January 16, 2013, 6:48 p.m. ET

Paul Moreno: Gold, Greenbacks and Inflation: A History and a Warning

The Federal Reserve's 100th birthday is no cause to break out the champagne.


The Federal Reserve, which celebrates its 100th anniversary this year, is tasked by Congress with managing the money supply so as to preserve price stability while maximizing employment. But with the central bank having increased the money supply by 25% since the financial crash of 2008—while the federal government has borrowed $5 trillion—can inflation be far off?

It won't be the first time. Inflation has often been popular, especially in democracies, since it benefits debtors, who are always more numerous than creditors. Inflation allows debtors to repay in money that is less valuable than the money they borrowed. This was the case after America's Revolutionary War, when economically distressed debtors demanded that state governments ease their burdens. State after state enacted paper-money laws, so that debts contracted in scarce gold and silver could be repaid with infinitely expandable paper.

This sort of inflation was one of the principal reasons for the adoption of the Constitution, which forbids the states to "make any thing but gold or silver coin legal tender in payment of debts." In the Federalist Papers, James Madison referred to state paper-money laws as the sort of "improper or wicked project" that the new Constitution would prevent. Chief Justice John Marshall later recalled, in the 1819 Dartmouth College v. Woodward decision, that such laws had "weakened the confidence of man in man and embarrassed all transactions between individuals by dispensing with a faithful performance of engagements."

The adoption of an anti-inflationary Constitution was a remarkable example of democratic self-restraint, and it worked wonderfully to control inflation for the next century and a quarter.

The only significant inflation came with the Civil War, via $500 million in paper "greenbacks"—the Constitution being silent on Congress's power to issue paper money. Rather than an act to relieve private debtors, the Civil War inflation was a way to pay the government's bills, a kind of de facto taxation. Still, private debtorsthose who borrowed in gold before the war and could pay back their debts in depreciated greenbacks—were happy, and there were calls for still more inflation after the war.

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Those calls led to the "Greenback Party," which enjoyed some success at the state level and sent some 20 members to Congress. But the government showed remarkable discipline in resisting such demands, and the greenback was as good as gold by 1879. Nevertheless, the inflationary experience led lenders to insert "gold clauses" in contracts specifying repayment in gold coin (provisions that were effective until Congress canceled them in 1934, a move upheld by the Supreme Court the following year).

The ending of the Civil War-era inflation, plus the massive increases in productivity in the largely free market of the following decades, led to a modest deflation—which meant that as prices gently declined, the real value of wages increased. Still, special interests such as southern and western farmers with mortgages pushed incessantly for an increase in the money supply. The high point came in the election of 1896, the famous "battle of the standards," when the gold-standard Republicans won a decisive victory over the silver-inflation Democrats.

The era of stable or declining prices came to an end in the 20th century. Inflation began innocently, with gold discoveries in Alaska, South Africa and Australia that increased the money supply in the only way possible under a gold standard. But the great engine of inflation was the enactment of the Federal Reserve System in 1913, and a dangerous delegation of monetary power to an unelected bureaucracy. From 1800 to 1913, prices rose 176%; since then they have risen 448%.

The Fed got to work right away, helping to keep the government's borrowing costs low during World War I. It increased the money supply by 75%, and consumer prices doubled from 1914 to 1920. The central bank became the best illustration of the adage that "in politics, nothing succeeds like failure."

As Milton Friedman and Anna Schwartz showed in their "Monetary History of the United States," the Fed mismanaged the postwar reconversion, kept interest rates lower and prices higher than they should have been in the 1920s, and aggravated the Great Depression by keeping rates too low before the crash and raising them after it. Yet the Fed was rewarded with greater power, especially by the Banking Act of 1935.

The bank continued to facilitate low-interest Treasury borrowing in World War II and the Korean War. But during that latter conflict it finally bridled against Treasury demands to keep borrowing rates artificially low. In 1951 it negotiated a landmark "accord" with the White House reasserting its "independence."

Yet inflationary pressures built up again in the late 1960s thanks to the Fed's accommodation of deficit spending on Lyndon Johnson's Great Society programs and the Vietnam War. That, plus the abandonment of the gold standard and the collapse of the Bretton Woods system of fixed exchange rates, led to the infamous "stagflation" of the 1970s. The Fed eventually tamed inflation under the chairmanship of Paul Volcker in the early 1980s, though prices still have more than doubled since then.

Now the inflationary potential of deficit financing has grown enormously over the first Obama term. The lesson of American history is that it is difficult enough for the government to resist popular demands for inflation to relieve private debts. When the government itself is the country's chief debtor, resistance is all but impossible.

Mr. Moreno, a professor of history at Hillsdale College, is the author of "The American State from the Civil War to the New Deal," forthcoming from Cambridge University Press.

China’s Antifragile Ambitions

Andrew Sheng, Xiao Geng

Jan. 16, 2013

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                  Illustration by Chris Van Es

HONG KONGChina has once again reached a crossroads on its journey toward inclusive, sustainable prosperity. At the Chinese Communist Party’s congress in November, the new leadership was tasked with plotting the country’s path for the next ten years, which entails modernizing China’s social, political, and economic systems within the constraints of its history and changing geopolitical context.

By any standards, the reform agenda is ambitious – especially given a fragile and unaccommodating external environment. Within the next decade, China’s leaders must design and implement reforms to combat corruption; support migration to cities (such as liberalizing the house-registration system); promote technological innovation; rebalance sources of economic growth; raise environmental and labor standards; and build the country’s social-welfare system, including health care, education, and social security.
To ensure a system’s sustainability, its design must account for what Nassim N. Taleb called rareblack swan events – which, as the global economic crisis demonstrated, do occur, with devastating consequences. But measures to make systems moreresilient” or “robust” would be incomplete. They should not only be able to withstand volatility; they should be primed to profit from stress and chaos.
Recently, Taleb coined the termantifragile” to describe a system that benefits from inherent uncertainty, volatility, and disorder. He pointed out that, while rigid systems may seem more stable, they are not equipped to cope with unexpected shocks, making them fragile in the long run. By contrast, frequent exposure to localized, temporary volatility forces systems to become more dynamic and flexible, enhancing their capacity to thrive under pressure.
Given this, rather than allowing demands for maximum efficiency to push structures to their limits, redundancies (equivalent capabilities implemented in multiple ways) should be built into systems. These low-cost measures nurture long-term antifragility, while capturing future upside gains that could compensate for black swan events.

Antifragility is crucial in large economies like China, where administration is largely centralized, but activities are dispersed among families, civil society, markets, and the various levels of government. China’s greatest challenge lies in balancing its decentralized, family-based traditions with its centralized governance, thereby developing in its institutions the kind of antifragility that is already present in its culture.

China has been struggling to balance centralization and fragmentation – that is, control and uncertaintythroughout its long history of rising and falling dynasties, domestic decay, and foreign invasion. While the open, meritocratic selection of “scholar-officials” helped to sustain China’s closed dynastic governance structure for more than 2,000 years, it could not offset the system’s growing fragility under the Qing Dynasty, as territorial gains increased the empire’s population from 150 million to 450 million. Rampant corruption, rising social unrest, and the inability to resist modern Western powers ultimately caused the dynasty, and the world’s longest-lasting bureaucracy, to crumble in 1912.
The nationalist government that followed, which established the Republic of China, also failed to address the tension between centralization and fragmentation – what the macro-historian Ray Huang called China’smathematical unmanageability.” Indeed, it never developed the property-rights infrastructure or the monetary and fiscal policies needed in a family-dominated agrarian economy with an elite-run government.

By effectively enforcing property rights and implementing national policy, the Chinese Communist Party became the institutional mechanism that bridged the divide between the elites (the Party) and the masses. But, in 1958-1961, excessive central planning to support the Great Leap Forward (Mao Zedong’s intensive campaign to industrialize and collectivize China’s economy) generated systemic fragility.

The situation began to improve in 1978, when Deng Xiaoping began to implement market-oriented reforms and open up the economy, giving China access to new opportunities for economic growth and employment. Through the so-called Four Modernizations, the crucial sectors of agriculture, industry, national defense, and science and technology were strengthened.

At the same time, China was slow to open up its financial system – even as other East Asian economies pursued efficiency by liberalizing their capital accounts in the 1990’s. As a result, when the Asian financial crisis struck in 1997, China was insulated from the volatility that ravaged its fragile neighbors. In fact, the crisis became an opportunity, prompting China to join the World Trade Organization, implement reforms of its financial system and state-owned enterprises (SOEs), list major banks publicly, and privatize civil-service housing.
But many of China’s antifragile measures have been piecemeal and incomplete. The need to overhaul SOEs, for example, remains on the agenda, owing to the power of vested interests that oppose further privatization and market-based reforms.

China’s leaders now must identify the specific areas in which to build antifragility, and approach the required reforms prudently. While they must ensure that reforms are comprehensive, they also must avoid attempting too much too fast, which could trigger resistance from deeply entrenched players or unintentionally trigger dangerous chain reactions.

Fortunately, China’s relatively strong fiscal and foreign-exchange positions can cushion the economy against short-term shocks. And, notwithstanding corruption-induced fragility, the bureaucracy’s capacity to implement policy is sound.

A major challenge will be delineating the roles and responsibilities of the Party, the state, the market, and civil society. Given the government’s proven capacity to intervene, the default option during a crisis has been to rely on administrative measures rather than on market forces. To allow disorderly self-correction by markets would require confidence at all levels of governance, from the central government to village administrations, and among SOEs.
Moreover, China’s leaders must build sufficient institutional power within the judiciary, civil society, and the media to implement the rule of law and enhance long-term antifragility. This entails preventing administrative abuses, establishing a level playing field for SOEs and other companies, and divorcing regulators from regulated entities.

As they undertake structural reforms across multiple sectors, China’s leaders have the opportunity to bolster their country’s long-term prosperity. But success will require striking a balance between maintaining systemic stability and allowing the country’s massive economy to adapt and grow – a challenge with which China has struggled for centuries.

Andrew Sheng, President of the Fung Global Institute, is a former chairman of the Hong Kong Securities and Futures Commission and is currently an adjunct professor at Tsinghua University in Beijing. His latest book is From Asian to Global Financial Crisis.

Xiao Geng is Director of Research at the Fung Global Institute.

January 16, 2013 6:00 pm
Passionate European’s case for leaving
It is irresponsible to ask a country to renew vows to a marriage it cannot abide, writes Simon May

For a passionate European there is now a strong case for Britain to leave the EU. By passionate European, I mean someone who sees the EU, for all its absurdities, as the noblest of postwar political projectsone that must and will lead to a federation, probably of a loose, Swiss kind, with a directly or indirectly elected president and a European Parliament with teeth. Someone who would love Britain to support this, but who realises it never will.

Why want a federal Europe? To create a powerful political centre, based on the supranational rule of law supervised by an independent court of justice, which can be the ultimate focus of loyalty for nations that have lived under dictatorship and whose memories of its horrors cannot be erased.

The euro crisis is a fillip to this process, despite the error of including southernClub Mednations from the outset. Even if they leave the single currency, they will not stand aside from a banking union, not to mention other federalising moves.

The process is far from over. The fundamental mission of the EU – to inspire and attract the loyalty of democracies, whether or not they join as full members – will continue on account of its supranational law and the cohesion this brings.

No postwar British prime minister has accepted this moral case for federalism. Even Edward Heath, the most pro-European, had no vision for Britain in Europe beyond entry.

It is irresponsible to ask, yet again, a country with virtually no interest in such a development to renew its vows to a marriage whose very purpose it cannot abide. And it is irresponsible to the rest of the EU – especially the core countries of Germany, Benelux, Italy and even France – which have a profound need to develop into a confederation.

Yet, oblivious to the incompatibility of British and most continental visions, the oldpragmaticcase for UK membership is trotted out: the EU offers our exporters the single market and our nation crucial influence in the world.

But Britain will continue to have access to the EU market if it leavesjust as Switzerland does, a country that also sends about half its exports to the EU. Competitiveness, not market access, is Britain’s problem. It has the same access as Germany to the vast Chinese and US markets but is far less successful in both. Switzerland, with a population smaller than the English Midlands, exports almost as much to Germany from outside the EU as Britain does from within it.

What about influence? Will Britain outside the EU become a nobody? In global trade talks it will suffer most, though the bloc will have strong reasons to co-opt Britain, for example in free trade talks with the US. Beyond trade, it is anyway hard to think of a significant global problem over which the EU has exerted decisive influence, from the Israeli-Arab dispute and Bosnia to Russia’s regional conflicts. As to sanctions and other instruments of trade policy, Britain can join EU action, say towards Iran, from the outside almost as well as from within.

Besides, most major UK foreign interventions have been as a US sidekick most recently in Afghanistan, Iraq and Libya. Can one imagine the US, whatever its warnings to Britain not to leave the union, saying to its number one European military ally: “No, we can’t accept your help in Iraq or Libya if you aren’t in the EU”?

But how can a pro-European bring himself to think Britain should leave? Because if Britain (ironically, given its own commitment to liberty) repudiates the moral case for the EU, its membership is demoralising both to the country and to the EU.

The fudge yet again being urged on Britain by pro-Europeans in all UK parties, the CBI employers’ body and now the US, will not go on working. The fall of the Berlin Wall, the resurgence of Germany and the deepening weakness of France have changed everything. We are heading for a federal Europe, whether or not the euro ends up as a northern enclave around Germany.

Paradoxically, the end of the communist threat to Europe has turned out to be a more powerful spur to its integration than Soviet aggression. From now on, federalism is for real – which is why pressure from the US on Britain to stay in the EU is unwise.

There must be a referendum on UK membership, and the only honest choice is in or out. Since Britain will never feel comfortable in a federal projectany more than it would as the 51st US state – it should leave this unnatural marriage, which regularly tears apart its main political parties, and find a role fit for its lonesome, imaginative and tactically adroit self.

Both the US and EU need Britain as an ally, and it will have a bright future as a semi-independent broker in world affairs. The greatest advance in Middle East peace for decades – the 1993 Oslo accords – was brokered by Norway, precisely because of its independence. If Norway can do it, Britain can do it in spades.

The writer is visiting professor of philosophy at King’s College London and was a cabinet member in the European Commission

Copyright The Financial Times Limited 2013

viernes, enero 18, 2013



Wednesday, January 16, 2013

The Path to $20,000 Gold

Boston, Jan.17, swing trading .- The global monetary system rests on a fragile foundation of trust.
But thanks to the regrettable actions of central banks around the world, especially those of the Federal Reserve, that foundation of trust is rotting away beneath beneath us.

All hope is not lost, however.

A goldenreset button could strengthen the fragile global monetary system. It would require reintroducing some sort of gold standard. Holders of gold own the crucial ingredient for a reset. And holders of gold mining stocks own in-ground gold supplies that could form the foundation of a future monetary system.

Since the end of the gold standard, debt has skyrocketed. Public- and private-sector debts amount to tens of trillions of dollars. Debt weighs down the economy. Pushing interest rates down to zero for years and years is no real solution. Look at Japan! Its economy has been half-alive for 20 years.

Writing off debt is the only way to restore solvency. The economy would be unshackled from its burden of servicing debts. But there is a way to slash debt without resorting to a deflationary collapse. It involves restoring the gold standard at prices of $10,000, $20,000 or even higher.

In a recent investor letter, QB Asset Management explains how an inflationary reset button could slash the real value of the rapidly growing US national debt:

Using the US as an example, the Fed would purchase Treasury’s gold at a large and specified premium to its current spot valuation. The higher the price, the more base money would be created and the more public debt would be extinguished. An eight-tenfold increase in the gold price via this mechanism would fully reserve all existing US dollar-denominated bank deposits (a full deleveraging of the banking system).

QB maintains a chart of the shadow gold price (SGP). The SGP uses the Bretton Woods calculation for determining the exchange rate linking gold to the US dollar. The calculation is base money divided by US official gold holdings. Here is QB’s latest chart. It includes projections of the base money supply through June 2015, assuming the Fed prints $85 billion per month. The SGP soars to $20,000 per ounce:

If the ratio between the SGP and actual gold prices stays constant, gold could be $3,400 per ounce by 2015!

If gold rallies anywhere close to $3,400 by 2015 (QB Asset Management’s scenario), quality gold mining stocks could rally by several hundred percent.

You could consider adding some of the midsized gold miners in the table below. The estimates are from RBC Capital Markets.

Investors will pay a premium for gold miners with consistent execution and low, stable cash costs.

The companies in the table below, courtesy of RBC Capital Markets, have these qualities. Stable cash costs should translate into good stock price performance.

Let’s assume QB Asset Management’s scenario: a steady doubling in gold prices over the next three years. Most miners in this list would produce vast amounts of free cash flow in 2014. Any rise in gold prices above cash costs would flow straight to the bottom line. The most shareholder-friendly companies, like Agnico-Eagle Mines, for example, would probably return this cash to shareholders, rather than reinvest in the ground when project costs are too high.

Such a scenario would grab the attention of mainstream investors. Investors who now ignore gold stocks would fall in love with them. High-quality gold stocks remain very cheap and will one day become expensive. Meanwhile, dividend yields pay you to wait.


Dan Amoss