The Historic Gold and Bond Bull-Market Tango

Under the Gold Standard, or any other metallic standard, the value of money is not really derived from gold. The fact is, that the necessity of redeeming the money they issue in gold, places upon the issuers a discipline which forces them to control the quantity of money in an appropriate manner; I think it is quite as legitimate to say that under a gold standard it is the demand of gold for monetary purposes which determines that value of gold, as the common belief that the value which gold has in other uses determines the value of money. The gold standard is the only method we have yet found to place a discipline on government, and government will behave reasonably only if it is forced to do so--Friedrich A. Hayek 

The Historic Gold and Bond Bull-Market Tango 

Remember my outlook on Gold last February? 

What you are about to see is a defining monumental process in financial history!  

Lo and Behold, Gold’s phenomenal rise against central banking’s Fiat Money standard! 

Aside from all other (fiat) currencies, gold prices broke to record highs this week against the last holdover, the USD.  

Oh, Gold!!!! February 23, 2020  

 

From the US perspective, record USD gold prices have been attained as USTs hit record low yields amidst a flattening curve. Furthermore, gold prices have surged along with a resurgent buildup of global negative-yielding bonds, even as personal savings rate hit record highs.  

There are those who want to excoriate Nobel Laureate Milton Friedman for saying that inflation was everywhere and always a monetary phenomenon. But he also proposed the Permanent Income Hypothesis. The Permanent Income Hypothesis, according to the Wikipedia, supposes that a person's consumption at a point in time is determined not just by their current income but also by their expected income in future years—their "permanent income". In its simplest form, the hypothesis states that changes in permanent income, rather than changes in temporary income, are what drive the changes in a consumer's consumption patterns. Its predictions of consumption smoothing, where people spread out transitory changes in income over time, depart from the traditional Keynesian emphasis on the marginal propensity to consume. It has had a profound effect on the study of consumer behavior, and provides an explanation for some of the failures of Keynesian demand management techniques. 

Though the monetary mechanism is necessary for inflation to occur, it is insufficient. Other real factors are material to its existence. 

The surge in personal savings appears to reinforce Friedman’s PIH theory.   

The deflationary impact of a recession must be remedied by an increase in savings.  

Wrote the dean of the Austrian school Murray N. Rothbard*,  

Furthermore, deflation will hasten adjustment in yet another way: for the accounting error of inflation is here reversed, and businessmen will think their losses are more, and profits less, than they really are. Hence, they will save more than they would have with correct accounting, and the increased saving will speed adjustment by supplying some of the needed deficiency of savings. 

*C. Secondary Developments of the Business Cycle; Man, Economy, and State, with Power and Market 

Even in the Philippines, the same process is in motion. This excerpt showcases how businesses are likely to react to the disruptions caused by work stoppage policies to contain the virus. 

From Philstar (August 2): Enterprises hit by the pandemic may have to pause operations temporarily once their cash flow turns negative and consider other opportunities in agriculture and digital space, Presidential Adviser on Entrepreneurship and Go Negosyo founder Joey Concepcion said. “My advice to many of our MSMEs (micro, small and medium enterprises) and I always share this with them: You have to have a plan. You have to remain cash flow positive and if you turn cash flow negative, at a certain point in time, don’t wait until it depletes your entire working capital or even your family’s savings.” “Close the business for the time being because it’s not going to be worth wasting all your family’s savings and it will create more problems for you. That’s my advice to many of our entrepreneurs,” he said in an interview on the The Chiefs aired on One News.” This counsel goes against the mainstream ivory tower based ludicrous prescription that one should take advantage of low rates and borrow to spend. 

Furthermore, based on the analysis of sectoral balances, fiscal deficit equates to net private saving or private sector surplus. So the financing of the US record deficit would translate to massive increases in domestic and or foreign private savings. 

That buildup of savings appears to be consistent with the recent spike in deficits. 

However, the US isn’t the only nation experiencing unprecedented deficits. Most of the world have ramped up public spending such that McKinsey and the IMF expect the global deficit to reach a historic $11 trillion in 2020! That’s about 12% of the $90 trillion global GDP. 

So if sopping up of savings wouldn’t be sufficient, global central banks are likely to be filling in the vacuum through debt monetization. Global debt hit a record of $258 trillion or 331% of the Global GDP in the 1Q. But debt issuance picked up speed in the 2Q, according to the Reuters, "Overall gross debt issuance hit an “eye-watering” record of $12.5 trillion in the second quarter, compared with a quarterly average of $5.5 trillion in 2019, the IIF said. It noted that 60% of those issues came from governments". 

Nevertheless, the current amount of money printing may be inadequate to offset structural deflationary forces embedded in the system, such as excessive debt, overcapacity in several significant sectors, and zombie financing, as well as, recent policies used to constrict the spread of the pandemic.   

For instance, even after the $2.2 trillion bailout package called the Cares Act and the $3 trillion expansion of the Federal Reserve’s assets, the US GDP suffered a 9.5% YoY (32.9% quarter annualized)! But their stock markets rocketed instead. 

For a broader purview of the economic damage caused by recent policies to contain Covid-19:  Singapore suffered a 41.2% contraction quarter on quarter and 12.6% year on year. Hong Kong shrank by 9% YoY. The Euro-zone area declined by 12.1% YoY while the US suffered a 9.5% YoY (32.9% quarter annualized) even after the $2.2 trillion Cares Act and the $3 trillion expansion of the Federal Reserve’s assets. China escaped a recession by posting a positive 3.2%. 

As an aside, the Philippines will be reporting its 2Q GDP on August 6th. Based on the PSA’s data on Gross Regional Domestic Product, the NCR and CALABARZON area contributes about 52% of the total statistical economy (2018).  Along with the rest of Luzon, during the ECQ or MECQ period, economic activities were mostly suspended within these areas.  And strict quarantine policies were also implemented in parts of Visaya and the Mindanao region.  If only 30% of the capacity of the CALABARZON and NCR had been in operations in 2Q, not counting other parts of the nation, how much loss of output will these translate to?    

Lastly, inflation is not set on the stone by Federal Reserve asset purchases or QE as exhibited by the immediate post World War II era. Though monetary actions matter, again, many other factors will determine inflation’s appearance.   

 

As the Eurodollar wiz Alhambra Partner’s Jeffrey Snider wrote of the Fed’s inflationary panic episodes post-World War II:  

Like the 1947-48 bond buying episode (the Fed’s inflation panic), we’re supposed to believe that the central bank played the pivotal role in keeping the financial situation orderly, trading off that priority by risking an inflationary breakout. Bullshit. That’s the myth that has been conjured, hardly in keeping with the reality of the situation. 

Sure, the Fed monetized the bills during WWII, but so what? The depressionary conditions rampant throughout the markets and economy led the private system to easily monetize everything else, the vast majority. Even the Fed’s inflation panic in bond buying was a tiny drop in the bucket. 

Yields said so. 

Furthermore, record money supply’s transmission into street inflation represents a time-consuming complex process that will have to confront opposing forces that may offset its impact. And there will be action-reaction feedback loops that contribute to the process.   For instance, if money creation adds to the money supply, debt defaults subtract to it. 

That is, should global central banks succeed in the re-combusting of inflation, this would only happen when inflationary monetary forces overwhelm deflationary structures, which would take time. 

As I concluded last February, 

Whether street inflation surges or not, in reaction to the massive supply-side disruptions from a crucible of real adverse forces in the face of central bank actions, the escalating uncharted experiments on monetary inflation have pointed to the magnification of uncertainty on a global scale. 

The bottom line: Gold's uprising against central banking fiat currencies warn that the world is in the transition of entering the eye of the financial-economic hurricane! 

Video: Milton Friedman: Only Government Create Inflation

In this video, the illustrious Nobel laureate the late Milton Friedman eloquently explains that what we hear from media and politicians are inaccurate and misleading. (source Liberty Pen)

(1:37) Any other attribution to growth in inflation is wrong. Consumers don’t produce it. Producers don’t produce it. Trade unions don’t produce it. Foreign sheiks don’t produce it. Oil imports don’t produce it. What produces it is too much government spending and too much creation of money and nothing else.

Risk OFF Environment: Surging US Dollar

The Bloomberg reports

The dollar is proving scarce, even after the Federal Reserve flooded the financial system with an extra $2.3 trillion, as the amount of the highest-quality assets available worldwide shrinks.

From last year’s low on July 27, the greenback has risen against all 16 of its major peers. Intercontinental Exchange Inc.’s Dollar Index surged 12 percent, higher now than when the Fed began creating dollars to buy bonds under its extraordinary stimulus measures at the end of 2008.

International investors and financial institutions that are required to own only the highest quality assets to meet investment guidelines or new regulations are finding fewer options beyond dollar-denominated assets. The U.S. is one of only five major economies with credit-default swaps on their debt trading at less than 100 basis points, meaning they are viewed as almost risk free. A year ago, eight Group-of-10 nations fit that category, data compiled by Bloomberg show.

“The pool of high-rated assets has been shrinking, not just in the euro zone but elsewhere as well,” Ian Stannard, Morgan Stanley’s head of Europe currency strategy, said in a May 22 telephone interview. “With the core of Europe shrinking, and the available assets for reserve purposes shrinking, it makes the euro zone less attractive.”

In a world where debt has been the elephant in the room, especially for major economies then it would be obvious that once there will be pressure on the claims to debts then this would mean an increased demand for the US dollar. This is because debts have been denominated in fiat currencies mostly on the US dollar. Some people may have forgotten that the world still operates on a US dollar standard.

For instance, intra-region bank run in the Eurozone will likely extrapolate to higher demand for the ex-euro currencies, mainly the US dollar

From Kyle Bass/Business Insider

This means that anxieties over a shrinking pool of “high-rated assets” has also been misguided, because much of these so-called high-rated assets revolve around the problems which we are seeing today: DEBT!!!

In short, what has been discerned by the mainstream as risk-free or safe assets epitomizes nothing short of a grand myth, founded on the belief that government edicts can defeat or are superior to the laws of economics.

Yet the US dollar has not been immune to debt, except that current instances reveal that the locus of market distresses have mainly been from ex-US dollar assets or economies, particularly the EU and China.

And since current predicament has been about debt deleveraging where central bankers have been fire fighting these with intensive money printing, then the pendulum of volatility swings from either asset deflation to asset inflation—or the boom bust cycles.

As one would note, gold has mostly moved in the opposite direction of the US dollar index. The euro has the largest weighting (about 58%) in the US dollar basket.

This simply debunks the flawed idea that gold is a deflation hedge under a paper currency system.

And as Professor Lawrence H. White aptly points out on an essay over monetary reforms,

We should not expect a spontaneous mass switchover to gold, or to Swiss francs, as long as dollar inflation remains low. The dollar has an incumbency advantage due to the network property of a monetary standard. The greater the number of people who are plugged into the dollar network, ready to buy or sell using dollars, the more useful using dollars is to you.

Where the US dollar continues to surge amidst staggering gold prices, then this only means central banking actions have been momentarily overwhelmed by apprehensions over debt mostly via political stalemates, whether in the EU or in China.

Yet we should not discount that central bankers to likely step on the inflation gas to save the current political institutions based on welfare-warfare state, central banking and the political clients—the banking sector.

Prices of commodities will now serve as crucial indicators as to the conditions of monetary inflation-debt deflation tug of war.

The Risk ON Risk OFF conditions may not last, we may morph into a stagflationary landscape.

QE 3.0: How Does Ben Bernanke Define Change?

News reports say that Federal Reserve Chairman Ben Bernanke is considering the next round of quantitative easing.

From the Bloomberg,

Federal Reserve Chairman Ben S. Bernanke said the economy is barely expanding at a sustainable pace and that it’s possible the Fed may expand bond purchases beyond the $600 billion announced last month to spur growth.

This is really no news for us.

Nevertheless the following looks like the kicker…

From the same article, (bold emphasis mine)

The Fed’s policy of purchasing Treasury securities shouldn’t be considered simply printing money, Bernanke said.

“The amount of currency in circulation is not changing,” he said. “The money supply is not changing in any significant way. What we’re doing is lowering interest rates by buying Treasury securities.”

Let me repeat: The amount of currency is NOT changing (chart above and below from St. Louis Federal Reserve)

Also, the money supply is not changing in a significant way.

Given the above graphs, the question that intuitively pops into my mind is how does Mr. Bernanke quantify change?

Like this?

That’s “change” in terms of the exponential growth in currency during the Germany’s Weimar Hyperinflation (chart from nowandfutures.com).

And above is the chart of how the hyperinflation unfolded.

For bureaucrats, change seems like an abstraction. (this applies to politicians as well).

Ireland’s Financial Crisis Equals The Euro End Game?

There have been many commentaries suggesting that the Irish financial crisis represents as the Euro Endgame.

Well, not so fast.

This from Bloomberg, (bold emphasis mine)

Ireland’s banks will get as much as 35 billion euros ($46 billion) of aid while senior bondholders will escape the cost of the bailout led by the European Union and International Monetary Fund, the government said.

Banks will get an immediate 8 billion euros to bolster capital, and will raise a further 2 billion euros by shedding assets, the central bank said in a statement yesterday. Lenders will be able to draw on a further 25 billion euros depending on how they fare in a round of stress tests in the first half of next year, the government said in a statement…

The banks are getting the money after rising loan losses and shrinking deposits forced the government to seek the rescue. The state pledged to back all deposits in Irish banks two years ago, requiring the government to inject 33 billion euros into the lenders. The estimated cost of rescuing the banks rose to as much as 50 billion euros in September after losses from the collapse of the country’s decade-long real estate boom jumped, fueling concern Ireland couldn’t fund a rescue itself.

Ireland will in total receive 67.5 billion euros from the EU and IMF, Prime Minister Brian Cowen told reporters in Dublin yesterday after EU finance ministers backed the plan at a meeting in Brussels. The country will pay average interest of about 5.8 percent. The government will meet about half the cost of the 35 billion-euro banking bailout from its own resources, including the National Pension Reserve Fund, Cowen said.

Lenders will use the money to boost their core capital ratios, which gauge financial strength, to at least 12 percent. Bank of Ireland Plc and Allied Irish Banks Plc, the country’s two biggest lenders, will also be able to transfer all their remaining “vulnerable” commercial real estate loans to the National Asset Management Agency, the so-called bad bank set up to take over lenders’ riskiest loans, by the end of March.

As we earlier said, one of the primary role of central banks is to finance government directly or indirectly. And such redistribution process means ‘rescuing’ political privileged interest groups. Apparently this has been the case with Ireland.

Alternatively this means much of the bailouts will be coursed through stealth monetary inflation. Yes, this means you won’t read them on the papers.

To say that the Euro would disintegrate because of the populist upheaval predicated on ‘lack of aggregate demand’ or the rejection of the proposed reduction in social spending programs is pure hooey. While part of the adjustments (reductions) will reflect on the fiscal side, the offsetting (expansionary) part will be the support for the banking system which benefits from such bailouts.

And we should expect to see more of this.

Central banks will use to its hilt their ‘magic wand’. The power to control money signifies an immense privilege, political and economic. It’s not a privilege that would be easily sacrificed by the bureaucracy.

Nonetheless the degree of monetary inflation will always be relative.

Besides, throughout history people flee their currency not because of fiscal austerity or discipline or bankruptcy, but because of rampant debasement or from war.

Russia’s Putin even suggests that Russia may join the Eurozone.

This from the Bloomberg

Russian Prime Minister Vladimir Putin said Friday he was confident in the euro despite Europe's debt crisis and said his country might even join the currency block itself one day.

Putin also sharply criticized the dollar's dominance as a world reserve currency.

Despite the problems in some heavily indebted eurozone countries, the euro has proven itself "a stable world currency," Putin said.

"We have to get away from the overwhelming dollar monopoly. It makes the world economy vulnerable," he told a gathering of business leaders in Berlin through a translator.

In short, like earlier said, Euro bears will be proven wrong again.

And as we earlier wrote, hardline stance by policymakers will crumble in the face of market pressures. Again current developments appear to be validating my view.

This from Bloomberg,

European finance leaders backed a Franco-German compromise on post-2013 sovereign bailouts that waters down calls by German Chancellor Angela Merkal for investors to assume losses and share the costs with taxpayers.

The paper money system is fundamentally deeply flawed. But one system is more flawed than the other. Eventually, like in all historical accounts, the whole system collapses and reverts to the commodity system or a replica of it.

This time won’t be different.