The Federal Reserve's Explicit Goal: Devalue the Dollar 33%

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The Daily Reckoning | Tuesday, February 14, 2012 Are you ready to hand the Feds another 1/3 of your savings? From ’65 to ’12...glory to Hell...the plight of the United States, Plus, Bill Bonner on differing with Buffett and plenty more... ------------------------------------------------------ The LAST STOCK You’ll Ever Need You’re about to witness a shocking, hidden story. This could also be the biggest market story in history But you must act on this urgent wealth creation event before midnight tonight, February 14th. Here’s why...!   The Test of Time How Warren Buffett Looks at Stocks vs. Gold Investing   Bill Bonner Reckoning today from Rancho Santana, Nicaragua... Where we part company with Warren Buffet... Here’s the Sage of Omaha, explaining, in Fortune Magazine, why bonds are dangerous: Investments that are denominated in a given currency include money- market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge. Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control. Even in the US, where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.” For taxpaying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of US Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It’s noteworthy that the implicit inflation “tax” was more than triple the explicit income tax that our investor probably thought of as his main burden. “In God We Trust” may be imprinted on our currency, but the hand that activates our government’s printing press has been all too human. High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments — and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label. Under today’s conditions, therefore, I do not like currency-based investments. Buffet goes on to explain why he doesn’t like gold either. He points out that since 1965 the total return on gold (not adjusted for inflation) was 4,455%. But the total return on stocks was higher, at 6,072%. The difference between the two is that gold is a ‘sterile’ investment, says Buffet. Stocks are not. He’s right. Gold is only useful at protecting purchasing power when the monetary system is in danger. At almost all other times, you’re better off with stocks...businesses...farmland or another productive asset. That’s why Buffet now prefers stocks. And it is why we now prefer gold. Buffet willingly gives up the protection of gold in order to the get the upside from stocks. We willingly give up the upside from stocks in order to get the protection from gold. Who’s right? Only time will tell. Our guess is that time will tell us that Buffet is right...in the near term. But we’re still not going to switch to stocks. Because the risk is too high that time will be on our side. In other words, the most likely outcome...as far as we can tell...is that the financial world will stumble along more or less in the same direction it is going now. Perhaps for many years. Gold, already expensive in terms of purchasing power, may go nowhere...or even down. After all, we’re still in a Great Correction. As long as we follow in Japan’s footsteps there’s no particular reason for gold to rise. But we do not bet on the most likely outcome. We bet on the outcome that is underpriced. The outcome that is most likely to pay off...or blow us up. In our view, investors do not yet fully appreciate the risks of a financial catastrophe, a war or a revolution. In yesterday’s news, we learned that 100,000s of Greeks had taken to the streets. “Rioters burn buildings...” reports Bloomberg: Feb. 12 (Bloomberg) — Rioters set fire to buildings and battled police in downtown Athens as the Greek Parliament prepared to vote on Prime Minister Lucas Papademos’s austerity package to avert the nation’s collapse. Ten fires were burning in central Athens including buildings housing a Starbucks Corp. cafe, a bank and a movie theater, a fire department spokesman said, speaking on the condition of anonymity in line with official policy. The blazes were near a bank that was set on fire in May 2010, killing three bank employees, during a general strike against Greece’s first bailout package. “Today at midnight, before markets open, the Greek Parliament must send a message,” Finance Minister Evangelos Venizelos told lawmakers in Athens today as the final debate on the accord to secure a 130 billion-euro ($171 billion) second aid package got under way. “We must show that Greeks, when they are called on to choose between the bad and the worst, choose the bad to avoid the worst.” “We are seeing Athens go up in flames again,” Mayor George Kaminis, said in an interview on ANT1 television. “This must stop. What they are trying to do to Athens is what they are trying to do to the entire country.” Meanwhile, hardly a day passes that we don’t hear of an impending attack on Iran. The developed economies are borrowing money at 2 to 5 times the rate of GDP growth. And the world’s major central banks eagerly print money. Maybe Buffet will be right. Maybe the next 47 years will be like the last. But it seems like a bad bet to us. All the key circumstances are completely different — even opposite. You remember the years from ’65 to 2012. They weren’t perfect. But they weren’t bad. The US was on top of the world...and headed higher. It was owed more money by more people than any nation ever had been. It was the leading energy exporter. It was the world’s leading capital investor. Its people were earning more and more money — in real terms. Total consumer and government debt, as a percentage of GDP, was barely a fifth of today’s level. Of course, it wasn’t all good. The US was getting deeper and deeper into a costly and losing war. This would lead to some big bills to pay in the ’70s...and to some tough times. But, overall, America’s best days were still ahead. And today? Now, the emerging markets are growing much faster...taking more and more market share from the US. America is deep in debt...and adding more debt every day. Major industries have been zombified. More than half the voters depend on money from the government. America’s degenerate capitalism...and its geriatric democracy cannot adapt to the challenges it faces. And the typical working man hasn’t had a real increase in wages since the Johnson administration. In ’65, the US was heady for glory. In ’12, it may be going to Hell. But who knows? Maybe Buffet will be right. Still...we’ll stick to our formula. Buy gold on dips. Sell stocks on rallies.   Expires Tonight at Midnight — $1,205 off Agora Financial’s Most Popular Research... This amazing offer centers on a shocking news story that just broke days ago. At midnight tonight — this one-time deal disappears. Click here for the full story. The Daily Reckoning Presents The Federal Reserve’s Explicit Goal: Devalue the Dollar 33%   Charles Kadlec The Federal Reserve Open Market Committee (FOMC) has made it official: After its latest two day meeting, it announced its goal to devalue the dollar by 33% over the next 20 years. The debauch of the dollar will be even greater if the Fed exceeds its goal of a 2 percent per year increase in the price level. An increase in the price level of 2% in any one year is barely noticeable. Under a gold standard, such an increase was uncommon, but not unknown. The difference is that when the dollar was as good as gold, the years of modest inflation would be followed, in time, by declining prices. As a consequence, over longer periods of time, the price level was unchanged. A dollar 20 years hence was still worth a dollar. But, an increase of 2% a year over a period of 20 years will lead to a 50% increase in the price level. It will take 150 (2032) dollars to purchase the same basket of goods 100 (2012) dollars can buy today. What will be called the “dollar” in 2032 will be worth one- third less (100/150) than what we call a dollar today. The Fed’s zero interest rate policy accentuates the negative consequences of this steady erosion in the dollar’s buying power by imposing a negative return on short-term bonds and bank deposits. In effect, the Fed has announced a course of action that will steal — there is no better word for it — nearly 10 percent of the value of Americans’ hard earned savings over the next 4 years. Why target an annual 2 percent decline in the dollar’s value instead of price stability? Here is the Fed’s answer: “The Federal Open Market Committee (FOMC) judges that inflation at the rate of 2 percent (as measured by the annual change in the price index for personal consumption expenditures, or PCE) is most consistent over the longer run with the Federal Reserve’s mandate for price stability and maximum employment. Over time, a higher inflation rate would reduce the public’s ability to make accurate longer-term economic and financial decisions. On the other hand, a lower inflation rate would be associated with an elevated probability of falling into deflation, which means prices and perhaps wages, on average, are falling — a phenomenon associated with very weak economic conditions. Having at least a small level of inflation makes it less likely that the economy will experience harmful deflation if economic conditions weaken. The FOMC implements monetary policy to help maintain an inflation rate of 2 percent over the medium term.” In other words, a gradual destruction of the dollar’s value is the best the FOMC can do. Here’s why: First, the Fed believes that manipulation of interest rates and the value of the dollar can reduce unemployment rates. The results of the past 40 years say the opposite. The Fed’s finger prints in the form of monetary manipulation are all over the dozen financial crises and spikes in unemployment we have experienced since abandoning the gold standard in 1971. The financial crisis of 2008, caused in no small part by the Fed’s efforts to stimulate the economy by keeping interest rates too low for, as it turned out, way too long is but the latest example of the Fed failing to fulfill its mandate to achieve either price stability or full employment. The Fed’s most recent experience with Quantitative Easing also belies the entire notion that monetary manipulation can spur the economy. Between November 2010 and June 2011, the Fed tried to spur economic growth by purchasing $600 billion in Treasury securities, flooding the banking system with reserves and keeping interest rates low. In response the economy, which had been growing at a 3.4% annual rate, slowed to a 1% annual rate in the first half of 2011. Once the Fed stopped supplying all of that liquidity, economic growth in the second half of the year accelerated to a 2.3% annual rate. Second, the Fed does not use real time indicators of the price level. Instead, it views inflation through the rear view mirror of the trailing increases in the PCE. And, even when it had evidence of rising inflation — as it did in the first quarter of last year — it chose to temporize, betting that the spike in inflation would prove temporary. This spike in inflation did prove temporary, as Fed Chairman Bernanke predicted at the time, but not for the reasons — a slack economy — that he cited. Instead, the growing debt crisis in Europe led to a massive shift in deposits out of the euro and into the dollar — an event totally out of the Fed’s control. Yet, this increase in the demand for dollars was far more important than any action taken by the Fed because it increased the value of the dollar and produced a slowdown in the inflation rate. What we are left with is a trial and error monetary system that depends on the best judgment of 19 men and women who meet every six weeks around a big table at the Federal Reserve in Washington. At the end of a day and a half of discussions, 11 of them vote on what to do next. The error the members of the FOMC fear most when they vote is deflation. So, they have built in a 2% margin of error. Given the crudeness of the tools the FOMC uses to set monetary policy, allowing for such a margin of error is no doubt prudent. For example, when the economy slowed in the first half of last year, inflation picked up, accelerating to a 6.1% annual rate during the second quarter. And, when the economic growth accelerated in the second half, inflation slowed. These results are the precise opposite of what the Fed’s playbook says are supposed to happen. The best the Fed can do — an average debauch in the dollar’s value of 2% a year while producing recurring financial crises and a more cyclical economy — is demonstrably inferior to the results produced by the classical gold standard. Here’s just one example. The largest gold discovery of modern times set off the 1849 California gold rush and increased the supply of gold in the world faster than the increase in the output of goods and services. The price level in the US did increase by12.4 percent over the next 8 years. That translates into an average of just 1.5% a year. The gold standard at its worst was better than the best the Fed now promises to do with the paper dollar. The Fed’s best is hardly good enough. The time has arrived for the American people to demand something far better — a dollar as good as gold. Regards, Charles Kadlec, for The Daily Reckoning Ed. Note: Mr. Kadlec is a member of the Economic Advisory Board of the American Principles Project, an author and founder of the Community of Liberty.   World oil production is about to be shaken to its core... You won’t believe which nation analysts at Wall Street’s biggest banks expect to become the world’s biggest energy producer by 2017 — or the effect it will have on America... our economy... our future... Click here to see who is set to become the new king of oil — and how you can use the news to go for big profits as early as this MAY!   And now back to Bill Bonner with more thoughts...   “Wanna lose some money?” Easy. Buy Facebook. It’s said to be going public at 150 times earnings. In order to justify the price, says our colleague, Chris Mayer, Facebook would have to sign up every human being on the planet...and a few extraterrestrials too. The whole Internet complex is a “bubble that’s about to pop,” he says. “It’s rumored that Facebook’s IPO will value the company somewhere between $75 and $100 billion — about 150 times 2011 net income, 212 times free cash flow, and just shy of 27 times last year’s sales. Facebook’s sales have grown 77-fold since 2006, and its valuation based on private secondary markets has soared 92-fold during the same time.” Wow! How do you beat that? We tried to use Facebook. It just seemed like too much trouble. And what do you get out of it? Another way to keep up with your friends? That is, another way, in addition to phone, mail, SMS, email...and carrier pigeon. Seems like more than enough ways already. We also tried LinkedIn. We signed up. But we could never figure out what the point is. So...we apologize to all the many people who offered to make us a ‘friend’ or a ‘contact.’ I’m afraid we had to ignore them all. Not because we don’t want them as friends and contacts. But simply because we can’t keep up with the volume of contacts we have already. Our advice to Dear Readers: Sell Facebook and LinkedIn...as soon as you get a chance. Turn off Facebook. Unplug yourself from LinkedIn. Tune out. Turn off. Buy gold. Be happy. Regards, Bill Bonner for The Daily Reckoning ---------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com How to Ruin Your Economy and Influence People Why US Job Creation Heats Up in Cold Weather Debt Beats the Economy in a Growth Race Moody’s Downgrades Six Eurozone Nations The Greek Parliament Bails Out the Markets The Next American Oil Boom? The Daily Reckoning: Now in its 11th year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists. Cast of Characters: Bill Bonner Founder Addison Wiggin Publisher Eric Fry Editorial Director Joel Bowman Managing Editor The Mogambo Guru Editor Rocky Vega Editor Additional articles and commentary from The Daily Reckoning on: Twitter Facebook DR iPhone APP To end your Daily Reckoning e-mail subscription and associated external offers sent from Daily Reckoning, cancel your free subscription. 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