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! 

As Predicted, The Global Recession has Arrived, Will Depression Be Next?

A permanent lowering of the interest rate can only be the outcome of increased capital formation, never the result of any technical banking measures. Attempts to achieve a long-term lowering of interest rates by expanding the circulation credit of the banks ineluctably result in a temporary boom that leads to a crisis and to a depression—Ludwig von Mises

In this issue

As Predicted, The Global Recession has Arrived, Will Depression Be Next?

-The Wile E. Coyete Moment: From China to the World

-We Live in Interesting Times! Negative Oil Prices and Worst US Job Losses Since the Great Depression

-The Unseen Consequences from the Uncharted Global Fiscal and Monetary Bailout! Depression Ahead?

-The Bernanke Doctrine in Motion!

As Predicted, The Global Recession has Arrived, Will Depression Be Next?

The Wile E. Coyete Moment: From China to the World

When about 760 million or 50% of China’s population had been immobilized and placed under home quarantine by their government in response to the COVID-19 epidemic, I predicted that this would spur a global recession.

Back then*, I called this China’s Wile E. Coyote moment.

*Batten Down the Hatches! Global Recession Ahead: The New Coronavirus Pushes China’s Economy to a Freefall! February 16, 2020.

Figure 1

In the fulfillment of this watershed moment, last mid-April, China’s first-quarter GDP reported a 6.8% contraction, its first in a few decades!

And considering that the lockdown, which began on the 23rd January in Wuhan, Hubei which spread to over 80 cities in nearly 20 provinces and municipalities that lasted mostly through March, many analysts have come to dispute the reported GDP’s accuracy. The Wuhan lockdown was lifted on April 8th.

Nevertheless, the record economic contraction has prompted the Chinese government to rethink about setting up GDP targets for 2020. According to a report from the Bloomberg/Economic Times, “China’s leaders are considering the option of not setting a numerical target for economic growth this year given the uncertainty caused by the global coronavirus pandemic, according to people familiar with the matter.” Is this a facing saving measure for an embattled ruling class, the CCP?

In the meantime, the rapid transmission of COVID-19 across the globe has eventually prompted the World Health Organization (WHO) to admit on March 11 that this was a pandemic, more than a month after declaring a public health emergency on January 30. Given the speed of transmission, why did it take so long for them to consider?

The pandemic character has been so obvious that even this layman** can distinguish!

**The Coronavirus Pandemic: Who is Panicking? More From the Year of the Rat: Will History Rhyme? February 2, 2020

To “flatten the curve” by social or physical distancing, many countries embraced the authoritarian approach of epidemic containment by forcibly shutting down significant segments of or the entire country, although at varying degrees.

By early April, about 3.9 billion people or half of the world’s population were under home quarantine (house arrests?)!

Figure 2

Hence, the Wile E. Coyote moment wasn’t limited to China; it became a worldwide phenomenon!

As such, in the 1Q, the Eurozone’s GDP shrank 3.8%, its fastest rate on record, while the US GDP reported a 4.8% decrease, its steepest contraction since 2008!

Bloomberg estimates that the Global GDP in April plunged by 4.8%!

But there is more behind the headline numbers.

We Live in Interesting Times! Negative Oil Prices and Worst US Job Losses Since the Great Depression

Things that could not seem to happen—have actually been happening!

And here are just a few of them.

 

Figure 3

With a sharp decline in demand, which came in the face of a dearth of storage space, oil price futures fell to negative in the third week of April! Depressed prices put in peril debt-ridden oil companies and oil-producing nations with untenable welfare systems.

In the US, a record 20.5 million people have lost their jobs last April, sending the unemployment rate to 14.7%, the highest since the Great Depression! Yet, there were 33.5 million people who have filed for unemployment or jobless claims in the last seven weeks!

Minneapolis Federal Reserve Bank President Neel Kashkari in a CNBC interview recently said that though the reported unemployment rate could be as high as 17% — a brutal number, no doubt — but he says the true number may be as high as 24%. “It’s devastating.”

April’s job losses have virtually erased job gains of the last two decades! That’s Nassim Taleb’s Turkey Principle in action!

The US private sector employment-to-population, a measure of the number of people employed against the total working-age population (Investopedia), crashed to a harrowing 51.3% last April, the worst since, again, the Great Depression!

The highest unemployment rate during the Great Depression was 24.99% in 1933, according to the Balance.

Again, that’s only a piecemeal of the overall picture.

And because the great Wile E. Coyote moment has only scratched the surface, governments around the world backed by their respective central banks launched a series of unprecedented measures to bailout both their financial systems and the economies.

The Unseen Consequences from the Uncharted Global Fiscal and Monetary Bailout! Depression Ahead?

Figure 4

Governments around the world have collectively unleashed at least USD 8 trillion worth of subsidies to cushion the impact from the economic shutdown caused by both COVID-19 and the political response to contain its spread. Bank of America’s Michael Hartnett estimates that fiscal spending support has reached $16.4 trillion, about 19% of the 2019’s USD 86 trillion Global GDP!

With depressed economies, spending at this scale translates to massive fiscal deficits, which will require extraordinary amounts of borrowings and or support from the central banks.

And as a result, in 2020, 107 rate cuts have been imposed by about 78 central banks as of May 8th.

And to ensure liquidity, global central banks have engaged in balance sheet expansion by financing their respective governments through asset purchases.

Since surging fiscal deficits signify a global phenomenon, debts and central bank assets have exploded.

Despite the Trump government’s unleashing an accrued $2.4 trillion of spending support for the main street, backed by about $ 2.41 trillion of asset purchases by the US Federal Reserve, which has been faster than the Great Recession or the Financial Crisis (GFC) of 2007 to 2008, the yield of US 2-year Treasury note dropped to a RECORD low, while Fed Fund rate futures turned NEGATIVE before bouncing above zero late last week! The Fed’s balance sheet has soared to a milestone USD 6.712 trillion and has been expected to rocket to $10 trillion by early next year!

The details of the USD 2.4 trillion spending stimulus and the various support programs bankrolled by the US Federal Government can be found here and here.

And rumors of the second phase of support from the Federal Government have been afloat due to the recent job numbers.

Yet the carrying costs of the subsidies from the Great Recession or Financial Crisis of 2007-2008 has been immense. It lowered the trajectory of the rate of economic growth, increased dependency towards leveraging or debt for financing, redirected financial activities from the economy towards debt financed asset speculation, thereby, fueling asset market bubbles, nurtured the rise of zombie firms and industries, which siphoned resources that contributed to maladjustments that decreased economic productivity, promoted the widening of inequality, and entrenched economic structural imbalances, where central bank emergency policies became the norm that ultimately increased systemic global financial and economic fragility. 

Thus, COVID-19 fundamentally exposed such embedded vulnerabilities!

And here is the thing, the US signified the epicenter of the Great Recession or Financial Crisis of 2007 to 2008 (GFC) that spread to the world.  Hence, using domestic policies and international cooperation, much of the world was able to erect defenses against the contamination.

But this time is different.

In 2020, the IMF expects about 170 nations or 90% of its 189 members to register negative per capita income growth! Over 100 countries have approached the IMF for emergency financing. Though the IMF brags that it has USD 1 trillion in lending capacity, the irony is, some of the sources of financing may be from countries that are presently in need of it!

While access to bridge financing for countries undergoing economic stress had been made available from bilateral or multilateral sources during the GFC, that’s unlikely the case today.

Moreover, today's bailouts will be like funding deadbeats, where a financial blackhole exists to continually drain resources. For instance, Argentina received a rescue package from the worth $57 billion in 2018, the biggest loan from the IMF ever. Today, or less than two years from the rescue, Argentina is on the brink of its ninth default!

Furthermore, while it took over 10-years to expose the embedded costs from bailout policies of the GFC, the imbalances built from the present simultaneous fiscal and monetary support will extrapolate to the acceleration of capital consumption.

Besides, the economic shutdown has seriously impaired the availability of capital and capital goods in the global economy!

Yet to surface and be accounted for are the second-, third- and nth order from the current ambit of socio-economic and political events, which means, the current crisis is at its incipient phase!

A prolonged recession could morph into a Depression!

The Bernanke Doctrine in Motion!

Figure 5

And imbalances?

Since the GFC, US Federal Reserve policies have greatly influenced the direction of the US stock market. In a single month, the Fed’s USD 2.4 trillion asset expansion has encapsulated such rescues!

The financial markets have been 'totally' detached from the economy, the Mainstreet, or from “fundamentals”.

Mr. Ben Bernanke penned the below, even as a professor in 2000, or before to his entry to the US central bank. He would eventually assume the highest post as Fed Reserve Chairman from 2006 to 2014:

There’s no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the U.S. economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat. History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.

Central bank policies today continue to hallmark the Bernanke Doctrine and throw gasoline to the fire!

And because of this, millions of people have been hurt, and more are to suffer. This policy-induced pain represents its consequence, a somber reality of the business cycle.