Tag Archives: US Debt

SEMI-MONTHLY FISCAL/MONETARY UPDATE – NOT A QUESTION OF “IF”, JUST “WHEN”

SEMI-MONTHLY FISCAL/MONETARY UPDATE – NOT A QUESTION OF “IF”, JUST “WHEN”

There have been numerous ongoing fundamental developments that support our long held view that a day of reckoning is an inevitable consequence of the unimaginable mountain of debt that has been created by Central Banks, worldwide, over the last forty years. As our readers know , we view gold and the gold mining stocks as one of the best hedges against the prospective financial/political/social upheaval that lies (somewhere) ahead. It’s been said that a bet on gold is a bet against Central Bankers’ colored paper. Central Bank credibility continues to be at stake, and we suggest, in summary, that you can’t get out of a hole by continuing to dig.

Several current developments, which we have not recently discussed, support  our long term strategy.

First, Central Bankers collectively continue to purchase large quantities of gold bullion. purchasing 333.2 tons, an increase of 39% over the 5-year average in the first half, and about 199.9 tons during Q2. The largest purchases were recorded in Germany, Thailand, Hungary and Brazil. We should note that Russia and China, the most obvious political, economic, and military adversaries of the USA, have consistently added to their gold reserves over the last ten years. China updates their gold holdings only sporadically, supposedly owning only about 2,000 tons, but they are the world’s largest miner, about 400 tons annually, and none of it gets out of China.  When pressed as to what event might finally ignite the price of gold, we suggest that China, who has indicated their plans for a digital currency in 2022, will, in one form or another back their currency or their debt with gold bullion. They have encouraged the Chinese public to use gold backed savings accounts and demand for gold jewelry doubled in China in the first half of 2021. Central Banks are voting with their wallets as to whether they prefer fiat paper currencies or gold bullion as the real money over the long haul.

Secondly: The debate continues as to whether all the new money being printed will finally ignite inflation, which (up until the pandemic driven shortages) it hasn’t. Something like $20 trillion has been created by worldwide Central Banks since 2009. However, what happened in the US, for example, is that while the Fed printed money, at the same time they raised the capital and reserve requirements in banks, reducing the “velocity” of the new funds. The Fed bought Treasuries, created money, which wound up in the banks and then was redeposited at the Fed. The money, therefore, never really entered the money supply so wasn’t inflationary. However, in the last twelve months the M-2 money supply was up about 25 per cent last year and could well be the precursor of inflation such as we had in the 1970s (when gold went from $35 to $850/oz.).

You don’t need a PHD in economic. It’s common sense.  What if the Central Banks were to create $100 trillion of new currency, with no increase in available goods and services? Prices would be sure to go up, right? Well, $20 trillion didn’t do it over the last ten years but $100 trillion would. Somewhere between $20T and $100T is “ignition” and we suspect it is closer to the former.

We wrote the above commentary a couple of days ago. This evening we read the September 1st  commentary of James Grant, publisher of Grant’s Interest Rate Observer, and among the world’s most respected monetary historians. While he would be the first to admit that is timing is often in question, his views over the last forty years have been consistently borne out.  We hope he won’t mind if we quote a few sections of the current issue. The underlining is of our choosing.

Grant describes how the suppression of interest rates distorts economic activity, and ends badly:

“Chair Powell last Friday ignored the dollar mountain that figuratively rivals the Grand Tetons. He acknowledged no such thing as the inflation of credit, which leads to the inflation of asset values and thereby promotes overleverage, misdirected investment and financial fragility. He neglected to mention that a zero-percent interest rate in a resurgent economy is one for the monetary record books. And he omitted reference to the thinkers who correctly posit that when the central bank’s policy interest rate is pitched artificially low—e.g., below the expected rate of return on capital—boom and bust surely follow. Everyone living today knows about booms: Credit proliferates, eager financiers swarm venture capitalists, construction cranes ascend and YouTube influencers get their pictures in The Wall Street Journal. But as the boom roars on, the structure of enterprise becomes distorted. Negligible borrowing costs (and the expectation that they will long so remain) bring forth SPACs, NFTs, towering equity valuations, grandiose M&A activity and uninhabited luxury residential towers. The bust starts when credit stops.”

Grant talks about the unprecedented recent growth in the money  supply, with the likelihood that inflation will follow:

“In the two years to May 2021 M-3 broad money rose by 35%, by far the highest number for such a short period since the Second World War. On the basis of the money supply developments, we have argued that the annual rate of U.S. consumer inflation will lie between 5% and 10% until at least the end of 2022. Views are shifting, but our forecast remains far above the prevailing consensus.” Milton Friedman was sometimes wrong, but perhaps now, when his monetary-policy legacy is either forgotten or derided, and when the money-supply data certainly look alarming, he could be a little right.”

Grant describes the unbelievable leverage involved in the Fed’s “business model”, how dangerous it is, and how uncontrolled market forces (i.e. when “bond vigilantes” will say “basta” and require a much higher return to invest in US debt) will eventually end the party:

“Systemwide, the Fed shows assets of $8.33 trillion versus capital of $39.8 billion, for a leverage ratio of 209:1. If the average conscientious Federal Reserve bank examiner encountered such a balance sheet as this one, he or she might dial 911. However, the New York Fed, with assets of $4.156 trillion and capital of $13.3 billion, exhibits a leverage ratio of 311.6:1. For perspective, on June 30, JPMorgan Chase showed a ratio of assets to stockholders’ equity of 12.9:1. What makes the New York Fed so confident that it can manage a balance sheet almost nine times more distended than the one that almost took down Morgan Stanley in 2008? Footnote 15 on page 7 of form H.4.1—the weekly Federal Reserve balance sheet emission— dated Jan. 6, 2011, has the answer. It discloses that future losses at the central bank will be treated as a negative journal entry to the Treasury rather than a reduction in the Fed’s capital and surplus account. In the ordinary course of business, the Fed remits its operating income to the Treasury—the New York Fed, just this past week, journaled $728 million over to Janet Yellen. In case of a substantial loss, for example, an inflation-induced markdown to bond prices, the central bank would effectively draw a government loan. Fearless in the face of its extreme leverage, the Fed is a kind of financial free agent. It formally answers to Congress and may one day soon have to answer to Mr. Market.”

Back to a conclusion, our way:

Just as Grant described, huge distortions in financial markets are taking place. Around the world, $15.9 trillion’s worth of bonds are priced to yield less than zero, though not in the US (yet). An illustrative example of this absurdity is that the Greek government zeros of 2026, for example, are priced to yield negative 0.08% versus the positive 0.77%  from five-year Treasuries and that is why US Treasuries, surely safer than Greek debt, are a relative bargain. This is the definition of “the best house in a terrible neighborhood”. Another description goes “a race to the bottom”.

Step back for a moment. The US Treasury needs more capital to finance the $3-4 trillion annual deficit, so sells bonds to the Fed, which prints it out of thin air and lends it to the US government at a minimal interest rate. There is no limit to how much currency can be created so there is no limit to how much money the US politicians can piss away. The interest (even at the low rate) earned by the Fed is periodically rebated (after the Fed’s billions of administrative overhead) back to the US government, reducing the deficit just a little from what it would have been. The interest on the debt has therefore been recycled (after paying the salaries of hundreds of economic PHDs and thousands in staff) and the principal borrowed (forgetting about the wasteful spending) doesn’t ever need to be repaid, except by newly created Fed currency. This is how the Fed’s balance sheet has gone from $1T ten years ago to over $8T today and the annual US deficit, which was $100B in 1980 is $3-4T today.

Does this “scheme” seem sustainable to you? Well, sort of, except that a 1913 dollar is worth $.02, and a $1971 dollar is worth about $0.15. In the history of the planet, there has never been an unbacked “fiat” currency that has survived. It is just a question of how long it will take the politicians of the day to destroy it and nobody would suggest that today’s politicians are any different. An important caveat, however, is that a deflationary bust could interrupt the inflationary party, ala’ the deflationary 1930s, before a new monetary system (with at least some temporary restrictions) takes shape. This brings us back to gold related assets, that have proven over the centuries to protect purchasing power in both inflationary and deflationary times.

Roger Lipton

ROGER’S “FOLLOW THE MONEY” APRIL ARTICLE – in the prestigious RESTAURANT FINANCE MONITOR

ROGER’S “FOLLOW THE MONEY” – APRIL ISSUE, RESTAURANT FINANCE MONITOR

Inflation is Coming and My Thoughts on Franchising

By Roger Lipton

INFLATION IS COMING

The U.S. Federal Reserve Bank was formed in 1913 to control inflation and manage the economy so as to avoid severe economic cycles. It has clearly failed in terms of controlling inflation, since a 1913 U.S. Dollar is worth about $.02 today.  More recently, since the U.S. went off the gold exchange standard in 1971, the Dollar has declined by about 85%. In terms of controlling business cycles, the U.S. has ad: the Roaring Twenties, the Great Depression in the 1930s, World War II, which had to be financed with debt in the ‘40s, inflation running to 12% and the Fed Funds Rate at 18% in the ‘70s, the dotcom bubble and burst of 1999 to 2001, the financial crisis of 2008-09, and the monstrous debt buildup and suppressed interest rates over the last 10 years.

More “money” has been created by the Fed in the last 18 months (adjusted for inflation) than was needed to pay for five years of World War II, and the debt as a percentage of GDP is above where it was in 1945. The M2 money supply in the US has increased by 24% over the last 12 months, the highest within recorded data over 150 years, and 27% most recently.

Fed Chairman, Jerome Powell, says there is a need to raise interest rates and reduce the Fed balance sheet, but adds “There will be a time, but not now.” However, the US debt has increased every year since 1957. There was a budget “surplus” in the last three years under President Clinton and the first year under President George W. Bush, amounting to just under $800 billion over four years, but the debt still increased each year due to “off-budget” items. (Only in D.C. can this happen.) Powell has reiterated the Fed’s objective to generate inflation of 2%+, indicating potential rampant inflation can be controlled, but the current financial experiment is unprecedented in time and magnitude. Our bet is that inflation is coming, higher than the Fed expects and it will be difficult to get the genie back in the bottle. Manage your business accordingly.

THE TIMES THEY ARE ‘A CHANGIN’ IN THE FRANCHISE  WORLD

We wrote here last month that almost all of the mature publicly held franchising restaurant chains are hardly growing their U.S. units. We pointed out that, for a number of reasons, the unit level economics are just not attractive enough for franchisees to encourage unit expansion. Needless to say, higher sales would be transformational. The less obvious, and potentially contentious “adjustment” that could help a great deal is a revision of the franchise structure.

When Ray Kroc started franchising McDonald’s more than 60 years ago, the royalty rate was 1.9% By the 1960s, franchisors had started charging 2%-3%, by the 1970s 3%-4%, and 5% seems to be the standard today, plus at least 2% for advertising and other fees.

Some franchisees, at chains such as Dunkin’, Burger King and Jack in the Box are still making decent returns at  the store level because the store leases were signed 10 or 15 years ago and occupancy expenses are lower  than today’s economics would allow. While single unit franchisees who personally manage their stores can still make a living, a multi-unit owner, who  is the best prospect for unit expansion, paying a non-family store manager, is typically fortunate to be making 17-18% store level EBITDA, of which depreciation is not free cash  flow in the long run. Subsequently, rebating 7 points or more out of 17 or 18 points starts to feel like a pretty big load, and there is still local G&A to be carried. Even if store level EBITDA, before royalties, is in the low 20s, rebating over 7 points is a heavy price to pay. Considering the changing economics over the last two to three decades, there are no material operating expenses that are lower as a percentage of sales, certainly not occupancy or labor, and food costs are unpredictable commodities. The biggest single negative trend that nobody would debate is the intensive competition that has become commonplace.

The time has come for lower fees, especially ongoing royalties. We understand that this suggestion will be resisted by existing large chains, most especially those publicly held, because it would be an obvious reduction of the current royalty stream. However, well established franchisors could, and should, absorb more of the additional systemwide needs, such as technology upgrades. “Mid-cap” franchising companies could put some part of the following suggestions in place.

If I were running an early stage franchise company, I would put in place a sliding scale royalty system, charging 2.5-3.0% at a modest sales level, higher if the franchisee does better. Give them a little room to make money if the store doesn’t do quite as well as everybody hopes. If the store clicks, everybody is happy and the 4-5% on the higher sales won’t seem like such a burden. For my multi-unit franchisees, I would charge lower up front fees for additional stores and this is sometimes already being done (whether  admitting it to Wall Street or not). This is logical and appropriate because less franchise support is required as a franchisee builds local infrastructure.

It seems to us that a young franchise company adopting this strategy would have a huge competitive edge and the total royalty stream is likely to build more rapidly using this progressive approach. Profitable franchisees, and a more appropriate sharing of store level profits, considering today’s economic realty, make for a successful system in the long run.

Roger Lipton has followed the restaurant industry for four decades. Founder of money management and investment banking firm, Lipton Financial Services, Inc., he publishes regularly at www.rogerlipton.com.   He can be reached at lfsi@aol.com and 212 600 2266.

SEMI-MONTHLY FISCAL/MONETARY UPDATE – BELIEVE THE FED AT YOUR OWN PERIL!

SEMI-MONTHLY FISCAL/MONETARY UPDATE – BELIEVE THE FED AT YOUR OWN PERIL!

IT’S NOT PHD ECONOMICS, IT’S ARITHMETIC

I was amazed by Fed Chairman Powell’s remarks last week. Predictably he reiterated the Fed’s dedication to raising the inflation rate to a “symmetrical 2%”, i.e. over 2% for a while to compensate for the last ten years when it has been running under 2%. Forgetting about the fact that the Federal Reserve was formed in 1913 to control inflation, not create it: relative to the need for higher interest rates and less stimulus, he said “There will come a time—and that time will be when the economy is back to full employment, and taxes are rolling in, and we’re in a strong economy again-when it will be appropriate to return to the issue of getting back on a sustainable fiscal path, but that time is not now.”

Do you know how many years there have been since 1971, when the US went off the gold standard, that the US debt has not increased? Take a moment….. the answer is ZERO. Even in the last three years of the Clinton administration and the first year under GW Bush, when the “surplus” in total over the four years was $972B, the debt still increased every year, because “off budget” spending eliminated the so called surplus. In the fiscal year ending 9/30/20, for example, the US “deficit” was $3.1T and the debt went up by a cool trillion dollars more. As far as Jay Powell’s remark noted above, there will never be a time, not in his administration, and possibly not in our lifetimes.

AND THE NUMBERS ARE MINDBOGGLING

“A billion here and a billion there and pretty soon you are talking about real money” is the political commentary from thirty or forty years ago. Three zeros have been added, taking the billions to trillions, but the economy is not three zeros (1,000x) larger. Here’s another way to picture the situation: The US debt went up by $4 trillion last year and will go up by $4-$5 trillion more this year, even without the Green New Deal currently under discussion. The table just below provides a decade by decade (with mid-decade 1945, the end of WWII, thrown in) picture of the debt as a percentage of GDP.

The most expensive prior single undertaking in the last hundred years was WWII, which cost $4.1 trillion in today’s dollars in total. The US government, therefore, will spend about double, over 18-24 months, the amount that it cost to conduct WWII over five years. The problem is that there is no postwar industrialization by a surplus nation on the gold standard to help us work our way out of this situation.

AND HIGHER TAXES ARE NOT GOING TO PAY FOR IT

We are hearing and reading about the Biden administration’s inclination to raise taxes to pay for the new infrastructure spending. Before you conclude that more taxes are unfortunately necessary to make the books balance, here are a few numbers.

Total spending was about $7.5 trillion, represented by the $3.1 trillion deficit (in excess of the $3.4 trillion of receipts) plus additional “off budget” spending of about $1 trillion. The $3.4 trillion of receipts  broke down this way: Personal Income Taxes were $1.6T, Social Security and Medicare Payroll Taxes were $1.3T, Corporate Taxes were $.212 T (only $212B).revenues of $3.4 trillion dollars in the fiscal year ending 9/30/20. The remaining $0.3 trillion came from excise taxes ($.087T), customs duties ($.069T), estate taxes (only $.018T = $18B), and miscellaneous sources ($.117T).

Since the Federal Reserve is financing well over half of the deficit with freshly printed money, as their balance sheet expands at an annual rate of close to $2 trillion, an increase in personal income taxes, corporate taxes, social security or medicare taxes, especially the minimal estate taxes, would be of small consequence to paying back the cost of new infrastructure.  This is why the politicians always talk about RECOUPING, say $1 trillion of RELATIVELY SHORT TERM SPENDING with $100 billon of higher taxes on this or that OVER A MUCH LONGER TERM. Obviously, with the timing mismatch,  our legislators will have found trillions more to spend, and receipts can never catch up with expenditures.  Taxes could never be raised enough to make a serious dent in the increasing debt burden. It’s actually kind of ridiculous to bother the public with a long term ax burden when it is a lot easier for the Fed to instantly create an extra trillion dollars or so.

The Fed and the politicians like to tell us that all this newly created currency will not be inflationary, because the “velocity” of the funds is at an all time low, and  the price of goods and services (by their calculation) hasn’t changed much. Let’s create am extreme example. If one hundred trillion dollars worth of colored paper was distributed, do you think  quite a bit of it would start moving around and the price of goods and services would move higher?

Don’t ever believe that it doesn’t matter how much debt the US carries, as long as interest rates remain minimal. Someone along the way once said “there is no free lunch”.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE BEAT GOES ON!! FED CHAIR POWELL’S REMARKS ARE NOT COMFORTING!

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE BEAT GOES ON !! FED CHAIR POWELL’S REMARKS ARE NOT COMFORTING!

As a backdrop, the US deficit in February was announced at $311B, up 32% YTY. Five months into the US government’s fiscal year ending September, the deficit is $1.05 trillion, up 68.3% YTY. Of course, the big spending, to cope with Covid-19, last year started in April, running the deficit in the year ending 9/30/20 to $3.1T. The most recent Congressional Budget Office (CBO) estimate for this year was $2.3 trillion (about 11% of GDP), which is higher than ever except in WWII, but that was before the $1.9 trillion Covid-relief bill was passed. This year’s deficit is therefore going to be well in excess of last year’s $3.1T and the Biden administration says a multi-trillion, multi-year infrastructure effort is coming. All this is only possible with the help of our Federal Reserve, which is funding over half of the deficit with fresh currency created by the click of a computer. It is worth noting that foreign buyers of US debt are steadily reducing the percentage of their participation in the US debt auctions. Their holdings of US Treasuries as a percentage of their foreign exchange reserves is also coming down, so perhaps they know something?

Chairman Powell’s remarks, two days ago, were not comforting and not even logical. He doesn’t see a bubble in the capital markets but he has also said that it is very hard to spot a bubble when it is in progress. He obviously doesn’t consider that almost $200B of “blank checks” that have been written in the SPAC market in the last fifteen months, to be leveraged with relatively low cost debt to over a trillion dollars of buying power, is a bubble. He also isn’t concerned that the market value of Bitcoin is about a trillion dollars, which translates into potential purchasing power of goods and services.  Setting aside the speculative activity in Gamestop, he apparently doesn’t view the dozens of tech stocks that are a long way from profitability, each trading for tens of billions of dollars to be a source of concern.  He isn’t concerned that investor margin debt has accelerated recently to a new high, which has almost invariably signaled a recession just ahead.

Chairman Powell suggested that the trillions of dollars of newly minted dollars over the last ten years, as well as the interest rates suppressed to levels close to zero, will not spark uncontrolled inflation because “it has not happened so far”. The metaphor we suggest is snow accumulating on a mountain slope. It is unknown which “flake” will trigger the avalanche, but it is best to have an escape plan.

Chairman Powell discussed how inflation is still firmly “anchored” in a sub two percent level and the Fed objective is to stimulate a level above two percent for an indeterminate time frame, producing “symmetrical” two percent over the long term. First, the inflation rate, as measured by the Consumer Price Index, is debatable, to say the least. The CPI has been “adjusted” a number of times, always resulting in less sensitivity to true consumer spending. Powell is not living in the same world as the rest of us if he really thinks that his cost of living is rising less than 2% per year. On this score, the capital markets are signaling a coming increase, bond prices in particular moving sharply upward, and bond market investors have historically predicted economic trends far better than the Fed.

On the subject of interest rates, the Fed has, with their intervention in capital markets, destroyed current interest rates as (1) an economic indicator and (2) a controlling influence on risk and reward. Interest rates have been described by the legendary monetary historian, James Grant, as the economy’s “pituitary gland”. The pituitary is the “master” gland, secreting hormones that regulate blood pressure and reproduction, affecting vision, the brain, skin and other organs. The Fed has therefore become a doctor evaluating the patient after destroying a crucial diagnostic instrument.

Chairman Powell described how the increases in short term interest rates have been “orderly”, so should not be of concern. The implication is that the inflation to come would also be orderly, and the few current indicator upticks would be “transitory”, in any event. The objective is for inflation to be modestly (our word, not his) above 2% for a while anyway, so it’s all “okay”. We wonder: when inflation hits a 3% rate, will that be “transitory”? At what point, and for how long, does a 3%, 4%, 5% become something other than transitory, and require the Fed to move, or allow the market to move, interest rates higher. Would he be concerned, at that point, that, based on today’s $28 trillion of debt, every point of new interest expense would amount to $280 billion.

It seems to us that Powell becomes more dovish every time he speaks. The interest rate rise is “orderly”. The inflation indicators are “transitory” and “well anchored”. He continues to “not even think about thinking about” raising interest rates or reducing Fed bond purchases. There is no “taper tantrum”, cessation of the increase of the Fed balance sheet,  in the cards and says he would warn the market when that time comes. He doesn’t see any signs of bubbles in the capital markets, so the Fed is sticking with their plan.

Jerome Powell, to be fair, did not create this mess. It is a result of decades of fiscal and monetary mismanagement. There is just no graceful solution. The “Maestro”, Alan Greenspan kicked it off in response to Y2K, the deflation of the dotcom bubble, and two wars, then escaped the consequences.  Bernanke escaped, Yellin escaped, Powell may also escape the “chickens coming home to roost”. These trends take a long time to play out, but the snow keeps accumulating on the mountain. It’s just a question of time.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – LOTS OF MOVING PARTS SUDDENTLY – THE RESULT?

SEMI-MONTHLY FISCAL/MONETARY UPDATE – LOTS OF MOVING PARTS SUDDENTLY – THE RESULT?

THE BACKDROP

It’s becoming a common refrain: “don’t fight the Fed”, originally coined by the late and great market strategist, Martin Zweig, back in the 1980s.

Jerome Powell, Fed Chairman, has made it clear that he will do “whatever it takes” to get back to relatively full employment and balanced economic growth, “balanced” referring to a narrowing of the wealth gap. He has reiterated that he is “not even thinking about thinking about raising interest rates”, signaling that the Fed will continue to expand its balance sheet, keeping interest rates very low, bond markets and the stock markets still supported by the “Fed put”. The Fed’s largesse has no doubt been an important contributing cause of the weakness in the US Dollar, which supports exporting US industries.

Enter Powell’s predecessor, Janet Yellen, likely to be confirmed by the Senate as new Treasury Secretary. While the Fed and the administration’s Treasury Secretary are theoretically independent of one another, it has long been the case that the Fed is responsive to political concerns. Interest rates have firmed up a bit in the last two weeks, and the dollar has also bounced off its lows since early January.

Some headlines have said that “Yellen does not seek a weaker dollar for competitive purposes”, implying that she will favor a stronger dollar, likely accompanied by higher interest rates. Not exactly. She also said she is in a favor of a “market driven dollar”. She is therefore agnostic as to where the Dollar trades. We’ll see how she puts it in her testimony later today.

Now let’s see what is going on in the economy and how Fed/Treasury policy will play out.

THE ECONOMY IS WEAK

Retail Sales Are Weak – December sales came in weaker than expected, down 0.7% YTY and November was revised to down 1.4% vs. originally estimated negative 1.1%. Further breakdowns of the overall numbers look even worse. Restaurant sales were down 4.5%, electronics -4.9%, appliances and furniture -0.6%, online sales -5.8% after -1.7% in November.  In essence, aside from restaurant sales, “stuff” in demand due to the Covid seems to have run its course. While we don’t doubt that a certain amount of demand will be released when the Covid-related cabin fever breaks, a case can be made that a traumatized consumer, who have saved or paid down credit balances with stimulus checks may well spend less and save more than was the case before the pandemic. From March through November, 2020, American households saved $1.6 trillion more than a year earlier, while credit balances collapsed  at a record 14% annual rate.

EMPLOYMENT GAINS HAVE STAGNATED

Jobless claims in December were 965k, versus an estimate of $790k, in spite of Christmas retail hiring, much higher than November which was revised lower by 3k to $784k.

US GDP STILL VERY WEAK

US real GDP is improving relative to the disastrous 2nd and 3rd quarters, but still down very sharply from a year ago. While it is well accepted that 2020 will be a lost year, economists and commentators are quoting “growth of something like 6% in 2021. Goldman Sachs just raised their forecast from 6.4% to 6.6%, fueled by $1.9 trillion (or something close) stimulus’ affect on disposable incomes and government spending. The reality is, however, that the US economy has been growing at a tepid low to mid 2%+ range for twelve years now. It grew at an average of about 2.3% for eight years under President Obama. In the four years of the Trump administration, with the tailwind of lower taxes, major government deficit spending, less governmental regulation, a trillion dollars of repatriated overseas capital and interest rates very close to zero, GDP grew at an average of about 2.5%. This can fairly be called “the law of diminishing returns”, a lower “marginal return on invested capital” or, less charitably a “misallocation of capital”.

At the same time that economic signals are weakening, inflationary signals are more apparent.

THE DEBT AND DEFICITS CONTINUE – INFLATIONARY IN THE LONG RUN

The deficit so far this fiscal year, the three months through December, show a deficit 58% higher than a year ago. Unfortunately the new fiscal stimulus package, proposed at $1.9 trillion, will inflate the government spending again this year. Though the amount is negotiable, President Biden has stated that it is only a “downpayment” on future plans. It seems reasonable to expect this fiscal year’s deficit to at least approach the $3.1 trillion of last year, perhaps even exceed it.

We point out again that the debt increases almost every year at much more than the annual deficit would suggest. This is due to “off budget” spending, and those dollars are in large part borrowed from the social security fund.  The deficit shown above in ’19 was $984 billion but the debt went up by $219 billion more, $1.2  trillion higher in total. The deficit in the Y/E 9/30/20 was $3.1 trillion but the increase in debt was $4.2 trillion. People….these are not  trivial differences, and this huge accelerating debt load will further drag on our economy.

INFLATIONARY SIGNALS ARE APPEARING

First, the parabolic increase in the M2 money supply has to be some cause for concern.

Secondly, reported import and export prices for December are cause for inflationary concern, and this could be one contributing factor to the rise in interest rates and the US Dollar. December import prices were up 0.9% instead of the expected 0.6%. November was revised slightly upward, from 0.1% to 0.2%. Export prices were also up much more than the expected 0.6% in December to 0.9%. November was also revised upward by 0.1% to 0.2%.

Third, the charts just below, showing the trend in commodity prices, could be indicative.

Lastly, the seemingly inevitable move to a nationwide $15 minimum wage could also contribute. While it is true that perhaps only 3 or 4 percent of the workforce earn the $7.25 minimum wage, with the lowest paid sector (leisure/hospitality) earning $17/hr, a higher minimum could well provide upward pressure. That $17/hr worker might not be happy earning just over the acknowledged subsistence level, and expect a bit more.  Its also true that employers will attempt to hold the pricing line by absorbing labor increases by way curbing expenses elsewhere, but a great deal of that may already be in place. In any event, we haven’t seen any arguments that a higher national minimum wage will be deflationary.

In spite of the factors provided above, the month to month CPI report doesn’t show much yet, up 0.4% in December but up just 1.4% for the twelve months ending December. The all items CPI, less food and energy, was up just 0.1% in December, up 1.6% for twelve months. The Fed, of course, has clearly stated a policy to allow inflation to run  higher than 2% annually for a while because it has been under 2% for so long. Keep in mind that, while prices of goods and services (except for major expenses like education and health care) have been stable, asset price inflation has been huge. There is a reason why very rich people are paying over $100M for a residence or a rare painting, anything but cash which they know will be worth a lot less in the future. As always, inflation is the cruelest tax, affecting the rich the least. They have their land, homes, art, stock and stock options, gold, etc. It’s the lower and middle class that gets hurt, left to wonder why they are making more in nominal terms but have to work harder to make ends meet.

THE RESULTANT FEDERAL RESERVE/TREASURY DILEMNA

The Federal Reserve and the supposedly independent US Treasury, as a result of at least forty years of fiscal/monetary promiscuity have incompatible masters to serve.

On one hand they are supposed to keep inflation at a tolerable level, these days no higher than a “symmetrical” 2%, At some point that will call for higher interest rates, and normalization to 150-200 bp above the rate of inflation, a range of 3.5-4.0%, providing a “real” return to savers. Unfortunately that would add an unacceptable $800-900 billion of annual interest to government expenses, blowing the deficit even higher, exacerbated further yet because tax receipts would contract as businesses cope with higher interest rates. So….interest rates might edge up, but not by much.

On the other hand the Fed’s second mandate is to foster full employment. This requires relatively low interest rates and continued government fiscal stimulus, which along with a weaker dollar will support US business activities. These policies problematically fosters the inflation that they don’t want to get out of control.

The objectives are inconsistent.

THE RESULT

When in doubt, the policymakers will choose the inflation every time. The public, especially the lower and middle class, doesn’t quite understand why they have to work harder and longer to make ends meet.  It is very apparent, on the other hand, when interest rates and/or taxes are going up and unemployment is rising. Far better for the incumbent politicians to stimulate the economy by way of government spending, low interest rates, and a lower dollar. Somebody else can deal with the inflation later. Paul Volker came along in 1979 and Ronald Reagan stuck with him, enduring the higher interest rates of the early 1980s to squeeze out inflation, but there is no Paul Volker or Ronald Reagan these days and the problems (the deficits, the debt, the tepid economy, the already very low interest rates) are an order of magnitude larger.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY REPORT – GOLD AND THE GOLD MINERS CONTINUE THEIR MOVE, NEW PRICE OBJECTIVES !

SEMI-MONTHLY FISCAL/MONETARY REPORT – THE STIMULUS IS MIND BOGGLING – GOLD AND THE GOLD MINERS HAVE JUST BEGUN THEIR MOVE !

The Coronavirus will pass, but the economic ramifications will be far longer lasting.  You don’t get out of a fiscal/monetary hole by continuing to dig. The current health crisis has brought forward, accelerated, and magnified the economic trends that were already in place. The monstrous buildup in debt is important because economic history has clearly shown that the higher the debt burden the bigger the drag on productive growth. This is why “the longest (and falsely promoted as “the strongest”) economic expansion in US history only provided 2.3-2.4% annual real GDP growth from ’10 through ’19. You heard it here first: there is no chance in hell that future growth (after the “dead cat bounce” from current levels) will be higher than 2% or so, likely to be materially  lower, with the new debt burden that the world will be carrying. 

We all know that the Fed balance sheet is exploding, as it finances the monstrous government spending. It is instructive to look at the pattern of growth over the last dozen years, as the supposedly apolitical Fed ignores the conservative side of the Keynes economic equation. John Maynard Keynes suggested, the in the late 1920s and early 1930s that the Fed should provide stimulus in hard times and pull it back in better times, presumably muting potential booms and busts. Unfortunately, economic conditions never seem to get good enough to remove the previous accommodation. Recapping the last dozen years: The Fed Balance sheet was under $1T in early ’08. It grew to about $2.2T by late’08, stayed around that level until mid ’09 when it started moving to about $3T by late ’11. From late ’12 to late ’14 it moved to $4.5T where it stayed until early ’18. The economy apparently never got quite good enough to pull back between ’10 and late ’17. In early ’18 the Fed announced a program of “automatic” reduction, with the implied objective to get back to perhaps $2.5-3.0T. It got back (only) to $3.7T by the end of ’19, but with the economy softening and distortions in the short term “repo” bond market, the Fed backed off and built its asset base to $4.2T, clearly on the way to a new high by mid’20. Which brings us to the current “new world”. Since March 4, 2020, the Fed has taken its balance sheet from $4.2T to $7.0T, and Chairman, Jay Powell, has indicated that he will do “whatever it takes”. We expect it to be $10T or more in a matter of months. People, this does not provide organic, productive, sustainable economic growth. This only provides an addictive high (not so high, in this case), supportive by always increasing doses of fiscal/monetary drugs.

The debt and deficits that require the Fed’s intervention are likewise exploding. The US debt, excluding unfunded entitlements like Social Security, is now over $25T, up from $22.7 at 9/30/19. The operating deficit which was supposed to be about $1.2T for the full year ending 9/30/20 is now expected to be at least $4.0T. The deficit in April alone was $738B. At this junction, after trillions of dollars have already been provided, it is clear that there is much more fiscal/monetary stimulus to come and nobody knows the ultimate magnitude or duration. Most importantly: virtually everyone, fiscal hawks and doves alike, bipartisan in nature, agree that the support must be provided, and we can all worry about the ramifications later.

THE PRICE OBJECTIVE FOR GOLD BULLION

The price of gold has shown a strong long term correlation with the federal US debt. The buildup of the Federal Reserve balance sheet over the last fifteen years has also strongly correlated with the gold price. The above discussion therefore supports a materially  higher price of gold related securities.

We believe that gold has proven itself for thousands of years as a store of value and the ultimate currency. It competes with paper currencies as the supply and demand of one currency (gold) must relate to the supply and demand of (these days) unbacked colored paper. The following chart shows the value of the gold held by the United States, since 1918 (shortly after the Fed was established in 1913), relative to the adjusted monetary base. A chart looks similar on a worldwide basis. You can see that from 1913 until just before the end of WWII, the value of the gold was about 35% of the monetary base. After the Bretton Woods agreement in 1944 whereby the US Dollar was established as the reserve currency, the percentage drifted down. The monetary base was growing steadily, and the US gold backing was declining, but the world was relatively unconcerned during a postwar recovery period. In the late 1960s, however, as US spending for the Vietnam War and President Lyndon Johnson’s Great Society accelerated, US trade and operating deficits became widely anticipated. Over 50% of the US gold was exchanged for dollars within eighteen months prior to August, 1971, when Richard Nixon “closed the gold window”. At that point, our gold amounted to only 6-7 % of the US monetary base. This level is important because we are back to that same level today.

We are not suggesting that the US, or anyone else, will make their paper currency convertible into gold any time soon. It wouldn’t work for long, in any event, because deficits in all major trading countries are larger than ever, and paper currencies would once again be tendered for gold. No country could back their currency with gold, unless they were “balancing their books” or, at the least, that prospect was in sight. We do, however, feel that the value of the gold “in circulation” should have a relationship to the value of alternative currencies. You might be surprised to learn that the country most able to make their currency convertible into gold would be Russia, perhaps our most prominent political adversary and a consistently large buyer of gold.

he chart above indicates that 7% could be 35%, or five times the current price. This  ballpark calculations indicate what we consider to be a rational value of 5-6x the current $1740/oz, or $8700 to $10,440/oz. This ballpark price range objective is at the current time. The monetary base is now rising at about 20% per year with all the money printing to support the economy in the current crisis. Though gold is now moving steadily higher, the monetary base is also rising so the price objective within just the next few years could be well over $10,000/oz.

THE TIMING – FOR GOLD BULLION PRICES

The following two charts provide insight into the possibility of an imminent major upward move. The first chart shows the high correlation of the gold price to the amount of worldwide sovereign negative yielding debt, which peaked at $16-17T in mid ’19 and is now in the low teens. Even in Germany, the strongest European country, the entire yield curve has been negative or close to it. We believe that the amount of negative yielding debt will continue its upward march and could even include some of the US debt, especially based on President Trumps implied blessing just in the last couple of days. The continued upward trend of this indicator could be influential in breaking the gold price out above the previous all-time high of $1911. That, in turn, could ignite the price toward the price objectives noted above.

The second chart shows a nineteen-year price chart of gold. It shows the end of an 11-12-year bull market, ending in 2012, then a 6-7 year “consolidation”. The price has now clearly broken above $1400, the previous high. Chart technicians would say that the longer the base, the bigger the move. It is conceivable that a new bull market has begun that could last for quite a few years. This would tie in to our logic that the price of gold could be 5-6 times higher over a number of years.

There are other charts we could provide that show a long term correlation of the price of gold to the level of US debt. Over the last fifteen years the same sort of correlation has taken place between gold and the buildup of the Federal Reserve balance sheet.

THE GOLD MINING STOCKS

The chart just below shows the gold mining index, XAU, relative to the price of gold bullion. Since 2008, the relative valuation of gold equities to gold bullion has fallen 75% from the prior 25-year average. The ratio of the XAU Index to spot gold averaged 0.25x for a quarter century through 2008. As of 3/31/2020, the ratio was 0.05x.

We believe that the substantial divergence in performance is due to mostly outdated opinions, the justification for which have been corrected over the last 10-12 years. Managements have been improved, balance sheets have been strengthened, operations have been streamlined. Additionally, energy costs, which are 15% or more of mine operating expenses are 60-70% lower today than they were a decade ago. Combined with sharply higher gold prices, results from established miners have been impressive recently and should become even more so.

SUMMARY

The healthcare crisis has accelerated, magnified, and brought forward in time many of the long term fiscal/monetary trends, as well as fundamental developments in our society. We believe that the worldwide economy will stagnate, at best, after the short term sequential bounce from the current situation. Some companies will survive and prosper, many will not. All will change to varying degrees. Profit margins will change, mostly for the worse. From an investment standpoint, we continue to feel that gold mining companies are the single best asset class in terms of reward versus risk. We’ve been joined lately in our conviction relative to gold by legendary investors and portfolio strategists such as David Rosenberg, Jeff Gundlach, Ray Dalio, Jim Roberts, Stanley Drukenmiller, David Einhorn, Stephanie Pomboy, Luke Gromen and others. Long term proponents of gold and gold miners such as John Hathaway Fred Hickey, Bill Fleckenstein and Peter Schiff are more convinced than ever. Though it’s nice to have some “smart money” in our camp, the investment world in general is just beginning to take small positions in this sector. Gold bullion is up about 15% this year at this moment (a safe haven, after all). The miners, which were down for the year a month ago, are now in positive territory and catching up with bullion. In the last six weeks, gold mining stocks have moved about 4x the price change of bullion.  We believe we are still in the first inning of the resumption of the long term bull market for gold related securities.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY REPORT – FED FINANCES MOST OF US DEFICIT – WALL STREET JOURNAL SAYS US HAS CHINA WHERE WE WANT THEM, NOT ON YOUR LIFE!!

SEMI-MONTHLY FISCAL/MONETARY REPORT – FED FINANCES MOST OF US DEFICIT – WALL STREET JOURNAL SAYS US HAS CHINA WHERE WE WANT THEM, NOT ON YOUR LIFE!!

THE DEFICITS AND THE FED

The new fiscal year for the US government started October 1st. In the two months ending 11/30, the current deficit has been $337B, up 10.4% from a year earlier, headed comfortably over $1T for the current year, up from $984B.  As always, the increase in debt is higher, up $360B, the difference being the “off-budget” spending, mostly to finance the deficit in the social security entitlement account. Most years, this off budget spending totals a couple of hundred billions, still a serious amount of money.

It’s no coincidence that the Fed Balance Sheet has increased, from 9/25 until 11/27 by $194B so the Fed has financed about 57% of the two month operating deficit. It’s clear therefore that the Fed has no choice but to continue expansion of its balance sheet. Now at $4.095T, it is clear that a new high above $4.5T is in the cards by the end of the current fiscal year ending 9/30/20.  Of course, the old high was put in place to stimulate growth in the wake of the 2008-2009 financial crisis. The new high will take place in the middle of “the greatest economy the country has ever experienced.”

THE QUESTION: What’s the matter with this picture?

THE ANSWER: In the 2008-2009 crisis the Fed balance sheet went up by $3.5T. Might the Fed need to take its balance sheet to at least $7-8T to forestall the next downturn. With any addiction it always takes a bigger hit to maintain the high. Economic policy would be simple if recessions (and worse) could be easily avoided by the printing of new money. Do you not suppose that a price must be paid at some point ? It’s trite but true: if something can’t go on forever, it won’t.

OUR LEVERAGE, OR LACK THEREOF, NEGOTIATING WITH CHINA

Today’s Wall Street Journal describes how the US is in a relatively strong bargaining position relative to trade negotiations. We respectfully disagree. (1) Both economies are increasingly burdened  by debt and supported by government spending.  China, though growth is apparently slowing to a mid single digit pace, with financial strains to be sure, still owns the fastest growing major economy in the world. The US, with its own set of economic distortions, is growing at a tepid 2% rate. (2) China, though diversifying away from dollar denominated securities, still owns over $1T of our debt, and could create havoc by forcing worldwide interest rates higher with their sales. While the markdown on their remaining position might create some discomfort at home, this remains a possibility (3) China can offset new tariffs by weakening the Yuan, requiring retaliation by the US and other trading partners (4) China is dedicated over the long term to joining, or replacing, the US Dollar with the Yuan as a reserve currency. Most students of the situation believe that China is very substantially understating gold reserves. We believe that many other Chinese agencies besides the People’s Bank of China have been buying physical gold, and far more than the PBOC has reported. Add the fact that adversarial Russia continues to purchase physical gold. Nothing would please China, or Russia, more than to replace the US Dollar with a new reserve currency that is backed by gold, and we believe that is where the worldwide monetary system is headed. It so happens that China and Russia are in the best position to do so. The key question remains: when ???

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE DEFICITS AND DEBT – HERE WE GO AGAIN!

SEMI-MONTHLY FISCAL/MONETARY UPDATE

The general capital markets were up modestly in July, gold bullion was down 2.3%. The gold mining stocks were down about 3.5%.  Most importantly, our conviction hasn’t changed regarding the long term outlook for our portfolio that is heavily invested in gold mining stocks.

While last month we outlined a group of tangible factors that support our thesis, it could be useful to go back to the biggest single reason that gold will be the surviving “currency”, protecting purchasing power best. The worldwide credit pyramid that has fueled the economic growth over the last forty years must be liquidated. Debts must be paid off, and the numbers are too large for the worldwide economy to grow out of the problem. “Default” will be the result, but refusal to pay is too obvious and makes the politicians look bad. Inflation is the only other solution since the voting public doesn’t understand who caused it. Gold has gone from $250/oz. to $1200/oz. since 2000, starting with the President GW Bush debts to finance the aftermath of 9/11 and then the two wars. Gold doubled from $900 in ’09 and the gold mining stocks quadrupled and more) as the deficit spending ramped up even further under President Obama.

Here we go again: The projected US deficit in the fiscal year ending 9/30/18 is projected to be about $800B, up from $600B last year. However, the cumulative debt in the 10 months ending today ($21.2 trillion) is already one trillion dollars higher than last September and is projected to be higher by $1.2 trillion by 9/30.

Only in governmental accounting can the annual deficits not total the cumulative increase in debt. This is not new. You have no doubt heard from politicians and economists who are concerned about the future deficit spending. Republicans are concerned when Democrats are in power, and now the situation is reversed. However, they don’t talk about the excess debt, on top of the budgeted spending, called other borrowing. Over the last ten years, the cumulative debt increase has exceeded the total of annual deficits by a cool three trillion dollars. People, this is a lot of money. While the annual deficits going forward are projected to be over a trillion dollars annually over the next decade, you can only imagine what the cumulative debt will look like after the other borrowing. We have described the situation in terms of US debts, but enormous potential credit problems also overhang the economies of China, Japan, and the Eurozone, the largest after the USA. What the endgame looks like is unknown, but it won’t be pretty.

Stay healthy. Stay financially flexible.

Roger Lipton

SEMI-MONTHLY FISCAL/MONETARY UPDATE – BUDGETS & DEFICITS – TALK ABOUT “FAKE NEWS”!!

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  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • Opportunity to “Ask Rog” about your personal concerns, regarding individual companies or broader economic trends. Roger will use his best efforts to answer questions submitted, obviously limited by the number of requests . He may answer your question by email directly and/or include your question with his “Roger’s Rap” releases.
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SEMI-MONTHLY FISCAL/MONETARY UPDATE – STOCKS UP BIG – BONDS AND GOLD DOWN – SUSTAINABLE?

To access this content, you must purchase Website Subscription.

INCLUDED IN YOUR ANNUAL SUBSCRIPTION:

  • Broad economic insight. As described in “Restaurants/Retail – Why Bother?” the restaurant and retail industries provide a leading indicator of far broader economic trends. You no longer have to be the last to know.
  • Two to three analytical pieces per week (“Roger’s Rap”) personally written by Roger Lipton describing corporate developments within his industry specialization, including their relevance to the broader economy.
  • Periodic “macro” discussions personally written by Roger Lipton, analyzing fiscal and monetary matters that will likely affect your investments and your business.
  • Opportunity to “Ask Rog” about your personal concerns, regarding individual companies or broader economic trends. Roger will use his best efforts to answer questions submitted, obviously limited by the number of requests . He may answer your question by email directly and/or include your question with his “Roger’s Rap” releases.
  • You are provided access to “Friends of Rog”, depending on your financial and operational needs. The outstanding individuals suggested here, have been personally “vetted” by Roger over decades. Roger receives no compensation based on whether or not use their services.
  • A free copy of the legendary best selling book, How you can Profit from the coming devaluation, as shown at right, written in 1970 by Harry Browne, which predicted the 2000% rise in the price of gold. This profound piece is more relevant today than ever, so Roger re-published it in 2012. This book will help you preserve the fortune you are in the process of accumulating.