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!
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?
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
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
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 –
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
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.