Saturday, July 04, 2015

You're Not As Free As You Think You Are, America

More than any other day, Americans take pride in celebrating our freedoms on Independence Day. It is a day of national honor.

However, observed objectively, Americans aren't nearly as free as they'd like to believe. While Americans are renowned for believing "we're number one!" in any and all manner of worthy rankings, when it comes to freedom — undoubtedly the most important ranking of them all — we're far from number one.

The United States ranks 21st worldwide in personal freedom.

The Legatum Institute in London finds that 20 other nations rank ahead of America in regard to personal freedom, which is calculated based on protections of civil rights and civil liberties. The U.S. ranking has dropped significantly in recent years; in 2010 it was in ninth place.

The researchers at the Legatum Institute measure a nation's prosperity on a number of factors including health, safety, education, economy, opportunity, social capital, governance and personal freedoms.

The research shows that citizens of countries including France, Uruguay, and Costa Rica now feel that they enjoy more personal freedom than Americans.

Yes, France, the country that so many Americans love to hate because it is "socialist," ranks ahead of the U.S.

This is not some liberal screed either.

Even the Heritage Foundation, the famed conservative research think tank, ranks the U.S. 12th in the world in its 2015 Index of Economic Freedom.

Freedom of the press was so critical to our nation's founders that they enshrined it as the very first amendment to the U.S. Constitution.

They would be horrified by our lack of press freedom today.

Reporters Without Borders issues an annual worldwide ranking of press freedom. This year, the United States is ranked 49th.

That is the lowest ranking ever during the Obama presidency, and the second-lowest ranking for the U.S. since the rankings began in 2002 (in 2006, under George W. Bush, the U.S. was ranked 53rd).

Frankly, no nation should rank ahead of the U.S. Period. If there is one area we should be able to proudly brag about being No. 1, it is press freedom.

Sadly, that is far from the truth.

There is a long, unfortunate history of American jingoism and chauvinism. There is an enormously misplaced sense of national pride that America is the greatest in every way. Most of that is rooted in the notion that we are the most free people in the history of the world, and that all other nations seek (or at least should seek) to be just like us.

The reality is quite different.

Of the 167 countries in the world (165 of which are members of the United Nations), 76 are democratic. While the democratic nations account for less than half of the nations in the world, the U.S. is far from unique.

Most critically, we are not a model of freedom or democracy.

So while the U.S. has a litany of things to be proud of (the list of things invented by Americans is stunning), including aviation, the telephone, the internet, rock & roll, jazz, blues, blue jeans, baseball, putting men on the moon, and on and on, we did not invent freedom. That honor goes to the ancient Greeks, the world's first democratic society.

Ultimately, we don't hold some exclusive claim to freedom. In fact, we have lots of room for improvement.

We have a nation of stunning beauty, filled with kind, giving people who are always willing to lend a hand in a natural disaster or any other national tragedy.

But we shouldn't fool ourselves about how free we are, especially on a day such as today.

What we should do, instead, is look at all the countries ranked ahead of us in various measures of freedom, and aspire to be more like them.

We should demand better, because we deserve better.

Sunday, June 14, 2015

Criminality Endemic at Big Banks

Since the 2008 financial crisis, at least, many Americans have come to view bankers in a negative light. It is not an uncommon view that the Big Banksters are seedy, unethical, crooked and even criminal.

Wall St. (and other) banks were handing out mortgages to anyone with a pulse. People with no reasonable expectation of servicing a home loan were extended credit, sometimes in absurd amounts. The massive debt expansion that ensued eventually caused a historic residential and commercial real estate bust that nearly torpedoed the US and global economies.

The banks that made these reckless loans quickly sold them off to other lenders as if they were handing over grenades without their pins. Get away quick! Millions of dubious loans were bundled and sold as Wall St. securities to countless investors. It was like selling well-masked time bombs.

But that story — as famous and historic as it is — was just the surface, the most public aspect of outright criminality by the Big Banks.

Just this week it was reported that the Justice Department is looking into possible fraudulent manipulation of the $12.5 trillion Treasurys market. The focus of the probe is on Treasury auctions, a secretive process when interest rates are set for the offerings.

Treasury rates affect a whole range of borrowing costs — including home mortgages, auto loans, credit cards and corporate bonds.

If criminal wrong doing is eventually discovered, it will not be the least bit unique or surprising. And it will merely result in a paltry fine (by banking standards) that will change nothing. For banks, fines are merely a marginal operating cost in a very lucrative business.

Traders from Citigroup, J.P. Morgan, UBS, RBS and Barclays are known to have rigged the currency market. In fact, the traders referred to themselves as "the cartel."

As a result, regulators around the globe fined these banks nearly $6 billion in May.

Yet, $6 billion in fines is merely the cost of doing business for the Big Banks. Breaking the law is incentivized if a penalty of $6 billion is the consequence of earning hundreds of billions of dollars.

Such a fine is not a penalty; it is an inducement and an enticement. It encourages and guarantees the status quo: more rigging, more corruption and more law-breaking.

Criminality and fraud are endemic in modern banking.

Bloomberg reported the following in 2010:

"Wachovia, it turns out, had made a habit of helping move money for Mexican drug smugglers. Wells Fargo & Co., which bought Wachovia in 2008, has admitted in court that its unit failed to monitor and report suspected money laundering by narcotics traffickers -- including the cash used to buy four planes that shipped a total of 22 tons of cocaine.

"Wachovia admitted it didn’t do enough to spot illicit funds in handling $378.4 billion for Mexican-currency-exchange houses from 2004 to 2007. That’s the largest violation of the Bank Secrecy Act, an anti-money-laundering law, in U.S. history -- a sum equal to one-third of Mexico’s current gross domestic product."

There are many more cases of blatant criminality by the Big Banks.

"Bank of America, Western Union, and JP Morgan, are among the institutions allegedly involved in the drug trade. Meanwhile, HSBC has admitted its laundering role, and evaded criminal prosecution by paying a fine of almost $2 billion," reported the Huffington Post in January, 2014.

If laundering money for drug cartels wasn't bad enough, HSBC was found to have laundered money for terrorist groups and the Iranian government, which is listed as a state sponsor of terrorism by the US.

HSBC actively circumvented rules designed to “block transactions involving terrorists, drug lords, and rogue regimes.”

In other words, this behavior was not inadvertent or unintentional. To the contrary, it was willful and purposeful.

The bank’s regulator, the Office of the Comptroller of the Currency (OCC) failed to monitor $60 trillion in wire transfer and account activity, and didn't take a single enforcement action against HSBC despite numerous violations by the bank.

The global economy is roughly $77 trillion, so that gives you a sense of proportion here.

The US government, which has been co-opted by the Big Banks, turns a blind eye to nefarious and illegal activities. So, what's the point of having a regulator? The foxes are guarding the henhouse.

Major global banks were also found to have manipulated the Libor (London Interbank Offered Rate), which is the interbank lending rate. Banks were falsely inflating or deflating their rates to profit from trades.

Libor underpins approximately $350 trillion in derivatives, so this is a really big deal.

Mortgages, student loans, financial derivatives, and other financial products often rely on Libor as a reference rate. So, the manipulation of Libor can have significant negative effects on consumers and financial markets worldwide.

Federal Housing Finance Agency Inspector General and auditor Steve A. Linick said that Fannie Mae and Freddie Mac may have lost more than $3 billion because of the manipulation.

Additionally, it is estimated that the manipulation of Libor cost US municipalities at least $6 billion.

The Big Banks involved in the Libor scandal, such as Barclays ($360 million) and UBS $1.2 billion), were merely fined. These fines are chump change relative to the billions that were collected through fraud and rigging. Critically, no one involved went to prison.

Fraud and rigging are rampant at the Big Banks. Criminality is endemic. It is their method of operation.

The fact that no one from these banks is serving time for these assorted crimes is, itself, criminal. This miscarriage of justice simply reinforces criminality. The profits of criminal banking are so grand, and the penalties so weak, that the Big Banks are incentivized to break the law. And our government (via the Justice Department) tolerates it. In fact, it implicitly condones it.

There is no morality, ethics, scruples or decency to be found at the Big Banks. There is only the quest for profit and power.

There is no justice in the corridors of power, or for those who run the Big Banks.

The Banksters make the rules, and when they can't, they simply break them with impunity.

Friday, March 27, 2015

Greek Tragedy Nearing its Final Act

Despite occasionally falling out of the news for certain periods of time, the Greek debt problem has never gone away. In fact, the problem has grown continually worse.

Greece remains in a full blown depression. The economy suffered through a six-year recession (meaning output continually contracted), from which it only emerged last year. The unemployment rate is a staggering 26 percent, while youth unemployment stands at a whopping 60 percent.

That always leads to societal unrest, and rising crime. Leaving so many young men idle for so long is a recipe for disaster.

The European Commission, the International Monetary Fund (IMF) and the European Central Bank (the so-called Troika) have been granting loans to Greece for the past few years to keep it afloat.

Further increasing Greece's debt as a means of solving its debilitating debt problem is no solution at all. It is madness. It's akin to a son asking his parents for $100 to repay them the $100 he owes them.

Greece hid the magnitude of its debt problem prior to its entry into the European Union.

The 28 Member states of the European Union agreed to the Stability and Growth Pact in 1997, which limits government deficits to 3% of GDP and debt to 60% of GDP.

Greece was well above those limits at the time, which should have precluded it from inclusion. But no one outside the Greek government knew this back then. In fact, the Greek government didn't admit the falsifications of its predecessors until February 2010, years after the fact and well into its national crisis.

It is now known that by 1996, the Greek debt-to-GDP ratio stood at 95 percent. By the end of 2009, Greek government debt had reached 130 percent of gross domestic product, or more than twice the agreed upon limit. And by 2013, the debt-to-GDP ratio had soared to 175 percent.

About three quarters of Greek debt is owed to the EU and the IMF. In other words, Greece's creditors have given it just enough rope to hang itself.

Greece recorded an enormous government budget deficit equal to 12.7 percent of the country's gross domestic product in 2013.

While the country is expected to post a small budget surplus this year, that is before its debt payments are taken into account. Debt service won't allow Greece to get out of its cavernous hole. It is a country on its knees.

With such a weak economy, Greece cannot be expected to ever grow its way out of debt. During a recession, tax revenue shrinks along with economic output. Even in the absence of further annual deficits (which were still mounting), Greece hasn't possessed the means to service its existing debt for years.

Yet, it was continually adding to it, with the help of the Troika.

The IMF predicted the Greek economy would grow as the result of its 2010 aid package. Instead, the economy has shrunk by 25%. Wages are down by the same amount.

Meanwhile, Greece has a notorious tax evasion problem, which only makes its fiscal and debt problems worse. Greeks are fearless and defiant about not paying their taxes, yet the government lacks the resources, or infrastructure, or authority to do anything about it. The Greek government appears to be neutered.

Tax revenues so far this year are more than 1 billion euros below target; that's a lot of money for an economy that totaled just $179 billion last year.

The reality is that Greece has no means to ever repay its debts, and the Troika surely knows this. But the hope of central bankers everywhere is to create unlimited debts that can never be repaid, with interest payments continuing in perpetuity.

What we have right now is a game of chicken between the Troika and the new Greek government, which was elected on a mandate to rebel against the crippling austerity and debt payments imposed by its creditors. So, who will blink first?

Greece represents just 1.4% of the EU economy, so it really amounts to a bit player. If Greece were to leave the EU, economically it wouldn't be missed.

The trouble for the EU is the legal unwinding of a Greek exit. There is no mechanism in place for this because no one imagined such a scenario when the EU was created.

The other problem is that a Greek exit would set a precedent that could allow a much bigger economy, such as Spain or Italy, to make a similar exit. Such a scenario would be crippling, and it would set off a cascading series of government defaults and bank failures.

At present, there is no concern about either Italy or Spain exiting, as they are both enjoying cheap and easy access the debt markets, as seen below.

10-Year Government Bond Yields

United States 2.05%
Italy 1.26%
Spain 1.24%

It is patently absurd that yields in Italy and Spain are substantially lower than those in the US. There is no good reason for that. In a normal world, those yields would more than twice as high as the US. At some point, reality will set in and the bond market will realize that Italy and Spain are nearly as bad as Greece, with unsustainable debts and weak economies.

That's why the possibility of a Greek exit is so worrisome to EU leaders. It would set a very dangerous precedent.

This is the leverage the Greek government wields over the Troika.

At best, Greece's leadership failed its people through years of mismanagement and continual debt spending. At worst, they were a bunch of lying, duplicitous crooks and frauds.

The new government is trying to come to grips with the sins of the past, and it seems to have remembered an age old principle: The best way to get out of a hole is to first stop digging.

A recent report says that Greece may run out of money as soon as April 9. Without another round of loans, the Greek government's coffers will soon run dry.

It's not simply a matter of it being unable to service its debt payments; Greece won't be able to pay government workers or retirees. Furthermore, Greek banks are running out of money. Fearful depositors are withdrawing their money en masse.

In other words, if Greece runs out of money, there will be societal chaos.

This is the leverage the Troika wields over Greece.

Under the current terms, there is no way for Greece to get out of its debt crisis. Yet, its creditors cannot stomach the notion of a debt write down.

The day of reckoning is near. Everyone involved has tried to avoid some uncomfortable realities, but those realities are now becoming unavoidable. The can has been kicked down the road for far too long, and they have finally run out of road.

So, who prevails and who buckles?

Well, it can be easily argued that Greece needs the EU more than the EU needs Greece. The Greek economy is so small that it is hardly important to the larger union. And the Greek crisis will reach entirely new levels of social catastrophe without further loans.

On the other hand, if Greece stops repaying its loans, its financial position would be greatly improved. That money could then be redirected into the Greek economy. Greece would have to go back to its former currency, the drachma, and it would lose access to the international debt markets for a few years. But keeping that money at home might be enough to at least help it get back on the road to solvency.

That said, not servicing its debts won't correct Greece's tax evasion and corruption problems. That requires a strong government committed to genuine reform.

The new Greek government is in a desperate situation, with its back is against the wall. That makes its response unpredictable. Since it is a new government with new leaders, elected on a platform of resistance — even defiance — there is no precedent to predict how they will act or what they will do next.

This Greek tragedy is at last entering its final act. Like all good dramas, it is both riveting and unpredictable.

Wednesday, March 18, 2015

Deflation, Not Inflation, Is the Fed's Big Threat

It was little surprise to me that the Federal Reserve announced today that it will not raise interest rates in June. In fact, the Fed gave no definitive timeline for a rate hike, but many market watchers presume the first bump will come in September.

The Fed wants more time to watch how things pan out.

There's good reason for the central bank's hesitation. According to the latest “nowcast” from the Atlanta Fed, first-quarter gross domestic product could come in at just 0.3%.

Given the continued weakness in the economy, tepid wage growth, plunging oil prices and the tendency toward deflation, a rate hike seems imprudent to me. In fact, in normal circumstances, a rate cut would be more likely.

But these aren't normal times we're living in.

Perhaps the central problem that central banks around the world are grappling with right now is a lack of consumer demand, which is leading to weak economic growth, low inflation and even deflation.

When inflation in the US was very high in the late '70s and early '80s, Fed Chairman Paul Volker raised rates repeatedly and vigorously to crush it, and the strategy worked.

In a time of low inflation, or even deflation, the opposite tactic (cutting rates) is typically employed. However, the US has been living with near-zero interest rates for over six years. There is little room left to maneuver without going into negative territory.

While low interest rates generally stimulate the economy, they have not really stimulated demand in recent years. Cautious consumers are wary of spending and have not been compelled to borrow at previous levels. After all, excessive borrowing is what ultimately blew up our economy in 2008.

People haven't forgotten that yet.

Perhaps they expect a crisis event, such as another war or market crash. One way or the other, people aren't spending strongly enough to reinvigorate our consumption-based economy.

Inflation over the past 12 months turned negative (0.1%) for the first time since 2009. With the menace of deflation becoming all too real, how will the Federal Reserve respond?

There is a fairly recent precedent for cutting rates to fight the specter of deflation.

The Federal Reserve cut its key interest-rate (the Federal Funds Rate) to 1% in 2003, which at the time was its lowest since 1958.

But as the Wall St. Journal noted at the time, "Below 0.25%, the market for Treasury bills, eurodollars and other short-term IOUs would function less smoothly."

Therein lies the problem: The Federal Funds Rate has been at 0.25% since December 2008.

A quartet-point reduction, which is the minimum level the Fed will typically raise or lower rates, would result in zero — no interest at all. That could kill the bond market, but it might just might stimulate the precious metals markets.

After all, why keep money in the bank if it earns nothing?

But what about rates of less than zero, as is the case at some European banks at present? Central banks cannot easily push their policy rates into negative territory.

Gold may not earn interest, but zero interest it still higher than negative interest.

Deflation is worrisome because falling prices make it hard for the government and companies to repay debts. It leads to falling wages and layoffs, and can be the prelude to a bad recession. Once it takes hold, deflation is very difficult to defeat, as the Japanese can attest.

Former Fed Chairman Alan Greenspan said in 2003 that the serious consequences of deflation required a wide "firebreak" against it and that the Fed would "lean over backwards" to prevent it.

Inflation is generally perceived as rising prices, while deflation is the opposite. However, while inflation is really a decline in the purchasing power of the dollar, deflation is ultimately an increase in the purchasing power of the dollar. That makes the current environment all the more troubling.

The dollar is at its highest level since 2003. In fact, the dollar is now reaching parity with the euro, after being less valuable for many years.

So, what's the Fed to do about this?

An interest rate hike would just make the dollar even stronger against other currencies. That would hurt the US export market even more than it's already hurting. It would also make American-made goods less competitive at home against cheaper imports.

An interest rate hike would also add to deflationary forces. In simple terms, a stronger dollar increases the risk of deflation.

A strong dollar makes imports cheaper, most critically oil. Cheaper oil lowers the cost of all transported goods, which means essentially everything.

Cheap oil is already a prime deflationary force. Crude plunged below $43 a barrel on Monday, the lowest price since 2009.

Deflation is the biggest fear of both governments and central bankers. But the primary means to fight it — a cut in interest rates— may not be that effective since we're just a quarter-point away from zero.

The possibility of negative interest rates should concern everyone. There is, however, current precedent; it's happening right now in Europe.

It costs money to leave deposits at some European banks. In essence, a depositor's principle is guaranteed to lose value.

That's something most Americans can't even imagine.

But neither could most Europeans, until recently.

Wednesday, March 11, 2015

Federal Reserve Has No Good Options in Rate/Currency War

There are many opposing forces at play in the global economy today. We are living in truly historic, and unprecedented, times.

Central banks around the world have been steadily cutting interest rates — some into negative territory, a stunning development — as they fight to stimulate their beleaguered economies.

This is seen as an antidote to weak consumer demand; low interest rates are meant to discourage saving and instead encourage spending.

Low rates also typically devalue a nation's currency, which keeps exports competitive.

Government bond yields in the eurozone have plummeted to record lows since the European Central Bank started purchasing government debt and other bonds this week. It's all part of a €60-billion-a-month quantitative-easing program aimed to stimulate the eurozone’s sluggish economy.

But yields in some european countries were already negative before the QE program began, and the market didn't seem to fully price in the arrival of QE. That means yields could be driven even lower — in some cases further into the negative.

Falling yields elsewhere in the world have drawn many investors into US Treaurys, which have a better return. However, this demand is only pushing Treasury yields lower. Call it an unintended consequence.

The flight from the euro and other currencies has pushed the dollar to 12-year highs.

The ICE dollar index, which measures the greenback’s strength against a basket of six rivals currencies, rose 0.66% to 99.26 on Wednesday. The index was on track to hit the 100-mark for the first time since April 2003.

The dollar has already gained nearly 13% versus the euro this year, and the two currencies are now nearing parity. That will hurt US companies that sell to Europe, one of our largest export customers.

Europe is a half-trillion dollar market for US exporters. A higher dollar makes US goods more expensive overseas.

Meanwhile, the Federal Reserve seems poised to raise interest rates this summer, which would only exacerbate the currency divergence.

Big American firms that generate a large portion of their sales overseas will likely to see the impact of the stronger dollar when they report their first quarter results. Many companies are already warning that the stronger greenback will hurt their sales and profits this year. Foreign revenues will wind up looking weaker when converted back into US dollars.

With foreign interest rates so historically low, investors will keep buying the dollar. Simply put, the dollar looks like a better, safer, store of value right now, compared to other currencies.

The other side of the coin is that a stronger dollar also makes imports cheaper, including oil and other commodities. While that sounds good for the US economy, there are other consequences.

The US is the world's No. 3 oil producer, so plunging prices are hurting a major domestic industry.

At roughly $50 per barrel, the price of oil is leading to layoffs in the energy sector, particularly in states like Texas and North Dakota, whose economies have boomed in recent years due to fracking. The real estate markets in these states are now imperiled.

So, what will the Federal Reserve do next?

Inflation is barely existant. In fact, deflation is a bigger concern at the moment.

Consumer prices fell 0.7%,in January, the third straight monthly decline, while inflation over the past 12 months turned negative (0.1%) for the first time since 2009.

While that was largely driven by the huge drop in oil prices, surely it has given pause to Fed policy makers. Interest rates are typically raised to thwart inflation. Clearly, that's not an issue at present.

Additionally, raising interest rates would only: 1. Strengthen the dollar; 2. Funnel more foreign money into the US; 3. Hurt US exports; 4. Drive crude prices even lower; and 5. Further prop up the stock market bubble.

The Fed's zero interest rate policy (ZIRP) has fueled increased risk-taking by borrowers and yield-hungry lenders. The result has been a massive mispricing of financial assets, such as housing and stocks.

Yet, even with near-zero interest rates, demand for credit remains weak. Consumers aren't spending as robustly as they were prior to the Great Recession, and consumer spending drives roughly 70% of our economy. Higher rates will ultimately hurt housing and autos, etc.

On the other hand, low rates are hurting savers and discouraging saving.

You can see why the decision to tighten (raise rates) has to be such a tough one for the Fed at present.

Deflation is the biggest nightmare of governments and central banks because it makes it harder for countries to pay off debts. The US is currently grappling with an $18 trillion national debt. That's why the Fed may feel compelled to act.

But there are so many wheels simultaneously in motion throughout the global economy. Any Fed action will have resulting reactions, not all of which will be intended or desired.

It's easy to argue that there are no good choices. Fed policy makers are damned if they do, and damned if they don't.

This is shaping up to be another stunning year for the global economy. Watching it all unfold will be equally fascinating and unpredictable.

Friday, February 06, 2015

US Economy Burdened by Perpetual, Massive Trade Deficits

The U.S. trade deficit soared 17.1% in December, reaching a two-year high. The trade gap spiked to $46.6 billion from a revised $39.8 billion in November, the Commerce Department said Thursday.

It was the biggest percentage increase since July 2009, and the largest month-over-month increase, in dollar terms, ever recorded.

U.S. exports slipped 0.8% to $194.9 billion, while imports increased 2.2% to $241.4 billion. The stronger dollar made imports more affordable, while making exports more expensive. The dollar has strengthened steadily since July, recording its second fastest acceleration in 20 years.

For all of 2014, the goods and services deficit was $505 billion, up $28.7 billion (6 percent) from $476.4 billion 2013, the Commerce Department reported. Exports were $2.35 trillion, up $65.2 billion or 2.9 percent. But imports were $2.85 trillion, up $93.9 billion or 3.4 percent.

So, imports were higher than exports in terms of total dollars, in terms of an increase in dollars, and as a percentage increase.

Annual trade deficits of half-a-trillion dollars are now the norm.

Year after year, the trade deficit sucks hundreds of billions of dollars, and millions of jobs, out of the U.S. as we continually buy products from overseas that could instead be made here at home.

The trade deficit in 2013 was $476.4 billion, which was the lowest since 2009. Think about that for a moment; the trade deficit in 2013 was nearly half a trillion dollars, yet it was the smallest in four years. It was down from $534.7 billion in 2012, according to the Commerce Department. The deficit shrank in 2013 due to lower petroleum imports.

The unfortunate reality is that the trade gap is a decades-old problem.

The United States has been running persistent trade deficits since 1974 due to high imports of oil and consumer products. The trade gap increases the debt held either by Americans or by the federal government.

Since a strong U.S. dollar makes American exports more expensive, the trade deficit will almost certainly increase again this year. As long as the trade deficit persists, the U.S. will continue borrowing from abroad to pay the difference between imports and exports.

Every $1 billion of a larger deficit subtracts about 0.1 of a percentage point from the annualized GDP growth rate. That's bad news for an economy that is currently struggling to eek out a mere 2 percent annual growth rate.

Traditionally, countries that have a trade surplus with the U.S. have used their surplus dollars to buy government or corporate bonds, to make investments in U.S. real estate, or to invest in the U.S. stock markets.

But what if a country, such as China, decides to use its surplus dollars to instead purchase gold? Unless that gold is purchased from the U.S., those dollars are never repatriated. In essence, they never come home.

China has a ravenous, and apparently growing, appetite for gold. While the world's second-largest economy has not formally disclosed any changes to its gold holdings since 2009, when it claimed to possess 1,054.1 tonnes of gold, it is now estimated by gold analysts to have around 2,000-3,000 tonnes of gold reserves.

As sovereign bond yields plummet, the tendency for gold will be to move higher. Though gold has a zero interest rate, that is still higher than the negative rates currently being offered in some countries.

When China diverts its dollar holdings for the purchase of gold, those dollars no longer have any beneficial investment affect in the U.S.

The danger of a trade deficit was spelled out quite clearly in Discourse of the Common Wealth of this Realm of England, in 1549: "We must always take heed that we buy no more from strangers than we sell them, for so should we impoverish ourselves and enrich them."

This is not a new concept. No nation can indefinitely buy more than it sells.

A wider trade deficit creates a drag on economic growth because more of the nation's consumption is coming from overseas rather than from domestic production.

The U.S. has led the world in imports for decades. Meanwhile, exports represent just 13.5% of our economy, according to the World Bank. It's a bad combination.

The massive U.S. trade deficit is emblematic of the fact that we are the world's biggest debtor nation.

For decades, we have imported more than we have exported, consumed more than we have produced, and spent more than we have saved. The result is that we must continually borrow to fund our nation — to fund our debt-driven ways.

It's all led to an unsustainable debt problem that will likely have a very bad ending.

Monday, January 19, 2015

Negative Interest Rates an Alarming Development

If you think you've got it bad because your bank pays you just 0.10 percent (or even 0.01 percent) for keeping your money in a savings account, consider the plight of European bank customers.

Many European banks (such as those in Sweden, Switzerland, Denmark, etc.) pay negative interest. Depositors are actually charged to keep their money in an account. In essence, depositors are lending money to borrowers for free. Consequently, the banks are making money coming and going; both borrowing and lending.

The idea is to dissuade people from saving and instead encourage spending, with the hope that this will stimulate the economy.

While high interest rates discourage borrowing and encourage saving, low rates have the inverse effect.

However, the central banks in some countries are also attempting to make their currencies less valuable. A lower valued currency makes exports cheaper, and increasing exports can also stimulate an economy.

The European Central Bank (ECB), for example, cut a key interest rate below zero in June — the rate it pays to banks on reserves held at the ECB. The idea is to compel banks to lend money, rather than lose principle by having it sit idly at the central bank.

The ECB will vote this week on whether to engage in a money-printing / bond-buying scheme known as "quantitative easing." However, due to Germany's history with hyperinflation after WWI, it has been hesitant to approve such a strategy, which is intended to stimulate the eurozone economy and combat deflation. Despite this, the plan is expected to pass.

A "quantitative easing" program of this type would drive down the value of the euro, pushing higher the value of other currencies, such as the dollar.

These are strange times indeed, and policy makers are willing to employ the most extreme measures to stimulate their economies, fight deflation, and boost exports.

However, negative interest rates can have unintended consequences, such as compelling depositors to remove their money from banks and seek higher yielding assets or investments.

Money market funds, for example, can plunge as investors exit. Yet, money markets are key sources of short term financing for banks and corporations. If money markets crash, the entire financial system would be thrown into turmoil.

Most critically, when a central bank offers negative interest rates, other banks are disinclined to keep deposits parked there. Rather than encouraging lending (the desired outcome), this can instead cause increased speculation and risk taking through "yield chasing."

While the Federal Reserve and US banks are not (yet) offering negative rates, they could be compelled to follow Europe's lead to fight deflation, or to help boost US exports and lower the massive trade deficit.

A financial crisis can quickly become an economic crisis, and both can lead to contagion. The 2008 financial crisis, which initiated in the US, quickly went global. The international response became a game of follow the leader.

With that in mind, the precedent for negative rates has been set, and it's not unimaginable that US banks might eventually offer negative interest rates as well. But that would just cause Americans to hoard cash in safes, vaults, and bank deposit boxes, rather than deposit it.

Though all export countries want a devalued currency to make their exports more desirable, such a strategy is a race to the bottom. Not everyone can have the cheapest currency and the cheapest exports.

A devalued currency also makes the repayment of fixed debts less painful, which is why governments generally favor devaluation.

But this is not a zero sum game. Every central bank is pursuing the same strategies, and hoping for the same outcomes. That is not possible.

If every country has a cheap currency, then none of them do. And investors will always chase higher yields — even the highest yields — despite the risks involved.

Perhaps the most sobering takeaway is this: If central banks aren't intentionally reducing the value of your money through inflation, they are willing to depreciate the value of your savings with negative interest rates.

Heads, they win. Tails, you lose.