The Next Recession Looms Large

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.

By: 

Peter Schiff

Friday, October 7, 2016

Currently economists and market watchers roughly fall into two camps: Those who believe that the Federal Reserve must begin raising interest rates now so that it will have enough rate cutting firepower to fight the next recession, and those who believe that raising rates now will simply precipitate an immediate recession and force the Fed into battle without the tools it has traditionally used to stimulate growth. Both camps are delusional, but for different reasons.

Most mainstream analysts believe that the current economy can survive with more normalized rates and that the Fed’s timidity is unwarranted. These people just haven’t been paying attention. The “recovery” of the past eight years hasn’t been just “helped along” by deeply negative real interest rates, it is a singular creation of those policies. Since June 2009, when the current recovery began, traditional economic metrics, such as GDP growth, productivity, business investment, labor force participation, and wage growth, have all been significantly below trend. The only strong positives have been gains in the stock, bond and real estate markets. We have had an “asset price” recovery rather than a bona fide economic recovery. This presents unique risks.
 
Asset price gains have been made possible in recent years because ultra-low rates have driven down the cost of borrowing, encouraged speculation, and pushed people into riskier assets. Donald Trump was right in the presidential debate when he noted that the whole economy is “a big fat ugly bubble.” Any rate hike could hit those markets hard across the financial spectrum and can tip the economy into contraction. Look what happened this January when the market had a chance to digest the first rate increase in 10 years. The 25 basis point increase in December 2015 led to one of the worst January's in the history of the stock market. Since then, the Fed has held off from further tightening and the markets have treaded water. There is every reason to believe that the sell-off could resume if the Fed presses ahead.
 
Our current “expansion,“ which began in June of 2009 is 88 months old, and is already the fourth longest since the end of the Second World War (post-war expansions have averaged  61 months) (based on data from National Bureau of Economic Research and Bureau of Labor Statistics). But although it is one of the longest it has also been the weakest. Despite fresh optimism nearly every year, we have not had a single year of 3 percent GDP growth since 2007. More ominously, the already weak expansion is beginning to slow rapidly. GDP growth has been decelerating, averaging just 1% in the past three quarters. (Bureau of Economic Analysis) And while hopes were high for a significant rebound in Q3, as has been the pattern all year, rosy estimates have recently been sharply reduced.
 
Typically rate-tightening cycles start in the early stages of a recovery when the economy is still gathering momentum. As I have argued before, a rate tightening campaign that begins in the decelerating tail end of an old and feeble recovery is bound to unleash problems.  
 
So I agree with those who believe that rate hikes now will bring on recession, but I disagree that we should keep rates where they are. They believe we need to keep the stimulus pedal to the metal…and when that’s not enough, to cut a hole in the metal and push harder. I believe that despite the short term pain that will surely follow, we need to raise rates now to break the addiction before it gets worse.
 
The “keep rates at zero camp” argues that global economic developments have made traditional GDP growth nearly impossible to achieve. These believers in “the new normal” fear that the Fed is mistakenly waiting for growth that will never come. Larry Summers, the leader of this group, recently argued in the Washington Post that the Fed will never be able to raise rates enough in the short term (without plunging the economy into recession) to gather enough ammunition to effectively fight the next recession. In his view, to raise rates now would be to risk everything and get nothing.
 
Summers knows that central bankers now do not have the caliber of bazookas that their predecessors once carried (Bernanke was able to slash interest rates over 400 basis points in a few months). So he advocates continued stimulus until newer means can be developed to head off the next recession before it develops. (He promises to reveal those new ideas soon…really). 
 
Given all the economic realities that central banking has attempted to suspend in recent years (such as the antiquated belief that lenders should be paid to lend rather than being charged for the privilege), it’s no great stretch for them to consider the next big leap and call for an age of permanent expansion.
 
To do this they must short-circuit the business cycle, which up until now has regulated prior monetary mismanagement. Rather than being some naturally occurring process, the business cycle actually results from artificially low interest rates. Mistakes are made during the booms, when rates are held artificially low, and are then corrected during the bust, once those rates are allowed to normalize. Ironically, the busts are actually the benign part of the process, and should not be resisted, but embraced. But to mitigate the short-term pain associated with actually correcting those mistakes, central banks typically opt to paper them over for as long as possible. The problem is that this time the papering over process has gone on for so long, and involved a record amount of paper, that correcting the mistakes now will necessitate a recession so severe that it is unthinkable. The only apparent “solution” is to make sure one never arrives.  
 
To do so Fed must replace the “ups and downs” of the economy with the “ups and ups.”  This futile process will likely involve the Fed intervening directly in the equity markets (by actually buying shares), or in the real estate market (by buying properties or making loans) or into the consumer economy by directly distributing money to citizens. But since contractions are necessary and healthy, especially when markets have gotten ahead of themselves, attempting to short-circuit them does more harm than good. Yet despite how crazy such a policy sounds, Yellen just suggested that she thinks it’s not only a good idea, but that the Fed is already giving it serious study. Given the damage our crazy monetary policy has already inflicted in the past, one can only imagine what kind of devastation awaits.
 
Just this week the International Monetary Fund issued a report about the dangers of global debt growth, which has reached $152 Trillion, or roughly twice the size of global GDP. They noted that the growth of private debt has recently led the upswing. With negative rates actually paying some companies to borrow, should this be a surprise? And while it’s nice that the IMF raised a red flag, it’s pathetic that their only proposed solution is to call for governments to increase public debt through fiscal stimulus (based on what should now be the debunked theory that deficit spending creates growth).
 
Even more pathetic is Alan Greenspan attempt on CNBC this week to blame the current low growth economy on Congress, and its failure to reign in entitlements. Greenspan is correct in his determination that "the new normal" results from the plunge in productivity gains that is a function of drops in savings and capital investment. But he can’t absolve the Fed. Had they not monetized the ever growing Federal deficits, or kept interest rates artificially low for so long, market forces would have forced cuts in entitlement spending years ago. These actions, originated with Greenspan himself, enabled Congress to repeatedly kick the can down the road.
 
According to Greenspan, to spare the public the pain of higher interest rates the Fed has no choice but to hold its nose and accommodate any level of debt Congress chooses to accumulate. But the ability to pursue unpopular policy is precisely they are supposed to be politically independent. What good is an independent central bank that simply helps incumbents win reelection?
  
Given that the Fed has already unsuccessfully exhausted so much firepower, it is unfortunate that it never seriously questions whether their policies are actually harmful. Modern economists simply can’t imagine that throwing ever more debt on the back of a weak economy actually prevents it from recovering.
 
I think it’s high time the Fed finally moves rates well into positive territory. The next recession has been on its way for years, and it will arrive no matter what the Fed does, if it’s not already here. Sometimes reality hurts, but fantasy can be more damaging in the long run.
 
The real choice is not between recession now or recession later. It’s between a massive recession now, or an even more devastating one later. Either way, there is no Fed policy that will be able to fight it. But that is not because the Fed is out of bullets, but because it never had any real bullets to fire in the first place. All it had was morphine to numb the pain as the wound festered. Now is the time to bite the bullet, endure the pain, and allow the wound to actually heal. This will also allow us to finally bury the idea of a new normal, enjoy a real recovery with all of its traditional benefits, and actually make America great again.
 
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Source: Commentaries By Peter Schiff

Gold vs. Paper: The Only Debate That Matters

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.

By: 

Peter Schiff

Thursday, September 29, 2016

While a record audience watched the first presidential debate between Hillary Clinton and Donald Trump, the sad truth is that the candidates differ very little on the issues that matter most. As president, both Clinton and Trump are likely to drive the country deeper into debt, expand government power, and further curtail individual liberty and economic freedom. Though we can vote against the candidate we feel will accelerate this trend, our votes may do nothing to change the direction we are headed.
 
But there is one vote that may actually make a difference.  The real source of government power is its monopoly over money.  Working hand and glove with the Federal Reserve, the Federal government has been able to finance permanent deficits by creating purchasing power out of thin air. Voters think government spending in excess of taxation means that the public gets something for nothing. But the more invisible “inflation tax” is not only more expensive than the overt official taxes, but does even more damage to our economy.
 
While government taxation and regulation have worked to limit productivity, private sector investment and innovation have worked to enhance it. But the recent rise and acceptance of activist central banking has tilted the balance in favor of government. Interest rates held at close to zero have short-circuited the economy’s natural vitality. As a result, living standards have spiraled downward for rank and file Americans. Despite government statistics that seek to paint a brighter picture,  this dissatisfaction has been clearly reflected in the tone and tenor of the current election. But if we really want to take our country back, we need to start by taking our monetary system back.
 
The United States was built on a foundation of sound money, and is now crumbling without one. A constitutional gold standard served us well for nearly 200 years, until Richard Nixon decided to do away with it “temporarily” in 1971. It’s been 45 years and we are still waiting for the return. As the Federal Reserve prepares to stamp out any remaining integrity that our currency may still possess, I suggest that we can’t afford to wait any longer for our government to honor Nixon’s promise. We must do it ourselves.
 
Goldmoney is an Internet startup that has developed a new super-charged gold standard that works better than the original. It provides all of the conveniences of money substitutes, such as paper currency, bank accounts, credit cards, etc., with none of the disadvantages. It’s a Gold Standard 2.0 that everyone can adopt today.  It doesn’t matter which candidate wins this election. Elections only change the players. But Goldmoney changes the game,  empowering us to individually reject fiat money, and return en masse to the gold standard, one American at a time. Without firing a shot, we can win a second American revolution. You may have seen the news recently that my gold sales company, SchiffGold, was recently purchased by Goldmoney. I am now working with them to offer the public a convenient and comprehensive gold savings and spending platform.
 
With Goldmoney, consumers can buy gold instantly and inexpensively using a laptop or cell phone. It’s real gold that you own.  You can take delivery whenever you want, in quantities as small as 10 grams or, if you prefer, your gold can be stored free of charge by Brinks (a 157-year old 3rd party custodian) in a vault in the international city of your choice.  Goldmoney provides a platform that gives you 24/7 access to your gold, enabling you to spend it*, or transfer** any portion of your holdings free of charge. In addition, Goldmoney provides free debit cards, enabling you to convert your gold into any currency and spend it wherever MasterCard is accepted, including cash withdrawals from ATMs.
 
Throughout history gold beat out all commodities to become the people’s choice for money. Along the way, governments tried to force people to accept paper instead, but their efforts always failed. Now you can help this most recent attempt fail as well. Just as Fedex once disrupted the U.S. postal monopoly, and companies like AirBnb and Uber are now upending the hotel and taxi industries, Goldmoney could be a game changer for the Federal Reserve and its irredeemable notes.  Money needs to be a reliable store of value, and the Fed’s product fails that test miserably. In fact, as official policy now mandates at least two percent annual inflation, it can be argued that the Fed’s product is designed to fail. Two percent inflation means your savings lose two percent of its value every year. My guess is that this target will be moved higher over time, so the annual rate of loss will accelerate in the years ahead. Gold, on the other hand, cannot be debased as its supply is extremely scarce and mining output will not even come close to matching the rate at which new Federal Reserve notes will be conjured into existence.

When the Federal Reserve was at least perceived to be an inflation fighter, and savings accounts paid interest of five percent or more, the convenience of fiat money and a modern banking system made a gold standard seem expensive and obsolete. But with the Fed now an unapologetic inflation creator and a possible looming threat of bank failures and “bail-ins” in the traditional financial system, the case for opting out of fiat money and into gold has been made all the more compelling. With Goldmoney, the path has never been easier. Goldmoney lets everyone easily save, earn*** and spend in gold. Don’t be the last one on your block to make the transition. In fact, being an early adopter has its advantages. The sooner you make the switch to gold, the sooner the government will no longer be able to tax you with inflation.

 
But it’s not just about preserving the purchasing power of your own savings, but about helping your friends protect theirs. Through the Goldmoney referral program, you can earn free gold every time one of your friends opens an account as a result of your invitation.  It’s as easy as sending a text or an email. In fact, if you open your account today, Goldmoney will fund it with some free gold to help you get started. You can easily add to your account with an additional purchase using your debit or credit card, begin inviting your friends to open accounts, and sit back and watch your personal gold holdings increase. 
 
But the decision to open a Goldmoney account is not only a good financial decision for yourself, but a good political one for our nation. Voting may be a waste of time as no matter who wins elections nothing ever seems to change. But a vote for gold is a vote our politicians will not be able to ignore. If enough people reject their flawed monetary system, the government will have no choice but to bow to the competition. To compete with Goldmoney, and win back lost market share, the government will be forced to cut spending, balance its budget, and raise interest rates.  Just as the gold standard of yesterday restrained the growth of government and preserved individual liberty, a new gold standard can deliver the same benefits today. But our government will not voluntarily surrender its power. We will need to take if from them. Thanks to Goldmoney we now have a means to do it!
 
* Fee is charged to fund and to spend
** So far physical transfers have only been approved for residents in the following states: TX, CO and OH.
*** Sending payments with Goldmoney is not currently available to US residents

There will be potential taxes on the gains or income deferral on the losses in transacting and saving in gold.

Physical ownership of gold will not yield income.

Peter Schiff is a shareholder of Goldmoney and a spokesperson for the company, for which he receives remuneration as part of its referral program.

 
Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, John Browne, and other Euro Pacific commentators delivered to your inbox every Monday!
 


To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy – How to Save Yourself and Your Country, click here.

For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.


Source: Commentaries By Peter Schiff

Apple Tax Grab by EU Invades IRS Airspace

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

By: 

John Browne

Thursday, September 15, 2016

On August 30th, the European Union (EU) Commission ordered the Irish government to reclaim some $14.6 billion of so-called back taxes plus interest from Apple Inc. The order challenged sovereign tax authority within the EU and well-established international tax rules. The aggressive stance of the Commission set off a furor of high level political argument among taxing authorities and multinational companies accustomed to complex but legal international tax planning. Apple’s case was big enough to place it at center stage in a simmering problem for governments in striking a balance between attracting businesses, creating jobs, generating taxes and deciding precisely what type of earnings can be taxed.
 
In a testament to how strange the taxing regimes have become, the Irish government has protested loudly and is reluctant to take the nearly 15 billion the EU says it is entitled. When small countries turn down such sums, it should be clear that the stakes are much higher.
 
With uncontrolled socialism and Keynesian monetary policies killing economic growth around the world, governments have ever greater need to wring revenue from the relatively stagnant pool of corporations and wealthy individuals. While the crackdown on personal tax havens, in Switzerland and the Channel Islands for instance, has been largely successful, corporations have become extremely adept using legal loopholes and creative international accounting to move revenues from high tax jurisdictions to countries where rates are lower. As of October, Reuters reported that U.S. based companies have some $2.1 trillion parked abroad in order to avoid high domestic taxes. Apparently Apple, the world’s largest company by market capitalization, accounts for over $180 billion of this total.
 
The U.S. corporate tax rate of 35 percent is widely considered to be uncompetitive and even excessive when compared with Ireland’s 12.5 percent rate (and even the 20 percent in the UK). It is an old adage that capital flows to where it is treated best. Ireland rolled out the red carpet for Apple, a decision that greatly benefited both.
 
Apple established a company in County Cork, Ireland in October 1980, sometime before Apple blossomed financially. Since then, Apple has become one of the largest taxpayers in the world and, according to its CEO, Tim Cook, the largest taxpayer in Ireland where it employs almost 6,000 people, mostly in high paying jobs, adding great benefit to the Irish economy both directly and by encouraging copycat corporations. (A Message to the Apple Community in Europe, 8/30/16)
 
In the last quarter, Apple paid nearly $3 billion in taxes or about $12 billion at an annual rate. Naturally, by using such mechanisms as licensing, pricing differentials and overhead allocations, profits, unlike sales revenues, are somewhat mobile. This is so especially since high value commerce evolved from trading physical goods to intellectual property.
 
The World Bank reports that in aggregate (2015) the EU is the world’s second largest economy. However, despite its population of over 510 million, the EU has failed to spawn new technology giants such as Apple, Google, and Amazon. Many observers blame the socialist and over-regulated nature of the EU. Certainly these factors provided reasons for the Brexit vote in June 2016. Many feel that the Brexit vote may have persuaded EU officials to soften their regulatory aggression, out of fear of encouraging other countries to seek the exits. Regardless, for some two years, the unelected EU Commission has been investigating the theoretical tax liabilities of U.S. companies such as Apple, Google, Amazon, McDonald’s and Starbucks.
 
Until August 30th, all EU member countries were free to establish their own tax regimes. The EU’s order for Ireland to demand some $14.6 billion in ‘back’ taxes from Apple was an unexpected and unabashed power grab by unelected EU regulators over the democratic government of Ireland. The assessment did not result from the non-payment of an actual tax but on a theoretical tax that the EU Commission felt should have applied. This is a bold move.
 
EU Competition Commissioner Margrethe Vestager described the prior arrangements made between Apple and the Government of Ireland as an “inconsistency” or state aid, illegal under the EU rules. The Irish finance minister, Michael Noonan, said that his government would appeal the decision, adding that it was “…necessary to defend the integrity of our tax system; to provide tax certainty to business; and to challenge the encroachment of EU state aid rules into the sovereign Member State competence of taxation.” (Lexology, Ronan Daly Jermyn, 8/31/16)
 
Understandably, the Irish government is balking at what it sees as EU overreach into Ireland’s sovereign right to administer its own tax affairs. They maintain there was no ‘special’ or ‘sweetheart’ deal. Meanwhile, some UK government ministers, soon to negotiate their freedom from the EU, reportedly told The Daily Mail that they see the Commission’s demand as representing a significant “opportunity” for the UK to attract more international companies.
 
The U.S. government is faced with somewhat of a conflict. Bloomberg reported a U.S. Treasury spokesman illustrating this point when he said, “We believe that retroactive tax assessments by the [EU] commission…call into question the tax rules of individual [EU] Member States. …” That all sounded very fair and pro free enterprise. But then, in a stinging globalist sentence, the Treasury spokesman added, “…we will continue to work with the [EU] commission toward our shared objective of preventing the erosion of our corporate tax bases.” (Nate Lanxon, 8/30/16)
 
The U.S. Treasury has described the EU ruling as “deeply troubling.” The U.S. Congress is bringing pressure on Treasury Secretary Jacob Lew, urging him to consider retaliation including taxes on European companies and individuals. Meanwhile, Secretary Lew maintained in a speech at the Brookings Institution that the EU Commission “is using a theory to make tax law, is doing it in a way that is retroactive and that overrides national tax law authority.” (Alan Rappeport, The NY Times, 8/31/16)
 
Apple is just one of the companies holding profits offshore to avoid paying U.S. taxes. According to Bloomberg, Apple has $232 billion in cash, of which about $214 billion is held outside the U.S. with its 35 percent corporate tax rate. The thought that the EU might grab some of the offshore money may reinvigorate Congress to revise the complex U.S. tax code. In other words, allow repatriation now to avoid the grasping claws of foreign governments later. It may even pressure Congress to bring the U.S. corporate tax rates down to more competitive levels.
 
It is conceivable that the litigation will continue over the next three or four years. Whatever the EU court decides ultimately, the ramifications for international commercial tax planning could be profound. It might lead to major changes in corporate structures. Investors should be aware that this issue could affect corporate profitability to an important degree.
 
Most importantly, the affair provides a clear example of how high taxes kill growth. Regrettably, those lessons appear to be lost on regulators on both sides of the Atlantic.
 
John Browne is a Senior Economic Consultant to Euro Pacific Capital.


Source: John Brownes Market Commentary

Big Policies, Bigger Failures

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.

By: 

Peter Schiff

Friday, August 19, 2016

Economics is far simpler than most in academics or government would have you believe. To make accurate predictions all you really need is an honest appreciation of the self-interest that is at the heart of free market transactions and an ability to understand how regulations that attempt to “correct” these realities don’t work. This is certainly the case with the completely predictable slow-motion train wrecks that are the signature U.S. domestic policy experiments of the last eight years: Obamacare and Federal Reserve stimulus. From the start, I issued countless commentaries on why both would fail spectacularly. The jury has started to come back on Obamacare, and the results are a disaster. And while the verdict on the Fed’s policies has yet to arrive in similarly stark terms, I believe that its failure is just as certain. 
 
As I explained in my July 30, 2012 commentary “Justice Roberts is Right: The Plan Won’t Work,” the central flaw (among many others) in Obamacare is that it incentivizes younger, healthier people to drop out of insurance coverage while encouraging older, sicker people to sign up. The result would be a pool of insurance participants that would guarantee losses for those providing coverage. That’s exactly what we are seeing.
 
After only four years of operation, there is now wholesale defection by insurance companies to abandon the Obamacare marketplace because they are hemorrhaging money faster than just about anyone predicted. To believe that any other outcome was possible would have been the equivalent of believing in the Tooth Fairy.
 
According to the Wall Street Journal, the four biggest U.S. health insurance companies, Anthem, Aetna, UnitedHealth and Humana are losing hundreds of millions of dollars on their Obamacare plans. And since these companies can’t be compelled to operate a business that loses money, all four have significantly scaled back their offerings. UnitedHealth has already exited 31 of the 34 states where it sells ACA policies. Humana is now offering coverage in just 156 counties of the 1,351 counties in which it was active a year ago. The latest shoe to drop came this week when Aetna said it would stop selling Obamacare plans in 11 of the 15 states where it is currently active (Bloomberg Businesweek, 8/17/16).
 
It’s no secret why the companies are losing so much money. Enrollees into the new plans take out far more money in benefits than they pay in premiums, despite the fact that premiums have increased substantially. That’s because the pool of insures in the Obamacare plans differ sharply from those that exist in the private marketplace. Why this has happened should have been stunningly obvious to anyone. To quote from my 2012 commentary:
 
“…the ACA makes it illegal for insurance providers to deny coverage to anyone for any reason. This allows healthy people to drop insurance until they actually need it without incurring any risk. It's like allowing homeowners to buy fire insurance after their houses burn down.” Given the high cost of insurance, the law allowed millions to take a free ride.
 
I argued then that penalties that would hit those who remained uninsured were insufficient to compel them to make an uneconomic decision. This was the same rational that was used by Chief Justice Roberts when he ruled that the plan was constitutional. He argued that since the penalties were not high enough to compel behavior, they should be seen as constitutional “taxes,” not unconstitutional “penalties.”
 
Similarly, by guaranteeing that no one could be denied insurance for any reason, and that the sick would pay the same premiums as the healthy, the plans have sucked in lots of people guaranteed to take out more in benefits than they pay in premiums. Add these factors together and you get the recipe for guaranteed losses. In retrospect, it is simply incredible that supposedly smart people argued against this outcome while the law was being drafted and passed.
 
At this rate, there may essentially be no private companies offering insurance through the exchanges within a few years. This will mean that unless president Clinton (Trump has promised to repeal Obamacare) passes a new law requiring companies to lose money for the good of the country (not too outlandish a possibility), or if the Supreme Court allows massive increases in the penalties for not buying insurance (thereby creating the coercive force that Justice Roberts argued was absent in the original law), then the government itself will have to step in and absorb the losses that are currently hitting the private insurers. At that point, Obamacare will become just what its critics always thought it was: an enormous new unfunded and open-ended government entitlement. 
 
While the flaws of Obamacare were incredibly easy to see, so too are the flaws in the Federal Reserve’s stimulus policy. What’s amazing to me is that more people aren’t able to see through it as easily.
 
Although few realized it while it was occurring, everyone now sees that the dotcom mania of the late 1990’s was a bubble that had to end badly. Most also realize now, as they didn’t realize then, that the housing bubble of the early years of the 21st Century (which took us out of the 2001 Recession) was a bubble created by the Federal Reserve’s unprecedented low interest rates in those years.  
 
But while we have gotten better at recognizing bubbles after they have burst, we are still totally blind to the ones that are currently forming. Ever since the Recession of 2008, the Federal Reserve has held interest rates at zero and has injected trillions of dollars into the financial markets through its quantitative easing policies. These moves have clearly inflated prices in the bond, stock, and real estate markets, an outcome that was an expressed aim of the policies.There is also clear evidence that these asset prices will come under intense pressure if interest rates were allowed to rise.
 
Recent history confirms this. Back in January of this year, just a few weeks after the Federal Reserve delivered the first rate increase in nearly a decade, the stock market entered a free fall. We had the worst opening two weeks of the calendar year in stock market history. The bleeding stopped only when the Fed backed off significantly from its prior rate hike projections. Since then, the market action has been clear to see: stocks rally when they believe the Fed will keep rates low, and then fall when they think they will rise. And so the Fed has played a continuous game of footsy with the market…forever hinting that hikes are possible but never actually raising them.
 
But given how close the economy could be trending toward recession, can anyone seriously believe that the Fed will risk kicking a potential recession into high gear by actually delivering another rate increase? It should be clear that it won’t, but somehow the best and brightest on Wall Street appear convinced that it will. Perhaps this explains why hedge funds have so consistently underperformed the market thus far in 2016.
 
To me, the fate of the Fed's stimulus policy is as clear as that of President Obama's failed experiment in healthcare. It's a disaster hiding in plain sight. The stimulus itself has so crippled the U.S. economy that it can now barely survive without it. As it limps along the crutch must grow ever larger, as the support it provides weakens the economy to the point where it becomes too small to provide adequate support. But rather than acknowledging that the Fed's policies have failed (an admission that any honest proponent of Obamacare should make), the proponents of stimulus are doubling down.
 
Earlier this week, John Williams, the president of the San Francisco Fed and widely believed to be a close confidant of Chairwoman Janet Yellen, issued an economic letter on the FRBSF website that lays the foundation for much greater stimulus for years to come. The centerpiece of Williams’ suggestions is that he would like to see the Fed raise its inflation target past the current 2%, and that the government be prepared to run much larger deficits to combat persistent economic weakness. In other words, ramp up the dosage of the medicine we have been taking for years, even though that medicine hasn’t worked. This shows a stunning inability to recognize a failed policy when it is staring at them in the face.
 
Absent from his analysis is any understanding that the stimulus policies of the past two decades may have actually created the conditions that have locked our economy into a perpetually weakened state. By preventing needed contractions, debt reductions, investment re-allocations and rebalancing, perennial stimulus has frozen in place a listless economy dependent on monetary support just to tread water. Just as Federal tax policy and healthcare regulations raised the costs of healthcare to the point where another bold (and ultimately futile) regulatory framework was launched to solve the problem, new forms of stimulus are being conjured to fix problems created by prior stimulants. But since Williams does not realize the stimulus he and his fellow quacks at the Fed have prescribed actually acts as a sedative, he has misdiagnosed the resulting condition of slower economic and productivity growth and as being the new normal.
 
Proof of this circular logic is Williams expressed desire to use monetary policy to push up “nominal GDP,” which is simply the GDP figures that are not adjusted for inflation. What good will it do for the average citizen if we get a higher GDP number that results merely from rising prices rather than actual economic growth? While the stimulus crowd likes to suggest that rising prices are a required ingredient for real growth because they encourage people to go out and spend before prices rise further, their asinine theory is completely unfounded. The entire purpose of deflating nominal GDP is to separate actual growth from rising prices. Pretending the economy is growing by targeting nominal GDP will only stifle real economic growth that might actually solve the problems the Fed still has no idea it created.
 
It is somewhat heartening that there is a greater recognition now of the inherent flaws in Obamacare. Hopefully such realizations will soon be widely raised about our current stimulus experiments, and that these insights will arrive in time to change course. However, confidence should be extremely low on that front.

To me, the fate of the Fed's stimulus policy is as clear as that of President Obama's failed experiment in healthcare. It's a disaster hiding in plain sight.  The stimulus itself has so crippled the U.S. economy that it can now barely survive without it.   As it limps along the crutch must grow ever larger, as the support it provides weakens the economy to the point where it becomes too small to provide adequate support.  But rather than acknowledging that the Fed's policies have failed (an admission that any honest proponent of Obamacare should make), the proponents of stimulus are doubling down.

Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, John Browne, and other Euro Pacific commentators delivered to your inbox every Monday!
 


To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy – How to Save Yourself and Your Country, click here.

For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.


Source: Commentaries By Peter Schiff

Central Banks Are Choking Productivity

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.

By: 

Peter Schiff

Friday, August 12, 2016

If the Economy were a car, productivity would be the engine. Heated seats, on-demand 4-wheel drive and light-sensitive tinted windshields, are all very nice. But they mean little if the engine doesn’t turn and the car just sits in the driveway. The latest productivity data from the Commerce Department confirms that our economic engine is sputtering.
 
If you strip away all the bells and whistles of economic analysis, the simple truth is that the increased living standards that have taken us from the stone age to the digital age happened because we increased our productivity. Better plows, windmills, bulldozers, factories and, more recently, better software, technology and automation, have allowed economies to produce more output with less human effort. This means there are more goods and services for more people to share and workers can work less to acquire those goodies. When productivity stops increasing, no amount of financial gimmickry can compensate.
 
With this in mind the latest batch of productivity data should have significantly changed the conversation. But like other pieces of evidence that point to a weakening economy, the news made scarcely a ripple. The fact that few opinions about our economic health changed as a result, confirms just how big our blinders have become.
 
Most of the economic prognosticators were fairly confident about the Second Quarter numbers. After all, productivity had unexpectedly declined for the prior two quarters, and given the optimism that is ingrained on Wall Street and Washington, a big snap back was expected. The consensus was for an increase of .5%. Instead we got a .5% contraction. That’s a huge miss. The contraction resulted in three consecutive declines, something that hasn’t happened since the late 1970’s, an era often referred to as the “Malaise Days” of the Carter presidency. That time, which spawned such concepts as “stagflation” and “the misery index,” was widely regarded as one of the low points of U.S. economic history. Well, break out your roller disco skates, everything old is new again.
 
But it gets worse. Productivity declined by .4% from a year earlier, marking the first annual decline in three years. According to data from the Bureau of Labor Statistics, the total magnitude of the three quarter drop was the largest decline in productivity since 1993. The last three quarters mark a significant decline from the already abysmal productivity growth we have since the Financial Crisis of 2008. According to the Wall Street Journal, during the 8 years between 2007 and 2015 productivity growth averaged just 1.3% annually, which was less than half the pace that was seen in the seven year period between 2000 and 2007.
 
The talking heads on TV can’t seem to offer any real reason why productivity has gone missing. Some feebly suggest that globalization is the problem, or that automation has moved so fast that the benefits usually offered by technological improvements have lost their power.  But it would be hard to come up with a reason why trade, which has universally benefited local, regional, and international economies through comparative advantage and specialization, has suddenly become a problem. Similarly, when does greater efficiency become a problem rather than a solution? So they are stumped.
 
But these economists ignore the major change that has befallen the world over the last eight years, a change that has coincided neatly with the global collapse in productivity. The Financial Crisis of 2008 ushered in an age of central bank activism the likes of which we have never before seen. All the worlds’ leading central banks, most notably the Federal Reserve in Washington, have unleashed ever bolder experiments in monetary stimulus designed to reflate financial markets, push up asset prices, stimulate demand, and create economic growth. And while there is little evidence that these policies have produced any of the promised benefits, there is every reason to believe that the scale of these experiments will just get larger if the global economy doesn’t improve.
 
But very few brain cells have been expended about the unintended consequences that these policies may be creating. But let’s be clear, there is nothing natural or logical about a set of policies that result in an “investor” paying a borrower for the privilege of lending them money.  So in this strange new world, we should expect some collateral damage. Productivity is a primary casualty. Here’s why.
 
Another set of statistics that has accompanied the decline in productivity is the severe multi-year drop in business investment and spending. Traditionally, businesses have set aside good chunks of their profits to invest in new plant and equipment, research and development, worker training, and other investments that could lead to the breakthroughs and better business practices. The investments can lead to greater productivity.
 
But the business investment numbers have been dismal. But it’s not because corporate profits are down. They aren’t. Companies have the cash, they just aren’t using it to invest in the future. Instead they are following the money provided by the central banks.
 
Ultra low interest rates have encouraged businesses to borrow money to spend on share buybacks, debt refinancing, and dividends. They have also encouraged financial speculation in the stock market, the bond market, and in real estate. Investors may believe that central bankers will not allow any of those markets to fall as such declines could tip the already teetering global economies into recession. The Fed, the Bank of England, the Bank of Japan, and the European Central Bank have already telegraphed that they will be the lenders and buyers of last resort. These commitments have turned many investments into “no lose” propositions. Why take a chance on R&D when you can buy a risk free bond?
 
Higher interest rates are actually healthy for an economy. They encourage real savings, with lenders actually concerned about the safety of their loans. Without the backstop of central banks, speculators could not out bid legitimate borrowers who make capital investments that produce real returns. But with central banks conjuring cheap credit out of thin air, supplanting the normal market-based credit allocation process; the result is speculative asset bubbles, decreasing productivity, anemic growth, and falling real wages. Welcome to the new normal. 
 
If the cost of money is high, people think carefully about where they want to put their money. They select only the best investments. This helps everyone. When money is cheap, they throw darts against a wall. This is not the best use of societies' scarce resources. Is it any wonder productivity is down? 
 
Many economists are now saying that the Fed won’t be able to raise rates until productivity improves. But productivity will never improve as long as rates stay this low. This is the paradox of the of the new economy.
 
When will central bankers conclude that it’s their own medicine that is actually making the economy sick?  They will not make that connection until they succeed in killing the patient…and even then they may continue to administer the same toxic medicine to a corpse. The political pressure is just too great to ever admit their mistakes, so they repeat them indefinitely.
 
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Source: Commentaries By Peter Schiff

UK’s Prime Minister Commits to Successful Brexit

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

By: 

John Browne

Thursday, August 4, 2016

On June 23rd, despite months of fear mongering by former Prime Minister David Cameron and his allies, doomsday global economic forecasts offered by the International Monetary Fund and the Obama Administration, and a steady drumbeat of anti-Brexit news stories by the BBC, The Economist and the Financial Times, the British people delivered an unexpected event to the global financial system by voting to take Britain out of the European Union. Despite the forecasts of doom and gloom, the people voted for freedom, democracy and common law.

Most of the elites continue to warn of dire consequences for Britain and many believe that the separation process will be long, messy, and perhaps even farcical. Many argue that Britain will seek some sort of reconciliation once it realizes the true costs of its hubris. A July visit to the UK convinced me otherwise.

While in England, I had the good fortune to attend the first parliamentary question session with newly minted Prime Minister Theresa May. Those fiery exchanges convinced me that she will take her time to negotiate a sensible and mutually beneficial Brexit treaty. Provided she can control the civil service apparatus (dominated by interests that leaned heavily toward the “remain” camp), May appears set to achieve Parliamentary approval and Royal Assent.

Tickets for in-person attendance to Prime Minister’s Questions (or PMQ’s as they are known) are typically hard to come by. This is particularly true when a new Prime Minister is being tested in the ring for the first time. Sitting on a special bench on the floor of the House in the immediate vicinity of Members afforded me the rare opportunity to sense the mood and ‘music’ of the House. It had been 37 years and one month since as a Member of Parliament I had listened to Margaret Thatcher tackle her initial PMQ’s as the UK’s first female Prime Minister. The comparison was not only interesting, but it influenced my outlook for the prospects of Brexit.

As Big Ben struck noon on July 20th, Mr. Speaker called “Questions to the Prime Minister.” Theresa May rose to Conservative cheers. Like Thatcher, she radiated composure and authority. With long experience as Home Secretary, she was very confident at the dispatch box even congratulating one Brexit questioner, Sir Edward Leigh, on his birthday. Most importantly, she established the central theme of her initial EU strategy by saying: “…Yes, the United Kingdom will leave the European Union, but the United Kingdom is not leaving Europe and our cooperation will continue.” (Sputnik International, UK-EU Security Cooperation, 7/20/16) Subsequently, other ministers echoed this pivotal position.

As PMQ’s continued, one could not help contrasting May with Thatcher. Like Thatcher, May appeared utterly convinced of her cause. She is tough and unafraid to shed blood. She cut swathes in Cameron’s cabinet, even sacking Chancellor Osborne. However, rather than exhibiting a Thatcher-like delight in verbal combat, May preferred persuasion as the vehicle to bring House and country together, saying: “… The Conservative party will be spending those [recess] months bringing this country back together.” (Reuters, Kylie MacLellan & William James, 7/20/16) To a considerable extent May is a mirror of Thatcher, but with some important updated improvements. Less verbally combative, she has the ability to inject humor, which Thatcher found somewhat difficult.

I went to London deeply skeptical that, as a ‘remain’ voter, May would negotiate a Brexit treaty that she would then allow to be defeated piecemeal by the civil service or by the House. I came away feeling somewhat less skeptical. Apparently, May intends to play a long game to allow Chancellor Angela Merkel, the EU’s effective leader, to encourage cooler heads to prevail in negotiating a workable, mutually acceptable treaty. Such a delay would allow time for other nations to push for changes within the EU (like those urged by Italy for other nations to rescue its failing banks). Such suggestions of intraEU changes might strengthen the UK’s negotiating position.

Following PMQ’s, I spoke to Boris Johnson and some former Brexit colleagues. They agreed with this analysis and although I did not discuss it with Johnson, all the others thought May’s performance was outstanding and that the UK would flourish under her leadership. Doubtless, the Brexit vote came as a shock to the British Establishment and resulted in some immediate uncertainty and alarm. In the medium term it can be expected to delay some investment and business decisions.

For example, the Common Agricultural Policy (CAP) lavished considerable sums on certain large farms in return for their commitments to reduce crop production. Of course, the CAP was designed in part to subsidize French farming and to reduce competition from larger more efficient farmers.

With Brexit, British farmers will be free again to farm all their land and so reduce not only the UK’s contributions to the CAP, but also help decrease Britain’s balance of payments! Furthermore, unrestricted by the absence of EU trade agreements with the U.S., Japan and China, the UK will be free to negotiate treaties with three of the world’s largest economies tailored to its own productive strengths, as opposed to those benefitting Germany and France. Already, Britain’s new trade negotiations with China are causing ruffled feathers in the U.S.

In an article appearing in The Washington Post on June 24 on Brexit, economist Larry Summers said: “…the prospects for Europe may in some ways be worse than for the UK.” He is not alone in this opinion. At a weekend house party in the English countryside attended by a Member of Parliament, a senior investment banker, a former IBM executive, a former member of MI5 and a graduate of INSEAD, the leading European business school, I found a consensus that implementing Brexit was in the best interests of the UK.

Later, I had an interesting exchange with a highly successful businessman who told me that in retrospect he should have voted for Brexit instead of the “remain” vote that he had cast.

If Theresa May continues to enjoy good chemistry with the German Chancellor while inspiring parliamentary and civil service support, it may be that, following a period of uncertainty, Brexit will succeed and prove beneficial to the UK. If this happens, it is possible that Sterling, currently at $1.31, will be seen as undervalued. The same could hold true for British stocks, many of which sold off sharply following the Brexit vote. 

Conversely, if the EU fails to respond positively to the challenges presented by Brexit, the euro could be seen as overvalued, if not flawed fatally. But a successful British disengagement from the EU may encourage other European nations to also seek exit, which could further weaken the euro. In other words, I believe Brexit does not offer a good outcome for the euro in just about any scenario.

If there is a major move out of the euro, it may result in a stronger pound sterling and possibly a stronger dollar. This would likely push the prospect of a Fed rate hike even further into the future as the Fed has already voiced concern that the dollar is valued too highly. The economic catastrophe promised by those who opposed Brexit may have been nothing but a smoke screen.

John Browne is a Senior Economic Consultant to Euro Pacific Capital.


Source: John Brownes Market Commentary