ZERO INTEREST RATE POLICY IS A TRAP

GOLD STATER DEBT COMMENT: ZERO INTEREST RATE POLICIY IS A TRAP.

TOTAL WORLD DEBT TO WORLD GDP HAS BEEN GROWING THROUGHOUT THE "BAILOUTS" OVER THE LAST TWO YEARS.

Central bankers tend to believe that inflation and default are mutually exclusive outcomes and that they have been anointed with the power to choose one path that is separate and exclusive of the other. Unfortunately, when countries are as indebted as they are today, these choices become synonymous with one another – one actually causes the other.

ZIRP (Zero Interest Rate Policy) Is a TRAP

As developed Western economies bounce along the zero lower bound (ZLB), few participants realize or acknowledge that ZIRP (Zero interest rate policy) is an inescapable trap.

Consider the United States’ balance sheet. The United States is rapidly approaching the Congressionally mandated debt ceiling, which was most recently raised in February 2010 to $14.2 trillion dollars (including $4.6 trillion held by Social Security and other government trust funds). Every one percentage point move in the weighted-average cost of capital will end up costing $142 billion annually in interest alone. A move back to 5% short rates will increase annual US interest expense by almost $700 billion annually against current US government revenues of $2.228 trillion (CBO FY 2011 forecast).

In other words because of the size of the debt the Fed can not afford to move off Zero Interest Rate Policy - which, by design, creates ever more debt.

Ben Bernanke wrote a paper in 2004 outlining the RISK TRAP associated with a Zero Interest rate Policy. To quote the very man who has now instituted that policy:

"Maintaining a sufficient inflation buffer and applying preemptive easing as necessary to minimize the risk of hitting the zero bound — still seems to us to be sensible. However, such policies cannot ensure that the zero bound will never be met, so that additional refining of our understanding of the potential usefulness of nonstandard policies for escaping the zero bound should remain a high priority for macroeconomists.

So when you hear analysts (Including, now, Ben Bernanke) talk about how easy it is to reverse the Zero Interest Rate Policy - well, it didn't seem so easy to DR BEN before he instituted this policy.

IS IT DIFFERENT THIS TIME?

DEBT TO GDP LEVELS RISING SHARPLY:

As Professor Ken Rogoff (Harvard School of Public Policy Research) describes in his new book, This Time is Different: Eight Centuries of Financial Folly, sovereign defaults tend to follow banking crises by a few short years. His work shows that historically, the average breaking point for countries that finance themselves externally occurs at approximately 4.2x debt/revenue.

The Bank of International Settlements released a paper in March 2010 that is particularly sobering. The study focuses on twelve major developed economies and finds that “debt/GDP ratios rise rapidly in the next decade, exceeding 300% of GDP in Japan; 200% in the United Kingdom; and 150% in Belgium, France, Ireland, Greece, Italy and the United States”.

So, clearly, according to this formula we're not at the breaking point yet. However: minute increases in the weighted‐average cost of capital for these governments will force them into a position where debt service alone exceeds revenue.

DEBT TO REVENUE LEVELS AT THE DANGER POINT:

ICELAND, GREECE, AND THE UNITED STATES all have Government Debt to Revenue ratios of over 300 Per Cent. (Most of Europe is at 200 percent.)

As governments’ structural deficit grows wider - driven by the increasing cost of higher debt service, and secularly declining revenues - the divergence between savings and the deficit will increase.

Interestingly enough, Alan Stanford and Bernie Madoff have recently shown us what tends to happen when this self-financing relationship inverts. When the available incremental pool of capital becomes smaller than the incremental financing needs of the government or a Ponzi scheme, the rubber finally meets the road.

We are very near that point.

How does Gold protect you in this environment?

Gold rises as debt rises, because debt destroys paper currencies.