How does Government Debt go negative?

Today came the news that short-term German government paper was following the Swiss example and turning negative, not only that but its expected that it won't be very long until the 10-year Bund follows suit.

Quizzical isn't it? Why would anyone pay for the privilege of lending someone money?

Friends and colleagues of mine, having a hunch that I know a little more about finance than they do have been asking me about this quite a bit recently and to be honest I have struggled to give them an answer they could happily digest. Well it certainly is a "new normal" and set to spread throughout the developed world as things get worse but how and why is it happening?

In short this is what Quantitative Easing has wrought. Institutions paying for the privilege of lending their money to insolvent governments. Not because those borrowers are such low risk counterparties, but rather because now real investors must compete with totally price-insensitive Central Banks hoovering up sovereign debt with freshly 'Printed' money.

If you want to understand this mechanism in a little more detail here is an excellent blog post by David Stockman who is examining a fascinating new blog by none other than the architect of this mess, Ben Shalom Bernanke.

This is the crux of his conceit:

A similarly confused criticism often heard is that the Fed is somehow distorting financial markets and investment decisions by keeping interest rates “artificially low.” Contrary to what sometimes seems to be alleged, the Fed cannot somehow withdraw and leave interest rates to be determined by “the markets.” The Fed’s actions determine the money supply and thus short-term interest rates; it has no choice but to set the short-term interest rate somewhere.

He doesn't even know what this mythical rate should be, but whatever figure he comes up with I'm sure it will be agreeable to the bankrupt sovereign states of the West.


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Is the right way possible?

The state is always and everywhere a danger, even when it has no monopoly on money and no printing press that can create money tickets at will. But a state with the ability to make its own money is a grave and relentless threat to prosperity and freedom. It leaves the future entirely to the discretion of the money managers. Every day we live under the threat that the United States could be the next Weimar Republic or even another Zimbabwe. All that stands between us and that day is the wisdom and prudence of the Fed.

Llewellyn H. Rockwell, Jnr - talk given on 1 November 2008

Now, how do we mice bell the cats?

And if a foreign nation that trades with you uses currency inflation to support its domestic employment and its exports to you, are you prepared to see a slump in your own economy in order to maintain the integrity of your currency? Can virtue be rewarded, or is it (as seems to happen in this world) severely punished?

Murky support for the dollar

Brad Setser looks at data from the US Treasury International Capital System (TIC), trying to work out what's been going on in the money supply and why the dollar hasn't collapsed in all this brouhaha. Setser, who gave evidence to a Congressional committee last year, admits that the picture is not clear, despite his expertise.

He thinks real purchases of Treasury securities (2000 - mid-2007) are about double the official amounts, and points out that when the dollar weakens, it is supported by further buying from central banks. Also, Americans have sold a lot of foreign equities recently and the money has come home.

A significant change in the pattern is the reduction of private holdings of Treasury securities - more and more, the support is coming from official sources, as the following graph suggests:

This seems to me like another straw in the wind: "power to the people", not.

Bust - or false boom and mega-bust?

Ron Paul and others discuss the state of the American economy here. Don Boudreaux (the economist who writes the Cafe Hayek blog) agrees with Ron Paul that the central bank should stop "doing something".

This also chimes with what Marc Faber said last year: the crisis should be allowed to burn through and take out some of the players. Of course, those who are in a position to "allow", are part of the club that includes the players, and there's the rub.

What goes around, comes around

Rob Kirby quotes the Privateer newsletter's report that the European Central Bank is furious with Britain, for borrowing vast sums of Euros and forcing the stock of Euros to inflate.

Interestingly for me, he relates this action in part to the UK's having taken on so much of US Treasury debt, a matter on which I commented repeatedly some time ago.

Stop engines

(image source)

Julian Phillips (Financial Sense, today) explains why he thinks central banks may soon have to stop selling gold, and may even need to start buying.

Gold: forget the charts

Gold is currently nearly $820/oz. and it's natural to look at the historical charts to see where this puts us. We did this yesterday.

But what use are the charts? The wiggly lines on them don't show the full context: the wild monetary inflation and cumulative trade and budget deficits of the past few years, which (if we believe the analysts) are unprecedented.

Instead of drawing conclusions from the graphs, we should be asking questions - especially, why hasn't gold zoomed more and earlier? After all, governments must feel that gold is at least a vestigial or potential measure of the worth of their currency; otherwise, they wouldn't be storing thousands of tons of the unproductive stuff in expensive facilities. So, why hasn't gold acted as the thermometer of this financial fever of the last, oh, seven years?

One answer is that the world gold market is small enough to be deliberately distorted. Frank Veneroso could be right: central banks may have been secretly drip-releasing portions of their bullion reserves. That would be to reassure us - or rather, kid us - that everything's under control. Since the gold price matters, it becomes important for officials to manipulate it, and so (according to this theory) the charts will actually tell us nothing.

Until the reserves get so low that the game can't continue. Central banks will suddenly get vertigo and freeze-cling to what they have left, and the gold market will explode, as confidence in the currency starts to collapse.

And Veneroso cottoned on early, simply because the scam worked too well. The smile was too bright, the walk a little too confident. If he's right - and I more than half suspect he is - we needn't bother with the past price data, or with worries about short-term corrections.

Veneroso: up to half the gold has gone

GoldSeek (November 1) relays Frank Veneroso's assessment that central banks may have disposed of up to 50% of their gold bullion:

... The manipulation of gold prices was first noticed in the 1990s by Frank AJ Veneroso, one of the world’s top investment strategists. As more gold bullion came onto the market depressing the price of gold, Veneroso believed the central banks were its source.

When queried, central banks denied Veneroso’s assertions. Central bank records, in fact, showed their gold reserves to be stable. But Veneroso was right and the central banks were lying. The gold moving onto the markets was indeed coming from central banks via their co-conspirators in capping gold, the investment banks.

Investment banks were borrowing central bank gold at 1 %, selling it thereby depressing gold’s price and investing the proceeds in higher yielding government debt; and, as long as the price of gold moved lower, the profits of investment banks increased (see The Manipulation of the Gold Market, http://www.gata.org/node/11).

The International Monetary Fund was complicit in this deceit as IMF regulations allowed central banks to count gold “swapped” or “loaned” as still being on deposit in their vaults. Veneroso now believes that up to 50 % of gold reserves claimed by central banks have already been sold—a fact that will be instrumental in our collective bet against central banks in their house of cards...

... Veneroso believes central banks sold 10,000–15,000 tons, equal to 320,000,000 to 500,000,000 ounces of gold over the last 20 years. Just imagine how high the price of gold would be if the central banks had not sold this staggering amount.

Today’s $800/oz. gold is a bargain—as is $2,000/oz. or $3,000 oz. gold—a bargain that exists only because central banks literally sold thousands of tons of our gold onto the market in their attempts to prove gold a poorer alternative to debt-based paper currencies.

Over a year ago, Veneroso estimated central banks had less than three years supply left to cap gold’s price. He also predicted the central banks would capitulate before then, keeping what little gold they had left. When this happens, the central bank subsidy of gold will end and the price of gold will skyrocket.

On the same site, Adrian Ash (November 2) looks at gold's disadvantages and decides that it is best defined not as a commodity, but as a currency:

Given that gold doesn't pay you anything in yield, interest or dividends – and that it does not have any real industrial value – the "investment motive" for gold can only be explained as desire to quit other assets. Or at least, to hold an asset entirely free from what drives other asset markets up and down.

... perhaps the gold market says investors are looking for protection against falling bond, real estate and equity values – as well as a falling US Dollar and slumping US economy.

So they are buying protection ahead of time. And to do that, they're buying gold – a wholly different asset from everything else.

One for the speculators. Meanwhile, perhaps the non-rich among us should take the precaution of paying off overdrafts, credit card debts and any other loans that can be called in at short notice.

Frank Veneroso elaborates on the gold bubble

I am impressed by the courtesy of important people.

After reporting on his April 2007 presentation to World Bank people (see yesterday's post, "Gold bubble"), I emailed Frank Veneroso, and have received a reply from him today. I wanted to follow up on his essay of May 2001. Here's what I asked:

In 2001, you wrote a very intriguing article, posted on GATA, theorising that central banks actually hold much less physical gold than they pretend, because of loan-outs and possibly surreptitious selling. If I may, I should like to ask a few questions:

1. Are you still of that opinion?
2. What do you think is the present situation regarding gold holdings by central banks?
3. What evidence do we now have?

Here is his reply:

That was my opinion. It still is. However I gave ranges regarding that amount. I now believe that central bank loan outs and undisclosed sales were at the low end of my expectations. Why? I have no direct evidence. My evidence is the following.

I believe that we are near the end of a commodity bubble that is the largest in all history. The greatest extreme is in metals. Hedge funds have accumulated futures, forwards and physical on a scale that simply has no precedent. The greatest excesses are in base metals but these same funds all hold large gold positions. I believe that individual funds may hold positions in copper or gold that are as large in value as the ETF. I know that sounds unbelievable. But I have a great deal of evidence.

If this is so, the price of gold should be much higher. My only explanation for why it is not is that central bank holdings must be very large for this to happen.

I should add, I believe there will be a coming crash in the metals sector that will surface. There will be an unprecedented investor revulsion toward this sector.

Gold’s fundamentals are totally different from those of base metals and silver. However, because the same funds also hold gold, I cannot see how gold can escape forced liquidations from these portfolios.

Mr Veneroso has kindly given his permission to publish the above comments.

From the prospectus for a conference in New Orleans in 2006:

Frank Veneroso — Perhaps the most highly regarded market economist of our time, Frank Veneroso has advised countless governments, as well as the World Bank, on economic policy, served as a senior partner in one of the world's largest hedge funds, and is a confidant and private advisor to many of today's most influential investors and economic leaders.

He was among only a handful of analysts who clearly predicted the Tech Wreck, and followed it up with a deadly-accurate forecast of today's gold bull market.

Now, Mr. Veneroso is stunning the world with predictions of a major train wreck in no less than two high-flying sectors of the global economy. Virtually no one is expecting these dramatic events...

Puplava: this isn't the big one

I'm a bit behind on my listening to Financial Sense Newshour, but as ever, the issues we're talking about aren't momentary. Jim Puplava's view (8 September) is that this crisis isn't the big one: the US will reflate its way out. It can't do that on its own without sacrificing the dollar, so (as has been happening for a long time) there will be cooperation with other nations' central banks. In effect, we are in an international currency inflation cartel, since no trading nation wants a hard currency that leaves its industries high and dry.

But, says Jim, the next recovery will be shorter, and the next fall back much worse. He sees this as happening around 2009/2010, which coincides with the time of Peak Oil, in which he is a big believer. That's when he feels the energy and credit crunches may come together. He sees gold and silver soaring to levels that currently seem fantastic.

For us ordinary people, that may be less interesting than the effects of energy shortage on our daily transportation and domestic heating.

What Bank of England?

Further to yesterday's piece on the licence to the European Central Bank to seize the Bank of England's assets, here are two relevant articles from the Maastricht Treaty. The Campaign for an Independent Britain was stating no more than the truth. (In the extracts, red highlighting is mine.)

ARTICLE 30

Transfer of foreign reserve assets to the ECB

30.1. Without prejudice to Article 28, the ECB shall be provided by the national central banks with foreign reserve assets, other than Member States’ currencies, ECUs, IMF reserve positions and SDRs, up to an amount equivalent to ECU 50,000 million. The Governing Council shall decide upon the proportion to be called up by the ECB
following its establishment and the amounts called up at later dates. The ECB shall have the full right to hold and manage the foreign reserves that are transferred to it and to use them for the purposes set out in this Statute.

30.2. The contributions of each national central bank shall be fixed in proportion to its share in the subscribed capital of the ECB.

30.3. Each national central bank shall be credited by the ECB with a claim equivalent to its contribution. The Governing Council shall determine the denomination and remuneration of such claims.

30.4. Further calls of foreign reserve assets beyond the limit set in Article 30.1 may be effected by the ECB, in accordance with Article 30.2, within the limits and under the conditions set by the Council in accordance with the procedure laid down in Article 42.

30.5. The ECB may hold and manage IMF reserve positions and SDRs and provide for the pooling of such assets.

30.6. The Governing Council shall take all other measures necessary for the application of this Article.


ARTICLE 42

Complementary legislation

In accordance with Article 106(6) of this Treaty, immediately after the decision on the date for the beginning of the third stage, the Council, acting by a qualified majority either on a proposal from the Commission and after consulting the European Parliament and the ECB or on a recommendation from the ECB and after consulting the European Parliament and the Commission, shall adopt the provisions referred to in Articles 4, 5.4, 19.2, 20, 28. 1, 29.2, 30.4 and 34.3 of this Statute.

(Remember that "consulting" may mean no more than finding out how much we hate their plan, before they go ahead and implement it anyway.)

$42 gold: what is the future of the dollar, and central banks?

German 1,000 Mark note - overprinted to make it one billion Marks

I think I was right to puzzle over the footnote (in 6-point type!) to the US reserve accounts, which states that gold has been valued at $42 dollars an ounce and that certificates on that basis have been issued to the Federal Reserve.

It looked like dodgy accounting to me, and searching for some further clarification, I found this article in Gold-Eagle.com, dating from 2003. It's by Alex Wallenwein and the style hyperventilates somewhat, but here's some edited highlights:

[France and Germany's] new common currency, the euro, has taken on a characteristic that puts it into direct conflict with the US dollar.

The dollar is a purely debt based currency with an adverse relationship to gold. Gold is the dollar's nemesis. When the gold price goes up, confidence in the dollar decreases and people start selling dollars.. It's usually a sign of impending or prevailing inflation.

The euro, on the other hand, has a "positive" relationship to gold. The European Central Bank, and all the euro member's central banks, value their gold reserves quarterly at actual market prices. That means, as the price of gold goes up, the value of their currency goes up as well, and by signing the "Washington Accord" in 1999 they have announced to the world that the dollar's gold-suppression jig is up.

The dollar is still hamstrung by being tied to an artificial, government-decreed, quasi-official price of gold at the whopping rate of $42.222 per ounce. [See Title 31, United States Code, Section 5117(b).] Obviously, with the market price of gold currently above $330 (i.e. in 2003), that "official price" has nothing to do with the realities of the gold market. It is actually a remnant of the gold standard days when every dollar was immediately convertible into gold on demand, at a stated rate.

Being thus tied down, the US government and banking elite can never afford to let the price of gold float freely according to actual market forces...

This little difference in the valuation of gold makes the euro the undisputed, hands-down future winner of the euro vs dollar conflict... free market forces can never be violated with impunity for a very long time. They always reassert themselves - sooner or later.

The euro was constructed to take advantage of free market forces - especially the free market of gold. The dollar is anchored in a useless, repressive scheme that cannot allow market forces to prevail vis-a-vis gold.

Ergo, the dollar is doomed...

Once it is replaced as the world's reserve currency, the dollar - and with it the United States - will cease to be a world superpower... And all of America's current military might will [be laid to] waste when the international currency reserve dollars return home, causing hyper-inflation and economic havoc...

As the dollar crumbles and loses its control of the price of gold, the yellow metal will soar to heights heretofore unimagined. Nothing will stop it. All economic forces will aid it in its ascent... including... the world's most powerful central banks.

For then, a rising gold price will boost their collective reserves, and therefore their currencies' values, not undermine them as has been the case before the euro's advent.

Gold will be free, and the dollar will be dead: so be careful where you put your money !

The official US price above (still current) is about one-sixteenth what its gold would now fetch on the market. And as I figured late last month, even at open market prices, America's gold reserves only cover around 1.5% of the dollar money supply defined as M3.

In other words, the official price of Treasury bullion makes its total holding worth over 1,000 times less than the amount of money it has in circulation. If ever the world should divorce from the dollar standard, the results could indeed be chaotic.

Now, Iran wants yen from Japan in exchange for oil; the Chinese re-pegged the yuan in 2005 to a "basket of currencies" instead of exclusively to the dollar; the Euro has the potential to be backed by significant national holdings of gold, especially Germany's; an Islamic gold dinar is making its appearance (in Kelantan, Malaysia). I understand that Malaysia is even beginning to entertain the notion of doing away with central banks altogether and taking direct control of its own currency - a financial revolution could be brewing.

Before I get accused yet again of being a gold bug, let me say that I'm not - gold doesn't do anything much except look beautiful, same as our local stray cats. This is not about gold, but about the fiat currencies' potential for real catastrophe, on a Germany-in-1923 scale.