• Goldman Sachs Group Inc. (NYSE: GS) representatives are yesterday (Tuesday) defended their commodities trading business on Capitol Hill, where regulators may set limits on speculators in the sector. The Commodity Futures Trading Commission (CFTC) said that the energy trading community may have played a major role in the volatility of energy prices over the last few years, and may need to expand its oversight of the practice. “The American people are tired of excessive speculation and bubble economies caused by Wall Street greed,” Senator Bernard Sanders, an independent from Vermont, said at the hearing, according to The New York Times. “They are tired of hedge fund managers and firms like Goldman Sachs making a fortune betting that the subprime mortgage market will continue to get worse or that more companies will go bankrupt.”

• Consumer confidence in the United States continues to wane: The Conference Board’s confidence index fell to 46.6 this month following a 49.3 reading in June. The key factor affecting confidence is unemployment. “Folks are still concerned about their jobs,” Mark Vitner, a senior economist at Wells Fargo Securities LLC told Bloomberg News.

• Month-to-month U.S. home prices in May grew 0.5% in May, the first increase in nearly three years according to the Standard & Poor’s/Case-Shiller Home Price Indicies. Year-on-year prices continue to decline on the 20-city index, falling 17.1%. “The pace of descent in home price values appears to be slowing,” said David M. Blitzer, chairman of the Index Committee at S&P in a prepared statement. “While many indicators are showing signs of life in the U.S. housing market, we should remember that on a year-over-year basis home prices are still down about 17% on average across all metro areas, so we likely do have a way to go before we see sustained home price appreciation.”

• In a move that should appease public outrage over Wall Street pay, the U.S. House Financial Services Committee approved legislation that would enable regulators to ban incentive pay at banks and give shareholders a vote on bonuses, Bloomberg News reported. The bill, adopted 40-28 yesterday (Tuesday),would allow agencies such as the Securities and Exchange Commission (SEC) to prohibit compensation that encourages financial companies to take “inappropriate risks.” The House of Representatives and Senate must pass the bill before U.S. President Barack Obama signs it into law. The House could vote as soon as Friday.

• International Business Machines Corp. (NYSE: IBM) acquired Chicago-based predictive analytics firm SPSS Inc. (Nasdaq: SPSS) for $1.2 billion in cash, or $50 per share. The deal was valued at 40% above SPSS’ closing price of $35.09 on Monday. SPSS’ shares soared on the news yesterday (Tuesday), closing at $49.45, up 40.92% or $14.36. The worldwide market for business analytics software will swell to $25 billion this year, growing 4% over 2008, IBM said, citing Interactive Data Corp. (NYSE: IDC) information.

• Viacom Inc. (NYSE: VIA) suffered a 32% drop in its second quarter bottom line, citing a challenging global economy. The media giant’s profit fell to $277 million, or 46 cents a share on revenue of $3.29 million for the quarter ended June 30. That compares to a net income of $406 million, or 64 cents a share on revenue of $3.85 billion in the same period last year. The company was encouraged that its premium movie channel, Epix, coming this fall, will appear in the lineup for subscribers of Verizon Communications Inc.’s (NYSE: VZ) FiOS television service. “While we view this as an encouraging sign, we note that Verizon FiOS has a very limited base of TV subscribers,” Spencer Wang said in a Reuters report. “We continue to believe securing distribution from larger operators [such as major cable companies] will be challenging.”

Source: Investment News Briefs Wednesday, July 29, 2009

A few days ago, billionaire hedge-fund manager, John Paulson, spent $1.28 billion to buy a piece of AngloGold Ashanti (AU: NYSE), the large South African gold miner. Paulson paid $32 a share for an 11.3% stake in the company. The following day, Fed Chairman Ben Bernanke delivered the shocking news that the U.S. Federal Reserve would buy up to $1.2 trillion of U.S. Treasury debt. And just like that, the price of gold soared, as did the price of AngloGold – handing Paulson a prompt $240 million profit.

But we’re guessing Paulson will hang around for awhile longer. We’re guessing the savvy investor is looking for a double on this investment, at least.

“Apparently, Mr. Paulson sees a solid-gold opportunity,” observes Byron King, the man who urged the subscribers of Outstanding Investment to buy AngloGold three weeks before Paulson made his high-profile purchase. “And Paulson, you may know, has pretty good eyesight, investment-wise. He’s the hedge-fund manager who made $10 billion in 2007 and 2008 betting that the subprime mortgage market would implode.

“Mr. Paulson’s purchase of AngloGold Ashanti is, in essence, a $1.3 billion bet that the U.S. government is pursuing a long-term policy to debase the dollar,” Byron continues. “Seems like a winning bet to us.”

AngloGold is not Paulson’s only wager on the yellow metal. He also owns 4.1% of Kinross Gold. Likewise, David Einhorn, the hedge fund manager famous for predicting the demise of Lehman Bros., is accumulating gold-focused investments (as we reported in the February 23, 2009 edition of the Rude Awakening, “Buy Gold…We Really Mean it This Time.”)

“Dollar debasement will doubtless trigger inflation,” Byron insists. “Over time, this will cause a flight from paper currencies to gold. I’ve already predicted gold at $3,000 within 30 months. I’ve heard other gold analysts forecasting gold at $4,500 within three years. So there’s a lot of room on the up-side.”

It’s true; the bullish case for gold has rarely seemed more compelling. But every investor has cause to wonder whether the bullish case for gold is also timely. Sure, gold could soar to $3,000 an ounce. But will it drop to $600 an ounce first…and stay there a while?

No one knows the answer, of course. Not even Byron King, an experienced geologist and student of financial history. Nor does John Paulson, a guy who knows how to make a few billion dollars by betting against the crowd. Nor does David Einhorn, an investor with an eye for profiting from adversity. But we’re inclined to trust the instincts of all three gentlemen. We are also inclined to trust the “instincts” of the market itself.

Six times during the last six years, gold stocks charged out ahead of gold bullion, signaling an imminent gold rally. Veteran observers of the gold market understand that major rallies usually BEGIN with gold stocks; not with the metal itself.

The chart above illustrates this phenomenon. In August of 2007, gold stocks advanced nearly 20% in three weeks, while the gold price barely budged. But during the next three months, gold soared from $650 an ounce to a new 17-year high of $825 an ounce.

A similar divergence has unfolded during the last few trading days. Gold stocks have jumped 30% – or double the gain of the S&P 500 Index – while gold, itself, has advanced only 4%.

Are gold stocks – like Lassie – trying to tell us something? We aren’t certain. But if we understand what the gold market is trying to say, either Timmy fell into a well or Ben Bernanke has incited the greatest inflationary episode in America since the 1970s.

Source:  Silver and Gold

Like a parent dispelling a childhood nightmare, FDR soothed the masses with the assurance that they had nothing to fear but fear itself. To this day, he is revered for turning a depression into the Great Depression. In the aftermath of the dot-com bubble, Fed Chairman Alan Greenspan came to the rescue with a brand-new bubble in real estate.

Even if there was someone out there who could pull off one more illusionary rescue, it would only delay the inevitable and worsen the pain. Pain now or more pain later. The compassionate solution is to let Adam Smith’s invisible hand guide us, as should have been happening all along. Almost no public figures have the backbone to speak honestly about what’s wrong. There is no free lunch. Still, voters believe the promise that “I will give you what you want and make someone else pay for it.” Neither Congress nor either presidential candidate can take us back to the fairytale world of mortgaged opulence we blissfully enjoyed in the recent past.

It pained me to see former Fed Chairman Alan Greenspan struggle to salvage some remnant of his tattered legacy under the brutal and self-righteous questioning of Henry Waxman’s House Oversight and Government Reform Committee. Waxman chided Greenspan that “The Federal Reserve had the authority to stop the irresponsible lending practices that fueled the subprime mortgage market.” Talk about the pot calling the kettle black! Greenspan failed to come to the defense of the free market, even conceding that his faith in free markets was “flawed.” He declined to remind Waxman that congressional pressure to make mortgage loans available to those who had no business living in a house, not to mention owning one, rendered the markets less than free.

How could this one-time compatriot of Ayn Rand have strayed so far from his roots? Even today, Greenspan’s 1966 essay “Gold and Economic Freedom” provides a refreshingly simple and straightforward explanation for how we arrived at this sorry state of affairs. The Maestro’s essay appeared in the newsletter The Objectivist in 1966 and was later reprinted in Rand’s Capitalism: The Unknown Ideal. This is what Greenspan wrote:

An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense – perhaps more clearly and subtly than many consistent defenders of laissez-faire – that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other.

In order to understand the source of their antagonism, it is necessary first to understand the specific role of gold in a free society.

Money is the common denominator of all economic transactions. It is that commodity which serves as a medium of exchange, is universally acceptable to all participants in an exchange economy as payment for their goods or services, and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.

The existence of such a commodity is a precondition of a division of labor economy. If men did not have some commodity of objective value which was generally acceptable as money, they would have to resort to primitive barter or be forced to live on self-sufficient farms and forgo the inestimable advantages of specialization. If men had no means to store value, i.e., to save, neither long-range planning nor exchange would be possible.

What medium of exchange will be acceptable to all participants in an economy is not determined arbitrarily. First, the medium of exchange should be durable. In a primitive society of meager wealth, wheat might be sufficiently durable to serve as a medium, since all exchanges would occur only during and immediately after the harvest, leaving no value-surplus to store. But where store-of-value considerations are important, as they are in richer, more civilized societies, the medium of exchange must be a durable commodity, usually a metal. A metal is generally chosen because it is homogeneous and divisible: every unit is the same as every other and it can be blended or formed in any quantity. Precious jewels, for example, are neither homogeneous nor divisible. More important, the commodity chosen as a medium must be a luxury. Human desires for luxuries are unlimited and, therefore, luxury goods are always in demand and will always be acceptable. Wheat is a luxury in underfed civilizations, but not in a prosperous society. Cigarettes ordinarily would not serve as money, but they did in post-World War II Europe where they were considered a luxury. The term “luxury good” implies scarcity and high unit value. Having a high unit value, such a good is easily portable; for instance, an ounce of gold is worth a half-ton of pig iron.

In the early stages of a developing money economy, several media of exchange might be used, since a wide variety of commodities would fulfill the foregoing conditions. However, one of the commodities will gradually displace all others, by being more widely acceptable. Preferences on what to hold as a store of value, will shift to the most widely acceptable commodity, which, in turn, will make it still more acceptable. The shift is progressive until that commodity becomes the sole medium of exchange. The use of a single medium is highly advantageous for the same reasons that a money economy is superior to a barter economy: it makes exchanges possible on an incalculably wider scale.

Whether the single medium is gold, silver, seashells, cattle, or tobacco is optional, depending on the context and development of a given economy. In fact, all have been employed, at various times, as media of exchange. Even in the present century, two major commodities, gold and silver, have been used as international media of exchange, with gold becoming the predominant one. Gold, having both artistic and functional uses and being relatively scarce, has significant advantages over all other media of exchange. Since the beginning of World War I, it has been virtually the sole international standard of exchange. If all goods and services were to be paid for in gold, large payments would be difficult to execute and this would tend to limit the extent of a society’s divisions of labor and specialization. Thus a logical extension of the creation of a medium of exchange is the development of a banking system and credit instruments (bank notes and deposits) which act as a substitute for, but are convertible into, gold.

A free banking system based on gold is able to extend credit and thus to create bank notes (currency) and deposits, according to the production requirements of the economy. Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks). But since it is rarely the case that all depositors want to withdraw all their gold at the same time, the banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits (which means that he holds claims to gold rather than gold as security of his deposits). But the amount of loans which he can afford to make is not arbitrary: he has to gauge it in relation to his reserves and to the status of his investments.

When banks loan money to finance productive and profitable endeavors, the loans are paid off rapidly and bank credit continues to be generally available. But when the business ventures financed by bank credit are less profitable and slow to pay off, bankers soon find that their loans outstanding are excessive relative to their gold reserves, and they begin to curtail new lending, usually by charging higher interest rates. This tends to restrict the financing of new ventures and requires the existing borrowers to improve their profitability before they can obtain credit for further expansion.

Thus, under the gold standard, a free banking system stands as the protector of an economy’s stability and balanced growth. When gold is accepted as the medium of exchange by most or all nations, an unhampered free international gold standard serves to foster a world-wide division of labor and the broadest international trade. Even though the units of exchange (the dollar, the pound, the franc, etc.) differ from country to country, when all are defined in terms of gold the economies of the different countries act as one-so long as there are no restraints on trade or on the movement of capital. Credit, interest rates, and prices tend to follow similar patterns in all countries. For example, if banks in one country extend credit too liberally, interest rates in that country will tend to fall, inducing depositors to shift their gold to higher-interest paying banks in other countries. This will immediately cause a shortage of bank reserves in the “easy money” country, inducing tighter credit standards and a return to competitively higher interest rates again.

A fully free banking system and fully consistent gold standard have not as yet been achieved. But prior to World War I, the banking system in the United States (and in most of the world) was based on gold and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.) It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World Was I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion.

But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline – argued economic interventionists – why not find a way of supplying increased reserves to the banks so they never need be short! If banks can continue to loan money indefinitely-it was claimed-there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of twelve regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled, and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. Technically, we remained on the gold standard; individuals were still free to own gold, and gold continued to be used as bank reserves. But now, in addition to gold, credit extended by the Federal Reserve banks (”paper reserves”) could serve as legal tender to pay depositors.

When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve’s attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain’s gold loss and avoid the political embarrassment of having to raise interest rates. The “Fed” succeeded; it stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930’s.

With a logic reminiscent of a generation earlier, statists argued that the gold standard was largely to blame for the credit debacle which led to the Great Depression. If the gold standard had not existed, they argued, Britain’s abandonment of gold payments in 1931 would not have caused the failure of banks all over the world. (The irony was that since 1913, we had been, not on a gold standard, but on what may be termed “a mixed gold standard”; yet it is gold that took the blame.) But the opposition to the gold standard in any form-from a growing number of welfare-state advocates-was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state). Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale.

Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government’s promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which-through a complex series of steps-the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.

November 4 is right around the corner. Once again, the masses are clamoring for a savior. To rephrase Walt Kelly and the famous words of the possum Pogo, “We have met our savior and he is us.”

Donald Grove is a Washington D.C.-based lawyer and Washington correspondent for Casey Research, LLC., one of the nation’s oldest and most respected newsletter publishers, providing unbiased investment guidance for individual and institutional investors. You can now kick the tires on Casey Research’s flagship publication, The Casey Report, risk-free — learn more about our special $9.95 two-month trial offer. Click here.

By Donald Grove,
Washington Correspondent
Casey Research, LLC.- The Casey Report

Source: Why a Gold Standard

It’s one year later. From what I hear from my dad, after plunging the Merrill Lynch bond is back up. And the Bank of Nova Scotia’s shares are exactly where they were a year ago. That’s much better than most North American banks have done over the past year.

No harm, no foul?

I’d be the stupidest guy on the planet if I thought that there were no lessons to be learned just because these investments didn’t turn to mush.

Fact is, my assumptions have changed. If my dad showed me the same Merrill Lynch bond today, I would’ve told him not to touch it.

And I wouldn’t have cared if a high-ranking official from an American bank swore to me they weren’t exposed to the subprime mortgage market. I wouldn’t have believed him. I would definitely have put off investing.

The housing bust, subprime mess, credit crunch and resulting financial crisis have done more than just bring the market down.

They’ve led to a stunning collapse of confidence that has infected the entire investment world. Banks don’t want to lend to each other … institutional investors don’t know what’s safe anymore … and retail investors don’t believe anything anymore.

How can they? The rating agencies have proved beyond a shadow of a doubt that they do not understand derivatives. Their ratings are worthless.

And the brokers and analysts who follow every twist and turn the market makes? It must have made them so dizzy that they can’t see the forest for the trees. They’ve been making one bad call after another.

Just a couple of weeks ago, for example, Buckingham Research estimated that Bear Stearns had $35 billion in liquid assets and borrowing capacity, enough to operate for 20 months. Turns out it had enough for three days. This is one of dozens of examples I could cite.

There’s so much uncertainty in the investment world that we can no longer fall back on our long-held ideas of what makes a safe investment.

Munis? Sorry, thanks to the shaky status of the monoline insurance companies (which insure munis), they’re no longer the safe investments they used to be.

Money market funds? They’ve been hit too. Some brokerages are covering losses with their own money rather than pass it on to those who invested in these supposed safe havens.

Good move. I don’t blame them.

Corporate bonds? The spread on what you can earn from them is tempting, but along with falling employment there is increasing evidence that Wall Street’s problems have become Main Street’s. By no means can these be considered rock-solid safe investments.

What’s left? Oh, yes, how could I forget. U.S. government bonds. Okay, they’re still safe but are they really investments? I mean, can anything you get a negative return on be considered an “investment?”

I don’t think so, and that’s exactly what you’re getting with them. A ten-year note would give you 3.6 percent yield.

Inflation is running at 4.1 percent, and that excludes food and energy prices. The real rate of inflation (as my colleague Rusty McDougal would attest) would be much higher.

U.S. bonds are worse than giving the government a free loan. Instead of the government paying you extra money for the loan, you pay the government for the privilege of loaning it money.

Do you feel honored? Or cheated?

Well, I can’t speak for you. But this is the kind of honor that could land me in the poor house. I’d say cheated.

Well, is there any investment that is truly safe?

There sure is. Australian government bonds have never looked better than they do right now. And it’s the perfect time to jump into them…

Not only because Australia has one of the strongest economies in the world. Unemployment is at a 33-year low. And prices of its two big exports – coal and iron ore – are at historical highs. It doesn’t hurt that around 66 percent of Australia’s exports are commodities.

And not only because Australia is effectively shielded from the problems we’re having in the U.S. They trade mostly with fast-growing Asia. In fact, 60 percent of its exports go to Asia.

The biggest reason the timing couldn’t be better is because the Aussie government has been raising its key interest rate to stave off inflation. They’ve raised it all the way to 7.25 percent.