The State Bailouts Continue

As I noted earlier, the bailout of bankrupt US states has already begun in a quiet program that has eluded the media's attention. That's not surprising because state bailouts would turn into an explosive issue if the American people understood how much of their money was being redirected to the most irresponsible states. Our pro-socialist media are loathe to report any story that threatens the central government's ability to allocate funds.

Now, the Economic Policy Journal is reporting that the federal government has begun funding state unemployment payments for 32 states. California, Michigan, New York and Pennsylvania account for 45% of the total to date. Although this funding is reportedly structured as a loan, it's actually a bailout. Every global bailout has been structured as a loan, but a true loan requires some expectation on the part of the lender that they'll be repaid. Anything else is a gift. Does any believe that California will be paying $6.9 billion back to the federal government? Does anyone believe that California will pay interest on that amount to the federal government?

Just like every other form of deficit spending and money printing that has occurred in recent years, the people who pay in the end will be US dollar savers. It's gotten to the point where it's probably pointless to keep repeating this theme, but the US dollar is toast. This money will pass from state debt, to federal debt, to monetization. People who saved their money will pick up the tab. If you are holding dollars in a bank account, or a CD, or cash in a sizeable amount, you will pick up the tab. Eventually stock and bond holders will pick up the tab too, as the value of their assets severely underperforms the cost of living.

Meanwhile, the calls for deflation are rising to a new crescendo in the financial media and among Wall Street prognosticators. The folks making these calls are simply providing cover for our central bank to print more money. Wall Street loves money printing, because a large chunk of that money goes straight to their balance sheet. That's why we get a huge market rally every time global governments announce some new massive bailout. And all that printed money piles up and up and up, until at some point people lose confidence and begin to spend it. That's when the US dollar dies.

ECB will sterilize bond purchases. Right.

The European Central Bank announced this weekend that they would begin printing Euros and buying up the besieged debt of various EU governments. At the same time, in an attempt to allay inflation fears, they said they would sterilize those money flows to prevent a sharp increase in the money supply and thus inflation. That statement is almost certainly a lie. To understand why, here's a little primer on monetary sterilization.

Occasionally an economy is faced with rapid increases in currency inflows, for example due to increased foreign investment or trade flows. If left to slosh around in the economy, that increased money supply can lead to a spike in inflation. Central bankers have a way to take some excess money out; they sell various debt instruments to the banks, and then either hold the resulting funds or exchange them in the foreign exchange markets. The relevant point is that the central bank is selling something, almost always debt instruments.

In their new bailout plan, the ECB has pledged to lower funding costs for over-indebted EU governments by buying their debt. So then, to sterilize they do what? Turn around and sell bonds or bills to remove that excess capital that they just injected? Whose debt do they sell? Where do they sell them? Will they buy Greek bonds and then immediately sell German debt to Greek banks, or French banks, or Spanish banks? While that may lower Greek debt costs, it's basically exchanging German debt for Greek debt. I don't believe that will be acceptable for Germans.

Practically speaking, any attempt at sterilization will end up being some kind of debt swap. The end result will be a convergence of interest rates across the EU, punishing the countries that have been better stewards of their economies, rewarding those who have spent themselves into insolvency. That will not work on anything other than a token scale. It is only there as a figleaf to cover the looming inflation risk of this debt monetization plan, in hopes the market continues to ignore obvious fiscal and monetary insanity.

Gold investors see through the whole charade. The price of gold in Euros has gone vertical in recent weeks hitting new highs nearly every day. The German delegates to the ECB can not be happy with this. They understand gold's message; once the printing starts, it can never stop and it cannot be sterilized. The Euro is headed the way of the German Papiermark.

In for a penny

If future historians regard this period as marking the demise of fiat currencies, then today will be a key date of recognition. With Europe's nearly $1 trillion bailout of countries and banks, plus the onset of Euro printing by the ECB, the final obstacle to unabated global monetary excess has been removed. The German memory of hyperinflation was our last hope, but their politicians bowed to external pressure instead of the desires of their own electorate.

I'm disappointed, but not surprised by what Europe has done this weekend. Socialism and easy money go hand in hand, and it stood to reason that Europe would follow the US, Japan, UK, and China down this road. Now every world government of enough size to change anything has placed their bets. In order to thwart the opinion of free markets, they went all in. This is not the sort of bet where you can later cut your losses and walk away. Unfortunately, it's a bluff. They have an unwinnable hand and the ironclad laws of economics are sitting on the other side of the table. The time for debating the fine points of policy are past. Future government decisions will revolve around how much to print and who gets the handouts. This won't stop, can't stop because the debt loads will only get worse.

Smart individuals around the world will begin to fully divest themselves of fiat currency savings. That process is already underway, it's been driving equity markets and precious metals and commodities. Within the next few years flight from fiat will accelerate. When it does, governments will up the ante again and start monetizing their debts en masse. In for a penny, in for a pound.

Here Comes the "Liquidity"

Bank of Japan fires the first shot in the latest round of fiat money injections in response to the "Greek Crisis". The yen moved sharply higher against both the Euro and US dollar today, plus the Nikkei 225 was down about 4% at the open tonight. The JCB wasted no time in making sure those trends did not continue. It looks as if competitive currency devaluations are in full swing now.

Modern central banking could be practiced by a well trained dog. Stocks drop more than 5%, step on the $50 billion button, which then sends dump truck loads of free money to large money center financial institutions. Stocks drop 10%, step on the $100 billion button. Over 20%, hit the $1 trillion button repeatedly until stocks start going back up. I guess that's why they say dogs are a bankers best friend.

Gold Says Bad Inflation This Way Comes.

Today the US stock market dropped 3 percent, bond yields plunged, commodities dropped, and deflationists declared victory in the ongoing debate over inflation vs deflation. There's just one small fly in the ointment. Gold rose $23 per ounce, to nearly $1200. This happened on a day when the US dollar trounced every other currency, including those of commodity exporters like Australia and Canada. But gold is now the strongest currency of all, and is threatening the US dollar hegemony as world's reserve currency.

Why is gold at or near new highs in practically every major global currency? Is it a "safehaven" due to market panic, as the mis-informationists at CNBC would have us believe? No, that's not the reason at all. The move in gold is perfectly logical, calculating and rational. Gold is predicting governments' response to widespread insolvency, and what gold investors see is hyperinflation in our future. Notably silver also rose today, and silver is generally an economically sensitive commodity that falls with the other industrials. Now silver is beginning to trade as money too, moving in opposition to the industrial metals.

So why would gold see inflation when the media and economic "experts" are screaming deflation? It's very simple, actually. The case of hyperinflation in the Weimar Republic, circa 1920 is a good illustrative example. At that time, Weimar Germany was severely over-indebted due to the costs of losing WWI. The extreme levels of debt led, as is extreme debt's wont, to deflation. Lack of confidence in the economy caused lenders to stop lending, and consumers to stop consuming. People began to hoard cash and the velocity of money dropped. Prices dropped. Then, the central bank decided, not unlike Ben Bernanke, that they had a shortcut way to thwart the economic reality of too much debt. They'd just print more money to add liquidity to the system; get the banks lending again and everything would be hunky dory.

But, it didn't seem to work. The more the central bankers printed, the more people and banks hoarded money, and prices dropped more. The mark actually appreciated dramatically against other world currencies, despite the economy's precarious condition. As debt levels piled up due to war reparations, the population began to lose confidence in the government's ability to pay down debt and, ultimately, in its curency. So they pulled out their savings and began to buy necessities. Instead of hoarding useless paper, they began hoarding hard assets. A massive outpouring of marks flowed from every quarter and the velocity of money soared. Prices skyrocketed and within a year the currency was worthless.

Note that declining velocity of money is cited by every modern deflationist as the reason why Bernanke's already excessive printing can't cause inflation. It will be cited in the near future as the reason why Bernanke must print more, to revive our "animal spirits" and get the economy flowing again. And all that money will accumulate on bank balance sheets, or in money market funds, savings accounts and short term treasuries. But, the loss of confidence is beginning to build. Gold is the telltale. It's an inert metal, with no industrial use, doesn't draw interest or pay a dividend. No use at all other than as hard money.

Gold is signalling a global loss of confidence in fiat currencies, and the wave is building at a rapid pace. Governments are bailing out an ever wider swath of bankrupt entities, from pension plans to companies to states to sovereign govenments. In the process, they are destroying confidence in their own ability to pay off debt in real terms, and thus destroying confidence in their own currencies. The money is beginning to flow into hard currency, gold and silver, but soon it will flow into other more important assets like oil and food. Economic fundamentals will no longer matter. Once confidence in money is lost, it's almost impossible to regain. Given our central bank's predilection towards easy money, they will not be up to the task of reigning in run away inflation.

If governments do not stop printing now, stop the bailouts now, stop the deficit spending, this has only one possible outcome. The price of hard assets will spiral out of control, and will eventually be impossible to buy using fiat currency. Global hyperinflation and ultimately war over natural resources will ensue. Tomorrow, Germany holds a vote on whether to bail out Greece. I hope the German public opposition carries the day and Greece is allowed to default. We don't have many more chances to stop this insanity

The Fiat Money End Game

Incisive commentary in this article by Michael Rozeff on the subject of how our freely floating dollar will meet its demise. He does a good job of explaining why any course other than inflation is unlikely.

Regarding the IMF/EU bailout of Greece:

"The rescue team, which consists of the stronger countries and the IMF, are damned if they do and damned if they don't. Instead of banks being insolvent with runs occurring on them as in the 1930s and 2008, we have whole countries being bankrupt, but their paper is held by banks in France and elsewhere, so there is a contagion thing to worry about. If the EU lets default happen, there is a run against all the bonds of all the weaker countries. Their yields rise, and they have to default too, and then that weakens a host of banks and others who hold the paper, and then they demand to be bailed out. If instead they rescue Greece and others, then the rescuing governments have to issue more debt, or else the IMF does too, or else the ECB gets into the act too, and this weakens the stronger countries and drives down the euro."

Basically every low interest sovereign borrower in the world is taking on an exponentially expanding debt load to bail out higher risk borrowers, private, public and sovereign, who can no longer obtain affordable credit. We'll soon reach the stage where the low interest sovereigns, the US, Germany, France, Japan, the UK, are also unable to obtain affordable financing. In light of recent debt monetization programs, conducted under the technical sounding euphemism of Quantitative Easing, one may even surmise that we've already reached that point as governments fund their deficits through central bank printing. Debt to GDP ratios in this group are already high, and rising rapidly. Higher interest rates can't be tolerated, but the only way to prevent them is for central banks to buy their own government bonds. Once a country gets on that track, as the US, UK, and Japan have recently, it may prove impossible to get off.

On why governments choose inflation:

"Faced with handling mountainous debt levels, the governments either walk away from all bondholders everywhere, this is feasible, or else they inflate and pay them off in nominal terms, or some combination of these two paths. It's these two options that we need to think through as to their effects, in order to decide which one they are likely to choose. So far, the big guys, the U.S. and Britain and Japan and probably China, have gone for inflating. They're trying not to default outright. Why? The outright default basically ends the government's ability to pay pensioners, poor people, and keep government spending up. So it revolutionizes the government itself. It ends government as we know it for awhile, and as far as politicians are concerned who have only one life to live, that's too long."

This rationale is exactly right. Politicians have power only as long as they control the supply of money. Fiat printing allows politicians to enrich whatever constituency holds greatest potential to keep them in power. Outright default robs the government of the ability to borrow, which takes power away from the politician and puts it back in the hands of the individual. That will never be tolerated.

On how this globally interconnected debt fest has survived til now:

"The only reason that the smaller countries who default (there are many, many such defaults) have survived their defaults and kept going is that the bigger countries refinance them, through their banks and through the IMF and World Bank. But there's no one who can finance the U.S. if it defaults!!! So it won't default, because of the revolutionary results of shrinking the government drastically. Therefore, of the two options, it will choose inflation."

Practically every non-antagonistic country that has defaulted over the last few decades has been bailed out in some way shape or form by the international financial community. Default has been pushed under the rug, or more accurately under the much larger heaps of debt being steadily accumulated in the developed world. The private banking system has become more interconnected, more leveraged, and less tolerant of default from any source. So governments have added it to their unpayable bar tab.

The entire article by Mr. Rozeff is a good read.

Get Ready for QEII: Bernanke Strikes Back

The Euro plunged to new 52 week lows against the US dollar today, as traders finally began to acknowledge that sovereign debt loads pose a severe threat to the viability of the young currency. The Germans bowed to widespread pressure and agreeed to bail out Greece, despite clear evidence that Greece will never pay off its debt. Also, the ECB chipped in to help by trashing EMU rules about allowing junk rated sovereign debt to be used as collateral for central bank loans. These actions, together with the general air of confusion and desperation emanating from EU authorities, have served to send the currency on a downward spiral against even the hapless dollar and British pound.

Now that the Europeans have proven themselves worthy adversaries in the game of Beggar Thy Neighbor, dollar holders should prepare for the American response. In March, Barack Obama pledged to double US exports over the next five years. It's an honorable goal, but the best way to do it would be to make America competitive by stepping on the toes of some key democrat constituencies. Like the trial lawyers, and the environmentalists, and the labor unions and the high tax, wealth redistribution, pro-regulatory left wing base. In short, Obama would have to turn his back on his party and that seems farfetched. The cheater's way to improve exports is to devalue the currency, which fits right in with our central bank's long held tendency toward ever cheaper money. The fact that we've taken interest rates to zero will not be a hindrance to Bernanke, because he has a printing press. But now Europe has raised the ante in this fiat race to the bottom, threatening Bank of Japan and the Fed's battle for title of most accomodative central bank in the world.

The Euro's drop is now impacting the US equity market, and that impacts the wealth effect so carefully nurtured by manipulating stocks inexorably higher over the last 14 months. Ben won't stand idly by and watch all his good work go down the toilet. If the S&P drops much more than a standard 10% correction, I look for Bernanke to once again flood the US economy with dollars, driving stocks back up and sending a message that no currency will be allowed to underperform the US fiatsco. It's possible that he'll resume buying government debt or mortgage securities from the primary dealers like Goldman Sachs and JP Morgan. They've proven quite adept at sending stocks to the moon if given enough free capital to play with. Or Bernanke could buy stocks directly. That seems less likely because it would raise fears of government ownership of private corporations (not that we haven't already headed down that slippery slope).

Either way, when the economy and the stock market dips, have no doubt that more free money is close at hand. It's been that way for 20 years and it would be folly to assume otherwise until proven to be the case.