The Monetary Crisis VII

jwr1947

The world is engaged in several severe monetary battles. One of these battles is the battle between inflationary and stable currencies. Having suffered from catastrophic inflation and three 1 monetary reforms German voters resist the idea of inflation as a solution to debts. Although the German government officially claims to support the stable Euro the 5% 2-inflation already overruns the market and in fact this battle is over. The Euro already is as weak as the dollar. Lost stability is lost quality. And several investors need a quick redesign for their investment strategy. No serious investor is interested in bad investments. They will all switch to higher qualities. The other battles however are devastating in their intensity and nobody seems to notice their impact. All currencies are balancing their exchange rate towards the dollar. This equilibrium is quite unnatural. The US-economy exports the freshly printed dollar in large quantities. In fact this is their main export article. In quality these paper sheets are inferior and it is the quantity, which causes the impact. The largest bankruptcy in U.S. history had been filed on September 15, 2008, resulting in a huge imbalance in the Fed-reserve, which triggered the global monetary battles. The printing of fresh money obviously started at a large scale at the beginning of 2009 Quantitavive Easing (QE, 13.1.2009), in which large volumes of other assets were converted in liquidity swaps. The effects of QE may be observed in the curve.

Fig. 1: asset side of the Federal Reserve System balance sheet

Components of the asset side of the Federal Reserve System balance sheet using statistical release dates from January 4, 2007 to Arpil 2, 2009. This is the assets of all 12 Federal Reserve Banks combined as reported by the Federal Reserve. This image was created using openoffice.org Calc spreadsheet program. See table below for source data. The graphics (and data) was obtained from: http://www.federalreserve.gov/releases/h41/ published in public domain by Analoguni 1 Monetary reforms in 1923 (Hyperinflation), 1948 (World War II) and 2002 (introduction of the Euro) 2 Statistical Bureau Wiesbaden (D): Between October2010 and 2011 a 5,3% inflation (source: Zehn Jahre Teuro Focus Online Report, 29.11.2011)

The Fed
It must be noted that the Fed in fact is a private company, not a governmental institute. The Wikipedia Fed-site defines: The Federal Reserve System has both private and public components, and was designed to serve the interests of both the general public and private bankers. The result is a structure that is considered unique among central banks. It is also unusual in that an entity outside of the central bank, namely the United States Department of the Treasury, creates the currency used. In fact the liability-instabilities started a year later at 09/11/2009: Even if the numbers are not understood it may be impressive enough to see how badly the balance in the US-system has been disturbed.

Fig. 2: liability side of the Federal Reserve System balance sheet

Components of the liability side of the Federal Reserve System balance sheet using statistical release dates from January 4, 2007 to Arpil 2, 2009. The data was obtained from: http://www.federalreserve.gov/releases/h41/ published in public domain by Analoguni

The curve of the liability side of the Federal Reserve System balance sheet seems to be stabilizing at a high level of 2,000 billions of $. This basically is also shown in other graphics, which have been validated to 2010. Debts are not being decreased, but they are slightly increasing.

Instability
There is no doubt these self-made knock-outs ruined the US-economy on a large scale. Of course the Fed-system desperately tried to export their problems and debts to other currencies. In fact they raised their export volumes in dollars, paying attractive interest rates in newly printed greenbacks. As of 2012, the majority of new federal government debt will stem from interest on existing debt. Treasury bond issues totaled $2.55 trillion in 2010, roughly 2x the federal budget deficit of $1.3 trillion. The US-federal debt is expected to increase from 100% GDP (in 2009) up to 350% in 2050. The newly printed money however does not go to the middle-class people, but to the banking industry and the rich people3. The Fed's strategy did not really help the US-economy 4, but caused some trouble in the Euro-zone. The Euro may survive if the Euro follows the Fed's concept in printing fresh money to dilute the poisoned bonds. If they are lucky it will not result in hyperinflation within months. The problem of printing money is the very point of stopping printing, which is a rather harsh impact in a running system. Nobody seems to have an idea how to stop printing the bills. The Fed's concept (named "credit easing") may deviate from a simple QE-idea. Credit easing involves increasing the money supply by the purchase not of government bonds, but of private sector assets such as corporate bonds and residential mortgage-backed securities.[66][67] When undertaking credit easing, the Federal Reserve increases the money supply not by buying government debt, but instead by buying private sector assets including residential mortgage-backed securities.[66][67] In 2010, the Federal Reserve purchased $1.25 trillion of mortgage-backed securities (MBS) in order to support the sagging mortgage market. These purchases increased the monetary base in a way similar to a purchase of government securities.[68] 5 The problem however is the assets' value. Are these assets really secure? Security can only be defined by an accepted standard. A standard referring to a sheet of paper cannot be considered as a stable value. In fact the last stable currencies have been abandoned with the Euro's weakness. I would not trust any validation of the mortgage-backed securities bought by the Federal Reserve. It would be easy to validate any regular home (or corporate bonds) to any price between 1 thousand US$ or 1 million US$. These are floating markets just like bananas and oranges.

The Euro
The relatively long stability for the Euro-zone has been paid with a rather high volatility at the instability phases in which the monetary system runs out of control. The price paid for the instability phases is much higher than the cost for a series of instabilities in the original DM-era. Now a vast amount of fiat money is available and waiting to be converted into stable currencies if any of these were available. The only alternatives are gold, silver, diamonds, etc., but certainly not dollars or Euros.

3 See: How the U.S. Will Become a 3rd World Country (Part 2) 4 Unemployment, lack of economic opportunity, falling real wages and household incomes, growing poverty and increasing concentration of wealth are major trends in the U.S. today. See: How the U.S. Will Become a 3rd World Country (Part 2) (Part 1 found here) 5 Source: Wikipedia: QE

Gold
The first step in defining any parameters is to refer to accepted, stable standards. The globally accepted monetary standard is metallic gold. In fact the gold price merely revealed a short 20% upward impulse at the largest bankruptcy in U.S. History at September 15, 2008. Shortly after this impulse however the curve started an exponential growth rising from 800US$ to 1700US$ today, indicating a massive turbulence. From the Fed's assets' graphics we may observe the minimal volumes of gold reserves in the assets. As long as the dollar is trusted the gold assets may be ignored: they cannot contribute to any kind of solution. This however may change at a drastic drop of the dollars' monetary value or a steep rise of the gold price. In August 1971 the gold standard has been released. The standard had been in place since the Bretton Woods Agreement of 1944 and fixed the conversion rate for one Troy ounce of gold at $35. In 1980 the gold-price experienced a very steep spike6, which had been caused by several events: In January 1980 gold was fixed at a record 850 USD an ounce while double-digit high inflation, strong oil prices, Soviet intervention in Afghanistan as well as the frightening impact of the Iranian revolution7 prompted investors to heavily buy the metal.

Fig. 3: Gold price history in 1960-2011

Historical gold price in USD and inflation adjusted gold price in USD. The above chart shows Silver Thursday event as a peak in 1980 when Hunt brothers drove up the price of silver through speculations and after it they lost about a billion dollars. The curve shows a second peak in 1982.8 Realterm released this work into the public domain. See: Gold as an investment

6 Source: What Happened to the Gold Price in 1980? 7 Iranian radicals in Nov. 1979 took over the US embassy in Tehran 8 See Gold as an investment, whereas the linear curve is shown in Goldpreisentwicklung Historisch

There are many differences between the 1980 spike in the gold price and the current steady rise in gold value. In fact the 1980-spike had been based on panics for military activities. Today's raise is based on exaggerated debts, which do not cause spikes, but result in steadily growing gold-prices. Apart from the spike there is a much lower and broader maximum which may represent the doubledigit inflation of 1980. Both the spike and the maximum disappeared with the military activities and the inflation.

My expectations for 2011/2012

This is not to be expected in 2011. The debts and the inflation remain unsolved. That's why the gold-price is due for higher regions. Substantial additional military activities in Iran would merely cause additional spikes to the gold-price, which are to vanish as soon as the problems are over. Oversized debts may not be vanishing at all in phases of "credit easing". Instead they will lead to a global monetary reform or a series of local monetary reforms, both of which are bound to be considered as catastrophic impacts on the global economy. The Fed has started a Cernobyl-like monetary experiment close to the core-melting temperature of risking the US-economy and the global stability. It is rather unclear how quickly the melting level is to be reached, but something will be melting soon... Of course the US-economy is too big to fail yet. Up to 2050 other economies will have grown up to a level to take over the responsibility for the global economical leadership. In the meantime will have to take care not to be swallowed or overrun by the next Federal experiment. Of course these notes are my own remarks and opinion, based on private investigations without any guarantee for correctness.