27 Dec 2012

Eric Sprott: Why Are Investors Buying 50 Times More Physical Silver Than Gold?

As long-time students of precious metals investing, there are certain things we understand. One is that, historically, the availability ratio of silver to gold has had a direct influence on the price of the metals. The current availability ratio of physical silver to gold for investment purposes is approximately 3:1. So, why is it that investors are allocating their dollars to silver at a much higher ratio? What is it that these “smart” investors understand? Let’s have a look at the numbers and see if it’s time for investors to do as a wise man once said and “follow the money.”
Average annual gold mine production is approximately 80 million ounces, which together with an estimated average 50 million ounces of annual recycled gold, totals around 130 million ounces available per year. In comparison, annual mined silver production has averaged around 750 million ounces, while recycled silver is estimated at 250 million ounces per year, which adds up to approximately 1 billion ounces. Using this data, there is roughly 8 times more silver available to buy than there is gold. However, not all gold and silver is available for investment purposes, due to their use in industrial applications. It is estimated that for investment purposes (jewelry, bars and coins), the annual availability of gold is roughly 120 million ounces, and of silver it is 350 million ounces. Therefore, the ratio of physical silver availability to gold availability is 350/120, or ~3:1.1
Now, let’s examine how investors are allocating their investments between gold and silver. The data below is from the US Mint showing gold and silver sales in ounces:

Source: US Mint (www.usmint.gov [9])

As you can see, investors are choosing to buy silver at a ratio to gold that is well above what is available. This uptrend doesn’t show any signs of slowing either. The ratio of the physical silver to gold is both rising and extraordinarily above the availability ratio of 3:1.
We can also use other data such as the most recent issues of the Sprott Physical Gold and Silver Trusts. The last Gold Trust issue in September 2012 raised US$393 million and the last Silver Trust issue raised US$310 million. On the basis of prices for each metal at the time of issue, we could purchase ~213 thousand ounces of gold and ~9.1 million ounces of silver. This represents a purchase ratio of 43:1.
If we examine ETF holdings in both gold and silver, we note that in the period from 2007 to 2012, the increase in silver holdings amounted to 12,000 tonnes, compared to 1,200 tonnes of gold – meaning, investors purchased ten times more silver than gold.
These are only three factual data points to consider, but there are other indications that silver investment demand is way out of line with availability. Our favourite question to the bullion dealers we meet, is to ask the ratio of their dollar sales in gold versus silver. The answer is that dollar sales are equal, which means that physical silver sales relative to gold are greater than 50:1.
A recent news headline on Mineweb read, “Silver Sales to Outshine Gold in India.2” It went on to quote a bullion dealer that “investors and jewelry lovers prefer silver jewelry these days.” As the largest importer of gold in the world, it would be impossible for India to purchase an equivalent amount of silver, as it would require more than one billion ounces, essentially more than the current annual mine production.
While these last two confirmations of silver demand are anecdotal, the statistics from the US Mint, the ETFs, and our Physical Trust issues, are factual.
For the time being, the silver price is essentially set in the paper market where the daily average trade on the Comex is approximately 300 million ounces. An outrageous number when you compare it to the daily mine production of about 2 million ounces. As Bart Chilton, Commissioner of the Commodity Futures Trading Commission stated on October 26, 2010, “I believe there have been repeated attempts to influence prices in silver markets. There have been fraudulent efforts to persuade and deviously control that price. Based on what I have been told and reviewed in publicly available documents, I believe violations to the Commodity Exchange Act have taken place in the silver market and any such violation of the law in this regard should be prosecuted.”3
Which brings us back to the phrase “Follow the money.” In our view, it is almost inconceivable that investors would allocate as many dollars to silver as they would to gold, but that is what the data shows.
The silver investment market is very small. While the dollar value of gold in the world approaches $9 trillion, the value of silver in the forms of jewelry, coins, bars and silverware is estimated at around $150 billion (5 billion ounces at $30 per ounce). This is a ratio of 60:1 in dollar terms.4
How long can investors continue to buy silver at the current ratios when the availability for investment is only 3:1? We are surprised that the price of silver has remained at such a depressed level compared to gold. Historically, the price ratio between gold and silver has been 16:1, when both were currencies. Today the ratio is 55:1, so what are the numbers telling us? We believe this is one of those times when smart investors will be well rewarded to “Follow the money.”
On behalf of all of us at Sprott, I wish you safe and happy Holidays and a prosperous New Year.

P.S. – US Mint Sold Out of Silver Eagle Bullion Coins Until January 7, 2013
The Mint recently informed authorized purchasers that all remaining inventories of 2012-dated Silver Eagle bullion coins had sold out and no additional coins would be struck. Since the 2013-dated coins will not be available to order until January 7, 2013, this leaves a three week void for the Mint’s most popular bullion offering.
1Sources: Gold data is from World Gold Council www.gold.org [10], and silver data is from Silver Institute, http://www.silverinstitute.org/site/supply-demand/
2Source: Mineweb.com
3Source: Bloomberg: http://mobile.bloomberg.com/news/2010-10-26/silver-market-faced-fraudulent-efforts-to-control-price-chilton-says.html
4Sources: Gold data is from World Gold Council, silver data is from United States Geological Survey (USGS) and Silver Institute.


26 Dec 2012

Silver & Gold Investors: Abandon Hope All Ye Who Enter?

The “fiscal cliff” is a myth

Instead, what we are facing is a descent into lawlessness.

Wikipedia notes:
In many situations, austerity programs are imposed on countries that were previouslyunder dictatorial  regimes, leading to criticism that populations are forced to repay the debts of their oppressors.
Indeed, the IMF has already performed a complete audit of the whole US financial system, something which they have only previously done to broke third world nations.
Economist Marc Faber calls the U.S. a “failed state“. Indeed, we no longer have a free market economy … we have fascism, communist style socialism, kleptocracy, oligarchy or banana republic style corruption.

Let’s look at some specific examples of our descent into lawlessness.

Lawless Looting and Redistribution of Wealth

The central banks’ central bank – the Bank for International Settlements- warned in 2008 that bailouts of the big banks would create sovereign debt crises … which could bankrupt nations.
That is exactly what has happened.
The big banks went bust, and so did the debtors. But the government chose to save the big banks instead of the little guy, thus allowing the banks to continue to try to wring every penny of debt out of debtors.

Treasury Secretary Paulson shoved bailouts down Congress’ throat by threatening martial law if the bailouts weren’t passed. And the bailouts are now perpetual.


The bailout money is just going to line the pockets of the wealthy, instead of helping to stabilize the economy or even the companies receiving the bailouts:
Bailout money is being used to subsidize companies run by horrible business men, allowing the bankers to receive fat bonuses, to redecorate their offices, and to buygold toilets and prostitutes
A lot of the bailout money is going to the failing companies’ shareholders
Indeed, a leading progressive economist says that the true purpose of the bank rescue plans is “a massive redistribution of wealth to the bank shareholders and their top executives”
The Treasury Department encouraged banks to use the bailout money to buy their competitors, and pushed through an amendment to the tax laws which rewards mergers in the banking industry (this has caused a lot of companies to bite off more than they can chew, destabilizing the acquiring companies)

And as the New York Times notes, “Tens of billions of [bailout] dollars have merely passed through A.I.G. to its derivatives trading partners”.

In other words, through a little game-playing by the Fed, taxpayer money is going straight into the pockets of investors in AIG’s credit default swaps and is not even really stabilizing AIG.

Moreover, a large percentage of the bailouts went to foreign banks (and see this). And so did a huge portion of the money from quantitative easing. Indeed, the Fed bailed out Gaddafi’s Bank of Libya, hedge fund billionaires, and big companies, but turned its back on the little guy.

A study of 124 banking crises by the International Monetary Fund found that propping up banks which are only pretending to be solvent often leads to austerity:

Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.

Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.

All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.

In other words, the “stimulus” to the banks blows up the budget, “squeezing” public services through austerity.
Numerous top economists say that the bank bailouts are the largest robbery and redistribution of wealth in history.

Why was this illegal? Well, the top white collar fraud expert in the country says that the Bush and Obama administrations broke the law by failing to break up insolvent banks … instead of propping them up by bailing them out.

And the Special Inspector General of the Tarp bailout program said that the Treasury Secretary lied to Congress regarding some fundamental aspects of Tarp – like pretending that the banks were healthy, when they were totally insolvent. The Secretary also falsely told Congress that the bailouts would be used to dispose of toxic assets … but then used the money for something else entirely. Making false statements to a federal official is illegal, pursuant to 18 United States Code Section 1001.

So breaking the rules to bail out the big, insolvent banks, is destroying our prosperity.
Lawless Justice System

A strong rule of law is essential for a prosperous and stable economy, yet the government made it official policy not to prosecute fraud, even though main business model adopted by the biggest financial crime in world history, the largest insider trading scandal of all time, illegal raiding of customer accounts andblatant financing of drug cartels and terrorists have all gotten away scot-free without any jail time.

There are two systems of justice in America … one for the big banks and other fatcats, and one for everyone else.
While Iceland prosecuted its top criminal bankers, and thus quickly got through its financial problems and now has a vibrant economy, the American government has done everything it can to cover up fraud, and has been actively encouraging criminal fraud and attacking those trying to blow the whistle.

The rule of law is now as weak in the U.S. and UK as many countries which we would consider “rogue nations”. See this, this, this, this, this, this, this, this, this, this and this.

This is a sudden change. As famed Peruvian economist Hernando de Soto notes:

In a few short decades the West undercut 150 years of legal reforms that made the global economy possible.

Moreover, U.S. government personnel are on the take. They have become so corrupt that regulators are literally sleeping with industry prostitutes … while they pimp out the American people.

The corruption of government officials is staggering, and the system of government-sponsored rating agencies had at its core a model of bribery.

We’ve gone from a nation of laws to a nation of powerful men making one-sided laws to protect their own interestsin secret. Government folks are using laws to crush dissent. It’s gotten so bad that even U.S. Supreme Court justices are saying that we are descending into tyranny.

It’s not a “fiscal cliff” … it’s an attempt to rape America … just like Greece and Ireland have been plundered.

Economics professor Randall Wray writes:

Thieves … took over the whole economy and the political system lock, stock, and barrel. They didn’t just blow up finance, they oversaw the swiftest transfer of wealth to the very top the world has ever seen. They screwed workers out of their jobs, they screwed homeowners out of their houses, they screwed retirees out of their pensions, and they screwed municipalities out of their revenues and assets.

Financiers are forcing schools, parks, pools, fire departments, senior citizen centers, and libraries to shut down. They are forcing national governments to auction off their cultural heritage to the highest bidder. Everything must go in firesales at prices rigged by twenty-something traders at the biggest and most corrupt institutions the world has ever known.

Economics professor Michael Hudson agrees … saying that the banks are trying to roll back all modern laws and make us all serfs.

Professor Hudson explained in 2008:

You have to realize that what they’re trying to do is to roll back the Enlightenment, roll back the moral philosophy and social values of classical political economy and its culmination in Progressive Era legislation, as well as the New Deal institutions. They’re not trying to make the economy more equal, and they’re not trying to share power. Their greed is (as Aristotle noted) infinite. So what you find to be a violation of traditional values is a re-assertion of pre-industrial, feudal values. The economy is being set back on the road to debt peonage. The Road to Serfdom is not government sponsorship of economic progress and rising living standards, it’s the dismantling of government, the dissolution of regulatory agencies, to create a new feudal-type elite.

Foreign Policy magazine ran an article entitled “The Next Big Thing: Neomedievalism“, arguing that the power of nations is declining, and being replaced by corporations, wealthy individuals, the sovereign wealth funds of monarchs, and city-regions.

Indeed, this isn’t the “Great Recession”, it’s the Great Bank Robbery. The big banks have pillaged and looted the rest of the world.

A lawless justice system is ruining the economy.

Lawless Central Bank
The non-partisan Government Accountability Office calls the Fed corrupt and riddled with conflicts of interest. Nobel the World Bank would view any country which had a banking structure like the Fed as being corrupt and untrustworthy. The former vice president at the Federal Reserve Bank of Dallas said said he worried that the failure of the government to provide more information about its rescue spending could signal corruption. “Nontransparency in government programs is always associated with corruptionin other countries, so I don’t see why it wouldn’t be here,” he said.

Moreover, the Fed has broken the law by withholding information from Congress, letting unemployment rise in order to keep inflation low, and otherwise exceeding its authority under the Federal Reserve Act.

Our central bank’s lawless and unaccountable actions are hurting the economy.

Lawless Attack on Democracy

The ability of the people to participate in their government’s decision-making is vital for a nation’s prosperity. But we no longer have democracy or a republican form of government in America.

The big banks own Washington D.C. politicians, lock stock and barrel. See this, this, this and this. Two leading IMF officials, the former Vice President of the Dallas Federal Reserve, and the the head of the Federal Reserve Bank of Kansas City, Moody’s chief economist and many others have all said that the United States is controlled by an “oligarchy” or “oligopoly”, and the big banks and giant financial institutions are key players in that oligarchy.

Laws are being passed in secret, and not even Congress knows what’s going on.

In other words, not only the justice system, but the entire system of American representation has been corrupted, thus harming the economy.
Lawless Infringement of Freedom

Personal freedom and liberty – and freedom from the arbitrary exercise of government power – arestrongly correlated with a healthy economy, but America is descending into tyranny.

Authoritarian actions by the government interfere with the free market, and thus harm prosperity.

U.S. News and World Report notes:

The Fraser Institute’s latest Economic Freedom of the World Annual Report is out, and the news is not good for the United States. Ranked among the five freest countries in the world from 1975 through 2002, the United States has since dropped to 18th place.

The Cato institute notes:

The United States has plummeted to 18th place in the ranked list, trailing such countries as Estonia, Taiwan, and Qatar.


Actually, the decline began under President George W. Bush. For 20 years the U.S. had consistently ranked as one of the world’s three freest economies, along with Hong Kong and Singapore. By the end of the Bush presidency, we were barely in the top ten.

And, as with so many disastrous legacies of the Bush era, Barack Obama took a bad thing and made it worse.

But the American government has shredded the constitution, by subjecting us to indefinite detention,taking away our due process rights, deploying drones above our heads, spying on all Americans, and otherwise attacking our freedoms.

Indeed, rights won in 1215 – in the Magna Carta – are being repealed.

Economic historian Niall Ferguson notes, draconian national security laws are one of the main things undermining the rule of law:

We must pose the familiar question about how far our civil liberties have been eroded by the national security state – a process that in fact dates back almost a hundred years to the outbreak of the First World War and the passage of the 1914 Defence of the Realm Act. Recent debates about the protracted detention of terrorist suspects are in no way new. Somehow it’s always a choice between habeas corpus and hundreds of corpses.

Of course, many of this decades’ national security measures have not been taken to keep us safe in the “post-9/11 world” … indeed, many of them started before 9/11.

And America has been in a continuous declared state of national emergency since 9/11, and we are in a literally never-ending state of perpetual war. See this, this, this and this.

In fact, government has blown terrorism fears way out of proportion for political purposes, and “national security” powers have been used in many ways to exempt big Wall Street players from the rule of lawrather than to do anything to protect us.

So lawlessness infringement of our liberty is destroying our prosperity.
Lawless Initiation and Prosecution of War

It is well-documented that war destroys the economy.

Top U.S. government employees lied us into war, and used illegal torture, assassinations and other crimes of war in prosecuting the wars they unnecessarily started. They were – at a minimum –criminally negligent for failing to stop 9/11 (and see this).

In the name of fighting our enemies – the U.S. has directly been supporting Al Qaeda and other terrorist groups for the last decade. See this, this, this, this and this.

Our use of torture has also created many more terrorists than it has prevented.

Security experts – including both conservatives and liberals – agree that waging war in the Middle Eastweakens national security and increases terrorism. See this, this, this, this, this, this, this and this.

Indefinite detention, drone-strikes on innocent civilians, occupation of foreign countries, and most of America’s other tactics in the “war on terror” increase terrorism.

Terrorism feeds the cycle of war … and is thus harming our economy. (And because terrorism spooks people, they spend less, which further harms the economy).

So lawlessness in starting and prosecuting war is destroying our prosperity.

17 Dec 2012

2013 The Final Act

If you have been with us for any length of time you know that I've been claiming that 2013 will probably usher in some pretty ugly world markets. I've called it everything from a massive roll over to an outright crash. Naturally I have to have some "reason" to believe this, and I figure that today is as good as any to discuss the "why's" of it all.

Frankly I have no idea if the big crash will occur in 2013, 2014 ,2015 or what have you. No one truly knows the future. But, I do know that enough things are already in process that the big crash is a mathematical inevitability. We have gone over the edge, we can't walk it back. Now it's simply a matter of waiting on the Grand Finale.

So what is it that is so egregious, that we're going to be facing this economic implosion? The simple fact that you're reading our letter means you already understand the unsustainable debt loads we're under. You're smarter than the average person because frankly most people hear the word debt and shrug it off as some form of abstract concept. Well it is neither abstract nor ignorable. It is real, it has grown to outlandish proportions, and it cannot be repaid.

Ever. The single greatest transfer of wealth the planet has ever seen is in full swing, it cannot be reversed and it will play out.

Some are simply too stupid to "get it". Yeah, I know that I'm not supposed to call someone stupid, but let’s just cut the air of PC for a while shall we? There are three subsets of folks when you are talking about the economic situation we all find ourselves in. The first class is either ignorant of the situation, or if they are aware of it, are just not smart enough to understand the ramifications. The next set knows full well what is really going on and have tried to secure themselves from the ravages of it. The final set, are those that "benefit immediately" from this situation, and don't give a rats ass about the consequences in the future. Most of our politicians fall into that category.

Let us consider Europe for a moment. The situation concerning Spain, Greece, Italy, Portugal and the other Club Med Countries is already terminal. There's no way to fix it. The relatively "good" economies such as Germany are being taxed to support the bad economies. As we speak there are more than 6 regions that want to "break away" from this nightmare. The Scots are holding a referendum to vote on the concept of breaking away from the UK and going their separate way. The cries to "stop the madness" will continue to rise and there's a very good possibility that Spain, Greece and possibly others will NOT be part of the Euro by the end of 2013. The great Socialist test tube experiment of joining 17 different "tribes" each with its own unique customs and languages, has indeed failed. Unfortunately, when it does dissolve, that will not be the end of the nightmare. See...the debts will still be there.

Spain has basically defaulted. Greece has defaulted. Yet to keep Goldman Sachs and JP Morgan from having to pay up on Credit default swaps, the ISDA has changed the language. They're calling it "collective and selective default" thus not requiring GS to have to pay up. Likewise they looked at Greece and said that because their bonds would have Salvage asset value, it’s not a default. Excuse me? When you create a Credit default swap, the deal goes like this... You want to buy Greek Bonds paying 7%, but you're afraid they might default and not pay you. So, you go to GS and buy a credit default swap. GS is basically selling you an insurance Policy. For a 1% "fee" they basically say that if Greece defaults, we'll make you whole. But you also have to agree to give GS the physical bonds. That's the "swap" part of the deal. GS gets the bonds because in any default there is some "salvage" value. Well, Spain and Greece have both defaulted and all the ISDA did was "fix it" so no one had to pay CDS payouts. How criminal does it get? Very.

So, part one of my theory of a pretty big market shake up is that the possibility of "Some - all" of the Euro zone to fly apart in 2013 is very real. Now, the ISDA (International Swaps and Derivatives Association, Inc.) has been able to keep their buddies at GS and JPM happy by not activating Credit default pay outs. But can they pull that off when the Euro dissolves? How many hundreds of billions are written against these bonds? If just "half" of them are forced to pay out, can GS and JPM find that much money? Does that spur another round of US bail outs because they're "too big to fail?" What I'm basically saying is that just because Europe is "way over there" and according to Jim Cramer "you don't shop at Europe".... their problems are rooted right here in the good ole US. Pension plans, Insurance companies and many other every day businesses have ties to Euro zone debt. Remember this in particular...if global activity causes the US interest rates to rise by just 3%, economic Armageddon would ensue. Yes you read that right. A 3% rise in interest rates implodes our entire system. Could the failure of Europe have that effect? It is possible.

Here in the US, we see something that can only be likened to as "get all you can while we're still solvent". The instance of outright fraud, the complete breakdown of moral justice is now in high gear. John Corzine took a billion dollars from Customers, money that was NEVER intended to be comingled with the firms’ money and lost it/stole it. He walks a free man, heck... he might even open another fund. Solindra was NEVER going to produce a single green product. Never. It was a shell company backed/owned by political "friends" that were given half a billion dollars and in less than a year, padlocked down. It was a scam, a complete "inside job". No charges, no one goes to jail. All in all, 26 supposedly "green" companies took taxpayer money, and folded like a cheap camera. Why did they need taxpayer money in the first place? Because they were scams. They could never attract private money because no one would lend to them. But hey, if you have a brother in law in Congress... then you get millions to play with and eventually steal.

PFG went belly up after regulators there found that just like MF GLobal (Corzine's outfit) they had mingled about 200 million worth of customer funds and lost it/blew it/stole it. Well it wasn't lost. It wasn't badly traded away. It was stolen in a Bernie Madoff like ponzi fashion.

Sentinel comes to mind next. After their customers sued in high court because Sentinel took customer money that by CONTRACT and by CHARTER had to be segregated. Kept separate...not mingled with the companies money for investment...Sentinel did just that. They comingled customer funds with their own, stole some, lost some, etc... But here's where the Concept of morality, justice and any believe in a rule of law goes right down the crapper... the Court sided with Sentinel. That's right and I wrote a lot about it when it happened. Our justice system is now made up of on the take criminals, not upholders of law and justice. They said that even though Sentinel promised not to co mingle customer funds with their own, doing it because they thought it would make the customers even more money was just a good intention gone wrong, nothing more. Are you kidding me?

So we have outright looting of the Treasury going on, and no one goes to jail. We have financial companies stealing customer funds and its swept under the rug. We have a judicial system that is now a farce, a bought and paid for circus. Shall I go on? You bet. Because our problems are no longer just "there's too much debt". Now our problems are considerably more wide spread.

Day after day we've had to endure all this talk about the fiscal cliff, and the bickering between the White House and the Congress. Please understand this... Cliff or no cliff, deal or no deal... the system will fail and fail horribly. Do NOT think that just because they reach some late hour deal that all is well and we can go on partying like it's 1999... it would be a colossal mistake. Yes we'd get a short term market boost on the news, but it doesn't fix or change anything. I repeat, our problems can NOT be fixed. ( Okay I take that back, yes our problems could be fixed if our Government did absolutely everything right...from opening all our lands to drilling and exploration, to getting rid of the insane laws of the EPA, to getting rid of the miles of red tape that stands in the way of opening something as insignificant as a lemonade stand, to opening 12 new refineries so we could have 2 dollar gas, to blah blah blah....as you see, it isn't going to happen)

This week, on Dec 11 and 12 the FOMC met concerning monetary policy. Remember folks, operation twist ends at the end of the year. If they had just let that expire, we would go from 80 billion a month being used to buy up treasuries and manipulate the interest rates... to "just" 40 billion. Well, just like a junkie needs ever more junk, credit markets need ever more bogus dollars. So, they announced they'd buy up 45 billion a month of Government paper, with money printed out of thin air. Just ponder that for a second. The 45 billion a month in QE4, which will go on top of the 40 billion a month in QE3.. we're talking about 85 billion a month which is $1.02 trillion a year. This is about a 14-15 trillion dollar economy and the FED is injecting one trillion straight into it...out of thin "AIR". 7% of our 14 trillion dollar economy is Bernanke's printing press. Can you say inflation? Can you say hyper inflation? Start practicing, its coming.

Consider something for a moment. Since Bernanke launched his ZIRP plan (Zero interest rate policy) We have seen an explosion in the amount of businesses that are using repo's and reverse repo's to create cash flow. In years gone by, a brokerage firm for instance, would deposit its customers account money in 90 day T bills. For instance in January of 2007, those notes were paying 5.1%. Most folks don't know this, but the bulk of most brokerage income was NOT generated by trading commissions. Nope, it was by buying reasonably safe 90 day Government paper. When Bernanke took rates to virtually zero, all these places had to scramble to come up with some way to replace that missing cash. Well, as you all know, you don't get big returns without big risk. So, what most of these outfits have turned to is the repo/reverse repo market. Don't just think it was Corzine, or PFG or Sentinel. It's just aboutevery bank, every brokerage, every insurance company, every union pension plan, etc. There are now so many derivatives and CDS's, that the exposure rates are mind boggling. You've seen me post the charts. JPM has "assets" of say 1.5 trillion. (customer deposits) but their exposure to derivatives is 48 Trillion. The leverage factor is insane. This goes for Citi and Goldman and Banc of America, etc etc etc. Consider for a moment Goldman Sachs. If you look at “assets on deposit” versus derivative exposure, they’re at a leverage rate of over 400 times. Am I to believe the world just continues along on its merry path and none of these over the counter derivatives go bump in the night?? Sorry, no can do.

What I'm saying is this... all of this junk is coming to a head. They can't hide it any more, they can't disguise it any more. One really big black swan event, one really crazy event and the cascade goes exponential. The problem however is that you cannot react to it. Consider this.. 77% of all trades now are "Algo's" meaning computers buying and selling to each other via high frequency trading. Virtually every one of those programs is written to go "no bid" in the event of a Black swan event. What do you do if one day something wicked has happened (lets just say an atomic bomb goes off)... in seconds the entire market would go no bid. You want to sell your shares/options/futures etc... but there's no bid. No one to buy them. What happens to all the CDS's, the Reverse repo's that are sitting on "off balance sheet" ledgers when something outside "normal" hits? The entire system will lock up, and fail.

We are there. We are 3 interest rate percent from a lockup. We are one black swan event from a lockup. We are one Eurozone disaster from a lock up. We are already AT the period where firms are sweeping customer accounts, to make up for bad bets, and many more will happen. Will all this happen in 2013? I don't know. But I do know that each and every day we march another inch closer to that swan, to that interest rate spike, to that "outside the bell curve" disaster. To the day YOUR money is no longer at your brokerage, it was stolen/lost. But unlike years gone by where you could call a human and find answers and solutions, now it's all computers. Algo's. Programs. My guess is that the market will start to sniff out these very real possibilities this coming year and begin fading off in advance of it.

So, what do you do? First off there's nothing perfect. I can't sit here and tell you that gold will make everything fine. I can't tell you silver will make everything fine. I can't say land, or cattle or trees or anything else will get you through this unscathed. But I feel fairly confident that you will be MUCH better off having your money in something physical, than in slips of paper with dead Presidents on them. I personally believe that having your "wealth" in gold, silver, property, weapons, ammo, trees, livestock, etc..is considerably better than having a computer entry at your bank. Think about it folks. Your supposed wealth is nothing more than computer digits. The MONEY is not there. Your bank does NOT have your money. Your mutual fund doesn't have your money. They've taken that money and bought swaps, repo's, sovereign debt, you name it. All you have in your possession is a statement that "says" you have "X" amount of money. But you really don't and neither do they. To me that's a very scary thing. One I don't like being part of in this bizarro economic atmosphere.

2013 has the ability to be very unsettled for all the reasons I just outlined. It might not all unfold in 2013, it could be 2014...but the point is this...it's coming. It cannot be stopped. As ugly as those words are, they are a mathematical certainty. Just like I learned after living through Sandy, being prepared is key. Get yourself prepared.

14 Dec 2012

No easing of pressure for Australia

BEN Bernanke made history on Thursday morning by explicitly tying his expansion of quantitative easing (QE) to a reduction in US unemployment - but the big takeaway for Australia is that QE is huge and here at least until the end of 2014. Upward pressure on the Australian dollar will continue as a result.
Until yesterday the Fed was promising to maintain what is effectively a 0 per cent cash rate until at least the middle of 2015. It also had a third leg of quantitative easing under way, in the form of monthly $US40 billion purchases of mortgage-backed securities using freshly printed money and monthly purchases of another $US45 billion of long-term US government debt with funds freed up by liquidation of its holdings of short-term US government paper.
Its stocks of short-term debt have been cleaned out so it will now print another $US45 billion every month to keep its long term bond-buying operation alive, taking its QE commitment to $US85 billion a month.
It has also replaced its promise to not raise interest rates until at least the middle of 2015 with a new commitment to run both low rates and QE for as long as the US unemployment rate stays above 6.5 per cent.
This is the first time a big central bank has openly targeted a specific unemployment rate and it remains to be seen whether it extends or truncates QE.
What is certain, however, is that QE is going to run for an extended period.
The US unemployment rate peaked at 10 per cent in October 2009 and has declined from 8.3 per cent to 7.7 per cent so far this year.
If it continues to fall at this year's pace and inflation does not get out of control, the Fed could inject $US85 billion a month into the system for about 22 months - $US1.87 trillion - before unemployment reaches 6.5 per cent. The programme could be even bigger, however.
The Fed held between $US700 billion and $US800 billion of government debt when it launched its first QE programme at the end of 2008 and now holds almost $US2.9 trillion of government debt, bank debt and high-grade securitised residential mortgage debt.
A double-barrel programme that ran for 22 months could boost its balance sheet to about $US4.8 trillion - but it is possible that unemployment will take more than 22 months to get to 6.5 per cent, keeping the Fed in the market for longer.
That's because the fall in US unemployment owes more to Americans giving up their search for jobs than it does to outright job creation: 60 per cent of the fall since October 2009 is due to lower workforce participation. If participation rises again, unemployment will fall more slowly.
Bernanke has changed the settings a bit. What was once thought likely to become ''QE Infinity'', Bernanke's version of European Central Bank boss Mario Draghi's promise in July to do ''whatever it takes,'' is now QE3+ - a program with no fixed end date but a clear target that will eventually be met.
That target is far enough away, however, to guarantee that QE3+ will be massive and that it will combine with low rates in the US and Europe to maintain upward pressure on the Aussie.
The Australian Reserve Bank has cut its own cash rate by 1.75 percentage points in 13 months to 3 per cent but 3 per cent is solid gold for global investors when northern hemisphere rates are so low that some central banks are charging investors to take deposits.
Quantitative easing itself, meanwhile, works to reduce mortgage and other long-term debt rates in the US, giving investors another reason to look at Australian fixed interest offerings, and bid up the Aussie if they decide to buy in.
As the Fed funds QE3+ by printing money, it is also debasing the currency and improving the US economy's international price competitiveness. When there's more greenbacks in circulation the value of each of them declines - and the Australian dollar's ascent since the global crisis reflects the greenback's fall as well as buying of the Aussie as export income is repatriated and as overseas investors chase our attractive interest rates.
Currency depreciation has been a zero-sum strategy for US-European exchange rates. The euro has falling at much the same pace as the US dollar has since Bernanke began his first round of quantitative easing late in 2008.
Both currencies have fallen heavily against other currencies including our healthy, relatively high yielding Australian dollar, however. The $A has averaged about $US1.03 this year, and has appreciated by about 5 per cent to about $US1.05 - but it has also risen by 69 per cent since Bernanke launched QE1 in 2008. On the other side, the US dollar has fallen by almost 40 per cent against the $A.
Australian dollar euro rates are also not much changed this year. A euro bought about $A1.23 yesterday, and the average for the year is the same. The $A is up 62 per cent against the euro since late 2008 however, and the euro is down against the $A by 38 per cent.
The Reserve Bank is acutely aware of all this. Reserve bank governor Glenn Stevens noted on Wednesday in a speech to Bank of Thailand that balance sheet expansion by central banks created ''spillovers'' into other economies and currencies and the ''degree of disquiet' was rising.
Central banks needed to ''continue to talk frankly with each other about how we perceive the interconnections of global finance to be operating, '' he said.
That sounded like a call on the official family and the Fed in particular to more candidly discuss the pressure QE and zero rates are creating in countries like Australia.
The Reserve will probably cut its cash rate again early in the new year. It knows however that the impact of rate cuts on the value of the $A will be offset to an extent by quantitative easing in the US and elsewhere until QE ends


13 Dec 2012

Aussie Central Bank Gets Ugly Case Of Truthiness

It seems the AsiaPac central bankers did not get the 'shut up and print' memo as today during another speech, an Australian central banker followed Hong Kong's lead and pronounced quantitative easing as potentially harmful and the volatility-dampening effects of excess monetary policy as "ultimately inimical to financial stability and hence macroeconomic stability." In the speech below Glenn Stevens (RBA Governor) provides some much-needed doses of sanity to the grossly addicted world desirous of moar money printing.

"Central banks can provide liquidity to shore up financial stability and they can buy time for borrowers to adjust, but they cannot, in the end, put government finances on a sustainable course... They can't shield people from the implications of having mis-assessed their own lifetime budget constraints and therefore having consumed too much."

Why are these AsiaPac bankers breaking ranks with the status quo? Perhaps they see a looming threat and prefer to front-run their governments' demands to "get to work".

Must Read:

Challenges Of Central Banking - Glenn Stevens (RBA Governor)

Monday marked the 70th anniversary of the commencement of operations of the Bank of Thailand, on 10 December 1942. Conceived under war-time occupation, the Bank has grown to be a key institution in Thailand. It is a pleasure and an honour to come to Bangkok to take part in one of a series of events to mark the anniversary, and I want to thank Governor Prasarn for the invitation.

The Reserve Bank of Australia has long enjoyed a strong relationship with the Bank of Thailand. In 1997, the RBA was among those central banks to enter a swap agreement with the Bank of Thailand shortly after the crisis broke. This was the first part of Australian assistance to the regional partners who were under pressure, which later extended to Korea and Indonesia. In fact, Australia and Japan were the only countries that offered direct financial support to all three countries.

It was a predecessor of mine, Bernie Fraser, who made the suggestion 17 years ago that cooperation in the Asian region might be improved by the establishment of a dedicated institution, along the lines of the Bank for International Settlements in Basel – the ‘Asian BIS’. Such a body has not come to pass – at least not yet! – but it is fair to say that this suggestion and others like it helped to spur the Basel BIS to reach out to Asia.

The central banks of the region, taking the initiative through the Executives Meeting of East Asian and Pacific central banks – EMEAP (not the most attractive acronym) – have improved cooperation substantially over the years. Thanks to long-term efforts at building relationships, and the vision of key governors and deputy governors, including at the Bank of Thailand, EMEAP has developed into a mature forum for sharing information, and continues to develop its ability to find common positions on global issues and to promote crisis readiness.

Yet as the central banks have grown closer and become more effective in their cooperation, the challenges we face have only increased. Today I want to speak about three of them.

First, I will talk about the framework for monetary policy and the need to allow that to consider financial stability.

Secondly, I will make some observations about the more prominent role for central banks' own balance sheets that we are seeing in some countries.

Then, thirdly, I will offer some observations about international spillovers. In so doing, I am not seeking to deliver any particular messages about the near-term course of monetary policy in either Australia or Thailand.
Monetary Policy and Financial Stability

It is more than two decades since the framework of Inflation Targeting (IT) was pioneered in New Zealand and Canada. The United Kingdom was an enthusiastic early adopter from 1992. Australia adopted IT in 1993.

Among the early adopters, the move to IT was driven by a mixture of principle and pragmatism. The key principle was that monetary policy was, in the end, about anchoring the value of money – that is, about price stability. The pragmatism arose because one or more previous approaches designed to achieve that – monetary targeting, exchange-rate targeting, unconstrained discretion – had proved at best ineffective, and at worst destabilising, for the countries concerned. Hence many of the adopters shared a desire to strengthen the credibility of their policy frameworks. As the initial adopters came to have a measure of success in combining reasonable growth with low inflation, other countries were attracted to the model.

According to the IMF, more than 30 countries now profess to follow some form of IT. The euro area could also be counted among this group though it also professes adherence to the ‘second pillar’ of ‘monetary analysis’. Even the United States can, I think, be counted as a (fairly recent) IT adopter, since the Federal Open Market Committee is these days quite explicit about its desired inflation performance.

The Bank of Thailand was one of a number of emerging economies that adopted IT around the turn of the century. Twelve years on, Thailand can boast an impressive record of price stability under this framework. A high level of transparency has ensured that financial market participants understand the framework, and view it as credible. Moreover, price stability has not come at the cost of subdued economic growth, with output expanding at a brisk pace in the 2000s.

While inflation targeting is not for everyone, the Thai experience illustrates that, when done well, it can enhance economic outcomes. I can endorse the favourable verdict offered on the Thai experience delivered by Grenville and Ito (2010).

So I think that the adoption of IT, including in Thailand, can be seen as a success in terms of the straightforward objectives set for it. To make such a claim is not, however, to claim that controlling inflation is, alone, sufficient to underwrite stability in a broader sense. If there were any thought that controlling inflation over a two or three year horizon was ‘enough’, we have been well and truly disabused of that by experience over the past half decade. Price stability doesn't guarantee financial stability.

Indeed it could be argued that the ‘great moderation’ – an undoubted success on the inflation/output metric – fostered, or at least allowed, a leverage build-up that was ultimately inimical to financial stability and hence macroeconomic stability. The success in lessening volatility in economic activity, inflation and interest rates over quite a lengthy period made it feasible for firms and individuals to think that a degree of increased leverage was safe. But higher leverage exposed people to more distress if and when a large negative shock eventually came along. This explanation still leaves, of course, a big role in causing the crisis – the major role in fact – for poor lending standards, even fraud in some cases, fed by distorted incentives and compounded by supervisory weaknesses and inability to see through the complexity of various financial instruments.

That price stability was, in itself, not enough to guarantee overall stability, should hardly be surprising, actually. It has been understood for some time that it is very difficult to model the financial sector, and that in many of the standard macroeconomic models in use, including in many central banks, this area was under-developed. Mainstream macroeconomics was perhaps a bit slow to see the financial sector as it should be seen: that is, as having its own dynamic of innovation and risk taking; as being not only an amplification mechanism for shocks but a possible source of shocks in its own right, rather than just as passively accommodating the other sectors in the economy.

Notwithstanding the evident analytical difficulties, the critique being offered in some quarters is that central banks paid too little attention in the 2000s to the build-up of credit and leverage and to the role that easy monetary policy played in that. It is hard to disagree, though I would observe that this is somewhat ironical, given that IT was a model to which central banks were attracted after the shortcomings of targets for money and credit quantities in the 1980s. It could be noted as well that the ECB always had the 2nd pillar, but the euro area still experienced the crisis – in part because of credit granted in or to peripheral countries, and in part because of exposures by banks in the core countries to excessive leverage in the US.

The upshot is that the relationship between monetary policy and financial stability is being re-evaluated. As this occurs, we seem to be moving on from the earlier, unhelpful, framing of this issue in terms of the question as to whether or not monetary policy should ‘prick bubbles’ and whether bubbles can even be identified. The issue is not whether something is, or is not, a bubble; that is always a subjective assessment anyway in real time. The issue is the potential for damaging financial instability when an economic expansion is accompanied by a cocktail of rising asset values, rising leverage and declining lending standards. One can remain agnostic on the bubble/non-bubble question but still have concerns about the potential for a reversal to cause problems. Perhaps more fundamentally, although the connections between monetary policy and financial excesses can be complex, in the end central banks set the price of short-term borrowing. It cannot be denied that this affects risk-taking behaviour. Indeed that is one of the intended effects of low interest rates globally at present (which is not to say that this is wrong in an environment of extreme risk aversion).

It follows that broader financial stability considerations have to be given due weight in monetary policy decisions. This is becoming fairly widely accepted. The challenge for central banks, though, is to incorporate into our frameworks all we have learned from the recent experience about financial stability, but without throwing away all that is good about those frameworks. We learned a lot about the importance of price stability, and how to achieve it, through the 1970s, 80s and 90s. We learned too about the importance of institutional design. We shouldn't discard those lessons in our desire to do more to assure financial stability. We shouldn't make the error of ignoring older lessons in the desire to heed new ones.

Rather, we have to keep both sets of objectives in mind. We will have to accept the occasional need to make a judgement about short-term trade-offs, but that is the nature of policymaking. And in any event, over the long run price stability and financial stability surely cannot be in conflict. To the extent that they have not managed to coexist properly within the frameworks in use, that has been, in my judgement, in no small measure because the policy time horizon was too short, and perhaps also because people became too ambitious about fine-tuning.

We also must, of course, heed the lesson that, whatever the framework, the practice of financial supervision matters a great deal. Speaking of supervisory tools, these days it is, of course, considered correct to mention that there are other means of ‘leaning against the wind’ of financial cycles, in the form of the grandly-labelled ‘macroprudential tools’. Such measures used to be more plainly labelled ‘regulation’. They may be useful in some instances when applied in a complementary way to monetary policy, where the interest rate that seems appropriate for overall macroeconomic circumstances is nonetheless associated with excessive borrowing in some sector or other. In such a case it may be sensible to implement a sector-specific measure – using a loan to value ratio constraint or a capital requirement. (This is entirely separate to the case for higher capital in lending institutions in general).

We need, however, to approach such measures with our eyes open. Macroprudential tools will have their place. But if the problem is fundamentally one of interest rates being too low for a protracted period, history suggests that the efforts of regulators to constrain balance-sheet growth will ultimately not work. If the incentive to borrow is powerful and persistent enough, people will find a way to do it, even if that means the associated activity migrating beyond the regulatory perimeter. So in the new-found, or perhaps re-learned, enthusiasm for such tools, let us be realists.
The Limits of Central Banking

That policy measures of any kind have their limitations is a theme with broader applications, especially for central banks. The central banks of major countries were certainly quite innovative in their responses to the unfolding crisis. Numerous programs to provide funding to private institutions, against vastly wider classes of collateral, were a key feature of the central bank response to the situation. In essence, when the private financial sector was suddenly under pressure to shrink its balance sheet, the central banks found themselves obliged to facilitate or slow the balance-sheet adjustment by changing the size of their own balance sheets. This is the appropriate response, as dictated by long traditions of central banking stretching back to Bagehot.

Conceptually, at least initially, these balance-sheet operations could be seen as distinct from the overall monetary policy stance of the central bank. But as the crisis has gone on such distinctions have inevitably become much less clear as ‘conventional’ monetary policy reached its limits.

It was fortuitous for some, perhaps, that the zero-lower bound on nominal interest rates – modern parlance for what we learned about as the ‘liquidity trap’ – had gone from being a text book curiosum to a real world problem in Japan in the 1990s. Japan subsequently pioneered the use of ‘quantitative easing’ in the modern era. This provided some experiential base for other central banks when the recession that unfolded from late 2008 was so deep that there was insufficient scope to cut interest rates in response. So in addition to programs to provide funding to intermediaries in order to prevent a collapse of the financial system when market funding dried up, there have been programs of ‘unconventional monetary policy’ in several major countries over recent years. These have been varyingly thought of as operating by one or more of:
reducing longer-term interest rates on sovereign or quasi-sovereign debt by ‘taking duration out of the market’ once the overnight rate was effectively zero
reducing credit spreads applying to private sector securities (‘credit easing’, operating via the ‘risk taking’ channel)
adding to the stock of monetary assets held by the private sector (the ‘money’ channel, appealing to quantity theory notions of the transmission of monetary policy)
in the euro area in particular, commitments to lower the spreads applying to certain sovereign borrowers in the currency union (described as reducing ‘re-denomination risk’).

As a result of such policy innovation, the balance sheets of central banks in the major countries have expanded very significantly, in some cases approaching or even surpassing their war-time peaks (Graph 1). Further expansion may yet occur.

Graph 1

It is no criticism of these actions – taken as they have been under the most pressing of circumstances – to observe that they raise some very important and difficult questions for central banks. There is discomfort in some quarters that central banks appear to be exercising an unprecedented degree of discretion, introducing new policies yielding uncertain benefits, and possible costs.

One obvious consideration is that central banks, in managing their own balance sheets, need to assess and manage risk across a wider and much larger pool of assets. Gone are the comfortable days of holding a modest portfolio of bonds issued by the home government that were seen as of undoubted credit quality. Central bank portfolios today have more risk. To date in the major countries, this has worked well in the sense that long-term yields on the core portfolios have come down to the lowest levels in half a century or more. Large profits have been remitted to governments. But at some point, those yields will surely have to rise.

Of course large central bank balance sheets carrying sizeable risk is hardly news around Asia. Once again, the Bank of Thailand has made an excellent contribution to the international discussion here, having recently held a joint conference with the BIS on central bank balance sheets and the challenges ahead. The difference is that in Asia the risks arise from holdings of foreign-currency assets which have been accumulated as a result of exchange-rate management. There is obviously valuation risk on such holdings. There is also often a negative carry on such assets since yields on the Asian domestic obligations which effectively fund foreign holdings are typically higher than those in the major countries. In effect the citizens of Asia continue to provide, through their official reserves, very large loans to major country governments at yields below those which could be earned by deploying that capital at home in the region.

For the major countries a further dimension to what is happening is the blurring of the distinction between monetary and fiscal policy. Granted, central banks are not directly purchasing government debt at issue. But the size of secondary market purchases, and the share of the debt stock held by some central banks, are sufficiently large that it can only be concluded that central bank purchases are materially alleviating the market constraint on government borrowing. At the very least this is lowering debt service costs, and it may also condition how quickly fiscal deficits need to be reduced. There is nothing necessarily wrong with that in circumstances of deficient private demand with low inflation or the threat of deflation. In fact it could be argued that fiscal and monetary policies might actually be jointly more effective in raising both short and long-term growth in those countries if central bank funding could be made to lead directly to actual public final spending – say directed towards infrastructure with a positive and long-lasting social return – as opposed to relying on indirect effects on private spending.

The problem will be the exit from these policies, and the restoration of the distinction between fiscal and monetary policy with the appropriate disciplines. The problem isn't a technical one: the central banks will be able to design appropriate technical modalities for reversing quantitative easing when needed. The real issue is more likely to be that ending a lengthy period of guaranteed cheap funding for governments may prove politically difficult. There is history to suggest so. It is no surprise that some worry that we are heading some way back towards the world of the 1920s to 1960s where central banks were ‘captured’ by the Government of the day.

Most fundamentally, the question is whether people are fully understanding of the limits to central banks' abilities. It is, to repeat, not to be critical of actions to date to wonder whether private market participants, and perhaps more importantly governments, recognise what central banks cannot do. Central banks can provide liquidity to shore up financial stability and they can buy time for borrowers to adjust. But they cannot, in the end, put government finances on a sustainable course and they cannot create the real resources that need to be found from somewhere to strengthen bank capital. They cannot costlessly correct earlier misallocation of real capital investment. They cannot shield people from the implications of having mis-assessed their own life-time budget constraints and as a result having consumed too much. They cannot combat the effects of population aging or drive the innovation that raises productivity and creates new markets. Nor can they, or should they, put themselves in the position of deciding what real resource transfers should take place between countries in a currency union.

One fears, in short, that while the central banks have been centre stage – rightly in many ways – in the early responses to the crisis, and in buying time for other adjustments by taking bold initiatives over the past couple of years, the limits of what they can do may become more apparent in the years ahead. A key task for central banks is to try to communicate these limits, all the while doing what they can to sustain confidence that solutions can in fact be found and pointing out from where they might come.
Challenges with Spillovers

Talking about the challenges associated with large balance-sheet activities leads naturally into a discussion about international spillovers.

In one sense, this is not a new issue. It has been a cause of anxiety and disagreement since the latter days of the Bretton Woods agreement at least. The remark attributed to the then Secretary of the US Treasury in regard to European concerns about the weakness of the US dollar in the 1970s of ‘it's our currency, but your problem’ was perhaps emblematic of the spillovers of that time. There have been other episodes since. In a much earlier time there was, of course, the ‘beggar thy neighbour’ period of the 1930s – something which carries cogent lessons for current circumstances.

In recent years, as interest rates across a number of major jurisdictions have fallen towards zero and as central bank balance-sheet measures have increased, these developments have been seen as contributing to cross-border flows of capital in search of higher returns. The extent of such spillovers is still in dispute. And, to the extent that they are material, some argue that a world in which extraordinary measures have been taken to prevent crises may still be a better place for all than the counterfactual.

The degree of disquiet in the global policymaking community does seem, however, to have grown of late. Perhaps one reason is the following. In past episodes expansionary policies in major countries, while having spillovers through capital flows, did demonstrably stimulate demand in the major countries. It is open to policymakers in those countries to claim that unconventional policies are having an expansionary effect in their own economies compared with what would otherwise have occurred. But the slowness of the recovery in the US, Europe and Japan, I suspect, leaves others wondering whether major countries are relying more on exporting their weaknesses than has been the case in most previous recoveries. One response to that can be efforts in emerging economies to make their financial systems more resilient to volatile capital flows, such as by developing local currency bond markets and currency hedging markets. This type of work is underway in various fora, such as the G-20 and EMEAP. But that takes time.Meanwhile people in the emerging economies, and for that matter several advanced economies, feel uncomfortable about the spillovers.

At the same time, it has to be said that spillovers go in more than one direction. While it was common for Asian (and European) policymakers to point the finger at the US for many years over the US current account deficit, with claims that the US was absorbing too great a proportion of the world's saving, the fact was that those regions were supplying excess savings into the global capital market because they did not want to use them at home. That surely had an impact on the marginal cost of capital, to which borrowers and financial institutions in parts of the advanced world responded. We may want to say, in hindsight, that policymakers in the US and elsewhere should have worried more about the financial risks that were building up by the mix of policies that they ran. But we would also have to concede that the US policymakers sought to maintain full employment in a world that was conditioned by policies pursued in parts of the emerging world and especially Asia.

Not only do spillovers go in more than one direction, but those which might arise from policies in this region are much more important now than once was the case. The rapid growth in Asia's economic weight means that policy incompatibilities which partly arise on this side of the Pacific have greater global significance. The traditional Asian strategy of export-driven growth assisted by a low exchange rate worked well when Asia was small. Asia isn't small anymore and so the rest of the world will not be able to absorb the growth in Asian production in the same way as it once did. More of that production will have to be used at home. This is understood by Asian policymakers and progress has been made in reorienting the strategy. I suspect more will be needed.

For central banks in particular, there has been talk about spillovers from monetary policy settings being ‘internalised’ into individual central banks' framework for decision making. Exactly how that might be done is not entirely clear, and discussion is in its infancy; a consensus is yet to emerge. The IMF does useful work on spillovers and the IMF offers, at least in principle, a forum where incompatibilities can be at least recognised and discussed. One more far reaching proposal is for there to be an ‘international monetary policy committee’. That seems a long way off at present.

For spillovers to be effectively internalised, mandates for central banks would need to allow for that. At the present time most central banks are created by national legislatures, with mandates prescribed in national terms. (The ECB of course is the exception, with a mandate given via an international treaty). It would be a very big step to change that and it certainly won't occur easily or soon, though national sovereignty over monetary policy within the euro area was given up as part of the single currency – so big changes can occur if the benefits are deemed to be sufficient.

Whether or not such a step eventually occurs, it is clear that spillovers are with us now. All countries share a collective interest in preserving key elements of the international system, even as individual central banks do what it takes to fulfil their current mandates. It is vital, then, that central banks continue to talk frankly with each other about how we perceive the interconnections of global finance to be operating. We may be limited at times by the national natures of our respective mandates, but those limitations need not preclude cooperative action altogether, as has been demonstrated at various key moments over the past five years. In this region, the EMEAP forum offers great potential to further our mutual understanding and ability to come to joint positions on at least some issues. Internationally, the BIS of course is also a key forum for ‘truth telling’ in a collegiate and confidential setting and one in which the central banks of this region are playing an increasingly prominent role. There will need to be much more of this in the future.

The Bank of Thailand and the Reserve Bank of Australia have, in our respective histories, faced challenges, some of them severe ones. We have learned much from those experiences. In recent years, we have had our own distinct challenges. Fortunately, we have not been directly at the centre of the almost unprecedented challenges faced by our colleagues in major countries, though we have all been affected in various ways.

The future in Asia is full of potential, but to realise that we have to continue our efforts to strengthen our own policy frameworks, learn the appropriate lessons from the problems of others, and continue our efforts to cooperate on key issues of mutual interest. As the Bank of Thailand moves into its eighth decade, I am sure you will rise to the challenge.

12 Dec 2012

Silver tipped to soar 500% but can it beat bullion in 2013?

Silver tipped to soar 500% but can it beat bullion in 2013?
While 2012 has proved a stellar year for the silver price, questions hang over whether the precious metal can replicate this performance and continue to outshine gold as we move into the new year.

Over the course of 2012, the silver price has risen by nearly 20%, outpacing gold’s 10% rise.

While gold is typically viewed as a safe haven and alternative currency, silver is viewed as more of a risk asset, making its price more sensitive to spells of risk aversion. Conversely, this also means silver is likely to rise further than gold when investors are in risk-on mode.

Indeed, some analysts are backing the latter scenario in the view that monetary policy will remain loose for the foreseeable future, especially following the re-election of Barack Obama in the US and the possibility Ben Bernanke will remain chairman of the Federal Reserve. Such a setting could be a boon for risk assets, including silver.

Ian Williams, chairman of Charteris Treasury Portfolio Managers, believes silver will rise over 500% in three years, based on technical and cyclical analysis rather than a reaction to the accommodative economic situation in the US.

Williams anticipates the precious metal is about to enter a bull market, which will take it from a current price of $32 an ounce to $165 an ounce by the end of October 2015.

So far it has risen from $8 an ounce in 2008 to around $32 an ounce, having peaked at $50 in 2011.

‘We expect silver to continue to dramatically outperform gold as the bull market in precious metals is by no means over,’ said Williams. ‘Our forecast for gold is for a rise to $2,500 but that is small beer to what we expect to see in silver.’

Consequently, he has been shifting the Way Charteris Gold fund away from pure gold mining stocks towards shares that have a much higher involvement with silver.

‘Also within our FTSE 100 equity fund, the Elite Charteris Income fund, we have made Fresnillo [the world’s largest Silver miner & FTSE 100 constituent] the largest holding,’ he says.

Silver lining

So what has fuelled silver’s recent strong performance, and can it really continue its exceptional rally?

‘The main reason silver has done so well is that people are looking at one of the better ways to play the move by the Fed to put in place an aggressive third round of quantitative easing,’ said Nick Brooks, head of research and investment strategy at ETF Securities.

‘So in the run up to, and in anticipation of, the QE3 announcement, silver rallied strongly. Investors have correctly looked at silver as one of the better ways to play an increase in risk appetite and an increase in economic growth – with silver benefiting from these more so than gold.’

However, despite the seeming correlation in performance, the fundamentals driving the performance of both metals differ substantially. Gold typically has an inverse relationship with the US dollar, which is why the depreciation of the currency on the back of QE saw the metal rise.

Silver demand is more purely related to industrial applications, so is more dependent on the state of the global economy and demand for the metal in growing economies. Nonetheless, as a risk asset, its course next year will be linked with the outcome of the impending fiscal cliff and global economy.

‘To the extent the US Congress and Obama come up with a compromise, investors will be more keen to buy cyclical assets – and silver is near the top of the list,’ said Brooks. ‘Also, as long as the US and China continue to recover, silver will perform well.’

However, he warns if the fiscal cliff is not avoided, there will be ‘a big correction’ in risk assets and silver ‘will be hit badly’.

Silver, often viewed as a leveraged play on gold, also tends to be volatile, having exhibited an average annualised volatility of 35% over the last 10 years. ‘It’s fair to say it’s likely to remain volatile next year,’ said Brooks.


8 Dec 2012

Fed Exit Plan May Be Redrawn as Assets Near $3 Trillion

A decision by the Federal Reserve to expand its bond buying next week is likely to prompt policy makers to rewrite their 18-month-old blueprint for an exit from record monetary stimulus.

Under the exit strategy, the Fed would start selling bonds in mid-2015 in a bid to return its holdings to pre-crisis proportions in two to three years. An accelerated buildup of assets would also mean a faster pace of sales when the time comes to exit -- increasing the risk that a jump in interest rates would crush the economic recovery.

The U.S. Federal Reserve building in Washington. Photographer: Andrew Harrer/Bloomberg

“There is certainly an issue about unwinding the balance sheet” in a way that “is effective and continues to support the recovery without creating inflation,” St. Louis Fed Bank President James Bullard said in an interview in October. The central bank might have to “revisit” the 2011 strategy, he added.

The Fed is already buying $40 billion a month in mortgage- backed securities to boost the economy, and policy makers meeting Dec. 11-12 will consider whether to purchase more assets. John Williams, president of the San Francisco Fed, has proposed adding $45 billion of Treasury securities a month.

The bigger the balance sheet, “the riskier the exit becomes,” Richmond Fed President Jeffrey Lacker said during a Nov. 20 speech in New York. “That is something we need to think carefully about.”

Krishna Memani, director of fixed income at OppenheimerFunds Inc., said a too-rapid sale of assets risks disrupting the $5.2 trillion market for agency mortgage debt.
Finding Ways

“They have to find ways of unwinding the balance sheet without dumping all of it in the marketplace,” said Memani, who oversees a bond portfolio of about $70 billion, including about $6 billion of mortgage-backed securities.

The central bank has been extending the maturities of its assets with Operation Twist, a program to replace $667 billion of short-term debt with the same amount of longer-term bonds that expires this month.

A decision to expand purchases could push the total assets to $4 trillion by the end of 2013, saidMichael Hanson, a senior U.S. economist at Bank of America Corp. Total assets stand at $2.86 trillion, up from $869 billion at the end of June 2007.

“The more they add to the balance sheet, the longer it will take to normalize,” said Hanson, who worked on designing tools that will be used in the Fed’s exit strategy as an economist in the monetary affairs division at the Board of Governors in 2009.
Holdings Expand

The central bank’s holdings expanded during the financial crisis as the Fed created several emergency loan programs. Chairman Ben S. Bernanke in November 2008 ordered the purchase of debt issued by housing agencies and mortgage-backed securities in a strategy that he called credit easing.

After the benchmark lending rate was cut almost to zero in December 2008, the Fed continued buying bonds as its primary easing tool. The Fed announced its third round of purchases in September without specifying a total quantity or end date.

Those central bank initiatives have helped push yields on Treasury and housing debt to record lows. The average fixed rate on a 30-year mortgage fell to 3.31 percent last month, according to a Freddie Mac index.

The yield on the 10-year Treasury note reached 1.39 percent on July 24 and, at 10:24 a.m. in New York, rose 0.03 percentage point to 1.62 percent after a report showed U.S. payrolls expanded last month more than forecast. U.S. Labor Department figures showed the U.S. added 146,000 jobs in November and the unemployment rate fell to 7.7 percent.
Transparency Push

The Fed announced the exit strategy in June 2011 as it sought to assure investors that it had the means to avoid igniting inflation once job growth, wages, and demand started moving up. The plan was part of Bernanke’s push for greater transparency and predictability.

The goal is to return the balance sheet to a pre-crisis size in two to three years and eliminate holdings of housing debt “over a period of three to five years.”

First, the Fed would allow assets to mature without being replaced, a process that will be slower now that the Fed has extended the average duration of its holdings. It would then modify its guidance on how long it plans to keep the federal funds rate near zero and begin temporary operations to drain excess bank reserves.

The Fed would next raise the federal funds rate, and finally, it would start selling securities.

The balance sheet averaged about 6.3 percent of nominal gross domestic product during the decade before the financial crisis. Today, a balance sheet of that size would be around $995 billion rather than $2.86 trillion.
Long Exit

“The exit is going to take a long time,” said Stephen Oliner, a resident scholar at the American Enterprise Institute in Washington and former Fed Board senior adviser. He estimates the Fed’s holdings could rise to more than $4 trillion.

If the Fed were to start bringing its holdings back to their pre-crisis level today, it would have to sell almost $2 trillion over a period of two to three years under its current exit plan. Assuming holdings grow to $4 trillion, asset sales could come to $3 trillion over the same period.

Fed officials haven’t publicly discussed an alternative plan for shrinking the balance sheet. One possibility, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey, would be to enlist the help of the U.S. Treasury.
One-time Swap

The Fed could ask to swap longer-term Treasury debt for short-term bills and notes, thus reducing the maturity of its portfolio to accelerate the runoff. The Fed and Treasury could do this partly in a one-time swap, and partly by allowing the Fed to bid on new issues and pay with its holdings of long-term Treasuries, Crandall said.

Because the Fed would have less debt to sell to return its portfolio to a normal size, it could be “more aggressive in the liquidation” of housing-agency securities, he said, which was a priority for Fed officials when they announced the exit strategy.

Asset purchases have made it harder to change the federal funds rate when the time comes to raise borrowing costs.

In the five years before the crisis, excess bank reserves averaged $1.7 billion, so the Fed could alter interest rates by buying or selling comparatively small amounts of short-term debt in open-market operations.

Those reserves are now more than 800 times larger at $1.4 trillion. To move the fed funds rate, the central bank will have to drain or lock up the supply of excess reserves.
Current Plan

Under the current exit plan, the Fed would soak up reserves by using reverse repurchase agreements or offering term deposits.

“I’m not sure we’ll really know, until they undertake a real program, what the effectiveness is” of such measures, said Bank of America’s Hanson. “The amount of reserves could be so large that the draining doesn’t do a whole lot.”

The central bank could lose credibility if its policy actions don’t move the federal funds rate, saidMarvin Goodfriend, a former adviser at the Richmond Fed.

“The Fed needs to delicately acquire inflation credibility in the exit,” said Goodfriend, a professor at Carnegie Mellon University’s Tepper School of Business in Pittsburgh. “We are used to tightly managed short-term interest rates.”

The Fed’s other tool is to extinguish reserves by selling bonds back to dealers. Even a fully-explained plan could push up home borrowing costs as traders account for hundreds of billions of dollars of new supply flowing back into the market.

“We are deep into experimentation at this point,” Oliner said. “It’s understandable that people are worried.”