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Van Eck 9-25-09

Van Eck 9-25-2009

This letter was forwarded to me from the:

Adrian Van Eck's Hotline on Money and the Economy
For: Friday, September 25, 2009

(800) 219-1333. This e-mail address is being protected from spam bots, you need JavaScript enabled to view it . VanEckTillman.com.

Readers have been asking that I go back and touch the base marked money supply. Some have complained that we are ignoring money at a time when news reports talk about incredible increases in money by the Fed. I apologize for failing to talk about what for years was our number one topic. The reason I do not talk about money often here in the Hotlines is that reports of money creation are far out of line with reality. In order for money to impact spending and cause inflation, it must be loaned out by the banks. That sounds strange to many people but it is a fact. The Fed has created tons of money but very little of that new money is circulating in the economy. The bulk of it is being held in reserve by the Fed itself to guarantee the nation and the world that the naughty practices of big U.S. banks will not be allowed to cause a panic stampede at banks here and overseas. It appears that money, plus quite large loans from the Treasury to eleven huge banks, has achieved that goal.

Now look with us at lending from these and other U.S. banks to American companies and consumers. You would be surprised to learn (if you do not know already) that the problem today is not over-large loans but quite the opposite – too small and too few loans. As a result, the velocity of money circulating in America has dropped sharply since 2000. The Fed has been scolding banks and urging them to pump more money into the economy. So far, banks have refused to do so and they are rebelling against hints by the Government that their obligation is to supply the loans that American businesses and citizens need… starting with loans for homes and cars. Many of the loans that are being made are going overseas. Goldman Sachs has loaned a quarter-billion dollars to the communist Chinese Government, in order to triple production at a state-owned car company. That firm has said in the past that it intends to make autos for export to the U.S. market. You decide for yourself if this is in the best interests of America.

Instead of helping big and small firms to develop jobs, incomes and profits here in America, many banks – especially the eleven giants that have been advised that they are too big to fail – have turned their attention inward. They have been focused on levying charges against their own customers to pile up easy profits. You have probably seen the grizzly details. When a customer overspends their debit account the banks will cover the shortage, in most cases. But they charge customers as much as $35 per shortage, even though the actual cost to the bank is a low as 60 cents. Not only that, they line the shortages up in a list, taking the biggest check out first. Chances are this is enough to allow them to charge $35 on each of those debit overdrafts too, whereas if they worked off the small ones first there would in most cases be enough to cover them. So they could end up charging $35 to pay for a $4 latte, according to the report we saw. And six of these overdrafts could cost a customer $210… for a total list of overdrafts running at perhaps $150. Pretty good, if you happen to be a bank.

The Fed has finally begun to deal with this situation, and as a result several banks have announced a major reform in the way they access charges for overdrafts. This is a good start but I have a hunch many other reforms are coming soon in the way banks treat their customers. I believe it likely that one major change will involve the current barbaric practice of taking away a house from someone who has faithfully paid their mortgage every month for years, just because the current slump in prices has temporarily driven the market price of their home down below the amount of their mortgage. This is a new rule mandated by Congress when homes were rising in price by 10% or more a year, and politicians wanted to let borrowers come back to get more and more from their bank. But now turn with me to the issue of money supply.

During the 1930s America stubbornly refused to spend money on defense even though it was plainly obvious that Germany and Japan were both arming to the teeth and preparing for massive wars of conquest. Congress decided we could not afford to buy weapons of national defense. The only major aircraft carriers we had were the legacy of President Calvin Coolidge, a wise penny pincher from Vermont who had paid attention to the lesson when Billy Mitchell shocked the Navy by sinking a battleship from the air. But after Pearl Harbor everything changed. The War Department wrote up orders for anything and everything they needed and wanted. Defense manufacturers were told to take those orders to their local bank, which would supply the money needed. The banks in turn drew funds from the Federal Reserve, which created money enough to fund the loans needed by defense firms for materials, buildings, workers, taxes, shipping and yes profits. Millions of people were hired, often with lavish overtime.

Their savings (made certain because no new homes or consumer goods were built for almost four years) were supplemented by record borrowings to pay for the war effort. We trounced both Germany and Japan. During the war price and wage controls allowed only slow and minor increases. But after the war the inevitable inflation from such a vast increase in real money caused wages and prices to rise sharply. There are no controls today. But the place of controls has been taken by the worldwide overcapacity and over-production of many commodities and manufactured goods. The reason you are seeing such an outbreak of protectionism is that many nations are trying to beggar their neighbors with cutthroat pricing that is wiping out millions of jobs and greatly disturbing workers’ lives, mortgage payments, city, town and state tax receipts and above all jobs held for years by highly trained and motivated workers. What is needed today is an end of deflation and then an annual price growth of at least 1% to 2%. This would stay within the range sought as a target by the Fed and the Federal Government.

This is not a new target. Back in the Eisenhower Administration the Commerce Secretary returned home to Newton, Massachusetts, a wealthy city where he had once been Mayor. He was being honored by the Rotary Club for his achievements. He was asked by the local press if the president was aware that we seem to have just slipped into a recession. “Aware of it?,” he said.” He added: “Yes, by all means. He caused it on purpose and he will keep this pressure up until the current 3% inflation is brought down to 1%. Then he will end it, because it will have served its purpose.” By the same token, the recent recession accomplished a great deal of positive change by wiping out a forest fire of runaway price gains in housing. As they settle at fair prices, America can stabilize and then resume economic growth. That is when you are likely to see new growth in bank lending, hiring, production and purchases - leading to new inflation – and we will then be off into a new cycle of prosperity and profits. More next week. Adrian Van Eck.

Next hotline will be updated no later than 8:00 P.M. EST on Friday, October 2, 2009