Not so far apart

A FEW years ago a prominent former treasury official came to lunch at The Economistand predicted that the debt level would become a national preoccupation. He expected Americans would grow weary of a large debt burden, but refused to say whether Americans would demand fewer services or higher taxes as a result. It turns out he was correct: Americans are both concerned about the nation's debt, and confused about how to solve the problem. Often lost in this confusion is the important distinction between the current deficit (not such a big deal) and the long-term structural debt (a big problem). The best solution for paying down America's long-term debt is some combination of spending cuts and tax increases. And if you listen closely to both Republicans and Democrats (at least the non-crazy ones) they actually seem to agree on that. Unfortunately they're talking past each other.

This post by Jonathan Chait illustrates the point. He accuses Glenn Hubbard, an advisor to Mitt Romney and Dean of Columbia Business School (full disclosure: I was once his student), of misunderstanding the extent of the long-term debt problem. Referencing the chart below, Mr Hubbard claims that the debt problem is real, largely caused by increases in future spending, and may result in very high future taxes.

We see two scenarios in these charts. The extended-baseline scenario assumes current laws (like the expiration of the Bush tax cuts and the implementation of Obamacare) will not be changed in the future, while the alternative fiscal scenario assumes that "widely expected" changes to current law (ie, revenue as a % of GDP remains the same and entitlement spending is not meaningfully cut) come to pass. According to the CBO, the extended-baseline scenario—what it takes to keep debt levels stable—poses significant costs.

Revenues would reach 23 percent of GDP by 2035—much higher than has typically been seen in recent decades—and would grow to larger percentages thereafter. At the same time, under this scenario, government spending on everything other than the major mandatory health care programs, Social Security, and interest on federal debt—activities such as national defense and a wide variety of domestic programs—would decline to the lowest percentage of GDP since before World War II.

Mr Chait accuses Mr Hubbard of misreading the chart and pushing a lop-sided agenda focused on cutting spending. But Mr Hubbard's position is simply that long-term spending is unsustainable and that the debt problem cannot be solved by tax increases alone. That conclusion is not so different from the research Mr Chait cites from the Center for American Progress, a liberal think tank. There is more common ground here than Mr Chait lets on.

Cutting entitlements and raising future taxes does not necessarily leave people worse off. People live progressively longer and the quality of health-care services, so far, has increased and gotten more expensive. So in principle, you can decrease the length of retirement or the level of benefits paid (especially to higher earners who live longer) and still provide a similar present value of real benefits to future generations. A problem with entitlements is that each new generation expects more than the last, longer retirement and the latest and greatest in health-care technology.

Record-high levels of revenue as a percent of GDP may not be so bad either, so long as society gets progressively richer. Taxing citizens 30% of GDP is a much bigger deal in Angola than Denmark because Angolans have much less income to spare. Though for developed countries the distributional consequences are tricky if income inequality continues to widen. Also there can be second order effects from higher taxes, resulting in lower growth. Fairness to future generations is also important. Punting reform to the future makes it more expensive and places a large burden on the young. Striking the right balance is hard, but possible, and the sooner the better. It is not clear that the current law, associated with the extended baseline scenario, gets it right. That probably requires a more efficent tax code and redefining retirement expectations. It belabours the point of just how necessary a thoughtful dialogue is.

The zero lower bound in our minds

PRIOR to the crisis, there was a general (if tenuous) accord among macroeconomists of many different stripes, that the Federal Reserve could and would act to stabilise the economy when necessary. Then, in December of 2008, the Fed hit the zero lower bound, when it dropped its target for the federal funds rate to between 0% and 0.25%, where it has sat ever since. At the time, the unemployment rate was 7.3%. It eventually peaked at 10% about a year later, and it has come down, very slowly and fitfully, to just 8.5% since then. For fully three years, America has been a zero lower bound world.

During that time, economists have been working very hard to figure out what the implications of the zero lower bound are for macroeconomic policy and unemployment. Are we stuck, or what? 

At a session this morning, I saw a few presentations on the topic. There was a general agreement among them on the nature of the zero lower bound problem and the liquidity trap. There are two different kinds of people in the economy: savers and borrowers. The borrowers borrowed heavily until the shock of the crisis changed the nature of their borrowing constraint and forced them to rapidly deleverage. Without an increase in demand elsewhere, the high rates of saving of the borrowers will plunge the economy into a deep recession. Normally, the real rate of interest should adjust downward until the savers cut their desired saving enough to offset the increase in desired saving of the borrowers; that is, they spend more to make up for the others furiously trying to pay off their bills. But in some cases, the extent of the deleveraging by borrowers may be great enough to drive the market-clearing real interest rate into negative territory. Since the Fed can't cut rates below zero, savers don't spend enough, there is excess saving, and the economy is stuck with high unemployment.

What then? Paul Krugman, who presented a paper in the session with Gauti Eggertsson, noted that fiscal policy was likely to prove effective in such a situation. The government could borrow from those wishing to save more and provide the economy with needed additional demand. At the zero lower bound, government spending doesn't generate crowding out of other investment activities via higher interest rates, so policy is even more effective than usual. And so on. There are other potential solutions, as well; one presenter noted that "unconventional fiscal policy" could replicate an ideal monetary policy through a combination of tax changes—a consumption tax scheduled to rise over time alongside a tax on labour that would decline over time.

But Stanford economist Robert Hall really nailed the crux of the question, so far as I was concerned. At the AEA meetings a year ago in Denver, I listened to Mr Hall speak a few times on this issue and point out that with the market-clearing interest rate below zero the economy was stuck with high unemployment. At the time, I wondered why, if that were true, that the answer wasn't simply a higher rate of inflation, which could combine with a zero nominal interest rate to move the real interest rate below zero.

This time around, Mr Hall addressed the point head on. He noted that in a liquidity trap, the real rate of interest was simply equal to the negative inflation rate. In other words, if the Fed's nominal rate is at 0% and the inflation rate is 2%, then the real rate of interest is -2%. If a -3% real interest rate is necessary to clear the economy, then all that's needed is a higher rate of inflation—3% rather than 2%. Mr Hall noted that this was an important point because potentially the Fed could have an enormously helpful impact on the economy simply by raising inflation just a little. And here's where things got topsy-turvy. Mr Hall argued that:

1. A little more inflation would have a hugely beneficial impact on labour markets,
2. And a reasonable central bank would therefore generate more inflation,
3. And the Federal Reserve as currently constituted is, in his estimation, very reasonable; therefore
4. The Federal Reserve must not be able to influence the inflation rate.

Now, perhaps there was a political economy subtext to this argument; if so, I missed it. Rather, he seemed to be saying (as others, like Peter Diamond, have intimated) that at the zero lower bound it is simply beyond the Fed's capacity to raise inflation expectations. Now admittedly I haven't done a rigorous analysis, but it seems clear to me that the Fed has been successful at using unconventional policies to reverse falling inflation expectations. Why is Mr Hall—why are so many economists—willing to conclude that the Fed is helpless rather than just excessively cautious? I don't get it; it seems to me that very smart economists have all but concluded that the Fed's unwillingness to allow inflation to rise is the primary cause of sustained, high unemployment. And yet...this is not the message resounding through macro sessions. Instead, there are interesting but perhaps irrelevant attempts to model the funny dynamics of a macro challenge that actually boils down to the political economy constraints (or intellectual constraints) facing the central bank. Let's focus our attention on that, for heaven's sake.

Is the liquidity trap almost over?

LIQUIDITY traps: we can't stop talking about them. Since late 2008, the nominal interest rate target suggested by most standard monetary policy rules has been negative, leaving the American economy in a liquidity trap. Eddy Elfenbein recently ran a monetary policy rule devised by Greg Mankiw through the data and found that an exit from the trap might be closer than many think. The rule is:

Federal funds rate = 8.5 + 1.4 (Core inflation – Unemployment)

And when run against the data it produces:

At this rate, it seems, the recommended policy rate will be positive in no time. Maybe. The recent, steep increase is unlikely to continue. Core inflation is expected to level off and might well decline in 2012. The recent decline in unemployment is also unlikely to continue. Labour force departures have overstated the health of the labour market as captured in the unemployment rate, and if the job market continues to strengthen, then rising labour force participation will prevent a too-rapid drop in the unemployment rate. The rule might recommend a positive rate by the end of the year (2% core inflation and an 8% unemployment rate would just about do it), but it's far from certain that it will.

Neither should the Fed follow the rule right away when it begins recommending rate increases. Monetary policy gains traction in a liquidity trap by raising expected inflation. To achieve that, the Fed has to promise to let inflation rise above what the rule might normally recommend; it needs to credibly signal that there will be some catch-up inflation.

That's a tough thing for a central bank to do, and it gives rise to a time inconsistency problem in liquidity-trap monetary policy. The Fed can promise to behave "irresponsibly" in the future, but if most people think that no matter what Ben Bernanke says now he'll keep inflation at 2% later on, then the Fed will struggle to spark a recovery. A policy that explicitly allows for catch-up inflation, as through a level target, would make liquidity-trap fighting more credible. The Fed is none too anxious to head in that direction, however, lest it "lost credibility" as an inflation fighter. Which, of course, is precisely what's needed.

America’s next CEO?

Paint it grey
Start with the advantages. The most important fact about Mr Romney is that he is a non-ideological man who did something that America needs a lot more of. In 2002 he was elected to govern Massachusetts, normally a Democratic stronghold. He passed a version of health-care reform that is at once his proudest achievement and his biggest liability. Back then a system based on obliging everyone to buy private health insurance was a conservative idea, and Mr Romney did a good job of working with a hostile legislature to get it passed. (Today, his party viscerally opposes Mr Obama’s health reforms, which are closely modelled on Mr Romney’s; such are the twists of politics.) He also turned round Massachusetts’s finances, just as he had earlier righted the Salt Lake City Winter Olympics. Mr Romney needs to make these successes count for more than they have so far. Once the primaries are over, and America’s independents rather than the Republican Party faithful become the electorate to win over, he may be able to.
Second, Mr Romney has something that the president and his Republican rivals sorely lack: business experience. For 25 years he made himself and the management consultancies BCG and Bain a lot of money by making companies more efficient which, yes, sometimes means firing people, but also drives economic growth (see article). So far, Mr Romney has done a poor job of defending himself against attacks which are really aimed at the creative destruction which is the essence of capitalism itself. He says he created a net 100,000 jobs during his time at Bain. That figure is impossible to prove, but he could do more to argue that the benefits outweigh the costs. His task has not been helped by disgraceful attacks from fellow-Republicans on corporate restructuring.
Third, Mr Romney seems sure-footed. It is hard to think of a single misstep in this campaign. He may be wooden, but no scandal has ever attached to him. His family life is impeccably monogamous and progenitive. Those who have worked closely with him tend to admire him. On both the economic and the foreign-policy sides, he has already put together impressive and above all sensibly moderate teams.
The debit side of the ledger
A useful list, to be sure: but can it outweigh the negatives? Mr Romney’s pragmatism has an inconvenient flip side: no one is quite sure where he stands. The Republican base does not think he is reliable on such things as gay rights and abortion. That will not matter so much to independents (who will probably also accept that any Republican has to say a few mad things to win a nomination). But people have to trust a president on the main issues, and, despite publishing a long economic manifesto, Mr Romney remains vague over how a lot of it is to be accomplished.

Explore our interactive map and guide to the race for the Republican candidacy

It is not at all clear how he would reform America’s ruinously expensive health-care and pensions systems. His views on what he wants to do about America’s 12m illegal immigrants are also unsettlingly gnomic. And where he has been clear, he has sometimes been wrong: his insistence that, on day one of his presidency, he will brand China as a currency manipulator represents dangerous pandering to populists. His pledge to cut federal spending to no more than 20% of GDP, a sop to his party’s fiscal extremists, would also be dangerous if applied as quickly as he implies.
Mr Romney will have other problems in wooing the electorate. He would be the richest candidate ever to win a big-party nomination and he reeks of privilege. His father was a governor as well, and he himself studied law at Harvard. On the other hand, Mr Obama is a millionaire several times over, can give a fair impression of having come from the planet Vulcan, and also studied law at Harvard. Mr Romney’s lack of charisma is a problem; but perhaps America wants fewer soaring speeches and more pragmatic restructuring plans.
Mr Romney’s last difficulty is one that should not be a problem at all. He is a Mormon and, despite Mormons’ protestations to the contrary, a third of Americans do not consider them to be Christians. There is not much Mr Romney can do about this. He could explain the Mormons’ extraordinary missionary work, but he can hardly risk saying that it is not really any more incredible that God communicated His plans to man in upstate New York in 1820 than He did in Palestine in 0AD. We recall, however, that America was for decades “not ready” for a Catholic president, or for a black one. Eventually, Americans thought better of those attitudes. Prejudice would be a silly reason for the Republicans to reject a man who offers their best chance of beating Mr Obama.

Gold, God and forgiveness

 Gold, God and forgiveness

DO BANKERS inevitably go to hell? What many people today merely hope will come to pass was for Christians in the early 1400s a matter of faith. After all, the Bible, like the Koran, was explicit in its condemnation of lending money at interest, the basis of most banking operations. So in many parts of Christendom moneylending was left to Jews. In several northern cities of medieval Italy, however, ingenious Christians started to find ways round the banking ban. Their contrivances, though legal, were not popular with the church, which held that usurers, by charging for the duration of a loan, were not trading in goods but in time, and this was God’s.
The prospect of an eternity of hellfire was particularly acute in Florence, since it was here that the foundations of modern banking were being laid. As it happened, Florence was also witnessing the first stirrings of an extraordinary flowering of the arts. Before long guilt-ridden bankers were commissioning great works of religious art in the hope that they might after death escape the damnation that the scriptures foretold. In this way were the birth of the international financial industry and that of the Renaissance intimately connected.

 

The connection might perhaps be reduced to a single word, whether patronage, or atonement, or Medici. A
longer, and far more pleasurable, elaboration can be found in text, pictures and objects at the Palazzo Strozzi in Florence, where an exhibition devoted to “Money and Beauty” continues into 2012. Subtitled “Bankers, Botticelli and the Bonfire of the Vanities”, it explores the motives of Florence’s bankers in their artistic commissions; the reactions of churchmen to rich Florentines’ displays of luxury and wealth; and the effects of both penitential patronage and ecclesiastical reproach on the works of art that, throughout the 1400s, or Quattrocento, tumbled forth from Florence like coins from a slot machine.
In the background of the exhibition are the Medici, the wool-traders turned bankers who held sway over the Florentine republic in its golden age under Lorenzo the Magnificent, and who produced popes and queens and Tuscan grand dukes until the last of the dynasty died in 1737. Their grip was interrupted by the invasion of Charles VIII of France in 1494, which brought in its wake the brief rule of Girolamo Savonarola, the austere Dominican friar from Ferrara who berated the Florentines for their luxuries, gambling, carnivals, and particularly their wanton paintings, which made “the Virgin Mary look like a harlot”. He called for children to spy upon their parents, prostitutes to be chastised, sodomites burned alive and irreligious frivolities prohibited. Hence the great Bonfires of the Vanities in the Piazza della Signoria in 1497 and 1498, when countless works of art, as well as cards, books and dresses, went up in flames.
Sandro Botticelli, a central figure, was not one of the artists who flung their paintings onto the fires, but he nevertheless fell under Savonarola’s spell, as his later works clearly show. Gone, in these, were the sensuous depictions of idealised beauty seen in his early paintings, such as the “Birth of Venus”. Now Botticelli’s figures were more likely to bear agonised expressions of intense piety, as in “Madonna and Child with the Young St John”.
In between came works like “The Calumny” (pictured above). This shows Midas on his throne, receiving the counsels of Ignorance and Suspicion, with a hooded Envy clasping the hand of Calumny, who in turn, with Deception and Fraud attending, is dragging the unidentified victim by the hair, while Penitence turns hopefully towards stark-naked Truth. Though not overtly religious, the sentiment is morally correct and therefore Savonarola-suitable, as is the turbulent mood, so far removed from the sumptuous lyricism of Botticelli’s earlier, mythological works. When those were made, as the chronicler Giorgio Vasari noted over half a century later, he worked happily for many Florentine families painting “very nude women”.
“Money and Beauty” was proposed in 2006, just after the birth of the foundation that runs the Palazzo Strozzi, a 15th-century building in the middle of Florence built by mercantile rivals of the Medici. Five years of incubation, however, have only improved the show’s timeliness, allowing reflections not just on the role of bankers in general but even on some familiar banking terms whose origins are Tuscan. The most notable may be “risk”, which derives from Tuscan rischio, the amount considered necessary to cover costs when lending money, ie, a euphemism for interest. Another is “florin”. First coined in Florence, florins circulated widely in Europe for centuries—in Britain until 1971—and may yet perhaps make a post-euro return.
It is not just its timing, though, that makes this show so successful. Its themes, and the abundance of artefacts and paintings on which the curators could draw, allow every point to be illustrated with a wonderful work of art: a panel commissioned by the mint; an altar painting showing Filippo Strozzi, who paid for it, almost as prominently as the entire Holy Family; keys, locks, letters of exchange; an account book pointing to the perils of sovereign default (three banks had gone bust when Edward III of England reneged on large loans); a codex containing the sumptuary laws that forbade flashy clothes and ostentatious funerals. (Even Fra Angelico—see next story—so pious he could not paint a crucifix without tears running down his cheeks, chose to depict the Virgin’s obsequies in the manner of an unashamedly opulent 15th-century Florentine funeral.)
The images are merciless. Miserly bishops are shown being whipped with their own moneybags; St Anthony causes a usurer’s heart to be found in a strongbox; a moneylender meets the figure of Death. Balancing these are numberless images of devotional scenes, the Nativity, the Madonna and other religious figures. And also shown are the events with which Lorenzo’s magnificent era ended: Charles VIII’s entry into Florence, Savonarola preaching against luxuries in a city that derived so much wealth from making them, and the fundamentalist friar’s own execution in the very square in which the Bonfires of the Vanities had been held. This is the visual telling of a tale of beauty and bloodshed, lucre and licentiousness, morality, hypocrisy and propitiation.
The telling is not all the work of the Quattrocento. The exhibits benefit enormously from the commentaries of two curators, Ludovica Sebregondi, a specialist in the religious art of the Renaissance, and Tim Parks, a British novelist and author of “Medici Money” (2005). While one puts the exhibits in their art-historical context, the other explains the social and wider significance. With different styles, and sometimes conflicting views, they add considerably to the pleasure of the show.
And should today’s bankers take heed? Though usury has long since lost its power to inspire any penitential effort among Christians, modern moneylenders are accused of other sins: Pope Benedict calls for “moral renewal” in Italy and the Church of England agonises about the godlessness of the City of London. Yet most bankers seem to dread damnation in the hereafter as little as censure in the here and now. Too bad. Without the fear of God, they are unlikely to pay for a new Renaissance.

 

Behind every cloud, another cloud

A decade ago, Britain came through the dotcom bust with barely a scratch, thanks to a consumer-credit boom and deficit-financed public spending. Those days of easy credit are long gone: consumers are paying down their debts and government finances are deep in the red. The economy’s best hope lies with export demand, but this is growing scarce. The economic outlook for America, Britain’s biggest single-country export market, looks dark. The euro zone, where half of Britain’s exports go, is at risk of imploding.

In September the IMF cut its forecast for Britain’s GDP growth in 2012 to a sluggish 1.6%. Even that may soon look too optimistic; the Economist Intelligence Unit, a sister company of The Economist, expects 0.7% (see “The world in figures”). It seems far likelier that the economy will disappoint than offer a pleasant surprise. The British policy brass feels vindicated for its wariness about the single European currency but scepticism will be no protection against the fallout from the euro’s troubles. Britain is the one big country outside the currency zone that is heavily exposed to euro trouble through its trade and financial links.

Related topi

The continuing crisis in Europe will have implications for Britain’s deficit-cutting plans. The logic behind the government’s fiscal austerity is that the bond market’s ire can turn quickly from errant euro-zone countries to others (such as Britain) that have large budget deficits. But as Europe’s woes deepen, the harm done by sticking rigidly to the fiscal plan is likely to prove greater than any damage done by deviating from it.
That is in part because money pulled from the euro zone’s trouble-spots has to go somewhere. Some of it will end up in British government bonds, which will look among the soundest of the rich-country credits (admittedly not a healthy peer group). Meanwhile, a dearth of export orders for British companies will push the government to adopt measures in support of the economy. Deep cuts in the state’s day-to-day running costs, including reductions in welfare benefits, will go ahead as planned. But the Treasury will find itself having to finance new capital projects to make up for a shortfall in aggregate demand.
The economy will be lucky to avoid at least one quarter of contraction during 2012. The unemployment rate will be stuck above 8%, the highest rate since the mid-1990s. But two factors militate against a deep downturn.
First, businesses anxious about the economic outlook and fearful of a renewed tightening of credit conditions tend to trim their stocks, postpone planned investment and stop hiring new employees. But this tendency to conserve cash will be limited in the coming months because many British companies have already been piling up rainy-day money. The excess of corporate income over spending has risen above 4% of GDP. That offers a degree of protection against savage cuts in stocks, investment and jobs.
Easy does it
A second helpful factor is the prospect of lower inflation. It is set to fall steadily from a peak of 5% to around 2% by the end of 2012, as vat and energy-price increases drop out of the annual rate (see chart). That will bring some relief to hard-pressed consumers, who suffered a large fall in real income during 2011. Lower inflation will also make it easier for the Bank of England to justify a more aggressive dose of “quantitative easing” (QE)—boosting the money supply by buying government bonds. Because investors will be increasingly reluctant to finance commercial banks, amid worries about their exposure to the euro zone’s sovereign-debt problems, the Bank of England will find itself compelled (with Treasury backing) to buy long-term bonds issued by banks as part of its QE programme.

The pound is set to fall further against the dollar

London will look a cheap holiday destination for Americans next summer but a lot of Europeans are likely to stay at home. The pound is set to fall further against the dollar in the early months of 2012, in part because of Britain’s exposure to the euro zone but also because the dollar rises against other currencies when the world is in trouble. At the low point for the global economy in March 2009, the pound fell to $1.38. It could easily fall as far again in 2012 given how fearful investors are likely to become.
Only the euro looks more vulnerable to a fall. But it will not be much comfort for Britons that some other European economies will be in even worse shape than their own.

How to run the euro?

How to run the euro?

• er during the euro crisis: the markets and the politicians. In 2012 the battle will become a lot more complicated, as the politicians splinter into factions. It sounds dangerous—and it is—but thrashing out political arguments is an essential part of bringing the crisis to an end.

Amid the banks’ plunging shares and the soaring yields of government bonds, it is easy to lose sight of the political questions being asked of Europe. Markets have forced Europe’s troubled economies to confront austerity and reform, but politics will determine how they do so. Markets have demanded that Germany and other creditor nations finance a rescue, but politics will decide what they demand in return. Markets want a revamp of the euro’s governance, but politics will ordain how energetically the European Union embraces federalism.

Austerity and a rescue are now under way, though a descent of Greece into anarchy could yet throw them off course. But the third element—renovating the governance of the euro—is still highly uncertain. In 2012 Germany’s Angela Merkel and her fellow euro-zone leaders will set out the sketches for that design.

Try this for a blueprint

If you were sitting down with a blank sheet of paper, you would advise the euro zone to complement its one-size-fits-all monetary policy by pooling sovereignty and creating new institutions. You would set up a European mini-IMF (call it an EMF) with enough funds to tide over troubled countries as they adjusted their economies. A pan-European banking regulator and a bail-out fund could ensure that large European banks were not at the mercy of their vulnerable sovereign borrowers. To stop the markets from picking off weaklings, you might organise centralised borrowing—in which all countries jointly stood behind the debt of each government. And, to stop spendthrift governments from exploiting these mechanisms, euro-zone countries would agree to submit their fiscal policies to the say-so of everyone else.

It amounts to a blueprint for the United States of Europe. And it is utterly beyond reach.

For starters nobody can agree on which central authority should hold all these new powers. France and Germany would refuse to boost the European Commission, which they mistrust. Smaller countries and Germany’s constitutional court would refuse to endow an ad hoc intergovernmental council. Many national leaders heartily detest the European Parliament.

Moreover, many governments are nervous about other euro-zone countries having a say about their own public spending. And the entire EU was scarred by the eight-year-long attempt to restructure the union, first by writing a new constitution—rejected and abandoned—and later by repackaging the constitution into the Lisbon treaty, which limped into force in 2009. You do not find much appetite in Brussels for a repeat performance.

Shape up, for the euro’s sake

Where does that leave the redesign of the euro? Euro-zone governments have agreed that leaders will meet at twice-yearly summits. They have set up a proto-EMF and a European Banking Authority. And they have agreed to monitor the economies of euro-zone members in a souped-up Stability and Growth Pact.

New sanctions might require a new treaty

But more is needed, especially with sanctions. Some could be enforced at the level of the nation. Euro-zone members might have to write caps on deficits and debt into their constitutions, or create independent offices of statistics and budget sustainability, rather as they must have an independent central bank today.

Ultimately, though, new sanctions might require a new treaty. But new treaties take a long time. Countries can weigh them down with their own agendas (Britain, for instance, wants to repatriate powers even though it is not a member of the euro zone). And referendums can reject treaties (just ask the Irish).

These difficulties have answers and the EU has had more than enough practice in fashioning compromises out of unpromising ingredients. But if the euro zone gets it wrong in 2012, it will be laying the foundations of the next currency crisis. 

Will 2012 be another stellar year for gold investors?

NEW YORK - 

In contrast to the closing months of 2011, gold has begun the new year on a more positive note.  Whatever the metal's short-term prospects - indeed even if gold takes another dive - we believe 2012 will be another stellar year for gold investors.

Gold topped out at an all-time high just over $1,924 an ounce in early September - a whopping gain of some $600 or about 50 percent from last January's low point.  But as investors know all too well, gold prices can be quite volatile - with big upswings often followed by big downturns, albeit around a rising long-term trend.  Such has been the experience of the past four months with gold shedding roughly 30 percent from its all-time high to its recent late-year low point of $1,522.  But, let's not forget, even allowing for this deep price correction, gold still closed the past year with just about the best annual gain of any asset class!

Looking ahead, 2012 could well turn out looking much like the past year for gold - with sizable gains, possibly as much as 50 percent (or more) from the recent lows, but also with occasional big declines that may lead many observers of the gold scene to mistakenly declare an end to the yellow metal's bull market.  Just as gold bears have been wrong over and over again in the past decade, so will they continue to be wrong in 2012.

The story of gold in recent years has been a tale of institutional traders and speculators - including hedge funds, commodity funds, and the trading desks at the big banks and financial firms - producing great two-way volatility as they rushed into gold (as we saw last summer) and then, not just unwinding long positions, but shorting the metal in a big way (as we saw this past fall).

Driving these institutional players, in addition to momentum and technical trading indicators, has been the flight from the euro into U.S. dollar assets - and the appearance of dollar strength pushing gold lower, particularly at times of massive euro capital flight.

Importantly, much of this negative activity has taken place in gold derivative markets - but, all the while, long-term physical demand has remained fairly robust.

Buying from the Asian gold-market giants - China and India - for both jewelry and investment has continued to remain firm in spite of higher prices that years ago might have discouraged continued accumulation.

Having just returned from two weeks in China and meetings with many players in the country's gold market, I can tell you that gold demand remains strong despite the recent slowdown in economic activity, thanks to personal income growth albeit at a slower pass, rising wealth among those most likely to buy gold, and also inflation fears.  Moreover, higher gold prices, rather than discouraging demand, have attracted new investors to the market.

Meanwhile, global net central bank gold buying has not just continued but has accelerated as reserve managers look for opportunities to shed U.S. dollars - and euros too - in favor of something that has a longer track record as a reliable store of value.

Central bank reserve managers, ever sensitive to buying without disrupting the market, have used episodes of price weakness to step up their buying.  This behavior now reduces downside risk while it is also helping set the stage for a surprising sizable snap-back in the metal's price.

What few gold pundits realize is that the amount of physical gold available in the world gold market - the "free float" - is shrinking, thanks not only to Chinese and other Asian buyers, many of whom are unlikely to sell, but also due to renewed interest and accumulation of gold by a growing number of central banks.  For central banks, the holding period may be measured in decades if not longer.  As a consequence, future demand will have a much more high-powered affect on the price of gold - and this is one of the reasons we expect much higher prices in the years ahead.

Short-term trading in derivative markets may, at times, produce a great deal of gold-price volatility - and can trigger significant price corrections - but, in my book, it does not affect the long-term price trend.  What governs the price of gold over the long term are the market's real-world supply and demand fundamentals - and these have been decidedly bullish and are becoming even more so.  Hence, my long-standing long-term forecast of higher gold prices over the next several years.

Jeffrey Nichols, Managing Director of American Precious Metals Advisors, has been a leading gold and precious metals economist for over 25 years. He is also Senior economic Advisor to Rosland Capital.  See www.nicholsongold.com

LBMA Forecasters See Gold Reaching $2,055 This Year

The London Bullion Market Association published the results of its Forecast on Monday, the firm’s annual survey on the direction of precious metals prices for the coming year.  The large majority of respondents – comprised of analysts and strategists from investment banks and other financial firms across the globe – predicted that gold will rise for a 12th consecutive year on its way to further new all-time highs.

The average maximum gold price estimate among the 26 respondents came in at $2,055 per ounce, a 6.9% increase over the yellow metal’s $1,923 record high in 2011.  In addition, the highest individual estimate came from UBS’s Edel Tully – last year’s most accurate gold price forecaster – who predicted that gold will reach a high of $2,500 per ounce in 2012.

The average of the mean gold estimates was $1,766 per ounce, 12.3% above the $1,572 average price in 2011.

While the analysts were quite bullish on gold in the year ahead, they were considerably less constructive on other precious metals.  The average estimate for silver in 2012 came in at $33.98 per ounce, 3.2% below 2011′s average of $35.11 per ounce.  Platinum’s 2012 average estimate was $1,624, 5.6% below 2011′s average of $1,720 per ounce. Lastly, palladium’s 2012 average estimate of $735.52 per ounce was just 0.3% above 2011′s average of $733.63 per ounce.

The numerical results of the LBMA Forecast are available at the web address below:

http://www.lbma.org.uk/assets/LBMA%20Press%20Release%202012%20Forecast%2020120106.pdf

The LBMA also noted that “The full survey, including specially written commentaries together with analysis of the historical performance of the Forecast, will be published later this month and posted on the LBMA website in mid-January.”

about 2011 summy og gold and selver interest and opportunites for trading

If you're bullish about the long term for gold and silver, it's mouthwatering to watch them undergo a major correction after taking earlier profits that added to your deployable cash. For a little historical perspective on pullbacks, consider the following charts.


The current 15.6% gold decline, while considered a "major" correction, is not out of the ordinary, particularly following the late summer spike. And after each big selloff, there was a price consolidation phase that in every instance led to higher prices. The message: hold on, and buy the big dips.




Not surprisingly, silver's biggest corrections are larger than gold's. This is also true for the rebounds; they've been quite dramatic. If we apply the biggest three-month recovery of 44.3% to the current correction, that would take silver to $40.63… meaning we probably shouldn't expect $60 silver by year-end.
[There's still time to capitalize on the anomaly in the metals market that will bring amazing profits to those who are positioned for it. This report will help you get started… and offers a special bonus, too. Don't delay – the tide could turn very soon.]
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