I’ve written quite a bit about Peter Schiff here on the blog, and finally got around to including one of his video blogs.  In it, you’ll hear Schiff address a couple of issues that I believe escape true public scrutiny, given the way these stories are shaped by the media.

With respect to gas prices, we’re now being subjected to the usual refrain that greedy oil companies are once again fleecing us at the pump.  But this infantile argument begs an easy counterattack if one were to think about it for a mere minute or two.  For example, when gas prices were falling, was that due to oil companies generosity?  I mean, c’mon -- if rising prices are due to their greed, then falling prices must be due to their generosity.  So how come we didn’t hear about the “generous” oil companies from 2009-11?  Bottom line is, the people touting this line of reasoning (or substitute it with the “blame Iran/Wall St greed/etc” screed) would have been rank-and-file “the-earth-is-flat” cheerleaders centuries ago.

I also enjoyed Schiff’s analysis of Warren Buffett’s crusade to get millionaire’s to pay more taxes (good thing he’s a billionaire so he can avoid too hard a hit).  Would be nice if Buffett was more up front about how he hides 99% of his income from the tax man.

Enjoy.

Last week, the Federal Reserve announced the next step it planned to take to intervene in the economy and attempt to aid in its recovery.  This step is called "Operation Twist."  I want to briefly discuss it here so you understand what's actually being referred to when you hear this term.

US Treasury bonds range from short term (such as 2 year notes, though there are even shorter terms than that) to long term (30 year Treasuries).  The bonds have price and yield characteristics that move opposite each other (picture a seesaw -- when a bond's price rises, its yield falls, and vice versa).  These characteristics can be plotted along what's called a "yield curve," which under normal circumstances, depicts low yield for short term bonds and high yield for longer term bonds.  The reason for this is, if you buy a short term bond, the duration of time over which you're risking your capital is brief, and therefore lower on the risk scale -- thus, you don't get much yield back for it.  On the other hand, if you risk your capital over a long period of time, say 30 years, you would normally be rewarded for it by receiving a higher yield.

That's under normal circumstances.  We are not operating under normal circumstances.

The Fed has already used various monetary policies to push down interest rates to the 0-0.25% range, which influences the rate at which banks lend to their customers (and which has resulted in historically low rates for borrowers today).  The problem is, there still isn't as much borrowing going on as the government/Fed would like.  The reasons for this are not the point of this article -- suffice it to say that borrowing remains below target.

Enter Operation Twist.  Picture that yield curve again, with the line sloping upward from the 2 year note to the 30 year bond.  If you could grab each end, like a dishrag, and twist it (like you were ringing it out), you'd flatten out that curve.  Yields on 2 year notes would rise; yields on 30 year bonds would fall.  That's the objective behind this policy move.

So how does the Fed accomplish this?  Simple.  The Fed has a certain number of 2 year notes on its balance sheet.  It sells them in the open market.  This increases the supply of 2 year notes, diluting demand and thus lowering the value/price of the notes.  As the price falls, yields rise.

With the money it receives from the sale of the 2 year notes, the Fed enters the 30 year bond market and buys those Treasuries.  As it buys them, supply drops, increasing demand and thus increasing the value/price of those bonds.  As the 30 year prices rise, their yields fall.

Ultimately, as the 30 year bond yield falls, the eventual interest rate you or I might receive on a 30 year loan (read: mortgage) should fall, as well.  At least that's the hypothesis.  Whether banks actually lower the rates any further than they already have (as opposed to just pocketing the wider margin), remains to be seen.

But in the abstract, what does all this really signify?

Desperation.

The government, using the instrument of the Fed, is desperate to juice the economy, by stimulating more borrowing and consumption on the part of the consumer.  Specifically, juicing the housing market has all kinds of (temporary) positive effects on the economy, since so many industries benefit from home construction/remodeling/etc.  Of course, I'd thought we'd already found out in 2007-09 what happens when a housing bubble bursts...but hey let's face it, we don't learn lessons too well around here.

The key point is to see past the fancy jargon and terms of reference that the government and the Fed will throw at you, which only serves to obscure the often negative reality involved, and to understand what is actually happening and how it affects you.

As our economy continues to struggle, with both parties in our political structure pointing the finger back and forth, I thought it might be helpful to dredge up an old article I wrote back during the 2008 Presidential campaign season (located on my previous blog, "Austrian School"), titled "Your Presidential Candidate Doesn't Matter (Subtitle: You'll Be Worse off Economically in 2016 No Matter Who Gets Elected)."

Now, I hate to jump the gun by five years, but I'm starting to feel like I was more right than I even imagined in the first place.  I suspect that if you had read this article of mine when it was first published, at the very least you were a bit skeptical...but now here we are, worse off than we were then, and all signs pointing downward.

While I encourage you to read the whole article, I did want to share and comment on a couple of excerpts here.  To begin:

To quickly summarize: when inflationary policies are instituted, and money is created out of nothing, that money flows to entities that can utilize it before its price-raising effects seep into the larger economy. These entities (investment banks, corporations, the wealthy) can invest it or capitalize it in a fashion that is advantageous to them, such as by investing in real estate, stocks, derivative investments (options, collateralized debt obligations), or anything else for that matter. Then when the added money trickles down to the consumer (read: you and I), we are left with one thing: higher prices. Less purchasing power. Smaller paychecks. Whatever you want to call it, it's not good.

I like this paragraph because it captures, in essence, this prescription we've received of more government borrowing/money printing/spending (through Quantitative Easing I [February 2009], Quantitative Easing II [November 2010], and Operation Twist [September 2011]), which so many of us take for the beginnings of an economic recovery.  Unfortunately, it is actually the poison that will eventually do us in.  It LOOKS good -- "Great! The government is actually doing something, they're helping us out."  It SOUNDS good -- "This government spending will create more construction/infrastructure/etc jobs."  It FEELS good -- "We've GOT to do something, we can't just do nothing."

But it is NOT good, and it will turn out very badly as time goes by.  Briefly said, it will ultimately achieve only the following:

1) Add to the national debt, burdening us with increasing interest payments over time in order to service that debt.
2) Contribute to devaluation of the currency, weakening the value of each dollar, lowering our purchasing power, and leading to a lower standard of living.
3) Crowd out more jobs than it creates; for every job created by the government, the fact that it had to borrow/spend to create it destroys 1+X jobs (we'll never know what the X is).

I also wanted to highlight this excerpt, the closing paragraph of the August 2008 article:

Allow me to proclaim with even more emphasis the following: no matter who becomes President - Barack Obama or John McCain - your economic situation will be worse after the presumptive two terms that individual will serve. By worse, I mean some combination of the following conditions: less home equity, devalued investments in stocks and bonds, lower purchasing power, less available savings, more reliance on credit to buy the essentials, you name it. It won't be pleasant.

Gloom and doom.  Yeah, I know everyone is tired of it, but it's way past the time to face facts.  The government does not have a shred of a clue how to fix the economy, aside from their misguided appropriation of our wealth and the subsequent redistribution of it.  And we see where that has gotten us today.

Actually, it's got to be somewhat unnerving for those who have put so much faith in the government's ability to aid an economic recovery, to see the ineffectiveness of these policies.  I honestly don't know how anyone could actually believe at this point that the government has a viable approach for fixing the problem.  Every policy has failed, and indeed has worsened the conditions under which we're subjected to economically (rising inflation, higher national debt, etc.).

I hate to say it, but at this point in looking ahead to the 2012 election, it really matters not who ends up President.  There is no political will nor ability to compromise on the big issues and problems to suggest that the economy will once again prosper and thrive.  The election season and campaigns will roll on with theatrical flourish, and you and I will continue to witness a declining standard of living.

Followers of this website know that along with Nassim Taleb, Peter Schiff is the other market and investing guru that I follow closely and have a deep respect for -- and so you wouldn’t be too surprised how happy I was to hear that he was given an opportunity to testify before Congress on the current economic conditions.  The testimony occurred back on September 13, and you can watch part 1 and part 2 of his testimony on YouTube.

Basically, Schiff sticks right to the same message that he’s been touting for years, and that he used as a platform for his unsuccessful Senate run in 2010.  The major points you’ll hear in the testimony:

-- The government is a net destroyer of jobs.  For every job we see created in the tangible sense, we have no way of estimating how many jobs were destroyed or stopped from being created due to the burden of higher government spending, debt, taxes, regulation and overall intrusion into the economy.

-- Stimulating the economy with more borrowed or printed money does not make for an economic recovery; rather, it lays the foundation for greater economic pain down the road, by acting as a “sedative” that delays the necessary corrective forces in the market, thus exacerbating them when they finally run their course.

-- Speaking as a businessman (Schiff owns and runs Euro Pacific Capital), he emphasizes the fact that he has been discouraged from hiring new workers due to the high-tax, high-regulation environment our economy is subjected to.  Schiff goes so far as to point out that he has now resorted to opening new offices/branches overseas (he mentions Singapore and the Caribbean) in order to escape the tax and regulatory burden here in the States.  Effectively, these are jobs the government has driven out of the country through various misguided laws and policies.

Of course, these are just a few high points from the testimony.  If you enjoy following Schiff, or want to hear an alternative argument as to how to truly stimulate the economy as opposed to the ones consistently put forth by the government, then I recommend you take a look at the video clips contained in this post.

I think we might be witnessing the last vestiges of the Keynesian economic model dissipating before our very eyes.  The supposed economic recovery that has been touted for the last several months is faltering in all-too-rapid fashion, and even the government's cheerleaders are sobering up to the notion that there might never have been a recovery to begin with.  The last few weeks have seen one disappointing economic report after another, and Friday’s job report drove the point home with uncomfortable emphasis.

It’s a momentous occasion, so it’s worth saying again: I think we’re witnessing the beginning of the end for the Keynesian economic theory.

John Maynard Keynes, an esteemed economist in the first half of the 20th century, maintained that government involvement in the economy was a healthy thing, and that money supply expansion during economic downturns was a viable option for reversing such downtrends.

Austrian School theorists have always maintained that Keynes had it all wrong -- money supply expansion was dangerous in terms of its propensity for causing inflation, and government involvement would invariably lead to market distortions and myriad unintended consequences for the whole of the economy.

For decades now, there hasn't been much in the way of hard and fast evidence with which to prosecute the Keynesian model.  However, the 2008 financial crisis, and the response to it since then, has placed Keynesian theory front and center, where it may now be subjected to the most rigorous scrutiny to date.

You see, the Keynesian response to the crisis -- the swift and unprecedented expansion of the money supply, on a scale never before attempted -- has seemingly produced little effect on our overall economic health.  Trillions of new dollars pumped into circulation (quantitative easing, or QE) have provided only the smallest of bounces to the economy, contrary to the belief that we'd be placed on a firmer path to recovery after QE1 (early 2009) and QE2 (late 2010).

Of course, expect defenders of this approach to simply claim that the efforts weren’t on a large enough scale.  “Had we just circulated a few trillion more dollars into the economy, everything would be fine now.”  This is the only remaining defense for the QE/Keynesian proponents.  To them I’d ask, how big is big enough?  Instead of $3 trillion, should we have printed 30 trillion?  Or maybe 300 trillion?  Why stop there?  If printing money is the road to prosperity, why did we go so small in the first place?  Print a few quadrillion dollars, and we’ll all be rich.

In other words, a little common sense goes a long way when debating with a Keynesian.  But I’m digressing...

The real point here is the recovery is ephemeral, and we need to recognize this fact and begin adjusting to that reality.  I expect a cocktail of gradually-worsening economic data to continue surfacing, and will be looking for the subsequent effect on the stock market.  In a nutshell, the declining manufacturing numbers, worsening employment situation, anemic housing market, high gas prices, decreasing consumer confidence and consumption metrics, and steadily rising inflation will create a significant drag on the economy.  I anticipate the Federal Reserve will also do their part to help lay the foundation for another financial crisis, as they toy with the idea of QE3 and leave interest rates at rock bottom levels for who knows how long.

As always, check your portfolios.  The market is down 5% in just the last few weeks, so whether it’s the beginning of a bear market or only a hiccup, either way it’s good practice to review your holdings.

On February 9, Fed Chairman Ben Bernanke went before Congress for his usual round of testimony, and he delivered the good news that inflation was under control; in fact, according to Bernanke, it was virtually nonexistent.  While he made a brief nod to rising gas and food prices, he followed that with the following remarks:

“Nonetheless, overall inflation is still quite low and longer-term inflation expectations have remained stable. Over the 12 months ending in December, prices for all the goods and services consumed by households (as measured by the price index for personal consumption expenditures) increased by only 1.2 percent, down from 2.4 percent over the prior 12 months. To assess underlying trends in inflation, economists also follow several alternative measures of inflation; one such measure is so-called core inflation, which excludes the more volatile food and energy components and therefore can be a better predictor of where overall inflation is headed.”

On February 15, the World Bank reported that global food prices have reached “dangerous levels” (its words, not mine).  According to the Associated Press report on this story, the food price situation “could contribute to political instability, push millions of people into poverty and raise the cost of groceries, according to a new report from the World Bank.”

Today, I read that gasoline prices hit 28-month highs.  But you don’t need me to tell you much about this fact -- you’re already experiencing it when you go to the pump, no doubt cringing as you watch prices rise almost weekly.

Another report today regarding inflation concerns pointed out that wholesale prices (measured through the Producer Price Index) rose 0.5%, the highest amount since October 2008. 

Hmm.  So inflation doesn’t sound as “stable” as Bernanke would like us to believe.

Strangely enough, throughout all of the discussion on these sordid data points, I’ve heard every explanation for them under the sun: supply issues, weather impacts, political unrest, China, greedy corporations...you name it.  Every explanation has been trotted out, except for this one:

The US (Federal Reserve) has printed over $2 trillion dollars in the last 2-plus years.  Food and energy products are priced in dollars on the global markets.  Since now there are a lot more dollars in circulation, food and energy products now cost a lot more dollars too.

Even more directly: the money we’ve been printing has led in part to the rise in food and energy prices.  But no one will acknowledge this fact, including our Fed Chairman.

How Bernanke can routinely get away with this willful ignorance of reality is nothing short of stunning.  The fact that he is responsible for our monetary policy is nothing short of chilling.

On the larger scale, I’m continually amazed at the lengths that the financial and media establishments will go to to deny the connection between the expanding supply of dollars and the rise in the prices of commodities like food and energy.  And when inflation statistics are reported, food and energy are discounted because they’re categorized as “volatile.”  Of course they’re volatile -- that volatility comes at least in part from the fluctuation of the value of the dollars they’re priced in.

So the takeaway here is, when you listen to official metrics such as the Consumer Price Index (CPI), remember that the critical items like food and energy -- the kinds of things you can’t live without -- are not reflected in those metrics.  You’re being given an incomplete picture of this important aspect of the economic conditions in our country.  The threat of inflation is being misrepresented, and it’s something you should still be accounting for when you do your personal financial planning regardless of what the government’s statistics say. 

Yes, I know it’s hard to believe.  One would think that the very entity that facilitates your loss of purchasing power and instigates US and global economic collapses would hardly be a source of amusement for anyone.  I thought the same until I came across this video here.

A couple of notes about the link (which will open up to a YouTube video when you click on it):

-- The dialogue is meant to explain quantitative easing, which the Fed announced a second round of several weeks ago to the tune of $600 billion.  Keep in mind that the video isn’t covering every last detail behind this concept and therefore may oversimplify some aspects of it.  Recommend you conduct further reading on the subject if this is the first exposure you’re having to the topic.

-- The website used to create this video (www.xtranormal.com) is open to anyone who wants to make text-to-video clips, and thus you’ll notice many different YouTube videos on a variety of subject matter that appear in this format.  By recommending you view the enclosed link, I am not endorsing or recommending any of the other links that appear similar to it.

-- The video clip I’ve linked to here does include some coarse language, so please beware of opening around children.

-- Keep in mind that this video is meant primarily for amusement purposes, though I think that any medium that can effectively communicate a complex and important subject such as this one in an entertaining manner is worth incorporating into your research.

Enjoy.