Financial Death by “Extraction”

Addison Wiggin – August 10, 2011

  • Financial death by “extraction”… TV anchor’s meltdown highlights the Fed’s plan for you…
  • More details of “financial repression” in action… and how to protect yourself
  • Risk spotlight shifts to Europe… only to shine right back on U.S. money market funds…
  • Grateful the British riots are happening “over there”? How they’ve already arrived “here”…
  • A surge in mutton theft… a reader inquiry about silver prejudice… how the Fed’s relationship with you is like a bad marriage… still, some big currency gains… and more!

   Something — we’re not altogether sure what — touched off MSNBC’s Dylan Ratigan yesterday.

We love it when these guys lose their cool. This is not nearly as entertaining as Jim Cramer’s tantrum imploring the Fed to “open the discount window” in 2007, but pay attention to the content…”

(Also watch the faces of the support staff behind him! Heh…)

We’re not 100% sure what Mr. Ratigan means by “extraction.”

“Privatized profits, socialized risk” is a theme you should be familiar with here in The 5. “Financial repression” is another we heard a lot about during the Symposium in Vancouver.

“Extraction” sounds more like a dental procedure, but from the context, we believe he means a class of financial engineers intentionally stripping the productive classes of their remaining assets.

That’s our best guess… considering his rant came two hours after the Federal Reserve made its own extraction plans known to the world.

   Yesterday, the Fed put savers on notice: You’re screwed for the next two years. At least.

The pertinent background: On Dec. 16, 2008, the Federal Reserve launched the first round of “quantitative easing,” accompanied by a decision to slash the federal funds rate to an unprecedented 0-0.25%. The Fed statement said conditions would warrant these “exceptionally low” levels “for some time.”

On March 18, 2009, the Fed sought to be more precise in its time horizon, promising these “exceptionally low” levels “for an extended period.”

Every six weeks, the same language has turned up in the Fed’s statements — an all-too-easy source of mockery for your 5 Min. editors.

Yesterday, the fun stopped. Now there’s an actual date (well, year, anyway) attached to the “extended period.” Boo.

   “The committee currently anticipates that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”

There you have it: The Fed has acknowledged the economy is going to be jonesin’ for at least two more years and will require the IV drip of near-zero interest rates just to stay alive.

   Following the Fed’s decision, the yield on a 10-year Treasury note sank to 2.14%. That’s only 7 basis points away from the all-time panic low reached a couple of days after that first QE declaration from the Fed in December 2008.

More to the point, the Fed has made it plain that savers will continue to be relentlessly flogged.

“From this day onward,” wrote former hedge fund manager Bruce Krasting at his blog last night, “every buy-and-hold investor who acquires Treasury debt with maturities of less than five years is guaranteed to lose money.”

This is the reality of something we discussed in Vancouver last month: Financial repression. The Fed will keep interest rates artificially low so the Treasury can keep its own debt service costs down.

The Treasury Department blows through $3.8 trillion in a year on $2.2 trillion revenue. But at the moment, barely 5%of that total goes toward interest payments on the debt they issue to make up the difference. That’s a sweet deal. Treasury officials would love to keep the drip going for as long as possible.

Good for the Treasury, not so good for you… because it means you get still more in the way of “negative real interest rates.” This morning, a 5-year CD yields 2.25%. But consumer prices are running at a 3.6%annual clip. So your CD is actually losing you 1.35%in purchasing power… before taxes.

That’s financial repression.

   To borrow a phrase from the computer world, this isn’t a bug: It’s a feature. The Fed is purposely forcing you “out onto the risk curve” so that prudent savers will buy stocks and prop up the stock market.

In another 2007 flashback, Alan Greenspan accidentally gave away the game in his Daily Show interview with Jon Stewart:

    Stewart: When you lower interest rates, it drives money to stocks and lowers the return people get on savings.

    Greenspan: Yes, indeed.

    Stewart: So they’ve made a choice — “We would like to favor those who invest in the stock market and not those who [save]”…

    Greenspan: That’s the way it comes out, but that’s not the way we think about it.

We featured the segment in I.O.U.S.A. despite Greenspan’s own proclamations in the film that “without savings, there would be no future.”

“In a negative rate world,” said David Franklin of Sprott Private Wealth during the Symposium in Vancouver, “speculation must be part of your portfolio.” And gold is the safest among those speculations.

   Sure enough, gold is powering to new highs… again. The spot price crested $1,800 briefly today, later pulling back to $1,777. Only 72 hours ago did the price break through $1,700 for the first time.

Silver is also rallying at the moment, to $39.28.

   The stock market managed an improbable late-day rally yesterday, closing up at 430 points on the Dow, following a 662-point upside swing.

Alas, whatever gains stocks made by day’s end yesterday vaporized this morning.

The volatility index, which had settled down to 35 yesterday, moved up past 42 again today.

   The Fed-induced euphoria yesterday immediately gave way to new panic attacks over the eurozone.

This time the problem is France. And that’s a big problem. France is Europe’s second-largest economy after Germany.

Unlike the United States, France is still a AAA country in the eyes of the rating agencies. So is Germany. But in the bond market, investors want 2.21%for a 10-year German government bond… while they’re demanding 3.11%for a 10-year French bond.

In the credit default swap market, the cost of insuring French debt hit a record high today.

   Fundamentally, the European Central Bank’s $440 billion bailout fund is barely big enough to handle Greece, Ireland and Portugal. It would gorge itself on Spain, choke on Italy and die on France.

That’s bad news for the European banks that bought all that European government debt.

It’s even worse news for U.S. money market funds, about half of whose assets sit in European bank debt:

Unfortunately for those holding U.S. money market funds, France is the largest single recipient of those funds’ interest.

“Financial repression” makes even the “safest” of assets like money market funds a gamble… and events on other continents could trigger an epic crisis here at home.

   “What I worry about the most,” said Rep. Ron Paul on CNBC this morning, “is the consequence of currency destruction is violence. And boy, every day there’s more and more violence, whether it’s in London, demonstrations in Israel, all around the world, revolutions going on,” he said. “And this is all related to, sometimes, prices of food going up.”

We’re struck especially by the riots in Britain… not just for what they might portend closer to home, but for the guerrilla tactics adopted by the rioters. “Much more going on here than a simple riot or looting,” writes military theorist John Robb at his blog “It’s a learning lab.”

“Communicating via BlackBerry instant-message technology that the police have struggled to monitor, as well as by social networking sites like Facebook and Twitter, they repeatedly signaled fresh target areas to those caught up in the mayhem.”

One hell of a learning lab

“They coupled their grasp of digital technology with the ability to race through London’s clogged traffic on bicycles and mopeds, creating what amounted to flying squads that switched from one scene to another in the London districts of Hackney, Lewisham, Clapham, Peckham, Croydon, Woolwich and Enfield, among others — and even, late on Monday night, at least minor outbreaks in the mainly upscale neighborhood of Notting Hill and parts of Camden.”

Now that we think about it, perhaps these events are closer to home than you might realize: the “flash mobs” that clean out stores of their merchandise in Chicago, Philadelphia and elsewhere in broad daylight — their rendezvous points and escape routes communicated via text message.

For the moment, the difference between the U.S. and the U.K. is merely one of scale. It brings a new dimension to our recent forecast: “At the very worst, mobs will erupt in anger and violence. No longer will chaos in the streets be something you see on the news happening in far-off lands.”

If you haven’t reviewed this forecast… or if you have and blew it off… it’s worth a look.

   The euro is plunging, down from over $1.43 a few hours ago to $1.418 now. The dollar index, which broke below 74 after the Fed’s statement yesterday, has rallied to 74.7.

   Oil prices are finding their bearings today. A barrel of West Texas Intermediate fetches $80.24. Hard to believe last Thursday, it was still above $90.

   “The sell-off in oil is too much, too fast,” says Byron King. “It’s not due to excess oil supply, and it’s not due to inadequate demand. Oil fundamentals just don’t change that fast.

“My strong hunch is that the speculator side of the trading business is disgorging. That is, speculators and hedge funds are unwinding positions, and doing so brutally FAST.

“We’re watching a speculator-driven sell-off as the specs despeculate. It’s not a reflection of the realities of the oil patch. The engineering reality is that in the future, there will be not enough supply, meeting too much demand.

“For now, we have to ride out the storm. When the dust settles and the market finds a bottom, we’ll still live in a world where there’s not enough oil, and there’s too much demand, looking forward.

“Point is, the sell-off took a lot of great oil and oil-sector companies down in the suction. It’ll be those guys that bob back upward the fastest amidst the market debris.”

If you’re of a mind to go bargain hunting in the energy patch, Byron has some great suggestions here.

   To our list of manhole covers, guardrails, central air-conditioning units and other odd thievery targets, we add another today: sheep.

Incidents of sheep rustling in the U.K. have doubled in the last six months. The National Farmers’ Union reports 32,926 sheep stolen from British farms and fields since the first of the year. For all of last year, the number was 38,095.

The thefts, according to The Independent, are the work of organized gangs using dogs, bolt cutters, trailers… and frequently firearms. In one recent case, the thieves used silencers and shot an entire flock in the neck, to better to preserve the meat.

“Sheep rustling”: relatively easy in real life

Why sheep and not other animals? Usually, they’re in fields far from the farmhouse. “It is often impossible to catch the culprits because they can be very stealthy,” an investigator tells the paper.

The National Sheep Association says a sheep can fetch an average of $122 — more than double the figure three years ago.

   “Why isn’t silver following gold in its upward spiral?” a reader inquires somewhat breathlessly.

“Could it be that when wealthy gold bugs saw the newly created ‘paper’ millionaires that played the silver market, they forced, behind the scenes, the major hikes in margin requirements needed to trade silver? That move wiped out many traders who could not afford a can of beans now, let alone invest in silver…

“Gives you something to think about… the rich get richer, the poor get poorer and the middle class get wiped out on a billionaire’s whim or fear.”

The 5: Um, either that or silver has more industrial uses than gold. If traders perceive the economy’s going back into the tank, there’ll be less industrial demand for it.

   “On the subject of big banks,” a reader writes: “Wells Fargo just refinanced one of our rentals. Their rules include loaning up to 125%of equity if you have good credit. The refit knocked a couple of hundred dollars a month off our payments with only a slight increase in balance.”

“It’s good to be a debtor?! They called us and made the offer. What’s up with these guys?! A pox on all of ’em.”

The 5: Debt is their business. As in the last several refi booms, the sales guys are just trying to make their numbers and collect fees. With the Fed’s definitive promise to keep rates near zero for the next two years, you can expect more competition to creep into the refi market… and even better deals for borrowers! Yeehoo!

   “May I make a further comparison?” a third reader asks politely after we pointed out how politicians are currently framing the debate: The “professional politicians” are spending the “proper” amount money relative to GDP… assuming “we, the public,” fork over enough money to fund their schemes.

“This is very much like my previous marriage, in which my ex had her own income. However, she constantly spent far more than her income and continually berated me for not earning enough to cover her extravagance.”

“I can only hope that the marriage between the Fed and the people ends with the same result as my marriage did. I was left with a laundry list of bad debt that I eventually washed, returning to my own AAA credit rating. Then I remarried to a wonderful woman who works together with me as we build a thriving business.”

“My ex, on the other hand, has gone through a series of bad relationships. Finally, she has wound up alone and stuck complaining about never having enough money.”

   “In the long run,” our last reader writes facetiously (we hope), “state and local indebtedness should not be a problem.”

“Under current law, anyone with more than $10,000 cash is presumed to be engaged in ‘money laundering’ and can be stopped and detained. Their money can be confiscated even if they are not charged with any crime. This money typically goes to the police agency that made the stop.”

“Once inflation gets really going, the police need merely wait in front of the local grocery store and stop the shoppers who may very well be carrying an ‘excessive’ amount of cash in order to buy their groceries. Now, that will be interesting!”

“Thanks for the wonderful job you do by bringing the best of the news to us every day.”

The 5: Again, and for God’s sake, don’t give them any more ideas.

Cheers,

Addison Wiggin
Agora Financial’s 5 Min. Forecast

P.S.The rising gold price delivered a fast double this morning for readers of Strategic Currency Trader. A gold play Abe Cofnas recommended on Monday… good for a 100%gain on Wednesday.

That’s how it works in the market Abe follows, unique among all North American trading advisories: In on Monday, out by Friday. Or in this case, even sooner.

Abe will have a new set of recommendations first thing Monday morning. You can be ready for them… and snag a membership in Strategic Currency Trader at half off… right here.

rspertzel

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