For years we have been warned by Keynesian economists to fear the so-called “liquidity trap,” an economic cul-de-sac that can suck down an economy like a tar pit swallowing a mastodon. They argue that economies grow because banks lend and consumers spend. But a “liquidity trap,” they argue, convinces consumers not to consume and businesses not to borrow. The resulting combination of slack demand and falling prices creates a pernicious cycle that cannot be overcome by the ordinary forces that create growth, like savings or investment. They say that a liquidity trap can even resist the extraordinary force of monetary stimulus by rendering cash injections into useless “string pushing.” Some of these economists suggest that its power can only be countered by a world war or other fortunately timed event that leads to otherwise politically unattainable levels of government spending.

Putting aside the dubious proposition that the human desire to strive and succeed can be permanently short-circuited by an economic contraction, and that modest expected price declines can quell our desire to consume, the Keynesians have overlooked a much more dangerous and demonstrable pitfall of their own creation: something that I call “The Stimulus Trap.” This condition occurs when an economy becomes addicted to the monetary stimulus provided by a central bank, and as a result fails to restructure itself in a manner that will allow for robust, and sustainable, growth. The trap redirects capital into non-productive sectors and starves those areas of the economy that could lead an economic rebirth. The condition is characterized by anemic growth and deteriorating underlying economic fundamentals which is often masked by inflation or asset price bubbles (I look at how stimulus has impacted the U.S. stock market in the March edition of my newsletter).

Japan has been caught in such a stimulus trap for more than a decade. Following a stock and housing market boom of unsustainable proportions in the 1980s, the Japanese economy spectacularly imploded in 1991. The crash initiated a “lost decade” of de-leveraging and contraction. But beginning in 2001, the Bank of Japan unveiled a series of unconventional policies that it describes as “quantitative easing,” which involved pushing interest rates to zero, flooding commercial banks with excess liquidity, and buying unprecedented quantities of government bonds, asset-backed securities, and corporate debt. Although Japan has been technically in recovery ever since, its performance is but a shadow of the roaring growth that typified the 40 years prior to 1991. Recently, conditions in Japan have deteriorated further and the underlying imbalances have gotten progressively worse. Yet despite this, the new government is set to double down on the failed policies of the last decade.

I believe that the United States is now following Japan into the mire. After the crash of 2008, we implemented nearly the same set of policies as did Japan in 2001. In the past two years, despite the surging stock market and apparently declining unemployment rate, the size and scope of these efforts have increased. But as is the case in Japan, we can clearly witness how the stimulus has perpetuated stagnation. (See my analysis of the new plans of the Japanese government).   

In 2008, one of the country’s biggest problems was that we had over-leveraged too many non-productive sectors of the economy. For instance, we irresponsibly lent far too much money to people to buy over-priced real estate. Since then, the problem has gotten worse. Currently the process of writing, securitizing, and buying home mortgages has been essentially nationalized. Fannie Mae and Freddie Mac (which are now officially government agencies) write and package the vast majority of new home mortgages, which are then guaranteed (almost exclusively) through the Federal Housing Administration, and then sold to the Federal Reserve. According to a tally by ProPublica, these government entities bought or insured more than nine out of 10 home mortgages originated last year, a $1.3 trillion business. Compare this to 2006, when the government share was only three in 10. As a result of this, our lending is far more irresponsible than it has ever been.

In the fourth quarter of 2012, 44% of all FHA borrowers either had no credit score or a score of 679 or lower. In addition, the overwhelming majority of FHA guaranteed loans are being made at 95% or greater loan-to-value. This means down payments are an afterthought. Under the FHA’s Home Affordable Refinance Program (HARP), loans are now even extended to underwater borrowers whose mortgages may be worth far more than their homes. As a result, the FHA could be exposed to enormous losses in the event of future housing market downturns. Such an outcome would be likely if mortgage interest rates were ever to rise even modestly from their current low levels. 

In fact, losses on low-quality mortgages have already left the FHA with $16 billion in losses. To close the gap, it has had to raise the insurance premiums it charges to borrowers. With those premiums expected to rise again next month, many fear that marginal borrowers could be priced out of the market. But rather than learning from its mistakes, the government just announced that Fannie Mae would pick up the slack, lowering its lending standards to match the ones that had led to losses at the FHA. In other words, we haven’t solved the problem of bad lending – we have simply made it bigger and nationalized it. 

The overall financial sector is equally addicted to cheap money. Banks have seen strong earnings and rising share prices in recent years. But their businesses have largely focused on the simple process of capturing the spread between the zero percent cost of Fed capital and the 3% yield of long term Treasury debt and government insured mortgage backed securities. As a result, banks are not making productive private sector loans to businesses. Instead, the capital is being used to pump up the already bloated housing and government sectors.

Corporate profits are indeed high at the moment, but much of that success comes from the extremely low borrowing costs and extremely high leverage. Investors chasing any kind of yield they can find are pouring money into companies with dubious prospects. This January, yields on junk rated debt fell below 6% for the first time. Currently they are approaching 5.5%. Consumers are using cheap money to buy on credit. Savings rates are now hitting post-recession lows.

Lastly (but certainly not least), the Federal government is now totally dependent on the Fed’s largess.  Without the Fed buying the bulk of Treasury debt, interest rates would likely rise, thereby increasing the cost of servicing the massive national debt.  While Congress and the media have focused on the $85 billion in annual cuts earmarked in the “Sequester,” an increase of Treasury yields to 5% (3% higher than current levels) on the $16 trillion in outstanding government debt would translate to $480 billion per year of increased interest payments. Such an increase would force a tough choice between raising taxes, cutting domestic spending or reducing interest payments sent abroad for debt service. If foreign creditors begin to doubt that America has the resolve to make the hard choices, they may refuse to roll-over maturing obligations, forcing the government to actually repay principal.  With trillions maturing each year, actual repayment is mathematically impossible.

But for now most people feel that the transition is underway to a healthy economy. The prevailing debate is when and how the Fed will let the economy fly on its own. Many of the top market analysts have great faith that Ben Bernanke can pull the monetary tablecloth off the table without disturbing the dishes. Those who hold this view fail to understand that the United States is caught in a stimulus trap from which there is no easy exit. How can the Fed wean the economy from stimulus when stimulus IS the economy?  In truth, the trick Bernanke must actually perform is to pull the table out from beneath the cloth, leaving both the cloth and the dishes suspended in air. (Read how Iceland confronted its own crisis while avoiding the stimulus trap).

What would happen to the Treasury market if the Federal Reserve, by far the biggest buyer and largest holder of Treasury bonds, became a net seller? Who will be there to keep the sell off from becoming an interest rate spiking rout? It may sound absurd to those of us who remember the economy before the crash, but our new economy can’t tolerate “sky high” rates of four or five percent. What would happen to the housing market and the stock market if interest rates were to return to those traditional levels? The red ink would flow in rivers. With yields rising and asset prices falling, how long would it take before the Fed reverses course and serves up another round of stimulus? Not long at all.

That means any talk of an exit strategy is just that, talk.  Not only can the Fed not exit, but it will have to delve further into the stimulus abyss.  While doing so, the Fed will continuously insist that the exit lies just behind an ever moving horizon. It will repeat this mantra until a currency crisis finally forces a painful exit.

Unfortunately, the longer the Fed waits to exit, the more painful the exit will be. But trading long-term pain for short-term gain is the Fed’s specialty. In the meantime, Wall Street watches in uncomprehending stupor as the economy settles deeper and deeper into the stimulus trap. 

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

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! 

And be sure to order a copy of Peter Schiff’s recently released NY Times Best Seller, The Real Crash: America’s Coming Bankruptcy – How to Save Yourself and Your Country.  

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1.   Please click here now. That’s a link to a nice article published by Canada’s Globe & Mail newspaper. It     shows that gold company insiders are aggressive buyers of their own stock, at current price levels.

2.   In the big picture, that’s great news for gold stock investors!

3.    Unfortunately, while long term market fundamental & technical indicators suggest that gold offers tremendous value to investors, the daily charts of gold and related assets… seem to be presenting quite a different picture.

4.    Please click here now.  You are looking at the daily T-bond chart.  Quantitative easing is a big factor in this crisis.  Generally speaking, as long as QE is in play, when bond prices rise, gold prices rise.

5.    So, unless the T-bond can rise above HSR at about 145, gold will likely have a very hard time making upside progress.

6.   Please click here now.  That’s the daily gold chart, and I’d like you to make careful note of the position of my “stokeillator” (Stochastics 14,7,7 series). 

7.    Technically, gold is beginning to become overbought, in the short term.  If you make the assumption that the T-bond can make it to the 145 level, it’s reasonable to project a little higher gold price, too. 

8.    That would make gold even more technically overbought than it is now, and quite vulnerable to a more substantial sell-off.

9.   A week ago, as the gold price arrived in the $1615 zone, I suggested that it had broken out upside, from a symmetrical triangle.  I said that it was due to pull back, immediately, to about $1585.

10.   Gold’s rise did stop there, in that $1615 area.  Yesterday it fell to $1590, and then blasted higher, to about $1608. 

11.   My concern now is not that it pulled back to $1590, but how it did so.  Please click here now. That’s the hourly bars gold chart, and you can see that a head & shoulders top pattern formed.

12.  The neckline has broken.  To abort the pattern, and put the bulls back in control, gold needs to rise over the right shoulder high, which sits at about $1615.

13.  That hasn’t happened.  Instead, gold has started a fresh decline this morning, and is doing so against the background of that overbought “stokeillator”, on the daily chart.

14.  Gold needs an immediate-term fundamental catalyst of size, to “blast” it over daily chart HSR at $1617, and $1627-$1640. 

15.   There are quite a few key economic reports scheduled for release today; hopefully one of them is just what the gold doctor has ordered.

16.  Silver is also having a tough time right now, and a lot of market timers are becoming increasingly frustrated.  It seems to be almost incapable of mounting a significant rally.

17.  Please click here now.  Silver is trading within the boundary lines of a near-perfect symmetrical triangle. 

18.  Aggressive traders should watch for a move beyond those lines, as a breakout signal. 

19.  The triangle suggests that silver should either fall to the $27 area, or rise to about $31. 

20.  Technically, the odds are about 67% that the break comes to the downside, but there is another technical event that needs to be considered, before you get too glum!

21.   Please click here now.  That’s another look at the daily silver chart.  Note the bullish wedge pattern that is forming.  It’s defined by the converging blue trend lines.

22.   This wedge indicates that regardless of how the triangle pattern is resolved, a trending move to the upside is becoming much more likely.

23.  Please click here now.  That’s the weekly GDXJ chart.  It’s very possible that after breaking out from a huge bull wedge, junior gold stocks (and silver stocks) have simply pulled  back to the supply line (in green here) of that huge wedge, and done so in a narrow drifting parallel channel. Watch the upper blue supply line for a breakout.  It may hold more significance that it appears! 

24.   I’m more net long gold & silver stocks that ever, and company insiders clearly are taking a similar approach, at this point in market price and time!  Be aware that insider buying doesn’t necessarily translate into an immediate parabolic move to the upside.  Patience continues to be the gold stock investor’s very best friend!

Mar 26, 2013

Stewart Thomson
Graceland Updates
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Stewart Thomson is no longer an investment advisor. The information provided by Stewart and Graceland Updates is for general information purposes only. Before taking any action on any investment, it is imperative that you consult with multiple properly licensed, experienced and qualifed investment advisors and get numerous opinions before taking any action. Your minimum risk on any investment in the world is 100% loss of all your money. You may be taking or preparing to take leveraged positions in investments and not know it, exposing yourself to unlimited risks. This is highly concerning if you are an invetor in any derivatives products. There is an approx $700 trillion OTC Derivatives Iceberg with a tiny portion written off officially. The bottom line:

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Last week I noted, “Another week, another new all-time high for the Dow,” and I wondered what might possibly “derail” the bullish Market Psychology that has driven stocks higher since mid-November…a rally reminiscent of the fabulous Nasdaq run for the roses in 1999…this time driven by extraordinary Central Bank “money printing.” I speculated that Europe might be the catalyst…specifically Italy…following an election where voters repudiated the “Austerity” forced upon them by the EuroElite…I thought Italy might cause Market Psychology to waver…

But…rather than Italy…a European “Black Swan” appeared…Cyprus…another sovereign highlighting the “North/South” divide of Europe…a poor Southern country with “poor” financial management skills (no kidding!)…that now desperately needs aid…and the EuroElite, as a condition of providing “aid” demanded that all depositors in Cyprus banks suffer a “haircut”…lose some of the money that they have in Cypriot banks. (Note: On March 23/13, one week after the “haircut” story broke, German Finance Minister Wolfgang Schaeuble says that it was the Cypriot Government’s idea to levy a “haircut” on accounts of less than Euro 100.000…that the idea did not come from Germany, the EU or the IMF. Given the emotional impact of the “haircut” story it seems odd that the EuroElite would wait a week before trying to “set the record straight.” It does appear, however, that regardless of who came up with the idea of a “haircut” that the EuroElite was willing to go along with it.)    

This “depositor haircut” idea from the EuroElite was a game-changer for me. Yes, I know the Cypriot banks were over-stuffed with foreign [especially Russian] money…and as a result of those deposits…which dwarfed the Cyprus GDP…the banks…and here we can blame poor choices for compensating bank employees…chose to invest huge sums in Greek bonds…which was a really BAD investment idea… BUT…the EuroElite demanded that every depositor in Cyprus banks must suffer a haircut as a condition of “aid” being granted to the country.

Talk about a breach of trust.

Remember over the last two years when bank runs in Greece and other southern countries were taking place…citizens rightly realized that their country might drop out of the Euro and revert to national currencies…with significant devaluations… the citizens and corporations decided to move their assets to a “safer” place…Germany or Switzerland…and that the “bank runs” were cooled by talk of depositor guarantees…and statements such as, “We will do whatever it takes,” from the head of the ECB.

So now…having seen these depositor haircut demands…if you are a citizen or corporation in Spain or Portugal or Italy…and you have money in the local bank…you have to ask yourself…or be prepared to meet with your corporation’s executive committee and answer their questions…”What happens to the money we have in the local bank if our government asks the EuroElite for aid? Will we get a depositor haircut? Have we moved our money to a “safer” jurisdiction in advance of that possibility? And if not, why not?”

Wouldn’t it be an awful feeling if your government just took some of your money…money you thought was safe in your local bank…and wouldn’t you be the village idiot if you saw them take your neighbours’ money and you just left yours sitting there?

Got GOLD?

 …..read more HERE