For a while there it looked like Japan had the answer. A strong new leader comes in and cuts through all the indecision, orders the central bank to flood the system with cash to depreciate the currency now rather than later – and boom, the stock market soars, exports rise and the economy starts growing again.

The entire left-of-center world eyed this process hungrily, sensing both vindication of their views and the coming economic nirvana when their governments finally accepted the truth about debt (it doesn’t matter) and easy money (a free lunch that always creates wealth). If Japan’s success proved sustainable, within a matter of months the European Central Bank would have no choice but to join the money creation orgy. And with the euro and yen both falling like rocks, the US Fed would soon have to follow.

But Japan’s success, to put it mildly, didn’t turn out to be sustainable. Just as Austrian economists and common sense predicted, interest rates on Japanese bonds soared, as the global markets subtracted the 2% target inflation rate from the 1.5% or so yield on long bonds, and decided that a negative real interest rate probably wasn’t the best deal. They sold, bond prices plunged, yields rose, and Japan hit the wall that Kyle Bass and others have been predicting it would hit for, it seems, ever. Japan’s stock market, now unsure exactly what is going on, has sold off in huge, bloody chunks. (The following chart does not show today’s 518 point drop.)

Here in the US something similar is happening. Share prices are at record levels and real estate is booming, which is a recipe for instability, so the Fed has been making noises about easing back on the asset purchases. And the stock market, no surprise, has started doing what it always does when the Fed tries to siphon off the river of liquidity. It is tanking, down another 200 points on the Dow as this is written on June 5.

What does this mean? Well, the obituary of the supercycle credit bubble that began in the 1940s has been written so many times that it would be crazy to say anything that definite. But it is safe to say that the corner central banks have been painting themselves into has gotten a lot more cramped in the past few weeks. The global economy, led by Europe but with the US close behind, is slowing despite debt monetization that would have been labeled insanely inflationary by pretty much the entire economics profession two decades ago. But shifting the printing press into an even higher gear is very risky, based on the Japanese experience.

So our options appear to have narrowed to just two: Roll the dice on complete monetization in which the central bank buys up all the debt being issued — government, corporate, asset backed – and accept that an asset inflation might ensue (a global debt-for-equity swap, in other words). Or retrench, let interest rates rise to normal levels, and hope that that doesn’t send the leveraged speculating community (which includes the governments issuing and rolling over trillions of dollars of short term debt) into cardiac arrest.

Ed Note: Read Currency War Part 1 HERE

The third-largest global economy is taking reckless steps to jump-start its languishing economy. Specifically, Japanese Prime Minister Shinzo Abe is taking unprecedented monetary action in an effort to reduce the value of the yen. The near-term effects may be positive for the weak Japanese economy. But the global econo

Since the price dive in April, gold fought its way back to $1480 before succumbing to renewed selling as general equity indices rallied and the US Dollar took off.   It has traded back close to, but above, it’s April low before regaining some traction.  As this was written gold is trading in the $1380 range.

As long as gold can continue to gain the recent trading activity has the look of a double bottom.   This is a strong technical formation, but it won’t be considered confirmed unless gold manages to get back above its late April/early May high.  This may not be easy as we enter the traditionally weak period for physical demand but there are other factors at work.

As noted in the last issue, recent market activity for gold has been the story of ETF selling and physical buying.   For all the breathless angst by mainstream journalists, the physical market has actually been absorbing selling by gold ETF holders.   Nice though it is to have ETF buying adding to tailwinds during bullish periods there is little doubt that owners of GLD and other exchange traded bullion funds are the “weak hands” of the bullion market. 

I still view the contrarian indicators as being supportive.  It’s impressive how negative they remain, with most indicators still showing, literally, zero positive sentiment.   This too is reflected in mainstream media coverage.  This is also 100% negative, at least the mainstream financial sites I look at.  

The same is also true of brokerage house coverage, with few exceptions.   I find it interesting that so many market strategists that completely missed the gold bull market – gold is about the most successful asset class this century – suddenly feel the pressing need to have an opinion about gold.   If they didn’t know it was going to go up 600% you should wonder how they are suddenly experts on what it will do next.

The negative mainstream journalists have been pointing out, correctly, that we are entering the weak seasonal period for physical gold demand.   Buying out of China and India has been heavy and there has been support from some central banks.  April-May is usually a good demand period but things get much slower through the summer before entering the strongest period of the year in the fall.  

Gold’s near term performance will also depend on if and when selling in the ETF paper market slows. That in turn will depend on how other markets are doing.  The charts on the following page show recent price action for gold and the US Dollar.  There is little doubt that the second bottom in gold related to the incredible strength of the $US through most of May.

HRA has been telling subscribers for months that new discoveries would be a key driver for a turnaround in the junior resource market. At the same time, we have been suggesting a handful of well-financed juniors with discovery potential. And in most cases, HRA is the only publication following them. 

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In recent sessions the Dollar has reached at least a short term top.  This is due to some strength in the Yen, slightly better news from Europe and concerns that the US Fed would start tapering QE soon.   It’s a bit odd that fear of the Fed cutting QE would lead to Dollar weakness.  One would expect a currency to strengthen if there was risk that monetary expansion would slow and interest rates rise.  It’s a measure of how unusual this market is that a potential end to QE would weaken the greenback.  The very high volatility in the Dollar market also indicates traders with warring views.

Bernanke’s Congressional testimony last week was a bravura performance, just the sort that gives central bankers their aura of omniscience.   He managed to tell basically everyone listening what they wanted to hear without saying much of anything, really.  The confusion he managed to create was obvious, with most markets swinging a percent or more in both directions in a matter of minutes.

The consensus view was that Bernanke said he plans to cut back on QE within a few months at most.  That might be the case but that wasn’t what I heard.  He sounded more reticent to me.  Part of that is that the economy, particularly employment which is still not meeting the conditions he has set out for ending QE. 

I’m not bearish on the US economy.  I expect it to do better than most.  For that reason I don’t want to be too optimistic about Fed money printing.  That said, it’s no secret what will happen to US interest rates if the Fed is not constantly pushing bond yields down with QE buying.  

10 year Treasury yields have gone up half a percent since early May.  If the Fed were to announce a large cutback in bond buying yields could go even higher, and fast.  Equity markets would get slaughtered in that scenario which could hurt consumer sentiment that the Fed has worked so hard to improve.   It wouldn’t do the US housing market any favors either. The Fed WILL have to stop the bond buying at some point but I think Bernanke is more hesitant than some assume.

A second but related reason I think Bernanke will be cautious is inflation levels.   The third chart on the previous page displays values for the Personal Consumption Expenditures (PCE) deflator index, which is the preferred inflation measure for the US Fed.  The yellow line is the full index and the green line is the less volatile version that has had price changes for food and energy removed.  

The PCE index has been trending lower since early 2012.  It is now sitting at about 1% year-over-year change, half the range that the Fed board indicates is its comfort zone. This is the lowest level since this measure started being calculated in 1959. However optimistic consumers might be this measure shows how much slack there still is in the US economy.

Remember that Bernanke’s academic background is as a Depression scholar.   He has a long held opinion that central bankers in the 1930s made the situation much worse than it needed to be by tightening monetary conditions at exactly the wrong time.  He has commented on this many times in the past few years.  Bernanke has made it clear he has no intention of repeating the mistakes of the 1930s.

Many that worry about QE triggering higher inflation readings and that possibility is real, eventually.   I can assure you that if Bernanke is lying awake nights worrying, its deflation that’s on his mind right now.  With interest rates at zero, the Fed has plenty of ammunition to defeat an inflation spike but deflation is much, much harder to reverse.  Just look at Japan.  Japan’s central bank is planning to double the monetary base in an attempt to get out of a deflationary spiral that has been going on for fifteen years.   We all know how Japan’s economy has performed during that period.

As I said, I’m relatively bullish about the US economy so I’m not assuming disinflation will become outright deflation but the possibility can’t be ruled out.  As long as that is the case I think Bernanke keeps the printing presses going.   He might slow the rate of QE but I don’t see it ending until PCE has established a firm upward trend.

Market worries about QE ending may put at least a short term top on major US indices.  These markets have had a very long one way run.  It would be perfectly reasonable for them to correct a bit.   That sort of market action might make gold ETF holders less likely to sell out.   Recent volatility in equities seems to have slowed ETF sales to a trickle. If that trend continues it will be supportive of gold prices during the coming weak physical demand period.

Although gold’s move from its second bottom is hardly the stuff of legend gold miners have been showing some relative strength lately.   This could be just another blip but it’s an encouraging sign. Those that wanted out of these stocks are gone and the sector could generate a good rally on any real price strength for bullion.

The juniors are faring a bit better with stronger bids on shares of companies that are actually planning to work on projects this summer.  Nothing spectacular here either but also encouraging.   I still expect the summer to have a positive tone though that heavily depends on a few explorers continuing to deliver good news.

The explorer holding everyone’s attention, Colorado Resources, is updated below.  In addition, I have appended a transcript of an interview I recently did with Colorado CEO Adam Travis.   Its good background and well worth reading and also part of the reason this Dispatch is a little late and very long.  CXO has a very strong technical management group that are both well respected and well liked through the industry.  Only time will tell if North ROK is a major discovery but it’s already roused the animal spirits on the Venture exchange.  However things end for North ROK it’s nice to see the good guys win one for a change. 

Ω

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Behind the scenes there has been scrambling as Southern Europe moves closer and closer to outright collapse. I warned previously that our contacts high up in the German government made it clear more than one year ago that if the choice comes down to abandoning the Euro or Austerity, the Euro will win. Letting the Euro go will be far too great of a public political failure and politicians will lock up everyone, execute them and their families, before they will EVER admit they have caused this entire mess. That day has come during the week of 05/20 in line with our model.

Inquiring minds with extra time on their hands this morning (May 23rd) g are plodding through the Full Transcript of Bernanke’s Testimony To Joint Economic Committee, U.S. Congress looking for the usual collection of half-truths, distortions, and outright lies it usually contains.

Here are some point-by-point statements by Bernanke with my comments immediately following each set of statements.

Bernanke: Conditions in the job market have shown some improvement recently. The unemployment rate, at 7.5 percent in April, has declined more than 1/2 percentage point since last summer. Moreover, gains in total nonfarm payroll employment have averaged more than 200,000 jobs per month over the past six months, compared with average monthly gains of less than 140,000 during the prior six months.

Mish: What Bernanke failed to say is real wages are anemic and the Fed’s low interest rate policy is making it easy for corporations to borrow at excessively low rates and use the money to invest in hardware and software robots to fire workers. Excessively low rates also punish savers and those on fixed income.

Bernanke:  Payroll employment has now expanded by about 6 million jobs since its low point, and the unemployment rate has fallen 2-1/2 percentage points since its peak.

Mish: Even if those were all full-time jobs, this was a very anemic recovery by historic standards. 

Bernanke: Despite this improvement, the job market remains weak overall: The unemployment rate is still well above its longer-run normal level, rates of long-term unemployment are historically high, and the labor force participation rate has continued to move down. Moreover, nearly 8 million people are working part time even though they would prefer full-time work. High rates of unemployment and underemployment are extraordinarily costly: Not only do they impose hardships on the affected individuals and their families, they also damage the productive potential of the economy as a whole by eroding workers’ skills and–particularly relevant during this commencement season–by preventing many young people from gaining workplace skills and experience in the first place. 

Mish: That is a reasonably accurate set of statements but nowhere does the Fed admit its role in creating those conditions with its boom-bust, moral-hazard monetary policies.

Bernanke: The loss of output and earnings associated with high unemployment also reduces government revenues and increases spending on income-support programs, thereby leading to larger budget deficits and higher levels of public debt than would otherwise occur.

Mish: The fiscal deficit is high because of perpetual overspending by Congress on top of the Fed’s boom-bust, moral-hazard monetary policies.

Bernanke: Consumer price inflation has been low. The price index for personal consumption expenditures rose only 1 percent over the 12 months ending in March, down from about 2-1/4 percent during the previous 12 months. This slow rate of inflation partly reflects recent declines in consumer energy prices, but price inflation for other consumer goods and services has also been subdued. Nevertheless, measures of longer-term inflation expectations have remained stable and continue to run in the narrow ranges seen over the past several years. Over the next few years, inflation appears likely to run at or below the 2 percent rate that the Federal Open Market Committee (FOMC) judges to be most consistent with the Federal Reserve’s statutory mandate to foster maximum employment and stable prices. 

Mish: The Fed has no idea what inflation is or why because the Fed ignores asset bubbles in stocks, in bonds, and in houses. It uses fatally flawed definitions of inflation, inaccurately measured at that.

Berrnanke: Over the nearly four years since the recovery began, the economy has been held back by a number of headwinds. Some of these headwinds have begun to dissipate recently, in part because of the Federal Reserve’s highly accommodative monetary policy. Notably, the housing market has strengthened over the past year, supported by low mortgage rates and improved sentiment on the part of potential buyers. Increased housing activity is fostering job creation in construction and related industries, such as real estate brokerage and home furnishings, while higher home prices are bolstering household finances, which helps support the growth of private consumption.

Mish: Housing sentiment has indeed improved, but that is of course what happens when central banks artificially suppress rates with the purposeful intention of creating asset bubbles, not to help consumers, but to bail out banks still stuck with housing inventory they need to unload.

Bernanke: Over the past four years, state and local governments have cut civilian government employment by roughly 700,000 jobs, and total government employment has fallen by more than 800,000 jobs over the same period. For comparison, over the four years following the trough of the 2001 recession, total government employment rose by more than 500,000 jobs.

Mish: At best, that’s a start. And it fails to address untenable union wages and benefits and absurd collective bargaining agreements of public workers.

Bernanke: At the same time, though, fiscal policy at the federal level has become significantly more restrictive. In particular, the expiration of the payroll tax cut, the enactment of tax increases, the effects of the budget caps on discretionary spending, the onset of the sequestration, and the declines in defense spending for overseas military operations are expected, collectively, to exert a substantial drag on the economy this year. The Congressional Budget Office (CBO) estimates that the deficit reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points during 2013, relative to what it would have been otherwise.  

Mish: It is preposterous to whine about pissy cuts in spending when the cuts have all been back-end loaded, and there are no real cuts in the first place. Congress did not really cut anything. It decreased the amount of expected budget increases and called that a cut. 

Bernanke: In present circumstances, with short-term interest rates already close to zero, monetary policy does not have the capacity to fully offset an economic headwind of this magnitude.

Mish: Headwinds? From non-existent cuts? From a rollback of tax cuts that should never have happened in the first place?

Bernanke: Although near-term fiscal restraint has increased, much less has been done to address the federal government’s longer-term fiscal imbalances. Indeed, the CBO projects that, under current policies, the federal deficit and debt as a percentage of GDP will begin rising again in the latter part of this decade and move sharply upward thereafter, in large part reflecting the aging of our society and projected increases in health-care costs, along with mounting debt service payments. To promote economic growth and stability in the longer term, it will be essential for fiscal policymakers to put the federal budget on a sustainable long-run path.

Mish: Note the blatant hypocrisy of Bernanke whining about non-existent cuts and about tax rollbacks the country could not afford, while warning Congress that something must be done to put the federal budget on a sustainable long-run path. 

Bernanke: Importantly, the objectives of effectively addressing longer-term fiscal imbalances and of minimizing the near-term fiscal headwinds facing the economic recovery are not incompatible. To achieve both goals simultaneously, the Congress and the Administration could consider replacing some of the near-term fiscal restraint now in law with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run.

Mish: Yeah, right. Like what? Of course that’s not his problem. He just begs Congress to kick the can down the road, which of course is all the Fed ever does too, while ignoring every asset boom-bust cycle along the way.

Bernanke: With unemployment well above normal levels and inflation subdued, fostering our congressionally mandated objectives of maximum employment and price stability requires a highly accommodative monetary policy. Normally, the Committee would provide policy accommodation by reducing its target for the federal funds rate, thus putting downward pressure on interest rates generally. However, the federal funds rate and other short-term money market rates have been close to zero since late 2008, so the Committee has had to use other policy tools. The first of these alternative tools is “forward guidance” about the FOMC’s likely future target for the federal funds rate. 

Mish: Got that? Forward guidance is supposedly a tool. In reality, the Fed is totally clueless about the economy, about housing, about jobs, and about where interest rates should be (as directly evidenced by repeat bubble-blowing exercises).

Bernanke: The second policy tool now in use is large-scale purchases of longer-term Treasury securities and agency mortgage-backed securities (MBS). These purchases put downward pressure on longer-term interest rates, including mortgage rates. For some months, the FOMC has been buying longer-term Treasury securities at a pace of $45 billion per month and agency MBS at a pace of $40 billion per month. The Committee has said that it will continue its securities purchases until the outlook for the labor market has improved substantially in a context of price stability. The Committee also has stated that in determining the size, pace, and composition of its asset purchases, it will take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

Mish: Note the dual mandate nonsense of jobs and inflation. It is impossible for bureaucrats and central planners to target one factor of the economy accurately. Two is insane. Yet, price stability is easy enough to achieve. Simply get rid of the Fed and fractional reserve lending. Here are some links on the absurdity of dual mandates.

Bernanke: At its most recent meeting, the Committee made clear that it is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes.

Mish: That makes sense (in a perverse sort of way). The Fed has no idea what it is doing so it needs to be prepared to do anything. Also note the irony of being prepared to do anything while promoting “forward guidance” as a tool.

Bernanke: In the current economic environment, monetary policy is providing significant benefits. Low real interest rates have helped support spending on durable goods, such as automobiles, and also contributed significantly to the recovery in housing sales, construction, and prices. Higher prices of houses and other assets, in turn, have increased household wealth and consumer confidence, spurring consumer spending and contributing to gains in production and employment. Importantly, accommodative monetary policy has also helped to offset incipient deflationary pressures and kept inflation from falling even further below the Committee’s 2 percent longer-run objective.

Mish: What a bunch of self-serving nonsense. Higher asset prices have primarily benefited the wealthy. For discussion, please see Who Won? the 93% or the 7%? Why? 

Moreover, Bernanke does not understand the simple math of 2% inflation over time. When wage growth does not keep up, and it hasn’t, huge economic distortions arise along with dependency on food stamps, disability, and other programs. In short, 2% stability, is very destabilizing. I spoke about this at length in Fallacy of Inflation Targeting.

Here is the key chart.

Over time, prices rise, but wages for the masses do not. Worse yet, Bernanke’s cheap money philosophy makes matters worse because it encourages businesses to invest in hardware and software robots that will enable companies to fire more workers.

There are no benefits of artificially low rates, at least to the average worker.

Economist Steve Keen commented on that chart in Exponential Credit Petri Dish; Steve Keen Responds to “World Economic Forum Endorses Fraud” Post

Bernanke: That said, the Committee is aware that a long period of low interest rates has costs and risks. For example, even as low interest rates have helped create jobs and supported the prices of homes and other assets, savers who rely on interest income from savings accounts or government bonds are receiving very low returns. Another cost, one that we take very seriously, is the possibility that very low interest rates, if maintained too long, could undermine financial stability. For example, investors or portfolio managers dissatisfied with low returns may “reach for yield” by taking on more credit risk, duration risk, or leverage. 

Mish: The committee would not recognize risk if it jumped up and spit in Bernanke’s face. Low interest rates have already undermined future financial stability by encouraging “reach for yield” excessive credit risk, duration risk, and leverage. 

Bernanke: Because only a healthy economy can deliver sustainably high real rates of return to savers and investors, the best way to achieve higher returns in the medium term and beyond is for the Federal Reserve–consistent with its congressional mandate–to provide policy accommodation as needed to foster maximum employment and price stability. Of course, we will do so with due regard for the efficacy and costs of our policy actions and in a way that is responsive to the evolution of the economic outlook.

Mish: Bernanke took one last opportunity to hide behind a ridiculous dual mandate while turning a blind eye to the destabilizing asset bubbles it creates.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com 

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