“Who suffers most from inflation? Who suffers most from rising prices? It’s the poor, not the rich. The rich can protect themselves from inflation; poor people can’t.”

— Jean-Claude Trichet, head of the European Central Bank (ECB)

THE FINANCIAL TIMES CHOSE JEAN-CLAUDE TRICHET — head of the European Central Bank (ECB) — as its 2007 Person of the Year.

OK, so Time magazine had to settle for Vladimir Putin — the former KGB spook now rehearsing his puppeteer skills at the Kremlin. But was the FT’s shortlist really that bad? Couldn’t Lindsay Lohan clear a space in her party schedule to claim the award instead?

At least the inebriated actress delivered as promised last year, denting only good taste in the process. Monsieur Trichet’s inflated celebrity, on the other hand, now threatens to cost the world dearly.

Trichet’s No.1 task as president of the ECB is supposed to be delivering “price stability” to the 320 million citizens of the eurozone (Malta and Greek-speaking Cyprus joined the fun on New Year’s Day).

Put another way, his 2% inflation target means €1.00 of living expenses today should cost no more than €1.02 by this time next year. But anyone shopping in euros last Christmas, however, found the cost of living 3.1% higher on average than in December 2006 — or so says the Eurostat agency.

Europe’s festive inflation outran even November’s seven-year record. It came close to undoing almost 14 years of inflation fighting by the ECB and its pre-euro ancestors. And things had been going so well too!

For 2007 as a whole, consumer price inflation in Europe averaged 2.14%. But curiously, that’s exactly the rate it hit in September, before racing higher as Christmas drew nigh. What changed in the summer of Trichet’s star year? “One of his strengths is his ability to manage a crisis — he enjoys that,” says Olivier Garnier, adviser to the ECB chief in his former life at the French Treasury in the early 1990s. And by golly, but Trichet got a crisis to relish this summer!

Relaxing in the sleepy French fishing port of Saint-Malo, Jean-Claude Trichet awoke one August morning to find “the first financial market crisis fought by BlackBerry from the beach” surging across the Atlantic toward him, gushes the Financial Times.

“As the ripple effects of the collapsing U.S. subprime mortgage market caused global finance to seize up, the ECB announced it would unilaterally pump in unlimited overnight liquidity: In the end, it added almost €95 billion ($136 billion, £69 billion)…

“Initial shock at this unexpectedly radical intervention gave way to admiration of [the ECB’s] steady hand,” the newspaper goes on, hardly able to contain its praise.

“As the drama unfolded, the ECB appeared to be setting the pace among central banks. In the ultimate compliment, the venerable U.S. Federal Reserve and the Bank of England copied the tactics of an institution not yet 10 years old.”

Hurrah for Trichet! Three cheers for unlimited liquidity! Hosing Paris and Frankfurt with overnight loans, Monsieur Trichet secured his place in history as “one of the few to emerge from the turmoil with his reputation enhanced,” the FT declares. He certainly helped save the blushes of BNP Paribas, proximate cause of the interbank lending panic when it suspended three investment funds on Aug. 9 after the “complete evaporation of liquidity” in the subprime U.S. mortgage bond market.

But our brave little pompier actually hosed so much cash into Europe’s money market, he’s since felt the need to mop up the puddle 14 times in the last 14 weeks, draining a total of €390 billion in Christmas week alone.

In the 456 weeks between the ECB’s birth and October, by contrast, the bank drained “excess” liquidity from Europe’s money market only a total of 21 times, offering government bonds in exchange for cash.

It’s a pity, in fact, that Monsieur Trichet didn’t think to take a couple of euros out of the market before last summer’s turmoil began…

Under the European Bank’s first president, Wim Duisenberg, the ECB’s open-market liquidity auctions averaged €64.6 billion. Since “Tricky” Trichet took over on Nov. 1, 2003, that’s more than trebled to €204 billion.

Indeed, our chart seems to show how the real hosing came to end when the world’s money markets froze back in August. But the number of ECB auctions helped pick up the pace, reaching 7.8 on average per month, versus 5.5 averaged per month during the preceding eight years. The average value, meanwhile, has risen to €136 billion, from €130 billion between 1999-2007.

Was this flood of short-term liquidity really needed to help save the world’s financial system? Funnily enough, said Trichet himself to the European Parliament on Dec. 19, “There has been little evidence that the financial market turbulence since early August 2007 has strongly influenced the dynamics of broad money and credit aggregates.

“Indeed, the expansion of loans to households and nonfinancial corporations has remained robust, which may suggest that the supply of credit has not been impaired.”

No fooling, Jean-Claude!

Controlling growth of the money supply is supposed to make up one half of the ECB’s policy tool kit. Indeed, capping the number of monetary units in circulation used to be the “first pillar” of the grand anti-inflation stance it adopted at the dawn of Christendom’s third millennium.

But the idea of actually using Bundesbank-style discipline to deliver German-style low inflation soon lost out to watching “broad economic data” instead. Now playing second fiddle to what Wolfgang Munchau of the Financial Times tellingly calls “the real-world view” of economic growth, consumer prices, and trade-weighted exchange rates, the ECB’s initial money-supply target — under which the broad M3 measure of liquidity would grow by no more than 4.5% per year — has quietly slipped from the ECB’s speeches, press releases, and official statements.

Unloved and unmentioned, it’s come to look like some ridiculous ex-spouse…still bent on sending a Valentine’s card each year but using his left hand to scrawl “Guess who…?” Since the euro became flesh at the start of 2000, however, actual growth in Western Europe’s money supply has outpaced the “reference value” by more than one-third. It met or fell below that target for barely 10 months.

And right now, the quantity of euros in circulation — both physical and digital — is growing at a pace 2 1/2 times faster than the ECB’s initial prescription, taking the eurozone back to the runaway credit inflation of the late 1970s.

No wonder, then, that “At a global level, the risks for [price] inflation are on the upside,” as Monsieur Trichet told the Bank for International Settlements (BIS) in Basel, Switzerland, on Jan. 7.

No wonder, either, that the gold price in euros has exploded as a result. The citizens of France, Germany, and Italy saw the gold market scoot higher toward €600 per ounce as Monsieur Trichet’s year of 2007 reached its end.

Will his policies at the ECB cap inflation — and stall the surging value of gold prices — in 2008? Here at BullionVault, we think a fireman hosing a burning house with kerosene would have a greater chance of saving the furniture.

“There is a danger of second-round effects on headline inflation,” as the FT’s Person of the Year told the BIS. Perhaps he was thinking of Berthold Huber — head of Germany’s IG Metall union — promising his members “a mega year” for pay awards, starting with demands for an 8% increase in the steel sector.

Or maybe Jean-Claude Trichet was thinking of the six public sector unions now threatening to strike over higher wages and pensions in his homeland, France…or the failure of above-inflation pay awards in Italy’s public sector to prevent fresh strikes this month…or maybe the current wage talks in Spain, where annual pay awards are still linked to inflation — which is currently running at 4.1% from this time last year.

In Germany, even the very poorest workers — those who “suffer most from inflation,” according to Trichet himself in an interview with EuroNews last year — have come to expect an inflation-beating pay raise this year. The Social Democratic Party is pushing for a minimum wage of €7.50 per hour (some $11) in the world’s third largest single economy. Sharing power with Angela Merkel’s Christian Democrats in her “grand coalition,” the SDP might just force the issue too.

Several big unions, however, are pushing for an even greater “second-round effect” of the ECB’s failed inflation busting, worth a massive €11 per hour (more than $16).

In short, “There is no room for complacency [on inflation],” as Monsieur Trichet, a former member of France’s militant PSU party, told his audience in Basel. But what else beyond complacency would explain the surging M3 money supply…now growing fast enough to match the surging rate of monetary expansion in the United States and not far behind the wanton inflation of Britain and China?

It’s the poor — and the poor middle classes, especially pensioners on fixed incomes — who pay most when money loses its value. Top earners, led by Europe’s hottest financial hotshots in Frankfurt and La Defense, can look after themselves.

Not least with a flood of central bank money so great, it needs mopping up by the very firemen themselves!

So for all the good he’s done defending the value of euros, Trichet may seem a weird choice for 2007 Person of the Year. But for saying one thing and doing another…and for helping the forces of inflation to mass, even as he claimed to stand firm against them…he has corralled the spirit of our financial age better than even Ben Bernanke at the U.S. Federal Reserve.

Jean-Claude Trichet, we salute you. Truly, you are the man of the moment!

Regards,
Adrian Ash
January 23, 2008
BullionVault

Euros, Gold and the FT’s Person of the Year was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

From Coach Paterno’s perspective, the football program at Penn State had a black eye. The transgressions of the few had embarrassed the many. Coach Paterno determined that as punishment for some of the team members getting into a fight, the entire team would have to help clean up the Penn State football stadium after every game of the 2007 season. And Penn State’s football coliseum, Beaver Stadium, is no diminutive structure. It seats almost 110,000 oft-crazed fans of the Blue and White.

So on the morning of Sunday, Sept. 2, 2007, the day after walloping Florida International University by the score of 59-0, the entire Penn State football team (110 well-muscled bodies, including the practice squad) could be found wearing work gloves and lugging trash bags, pulling garbage detail at Beaver Stadium. And this was no fluffy publicity stunt. According to news accounts, many of these student athletes were breaking a sweat. After a couple of hours of stooping in the hot sun, the team members began to drift toward the buses to take them back to their dormitory rooms. Coach Paterno thereupon inspected the effort and announced that they “didn’t do a good enough job.” Thus, did the gridiron squad, from first string to the water boy, have to head back into the stands of the massive stadium to finish the task. One could say that the Penn State football team cleaned up its home turf, after a fashion, on both Saturday and Sunday.

If you happen to be a fan of another school or football team, you can say what you will about Coach Paterno or Penn State. But you cannot say that Joe Paterno lacks a sense of moral compass or that he does not work to instill some of that sense of direction into the hearts of his players. Paterno follows the golden rule.

Monetary Policy Mess

It is a shame that more of the monetary policymakers in the U.S. have never played football for Joe Paterno. I’m inclined to think that they might have learned something from the guy, even if they never had to clean up Beaver Stadium.

I won’t bore you by rehashing the monetary policy mess that the U.S. Federal Reserve has made of the U.S. dollar over the past 94 years, let alone in the past decade or even the last year. If you read this newsletter — or most any other publication from Agora Financial — on a regular basis, you know what we tend to say on that subject. The central bank’s never-ending overexpansion of credit and liquidity has far exceeded the underlying needs of the U.S. economy. Thus, not only have we been living in credit bubbles of one sort or another for several decades, we have learned to live with a consistent and persistent realm of monetary inflation. The slow but sure erosion of the purchasing power of the dollar over time is simply one more fact of life. This monetary phenomenon is hard-wired into the economy in almost countless ways to where the phenomenon has a life of its own via the expectation of cost-of-living adjustments, or “COLAs.”

Thus, the first rule of making money in our economy is to structure your portfolio, not to lose it. Even if you are 100% in cash stuffed in a mattress, you have made a certain investment decision and condemned yourself to lose purchasing power over time as inflation robs you. Of course, if you play the stock markets, on any given day, stocks can go up or down, responding to one piece of news or another, to this trend or that. But at the end of the day, you have to ask yourself what you should do about the long-term erosion in value of the dollar.

As I do for my Outstanding Investments subscribers, I recommend investments in the energy and natural resource sectors, where the basic resource commodities support their own forms of long-term value.

Precious Metals

This spring, my colleague and friend, Kevin Kerr, and I went over all of the precious metals stocks in the Outstanding Investments portfolio. We thought then (and still think) that, long term, we think that gold and silver will keep on rising in price, just as they have been doing for the past five years or so. We believe that precious metals, as with oil and natural gas and most other commodities, are in a long-term bull cycle.

On occasion, readers send us e-mail asking why the precious metals have not broken out into new highs during the past couple of months. We think that the answer is that the dollar is declining in value slowly, and not simply falling off of a cliff. But the long-term answer is also to be patient. Do not be disheartened that there has not been some sort of massive upward spike in the price of gold or silver or in mining shares during the past few months. Yes, it always nice and reassuring to buy a stock and watch the share price move upward almost immediately afterward. It makes you feel smart, if not lucky.

But when it comes to the monetary future — and the fate of the U.S. dollar — we are in no hurry to see a precipitous decline of the world’s reserve currency. It is not that we don’t believe that the decline of the dollar is inevitable. (Our good friend Addison Wiggin wrote a bestselling book with almost exactly that title, The Demise of the Dollar.) The demise just may or may not be imminent. In the meanwhile, consider this “your” time to accumulate precious metals shares at relatively low prices, setting your portfolio up for the long-term rise.

What About Cash?

We have received numerous inquiries from readers along the lines of “What about cash?” That is, readers want to know what we think about selling off some part of the portfolio and just keeping cash in an account, if not under the mattress or in a coffee can buried in the backyard.

As far as coffee cans and mattresses go, we can think of quite a few more secure places to store your savings. Then again, as long as you remember where the coffee can is buried, it never hurts to have some hidden treasure out in the backyard.

And as for cash generally, let me quote my Agora colleague Eric Fry: “You can’t take advantage of a fire sale if you’re inside the warehouse when it burns down.” Well put, Eric. When things go up in smoke, you want to be outside the warehouse with your pockets full of cash. You also want to be holding a list of all the assets you want to own when the smoke clears.

So there are times to be, as the saying goes, “fully invested.” And there are times to hold more cash in anticipation of buying opportunities. Now just may be one of those times to have some cash in an account, ready to pounce on buying opportunities. For example, in the past month and a half, the oil service sector went through some significant declines, along with much of the rest of the stock market. And for a few brief moments — and I do mean “brief” — you could have snapped up many other great companies at real discounts. But you had to have some cash, and you had to be ready to make the move. If you delayed because you did not have the cash, let alone because you were on vacation at the shore, you missed the chance. Great deals do not hang around down at the beach.

But just because this particular buying opportunity occurred in August and now the opportunity has passed, does it mean that nothing like it will ever happen again? No way, not at all. The summer sell-off was triggered by crises in the subprime lending sectors, when the value of risk was re-priced dramatically downward. This fundamental problem spilled over like a bursting dam into the rest of the financial world. People sold what they had to sell to cover positions and meet margins. They did not necessarily sell what they wanted to sell. So a lot of great companies went on short-term fire sales.

Looking forward, have the subprime lending problems gone away? No, not at all. In fact, the next year may well reveal even more rot within the financial sector, as millions more mortgages have the potential to go bad. It is quite possible that hundreds more large banks, financial institutions, hedge funds and other overleveraged groups will have to bail out of their untenable positions. So the point is it will be quite beneficial to hold some amount of cash going forward. How much? That depends on how well you sleep at night. You should amass enough cash that you can wake up refreshed each day. Then watch the news for the next market meltdown. Sooner or later, it will occur. And when it does, buy gold miners and oil service companies.

Six Years Later

And now, dear readers, there are some things that transcend money. So we cannot let the moment pass without recalling the events of Sept. 11, six years past. Do you remember where you were? (It was like the Kennedy assassination, if you are old enough to recall that event.) Do you remember what you were doing, how you felt? Do you remember turning on the television, wondering what in the hell was going on and watching the flames and smoke spill out of the Twin Towers? I still remember the sick feeling in my stomach, watching close-up shots of people hanging out of broken windows and gasping for air. I remember just shaking my head, because deep down I knew what was going to happen. And then some of them jumped. And I will never forget the sound of the secretaries in my office, shrieking in horror and pain, as we watched the first of the towers collapse.

A lot of people lost somebody that day. Later on, I learned that a couple of my old Navy acquaintances died. One of the deceased was Charles “Chic” Burlingame, aged 51 (his 52nd birthday would have been Sept. 12, the next day), a retired Navy captain, Gulf War veteran and the pilot of American Airlines Flight 77 that hit the Pentagon. A number of conspiracy theorists have used Chic’s connection with the U.S. Navy to say that he was part of some grand hoax, that there were no hijackers aboard his aircraft and that no airplane ever hit the Pentagon. Yet I actually walked amidst the Pentagon wreckage and picked up pieces of a broken airliner with my own hands. And Capt. Burlingame is buried at Arlington National Cemetery, his body having been recovered from the wreckage of a certain Boeing 757-223, registration number N644AA, located within the burnt walls of the Pentagon.

The other of my acquaintances was Wilson “Bud” Flagg, aged 62 and a retired admiral who was also aboard American Airlines Flight 77, along with his wife Darlene, when it crashed into the Pentagon. Adm. Flagg was an expert in aerial reconnaissance. Earlier in his career, Bud had logged more flight time in the F-8 Crusader aircraft than any other pilot in Navy or Marine Corps history. Again, over the course of time, some people have actually tried to convince me that no airplane ever hit the Pentagon on Sept. 11. They say that the Pentagon attack was a big conspiracy put together by an evil cabal, and that any damage to the building was caused by a remote-control cruise missile. Of course, this does not explain why the bodies of Adm. and Mrs. Flagg were also found within the impact area of the American Airlines Boeing on the grounds of the Pentagon.

To everyone else who lost somebody that sad day, you have our sympathy. The least we here at Whiskey & Gunpowder can do on certain occasions is to remember our friends. Life goes on, we know, and life is for the living. But still, while time takes us further away, it does not truly ease the pain. So we have our moments when we remember our old friends and feel the true meaning of “Auld Lang Syne.”

Until we meet again…
Byron W. King

September 26, 2007

“Don’t Get Joe Mad” was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.