I can’t tell you how long I have been hearing people say that bonds just can’t go any lower.  I remember people telling that to Harry Browne on his radio show when he was discussing his permanent portfolio plan.  Just for a time frame, Harry Browne passed away over 5 years ago.

The 10-year yield is currently just under 2% as of this writing.  It was down to almost 1.8% just a few days ago.  Needless to say, mortgage rates are near all-time lows right now.

I am an advocate of the permanent portfolio plan, which consists of 25% long-term government bonds.  While bonds may seem like a terrible investment idea, they seemed like that 5 or more years ago too.  Yet bonds have performed quite well for the permanent portfolio.  They have also helped lessen the volatility of the plan.  In the fall of 2008, stocks and gold both did terrible and the bond portion helped keep the short-term losses down.

While I advocate the permanent portfolio, I do say that it is reasonable to speculate with a certain portion of your money, as long as it is money that you are willing to risk and willing to lose.  So the question remains, is it finally time to bet against bonds?

Bonds go up in value when interest rates go down.  In a recessionary/ deflationary environment, interest rates will probably go down as we saw three years ago during the major economic turmoil.  Of course, interest rates can also go up if there is a risk of default (see Greece and the other PIIGS) or if there is high price inflation (see the 1970’s).

While I think that higher price inflation is almost inevitable, I don’t discount the possibility of another deep recession.  It continues to be a tug-of-war between the two.  We may end up with an inflationary depression eventually, but I think one side will probably shine in the short run.

At this point, I am still not ready to short the bond market.  I think it is a good speculative play for day traders who get in and out quickly and play the swings, but I am not confident that interest rates will be going up significantly in 2012.  Aside from the threat of a recession, there is also the threat of the Federal Reserve.  The Fed can buy U.S. treasuries any time it wants.  The Fed literally has an unlimited amount of money.  I’m not sure that I want to bet on something going down in value that the Fed can buy at will, especially when the Fed keeps coming up with more tricks.

I think interest rates will go up eventually.  When they do, it will be a reflection of the Fed’s money creation.  It will be a response to price inflation.  It will be a response to a lower demand for money.  I doubt it will be like Greece where people fear a default.  Perhaps that day will come, but not in 2012.  It is amazing how long the Fed and the government can kick the can down the road.

The politicians in DC are supposedly arguing over an extension to the payroll tax cut.  The payroll tax cut is a reduction of the employee’s Social Security tax from 6.2% to 4.2%.  When the legislation was signed last year, it was effective for 2011 only.  The two major parties in DC (both for big government) were supposed to have an agreement to extend it by two months and now the Republicans won’t agree to that because they want it extended for a year.  There is also a dispute about how to pay for it, as though letting Americans keep more of their money has to be “paid” for.

If both sides were serious about helping the unemployment situation, they would be cutting the payroll tax for the employer portion, so that labor would be cheaper and businesses would be more likely to hire people.  I have discussed this before.

So what about paying for this?  The Republicans were originally pushing to build an oil pipeline as part of the extension of the payroll tax cut, as if one should have anything to do with the other.  Of course, the Democrats always want to tax the rich or tax something in order to “pay” for it.

If the Republicans really wanted smaller government, why couldn’t they put together a proposal with specific budget cuts to go along with the tax cut?  They could claim that the tax cut extension would then not increase the debt.  Some will say that the Senate won’t pass it or Obama will veto it.  But let that happen.  If the Republicans put out a bill that cut foreign aid to Saudi Arabia and African dictators and cut farm subsidies to farmers, wouldn’t that be rather embarrassing for the Senate Democrats to vote it down or for Obama to veto it?  The reason that the Republicans in DC won’t do this is because they are not really in favor of smaller government.

There is one more thing to mention about this payroll tax cut extension.  As of right now (December 20), there is no agreement.  People don’t know what their tax rate will be in just 12 days.  This is 2% of the paychecks of most workers.  This can mean over $100 per month for some families.

Robert Higgs talks about the Great Depression and that one of the factors was “regime uncertainty”.  While I believe that spending, regulations, and monetary policy play the biggest role in determining the strength of the economy, there is an argument to be made that regime uncertainty is playing a role too in our current economy.  People do not know what to expect.  How can people properly plan when they don’t even know what their paycheck will look like in a few weeks?

Personally, I hope the tax cut is extended.  The U.S. government is going over a cliff anyway.  I will take what I can get now.  We will have major trouble ahead with or without a payroll tax cut extension.

North Korea’s supreme “leader”, Kim Jong Il, has died.  There are scenes on television of people in North Korea breaking down in tears over the news.  It is hard to know for sure if these scenes are staged, but it is not difficult to believe that people would be that brainwashed.

Kim Jong Il ruled with an iron fist, but don’t think for a minute that that is the sole reason for the misery in North Korea.  A dictator can rule over people with brutality, but this is only possible by having the consent of the people being ruled.

This is not supposed to be a collectivist statement and paint everyone the same.  For sure, I’m sure there are a few people living in North Korea who want actual freedom and cannot speak up for fear of being punished or even killed.  However, for someone to be able to oppress a group of people like that, there is no question that the majority of the people there are giving their consent to be ruled.

The same situation exists in the U.S. and everywhere else in the world.  It is not hard to imagine Americans weeping if something happened to a politician in America.

While most Americans say they value freedom, they still consent to being governed.  Most people think we absolutely have to have government for certain things.  I am not just talking about the few minarchists who believe we need government for courts and police.  I am talking about the large majority who think the government should provide education, healthcare, business regulations (aside from those simply to protect against force and fraud), retirement, libraries, etc.

A government can only rule with the consent of the people.  If enough people change their opinion and believe that big government is completely unnecessary, then the government will eventually shrink or collapse.

The Berlin Wall fell in 1989 and the Soviet Union completely fell apart a couple of years after that.  Don’t think that Gorbachev was the reason.  I can credit Gorbachev for not using violence in the collapse, but I don’t credit him with breaking up the Soviet Union.  Gorbachev was a communist and I’m sure he would have been more that happy to continue the communist system.  But the system fell apart because of the vast number of people who no longer believed in the system.  People living in the Soviet Union realized that communism was a horrible way of life and they could see this by catching a glimpse of the relatively capitalist western countries.

It is hard to know what will happen next in North Korea.  Kim Jong Il’s son is supposed to be taking over.  If he is less oppressive than his father, then he can certainly make things better.  But ultimately, it is up to the people of North Korea.  They have to open their eyes and see that their neighbors to the south are rich and prosperous compared to them.  They have to realize that freedom is the answer to many of their problems, not another thug dictator.

It is the Christmas season and a lot of Americans are out doing their Christmas shopping.  Of course, on CNBC and other newscasts dealing with the state of the economy, we will hear reports about how strong or weak Christmas sales are.  The strength of sales will be used by the pundits to determine the strength of the economy.

This is really one of the great economic myths.  There is confusion about cause and effect.  Consumer spending does not help or improve the economy.  It is just about the opposite.  A strong economy is what allows people to spend.

So while there may be some correlation between spending and the economy in the long run, spending should not be used as a marker about how the economy is doing or how it will be doing in the near future.

You can take a family budget as an analogy.  Someone making a million dollars a year is most likely going to spend more than someone making $40,000 a year.  But you don’t use just their spending habits to judge how someone is doing.  If the person making $40,000 ups his spending from $35,000 per year to $45,000 per year, but is still making the same amount of money each year, this person is actually worse off because of the increase in spending.

The consumer can only consume what has already been produced.  But for there to be future production, there has to be savings and investment to fund it.  Just because there is a desire to spend money, it does not make products appear.  There has to be prior savings.

I’m sure the people of Ethiopia would all love to go out and buy a big house and a 55 inch big screen for their living room.  I’m sure they would love to eat gourmet meals every night.  The bottom line is that most people in Ethiopia cannot do this because they simply don’t have the wealth.  To ever get to this point, the country would have to adopt a system of strong property rights and the economy would have to grow to this stage through heavy savings and investment.

If you go Christmas shopping, you are not really helping the economy.  You may be helping one particular person or business, but you are actually consuming goods and services away from others.  There is nothing wrong with consumption if you are using money that you obtained through trade or labor.  You contributed something to society and you are using your receipt of contribution to get something in return.

The person who saves his money and barely spends beyond basic necessities is actually helping the economy more.  He has contributed something to society and now has a receipt for his contributions.  However, he is not cashing in on it.  He is leaving more for others to consume (which will mean lower prices on the margin).  He has contributed more to society than he is consuming.

Again, there is nothing wrong with consumption if it is backed by prior savings.  There is nothing wrong with shopping for the holidays and enjoying gifts.  But if you really want to help the economy, increase your savings and stop spending as much money.

The last Republican presidential debate before the Iowa caucuses has just wrapped up.  While there was nothing shocking that happened and there was no major game-changer, I still have some comments about a few things from the debate.

Ron Paul had another strong performance.  I thought his answer about congressional earmarks was strong, although I’m not sure if the average American will understand what he was saying.  Basically, Ron Paul votes “no” on all of these spending bills, but he tries to get funds earmarked for his district even though he is against the overall legislation.  As he pointed out, if the funds are not earmarked by Congress, then the executive branch will decide where to spend the money.  Paul’s actions in no way increases spending.  He is simply trying to get back some of the stolen loot for his district.

The best part of the debate was on foreign policy.  Ron Paul could not really be more different than the other Republican clowns (sorry, no disrespect to clowns).  He advocates a foreign policy of peace.  The others advocate a foreign policy of war and massive intervention.  They think America is the best country in the world and therefore Americans are morally permitted to run the world and dictate orders to other countries.

Michele Bachmann gets scarier every time I listen to her.  I used to have a little bit of respect for her, only because her economic views seem to be half decent.  However, I’m not even sure if she is all that good on economic matters.  Of course, how can she be a fiscal conservative when she will have to spend many trillions of dollars more if she wants to fight all of the wars she is promoting?

Bachmann has actually become one of the more frightening figures in my eyes.  She was saying that she was 100% certain that Iran would use a nuke if it obtained one.  That in itself is an absurd statement.  Iran is not run by a bunch of madmen any more than the U.S.  The Iranian politicians may be Keynesians and egomaniacs, but so are most U.S. politicians.  The Iranian politicians are not going to be foolish enough to casually use nuclear weapons as they know that it would quickly lead to their own demise.

Newt Gingrich is a good talker and I try not to underestimate his skills.  He is a good debater.  With that said, he is still a snake and he can’t be trusted.  When he was being questioned about Fannie Mae and Freddie Mac, he contradicted himself within the matter of 20 seconds.  He said that these government sponsored enterprises (GSEs) help people on the margin buy homes.  In another breath he said that we need to dismantle them.  So which is it Newt?  Do you want to get rid of these government agencies or don’t you?  I’m pretty sure I know where he would come down on this if he were elected.

Iowa will be interesting.  Ron Paul needs to win it or come very close.  The whole race is down to Romney, Gingrich, Paul, and one other candidate.  I think that one other candidate that has a chance to emerge is Rick Perry.  He is a poor debater, but he has a lot of money.  If Newt stumbles, the pro-war conservatives will have to turn to someone else, and that might be Perry.

Meanwhile, Ron Paul continues to deliver his libertarian message to millions of people.  Let’s hope the pro-liberty enthusiasm stays around for a long time after his campaign is over, regardless of the outcome.

Unless there is a major catastrophic event in the next couple of weeks, gold will not hit $2,000 per ounce before the end of 2011.  In fact, the price may will probably be below $1,600 at the end of the calendar year.

Gold had a major correction today (December 14).  It was down over $75 per ounce.  It is currently below the $1,600 mark.  This is quite bearish for the yellow metal in the short run.  The good news is that if you have been late to the game and are looking to buy some gold, there is some opportunity to do so.

It is hard to say where the bottom will be this time.  There are a lot of uncertainties out there, which can be good or bad for gold.  Today, it happened to be bad.  The euro has been extremely weak this week, which has meant a strengthening of the dollar.  This has led to a big decline in the price of gold in terms of U.S. dollars.  People wanted to get out of euros this week and they are turning to the U.S. dollar this time, instead of gold.

There continues to be a tug-of-war going on with the economy.  The monetary base has tripled in the last 3 years and most of this newly created money has gone into banks as excess reserves.  There is a tug-of-war between inflationary forces and a deep recession.  Both sides might end up pulling each other into the mud pit and we may end up with both eventually.

For a little while, it looked like we might see a little mini-boom, courtesy of low interest rates and easy money.  Today, it went the other way and it looks like we might be headed for a deep recession.  The 10-year treasury yield went down today and is pointing to continuing fear.

This roller coaster will continue until one side wins out (either way we lose) or until there is a big shift in Fed policy.  The Fed has been tight (monetarily speaking) since QE2 ended in June.  We will have to see how bad the economy will have to get before they entertain QE3.  While the best thing would be for the Fed to do nothing and the government to dramatically cut spending (which would trigger a recession), I don’t see that as a likely outcome right now.

I don’t like making predictions, but I’ll do it anyway this time.  I think there is an 85% chance that gold will be higher (in terms of U.S. dollars) one year from today than it is now.  If the price of gold is lower in one year than it is today, then I think there is a 99% chance that we will be in a deep recession at that point.

It is not hard to find these accusations, particularly from those on the left.  We hear that capitalism is dog eat dog.  We hear that capitalism is a system where only the strongest survive.  We hear that the weak and poor suffer the most under capitalism.

In a sense, it may be true that the weakest are the worst off in a capitalist system, if by weakest we mean those who are the least hardworking, the least intelligent, and the least connected, or some combination of those things.  But in a capitalist system, even the poorer people will be far better off than the poor people of a less capitalist system.

There is a certain amount of dog eat dog competition in a capitalist system, but that competition is simply trying to please consumers.  If you are not doing a good job of pleasing consumers, then another person or business is going to do better.  Those who are the most innovative and who know how to please customers the best are the ones who will likely be rewarded the most.

The ironic thing is that in a capitalist system, the weak can survive better than in any other system.  Whether we are talking about being physically weak or intellectually weak, these people can still live a decent life in a relatively free society (just think of all of the rich dumb people in America).

In a system where brute force is used, then the weak will not survive, unless they can develop their own weapons to defend themselves.  But who would want to live in such a society?  There would be little or no division of labor and everyone would be living as savages, if living at all.

In a system that is heavily centrally planned by a government, those with the most political connections and those who are the most corrupt are the ones who are the most likely to benefit.  Perhaps some highly intelligent people, who are not necessarily corrupt, will do reasonably well in comparison to others, but they will still be worse off than they otherwise would have been.

If you live in a relatively rich country with a decent system of law and property rights, then you can flourish, even if you are just average.  Even opportunities arise for the poor and uneducated, even if they won’t be equal to others in terms of wealth.  In addition, a rich country has the means to provide charity for those who are really down on their luck or who are severely handicapped.

Capitalism is a system where everyone benefits, except maybe the politicians and the politically connected.  But even the politicians would benefit financially in the long run as everyone shares in the benefits of economic growth and increasing technology.

If certain poor countries were isolated from the rest of the planet, the dictators/ politicians there would be living far worse than the average American.  It is safe to say that the wealthiest people on this planet just twenty years ago did not have ipads, iphones, or high definition broadcasts for their cable channels.

In conclusion, capitalism benefits nearly everyone over time.  A rising tide really does lift all boats.  There is inequality in poor countries and rich countries.  If there is going to be an inequality of wealth, wouldn’t it be better for everyone to have more?

The associated press released a story yesterday in which they did a “fact check” on things that were said in the recent Republican presidential debate.  While the story went after several of the candidates, I want to analyze just the portion that was devoted to Ron Paul.  The story from the AP said this:

There are so many things wrong with these two paragraphs labeled “THE FACTS”, that it is hard to know where to begin.

First, the AP is saying that nearly all of the money has been paid back with interest.  But it is hard to know all of the facts because the Federal Reserve system and the bailouts are so secretive.  However, it is fairly well known that the Fed exchanged U.S. treasuries for a bunch of junk assets in the form of mortgage-backed securities.  So the government bought these bad assets at full price from the financial institutions.  Were all of these bad assets sold back to the institutions?  I don’t think so.

Let’s say I bought a bunch of shares of a stock for $50 per share and the price of the stock then fell to just $10 per share.  Then the Fed comes along and buys those shares from me and pretends they are still worth $50 per share.  So I get my $50 per share.  Meanwhile, I also take a loan from the Fed and pay it back with interest (at a very low rate).  Should we all boast about how the Fed was brilliant and how it didn’t cost taxpayers anything?

These banks got bailed out.  It wasn’t just loans, although that would have been bad enough.  Without the backing of the Fed, these banks and other institutions would have gone bust.

One thing that the writers of this story fail to understand is that even if the Fed had just loaned out money and all of the money had been paid back, it would still be harmful to the economy.  First, it is propping up the bad companies and the bad debt.  If every company in America is bailed out that is on the verge of bankruptcy, then we will soon be a very poor country.  There is no incentive to perform well and please customers.  Money is constantly being allocated to inefficient firms.

Another thing that the writers don’t understand is that by diverting funds to these failing businesses, it is preventing other individuals and companies from using this capital in a better way.  This is what Bastiat and Hazlitt taught.  You have to look at the unseen consequences.  By diverting hundreds of billions of dollars in capital, there are many businesses and products that would have been developed but which we will never know about.

In the last part of the AP’s story on Ron Paul, it says that the Fed does not operate on taxpayer money and does not receive any operating funds from the Treasury.  Yeah, no kidding Einsteins.  The Fed has a legal monopoly to create new money out of thin air.  Why would it need to collect directly from the taxpayers when it can just create whatever it needs?

Give me a legal monopoly to print money and I will be very profitable too.  I will fund my own operations and remit money back to the Treasury each year.  These writers are absolute geniuses.

In conclusion, the biggest part of the Fed bailout was buying up all of the toxic assets and paying the original full values.  This is highly inflationary in the long run because the Fed cannot sell them on the open market for anywhere close to what was paid for them.

It may be technically correct to say that the bailouts didn’t actually cost taxpayers.  It cost everyone who holds dollars (which is most taxpayers).  The TARP bailouts were inflationary and we will continue to see the effects, even if they can’t be seen directly.

I am continuing my commentary following Republican presidential debates.  It is important because it will shape our future and this is a rare race in that people actually have a choice.  If Ron Paul were not in this race, I would not be devoting even one quarter of the time that I have.

This debate had a slightly different feel, as there was no Jon Huntsman and Herman Cain.  With only six candidates on stage, it allowed them to have more time to answer questions.  It was also a little different with Newt Gingrich being one of the current front runners.  He was attacked a lot more (and rightly so) and it forced him to start being critical of the other candidates, instead of him just being critical of the media and Obama as he has done in the past.

Early on in the debate, Romney was pointing out some of his differences with Gingrich.  One of those things had to do with the space program.  Gingrich said he thinks America needs a place in space.  But doesn’t this just go to the heart of Gingrich’s philosophy?  I love space and the idea of exploration, but I don’t think it is the role of government to explore space or fund it.  Gingrich is equating America with government.  He thinks the bureaucracy in Washington DC is America.  He thinks that the only way Americans will be in space is if it is run and funded by government.

Rick Perry continued to stumble with his words, but I still can’t count him out.  He has a lot of money and he may still be an alternative to some people if Gingrich self destructs.

I don’t think there is much to add about Romney, Bachmann, or Santorum.  There was nothing significant that stood out to me from the things they have said in the past.

As for Ron Paul, I thought he did an excellent job in the debate.  It is always tough for me to judge on how a non-libertarian might view some of his answers.  But I got the feeling that many non-libertarians would have liked many of his answers.

I liked Paul pointing out that he is the candidate that has remained consistent.  Just about everyone who has been paying attention understands that this is the case, whether they agree with him or not on the issues.

I also liked that Paul pointed out that government is force.  He was responding to a question related to healthcare and Obamacare.  He pointed out an obvious but rarely mentioned fact that having to pay Medicare taxes is a mandate as you are essentially forced to do it.  I don’t know if that will win a lot of new votes, but it may convert a few more people towards libertarianism.

It was interesting that in the last round of questioning, both Romney and Perry gave compliments to Ron Paul.  I think Perry’s comment about thanking Ron Paul for hammering away on the Fed and leading him to studying it more shows a lot.  It shows that Paul has been quite successful in his quest to educate people about the Federal Reserve.  This is an issue that most people did not care about or even know about five years ago.  Now it gets a lot of attention and the other candidates are realizing that the Fed is an issue that appeals to some voters.

Overall, I think this debate will benefit Ron Paul.  His poll numbers have been rising slowly and steadily.  Most of his supporters are not going anywhere, so I would be surprised to see his poll numbers drop (except for variances in the type of poll and the statistical sampling).

Ron Paul needs to win Iowa or come in a very strong second.  His chances are better than I would have imagined just a few months ago.

You can view the short-term adjusted monetary base here:
http://research.stlouisfed.org/publications/usfd/page3.pdf

You can view a longer term chart of the monetary base here:
http://research.stlouisfed.org/fred2/series/BASE

You can view the excess reserves held by commercial banks here:
http://research.stlouisfed.org/fred2/series/EXCRESNS

The adjusted monetary base is indicating that a recession is ahead.  The Austrian Business Cycle Theory tells us that an artificial boom will turn into a bust when the there is a deceleration in the money supply.  There does not have to be a contraction in the money supply.  It just has to be a reduction in the rate of increase.  If the money supply is growing at 10% per year and then it slows down to 5% per year, this could be enough to cause a bust.

In our current situation, there is actually a slight decrease in the adjusted monetary base since the end of QE2 back in June of this year.  Although we have not really seen a boom, the large increase in the money supply in the last 3 years indicates that things may have seemed better that they otherwise would have been without the large monetary increase.  Regardless, the monetary inflation of the last 3 years has misallocated resources and this will need to adjust at some point.  The bigger problem is that the original large misallocation that took place prior to 2008 was never allowed to correct.

So in just looking at the chart of the monetary base, it looks like we should see a recession coming.  However, there is a big “but” here.  Starting in late 2008, we saw something that we had never really seen before.  The excess reserves held by commercial banks increased dramatically as shown in the link above.

Typically, banks will lend almost all of their money and keep just enough to stay within the reserve requirements.  If they fall below the reserve requirements, then they can borrow money from the Fed on an overnight basis, which is the Fed funds rate that the Fed controls directly (except now because banks don’t need overnight borrowing, which is why the Fed funds rate is so low).

In 2008, the Fed started paying banks interest to keep their excess reserves with the Fed.  However, I have never really believed that this is the reason that banks have dramatically increased their reserves.  The Fed is only paying a quarter of a percent interest.  I think the reason the banks have increased their reserves as never before is because of their bad financial positions and their fear of what is still looming in the economy.

Regardless of the reasoning, the increase in the excess reserves has just about imitated the dramatic increase in the monetary base since the fall of 2008.  This has kept price inflation in check.

So while the monetary base is indicating a recession, the excess reserves are not.  If we see a drop in the monetary base with an increase of reserves (or at least no change), then a recession is more likely.  On the other hand, if the Fed keeps the monetary base steady and we see a big drop in excess reserves by the banks, then you should prepare for severe price inflation.

Right now, it is still a tug-of-war.  I would not be surprised to a see a mini-boom cycle with the stock market and commodities continuing to go up in price.  I also would not be surprised to see a recession.  There are a lot of factors out there.  Right now, we should be in asset protection mode and we should keep watching the charts above.  If there is any big change, I will be sure to let you know.