy, but market participants have chosen to focus on some of the more hawkish comments that she made. She acknowledged that the Fed may have been too optimistic about the economic outlook recently. Yet, she and the Fed largely stuck to their projections for how growth and inflation will unfold in the coming years.

 

It is important to remember that the Fed did not predict or foresee at all the sub prime crisis, the housing bubble, Bear Stearns, Lehman, the global financial crisis and subsequent recession.

The dollar is set to be structurally weak in the coming years given the still significant imbalances in the U.S. economy and still very poor fiscal state of the economy. No amount of jaw boning or Fed tinkering with interest rates will change that.

While interest rates may rise from nearly 0%, they are set to remain low for the foreseeable future. At least until the bond markets decide to enforce fiscal discipline on the U.S. Then interest rates will likely rise substantially leading to a severe U.S. recession.


US Govt 10 Year Yield, 1971 to March 2014 – (Bloomberg)

On a long term basis, it is likely that the dollar will remain weak and gold’s bull market will continue until the end of the interest rate tightening cycle which will likely be between 2020 and 2025.

This was seen in the 1970s when interest rates surged higher that decade from a low in March 1971, to a high in September 1981. The U.S. 10 Year went from 5.38% to 15.84% during that period and gold rose from near $35/oz to over $850/oz in January 1980 (see charts).

 

Thus, contrary to the popular perception, rising interest rates are not bearish for gold. High interest rates and real positive interest rates in a sound economy are very bearish for gold prices and will burst the coming gold bubble. However, that is a long way off – likely between 2018 and 2025 and likely when gold prices are well above their inflation adjusted high (CPI) of $2,500/oz. Indeed, longer term prices over $4,000/oz or $5,000/oz are quite feasible.

EU Agrees Banking Union – Bail-Ins Cometh … 

In the early hours of yesterday morning European Union politicians struck a deal on legislation to create a single agency to handle failing banks and bail-ins in the Eurozone after another all night negotiating marathon ahead of a summit of EU leaders starting in Brussels today.

German Finance Minister Wolfgang Schaeuble was drawn into the talks around 0530 GMT as the negotiations dragged on into the night. The politicians emerged around 0715 GMT with the deal, which now will need formal approval by the European Parliament and by national governments.

Negotiators persuaded nations that had been opposed to the proposed Single Resolution Mechanism and the legislation for bail-ins to agree.

Insolvent banks will be treated equally regardless of the country they are based in. Failed banks creditors, both bond holders and depositors, will be subject to bail-ins in the same way in all countries.

“It’s a very good agreement,” European Central Bank President Mario Draghi said before the meeting of EU leaders in the Belgian capital. The banking union was shaped in part by Draghi and he hailed the compromise plan as “great progress for a better banking union. Two pillars are now in place.”

Plans for a single banking union were put together two years ago due to fears for the euro and the EU’s 6,000 banks. Countries wanted to break the link between sovereigns and insolvent banks to ensure taxpayers were not forced to bail out insolvent banks and to prevent contagion and a systemic crisis.

It had already been agreed that shareholders and importantly now depositors will be bailed in before the single resolution fund can be tapped. About 100 banks plus transnationals and those already bailed out will come under the direct supervision of the ECB from January.

While most of the coverage is on the European Union member states and the European Parliament agreeing the final details of a single resolution mechanism (SRM) to wind up failing banks, there is little coverage of the developing bail-in regimes and the heightened risk that depositors in the Eurozone now face.  

Banks in the Eurozone remain extremely vulnerable. Our research on bail-ins and the developing bail-in regimes clearly shows how banks remain very vulnerable and it is now the case that in the event of bank failure, your deposits could be confiscated as happened in Cyprus.

It is important to realise that not just the EU but also the UK, the U.S., Canada, Australia, New Zealand and most G20 nations all have plans for bail-ins in the event that banks and other large financial institutions get into difficulty.

The coming bail-ins will pose real challenges and risks to investors and of course depositors – both household and corporate. Return of capital, rather than return on capital will assume greater importance.

Evaluating counterparty risk and only using the safest banks, investment providers and financial institutions will become essential in order to protect and grow wealth.

It is important that one owns physical coins and bars, legally in your name, outside the banking system. Paper or electronic forms of gold investment should be avoided as they along with cash deposits could be subject to bail-ins.

Educate yourself about this emerging threat to your livelihood by reading:
Bail-In Guide: Protecting your Savings In The Coming Bail-In Era (10 pages)

Bail-In Research: From Bail-Outs to Bail-Ins: Risks and Ramifications (50 pages)  

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