Please visit the NEW AND UPDATED website of Peter Macfarlane and Associates here:

Click here for Peter Macfarlane & Associates website

The information you see here is for archive purposes only and may not be updated.

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Welcome to my personal homepage and blog on asset protection, offshore banking and investing issues.

As of today with the help of my assistants I have updated the consultation information here. This has become necessary because of the sheer volume of consultation requests. In the past I have given a lot of my time away for free, but this makes sense for nobody and ends up counterproductive. It diverts my time and attention away from serious personal consulting clients. It is unquestionably more efficient for me to charge properly for my time and then be able to dedicate the time necessary to serious clients. My fees are completely transparent and you can now book and pay for your e-mail or telephone consultation directly online.

It’s encouraging that so many people are getting the message.

First time here? If you are not familiar with my work, please visit Q Wealth Report and feel free to sign up for the free Q Bytes newsletter in order to receive free e-mail news and updates.

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As you may have noticed, we are no longer updating this blog. The main reason for this decision is that a certain major search engine de-indexed it. We won’t speculate as to why. But this is like the kiss of death for a blog – it gets hardly any traffic any more.

Nonetheless, we do still get some visitors, so we will continue to leave the archives accessible.

All new material written by Peter is published and updated regularly on the main Q Wealth Report site.

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By Bud Conrad and David Galland, Editors, The Casey Report

Here at Casey Research, we’ve been watching the actions of foreign holders of U.S. dollars as closely as a Las Vegas pit boss watches a card player on a $1 million winning streak.

Many of those in the deflation camp largely, or entirely, ignore the potential role these foreign holders may play in the drama now unfolding. But in fact, foreigners have, over the last decade, been by far the single most important source of buying for U.S. Treasuries.

Given the Treasury’s need to flog on the order of $3 trillion worth of its unbacked paper this year just to keep the government’s doors open – and that is a four- or fivefold increase over 2008 – the foreign buyers not only have to show up for the Treasury auctions, they have to show up in droves.

In mid-July, the Associated Press reported that “Foreign demand for long-term U.S. financial assets dropped by the largest amount in four months in May, as Japan and Russia trimmed their holdings of Treasury securities . . . foreigners actually sold $19.8 billion more long-term U.S. securities than they purchased in May. That compared with net purchases of $11.5 billion in April.”

Below you see the big picture of all cross-border flows in May as published by the U.S. Treasury. It shows both foreign investment in the U.S. and U.S. investment abroad. It includes Treasuries, agencies, corporate bonds, equities, and short-term instruments like T-bills. Foreigners bought a lot of T-bills when the credit crisis became acute.

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This should be a serious situation with a big drop in foreign investible funds for meeting U.S. borrowing needs. The borrowing by households and business has dropped close to zero, decreasing demand, while government borrowing has jumped but is still smaller than the private borrowing drop. The Fed has added some lending.

A look at just the longer-term Securities (not T-bills) is even more convincing of the slowing of lending by foreigners:

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This decrease in credit should pressure rates higher.

And here is the breakdown of foreign investment into the U.S. Foreigners only continued to buy Treasuries, shunning new investment and selling off agencies in the riskier real estate market.

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It’s not for nothing that the Goldman Sachs Secretary of the Treasury Timothy Geithner is hotfooting it around the world lately, last week to Saudi Arabia and the UAE… last month to China.

The purpose of his trip, Geithner told reporters in Paris, he was doing this tour ”to make sure we keep working with governments around the world to continue to provide enough support to lift this global economy back to a sustained pattern of growth.”

Translation: Look here, we’re all in this together. If you jump ship now, we’re all doomed… DOOMED, I say!

But the fact remains that the foreign holders of U.S. dollars have it within their ability – either deliberately or inadvertently as the result of a panic setting in – to literally destroy the U.S. currency.

The latest report shows Russia and longtime monetary ally Japan edging toward the door. China and the oil-exporting nations continue to convert an increasingly moderate amount of their trade surplus into Treasury bills – but not on a nearly large enough scale to meet the inflated (and inflating) borrowing needs of the utterly bankrupt U.S. government. And how long will they continue to show up, when an increasing number of other foreign buyers start selling their Treasuries? No one likes to be the last one to leave a party, especially when the bananas flambé has tipped over on the floor and the curtains are on fire.

Put simply, the only thing now standing between the U.S. dollar holding its own and an almost overnight debasement (and history has shown us that when things go wrong with a currency, they can go wrong very quickly) is the willingness of foreigners to play nice. This was never a threat that the Japanese had to deal with during the worst of their recent dark days, but it’s a very real risk here and now in the United States.

That that risk sits on top of the monetary inflation that has been the steady response of the U.S. government so far –  and will continue to be its response as the economy further erodes – is not something to be sniffed at.

On July 17, Bloomberg reported that “China’s finance ministry failed to meet its debt-sale target for a third time in two weeks at a 182-day bill sale, according to traders at Galaxy Securities Co. and China Citic Bank in Beijing. The ministry had tried to sell 20 billion yuan of bills and only sold 18.51 billion yuan, traders said. The average yield for the bills sold was 1.6011 percent, they said.”

Here’s our take on this news item: The problem from the Chinese government’s point of view is that they were not able to borrow as much money as they wanted, in the light that they are now spending at a very fast clip with a big stimulus program to keep their own economy (bubble?) growing. So how can they fund the spending? They can sell off the stash of foreign-currency-denominated holdings they are sitting on. That could mean Treasuries dumped on the world market.

There are other alternatives, like getting the People’s Bank of China to print up some new money for the government, which would inflate the renminbi (RMB) and decrease its international price and attractiveness. They might like to let the RMB fall to encourage exports and keep relative worker pay low on the world competitive scene. But they are also trying to make the RMB a world currency by itself, so they don’t want it to look weak and at risk.

Our guess is that they are selling Treasuries and not telling.

[Ed. Note: In latest news this week, Chinese Prime Minister Wen Jiabao said China “will use its foreign exchange reserves to support and accelerate overseas expansions and acquisitions by Chinese companies.” Jiabao called it China’s “going out” strategy. Going out (with a bang), though, may be a better description of what the U.S. will ultimately do.]

This is what The Casey Report, Casey Research’s flagship publication, does: spotting budding trends in the economy and the markets, and then devising ways to profit from them. A strategy that – as thousands of happy subscribers can vouch for – is paying off… and paying off big. Right now, one of our favorite plays, and surest bets, on the economic quagmire we’re in is an investment that is almost guaranteed to be a winner. Let Casey Chief Economist Bud Conrad tell you all about it in his free report. Click here to learn more.

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The article below was recently provided to us by the team of Big Gold at Casey Research. They are offering a free report on offshore gold storage to all our readers. I’ve checked out the report and it is well worth the price :) In fact, it’s worth a lot more, so considering it’s free, I would recommend signing up for it!

This article also considers the stability of Swiss banks and the exposure of Switzerland and the Swiss Francs to Eastern Europe, another topic we have touched on previously…

At Casey Research, our task is to accurately forecast trends, do it early, and help investors profit from what we’ve found. Without claiming infallibility, we’ve gotten it right more often than not, and by distinctly profitable margins.

But research to anticipate what to expect is the easy part. It’s the when-to-expect-it-to-happen that’s tricky, and waiting for a predicted trend change or crisis sometimes can test our confidence. The crisis we warned about years ago is now here, and its arrival has altered many of the rules for investing.

If you’re reading this report, you probably followed our earlier advice and have accumulated a nice-size crisis insurance policy in the form of physical gold. Now you need to decide what to do with that stash of Midas cash. It may have been born in a corner of your sock drawer, but perhaps now it’s stress-testing an attic rafter. Unlike gold ETFs and mining shares resting digitally in your brokerage account, physical gold brings with it questions of space and place: how and where to store it.

As to the how, the most common methods for storing physical gold will be obvious to most investors: concealment, a home safe, or a bank safe deposit box. In BIG GOLD, we recommended using a home safe because 1) it keeps the gold under your immediate control, and 2) it eliminates any risk that storage at a bank carries: emergencies don’t schedule themselves bankers’ hours; if a “bank holiday” occurs, access to a safe deposit box will be lost when it’s needed most; and a court can order the seizure of its contents, or the IRS can freeze your assets.

So that’s it? A one-size-fits-all storage solution?

No, not quite.

As your gold holdings grow, or if you already own sizable weight or are considering a large purchase, keeping all your golden eggs in one steel-and-combination-lock basket may not be the right solution. As we encourage above, having some gold in your immediate control assures that you can see yourself and your family through any calamity. Now ask yourself: can I keep a secret and not discuss it with anyone? Loose lips can only lead to a late-night, ski-mask-clad, armed visitation. How about the “security” company that installed the safe – how tight are their lips?

Further, keeping large amounts of gold in your possession exposes you to a latent threat: political risk. Or in ‘round the water cooler jargon, a “government gold grab.”

Think it won’t happen in the good ol’ U.S. of A.? Consider the surge of government pushiness over just the past six months. The U.S. government has usurped the free market by subsidizing entire industries and embarking on mega-dollar “stimulus” spending schemes, committing trillions to its efforts – money it doesn’t have and must borrow or print. With tax receipts falling off and government debt exploding, the government’s hunt for revenue could lead to increasingly desperate measures.

We’ve seen the 1933 black-and-white version of this script, in which the plot develops into a presidential diktat forcing delivery (confiscation) of gold owned by private citizens to the government in exchange for compensation at the price it finds most convenient. Will the temptation again prove too great? We don’t know. What we do know is that once the credits roll, it’s too late to start preparing.

So the final storage question must be confronted: where should your gold be stored?

Sending Out an SOS: Swiss Offshore Storage

One fundamental rule of investing that hasn’t changed is diversification, and the principle applies to the locations you choose for storing gold bullion. Follow the principle where it leads, and you find yourself thinking about “internationalizing” your gold by holding some of it in another country. But it should be the right country.

So exactly where is where?

The answer is the safest country with the most secure facilities: Switzerland. Yes, still Switzerland.

For our money, er, gold, we can’t think of a country with a stronger legacy of respect for private property. The country traces its formation back to 1291, and the first Swiss Confederation was formed in 1353. Complete independence came in 1648, when the Treaty of Westphalia recognized the final separation of Switzerland from the Habsburg Empire. Over the 361 years following the treaty, Switzerland has maintained its neutrality and shunned foreign military entanglements. Now that’s shock and awe.

The country’s domestic politics are characterized by stable, non-intrusive coalition governments. Such habitual civility, together with Switzerland’s long tradition of respect for individual privacy, has kept this small, largely alpine country atop the list of the world’s most trusted safe havens.

The Franc: Swiss Hit or Swiss Miss

The global financial and economic crisis has recently found its way into Eastern Europe, and the troubles brewing there center on the Swiss franc. The apparently dire situation led economist Arthur P. Schmidt to predict that Eastern Europe’s difficulties would pour over disastrously into Switzerland. His predictions grabbed the headlines and a bit of attention.

So, in keeping with the Casey, “Intensely Curious, Focused on Facts,” we dug behind the headlines. Here’s the big nothing we found.

Engaging in a carry-trade-like gamble, individuals and businesses in Poland, Ukraine, Croatia, Hungary, Latvia, and Belarus borrowed heavily in Swiss francs, attracted by low interest rates. They crossed their fingers for trouble-free repayment as, for a while, their currencies strengthened against the franc. But that strength didn’t last. The global economic slowdown hit Eastern Europe hard, and their currencies fell sharply against the Swiss franc, turning mortgages and other franc-denominated debts into horrible burdens. Said fingers are now doing a lot of pointing at who’s to blame. The size of the problem, according to Schmidt, is 230 billion Swiss francs (US$200 billion), and the difficulty of collecting on the loans supposedly threatens Swiss banks with huge losses that could bankrupt the country. Schmidt refers to Iceland’s recent national bankruptcy as a model.

We don’t blame him for trying, but the report incorrectly assumes that all the Swiss franc loans to Eastern Europe originated at Swiss banks. They didn’t. In fact, it’s Austria’s banks that have the greatest exposure to Eastern Europe. The day after the headlines, Credit Suisse released a report citing the latest figures from the Swiss National Bank that show Swiss bank loans to Eastern Europe totaled just SF33 billion (US$28.7B), or 6% of Switzerland’s GDP. In contrast, Iceland’s banks had lent over 1,000% of GDP.

Our conclusion: we see no evidence of an impending banking crisis or national bankruptcy in Switzerland. Heidi is safe.

To read the full report and learn all about Swiss specialist depositories, click here.

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Sometimes, you can achieve the most privacy by hiding in plain sight.

With all the hullabaloo about offshore banking, remember the basic fact that databases only know what you tell them. Sometimes going offshore can raise red flags, and there are more discreet and private banking options in major OECD or G20 member countries themselves… like the United Kingdom.

With this in mind, I’m grateful to a reader for sending in this submission for my blog. He’s drawing attention to how pre-paid credit cards from the UK can be a useful privacy tool, whether or not (maybe even especially if you are not) based in the United Kingdom.

Begin quote…  Hello Peter, as a wannabe travel journalist hoping to specialise in “OFFSHORE” area in the very near future, please feel free to use this sir.

Sorry for writing to you ad hoc, but one of your articles in the Q Wealth Report has inspired me to send you my thoughts. I’m VERY new to the offshore and privacy game after a tenuous bankruptcy in which I lost a lot. However, I have since done a lot of work with Prepaid cards issued in Britain, and I think these products are amazing. In Britain, they issue a prepaid Visa or Mastercard card without ID if they can find you on the electoral register… if not, you send them in a UTILITY BILL as identification proof and away you go. It’s not that hard to get hold of a utility bill Peter.

Also, there are no central database of these cards as they are not reportable (yet) and you can hold up to £5000 in them. Even better, you can have your wages/salary pad in to the cards, and some even allow you to pay direct debits and standing orders from the cards. Check out www.tuxedomoney.com admittedly expensive, but a superb way of having UK facilities, but not having all the unnecessary extras that goes with an average current account. Plus, and my favourite use of the cards, is that they build your credit rating dramatically.

There are 2 cards in the UK, the cashplus card, www.mycashplus.co.uk and www.sterlingcard.co.uk that offer a facility called credit builder. Here, they use the monthly fee you pay for the card, and issue it as a loan amount paid off over 12 months, and report each monthly payment to the credit reference agencies. Interest free too of course. So you are building a credit rating to develop in to other things, while also having a useful tool for socking away a few quid.

The Cashplus and Sterling pre pay cards both offer section 75 protection, so if a retailer goes bust, purchases are damaged etc, you can claim like you would a normal credit card. I thik this is unique also amongst pre pay providers.

I think that the all round use of UK prepaid cards, and the fact that they are very easy to obtain make them a winner for most of your readers sir, and a useful tool for most arsenals.

I was asking for advice on any particular investments etc, that an absolute beginner can work at, and the best methods of opening an offshore account for a very small player. I only have a small amount monthly to invest just now, but I’m hoping to get to another offshore financial haven, New Zealand and pursue my travel writing dream in the future.

Your offshore articles are superb, the VERY best that I have read, and it’s obvious that you know your onions. I will also publish some future articles about more British loopholes in due course.

You can also add on to the article that if anybody requires any help,  I would be glad to assist wherever possible sir. If they contact yourself, and then you may forward to this address. End quote!

Remember, if you would like to get in contact with the writer, please see my contact details here.

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A Guest Post by Doug Hornig, Editor, BIG GOLD

The Chinese Fake It

You probably remember movies about the Old West, wherein a shady-looking character would offer to exchange a gold coin for a horse, and the seller would bite down on the coin to verify its authenticity. That was about all you could do if you lacked proper assaying equipment and had to make a snap judgment: depend on your teeth to tell you whether the metal in your hand was sufficiently soft to be genuine gold.

The bite test is actually a pretty good one since gold, despite being among the heaviest metals, is also very soft. If you chomp down and shatter a tooth, it ain’t gold. But before you go munching on your coin collection, you might want to ask yourself, why bother?

Well, because of the Internet. While the Net has become an indispensable resource and we’d never want to return to the days when basic research meant a long day in the library, it also has the ability to stir up a hornet’s nest of concern at the drop of a stick.

One such hornet release followed the recent publication of a three-part series by Coin World, dealing with the subject of coin counterfeiting in China, where it’s quasi-legal. Instantly, the Web was buzzing with the worries of bloggers and eBay shoppers, and the pontifications of pundits about this dire threat.

Before we got too worked up about it, first thing we did was carefully read the source material. Yes, the Coin World articles raise the issue, and they feature an in-depth interview with one Chinese counterfeiter, although that’s not what he calls himself. He’s a proud artisan who produces replicas.

Of what? As it turns out, it’s primarily copies of ancient Chinese coins, which are sold to tourists. A few fake U.S. silver dollars are put up each week on eBay, but they are required to carry a Replica stamp.

Do all Chinese counterfeiters abide by this regulation? Perhaps not. But eBay has always been a place where caveat emptor rules, so the best policy would probably be simply to avoid coin purchases from China.

Problem Areas

Next, we consulted with our favorite gold coin dealer, asking if they come across many fake bullion coins, such as Eagles or Maple Leafs. The answer was no. They’ve only seen a handful during their thirty years in business.

Not that it’s hard to do. With modern 3-D laser imaging, a die can be created that mimics the real thing in perfect detail. The good news is that it’s impractical. The difficulty is that any counterfeit bullion coin would likely have to be gold in order to pass. If it were pure, then the profit margin would be too small to make the deal worthwhile. And if the counterfeiter skimped on the gold content, the coin’s weight would be a dead giveaway.

The only alternative would be to gold-plate a coin made out of some other metal. But again, getting the weight right while preserving the correct size would be a challenge.

Which brings us to the areas where counterfeiting can be a real problem. The most significant is rare coins. These can be made with the proper gold (or silver) content, then artificially aged so that only an experienced numismatist could pick them out. Because of the premium they command, rare coins made with real gold would be highly profitable where a bullion coin would not.

This is one of the reasons (disinterested grading is the other) why many collectors will only trade coins graded and slabbed by third-party specialists like Professional Coin Grading Service (PCGS) or Numismatic Guaranty Corp. (NGC).

Ominously, though, some counterfeit coins are turning up inside phony slabs. If you collect rare coins and have any reason to suspect them, it’s pretty easy to sort the real slabs from the fakes. Coin World provides illustrations on just how to do that here. (http://www.coinworldonline.com/articles/ChineseCounterfeit/Diags.aspx)

Gold bars are a different matter. Fakes do show up in the market from time to time, and they’re hard to identify. Generally speaking, counterfeiters don’t bother with the smaller ones, which are stamped, numbered, and sealed. They concentrate, our dealers tell us, on 1-kilogram or larger sizes. These are poured, rather than stamped, and can be easily adulterated or even hollowed out and filled with lead or some other metal. Compounding the problem is a lack of standard weights, even among good delivery gold bars. The “400-ounce” bar, for example, can vary anywhere from 390 ounces to 420.

How to Protect Yourself

As noted, we don’t believe that there is a serious issue with counterfeit bullion coins at the moment. But that doesn’t mean that they don’t exist, nor does it mean that evolving technology might not make them more profitable in the future than they are now.

The best precaution is the simplest: deal with someone you trust. Establish a relationship with a coin dealer who has built a strong reputation, preferably over a matter of decades, such as the dealers we recommend in BIG GOLD. Buy from them, even if you stumble across some mail order supplier who is charging less of a premium.

For small bars, purchase only those that carry the stamp of one of the known, trustworthy refiners, such as PAMP, Credit Suisse, or Johnson Matthey. For bigger orders, ask your dealer if they do assays. Reputable outfits generally assay bars that are a kilogram or larger. If you want a 100-ounce bar, consider buying direct from the Comex, which will also vault it for you. That removes the assay requirement when you buy, but remember that if you take physical delivery of a large bar, you’ll need an assay when you sell. Do not, under any circumstances, buy a larger gold bar on the Internet or from a private seller you don’t personally know.

If you’re still worried about a coin, there are tests you can perform to check it out.

• For gold, you can bite it, although you may not want to mar the surface of the real thing. Silver coins you can drop on the floor and they will ring; alloys won’t. The ring test is less useful with gold, since 24-karat gold doesn’t ring; less than 22 karats does, but so does brass.

• Size and weight are good measures. Make a list of the diameters of genuine coins for comparison purposes. Get a scale calibrated to hundredths of a gram. If a bullion coin weighs light (or, possibly, heavy), it’s bogus. Here’s a handy list of gold coins with all weights, diameters and thicknesses: http://www.onlygold.com/TutorialPages/Coin_specsFulScreenVersion.htm.

• A good counterfeiter may be able to get all other aspects of an adulterated coin right, but he won’t be able to fake density. Gold has a higher specific gravity than other metals, and you can test for that. Many Internet reference sites will tell you how.

• You could buy a commercial counterfeit detector. They aren’t cheap, but will quickly and easily test for weight, thickness, and diameter.

• If you happen to have some nitric acid and are a very careful person, you can drop your coin into a beakerful. Base metals will react, gold won’t.

• Rare coins are more of a challenge. If that’s where your interest lies, look for specimens that have been graded and slabbed. Otherwise, there’s no substitute for experience. Examine coins with a magnifying glass, heft them in your hand. Get to know what the real deal looks and feels like. Read up on the kinds of imperfections that characterize the phonies. Become your own expert.

Precious metals are going to be attractive to con artists, just like anything else of real value. But there are some decent safeguards already built into the system. Supplement them with your own knowledge and common sense, and it shouldn’t be difficult to avoid becoming a victim.

Good thing you don’t really have to worry about purchasing fake bullion coins… because it’s the best time to buy gold, and maybe one of the last chances you get to buy at $800+ levels. Read our report on why ultra-low interest rates could make gold rise to $1,500 (and higher) in the near future – and how you can profit: Click here to learn more.

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Jon Herring recently asked on Investors’ Daily Edge how it is that gold – “the world’s greatest inflation hedge” – is roughly the same price today that it was in 1980, after 30 years of inflation?

There is a simple answer: manipulation of the markets by the Gold Cartel . That will be nothing new to readers of this blog or The Q Wealth Report. What’s interesting about Jon’s article is his take on conspiracy theories. Things that you might only have wanted to whisper to trusted friends a few years ago have become facts accepted by the mainstream today…

It used to be that you didn’t speak about market manipulation in polite company. Everyone knows those conspiracies don’t exist. Who could do such a thing? We now know those sentiments are woefully naïve. There is now a deep and wide body of evidence that points to willful and ongoing, official and unofficial suppression of gold prices. Much of this evidence has been compiled and documented by the good folks at the Gold Anti-Trust Action Committee

Jon continues explaining not just why but how the cartel manipulates the gold price.

What our readers have long known, however, is that the quoted spot gold price is increasingly diverging from reality. There is one price for ‘virtual’ or ‘electronic’ gold – and a completely different spot price if you actually want to take delivery, touch and hold the bullion itself in the form of bars, coins or ingots (which, as a savvy investor, you should.) In fact, it has become increasingly difficult to buy gold bullion at all. Though fortunately, help is at hand… if you want to read my Q Wealth piece about How to Buy Gold Bullion Offshore.

One of my best discoveries in recent years has been a little-known way that you can purchase gold outside the cartel and completely offshore. Fortunately gold is impossible to forge or fake – its purity can be tested very easily and of course it can be weighed quite easily too. So if you have the right contacts you can buy gold direct from small, artisanal producers and be sure you are not being scammed. That way you don’t have to deal with snooty Swiss bankers with huge minimum handling fees for gold purchases. All this is explained (including contact information) in my special report named appropriately enough The Gold Report, which is available free, provided you are a member of The Q Wealth Report. If you are not yet a member, well a Q Wealth Report Subscription at $87 won’t exactly break the bank and will entitle you to a host of other benefits that you’ll find listed at that site.

Investing in Gold and Silver Coins – by which I don’t mean bullion coins but rare collectors coins – is another interesting angle – a way to diversify your portfolio and thereby spread risk. We have long referred interested readers without charge to our ‘Coyne Chap’ – who was one of North America’s most respected coin dealers, until he took early retirement and moved offshore. He’s a fascinating and knowledgeable person, and welcomes like-minded visitors at his home in South East Asia… so if youare living or traveling in that region and are a Q Wealth subscriber don’t hesitate to make contact with the offices in London to request a referral.

Anyway to get back to the original point, if I haven’t made myself clear by now, it’s that you should buy gold bullion because although it’s manipulated by the means mentioned above and by many other underhand methods covered in Jon’s article such as IMF and Central Bank gold leasing, it is much harder for the cartel to manipulate the real physical stuff you can carry around in your suitcase!

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Guest post for petermacfarlane.net by Terry Coxon, Editor, The Casey Report

We don’t yet know how many trillions will be swallowed up by the government’s rapidly breeding herd of stimulus-bailout-help!help! measures. But additional bold steps are sure to come, some already in R&D and others to be invented on the fly to answer each new wave of bad news. Expect price tags suitable for proving how serious and determined the authors are.

The doubts that meet each new plan – does it really need to be that big… hasn’t something like that been tried before… is it smart to keep wrong-headed decision makers in high places… isn’t too much debt at the heart of the problem… if you don’t know what causes inflation, are you sure you know what causes babies – are all answered with the same rhetorical question: “We can’t just do nothing, can we?”

Yes, we can. But we won’t, because the decisions about our wealth and our freedom are being made by career politicians, for whom stepping aside is the only truly unacceptable plan. Nonetheless, even though the idea of government doing nothing in the face of credit crisis, bank insolvencies, and recession has been reduced to a hypothetical, such a policy deserves a little exploring, since it can tell us something about where all the big-dollar solutions coming out of Washington are likely to lead.

Background

It’s possible to train people to be crazy. If you’re acquainted with a psychotherapist (socially, of course), ask him to explain how it’s done. Training people to be crazy wasn’t what the U.S. government set out to do when it ended the dollar’s convertibility to gold in 1973. But it turned out to be one of the results.

Untethered from the gold standard, the Federal Reserve was free to create new dollars whenever it saw fit. But the policy it drifted into wasn’t steady inflation, day in and day out, it was rescue inflation. The Fed would step up the expansion of the money supply whenever it saw a risk of widespread defaults in credit markets. The unintended effect was to train both lenders and borrowers, by repeatedly rescuing them from damaging defaults, to appraise financial risk unrealistically and to regard what is in fact a source of danger as a manageable nuisance. It made the managers of financial institutions functionally crazy, and the longer rescue inflation continued, the worse they got. (When you read about investment bankers running a business with 30-to-1 leverage and tell yourself, “Those people must be crazy,” you’ve got it about right. But they weren’t born that way. They were trained.)

That’s how the credit crisis was nurtured. And here is what the government has done about it so far.

• August 2007. The credit crisis is just going public. Commercial banks, investment banks, and other financial institutions are waking up to the reason they were getting such great returns on junk paper – it really is junk. To ease the shock, the Federal Reserve begins a vast and unprecedented program of swapping out Treasury securities from its own sizeable (nearly $1 trillion) investment portfolio in exchange for the embarrassing and worrisome securities that seem to be paralyzing the lending departments of the banks that own them. A novel approach, and not really inflationary, since no new cash is produced.

• September 2008. Lehman Brothers informs the Federal Reserve that the novel approach, admirable though its inventiveness might be, isn’t working and drops dead in front of Ben Bernanke’s desk. The Fed abandons the hope of a non-inflationary remedy and begins a vast and unprecedented program of expanding the monetary base (buying Treasury securities and other IOUs in the open market with brand-new dollars).

• October 2008. President Bush signs a vast ($700 billion) and unprecedented bailout bill. It has been sold to Congress as a measure to help banks survive and keep lending, but the details are vague in the extreme, leaving the secretary of the Treasury with the authority to use the money for almost anything, including, if he should find it advisable, “for carrying on an undertaking of great advantage; but nobody to know what it is.”

Other vast and unprecedented programs have followed, including tens of billions for any car company willing to drive (not fly) to the teller window, hundreds of billions to get messy home mortgages house-trained, and unspecified mega-billions for Timothy Geithner’s proposal to unburden banks of bad assets through a plan of great advantage but nobody to know what it is.

And today, 21 months after the doctors started scribbling prescriptions, most markets continue down, the economy is still shrinking, and worries are still growing.

Now roll the tape back to August 2007. What would have happened if the U.S. government had simply kept its long-standing commitments (in particular, protecting FDIC-insured deposits and preventing the money supply from shrinking) and otherwise had done nothing? No good-asset-for-bad-asset swaps, no wild expansion in the monetary base, no bailouts, no arranged marriages with taxpayer-financed dowries for failing institutions.

Nothing.

If that sounds extreme, perhaps you’ll find it a little more acceptable if I put it this way: what would have happened if George Bush, Ben Bernanke, Nancy Pelosi, Harry Reid, Barney Frank, and Barack Obama had done nothing?

It would have been spectacular, a mass die-off of the incautious. Bear Stearns, Morgan Stanley, and other practitioners of ultra leverage, including perhaps Merrill Lynch, would have folded. When you borrow to carry $30 of investments for each $1 of company capital, it only takes a 3.4% drop in the prices of your assets to put you under water. And when you’re getting that 30-to-1 leverage through overnight borrowing, even a whiff of doubt can make it impossible to roll over your financing from one day to the next. Either way, you’re out of business.

From there, the trouble would have fanned out. The firms just pronounced dead were counterparties to trillions of dollars in derivatives. The investors on the other side of all those deals (largely banks, insurance companies, and other brokers) would have been left holding the bag. Some of them would have failed, and all that survived would have been left weakened and living in fear.

Growing mortgage losses would have forced Fannie and Freddie (and also Countrywide Financial) into bankruptcy, which would have turned their trillions in outstanding bonds into junk debt, doing great injury to the banks, insurance companies, and other investors that held them. Citibank and Wachovia would have gone under. And with Fannie, Freddie, and Countrywide gone, the biggest sources of mortgage money would be unavailable, which would have turned the housing market from a corpse into a mutilated corpse. AIG, which had turned itself into a sink of follies by insuring other companies against losses on junk debt, would also have joined the departed – and the companies that had been depending on AIG credit insurance would have gotten sorted out between the failed and the merely damaged.

Bank of America, having been spared the irresistible invitations to acquire Countrywide and Merrill Lynch, might be in much better shape than it is today.

With a hundred-car pile-up in the financial sector, lending to businesses and consumers would have shriveled, and the rest of the economy would have slipped into a depression. No more General Motors. No more Chrysler. Ford maybe.

And those are just the big names. Tens of thousands of other companies would have gone out of business. Most others would have laid off workers. The unemployment rate would have moved deep into double digits. With so many companies cutting inventories to raise cash for survival, the wholesale price index would have gone off a cliff, and the consumer price index also would have slumped.

It’s an ugly picture, with pain and hardship for millions of people and grave worries for the rest. But before you start preparing thank-you notes for the good people in Washington who’ve acted so boldly, consider this:

If they had done nothing, the whole sorry business might be over by now. Without the promise of rescue and blow-softening, events would have moved quickly. The collapse of the overleveraged financial companies would have started soon after credit market jitters began in August 2007. (Leverage built on overnight borrowing invites swift justice.) The disaster in the financial sector might have been over by the end of that year or soon after. The year 2008 would have seen the wave of layoffs and bankruptcies in operating companies and the fall in wholesale and consumer prices.

A simple process would have brought the contraction to an end. With the prices of most things falling, the real value of the money in everyone’s pocket would be rising. That would continue until large segments of the population came to feel cash rich and started spending. Dollars appreciated in value, not dollars newly printed, would finance the recovery.

And it would be a thoroughly healthy recovery, because the bankruptcy proceedings that came before it would remove the billion-dollar bunglers of recent years from positions where they can make expensive mistakes. Decision making about the allocation of capital would fall to the survivors, who, by their survival, had proven their ability and readiness to decide wisely.

There is precedent for this. In the depression of 1920-1921, for example, wholesale prices fell by nearly one half, and most of that fall occurred in a period of just six months. It was a violent experience, with widespread bankruptcies, but it was over in a year and a half. It ran fast because the government did so little to try to stop it. Nancy Pelosi hadn’t been born yet.

So much for the hypothetical. Instead, with all the government efforts to make things right, we have:

• An economy that continues to contract;
• A continuing mystery as to which banks are solvent and which are not;
• Financial institutions still under the control of individuals who’ve proven they should be doing something else;
• Car companies on apparently permanent life-support at taxpayer expense;
• A retarded decline in housing prices that is extending, by years, uncertainty as to how severe mortgage losses are going to be;
• A flock of new government programs that will continue to soak up billions of dollars per year long after the recession is over;
• A vast and unprecedented (that again) increase in the basic money supply, which is jet fuel for price inflation;
• A vast and unprecedented increase in peacetime government borrowing, which, when the recovery begins, will trap the government in a choice between letting interest rates rise (and risk choking off the recovery) and continuing to inflate the money supply (and kiss runaway price inflation on the mouth).

Yes, it does seem cruel to do nothing when disaster is unfolding. But consider the likely consequences of the alternative.

Doing nothing might be appropriate for Washington at this point in time… but it is not what you should do as an investor. Making the trend your friend is the strategy that will get you through tough economic times like this and provide you double- and triple-digit returns.

The Casey Report focuses on emerging trends to profit from even in highly volatile markets – whether it’s shorting stocks squarely in the way of the accelerating economic avalanche or investing in commodities that stand to gain big in the coming months. Test it now risk-free with our 3-month, 100% money-back trial… click here to learn more.

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By the editors of Casey Research

“We’ve averted” the risk of a depression, Federal Reserve Chairman Ben Bernanke said this week. “Now the problem is to get the thing working properly again.”

Appearing on CBS network’s 60 Minutes, Bernanke told correspondent Scott Pelley that concerted efforts by the government likely averted a depression similar to the 1930s. He also stated the nation’s largest banks are solvent and that he doesn’t expect any of them to fail; and that the U.S. recession will come to an end “probably this year.”

Is this finally the light at the end of the tunnel for the U.S. economy?

We don’t want to appear as perpetual gloom-and-doomers, but fact is, when Bernanke tries to predict the future, he’s usually wrong.

Prediction: The subprime mess is grave but largely contained, Bernanke reassured the Federal Reserve Bank of Chicago in a speech on March 15, 2007.

While rising delinquencies and foreclosures will continue to weigh heavily on the housing market, it will not cripple the U.S. economy, he said. “Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited.”

Reality: The median price of a home sold in the U.S. fell to $170,300 in January 2009, down 26% from a year and a half earlier, according to the National Association of Realtors. This housing crash has spread pain more widely than any before it. Home prices fell about 30% during the Great Depression, according to calculations by Yale University economist Robert Shiller. But back then, the nation was less concentrated in urban centers, and much fewer Americans owned homes.

Other housing downturns in recent decades have been regional; this one is national. Prices in the fourth quarter of 2008 fell in nearly 90% of the top 150 metro areas, according to the Realtors group. And 5.4 million homeowners, about 12%, were in foreclosure or behind on mortgage payments at the end of last year. The Federal Reserve now estimates home prices could fall 18%-29% more by the end of 2010.

Prediction: “I expect there will be some failures” of smaller banks, said Bernanke in February 2008. “Among the largest banks, the capital ratios remain good and 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

Reality: IndyMac Bank failed in July 2008, with $32 billion in assets. Washington Mutual failed in September 2008, the largest bank failure in history with $307 billion in assets. Wachovia was sold to Wells Fargo in October 2008, amid concerns about its financial health, and Citigroup still scrambles to raise cash from both the government and private sources.

Fortunately for Bernanke, and unlike us at Casey Research, he doesn’t make a living by being right about the future. If he did, we strongly suspect that by this time, he would find himself without subscribers.

Thus, it is a mystery to us why the mainstream media still seem to eagerly soak up his every word, much like a devout Catholic would absorb a papal ex cathedra proclamation. But until the last American has woken up to Bernanke’s fallibility, that likely won’t change.

In the meantime, we recommend using the Fed chair’s economic outlooks as a contrarian indicator – if he says the market looks good, run for cover as fast as you can.

***

Bernanke may be wrong more often than not and still keep his job – we at Casey Research cannot afford that luxury. Our subscribers depend on us researching, correctly analyzing, and predicting market currents and emerging trends… which also includes the movements and changing policy decisions of Big Politics.

Our fresh-off-the-presses, FREE special report Obama’s Newer Deal, Part 2 tells you all about the president’s Stimulus Plan, its impact on and implications for your personal life and finances. Don’t miss it – click here now!

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