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Bad ideas – not the Euro, corruption or speculation – did for the Irish economy...

AS THE BAIL-OUT of Ireland begins in earnest, many in the media are asking "What went wrong?" and coming to some dubious answers, writes Robert Thorpe at the Cobden Centre.

The circumstances are well known. Ireland saw a long boom before the financial crisis. That boom was accompanied by a large rise in house prices and a boom in building construction. After the financial crisis and ensuing world-wide recession, many Irish banks were bailed out by the government or nationalized. The Irish government practiced austerity policies, increasing taxes and reducing expenditure. But, as the cost of the bailouts increased, so did the budget deficit.

Many commentators are now claiming that Ireland's membership of the Euro was the underlying problem (for example, Peter Oborne at The Telegraph). In this argument many sound economic ideas have been mixed with careless ones.

One argument is that if Ireland had not been part of the Eurozone it would have been able to devalue it's currency. It's true that if Ireland still had the Punt then this would be possible, but it's not as significant as many people believe. In today's world, with floating fiat currencies controlled by central banks, there is no clear concept of "devaluation" any more. The economic prospects of the region encompassed by each currency and the policies of the central banks are taken into account by the exchange rate market, and the exchange rate fluctuates minute by minute. This means there are two different arguments. The first, which focuses on the private sector, is that when a country enters recession the value of it's currency falls allowing a growth in exports. This is a dubious argument, but whatever its merits it could not have seriously improved the financial situation of the Irish banks or the Irish government.

The second argument is that in a crisis the state's central bank may create money and use it to pay debts and finance bailouts. A modern state can easily create new money without having additional assets. If Ireland had kept the Punt, its own fiat currency, then the government could have bailed out the banks using newly created money. But, that would simply be a hidden tax. Inflation would ensue then holders of money and money-substitutes would see the real value of those assets fall. Holders of assets denominated in money such as loans and bonds would see those fall in value in real terms too. The tax would be paid by the people through this loss of purchasing power.

Any permanent increase in the stock of money must lead to inflation, though there may be a time lag until it becomes noticeable. A temporary increase could only be achieved by withdrawing money from circulation afterwards, and that could only be done with taxation. That governments can create money to get themselves out of sticky situations is beneficial to governments, but not to the people they're supposed to serve.

Critics of the Euro also claim that the Eurozone currency area could not have worked. According to this view the ECB must run monetary policy to suit the core Eurozone countries. But interest rates that are a good fit for Germany and France will cause problems in other Eurozone countries. There is some truth in this. In the years before the crisis, the ECB ran low interest rates to stimulate the northern European economies, particularly Germany and France which were struggling with rigid labor markets. A side-effect of that policy was the building booms in Southern Europe and Ireland which weren't sustainable. Though there is some truth in this view, it's still confused, too.

The idea that labor market problems can be successfully compensated for by reducing interest rates is from Keynesian economics. The idea that central banks reducing interest rates to excessively low levels causes unsustainable booms is from Austrian economics. These views can't be mixed because they come from conflicting theoretical starting points. It isn't possible that Keynesian economists are right in France and Germany but Austrian economists are right in Ireland and Portugal. In my view, the ECB's low interest rates may have been an attempt to stimulate the Northern European economies, but that policy wouldn't have worked under any circumstances. The ECB's policy came at a cost to Ireland and the Southern European countries when the property bubbles burst, but that cost doesn't reflect any benefit to the Northern European countries.

It's true that a Central Bank faces greater problems if the currency area that it regulates spans many countries with different conditions. But, as we have seen, Central Banks can't avoid recessions and crises even if they only regulate the currency of a single sovereign nation.

Many countries have found themselves facing the consequences of the bad decisions made by Central Banks. Ireland isn't unique in that respect. What makes Ireland unique is the extraordinary lengths that the government have taken to support banks and property developers.

In September of 2008 the Irish government guaranteed for two years all bank accounts with Irish banks and almost all loans to those banks. This September, when that guarantee was due to expire, it was extended for another three months. The government decided that rather than risk paying out on that guarantee they would bail out banks as and when they needed it. They nationalized the worst-affected bank – Anglo Irish Bank in 2008. So far, through several bailouts Anglo-Irish Bank has cost the Irish government €22.9 billion and the other banks have cost €10.1 billion, though the extent of losses hasn't been fully recognized and will probably be much greater. It is these debts that have caused Ireland's budget deficit to rise much more than those of other countries.

There have been many rumors about corruption in the Fianna Fail and in Anglo-Irish bank. The actions of the former board of Anglo-Irish bank are under investigation by financial regulators and the police, the former CEO has been declared bankrupt. There are close links between the ruling Fianna Fail party and many property developers, that was the subject of jokes long before the crisis. The previous Taoiseach Bertie Ahern was investigated for receiving bribes from property developers. I think there's probably some truth in these allegations of corruption. But the politicians that form the government had many ways they could abuse their power for personal gain. A politician has many ways he can make a little on the side without bankrupting his country.

It's ideas rather than corruption that have created such a great crisis for Ireland. The government thought that the resources the state could lay claim to were inexhaustible. They believed that if the state guaranteed bank accounts that this guarantee alone would satisfy the markets. Indeed, Finance minister Brian Lenihan once called the guarantee the "cheapest bailout in the world so far."

But the government forgot that the power of the state isn't magical. A government can transfer the liabilities of banks onto the taxpayers, but they can't abolish them. Back in 2008, the government were worried that the failure of a bank would harm Ireland's reputation, but in the long run their cure was worse than the illness.

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Hyperinflation is not simply inflation times 10. In fact, it's when real prices fall...

SO the FEDERAL RESERVE's second-round of quantitative easing, announced on November 3rd, was a shoo-in – a fait accompli – already decided when the policy team first sat down the previous day, writes Adrian Ash at BullionVault.

How come? As the minutes released this week show, Brian Sack – manager of the New York Fed's System Open Market Account (SOMA) – opened the meeting. And asked to judge the matter, he told the 64 other policy-wonks gathered in the Eccles Building that his team "could purchase additional longer-term Treasury securities at a pace of about $75 billion per month while avoiding disruptions in market functioning."

Moreover...

"Implementing a sizable increase in the System's holdings of Treasury securities most effectively likely would entail a temporary relaxation of the 35% per-issue limit on SOMA holdings under which the Desk had been operating."

Hey presto! The following day, and after apparently intensive debate, a monthly target of $75 billion in Treasury bond purchases – plus a relaxation of the 35% limit on Fed holdings of any particular bond issue – was announced.

Does that make the Fed meeting a sham? No matter. "It's not as if the Fed is doing anything radical," says Princeton professor Paul Krugman. It's simply looking "to boost the flow of economy-wide spending by changing the mix of privately-held assets," agrees Berkeley professor Brad DeLong.

"It buys government bonds that pay interest in exchange for cash that does not. That is totally standard."

But totally standard where, exactly?

Sure, buying and selling government debt in the open-market is how central banks control short-term interest rates. That's why the Fed Funds rate is a target, and the actual outcome in the marketplace is instead known as the Effective Fed Funds. Bidding short-term bills higher (or lower) in price, the New York Fed thus pushes down (or up) the interest rate paid on those bills. But stuffing the market with money, in contrast, is a very different aim. Not least when you do it by buying longer-term bonds. And by only buying, rather than fine-tuning purchases with sales. And by doing it amid the heaviest net issuance of government debt in history. And by doing it so hard that, despite that record issuance, you still need to break your own limit on the proportion of any individual maturity-date you're allowed to own.

So again, we ask here at BullionVault: Where in the world is such money creation "totally standard"...?

"I think using quantitative easing is a perfectly legitimate thing to do. And for heaven's sakes, it's not as if we're in any danger of inflation any time soon."
– White House advisor and former director of the Congressional Budget Office, Alice Rivlin, speaking to CNBC on 15 November 2010

"We have no 'dangerous flood of paper'...On the contrary, our paper [money] circulation, though it shows a terrifying array of billions, is really not excessively high..."
– Vossische Zietung newspaper, 16 August 1922

"Several [Fed policy] participants saw a risk that a further increase in the size of the...monetary base could cause an undesirably large increase in inflation. However, it was noted that the Committee had in place tools that would enable it to remove policy accommodation quickly if necessary."
– Federal Reserve minutes from 3 November 2010

"Even if the quantity of money were three times its present size, it would constitute no real obstacle to stabilization..."
– Berliner Börsener newspaper, 18 August 1922

Okay, so pasting a couple of quotes next to each other doesn't mean the United States is headed straight for wheel-barrows and stormtroopers. Like everyone agrees, 1,000,000% inflation looks a long way off right now. But no central bank ever began a hyper-inflationary policy because it feared inflation. Such disasters always come because of vanished credit and economic depression. And whether in Germany nine decades ago, or in Argentina twenty years back, or in Robert Mugabe's Zimbabwe around the turn of this century, stuff actually gets cheaper – not more expensive – in real terms during hyperinflation. It's just that the local currency falls in value faster still, turning the "money illusion" we're all prey to into a livid nightmare.

Hence the daily flood of French citizens across the border at Strasbourg each day during the early stages of the Weimar madness, emptying the stores with their highly-prized Francs. Hence the real-estate bargains snapped up by wily speculators during Argentina's last-but-one collapse. Hence the zero-change in inflation – net net – for US Dollar earners during the early phase of Zimbabwe's hyperinflation, followed by massive a deflation, in US Dollar terms, even as prices in the local currency soared.

On the ground, amidst these crises, it was monetary contraction – not soaring prices – that most worried policy-makers. "The lack of money [now] has a worse effect than the devaluation itself," said one Berlin newspaper in summer 1922, as the Weimar Republic began to run the presses 24/7.

"The government printed notes to satisfy everyone," writes Adam Fergusson in his history of the disaster, When Money Dies, "telling itself that as the granting of credit...had so greatly decreased, the actual currency in circulation had to be so much greater."

But let's not get perverse. The latest flat-lining in America's official Consumer Price Index does not mean that hyperinflation is in fact underway. The critical factors to watch out for remain a collapse in tax revenues, plus demands for immediate payment from foreign creditors. It bears repeating nevertheless, however, that – contrary to the worldview presented by academic economists and professional wonks – demand-push inflation is not how hyperinflation begins. Real values in fact fall as a genuine currency crisis takes hold.

And the fact that the Federal Reserve is so dead-set on its "emergency" response that it scarcely needs to meet to agree it, doesn't mean the Fed actually knows what it's doing.

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Surely not! Buying Gold AND buying the US Dollar...?!

In THE LATEST ISSUE of True Wealth, one of my recommendations was to BUY the US Dollar, writes Dr. Steve Sjuggerud in his Daily Wealth email.

The Dollar now is a simple story. It's cheap, hated, and we have the start of an uptrend... It's what we look for in True Wealth, so we're buying.

But paid-up subscriber Jeff called me out on it. In an e-mail, he said:

"Isn't it highly likely that if the Dollar rises and the Euro declines, that silver and gold will decline?"

Great question, Jeff!

I've probably had more subscribers cancel over this idea (Buying Gold AND buying the Dollar) than anything else in the history of True Wealth.

Why? They call me crazy. They say, "You can't bet on a rise in both gold AND the Dollar. When one goes up, the other goes down."

That's right...in theory. But occasionally, theory and practice differ. We've successfully capitalized on this numerous times in True Wealth.

The last two times were:

• In 2005 (starting in the December 2004 issue);
• In the first half of 2010 (starting in the December 2009 issue).

Both times, the Dollar went up (the Euro went down), as predicted. And both times, gold went up, too.

It looks like it's happening again. Just yesterday, the Dollar was up (the Euro was down) and gold was...up! Readers tell me it can't happen. But it does. And we've made money on it.

We're going to again. As I said, the dollar is cheap, hated, and now in an uptrend.

My friend Jason Goepfert does a fantastic job of tracking investor sentiment at www.SentimenTrader.com. His charts clearly shows investors are bearish on the dollar... the most bearish they've been this year.

You can also see the Dollar has started an uptrend, from 76 to 79 on the trade-weighted foreign currency index.

Will it hold? I don't know. But this chart shows the Dollar is hated, and it shows the start of an uptrend.

What about cheap? From firsthand experience last week, I know the Dollar is cheap. Last week, I was in Europe. The Dollar was so cheap, it was near worthless. Here are some actual prices we paid: $90 for pizza and Cokes for four at a small-town pizzeria...$20 for a cheeseburger at a diner...$6 for a soda. (I loved the trip...but I was glad to get back home!)

The Dollar rose in 2005...and so did Gold Prices, The Dollar rose in the first half of 2010...and so did gold.

So can both gold and the dollar rise in the first half of 2011? Yes.

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Gold Price movements have led oil dramatically this year to date...

HARD ASSET prices sold off hard last week as concerns over credit tightening in the Chinese market prompted traders and investors to rethink their inflation notions, says Brad Zigler at Hard Assets Investor.

Unexpectedly, in October, year-over-year inflation on the Chinese mainland rose to 4.4%, prompting authorities to jawbone a jack-up of interest rates and price controls.

Thus Gold Prices tumbled from that $1400-per-ounce level reached after a nearly unabated three-month rise. Industrial commodities also took it on the chin, as fears of slowing growth in China percolated.

But the most industrial of commodities is, of course, oil. Oil had rallied in autumn along with gold, albeit with greater volatility, and with punier returns as well. Gold Prices chugged uphill from July's end to a 14.8% gain ahead of the November election. Simultaneously, oil pitched and rolled 3.2% higher.

The wheels on the commodity undercarriage started wobbling after the votes were tallied and, more importantly, once the Fed laid out the parameters of its second tranche of quantitative easing. Then oil and gold both tumbled.

Gold Prices led the way down, just as they had led the way up. Since the top of November, bullion's slumped 1.7%, while front-month WTI crude prices have slid 1.3%.

Recently, oil prices have gyrated nearly twice as much as gold. This autumn, the annualized standard deviation in oil's daily close has been 27.8%, while gold's wobbled at a 14.7% rate.

But most arresting is the expectations of future volatility reflected in option prices. As gold topped the $1400 mark, the CBOE Gold Volatility Index (CBOE: GVZ) jumped to 24.65. This index represents the near-term variance in the price of the SPDR Gold Shares Trust (NYSE Arca: GLD) – here, an annualized 24.65% – as imputed to option premiums. A week before, when gold was $50 lower, the volatility index registered 21.87.

Metrics like the CBOE Gold Volatility Index are often called "fear indexes", because their gyrations measure the cost of insuring their underlying assets. Options are, after all, insurance contracts. Owners of assets like gold or gold proxies, for example, can purchase put options to protect their investments in anticipation of stormy market activity. The put sets a worst-case sales price for the asset in the event of a plunge. If the storm passes or never materializes, the insurance can be peeled off or allowed to expire while the underlying asset is retained.

A fear index exists for oil prices, too. The CBOE Oil Volatility Index (CBOE: OVX) tracks the risk in United States Oil Fund (NYSE Arca: USO) contracts. At gold's recent peak, oil traded for $86.72, pegging the fear index at 30.93. The volatility trajectory for oil, though, was opposite gold's. A week before, the CBOE Oil Volatility Index was 31.56.

And now? What's the options market telling us of future volatility? At last Wednesday's close, GVZ had drifted down to 22.09, while OVX ballooned to 33.69. The message here is that option traders were growing more comfortable with the trend in gold's price than oil's.

Does that mean that traders think gold is likely to bounce while oil continues downward? Perhaps, but not necessarily.

These volatility indexes take the measure of puts together with calls – contracts that afford their owners protection against higher prices. To be sure of professional expectations, we have to isolate the puts from the calls. That allows us to monitor the market for downside protection.

In fact, the cost indexes for puts on gold and oil proxies have moved in opposite directions recently. The chart below plots values since the gold top on Nov. 9.

Gold puts (or here, downside protection on the GLD proxy) have cheapened relatively. Oil puts (again, puts on the USO exchange-traded fund) got more expensive. Thursday last week, oil insurance costs spiked B-I-G time. So, is that a harbinger of lower oil prices in the immediate future? Well, it says that traders believe the odds of another down leg have certainly increased.

Is that a guarantee of lower oil prices? Of course not. Option traders, remember, deal in probabilities and cost/benefit trade-offs. After the recent sell-off, the prospect of a relief rally shouldn't be discounted. Given the oil market's volatility, though, having a floor price locked in just seems like good business.

Traders' fears were heightened by the increase in oil's downside momentum despite Wednesday's bullish inventory report. Earlier, commercial traders signaled their concern about lower prices by amassing a record-high net short position in WTI futures.

With Wednesday's support taken out, crude is now poised, after the relief reaction, to aim for the $78 level I reckon – the halfway point of its May-November ascent.

Not that there won't be some volatility along the way, mind you.

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Capital Gold Group is a BBB Accredited Business. Listeners are welcome to receive a free precious metals guide by going to or call 1(800)510-9594. If you’d like to listen to the rest of the show, visit StartWithGold.com to subscribe to the podcast. Gold Price has continued to rise over the past ten years. There is a flight to safety and security by holding on to a tangible as…

What the Irish crisis already revealsabout the Eurozone project...

The IRISH GOVERNMENT may havediscovered a fatal flaw in the Eurozone central banking system –the discount window, writes Robert Thorpe at the Cobden Centre.

In 2008 the Irish government bailed outAnglo-Irish Bank and effectively nationalized it. Since then theyhave been periodically supplying more bailout funds to it as losseshave emerged. Because of this, together with the bailouts of otherIrish banks and loss of tax revenues the Irish state’s finances arevery bad. Currently the interest rate on Irish bonds is 8%, muchhigher than the Eurozone interest rate, indicating that the marketconsiders the possibility of default to be high.

Many commentators have pointed out thathaving separate states issuing their own bonds and using their owntax policies within one currency area is destabilizing. But thecurrent crisis in Ireland has revealed a problem that may be muchbigger in the long run – the European Central Bank’s discountwindow.

The ECB, like most central banks,controls the rate of interest by two methods. They perform Open Market Operations,which are the buying and selling of bonds in exchange for base money.If the central bank buys a bond using base money then it increasesthe amount of base in circulation as reserves between the commercialbanks. The central bank is also the lender-of-last resort. As part ofthat role the bank makes short term loans to the most marginal, thatis most unstable, commercial banks. This is the “discount window”which the European central bank calls the marginal lending facility.The central bank can alter the rate of interest by offering discountwindow loans at higher or lower rates, though modern central banksdon’t generally do this, they use OMOs instead.

The problem the ECB now faces is thatit must make discount window loans to Irish banks that are owned bythe Irish state. The ECB is, in effect, lending to the Irishgovernment. As Ambrose Evans-Pritchard at The Daily Telegraph wroteyesterday: “…the ECB is already propping up Ireland and Club Medby unlimited lending to local banks that then rotate into their owngovernment debt in an internal ‘carry trade’.”

Since the ECB discount window rate is1.75% and the interest rate on Irish government bonds is ~8% thatmeans that Ireland is getting a good deal.

The ECB could stop this lending anytime, and probably will. The problem, though, is the impartialitynecessary in central banking. In the 19th century the Bank of Englandwould occasionally lend to commercial banks having problems; it wasthe lender of last resort. But, as Bagehot pointed out, many problemswere caused by the central bank playing favourites.

Commercial banks with good connectionsat the Bank of England got loans and other banks without connectionsdidn’t. So, it became a policy that the central bank should offerdiscount window loans at a rate higher than the prevailing interestrate to all commercial banks if they posted good collateral. Latercentral banks began performing regulatory probes into banks thatborrowed from the discount window facility, thereby increasing thedisincentive for banks to use it. The advantage of this system to thecentral banks was that the market knew that any commercial bank couldborrow from the discount window, and that reduced the risk the bankstook when lending to each other. This made monetary expansion mucheasier for the central bank to initiate than it had been before.

In the current situation, though, theECB must play favourites. The ECB could justify that if it decidesthat the assets posted as collateral by the Irish banks are notsatisfactory, and therefore that those banks are insolvent, notmerely illiquid. But that would be mean that the ECB would beeffectively judging that the Irish state is insolvent. Politicallyspeaking, can a central bank make that judgement? If the ECB allowsIreland to continue borrowing from the discount window then the otherwobbly Eurozone countries will follow Ireland — they willnationalize banks and use them to access the discount window. But ifthe ECB cut off lending to Ireland then this increases uncertaintyfor other Eurozone banks and states greatly.

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Capital Gold Group is a BBB Accredited Business. Listeners are welcome to receive a free precious metals guide by going to or call 1(800)510-9594. If you’d like to listen to the rest of the show, visit StartWithGold.com to subscribe to the podcast. Gold price breaking over $1400 an ounce. Gold price jumps dramatically due to further quantitative easing via the Federal Reserve…