SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE BEAT GOES ON !!

The general equity markets were up modestly in April. Gold bullion was down a fraction of 1%. The miners, which had outperformed gold bullion in the first quarter gave back their gain. For the year to date both gold bullion and the gold mining stocks are essentially flat. Considering that the US Dollar is at a high and the general equity market has been strong, that is reasonably good performance for a non-correlated asset class.  Fundamentally: nothing has changed regarding the long term fiscal/monetary trends. In fact, the prospect for a major move in gold bullion and an even larger move in the gold mining stocks has only improved. The longer the fundamental factors that we present prevail,  the larger the price move in gold bullion and the mining stocks will be.

 Over the last month, the following bullet points come to mind:

• Ten years after the sub-prime bubble of ’08-09, new financial excesses have arisen, including a private equity mania (Lyft, Uber,  Wework, etc.), a subprime auto bubble, a student loan bubble, a sovereign debt bubble among emerging economies, a “levered loan” bubble.
• Central Banks continue to buy record amounts of gold bullion. They understand that the paper currencies are being diluted and are increasingly aggressive in diversifying their foreign exchange reserves away from US Dollar. China and Russia, increasingly considered our adversaries, are the most prominent gold bullion buyers. In India, where the public traditionally accumulates gold, the central bank has again become a substantial buyer, increasing their holdings by 50 tons (the total by over 10%) in just the last 15 months.
• Debt creation as a GDP stimulant is increasingly impotent. As calculated by highly regarded economist, David Rosenberg, since 2007 “global debt has ballooned by $140 trillion while global GDP has risen by only $20 trillion. The “bang for the debt buck” is clearly diminished, and that will only get worse over time.
• The highly touted 3.2% growth in US real GDP was largely dependent on non-recurring factors. Inventory build, government spending, and lower imports together contributed 2/3 of the total. The 3.2% number was also calculated based on only 0.8% annualized inflation, and that assumption is questionable. One thing we can count on, however,  is that economic performance in the US will continue to be presented in the most favorable possible  light between now and November, 2020.
• Following on the previous point, just this morning Steven Mnuchin, Sec’y Treasury, pointed out that the US debt limit, which has already been exceeded, will have to be raised within six months, because our financial flexibility will have been utilized. $22 trillion is comfortably in the rear view window, and $23 trillion is months away.

The following discussion is a bit “technical” in nature, but we feel is crucial in terms of long term expectations for financial markets.

CENTRAL BANKS BUY STOCKS AND BONDS – A RECIPE FOR LONG TERM DISASTER !! – A LESSON IN “MARKET MAKING”

It’s been a number of years since we had an active market in the US for initial public offerings. Decades, and a number of stock market cycles ago, this then young analyst watched quite a few small companies come public, in many cases underwritten by brokers much smaller than the surviving investment bankers of today. Some of those underwriting firms, well intentioned to be sure, supported the brand new issue with a supporting bid, figuring it was just a question of time before the market figured out that the stock was attractive, the supporting bid could be removed, the stock would be freely trading and move up, the public customers would be happy, and the broker might even make a profit when selling their acquired inventory. Other underwriters, not so committed to supporting the new issue price, allowed the stock to trade freely immediately, tolerating the higher volatility, and allowing the free market to establish (“discover”) the price, for better or worse.

The interesting aspect of these two approaches was as follows: The firms that intervened in the marketplace in many cases finally choked on the inventory, their capital was not sufficient to buy the stock forever, and they ultimately went out of business. The more prudent underwriters that allowed for “price discovery” (as the PHDs would put it) by the normal supply and demand of the marketplace lived to play another day.

This small scale example applies to the trading habits of worldwide central banks today. As the US government builds its debt over $22 trillion, which is more than 100% of our GDP, lots of observers say it is no big deal since Japan, for example, has government debt at 250% of their GDP. The Japanese economy is still functioning, with slow growth to be sure, but there is no evident crisis. This reminds me of the cartoon where the guy jumps off the cliff, and, while in the air, calls out: “I feel fine !!”

There are over $10 trillion of government securities trading with less than a zero percent yield. This is as a result of the US, ECB, Japanese and Chinese central banks buying stocks and bonds, supporting the price of stocks and bonds, and suppressing fixed income yields. In this absence of true price discovery by the marketplace, fixed income savers have been penalized, to the benefit of stock and bond holders, creating a wealth effect for the latter. This good fortune on paper could (and will) be temporary, but for the moment, just like the guy who jumped off the cliff, we feel fine !!

Where are we in this process ??  In addition to the negatively yielding fixed income government securities, the Bank of Japan (that has been doing this for almost thirty years) now owns about $250 billion of Japanese ETFs, or 75% of that entire market of ETFs. On the fixed income side, the Bank of Japan owns about 45%, or $4.5 trillion worth of all the Japanese government bonds outstanding. With it all, the Japanese economy is still running well below 2% real growth, with inflation at well under the 2% objective. It is of course an important sub-text that central banks worldwide are trying to stimulate inflation, rather than subdue it, which was the original objective.  Closer to home, we have been informed that our Fed is abandoning QT, preparing for a new form of QE, which, some have suggested, could include the purchase of US equities as well as bonds.

Here’s a quick economic lesson for the hundreds of PHDs that are working within central banks, which we guess isn’t part of the new Modern Monetary Theory. Don’t intervene in a market unless you are prepared to BUY IT ALL, because you will, eventually. Witness the holdings of the Bank of Japan, who have been at this game the longest, still without the result they have been reaching for. Aside from a long list of unintended consequences that have yet to play out, the attempt to lighten the inventory, (Sell to whom?) has just been demonstrated in the US. One down month in the stock market (December) with the two year treasury rate approaching 3% and the US Fed caved. Whom do you think the Japanese Central Bank can sell to?

The above described central bank intervention in capital markets will inevitably destroy most international currencies, including the US Dollar, because the money will have to be created to support the capital markets and the presumed wealth effect that will prevent economic collapse and that will be highly inflationary. This is the “bubble” that Donald Trump described when he was campaigning but that he has forgotten about since he is in office. The politicians and central bankers will continue to chase their long term (NEW) goal of creating inflation substantial enough to service long term debt obligations. We described early in the article how the debt increase in increasingly impotent in terms of stimulating GDP growth. The corollary is that the debt, worldwide, is far too large to be paid off in the currencies of today. Substantial inflation is the only politically acceptable remedy, since outright default is too obvious to the voting public.

Roger Lipton