SEMI-MONTHLY FISCAL/MONETARY UPDATE – “TAPER TALK” IS JUST TALK
September was a weak month in all the capital markets: stocks, bonds and gold related securities as well. Gold bullion was down about 3.2%, with the gold mining stocks down more because of their leverage relative to the gold price. In the wake of congressional testimony from Fed Chair, Jerome Powell, and Treasury Secretary, Janet Yellen, gold bullion went up almost 2% yesterday, the 30th, and the gold mining stocks followed. Perhaps it is beginning to dawn on investors how disingenuous the presentations were and how hopeless the fiscal/monetary situation is.
First, we have to comment on the absurdity of Powell and Yellen appearing together before Congress, presenting a united front. This is directly contrary to the guiding principle for the last 108 years, that the Federal Reserve and the US Treasury are designed to be independent of one another.
In any event, the talk all month was of the plans for the Federal Reserve to “taper”, that is to reduce the amount of securities they are purchasing (which has been running about $120B per month), allow interest rates to rise, in turn strengthening the US Dollar, which tends to weigh on the price of gold in the short run. For months now Powell has been describing the now obvious escalation in consumer prices (lately at 5%, well above the 2% Fed target) as “transitory” and “isolated”, and reiterating the Fed’s intention to reduce their monetary “accommodation” soon. The Fed would then purchase fewer Treasury securities, leading (some day) to a reduction of the Fed’s $8.5 trillion balance sheet, and allow worldwide interest rates to normalize from levels unseen in the 4,000 year recorded history of interest rates. Recall that after building the Fed balance sheet from $1T to $4.2T in ’08-’09, the taper at the time took it back 10%, to $3.7T before ramping it up to the current $8.5T. Can anyone say $20 trillion?
The problems with the plan, at the moment, are (1) The economy is not strong enough to withstand a material rise in interest rates, and a one point rise in interest rates would cost the US Government an extra $280B a year on its $28 trillion of debt. The burden would not be immediate because existing bonds would continue to exist but more than half of the $28 trillion matures within 5-6 years and it would not take long for the interest expense to build. In addition, the current annual $3T deficit would need to be financed as we go. (2) The Fed has been the “buyer of last resort” with their newly printed currency, its purchases approaching half of all Treasuries issued. China and Japan have been increasingly reluctant to maintain previous buying patterns, which is no wonder as they watch the Fed’s massive dilution of the US Dollar. (3) Jerome Powell was counting on inflation being “transitory” and “isolated”, allowing for the economy to recover without stagnating and allowing for a noticeable but not too burdensome rise in interest rates. You would think that the hundreds of PHDs at the Fed would have noticed that oil and gas prices have risen, menu prices are up, the minimum wage is a lot higher, supply chain challenges are commonplace and Dollar Tree Stores says more items will be priced over one dollar. Powell, just in the last few days, has suggested that inflation is running hotter and may not be as short lasting as he previously thought. He, at the same time, admitted that the economy “is not even close to satisfying requirements for a rate hike”. We can add that 25 or 50 basis points of higher rates is going to have virtually no effect, other than window dressing, on risk and reward within the economy. In 1979-80, Paul Volcker took the Fed Funds Rate to 18% to squeeze out inflation, which precipitated a recession that lasted until late 1982. We need not describe what effect a similar discipline would have on the worldwide economy today. The total US debt was $1 trillion in 1981 and the annual deficit was $100 billion. Though today’s economy is six times as big, today’s deficits and debt are 3-4x as big in constant dollars.
On the disingenuous front: Janet Yellen told us yesterday that the debt is not a problem because interest rates are so low. She did not elaborate that interest rates are so low because our Federal Reserve is buying half our debt with currency minted out of thin air. Yellen also informed our legislators that not increasing the debt limit (again) would be “catastrophic”, because we must, at all cost, pay off our existing creditors. A cynic might call this a “Ponzi scheme”, whereby new investors buy out the old investors. Jerome Powell, after admitting that the current inflation is surprising, says the Fed is “prepared to use its tools” to control the situation, but he omitted details and the congressional legislators did not press the subject.
Our conclusions are not drawn out of thin air. Taper “talk” is just that. The Fed’s balance sheet has grown from $7.06 trillion on 9/30/20 to $8.49 trillion last week, growing at about $120B a month on virtually a straight line, and we don’t believe it flattens much any time soon. It is interesting that the $1.43 trillion increase is almost exactly half of the $2.7 trillion US deficit in the last eleven months. In short, the beat goes on, and the reasons referenced above indicate that there is no graceful way out of this situation.
Our best guess remains that a “stagflationary” period is ahead of us, perhaps begun already, similar to the 1970s. On January 6, 1974 the NY Times said “There is One Surfeit: Shortages.” In August, 2021, they said “The World is Still Short of Everything. Get Used to It.” In 1973 the CPI was rising at 5.3% and the Fed Funds Rate was 6.75%. The Federal Reserve predicted that the jobless rate, then at 5%, would average 4.5-5.0% over the next few years, with consumer prices up 4.0-4.5%. Their objective at the time had been 2.5%, similar to today, ex “transitory” influences. By May, 1975, unemployment hit 9% and inflation averaged more than 10% in 1974-5. By 1979, the CPI hit 12% and the Fed Funds Rate reached 18%. In more recent times, Ben Bernanke, Fed Chairman in 2007, predicted that housing prices would remain elevated for the foreseeable future. So much for the Federal Reserve’s predictions and control over the situation. From 1971 to 1979 gold bullion went from $35/oz. to $850/oz.
We believe that the “taper talk”, valid or not, affected all capital markets in the last couple of months, increasing interest rates and improving the US Dollar’s relative value (which weighs on the price of gold), at the same time backing off both the stock and bond markets. On the last trading day of September, while the stock and bond markets meandered, gold and the gold miners were strong, so perhaps this was a case of “selling the rumor and buying the news” (after the Powell/Yellen testimony).
We continue to feel that gold bullion, and the gold miners leveraged to the price of bullion, should be an important asset class within any diversified portfolio.
Roger Lipton