Click chart to enlarge today’s 12 hour action in gold in PDF format as of 12:30 pm CDT with commentary from Trader Dan Norcini.
Today the Treasury released its International Capital Flows data for the month of September 2008. There are several noteworthy points that I feel deserve some comments.
First of all, the headline number was met with great accolades from various pundits as it showed that net flows were the largest since January 2006. On the surface that was indeed remarkable. However, it should be noted that since late last year but especially since the middle of 2008, a trend has developed which can in part explain why we are witnessing continued capital inflows into the US even with all the uncertainties surrounding the massive bailouts that we knew were coming earlier this year and have only increased as we near the beginning of 2009.
If you look at the first chart I have posted, you will see it is labeled, “Net Purchases or Sales by US Residents of Long Term Foreign Securities”. Extracting this portion of the data from the Treasury’s report we can see whether or not US investors were net buyers or net sellers of foreign securities. If they were net buyers, the numbers on the chart will be negative meaning money was FLOWING OUT OF THE US in order that US based investors could buy securities in emerging markets or other foreign markets. If the numbers on the chart are positive, it means that money was FLOWING INTO THE US as these same US based investors were SELLING their holdings abroad and REPATRIATING the money back into the US.
For the sake of the Treasury’s reports, money that is being repatriated from abroad by US based investors is counted as a positive to the NET FLOWS data. What some folks are unwittingly doing is taking the headline number which shows a huge inflow and are making assumptions that fail to take into account that in some instances, more than half of the net flows coming into the country are NOT NEW PURCHASES of US securities by foreign investors and Central Banks but are merely the result of US investment funds and hedge funds selling their overseas holdings and bringing the cash back home. Whether they are doing this to meet margin calls, get liquid, pay out client redemption requests, or out of fear dumping everything and anything they own is irrelevant. The fact is that they are bringing the money back home and that is, in my opinion, clouding the true picture that the TIC report is showing.
Just look at the chart and you will see that since the inception of the data plot, the recent repatriation dwarfs anything that we have seen since 2000. If you want to know where the strength in the Dollar is coming from, look no further than this chart because all of that repatriation means that foreign currencies were exchanged for US Dollars. When this repatriation comes to an abrupt end and the hedge fund deleveraging is complete, all of the buying that has pushed the Dollar higher into a near vertical rally will abruptly cease and when it does, down will come baby, cradle and all.
A second noteworthy point – this data, which is two months old, shows an historical occurrence, namely, that China has now surpassed Japan as the number one holder of US Treasury debt. I have been pointing out for several months now that based on the rate of Chinese buying of US Treasuries, and the slow and steady rate at which Japan was becoming a net seller, the Chinese would soon become number one. They have now arrived.
Also, since it is highly likely that the vast majority of buying that is coming out of London and is grouped into the category of Great Britain’s holdings is for Chinese customers, their share of US Treasury holdings is likely much larger than the reported $585 billion.
Is it any wonder that China now has such a great stake in what happens to the US Dollar, the bailouts and the general health of the US fiscal condition? If I were them, I think I would sleep much better if I began accumulating gold as a decent sized portion of my reserves!
I call your attention to the following story from the Dow Jones wire service…
The amount of gold being discussed would make China the second largest holder of gold among the nations of the world, surpassed only by the US with its reported 8,133.5 tons. The more we see stories of this nature coming out of the various Chinese newspapers, the more credible this story becomes. I think it is a done deal and that the Chinese are going to be large buyers from this point forward. That should help to provide very strong buying support beneath the gold market.
I like to fantasize just a bit that they will come to the Comex and clean it all out in one night!
China PBOC Mulls Raising Gold Reserve By 4,000 Tons – Report
Tue Nov 18 20:51:38 2008 EST
BEIJING (Dow Jones)–China’s central bank is considering raising its gold reserve by 4,000 metric tons from 600 tons to diversify risks brought by the country’s huge foreign exchange reserves, the Guangzhou Daily reported, citing unnamed industry people in Hong Kong.
The Guangzhou-based newspaper didn’t elaborate on the plan.
China’s forex reserves, at US$1.9056 trillion at the end of September, is the world’s largest. U.S. dollar-denominated assets, including U.S. treasury bonds and mortgage agency bonds, account for a big proportion of the forex reserves.
If Chairman Volcker became Secretary of the US Treasury at this time that would be friendly to gold. However his suggestions contained herein are the opposite of what Obama has been saying in the last few days.
If Lie-bor was telling the truth Volcker would not have made certain statements. Think about it. Last April people were jumping up and down because of the lies of Lie-bor. Now when it suits them there is total silence.
I present you with this article where an Obama plan for an economy in OTC derivative convulsions is discussed. The problem is until you address the problem you treat symptoms. The problem continues to grow and you fail.
Volcker issues dire warning on slump
Paul Volcker, the former chairman of the US Federal Reserve, has warned that the economic slump has begun to metastasise after a shocking collapse in output over the past two months, threatening to overwhelm the incoming Obama administration as it struggles to restore confidence.
By Ambrose Evans-Pritchard Last Updated: 10:39PM GMT 17 Nov 2008
"What this crisis reveals is a broken financial system like no other in my lifetime," he told a conference at Lombard Street Research in London.
"Normal monetary policy is not able to get money flowing. The trouble is that, even with all this [government] protection, the market is not moving again. The only other time we have seen the US economy drop as suddenly as this was when the Carter administration imposed credit controls, which was artificial."
His comments come as the blizzard of dire data in the US continues to crush spirits. The Empire State index of manufacturing dropped to minus 24.6 in October, the lowest ever recorded. Paul Ashworth, US economist at Capital Economics, said business spending was now going into "meltdown", compounding the collapse in consumer spending that is already under way.
Mr Volcker, an adviser to President-Elect Barack Obama and a short-list candidate for Treasury Secretary, warned that it is already too late to avoid a severe downturn even if the credit markets stabilise over coming months. "I don’t think anybody thinks we’re going to get through this recession in a hurry," he said.
He advised Mr Obama to tread a fine line, embarking on bold action with a "compelling economic logic" rather than scattering fiscal stimulus or resorting to a wholesale bail-out of Detroit. "He can’t just throw money at the auto industry."
Mr Volcker is a towering figure in the US, praised for taming the great inflation of the late 1970s with unpopular monetary rigour. He is no friend of Alan Greenspan, who replaced him at the Fed and presided over credit excess that pushed private debt to 300pc of GDP.
Jim Sinclair’s Commentary
The following are the key points of the article:
1. "Then there is the need for increased public spending on infrastructure and federal grants to state and local governments to offset the collapse of private spending."
2. "Candidate Obama spoke of $150 billion of fiscal stimulus. But if this recession turns out to be the deepest since World War II, as now seems certain, the appropriate figure will be at least four times that large. Anything less would fail to cushion the downturn."
3. "Then there is the problem of the auto industry. The best course normally would be Chapter 11 bankruptcy. This would allow the Big Three to shed bad management and contracts, both of which would be thrown out in the bankruptcy process."
4. "A further complication arises from the fact that cars last for years and when they break down are expensive to repair. Warranties matter, in other words. If a producer was undergoing bankruptcy reorganization, from which it might or might not emerge, consumers would question whether its warranties were worth the paper they were written on."
"But if this is the problem, then the government can guarantee the warranties."
6. He can ramp up spending on education and training.
Commentary: How Obama can fix the economy
By Barry Eichengreen
Special to CNN
BERKELEY, California (CNN) — President-elect Barack Obama has been holding his economic cards close to his vest. He did not participate in person at last weekend’s meeting of G20 leaders.
He has been reluctant to encourage the lame-duck Congress to adopt a major fiscal stimulus package.
He may be right in saying that the U.S. has only one president at a time. But this makes it all the more important that he hit the ground running on January 20.
This will mean, first of all, addressing the credit crisis. Despite all the actions of the Fed and the Treasury, the banks are still not lending. In some cases this is because their own finances are weak. But in others it is because they have other more convenient uses for their funds, ranging from acquisitions to dividend payments.
This reflects a flawed bank recapitalization scheme that gives the government no voting shares in the banks into which it is injecting public funds and hence no say in their decisions. Fortunately (as it were) there will be an opportunity to correct this, since as the recession deepens there will be more loan losses and the need for more capital injections. The next round of public money should come with voting rights so that taxpayers’ interests are protected.
Jim Sinclair’s Conclusion
The solution remains to throw money at it via quantitative easing and fiscal stimulus. The consequences without any doubt will be hyperinflation in a depression like all other examples of hyperinflation in history. Also keep in mind that the re-emergence of gold in the monetary system will not be as a convertibility item but as a control item in the FRGCR.
If you read yesterday’s notes on hyperinflation you now know the common belief that an economy must be in a recovery phase to motivate the velocity of money, which in turn converts expansion of money supply into significant inflation, is a BUSTED ECONOMIC MYTH. History speaks loud and clear to that.
Hyperinflation comes about via a loss of confidence in money. This can be political as well as economic. It can happen to any major currency that weakens. It simply has never occurred by an upturn in business.
The mistaken belief that an up-turn in business activity as an absolutely necessary criterion for the enormous funds now injected and to be injected into the economic system to transmute in an out of control inflation is convenient spin.
Hyperinflation in every case, even those considered political, has been a product of variations of quantitative easing, the process we are now entering.
The key reason why quantitative easing has been so successful at causing hyperinflation is because this method of direct injection is made of liquidity and therefore effectively eliminates and sterilizes the funds so injected.
The reason all historical hyperinflationary events have occurred is due to the failure of attempts to unlock credit lock ups.
The Federal Reserve has no other option than moving to quantitative easing because the Federal Reserve Begging Bowl and the TARP have only served the Good Ole Boy’s Club of Banking.
GE is simply too big to fail. GM is simply too big to fail. Quantitative easing can prevent this but as always, with CONSEQUENCES.
Currency relationships are the final determinant of hyperinflation in every case in history going back to Rome.
The technical dollar rally had to be engineered otherwise TARP or the Begging Bowl could not have been applied.
The credit of unlimited dollars via quantitative easing carries defined dollar consequences that no carry trade nor repatriation can nullify.
So let’s summate what we have discovered by a review of all significant hyperinflationary events in history:
1. The velocity of money increase that transmutes money supply into runaway inflation is currency related in every instance, not business recovering activity related.
2. The tip off to impending hyperinflation is always a currency event. This is without exception and never fails to occur.
3. More than 95% of all hyperinflation events, if not all, started in a business recession or depression, not in a recovery phase of that country’s business activity.
I invite you to try to prove me wrong, knowing you cannot.
The instant the technical dollar rally based on repatriations and carries end, and it will, the process leading to hyperinflation will have begun.
Until then big money will be the buyers of any gold weakness as were certain Middle Eastern entities a week ago.
Those who take delivery of their COMEX contract out of COMEX storage are doing themselves and all of us a favour.
Madness or Reality
Those who are frustrated by gold need to understand that the masses are driven via spin to illusions and madness.
When reality dawns via a break in markets that via spin they have gone mad over, it is too late to do anything but go belly up.
There is a great story that proves this.
Back in 1824 there was a blue-collar worker who had the ability to be a great public speaker.
His topic was his relationship to the then mayor of New York and his observation that the lower end of Manhattan Island was in the process of sinking. He claimed to have been retained by the Mayor of New York to promptly and permanently fix this problem.
The process was simple. He would saw off the lower end of Manhattan then tow it out to sea, turn it around and bring it back properly connecting it with Manhattan, therein resolving the dire problem.
Although that sounded ludicrous and was derided in publications, Lozier persisted. Lozier, purporting his authority, began to order all kinds of supplies, hire workers, and order huge amounts of livestock as food. All of this was in the thousands.
Then came the day for work to start. All items were delivered that day and a huge number of staff as well as lines of workers appeared ready for the task.
The only person missing was Lozier. He was never prosecuted, as everyone fooled by him were too embarrassed to admit they had been had.
This is those in the market who buy the spin that hyperinflation can only be the product of an improving business climate.
You can read about this in the “Grand Deception” by Alexander Klein.
What is occurring now is a “Grand Deception” which due to the unlimited amounts of funds being and to be created gives today’s Lozier an extremely short lifetime.
Click chart to enlarge today’s 12 hour action in gold in PDF format as of 12:30 pm CDT with commentary from Trader Dan Norcini.
Hi Mr. Sinclair,
I am a roofing contractor in New Hampshire. I recently renewed my liability insurance with Essex Insurance. On the declarations page was a small annotation that last year’s policy did not have.
It was typed in red ink which does not show up on a fax or photocopy (coincidence?).
I quote verbatim – "If the company issuing this policy becomes insolvent, the New Hampshire Guaranty Fund shat not be liable for any claims made against the policy."
First it was a currency in Crisis, then the “Mother of All Crises.”
The following is the ratio of marks to the dollar through the Weimar experience:
July 1914 – 4.2 marks to the dollar
January 1919 – 8.9
July 1919 – 14.0
January 1920 – 64.8
July 1920 – 39.5
January 1921 – 64.9
July 1921 – 76.7
January 1922 – 1919.8
July 1922 – 493.2
January 1923 – 17,972
July 1923 – 353,412
August 1923 – 4,620,455
September 1923 – 98,860,000
October 1923 – 25,260,208,000
November 15, 1923 – 4,200,000,000,000 (Yes, trillion)
(Source: Gordon Craig, "Germany 1866-1945")
As you can see from the chart below the velocity of money began an upward trip towards hyperinflation as the currency was trading at 76.7 in June/July of 1921. That indicates a significant decline in confidence but not a wholesale rollover of confidence.
The chart below is a good indicator of business activity as it represents unemployment. It must be noted this record comes from Trade Union so it would be somewhat prejudice to the low side as these workers are the most skilled at that time.
The conclusion I come to is the argument that business must be flat to improving in order for the process of hyperinflation to start is not an axiom. It was not true in the Weimar experience as well as most of the modern experiences generally limited to a country or closely allied trade area.
Excerpts From Wikipedia: http://en.wikipedia.org/wiki/Hyperinflation
1. Since hyperinflation is visible as a monetary effect, models of hyperinflation center on the demand for money. Economists see both a rapid increase in the money supply and an increase in the velocity of money. Either one or both of these encourage inflation and hyperinflation. A dramatic increase in the velocity of money as the cause of hyperinflation is central to the "crisis of confidence" model of hyperinflation, where the risk premium that sellers demand for the paper currency over the nominal value grows rapidly. The second theory is that there is first a radical increase in the amount of circulating medium, which can be called the "monetary model" of hyperinflation. In either model, the second effect then follows from the first — either too little confidence forcing an increase in the money supply, or too much money destroying confidence.
2 “Governments will often try to disguise the true rate of inflation through a variety of techniques. These can include the following:
- – Outright lying in official statistics such as money supply, inflation or reserves.
- – Suppression of publication of money supply statistics, or inflation indices.
- – Price and wage controls.
- – Forced savings schemes, designed to suck up excess liquidity. These savings schemes may be described as pensions schemes, emergency funds, war funds, or something similar.
– Adjusting the components of the Consumer price index, to remove those items whose prices are rising the fastest.
None of these actions address the root causes of inflation, and in fact, if discovered, tend to further undermine trust in the currency”
3. In the confidence model, some event, or series of events, such as defeats in battle, or a run on stocks of the specie which back a currency, removes the belief that the authority issuing the money will remain solvent — whether a bank or a government. Because people do not want to hold notes which may become valueless, they want to spend them in preference to holding notes which will lose value. Sellers, realizing that there is a higher risk for the currency, demand a greater and greater premium over the original value. Under this model, the method of ending hyperinflation is to change the backing of the currency — often by issuing a completely new one. War is one commonly cited cause of crisis of confidence, particularly losing in a war, as occurred during Napoleonic Vienna, and capital flight, sometimes because of "contagion" is another. In this view, the increase in the circulating medium is the result of the government attempting to buy time without coming to terms with the root cause of the lack of confidence itself.
4. Since hyperinflation is visible as a monetary effect, models of hyperinflation center on the demand for money. Economists see both a rapid increase in the money supply and an increase in the velocity of money. Either one or both of these encourage inflation and hyperinflation. A dramatic increase in the velocity of money as the cause of hyperinflation is central to the "crisis of confidence" model of hyperinflation, where the risk premium that sellers demand for the paper currency over the nominal value grows rapidly. The second theory is that there is first a radical increase in the amount of circulating medium, which can be called the "monetary model" of hyperinflation. In either model, the second effect then follows from the first — either too little confidence forcing an increase in the money supply, or too much money destroying confidence.
In the confidence model, some event, or series of events, such as defeats in battle, or a run on stocks of the specie which back a currency, removes the belief that the authority issuing the money will remain solvent — whether a bank or a government. Because people do not want to hold notes which may become valueless, they want to spend them in preference to holding notes which will lose value. Sellers, realizing that there is a higher risk for the currency, demand a greater and greater premium over the original value. Under this model, the method of ending hyperinflation is to change the backing of the currency — often by issuing a completely new one. War is one commonly cited cause of crisis of confidence, particularly losing in a war, as occurred during Napoleonic Vienna, and capital flight, sometimes because of "contagion" is another. In this view, the increase in the circulating medium is the result of the government attempting to buy time without coming to terms with the root cause of the lack of confidence itself.
In the monetary model, hyperinflation is a positive feedback cycle of rapid monetary expansion. It has the same cause as all other inflation: money-issuing bodies, central or otherwise, produce currency to pay spiralling costs, often from lax fiscal policy, or the mounting costs of warfare. When businesspeople perceive that the issuer is committed to a policy of rapid currency expansion, they mark up prices to cover the expected decay in the currency’s value. The issuer must then accelerate its expansion to cover these prices, which pushes the currency value down even faster than before. According to this model the issuer cannot "win" and the only solution is to abruptly stop expanding the currency. Unfortunately, the end of expansion can cause a severe financial shock to those using the currency as expectations are suddenly adjusted. This policy, combined with reductions of pensions, wages, and government outlays, formed part of the Washington consensus of the 1990s.
Whatever the cause, hyperinflation involves both the supply and velocity of money. Which comes first is a matter of debate, and there may be no universal story that applies to all cases. But once the hyperinflation is established, the pattern of increasing the money stock, by whichever agencies are allowed to do so, is universal. Because this practice increases the supply of currency without any matching increase in demand for it, the price of the currency, that is the exchange rate, naturally falls relative to other currencies. Inflation becomes hyperinflation when the increase in money supply turns specific areas of pricing power into a general frenzy of spending quickly before money becomes worthless. The purchasing power of the currency drops so rapidly that holding cash for even a day is an unacceptable loss of purchasing power. As a result, no one holds currency, which increases the velocity of money, and worsens the crisis.
That is, rapidly rising prices undermine money’s role as a store of value, so that people try to spend it on real goods or services as quickly as possible. Thus, the monetary model predicts that the velocity of money will rise endogenously as a result of the excessive increase in the money supply. At the point when ordinary purchases are affected by inflation pressures, hyperinflation is out of control, in the sense that ordinary policy mechanisms, such as increasing reserve requirements, raising interest rates or cutting government spending will all be responded to by shifting away from the rapidly dwindling currency and towards other means of exchange.
During a period of hyperinflation, bank runs, loans for 24 hour periods, switching to alternate currencies, the return to use of gold or silver or even barter become common. Many of the people who hoard gold today expect hyperinflation, and are hedging against it by holding specie. There may also be extensive capital flight or flight to a "hard" currency such as the U.S. dollar. This is sometimes met with capital controls, an idea which has swung from standard, to anathema, and back into semi-respectability. All of this constitutes an economy which is operating in an "abnormal" way, which may lead to decreases in real production. If so, that intensifies the hyperinflation, since it means that the amount of goods in "too much money chasing too few goods" formulation is also reduced. This is also part of the vicious circle of hyperinflation.
Once the vicious circle of hyperinflation has been ignited, dramatic policy means are almost always required, simply raising interest rates is insufficient. Bolivia, for example, underwent a period of hyperinflation in 1985, where prices increased 12,000% in the space of less than a year. The government raised the price of gasoline, which it had been selling at a huge loss to quiet popular discontent, and the hyperinflation came to a halt almost immediately, since it was able to bring in hard currency by selling its oil abroad. The crisis of confidence ended, and people returned deposits to banks. The German hyperinflation of the 1920s was ended by producing a currency based on assets loaned against by banks, called the Rentenmark. Hyperinflation often ends when a civil conflict ends with one side winning. Although wage and price controls are sometimes used to control or prevent inflation, no episode of hyperinflation has been ended by the use of price controls alone. However, wage and price controls have sometimes been part of the mix of policies used to halt hyperinflation.
As noted, in countries experiencing hyperinflation, the central bank often prints money in larger and larger denominations as the smaller denomination notes become worthless. This can result in the production of some interesting banknotes, including those denominated in amounts of 1,000,000,000 or more.
* By late 1923, the Weimar Republic of Germany was issuing fifty-million Mark banknotes and postage stamps with a face value of fifty billion Mark. The highest value banknote issued by the Weimar government’s Reichsbank had a face value of 100 trillion Mark (100,000,000,000,000; 100 billion on the long scale). . One of the firms printing these notes submitted an invoice for the work to the Reichsbank for 32,776,899,763,734,490,417.05 (3.28×1019, or 33 quintillion) Marks.
* The largest denomination banknote ever officially issued for circulation was in 1946 by the Hungarian National Bank for the amount of 100 quintillion pengő (100,000,000,000,000,000,000, or 1020; 100 trillion on the long scale). image (There was even a banknote worth 10 times more, i.e. 1021 pengő, printed, but not issued image.) The banknotes however didn’t depict the number, making the 500,000,000,000 Yugoslav dinar banknote the world’s leader when it comes to depicted zeros on banknotes.
* The Z$100 billion agro cheque, issued in Zimbabwe on July 21, 2008, shares the record for depicted zeroes (11) with the 500 billion Yugoslav dinar banknote.
* The Post-WWII hyperinflation of Hungary holds the record for the most extreme monthly inflation rate ever — 41,900,000,000,000,000% (4.19 × 1016%) for July, 1946, amounting to prices doubling every thirteen and one half hours.
One way to avoid the use of large numbers is by declaring a new unit of currency (an example being, instead of 10,000,000,000 Dollars, a bank might set 1 new dollar = 1,000,000,000 old dollars, so the new note would read "10 new dollars".) An example of this would be Turkey’s revaluation of the Lira on January 1, 2005, when the old Turkish lira (TRL) was converted to the New Turkish lira (YTL) at a rate of 1,000,000 old to 1 new Turkish Lira. While this does not lessen the actual value of a currency, it is called redenomination or revaluation and also happens over time in countries with standard inflation levels. During hyperinflation, currency inflation happens so quickly that bills reach large numbers before revaluation.
Some banknotes were stamped to indicate changes of denomination. This is because it would take too long to print new notes. By time the new notes would be printed, they would be obsolete (that is, they would be of too low a denomination to be useful).
Metallic coins were rapid casualties of hyperinflation, as the scrap value of metal enormously exceeded the face value. Massive amounts of coinage were melted down, usually illicitly, and exported for hard currency.
Governments will often try to disguise the true rate of inflation through a variety of techniques. These can include the following:
* Outright lying in official statistics such as money supply, inflation or reserves.
* Suppression of publication of money supply statistics, or inflation indices.
* Price and wage controls.
* Forced savings schemes, designed to suck up excess liquidity. These savings schemes may be described as pensions schemes, emergency funds, war funds, or something similar.
* Adjusting the components of the Consumer price index, to remove those items whose prices are rising the fastest.
None of these actions address the root causes of inflation, and in fact, if discovered, tend to further undermine trust in the currency, causing further increases in inflation. Price controls will generally result in hoarding and extremely high demand for the controlled goods, resulting in shortages and disruptions of the supply chain. Products available to consumers may diminish or disappear as businesses no longer find it sufficiently profitable (or may be operating at a loss) to continue producing and/or distributing such goods, further exacerbating the problem.