Don't Catch Recovery
Fever by Peter Schiff |
April 9, 2012
Gold has been holding steady in the the
$1,600-$1,800 band since early October. This could be attributed
to consolidation after last summer's historic run up to
$1,895, but I think this wait-and-see attitude reflects
current market sentiment toward the US dollar.
In fact, the first few days of April have
seen a sharp dollar rally and decline in gold. This is rooted
in deflated expectations of a third round of Quantitative
Easing (QE3) after the most recent Fed Open Market Committee
(FOMC) meeting. Once again, the markets are responding to
the headlines while losing sight of the fundamentals.
This is especially peculiar because the
Fed did not explicitly take QE3 off the table. In fact,
according to the minutes, if the recovery falters or if
inflation is too low, the Fed is already prepared to launch
QE3. While there is not much chance of low inflation, I'll
explain below why the recovery is not only going to falter
– it's going to evaporate like the mirage that it
is!
Trade Deficits
The Obama Administration is touting recent
job growth, and while this is a pleasant story to hear in
an era of massive unemployment, it disintegrates when put
in context. The 227,000 jobs gained – which merely
kept the unemployment rate steady at 8.3% – were counterbalanced
by a much worse trade deficit tally: $52.4 billion, the
highest level since just before '08 crash.
The trade deficit is a real measure of
whether our jobs are producing enough wealth to pay for
our consumption. If we were adding productive jobs, I would
expect the deficit to be shrinking. A look at the data shows
that employment increased by only 16% in the primary and
secondary sectors, where we need them the most. The majority
of new jobs are still inflated sectors like healthcare (26%),
temp work (20%), hospitality (19%), and consulting (16%),
which will disappear as fast as they appeared when the bubble
collapses. This is what we saw in finance and real estate
when the housing bubble burst in '08.
Imagine the trade deficit is like a corporate
balance sheet. You hire a bunch of new employees for your
company, but instead of making bigger profits, you find
yourself losing even more money than when you started. Are
you going to hold on to those people?
Stress Tests
While President Obama is focused on jobs,
the Fed has been promoting a recent round of "stress
tests" that show the financial system to be in good
shape. Unfortunately, yet again, the headlines are not what
they seem.
The recent tests were designed to measure
big banks' ability to survive another significant drop in
housing and stock prices; but those bubbles have already
largely popped. What the tests failed to account for is
what I consider the most likely scenario: rapidly rising
interest rates amidst a dollar crisis.
Interest rates are the real risk. I think
the Fed knew the banks would fail this test, so they simply
ignored it. It wouldn't be the first time the Fed has turned
a blind eye to a bubble market. For years, Chairman Bernanke
and other Fed officials denied the housing bubble existed;
and as late as 2008, well after it popped, they assured
us the damage would be contained.
Supporters say the Fed knowingly didn't
account for interest rates because the central bank has
complete control over them. Many in Washington and on Wall
Street honestly believe that the Fed can continue to print
money to buy Treasuries without increasing inflation. A
scenario in which the Fed is forced to choose between US
government bankruptcy and US dollar collapse seems impossible.
In fact, higher interest rates are not only
possible, but probable. The stress tests assume long-term
Treasury note yields stay under 1.8%; but that figure is
the current six-month low on the 10-year, which is already
dragging along its historical floor. As I write, yields
are already up to 2.2%. The post-war average is about 5.2%
– high enough to crater today's banking system.
Remember, the rate needed to break the back
of inflation in 1981 was a whopping 20%. At that level,
there wouldn't be federal tax money left for the military,
Medicare, Social Security, or even law enforcement –
it would all be going to interest payments.
Even now, interest rates are a complete
farce. In 2011, the Fed purchased 61% of new Treasury debt,
compared to virtually none before the financial crisis started.
This shows that at current rates, demand for US debt is
already drying up.
Extended Interest Rates Pledge
It should be no surprise, then, that the
Fed has paradoxically celebrated economic recovery while
pledging to keep interest rates near zero through 2014.
First, even with an economic recovery, these
low rates will continue to drive precious metals higher.
Anyone who says this "recovery" will sink the
gold market is misunderstanding what drives the gold prices
– inflation.
Second, the Fed wouldn't be keeping rates
so low if the recovery were genuine. If I say to you, "Yes,
you can now ride a bike," but I refuse to take off
the training wheels, would you believe me?
The truth is that Bernanke knows the recovery
is phony and is using inflation to mask it. This bodes doubly
well for gold.
CPI
Another fever notion is that inflation isn't
really a threat, no matter what the Fed does. This is borne
of the belief that "deflationary forces" are so
strong that no amount of printing will overcome them. Core
CPI figures are cited as proof.
Last quarter, Core CPI was up only .01%
in February (the latest figure). This sounds low until you
add in food and fuel – then it jumps to .04%, yielding
an annualized figure of over 5%. This is well above the
Fed's self-proclaimed target of 2% per annum, yet we hear
no explanation or apology.
The reality is even worse, as the true rate
of inflation as calculated by independent observers is closer
to 10%. This means you can expect gold to rise 10% per year
just to maintain your purchasing power.
Consider the price of gas which is almost
$4 a gallon. President Obama is pledging to release oil
from the strategic reserves to keep the price down –
but it's not a supply problem. Those reserves are for a
short-term crisis that disrupts the oil supply, but there
is no disruption – oil is flowing. Oil production
in the US is the highest it has been since 1993 and consumption
is down below '97 levels due to the recession. After all,
there's no reason to buy gas to commute if you're unemployed.
The problem is inflation making the money we use to buy
gas worthless.
Proof? A couple of pre-'65 silver dimes
can still buy you a gallon of gas, while a couple of post-'65
base metal dimes won't even buy you a pack of gum in the
convenience store.
The dollar has lost so much value that the
government actually loses money on every penny it creates.
Not because they're made of copper, that became too expensive
long ago. They're actually made of zinc – a metal
so cheap it's priced by the metric ton – and they're
still too expensive.
So, where's the inflation? Everywhere!
Recovery Fever Will Be Broken
It's becoming very easy for a skeptical
observer to poke through the veil of recovery. Unfortunately,
most market participants still seem to hang on Uncle Sam's
every word. This is a great danger for our economy and a
great opportunity for the wise investor.
When an asset like gold moves sideways for
a while, even those with good instincts get complacent.
They start to view this as the "price level" rather
than an extended dip below true valuation.
Recovery fever will wear off as Washington
is forced to release propaganda that is more and more incongruous
with facts on the ground. And gold will resume its climb
in earnest.