domingo, 23 de marzo de 2014

domingo, marzo 23, 2014

Peter Schiff Is Wrong On Gold... Again

Robert Wagner

Mar. 20, 2014 6:52 AM ET





Summary

Peter Schiff's bullish argument for gold is unlikely to materialize as he outlines.

Gold is more likely to reach $770/oz before it reaches $2,000/oz.

Geopolitical and Chinese financial fears are driving gold, not fears of inflation.


Last year I wrote an article explaining why Peter Schiff was wrong about gold "going to the moon." At the time gold was trading around $1,400/oz and soon afterwards collapsed to under $1,200/oz.
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Since that article gold has been bouncing around between $1,200 and $1,400/oz.



Once again, like clockwork, gold has a "dead cat" and the media runs to Peter to get his view on gold and anti-Federal Reserve/Ben Bernanke/Janet Yellen invectives. One thing to note is that when the financial media wants an objective analysis of gold, they don't rush to Peter. The media rushes to Peter to get an over the top bullish story on gold.

A recent video highlights Peter's fatal flaw. His anti-Federal Reserve, anti-monetary policy, anti-fiat currency beliefs are held so strongly he has either never taken the time to understand how the current monetary system works, or he simply rejects it. Peter starts with a conclusion that printing money causes inflation and from that conclusion works backwards. He effectively uses the scientific method in reverse. Investors need to understand that Libertarians redefine "inflation" to make their financial model work. The deflationary Bitcoin is the result of Libertarian monetary policy. Ironically the one thing I agree with Peter on is his opposition to the Bitcoin. There is a battle between Libertarians as to whether Bitcoin or gold is the true Libertarian currency, but I won't get into that.

In the video Peter makes various claims, and I will try to address them.

1) "Gold is just getting started:"

Gold is forming the backside of a burst bubble. The 2008 financial crisis and following QEfinity generated fears of hyperinflation, largely promoted by people like Peter and gold merchants on cable TV. Unless you redefine inflation, those fears never materialized, nor are they likely to. Gold looks to have reached a peak back in inflation fear driven 2011.

2) "The gold rally has nothing to do with Crimea:"

Russia threatening to take over the Crimea and shut off its natural gas supplies to the EU have a lot to do with this recent rise in gold. The New Year started with an oversold bounce in gold, but the developments in Russia and the credit crisis in China turned a likely small dead-cat bounce into a sizable dead-cat bounce, but a dead-cat bounce all the same. Going forward, gold will likely track Russian and Chinese developments. If the Crimea issue gets peacefully resolved and the Chinese credit crisis is well contained, gold will likely be breaking $1,200 soon afterwards. We also have April 15th coming up, and that may trigger some gold selling as people take tax losses in 2014 to pay for taxes owed in 2013. I wrote the above paragraph on 3/17/2014, and this A.M. gold is down another $20/oz as the Russian situation continues to unfold. The market performance of gold is simply proving Peter wrong... again.

3) "Inflation is driving gold higher:"

Inflation is not driving the price of gold. Today the greatest threat to the global markets is deflation. Making the claim inflation exists in this environment demonstrates a dangerous level of overconfidence in a complete and utter misunderstanding of monetary policy and economic metrics like the CPI, PCE and/or PPI. Claiming inflation exists is completely wrong, in fact the Federal Reserve may be trying to boost inflation. Because of the anti-inflation, anti-Federal Reserve ideology that Peter Schiff follows, the concept of the Federal Reserve intentionally creating inflation is beyond his comprehension. It simply doesn't fit in his financial model. Libertarians simply reject the benefits of mild stable inflation.

One doesn't even have to rely on the government measures like the CPI which Peter will surely claim is rigged, here is the video. One simply needs to look at bond rates, specifically corporate bond rates that aren't distorted by the Fed's QE. Corporate bond rates are near record lows, and show no fear of inflation. Peter can make the paranoid's case of rigged government metrics, but he can't make the case for rigging all the entire global financial markets. Either Peter is right and all the global financial markets are wrong, or Peter is wrong and the world is right. I bet on the world being right over Peter, they follow the classic definition of inflation, that being an aggregate increase in prices. By the way, price shocks like the OPEC oil embargoes can cause inflation and have nothing to do with printing money. Inflation is simply more complex than what the Libertarian monetary model accepts.

4) "Fed has no way out of QE:"

That quote proves Peter doesn't have a solid grasp as to how modern monetary policy is implemented. That is what happens when one lets political ideology interfere with unbiased analysis. It also proves Peter follows a carriage in front of the horse understanding of monetary policy.

The Fed's path to exiting QE is very clearly defined. The Federal Reserve has specified very specific inflation and unemployment targets. Peter's financial model appears to follow a 16th century mercantilist monetary policy instead of the current monetary system as defined by the Fed's FOMC meeting minutes.


In fact, the exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5% (the majority of the Fed committee expects rates to start to rise in 2015). Also the Fed will continue to hold MBS and government bonds long after tapering ends, and will continue to re-invest interest and principal receipts. The critical take-away from the Feds announcement is that QE tapering will be highly dependent on continued economic growth, especially a further reduction in the unemployment rate (7.25% is now the critical level for tapering to begin and Bernanke expects the unemployment rate to be down at 7% by the time tapering ends) but also a rise in the inflation rate to around 2%.

Peter's model fails to grasp that monetary policy is nearly 100% dependent upon the success of fiscal policy. Yelling at the Fed for continuing to implement QE is like yelling at the clerk for the price of milk. Monetary policy is like "pushing on a string," it can only create the environment that is favorable to borrow, it can't force people and businesses to borrow and spend. That only comes with confidence, and Washington and all the uncertainty caused by constant change isn't a confident business environment. As long as Washington fiscal policy fails to stimulate economic growth, jobs and inflation, the Fed will continue QE. Once a successful fiscal policy is implemented, you can be 100% sure the Fed will be able to exit QE, but not sooner. The Fed can lead consumers and businesses to the water/bank/store, it can't make them drink/borrow/spend.


In conclusion, because the current administration is following a Keynesian model it is highly unlikely that the US economy will recover at a pace necessary to unwind the "taper" in a timely manner. Going forward I would expect economic growth to be anemic, inflation to remain subdued and unemployment to remain stubbornly high, and maybe even increase as more and more of Obamacare is implemented. The persistently high unemployment will prevent the Fed from quickly implementing the "taper" and will delay any increases in interest rates. I would imagine that 3% will serve as a ceiling for the 10-year Treasury bond rates, and represent resistance that will only be penetrated once a real recovery is underway.

5) "Economy is slipping into recession:"

On this point Peter may be correct, but I am 100% certain 0% interest rates won't cause the economy to fall into recession, it must be some other factor... like failed fiscal policy. I would love to see one of these reporters ask Peter how 0% interest rates can cause a recession. That is a whole lot like saying global warming causes ice ages, it just doesn't make any sense. Facts are 0% interest rates combined with successful fiscal policy is almost a 100% certain way to end the need for QE. The problem is, no amount of successful monetary policy can compensate for failed fiscal policy. Peter's model doesn't seem to incorporate that concept. His model's apparent singular focus on monetary policy prevents him from seeing the whole picture, and the reality of the critical interaction between monetary and fiscal policy. In scientific terminology of Y=mX+b , fiscal policy is the independent variable (X) and monetary policy is the dependent variable (Y). Peter's model apparently has its Xs and Ys mixed up, if in fact it even includes fiscal policy at all. His model appears to be completely backwards, incomplete or both.

6) "Fed is going to ramp up QE:"

That may be 100% true, see #5 above. Problem is Peter blames monetary policy when he should focus on fiscal policy. Peter is now even into "class warfare" and blaming the "IPO bubble" on the Fed. Peter's invective against the Federal Reserve is legendary, but blaming every bubble on them is bit of a stretch. Using that logic, maybe the Fed is causing the Bitcoin bubble, or caused the Tulipmania of the 17th Century (yes, I know the Fed didn't exist in the 17th Century, that is my point). No matter what happens, the Fed seems to be the cause. Peter is like a global warming "scientist" who sees CO2 as the cause of everything. He simply appears to have blinders on that prevent him from understanding how monetary policy truly impacts the markets.

7) "Wall street money drove gold down, gold weakness has driven speculators out of the market:"

Some of that may be true, but retail gold selling was largely matched by central bank buying of gold. For every oz of gold that is sold, there is also a buyer on the other side of the transaction. Selling gold doesn't make it disappear, it simply changes ownership. Now that gold has had a nice run up from $1,200/oz, there are plenty of people able to take profits.

8) "Climbing wall of worry:"

Peter is 100% dead on with this analysis, but that analysis is 100% contrary to his theory. Fear isn't a long-term investment strategy. Peter is right on the theme, but wrong on the source of fear. Peter thinks the markets fear inflation and the continuation of QE. That is proven 100% wrong by the global bond markets. If inflation was truly a threat, the bond markets would react. Ironically, the development of mild inflation will likely be very bad news for gold. In reality QE lowers interest rates so when investors seek a safe haven gold becomes a viable alternative to bonds that are yielding near 0%. It isn't fear of inflation that drives the gold demand, it is the facts that at low interest rates gold becomes a viable alternative to bonds as a safe haven. That won't likely happen as rates increase and the opportunity cost of holding gold increases.

The fear that is driving gold right now is coming from Russia and China, and with gold currently down $20/oz I'm watching the unwinding of the Russian fear premium as I write this article. If things in Russia and China worsen, gold will likely go higher. That won't, however, make Peter right on his thesis, it will make him lucky.

9) "Higher gold will cause a short squeeze"

Peter is 100% correct again, but what does a "short squeeze" have to do with a long-term investment thesis? "Short-squeezes" are the classic time to sell if you are long. People are far more likely to use a "short-squeeze" to exit their positions than to add to them. Peter should be using the "short-squeeze" to lighten his position, not add to it. Peter's argument is like a person that has dug themselves into a hole asking for a bigger shovel instead of a ladder. By the way, it looks like a short-squeeze is already underway, and may have been part of the reason the "dead cat" bounce was as strong as it was.

10) "Could reach $2,000 this year:"

Yep, and a cow may jump over the moon. There are possibilities and there are probabilities, it is "possible" gold will make it to $2,000/oz in 2014, but it isn't "probable." Anything is possible, but gold going to $2,000/oz without another 2008 type crisis is not likely. I expect gold to trade below $770/oz before it trades above $2,000/oz, but that will all depend upon fiscal policy and geopolitical events.

11) "Gold will go higher when Janet Yellen has to confess QE isn't working:"

Monetary policy is working, QE is working, that is what Peter doesn't seem to grasp. QE isn't the tool to force an economic recovery, that is what fiscal policy does. Monetary policy prevents the financial system from experiencing a Great Depression systematic catastrophic collapse, and the Fed's QE has done that. The Fed is like the emergency room doctor that stabilizes the patient, fiscal policy is like the doctor that takes over after the patient has stabilized. The Fed successfully stabilized the patient, now it is time for the fiscal policy doctor to nurse the patient through recovery. Monetary policy is a passive tool, it is like "pushing on a string," it is a carrot not a stick. Fiscal policy is the stick. Once Washington gets its act together and develops a solid pro-growth, pro-jobs, pro-profits fiscal policy, gold is a goner as is the Fed's QE.

The reason I write about this topic, and am critical of Peter Schiff's constant invectives against the Federal Reserve is because of what happened in 2008. Anyone that has even a casual understanding of the Great Depression knows that a major contributing factor was the Federal Reserve's inaction, and the resulting systematic catastrophic collapse of the banking system. The movie "It's a Wonderful Life" highlighted the economic horrors of an economy where the Fed failed to act as a "lender of last resort." Peter Schiff's invective towards the Federal Reserve is legendary, and it helps create a political tone that makes it very hard for our elected leaders to do what is right for the country during times of crisis.

In 2008 I watched in horror as the American people, spurred on by people like Ron Paul, Peter Schiff, and Libertarian "End the Fedders," demanded no bank bailouts. Even after the Lehman Brothers debacle the American people voted against the TARP program. America seemed intent upon cutting off her nose to spite her face, and repeat the mistakes of the Great Depression. The rise of the early 99%/Occupy Wall-Street type movement combined with the Tea Party and libertarian "End the Fed" movements created a toxic anti-Bankster, anti-Wall Street, anti-Federal Reserve environment. Just when we needed more understanding, reason and calm, social movements from all ends of the political spectrum were grabbing the pitchforks and lighting the torches. The angry mob wanted to burn a witch, and that witch lived on Wall Street.

Because of the political pressure and misguided beliefs, Treasury Secretary Hank Paulson pushed for one of the most misguided policy mistakes in world financial history, that being the bankruptcy of a "too big to fail" bank. The banking system is an interconnected web supported by nothing but trust, and once that trust was broken, the system crashed. It was the greatest unforced error in all of financial history. I can give the people in charge in 1929 a pass, they didn't have the Great Depression to study. The people in charge in 2008 had 80 years to study and learn those lessons and they failed as if they had never even read the cover of the book. America literally voted to trigger another Great Depression. People like Ron Paul and Peter Schiff weren't out trying to calm the mob, they were using the crisis to validate their misguided beliefs. The consequences to investors were catastrophic as the markets immediately collapsed upon the failure of the TARP vote. Saving Lehman Brothers was estimated to have required a $40 billion emergency loan, the failure of TARP cost an immediate $1.2 trillion.


Stocks crushed
Approximately $1.2 trillion in market value is gone after the House rejects the $700 billion bank bailout plan.

Facts are, there was 0% chance that a TARP program wouldn't have eventually passed, the markets would have made 100% sure of that. Everyone in America should have known that, but because we had people in the financial media and government encouraging such economically suicidal behavior, America had to relearn the hard way the lessons of the Great Depression. Lessons that we have yet to fully recover from.

President Bush once said "we have to abandon free market principles to save it." There is nothing written in any modern free market economic text book that would ever promote allowing a "too big to fail" bank to fail. Every free market economic textbook written post-1929 strongly argues against it. The banking system isn't part of the free market, it enables it. Free market principles do not apply to the banking system. The banking system is like the oil in an engine, or the operating system of a computer, it allows the system to run, but is removed from the system. There is an infinite difference between an auto bailout and a bank bailout. If GM (GM) goes bankrupt (which it did), they restructure or get bought out like Chrysler, and the overall economy will barely miss a beat, in fact it will likely emerge stronger. Free market principles apply to companies that exist in the free market. Banking doesn't exist in the free market, the banking system are the shoulders of Atlas on which the free market rests. Allowing a "too big to fail" bank to fail is like encouraging Atlas to Shrug and drop the whole system.

This "End the Fed" movement is founded on a misguided misunderstanding of the Austrian School of Economics concept of "mal-investment." The "mal-investment" Hayek wrote about doesn't apply to the banking industry. The kind of "mal-investment" Hayek wrote about can be seen today in the natural gas industry. That kind of "mal-investment" is caused by lack of information regarding future prices, not interest rates or monetary policy. The process is simple, and repeats itself over and over and over throughout history, with or without a Federal Reserve. The price of a commodity spikes, it draws long-term investment based upon elevated prices, the free market invests heavily to capture those extraordinary profits, plants, wells, railroads and mines take years to build/drill, because spot prices are different from future prices the new capacity eventually results in lower prices for the commodity, companies whose original decisions were made relying on $10mBTU natural gas are suddenly bankrupt when the new supply drives prices down to $2mBTU. That cycle is called the Austrian Business Cycle Theory or ABCT and it existed long before the Federal Reserve, has little to do with interest rates, and everything to do with the potential of extraordinary profits and imperfect information regarding the future prices of the commodity, product or service being targeted.

Letting the banking system go bankrupt doesn't eliminate any "mal-investment," at least not in the ABCT sense. Letting the banking system fail is like intentionally installing a virus on your computer that erases your hard-drive. The system crashes on an epic scale and good as well as bad programs and files get erased. There is no underlying financial principle like profit and loss that explains a business failure in a financial panic, it is a purely emotional market reaction that is self creating and self feeding. During a financial crisis, the baby gets thrown out with the bath water. During the 2008 crisis, the money market funds were threatened, as were bank accounts. If Federal Reserve opponents/ABCT proponents had gotten their way, they would be explaining today why people losing their entire life savings was good for the economy because it removed "mal-investment" from the system. To me that is pure misguided ideologically driven insanity.

It is estimated that a $40 billion emergency loan to Lehman Brothers could have prevented the entire 2008 collapse. There is an infinite difference between a "bail out" and issuing an "emergency liquidity" loan. Loans get paid back. The financial TARP program made the tax payers a fortune. The tax payers got paid for letting Congress save the day. The part of TARP that didn't make money was mostly related to GM. The GM "bailout" which wasn't part of the initial TARP however is a different issue than protecting the banking system. You don't get a global catastrophic systematic financial collapse from letting an auto company go bankrupt. A $40 billion emergency loan could have possibly prevented the multi-trillion dollar 2008 financial crisis. It was penny-wise and pound foolish on an epic scale.


Our ruling

Former President Clinton said government got the TARP money back plus interest.

That is correct for the money that went to banks. It is incorrect for TARP as a whole. The program remains about $34 billion in the red.

Peter Schiff may in fact be correct that gold is going higher, I can think of plenty of scenarios that will drive gold higher, but gold won't be going higher for the reasons Peter Schiff gives. Investors must be aware that the reasoning he uses, based upon the invectives that he continually levels against the Federal Reserve, can have catastrophic consequences to the global financial markets. Had we "Ended the Fed" before the 2008 crisis, it is highly unlikely that it would have ended in anything other than an extremely deep global depression.

The market's reaction to the failure of the first TARP vote proves this "End the Fed" movement is extremely dangerous, misguided and harmful to investors. Without the Federal Reserve's actions in 2008 nothing would have prevented the complete collapse of the financial system in 2008, there would have been no "lender of last resort?" Before investors buy into the anti-Federal reserve invectives, they need to ask "what better system could replace the Fed?" Anti-Federal Reserve proponents will likely call for a gold standard. If they do, ask them how they will "print gold out of thin air" during a panic? How would they prevent "bank runs and panics?" How would they have prevented the money markets and bank accounts from "disappearing into thin air" like they have in the past financial panics pre-Fed?

Facts are, to prevent money in a fractional reserve banking system from disappearing into thin air you need to be able to print money out of thin air, and that is what the Federal Reserve does, and does for a good reason. Until opponents of the Fed offer a better solution than the current Federal Reserve system, one that can stop bank runs and financial panics, supporting such policies can/do and have had catastrophic consequences to investments and the economy.

Had the Fed not acted in 2008, investors would have risked losing everything. The Federal Reserve isn't perfect, it is just a whole lot better than the solutions offered by its opponents, and infinitely better than the Bitcoin. Investors interested in this topic should read the book or watch the movie "Too Big To Fail." It does a great job demonstrating the importance of the concepts I tried to address in this article. Tampering with the banking system isn't for amateurs, and once broken, like Humpty Dumpty, it is extremely difficult to put back together.

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