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by Peter Schiff
Euro Pacific Capital
September 21, 2007

Coming at a time when rate increases were needed to combat the sinking dollar and surging gold, oil and other commodity prices, Ben Bernanke’s 50 basis point cuts in the Fed funds and discount rates this week may go down as the most irresponsible move in Fed history.

To America’s creditors around the world, whose mountains of dollar reserves will be debased by lower rates in the U.S., this action amounts to the monetary equivalent of “let them eat cake.” My prediction is that rather than doing so, they will just throw it back in our faces, and refuse to continue funding our deficits.

Wall Street bulls have heaped praise on the Fed, at times calling the rate cuts courageous and brilliant. From their response, you would have thought that Bernanke’s solution was akin to Einstein’s breakthroughs on relativity. In the first place, what is so brilliant about cutting rates? My five year old could do it and would gladly accept payment for his service in popsicles. 

Furthermore, a fifty basis point cut was not an act of bravery but one of cowardice. The brave thing to do would have been to raise rates and allow market forces to purge the economy of the imbalances built up during the Greenspan bubbles. It would have taken some real courage to level with the American public and let them know that our profligacy has consequences, rather than pretending it can ride to the rescue with a wave of its magic wand and a crank of the printing press. 

If Bernanke really had any guts he would have assured our creditors that they will be repaid with real purchasing power, and that the Fed was willing to put some teeth in our alleged “strong dollar policy”. His capitulation proves that this phony policy was pure propaganda all along, merely designed to fool foreign creditors into holding our paper. 

Those who believe the Fed should reduce interest rates to ward off a recession or stabilize home prices simply do not understand the situation. More credit is not the solution: it is part of the problem. Our economy is on the brink of disaster because irresponsible Fed policy encouraged Americans to borrow and spend too much and created an unprecedented national real estate bubble. The last thing the Fed should do is entice Americans to borrow more money they cannot repay, buy more imported products they cannot afford, and attempt to blow more air into the deflating real estate bubble. 

Bernanke’s attempt to circumvent the free market forces that are bringing on a long overdo recession (which is necessary to purge our economy of unsustainable imbalances) will lead to an even greater disaster. Make no mistake about it; had the Fed done nothing, or raised rates as I would have preferred, the economy would have clearly tipped toward a severe recession. However, by “coming to the rescue” with rate cuts, the Fed assures us that we will experience something far worse. 

Again, the coming recession is not the problem but the solution. Painful as it will be, a recession is the only way to cure our sick economy and we will need to grin and bear it. When it ends, our nation will be a lot poorer, but at least we will be clawing our way out of this gigantic hole. Cutting rates now only assures that we will dig ourselves into an even deeper hole. In the end, it will be that much harder for us to get out, and we will be that much worse off when we finally do. 

Although they may slow the process down for a few quarters, the rate cuts will neither prevent the recession nor keep house prices from collapsing. But they will cost us dearly. The dollar’s fall, which had been held somewhat in check by the possibility of a hawkish Fed, has accelerated in earnest now that the curtain has been pulled back. 

Unlike previous bouts of Fed easing, this time any additional liquidity will not artificially pump up the economy or the housing market, but merely accelerate the rise in consumer prices and eventually push up long-term interest rates as well. If Americans are having problems making mortgage payments now, think of how much more difficult the task will become when food and energy prices double. If you think mortgage rates are high now, wait to you see how much higher they rise after a few rate cuts. After all, with the dollar in free-fall, will foreign savers really want to buy our mortgage backed securities, or lend us any more money at single digit interest rates?

For some reason everyone seems to think the Fed can bail out homeowners and mortgage lenders without anyone picking up the tab. There is no such thing as free lunch, especially if served by the Fed. If Congress does not raise taxes to fund a legitimate, although ill-advised bailout, then the Fed can not perform the same task for nothing. As the additional dollars the Fed creates reduce the value of all other dollars already in circulation, the cost for the “bailout” is simply borne by all holders of U.S. dollars.

The irony of the situation is that on September 11th, while in Germany, Bernanke delivered a speech in which he admitted that we need to increase our savings and declared that the inevitable adjustment to our current account deficit would have both real and financial consequences. Bernanke’s actions, which reward borrowers and punish savers, merely exacerbate those imbalances, ensuring even greater consequences when the inevitable adjustment finally occurs.

Of course, the most comical spectacle of all was Alan Greenspan’s attempt to steal the spotlight. During his media blitz to promote his new book, he simultaneously disclaimed any responsibility for the problems we are now facing while forecasting that both inflation and interest rates would eventually rise to double digit levels. He even admitted on “60 Minutes” that he personally had already diversified his own assets out of the U.S. dollar. I guess it’s fairly easy to read the writing on the wall when you are the one with the spray paint. Greenspan sowed the wind. Unfortunately the entire nation is about to reap the whirlwind.

J. R. Nyquist

http://www.financialsense.com/stormwatch/geo/pastanalysis/2007/0921.html

It is lack of honesty and intellectual integrity that now accelerates America’s demise. Americans ought to know better. We ought to be adults who understand that falsifying reality won’t work. The enemies of the United States have watched and waited for a fatal flaw to emerge. And now, at long last, the corruption of the American character through too many decades of prosperity has opened the way. The people of the United States have lost sight of the truth. They have forgotten that the world is underpinned by economic hardship and war. The United States came to think of itself as exempt from this underpinning. But no nation is exempt. No nation can escape the grim realities of this world or the severe consequences of downplaying and dismissing these realities. Economic hardship and war are coming to America.

We must not suffer a recession, say the Americans. We cannot support a war, even in the defense of our own long-term interests because our country has no interests worth dying for. Let the dollar fall. Let our enemies take the oil fields. What will the world do against us? They must export to us, they must send oil to us; they must eat our bonds, our treasury notes, our worthless paper currency. This is how it has always been. This is how it must always be. If the Russians are deploying bombers and making dry runs at the American homeland, we do not care. Let them play their silly war games. We aren’t alarmed. If British intelligence has detected Chinese preparations for a surprise attack against the U.S. Navy, let us pronounce a decided “HO HUM” and go about our business. Let us shop until we drop. Let us watch cable television until the rest of the world sinks out of sight. Why should we contemplate the boozy Russian or the desperate Chinese? Why should the distant hovel interest us? We are fat from eating, and our eyes are glazed from entertainment.

But trouble comes. The enemy appears. The international position of trust, once held by the United States, is gradually lost through a series of abuses. Self-deluded and ignorant men have taken the helm, and they have set intellectual integrity aside. At long last the United States attempts to stave off a second Great Depression by yet another round of credit inflation. Only this time it isn’t going to work. America’s enemies have been preparing. Their propaganda machine has succeeded, and their guerrilla tactics in the Middle East have had a demoralizing impact. The American side grows weaker day to day.

The United States imports much of what it needs from other countries, including oil and natural gas. In exchange, the Americans now export inflation. This is an abuse, a patent fraud, and the world begins to lose its patience. Facing the prospect of deflation, the prospect of economic meltdown, the financial managers of America have decided to re-inflate. They have decided to hurt all those who hold dollars abroad. In doing so, they have invited a counter-attack. They have invited the dollar’s total destruction. Without realizing the seriousness of their move, they have opened the way to global economic chaos and open warfare. The enemies of the United States now what is happening. They have waited long and patiently, sharpening their weapons. The Russians, Chinese, Iranians, Syrians, North Koreans, etc. are in it together. Add to these the Communists in Cuba and Venezuela. And do not forget America’s domestic malcontents. Revolution is not simply a slogan. It is the essence of today’s anti-American religion.

The United States once held an international position of trust, and that trust has been abused. We say to ourselves that another drop in interest rates and we’ll avoid a recession. We’ll avoid the pain we’re due to suffer. Many decades ago the great economist, Ludwig von Mises, noted that a “drop in interest rates falsifies the businessman’s calculation.” The change in rates makes “some projects appear profitable and realizable which a correct calculation, based on an interest rate not manipulated by credit expansion, would have shown as unrealizable.” First there was a stock market boom, then came a real estate boom, and now we have to wonder what kind of boom we’ll see next. Perhaps it will be a “crack-up boom.” The United States has gotten away with financial abuses for a long time because the dollar is the international reserve currency. But the outside world is not stupid. They see that their investment in the dollar has resulted in a massive loss. The Chinese, Saudis, Japanese and British are losing trillions in buying power. The dollar’s decline is now accelerating, with massive consequences for all.

If you were an enemy of the United States, wouldn’t you take advantage of this opportunity?

Economic prosperity based on the inflation of credit, said Mises, “can only last as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market.” In real life there are no ever-filled purses. The magic of inflation isn’t magic after all. Over time a system based on inflation is destroyed through a process of self-attrition. Inflation cannot go on forever, noted Mises. Barriers exist that will inevitably prevent a boundless credit expansion. In the case of a prolonged and outrageous expansion, in which major threats to prosperity are answered with inflation, a breakup of the entire monetary system is indicated. In the wake of a serious credit expansion, says Mises, “The banks are faced with an increased demand for loans and advances on the part of business. The entrepreneurs are prepared to borrow money at higher gross rates of interest. They go on borrowing in spite of the fact that banks charge more interest.” Businessmen become addicted to credit, and the addiction leads to destructive behaviors. The banks find themselves in a credit crunch, and the only way to avoid real pain is a further injection of the original narcotic. Like a drug addict, the financial system must get another dose of lower interest rates. According to Mises, “They fail to see that in injecting more and more fiduciary media into the market they are in fact kindling the boom. It is the continuous increase in the supply of the fiduciary media that produces, feeds, and accelerates the boom.” And this eventually leads to what Mises calls a “crack-up boom.” As he further explained, “The credit expansion boom is built on the sands of banknotes and deposits. It must collapse.”

If the banks become frightened, the whole thing collapses in deflation. If the boom is pumped endlessly, the end must nonetheless come, said Mises, because any attempt to substitute additional fiduciary media for nonexistent capital goods is doomed to failure. “If the credit expansion is not stopped in time, the boom turns into the crack-up boom; the flight into real values begins, and the whole monetary system founders.” Think of what he is saying: The flight into real values cannot be prevented. Reality intrudes on the dreamer and his eyes are opened. According to Mises, “As soon as the afflux of additional fiduciary media comes to an end, the airy castle of the boom collapses. The entrepreneurs must restrict their activities because they lack the funds for their continuation on the exaggerated scale. Prices drop suddenly because these distressed firms try to obtain cash by throwing inventories on the market dirt cheap. Factories are closed, the continuation of construction projects in progress is halted, workers are discharged.”

The option of exporting inflation to a world that must sell goods to the American market is almost at an end. The ongoing credit inflation cannot continue forever because the world will not go along. “The final outcome of the credit expansion,” noted Mises, “is general impoverishment.” It is impossible for one nation – however powerful or important – to avoid the general impoverishment of all. In the present case, the disaster is amplified by America’s role in maintaining a peaceful international order. Without American power, the North Koreans would attack South Korea, China would invade Taiwan, Russia would flood into Europe, and the international trading system that supports over six billion people would barely support three billion.

We are on the brink. A once decent system, turned to dishonest practice, faces a day of judgment. Billions of lives are in danger. The flight into real values is about to begin. An age of blood and iron follows.

by Peter Schiff
Euro Pacific Capital
September 7, 2007

Now that home mortgage defaults are spreading like wildfire from coast to coast, there is a growing sense of certainty that the government will attempt to bail out homeowners and lenders. The ideas put forward last week by President Bush may be the camel’s nose pushing under the bottom of the tent. However, just as some things are too big to fail, this problem is far too big to fix. 

First of all, one has to consider the moral hazards inherent in any bailout. Immediate relief in the form of debt reductions and more favorable loan terms will create a powerful incentive to default. Why would anyone stretch to make a burdensome mortgage payment while others are being rewarded for failing to make theirs? 

Even without the incentives of a government bailout luring more people into default, policy makers simply have no idea as to the scope of the problem. Before this home mortgage correction runs its course, nearly every homeowner in the country who had availed themselves of an adjustable rate mortgage or a home equity loan will be in need of a bailout. Even a sizable percentage of those with traditional fixed rate mortgages will find themselves in danger. With millions, or perhaps tens of millions, of home owners on the rocks, there is simply no way the government can structure a bailout without bankrupting the country or destroying the currency. 

Bailout or not, the economy will still be in a prolonged and severe recession. Even if Federal aid prevents millions of foreclosures from happening, all of the home equity accumulated during the bubble years will be gone. Debt reduction and restructuring will not stop home prices from falling, and will not make homes easier to sell. After all, those looking to buy homes will no longer have access to the easy credit that made bubble prices possible in the first place. Home prices are a function of what future buyers can afford – not what past buyers paid. If new buyers are required to make 20% down payments, fully document their income, and fully amortize a fixed rate mortgage, they will not be able to pay nearly as much as what current owners paid during the bubble.

On the lo end, any comprehensive government bailout would easily surpass the $1 trillion mark. Where will the Federal government get the money, particularly during a severe recession? My guess is raising taxes will be out of the question. If people are having trouble making their mortgage payments now, significant tax increases will only make it that much more difficult. Borrowing the money also seems like a difficult task, as our minimal domestic savings means we will have to do so from abroad. Given that the budget deficit will likely be exploding as a result of the recession, foreigners are not likely to foot the bill. If they do, it will require significantly higher interest rates, which will only compound the mortgage rate problems for current and potential homebuyers.

Unfortunately, the only realistic way to “pay” for such a massive bailout would be for the Fed to monetize it. If that were to happen, the value of the dollar would plunge, and consumer prices would go through the roof. Now that the dollar Index has finally broken below the key 80 support level, an event that I have been forecasting would eventually occur for years, a run on the greenback may already be in motion. Ultimately, long-term interest rates will soar as a result, and we will experience unprecedented stagflation and a substantial decline in our collective standard of living. This week’s serge in the price of gold, which traded above $700 per ounce for the first time since May of 2006, reveals that some investors are finally beginning to figure this out.

Ironically, in a recession induced by the burst housing bubble, housing itself will not be among our most pressing problems. One of the few “benefits” of the housing bubble is that we now have a lot of houses, many of them vacant. Therefore, few former American mortgage holders will go homeless. However, the real problems for Americans, whether they own or rent their homes, will be maintenance costs (heating oil, electricity, etc.) and keeping their kitchens stocked with food. One thing is for sure: homeowners will certainly not be buying new furniture for their living rooms, big screen TV’s for their media rooms, granite counter tops for their kitchens, or new cars for their garages. 

The costs associated with the housing bubble will be huge. However, the price tag for a government bailout designed to prevent it from deflating will be much higher. Even those who get “bailed out” will ultimately be in worse shape as a result. Let’s hope that cooler heads prevail and that the rest of the camel never makes it into the tent. However, just in case they don’t, make sure to get rid of any remaining dollar denominated assets before it’s too late.

by Peter Schiff
Euro Pacific Capital
August 31, 2007

This week, Larry Kudlow and others strongly chastised Bernanke for his failure to read the writing on the wall and urged the Fed Chairman to quickly slash the Fed Funds rate. Methinks the pundits doth protest too much. For years, Kudlow, who practically coined the term “Goldilocks economy,” has dismissed with scorn suggestions that the American economy was anything less than ragingly healthy. If our economy is really so strong, why does he call so loudly for the artificial stimulus of a significant rate cut?

In truth, the writing has always been clearly on the wall all along. A credit bubble has been steadily inflating for at least the last six years, which in its final frenzy produced some of the most absurd mortgage funding products the world has ever seen. To anyone not dependent on the hysteria, a no-doc, no money down, negative amortization, interest only, adjustable rate jumbo mortgage was a just as clear a sign of pending catastrophe as $200 for a share of Pets.com, or 5,000 Dutch guilders for a single tulip bulb. 

The one thing all bubbles have in common is that they eventually pop, and ours just did. Unlike the popping of the last bubble in 2000-2001, this one will fall directly to our economy’s bottom line. And this time the Fed can not step up to the plate with unlimited liquidity injections. 

A record percentage of our GDP is comprised of consumer spending. The source of this spending was the housing bubble. Would our savings rate really be negative were it not for housing related “wealth?” Could consumers really have spent as much as they did without the benefits of temporarily low teaser rates and the ability to extract equity from their homes? How many service sector jobs are directly related to that extra spending? When the low mortgage payments and home equity disappear, so too will the spending and jobs they engendered.

Those who feel that the economy will keep growing must believe that discretionary consumer spending is unrelated to wealth or expenses. In other words, they believe that individuals will spend as much with no home equity and $3,000 per month mortgage payments as they did with $200,000 in home equity $1,500 monthly payments. Factor in other rising expenses; such as food, energy, insurance, and taxes and discretionary spending will not just slow, it will completely collapse. 

With the ugly truth laid bare, many now prod Bernanke and Bush for solutions. Unfortunately there are none. Based on absurd assumptions about real estate, we simply borrowed more money than we can ever hope to pay back. There is no magic elixir we can swallow to cure what ails us. The free market is the only force that can fix this mess. Unfortunately, the fix won’t be pretty. Prudent lending standards will return, guaranteeing that real estate prices collapse. This is an important connection that very few have made. There is no way the average American can afford to buy the average house at today’s prices with a mortgage he can afford. Assuming that the lax standards of 2005-2006 do not return, the only way this can happen is if real estate prices collapse, which is exactly what is happening.

The financial institutions that are calling most loudly for a bailout claim the Government must act to protect homeowners. However, the most severe losses will not be born by homeowners but by those who loaned them the money. Therefore any bailouts will ultimately go to lenders not borrowers. Homeowners who offered no down payment and who have no equity in their homes will in reality lose nothing in foreclosure, except perhaps a debt burden on an overpriced house. In addition, even those homeowners who made down payments likely extracted larger sums in subsequent refinancings or home equity loans. With plenty of available foreclosed homes on the market to rent it is unlikely that these former homeowners will become homeless. 

As a result, the only losses for most homeowners will be psychological, as their dreams of real estate riches vanish. For some paper millionaires, the sudden realization that they are flat broke will be somewhat disheartening. Also for those who thought retirement was simply a function of living in a home and allowing it to appreciate, the sudden realization that they will now have to finance their retirement the old fashioned way, by saving up, will be quite an eye opener. However, even if misguided government bailouts enable more borrowers to keep their homes the equity they thought they had will still be gone. 

In the final analysis, though it was Wall Street that served the punch, it was the Greenspan Fed that spiked it in the first place. Just as Fed policy enabled Wall Street to flood the world with worthless dot.com stocks it enabled an encore performance with subprime mortgage-backed securities. My guess is the Fed’s bubble blowing days are over. Once the inebriates sober up this time, the hangover will be so severe that no one will drink a drop of Wall Street’s punch again, meaning any more inflation the Fed creates will go strait into consumer prices.

© 2007 Peter Schiff

By JR Nyquist

http://www.financialsense.com/stormwatch/geo/pastanalysis/2007/0831.html

This week the French President, Nicolas Sarkozy, warned against Russia’s use of energy as an instrument of foreign policy. Speaking before his ambassadors, the French President said: “Russia is imposing its return [as a great power] on the world scene by employing its assets, notably oil and gas, with a certain brutality.” A great power ought to be gentle in its economic or political superiority. The Russians, however, are accustomed to a more cynical use of their advantages. The language of the Russian president includes mockery, condescension and threats. The West cringes, the East advances. Who cares what the weak countries think? Their feelings are without consequence.

Russia is not only engaged in a military buildup. Russia wants to use its economic muscles. You might ask what economic muscles Russia could have? It is bankrupt, backward, hobbled, demoralized and generally dismissed as an effective economic actor. We must remember, however, that positions in the world economy can change, that tables can be turned. Last June, at the International Economic Forum in St. Petersburg, the Russians called for a “new international financial architecture.” Here is Russia’s “Final Phase” economic strategy. The financial vulnerability of capitalism is growing. Keep pushing oil prices higher. Weaken the dollar. Precipitate the inevitable “crisis of capitalism.” Let the have-not nations rise up. Let them throw off their dollar shackles. Let them unite with Russia and China in “one clenched fist.”

Russian President Vladimir Putin believes the United States is vulnerable. The emerging economies of Brazil, India and China – combined with Russia – can shove the hollowed-out American economy aside. After all, American economic ascendancy is “archaic, undemocratic and unwieldy,” according to Putin. As for Europe, its dependence on Russian energy exports will assure a smooth process of “Finlandization.” Such a process begins with gentle warnings from Russia’s ambassadors in Europe and ends with self-censorship. Russia’s economic penetration of Europe gives special leverage to Moscow. In other words, the Kremlin has entered into the Fabric of European political life – through agent networks, influence operations and business pressure. These relationships can be used to influence powerful people, to adversely affect the careers of anyone who opposes Russian interests.

Economic influence means political influence. As America is humiliated, as America retreats, Russia advances. The day might come when Europe pays for its energy in rubles. If this occurs, Europe would have to acquire a large store of Russian currency. Russia’s economic position would grow, and so would Russia’s hold on Europe. Moscow wants to build a global oil exchange on Russian territory, knocking big financial players to one side. The Russians want to stun the American economy. They want to weaken an already weakened dollar.

In 1984 a Russian defector named Anatoliy Golitsyn wrote of the period following the collapse of communism. He warned of a renewed attack on the West, engineered by KGB strategists. He said that this attack had an economic dimension. In his 1984 book, New Lies for Old, he wrote: “’Liberalization’ in Eastern Europe on the scale suggested could have a social and political impact on the United States itself, especially if it coincided with a severe economic depression. The communist strategists are on the lookout for such an opportunity.” According to Golitsyn, the communist bloc tracks Western economic developments. They watch for developing weaknesses. “The communist bloc will not repeat its error of failing to exploit a slump as it did in 1929-32.” The smartest political observers know that a financial slump resurrects Marxism and its critique of economic freedom.

Referring to a deceptive phase of self-advertised Russian weakness, Golitsyn warned: “Information from communist sources that the bloc is short of oil and grain should be treated with particular reserve, since it could well be intended to conceal preparation for the final phase of the policy and to induce the West to underestimate the potency of the bloc’s economic weapons.” The economic weakness of Russia led Europe to feel safe about their growing dependence on Russian oil and gas. And now it is too late. Now we see how Russia and China have formed a military bloc. We see them supporting the nuclear ambitions of Iran, the paranoid buildup of Syria and Venezuela – the seduction of Latin America and the bloody unraveling of sub-Saharan Africa.

The U.S. financial situation worsens as the old communist bloc gathers its economic, political and military forces. Look at the new Russian weapons – nuclear missiles, tanks, jet fighters and more. Look at Latin America and notice what is happening in Venezuela, Bolivia and Colombia. The communists are advancing under various false flags. They seek the destruction of the United States. It doesn’t matter who is in the White House. It doesn’t matter what policy the U.S. is following. They want to destroy America, because America stands in the way of their plans.

If you live in America and want your children to be free, you’d better wake up. The actions of Russia are not in reaction to American “aggression” or “imperialism.” They are part of a long-established pattern of deception and exploitation. This is how the Russians behave. This is how they’ve always behaved. Most political pundits and “experts” will scoff at this statement. But let me ask them: Is it a coincidence that a KGB-regime has emerged in “democratic” Russia? Is it happenstance that this regime has formed a military alliance with communist China?

Shortly before her death, the Russian journalist Anna Politkovskaya asked whether the rise of Putin’s Russia was mere happenstance. In answer to this question she took a bullet in the back of the head. The silencing of those who ask the right questions is part of the old communist pattern. According to Mark Riebling, KGB defector Golitsyn’s 1984 book contains 148 falsifiable predictions. Of these predictions, 139 were “fulfilled by the end of 1993 – an accuracy rate of nearly 94 percent.” Today, Golitsyn’s accuracy rate is higher. Having predicted Russia’s use of oil as a weapon, having predicted a future alliance between Russia and China, it might be said that 141 out 148 of Golitsyn’s predictions have come to pass.

In recent months Russia tried to provoke a war between Israel and Syria. It turns out that the paranoia in Damascus was fueled from Moscow. The conventional analyst thinks the Russians are motivated by the prospect of further arms sales to Syria. But this is not the whole answer. Russia seeks to foment a greater military crisis with which to intensify the economic and energy crisis. The Russians and their allies are making trouble where they can. The hour is ripe. The U.S. president is weak. The American economy is troubled. One great push, one more straw upon the camel’s back, and capitalism might be overthrown – once and for all.

© 2007 Jeffrey R. Nyquist