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Pentonomics

A Funny Thing Happened on the Way to Raising Rates

It wasn't too long ago that the stock market was busy celebrating a "great" September jobs report. There were 248k net new jobs created and the unemployment rate dropped to 5.9 percent.

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Commentary

Gold Prediction for 2012

With gold selling off about 20 percent in the last few weeks, there appears to be much confusion as to what, if anything, has changed for the bullish scenario. But the truth is not much. Gold is now and always has been a hedge against a falling dollar, which is the result of an inflationary monetary policy on the part of our central bank.

However, despite the fact that Ben Bernanke's best friend is a crumbling currency, the U.S. dollar is currently increasing as measured by the Dollar Index. And so, in knee jerk fashion, investors have dumped gold. But this is sophomoric and egregious reasoning.

The domestic purchasing power of the dollar isn't increasing and there has been no change in the intrinsic fundamentals of the currency either. The dollar is only increasing when measured against the Euro-a currency that is used by several insolvent and imminently bankrupt nations. The reasons for a secular decline in the purchasing power of the U.S. dollar remain well intact. The Federal Reserve continues to delay the commencement of lifting their target interest rate above zero until years to come. As a result, real interest rates remain well into negative territory and have no sign of increasing. Money supply growth rates remain positive, with M2 rising nearly 10% in the last 12 months. And U.S. debt and deficits push inexorably out of control with the only hope of resolution being default-mostly likely through inflation.

It is for those reasons that the cyclical pull back in gold should be viewed as a buying opportunity delivered to us as the sole benefit of Europe's debt and currency crisis. Once the crisis in Europe lands on U.S. shores, the true decline in the dollar will no longer have the benefit of being masked behind a more faulty currency. The truth is that both currencies are in decline and while the dollar is falling off the cliff at 90 mph, the Euro is tumbling to towards earth at 110 mph. So it only appears like the dollar is flying if you are looking at the Euro. However, they both are destined to crash into the ground and the only reserve chute to be deployed is made of gold.

Therefore, the dollar price of gold may struggle in the first two quarters of 2012 as Euro weakness sends the dollar higher and commodity prices lower. However, a stubbornly high unemployment rate should bring Bernanke back into the QE game in the second half of this year. The likelihood of yet more dollar creation from the Fed, a continuation of negative real interest rates and a national debt that is most likely to be monetized should send gold to at least $1,800 per ounce by year's end.

Greece Receives Bailout

Greece has supposedly received a bailout and markets across the globe are soaring. In fact, they are rising in the same manner they did a few months after the bailout of the U.S. financial system, now known as the Emergency Economic Stabilization act of 2008. However, the truth is there is no such thing as a complete and genuine bailout; there is only a transfer of burden from the government and banks to the middle class.

In this latest example of government interference in the cathartic rebalancing that the free market demands must occur, the troika (ECB, IMF and EFSF) has agreed to leverage their European bailout fund to $1.4 trillion. From what source is this money supposed to come from? Perhaps from the Chinese, but I sincerely doubt they would divert 1/3 of their entire currency reserves to purchase European debt. And even if they did, the Chinese would have to sell bonds they currently hold of another country; most likely the U.S. But that would send yields sharply higher here and the Chinese would then soon be on the spot to bailout America.

The government of Greece must be elated because the principal on their debt has been cut in half. And European banks must be filled with alacrity because even though their holdings of Greek debt have been halved, the government has promised to recapitalize them with at least $150
billion-which is guaranteed to be woefully inadequate a number. Regardless, the commitment has been made and insolvent institutions will be allowed to survive another day.

But what about the citizens of Europe? If you are a private owner of Greek debt there is no money coming in to fill your hole. What you can look forward to is the knowledge that the European Central Bank will have to print hundreds upon hundreds of billions in Euros to support insolvent banks and countries. And that's the point which goes missing while politicians are busy patting themselves on the back for coming up with all these bailouts. They are indeed capable of saving insolvent institutions but in the process they bankrupt the middle class via inflation. The rich can afford to own gold and certain assets that rise when central banks counterfeit money. But the middle class becomes decimated because they can't afford to properly hedge against the destruction of the purchasing power of what little currency they own. Is it really any mystery why gold and gold stocks skyrocketed right after the announcement of the agreement to bailout Greece? European citizens of any means rushed to avail themselves of gold; the proven store of wealth when governments are busy corrupting their currencies.

By the way, the bailout of Greece concocted by the European Oligarchy is a complete farce on every level. The restructuring of Greek debt is supposed to bring Greece's Debt to GDP ratio down to 120% from the 170% today, by the year 2020. You can be sure of two things; Greek debt will never drop to that level by 2020, and even if it did so what! Italian debt to GDP is already 120% and their bond market is in full revolt. Even though the ECB has been actively buying over $100 billion worth of Italian debt in an effort to keep yields from rising, the yield on the Italian 10 year note closed above 6% for the first time since early August and is now surging past 6.3%. That's up from well below 4% just one year ago. And this has occurred despite the fact that Mario Draghi (designated to succeed Jean-Claude Trichet as President of the European Central Bank by November 2011) has promised to continue the practice. In his own words spoken on October 26th the incoming President stated that the ECB remains, "determined to avoid a poor functioning of money and financial markets." Translation, we will print all the money that banks and governments' will ever desire.

But all the money printing and inflation creation in the world can't save these countries. In fact, it will make matters much worse. Europe has now joined Japan in The Zombie Club of Nations. These nations have zombie banks and zombie-like GDP growth due to high levels of government debt that suck all available capital out of the private sector. And the sad truth is that America is next in line to join that ignominious club; if it hasn't done so already.

The bottom line is that real interest rates continue to fall across the globe as fiat currencies are being debased at an ever alarming rate. This is the case just as the debt of the U.S. continues to soar both in nominal terms and as a percentage of GDP. That leaves me to several conclusions: the U.S. dollar will soon lose its status as the world's reserve currency, inflation and nominal interest rates in our country are about to soar and the ultimate bailout of the American citizen can be found in owing gold.

Occupy the Fed

I believe these protesters have a legitimate gripe. They are acutely aware that the middle class of this country is not so slowly being destroyed. They know real median wages have dropped 10% in the last four years, just since the time Wall Street investment houses and Banks received their bailouts. Of course, their solutions involve wealth redistribution and the punishment of success. That would be completely unproductive. What they should strive for instead is the abolishment of the country's most powerful bank, which is the Federal Reserve. This institution systematically destroys the dollar and robs savers of their wealth. Our central bank is the culprit for the chasm that exists between the poor and the ultra-rich. By eroding the value of the dollar the Fed has stolen away the purchasing power of most Americans-causing discretionary income to plummet and leaving many unemployed.

It would be just fine if the wealth gap in this country was due to the fact that a relatively small percentage of citizens garnered their fortunes by producing goods and services. However, what cannot be denied is that a great preponderance of wealth has been acquired through the ownership of assets that have massively increased their value through the series of bubbles created by the Fed. Those who own a disproportionate amount of stocks, real estate and commodities have increased their fortunes at the direct expense of those who have seen their wealth stolen from them via inflation.

In addition, the tax, wage and regulation policies of this country have caused the all-important manufacturing base to become decimated. Without a solid and diverse manufacturing base our nation has mostly produced low-paying service sector jobs. It won't be until we once again embrace a balanced budget, sound money and less government that we will see significant job and real income gains. At that juncture we can stabilize the currency, increase savings, keep inflation in check and rejuvenate the middle class. Until then, we will witness the Occupy Wall Street movement metastasize at a daunting rate.

Why Bother Working?

Paul Krugman made an appearance recently with Fareed Zakaria on CNN’s program called Global Public Square. In the interview he claimed that the U.S. needs a good dose of inflation and another world war to rescue it from the current recession. He stated that inflation would bail out our debt problem by reducing our bill in current dollar terms and that he regarded World War II as a giant stimulus plan that actually worked. He did, however, thankfully state that, “Hopefully we don’t need a world war to get there.” But the need for government to hire people to dig holes or kill people was his prescription for getting the economy back on sound footing.

The truth is that wars are a miserable misallocation of capital and usually leave an onerous level of inflation and debt in their wake. It was not because the U.S. fought WWII but because we won the war that there was a resulting economic boom. It was the byproduct of having an unscathed manufacturing base, solid infrastructure, intact military, most of the world’s gold and the only reserve currency. 

What Krugman and others like him are actually saying is that working in productive employment is not at all necessary. To follow his logic to the fullest extent, we should just have people save gas and stay home. The government could borrow and/or print money, then send it to foreign countries that are dumb enough to produce goods and services for U.S. consumption. Former Chair to Obama’s Council of Economic Advisors, Christina Romer, also sided with Krugman in a commentary posted in Sunday's NY Times financial section. In it she opined on the lessons to be learned from the Great Depression saying, "It would be a mistake to respond by reducing the deficit more sharply in the near term. That would almost surely condemn us to a repeat of the 1937 downturn." According to Romer and Krugman, what the U.S. needs is an immediate dosage of inflation and debt. These Keynesian “cures” of endless inflation and debt to fix our economic malaise are offered because there is a profound lack of understanding of what causes a depression in the first place.

The cause of the Great Depression in the 1930s, and the Great Recession beginning in December 2007, was one and the same—an overleveraged economy. Easy money provided by banks eventually brings debt in the economy to an unsustainable level. At that point, the only real and viable solution is for the public and private sectors to undergo a protracted period of deleveraging. The ensuing depression is, in actuality, the healing process at work, which is marked by the selling of assets and the paying down of debt. Unfortunately, our politicians today are focused on fighting the natural healing process of deleveraging by promoting the accumulation of yet more debt.

During this latest economic contraction, the Federal Reserve has taken interest rates to near 0% for the past two and three quarter years and has just promised to keep them there for an additional two years. Meanwhile, the Obama administration is leveraging up the public sector to record levels in an effort to re-leverage the private sector. The government's philosophy is tantamount to sticking a frostbitten man in the freezer so he won't have to suffer the pain associated with the thawing of his extremities.

During the Great Depression, real gross domestic product plummeted 32%. The Great Recession, which we are still struggling through, began in December of 2007. But in contrast to the 1930s, GDP during this recession shrank only 3.6% from the fourth quarter of 2007 through its low point in the second quarter of 2009. Household debt as a percentage of GDP reached nearly 100% in 1929. Between the start of the Great Depression and the end of World War II, household debt fell from 100% to just above 20% of GDP. To put that number in perspective, household debt did not go back above 50% of GDP until 1985. And it was not until the first quarter of 2009 that household debt once again approached the Great Depression level of 99% of GDP.

Debt reduction is a painful process, but such de-leveraging is the only real cure for an economy swimming in debt. Thanks to government efforts to carry on our debt-fueled consumption binge, during today's Great Recession household debt has barely contract at all—it has only been reduced to 90% of GDP as of the first quarter 2011.

To make matters even worse, during this current crisis our government's response has been to dramatically increase its own borrowing. At the start of the Great Depression, gross federal debt was 16% of GDP. It peaked just below 44% when the Depression ended. While the national debt did increase significantly during that period, it was still relatively benign when viewed from a historical perspective. The U.S. entered this current Great Recession with gross national debt equal to 65% of GDP. It has since exploded to 98% of GDP! Comparing the relatively innocuous level of the 1930s with today's pile of government debt, clearly illustrates the perilous state of the economy.

National debt did rise dramatically during World War II, topping out at 120% of GDP in 1946. But consumer debt plunged concurrently. So while the nation was adding debt to fight and win a global war, households were taking the necessary steps to ensure their balance sheets were well prepared for the aftermath of the battle.

Today, for the first time in our history, gross national debt and household debt are both at least 90% of GDP.

Unfortunately, Mr. Krugman and many in government believe the government must spend more while consumers rein in their debts. Their strategy is based on the hope that once the economy perks up, the private sector can unwind that debt. But there are two problems with this Keynesian theory. One is that government spending doesn't increase GDP; it only chokes off private-sector growth and creates inflation. The other is that politicians never regard the present as a good time for the government to pay down its debts.

The result is that the country is left with a massive level of both private and public sector debt, the latter always leading to an increase in taxes, interest rates and inflation—which causes GDP to eventually contract even further and thus the ratio of debt to economic output increases faster.

Since we have yet to address the real cause of this recession, we are moving inexorably closer to causing The Greater Depression. If policymakers and main stream economists fail to understand that the progenitor of a depression is debt and inflation, they will also be unable to provide a genuine solution. And the “solutions” they do offer are tantamount to seeking the avoidance of a hangover by forcing down a few more drinks.

 

Back in June of 2010, Mr. Bernanke was talking about the Fed's exit strategy and most Wall Street pundits were predicting an increase in the Fed Funds Rate. However, Mr. Pento went on record writing a commentary entitled. "The Fed's next Move Will Be to Ease Interest Rates."

Bloomberg is on record crediting Michael Pento as having accurately predicted gold's high water mark in the past two years. "Michael Pento, who correctly predicted gold's highs for the past two years, forecast a 2011 high of $1,600."

In the summer of 2010 Pento predicted the short lived rebound in GDP would not last. He predicted the double-dip recession we are now in. Here's what he had to say on Bloomberg TV on June 9th; "In the heart of the Great Depression, total debt, now that includes national debt, state debt, local debt, household debt, corporate debt, financial debt, reached 299% of GDP.  It is now 370% of GDP and rising. We never started to heal in this Country because we continue to add on more and more leverage.  We need to sell assets and we need to allow the de-leveraging process to consummate.  We are going in the wrong direction and that's why the double dip recession is virtually assured."

Pento not only predicted the collapse of the housing market but also Fannie Mae in May of 2008. "Yesterday's earnings report from government sponsored Fannie Mae (FNM) should cause investors to question whether the very entity charged with saving the real estate market will actually need to be rescued itself...In the ongoing credit crunch shell game, it appears that all they're doing is shifting the burden from banks to these GSEs in order to buy some time for the housing market to heal. However, if the housing market does not make a quick price recovery--and by all indications that appears highly unlikely--the problems currently on the books of FNM and FRE may be transferred next to the balance sheets of the American taxpayer. Given Fannie Mae's troubles, by hoping it can somehow rescue the housing market aren't we really just asking the guy who can't swim to save the one who's drowning?"

While the Main Stream Media was espousing the notion of a healing economy and the only concern was over deflation, Pento warned of the real concern back in April of 2010; "A viable 'V' shaped recovery in the economy and markets has now become the accepted view. My view, however, is that the economic recovery will be ephemeral in nature, whereas the real and lasting recovery will be unfortunately found in the rate of inflation."

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