The Fear Index Goes Out On Top

By John Robino of Dollar Collapse .com

M3 died a controversial death this week. As for whether the Fed’s decision to stop reporting its broadest measure of money was simply a recognition that money has become too complex to quantify, or an attempt to hide the accelerating debasement of the dollar, time will tell. But one thing is certain: The best gauge of gold’s near-term direction has now become impossible to calculate. Called the “Fear Index,” it was created by GoldMoney’s James Turk in the 1980s, and since then it’s been nearly flawless (read on for its final prediction). Here’s how James and I explained it in our book, The Coming Collapse of the Dollar:

“The dollar is a balance sheet currency, which is to say an accounting fiction. Its value is derived from the assets held by the Federal Reserve and commercial banks, some of which, like gold, are real and tangible, and some, like bank loans, foreign currencies, and derivatives, are not. The Fear Index measures the relative importance of gold within the U.S. monetary system, and is calculated by multiplying the U.S. gold reserve (i.e., the weight of gold reportedly under the Treasury’s control) by gold’s exchange rate to get its total market value, and dividing this result by M3, the broadest measure of money supply.

A reading of, say, 2%, indicates that for every $100 circulating as M3, there is gold worth $2 sitting in the U.S Treasury’s vaults. Gold would thus account for 2% of the dollar’s value, with the other 98% dependent upon the financial assets of the Fed and the nation’s banks. The calculation for December 31, 2003 is as follows:

When the Fear Index is falling (that is, when the number of dollars in circulation is rising faster than the market value of the gold in U.S. reserves, or when the number of dollars is falling more slowly than the value of the gold reserves) the implication is that people are willing to hold these extra dollars because they’re optimistic about the prospects of the dollar and/or the U.S. economy. When the Fear Index is rising (which occurs when money is flowing into gold, pushing up its exchange rate and raising the market value of U.S. gold reserves), it’s usually because people are worried about the dollar or the health of the U.S. banking system, and are looking for alternative stores of value.

And when the Fear Index exceeds its 21-month moving average and the moving average rises above its level of the previous month, the result is a ‘Buy’ signal, indicating that gold is headed higher. As you can see from the chart below, there have been only five such signals in the past thirty-five years, all of which were followed by gold rallies.”

Investors who bought gold at the last Fear Index buy signal are up about 80% today. So now the question becomes, where’s the top (which is the same thing as asking where the dollar will bottom out). Without the Fear Index, this question has become a lot harder to answer. But it’s also a long way off. As James wrote in his most recent Freemarket Gold and Money Report newsletter:

“As we can see from the page-1 chart [posted below], the Fear Index has again been climbing over the past few years. There are a couple of noteworthy points to make as a result. There are two solid red downtrend lines on the page-1 chart. Look at what happened after the first downtrend line was broken. The Fear Index soared. Now look at what is happening.

The Fear Index is again soaring, and I expect it to continue climbing higher, repeating the experience of the 1970s. I’ve drawn two uptrend channels to show that I expect the Fear Index to climb within an uptrend channel just like it did through the 1970s. The second point to which I want to draw your attention on the page-1 chart is the dotted, red downtrend line.

I expect the Fear Index in time to reach and eventually break through that downtrend line. In other words, the Fear Index over the next several years is heading back to – and probably above – 10%. In fact, it is my expectation that within several years, the Fear Index will climb toward the peak reached during the Great Depression. It will do this as the problems with dollar fiat currency become more apparent, causing a flight from the dollar into the safety and security of gold. The flight out of the dollar is already underway. It’s only a matter of time before the rush for the exits turns into a torrent.

Assuming M3 grows at 8% a year over the next three years, and the Fear Index rises to 10%, implying that we’re worried as in the 1970s, the Fear Index yields a target gold price of $4,961 per ounce."

The Real U.S. National Debt

By John Robino of Dollar Collapse

Funny how some rituals persist long after their original point is forgotten. Take the federal debt limit, that relic of a time when lawmakers were actually embarrassed about piling debt onto our kids. Nothing embarrasses these guys any more, of course, and the annual process of raising the limit has devolved from tragedy to farce, with Treasury threatening to bounce Social Security checks (secure in the knowledge that it will never have to) and legislators pontificating on fiscal responsibility (certain that their pork won’t be touched), followed by a quiet vote to raise the bar by another half-trillion.

That was last week. Now comes the usual round of media hand-wringing, to which the don’t-worry-be-happy crowd will respond as it always does, with the observation that America’s “national debt” is no higher—and in some cases a lot lower—than that of other countries. Get ready to see variations of the following chart in the Wall Street Journal and on CNBC:

Viewed this way, Washington’s obligations actually do look pretty manageable. If we’re doing as well as Germany and better than Japan, how bad can it really be? Well, it can be very bad indeed, because the “national debt” in the above chart refers only to direct obligations of the federal government, and government doesn’t have to borrow to finance itself with debt. Consider: If the Fed lowers interest rates and liberalizes lending rules enough to convince me to build my dream house, I go out and borrow, say, $500,000, which generates taxable income for my mortgage banker and her support staff. Then I hire a contractor and crew, who spend six months earning good money and paying taxes. Then I furnish the house and landscape the yard, generating taxable income for furniture makers and gardeners. Government, by encouraging me to borrow, has pocketed tens of thousands of dollars that it doesn’t have to borrow for itself.

Now, at this point an astute reader might say, “Ah, but there’s a difference between a mortgage held by a bank and a bond issued by the Treasury. If you default on your mortgage, only the bank and its shareholders have a problem. This is private, not ‘national’ debt.”

Not so long ago, this would have been true. But no more. To understand why, let’s contrast yesterday’s banking practices with today’s New Age securitization machine. Back in, say, 1986 a bank that wrote a mortgage generally held onto it, collecting the monthly payments and netting them against the borrowing necessary to fund the loan, earning a profit on the difference. If a borrower defaulted, the problem was indeed strictly private-sector, impacting the bank and its owners but not the general public.

But that quaint arrangement is history, thanks to the emergence of Fannie Mae and Freddie Mac. These “government-sponsored enterprises,” or GSEs, were created decades ago by Washington to buy mortgages from banks, thus giving banks a little extra cash to lend to would-be homeowners. And for a long time, they stuck pretty much to their original charter, buying modest numbers of mortgages and helping banks fund modestly greater numbers of home purchases. But in the 1990s they had an epiphany: What they could do on a small scale, they could also do on a vast scale, making easy fortunes for their execs and shareholders in the process. They started buying literally trillions of dollars of mortgages from banks. Then they packaged them into bonds, slapped a guarantee on them (giving the bonds AAA ratings) and sold them to global investors for a nice profit. Then they started borrowing at really low rates (possible since everyone thinks they’re part of the government) to buy back portfolios of these same bonds, earning the spread between the bond yields and the GSEs’ borrowing costs.

Fannie and Freddie between them now own and/or insure about $4 trillion of mortgage debt, which means trouble at either would cause a financial earthquake. Picture a scenario in which a derivatives accounting problem costs a GSE its AAA rating, which causes all the bonds it has insured to fall, which lowers the value of its bond portfolio, which cuts its credit rating even further, and so on, in a death spiral that takes the whole global financial system along for the ride. No government that wants to stay in power will allow this to happen, which means that Fannie and Freddie are officially too big to fail, and taxpayers are on the hook for their liabilities.

We’ve seen this movie before, by the way. Back in the 1980s, easy money and lax regulations (the Feds actually encouraged S&Ls to buy junk bonds) allowed the junk bond market to inflate into a full-scale bubble. When it burst, those supposedly private sector bonds bankrupted thousands of S&Ls, which the government bailed out to the tune of several hundred billion dollars.

This time around the amount of money directly at stake is maybe twenty times as large. But that’s just the beginning. Because the value of the bonds Fannie and Freddie own and insure depends on the behavior of mortgages in general, you can make the case that taxpayers are now on the hook for the whole $10 trillion mortgage market. Viewed this way, the “national debt” doesn’t look nearly so benign.

Why Buy Gold and Silver

Best Quotes of February 2006
By John Rubino posted at Dollar Collapse .com

Texas Congressman Ron Paul
“Since printing paper money is nothing short of counterfeiting, the issuer of the international currency must always be the country with the military might to guarantee control over the system. This magnificent scheme seems the perfect system for obtaining perpetual wealth for the country that issues the de facto world currency. The one problem, however, is that such a system destroys the character of the counterfeiting nation’s people--just as was the case when gold was the currency and it was obtained by conquering other nations. And this destroys the incentive to save and produce, while encouraging debt and runaway welfare.

The artificial demand for our dollar, along with our military might, places us in the unique position to ‘rule’ the world without productive work or savings, and without limits on consumer spending or deficits. The problem is, it can’t last.

Price inflation is raising its ugly head, and the NASDAQ bubble-- generated by easy money-- has burst. The housing bubble likewise created is deflating. Gold prices have doubled, and federal spending is out of sight with zero political will to rein it in. The trade deficit last year was over $728 billion. A $2 trillion war is raging, and plans are being laid to expand the war into Iran and possibly Syria. The only restraining force will be the world’s rejection of the dollar. It’s bound to come and create conditions worse than 1979-1980, which required 21% interest rates to correct.”


Stephen Roach, Morgan Stanley
“Suffering from the greatest domestic saving shortfall in modern history, the US is increasingly dependent on surplus foreign saving to fill the void. The net national saving rate -- the combined saving of individuals, businesses, and the government sector after adjusting for depreciation -- fell into negative territory to the tune of -1.3% of national income in late 2005. That means America doesn’t save enough even to cover the replacement of its worn-out capital stock. This is a first for the US in the modern post-World War II era -- and I believe a first for any hegemonic power over a much longer sweep of world history.”


Richard Daughty, the Mogambo Guru
"But, for some perverse reason that future historians will make whole careers arguing about, the moronic people of America think all of these price inflations are good! Hahaha! A nation of morons! I sort of remember a quote by Benjamin Franklin, who was asked, when they finished work on the Constitution, 'And what kind of government do we have?' and he replied 'A democracy, if you can keep it.'

What he surely meant by that enigmatic phrase was if you let people decide tax policy, the numerous have-not people will always vote to give themselves somebody else's money. A democratic, majority-rule government always elects to provide a 'free lunch' for everybody! Whee! Thus, democracy will ultimately destroy the economy. That is why the Founding Fathers wrote into the Constitution that money shall only be of silver and gold, which is the only thing that would possibly prevent it.”


Ben Bernanke, Federal Reserve Board Chairman
"In the past, when the inverted yield curve presaged a slowdown in the economy, it was usually in a situation where both long-term and short-term interest rates were actually quite high in real terms, suggesting a good bit of drag on the economy. With the real interest rate not creating a drag on economic activity, I don’t anticipate that the term structure signals an oncoming slowing of the economy.”


Peter Schiff, Euro Pacific Capital
"The only way for housing prices to stay high is for the Fed to keep inflating. Conveniently, the captain currently at the helm of the monetary ship of state just happens to be Ben Bernanke, who as a Fed governor spoke about the Fed’s ability to fend of deflation by using the handy invention of the printing press. Though his words may have may have spoken in reference to consumer prices, his actions will certainly be concentrated on asset prices, especially housing. Like a lounge club magician, the Feb distracts the audience with short-term rate hikes, while behind its back it monetizes long-term government bonds. It creates the illusion of its being an inflation fighter, while in reality it is an inflation creator. No wonder it wants to further cover its tracks by no longer reporting M3!”


James Turk, GoldMoney
"We moving closer to that moment in time when silver breaks down from its current pennant formation, which is the first step needed for the precious metals to resume their uptrend in this ongoing bull market. If this first step happens, then I expect everything to fall into place. A breakout from the rising trend channel will not be far behind, and by then, the precious metals will be near or at new high prices - with silver leading the way.”


Bill Fleckenstein, Fleckenstein Capital
“But let me just ask you this: If you feared for the value of this piece of paper called the dollar and you put it into a hard asset, does that de facto constitute a bubble? Of course not. That constitutes a bull market. To be a bubble, in my opinion, behavior in and around the asset class under discussion has to spin so out of control as to distort the underlying economy. I don't believe the commodity markets are anywhere near that point. Maybe they'll reach it somewhere down the road, though I kind of doubt that. In the meantime, I anticipate a bullish chain of events for the metals: When the ‘right’ data emerge to support the fact that the economy is weaker than it appears, I believe the Fed will make clear that it's closer to pausing than people think. (Bernanke himself told Congress last Wednesday that whatever the Fed does will be ‘dependent on the data.’) If that turns out to be the case, I think there will an explosion in the precious metals and currencies, an outcome that I intend to capture.”


Ted Butler, Investment Rarities
"This proposed silver ETF, as well as any ETF on any commodity, is as dumb as a bag of rocks. Sure, it will make the price explode, and precisely for that aspect virtually all silver investors, including me, look upon it favorably. Suddenly take away a big chunk of any commodity’s supply and there will be a big impact on price. That’s elementary. But there is more to the story than that.

My main objection with commodity ETFs is that, in addition to artificially altering supply and demand, they turn legitimate commodity law and regulation on its head. The main thrust of commodity law is to prevent concentrated speculative buying and selling from artificially influencing prices. This primary premise and intent of commodity law is obliterated by the concentrated buying (and selling someday) that a commodity ETF insures. It’s as if someone sat down and devised an idea that would upend all the safeguards and regulations against manipulation that have taken many decades to develop.

Over twenty-five years ago, the weight of commodity law came to bear on the Hunt Brothers in the most famous manipulation of them all, the great silver manipulation. The basis of the manipulation was the related and concentrated buying and resultant price pressure brought on the price of silver. The proposed Barclays silver ETF promises to legitimize the very acts which the US Government succeeded in prosecuting. Talk about irony."


Doug Noland, PrudentBear
“A solid case can be made that 14 rate increases have failed to tighten monetary conditions. Despite the inverted yield curve, Credit conditions are generally as loose as ever and, as one would expect, imbalances balloon only larger. Of course, the bond bulls will contend that we are merely waiting patiently for the traditional monetary policy lag to run its course. I suggest there’s much more to it than that.

It is worth noting that broad money supply has rapidly approached $10.3 Trillion. It is also worth pondering that M3 has inflated almost 40% since Fed funds were last at 4.50% (May 2001). At a 5% rate, M3 savers will receive more than $500 billion of interest-income, a huge increase from only a couple years back when rates were 1% and M3 was significantly smaller. There is scant attention paid to this source of augmented income, with analysts instead focusing on the restraining effect of adjustable-rate mortgage resets. But with the ongoing proliferation and easy-availability of mortgage products with low initial payments (teaser-rate ARMs, negative amortization and option-ARMs, and balloon structures), I would be surprised if the household sector in aggregate experiences a significant increase in monthly mortgage payments this year.”


Steven Saville, Speculative Investor
"We would be extremely surprised if the uninterrupted inflation of the past 70 years were followed by a period of genuine deflation (a prolonged decline in the total supply of money and credit). One of the reasons this would surprise us is that there IS so much debt in the system. The high debt levels actually make deflation LESS likely, not more likely, because the current monetary system -- the world's greatest-ever Ponzi scheme -- could not survive a bout of genuine deflation. That is, deflation will never be a viable policy option regardless of how bad things get. Instead, the central banks of the world will likely risk destroying their currencies and obliterating the values of their bonds before they will permit deflation to occur."


Tom Au, TheStreet.com
"Another commentator opined that the U.S. government is probably underestimating inflation because it is focusing on the wrong type of inflation. I would agree with that, having identified no less than five different types of inflation: commodity inflation, wage inflation, monetary inflation, fiscal inflation, and foreign exchange inflation. Before discussing 'inflation,' it helps to identify which form of inflation is being talked about."