Category Archives: Economy and Meltdown

Nationwide "End the Fed" Protests … Libertarian Candidate Sues to Break Into Presidential Debates


Nationwide Protests to “End the Fed” This Weekend

 

There will be nationwide protests this weekend calling for an end to the Fed

The “official” End The Fed 2012 website lists protests at the following Federal Reserve Banks:

(There are 12 main Federal Reserve Banks, but quite a few additional branch offices.) Or check out this Facebook page.

Remember, numerous economists say that we must end or substantially rein in the Fed.

Most Americans agree.

Both liberal and conservative protesters – Occupy and Tea Party alike – have railed against the unchecked power of the Federal Reserve.

Indeed, the support among the public and House for auditing the Fed is almost 100% … but Democratic Senate leader Reid has vowed to kill an audit (even though he previously supported it).

Third Party Candidate – Who Is On the Ballot In All 50 States – Files Lawsuit Demanding Inclusion in Presidential Debates

 

The American people are sick of both the Republican and Democratic party, and yearn for something different.  See this, this and this.

No wonder … the mainstream Democratic and Republican parties agree on most matters which affect American lives the most directly.  Here, here, here here and here.  And – as this 4-minute video shows – they both ignore the desires of their own bases.

Obama and Romney are virtually indistinguishable on most core issues. For example: jobs, freedoms and favoring fatcats instead of the little guy.

The Founding Fathers warned – at the very birth of our nation – against a two-party system as being destructive to liberty.

For example, the Republican and Democratic parties have long formed Gentlemen’s agreements – through the “Presidential Debate Commission” – on what topics are “off-limits” (and which journalists can even ask questions) during presidential debates:

The Presidential Debate Commission (PDC) is run by former chairmen of the Democratic and Republican parties. The debates almost always exclude third-party candidates.

Gary Johnson is looking to change that.

The Libertarian candidate for president – who will be on all 50 states’ ballots this election, and who is currently polling at around 5% of the vote – Johnson (and his vice presidential running mate, retired judge Jim Gray) have filed an antitrust lawsuit against the PDC for excluding them from the debates:

The Gov. Gary Johnson/Judge Jim Gray Campaign has filed an antitrust lawsuit against the Democrats, Republicans, & the Commission on Presidential Debates for antitrust and anticompetitive acts. The voters deserve competition!

The lawsuit comes after the PDC’s failure to respond to the following letter from Johnson last month:

Dear [Commission Member]

I am writing to request that the national Commission on Presidential Debates reconsider your current – and exclusionary – requirements for participation in this Fall’s all-important Presidential and Vice-Presidential debates.

I am well aware of the history and genesis of the Commission, including the reality that it was created largely by the respective national leadership of the Democrat and Republican Parties. While I respect and understand the intention to provide a reasonable and theoretically nonpartisan structure for the presidential debate process, I would suggest that the Commission’s founding, organization and policies are heavily skewed toward limiting the debates to the two so-called major parties.

That is unfortunate, and frankly, out of touch with the electorate. You rely very heavily on polling data to determine who may participate in your debates, yet your use of criteria that are clearly designed to limit participation to the Republican and the Democrat nominee ignore the fact that many credible polls indicate that a full one-third of the electorate do not clearly identify with either of those parties. Rather, they are independents whose voting choices are not determined by party affiliation.

That one-third of the voters, as well as independent-thinking Republicans and Democrats, deserve an opportunity to see and hear a credible “third party” candidate. I understand that there are a great many “third party” candidates, and that a line must be drawn somewhere. However, the simple reality of our Electoral College system draws that line in a very straightforward and fair way – a reality that is reflected in your existing criteria. If a candidate is not on the ballot in a sufficient number of states to be elected by the Electoral College, it is perfectly logical to not include that candidate in a national debate. If, on other hand, a candidate IS on the ballot in enough states to be elected, there i s no logic by which that candidate should be excluded.

Nowhere in the Constitution or in law is it written that our President must be a Democrat or a Republican. However, it IS written that a candidate must receive a majority of the votes – or at least 50% – cast by electors, and that any candidate who does so, and otherwise meets the Constitution’s requirements, may be President.

As the Libertarian Party’s nominees for Vice-President and President, Judge Jim Gray and I have already qualified to be on the ballot in more than enough states to obtain a majority in the Electoral College, and we are the only candidates other than the Republican and Democrat nominees to have done so, or who are likely to do so. In fact, we fully intend and expect to be on the ballots of all 50 states and the District of Columbia.

However, the Commission has chosen to impose yet another requirement for participation: 15% in selected public opinion polls. Unlike your other requirements, this polling performance criterion is entirely arbitrary and based, frankly, on nothing other than an apparent attempt to limit participation to the Democrat and the Republican.

Requiring a certain level of approval in the polls has nothing to do with fitness to serve, experience or credibility as a potential President. Rather, it has everything to do with the hundreds of millions of dollars available to and spent by the two major party candidates, the self-fulfilling bias of the news media against the viability of third party candidates, and an ill-founded belief that past dominance of the Republican and Democrat Parties should somehow be a template for the future.

In all due respect, it is not the proper role of a non-elected, private and tax-exempt organization to narrow the voters’ choices to only the two major party candidates – which is the net effect of your arbitrary polling requirement. To the contrary, debates are the one element of modern campaigns and elections that should be immune to unfair advantages based upon funding and party structure. Yet, it is clear that the Commission’s criteria have both the intent and the effect of limiting voters’ choices  to the candidates of the two major parties who, in fact, created the Commission in the first place.

Eliminating the arbitrary polling requirement would align the Commission and its procedure for deciding who may participate in the critical debates with fairness and true nonpartisanship, which was the purported intent behind the Commission’s creation. As of right now, eliminating that requirement would not disrupt the process or make it unmanageable. Rather, it would simply allow the participation of a two-term governor who has more executive experience than Messrs. Obama and Romney combined, who has garnered sufficiently broad support to be on the ballot in more than enough states to achieve a majority in the Electoral College, and who, without the help of party resources and special interests, has attracted enough financial support to qualify for presidential campaign matching funds.

I urge and request you to remove the partisanship from the debates, and allow the voters an opportunity to hear from all of the qualified candidates – not just those who happen to be a Democrat or a Republican.

Thank you.

Governor Gary Johnson

 

Apple's OEM FoxConn Launching Its Own Retail Stores


Two weeks ago, when summarizing the state of the US vs China escalating patent war (for now manifesting itself in the courtroom brawl between Apple and Samsung, but soon to drag many more comparable companies down in drawn out litigation), we observed that while AAPL may have the upper hand, iPhone 5 map fiasco notwithstanding, that “the Chinese politburo can one day decide to pull FoxConn’s operational license, in the process bankrupting AAPL overnight” if China really wanted to turn the tables. Obviously, this was the “thought experimental” MAD outcome which leads to loses for everyone involved: both Apple and China (where Apple’s contract manufacturer FoxConn employs over 1 million workers). There is one other alternative: that FoxConn, by now having reverse engineered the peak of Apple’s brilliance (whose latest evolutionary step was “lighter” and “longer”, which anyone could have come up with), decides to brave it alone, and instead of being a contract manufacturer, to simply slap on a FoxConn sticker, a la Acer and ASUS, and sell all Apple-equivalent products at 50% off while collecting all the revenue. Impossible, you say, Apple would never allow it? It is already happening, first in high-growth Brazil, where FoxConn is now launching its own stores.

From Valor International:

Chinese contract manufacturer Foxconn, which produces Apple’s Iphone, will create a direct to consumer store at its new R$1 billion factory in Itu, in the state of São Paulo, offering several of the brands manufactured by the company. The plant’s project was presented Thursday in the São Paulo’s state government headquarters. It will be the 9th Foxconn factory in Brazil, but the first not to be created in leased land, representing a more permanent home for the Chinese giant. The new factory will employ between 5,000 to 10,000 people up to 2016.

As to what products will FoxConn will sell, it is for now unclear but will likely focus initially on merely being a reseller of Apple and other beneficiaries of its OEM supremacy. If this is the route Hon Hai’s factories decide to go, it means that the “magic” of the Apple retail experience will soon be rapidly commoditized, once the inventory of the Apple store is replicated down the street at another retail location, one which has its own selling culture.

One thing is certain: if and when it so chooses, FoxConn having reverse engineered a stunning half of the world’s entire OEM electronic device product flow, will have its choice of what it wants to bring direct to retail. As a reminder:

Apple’s position as the world’s leading computing device company has driven manufacturing partner, Foxconn, to seize an astonishing 50 per cent of the world’s electronic manufacturing services market, said iSuppli today. Half of the world’s production of consumer electronics devices come from a Foxconn factory, with Apple’s production demand driving this record, iSuppli explains. This is now an Apple world.

 

“Foxconn’s customers are some of the hottest companies in the electronics business today, most notably Apple,” said Thomas Dinges, iSuppli associate. “As Apple and others have gained share, so has Foxconn.”

 

With revenue of $17.1 billion, Taiwan’s Foxconn, aka Hon Hai Precision Industries, was the dominant EMS provider in the first quarter of 2010, dwarfing No. 2 player Flextronics International, which posted revenue of $5.9 billion during the same period. Apple represents the fastest-growing customer for Foxconn, which manufactures products including the iPad and the iPhone 4.

In simple terms it’s called “economy of scale”, or in this case “monopoly”, and soaring leverage to do whatever FoxConn chooses. Even if that means taking on some of its core OEM customers: after all where are they going to go?

Which begs the question: what happens to Apple margins and future innovation cycle if it ever were to lose its primary OEM channel should the infighting between the US, Korea (Samsung) and China (HTC), aka West vs East, continue escalating? Not to mention its $600 billion market cap.

And even if FoxConn merely becomes a reseller of Apple and other brands, how long until people realize that at the end of the day absent the creative genius that took Apple to the pinnacle of electronic device innovation under Steve Jobs, all it really is, is a sticker of a fruit affixed to a bunch of products made and packaged by a company operating out of China, which also is the beneficiary of the GDP boost courtesy of iPhone 5 sales, not the US – all the US consumer gets is the credit card bill to fund Chinese economic growth.

The Zero Hedge Daily Round Up #131 – 09/21/2012


I’ve got all these great ideas for insightful pieces, but I just can’t bring myself to write them. Young people have a mind of their own, albeit obscured by internet pornography and the music of Katy Perry and Pitbull. Bring on virtual reality!

I’m still trying to figure out what might even be vaguely viable. 

I’m going to make a bold statement of Zero Hedge, and claim that a majority of the content on this website is merely a regurgitation or manifestation of a previous article or Zero Hedge idea. 

To all the new people, this may seem insightful and radically different to anything else they’ve experienced in their life.

But after a couple of months, you kinda realise that it’s all the same shit repackaged into a ‘whole new revelation.’

Listen Mr. ZH! I get it, the government is trying to take away my rights. No really, I get it. But do I really need to read about it every day, just in some other slight variation?

Once you understand the basic premise of collapse, you realise how pointless this website is. A chart depicting America’s demise is great and all, but it’s to be expected, thus redundant. 

Thus, the issue of Zero Hedge lies not within it’s content as a news outlet, rather it’s biased angle. Get rid of the analytical bias and you fix the problem. The issue with this, is that Zero Hedge would no longer be Zero Hedge and people wouldn’t read it. 

Of course, this website caters to a specific reader. Clearly not myself, despite the fact that I do I podcast on it. I’d argue I do it for the comedy and the media, my two other passions. 

It’s great to bicker over how much you hate and feel over a current reigme through this outlet, but informing and influence aside, serves very little purpose to the average reader.

Insight is only relevant if you’re ignorant. If you don’t get it by now from all these uncanny guest posts from people who write the same crap every week, then you’re effectively a moron. 

Interesting, none-the-less. Our burning desire to learn. 

My two cents. 

This is the Zero Hedge Daily Round Up. 

http://www.youtube.com/watch?v=20qkSZb0V_Q

1. Greece Acharnes region suspends operations: No cash. 2. First Spanish bailout conditions. 3. South African gold miners in talks. 4. EU/IMF to delay report until after election. 5. Illinois prepare for federal bailout? 6. Gold baby! 7. Police kills protester on Government appointed holiday. 8. Apple success: Line waiters. 9. Romney 2011 tax filing. 10. NYSE volume 13 month highs. 11. LOCKHART QUOTE. 

Alternatively, you can download the show as a podcast on iTunes or any RSS capable device.

RSS Feed: http://thefinancialreality.podomatic.com/rss2.xml

Julius Reade

P.S. For those paranoid about the government:

http://thefinancialreality.podomatic.com/enclosure/2012-09-21T17_47_46-0…

We're Entering Another Economic Collapse… Right As Inflation Hits LIft Off!


 

By all counts, the latest ISM (a measure of manufacturing in the US) was a complete and total disaster. In August the ISM hit 49. Anything below 50 is considered a recessionary rating.

 

However, things are even worse below the surface. The ISM is made up of several components. Its Production component is back to May 2009 levels. The New Orders component is back to April 2009 levels.

 

And worse of all, Prices Paid is up to 54, up from a reading of just 39 in July.

 

In simple terms this tells us that inflation is hitting “lift off” in the US at the very same time that we are entering a recession that could be on par with that of 2008. And with corn and soybean prices at or near record highs, we could be on the verge of a stagflationary disaster combined with a food crisis at the very same time.

 

We get additional confirmation of a major economic contraction from corporate earnings. Recently we’ve seen earnings forecast cuts from Fed Ex, Bed Bath and Beyond, Proctor and Gamble, Adobe, Starbucks, McDonald’s and more.  Indeed, when you remove financials, S&P 500 earnings FELL year over year for 2Q12.

 

This is hardly indicative of a strong economy. The fact a record number of Americans are on food stamps doesn’t bode well either. And the Rasmussen Employment Index indicates worker confidence is at levels not seen since the FALL OF 2008!

 

What does this tell us? That the US Federal Reserve has failed miserably to generate an economic recovery, despite spending trillions of Dollars in bailouts and expanding its balance sheet to $2.8 trillion in size (it was just $800 billion before the Crisis):

 

  1. Median income today is lower than it was during at the end of 2009 (when the recession supposedly ended)

 

  1. The percentage of Americans on food stamps has increased from 11% to nearly 15%

 

  1. The average unemployment duration has increased from 30 weeks to nearly 40 weeks

 

  1. The civilian employment to population ratio hasn’t budged

 

 

I don’t see any of the above pointing towards a “recovery.”

 

To top it off, the ECRI (which is a much better predictor of recessions than the National Bureau of Economic Research or NBER) believes that the US re-entered a recession in June.

 

And this is happening at a time when inflation is soaring due to the Fed’s money printing/ loose monetary policies. Agricultural commodities have risen some 20% since the last recession supposedly “ended.” Over the same time, Oil has risen by nearly $30 per barrel.

 

There’s a word for an economic contraction marked by high inflation: it’s called stagflation, and the US is in it big time.

 

Folks, this is the reality we’re dealing with. The Fed has gone “all in” in its efforts to stop the debt implosion… and it’s failed. All it’s done is unleashed an even more serious inflationary storm than the one we were already facing.

 

The time to start preparing is now. The printers are running. The Great Currency Debasement has begun. Some folks will walk out of this mess winners. Most will walk out as losers.

 

At Phoenix Capital Research, we’re taking steps to insure our clients are among the winners. We have a host of FREE Special Reports devoted to helping readers prepare for the coming Debt Implosions in both the US and Europe.

 

We also feature a special report devoted to inflation as well as which investments will perform best during periods of high inflation (periods like the one we’re entering).

 

All of this is available 100% FREE at www.gainspainscapital.com

 

Best Regards,

 

Phoenix Capital Research

 

 

 

How to Measure Strains Created by the New Financial Architecture


Via Eric Fine of Van Eck Global,

We believe an unsustainable new global financial architecture that arose in response to the US and European financial crises has replaced an older, more sustainable, architecture. The old architecture was crystallized in Washington- and IMF-inspired policy responses to the numerous sovereign defaults, banking system failures, and currency collapses. Most importantly, the previous architecture recognized limits on fiscal and central bank balance sheets. The new architecture attempts to ‘back’, perhaps unconsciously, the entire liability side of the global financial system. This framing is consistent with a purely political—institutional stylized—fact that it is nearly impossible to penetrate the US political parties if the message is that there are limits to their power…or that their power requires great effort and sacrifice. This is why Keynesians (at least US ones) who argue there are no limits to a fiscal balance sheet are so popular with Democrats, and why monetarists (at least US ones) who argue there are no limits to a central bank balance sheet are popular with (a decreasing number of) Republicans. Party on! Again, nobody chooses hard-currency regimes – they are forced on non-credible policymakers. Let me put it more positively. If politicians want the power of fiat money, let alone the global reserve currency, they need to behave differently than they have.

 


Implications for Gold:

If the old architecture is maintained, in which only money and demand deposits (M1) are “backed” by gold, the gold price which equates this US central bank liability to gold reserves is roughly $9,000 ($8,612); in Europe, $18,000 ($17,608).

 

If the new architecture in which guarantees of off-balance sheet derivative liabilities are backed (our M-?), in addition to portions of M2, the gold price that equates this backing is multiples of the $37,000 price—a dangerous harbinger for inflation and/or systemic collapse

 

M-?: How to Measure Strains Created by the New Financial Architecture

The analysis below examines how one would look at reserve-currency balance sheets in a “scorched earth” scenario in which confidence in the reserve-currency country becomes questionable. Because it is the reserve currencies themselves being examined as “at-risk”, we use gold prices. None of the prices mentioned herein are actual target prices for gold. The numbers generated are measure of the strains on central bank balance sheets, and of strains that could potentially be put on central bank balance sheets based on future policymaker decisions.

Overview

  • An unsustainable new global financial architecture that arose in response to the US and European financial crises has replaced an older, more sustainable, architecture. ?? Most importantly, the previous architecture recognized limits on fiscal and central bank balance sheets. The new architecture attempts to “back”, perhaps unconsciously, the entire liability side of the global financial system. ?? Under the old architecture, in which only money and deposits (M11) are “backed”, the strain on the central bank balance sheet was much lower than it is under the new architecture.
  • The old architecture, in which only money and demand deposits (M1) are “backed” (and for our exercise, by gold), the gold price which equates this US central bank liability to gold reserves is roughly $9,000 ($8,612); in Europe, it is roughly $18,000 ($17,608).
  • If M2 is the monetary aggregate/liability which is ‘backed’ in the US, the dollar price of gold that equalizes this backing is $37,000, and for the EU, $32,000. This is a big increase in the strain on the US central bank’s balance sheet resulting from just one element of the unrecognized new architecture (remembering that parts of M2 were “temporarily” guaranteed by US policy in our recent crisis).
  • The real problem with the untested and unacknowledged new architecture is that it has created a new Federal Reserve liability, that I will call M-?. At the time, secret lending to global banks was “flash money”, designed to prevent a run on debt and derivative liabilities at US and other banks.
  • If the new architecture in which guarantees of off-balance sheet derivative liabilities are backed (our M-?), in addition to portions of M2, though, the gold price that equates this backing is multiples of the $37,000 price—a dangerous harbinger for inflation and/or systemic collapse.
  • It should be noted that, so far, Europe is avoiding guaranteeing the entire left side of its financial system, so if their conservative policy choice resists international pressures for US-style expansion (the “new architecture”), the strain as measured by this framework will be much less dramatic.
  • The potential result of all of this is if you think it is politically and practically sustainable for the Fed to back-stop a $700+ trillion derivatives market, everything is fine; if you think it is not sustainable, everything is not fine.
  • If this new architecture holds, capital controls would be an almost irresistible response on the part of status quo policymakers, undermining the reserve-currency status of many currencies, and boosting gold as a reserve asset and money.
  • There is some hope from our framing of this new architecture. Namely, it points to how easily confidence could be restored if M-? is not allowed to become a normal liability of the central bank (or the fiscal authority).
  • It is important to emphasize that no one chooses hard currency regimes such as gold standards – they are forced on non-credible policymakers. Put more positively, if politicians want the power of fiat money, let alone the global reserve currency, they need to behave differently than they have.

I believe an unsustainable new global financial architecture that arose in response to the US and European financial crises has replaced an older, more sustainable, architecture. The old architecture was crystallized in Washington- and International Monetary Fund-inspired policy responses to the numerous sovereign defaults, banking system failures, and currency collapses that characterized Northern Europe and Latin America in the ‘80s, Eastern Europe in the ‘90s, and Asia in the late ‘90s, among others. The Chinese menu of policy responses insisted upon by the IMF (or, in some rare cases, by responsible national-level policymakers themselves) included the items outlined in the subsequent paragraphs.

Most importantly, the old architecture put a sovereign default explicitly on the table if there was a “debt overhang” – it was considered senseless to provide liquidity if solvency could never reasonably be achieved. Second, deep structural reforms were required to ensure that growth would eventually arrive to maintain solvency and sustainability. Third, a plan for fiscal balance was required, for self-evident reasons (and by self-evident, I suppose I must exclude US-style Keynesians, for whom fiscal sustainability is not a self-evident requirement). Fourth, independent central banks that would never (and usually it was never again) become the endless lender to the fiscal authority were required, and they would often have to maintain high interest rates to prove their independence and firmly anchor inflation expectations. A final element was open capital markets to lubricate trade and growth and encourage a competitive banking and commercial system. This sounds fairly reasonable, especially since the countries that took advantage of this policy menu are now our creditors, have safer banking systems and more sustainable fiscal positions, and prevented or overcame social meltdown (generally speaking). They also outperformed us during the latest crises and some are experiencing inflows of flight capital and human capital.

To the extent that there were deviations from a totally freemarket- determined architecture in which bad decisions were punished by markets and the new last resort liquidity providers, it involved guaranteeing bank deposits to prevent society-wide panic. This was a widely accepted (and perhaps subsequently over-extended) conclusion from Milton Friedman’s study of the US Depression. If a bank had too many non-deposit liabilities to make a deposit guarantee credible, those liabilities would take a hit and equity could go to zero, and senior unsecured debt could take hits (in exchange for equity). After all, if there were no pain to reckless lenders, the reckless lending would return. Off-balance sheet liabilities?… don’t even consider putting them in the way of depositor confidence. It helped that in many of these crisis-toughened countries, the respect for societal equity was such that protecting those wealthy enough to own bank equity or debt, and not a simple depositor, was a non-starter. In any case, all of these hits to bank capital structure were designed to strengthen deposit guarantees —depositors knew there were multiple financing sources available well before we got to the level of deposits.

Before describing the biggest departure from this more sustainable orthodoxy, let us first acknowledge that when the US experienced its crisis in 2008, not only did the US not avail itself of a single item from the policy menu I just described, but we created a new entitlement program that was not financed (my point is not about the merits of healthcare, only on its lack of financing). We did nothing on structural reform, and neither party has a long-term fiscal plan comparable to those we insisted on in crisis-stricken countries that came to “us” (a definition in which I incorporate the IMF) for liquidity. Let us similarly acknowledge the fact that Fannie Mae and Freddie Mae’s gross (granted, not net) liabilities are roughly equal to our entire national debt. This is noteworthy, as such off-balance sheet fiscal liabilities were common to crisis-torn countries, and we normally insisted that they be recognized as formal liabilities (and then often defaulted on), which we have not done in our crisis. But, my point is not about these more traditional fiscal issues, as they are ultimately not as big as the US central bank’s potential liabilities, and in any case the superficial fiscal issues at least get discussed even by status-quo economists.

The real problem with the untested and unacknowledged new architecture is that it has created a new Federal Reserve liability, that I will call M-?. In the US phase of the crisis, not only were deposit guarantees greatly expanded (by 2.5x), but bank debt was guaranteed by the fiscal authority (in theory, only temporarily). The idea, of course, was that new banking system rules and good fiscal policy would be implemented during the bought time, which has clearly not happened given the greater concentration of too-big-to-fail (TBTF) banks and lack of a fiscal plan. The US banking system (which, post-crisis, generously included speculative entities such as investment banks) has about $15 trillion in liabilities, the largest elements of which are deposits, and their entirety appears to be guaranteed. But wait, there’s more…Bloomberg sued the Fed to clarify the precise amount of theretofore secret loans. Teams of economists are still deciphering the Fed’s dump of thousands of pages (to comply with a Federal judge’s order, after long resistance), and are arriving at numbers up to $16 trillion (roughly equal to US GDP). Huh, that’s strange, secret Fed lending during the crisis might have exceeded the total on-balance sheet liabilities of the US financial system!

These additional guarantees from the monetary authority were “flash money” designed to prevent a run on derivative exposures at US and other banks. Perhaps as a result of “over-learning” from the fallout from Lehman’s collapse—that a default on bank debt and off-balance-sheet derivative liabilities means systemic collapse—the monetary and fiscal authorities ensured that any claim on a bank was met. The loans of up to $16 trillion, plus Fed purchases of risk assets such as mortgage-backed securities, and all the other “stuff” we have read about by now, were enough to prevent the run. I should emphasize that this might have been the right decision, if it were conditioned on the isolation of the speculative activities of a bank from these guarantees in the future, the establishment of moral hazard (at least via firing bank boards and managements, given that bond defaults were deemed unacceptable), a long-term fiscal plan, etc. This was not the case.

As a 14-year veteran of a TBTF investment bank, I distinctly recall the day the Fed’s data dump indicated that my former employer received about $2 trillion in loans (all of which occurred after I had left the firm). I, and many of my former colleagues, assumed that this was a typo. But no correction followed. Why, I asked, would the Fed lend my TBTF investment bank so much? At the firm, I ran emerging markets economics research and then the emerging markets proprietary trading desk. However much I respected my colleagues and our work (which is ‘a lot’), I do not think anyone would have made the case that we were doing anything especially socially useful. Nothing evil, of course, but nothing worthy of taxpayer guarantees, and I certainly expected that the firm would be allowed to fail if it merited failure. It was not, and there were no conditions for such a privileged status.

The result of all of this is if you think it is politically and practically sustainable for the Fed to back-stop a $700+ trillion derivatives market, everything is fine; if you think it is not sustainable, everything is not fine. M-? is that liability. What’s worse is that recent moves to have the derivative liabilities of TBTF banks placed on their deposit-taking subsidiaries brings this very close to the fiscal authority. Instead of the Fed being on the hook, the FDIC and US Treasury will be. It is no surprise that the Fed supports such moves – who would want to be around the next time investors worry about counterparty risk and more than the previous up-to-$16 trillion in “flash money” required to prevent a run on liabilities? Who would want to explain to depositors that their guarantee is equal to a derivative counterparty’s? Who would want to explain that food stamps are being curtailed due to infusions from the fiscal authority into these bank liability guarantees? Who would want to explain that national defense spending is superseded by bank debt, and that the dollar might not remain the global reserve currency? I pity the academics, policymakers and politicians who will take responsibility for this scenario, though I suppose none will. The refrain will be that policy didn’t do enough borrowing and spending, and/or that the central bank didn’t expand its balance sheet enough.

As an aside, many will rightly argue that the net amount of these derivatives is by definition much lower. There is a counterparty on one side, and on the other, which can often be collapsed to zero, assuming the profit/loss is booked properly. The problem with this logic is that it assumes, in the daisy chain of counterparties, no counterparty will go down, and that the books are marked properly. We believe, and argue throughout this article, that the financial system is not sustainable. Even current market guides, as distorted as they are, show high credit spreads for TBTF financial institutions, and these discount rates are not(!) used to reduce the value of a derivative with that institution. As a result, we will have to discover the precise amount of the net liability via recognized insolvencies at financial institutions. By the way, this daisy chain crosses borders, and thus any one country’s financial authority. We argued above that the Fed has so far taken on the job of guaranteeing this daisy chain, which is why so many foreign banks received Fed support, and why the ECB gets swap lines from the Fed despite the Euro being, or pretending to be, a reserve currency in the “new architecture” mold of the US.

There is great hope from the preceding framework, namely, it points to how easily confidence could be restored if M-? is not allowed to become a formal liability of the central bank, and gold becomes the reserve asset. We have been talking about unsustainable liabilities…how are we talking about gold as the reserve asset? Let me explain. Gold standards are the functional equivalent of currency boards. Currency boards/hard-money standards come about when trust in the fiscal and monetary authorities has eroded. The most typical cause for the many currency boards/hard-money standards I have experienced is one of the following. Most commonly, a central bank becomes perceived as an endless lender to the fiscal authority. Given that the Fed has bought more than half of all US Treasuries issued in the past 12 months, I think it is safe to say that we can check that box. Another route to a hard-money standard is the discovery or creation of unsustainable guarantees for the financial system on the part of the fiscal and/or monetary authority. Check that box, too.

In these scenarios, the fiscal and monetary authorities are conflated. This can be put many ways. In one narrative, citizens lose trust when a central bank asset (Treasuries, for example) becomes viewed as supported/purchased only by a central bank liability (money, deposits…and hopefully nothing else) whose primary purpose is simply to buy that asset. This is one way of describing quantitative easing—printing money to buy Treasuries—and keep the Treasuries paying interest rates that are not market-determined. It could be put another way. Trust is lost when the fiscal authority’s liability (Treasuries) is viewed as unsustainable due to an excess of on- and off-balance sheet guarantees, and whose payment sustainability is only generated by suppressed interest rates on the part of a co-opted (i.e., not independent) monetary authority. The point is whether the Fed has the M-? liability or whether the Treasury eventually assumes it, it doesn’t really matter, as by that stage the fiscal and monetary are conflated and confidence is lost in both government debt (the central bank’s asset) and the country’s money (the central bank’s liability).

How can confidence be restored if confidence declines to “scorched earth” levels? Do not ‘back’ anything other than money and maybe deposits and use a reserve asset—for example, gold—that can not be created by a fiscal authority that has lost trust and credibility. Let us get one thing out of the way: the gold standard is very problematic and easy to attack, but proponents usually frame it as less bad than other regimes given the decisions made across the political spectrum in the US and much of Europe, as well as given the decisions made by policymakers throughout history. They also point out that it has a thousands of years old history as a store of value and, intermittently, as a unit of measure and means of exchange. This framing is consistent with a purely political—institutional stylized—fact that it is nearly impossible to penetrate the US political parties if the message is that there are limits to their power…or that their power requires great effort and sacrifice. This is why Keynesians (at least US ones) who argue there are no limits to a fiscal balance sheet are so popular with Democrats, and why monetarists (at least US ones) who argue there are no limits to a central bank balance sheet are popular with (a decreasing number of) Republicans. Party on! Again, nobody chooses hard-currency regimes – they are forced on non-credible policymakers. Let me put it more positively. If politicians want the power of fiat money, let alone the global reserve currency, they need to behave differently than they have.

I should emphasize that this is a “scorched earth” scenario in which confidence has been severely undermined. Policymakers in the US and Europe will presumably have many opportunities to respond and avoid such an outcome. Moreover, many reservecurrency status countries have achieved this with decades of credibility that has underlined the resultant confidence. As a result of this confidence, the central bank has never really had to “back” anything, other than with confidence-building measures and a very limited number of formal guarantees (such as those given by the fiscal authority on deposits). But, those promises proliferated during our recent crisis, as confidence declined, so it is important to measure this change. Policymaker decisions, moreover, should be made with an appreciation of the degree to which our new architecture is straining the central bank’s and the sovereign’s balance sheets. So far, this is, in fact, happening more transparently and courageously in Europe where at least defaults on sovereign and bank debt are contemplated as alternative financing methodologies, rather than the monetization path of the US. Europe’s problems, we have argued, are more political and game-theoretic. In any case, these “scorched earth” scenarios in which we divide gold reserves by a monetary aggregate are only proxies to measure the stress created by the new architecture…these are not price targets.

Let us start quantifying. If the old architecture is maintained, in which only money and demand deposits (M1) are “backed” by gold, the gold price which equates this US central bank liability to gold reserves is roughly $9,000 ($8,612); in Europe, $18,000 ($17,608). The exhibit below reflects a simple calculation. It divides the central bank liability one chooses to back (here, we’re assuming only physical cash/coins and demand deposits, or M1), by the new “reserve asset” (ounces of gold), and arrives at a price per ounce of gold. The fact that this number is not being obtained in the market is either a sustainable reflection of great confidence in our monetary and fiscal authorities, or an unsustainable one. Also note the US’ strong position relative to other countries. I will not belabor this, as most countries hold dollar-denominated securities as their reserve asset. The calculation for other countries is more complicated than this graph implies. Nonetheless, it highlights the US’ strong position under the old architecture. It also gives policymakers a gauge for the strains on the central bank’s balance sheet under the old architecture.

If M2 is the monetary aggregate/liability which is ‘backed’ in the US, the dollar price of gold that equalizes this backing is $37,000, and for the EU, $32,000. This is a big increase in the strain on the US central bank’s balance sheet resulting from just one element of the unrecognized new architecture. This is an important increase. M2 includes savings and money market accounts; the latter was explicitly guaranteed by US policy during our recent crisis. It has been assumed that this was a temporary one-off guarantee, but that does not seem realistic. In any case, one can judge for oneself whether another bout of systemic crisis will be met with a repeat of such guarantees. If the answer is “yes”, then this new number shows a big increase in strain on the central bank’s balance sheet. I should note that Europe so far is avoiding guaranteeing the entire left side of its financial system, so if their conservative policy choice resists international pressures for US-style expansion (the “new architecture”), the upside to gold prices via their policies are less dramatic.

If the new architecture in which guarantees of off-balance sheet derivative liabilities are backed (our M-?), in addition to portions of M2, the gold price that equates this backing is multiples of the $37,000 price—a dangerous harbinger for inflation and/or systemic collapse. Remember that the up to $16 trillion in Fed loans was “flash money” designed to prevent a run on off-balance sheet liabilities. It is very unlikely that any future run (and runs are a feature, not a defect, of the way fractional-reserve and leveraged banking systems are designed) will be satisfied with such a small amount of “money in the bank window”. As dollar holders (again, including cash in circulation, demand deposits, savings accounts, money market accounts, as well as derivative contract counterparties) start to doubt the currency’s store of value function, and the financial system’s sustainability, they will run on the central bank’s assets. First, perhaps, claiming Treasuries, but soon selling any dollar-denominated paper for real assets from equities (an ownership claim) to tractors, land and precious metals. In fact, we have long argued that policymakers will be increasingly tempted to use capital controls to prevent an unwind of their status quo, further undermining the reserve-currency status of the reserve currencies.

Accepting the framework described herein is very useful from a political-economy perspective, I believe, as it quantifies the so far unconscious choices of policymakers, quantifies potential damage done to savers, and takes partisanship out of a lot of economics. Let me conclude by listing the issues we will be able to transcend in our politics:

  • Derivatives and banks would no longer be “evil”, only government guarantees of them will be.
  • Depositors would have confidence that their guarantees are credible, and will not be diluted by massive, equal, competing claims.
  • The “austerity” versus “stimulus” debate would resolve, reconciled by default becoming a potential financing tool. After all, if austerity is killing an economy, and stimulus is a non-starter due to debt constraints, you most likely have a debt overhang, so default (the earlier the better).
  • The poor would be protected from inflation (and rising inflation expectations), business will be protected from uncertainty, and investors will no longer worry about the store of value of their wealth.
  • Guns vs. butter discussions would be forced upon the fiscal authority, as the status quo’s “yes to both” answer will be obviated by debt constraints; voters will have to make more mature trade-offs.
  • Societal equity would be strengthened by ending subsidies to wealthy lenders to, counterparties of, and employees of financial institutions whose social value (at least those that conduct purely speculative activities) is questionable.
  • Capital controls and protectionism—which would be very tempting policies for defenders of the status quo—are harder to discuss when we have a price gauge via gold that values the preservation of freedom in trade and capital movement.