SEMI-MONTHLY FISCAL/MONETARY UPDATE – IGNORE HISTORY AT YOUR OWN PERIL
The general market was up modestly in March while gold and the gold mining stocks were down modestly. For the year to date, in the first quarter, the gold mining stocks were up about 5-6%, fairly good considering the gold bullion was only up 0.6%, also considering that the general market and the US Dollar were strong, both of which normally track inversely to gold related assets. Monetary conditions are clearly becoming more accommodative, as central banks, worldwide, back off from raising interest rates and reducing balance sheets. The discussion below provides only a portion of the argument why there should soon be a resumption of the long term bull market for precious metal related assets.
IGNORE HISTORY AT YOUR OWN PERIL
John Maynard Keynes had some good ideas back in the 1920s: the Federal Reserve Bank had been formed in 1913, and would manage the economy, control inflation, reduce the frequency and severity of booms and busts, stimulate the economy in hard times, and pull back the accommodation in good times.
Keynes articulated this very well, in 1923: “Markets cannot work properly if the money, which they assume as a stable measuring-rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectations, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer–all proceed in large measure, from the instability of the standard of value”.
Harry Browne, the brilliant economist, and writer, who wrote “You Can Profit from the Coming Devaluation” in 1970 (which I republished in 2012), anticipating the devaluation of the US Dollar when Nixon closed in the gold window in 1971, put it another way. He said that “you can’t have a sound economy without a sound currency”.
Starting with the longer term view, under the management of our Federal Reserve, the 1913 Dollar (when the Fed was formed) has become worth about $.03. (In contrast, an ounce of gold still has roughly the same purchasing power.) More recently, over the last ten years, our Fed (with imitation by the ECB, Japan, and China) has given us several “QE’s”, during which short term interest rates have gone to zero, there is still something like TEN TRILLION of sovereign debt with rates at ZERO or less, and the Fed balance sheet went from $900B to $4.5 TRILLION
After several Quantitative Easings over the last ten years, a little over eighteen months ago the Fed announced that they would raise interest rates to “normalized” levels (presumably upwards of 3% for short rates and above 4% for thirty year paper) and, on an automatic programmed basis, reduce the balance sheet to a more tolerable $2.5 trillion (still almost a triple from where it started in 2008). We predicted that this program wouldn’t go far, because the economy couldn’t tolerate it, and interest rates on (now) $22 Trillion of debt would wreck the US budget. Sure enough: it is now clear that the interest rates will not rise further, and the Fed balance sheet will only shrink perhaps another $200B this year, down to about $3.7 trillion. This latest objective apparently provides comfort that the economy will not be choked off from the “steady” growth: one year, in 2018, at 3.0% (with lower tax rates, repatriation of $800B of dollars overseas, and reduced governmental regulation), projected from this point to be back to the 2.3% range of the Obama administration.
Back to John Maynard Keynes and Harry Browne:
Keynes: “Markets cannot work properly if the money, which they assume as a stable measuring-rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectations, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer–all proceed in large measure, from the instability of the standard of value”.
Browne “you can’t have a sound economy without a sound currency”.
Does any of this sound familiar? These days it’s called a “wealth gap”, and politicians are calling for rich people to “pay their fair share”. Savings haven’t been “lost”, but they are earning next to nothing unless large risk is undertaken.
THE STATED DEFICIT IS THE TIP OF THE ICEBERG
We’ve written extensively that the actual debt is increasing much faster than the “operating” cash flow statement implies. Some uninformed observers have said that this is just a question of short term working capital changes which even out over a number of years. The facts are (1) this phenomenon has happened almost every year. (2) Over the last decade, the increase in debt, above and beyond the total of annual deficits has amounted to a total over THREE TRILLION DOLLARS. That’s $3,000,000,000,000. A lot of zeros. (3) It is a result of “Intragovernmental Borrrowing”, which doesn’t run through the annual operating budget. Specifically, as of 9/30/18, there was about $6 trillion of “Non-Public Borrowing”. 51% of that is from the Social Security Trust Funds. 17% from Military Retirements and Health Care Funds, 16% from Civil Service Retirements and Disability Funds, 6% from Medicare Trust Funds, and 11% from other Trust Funds. So our legislators are hollowing out the various funds that should be safely set aside to meet their intended purposes. Before we leave this subject, it is important to know that certain observers have opined that the US is not really in debt by $22 trillion, it’s only $16 trillion, a much lower percentage of our GDP, not nearly so dangerous. After all, we owe that $6 trillion to “ourselves”, the implication being that it doesn’t have to be honored. Tell that to the social security recipients, military veterans, civil servants and medicare recipients.
We provide below a table showing the most recent monthly deficits and increase in debt. You can see that in the fiscal year ending 9/30/18 the monthly deficits totaled $779B, but the debt increased by $1.27T. We say again: this is not a one year phenomenon. Three trillion, over ten years, has been “borrowed” from various trust funds. This year, through February, the operating deficit was $234B in February, up from $215B a year ago. Cumulatively the deficit for the year through February is $544B, up 39.1%. Relative to the increase in debt, it is up $599B cumulatively, actually decreasing by 2%, but still on track to run something like $1.3T for the year versus an advertised estimated deficit of about $1 trillion.
The last point, on the specific subject of deficits and the possibility of progress: It should be clear to all of us that both political parties are already in full “positioning” mode for the 2020 election. There will be no substantive improvement in the fiscal/monetary position of our country, especially since that would require reductions in entitlements, defense, or interest rate spending, none of which will occur. By the end of fiscal 2020, at 9/30/20, the total debt will be on the order of $24 trillion and growing. The financial, social, and political implications of that reality have yet to play out.
WHERE DO WE GO FROM HERE?
We go to Quantitative Easing again, BUT MUCH LARGER. When an addict is hooked, each hit has to be bigger than the last, to maintain the high. The Fed balance sheet went from $900B to $4.5T, a quintuple, and will only have come down by about 18% to about $3.7T. Never before in the history of the planet has ongoing monetary accommodation (including $1 trillion current deficits) been necessary in the middle of a (relatively) strong economy. In addition to the modest reduction in the Fed balance sheet, short term interest rates, after going slightly negative, have only risen to 2.7% before the Fed said “basta” as the economy threatens to roll over. We can only imagine how much capital will need to be injected by the Fed, and how low or negative interest rates will be taken to counter the next recession.
In conclusion: Don’t believe the economic fiction that we need not fear inflation, from accommodation of the past or from further stimulation, that deficits don’t matter, that the new Modern Monetary Theory (described in today’s Wall Street Journal) will keep things under control. All kinds of assets have already been inflated in price, and that wealth effect has clearly been enunciated as a goal of the Fed. Unfortunately, the benefit has not been spread equally among citizens, and this is a worldwide problem. The saddest part is that the politicians of today, just as in the past, show no inclination to correct the fiscal/monetary policy in a constructive way. The longer this financial party continues, the worse will be the hangover. Nobody knows exactly what the “end game” looks like, but it is probable that gold related securities will be among the very best performing assets.
Roger Lipton