What The Fed Teaches Us About Housing, Stocks, And Precious Metals

by: Smarter Investor

Finding things or people to worship and adore seems programmed into the human psyche. British people worship the ground that royals walk on. Financial people worship the alleged powers of the Federal Reserve. It is not logical. It isn't sensible. It doesn't have to be. It's just the way it is.

History shows that neither royals nor the Federal Reserve are worthy of worship. The Federal Reserve has been wrong more often than right. Just look at the speeches of Chairman Ben Bernanke, immediately before the World Financial Crisis. He repeatedly claimed that real estate was NOT a bubble, and, even when the bubble was imploding, he claimed that it was "well contained" and would not affect the rest of the economy.

This illustrates that the Fed has no greater wisdom than anyone else. Indeed, given that Austrian School economists did see it coming, the Fed may have less insight and predictive capacity than others. Let us not mention that Ben Bernanke's predecessors, during the 1930s, were the primary cause of the Great Depression. Even Ben Bernanke admits that. Yet, in spite of the evidence, the financial community continues to believe and trust in the Federal Reserve.

In 1913, at the behest of New York City bankers, Congress abdicated its power over the coining of money, and gave it to the bank-created Fed. It also endowed the Fed with the power to set uniform interest rates. Why did it do that? Because people then, as now, wanted to believe in something greater than themselves. Since nothing greater existed, they had to create it.

Nowadays, markets are moved by every word uttered by Bernanke and his fellow Fed Mandarins. Market participants generally believe that the Fed knows more than they do. The Federal Reserve Note ((NYSEARCA:FRN)) is the currency it prints. It is usually referred to as the "US dollar," but it is an error to do so. The law, itself, does not define the FRN as a true dollar. It is not the type of dollar defined by the US Constitution and/or the Federal Reserve Act.

When the Fed was chartered, Congress allowed the Fed to create demand notes, called Federal Reserve Notes, but it also required that that they be exchanged for so-called "lawful" dollars upon request. This implies that they did not view FRNs as also being "lawful" dollars. Technically, the legal right to exchange of FRNs for "real" dollars still exists. The law has not changed in 100 years. It has simply been disrespected due to a series of Presidential orders beginning with that of Franklin Roosevelt in 1934.

As a practical matter, no such exchanges are ever done anymore. Through a combination of Presidential pronouncements, in practice, the Fed has been allowed to ignore the law. It is actually impossible to comply. The "lawful" dollars described in the Federal Reserve Act have gone the way of the dodo bird. They are extinct. For example, the US government no longer mints gold or silver dollar coins except as collector's items, marked with dollar values unrelated to metallic content. US notes, representing gold coins stored at Fort Knox, are no longer printed.

Federal Reserve Notes are now irredeemable, in direct violation of the Fed's enabling Act. But, it doesn't matter, because people accept them everywhere, as the alleged "dollar". Few folks actually read the law, and the ones that do don't care. With a monopoly over FRN printing, and with most people thinking the FRN is the "dollar", Ben Bernanke and the Fed can engage in so-called "quantitative easing" (QE3). They can print money potentially to infinity.

The Fed has not announced any limit, and, in fact, have specifically announced that no limit will be imposed. This has been done even as real interest rates are already deeply negative, and with nominal rates lower than ever before in the history of the world. Logic tells us that forcing rates still lower is unlikely to spur anything but a marginal increase in economic activity, if that.

Banks already hold over a trillion FRNs in reserve deposits, which they are not using. Yet, they are printing more! Only the Mandarins of the Federal Reserve Open Market Committee (FOMC) know why they made what appears to be a completely irrational decision to print more cash. But, the decision is only irrational if we assume that what they are telling the truth.

But, what if it's not the truth? What if QE3 is not designed to help unemployment, improve the lives of average Americans, or stimulate the economy? What if the primary purpose of QE3 is actually to do nothing more than to help mega-banks climb out of a hole? Remember, the FOMC membership is mainly composed of "Trojan horses", in the sense that they are people chosen by and/or recommended, directly or indirectly, by bankers. They would be likely to protect the interests of those who helped further their careers, in preference to millions of people they don't know very well... like you and me.

Consider that if the latest money printing orgy could be designed mostly to prop up mortgage backed garbage, and create a market when the current one is dying. If so, that explains a lot. Here is the reality. The free market is simply not willing to pay a lot for mortgage bonds, especially given the huge foreclosure problem even in prime markets now. Yet, mortgage backed securities are heavily owned by both mega-banks and insurers. Making matters worse, the mega banks are being sued on ever-increasing billions of dollars worth of fraud claims by the insurers. The agencies that issued the bonds are also trying to hand them back to the banks.

Remember, 99% of these are civil suits about money. We are not talking about criminal cases. The size of the eventual damage awards to the insurers and others will depend primary on the value of the mortgage backed bonds when cases get settled or go to trial. If you artificially raise the value of the bonds, even if the plaintiffs win on the issue of fraud, you reduce the settlement or award. That is because the loss will go down in proportion to the value of the bonds going up. Now, does it make more sense? It isn't irrational after all, when you see it for what it really is.

Buying mortgage bonds gives a new gift of cash to banks, helps bank balance sheets directly and indirectly, and is done at the expense of the rest of us. It also helps fund continued deficit spending by government. Agency bonds, obviously, are not the same as treasury bonds. But, most economists accept the concept that, when Fed buys any major fixed income investments, greater demand is created for treasuries because investors have fewer options. That allows the government to sell Treasuries more easily.

Beyond that, inflation is caused by any type of printing money. Inflation helps the debts get paid. Inflation is a stealth tax. It reduces the value of, and increases the quantity of, the units of currency. So, the government collects a larger and larger number of units, even as its obligations are fixed.

As noted, the Fed acts within a Congressional grant of power over money printing and interest rates. That means that although quantitative easing (QE3) represents an unconstitutional seizure of property, it will probably not be found to be that by a court of law. Such seizures are covert. Monetary debasement seizes value, rather than physical units, making the process translucent. It is very difficult for average people to understand. Wealth is transferred from citizens to banks, and, then, after a profit from "spread" and speculation, it moves on to the government. It is taxation without representation.

Not many people enjoy being the victims of unelected Mandarins. But, regardless, the Mandarins have power over our purses. But, that power exists only because we allow it to exist. We play their game by collecting and saving in the "monopoly money" they excrete. Remember, Federal Reserve Notes are backed by nothing and are no longer redeemable. So, why accept them? A lawful dollar, backed by gold and the US Constitution, no longer exists. If we want lawful money, and to stop playing their rigged game, we should save in the form of bullion bars and coins.

Remember, the buying power of FRNs is wholly dependent upon the capricious whims of a highly conflicted, self-interested group of men and women. This exposes the rest of us to covert theft, taxation without representation, as well as other people's greed and self-seeking behaviors. They can drain our bank accounts in ways that common thieves can never do. The FOMC is a "Reverse Robin Hood". It steals from the poor to give to the rich. It takes what it wants from the middle class and gives it to the richer part of the population. The Fed is in the business of seizing savings and converting them into value for those who own equities and other favored assets.

All this might be leading you to think that the United States of America is an evil nation. It is not. In fact, in many ways, it is one of the best nations in the history of the world. It is simply doing what all nations have always done. Money everywhere and always devalues to the cost of producing it. That's in the process of happening in America. Since electronic virtual money costs nothing to produce, it will devalue to nothing.

Most of the problem, of course, is human nature. Jesus said that all human beings are sinners. He was right. Humans are greedy, selfish, and prone to mischief. These tendencies can be countered by religious teachings and ethics learned in life, but countering them is very difficult. No human staffed institution can be completely trusted. It's been that way since Eve took the first bite of the forbidden fruit, and it will always be so. To create a more fair, orderly, prosperous and perfect society we must deal with people as they are, and not as we would like them to be. Checks and balances must be imposed.

Strictly enforced metallic money standards can help keep governments accountable. If we choose to allow the issuance of metal backed paper money, vaults must regularly inspected, and the contents tested and counted by independent third parties. Remember, the financial interests of the government are hostile to yours. Bureaucrats are self-perpetuating, and they will take what they need. If you play their game, it is an absolute certainty that they will take what is yours.

People who buy CDs don't understand this. Most never will. Most will be wiped out. While the actions of "upfront" burglars are easy to see and to punish, "dishonest" burglaries, done by means of monetary debasement, have no recourse. The conjuring of money out of thin air steals value from preexisting money. But, this form of theft is outside mainstream understanding. Many courts would side with the burglars. They are likely to hold that such government-sponsored thefts are not thefts at all, and not unconstitutional takings of property. Remember, judges also don't understand the nature of money. Also, QE benefits politicians, who appoint judges, so don't expect much help from that quarter.

The burning question is what can smarter investors do? They can think about the big picture, and protect themselves. Forget about fixating on day to day or even month to month price fluctuations. Your entire nest egg will be wiped out if you do nothing. QE can pump up favored asset values over the short to medium term. But, QE encourages people to put capital into inappropriate places. Central planning has never worked. It is what collapsed the former Soviet Union. It will eventually collapse the US economy. Real production and profits will fall, and real stock values will collapse, except viewed through the lens of a debased currency.

To illustrate this, let's look at what money printing and ultra-low interest rates have achieved so far. After the crash of the tech bubble in 2001, the Fed, along with most other major central banks, embarked on a policy of ultra-low interest rates, though not nearly as low as they are now. This created huge credit bubbles and unsustainable home prices in the USA, Spain, and other places. In 2007-2008, the worldwide credit bubble popped, wiping out the nest eggs of millions of innocent people. Millions lost their homes and their credit ratings. The evicted folks can no longer buy other homes, even though houses are now cheap, because their credit history no longer support them.

With prices down by 60+% in some areas, like Nevada and Florida, a lot of wealthy investors are buying up properties. They are then renting them back to the people who lost them. Rents are rising, even as home prices continue falling. The central bankers have succeeded in destroying a large part of the middle class already. They are enriching the few at the expense of the many. But, it is just beginning. The process will accelerate.

The Fed Mandarins now say that high inflation is not a likely result of their policies. But, they are often spectacularly wrong. Frederic Stanley Mishkin, an economist and Professor at Columbia University, was a member of the Fed Board of Governors from 2006 to 2008. In 2006, in exchange for a $124,000 consulting fee, Mishkin co-authored a report called "Financial Stability in Iceland", claiming the Icelandic financial system was strong. Two and a half years later, their banking system collapsed entirely. A documentary, "Inside Job" pointed out that the name was changed to "Financial Instability in Iceland" on Mishkin's CV, but after that, Mishkin corrected the resume.

In February 2008, the Fed's Chief Mandarin, Chairman Ben Bernanke, was speaking in response to a question about the possibility that a systemically important bank might fail. He stated: "I don't anticipate any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system."

By July, 2008, Bernanke went on to state that the two government sponsored mortgage insurers, Fannie Mae and Freddie Mac were strong and "in no danger of failing." By September 2008, Lehman Brothers, one of the world's largest financial institutions, went bankrupt. That same month, Fannie Mae and Freddie Mac went into receivership. It is now well acknowledged that, over the next few months, nearly every large systemically important bank tottered on the precipice of failure.

In spite of all this, American ingenuity survives. Oil and gas fracking technology, for example, will make us energy independent within 15 years. That has nothing to do with the Fed, but will be enormously helpful to building an eventual recovery. Between now and then, unfortunately, there is almost certain to be a long painful period of heavy stagflation. No doubt, the US government will be telling us about impressive GDP increases and low inflation, but it will not be the truth.

When we finally do recover, interest rates will either soar, or, if they continue printing money, the value of the FRN will collapse. In the midst of fast-rising rates, or a collapsing "dollar", mortgage-backed bonds, and other toxic assets will be worth very little. Potentially, they can revalue gold certificates to full market value, but, if gold is the only thing that can save the Fed, one must ask why we need a central bank at all. A strict gold standard can be pursued without the help of central banking, as it was in the past.

In absence of a revaluation of gold certificates, the Fed is sure to become insolvent. That's right. INSOLVENT. In capital letters! The Federal Reserve has sown the seeds of its own demise. Insolvency will eventually result in closure. Those who influence the actions of Fed Mandarins are very astute in finance, and they surely know this. That may explain why the Fed now fearlessly engages in the riskiest policies in its history. The Federal Reserve and its notes are going to become a footnote in history, and it is is likely to happen before the end of this decade, once the first signs of recovery begin.

Middle class investors need to preserve what they can. The FRNs they now hold are going to be worth much less by the time the currency ends. The replacement currency is likely to continue with the name "US dollar", but the new dollars won't be Federal Reserve Notes. The Federal Reserve Notes you will still be holding will be tradable for the new money, but the exchange rate will be terrible. Since the current FRN is the world's "reserve" currency, its death throes will shake the world financial system to its core. The Panic of 2008 is going to look like a picnic in the park. Those holding tangible metals will be in much better shape than those holding paper money.

The best long term investments, at this particular point in time, are tangible ones. Hobby farms are good investments. Rental homes are another question. They were not good investments during the Wiemar hyperinflation in 1920s Germany because of rampant inflation coupled with price controls. But, if the US currency devaluation can be held to double digit inflation per year, rather that triple or quadruple digits, rentals may be a solid investment. That is not to say that housing prices will not continue down for some time longer. The full impact of money printing takes a while. It may be best to wait a year or so, before buying in many areas, depending on regional conditions.

Within the universe of tangibles, gold, silver and platinum are and will continue to be very good investments. All three have monetary characteristics, meaning that they are inherently valuable, not because governments say they are, but because people desire them for what they are, or for what they can do. Gold is a pure monetary metal. Silver and platinum both have monetary characteristics and industrial uses. But, with an expanding world population, and fast-increasing industrialization in the emerging markets and undeveloped world, silver and platinum are going to be in heavy demand.

All three precious metals are now the subjects of artificial price volatility both up and down. Prices will continue to be a roller coaster ride. This is because trading is highly leveraged, markets (except for gold) are very tiny, governments appear to engage in sponsored gold and silver manipulation, and greed-motivated banks appear to engage in silver and platinum manipulations. But, in the longer run, all three will soar into the stratosphere when measured by fiat currencies like the dollar, Euro, pound, yen or yuan.

A position in precious metals can be taken in many ways. ETFs like (NYSEARCA:GLD), (NYSEARCA:SLV), (NYSEARCA:SIVR) and (NYSEARCA:PPLT) are easy to buy and convenient. You can buy them through any online broker. But, with a deeply corrupted financial system, and vague statements in prospectuses, metals stored in vaults belonging to short-selling banks with deeply incestuous ties to the Federal Reserve, alarm bells have been raised. The ETFs have high maintenance fees, in excess of what some well-established warehouse firms charge. No solid evidence of fraud exists, but such evidence was also absent prior to the collapse of MF Global and PFG Best.

ETFs will be a particularly bad choice once the end of the Federal Reserve Note is very close, because with that, a number of sponsoring banks could collapse. But, the window on that is probably several more years. ETFs are very useful for short to medium term trading strategies, so long as you are willing and ready to accept profits in the form of paper money. But, that shouldn't be a problem in the short run, since "US dollar" will be capable of buying things for several more years to come. Indeed, it is probable that a window period of FRN value will continue to exist, curtesy of emerging market central bankers. They are likely to continue buying it for a while, in the foolish pursuit of a "currency war", as nations race to the bottom. But, in the end, they will stop, and the FRN will collapse.

Another alternative is investing through the use of derivatives. The COMEX, NYMEX and NYSE-Liffe are all regulated exchanges which issue gold, silver and platinum contracts for 1000, 100, 50, 32.15 and 10 ounce bars, depending on what metal you buy. For people with a lot of money to invest, London bullion banks also offer "private" derivatives. These "forwards" promise delivery of a minimum of 400 ounce "bankers" bars. But, when you take delivery, you will be pushed into putting your alleged banker's bars into so-called "non-allocated" storage, which is actually not storage at all. Your bars will not physically exist, though you may pay a lot of money to store them.

Beyond that, derivatives are dangerously risk laden, highly leveraged, and depend upon the credit quality of counter parties, ncluding the clearing houses like COMEX and NYSE-Liffe. If a major primary dealer of the Fed were to go belly up, all the regulated exchanges will go belly up with it. Minimum security deposits, known as "performance bonds", are changed randomly, seemingly in synch with dealer attempts to manipulate prices up and down. This is often combined with highly coordinated "short selling", and the various actions appear designed to periodically fleece futures and forwards market participants. To make matters worse, when the end of the FRN comes, broker insolvency will be rampant. MF Global and PFG Best will look insignificant compared to the losses that will be incurred at the end of the FRN.

For those seeking more security, quasi-ETFs like the Central Fund of Canada and the Sprott funds (NYSEARCA:PHYS) and (NYSEARCA:PSLV) exist. These are run by men considered to be of impeccable integrity. Sprott stores metals at the Royal Mint of Canada, rather than inside the vaults of casino banks. The Mint is likely to survive any financial storm. Sprott also promises to physically deliver even small amounts of metal upon request. Accordingly, these trusts can be attractive. But, because of their attractiveness, they come with a heavy price, in terms of premiums over "spot". And, like casino bank sponsored ETFs, they charge high maintenance fees.

Metals can also be purchased in the form of physical bars and coins at a myriad of coin shops. If you hold physical metal in your own home, you'll have it close at hand when the end comes. There is also a peace of mind that comes with the ability to see and feel your precious metals. They can be stored anywhere the buyer chooses to hide them, including safe deposit boxes. If you choose to store them in a safe deposit box, make sure you choose a banking institution that is rated 4-5 stars by Baeur and/or Bankrate.com. These type of institutions may temporarily close during a government-declared bank "holiday", but they are probably solid enough to survive the storm.

A very real danger of theft exist when you store physical metals. That's why most writers recommend insurance. Insurance is expensive and it will be worthless in a systemic meltdown, but it will protect you against theft during the period before the heyday of the Federal Reserve Note is phased out. Near to that time, however, more insurance companies are going to fail than banks. So, don't count on insurance bailing you out if you lose access to your metals during a bank holiday.

Finally, a position can be taken in "metals in the ground". By this, I mean you can buy shares of mining companies. Gold miners include Barrick (NYSE:ABX), Newmont (NYSE:NEM), Gold Fields (NYSE:GFI), and many others. Silver miners include Hecla (NYSE:HL), Couer d'Alene (NYSE:CDE), Pan American (NASDAQ:PAAS) and many more. There are also a lot of platinum miners. Many people believe that mining shares are historically undervalued at this time. But, operational and management risk exists.

Hecla Mining, for example, operates in one of the most politically stable nations in the world (the USA), but managed to get one of its two big mines closed for failure to comply with fairly open and obvious safety standards. Platinum and gold miners of South Africa offer good dividends, and low valuations, but that comes with a price. Many South African miners face strikes and fast increasing operating costs. Such stocks can go down even as precious metals' prices go up.

If you buy mining stocks, and intend to hold them long term, you will be well-served by demanding that they be removed from "street name" and registered with the direct registration system. Direct registration is a means by which you are given title to electronic certificates in your own name. It will save you from the heartache that many others may be going through at that time. Tons of folks are going to be trying to collect from SIPC at the same time, in the midst of a likely bank holiday, amid a rash of broker bankruptcies, brought on by what will be the biggest financial meltdown in history. Don't be one of them.

Some online brokers, like TD Ameritrade, for their own reasons or from lack of knowledge, seem to try to convince people not to do direct registration. Steadfastly demanding it is a good idea, and it should cost virtually nothing. So, refuse any demand that you pay hundreds of dollars for this service. It bears noting that Charles Schwab, among others, has proven cooperative, and will transfer your mining shares to direct registration without charging any fee at all. If your broker wants to charge a lot of money for direct registration, get yourself another broker.

Contrary to the claims of those who disrespect precious metals, buyers do not need to believe in impending super-asteroid impacts, super-volcano eruptions that will soon destroy the world, or apocalyptic visions of chaos in the streets. Those things may happen, but, if they do, gold, and even guns and bullets are not likely to save you. Loose central bank monetary policies were, at least, partly at fault for a lot of things. Such policies created the roaring 1920's which led to the Great Depression of the 1930s. They caused the Great Inflation of the 1970's which led to the deep recession and debt crisis of the 1980s. The dot-com bubble of the 1990s, coupled with the multi-billion dollar bailout of failed hedge fund Long Term Capital Management (LTCM) led to the Tech Crash of 2000. Finally, the worldwide housing bubble from 2001 to 2007, led to the World Financial Crisis of 2008.

Precious metals will not protect against an "end of the world" scenario of biblical proportions. They simply give protection against the stupidity. incompetence and corruption of financial policy makers. They offer safety against counter-party risk and insolvency. They are valuable bulwarks against the kind of artificially induced inflation that rewards corruption and frivolity, punishes thrift, and allows governments to tax without representation. Central bankers are now engaged in the most money printing and in enforcing the lowest interest rates in history. More than ever, precious metals are an essential part of every investment portfolio.

Disclosure: I am long PPLT, SIVR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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